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Managed Funds Videos 236 videos

Finance: What is Efficient Markets Theory?
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What is the Efficient Markets Theory? The Efficient Markets Theory says that stocks trade at their fair value all of the time, assuming all informa...

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What is Collateralized Mortgage Obligation (CMO)? A CMO is a mortgage bond that consists of a large number of different individual mortgages bundle...

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Finance: What is the Sharpe Ratio? 6 Views


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Description:

The Sharpe Ratio is a calculation used by investors to measure the dynamics between risk and reward. TL;DR: lottery tickets=bad.

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English Language

Transcript

00:00

finance a la shmoop what is the Sharpe ratio well it's a calculation used by

00:08

investors in trying to figure out whether their investment was smart or [Sharpe ratio definition on 100 dollar bill]

00:12

just lucky or rather it's a measure to measure the amount of risk they took in [Smart and lucky on either side of balance scale]

00:18

order to get a given level of reward and remember risk and reward are joined at

00:22

the wrist like handcuffed politicians fighting for that one congressional seat [Politicians fighting over a chair]

00:27

in Alaska all right well for example if you spent five bucks on a lottery ticket

00:30

and won a million yes the outcome was mathematically good and yes you made 200

00:36

thousand times your money but was that a high Sharpe ratio investment no why

00:42

because your odds of winning were in fact one in a billion so you were just [Lottery billboard appears]

00:46

lucky like extremely lucky not necessarily good on the other hand what

00:52

if you had taken a deep dive and looked hard at Amazon in 1998 when it was [Woman with Amazon paper in library]

00:56

valued at a tiny fraction of where it's valued today well you could have done

01:01

the math on its profit margins which were nearly zero or negative for a very [Person using calculator]

01:05

long time you could have thought about how the public markets would perceive a

01:09

company growing revenues massively at such a level that in a decade they'd end [Amazon watering can sprinkles over revenues]

01:14

up beginning to destroy Walmart you could have looked at the amazing ease

01:18

with which product are delivered to lazy homeowners who love not having to get up [Man in frog onesie sitting on couch]

01:24

off their fat Duff's and drive to the store and park fighting crowds and angry

01:29

union cashiers who are upset to be bothered in the checkout line have you

01:33

done all this research and concluded that Amazon would go from a hundred [Amazon revenues graph rises]

01:37

million dollars in book sales to hundreds of billions of dollars of sales

01:43

of pretty much everything two decades later well then you would have done

01:47

high-quality research made a return analogous to your lottery ticket

01:52

winnings and maybe not two hundred thousand times but something close but

01:55

would have produced a very high Sharpe ratio because the quality of the

01:59

research and the risk management along the way was extremely high you also

02:04

could have gleaned that Amazon's growth when it was small was the envy of every [BestBuy and Oracle appear and look at amazon chart]

02:08

big-box retailer you know like Best Buy every technology firm like

02:13

Oracle and all the other establishment companies of the world from banks to

02:18

even oil companies probably certainly insurance companies such that for a

02:22

price amazon always would have been a relatively easy sale to one of those [Man taping up a box]

02:27

guys so that the downside on the investment all along the way was likely

02:31

a pretty limited so the bottom line high Sharpe ratios good research good smart

02:37

analysis good lottery tickets hugely bad very very bad

02:42

although investing in a company called chloroform energy drinks would probably [Man holds bottle of chloroform]

02:47

be even worse

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