How is risk-adjusted return defined?

Risk-adjusted return is defined as the return of an investment, considering the amount of risk taken. This concept is crucial in finance because it allows investors to evaluate the performance of an investment not just by its absolute return, but relative to the risks associated with it. By factoring in risk, investors can make more informed decisions, as a higher return may not always be attractive if it is accompanied by significantly higher risk.

The most common measures of risk-adjusted return include metrics such as the Sharpe ratio, which compares the excess return of an investment to its standard deviation, and the Treynor ratio, which considers the excess return relative to systematic risk (beta). Those metrics help investors determine whether the returns earned justify the risks taken.

Other options presented do not accurately capture the essence of risk-adjusted return. For instance, defining it without considering risk ignores critical aspects of investment performance. Similarly, a measure of return per unit of investment cost does not inherently address risk, and a formula apply only to fixed-income securities would limit the essential concept of risk-adjusted return to a narrow domain, whereas it is applicable across various asset classes, including equities and derivatives. Therefore, the definition focusing on the return while considering risk is comprehensive and widely recognized in financial