A hedge fund delivers an annualized return of 17.5%. The risk-free rate is 6.0% and the portfolio's Downside Semi-Deviation (Downside Risk) is 8.0%. What is the Sortino Ratio of the fund?

[ A ]1.44 (Excess return per unit of downside risk)[ CORRECT ]

[ B ]1.94

[ C ]2.19

[ D ]11.50%

Takeaway

The fund's Sortino Ratio is 1.44, calculated as excess return over the risk-free rate divided by downside semi-deviation rather than total standard deviation.

Derivation

Step 1: Excess return = 17.5% - 6.0% = 11.5%. Step 2: Sortino Ratio = Excess return / Downside Deviation = 11.5% / 8.0% = 1.4375, rounding to 1.44. Unlike Sharpe, which divides by total volatility (both up and down moves), Sortino uses only downside semi-deviation, so a fund with a favorable upside skew (large gains, contained losses) will show a materially higher Sortino than Sharpe ratio — a gap this calculation is designed to make candidates notice and interpret correctly rather than treating the two ratios as interchangeable.

Why the others fail

B — 1.94

1.94 does not correspond to (17.5-6.0)/8.0 or any correctly-derived figure from the given inputs — it is not produced by the Sortino Ratio formula applied to this data.

C — 2.19

2.19 results from dividing the fund's gross 17.5% return by the 8.0% downside deviation directly, skipping the necessary step of first subtracting the 6.0% risk-free rate.

D — 11.50%

11.50% is simply the excess return (17.5% - 6.0%) stated on its own, without dividing by the 8.0% downside deviation needed to express it as a risk-adjusted ratio.