Skip to content

FRM Part II · FRM Exam Part II · VaR and Risk Budgeting in Investment Management

A fund has a benchmark-relative active return of 2.0% per year and a tracking error of 4.0%. The fund's total volatility is 15%. Its investment committee wants a risk-adjusted measure of the active management skill relative to active risk. Which measure and value is appropriate?

The information ratio of 0.50 is appropriate. It divides the active return of 2% by the tracking error of 4%, measuring active return per unit of active risk. Using total volatility of 15% would give 0.13 and misstate skill relative to the benchmark.

  1. AInformation ratio of 0.50Correct
  2. BInformation ratio of 0.13
  3. CSharpe ratio of 0.50
  4. DInformation ratio of 2.00

Explanation

The information ratio is active return divided by tracking error: 2.0/4.0 = 0.50. Using total volatility (2/15 = 0.13) is the wrong base, and the Sharpe ratio uses excess return over the risk-free rate, not the benchmark. 2.00 inverts the ratio.

Did you get it right without looking?

One question tells you little. A timed set on VaR and Risk Budgeting in Investment Management shows your real accuracy, how long you take and where you lose marks.

Practise VaR and Risk Budgeting in Investment ManagementFree diagnostic mock

More VaR and Risk Budgeting in Investment Management questions