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

A manager has an information ratio of 0.50 and runs a portfolio with a target active (tracking) risk of 4% per year. Under the fundamental law framework, and ignoring the transfer coefficient, what is the expected active return (alpha)?

Expected active return is 2.0%. The information ratio is active return divided by active risk, so alpha equals the information ratio times tracking risk. Multiplying 0.50 by 4% gives 2.0% per year, assuming the manager implements views without constraints.

  1. A8.0%
  2. B0.5%
  3. C2.0%Correct
  4. D4.5%

Explanation

Alpha = IR x active risk = 0.50 x 4% = 2.0%. The 8.0% option divides by IR instead of multiplying. The 0.5% option confuses the figures, and 4.5% adds the two numbers.

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