FRM Part II · FRM Exam Part II · Portfolio Construction
A manager has an information ratio of 0.80 and the client permits annualized tracking error of 5%. Assuming the manager scales active risk to this level and the IR holds, what is the expected active return (alpha)?
Expected alpha is 4.00%. Since information ratio equals active return divided by tracking error, active return equals 0.80 times 5%. Scaling risk up or down changes alpha proportionally while the ratio stays constant.
- A6.25%
- B0.16%
- C4.00%Correct
- D5.80%
Explanation
Expected active return = IR x tracking error = 0.80 x 5% = 4.00%. The 6.25% option divides tracking error by IR (5/0.8). The 0.16% option divides IR by tracking error in decimals (0.8/5) and expresses it as a percent. The 5.80% option adds the two numbers.
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