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FRM Part II · FRM Exam Part II · Portfolio Performance Evaluation

A manager reports a portfolio return of 6% against a benchmark return of 4%, with tracking error of 4%. Active return is the portfolio minus benchmark. Which statement is correct about the information ratio and what it implies?

The information ratio is 0.50. It divides the 2% active return over the benchmark by the 4% tracking error, so it measures active return per unit of active risk, which is the usual gauge of manager skill relative to a benchmark.

  1. AThe information ratio is 0.50, measuring active return per unit of active riskCorrect
  2. BThe information ratio is 1.50, measuring portfolio return per unit of benchmark risk
  3. CThe information ratio is 0.50, measuring excess return over the risk-free rate per unit of total risk
  4. DThe information ratio is 2.00, measuring active return per unit of benchmark volatility

Explanation

IR = (6% - 4%) / 4% = 0.50, active return divided by tracking error (active risk). The Sharpe ratio, not the IR, uses risk-free excess return over total risk, which is the error in the third option. The other options use wrong numerators or denominators.

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