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

A manager reports an active return of 3% against the benchmark with tracking error of 4%. Which statement about the information ratio is correct?

The information ratio is 0.75, equal to the 3% active return divided by the 4% tracking error. It measures active return per unit of active risk relative to the benchmark, unlike the Sharpe ratio, which uses the risk-free rate and total volatility.

  1. AIt equals 0.75, measuring active return per unit of active riskCorrect
  2. BIt equals 0.75, measuring excess return over the risk-free rate per unit of total risk
  3. CIt equals 1.33, measuring tracking error per unit of active return
  4. DIt equals 7.0, being the sum of active return and tracking error

Explanation

Information ratio = active return / tracking error = 3% / 4% = 0.75. The option that describes risk-free excess return over total risk describes the Sharpe ratio. The 1.33 option inverts the ratio.

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