FRM Part II · FRM Exam Part II · Portfolio Performance Evaluation
A portfolio has a beta of 1.0 to its benchmark, volatility of 15%, and the benchmark has volatility of 12%. Assuming the portfolio's return equals the benchmark return plus an uncorrelated residual, what is the tracking error?
Tracking error is 9.00%. With a beta of one and an uncorrelated residual, portfolio variance equals benchmark variance plus tracking error squared, so 225 minus 144 equals 81, whose square root is 9%.
- A9.00%Correct
- B3.00%
- C19.2%
- D12.0%
Explanation
With beta 1 and uncorrelated residual, portfolio variance = benchmark variance + TE squared. 15^2 - 12^2 = 225 - 144 = 81, so TE = 9%. Subtracting volatilities gives 3%, a common error. Adding variances gives 19.2%. 12% is just the benchmark volatility.
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