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FRM Part II · FRM Exam Part II · Portfolio Risk: Analytical Methods

A portfolio has a target tracking error of 3% per year. The manager has an expected information ratio of 0.5. Assuming the IR is unchanged when risk is scaled, the manager is asked to raise the tracking error to 5%. What is the expected active return at the higher risk level, and what is the 95% one-year (1.65 multiplier, normal) relative VaR at 5% tracking error with zero expected active return?

Expected active return is 2.5% (0.5 times 5%), and the 95% relative VaR is 8.25% (1.65 times 5% tracking error, assuming zero mean active return). The 1.5% figure corresponds to the old 3% tracking error level.

  1. A1.5% active return; relative VaR 8.25%
  2. B2.5% active return; relative VaR 8.25%Correct
  3. C2.5% active return; relative VaR 5.00%
  4. D1.5% active return; relative VaR 4.95%

Explanation

Expected active return = IR x TE = 0.5 x 5% = 2.5%. Relative VaR = 1.65 x 5% = 8.25% with zero mean. 1.5% is the return at the old 3% TE.

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