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FRM Part II · FRM Exam Part II · VaR and Risk Budgeting in Investment Management

A portfolio manager forecasts returns on 25 independent securities each year, and her forecasts have an information coefficient of 0.08. Using the fundamental law of active management in its basic form, what is her expected information ratio?

The expected information ratio is 0.40. Under the basic fundamental law, IR equals the information coefficient times the square root of breadth. With IC of 0.08 and 25 independent forecasts, the square root of 25 is 5, giving 0.08 times 5, or 0.40.

  1. A0.20
  2. B0.40Correct
  3. C0.08
  4. D1.60

Explanation

The basic law gives IR = IC x sqrt(breadth). With IC = 0.08 and breadth = 25, IR = 0.08 x 5 = 0.40. The 0.20 option wrongly uses breadth of 6.25 (dividing by 2 instead of taking the square root of 25 correctly), the 0.08 option ignores breadth, and 1.60 mistakenly multiplies by 20.

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