FRM Part II · FRM Exam Part II · Portfolio Construction
A portfolio manager reports an annualized alpha of 2.0% against the benchmark and an annualized tracking error (residual risk) of 4.0%. Assuming alpha is measured relative to the benchmark, what is the information ratio?
The information ratio is active return divided by active risk. With alpha of 2.0% and tracking error of 4.0%, the ratio is 0.50. Inverting the fraction or multiplying the numbers would give wrong values, because the measure expresses excess return earned per unit of active risk.
- A0.08
- B0.50Correct
- C2.00
- D2.50
Explanation
The information ratio equals alpha divided by active (residual) risk: 2.0% / 4.0% = 0.50. Option 2.00 inverts the ratio. Option 0.08 multiplies the two figures (2 x 4 = 8, read as 0.08) instead of dividing them.
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