FRM Part I · FRM Exam Part I · Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)
A portfolio returned 9% while its benchmark returned 7%. The tracking error (standard deviation of active return) is 4%. The risk-free rate is 2%. What is the portfolio's information ratio?
The information ratio equals active return over the benchmark divided by tracking error. Active return is 9% minus 7%, or 2%, and dividing by the 4% tracking error gives 0.50. The risk-free rate is irrelevant because the comparison is with the benchmark.
- A0.50Correct
- B1.25
- C1.75
- D2.25
Explanation
Information ratio = active return / tracking error = (9% - 7%) / 4% = 0.50. The 1.75 option is the Sharpe-style excess over the risk-free rate (7%) divided by 4%, which wrongly uses the risk-free rate instead of the benchmark.
Did you get it right without looking?
One question tells you little. A timed set on Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM) shows your real accuracy, how long you take and where you lose marks.
More Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM) questions
- In the single-index model, the excess return of stock i is written as R_i = alpha_i + beta_i * R_M + e_i, where all returns are in excess of…
- Asset A has a volatility of 10% and Asset B has a volatility of 20%. Their correlation is 0.2. What weight in Asset A gives the minimum-vari…
- Asset A has a volatility of 20% and Asset B has a volatility of 30%. A portfolio holds 60% in A and 40% in B, and the correlation between th…
- The risk-free rate is 2%. Risky asset A has an expected return of 8% and volatility of 10%. Risky asset B has an expected return of 14% and …
- Stock A has beta 0.8 and residual standard deviation 20%. The market's standard deviation is 10%. Using the single-index model, what is the …
- Asset A has a standard deviation of 20% and Asset B has a standard deviation of 10%. A portfolio holds 50% in each, and the correlation betw…