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FRM Part II · FRM Exam Part II · The Investment Function in Financial Services Management

A treasury portfolio earned 7.0% against a benchmark return of 5.0% over the year. Its tracking error (standard deviation of active returns) was 4.0%. What is the portfolio's information ratio, and what does it measure?

The information ratio is 0.50, calculated as the 2% active return over the benchmark divided by the 4% tracking error. It measures the manager's benchmark-relative return per unit of active risk taken, not return per unit of total risk.

  1. A0.50; active return per unit of active riskCorrect
  2. B0.50; excess return over the risk-free rate per unit of total risk
  3. C1.75; active return per unit of active risk
  4. D1.75; return per unit of systematic risk

Explanation

Information ratio = active return / tracking error = (7.0% - 5.0%) / 4.0% = 0.50. It measures benchmark-relative return per unit of active risk. The 1.75 options divide the raw return by the tracking error, and the second option describes a Sharpe ratio.

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