FRM Part II · FRM Exam Part II · Portfolio Construction
Using the fundamental law of active management in its basic form, a manager has an information coefficient (IC) of 0.05 and makes 100 independent bets per year. What is the expected information ratio?
The expected information ratio is 0.50. The fundamental law says IR equals skill (the information coefficient) times the square root of breadth. With IC of 0.05 and 100 independent bets, the square root of 100 is 10, giving 0.05 times 10, or 0.50.
- A0.50Correct
- B0.05
- C5.00
- D0.25
Explanation
Basic fundamental law: IR = IC x sqrt(breadth) = 0.05 x sqrt(100) = 0.05 x 10 = 0.50. Using breadth directly (0.05 x 100 = 5.00) forgets the square root. Using 0.05 x sqrt(25) gives 0.25, which is not the data given.
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