CFA Level II ExamPortfolio Management and Wealth PlanningMedium
A portfolio manager is evaluating the performance of a passively managed index fund against its benchmark. The fund's return was 10.5%, and the benchmark return was 10.0%. The fund's tracking error was 0.5%. The information ratio (IR) is calculated as the active return divided by the tracking error. What is the information ratio for this fund?
- A1.00
- B5.00
- C0.50
- D2.00
Show answer & explanationAnswer & explanation
Correct answer: A. 1.00
Active Return = Portfolio Return - Benchmark Return = 10.5% - 10.0% = 0.5%. Information Ratio (IR) = Active Return / Tracking Error = 0.5% / 0.5% = 1.00.
Why the other options are wrong
- B. This is incorrect; it seems to be 0.5% / 0.1% or some other miscalculation.
- C. This would be the result if the active return was 0.25%, not 0.5%.
- D. This would be the result if the active return was 1.0%, not 0.5%.
Information Ratio (IR)
A measure of a portfolio's risk-adjusted return, calculated as the active return (portfolio return minus benchmark return) divided by the tracking error (standard deviation of active returns).
- Measures the consistency of a manager's active returns.
- Higher IR indicates better performance per unit of active risk.
- Useful for evaluating active managers against a benchmark.
Memory trick: Performance Ratios: Gauging Your Investment Score.