Additivity Principle - Information Ratio (Kaplan Pg. 231)

CFA Level II
#1

I’m having difficulty grasping what appears to be a simple enough concept - Additivity Principle for Information Ratios. I feel that Kaplan is making this hard than it is or I just need more coffee…

  1. can someone explain in simple terms the firm’s information ratio formula given at top of page?

IR (firm)^2 = IR (fixed income analyst)^2 + IR (equity analyst)^2

*** why the squared??

  1. the example provided at the bottom of the page (Question # 2). It involves calculating a “new information ratio” from the previously computed one given the following additional information:

*follows an additional number of stocks

*different IC for these additional stocks

Any and all guidance is greatly appreciated! Thank you to all in advance!

#2

I meant to put Kaplan Level 2 Book #5

#3

Mathematically, they’re assuming that the IRs are statistically independent: orthogonal (perpendicular). The firm’s IR li like the hypotenuse in a right triangle with the fixed income IR and the equity IR as legs.

#4

I had to sit back and think about it for a second, but that really makes sense!! You are awesome and soooooo helpful to everyone on here!! We appreciate it!

I took that methodology and applied it to #2 and got the correct answer!

#5

Cool!

#6

He is magician:D