# CFA MOCK1Q59 - Lets try this again

The table of Active Risk Squared Decomposition % of total active risk in Parenthesis Portfolio Industry Risk Factors Total Factor Active Specific Active Risk Squared S 10 (28%) 12 (33%) 22 (61%) 14 (39%) 36 T 2 (5%) 26 (65%) 28 (70%) 12 (30%) 40 What is the most appropriate conclusion based on Active risk analysis of the 2 portfolios? A. Port S assumed more active factor risk than Port T B. Port S earned a higher return from active asset selection C. Port T earned a higher return from active factor selection D. Port T was industry neutral compared to the benchmark portfolio Why isn’t the Answer C as also given in the question was the Information ratio for S = 0.25 and T= 0.55. The way I see it is T has a higher return (based on its Information Ratio) AND its active Factor risk of 28 is higher than that of Port S (22)? The answer says that with the industry factor risk = 2, portfolio T is essentially industry neutral compared to the benchmark portfolio. Which is the Benchmark portfolio?/ Can someone please explain?

I think I did not get this one either. I did not see any benchmark. I thought I have misread this question. I also think C is correct. You can calculate active return by IR * active risk. It is bigger for T. Why it is not the case?

For the first part I think the question says that the return for T is higher (as you said) but it doesn’t say its due to factor tilts or due to active asset selection. active risk is always measured against a benchmark portfolio, in this question you don’t need to think about it. What you need to know here is the the contribution of factor tilt to the active risk. For the industry factor factor tilt is 2 or close to zero, which means that the industry factor exposure for both portfolio T and benchmark is same.

Anyone? I have reformatted so its easier to read The table of Active Risk Squared Decomposition % of total active risk in Parenthesis Portfolio----Industry-----Risk Factors-----Total Factor-------Active Specific----Active Risk Squared S ------------10 (28%)----12 (33%)--------22 (61%)-----------14 (39%)---------------36 T -------------2 (5%)------26 (65%)--------28 (70%)-----------12 (30%)---------------40 What is the most appropriate conclusion based on Active risk analysis of the 2 portfolios? A. Port S assumed more active factor risk than Port T B. Port S earned a higher return from active asset selection C. Port T earned a higher return from active factor selection D. Port T was industry neutral compared to the benchmark portfolio Why isn’t the Answer C as also given in the question was the Information ratio for S = 0.25 and T= 0.55. The way I see it is T has a higher return (based on its Information Ratio) AND its active Factor risk of 28 is higher than that of Port S (22)? The answer says that with the industry factor risk = 2, portfolio T is essentially industry neutral compared to the benchmark portfolio. Which is the Benchmark portfolio?/ Can someone please explain?

HI frd The Factors are measured as desviation from the benchmark, i mean desviation from the benchmark explained by active factor and specific factors…so there is no need to know the benchmark. Also the question says “Use exhibit 3”…the 0.25 and 0.55 are not there Also, Active Risk = squared root of(active factor risk+active specific risk) the the industry factor is very low, basically neutral in explain the active risk I hope this help

kabhii Wrote: ------------------------------------------------------- > For the first part I think the question says that > the return for T is higher (as you said) but it > doesn’t say its due to factor tilts or due to > active asset selection. > > active risk is always measured against a benchmark > portfolio, in this question you don’t need to > think about it. What you need to know here is the > the contribution of factor tilt to the active > risk. For the industry factor factor tilt is 2 or > close to zero, which means that the industry > factor exposure for both portfolio T and benchmark > is same. I think this makes sense. What is a general guideline for a factor risk considered to be same as benchmark, less or equal to 5 %?

I don’t know if there exists a general guideline. For this question, I just went with the most appropriate of the four options.

I just read the similar example in CFAI book 6 page 405. All entries is percentage squared. So it is 2 % ^ 2, it is indeed a very small number. 5 % is percentage of total risk. It is irrelevant here.

^ the page 405 reference is excellent. Did this topic catch anyone off guard?

I had seen it only because I looked through the CFAI PM looking for 2008 Treynor Black scenarios…that portion is a paragraph in Schweser but has a lot more detail in CFAI. doesn’t mean I remembered it completely…but I saw it. Classic moment of picturing the page in my mind but having absolutely no idea what the actual info was saying.

I’m reading page 405 example, but I still don’t understand. It says Portfolio B and C are both approximately industry neutral relatively to benchmark, how was this concluded? Simply by looking at the column “Industry,” so they decided Industry 1.25(5%) is relatively low and thus relatively neutral to benchmark? If yes, then Portfolio C is even lower, 0.03(3%). Answer key to #59 seems like they only look at the absolute number that Industry=2, and it concluded it’s industry neutral. elparko Wrote: ------------------------------------------------------- > ^ the page 405 reference is excellent. Did this > topic catch anyone off guard?

sleepybird, industry factor for T is only 5%, that is very low in relative terms. I think if this question is based on excluding the information ratios, the answer is D, but if IR is used, C and D are both correct.