Information Ratio

[Allanps]

Guys, I have a question for anyone that has done the Practice Exam 2 - AM Book 1 Schweser.

Question 45.

Based on the portfolio manager’s estimates of residual risk and residual return, the annualized valued added for portfolio IMI-KAY is closest to:

A) 0.35%. B) 0.88%. C) 1.40%.

Your answer: C was correct!

annual α = (0.5) × 4 = 2%; annual ω = (1) × = 2% VA = α − (λ × ω²) = 2% − (0.15 × 2²) = 1.4%

Alternatively, quarterly VA = 0.5 − (0.15 × 1² = 0.35% annual VA = quarterly VA × 4 = 0.35% × 4 = 1.4%C

Where does this ω = (1) × come from ?

Why the annual w isn`t 4% ? The question says: The portfolio manager anticipates that the portfolio will generate QUARTERLY residual return of 0,5% with a residual risk of 1%.

[1jduanmu]

w is the standard deviation, when annualize, we should convert it to variance w^2 then time 4, the annual variance is 4*w^2, then annual std is sqrt(4*w^2)=2*w

[Allanps]

Thanks !!!

But where did you find this information ?

[1jduanmu]

I think this is some basic statistic concept, assume variance is identical independent distributed, then we can add the variance without worrying about covariance

[Allanps]

Thanks again !