- Why does the answer claim that Choice C (“VAR provides no information on the magnitude of loss beyond the minimum loss”) is a limitation of VAR? The explanation says, “VaR also only indicates the minimum loss at a given level of significance but gives an analyst no information on potential losses beyond this minimum amount.” To me, this seems wrong because VAR provides the maximum–not the minimum–risk. Page 125 of Schweser Book 4 says that VAR is stated as “95% chance that a fund will not lose more than 11.4% of its value.” So it seems to be describing the max loss, not the min loss. 39. Answer says, “The information ratio is active return divided by active risk and doesn’t apply to a tracking portfolio. For a tracking portfolio, active return is zero as it is a passive portfolio with an expected return equal to that of the benchmark (index) it is designed to track.” Why is active return zero? In a tracking portfolio you keep all the same weights as the benchmark but your returns should vary due to different stock selection no?
- This means over that over the assumed time period a loss exceeding 11.4% will occur only 5% of the time. As a result, we can conclude that the other 95% of the time it is possible to loose up to the minimum amount, 11.4%. This means it is describing the minimum loss with 95% certainty and we do not know by how much the loss exceeds 11.4% the other 5% of the time. In other words, we have no information on the the max loss. They are correct in their explanation. 39. Active return is return generated by using an active portfolio management process to select securities. Passive investing is tracking a benchmark, such as an index. So if we are tracking a benchmark all return generated is attributed to the benchmark and none due to active selection. Return will vary, but all of this return is generated by the benchmark tracking portfolio and none by active selction and thus no active return.
95% chance will not lose more than 11.4% put another way - 5% chance it will lose less than 11.4%. but how much less than 11.4%? [It could be 0, could be 11.4% in its entirety… whole range exists there]. I think this is what Investor83 is also saying.
You guys just need to switch your idea of VAR to the inverse. VAR is counterintuitive. 95% chance the investment will not loose more than 11.4%(you are correct CP) but… 5% chance it WILL loose more than 11.4%. By how much MORE the lose exceeds 11.4%, this we are unsure. Hope this helps you guys. This is pretty tricky. I read some Level 3 material to help clear this up because I thought Level 2 coverage was skimpy. It was very helpful. Good luck guys on your final review.
I got the VAR Q but am still struggling on the Information Ratio Q. Tracking Portfolios are not passive portfolios–by definition it has no exposure to factors exposures but makes active bets on asset selection. So how can you say no return is generated by active selection?
the show NY Wrote: ------------------------------------------------------- > I got the VAR Q but am still struggling on the > Information Ratio Q. Tracking Portfolios are not > passive portfolios–by definition it has no > exposure to factors exposures but makes active > bets on asset selection. So how can you say no > return is generated by active selection? For a tracking portfolio, all you are doing is replicating a benchmark (e.g. S&P500 index). There are no gains to be had from building a tracking portfolio unless you tilt the factors due to perceived expectations in the marketplace.
you are replicating the benchmark factor exposures but you make active bets on asset allocation. page 193 schweser book 5: “the manager constructs the portfolios to have the same factor exposures as the benchmark but then selects what they beleive to be superior securities, thus hopefully outperforming the benchmark.” so unless my definition of active return is off, there is for sure return above the benchmark (alpha) to be made.