Question #10
Reading: Reading 40 Analysis of Active Portfolio Management
PDF File: Reading 40 Analysis of Active Portfolio Management.pdf
Page: 4
Status: Incorrect
Correct Answer: A
Your Answer: B
Question
Zeta fund has active return and active risk of 1.6% and 8% respectively. Benchmark portfolio has a Sharpe ratio of 0.35 and standard deviation of benchmark returns is 10.5%. What is the level of active risk that an investor would need to take to maximize the Sharpe ratio of a portfolio consisting of Zeta fund and the benchmark portfolio?
Answer Choices:
A. 8%
B. 7%
C. 6% Radina Radichkova, CFA, is considering investing in one of three actively managed funds whose benchmark is the FTSE 100. The Sharpe ratio and standard deviation of the benchmark are 0.50 and 15%, respectively. Alpha Bankso Crystal Active return 3.2% 2.8% 12.5%
Explanation
Information ratio (IR) = 1.6% /8% = 0.2
Active risk of Zeta fund = 8%
Weight of Zeta fund = 6% / 8% = 0.75
Weight of benchmark = 0.25
(Module 40.2, LOS 40.b)
Radina Radichkova, CFA, is considering investing in one of three actively managed funds
whose benchmark is the FTSE 100. The Sharpe ratio and standard deviation of the
benchmark are 0.50 and 15%, respectively.
Alpha Bankso Crystal
Active return
3.2%
2.8%
12.5%
√BR
Optimal level of active risk = σ∗A =
σB =
(10.5) = 6%
IR
SRB
0.2
0.35
Active risk
4.1%
3.6%
15.5%
Radichkova is also analyzing an actively managed portfolio consisting of financials and
pharmaceuticals. The following table shows the weights and returns of the benchmark and
portfolio:
Sector
WB
WP
RB
RP
Financials
50% 70% 9.2% 17.8%
Pharmaceuticals 50% 30% 8.1%
6.3%
Radichkova makes the following comments about the two-sector portfolio:
Comment 1: The value added is 5.7%.
Comment 2: The asset allocation decision only accounts for 0.22% of the value added.
Radichkova is writing a summary of the fundamental law of active management. In that
section of the report, she states that the transfer coefficient can be viewed as the correlation
between:
1. ex-ante active returns and actual active weights
2. risk-weighted optimal active weights and risk-weighted actual active weights
3. ex-ante active returns and realized active returns