Question #19
Reading: Reading 40 Analysis of Active Portfolio Management
PDF File: Reading 40 Analysis of Active Portfolio Management.pdf
Page: 8
Status: Incorrect
Correct Answer: A
Your Answer: B
Question
Charles Griffith makes quarterly bets between stocks of industrial and utility sectors. The historical correlation between the returns of the two sectors is -0.20 and Griffith's bets have been correct 55% of the time. Further information is as below: Benchmark Sector E (R) σ Weight Industrial 12.00% 13.0% 80% Utility 5.2% 2.5% 20% The expected annualized active return of Griffith's sector rotation strategy is closest to:
Answer Choices:
A. 10.64%
B. 13.72%
C. 5.48%
Explanation
IC = 2(0.55) – 1 = 0.10
Combined active risk = σC = [σI
2 -2σIσUrIU+ σU
2]1/2
= [0.132 + 0.0252 – 2 (0.13)(0.025)(-0.20)]1/2 = 0.1372 or 13.72%
Annualized active risk = 0.1372 x (4)1/2 = 0.2744 or 24.44%
Annualized active return = IC x
x σA = 0.10 x (4)1/2 x 0.2744 = 0.0548 or 5.48%
Alternatively,
Active return from this strategy using a probability weighted average (given Griffith makes
correct calls 55% of time) of combined risk is:
(0.55)(0.1372) + (0.45)(-0.1372) = 0.0137 or 1.37% per quarter.
Annual active return = 1.37% x 4 = 5.48%.