Question #26

Reading: Reading 40 Analysis of Active Portfolio Management

PDF File: Reading 40 Analysis of Active Portfolio Management.pdf

Page: 12

Status: Correct

Correct Answer: A

Part of Context Group: Q26-29 First in Group
Shared Context
of 40 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 weight of benchmark portfolio in a portfolio consisting of Zeta fund and the benchmark portfolio assuming that the portfolio is constructed to have optimal active risk? A) 0.1667 B) 0.2 C) 0.25 Ufton Wealth Management's Ranger fund has proved popular with clients. An extract from the prospectus of the Ranger fund is shown in Exhibit 1. Exhibit 1: Ranger Fund Asset Portfolio weight Benchmark weight Expected portfolio return Expected benchmark return U.S. equities 15% 20% 11% 9% U.S. corporate bonds 35% 35% 8% 7% International equities 8% 40% 14% 10% U.S. real estate 42% 5% 7% 7% Ufton awards its best performing fund manager with a large cash bonus each year. Details of the performance of three funds is shown in Exhibit 2. Risk-free rate is 2%. Exhibit 2: Selected Fund Performance Fund Portfolio return Benchmark return Portfolio standard deviation Benchmark standard deviation Sharpe ratio Tracking error Saltire 8.46% 5.80% 6.13% 4.50% 1.05 1.58% Dragon 13.01% 11.56% 7.64% 5.15% 1.44 2.12% Rose 11.39% 11.37% 11.01% 11.14% 0.85 0.21%
Question
The expected level of active return expected to be achieved by the Ranger fund is closest to:
Answer Choices:
A. –9.00%
B. –0.09%
C. +3.49%
Explanation
The expected active return achieved by a portfolio are calculated as the difference between the expected return on the portfolio and the expected return on the benchmark: E(RA)=∑wPi × E(RPi) − ∑wBi × E(RBi) = E(RP) – E(RB) Exhibit 1: Ranger Fund Asset Portfolio weight Benchmark weight Expected portfolio return Expected benchmark return U.S. equities 15% 20% 11% 9% U.S. corporate bonds 35% 35% 8% 7% International equities 8% 40% 14% 10% U.S. real estate 42% 5% 7% 7% E(RP) = (0.15 × 11%) + (0.35 × 8%) + (0.08 × 14%) + (0.42 × 7%) = 8.51% E(RB) = (0.20 × 9%) + (0.35 × 7%) + (0.40 × 10%) + (0.05 × 7%) = 8.60% E(RA) = –0.09%
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