June 2015 Level II > Study Session 18. Portfolio Management: Capital Market Theory and the Portfolio Management Process. > Reading 53. Portfolio Concepts > m. explain sources of active risk, interpret tracking error, tracking risk, and the information ratio, and explain factor portfolio and tracking portfolio;
Information Ratio The information ratio (IR) is mean active return divided by active risk. It measures the increment in mean active return per unit of active risk.
Factor Portfolios A factor portfolio is a well-diversified portfolio constructed to have a beta of 1.0 on one factor and a beta of zero on any other factors. It represents the risk of that factor only. A portfolio manager can use a factor portfolio to hedge that risk or speculate on it. Tracking Portfolio A tracking portfolio is a portfolio with factor sensitivities that match those of benchmark portfolio or other portfolio. The idea is to match the systematic risk of the benchmark portfolio and at the same time to get excess returns through superior stock selection. For example, a portfolio manager can create a portfolio that has the same factor exposures as the benchmark portfolio (e.g. S&P 500). However, the portfolio contains a different set of securities. The portfolio manager may hope to get a better return than the benchmark portfolio.
I. Active return.
II. Active risk.
III. Tracking risk.
IV. Tracking error.
They all refer to the same thing.
A. active factor risk.
B. active specific risk.
C. asset selection risk.
A. speculation purposes only.
B. hedging purposes only.
C. both speculation and hedging purposes.
A. buy, is exposed to.
B. sell, is exposed to.
C. buy, is hedged to.
The factor portfolio is assumed to be hedged against all but time horizon risk. That is, it has zero sensitivities for all but time horizon risk.
A. active factor risk.
|murli: Adding the assets with lower correlation will reduce the risk of portfolio.|
|chuong: Lower coeffiriennt correlation -> lower covariance - > lower Portfolio variance|
|Criticull: it's not negative, but something is better than nothing.|
|jpducros: Can someone explain with its own word the Active Factor Risk and Active Specific Risk ? Is seems for me that the question here describes exactly these 2 risks. The sum of the 2 being the squared tracking risk, I answered C.|
|jpducros: not "squared" tracking risk, but merely "tracking risk", sorry.|