Financial Risk Manager Part 1
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An analyst examined the past performance of two commodity funds that follow the S&P500 as a benchmark. The analyst collected monthly return data and utilized the Information Ratio (IR) to evaluate which fund generated greater returns more effectively. The analyst then presented the results as follows:
| Fund A | Fund B | Benchmark | |
|---|---|---|---|
| Average monthly return | 2.63% | 2.54% | 2.35% |
| Average excess return | 0.28% | 0.19% | 0.00% |
| Standard deviation of returns | 0.51% | 0.48% | 0.45% |
| Tracking error | 0.56% | 0.53% | 0.00% |
What is the Information Ratio (IR) for each fund?
Other
Community
TTanishq
A
Fund A Information Ratio (IR) = 0.54, Fund B Information Ratio (IR) = 0.39
B
Fund A Information Ratio (IR) = 0.50, Fund B Information Ratio (IR) = 0.35
C
Fund A Information Ratio (IR) = 0.46, Fund B Information Ratio (IR) = 0.47
D
Fund A Information Ratio (IR) = 0.91, Fund B Information Ratio (IR) = 0.90
Explanation:
Explanation
The Information Ratio (IR) measures the excess return per unit of active risk (tracking error). The formula is:
Where:
- = Portfolio return
- = Benchmark return
- Tracking error = Standard deviation of excess returns
Fund A Calculation:
Fund B Calculation:
Key Points:
- The Information Ratio evaluates how effectively a fund manager generates excess returns relative to the benchmark
- A higher IR indicates better performance in selecting assets
- Fund A has a higher IR (0.50) than Fund B (0.35), suggesting Fund A performed better in generating excess returns relative to its tracking error
- The tracking error represents the volatility of the portfolio's returns relative to the benchmark
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