Explanation

Correct Answer: A

The information ratio is calculated as: $IR = \frac{\text{Active Return}}{\text{Tracking Error}}$ Where Active Return = Fund Return - Benchmark Return

Calculations:

• Fund X: Active Return = -1.5% - (-4.5%) = 3.0%
  IR = 3.0% / 1.2% = 2.50
• Fund Y: Active Return = 3.2% - 1.8% = 1.4% IR = 1.4% / 0.8% = 1.75
• Fund Z: Active Return = 2.3% - (-0.9%) = 3.2% IR = 3.2% / 1.6% = 2.00

Analysis:

• Fund X has the highest information ratio (2.50)
• Fund Z has the second highest (2.00)
• Fund Y has the lowest (1.75)

Fund X has the most favorable information ratio because it has the highest value (2.50), indicating the best risk-adjusted performance relative to its benchmark. A higher information ratio is considered more favorable as it shows the manager is generating more active return per unit of tracking error risk taken.