Explanation:
Grinold's fundamental law of active management states that:
Information Ratio (IR) = Information Coefficient (IC) × √Breadth
Where:
This formula shows that to maximize the information ratio, investors can either:
Option B correctly captures this relationship: "To maximize the information ratio, active investors need to either have high-quality predictions or place a large number of investment bets in a given year."
Why other options are incorrect:
The fundamental law demonstrates that both skill (IC) and opportunity (breadth) are important for successful active management.
Ultimate access to all questions.
Following Grinold's fundamental law of active management, one should find:
A
Sector allocation is the most important factor in active management.
B
To maximize the information ratio, active investors need to either have high-quality predictions or place a large number of investment bets in a given year.
C
A small number of investment bets decreases the chances of making a mistake and, therefore, increases the expected investment performance.
D
Investors should focus on increasing only their predictive ability relative to stock price movements.
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