Financial Risk Manager Part 2

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Explanation:

Explanation

Tracking error is defined as the volatility of active returns (the standard deviation of the difference between the portfolio returns and the benchmark returns).

Given the data:

Volatility of active returns: 1.7%
Tracking error limit: 2%

Since 1.7% < 2%, the manager did not breach the tracking error limit.

Analysis of other options:

Option A: Incorrect - Average active return (0.6%) is unrelated to tracking error limit
Option B: Incorrect - Return in excess of risk-free rate (2.8% - 1.2% = 1.6%) is unrelated to tracking error
Option D: Incorrect - Volatility of returns (1.9%) is the total portfolio volatility, not tracking error

Key Concept: Tracking error measures the consistency of performance relative to the benchmark, not the level of returns.

Explanation:

Explanation

Tracking error is defined as the volatility of active returns (the standard deviation of the difference between the portfolio returns and the benchmark returns).

Given the data:

Volatility of active returns: 1.7%
Tracking error limit: 2%

Since 1.7% < 2%, the manager did not breach the tracking error limit.

Analysis of other options:

Option A: Incorrect - Average active return (0.6%) is unrelated to tracking error limit
Option B: Incorrect - Return in excess of risk-free rate (2.8% - 1.2% = 1.6%) is unrelated to tracking error
Option D: Incorrect - Volatility of returns (1.9%) is the total portfolio volatility, not tracking error

Key Concept: Tracking error measures the consistency of performance relative to the benchmark, not the level of returns.

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A large pension fund requires that the fund's managers do not breach the 2% tracking error limit at any point in time. A fund manager's performance for the most recent period is summarized below:

Average return: 2.8%

Volatility of returns: 1.9%

Average return in excess of the benchmark (average active return): 0.6%

Volatility of active returns: 1.7%

If the current risk-free interest rate is 1.2%, which of the following is correct?

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The manager's average active return is below 2%, therefore the manager breached the limit.

0.0%

The manager's average return in excess of the risk-free interest rate is below 2%, therefore the manager breached the limit.

0.0%

The volatility of active returns achieved by the manager is below 2%, therefore the manager did not breach the limit.

92.3%

The volatility of returns achieved by the manager is below 2%, therefore the manager did not breach the limit.

7.7%