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Answer: The volatility of active returns achieved by the manager is below 2%, therefore the manager did not breach the limit.
## 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:
If the current risk-free interest rate is 1.2%, which of the following is correct?
A
The manager's average active return is below 2%, therefore the manager breached the limit.
B
The manager's average return in excess of the risk-free interest rate is below 2%, therefore the manager breached the limit.
C
The volatility of active returns achieved by the manager is below 2%, therefore the manager did not breach the limit.
D
The volatility of returns achieved by the manager is below 2%, therefore the manager did not breach the limit.