CFA Practice Question

There are 136 practice questions for this study session.

CFA Practice Question

Consider two individual securities whose active returns are independent.

Suppose the benchmark portfolio for the two securities is equally weighted (50% for each security) and the forecasted return on the benchmark portfolio is 5%. According to the basic fundamental law, the information coefficient is ______.

Correct Answer: 0.3

Portfolio weights and total expected returns for each security:
#1: 50% + 20% = 70%, 5 + 3 = 8%
#2: 50% - 20% = 30%, 5 + 2 = 7%

For the managed portfolio:
The forecasted total return: 0.7 x 8% + 0.3 x 7% = 7.7%
The expected active return: 7.7% - 5% = 2.7%

The active risk of the managed portfolio: [0.22 x 252 + (-0.2) 2 x 202]1/2 = 6.4%

The information ratio (IR) = 2.7/6.4 = 0.42

According to the fundamental law, IR = IC (BR)1/2, 0.42 = IC x 21/2, IC = 0.3.

User Contributed Comments 1

User Comment
davidt87 why wouldnt they keep 25 and 20 as percentage decimals? very confusing and unreliable way to work things out
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