Risk & Return Analysis Flashcards

A manager's portfolio earned 11% while the benchmark returned 8%. If the portfolio's tracking error is 5%, what is the information ratio?

Answer: 0.60

Information ratio = (11% − 8%) / 5% = 3% / 5% = 0.60.

According to Modern Portfolio Theory, the efficient frontier represents portfolios that offer:

Answer: Maximum expected return for a given level of risk

The efficient frontier consists of portfolios dominating all others by providing the highest return for each risk level.

Value at Risk (VaR) at the 95% confidence level over one day means:

Answer: There is a 5% probability that losses will exceed the VaR amount in a single day.

A 95% one-day VaR implies a 5% chance (1 in 20 trading days) of losses exceeding the stated amount.

Which limitation of VaR is directly addressed by Conditional VaR (CVaR)?

Answer: VaR does not indicate the magnitude of losses beyond the threshold.

CVaR (Expected Shortfall) measures the average loss given that the loss exceeds the VaR threshold, addressing VaR's tail-blindness.

A bond portfolio has a duration of 6 years. If interest rates rise by 50 basis points, the approximate percentage price change is:

Answer: −3.0%

Approximate price change = −Duration × Δy = −6 × 0.005 = −0.03 = −3.0%.

The geometric mean return is preferred over the arithmetic mean for measuring historical portfolio performance because it:

Answer: Accounts for the compounding effect and reflects the actual growth of wealth over time

The geometric mean captures compounding and equals the constant annual return that would produce the same ending wealth.

Kurtosis greater than 3 (leptokurtic distribution) in an asset's return distribution implies:

Answer: Fatter tails and higher probability of extreme returns than a normal distribution

Leptokurtic distributions have excess kurtosis > 0, meaning heavier tails and a higher likelihood of extreme outcomes.