Question

The following data are available relating to the performance of Sooner Stock Fund and the market portfolio for a time when the risk-free rate was 3%. What is the information ratio for the Sooner Fund?

	Sooner	Market
Average return	20%	11%
Standard deviations of returns	44%	19%
Beta	1.8	1.0
Residual standard deviation	2.0%	0.0%

• A.

  0.76

• B.

  1.30

• C.

  1.44

• D.

  2.60

• E.

  2.80

Answer 1

We know that: Information ratio = (Portfolio Return - Benchmark Return) / Standard deviation of the active returns or tracking error

Portfolio Return/ Stock Return = 20%

Benchmark Return using CAPM = risk-free rate + Beta x Market Risk Premimum

Benchmark Return = 3% + 1.8 x (11% - 3%) = 3% + 1.8 x 8% = 3% + 14.4% = 17.4%

Standard deviation of the active returns or tracking error = 2%

Information ratio = [20% - 17.4%] / 2% = 2.6% / 2% = 1.3

Information ratio is B. 1.30