Equity Valuation and Portfolio Management

QUESTIONS

1. Calculate the annualized alpha, tracking error, and information ratio based on the 12 monthly returns below:

   Month	Active Return (%)
   1	0.37
   2	−0.31
   3	−0.55
   4	0.09
   5	0.37
   6	−0.05
   7	−0.62
   8	0.06
   9	0.46
   10	−0.09
   11	0.58
   12	0.84

2. Assuming active returns are normally distributed, calculate the expected returns about the benchmark at various at the 67%, 95%, and 99% confidence levels assuming the following data:

   Expected active return (%)	2%
   Tracking error (%)	3%
   Benchmark expected return	8%

3. Suppose that a manager whose benchmark is the S&P 500 pursues an enhanced indexing strategy allocating 10% of the portfolio to be actively managed and 90% indexed. Assume further that the tracking error of the actively managed portion is 12% with respect to the S&P 500. What is the portfolio's tracking error?
4. Why is backward-looking tracking error not a good indicator of future risk?
5. In practice, how is forward-looking tracking error calculated?
6. Why is there no guarantee that the forward-looking tracking error at the start of a quarter will exactly match the backward-looking tracking error calculated at the end of that quarter?
7. 1. What does the marginal contribution to tracking error mean?
   2. Suppose that the marginal contribution to tracking error for some factor is negative. What does that mean?
   3. Why is the marginal contribution to tracking error a useful measure for a portfolio manager?

¹ Raman Vardharaj, Frank J. Fabozzi, and Frank J. Jones, ...