LOS p, (Part 2): Justify enhanced indexing on the basis of risk control and the information ratio.

Q1. Manager X follows the stocks in a broad market index and has made independent forecasts for 300 of them. Her information coefficient is 0.03. Manager Y has made independent forecasts for 100 stocks. His information coefficient is 0.05. Which manager has the better performance and why?

A)   Manager X because she has greater breadth.

B)   Manager Y because he has more accurate forecasts.

C)   Manager Y because he has greater breadth.

Q2. Manager X follows the stocks in a broad market index and has made independent forecasts for 500 of them. Her information coefficient is 0.02. Manager Y has made independent forecasts for 175 stocks. His information coefficient is 0.04. Which manager has the better performance and why?

A)   Manager Y because he has more accurate forecasts.

B)   Manager Y because he has greater breadth.

C)   Manager X because she has greater breadth.

LOS p, (Part 2): Justify enhanced indexing on the basis of risk control and the information ratio. fficeffice" />

Q1. Manager X follows the stocks in a broad market index and has made independent forecasts for 300 of them. Her information coefficient is 0.03. Manager Y has made independent forecasts for 100 stocks. His information coefficient is 0.05. Which manager has the better performance and why?

A)   Manager X because she has greater breadth.

B)   Manager Y because he has more accurate forecasts.

C)   Manager Y because he has greater breadth.

Correct answer is A)

The information ratio for each manager is calculated as the information coefficient times the square root of the investor’s breadth:

Although Manager X’s depth of knowledge (as measured by the information coefficient) is not as great, she has better performance as measured by the information ratio because she has a greater breadth of decisions.

Q2. Manager X follows the stocks in a broad market index and has made independent forecasts for 500 of them. Her information coefficient is 0.02. Manager Y has made independent forecasts for 175 stocks. His information coefficient is 0.04. Which manager has the better performance and why?

A)   Manager Y because he has more accurate forecasts.

B)   Manager Y because he has greater breadth.

C)   Manager X because she has greater breadth.

Correct answer is A)

The information ratio for each manager is calculated as the information coefficient times the square root of the investor’s breadth:

The information coefficient is measured by comparing the investor’s forecasts against actual outcomes. More skillful managers will have a higher information coefficient. Manager Y’s depth of knowledge is greater which accounts for his greater information ratio and better performance.

Thx!