Risk Assessment Flashcards

Tracking error is defined as the:

Answer: Standard deviation of the difference between portfolio and benchmark returns

Tracking error measures the volatility of active returns.

A manager has active return of 2% and tracking error of 4%. What is the information ratio?

Answer: 0.50

IR = active return / tracking error = 2% / 4% = 0.50.

Two assets with a correlation of −1.0 can be combined to:

Answer: Create a portfolio with zero volatility

Perfectly negatively correlated assets can be weighted so their fluctuations fully offset each other.

The Treynor ratio is most appropriate for evaluating a portfolio that:

Answer: Is one part of a larger, well-diversified portfolio

Treynor uses beta, so it fits when diversification has already removed unsystematic risk.

Which statement about stress testing is most accurate?

Answer: It assesses losses under extreme but plausible scenarios that VaR may miss

Stress tests look at tail events directly and do not assign probabilities, which complements VaR.

Maximum drawdown measures:

Answer: The largest peak-to-trough decline in portfolio value over a period

Maximum drawdown captures the largest cumulative loss from a high point before a new peak.

Fat tails (leptokurtosis) in return distributions mean that normal-distribution VaR will tend to:

Answer: Underestimate the likelihood of extreme losses

Fat tails put more probability on extreme events than the normal distribution assumes.