Reading 23 Equity EOC # 11 A. I do not understand the question and the answer.
Any explanations?
It’s asking to explain how misfit risk comes into the calculation of Total Active Risk. I think the answer may have a misprint. It says:
“The total active risk is greater than 6 percent because in the calculation, the long–short manager would be benchmarked to the Russell 1000 rather than the manager’s normal benchmark, which most closely captures the manager’s orientation. We can see this by noting the positive level of misfit risk. The misfit risk is calculated with the equation”
The Russell 1000 actually is the managers normal benchmark I think they meant to say Russell 3000 which was explained in the question the portfolio would be benchmarked against.
I’m always so hesitant to try and answer for candidates when I am one so hopefully s200magician will come around and correct us if we are wrong but Im pretty sure its a misprint (the answer explanation should say 3000 not 1000). It explicitly states the portfolio benchmark for equity asset class is the Russell 3000. However, the normal benchmark for the long/short Russell 1000 overlay is the Russell 1000 index and cash, which would be accurate. There would no misfit risk and total active risk would be 6% if benchmaked against its normal however since their benchmarked against the 3000 it’s more than 6% due to misfit risk.