Question

FUNDS

1. Consider the annual returns produced by a passive equity portfolio manager as well as those of the stock index with which they are both compared. What is the tracking error for the manager relative to the index?

Year

Manager (%)

Index

(%)

1

12.8

11.8

2

-2.1

-2.2

3

15.6

18.9

4

0.8

-0.5

5

-7.9

-3.9

6

23.2

21.7

7

-10.4

-13.2

8

5.6

5.3

9

2.3

2.4

10

19.0

19.7

2. What is the CAPE, if the Share Price is $45.20?

Year

Earnings Per Share

1

2.20

2

1.90

3

1.80

4

1.90

5

2.40

6

2.10

7

2.70

8

1.80

9

1.20

10

2.30

Answer 1

The tracking error is a measure to find out the measure of deviation of a portfolio or a mutual fund from the returns of a benchmark index, to see how well it is performing

It shows how actively the fund manager is trying to replicate the benchmark or any other modifications are being used in the process.

We can calculate the tracking error by using standard deviation:

The tracking error is calculated as the Standard Deviation of the difference of portfolio and benchmark returns.

= Standard Deviation of (Rp - Rb)

For the information above, the tracking error may be illustrated as follows:

Therefore, the tracking error is 2%.

b)The CAPE ratio or Cyclically-Adjusted Price to Earnings Ratio, is a valuation tool to measure the relationship between the company’s earnings per share over a period of 10 years and company’s stock price by averaging out the cyclical fluctations occuring during this time period.

It is calculated as:

CAPE Ratio = Stock Price / 10-Years Average EPS (adjusted for inflation)

For the information presented above, the CAPE ratio is illustrated as follows:

Therefore, the CAPE ratio = 22.27