7. Suppose the daily returns of a portfolio and a benchmark portfolio it is replicating are as follows:

What is the tracking error over the four day period?

3.16 bps

2 bps

10 bps

2.39 bps

Correct answer is A

A is correct. Tracking error is the standard deviation of the difference between the return of the managed portfolio and the benchmark portfolio.fficeffice" />

TE = sigma(R_P - R_B) = ( E[(R_P - R_B)^2] - E[R_P - R_B]^2 )^(1/2)

and

E[R_P - R_B] = (4 + (-2) + 6 + 0) / 4 = 2.00

E[(R_P - R_B)^2] = (16 + 4 + 36 + 0) / 4 = 14.00

So,

TE = (14.00 - 4.00)^(1/2) = 3.16 bps.

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