PM: Reading 55

I think you need to understand the formula (or maybe we could get away without knowing it).

I’ve encountered a question in schweser’s practice exam asking bout the weightings of the specific asset/portfolio given the unsystematic risk (variance) and the alpha.

the formula is something like w = (alpha_i/ variance_i) / {sum of all (alpha_x/ variance_x)}

It looks scary at first, but after putting some real numbers into the formula it’s not too bad.

Very similar to (sharpe ratio of 1 asset) / (sum of all sharpe ratio in the portfolio)

Sharpe ratio = {E(Rm) – E(Rf)} / standard deviation

and for treynor black it’s –> alpha / variance

At least that’s how i remember it.

Hi @ykilstein, welcome to 300hours 🙂

Seems like you’re not the only one, @vincentt and @cfaguru also asked about it before here and here.

My gut feel is you need to know what’s the model for, and how to interpret it. Not sure if you need to know those formulae per se. Other level II candidates: @diya, @cfaguru, @vincentt, @reena, @shantala, @dollarstodunts, @franz – any thoughts?

I agree with @Sophie that we need to know the Treynor-Black approach as they call it in the book. There are just so many questions dedicated to the Treynor-Black approach and I quote the CFAI book. It says,

“explain how an analyst’s accuracy in forecasting alphas can be measured and how estimates of forecasting can be incorporated into the Treynor-Black approach”

I can’t be sure about if we need to know the formula since it says “explain” and neither of the three LOS for this chapter have “calculate”. Also I find that CFAI EOC questions are tricky and like to use formulas because the best way to understand the formula is to use it.

Hi @ykilstein! As @vincentt said, understanding the concept is important. I’d say it’s safer to know the formula going into the exam.