The table below provides returns on a portfolio along with returns for the corresponding benchmark index for the past eight quarters. The table also provides the difference between portfolio returns and the benchmark index, the average of these differences over the past eight quarters and the standard deviation of these differences. $\begin{array}{cccc}
\text { Period } & \text { Portfolio } & \text { Index } & \text { Difference } \
\hline 1 & 0.05 & 0.027 & 0.023 \
2 & -0.036 & -0.046 & 0.010 \
3 & 0.022 & 0.019 & 0.003 \
4 & 0.012 & 0.022 & -0.010 \
5 & -0.003 & -0.001 & -0.002 \
6 & -0.023 & -0.03 & 0.007 \
7 & 0.089 & 0.081 & 0.008 \
8 & -0.008 & 0.006 & -0.014\
\text { Average } &&& 0.003\
\mathrm{SD} &&&0.011789\
\end{array}$ The annualized tracking error for this period is

Question

Quizplus · Accepted Answer

The annualized tracking error is the standard deviation of the differences between the portfolio returns and the benchmark index, multiplied by the square root of the number of periods in a year. In this case, the standard deviation of the differences is 0.011789 and the number of periods in a year is 4 (assuming quarterly data). Therefore, the annualized tracking error is 0.011789 * sqrt(4) = 0.023578, or 2.36%.

The Table Below Provides Returns on a Portfolio Along with Returns