Suppose you compute the tracking error of a portfolio to be 0.2689% per day. Explain how to interpret this number. [1 mark]

(b) Suppose you compute the correlation of the replicating portfolio with the benchmark index to be 0.935. Explain how to interpret this number and explain whether this replicating portfolio is accurate enough or whether it should be altered? [2 marks]

(c) Explain why the correlation between returns to bonds used in tracking-error minimization tend to be very high (close to positive 1)? [2 marks]