Question #19
Reading: Reading 36 Using Multifactor Models
PDF File: Reading 36 Using Multifactor Models.pdf
Page: 9
Status: Incorrect
Correct Answer: A
Your Answer: C
Question
A portfolio manager uses a two-factor model to manage her portfolio. The two factors are confidence risk and time-horizon risk. If she wants to bet on an unexpected increase in the confidence risk factor (which has a positive risk premium), but hedge away her exposure to time-horizon risk (which has a negative risk premium), she should create a portfolio with a sensitivity of:
Answer Choices:
A. −1.0 to the confidence risk factor and 1.0 to the time-horizon factor
B. 1.0 to the confidence risk factor and 0.0 to the time-horizon factor
C. 1.0 to the confidence risk factor and -1.0 to the time-horizon factor
Explanation
She wants to create a confidence risk factor portfolio, which has a sensitivity of 1.0 to the
confidence risk factor and 0.0 to the time horizon factor. Because the risk premium on the
confidence risk factor is positive, an unexpected increase in this factor will increase the
returns on her portfolio. The exposure to the time-horizon risk factor has been hedged
away, because the sensitivity to that factor is zero.