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Rob Tanner, portfolio manager at Alpha Inc. meets his old college friend Del Torres for
lunch. Torres excitedly tells Tanner about his latest work with tracking and factor portfolios.
Torres says he has developed a tracking portfolio to aid in speculating on oil prices and is
working on a factor portfolio with a specific set of factor sensitivities to the Russell 2000.
Did Torres correctly describe tracking and factor portfolios?
Tracking
Factor
A) No
Yes
B) Yes
No
C) No
No
Marianne Belair, CFA, is a wealth manager for a well-known company in Paris, France. She
has developed macroeconomic factor models on portfolios Alpha and Bravo.
Equations for the two portfolios:
RAlpha = 0.08 – 0.7 FINFL + 1.2 FGDP
RBravo = 0.13 + 0.6 FINFL + 2.3 FGDP
Belair has asked her colleague Pierre Louboutin to calculate the return attributable to a 1.5%
surprise in GDP for an equally weighted portfolio comprising Alpha and Bravo.
Meanwhile, Belair is looking at Merci, a beauty stock for which she has developed a
macroeconomic factor model. The arbitrage-pricing model shows a required return of 10%
and the company-specific surprise for the year was 2%. Exhibit 1 shows additional
information on the model:
Exhibit 1:
Variable
Actual Value (%) Expected Value (%) Factor Sensitivity
Interest rates
3.5%
2.5%
–0.3
Unemployment level
6.5%
5.5%
–0.7
Emily Grant, a senior manager at the firm, asks Louboutin to analyze the performance of
three managers using the information in Exhibit 2.
Exhibit 2: Decomposing Active Risk
Portfolio
Active
factor risk
squared
(%)
Active
specific risk
squared (%)
Active risk
squared
(%)
Active
factor risk
(% of Total
Active Risk)
Active
specific risk
(% of Total
Active Risk)
Active
risk (%)
EM
0.5
0.5
1
50
50
1
EC
25.2
10.8
36
70
30
6
EV
21.6
14.4
36
60
40
6
Finally, Belair would like to capitalize on her expectation that real business activity will
increase over the next year. As a separate concern, she has some existing positive exposure
to inflation risk, which she would like to hedge. To achieve her goals she can use the
portfolios in the Exhibit 3 which show the five relevant factors and respective factor
sensitivities:
Exhibit 3:
Risk Factor
A
B
C
D
E
Confidence
0.10 1.00 0.00 0.70 0.00
Time horizon
0.00 0.00 0.00 0.50 0.00
Inflation
1.00 0.00 0.00 0.30 1.00
Business cycle 0.90 1.00 1.00 0.00 0.00
Market timing
1.00 0.00 0.00 0.90 0.00