FRM Part II · FRM Exam Part II · Factors
A fund has factor exposures of 1.2 to market and 0.5 to value. Factor returns for the period were: market 6%, value -2%. The risk-free rate was 1% and the fund returned 7.5%. Using a factor model on excess returns, what is the fund's alpha for the period?
Alpha is the excess return not explained by factors. Excess return is 6.5%, and factor contribution is 1.2x6% plus 0.5x(-2%) = 6.2%. Alpha is therefore 0.3%. Forgetting to subtract the risk-free rate would wrongly give 1.3%.
- A1.3%
- B1.8%
- C0.3%Correct
- D-0.3%
Explanation
Excess fund return = 7.5 - 1 = 6.5%. Factor contribution = 1.2 x 6 + 0.5 x (-2) = 7.2 - 1.0 = 6.2%. Alpha = 6.5 - 6.2 = 0.3%. Using the raw 7.5% return without subtracting the risk-free rate gives 1.3%.
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