FRM Part II · FRM Exam Part II · Factors
A fund has returns with a standard deviation of 20%, the market's standard deviation is 15%, and the correlation between the fund and the market is 0.6. The fund's idiosyncratic variance, as a share of its total variance, is closest to:
About 64% of the fund's variance is idiosyncratic. The squared correlation of 0.6 gives an R-squared of 36%, which is the systematic portion, so the remaining 64% of total variance is specific risk unexplained by the market.
- A36%
- B60%
- C40%
- D64%Correct
Explanation
Systematic share of variance equals the squared correlation, R² = 0.36. Idiosyncratic share = 1 − 0.36 = 0.64, or 64%. The 36% option is the systematic share, the key distractor. Beta is 0.6×20/15 = 0.8, consistent with this.
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