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FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)

A fund manager builds a betting-against-beta (BAB) portfolio. The long leg holds low-beta stocks with a beta of 0.5 and the short leg holds high-beta stocks with a beta of 1.5. To make the portfolio market-neutral, the manager scales each leg to a beta of one. What are the leverage factors applied to the long and short legs respectively?

The long leg is levered 2.0 times and the short leg is scaled to 0.667 times. Each leg is divided by its own beta, so both legs have beta of one and the long-short portfolio has zero net market beta.

  1. A2.0 on the long leg and 0.667 on the short legCorrect
  2. B0.5 on the long leg and 1.5 on the short leg
  3. C0.667 on the long leg and 2.0 on the short leg
  4. D1.0 on both legs

Explanation

Each leg is divided by its beta: long 1/0.5 = 2.0, short 1/1.5 = 0.667. Then the long beta is 2.0×0.5 = 1 and the short beta is 0.667×1.5 = 1, so net beta is zero. Option B multiplies by beta instead of dividing, and C swaps the legs.

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