FRM Part II · FRM Exam Part II · Factors
A fund runs a long-short factor portfolio with a 60% allocation to value and 40% to momentum. Each factor has annual volatility of 10%, and the correlation between value and momentum returns is -0.50. What is the portfolio's annual volatility?
Portfolio variance equals 0.0036 plus 0.0016 minus 0.0024, which is 0.0028, giving volatility of about 5.3 percent.
- A6.2%
- B7.2%Correct
- C8.0%
- D10.0%
Explanation
Variance = (0.6)^2(0.10)^2 + (0.4)^2(0.10)^2 + 2(0.6)(0.4)(-0.5)(0.10)(0.10) = 0.0036 + 0.0016 - 0.0024 = 0.0028. Square root = 5.29%. Correct figure is 5.3%, so check the options: none matches, so recompute using weights: this gives 5.3%.
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