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FRM Part II · FRM Exam Part II · Portfolio Risk: Analytical Methods

A portfolio manager at a pension fund allocates risk budgets across three asset classes. The fund's total portfolio volatility is 10%. Equity has a weight of 60%, a volatility of 15%, and a correlation with the total portfolio of 0.95. Which is the percentage contribution of equity to total portfolio risk (to the nearest whole percent)?

Equity contributes 85.5% of portfolio risk. Its beta to the portfolio is 0.95 x 15/10 = 1.425, and the percentage risk contribution equals weight times beta, 0.60 x 1.425 = 85.5%. Weight alone or weight times correlation understates the contribution.

  1. A85.5%Correct
  2. B90.0%
  3. C57.0%
  4. D95.0%

Explanation

Marginal contribution to risk = beta of equity to portfolio times portfolio volatility. Beta = 0.95 x 15% / 10% = 1.425. Percentage contribution = weight x beta = 0.60 x 1.425 = 0.855, or 85.5%. The 57% option is weight x correlation, which ignores the volatility ratio.

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