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FRM Part II · FRM Exam Part II · Factor Theory

A portfolio manager builds a long-only factor portfolio and a long-short factor portfolio for the same momentum signal. Compared with the long-only version, the long-short version will most likely:

The long-short portfolio gives purer momentum exposure with lower market beta because shorts offset market movements. The tradeoff is the need for leverage, borrowing costs and shorting constraints, whereas the long-only version retains substantial market beta and captures the factor premium only partially.

  1. AHave greater market beta because short positions add equity exposure
  2. BProvide purer exposure to the momentum factor with lower market beta, but require leverage, shorting costs and implementation constraintsCorrect
  3. CHave identical factor exposure because both use the same signal
  4. DAvoid all transaction costs because long and short positions offset

Explanation

Shorting the low-signal stocks offsets market exposure, isolating the factor spread. This needs shorting, leverage and financing, which add costs. Long-only portfolios retain large market beta and capture only part of the premium.

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