FRM Part II · FRM Exam Part II · Factors
A portfolio manager decomposes a equity fund's return into exposures to market, size, value and momentum factors plus a residual. Which statement best describes the residual term in this factor model?
The residual is the part of a portfolio's return not explained by the chosen factors. It reflects security-specific return and possibly manager skill (alpha), because systematic compensation has already been attributed to the factor exposures in the model.
- AThe portion of return not explained by the chosen factors, which may reflect security-specific return or manager skillCorrect
- BThe portion of return explained entirely by the market factor
- CThe compensation for bearing systematic risk across all factors
- DThe transaction cost drag on the portfolio
Explanation
In a factor regression, the intercept and error capture return unexplained by the included factors. The intercept is interpreted as alpha relative to those factors, and the error as idiosyncratic return. Market exposure is already captured by the market factor, so it is not the residual.
Did you get it right without looking?
One question tells you little. A timed set on Factors shows your real accuracy, how long you take and where you lose marks.
More Factors questions
- A portfolio manager compares two approaches to explaining equity returns: the Fama-French model using portfolio-based factors such as SMB an…
- The risk-free rate is 3%, the expected market return is 9%, and a stock has a beta of 1.4. Using the CAPM, what is the stock's expected retu…
- Which statement best distinguishes macroeconomic factor models from fundamental (characteristic-based) factor models such as Fama-French?
- A fund's regression on the Fama-French three factors yields a statistically significant positive alpha. The same fund is then regressed on t…
- An analyst notes that, under the CAPM, the expected return on any asset depends on only one source of systematic risk. Which statement best …
- A fund manager compares two ways of building a multi-factor equity portfolio: (A) mixing separate single-factor portfolios (portfolio mix), …