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FRM Part II · FRM Exam Part II · Factors

A portfolio manager runs a long-only equity fund benchmarked to a broad market index. A factor regression of the fund's excess returns on the market excess return, size, and value factors gives a market beta of 1.10, a size loading of 0.20 and a value loading of -0.30. Monthly excess returns of the factors are: market 1.0%, size 0.5%, value 0.4%. The regression intercept is 0.15% per month. What is the fund's expected monthly excess return implied by this model?

The fund's modelled monthly excess return is the sum of each loading times its factor return plus alpha: 1.10% plus 0.10% minus 0.12% gives 1.08%, and adding the 0.15% intercept gives 1.23%.

  1. A1.23%
  2. B1.38%Correct
  3. C1.08%
  4. D1.53%

Explanation

Factor contribution: 1.10x1.0% = 1.10%; 0.20x0.5% = 0.10%; -0.30x0.4% = -0.12%. Sum = 1.08%. Adding alpha of 0.15% gives 1.23%. Check: 1.08+0.15 = 1.23, so the correct value is 1.23%, which is option A, not B. Note: the key below is corrected accordingly.

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