FRM Part II · FRM Exam Part II · Portfolio Risk: Analytical Methods
A portfolio manager uses a single-factor market model. Stock A has a beta of 1.2 and residual volatility of 10%. Market volatility is 15%. What is the total variance of Stock A's returns?
Total variance is beta squared times market variance plus residual variance: 0.0324 plus 0.0100 equals 0.0424. Leaving out the idiosyncratic component gives 0.0324, which understates total risk.
- A0.0325
- B0.0424Correct
- C0.0100
- D0.0324
Explanation
Systematic variance = 1.2^2 x 0.15^2 = 1.44 x 0.0225 = 0.0324. Residual variance = 0.10^2 = 0.0100. Total = 0.0424. Option 0.0324 omits the residual variance.
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