FRM Part II · FRM Exam Part II · Factors
A quantitative fund builds a momentum strategy that is long the top decile and short the bottom decile of stocks based on prior 12-month returns, skipping the most recent month. A risk manager notes that the strategy has historically experienced severe drawdowns shortly after sharp market rebounds following prolonged declines. Which explanation best describes this risk?
Momentum crashes occur because, after a market decline, the loser stocks held short are high-beta, so the portfolio carries negative market beta. When markets rebound sharply, the losers rally strongly and the long-short strategy suffers large losses. Its beta is time-varying rather than neutral.
- AMomentum portfolios tend to be short high-beta losers during a downturn, so a sharp rebound causes large losses (momentum crashes)Correct
- BMomentum portfolios hold large-cap stocks, which underperform in rebounds
- CMomentum returns are driven by dividend yield, which falls in rebounds
- DMomentum portfolios are market neutral by construction, so rebounds have no effect
Explanation
After a prolonged decline, past losers are typically high-beta, beaten-down stocks, so the short leg has high market beta and the portfolio has negative beta exposure. A sharp rebound causes these losers to surge, producing momentum crashes. Market neutrality by construction is not guaranteed; beta is time-varying.
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 ranks stocks by book-to-market ratio and buys the top tercile while shorting the bottom tercile, holding the position fo…
- A fund's returns are modeled with a Fama-French three-factor model. Market factor variance is 0.0400 (annual), SMB variance is 0.0100, HML v…
- Using a three-factor model, a fund's monthly excess return is modeled as: alpha + 1.10×MKT + 0.40×SMB − 0.25×HML. Over a month the factor re…
- A fund manager markets a minimum-variance smart beta strategy. Compared with its cap-weighted parent index, which feature should a risk mana…
- Which empirical finding is most commonly cited as a challenge to the CAPM's prediction that beta alone explains cross-sectional expected ret…
- A fund's active return volatility is 4% from a single factor tilt. It adds a second tilt with identical 4% active volatility, equal 50/50 al…