Skip to content

FRM Part II · FRM Exam Part II · Factors

A risk manager reports that 85% of a multi-asset portfolio's variance is attributable to the equity risk factor even though equities are only 50% of capital. Which action is most consistent with a risk-factor-based diversification approach?

The manager should rebalance so risk contributions are more evenly spread across factors, even if capital weights become uneven. Capital weights can hide concentration, as equities here are half of capital but most of variance, so equalizing capital would not address the factor concentration.

  1. AReallocate capital so that risk contributions across factors are more balanced, even if capital weights become more unequalCorrect
  2. BEqualize capital weights across all asset classes
  3. CIncrease equity weights because they have the highest expected return
  4. DEliminate all positions with positive factor exposure

Explanation

Capital allocation can differ greatly from risk allocation because assets have different volatilities and correlations. Risk-factor diversification targets balanced risk contributions, which may require less capital in equities and more in lower-volatility factors. Equal capital weights would not fix the concentration.

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.

Practise FactorsFree diagnostic mock

More Factors questions