FRM Part II · FRM Exam Part II · Factors
An analyst builds a long-only value tilt by weighting stocks in proportion to their book-to-market ratios instead of market capitalization. Compared with the cap-weighted benchmark, which outcome is most likely?
The portfolio will have positive value exposure and a non-zero tracking error against the cap-weighted benchmark. Weighting by book-to-market overweights cheap stocks, and different weights mean returns diverge from the benchmark even if the same securities are held.
- ALower exposure to the value factor and higher exposure to the size factor
- BPositive value exposure and a tracking error versus the benchmarkCorrect
- CExactly zero tracking error because holdings are the same stocks
- DNegative market beta because high book-to-market stocks are defensive
Explanation
Weighting by book-to-market overweights cheap stocks, producing positive value exposure. Because weights differ from the benchmark, tracking error is non-zero. Holding the same names does not imply the same weights, so zero tracking error is wrong.
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