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FRM Part I · FRM Exam Part I · The Arbitrage Pricing Theory and Multifactor Models of Risk and Return

An analyst regresses a fund's excess returns on the market excess return and a size factor return (SMB). The estimated coefficients are 0.95 on the market and -0.30 on SMB. Which interpretation is most appropriate?

The fund tilts toward large-cap stocks with market sensitivity slightly below one. A negative loading on the small-minus-big factor means the fund's returns move opposite to the small-cap premium, and a market beta of 0.95 is close to, but under, one.

  1. AThe fund has a tilt toward large-cap stocks, with market sensitivity slightly below oneCorrect
  2. BThe fund has a tilt toward small-cap stocks, with market sensitivity slightly below one
  3. CThe fund has no exposure to size because the coefficient is negative
  4. DThe fund is market neutral because the market beta is below one

Explanation

A negative loading on SMB (small minus big) means the fund tends to behave like large caps, since it moves opposite to the small-minus-big spread. The market beta of 0.95 shows near-market sensitivity, not neutrality.

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