FRM Part II · FRM Exam Part II · Factor Theory
An asset owner replaces a market-capitalization-weighted equity benchmark with a smart beta index that tilts toward stocks with low price-to-book ratios. Which statement best describes the main rationale for this tilt under factor theory?
The tilt aims to earn the value factor risk premium, a systematic return source beyond market beta. It does not remove market exposure, guarantee outperformance in every regime, or eliminate turnover, since factor premiums vary over time and portfolios need rebalancing.
- AIt seeks to harvest a systematic risk premium associated with the value factor that is not captured by market beta aloneCorrect
- BIt eliminates all exposure to the market factor so that returns depend only on security selection skill
- CIt guarantees higher returns than the cap-weighted index in every market regime
- DIt reduces turnover to zero because factor exposures never change
Explanation
Value tilts aim to capture a compensated factor premium beyond market beta. The premium is not guaranteed and can underperform for long periods. A value tilt does not remove market exposure and requires rebalancing.
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