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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

An equity market neutral fund holds long positions of USD 100 million and short positions of USD 100 million. The long book has a beta of 1.2 and the short book has a beta of 0.8. If the market rises 10% and the stock-specific returns net to zero, what is the approximate return from market exposure?

The fund has a net beta exposure of USD 40 million, from 120 million long beta-adjusted minus 80 million short beta-adjusted. A 10% market rise produces a USD 4 million gain. Dollar neutrality does not ensure beta neutrality when the books have different betas.

  1. AUSD 4 million gainCorrect
  2. BUSD 4 million loss
  3. CUSD 20 million gain
  4. DNo gain or loss because the fund is dollar neutral

Explanation

Beta-weighted net exposure is 100 x 1.2 - 100 x 0.8 = USD 40 million. A 10% market rise gives USD 4 million gain. Dollar neutrality does not imply beta neutrality, which is why the last option is wrong.

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