FRM Part II · FRM Exam Part II · Portfolio Construction
An investor builds a long-only portfolio with a benchmark beta of 1.00 to the market. Using a factor model, the portfolio has exposures of 0.40 to value and 0.20 to momentum, relative to the benchmark. Factor premia are 3% for value and 4% for momentum, with the two factors assumed uncorrelated. Assuming the model holds, what is the expected active return over the benchmark?
The expected active return is 2.0%. It equals the sum of each factor exposure times its premium: 0.40 times 3% gives 1.2%, and 0.20 times 4% gives 0.8%. Added together they equal 2.0% above the benchmark.
- A2.0%Correct
- B1.2%
- C0.8%
- D7.0%
Explanation
Expected active return = 0.40 x 3% + 0.20 x 4% = 1.2% + 0.8% = 2.0%. Option B counts only value, option C only momentum, and option D adds the premia without weighting by exposures.
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