13. Assuming the inflation surprise is 1.5% and the GDP surprise is 0%, the expected return for
the technology sector (using equally weighted securities) would be closest to:
A. 15.2%.
B. 16.7%.
C. 20.0%.
The following information relates to questions 14 – 16.
Ann Wiley, is a portfolio manager at Brooks Capital, a firm providing investment consulting and
portfolio management services to institutional clients. Wiley is meeting with a new assistant,
Paula Slater. Wiley begins the meeting with the following comment:
Comment 1: “We evaluate securities using multifactor models to determine the expected return
and risk of securities. Depending on our requirement, we choose one from the three types of
multifactor models: a macroeconomic factor model, a fundamental factor model, or a statistical
factor model. For macroeconomic factor models, the factors are the surprises in the selected
macroeconomic variables. For fundamental factor models, the factors are cross-sectional
differences in companies’ returns. In statistical factor models, we apply statistical techniques,
such as factor analysis or principal component analysis, to historical securities’ returns to identify
factors that best explain historical variances and covariances.”
Slater states: “What is the return generating process given by the arbitrage pricing theory (APT)
equation which is also a form of a multifactor model?”
Wiley responds, “APT specifies the appropriate number of factors to use in a multifactor model,
helps identify those factors, and gives the expected return of the asset being evaluated.”
Wiley continues:
Comment 2: “Multifactor models are also used to explain the active risk of a portfolio. In
analyzing risk, using active risk squared can be decomposed into two components: active factor
risk and active specific risk. Active factor risk is due to portfolio’s different-from-benchmark
exposures relative to factors specified in the risk model. Active specific risk measures the
residual risk of the portfolio.”
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