BASED ON ITS FACTOR SENSITIVITY, PORTFOLIO B CAN BE BEST CHARACTERIZED AS

4. Based on its factor sensitivity, portfolio B can be best characterized as:

A. an arbitrage portfolio.

B. a market-neutral portfolio.

C. a pure factor portfolio.

The following information relates to questions 5 - 8.

Delta partners is an investment management firm which manages portfolios for high net-worth

individuals. The firm uses multifactor models to explain asset returns. In a meeting with the

investment committee, Simon William, a senior portfolio manager at the firm, explains that he

uses a four-factor model with factors for the market (denoted as RMRF), market capitalization

(small minus big, or SMB), book value effect (high minus low, or HML), and momentum

(winners minus losers, or WML). He has estimated the risk premiums for these factors and

estimated factor sensitivities for three portfolios, as shown in Exhibit 2.

Exhibit 2: Factor risk premiums and portfolio sensitivities

Portfolio 3

Portfolio 2

Portfolio 1

Factor Factor risk

sensitivities

premium

RMRF 5.1% 0.8 1.0 0.9

SMB 1.4% 1.1 0.2 0.7

HML -0.8% 0.4 0.6 1.2

WML 0.5% 1.3 0.8 0.8

Simon further elaborates that he also uses different types of multifactor models. While presenting

a comparison of multifactor models to the investment committee, he states,