THE THREE-FACTOR MODEL DESCRIBED BY KRAMER IS MOST LIKELY A

26. The three-factor model described by Kramer is most likely a:

A. macroeconomic factor model.

B. statistical factor model.

C. fundamental factor model.

The following information relates to questions 27 – 28.

Shania Peters, portfolio manager at a global investment firm focused on consumer staples’ stocks

is conducting a workshop for new analysts at the firm. She explains that the firm uses a three-

factor model for portfolio construction by selecting securities after comparing them to their

respective sector index in their specific regions. Peters shares the following data given in

Exhibits 1 and 2 showing the regional sensitivities to the three-factor used in the model and

portfolios’ characteristics. She asks the participants to calculate the expected return for the

different regions, using 0.6% as the risk-free rate.

Exhibit 1: Factor Model and Portfolio Characteristics

β*

β

β

Information

Tracking

Mean Local

Sector

Index Return

Region

Ratio

Error

North

America 9.0% 0.4 0.3 2.0 1.47 5.0%

Eurozone 7.5% 1.1 1.1 0.6 1.30 7.0%

China 6.5% 0.8 0.9 0.7 2.56 4.5%

Note: The three factors used in the model are: price-to-sales, market capitalization, and dividend

yield.

Exhibit 2: Factor Values

Region P/S MKT Div Yld

North America 0.110 0.045 0.050

Eurozone 0.030 0.060 0.100

China 0.047 0.075 0.099