8. With regards to Simon's explanation of the statistical factor model, he is most likely:
A. correct.
B. incorrect, because statistical factor models don’t use standardized betas.
C. incorrect, because the definition of standardized beta is incorrect.
The following information relates to questions 9 - 12.
Greg Thompson and Marry Johnson are portfolio managers at Cimka Investments. They are
having a discussion on evaluating a portfolio's risk adjusted performance and analyzing its risk
exposures.
Greg states, "A portfolio's performance can be measured using the information ratio. During the
year my portfolio achieved an active return of 2% and had a variance of active returns equal to
36%, I believe the information ratio of 5.6 is quite impressive".
He further adds, "Active return is the sum of each factor's return multiplied by the difference in
the portfolio's sensitivity to that factor and the benchmark's sensitivity. Active risk can be
decomposed into total factor risk and active specific risk."
Mary then presents a decomposition of the active risk of three portfolios under management
given in Exhibit 3.
Exhibit 3: Decomposition of active risk
Portfolio 1 Portfolio 2 Portfolio 3
RMRF risk 10% 25% 10%
SMB risk 20% 15% 10%
HML risk 10% 20% 15%
WML risk 15% 15% 5%
Active specific risk 45% 25% 60%
Note: All figures are a percentage of total active risk squared.
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