THE EXPECTED PORTFOLIO RETURN USING A FOUR-FACTOR MODEL IS E(RP) = RF + Β1RMRF + Β2SMB + Β3HML + Β4WML

5. - CFA 2018 LEVEL 2 PORTFORLIO QUESTION BANK R48 INTRODUCTION TO MULTIFACTOR MODELS Q BANK
CFA 2018 LEVEL 2 PORTFORLIO QUESTION BANK R48 INTRODUCTION TO MULTIFACTOR MODELS Q BANK

5. A is correct. The expected portfolio return using a four-factor model is E(R

P

) = R

F

+

β

1

RMRF + β

2

SMB + β

3

HML + β

4

WML. The risk free rate is the same for all portfolios

therefore it doesn’t affect the relative returns. Portfolio 1's return exclusive of the risk free

rate is (5.1% x 0.8 + 1.4 x 1.1% + -0.8% x 0.4 + 0.5% x 1.3) = 5.95% which is higher than

Portfolio 2's 5.3% (5.1% x 1.0 + 1.4% x 0.2 – 0.8 x 0.6 + 0.5% x 0.8) and Portfolio 3's 5.01%

(5.1% x 0.9 + 1.4% x 0.7 -0.8% x 1.2 + 0.5% x 0.8) (RF rate is the same for all portfolios).