Deck 11: Factor Models

Question 1

______ or idiosyncratic risk is that portion of a security's total risk that is not related to moves in various common factors.

A) Systematic
B) Market
C) Factor
D) Nonfactor

Answer 1

D

Question 2

Diversification leads to an averaging of ___ risk in a one-factor model.

A) nonfactor
B) systematic
C) factor
D) market

Answer 2

C

Question 3

A process in which a security's return is assumed to be related to a market return is

A) the development of the riskfree borrowing rate.
B) the efficient set.
C) the tangency to the efficient set.
D) a return-generating process.

Answer 3

D

Question 4

The one-factor return-generating model assumes the correlation between the random-error term and the factor is

A) 1.
B) 0.
C) -.5.
D) -1.

Question 5

The one-factor model's sensitivity term relates to the market model's

A) Beta.
B) random error expected value.
C) random error variance.
D) forecast of the market return.

Question 6

_____ risk is that part of security's total risk that is related to moves in various common factors.

A) Nonfactor
B) Market
C) Factor
D) Margin

Question 7

The covariance between Security D and Security E is 90. In a one-factor model, the sensitivity for D is 4; the sensitivity for E is 1.5. The variance for the factor is

A) 15%.
B) 3.9%.
C) 540%.
D) 4.9%.

Question 8

In a factor model, the variable "B" measures the

A) sensitivity to the factor.
B) riskfree rate.
C) unique return of the security.
D) random error

Question 9

The GDP

A) is only calculated by the U.S.
B) is a measure of a country's total output of goods and services.
C) is not currently reported by the U.S. government.
D) ignores imports and exports.

Question 10

In the time-series approach to estimating factor models, the model builder begins with the assumption that

A) nonfactor risk can be diversified away.
B) the factors that affect security returns are known.
C) the smalll-stock index consists of stocks that are below the median NYSE size.
D) the growth rate of the gross domestic product.

Question 11

Using a one-factor model to develop the efficient set of portfolios eliminates the need to estimate

A) expected returns for each security.
B) covariances for each pair of securities.
C) the sensitivity of each security.
D) the riskfree return.

Question 12

Two-factor models use __ - regression analysis which refers to the fact that there is more than one variable on the right-hand sign of the equation.

A) binomial
B) multiple
C) univariate
D) linear

Question 13

In a one-factor model, the only correlation between the returns of two securities is assumed to be through

A) their corresponding sensitivities.
B) their unique variances.
C) their random error terms.
D) the factor.

Question 14

Factor models are a return-generating process that attributes the return on a security to the security's sensitivity to the movements of various ____ factors.

A) macroeconomic
B) market
C) risk
D) common

Question 15

________ is a measure of the responsiveness of a security's returns to a particular common factor.

A) Factor loading
B) Regression analysis
C) Factor risk
D) Sector factor

Question 16

The market model can be shown to be a specific example of a ____- factor model.

A) binomial
B) one
C) indexed
D) market

Question 17

A ____________ process is a statistical model that describes how the return on a security is produced.

A) factor-indexing
B) price-generating
C) return-generating
D) return-to-mean

Question 18

The assumption that the returns on all securities respond to a single ___ greatly simplifies the task of identifying the tangency portfolio.

A) common macroeconomic variable
B) common return
C) factor loading
D) common factor

Question 19

Sector-factor model is a special kind of a _________ - factor model in which some of the factors are particular industries or economic sectors.

A) multiple
B) single
C) market
D) linear

Question 20

In the cross-sectional approach to estimating factor models, the sensitivities of returns to the factors are sometimes referred to as ____.

A) attributes
B) elasticities
C) indexed-weighted
D) market-weighted

Question 21

A cross-sectional forecasting model

A) uses intuition and does not consider statistical significance.
B) uses estimated factor values to develop sensitivities.
C) uses given sensitivities to estimate factor values.
D) is confined to one time period.

Question 22

To develop the set of efficient portfolios, the one-factor model does not require the estimation of direct covariances between each security. Instead, it requires the estimate of the

A) variance for each security.
B) value of the factor.
C) riskfree return.
D) expected return for each security.

Question 23

To calculate the zero-factor from a multiple-factor model developed portfolio, the resulting zero-factor

A) will be 0.
B) is a weighted average based on the factor covariances.
C) is a weighted average based on the security proportions.
D) is not included.

Question 24

In an efficient portfolio, increased diversification results in an averaging of

A) total risk
B) factor risk
C) non-factor risk
D) attribution

Question 25

Multiple-factor models assume that several factors are necessary to model the return-generating process because

A) the economy is not a simple, monolithic entity
B) the process is random and requires more explanatory variables
C) more factors increase the diversification effects on the expected returns
D) the size of the standard error is reduced

Question 26

For a one factor model, the slope for Security X is 4, and the slope for Security Y is 5. The factor has a standard deviation of 3%. The covariance between Securities X and Y is

A) 90.
B) 180.
C) 120.
D) 60.

Question 27

A multiple-factor model requires the development of multiple

A) sensitivities.
B) zero factors for each security.
C) variances for each security.
D) expected returns for each security.

Question 28

Time series multiple-factor models

A) use variables with contemporaneous changes.
B) use factors that measure changes in expectations.
C) predict sensitivities.
D) are the least intuitive of the model choices.

Question 29

For a one-factor model, an analyst finds the variance of the factor is 4, the slope for the security is 2, and the variance of the random error is 12. The variance for the security is

A) 28.
B) 24.
C) 16.
D) 12.

Question 30

A choice that is not a major criterion in the selection of a factor is

A) it should have theoretical justification.
B) it should be measurable.
C) data are current and reliable.
D) if it is statistically significant, use it.

Question 31

For a 10-factor model, the analyst must develop 10

A) zero-factors.
B) random-error variances.
C) covariances.
D) sensitivities.

Question 32

In a factor model any portion of a security's return unexplained by the model is assumed to be _______ with unique elements of returns on other securities.

A) directly correlated
B) indirectly correlated
C) uncorrelated
D) somewhat correlated

Question 33

One of the basic assumptions of the time-series approach to estimating factor models is

A) the investor knows in advance the impact of inflation on historical returns
B) the investor knows in advance the relevant factors that influence security returns
C) the model builder begins with estimates of a security's sensitivities to certain factors
D) that the model builder knows nothing about factor values nor sensitivities

Question 34

In the factor-analytic approach to estimating factor models, factor analysis will identify factors but unfortunately they will be

A) based on the model builder's intuition rather than scientific testing of historical returns and sensitivities
B) based on the structure of the return data which is statistically unstable
C) unspecified beforehand as to what economic variables the factors represent
D) tempered with the judgment of the model builder to account for the static nature of the investment environment

Question 35

Factor analysis models

A) use given sensitivities to find the pertinent factors.
B) identify the economic variables of significant factors.
C) develop both the sensitivities and the significant factors.
D) use forecasted, future values to develop the model.

Question 36

Random diversification will tend to decrease

A) systematic risk.
B) the beta of the portfolio.
C) nonfactor risk.
D) individual security variance.

Question 37

Assume a one factor model for a security's return is 10% - 1.5 (CPI). For the year, the CPI's growth rate was 5%, and security's actual return was 8%. The security's unique return was

A) 2.5%.
B) -2.5%.
C) 8%.
D) 5.5%.

Question 38

A two factor model for the return for Security X is 2% - 3(CPI) + 2(GDP). If you forecast CPI to be 2% and GDP to be 6%, the expected return for Security X is

A) 20%.
B) 12%.
C) 2%.
D) 8%.

Question 39

One limitation on factor models is the problem that a good factor model in one period

A) may not be a good factor model in equilibrium
B) may be a good factor model when factors are numerous
C) may be not be appropriate for stock return series where price series do not follow a random walk
D) may not be a good in another period when conditions such as oil prices change due to economic innovations

Question 40

In the world of factor models the market model is an example where the factor is the

A) unemployment rate
B) growth of the money supply
C) factor utilization rate
D) market index

Question 41

The two-factor model for Security A is -4% + 6%(IP) + 2%(M) and for Security B is 1.5% + 3%(IP) + 2.5%(M). An analyst forecasts IP at 1.5% and M at 3% with respective variances at 3% and 2%. The Covariance of Securities A and B is 80.8. Covariance (IP, M) is

A) .1.
B) 1.4.
C) .8.
D) .6.

Question 42

The savings and loan industry would probably have a high sensitivity to a factor such as

A) national unemployment rates
B) real interest rates
C) exchange rates
D) utilization levels of fixed assets

Question 43

To find the variance between two securities using a two-factor model, an analyst does not need

A) the sensitivity of each security to each factor.
B) the year factor value.
C) the variance of Factor 1
D) the covariance (F1, F2).

Question 44

If a two-factor model used the growth rate of the gross domestic product and the level of oil prices as factors, what would the intercept term of the model represent?

A) the rate of growth of returns if the GDP and oil prices increased
B) the rate of growth of returns if the GDP and oil prices decreased
C) the expected return if the GDP and oil prices are zero
D) the rate of growth of expected growth if the GDP and oil prices remained constant

Question 45

For a one-factor model, an analyst finds the variance of the factor is 6 and the variance of the random error is 10. If the total variance for the security is 106, its sensitivity to the factor is

A) 2.
B) 5.
C) 6.
D) 4.

Question 46

The variance of a security's return will be reduced if in a two-factor model

A) there is a negative sensitivity to an increasing factor.
B) the forecasted change in a factor is large.
C) the covariance between the two factors is large and positive.
D) there is a large random error variance.

Question 47

Which one of the following approaches to estimating factor models would employ factors such as unemployment rates, money supply changes, and inflation rates?

A) factor-analysis
B) cross-sectional
C) CAPM
D) time-series

Question 48

Factor model relationships are built on the following critical assumptions EXCEPT

A) the random error term and factor are serially correlated in time-series approaches
B) the outcome of the factor has not bearing on the outcome of the random error term
C) the random error terms of any two securities are uncorrelated
D) the outcome of the random error term of one security has no bearing on the outcome of the random error term of the other

Question 49

Which of the following statements is NOT true about one-factor models and diversification?

A) it leads to an averaging of factor risk
B) for a well-diversified portfolio, factor risk will be insignificant
C) it can substantially reduce nonfactor risk
D) for a well-diversified portfolio, nonfactor risk will be insignificant

Question 50

You have a two-factor model to forecast the return for Security A: 4% + l.5(GDP) - 2(CPI). You forecast GDP at 4% and CPI at 3% with variances of 6% and 5% respectively. The covariance (GDP, CPI) is .8 and the variance of the random error is 9%. The variance for Security A would be

A) 47.3.
B) 37.7.
C) 52.4.
D) 38.3.

Question 51

The two-factor model for Security X is 3% + l.5(GDP) - 2(CPI) and for Security Y is 4% + 2(GDP) - .8(CPI). An analyst forecasts GDP at 4% and CPI at 5% with respective variances of 8% and 3%. Covariance (GDP, CPI) is .6. The covariance between Securities X and Y is

A) 25.7.
B) 28.8.
C)g.6.
D) 33.6.

Question 52

An analyst has a two-factor model to forecast the return for Security B: -2% + 4%(GDP) + 2.5%(IP). You forecast GDP at 3% and IP at 2% with variances of 4% and 6% respectively. The covariance (GDP, IP) is .4, and the variance of Security B is 125. The variance of the random error term is

A) 9.8%.
B) 22.4%.
C) 17.1%.
D) 15.5%.

Question 53

Factor models are a return-generating process that attributes the return on a security to the security's sensitivity to the movements of various ____ factors.
A) factory utilization and inflation rate

A) financial market
B) systematic and unsystematic risk
C) global