Factor analysis is a statistical estimation technique that uses the covariances between security returns to determine the common factors that generate the returns. It does not use macroeconomic time-series as proxies for the factors or establish the correlation between the changes in factors and undiversifiable risk. Additionally, factor analysis assumes that there is correlation between the factors affecting security prices.

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Factor Analysis

Question 11

Multiple Choice

Factor analysis:

A) uses macroeconomic time-series that capture changes in productivity,interest rates and inflation to act as proxies for the factors generating security returns.
B) is a statistical estimation technique based on the idea that the covariances between security returns provide information that can be used to determine the common factors that generate the returns.
C) establishes the correlation between the changes in one factor and the undiversifiable risk.
D) assumes that there is no correlation between the factors which affect the price of securities.

Correct Answer: