Portfolio Management brain exercise

CFA Level II
#1

I just reviewed Reading 66 (the first PM reading) and I have a bunch of random questions. I thought I would list them here–if anyone has an answer I’d appreciate it. Hopefully this can help others as well. 1. Market Model (pg. 226): Ri = interecept + B1R(M) + error What does this formula tell you? If it is a single factor model based on the market as the factor, is this not the same thing as the SML? 2. Macroeconomic factor model (pg. 232): Ri = E® + b1F1 + b2F2 + error What is the difference between E® and Ri? The way I see it, E® is your expected return derived from any of the pricing models we’ve covered (CML, SML, APT) and then when you add in the surprises and unsystematic errors, you arrive at Ri, which I interpret as an “expected return asjusted for macro surprises.” Accurate? 3. APT vs. Multifactor models (pg. 239): the book lists differences between the two. But isn’t APT a type of multifactor model? Pg. 237 even says “APT returns are derived from a multifactor model.” What am i missing? 4. Active return (pg. 240): Rp - Rb Is this basically the same thing as ex poste alpha? 5. Active risk squared (pg. 240): active risk squared = acive factor risk + active specific risk Why does summing those two things give you active factor SQUARED? 6. Tracking and factor portfolios (pg. 243) Since active factor risk tracks the deviations in industries and active specific risk tracks deviations in specfic assets, would it be correct to think of active factor risk as tracking the deviations in factor portfolios and active specific risk tracking the deviations in tracking portfolios? I know this is a long post but any help at all is appreciated, and hopefully other can add more questions too

#2

thought i would bump this and give it one more try now that it is not in the middle of the day…

#3

just accept them as they are… I don’t believe people here really want to explain/discuss things like why are they like that.

#4
  1. it gives u the required rate of return on a security and includes non-systematic risk (error term). To be honest I think its very similiar to CAPM just that it adds non-systematic risk 2) expected return is equal to the intercept when all macroeconomic factors are zero (i.e. no suprise macroeconomic event) is Ri = E® when all the factors are zero. RI is when u macroeconomic suprises 3) multi factor basically means a multi variable model (linear econometric with 2 or more independant variables). macroeconomic and apt are all basically multifactor models usually use time series data 4) looks like it to me but not 100% certain 5) dont remember this forumula n dont think its that important 6) sorry my brain is in accting right now and you worded the question poorly
#5

thanks for the help…just to clarify, for #1 youre prob right, since on the next page they take the expected return of that formula and they drop the residual, so it is just liek the capm

#6

wait guys, the market model has one distinct feature that is different from CAPM, which is it uses market return, NOT return premium IT IS a tricky model

#7

good catch, youre right. how does that change its use? i.e. how would you know when to use it in a problem vs subtracting out the rfr and using capm

#8
  1. Active risk squared (pg. 240): active risk squared = acive factor risk + active specific risk Here factor risk and specific risk are expressed as variance => so they are squared too!
#9

good catch, prob not that important as bipolar said. thank tho.