Index and Multifactor Models Flashcards
(17 cards)
What does alpha (α) represent in the Single-Index Model?
The asset’s return when the market excess return is zero.
What does the Information Ratio measure?
It compares the alpha of a portfolio to its residual risk.
How does the tracking portfolio strategy work?
It neutralizes market exposure, keeping alpha but removing beta (market risk).
What creates arbitrage in APT?
A mismatch between actual returns and factor-based expected returns.
How does APT differ from CAPM?
APT allows multiple factors and does not require a market portfolio.
What does beta (β) represent in the Index Model?
It measures an asset’s sensitivity to market movements (systematic risk).
What is the main limitation of the Single-Index Model?
It assumes all correlation between stocks is due to the market index, ignoring industry-specific factors.
Why is APT considered more flexible than CAPM?
It allows for multiple sources of risk and doesn’t rely on the market portfolio.
How does the APT define an arbitrage opportunity?
A zero-cost portfolio with a guaranteed positive return and no risk.
What does a positive alpha indicate in APT or the Index Model?
The asset is underpriced and expected to outperform based on its risk exposure.`
How does the Fama-French model improve upon CAPM?
It adds two additional factors — size (SMB) and value (HML) — to better explain asset returns beyond just market beta. This improves the model’s explanatory power by capturing returns related to small-cap stocks and value stocks.
What is a key advantage of the index model over the Markowitz procedure?
It requires far fewer input estimates, reducing the complexity and potential for estimation errors
What is the trade-off when choosing an actively managed portfolio over pure indexing?
The chance of superior performance must be weighed against the certainty of higher management fees.
How does the Fama-French HML factor help identify investment style?
It shows the manager’s exposure to value vs growth stocks. A positive HML coefficient means a value tilt, and a negative coefficient means a growth tilt.
What does the SMB (Small Minus Big) factor in Fama-French indicate?
It captures size exposure. A positive SMB coefficient suggests a preference for small-cap stocks; a negative one implies a large-cap focus.
How can market cap help identify an investor’s size focus?`
Lower market cap suggests a small-cap focus, while higher market cap suggests preference for large-cap stocks.
What does the market factor coefficient in regression analysis tell us?
It indicates whether the fund is tilted toward cyclical or defensive sectors based on market sensitivity (beta).
