honeycfa

In a multi-factor macroeconomic model the mean-zero error term represents:

A) the portion of the individual asset's return that is not explained by the systematic factors.

B) sampling error in estimating factor sensitivities.

C) the no-arbitrage condition imposed in multi-factor models.

---

The mean-zero error term represents the unsystematic, firm-specific, diversifiable risks that are not explained by the systematic factors.

honeycfa

The factor models for the returns on Omni, Inc., (OM) and Garbo Manufacturing (GAR) are:

R_OM = 20.0% –1.0(F_CONF) + 1.4(F_TIME) + ε_OM
R_GAR = 15.0% –0.5(F_CONF) + 0.8 (F_TIME) + ε_GAR

What is the expected return on a portfolio invested 60% in Omni and 40% in Garbo?

A) 20.96%.

B) 19.96%.

C) 18.0%.

---

The factor model for the portfolio is:

R_P = [(0.6)(20.0%) + (0.4)(15.0%)]
+ [(0.6)(?1.0) + (0.4)(?0.5)] (F_CONF)
+ [(0.6)(1.4) + (0.4)(0.8)] (F_TIME)
+ [(0.6) ε_OM + (0.4)ε_GAR]

= 18.0% ?0.80(F_CONF) + 1.16(F_TIME) + (0.6)ε_OM + (0.4)ε_GAR