Q35: APT forecast returns (T1.Grinold-Chapter-7)

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Hello,

Regarding Q35 on APT forcast returns (T1.Grinold-Chapter-7): I do not understand where the APT weights / sensitivities come from. Were these identified in the Grinold source text (which I do not have)?

If I understand correctly, the sensitivity factors are subjective (assigned by fund manager), so I am not sure how I would otherwise have come up with the values listed in the answer.

Thanks!

 

[David Harper CFA FRM]

Hi Roberto,

They are given (assumed) as illustrative in the Grinold; in fact, both the factor forecasts (e.g., growth firms will outperform such that a firm with 1.0 sensitivity to the growth factor will return +2%; i.e., analogous to the equity risk premium in CAPM) and the factor loadings/betas/sensitivities (which vary by firm) are given.

Much of the Grinold book generally is devoted to the art/science of developing the factor forecasts (what he calls "the hard part"). Chapter 7 gives extremely brief itemization of methods to develop; e.g., specify betas then regress to find factor forecasts; specify factor forecasts then regress to find betas; PCA; MLE ...
... but the exam will never ask you to derive, at most like the question, will ask you to use given number to compute the predicted excess return

hope that helps,
David