- CFA Exams
- CFA Level I Exam
- Study Session 16. Portfolio Management (1)
- Reading 44. Using Multifactor Models
- Subject 3. Multifactor models: selected applications

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**CFA Practice Question**

Portfolio A has a factor sensitivity to inflation of 1.0. Portfolio B has a factor sensitivity to inflation of 2.5. What is the most appropriate allocation to portfolio A and B to fully hedge the inflation risk?

B. Short 0.67 of portfolio B for every $1.67 invested in portfolio A.

C. Short 0.71 of portfolio B for every $1.71 invested in portfolio A.

A. Short 0.40 of portfolio B for every $1.4 invested in portfolio A.

B. Short 0.67 of portfolio B for every $1.67 invested in portfolio A.

C. Short 0.71 of portfolio B for every $1.71 invested in portfolio A.

Correct Answer: B

To fully hedge inflation risk, set the combined weighting in portfolio A and B equal to zero and solve for the portfolio weights, ω

_{A}and ω_{B}= 1 - ω_{A}0 = 1.0 x ω

_{A}+ 2.5 (1 - ω_{A})ω

_{A}= 1.67 and ω_{B}= 1 - ω_{A}= -0.67Thus, the allocation should consist of a short position of $0.67 of portfolio B for every $1.67 invested in portfolio A.

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