what is factor portfolio ?

CFA Level II Portfolio Management
#1

Can some1 explain me firstly what exactly we mean by factor portfolio when say we it has sensitivity of 1 to one risk factor and 0 to remaining?

Also in this problem [content removed by moderator] (unable to attach it here directly and hence uploaded on this link) it asks which strategy would be most appropriate if A and B given.

So in A after identifying factor portfolio it says manager would go Long here, what do we mean by going long here and how do we identify that whether to go long or short

Same for B how do we do that?

Kindly assist

#2

My guess:

Its like the beta risk with the CAPM model, probably extracted from a regression between the risk factor and the returns in the asset.

So, for a sensitivity of 1, if we only increase 1% the risk factor, the return un the asset will increase 1% as well.

If you are expecting one particular risk factor to increase, you’ll want to be exposed to that factor so to capture the returns associated.

#3

A factor portfolio is long stocks with the desired characteristic and short stocks with the undesired characteristic. For the Scorpius portfolio in your example, it is long small cap stocks and short large cap stocks. It provides the most pure exposure to the size factor (as opposed to a long-only portfolio). Any particular view can be implemented by going long or short (depending on the direction) the factor portfolio. In practice however, short selling/leverage constraints usually apply.

#4

There.

That’s better.