Question

Inputs to the Fama Decomposition model least likely include:

		Risk-free rate on interest
		The client's preferred beta
		The money manager's market timing skills
		The annualized rate of inflation

Answer 1

According to Fama Decomposition model, the total return of a portfolio is made up of of risk free return and excess return. The excess return comprises of two factors which are risk premium ( which is a reward for taking risk) and stock selection. Return due to risk premium is comprised of return for systematic and unsystematic risk.

(a) Incorrect. Risk free rate on interest is included in the model.

(b) Incorrect. Beta is included in the model. Investor's risk is taken care of by the model apart from manager's risk.

(c) Market timing skills play a role in stock selection. Excess return can be generated if the manager is able to time the market properly.

(d) Correct. The inflation rate plays no role in the model.

Thus, the correct answer is annualized rate of inflation.