1

Investment Assignment /AUAF Spring 2016

Title: Fama and French Common Risk Factors-Stocks and
Bonds
By: Rahmatullah Rahmati: ID # 13596
In finance calculations and analyzing the factors that describe the
relationship between risk and return of investment had only one module
which was CAPM before 1992. In 1992 Eugene F. Fama and Kenneth R. French
two professors developed a three model factors which best describes the
relationship of common risk factors of Stocks. They also developed two
factors which will define the bond Market Risk Factors. Three Factors of Stock
are as follows:

1. Market Risk Factor

The first risk factor in the Fama/French Three-Factor Model is the

amount of exposure to the overall stock market or the market risk
factor. Exposure to this factor is determined by the amount of a
portfolio that's invested in or exposed to stocks. The greater this
exposure, the higher the return in comparison to U.S. Treasury bills.

2. Size Risk Factor

The second risk factor in the Fama/French model is the amount of
exposure to small company stocks or the size risk factor. Exposure to
this factor is determined by the amount of a portfolio that is invested in
small company stocks. The greater this exposure, the higher the return
in comparison to large company stocks. 3. Value Risk Factor

3. The third risk factor

In the Fama/French model is the amount of exposure to low priced
stocks, which is measured by a book-to-market (BTM) value ratio. The
book value of a company is just an accounting term for its net worth,
its assets minus its liabilities. The market value of a company is its
price per share times the number of shares outstanding. This risk
factor is known by several different designations. It has been referred
to as the value factor, BTM factor, style factor and price factor.

Bonds have two common risk factors:

4. maturity risk or Term:
The difference between the monthly long-term government bond
return and the one month Treasury bill rate measured at the end of
previous month.

5. credit risk or Default:

The Difference between the return on a market portfolio of long-term
corporate bonds and the long term government bond return.

American University of Afghanistan / By Rahmatullah Rahmati ID# 13596

Investment Assignment /AUAF Spring 2016

American University of Afghanistan / By Rahmatullah Rahmati ID# 13596