Answer: Factor 1

## Explanation The question asks for the factor with the smallest downside risk as measured by the **weighted average of all losses that exceed a threshold**. This definition corresponds to **Conditional Value at Risk (CVaR)**, also known as Expected Shortfall. **Key Points:** - **CVaR (95%)** represents the average loss in the worst 5% of cases - Lower CVaR indicates smaller downside risk - From the table: - Factor 1: CVaR = 12.1% - Factor 2: CVaR = 15.7% - Factor 3: CVaR = 16.8% **Analysis:** - Factor 1 has the lowest CVaR (12.1%), indicating the smallest downside risk - This makes sense because CVaR measures exactly what the question describes: the weighted average of losses beyond the VaR threshold **Why not VaR or Maximum Drawdown?** - VaR only shows the threshold loss, not the average beyond it - Maximum drawdown shows the largest peak-to-trough decline, not the average of extreme losses **Conclusion:** Factor 1 has the smallest downside risk as measured by Conditional VaR.

Author: LeetQuiz Editorial Team