PORTFOLIO MANAGEMENT

PORTFOLIO RISK AND RETURN: PART I

HISTORICAL RISK AND RETURN

a. describe characteristics of the major asset classes that investors consider in

forming portfolios.
➢ Figure 20.1: Risk and Return of Major Asset Classes in the United States

RISK AVERSION

b. explain risk aversion and its implications for portfolio selection.

➢ risk-averse, risk-seeking, risk neutral
c. explain the selection of an optimal portfolio, given an investor's utility (or risk
aversion) and the capital allocation line.
➢ utility functions, indifference curve
➢ Figure 20.2: Risk-Averse Investor's Indifference Curves
➢ risk aversion coefficient
➢ (Formula 1), (Formula 2), (Formula 3)
➢ two-fund separation theorem, capital allocation line
➢ Figure 20.3: Capital Allocation Line and Risky Asset Weights
➢ Figure 20.4: Risk-Averse Investor's Indifference Curves
➢ Figure 20.5: Portfolio Choices Based on Two Investors' Indifference
Curves

PORTFOLIO STANDARD DEVIATION

d. calculate and interpret the mean, variance, and covariance (or correlation) of
asset returns based on historical data.
Variance (Standard Deviation) of Returns for an Individual Security
➢ (Formula 1), (Formula 2)
Covariance and Correlation of Returns for Two Securities
➢ (Formula 1), (Formula 2), (Formula 3)
➢ Correlation
e. calculate and interpret portfolio standard deviation.
➢ (Formula 1), (Formula 2), (Formula 3), (Formula 4)
THE EFFICIENT FRONTIER

f. describe the effect on a portfolio's risk of investing in assets that are less than
perfectly correlated.
➢ (Formula 1)
➢ Figure 20.6: Risk and Return for Different Values of ρ
g. describe and interpret the minimum-variance and efficient frontiers of risky
assets and the global minimum-variance portfolio.
➢ minimum-variance portfolios, minimum-variance frontier
➢ efficient frontier, global minimum-variance portfolio
➢ Figure 20.7: Minimum-Variance and Efficient Frontiers

PORTFOLIO RISK AND RETURN: PART II

SYSTEMATIC RISK AND BETA

a. describe the implications of combining a risk-free asset with a portfolio of risky

assets.
➢ (Formula 1), (Formula 2), (Formula 3)
➢ Figure 21.1: Combining a Risk-Free Asset With a Risky Asset
b. explain the capital allocation line (CAL) and the capital market line (CML).
➢ capital allocation line (CAL)
➢ Figure 21.2: Risky Portfolios and Their Associated Capital Allocation Lines
➢ market portfolio
➢ Figure 21.3: Determining the Optimal Risky Portfolio and Optimal CAL
Assuming Homogeneous Expectations
➢ capital market line (CML)
➢ (Formula 1), (Formula 2), (Formula 3)
➢ market risk premium
➢ Figure 21.4: Borrowing and Lending Portfolios
➢ passive investment strategy, active portfolio management
c. explain systematic and non-systematic risk, including why an investor should not
expect to receive additional return for bearing non-systematic risk.
➢ unsystematic risk, systematic risk
➢ Figure 21.5: Risk vs. Number of Portfolio Assets
Systematic Risk Is Relevant in Portfolios
d. explain return generating models (including the market model) and their uses.
➢ Return generating models, Multifactor models
➢ (Formula 1)
➢ factor sensitivity or factor loading
 ➢ (Formula 1)
➢ single-index model, market model
➢ (Formula 1)
e. calculate and interpret beta.
➢ Beta
➢ (Formula 1), (Formula 2), (Formula 3)
➢ Figure 21.6: Regression of Asset Excess Returns Against Market Asset
Returns
➢ security characteristic line
➢ (Formula 1)

THE CAPM AND THE SML

f. explain the capital asset pricing model (CAPM), including its assumptions, and
the security market line (SML).
➢ calculate and interpret the expected return of an asset using the CAPM.
➢ security market line (SML)
➢ Figure 21.7: Security Market Line
➢ (Formula 1), (Formula 2), (Formula 3)
➢ capital asset pricing model (CAPM)
➢ Figure 21.8: The Capital Asset Pricing Model
➢ (Formula 1), (Formula 2)
➢ assumptions of the CAPM
Comparing the CML and the SML
➢ (Formula 1)
➢ Figure 21.9: Comparing the CML and the SML
g. describe and demonstrate applications of the CAPM and the SML.
h. calculate and interpret the Sharpe ratio, Treynor ratio, M2, and Jensen's alpha.
i. Calculate and interpret the Sharpe ratio, Treynor ratio, M2, and Jensen's alpha.
➢ Performance evaluation, Attribution analysis
➢ Sharpe ratio
➢ (Formula 1)
➢ Figure 21.10: Sharpe Ratios as Slopes
➢ (Formula 1), (Formula 2)
➢ M-squared (M2), M2 alpha
➢ (Formula 1), (Formula 2)
➢ Figure 21.11: M-Squared for a Portfolio
➢ Treynor measure and Jensen's alpha
➢ (Formula 1), (Formula 2)
➢ Figure 21.12: Treynor Measure and Jensen's Alpha
PORTFOLIO MANAGEMENT: AN OVERVIEW
PORTFOLIO MANAGEMENT PROCESS

a. describe the portfolio approach to investing.

➢ portfolio perspective
➢ diversification ratio
b. describe the steps in the portfolio management process.
➢ planning step, investment policy statement (IPS)
➢ execution step
➢ feedback step, rebalance
c. describe types of investors and distinctive characteristics and needs of each.
➢ Individual investors
➢ Institutions, endowment, foundation
➢ Bank
➢ Insurance companies
➢ Investment companies, mutual funds
➢ Sovereign wealth funds
➢ Figure 85.1: Characteristics of Different Types of Investors
d. describe defined contribution and defined benefit pension plans.
➢ defined contribution pension plan, defined benefit pension plan

ASSET MANAGEMENT AND POOLED INVESTMENTS

e. describe aspects of the asset management industry.

➢ buy-side firms, sell-side firms
➢ Full-service asset managers, Specialist asset managers, multi-boutique
firm
➢ Active management, Passive management, smart beta
➢ Robo-advisors
f. describe mutual funds and compare them with other pooled investment
products.
➢ Mutual funds, pooled investments, net asset value (NAV)
➢ open-end fund, redeem, No-load funds, Load funds
➢ Closed-end funds
Types of Mutual Funds
➢ Money market funds
➢ Bond mutual funds
➢ stock mutual funds, Index funds, passively managed, Actively managed
 Other Forms of Pooled Investments
➢ Exchange-traded funds (ETFs)
➢ separately managed account
➢ Hedge funds, Private equity, venture capital

BASICS OF PORTFOLIO PLANNING AND

CONSTRUCTION
PORTFOLIO PLANNING AND CONSTRUCTION

a. describe the reasons for a written investment policy statement (IPS).

➢ investment policy statement
b. describe the major components of an IPS.
c. describe risk and return objectives and how they may be developed for a client.
➢ risk objectives, absolute risk objective
➢ Relative risk objectives
d. explain the difference between the willingness and the ability (capacity) to take
risk in analysing an investor’s financial risk tolerance.
➢ ability to bear risk, willingness to bear risk
e. describe the investment constraints of liquidity, time horizon, tax concerns, legal
and regulatory factors, and unique circumstances and their implications for the
choice of portfolio assets.
➢ Investment constraints, Liquidity
➢ Time horizon
➢ Tax situation
➢ Legal and regulatory
f. explain the specification of asset classes in relation to asset allocation.
➢ strategic asset allocation
➢ Figure 86.1: Strategic Asset Allocation
g. describe the principles of portfolio construction and the role of asset allocation
in relation to the IPS.
➢ tactical asset allocation, Security selection
➢ risk budgeting
➢ core-satellite approach
h. describe how environmental, social, and governance (ESG) considerations may
be integrated into portfolio planning and construction.
➢ Negative screening
➢ Positive screening
➢ Thematic investing
 ➢ Impact investing
➢ Engagement/active ownership
➢ ESG integration

THE BEHAVIORAL BIASES OF INDIVIDUALS

COGNITIVE ERRORS VS. EMOTIONAL BIASES

a. compare and contrast cognitive errors and emotional biases.

➢ Cognitive errors
➢ Emotional biases
b. discuss commonly recognized behavioural biases and their implications for
financial decision making.
Cognitive Errors: Belief Perseverance
➢ cognitive dissonance
➢ Conservatism bias
➢ Confirmation bias
➢ Representativeness bias; Base-rate neglect, Sample-size neglect
➢ Illusion of control bias
➢ Hindsight bias
Cognitive Errors: Information-Processing Biases
➢ Anchoring and adjustment bias
➢ Mental accounting bias
➢ Framing bias
➢ Availability bias

EMOTIONAL BIASES

➢ Loss-aversion bias
➢ Overconfidence bias
➢ Self-control bias
➢ Status quo bias
➢ Endowment bias
➢ Regret-aversion bias
c. describe how behavioural biases of investors can lead to market characteristics
that may not be explained by traditional finance.
➢ halo effect
➢ home bias
INTRODUCTION TO RISK MANAGEMENT
INTRODUCTION TO RISK MANAGEMENT

a. risk management.
➢ risk management
b. describe features of a risk management framework.
➢ risk management framework
c. define risk governance and describe elements of effective risk governance.
➢ Risk governance
d. explain how risk tolerance affects risk management.
➢ risk tolerance
e. describe risk budgeting and its role in risk governance.
➢ risk budgeting
f. identify financial and non-financial sources of risk and describe how they may
interact.
➢ Financial risks; Credit risk, Liquidity risk, Market risk
➢ Non-financial risks; Operational risk (cyber risk), Solvency risk,
Regulatory risk, Governmental or political risk (tax risk), Legal risk, Model
risk, Tail risk, Accounting risk
➢ mortality risk, longevity risk
g. describe methods for measuring and modifying risk exposures and factors to
consider in choosing among the methods.
➢ Standard deviation, Beta, Duration
➢ Derivatives risks; Delta, Gamma, Vega, Rho
➢ Tail risk, downside risk
➢ Value at risk (VaR)
➢ Conditional VaR (CVaR)
Subjective and Market-Based Estimates of Risk
➢ Stress testing, Scenario analysis
Modifying Risk Exposures
➢ Diversification, self-insurance, risk transfer
➢ surety bond, fidelity bonds
➢ Risk shifting
Choosing Among Risk Modification Methods