CFA (Chartered Financial Analyst) Portfolio Management and Wealth Planning Syllabus

Portfolio Management and Wealth Planning syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Portfolio Management and Wealth Planning in CFA (Chartered Financial Analyst), not a summary of it.

1. 1

   Portfolio Theory and Construction

   4 topics

   • Portfolio management process and the IPS
   • Risk and return foundations
     • Mean-variance analysis and the efficient frontier
     • Capital allocation and the CAL/CML
   • Asset pricing models
     • CAPM and the security market line
     • Multifactor models and arbitrage pricing
   • Basics of portfolio planning and construction
2. 2

   Asset Allocation and Risk Management

   4 topics

   • Asset allocation approaches
     • Strategic vs tactical allocation
     • Liability-relative and goals-based allocation
   • Capital market expectations
   • Risk management frameworks and measures
   • Trading, performance evaluation, and attribution
3. 3

   Private Wealth and Institutional Management

   4 topics

   • Private wealth management
     • Individual investor profiling and behavioral biases
     • Taxes, estate planning, and goals-based investing
   • Managing institutional portfolios (pensions, endowments, insurers)
   • Trading and execution strategies
   • Investment manager selection and overlay management

Portfolio Management and Wealth Planning flashcards for CFA (Chartered Financial Analyst)

23 of 53 cards from the Portfolio Management and Wealth Planning deck — real questions with worked answers.

1. What are the three main steps of the portfolio management process?

   (1) Planning — analyze the investor's objectives/constraints and create the Investment Policy Statement (IPS); (2) Execution — asset allocation, security analysis, and portfolio construction; (3) Feedback — monitoring, rebalancing, and performance measurement/evaluation.

2. What is an Investment Policy Statement (IPS) and what two broad categories does it specify?

   A written document governing the client-manager relationship that specifies (1) Objectives — return requirements and risk tolerance, and (2) Constraints — Liquidity, Time horizon, Taxes, Legal/regulatory, and Unique circumstances (mnemonic: RR/RT + L-T-T-L-U).

3. Distinguish between an investor's ability and willingness to take risk, and how to resolve a conflict between them.

   Ability depends on objective factors (wealth, time horizon, liquidity needs, importance of the goal); willingness is a subjective/psychological attitude. When they conflict, the prudent approach is to conform to the lower of the two (or counsel/educate the client), so risk tolerance is set by the more conservative measure.

4. How is the holding period return (total return) for a single period calculated?

   $$R = \frac{P_{1} - P_{0} + D_{1}}{P_{0}}$$ where $P_{0}$ is the beginning price, $P_{1}$ the ending price, and $D_{1}$ the cash flow/dividend received.

5. What is the formula for the expected return of a two-asset portfolio?

   $$E(R_{p}) = w_{1}E(R_{1}) + w_{2}E(R_{2})$$ where $w_{1}+w_{2}=1$ are the portfolio weights.

6. What is the variance of a two-asset portfolio?

   $$\sigma_{p}^{2} = w_{1}^{2}\sigma_{1}^{2} + w_{2}^{2}\sigma_{2}^{2} + 2w_{1}w_{2}\rho_{12}\sigma_{1}\sigma_{2}$$ where $\rho_{12}$ is the correlation between the two assets' returns.

7. How does the correlation coefficient between two assets affect diversification benefits?

   The lower (more negative) the correlation $\rho$, the greater the diversification benefit and the lower the portfolio risk. Benefits exist whenever $\rho < 1$; at $\rho = -1$ a risk-free portfolio can be constructed; at $\rho = +1$ there is no diversification benefit.

8. What is the covariance between two assets in terms of correlation, and its definition?

   $$\mathrm{Cov}(R_{i},R_{j}) = \rho_{ij}\,\sigma_{i}\,\sigma_{j} = E\big[(R_{i}-E(R_{i}))(R_{j}-E(R_{j}))\big]$$ Correlation is the standardized covariance: $\rho_{ij}=\frac{\mathrm{Cov}(R_{i},R_{j})}{\sigma_{i}\sigma_{j}}$.

9. Define the efficient frontier in mean-variance analysis.

   The set of portfolios that offer the maximum expected return for each level of risk (or the minimum risk for each level of expected return). It is the upper portion of the minimum-variance frontier, lying above the global minimum-variance portfolio.

10. What is the global minimum-variance portfolio (GMVP)?

    The single portfolio of risky assets on the minimum-variance frontier that has the lowest possible standard deviation (variance). It marks the left-most point and the boundary between the efficient (upper) and inefficient (lower) parts of the frontier.

11. Why is the efficient frontier concave (bowed toward the vertical axis)?

    Because correlations among assets are generally less than $+1$, combining assets produces diversification: portfolio risk rises less than proportionally with expected return, curving the frontier and creating the risk-reduction 'bulge' to the left.

12. What does an investor's indifference curve represent, and how is the optimal portfolio chosen on the efficient frontier?

    An indifference curve plots combinations of risk and return giving equal utility; steeper curves indicate greater risk aversion. The optimal portfolio is where the investor's highest attainable indifference curve is tangent to the efficient frontier.

13. State the common investor utility function used in mean-variance optimization.

    $$U = E(R) - \tfrac{1}{2}A\,\sigma^{2}$$ where $A$ is the risk-aversion coefficient. Higher $A$ means more risk-averse; risk-neutral investors have $A=0$ and risk-seeking investors have $A<0$.

14. What is the Capital Allocation Line (CAL)?

    The line representing all combinations of a single risky-asset portfolio and the risk-free asset available to one investor. Its intercept is $R_{f}$ and its slope equals the Sharpe ratio of the chosen risky portfolio: $\frac{E(R_{p})-R_{f}}{\sigma_{p}}$.

15. What is the equation of the CAL for a portfolio combining the risk-free asset and risky portfolio $p$?

    $$E(R_{c}) = R_{f} + \left[\frac{E(R_{p}) - R_{f}}{\sigma_{p}}\right]\sigma_{c}$$ where the bracketed term is the Sharpe ratio (slope) and $\sigma_{c}$ is the standard deviation of the combined portfolio.

16. What is the Capital Market Line (CML) and how does it differ from a CAL?

    The CML is the special CAL that runs from $R_{f}$ tangent to the efficient frontier at the market portfolio $M$. It uses the market portfolio as the optimal risky portfolio for all investors (under homogeneous expectations), whereas a CAL can be drawn for any risky portfolio.

17. What is the Sharpe ratio and what does it measure?

    $$\text{Sharpe} = \frac{E(R_{p}) - R_{f}}{\sigma_{p}}$$ It measures excess return per unit of total risk (standard deviation). It equals the slope of the CAL/CML and is used to rank portfolios on a risk-adjusted basis.

18. State the two-fund separation theorem.

    All investors, regardless of risk preferences, hold the same optimal risky portfolio (the market portfolio $M$) and adjust their overall risk only by mixing it with the risk-free asset. The investment decision (choosing $M$) is separated from the financing/allocation decision (how much in $R_{f}$).

19. What is a lending versus a borrowing portfolio on the CML?

    A lending portfolio invests part of wealth in the risk-free asset (positive $R_{f}$ weight) and lies between $R_{f}$ and $M$. A borrowing portfolio is leveraged — the investor borrows at $R_{f}$ to invest more than 100% in $M$ — and lies to the right of $M$.

20. Distinguish systematic from unsystematic (nonsystematic) risk.

    Systematic (market/non-diversifiable) risk affects all assets and cannot be diversified away; it is the only risk priced (rewarded) by the market. Unsystematic (firm-specific/diversifiable) risk can be eliminated through diversification and earns no risk premium.

21. What are the key assumptions underlying the CAPM?

    Investors are risk-averse, utility-maximizing, rational mean-variance optimizers; markets are frictionless (no taxes/transaction costs); investors can borrow and lend at the risk-free rate; investors have homogeneous (identical) expectations over a single period; all assets are marketable/divisible.

22. State the Capital Asset Pricing Model (CAPM) equation.

    $$E(R_{i}) = R_{f} + \beta_{i}\,[\,E(R_{m}) - R_{f}\,]$$ where $\beta_{i}$ is the asset's systematic risk and $[E(R_{m})-R_{f}]$ is the market risk premium.

23. How is beta ($\beta$) defined?

    $$\beta_{i} = \frac{\mathrm{Cov}(R_{i},R_{m})}{\sigma_{m}^{2}} = \rho_{i,m}\,\frac{\sigma_{i}}{\sigma_{m}}$$ It measures an asset's sensitivity to market movements; the market beta is $1$, the risk-free asset's beta is $0$.

See more Portfolio Management and Wealth Planning flashcards →

Planning Portfolio Management and Wealth Planning for CFA (Chartered Financial Analyst)

Portfolio Management and Wealth Planning (CFA (Chartered Financial Analyst)) FAQ