CFA 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, not a summary of it.

1. 1

   Portfolio Management

   2 topics

   • Portfolio Risk and Return
   • The Investment Policy Statement (IPS)
2. 2

   Asset Allocation

   2 topics

   • Strategic Asset Allocation
   • Tactical Asset Allocation
3. 3

   Risk Management

   2 topics

   • Risk Management Framework
   • Risk Identification and Measurement

Portfolio Management and Wealth Planning flashcards for CFA

23 of 51 cards from the Portfolio Management and Wealth Planning deck — real questions with worked answers.

1. 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 $w_1$ and $w_2$ are the portfolio weights (summing to 1) and $E(R_i)$ is the expected return of each asset.

2. Write the formula for 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 and $\sigma_1\sigma_2\rho_{12}$ equals the covariance $\text{Cov}(R_1,R_2)$.

3. How is the covariance between two assets related to their correlation coefficient?

   $$\text{Cov}(R_1,R_2) = \rho_{12}\,\sigma_1\,\sigma_2 \quad\Longleftrightarrow\quad \rho_{12} = \frac{\text{Cov}(R_1,R_2)}{\sigma_1\,\sigma_2}$$ Correlation is bounded: $-1 \leq \rho_{12} \leq +1$.

4. What is the diversification benefit of combining two assets, and when is it greatest?

   Portfolio risk falls below the weighted average of individual risks whenever $\rho_{12} < 1$. The benefit is greatest when $\rho_{12} = -1$, at which point risk can be eliminated entirely for the right weights.

5. Define the Sharpe ratio and state what it measures.

   $$\text{Sharpe} = \frac{E(R_p) - R_f}{\sigma_p}$$ It measures excess return per unit of total risk (standard deviation). Higher is better; it is the reward-to-total-volatility ratio.

6. What distinguishes systematic risk from nonsystematic risk?

   Systematic (market) risk is undiversifiable and affects all assets; it is priced (rewarded). Nonsystematic (idiosyncratic/firm-specific) risk is diversifiable and is not rewarded because investors can eliminate it by holding a diversified portfolio.

7. 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.

8. How is an asset's beta defined mathematically?

   $$\beta_i = \frac{\text{Cov}(R_i, R_m)}{\sigma_m^{2}} = \rho_{i,m}\,\frac{\sigma_i}{\sigma_m}$$ It measures the sensitivity of the asset's return to market returns. The market itself has $\beta = 1$.

9. What is the equation of the Capital Market Line (CML)?

   $$E(R_p) = R_f + \frac{E(R_m) - R_f}{\sigma_m}\,\sigma_p$$ The CML plots expected return against total risk ($\sigma_p$) for efficient portfolios combining the risk-free asset and the market portfolio.

10. How does the CML differ from the Security Market Line (SML)?

    The CML uses total risk ($\sigma_p$) on the x-axis and applies only to efficient portfolios. The SML (the CAPM graph) uses systematic risk ($\beta$) on the x-axis and applies to all assets and portfolios, efficient or not.

11. What is the efficient frontier?

    The set of portfolios offering the maximum expected return for each level of risk (or minimum risk for each level of return). Rational investors choose only portfolios lying on this frontier; those below it are dominated.

12. What is the global minimum-variance portfolio?

    The single portfolio on the Markowitz efficient frontier with the lowest possible standard deviation. It marks the leftmost point of the frontier; portfolios below it are inefficient.

13. State the M-squared ($M^2$) measure and what it expresses.

    $$M^{2} = (E(R_p) - R_f)\,\frac{\sigma_m}{\sigma_p} - (E(R_m) - R_f)$$ It expresses a portfolio's risk-adjusted performance in percentage-return terms relative to the market, after scaling the portfolio to the market's volatility.

14. Define the Treynor ratio and contrast it with the Sharpe ratio.

    $$\text{Treynor} = \frac{E(R_p) - R_f}{\beta_p}$$ It measures excess return per unit of systematic risk (beta). Unlike the Sharpe ratio, which uses total risk $\sigma_p$, Treynor uses only $\beta$, making it appropriate for well-diversified portfolios.

15. What is Jensen's alpha?

    $$\alpha_p = R_p - [\,R_f + \beta_p(R_m - R_f)\,]$$ It is the portfolio's return in excess of its CAPM-required return. Positive $\alpha$ indicates outperformance on a risk-adjusted basis.

16. How is a portfolio's beta computed from its constituent assets?

    $$\beta_p = \sum_{i=1}^{n} w_i\,\beta_i$$ Portfolio beta is the weighted average of the individual asset betas, using portfolio weights $w_i$.

17. What is the utility function commonly used in mean-variance analysis?

    $$U = E(R) - \tfrac{1}{2}A\sigma^{2}$$ where $A$ is the investor's risk-aversion coefficient. Higher $A$ means greater risk aversion, lowering the utility of a given amount of variance.

18. On an indifference-curve/utility diagram, how do risk-averse, risk-neutral, and risk-seeking investors differ?

    Risk-averse investors have $A > 0$ (upward-sloping indifference curves, demanding higher return for more risk). Risk-neutral investors have $A = 0$ (care only about return). Risk-seeking investors have $A < 0$ (prefer more risk).

19. What is the primary purpose of an Investment Policy Statement (IPS)?

    To govern the investment process by documenting the client's objectives and constraints, establishing benchmarks and a review schedule, and providing a durable framework that guides decisions and protects both client and manager over time.

20. What are the two broad categories of components in an IPS?

    Objectives — the client's return requirement and risk tolerance; and Constraints — Liquidity, Time horizon, Taxes, Legal/regulatory, and Unique circumstances (remembered by the mnemonic RR + LTTLU).

21. List the five constraints in an IPS.

    Liquidity needs, Time horizon, Tax concerns, Legal and regulatory factors, and Unique circumstances. (Mnemonic: L-T-T-L-U.)

22. How do ability and willingness to take risk combine to set risk tolerance?

    Risk tolerance is the lower of the two when they conflict; ability (based on wealth, time horizon, liquidity, and required return) is generally the binding constraint, while willingness (psychological) must be reconciled through client education. Below-average ability normally governs.

23. What factors increase an investor's ability to take risk?

    A longer time horizon, larger asset base relative to liabilities/needs, low liquidity requirements, stable income, and a low required rate of return. These give greater capacity to absorb losses.

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