Chartered Financial Analyst (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 Chartered Financial Analyst (CFA), not a summary of it.

1. 1

   Portfolio Management Foundations

   3 topics

   • Portfolio Management Process
     • The portfolio perspective and risk-return tradeoff
     • Types of investors and their needs
     • Steps in the portfolio management process
   • Risk and Return Concepts
     • Measuring portfolio risk and return
     • Diversification and correlation effects
     • Utility theory and the efficient frontier
   • Portfolio Risk and Return Models
     • Capital allocation line and the market portfolio
     • Capital asset pricing model (CAPM) and the SML
     • Beta, systematic risk, and performance measures
2. 2

   Asset Allocation and Investment Policy

   3 topics

   • Basics of Portfolio Planning and Construction
     • The investment policy statement (IPS)
     • Return objectives and risk tolerance
     • Constraints: liquidity, time horizon, taxes, legal, unique
   • Principles of Asset Allocation
     • Strategic asset allocation approaches
     • Mean-variance optimization and its limitations
     • Liability-relative and goals-based allocation
   • Asset Allocation with Real-World Constraints
     • Tactical and dynamic asset allocation
     • Rebalancing policy and transaction costs
     • Behavioral influences on allocation
3. 3

   Portfolio Construction and Risk Management

   4 topics

   • Equity and Fixed-Income Portfolio Management
     • Passive, active, and factor-based equity strategies
     • Liability-driven and index-based fixed-income strategies
     • Yield curve and credit strategies
   • Risk Management Framework
     • Risk governance and risk tolerance
     • Measuring and modifying risk (VaR and sensitivities)
     • Using derivatives for risk management
   • Trading, Performance, and Manager Selection
     • Trade execution and transaction cost analysis
     • Performance attribution and appraisal
     • Investment manager selection
   • Currency and Overlay Management
     • Currency risk and hedging decisions
     • Active currency management strategies
4. 4

   Private Wealth and Institutional Management (Level III)

   4 topics

   • Private Wealth Management
     • Individual investor profiling and goals
     • Tax-efficient investing and asset location
     • Estate planning and wealth transfer
   • Institutional Portfolio Management
     • Pension funds and endowments/foundations
     • Insurance companies and banks
     • Liability characteristics and constraints
   • Behavioral Finance in Practice
     • Cognitive errors and emotional biases
     • Behavioral portfolio construction and advisor-client relations
   • The Investment Manager Code and Reporting
     • Asset Manager Code of Professional Conduct
     • Performance evaluation and client reporting

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

23 of 55 cards from the Portfolio Management and Wealth Planning deck — real questions with worked answers.

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

   (1) Planning — analyze investor needs 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 are the two broad categories of a written Investment Policy Statement (IPS)?

   (1) Return and risk objectives, and (2) constraints. Constraints are remembered by the acronym Liquidity, time horizon, Taxes, Legal/regulatory, Unique circumstances (L-T-T-L-U).

3. Distinguish between an investor's ability and willingness to take risk.

   Ability to take risk is objective, based on financial circumstances (wealth, time horizon, liquidity needs, required return). Willingness is subjective, based on the investor's psychological attitude. When they conflict, the lower of the two generally governs (the more conservative position prevails).

4. Define holding period return (HPR) for a single period.

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

5. What is the difference between the arithmetic mean return and the geometric mean return?

   The arithmetic mean is the simple average of periodic returns; it is the best estimate of next period's expected return. The geometric mean compounds returns: $$R_{G} = \sqrt[n]{\prod_{t=1}^{n}(1+R_{t})} - 1$$ and measures the actual compound growth rate over the full period. $R_{G} \leq R_{arithmetic}$.

6. How does the money-weighted rate of return differ from the time-weighted rate of return?

   The money-weighted return is the IRR of all portfolio cash flows, so it is sensitive to the timing and size of deposits/withdrawals. The time-weighted return measures compound growth of one unit of money and is unaffected by external cash flows, making it the preferred measure for evaluating manager performance.

7. What is the formula for the variance and standard deviation of a single asset's returns (population)?

   $$\sigma^{2} = \frac{1}{N}\sum_{i=1}^{N}(R_{i} - \mu)^{2}, \qquad \sigma = \sqrt{\sigma^{2}}$$ The standard deviation is the most common measure of total (absolute) risk.

8. Define covariance and correlation between two assets, and give their relationship.

   Covariance measures co-movement: $$\text{Cov}(R_{i},R_{j}) = E\big[(R_{i}-\mu_{i})(R_{j}-\mu_{j})\big]$$ Correlation standardizes it: $$\rho_{ij} = \frac{\text{Cov}(R_{i},R_{j})}{\sigma_{i}\sigma_{j}}, \quad -1 \leq \rho_{ij} \leq 1$$

9. What is the expected return of a two-asset portfolio?

   $$E(R_{p}) = w_{1}E(R_{1}) + w_{2}E(R_{2})$$ A weighted average of the component expected returns, where weights sum to 1.

10. Write the formula for the variance of a two-asset portfolio.

    $$\sigma_{p}^{2} = w_{1}^{2}\sigma_{1}^{2} + w_{2}^{2}\sigma_{2}^{2} + 2w_{1}w_{2}\rho_{12}\sigma_{1}\sigma_{2}$$ Diversification benefit increases as $\rho_{12}$ decreases below 1.

11. What is the diversification effect when two assets have a correlation of exactly +1?

    There is no diversification benefit. Portfolio standard deviation is just the weighted average of the individual standard deviations: $\sigma_{p} = w_{1}\sigma_{1} + w_{2}\sigma_{2}$, and the efficient frontier between the two assets is a straight line.

12. Define systematic risk and unsystematic risk, and state which is priced.

    Systematic (market/non-diversifiable) risk affects all assets and cannot be eliminated by diversification. Unsystematic (firm-specific/diversifiable) risk can be removed by holding a well-diversified portfolio. Only systematic risk is compensated (priced) in equilibrium models like the CAPM.

13. What is the Capital Allocation Line (CAL) and what does its slope represent?

    The CAL plots expected return against risk for combinations of a risky portfolio and the risk-free asset: $$E(R_{C}) = R_{f} + \frac{E(R_{P}) - R_{f}}{\sigma_{P}}\,\sigma_{C}$$ Its slope is the Sharpe ratio (reward-to-variability) of the risky portfolio.

14. What is the Capital Market Line (CML) and what risky portfolio does it use?

    The CML is the special CAL that uses the market portfolio as the optimal risky portfolio: $$E(R_{P}) = R_{f} + \frac{E(R_{M}) - R_{f}}{\sigma_{M}}\,\sigma_{P}$$ It applies only to efficient portfolios and uses total risk ($\sigma$) on the x-axis.

15. State the CAPM equation and define beta.

    $$E(R_{i}) = R_{f} + \beta_{i}\big[E(R_{M}) - R_{f}\big]$$ Beta measures an asset's systematic risk relative to the market: $$\beta_{i} = \frac{\text{Cov}(R_{i},R_{M})}{\sigma_{M}^{2}}$$

16. What is the Security Market Line (SML) and how does it differ from the CML?

    The SML is the graphical representation of the CAPM, plotting expected return against beta (systematic risk). Unlike the CML, which uses total risk and applies only to efficient portfolios, the SML uses beta and prices all securities and portfolios, efficient or not.

17. List the four common risk-adjusted performance measures and what risk each uses.

    Sharpe ratio: $\frac{R_{p}-R_{f}}{\sigma_{p}}$ (total risk). Treynor ratio: $\frac{R_{p}-R_{f}}{\beta_{p}}$ (systematic risk). Jensen's alpha: $R_{p} - [R_{f} + \beta_{p}(R_{M}-R_{f})]$ (excess over CAPM). M-squared ($M^{2}$): risk-adjusted return on the same risk basis as the market.

18. What is the major assumption underlying mean-variance analysis regarding investor utility?

    Investors are risk-averse and base decisions on only two parameters — expected return (mean) and variance (or standard deviation) of returns. This requires either that returns are normally distributed or that investors have quadratic utility functions.

19. What does the efficient frontier represent, and what is the global minimum-variance portfolio?

    The efficient frontier is the set of portfolios offering the maximum expected return for each level of risk (the upper edge of the feasible set). The global minimum-variance portfolio is the single portfolio on the frontier with the lowest possible standard deviation.

20. In portfolio planning, what is the distinction between strategic and tactical asset allocation?

    Strategic asset allocation (SAA) sets long-term target weights based on the IPS and capital market expectations — the policy portfolio. Tactical asset allocation (TAA) makes short-term deviations from policy weights to exploit perceived mispricings; it is an active bet against the strategic benchmark.

21. What are the three traditional approaches to asset allocation?

    (1) Asset-only (e.g., mean-variance optimization, focusing only on the asset portfolio); (2) Liability-relative (asset/liability management, allocating to fund liabilities); (3) Goals-based (sub-portfolios mapped to specific investor goals, common in private wealth).

22. What characterizes asset classes that are useful for strategic asset allocation?

    Assets within a class are relatively homogeneous; classes are mutually exclusive; classes are diversifying (not highly correlated); together they cover the majority of investable wealth; and each class has the capacity to absorb a meaningful portion of the portfolio.

23. What is a risk-budgeting approach to asset allocation, and what is the risk parity criterion?

    Risk budgeting allocates a portfolio's total risk across positions/asset classes rather than allocating capital. Under risk parity, each asset class contributes equally to total portfolio risk, so the marginal contribution to risk is equalized across classes.

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