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

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).

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.

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.

Why does mean-variance optimization (MVO) tend to produce concentrated, unstable allocations, and what are common remedies?

MVO is highly sensitive to small changes in inputs (especially expected returns), producing extreme, error-maximizing weights. Remedies include adding constraints, reverse optimization, the Black-Litterman model, resampled efficient frontier, and Monte Carlo simulation.

List the key real-world constraints that complicate strategic asset allocation.

Asset size (too small or too large for certain strategies), liquidity needs, time horizon, regulatory/legal constraints, tax considerations, and external/governance constraints. These can force deviations from the theoretically optimal allocation.

How do taxes affect after-tax asset allocation and asset location decisions?

After-tax return $\approx R(1 - t)$ and after-tax risk $\approx \sigma(1 - t)$, so taxes shrink both. Asset location places heavily taxed assets (e.g., bonds, high-turnover strategies) in tax-deferred/exempt accounts and tax-efficient assets (e.g., equities held long term) in taxable accounts.

What is rebalancing, and what are the main rebalancing approaches?

Rebalancing realigns portfolio weights to strategic targets after market drift. Approaches: calendar rebalancing (fixed schedule) and percentage-of-portfolio/corridor rebalancing (rebalance when a class breaches a tolerance band). More volatile, less correlated, lower-transaction-cost assets warrant wider corridors.

Compare passive, active, and factor-based (smart beta) equity portfolio management.

Passive replicates a benchmark index (low cost, low tracking error). Active seeks to outperform a benchmark via security selection and timing (higher cost, higher active risk). Factor-based/smart beta systematically tilts toward rewarded factors (value, size, momentum, quality, low volatility) using rules-based construction.

Define active return and active risk (tracking error) and the information ratio.

Active return = portfolio return − benchmark return. Active risk (tracking error) is the standard deviation of active returns. The information ratio measures active return per unit of active risk: $$IR = \frac{R_{p} - R_{b}}{\sigma(R_{p}-R_{b})}$$

What is the Fundamental Law of Active Management?

$$IR \approx IC \times \sqrt{BR} \times TC$$ where IC is the information coefficient (skill), BR is breadth (number of independent decisions per year), and TC is the transfer coefficient (degree to which insights are reflected given constraints). Expected active return $= IR \times \sigma_{active}$.

Define duration and convexity in fixed-income portfolio management.

Modified duration estimates the percentage price change for a 1% yield change: $\%\Delta P \approx -D_{mod}\times \Delta y$. Convexity corrects for the curvature of the price-yield relationship: $$\%\Delta P \approx -D_{mod}\,\Delta y + \tfrac{1}{2}\,C\,(\Delta y)^{2}$$

What is liability-driven investing (LDI) and the technique of immunization?

LDI structures assets to meet future liabilities. Immunization protects against interest-rate risk by matching the (money) duration of assets to that of liabilities and ensuring sufficient convexity, so reinvestment risk and price risk offset for a single liability or a stream of liabilities.

Compare cash flow matching and duration matching for funding liabilities.

Cash flow matching builds a dedicated portfolio whose cash inflows exactly meet each liability outflow as it comes due (no rebalancing, no reinvestment risk, but costly). Duration matching (immunization) equates portfolio and liability durations and PV, requiring periodic rebalancing as rates and time change.

What is the primary purpose of a risk management framework, and is the goal to minimize risk?

A risk management framework identifies, measures, and modifies risk so that the risks taken are consistent with the organization's risk tolerance and value-creation objectives. The goal is not to minimize risk but to optimize the risk taken relative to expected reward (risk governance).

List the key components of an enterprise risk management framework.

(1) Risk governance (tolerance, oversight); (2) Risk identification and measurement; (3) Risk infrastructure (people, systems, data); (4) Defined policies and processes; (5) Risk monitoring, mitigation, and management; (6) Communication; (7) Strategic risk analysis and integration.

Define Value at Risk (VaR) and state one of its principal limitations.

VaR is the minimum loss expected over a given period at a given confidence level (e.g., a 5% one-day VaR of \$1M means a 5% chance of losing at least \$1M in a day). Limitation: it says nothing about the magnitude of losses in the tail beyond the threshold (addressed by conditional VaR / expected shortfall).

Name the three methods of estimating VaR.

(1) Parametric (variance-covariance) method — assumes a distribution (usually normal); (2) Historical simulation — uses actual past returns; (3) Monte Carlo simulation — generates returns from an assumed stochastic model.

Distinguish the option Greeks delta, gamma, and vega.

Delta ($\Delta$) measures sensitivity of option price to the underlying price. Gamma ($\Gamma$) measures the rate of change of delta (sensitivity to large underlying moves). Vega measures sensitivity to changes in implied volatility.

What is implementation shortfall as a measure of trading cost?

Implementation shortfall is the difference between the return on a hypothetical paper portfolio (executed instantly at the decision price) and the actual portfolio return. It captures explicit costs, market-impact (realized profit/loss) costs, missed-trade opportunity cost, and delay costs.

Compare market orders and limit orders in terms of execution risk.

A market order guarantees execution but not price (certainty of completion, exposure to price/market-impact risk). A limit order guarantees a price limit but not execution (price protection, exposure to non-execution / opportunity cost). Trading strategy chooses between immediacy and price.

What does the Brinson model attribution decompose active return into?

It decomposes active return into the allocation effect (over/underweighting sectors vs. the benchmark), the selection effect (security selection within sectors), and the interaction effect (the cross-product of allocation and selection decisions).

What three questions does performance evaluation seek to answer (its three components)?

(1) Performance measurement — what was the return? (2) Performance attribution — how/why was the return achieved (sources)? (3) Performance appraisal — was the return due to skill or luck (risk-adjusted, statistical significance)?

What key qualitative factors are assessed in manager selection (Type I vs. Type II errors)?

Selection considers investment philosophy, process, people, and performance (the 'four Ps'), plus operational due diligence. A Type I error is hiring/retaining a manager who then underperforms; a Type II error is rejecting/firing a manager who would have outperformed.

Distinguish the direct and indirect currency quote, and define the forward premium/discount.

A direct quote is domestic currency per unit of foreign currency (e.g., USD/EUR for a US investor); an indirect quote is the reciprocal. The forward premium/discount is $$\frac{F - S}{S}$$ a currency trades at a forward premium when its forward rate exceeds its spot rate (the lower-interest-rate currency).

What is the role of currency overlay management?

A currency overlay separates the management of currency exposure from the underlying asset (e.g., bond/equity) decisions, often via a specialist. It can pursue full hedging, partial hedging, or active currency alpha, allowing currency risk to be managed independently of asset allocation.

Compare the strategic choices of full hedging, no hedging, and a minimum-variance hedge for currency exposure.

Full hedging eliminates currency risk but incurs costs and forgoes diversification/return. No hedging accepts full currency exposure (suitable when currencies diversify or the horizon is long). A minimum-variance hedge ratio sets the hedge to minimize the volatility of the domestic-currency return, accounting for correlation between asset and currency returns.

What are the main tools used to implement currency hedges and overlays?

Currency forwards (most common, customizable, must be rolled), currency futures (standardized, exchange-traded), currency options (asymmetric protection for a premium), and cross-hedges/proxy hedges using a correlated currency when direct hedging is costly or unavailable.

In private wealth management, what distinguishes the human-capital vs. financial-capital framework for an investor?

Total wealth = human capital (PV of future labor earnings) + financial capital. Young investors are human-capital rich; as human capital declines with age, financial capital should grow. Bond-like human capital (stable salary) supports more equity in financial assets; equity-like human capital warrants more bonds.

What is the difference between situational and psychological profiling of private clients?

Situational profiling classifies clients by source of wealth, measure of wealth, and stage of life. Psychological profiling examines personality and behavioral biases (e.g., risk attitudes, decision style) to anticipate how a client will react and to tailor communication and the IPS accordingly.

Contrast the key objectives of a defined-benefit (DB) pension plan versus a foundation or endowment.

A DB plan's objective is to fund pension liabilities; risk tolerance depends on funded status, plan/sponsor financials, and workforce age — return must cover the actuarial discount rate. A foundation/endowment seeks to preserve real (inflation-adjusted) purchasing power in perpetuity while meeting a spending rate (e.g., 5%), giving long horizons and high equity tolerance.

List the institutional investor types and a defining liquidity/horizon feature of each.

DB pensions (long horizon, liquidity tied to retiree payouts); endowments/foundations (very long/perpetual horizon, spending-rate liquidity); banks (short horizon, high liquidity, manage interest-rate gap); insurers — life (long horizon, duration-matched) and non-life/property-casualty (shorter, lumpy liquidity needs); sovereign wealth funds (objectives vary by mandate).

Define the behavioral biases of overconfidence, loss aversion, anchoring, and herding.

Overconfidence: overestimating one's knowledge/predictive ability (excessive trading). Loss aversion: feeling losses more strongly than equivalent gains (holding losers, selling winners — disposition effect). Anchoring: over-relying on an initial reference value. Herding: mimicking the crowd, contributing to bubbles and crashes.

Distinguish cognitive errors from emotional biases in behavioral finance, and how each is best handled.

Cognitive errors stem from faulty reasoning/information processing (e.g., anchoring, framing, availability) and can often be corrected with education and information. Emotional biases stem from feelings/impulses (e.g., loss aversion, overconfidence, regret aversion) and are harder to correct, so advisors usually adapt the portfolio to accommodate them.

What are the six components (sections) of the CFA Institute Asset Manager Code of Professional Conduct?

Managers must: (1) act in clients' best interest with loyalty, prudence, and care; (2) act with integrity and competence in the marketplace; (3) maintain adequate trading practices; (4) maintain compliance and support functions; (5) ensure fair, accurate performance and valuation disclosures; (6) maintain confidentiality (disclosures/communications). General ethical principles plus six pillars.

What is the purpose of the Global Investment Performance Standards (GIPS), and what is a 'composite'?

GIPS are voluntary, ethical standards for calculating and presenting investment performance to ensure fair representation and full disclosure, enabling comparability across firms. A composite is an aggregation of all actual fee-paying, discretionary portfolios managed according to a similar strategy/mandate, preventing cherry-picking of results.