Chartered Institute for Securities & Investment (CISI) Qualifications Investment Analysis, Risk and Portfolio Management Syllabus

What is the Capital Market Line (CML) and what risk measure does it use?

The CML is the line from the risk-free asset tangent to the efficient frontier (touching the market portfolio). It plots expected return against total risk (standard deviation) for efficient portfolios: $$E(R_{p}) = R_{f} + \frac{E(R_{m}) - R_{f}}{\sigma_{m}}\,\sigma_{p}$$

State the Capital Asset Pricing Model (CAPM) equation for the required return on an asset.

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

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 systematic risk (beta), not total risk. It applies to all securities (efficient or not), whereas the CML plots return against total risk and applies only to efficient portfolios.

According to CAPM/SML, what does it mean if a security plots above the Security Market Line?

It is offering a higher return than required for its level of systematic risk, i.e. it is underpriced (a buy). A security plotting below the SML is overpriced (a sell).

List the key assumptions underlying the CAPM.

Investors are rational and risk-averse mean-variance optimisers; they can lend and borrow unlimited amounts at the risk-free rate; all investors have homogeneous expectations and a single holding period; markets are frictionless (no taxes or transaction costs); information is freely available; and all assets are infinitely divisible.

What is the strategic (long-term) asset allocation, and how does it differ from tactical asset allocation?

Strategic asset allocation sets the long-term target weights across asset classes based on the investor's objectives, risk tolerance and time horizon (the benchmark mix). Tactical asset allocation makes short-term deviations from those weights to exploit perceived market opportunities.

What is the difference between top-down and bottom-up investment approaches?

Top-down starts with macroeconomic analysis, then selects sectors/regions, then individual securities. Bottom-up ignores the macro picture and focuses on selecting individual securities on their own merits/fundamentals.

Distinguish active management from passive management.

Active management seeks to outperform a benchmark through security selection and/or market timing, incurring higher fees and turnover. Passive management aims to replicate (track) a benchmark index at low cost, accepting market returns rather than trying to beat them.

What are the three main methods used to construct a passive (index-tracking) fund?

Full replication (holding every constituent in index weights); stratified sampling (holding a representative subset matched to index characteristics); and optimisation/synthetic replication (using quantitative models or derivatives/swaps to match index returns).

How does the Efficient Market Hypothesis (EMH) support passive management?

If markets are efficient, prices already reflect all available information, so active managers cannot consistently outperform after costs. This implies investors should hold low-cost passive index funds rather than pay for active management.

Name and describe the three forms of the Efficient Market Hypothesis.

Weak form: prices reflect all past price/volume information (technical analysis cannot add value). Semi-strong form: prices reflect all publicly available information (fundamental analysis on public data cannot add value). Strong form: prices reflect all information, public and private (even insider information cannot add value).

What is the dividend discount (Gordon growth) model for valuing an equity?

$$P_{0} = \frac{D_{1}}{r - g}$$ where $D_{1}$ is next year's expected dividend, $r$ the required rate of return and $g$ the constant dividend growth rate (valid only when $r > g$).

How is the constant dividend growth rate $g$ commonly estimated?

$$g = b \times ROE$$ where $b$ is the retention (plough-back) ratio (the proportion of earnings retained, $= 1 - \text{payout ratio}$) and $ROE$ is the return on equity.

What does the price/earnings (P/E) ratio measure and how is it calculated?

The P/E ratio shows how much investors pay per unit of earnings: $$P/E = \frac{\text{Market price per share}}{\text{Earnings per share}}$$ A high P/E may indicate high expected growth (or overvaluation); a low P/E may indicate low growth expectations (or undervaluation).

What is the dividend yield and how is it calculated?

$$\text{Dividend yield} = \frac{\text{Dividend per share}}{\text{Market price per share}} \times 100\%$$ It expresses the income return on a share as a percentage of its price.

Define enterprise value (EV) and state its formula.

Enterprise value represents the total value of a business to all capital providers: $$EV = \text{Market capitalisation} + \text{Total debt} + \text{Minority interests} + \text{Preferred equity} - \text{Cash and cash equivalents}$$

What is the price-to-book (P/B) ratio and what does it indicate?

$$P/B = \frac{\text{Market price per share}}{\text{Book value per share}}$$ It compares market value to accounting net asset value. A P/B below 1 may signal undervaluation or impaired assets; it is widely used for asset-heavy businesses such as banks.

In fund and manager selection, what is the distinction between alpha and beta sources of return?

Beta is the return earned from exposure to the market (systematic risk), available cheaply through passive products. Alpha is the value added by the manager's skill above the market/benchmark return. Investors should pay active fees only for genuine, repeatable alpha.

What qualitative factors are commonly assessed when selecting a fund manager (often summarised as the 'P's)?

People (team quality and stability), Process (clear, repeatable investment philosophy and process), Performance (consistent risk-adjusted track record), Philosophy, and Price (fees). Operational due diligence and risk controls are also assessed.

Why is past performance an unreliable basis for selecting funds on its own?

Past performance does not reliably predict future returns; it may reflect luck, a favourable market regime, or risks that have not yet materialised. Surviving funds also create survivorship bias. Selection should combine performance with process, people and risk analysis.

What characteristics make a good investment benchmark (the 'SAMURAI' or similar criteria)?

A good benchmark is Specified in advance, Appropriate to the strategy, Measurable, Unambiguous, Reflective of current investment opinions, Accountable/owned by the manager, and Investable. It should be representative of the portfolio's universe and replicable.

Define tracking error and explain what a high value implies.

Tracking error is the standard deviation of the differences between the portfolio's returns and its benchmark's returns: $$TE = \sigma_{(R_{p} - R_{b})}$$ A high tracking error means the portfolio deviates substantially from the benchmark (more active risk); a passive index fund aims for tracking error close to zero.

What is the difference between ex-ante and ex-post tracking error?

Ex-ante (forward-looking) tracking error is an estimate of expected future deviation from the benchmark, derived from a risk model of current holdings. Ex-post (backward-looking) tracking error is the realised standard deviation of historical active returns actually achieved.

What is a time-weighted rate of return (TWRR) and why is it used to assess managers?

TWRR measures the compound growth rate of one unit of currency invested over the period, removing the distorting effect of the timing and size of external cash flows (which the manager does not control). It is the standard for comparing manager performance: $$1 + TWRR = \prod_{i=1}^{n}(1 + R_{i})$$

What is a money-weighted rate of return (MWRR) and when is it most appropriate?

The MWRR is the internal rate of return (IRR) that sets the present value of all cash flows (inflows and outflows) plus the ending value equal to the initial investment. It reflects the actual return earned by the investor including the impact of their cash flow timing, so it is most appropriate for evaluating the investor's own experience.

When will the time-weighted and money-weighted returns differ, and which is higher when an investor adds money before a strong period?

They differ whenever there are external cash flows during the period. If an investor adds money just before a period of strong performance, the MWRR will be higher than the TWRR because more capital was exposed to the gains; the reverse lowers the MWRR.

What is attribution analysis in portfolio performance measurement?

Attribution analysis decomposes a portfolio's active return (return relative to its benchmark) into the components that produced it - typically asset/sector allocation, security selection and an interaction effect - to identify the sources of out- or under-performance and the manager's skill.

In Brinson-style attribution, what does the allocation effect measure?

The allocation effect measures the value added by over- or under-weighting sectors/asset classes relative to the benchmark. Positive contribution comes from overweighting outperforming segments and underweighting underperforming ones, holding selection constant.

In Brinson-style attribution, what does the selection effect measure?

The selection (stock-picking) effect measures the value added from choosing individual securities that outperform the benchmark holdings within each sector, holding the sector weights at benchmark levels. It isolates the manager's security-selection skill.

What are the GIPS standards and what is their primary purpose?

The Global Investment Performance Standards (GIPS), maintained by the CFA Institute, are voluntary, ethical standards for calculating and presenting investment performance. Their purpose is to ensure fair representation and full disclosure so that performance records are consistent, comparable and not misleading to prospective clients.

What is a 'composite' under GIPS and why is it central to the standards?

A composite is an aggregation of all actual fee-paying discretionary portfolios managed according to a similar strategy or mandate. Firms must include every such portfolio in at least one composite, which prevents 'cherry-picking' only the best-performing accounts and ensures a fair, complete presentation of the strategy's track record.