Professional Documents
Culture Documents
Table of Contents
Reading 51: Portfolio Management: An Overview ................................................................................. 2
Reading 52: Portfolio Risk and Return: I ................................................................................................. 3
Reading 53: Portfolio Risk and Return: Part II ........................................................................................ 4
Reading 54: Basics of Portfolio Planning and Construction .................................................................... 6
Reading 55: Introduction to Risk Management ...................................................................................... 7
Reading 56: Technical Analysis ............................................................................................................... 8
Reading 57: Fintech in Investment Management ................................................................................. 12
2
Types of investors
• Defined benefit plan is where a company promises to makes a pre-defined future benefit
payments to the employees. The company bears the investment risk.
• Defined contribution plan is where a company contributes an agreed amount to the plan
and employees invest part of their wages to the plan. In a plan, investment and inflation risk
is borne by the employee.
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● Risk aversion is the degree of an investor’s inability and unwillingness to take risk.
● Risk neutral: an investor who is indifferent about the gamble or a guaranteed outcome, as
the investor is only concerned about returns.
● Risk-seeking: an investor who prefers a gamble, where the indifference curve is downward
sloping as the expected return decreases for higher levels of risk. This is uncommon.
● Risk averse: an investor who expects additional return for taking additional risks, i.e. the
indifference curve is upward sloping. Most investors are risk averse, the degree of risk
aversion varies. The steeper the indifference curve, the more risk averse they are.
● Minimum variance frontier is a line combining all portfolios with a minimum level of risk
given a rate of return.
● Global minimum variance portfolio is the portfolio with the lowest variance amongst the
portfolio of all risky assets.
● The efficient frontier is the part of the minimum variance frontier that is above the global
minimum variance portfolio, since it gives the highest return for a given level of risk. Note
that efficient frontier only consists of risky assets, there are no risk-free assets here.
CAL overcomes the shortfall of efficient frontier by showing a line representing possible
combinations of risk-free assets and optimal risky asset portfolio.
Optimal investor portfolio is the point where an investor’s indifference curve is tangential to the
optimal CAL.
4
If all investors have the same expectations, the capital market line (CML) becomes a special case of
optimal CAL, where the tangent portfolio is the market portfolio.
E(RP) = Rf + (E(RM)-RF/σ M ) σ P
Slope of CML line is the market price of risk, i.e. Sharpe ratio.
● Systematic risk is a non-diversifiable, market risk. Investors should get compensated for
taking on systematic risk.
● Non-systematic risk is a local risk that can be diversified away, investors are not
compensated for taking on this risk.
● A risk-free asset has zero systematic and non-systematic risk.
Beta
Beta is a measure of an asset’s systematic (market) risk, relative to the risk of the overall market.
Bi =Co vim/σm2
We can also put in in the context of correlation
P I m= Co vim/σ i σ m
To get
Co vim = Pim σi σm
We can also tweak the equation for BETA
Βi= Pimσiσm / σ2m = Pim(σi/σm)
E(Ri) = Rf + βi [E(Rmkt ) – Rf ]
5
CAPM assumptions:
CAPM limitations:
SML is a graphical representation of CAPM, which applies to all securities, whether they are efficient
or not.
IPS is a written document detailing the portfolio construction process designed to satisfy a client’s
investment objectives.
● Introduction
● Statement of purpose
● Statement of duties and responsibilities
● Procedures
● Investment objectives
● Investment constraints
● Investment guidelines
● Evaluation of performance
● Appendices
Investment constraints
Investment Description
constraints
Time horizon The longer the time horizon, the greater the ability to take risk and the lower
the liquidity needs.
Taxes Consider individual tax status, investment jurisdiction and tax treatment of
various types of investment accounts.
Liquidity Cash requirements varies by client and need to consider having a portion of
assets in liquid investments.
Legal / regulatory Consider if there are legal restrictions on investments or max percentage
allocation on certain assets.
Unique Usually individual constraints are present, such as avoid certain class of
circumstances security or industry, or ethical preferences etc.
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● Risk governance: a top-down process that defines risk tolerance and provides guidance to
align risk with company goals
● Risk identification and measurement
● Risk infrastructure
● Defined policies and processes
● Risk monitoring, mitigation and management
● Communications
● Strategic analysis or integration
● Risk tolerance: what risks are acceptable and how much risk should be taken
● Risk budgeting: how and where the risks are taken and quantifies tolerable risk by specific
metrics
● Financial risk: risks that originate from financial markets such as change in interest rates. 3
major types of financial risk are market risk, credit risk and liquidity risks.
● Non-financial risk: risks that arise from within an entity or externally. Examples of non-
financial risks are: operational risk, solvency risk, settlement risk, legal risk, regulatory,
accounting and tax risk, model risk, tail risk, political risk.
● Methods of risk measurements: standard deviation, beta, duration, delta, gamma, VaR,
CVaR, etc.
● Methods of risk modification: risk prevention/avoidance, risk acceptance (self-insurance
and diversification), risk transfer (insurance), risk shifting/modification (via derivatives).
8
Charts
Bar chart Shows open, close, low and high prices for each data point.
Candlestick Also shows open, close, low and high prices for each data point. White body means
chart closing price > opening price (i.e. Market closed higher), dark body means closing price
< opening price (i.e. Market closed lower).
Point and figure X means an increase in price whilst O means a decrease in price.
chart
Trend analysis
Uptrend Security prices are reaching higher highs and higher lows
Downtrend Security prices are reaching lower highs and lower lows
Support A price level where there is sufficient buying pressure to stop a further decline in prices.
Resistance A price level where there is sufficient selling pressure to stop a further increase in
prices.
Change in Once a support level is breached, it often becomes the new resistance level, and vice
polarity versa.
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Head and shoulders Consists of a left shoulder, head and right shoulder. This pattern indicates the
(H&S) pattern end of an uptrend.
Inverse head and This is a mirror image of the H&S pattern and indicates an upcoming uptrend
shoulders pattern following a preceding downtrend.
Double/triple tops Prices hit the same resistance level twice/thrice before falling down,
indicating the end of an uptrend.
Double/triple bottoms Prices bounces back from the same support level twice/thrice before going
up, indicating the end of a downtrend.
Triangles One trend line connects the highs, another trend line connects the lows.
3 types:
– Ascending: Highs form a horizontal line, lows form uptrend.
– Descending: Lows form a horizontal line, highs form downtrend.
– Symmetrical: Highs from downtrend, lows form uptrend.
Flags Similar to rectangles, but parallel trend lines over a short period
Rate of change (ROC) When ROC oscillator crosses 0 into the positive (negative) territory, it is
oscillator considered bullish (bearish).
Stochastic oscillator When %K line moves from below to above %D line, this is considered bullish.
Vice versa.
Technical indicators
Price-based indicators
Bollinger bands Lines representing moving average and moving average +/- set number of
standard deviation from average price.
Momentum oscillators
Sentiment indicators
Put/call ratio Volume of puts traded divided by volume of calls traded. High ratio means
market is bearish.
CBOE volatility index A measure of near-term market volatility calculated from S&P 500 stock
(VIX) options. High VIX indicates when investors are fearful of a market decline.
Margin debt Loans taken out by investors to fund stock purchase. When margin debt is
increasing, investors are buying aggressively and this will drive up stock prices.
Short interest Number of shares sold short relative to daily trading volume. A high short
interest ratio indicates a negative outlook on the security.
Arms index Measures the relative extent to which money is moving into and out of rising
(or TRIN) and declining stocks.
Margin debt Margin loans may increase stock purchases and declining margin balances
may force stock sale.
Mutual fund cash % of mutual fund assets held in cash. During bullish (bearish) market, cash
position position tends to be low (high).
New equity issuance IPOs are often timed when market is bullish for best valuations.
Secondary offering Similar to IPOs, secondary offerings are monitored to gauge changes in
equities supply.
11
Cycles
Presidential cycle The 3rd year following an election tends to show the best performance.
Market waves follow patterns that are ratios of the Fibonacci sequence
The Fibonacci sequence starts with the numbers 0, 1, 1, and each subsequent number in the
sequence is the sum of 2 preceding numbers: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34 …
12
In the context of portfolio management, recognizing behavioral biases can allow an adviser to
develop a deeper understanding of his clients
• Cognitive
• Emotional
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Cognitive Includes:
1. Loss-Aversion Bias
2. Overconfidence Bias
3. Self-Control Bias
4. Status Quo Bias
5. Endowment Bias
6. Regret-Aversion Bias
• Calendar effects
• Monday effects
• Turn of the month
• January effect
• Holiday effect