How to use this Quick Reference
This independent Quick Reference supports preparation for the Chartered Institute for Securities & Investment CISI Chartered Wealth Manager — Financial Markets exam, code CISI CWM FM. Use it to consolidate formulas, market vocabulary, instrument features, and exam-style decision rules.
Focus on three exam skills:
- Classify the instrument: equity, debt, derivative, fund, FX, money market, alternative.
- Identify the risk/return driver: rates, credit, inflation, currency, volatility, liquidity, market beta, leverage.
- Apply the client or portfolio context: income, growth, preservation, liquidity, hedge, diversification, time horizon.
High-yield market map
| Area | What to know | Exam trap |
|---|
| Money markets | Short-term borrowing/lending, cash equivalents, liquidity management | Low risk is not no risk: credit, reinvestment, liquidity, and rate risk still matter |
| Bonds | Price/yield inverse relationship, duration, credit spread, clean vs dirty price | A higher coupon usually lowers duration versus an otherwise similar low-coupon bond |
| Equities | Ownership, residual claim, dividends, voting, valuation ratios | P/E is not automatically “cheap” or “expensive” without growth, risk, and accounting context |
| FX | Spot, forward, direct/indirect quotes, bid/offer, interest-rate parity logic | The client buys at the dealer’s offer and sells at the dealer’s bid |
| Derivatives | Futures, forwards, options, swaps; hedge/speculation/arbitrage | Futures create symmetric exposure; options create asymmetric exposure |
| Funds | Open-ended vs closed-ended, active vs passive, NAV, premiums/discounts | ETF price and NAV can diverge intraday; closed-ended funds can trade at discounts/premiums |
| Alternatives | Property, commodities, hedge funds, private equity, infrastructure | Diversification benefit may disappear in market stress; liquidity terms matter |
| Market structure | Primary/secondary markets, exchange/OTC, order-driven/quote-driven | Clearing reduces counterparty risk but does not eliminate market risk |
| Portfolio risk | Volatility, beta, correlation, tracking error, VaR, drawdown | Correlation is not constant and is not causation |
Economic and market cycle reference
| Indicator/concept | Rising usually suggests | Falling usually suggests | Wealth-management relevance |
|---|
| GDP growth | Economic expansion, stronger earnings expectations | Slowdown or recession risk | Equity cyclicals, credit spreads, default expectations |
| Inflation | Higher input costs, possible rate rises | Disinflation or weak demand | Real returns, index-linked bonds, cash drag |
| Policy rates | Tighter monetary policy | Easier monetary policy | Bond prices, mortgage costs, discount rates, FX |
| Yield curve steepness | Growth/inflation expectations or term premium | Flattening may signal tightening or slower growth | Duration positioning and bank profitability |
| Credit spreads | Higher perceived default/liquidity risk | Better risk appetite or credit conditions | Corporate bond allocation and credit quality |
| Unemployment | Weak labour market if rising | Tight labour market if falling | Consumer demand, wage inflation, policy response |
| Currency strength | Capital inflows, higher relative rates, better sentiment | Weak external position or lower relative rates | Imported inflation, overseas holdings, hedging |
| Commodity prices | Cost pressure; sector winners/losers | Lower inflation pressure or weak demand | Inflation hedges, resource equities, emerging markets |
Monetary and fiscal policy distinctions
| Policy tool | Mechanism | Likely market effect | Common trap |
|---|
| Policy rate increase | Raises short-term risk-free rates | Bond prices down, currency may strengthen, equity discount rates up | Effect depends on expectations already priced in |
| Policy rate cut | Lowers discount rates and borrowing costs | Bond prices up, risk assets may rally, currency may weaken | Cuts during crisis may signal economic stress |
| Quantitative easing | Central bank buys assets, injects liquidity | Lower yields, tighter spreads, higher asset prices | QE affects long rates and liquidity, not just overnight rates |
| Quantitative tightening | Central bank balance sheet reduction | Higher yields/liquidity pressure possible | Impact may be gradual and market-dependent |
| Fiscal stimulus | Government spending/tax support | Growth boost, possible inflation/deficit pressure | Bond yields can rise if borrowing concerns dominate |
| Fiscal tightening | Spending cuts/tax increases | Demand restraint | Can improve fiscal credibility but hurt growth |
Use formulas with consistent units: annual with annual, period with period, percentage with percentage.
Return and compounding
\[
\text{Holding period return}=
\frac{\text{ending value}-\text{beginning value}+\text{income}}{\text{beginning value}}
\]\[
\text{Arithmetic mean}=\frac{r_1+r_2+\cdots+r_n}{n}
\]\[
\text{Geometric mean}=
\left[(1+r_1)(1+r_2)\cdots(1+r_n)\right]^{1/n}-1
\]\[
\text{Real return approximation}\approx \text{nominal return}-\text{inflation}
\]\[
1+\text{real return}=
\frac{1+\text{nominal return}}{1+\text{inflation}}
\]
Portfolio risk and return
\[
E(R_p)=\sum_{i=1}^{n} w_iE(R_i)
\]\[
\sigma_p^2=
w_A^2\sigma_A^2+w_B^2\sigma_B^2+2w_Aw_B\rho_{A,B}\sigma_A\sigma_B
\]\[
\beta_i=
\frac{\operatorname{Cov}(R_i,R_m)}{\operatorname{Var}(R_m)}
\]\[
E(R_i)=R_f+\beta_i\left[E(R_m)-R_f\right]
\]\[
\text{Sharpe ratio}=
\frac{R_p-R_f}{\sigma_p}
\]\[
\text{Information ratio}=
\frac{R_p-R_b}{\text{tracking error}}
\]
Bond price and yield
\[
\text{Dirty price}=\text{clean price}+\text{accrued interest}
\]\[
\text{Current yield}=
\frac{\text{annual coupon}}{\text{bond price}}
\]\[
\text{Approximate YTM}=
\frac{\text{annual coupon}+\frac{\text{face value}-\text{price}}{\text{years to maturity}}}
{\frac{\text{face value}+\text{price}}{2}}
\]\[
\text{Modified duration}=
\frac{\text{Macaulay duration}}{1+\frac{y}{m}}
\]\[
\%\Delta P\approx -\text{modified duration}\times \Delta y
\]
Equity and corporate actions
\[
\text{Earnings per share}=
\frac{\text{earnings available to ordinary shareholders}}{\text{weighted average ordinary shares}}
\]\[
\text{P/E ratio}=
\frac{\text{share price}}{\text{earnings per share}}
\]\[
\text{Dividend yield}=
\frac{\text{annual dividend per share}}{\text{share price}}
\]\[
P_0=
\frac{D_1}{r-g}
\]\[
\text{TERP}=
\frac{N(\text{old price})+M(\text{subscription price})}{N+M}
\]
Options and FX
\[
\text{Call payoff at expiry}=\max(S_T-K,0)
\]\[
\text{Put payoff at expiry}=\max(K-S_T,0)
\]\[
C+PV(K)=P+S
\]\[
F=S\times\frac{1+r_{\text{domestic}}}{1+r_{\text{foreign}}}
\]
Money markets and cash instruments
| Instrument | Typical issuer/user | Main purpose | Key risk points |
|---|
| Treasury bill | Government | Short-term government funding | Low credit risk, but price varies with rates |
| Certificate of deposit | Bank | Tradable bank deposit | Bank credit risk, liquidity varies |
| Commercial paper | Corporates/financial issuers | Short-term unsecured funding | Credit risk; rollover risk |
| Repo | Securities holder borrowing cash | Secured financing using collateral | Collateral value, haircut, counterparty risk |
| Reverse repo | Cash lender receiving securities | Secured cash investment | Collateral and counterparty risk |
| Interbank deposit | Banks | Short-term bank funding | Bank credit and liquidity risk |
| Money market fund | Fund vehicle | Cash management/diversification | Not identical to a bank deposit; NAV/liquidity rules matter |
Discount and yield conventions
| Concept | Meaning | Exam reminder |
|---|
| Discount instrument | Issued below face value, matures at face value | Return is embedded in price appreciation |
| Yield instrument | Pays explicit interest/coupon | Compare on same annualization and day-count basis |
| Bid/offer spread | Dealer buys at bid, sells at offer | Client selling receives bid; client buying pays offer |
| Basis point | 0.01 percentage point | 100 bps = 1.00% |
| Annualization | Converts period return to annual equivalent | Simple and compound annualization are different |
Fixed income reference
Bond terminology
| Term | Meaning | Why it matters |
|---|
| Par/face value | Amount repaid at maturity | Coupon is usually calculated on par |
| Coupon | Contractual interest payment | Higher coupon increases cash flow and often lowers duration |
| Maturity | Final repayment date | Longer maturity usually means higher interest-rate risk |
| Clean price | Quoted price excluding accrued interest | Common bond quote convention |
| Dirty price | Settlement price including accrued interest | Cash paid at settlement |
| Accrued interest | Interest earned since last coupon date | Paid by buyer to seller at settlement |
| Yield to maturity | Discount rate equating price to promised cash flows | Assumes holding to maturity and reinvestment assumptions |
| Current yield | Coupon divided by price | Ignores capital gain/loss to maturity |
| Credit spread | Extra yield over reference government/swap curve | Compensation for credit, liquidity, and risk premia |
| Duration | Weighted average timing/sensitivity of cash flows | First-order price sensitivity to yield changes |
| Convexity | Curvature of price/yield relationship | Improves approximation for larger yield moves |
Bond types and decision rules
| Bond type | Main feature | Best fit | Key risk |
|---|
| Government bond | Sovereign issuer | Core defensive allocation, rate exposure | Inflation and rate risk; sovereign risk varies |
| Corporate bond | Company issuer | Income and credit spread exposure | Default/downgrade risk |
| Investment-grade bond | Higher credit quality | Lower credit risk income | Still exposed to rates and spread widening |
| High-yield bond | Lower credit quality | Higher income/risk appetite | Equity-like downside in stress |
| Zero-coupon bond | No periodic coupon; issued at discount | Known future liability matching | High duration for maturity |
| Floating-rate note | Coupon resets to reference rate plus margin | Lower interest-rate sensitivity | Credit spread and reset risk |
| Index-linked bond | Principal/coupon linked to inflation measure | Inflation protection | Real yield changes; index methodology |
| Callable bond | Issuer can redeem early | Higher coupon potential | Reinvestment risk when rates fall |
| Putable bond | Investor can sell back to issuer | Downside/rate protection | Lower yield versus comparable non-putable |
| Convertible bond | Bond plus equity conversion option | Hybrid income/growth exposure | Credit, equity, dilution, option valuation |
| Asset-backed security | Cash flows backed by asset pool | Diversified credit exposure | Prepayment, structure, collateral quality |
Price/yield and duration traps
| If this changes | Bond price effect | Duration effect/comment |
|---|
| Yield rises | Price falls | Longer duration = larger fall |
| Yield falls | Price rises | Longer duration = larger rise |
| Coupon rises | Price may be higher; duration lower | More cash flow received earlier |
| Maturity lengthens | Usually more sensitive | Especially for low-coupon bonds |
| Credit spread widens | Price falls | Credit deterioration or risk aversion |
| Inflation expectations rise | Nominal yields may rise | Nominal bond prices may fall |
| Bond approaches maturity | Price pulls toward redemption value | Pull-to-par assumes no default |
Equity markets reference
Equity security types
| Security | Holder position | Typical rights | Risk/return profile |
|---|
| Ordinary share/common stock | Ownership residual claim | Voting, dividends if declared, capital growth | Highest corporate claim risk among standard securities |
| Preference share/preferred stock | Hybrid-like equity claim | Priority dividend vs ordinary; terms vary | Rate-sensitive, issuer-specific terms matter |
| Depositary receipt | Claim on foreign shares via receipt structure | Economic exposure to overseas issuer | Currency, country, custody, liquidity risk |
| Rights | Temporary entitlement to buy new shares | Allows participation in new issue | Value depends on share price and subscription price |
| Warrant | Longer-dated right to buy shares | Often issued by company or institution | Option-like leverage; expiry risk |
Valuation ratios
| Ratio | Calculation | Interpretation | Trap |
|---|
| P/E | price / EPS | Price paid per unit of earnings | Low P/E may reflect low quality or declining earnings |
| Forward P/E | price / forecast EPS | Market valuation using expected earnings | Forecast risk |
| Dividend yield | dividend / price | Income return from dividends | High yield may signal dividend risk |
| Price/book | price / book value per share | Useful for banks, asset-heavy firms | Book value may not reflect economic value |
| EV/EBITDA | enterprise value / EBITDA | Capital-structure-neutral operating multiple | Ignores capex, tax, working capital |
| ROE | net income / equity | Profitability relative to equity capital | Leverage can inflate ROE |
| Payout ratio | dividends / earnings | Share of earnings paid out | Very high payout may be unsustainable |
Corporate actions
| Action | What happens | Investor wealth effect before market movement | Exam reminder |
|---|
| Cash dividend | Cash paid to shareholders | Share price often adjusts down on ex-dividend | Total value includes cash plus share value |
| Scrip dividend | Shares issued instead of cash | More shares, lower price per share mechanically | Check tax/accounting assumptions in question |
| Stock split | More shares at lower price per share | No automatic wealth creation | Liquidity/psychological effects possible |
| Consolidation/reverse split | Fewer shares at higher price per share | No automatic wealth creation | Per-share figures change |
| Bonus/capitalisation issue | Free additional shares from reserves | No automatic wealth creation | EPS and price per share adjust |
| Rights issue | Existing holders offered new shares | Value depends on discount and participation | TERP and right value are common calculations |
| Share buyback | Company repurchases shares | Can raise EPS if shares reduced | Value depends on price paid and capital allocation |
Rights issue quick method
For a “1 for n” rights issue:
| Step | Action |
|---|
| 1 | Identify old share price before rights, subscription price, and ratio |
| 2 | Calculate total value: n old shares at old price plus 1 new share at subscription price |
| 3 | Divide by n + 1 to get TERP |
| 4 | Value per right is old price minus TERP, assuming one right attaches to one old share |
| 5 | Check whether the investor subscribes, sells rights, or lets them lapse |
Foreign exchange reference
Quote logic
| Quote type | Meaning | Example logic |
|---|
| Direct quote | Domestic currency per 1 foreign currency | If GBP investor sees GBP/USD in domestic terms, define the quote carefully before calculating |
| Indirect quote | Foreign currency per 1 domestic currency | Reciprocal of direct quote |
| Base currency | First currency in common market notation | In EUR/USD, EUR is base |
| Terms/quote currency | Second currency in common market notation | In EUR/USD, USD is quote |
| Bid | Dealer buys base currency | Client sells base at bid |
| Offer/ask | Dealer sells base currency | Client buys base at offer |
| Spread | Offer minus bid | Cost and liquidity indicator |
FX forward and hedge rules
| Situation | Typical hedge | Directional logic |
|---|
| Investor will receive foreign currency | Sell foreign currency forward | Locks domestic value of future receipt |
| Investor will pay foreign currency | Buy foreign currency forward | Locks domestic cost |
| Overseas asset held by domestic investor | Sell foreign currency forward or use FX overlay | Reduces currency translation risk |
| Overseas liability | Buy foreign currency forward | Matches future outflow |
| Expected currency volatility but uncertain timing | Options may suit | Premium buys flexibility |
| Currency with higher interest rate | Trades at forward discount under interest parity logic | Depends on quote convention |
FX traps
| Trap | Correct approach |
|---|
| Confusing base and quote currency | Write “1 base = quote amount” before calculating |
| Using mid-price when bid/offer is given | Use bid or offer based on client action |
| Adding forward points incorrectly | Follow the quote convention; positive points normally add to spot in that convention |
| Ignoring hedge ratio | Hedge notional should match exposure unless partial hedge intended |
| Treating forward hedge as free | Forward price embeds interest-rate differential and opportunity cost |
Derivatives reference
Forwards, futures, options, swaps
| Instrument | Exchange/OTC tendency | Obligation? | Main uses | Key risks |
|---|
| Forward | OTC | Both parties obligated | Tailored hedge of price, rate, FX exposure | Counterparty, liquidity, settlement |
| Future | Exchange-traded | Both parties obligated | Standardised hedge/speculation | Margin calls, basis risk |
| Call option | Exchange or OTC | Buyer has right, seller has obligation | Upside exposure or hedge short exposure | Premium loss for buyer; potentially large seller loss |
| Put option | Exchange or OTC | Buyer has right, seller has obligation | Downside protection | Premium cost; seller downside |
| Interest-rate swap | OTC | Exchange fixed/floating cash flows | Manage rate exposure | Counterparty, valuation, basis |
| Currency swap | OTC | Exchange currency cash flows/principal terms | Long-term FX funding/hedging | FX, counterparty, liquidity |
| Credit derivative | OTC | Transfers credit risk | Hedge/speculate on credit events | Documentation, counterparty, jump risk |
Option positions
| Position | Market view | Maximum loss | Maximum gain | Common use |
|---|
| Long call | Bullish, wants upside | Premium | Theoretically unlimited | Leveraged upside |
| Short call | Neutral/bearish or income | Potentially unlimited if uncovered | Premium | Covered call income if stock held |
| Long put | Bearish or protective | Premium | Large, limited by asset price falling to zero | Portfolio insurance |
| Short put | Neutral/bullish income | Large, limited by asset price falling to zero | Premium | Income with obligation to buy |
| Covered call | Hold asset, sell call | Downside on asset less premium | Upside capped | Income enhancement |
| Protective put | Hold asset, buy put | Limited below strike net of premium | Upside retained less premium | Downside hedge |
Option Greeks
| Greek | Measures | Long call sign | Long put sign | Interpretation |
|---|
| Delta | Price sensitivity to underlying | Positive | Negative | Hedge ratio; directional exposure |
| Gamma | Delta sensitivity to underlying | Positive | Positive | Convexity; large near at-the-money expiry |
| Theta | Time decay | Usually negative | Usually negative | Options lose time value as expiry approaches |
| Vega | Sensitivity to implied volatility | Positive | Positive | Higher volatility increases option value |
| Rho | Sensitivity to interest rates | Usually positive | Usually negative | Often less important than delta/vega for short-dated equity options |
Hedging decision table
| Risk to hedge | Possible instrument | Choose when | Watch for |
|---|
| Equity market fall | Index futures short | Liquid, low-cost beta hedge | Basis risk, margin calls |
| Equity market fall with upside retained | Protective put | Need floor and can pay premium | Strike, expiry, implied volatility |
| Known FX receipt | FX forward sale | Amount/date reasonably certain | Opportunity cost if FX moves favourably |
| Uncertain FX exposure | FX option | Need flexibility | Premium cost |
| Rising interest rates for borrower | Pay-fixed receive-floating swap | Wants fixed funding cost | Counterparty and termination value |
| Falling interest rates for investor | Receive-fixed swap or longer duration | Wants lock-in of fixed income | Rate forecast risk |
| Commodity input cost | Commodity future/forward | Need price certainty | Basis and delivery/roll issues |
Funds and pooled investments
Vehicle comparison
| Vehicle | Structure | Pricing | Key point |
|---|
| Open-ended fund | Issues/redeems units with investor flows | Usually NAV-based | Fund size expands/contracts with demand |
| Closed-ended investment company/trust | Fixed capital listed vehicle | Market price may differ from NAV | Can trade at premium or discount |
| ETF | Listed fund, often index-tracking | Exchange price plus NAV mechanism | Intraday trading; spread and tracking error matter |
| Index fund | Passive exposure to benchmark | NAV-based or ETF form | Low active risk, not no risk |
| Active fund | Manager selects securities | NAV or market price by structure | Performance depends on skill, costs, style |
| Fund of funds | Invests in other funds | NAV-based | Diversification but layered fees possible |
| Hedge fund | Flexible strategies | Periodic valuation/liquidity terms | Leverage, shorting, derivatives, liquidity gates possible |
| Private equity fund | Invests in private companies | Infrequent valuation | Illiquidity, capital calls, J-curve |
Fund metrics
| Metric | Meaning | Exam use |
|---|
| NAV per unit | assets less liabilities divided by units | Base valuation for open-ended funds |
| Premium to NAV | market price above NAV | Closed-ended/ETF market demand indicator |
| Discount to NAV | market price below NAV | May reflect sentiment, liquidity, fees, leverage |
| Ongoing charges | Recurring fund costs | Reduce investor return |
| Tracking error | Variability of active return vs benchmark | Passive implementation or active risk measure |
| Active share | Difference from benchmark holdings | High active share means more benchmark deviation |
| Turnover | Trading activity | Costs and style clue |
| Distribution yield | Income distributed relative to price | Not the same as total return |
Alternatives and real assets
| Asset class | Return drivers | Diversification role | Key risks |
|---|
| Direct property | Rent, occupancy, capital values | Income and inflation linkage potential | Illiquidity, valuation lag, concentration |
| REIT/property securities | Listed property exposure | Easier trading than direct property | Equity market correlation, rate sensitivity |
| Commodities | Spot prices, roll yield, collateral return | Inflation/geopolitical hedge potential | No inherent income; futures curve effects |
| Gold/precious metals | Real rates, currency confidence, risk aversion | Crisis hedge potential | No cash flow; sentiment-driven |
| Infrastructure | Contracted cash flows, economic usage | Long-duration income potential | Political, regulatory, leverage, liquidity |
| Hedge funds | Strategy alpha, market dislocations | Alternative return streams | Fees, leverage, opacity, liquidity |
| Private equity | Operational improvement, leverage, multiple expansion | Long-term growth | Illiquidity, valuation uncertainty, vintage risk |
| Structured products | Embedded derivative payoff | Tailored payoff profile | Issuer credit, complexity, liquidity |
Market structure and trading
Primary vs secondary markets
| Market | Function | Participants | Exam distinction |
|---|
| Primary market | New securities issued | Issuer, underwriters, investors | Raises capital for issuer |
| Secondary market | Existing securities traded | Investors, brokers, dealers, market makers | Provides liquidity and price discovery |
| Public offer | Securities offered broadly | Issuer, advisers, public investors | Disclosure and process requirements depend on jurisdiction |
| Private placement | Securities sold to selected investors | Issuer and eligible/sophisticated investors | Less liquid; terms negotiated |
| Rights issue | New shares offered to existing shareholders | Company and shareholders | Protects pre-emption/economic position if taken up or sold |
| Structure | How prices form | Strength | Weakness |
|---|
| Order-driven market | Buy/sell orders interact in order book | Transparency and competition | Liquidity can disappear in stress |
| Quote-driven market | Market makers quote bid/offer | Continuous liquidity provision | Wider spreads in difficult markets |
| Auction | Orders matched at clearing price | Efficient for opens/closes/illiquid securities | Timing concentration |
| OTC market | Bilateral trading | Customisation | Counterparty and transparency issues |
| Exchange-traded market | Standardised venue rules | Transparency, clearing, liquidity | Less customisation |
Order types
| Order | Meaning | Use | Trap |
|---|
| Market order | Execute immediately at best available price | Speed | Execution price uncertain |
| Limit order | Execute at specified price or better | Price control | May not execute |
| Stop order | Triggered when stop price reached | Risk control or breakout entry | Trigger price not guaranteed execution price |
| Stop-limit order | Stop trigger plus limit price | More control than stop | May fail to execute in fast market |
| Good-for-day | Valid for trading day | Short-lived instruction | Expires if not filled |
| Good-till-cancelled | Remains until cancelled/expiry rules | Persistent instruction | Must be monitored |
Clearing, settlement, custody, and operational risk
| Term | Meaning | Candidate focus |
|---|
| Trade date | Date transaction is agreed | Market exposure begins economically |
| Settlement date | Date cash and securities exchange | Settlement cycles vary by market/instrument |
| Delivery versus payment | Securities delivered only if payment made | Reduces principal risk |
| Central counterparty | Interposes between buyer and seller | Reduces bilateral counterparty risk; concentrates risk |
| Margin | Collateral for derivative/financing exposure | Initial vs variation margin |
| Custodian | Safekeeps assets and administers events | Asset servicing, income, corporate actions |
| Nominee | Registered holder on behalf of beneficial owner | Operational convenience; ownership records matter |
| Failed trade | Settlement does not complete on time | Liquidity, operational, and reputational risk |
| Reconciliation | Matching records across systems/parties | Key control against operational errors |
Risk types
| Risk | Definition | Example |
|---|
| Market risk | Loss from price movements | Equity index falls |
| Interest-rate risk | Loss from yield curve movement | Bond price falls when yields rise |
| Credit/default risk | Issuer/counterparty fails to pay | Corporate bond default |
| Spread risk | Credit/liquidity spread widens | Investment-grade bond falls despite stable government yields |
| Liquidity risk | Cannot trade quickly at fair price | Property fund redemption stress |
| Currency risk | FX movement affects value | Overseas equity falls in domestic terms |
| Inflation risk | Purchasing power erodes | Cash earns below inflation |
| Reinvestment risk | Cash flows reinvested at lower rates | Callable bond redeemed after rates fall |
| Concentration risk | Too much exposure to one issuer/sector | Employer stock concentration |
| Operational risk | Process, system, people failure | Incorrect settlement instruction |
| Model risk | Valuation/risk model is wrong | Mispriced structured product |
| Political/regulatory risk | Policy or rule change affects value | Sector affected by government decision |
| Measure | Plain calculation | Use | Trap |
|---|
| Absolute return | portfolio return | Did the portfolio gain or lose? | Ignores benchmark and risk |
| Relative return | portfolio return minus benchmark return | Active performance | Benchmark must be appropriate |
| Alpha | return above CAPM-expected return | Manager skill estimate | Can reflect omitted risk factors |
| Beta | sensitivity to market | Systematic risk | Beta changes over time |
| Sharpe ratio | excess return / total volatility | Risk-adjusted return for total risk | Penalises upside and downside volatility equally |
| Treynor ratio | excess return / beta | Reward per unit of systematic risk | Requires diversified portfolio assumption |
| Information ratio | active return / tracking error | Active manager consistency | High ratio may not persist |
| Tracking error | volatility of active return | Benchmark-relative risk | Low tracking error can still underperform |
| Maximum drawdown | peak-to-trough loss | Downside experience | Backward-looking |
| VaR | loss threshold at confidence over horizon | Tail risk summary | Not worst-case loss |
| Expected shortfall | average loss beyond VaR threshold | Tail severity | Model-dependent |
Time-weighted vs money-weighted returns
| Return measure | Cash flow treatment | Best use | Exam trap |
|---|
| Time-weighted return | Removes effect of external cash flow timing | Assess manager performance | Requires sub-period linking |
| Money-weighted return | Internal rate of return including cash flow timing | Assess investor’s actual experience | Heavily affected by when client adds/withdraws money |
Suitability-style decision rules for wealth management
| Client objective or constraint | Instruments/approaches often considered | Avoid assuming |
|---|
| Capital preservation | Cash, money market, high-quality short-duration bonds | That nominal capital preservation protects real purchasing power |
| Income | Bonds, dividend equities, property, income funds | That high yield is sustainable or low risk |
| Long-term growth | Equities, diversified multi-asset, selected alternatives | That volatility equals permanent loss for long horizons |
| Inflation protection | Index-linked bonds, equities, property, commodities | That every “real asset” hedges inflation in every period |
| Liquidity need | Cash, liquid funds, listed securities | That listed always means liquid at fair value |
| Liability matching | Bonds/cash flows matched to timing and currency | That return maximisation is the main goal |
| Currency exposure | FX forwards/options, natural hedges | That hedging always improves returns |
| Downside protection | Puts, structured payoffs, lower-risk allocation | That protection is free |
| Tax-sensitive investing | Asset location, turnover awareness, after-tax return focus | That pre-tax return is client outcome |
| Ethical/ESG preference | Screened funds, thematic funds, stewardship approaches | That labels alone define risk or impact |
Instrument selection matrix
| Need | More suitable | Less suitable | Reason |
|---|
| Known cash need in months | Cash/money market | Long-duration bonds/equities | Liquidity and capital certainty matter |
| Lock fixed income for a known future date | High-quality bond maturing near liability date | Perpetual or long equity exposure | Cash-flow matching |
| Hedge equity beta temporarily | Index futures | Selling every holding | Fast, cost-efficient overlay |
| Keep equity upside but limit downside | Protective put | Short futures hedge | Put preserves upside after premium |
| Generate extra income from held shares | Covered call | Naked short call | Covered call caps upside but avoids uncovered call exposure |
| Hedge known foreign currency receipt | Sell FX forward | Speculative FX option only | Forward locks future conversion rate |
| Reduce interest-rate sensitivity | Shorter duration or floating-rate exposure | Long zero-coupon bonds | Lower duration |
| Seek credit income | Diversified corporate bond fund | Single low-quality issuer | Diversification reduces idiosyncratic default exposure |
| Access illiquidity premium | Private markets allocation | Daily-liquidity cash reserve | Time horizon must support lock-up |
| Track broad market cheaply | Index fund/ETF | High-cost closet tracker | Lower active and fee drag |
Common calculation traps
| Trap | Correct habit |
|---|
| Confusing percent and decimal | 5% = 0.05; 50 bps = 0.50% |
| Treating basis points as percentages | 1 bp = 0.01 percentage point |
| Ignoring accrued interest | Bond settlement uses dirty price |
| Using current yield as YTM | Current yield ignores redemption gain/loss |
| Forgetting price/yield inverse relation | Yield up means bond price down |
| Applying duration to large yield moves without caution | Add convexity intuition for large moves |
| Ignoring sign of short positions | Short gains when price falls, loses when price rises |
| Using wrong FX side | Client buys at offer, sells at bid |
| Annualising incorrectly | Use same compounding convention as question |
| Comparing nominal and real returns | Adjust for inflation when purchasing power matters |
| Mixing arithmetic and geometric returns | Geometric is better for compounded multi-period performance |
| Ignoring dividends/coupons in total return | Include income unless question says price return only |
| Assuming diversification eliminates all risk | It reduces unsystematic risk, not systematic market risk |
| Treating correlation as stable | Correlations can rise in market stress |
Common conceptual traps
| Statement | Why it is incomplete or wrong |
|---|
| “Government bonds are risk-free.” | They may have low default risk but still have rate, inflation, currency, and liquidity risk |
| “A high dividend yield is attractive.” | It may signal falling price or expected dividend cut |
| “A low P/E means undervalued.” | It may reflect weak growth, cyclicality, accounting issues, or high risk |
| “Hedging removes risk.” | Hedging exchanges one risk for another: basis risk, cost, liquidity, opportunity cost |
| “Options are always riskier than futures.” | Long options have limited loss; futures have symmetric exposure and margin calls |
| “Closed-ended fund discount means bargain.” | Discount can persist or widen due to fees, leverage, performance, or sentiment |
| “Cash has no risk.” | Cash has inflation, reinvestment, currency, and institution risk |
| “Higher yield means better bond.” | Higher yield often compensates for higher credit, liquidity, or structural risk |
| “Passive funds cannot underperform.” | Fees, tracking error, sampling, taxes, and cash drag can cause underperformance |
| “VaR is maximum loss.” | VaR is a threshold estimate, not the worst possible loss |
Final review checklist
Before exam day, make sure you can quickly:
- Explain price/yield inverse movement and identify which bond has higher duration.
- Calculate holding period return, real return, current yield, approximate YTM, and TERP.
- Distinguish clean price, dirty price, and accrued interest.
- Use bid/offer correctly in FX and securities dealing questions.
- Select between forward, future, option, and swap for a hedge scenario.
- Compare open-ended funds, closed-ended funds, ETFs, and investment trusts/companies.
- Interpret Sharpe ratio, information ratio, tracking error, beta, alpha, VaR, and drawdown.
- Recognise when liquidity, currency, tax, inflation, and time horizon dominate instrument choice.
- Avoid treating labels such as “income,” “defensive,” “guaranteed,” or “alternative” as substitutes for risk analysis.
Practical next step
Next, practise timed mixed-question sets for CISI CWM FM and review every missed question by tagging the error type: formula, instrument feature, market convention, risk concept, or suitability decision.