CISI IM — CISI Investment Management (Level 4) Cheat Sheet

Use the tables for a quick pre-exam check. Expand a topic’s notes for explanations, examples, and additional distinctions.

Scope and study context

High-yield approach:

1. Learn the investment process: client objectives, constraints, asset allocation, implementation, monitoring.
2. Practise calculations: return, risk, beta, CAPM, bond pricing, duration, performance ratios.
3. Link theory to suitability: a technically correct product can still be unsuitable for the client mandate.
4. Watch wording: “nominal” vs “real”, “yield” vs “return”, “coupon” vs “YTM”, “systematic” vs “specific” risk.

It is designed to help you:

• Recall the core investment management framework.
• Spot common exam traps in portfolio construction, asset classes, risk, valuation, derivatives, and performance.
• Connect concepts to decision rules rather than memorising isolated definitions.
• Prepare for independent companion practice using original practice questions and a question bank.

This page is independent exam-prep support and is not affiliated with the Chartered Institute for Securities & Investment.

For CISI Investment Management (Level 4), passive reading is not enough. Use this Cheat Sheet to guide original practice questions in a structured way.

Recommended practice sequence

1. Topic drills

   • Start with one area at a time: fixed income, equities, derivatives, portfolio theory, performance, and ethics.
   • After each set, write down the rule that would have solved the question faster.

2. Mixed question-bank sets

   • Mix topics once individual areas feel familiar.
   • Focus on recognising the question type: calculation, suitability, definition, comparison, or scenario judgement.

3. Timed mock exams

   • Practise pacing and decision-making under pressure.
   • Review every uncertain question, including those answered correctly.

4. Detailed explanations

   • Use explanations to understand why the correct answer is best and why distractors are wrong.
   • Build an error log grouped by concept, not by question number.

5. Final review

   • Revisit weak topics.
   • Redo missed questions after a delay.
   • Practise “least likely” and “most appropriate” wording carefully.

Error log template

Missed topic	Why I missed it	Correct rule	Drill again?
Duration	Treated maturity as duration	Longer modified duration means greater price sensitivity	Yes
Performance	Used MWR instead of TWR	Use TWR to assess manager skill when cash flows are external	Yes
Derivatives	Confused right and obligation	Option buyer has right; futures/forwards create obligations	Yes
Suitability	Ignored liquidity need	Short-term cash need limits illiquid investments	Yes

Core Exam Map

Investment Management Process

Notes and examples

Strategic vs Tactical Asset Allocation

Feature	Strategic Asset Allocation	Tactical Asset Allocation
Purpose	Long-term policy mix	Short/medium-term deviation from policy
Based on	Client objectives and risk profile	Market views, valuation, cycle expectations
Time horizon	Long term	Shorter term
Risk	Policy risk if wrong long-term mix	Market timing risk
Exam cue	“Long-term target allocation”	“Overweight/underweight based on view”

Active vs Passive Management

Feature	Active	Passive
Objective	Outperform benchmark	Track benchmark
Source of return	Security selection, timing, factor exposure	Market/index return
Cost	Usually higher	Usually lower
Key risk	Underperformance, style drift	Tracking error, index concentration
Best fit	Inefficient markets, specialist mandates	Broad market exposure, cost-sensitive mandates
Exam trap	Active return must be judged after costs and risk	Passive does not mean risk-free

Client Suitability Checklist

Core Return and Risk Formulas

Holding period return:

\[ \text{HPR} = \frac{P_1 - P_0 + I}{P_0} \]

Where \(P_0\) is opening price, \(P_1\) is closing price and \(I\) is income received.

Real return approximation:

\[ r_{\text{real}} \approx r_{\text{nominal}} - \pi \]

Exact real return:

\[ 1 + r_{\text{real}} = \frac{1 + r_{\text{nominal}}}{1 + \pi} \]

Compound annual growth rate:

\[ \text{CAGR} = \left(\frac{V_n}{V_0}\right)^{1/n} - 1 \]

Expected portfolio return:

\[ E(R_p) = \sum_{i=1}^{n} w_i E(R_i) \]

Two-asset portfolio variance:

\[ \sigma_p^2 = w_A^2\sigma_A^2 + w_B^2\sigma_B^2 + 2w_Aw_B\sigma_A\sigma_B\rho_{AB} \]

Standard deviation:

\[ \sigma_p = \sqrt{\sigma_p^2} \]

Beta:

\[ \beta_i = \frac{\operatorname{Cov}(R_i,R_m)}{\operatorname{Var}(R_m)} \]

CAPM required return:

\[ E(R_i) = R_f + \beta_i \left(E(R_m) - R_f\right) \]

Jensen’s alpha:

\[ \alpha_i = R_i - \left[R_f + \beta_i(R_m - R_f)\right] \]

Portfolio Theory: Fast Distinctions

Notes and examples

Correlation Decision Rules

Correlation	Diversification Effect	Exam Cue
+1.0	No risk reduction from combining assets	Assets move perfectly together
Between 0 and +1	Some risk reduction	Common in real portfolios
0	Better diversification	No linear relationship
Between -1 and 0	Strong diversification	Assets often move in opposite directions
-1.0	Theoretically can eliminate risk with correct weights	Rare in practice

Risk-Adjusted Performance Measures

Notes and examples

Performance Measurement Traps

Trap	Correct Treatment
High return automatically means good manager	Adjust for risk, benchmark and costs
Sharpe and Treynor are interchangeable	Sharpe uses total risk; Treynor uses beta
Tracking error is underperformance	Tracking error is variability of relative returns
Positive alpha guarantees skill	Could be luck, model error, style exposure or omitted risk
Benchmark can be any index	Benchmark must match mandate, currency, risk and asset mix

Performance measurement and attribution

Performance questions often turn on selecting the right measure.

Measure	Use when	Key point
Time-weighted return	Evaluating manager skill independent of cash flows	Removes effect of external cash flow timing
Money-weighted return	Evaluating investor experience including cash flows	Influenced by timing and size of contributions/withdrawals
Benchmark-relative return	Comparing with mandate	Benchmark must match strategy
Sharpe ratio	Comparing total risk-adjusted performance	Uses total volatility
Information ratio	Comparing active management skill	Uses tracking error
Alpha	Excess return after expected risk exposure	Must be interpreted net of costs and risk
Attribution	Explaining sources of relative return	Allocation and selection effects matter

Attribution basics

Attribution effect	Meaning
Asset allocation effect	Value added or lost from overweighting/underweighting asset classes or sectors
Security selection effect	Value added or lost from choosing securities within a segment
Interaction effect	Combined impact of allocation and selection
Currency effect	Impact of foreign exchange exposure
Cost effect	Performance drag from fees, spreads, taxes, and trading

Performance traps

• Comparing an equity fund to a cash benchmark.
• Using money-weighted return to judge manager skill when cash flows were investor-driven.
• Ignoring risk taken to achieve return.
• Ignoring survivorship bias in fund comparisons.
• Looking only at recent performance.
• Comparing gross returns when net returns are relevant.
• Treating benchmark outperformance as good if absolute losses breach client objectives.

Time-Weighted vs Money-Weighted Return

Key trap: if the client controls cash-flow timing, money-weighted return reflects the client experience; if judging the manager, time-weighted return is usually more appropriate.

Asset Class Quick Matrix

Bonds and Fixed Income

Bond Price and Yield

Bond price as present value of cash flows:

\[ P = \sum_{t=1}^{n} \frac{C_t}{(1+y)^t} + \frac{M}{(1+y)^n} \]

Where \(C_t\) is coupon cash flow, \(M\) is maturity value and \(y\) is yield per period.

Approximate price change from yield move:

\[ \frac{\Delta P}{P} \approx -D_{\text{mod}}\Delta y \]

Modified duration:

\[ D_{\text{mod}} = \frac{D_{\text{Mac}}}{1 + y/m} \]

Fixed Income Decision Rules

Bond Risks

Yield Curve Interpretation

Notes and examples

Fixed income

Fixed income questions often test directionality: what happens to bond prices when yields, credit spreads, inflation expectations, or issuer quality change?

Bond fundamentals

Feature	Meaning	Exam point
Coupon	Periodic interest payment	Higher coupon generally lowers duration, all else equal
Maturity	Date principal is due	Longer maturity usually increases interest-rate risk
Yield	Return measure based on price and cash flows	Yield rises when price falls
Credit rating	Assessment of creditworthiness	Ratings can change and are not guarantees
Seniority	Claim ranking in default	Subordinated debt has higher credit risk
Callable feature	Issuer can redeem early	Investor faces reinvestment risk if called
Floating-rate coupon	Coupon resets with reference rate	Lower duration than fixed-rate debt, but credit risk remains
Inflation-linked bond	Cash flows linked to inflation measure	Protects real value depending on structure and holding period

Price and yield rule

Change	Typical bond price effect
Market yield rises	Price falls
Market yield falls	Price rises
Credit spread widens	Price falls
Credit spread narrows	Price rises
Longer duration	Greater sensitivity to yield changes
Higher coupon	Lower duration than otherwise similar lower-coupon bond
Lower credit quality	Higher required yield, higher default risk
Higher inflation expectations	Nominal yields may rise, pressuring fixed-rate bonds

Duration traps

• Duration is not maturity. It measures sensitivity to yield changes.
• Longer duration means more price volatility for a given yield change.
• Modified duration gives an approximation, not an exact result.
• Convexity matters more for large yield moves.
• Credit spread risk is separate from interest-rate risk.
• Holding to maturity reduces price-realisation risk only if the issuer does not default and the investor can truly hold to maturity.

Risk management

Risk is multi-dimensional. The exam may ask which risk is most relevant in a scenario.

Risk type	What it means	Example trigger
Market risk	Loss from market price movements	Equity market decline
Interest-rate risk	Bond price sensitivity to yield changes	Central bank tightening expectations
Credit risk	Issuer or counterparty fails to pay	Downgrade or default
Liquidity risk	Cannot sell quickly at fair price	Stressed property fund redemptions
Inflation risk	Real purchasing power falls	Cash returns below inflation
Currency risk	FX movement affects returns	Overseas holding translated back
Concentration risk	Too much exposure to one issuer, sector, or factor	Single-stock portfolio
Reinvestment risk	Future cash flows reinvested at lower rates	Callable bond redeemed early
Operational risk	Process, system, or human failure	Trade error
Counterparty risk	Other party fails to perform	OTC derivative default
Political/regulatory risk	Rule or policy changes affect value	Tax or market access changes

Risk measure review

Measure	Best use	Limitation
Standard deviation	Total volatility	Treats upside and downside volatility similarly
Beta	Market sensitivity	Ignores specific risk
Value at Risk	Estimated loss threshold over time/confidence	Does not show worst possible loss
Drawdown	Peak-to-trough loss	Backward-looking
Tracking error	Active risk versus benchmark	Low tracking error does not mean low absolute risk
Sharpe ratio	Excess return per unit of total risk	Sensitive to volatility assumptions
Information ratio	Active return per unit of active risk	Depends on benchmark quality

Equity Valuation and Analysis

Key Equity Formulas

Dividend discount model for a constant-growth share:

\[ P_0 = \frac{D_1}{r - g} \]

Required return rearranged:

\[ r = \frac{D_1}{P_0} + g \]

Earnings per share:

\[ \text{EPS} = \frac{\text{Profit attributable to ordinary shareholders}}{\text{Weighted average ordinary shares}} \]

Price/earnings ratio:

\[ \text{P/E} = \frac{\text{Share price}}{\text{EPS}} \]

Dividend yield:

\[ \text{Dividend yield} = \frac{\text{Dividend per share}}{\text{Share price}} \]

Total shareholder return:

\[ \text{TSR} = \frac{\text{Price change} + \text{Dividends}}{\text{Opening price}} \]

Theoretical ex-rights price:

\[ \text{TERP} = \frac{(N_{\text{old}}\times P_{\text{old}}) + (N_{\text{new}}\times S)}{N_{\text{old}} + N_{\text{new}}} \]

Equity Ratios

Equity Style Distinctions

Funds and Collective Investments

Notes and examples

Open-Ended vs Closed-Ended

Feature	Open-Ended Fund	Closed-Ended Fund
Units/shares	Created or cancelled with investor flows	Fixed share capital unless corporate action
Price anchor	Net asset value	Market supply/demand as well as NAV
Liquidity pressure	Manager may need to buy/sell assets for flows	Portfolio not forced to meet redemptions
Premium/discount	Usually limited	Can trade above or below NAV
Gearing	Usually more constrained	Investment trusts may use gearing
Exam cue	“Redeem with fund”	“Trade on exchange at premium/discount”

Passive Fund Terms

Term	Meaning
Tracking error	Volatility of difference between fund return and index return
Tracking difference	Actual return gap between fund and index over a period
Physical replication	Holds index constituents or sample
Synthetic replication	Uses derivatives to deliver index return
Full replication	Holds all index securities
Sampling	Holds representative subset
Securities lending	Lending holdings to earn extra income; adds counterparty/operational risk

Collective investments

Collective investments allow investors to access diversified portfolios, professional management, and specific strategies. The structure matters.

Structure or concept	Review point	Common trap
Open-ended fund	Units created/redeemed based on investor flows	Liquidity depends on underlying assets
Closed-ended fund	Fixed capital traded on market	Can trade at premium or discount to NAV
ETF	Exchange-traded fund, often index-tracking	Trading price, spread, and tracking error matter
Index fund	Seeks to replicate an index	Low cost does not mean no risk
Active fund	Manager seeks to outperform	Must justify fees and active risk
NAV	Net asset value of portfolio	Market price may differ for closed-ended vehicles
Ongoing charges	Cost drag on returns	Gross performance can mislead
Tracking error	Deviation from benchmark returns	Low tracking error is expected for passive funds
Gearing	Borrowing or leverage	Magnifies gains and losses

Fund selection checklist

1. Does the fund objective match the investor objective?
2. Is the benchmark appropriate?
3. Are charges reasonable for the strategy?
4. Is performance repeatable or explained by one market phase?
5. What risks are taken to achieve return?
6. Is liquidity consistent with the underlying assets?
7. Is the manager constrained by mandate?
8. Are income and accumulation share classes understood?

Derivatives Cheat Sheet

Option Payoffs

Call option payoff at expiry:

\[ \text{Call payoff} = \max(S_T - K, 0) \]

Put option payoff at expiry:

\[ \text{Put payoff} = \max(K - S_T, 0) \]

Option buyer maximum loss is the premium paid. Option writer may face much larger losses, especially on uncovered calls.

Derivative Instruments

Options Strategy Table

Greeks

Notes and examples

Derivatives

Derivatives derive value from an underlying asset, rate, index, currency, or other reference item. They may be used for hedging, efficient portfolio management, income enhancement, or speculation.

Derivative	Core feature	Buyer/holder position	Main exam distinction
Forward	Custom OTC agreement	Obligation to transact later	Counterparty risk and bespoke terms
Future	Exchange-traded standardised contract	Obligation to transact or settle	Margining and daily settlement
Call option	Right to buy	Benefits if underlying rises	Right, not obligation
Put option	Right to sell	Benefits if underlying falls	Downside protection use
Swap	Exchange of cash flows	Depends on swap terms	Interest-rate or currency exposure management

Option payoff logic

Position	View or purpose	Maximum loss concept
Long call	Bullish or upside exposure	Premium paid
Short call	Income, neutral/bearish	Potentially unlimited if uncovered
Long put	Bearish or protection	Premium paid
Short put	Income, willingness to buy	Large loss if underlying falls
Covered call	Income on held asset	Upside capped
Protective put	Downside protection	Cost of premium

Derivatives traps

Trap	Correct approach
Confusing futures and options	Futures create obligations; options give rights to buyers
Ignoring margin	Futures losses may require cash before final settlement
Calling all derivatives speculative	Derivatives can hedge or increase risk depending on use
Forgetting counterparty risk	OTC contracts depend on counterparty performance
Ignoring basis risk	Hedge may not perfectly match exposure
Treating option premium as irrelevant	Premium changes breakeven and return

Economics and Market Drivers

Notes and examples

Monetary vs Fiscal Policy

Policy Type	Tools	Transmission
Monetary policy	Interest rates, asset purchases/sales, liquidity operations	Affects discount rates, credit, currency, asset prices
Fiscal policy	Taxation, government spending, borrowing	Affects demand, sectors, deficits and bond supply

Economics and markets

Investment management questions often test the link between macroeconomic conditions and asset prices.

Macro factor	Typical effect	Watch the nuance
Rising interest rates	Bond prices usually fall; discount rates rise for equities	Floating-rate assets may be less sensitive
Falling interest rates	Bond prices usually rise; growth assets may benefit	Falling rates caused by recession may still hurt risk assets
Rising inflation	Erodes real returns; may pressure bonds	Real assets may help, but not perfectly
Strong economic growth	Can support earnings and credit quality	May also lead to tighter monetary policy
Weak growth	Defensive sectors and high-quality bonds may outperform	Credit spreads may widen
Currency appreciation	Helps domestic investors holding domestic assets; hurts foreign earnings translation	Depends on investor base and revenue exposure
Currency depreciation	Can boost overseas asset values in domestic currency	Also raises import costs and inflation pressure
Steepening yield curve	Longer yields rising relative to short yields, or short yields falling	Understand whether it reflects growth hopes or rate cuts
Inverted yield curve	Short yields above long yields	Often associated with expectations of slower growth or policy easing

Yield curve traps

Yield curve move	Meaning	Portfolio impact to consider
Parallel shift	All maturities move by similar amount	Duration is a useful approximation
Steepening	Long yields rise relative to short yields, or short yields fall more	Long-duration bonds may underperform
Flattening	Short yields rise relative to long yields, or long yields fall more	Short and long maturities behave differently
Credit spread widening	Corporate yields rise relative to government yields	Credit-sensitive bonds fall even if government yields are stable
Credit spread tightening	Corporate yields fall relative to government yields	Credit assets may outperform government bonds

Tax, Charges and Net Return Logic

Tax treatment can change with jurisdiction and time. For exam questions, use the tax rates, allowances or assumptions given in the question or current official study material.

Notes and examples

After-tax return when a single tax rate applies to a taxable return component:

\[ r_{\text{after tax}} = r_{\text{gross}}(1 - t) \]

Risk Types and Controls

Notes and examples

VaR and Stress Testing

Tool	What It Shows	Limitation
Value at Risk	Estimated loss threshold over a period at confidence level	Does not show maximum loss beyond threshold
Stress test	Portfolio effect of severe scenario	Scenario may not occur or may be incomplete
Sensitivity analysis	Impact of one variable changing	Ignores interaction between variables
Scenario analysis	Combined impact of multiple changes	Depends heavily on assumptions

Benchmarks and Attribution

High-Yield Calculation Traps

Mini Decision Tables

Which Performance Measure?

Notes and examples

Which Fixed Income Strategy?

Scenario	Better Fit
Expect yields to fall	Longer duration benefits more
Expect yields to rise	Shorter duration reduces price loss
Need inflation protection	Index-linked exposure
Need high certainty of liability payment	Match maturity/duration and currency
Seek extra income and accept credit risk	Corporate bonds
Concerned about default risk	Higher-quality issuers and diversification

Which Fund Structure?

Scenario	Better Fit
Low-cost broad market exposure	Index fund or ETF
Intraday trading required	ETF
Want manager to hold illiquid assets without redemptions pressure	Closed-ended investment trust
Need simple daily-dealt diversified fund	OEIC or unit trust
Willing to accept premium/discount and gearing risk	Investment trust
Need exact custom hedge	Derivative or segregated mandate, if suitable

Final Review Checklist

Before exam day, make sure you can:

• Calculate holding period return, real return, CAGR, portfolio expected return and two-asset risk.
• Explain why correlation below +1 reduces portfolio risk.
• Apply CAPM and interpret beta, alpha and market risk premium.
• Distinguish Sharpe, Treynor, Jensen’s alpha, information ratio and tracking error.
• Explain bond price/yield movement, duration and credit spread risk.
• Compare equities using P/E, dividend yield, EPS, ROE and growth assumptions.
• Identify when open-ended funds, closed-ended funds, ETFs and direct holdings are suitable.
• Interpret option payoffs and basic hedge positions.
• Choose between strategic and tactical asset allocation.
• Recognise suitability conflicts: liquidity, risk capacity, time horizon, tax and currency.

High-yield review map

Core investment management framework

A strong exam answer usually follows the investment process rather than jumping straight to a product.

    flowchart TD
	    A[Client or fund objective] --> B[Risk tolerance and capacity]
	    B --> C[Constraints: time, liquidity, tax, regulation, mandate]
	    C --> D[Strategic asset allocation]
	    D --> E[Security or fund selection]
	    E --> F[Implementation and dealing]
	    F --> G[Monitoring, rebalancing, performance review]
	    G --> A

Notes and examples

Key distinction: objective, constraint, and recommendation

Concept	Meaning	Exam trap
Return objective	Required or desired return target	Confusing desired return with achievable return
Risk tolerance	Willingness to accept risk	Treating willingness as the same as capacity
Risk capacity	Financial ability to withstand loss	Ignoring time horizon or liquidity needs
Time horizon	Period before funds are needed	Assuming all long-term investors can take high risk
Liquidity need	Need for cash or easy realisation	Recommending illiquid assets despite foreseeable withdrawals
Tax position	Impact of income, gains, wrappers, or jurisdictional treatment	Comparing gross returns when after-tax return is relevant
Mandate	Formal limits on what may be held	Selecting an asset outside permitted limits
Benchmark	Standard for performance and risk comparison	Using a benchmark that does not match the strategy

Fast decision rule

Before choosing an investment, ask:

1. What is the money for?
2. When is it needed?
3. How much loss can be tolerated and absorbed?
4. Is income, growth, capital preservation, or inflation protection the priority?
5. What constraints limit the solution?
6. How will success be measured?

Core formulas to recognise

Use formulas to understand relationships, not just to calculate.

\[ E(R_p)=\sum_i w_iE(R_i) \]\[ \sigma_p^2=w_A^2\sigma_A^2+w_B^2\sigma_B^2+2w_Aw_B\rho_{AB}\sigma_A\sigma_B \]

Capital Asset Pricing Model:

\[ E(R_i)=R_f+\beta_i(E(R_m)-R_f) \]

Sharpe ratio:

\[ \text{Sharpe ratio}=\frac{R_p-R_f}{\sigma_p} \]

Approximate price impact of a yield change:

\[ \frac{\Delta P}{P}\approx -D_{\text{mod}}\times \Delta y \]

Formula interpretation traps

Asset allocation

Asset allocation is often the largest driver of portfolio risk and return. Security selection matters, but the strategic split between asset classes usually sets the portfolio’s overall profile.

Notes and examples

Strategic vs tactical allocation

Allocation type	Purpose	Common mistake
Strategic asset allocation	Long-term policy mix based on objectives and constraints	Changing it too often based on short-term noise
Tactical asset allocation	Shorter-term deviations to exploit market views	Treating tactical views as guaranteed outcomes
Dynamic allocation	Adjusting exposure as conditions or risk levels change	Ignoring transaction costs and governance
Rebalancing	Restoring target weights	Letting winners dominate risk unintentionally

Equities

Equities represent ownership. Returns come from dividends, earnings growth, valuation changes, and currency effects for overseas holdings.

Notes and examples

Equity styles

Style	Typical features	Main risk
Value	Low valuation multiples, recovery potential	Value trap: cheap for a reason
Growth	High expected earnings growth	Valuation risk if expectations disappoint
Income	Higher dividend yield	Dividend cuts and sector concentration
Quality	Strong balance sheet, stable profitability	May become expensive
Small-cap	Smaller companies, growth potential	Liquidity and business risk
Momentum	Recent outperformers	Reversal risk

Equity valuation decision points

Question	Why it matters
Are earnings recurring or one-off?	Sustainable valuation depends on repeatable profits
Is dividend cover adequate?	Weak cover may imply dividend risk
Is debt high?	Leverage magnifies equity risk
Is valuation high because of quality or speculation?	The same multiple can have different implications
Is growth already priced in?	Good company does not always mean good investment
Is the investor exposed to currency risk?	Overseas equities add FX effects

Cash and money market instruments

Cash is not risk-free in every sense. It may reduce volatility and provide liquidity, but it can lose purchasing power after inflation.

Cash suitability traps

Alternatives and real assets

Alternatives can diversify portfolios but often introduce valuation, liquidity, leverage, and complexity risks.

Alternatives exam traps

• Diversification benefit is not guaranteed in stressed markets.
• Illiquid assets may be unsuitable for short time horizons.
• Appraised values can smooth reported volatility.
• Leverage can be embedded even if not obvious.
• Complexity should serve an investment purpose, not replace suitability analysis.

Portfolio theory and diversification

Diversification works when assets do not move perfectly together. The goal is not simply to own many securities, but to combine exposures that behave differently.

Notes and examples

Correlation decision table

Correlation	Diversification effect
+1.0	No risk reduction beyond weighted average
Between 0 and +1	Some diversification benefit
0	Assets unrelated; stronger diversification
Negative	Greater risk reduction potential
-1.0	Theoretical perfect offset if weights are right

Common portfolio theory mistakes

• Assuming a low-risk asset always reduces return without considering diversification.
• Treating volatility as the only relevant risk.
• Confusing beta with standard deviation.
• Ignoring concentration within funds that appear diversified.
• Assuming historical correlation will remain stable.
• Comparing returns without adjusting for risk and fees.

Tax, costs, and real return

Specific tax treatment depends on the applicable jurisdiction and official exam material. For review purposes, focus on the investment logic: investors keep after-tax, after-cost, inflation-adjusted returns.

Notes and examples

\[ \text{Real return}\approx \text{Nominal return}-\text{Inflation rate} \]

More exact relationship:

\[ 1+\text{Real return}=\frac{1+\text{Nominal return}}{1+\text{Inflation rate}} \]

Cost traps

Trap	Better answer
Choosing highest gross return	Compare net risk-adjusted return
Ignoring bid-offer spread	It matters for frequent trading or illiquid assets
Ignoring tax	Tax can change suitable strategy
Ignoring inflation	Capital may grow nominally but shrink in purchasing power
Assuming passive is always best	Passive may be efficient, but suitability and exposure still matter
Assuming active is always better	Active must justify fees and risk

Ethics, governance, and professional conduct

The CISI IM exam may test professional judgement as much as technical knowledge. When in doubt, favour suitability, fair treatment, disclosure, and documented reasoning.

Conduct question decision rule

If an answer choice involves hiding information, ignoring a mandate, failing to disclose a conflict, trading ahead of a client, exaggerating certainty, or recommending without understanding the client, it is usually the weak answer.

Scenario-based decision points

Common candidate mistakes

Concept mistakes

• Confusing risk tolerance with risk capacity.
• Treating yield as the same as total return.
• Forgetting that bond prices and yields move inversely.
• Assuming long maturity and high coupon have the same duration effect.
• Treating beta as total risk rather than market sensitivity.
• Assuming diversification means many holdings, rather than low concentration and imperfect correlation.
• Confusing NAV with market price for closed-ended vehicles.
• Forgetting that currency movements affect overseas returns.
• Treating derivatives as automatically unsuitable or automatically risk-reducing.
• Using the wrong performance measure for the question.

Notes and examples

Calculation mistakes

• Using percentages as whole numbers incorrectly.
• Forgetting to weight portfolio returns.
• Ignoring signs in duration calculations.
• Comparing nominal and real returns without inflation adjustment.
• Annualising incorrectly.
• Mixing benchmark-relative and absolute returns.
• Ignoring fees, taxes, or spreads where the question states them.
• Rounding too early in multi-step calculations.

Exam-reading mistakes

• Answering the product question before reading the client objective.
• Missing words such as “most appropriate,” “least likely,” or “except.”
• Assuming facts not given in the question.
• Choosing the technically correct answer that breaches the mandate.
• Ignoring time horizon and liquidity constraints.
• Selecting the highest return option when the question asks for suitability.

Quick tables for last-pass review

Asset class risk and return summary

Notes and examples

Active vs passive

Feature	Active	Passive
Objective	Outperform benchmark	Track benchmark
Cost	Usually higher	Usually lower
Risk	Active risk and manager risk	Benchmark risk and tracking error
Success measure	Alpha, information ratio, consistency	Tracking difference, tracking error, cost
Trap	Past outperformance may not persist	Low cost does not remove market risk

Income vs growth investing

Feature	Income focus	Growth focus
Primary aim	Cash flow	Capital appreciation
Typical assets	Bonds, dividend equities, income funds	Equities, growth funds, reinvestment strategies
Key risk	Income cuts, inflation, rate sensitivity	Valuation risk, volatility
Suitability driver	Spending needs	Time horizon and risk capacity
Trap	High yield may signal high risk	High growth may already be priced in

Hedging choices

Exposure	Possible hedge	Key limitation
Equity market fall	Index future, put option	Basis risk, cost, imperfect match
Currency exposure	FX forward, currency hedge share class	Hedge cost and rollover risk
Interest-rate rise	Shorter duration, futures, swaps	Yield curve and basis risk
Credit spread widening	Reduce credit exposure, diversify, credit derivatives	Liquidity and counterparty risk
Concentrated single stock	Diversification, collar, staged sale	Tax, costs, upside limitation

Final quick check before practice

Before moving into mock exams, make sure you can explain these without notes:

• Why bond prices fall when yields rise.
• Why duration is not the same as maturity.
• How diversification depends on correlation.
• The difference between systematic and specific risk.
• The difference between active return and absolute return.
• When to use time-weighted return versus money-weighted return.
• Why high yield may indicate high risk.
• How currency movements affect overseas investments.
• The difference between a forward, future, call, and put.
• Why suitability can override a technically attractive investment.

Put the review into practice