CISI IM — CISI Investment Management (Level 4) Quick Reference
Compact exam reference for Chartered Institute for Securities & Investment CISI Investment Management (Level 4) (CISI IM): portfolio theory, asset classes, valuation, risk, performance, tax and suitability.
How to Use This Quick Reference
This independent quick reference is for candidates preparing for the Chartered Institute for Securities & Investment CISI Investment Management (Level 4) exam, official code CISI IM. Use it to consolidate formulas, decision rules, asset-class distinctions and common exam traps.
High-yield approach:
- Learn the investment process: client objectives, constraints, asset allocation, implementation, monitoring.
- Practise calculations: return, risk, beta, CAPM, bond pricing, duration, performance ratios.
- Link theory to suitability: a technically correct product can still be unsuitable for the client mandate.
- Watch wording: “nominal” vs “real”, “yield” vs “return”, “coupon” vs “YTM”, “systematic” vs “specific” risk.
Core Exam Map
| Area | What to Know | Typical Exam Task | Common Trap |
|---|---|---|---|
| Client objectives | Return, risk, income, growth, time horizon, liquidity | Select suitable portfolio strategy | Focusing only on return and ignoring constraints |
| Asset allocation | Strategic vs tactical, diversification, rebalancing | Choose mix of equities, bonds, cash, alternatives | Treating diversification as eliminating all risk |
| Portfolio theory | Expected return, variance, correlation, efficient frontier, CAPM | Calculate portfolio risk/return or interpret beta | Confusing total risk with systematic risk |
| Bonds | Price/yield relationship, duration, credit risk, yield curves | Estimate price change after yield shift | Saying high coupon means high return |
| Equities | Valuation, earnings, dividends, ratios, corporate actions | Compare shares using P/E, dividend yield, growth | Ignoring sector, cyclicality and accounting quality |
| Funds | OEICs, unit trusts, investment trusts, ETFs, active/passive | Select wrapper or fund structure | Ignoring discounts, gearing, tracking error or charges |
| Derivatives | Futures, forwards, options, swaps, hedging | Identify payoff or hedge direction | Confusing option buyer risk with option writer risk |
| Performance | TWR, MWR, benchmarks, attribution, Sharpe, Treynor, IR | Assess manager skill and risk-adjusted return | Using wrong ratio for diversified vs non-diversified portfolios |
| Tax and charges | Income vs capital, wrappers, after-tax return, transaction costs | Compare net outcomes | Using gross yield when scenario asks net return |
| Risk control | Market, credit, liquidity, currency, operational, concentration | Identify dominant risk and mitigation | Treating VaR as a maximum possible loss |
Investment Management Process
| Stage | Key Questions | Exam-Relevant Outputs |
|---|---|---|
| Define objectives | What return is required? Income, growth or preservation? | Required return, risk tolerance, investment horizon |
| Identify constraints | Liquidity, tax, legal, ethical, currency, time horizon | Investment policy constraints |
| Set asset allocation | What long-term asset mix fits the mandate? | Strategic asset allocation |
| Adjust positioning | Are near-term market views being expressed? | Tactical asset allocation |
| Select instruments | Direct securities, funds, ETFs, derivatives, cash | Implementation choice |
| Monitor | Is portfolio still aligned with objectives? | Performance review and suitability check |
| Rebalance | Has asset mix drifted outside limits? | Buy/sell decisions, risk control |
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
| Factor | Questions to Ask | Portfolio Implication |
|---|---|---|
| Required return | What return is needed to meet objectives? | Drives risk budget and asset mix |
| Risk tolerance | How much volatility or loss can the client accept? | Limits equity, alternatives, leverage |
| Capacity for loss | Can client financially absorb losses? | More important than stated risk appetite |
| Time horizon | When is capital needed? | Longer horizons may support more growth assets |
| Liquidity | Are withdrawals expected? | Requires cash/short-duration assets |
| Income need | Regular withdrawals or reinvestment? | Income funds, bonds, dividend equities |
| Tax position | Income vs gains, wrappers, allowances | Net return and product selection |
| Currency | Liabilities in domestic or foreign currency? | Hedge or match currency exposure |
| Ethical/ESG constraints | Exclusions or positive screening? | Universe and tracking error affected |
| Benchmark | What is success measured against? | Suitable benchmark and risk limits |
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
| Concept | Meaning | Exam Interpretation |
|---|---|---|
| Expected return | Probability-weighted average return | Forward-looking estimate, not guaranteed |
| Variance | Average squared deviation from mean | Risk measure in mean-variance analysis |
| Standard deviation | Square root of variance | Measures total volatility |
| Covariance | Direction and magnitude of co-movement | Hard to compare directly across asset pairs |
| Correlation | Standardised co-movement, -1 to +1 | Lower correlation improves diversification |
| Efficient frontier | Best expected return for each risk level | Portfolios below frontier are inefficient |
| Risk-free asset | Theoretical asset with no uncertainty | Used in CAPM and capital market line |
| Market portfolio | Portfolio of all risky assets in theory | CAPM benchmark for systematic risk |
| Systematic risk | Market-wide risk | Cannot be diversified away |
| Specific risk | Issuer/security-specific risk | Can be reduced by diversification |
| Beta | Sensitivity to market movements | Beta above 1 = more market-sensitive |
| Alpha | Return above required CAPM return | Positive alpha suggests outperformance after risk adjustment |
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
| Measure | Plain Formula | Best Used When | Interpretation |
|---|---|---|---|
| Sharpe ratio | (Portfolio return - risk-free rate) / portfolio standard deviation | Total portfolio, not fully diversified | Reward per unit of total risk |
| Treynor ratio | (Portfolio return - risk-free rate) / beta | Well-diversified portfolio | Reward per unit of systematic risk |
| Jensen’s alpha | Actual return - CAPM required return | CAPM-based performance review | Positive alpha = exceeded required return |
| Information ratio | Active return / tracking error | Active manager vs benchmark | Higher means more active return per unit of active risk |
| Tracking error | Standard deviation of active returns | Passive or benchmark-aware portfolios | Lower means closer benchmark tracking |
| Sortino ratio | Excess return / downside deviation | Downside-risk focus | Penalises harmful volatility only |
| Maximum drawdown | Peak-to-trough loss | Loss experience and behavioural risk | Larger drawdown may be unsuitable |
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 |
Time-Weighted vs Money-Weighted Return
| Return Measure | What It Measures | Cash Flow Treatment | Use Case |
|---|---|---|---|
| Time-weighted return | Manager performance excluding timing of external flows | Breaks period at cash flows and geometrically links sub-periods | Comparing managers |
| Money-weighted return | Investor’s actual internal rate of return | Sensitive to size and timing of cash flows | Client outcome analysis |
| Simple return | One-period percentage return | Ignores compounding | Short periods |
| Geometric return | Compound average return | Captures compounding | Multi-period performance |
| Arithmetic return | Simple average of periodic returns | Usually higher than geometric when volatile | Expected single-period return estimate |
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
| Asset Class | Main Return Sources | Main Risks | Useful In | Exam Traps |
|---|---|---|---|---|
| Cash | Interest | Inflation, reinvestment, bank/counterparty | Liquidity, capital stability | Nominal stability can still mean real loss |
| Government bonds | Coupons, price movement, redemption | Interest-rate, inflation, duration | Income, diversification, liability matching | “Government” does not remove duration risk |
| Corporate bonds | Coupons, spread tightening, redemption | Credit, downgrade, liquidity, duration | Higher income than government bonds | Higher yield usually means higher risk |
| Index-linked bonds | Real coupons/principal linkage | Real yield changes, inflation index lag, duration | Inflation protection | Can fall if real yields rise |
| Equities | Dividends, earnings growth, capital gains | Market, business, valuation, liquidity | Long-term growth | Dividend yield is not total return |
| Property | Rental income, capital appreciation | Liquidity, valuation, tenant, leverage | Income, inflation sensitivity | Direct property is illiquid and valuation-lagged |
| REITs/property shares | Dividends, property exposure | Equity market, property, gearing | Liquid property exposure | More correlated with equities in stress |
| Commodities | Spot price changes, roll yield | Volatility, storage, geopolitics | Inflation or diversification exposure | No inherent income stream |
| Hedge funds/alternatives | Strategy-specific alpha, risk premia | Liquidity, leverage, opacity, manager risk | Diversification if low correlation | “Alternative” does not mean low risk |
| Private equity | Business growth, leverage, exit valuation | Illiquidity, valuation, leverage, vintage risk | Long-term growth | Reported volatility may be smoothed |
| Derivatives | Hedging, leverage, payoff engineering | Counterparty, margin, leverage, basis | Risk control or efficient exposure | Small premium/margin can create large exposure |
| Foreign currency | FX movement, interest differentials | Exchange-rate volatility | Global investing, liability matching | Overseas asset return can be offset by FX loss |
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
| Rule | Meaning |
|---|---|
| Yield up, price down | Bond prices move inversely to yields |
| Longer maturity, higher duration | More sensitive to yield changes |
| Lower coupon, higher duration | More cash flows arrive later |
| Higher credit spread | Market demands extra return for credit/liquidity risk |
| Premium bond | Coupon rate above current yield environment, price above par |
| Discount bond | Coupon rate below current yield environment, price below par |
| Pull to par | As maturity approaches, price tends toward redemption value if no default |
| Clean price | Excludes accrued interest |
| Dirty price | Includes accrued interest; actual settlement amount basis |
Bond Risks
| Risk | Description | Most Relevant To |
|---|---|---|
| Interest-rate risk | Price falls when yields rise | Longer-duration bonds |
| Reinvestment risk | Coupons reinvested at lower rates | High-coupon bonds, falling-rate environments |
| Credit/default risk | Issuer fails to pay | Corporate/high-yield debt |
| Spread risk | Credit spreads widen | Corporate bonds and emerging-market debt |
| Inflation risk | Real value of fixed payments falls | Conventional fixed-rate bonds |
| Liquidity risk | Hard to sell at fair price | Smaller issues, stressed markets |
| Call risk | Issuer redeems early | Callable bonds when rates fall |
| Currency risk | FX moves affect domestic return | Foreign-currency bonds |
Yield Curve Interpretation
| Yield Curve Shape | Typical Interpretation | Portfolio Implication |
|---|---|---|
| Upward sloping | Longer yields above shorter yields | Normal compensation for term/inflation risk |
| Flat | Similar short and long yields | Transition or uncertainty |
| Inverted | Short yields above long yields | Tight policy or recession expectations |
| Steepening | Long yields rise relative to short yields, or short yields fall | Duration positioning matters |
| Flattening | Long and short yields converge | May signal policy tightening or growth concerns |
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
| Ratio | Plain Formula | Use | Trap |
|---|---|---|---|
| P/E | Share price / EPS | Market price per unit of earnings | High P/E may reflect growth or overvaluation |
| Dividend yield | DPS / share price | Income comparison | High yield may signal distress |
| Dividend cover | EPS / DPS | Sustainability of dividend | Backward-looking if earnings are volatile |
| Payout ratio | DPS / EPS | Portion of earnings paid out | High payout may limit reinvestment |
| Price/book | Share price / book value per share | Asset-heavy sectors, banks | Less useful for asset-light businesses |
| ROE | Profit / equity | Return generated on shareholders’ funds | Can be boosted by leverage |
| EV/EBITDA | Enterprise value / EBITDA | Capital-structure-neutral comparison | Ignores capex, working capital and debt service |
| PEG | P/E / growth rate | P/E adjusted for growth | Growth estimates can be unreliable |
Equity Style Distinctions
| Style | Characteristics | Performs Best When | Main Risk |
|---|---|---|---|
| Growth | High expected earnings growth, higher valuations | Growth is scarce and rates supportive | Valuation compression |
| Value | Low valuation relative to fundamentals | Mean reversion, recovery, rising rates | Value trap |
| Income | High and stable dividends | Demand for yield, mature companies | Dividend cuts |
| Quality | Strong balance sheet, profitability, cash flow | Uncertain markets | Overpaying for defensiveness |
| Small-cap | Smaller companies, less researched | Expansionary conditions, risk appetite | Liquidity and volatility |
| Momentum | Recent winners continue to outperform | Trending markets | Sharp reversals |
Funds and Collective Investments
| Vehicle | Structure | Pricing | Key Benefits | Key Risks/Traps |
|---|---|---|---|---|
| OEIC | Open-ended fund company | Based on NAV | Diversification, professional management | Dilution/transaction costs, fund charges |
| Unit trust | Open-ended trust | Based on underlying NAV | Similar to OEIC, trustee structure | Bid-offer pricing may matter |
| Investment trust | Closed-ended company | Share price set by market | Can use gearing, stable capital base | Trades at premium/discount to NAV |
| ETF | Exchange-traded fund | Market price during trading | Low cost, transparent, intraday trading | Tracking error, spread, liquidity, synthetic risk |
| Index fund | Passive fund | NAV-based or exchange-traded | Low cost index exposure | Index concentration and tracking difference |
| Hedge fund | Flexible strategy vehicle | Strategy-specific | Diversification/absolute-return aim | Leverage, liquidity, opacity, fees |
| Fund of funds | Invests in other funds | NAV-based | Manager diversification | Layered charges |
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 |
Derivatives Quick Reference
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
| Instrument | Obligation or Right? | Exchange/OTC | Typical Use | Main Risk |
|---|---|---|---|---|
| Forward | Obligation | OTC | Custom hedge | Counterparty risk |
| Future | Obligation | Exchange-traded | Standardised hedge/speculation | Margin calls, basis risk |
| Call option | Right to buy | Both | Upside exposure or hedge short position | Premium loss for buyer |
| Put option | Right to sell | Both | Downside protection | Premium cost |
| Swap | Exchange cash flows | OTC | Rate, currency or return exposure | Counterparty and valuation risk |
| CFD/spread bet | Leveraged price exposure | Provider-based | Speculation/hedging | Leverage, financing, provider risk |
Options Strategy Table
| Strategy | Position | Market View | Risk/Reward |
|---|---|---|---|
| Long call | Buy call | Bullish | Limited loss, upside potential |
| Long put | Buy put | Bearish or protection | Limited loss, gains if underlying falls |
| Covered call | Hold asset, sell call | Neutral/slightly bullish | Income but caps upside |
| Protective put | Hold asset, buy put | Wants downside floor | Protection costs premium |
| Collar | Hold asset, buy put, sell call | Protect downside, sacrifice upside | Reduces net hedge cost |
| Short naked call | Sell call without underlying | Bearish/neutral | Potentially unlimited loss |
| Short put | Sell put | Bullish/neutral | Loss if underlying falls significantly |
Greeks
| Greek | Measures | Position Impact |
|---|---|---|
| Delta | Sensitivity to underlying price | Hedge ratio; calls positive, puts negative |
| Gamma | Sensitivity of delta to underlying price | Higher gamma means delta changes quickly |
| Theta | Sensitivity to time passing | Usually negative for option buyers |
| Vega | Sensitivity to volatility | Long options benefit from rising volatility |
| Rho | Sensitivity to interest rates | Often less central than delta/vega/theta |
Economics and Market Drivers
| Driver | Usually Positive For | Usually Negative For | Exam Nuance |
|---|---|---|---|
| Falling interest rates | Bonds, growth equities, leveraged assets | Cash yields, bank margins in some cases | Bond benefit depends on duration |
| Rising interest rates | Cash income, some financials | Long-duration bonds, high-growth equities | Rate rises may reflect strong growth or inflation |
| Rising inflation | Real assets, index-linked income | Fixed nominal bonds, cash in real terms | Inflation protection can be imperfect |
| Strong growth | Cyclical equities, credit spreads | Defensive assets may lag | Can also bring policy tightening |
| Recession | High-quality bonds, defensives | Cyclicals, high yield, property | Credit risk rises as profits fall |
| Currency appreciation | Domestic investors in domestic assets | Overseas assets when unhedged | FX can dominate local asset return |
| Currency depreciation | Exporters, unhedged overseas assets | Importers, foreign-currency liabilities | Consider client liability currency |
| Tight credit conditions | Cash-rich firms, quality bonds | Leveraged firms, high yield, property | Liquidity can dry up quickly |
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 |
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.
| Item | Exam Logic |
|---|---|
| Income vs capital | Interest, dividends and realised gains may be taxed differently |
| Gross vs net yield | Net yield is after tax/charges where relevant |
| Accumulation units | Income is reinvested but may still have tax implications depending on rules |
| Income units | Distribute income to investor |
| Capital gains | Focus on disposal proceeds less allowable cost when scenario supplies data |
| Wrappers | Tax-advantaged wrappers can alter suitability and net return |
| Transaction costs | Reduce realised return and matter more with high turnover |
| Ongoing charges | Compound drag on long-term performance |
| Performance fees | Can improve alignment but create complexity and hurdle/high-watermark issues |
| Stamp/transaction taxes | Apply only if specified or in official context; do not assume unprovided rates |
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
| Risk | Description | Control |
|---|---|---|
| Market risk | General price movement | Diversification, hedging, asset allocation |
| Specific risk | Issuer-level risk | Diversify holdings |
| Interest-rate risk | Yield changes affect bond prices | Duration management |
| Credit risk | Borrower/issuer default or downgrade | Credit analysis, limits, diversification |
| Liquidity risk | Cannot trade at fair price quickly | Liquidity limits, cash buffer |
| Counterparty risk | Other party fails to perform | Collateral, clearing, counterparty limits |
| Currency risk | FX movements affect return | Currency matching or hedging |
| Inflation risk | Purchasing power eroded | Real assets, index-linked exposure |
| Reinvestment risk | Cash flows reinvest at lower yield | Laddering, matching, duration planning |
| Concentration risk | Excess exposure to issuer/sector/factor | Position and sector limits |
| Operational risk | Process, system or human failure | Controls, reconciliation, governance |
| Model risk | Valuation/risk model wrong | Stress testing, validation, judgement |
| Leverage risk | Losses magnified by borrowing/derivatives | Margin control, exposure limits |
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
| Concept | Meaning | Exam Use |
|---|---|---|
| Benchmark | Reference portfolio/index for mandate | Must match asset class, currency and risk profile |
| Active return | Portfolio return minus benchmark return | Measures relative performance |
| Active risk | Tracking error | Volatility of active return |
| Allocation effect | Value added by overweighting/underweighting sectors/assets | Asset allocation skill |
| Selection effect | Value added by choosing securities within sectors/assets | Stock selection skill |
| Interaction effect | Combined allocation and selection impact | Often included in attribution |
| Style drift | Manager deviates from stated style | Suitability and monitoring issue |
| Peer group | Comparison with similar funds/managers | Can be biased by survivorship or style differences |
High-Yield Calculation Traps
| If the Question Says… | Do This |
|---|---|
| “Real return” | Adjust nominal return for inflation |
| “Total return” | Include income plus capital gain/loss |
| “Annualised” | Compound unless question specifies simple annualisation |
| “After tax” | Apply tax only to taxable component specified |
| “Portfolio beta” | Weighted average of asset betas |
| “Two-asset risk” | Include correlation/covariance term |
| “Yield rises by 1%” | Use 0.01 in duration approximation |
| “Price quoted clean” | Add accrued interest for dirty/settlement price if required |
| “Option profit” | Payoff minus premium for buyer; premium minus payoff for writer |
| “Unhedged overseas return” | Combine local asset return and FX movement |
| “Manager skill” | Compare with benchmark and risk-adjusted metrics, after costs if stated |
Mini Decision Tables
Which Performance Measure?
| Scenario | Prefer |
|---|---|
| Total portfolio with incomplete diversification | Sharpe ratio |
| Well-diversified portfolio relative to market risk | Treynor ratio |
| CAPM-based excess return | Jensen’s alpha |
| Active manager against benchmark | Information ratio |
| Client’s actual return including deposits/withdrawals | Money-weighted return |
| Manager performance excluding external cash-flow timing | Time-weighted return |
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.
Practical Next Step
Use this Quick Reference as a final consolidation sheet, then move immediately into timed CISI IM-style practice questions. For each missed question, tag the error as formula, concept, suitability, wording or time pressure, then revise the relevant section above before attempting another timed set.