IMT Exam 2 — CSI : Investment Management Techniques Quick Review

Independent Quick Review

This page is an independent review aid for candidates preparing for the Canadian Securities Institute CSI IMT Exam 2: Investment Management Techniques — official exam code IMT Exam 2. Use it as a fast final-pass review before working through topic drills, mock exams, and detailed explanations.

The goal is not to replace the course material. The goal is to help you quickly reconnect the major concepts: portfolio construction, asset allocation, fixed income, equity valuation, derivatives, risk measurement, performance evaluation, and practical investment-management decision rules.

High-Yield Exam Mindset

The exam is likely to test whether you can apply investment management concepts, not merely define them.

Focus on:

• Choosing the right metric for the situation.
• Distinguishing risk types that look similar.
• Knowing when a formula is appropriate.
• Interpreting portfolio changes, not just calculating them.
• Recognizing client constraints and portfolio objectives.
• Understanding why an investment technique is used.
• Avoiding traps involving nominal vs. real returns, before-tax vs. after-tax results, correlation vs. covariance, duration vs. maturity, and systematic vs. unsystematic risk.

Rapid Topic Map

Core Formulas to Remember

Return and Risk

Holding-period return:

\[ \text{HPR} = \frac{\text{Ending Value} - \text{Beginning Value} + \text{Income}}{\text{Beginning Value}} \]

Expected return:

\[ E(R_p) = \sum w_i R_i \]

Portfolio variance for two assets:

\[ \sigma_p^2 = w_1^2\sigma_1^2 + w_2^2\sigma_2^2 + 2w_1w_2\sigma_1\sigma_2\rho_{12} \]

Beta:

\[ \beta_i = \frac{\text{Cov}(R_i,R_m)}{\sigma_m^2} \]

CAPM required return:

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

Bond Price Sensitivity

Approximate price change using modified duration:

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

Duration plus convexity approximation:

\[ \%\Delta P \approx -D_{\text{mod}}\Delta y + \frac{1}{2}C(\Delta y)^2 \]

Equity Valuation

Constant-growth dividend discount model:

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

Required return from DDM:

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

Performance Ratios

Sharpe ratio:

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

Treynor ratio:

\[ \text{Treynor} = \frac{R_p - R_f}{\beta_p} \]

Jensen alpha:

\[ \alpha_p = R_p - \left[R_f + \beta_p(R_m - R_f)\right] \]

Information ratio:

\[ \text{IR} = \frac{R_p - R_b}{\text{Tracking Error}} \]

Formula Selection Table

Portfolio Theory Quick Review

Diversification

Diversification reduces unsystematic risk, not systematic market risk.

Key point: adding securities helps most when correlations are low or negative.

Correlation Decision Rules

Common trap: low correlation does not mean low risk. A risky asset can still reduce portfolio volatility if its returns do not move closely with the rest of the portfolio.

Efficient Frontier and Asset Allocation

The efficient frontier represents portfolios that offer the highest expected return for a given risk level or the lowest risk for a given expected return.

Key Terms

Strategic vs. Tactical Allocation

Exam trap: tactical shifts should still respect the investor’s objectives, constraints, and risk tolerance.

Investment Policy Statement Review

For investment management questions, always anchor decisions to the client’s objectives and constraints.

Core IPS Elements

Decision Rule

A recommendation may be technically attractive but still unsuitable if it conflicts with:

• Time horizon.
• Liquidity requirements.
• Risk tolerance.
• Tax circumstances.
• Concentration limits.
• Stated client restrictions.
• Need for income or capital preservation.

Equity Investment Techniques

Common Equity Valuation Approaches

DDM Traps

• Use next dividend, not last dividend, in the numerator.
• Constant growth model requires growth below required return.
• A small change in growth can cause a large change in value.
• High dividend yield does not automatically mean undervaluation.
• Non-dividend-paying companies usually require another valuation method.

Growth vs. Value

Fixed Income Quick Review

Bond Price-Yield Relationship

This relationship is:

• Inverse.
• Non-linear.
• More sensitive for longer-duration bonds.
• More sensitive when coupon rates are lower.
• More sensitive when yields are lower.

Duration Concepts

Duration Decision Rules

Immunization

Immunization attempts to offset interest-rate risk by matching asset duration to liability duration.

Key points:

• Used to fund future liabilities.
• Duration matching is not permanent; portfolios need rebalancing.
• Convexity matters when yield changes are large.
• Cash-flow matching is more exact but can be more expensive or restrictive.

Yield Measures

Credit and Spread Risk

Credit spread compensates investors for risks beyond the benchmark rate.

Spread Drivers

Common trap: a bond can lose value even if benchmark interest rates are unchanged, because credit spreads can widen.

Derivatives Quick Review

Derivatives are often tested conceptually: payoff direction, hedge purpose, leverage, and risk exposure.

Options

Option Moneyness

Intrinsic value:

• Call: max(0, stock price - strike price)
• Put: max(0, strike price - stock price)

Futures and Forwards

Hedge Direction Rules

Common trap: hedging reduces unwanted risk, but it can also reduce upside.

Alternative Investments

Alternative investments may offer diversification, but they often introduce valuation, liquidity, leverage, and transparency risks.

Exam trap: “alternative” does not automatically mean safer or better diversified. Look at correlation, liquidity, leverage, valuation method, and client suitability.

Active vs. Passive Management

When Active May Be More Plausible

• Less efficient markets.
• Smaller or less-followed securities.
• Specialized mandates.
• Market dislocations.
• Skilled manager with disciplined process and reasonable fees.

When Passive May Be More Plausible

• Highly efficient markets.
• Cost-sensitive clients.
• Need for broad exposure.
• Benchmark-relative mandate.
• Low tolerance for manager underperformance.

Rebalancing

Rebalancing keeps the portfolio aligned with policy targets.

Rebalancing Methods

Common trap: rebalancing can force selling recent winners and buying recent losers. That is the discipline, not a mistake, if it is consistent with the policy.

Risk Measures and What They Mean

Performance Measurement Decision Tree

    flowchart TD
	    A[What are you evaluating?] --> B[Whole portfolio total risk]
	    A --> C[Well-diversified portfolio market risk]
	    A --> D[Active manager vs benchmark]
	    A --> E[Bond portfolio rate sensitivity]
	
	    B --> B1[Use Sharpe ratio]
	    C --> C1[Use Treynor ratio or Jensen alpha]
	    D --> D1[Use active return, tracking error, information ratio]
	    E --> E1[Use duration, convexity, yield/spread analysis]

Performance Evaluation Quick Table

Taxes, Costs, and Implementation

Investment decisions should be evaluated after considering friction costs.

Common Frictions

Common trap: the best pre-cost strategy may not be the best net strategy.

Currency Risk

Currency exposure matters when assets, liabilities, income, or spending needs are in different currencies.

Hedging currency risk can reduce volatility, but it may also remove currency gains.

Behavioural Finance Review

Behavioural concepts often appear as practical traps in client or portfolio scenarios.

Exam trap: identify the bias from the behaviour, not from whether the investment outcome was good or bad.

Common Candidate Mistakes

Calculation Mistakes

• Using percentages instead of decimals inconsistently.
• Forgetting to include income in holding-period return.
• Using beginning value and ending value in the wrong places.
• Treating correlation as covariance.
• Using standard deviation when beta is required.
• Forgetting the negative sign in duration price-change estimates.
• Using last dividend instead of next dividend in the DDM.
• Ignoring benchmark return when calculating active return.
• Confusing yield change in basis points with percentage points.
• Applying a constant-growth formula when growth is not stable.

Conceptual Mistakes

• Assuming diversification eliminates all risk.
• Treating a low-volatility asset as automatically suitable.
• Ignoring liquidity needs.
• Assuming higher return always means better performance.
• Equating high dividend yield with low risk.
• Forgetting that leverage magnifies losses as well as gains.
• Ignoring tax and transaction cost drag.
• Confusing hedging with speculation.
• Assuming derivatives are always inappropriate.
• Assuming alternatives are always diversifying.

High-Yield Decision Rules

Portfolio Construction

1. Start with client objectives and constraints.
2. Set strategic asset allocation first.
3. Use diversification to reduce unsystematic risk.
4. Evaluate risk at the portfolio level, not just security level.
5. Rebalance when drift creates unintended risk.
6. Consider taxes, fees, liquidity, and implementation costs.

Fixed Income

1. If rates rise, bond prices fall.
2. Longer duration means greater rate sensitivity.
3. Credit spread widening can hurt returns even if rates are stable.
4. Callable bonds behave differently when rates fall.
5. Immunization requires monitoring and rebalancing.
6. Yield to maturity is not guaranteed unless assumptions hold.

Equity Valuation

1. Use DDM only when dividends are meaningful and growth assumptions are reasonable.
2. Use relative valuation only with comparable companies.
3. High P/E may signal growth expectations, not necessarily overvaluation.
4. Low P/E may signal value, distress, or cyclically high earnings.
5. Growth assumptions drive valuation heavily.

Derivatives

1. Long options have limited loss equal to the premium.
2. Short uncovered options can create large or unlimited losses.
3. Futures create obligation, not optionality.
4. Hedging reduces exposure but can reduce upside.
5. Leverage means small price changes can produce large gains or losses.

Performance

1. Sharpe ratio uses total risk.
2. Treynor ratio uses beta.
3. Jensen alpha compares actual return to CAPM-required return.
4. Information ratio evaluates active return per unit of active risk.
5. Always compare performance to the correct benchmark.

Quick Practice Prompts

Use these prompts before moving into topic drills or a question bank.

Portfolio Theory

• If two assets have the same expected return but different correlations with the portfolio, which improves diversification more?
• What happens to total portfolio risk as more imperfectly correlated securities are added?
• Which risk remains after full diversification?

Fixed Income

• Which bond has greater duration: long maturity or short maturity?
• What happens to a bond’s price when yields rise?
• Why does convexity matter for large yield changes?
• How can a bond portfolio lose money if benchmark yields are unchanged?

Equity

• When is the dividend discount model appropriate?
• Why can a low P/E ratio be misleading?
• How does a higher required return affect intrinsic value?

Derivatives

• Which option protects an existing stock position from downside risk?
• What is the difference between a futures contract and an option?
• Why can a hedge reduce both risk and potential gain?

Performance

• Which ratio should be used for total portfolio risk?
• Which ratio is best for benchmark-relative active management?
• What does positive Jensen alpha indicate?

Final Review Checklist

Before mock exams, make sure you can:

• Explain systematic vs. unsystematic risk.
• Calculate and interpret expected return.
• Interpret correlation and diversification effects.
• Apply CAPM and identify required return.
• Select Sharpe, Treynor, Jensen alpha, or information ratio.
• Explain the inverse bond price-yield relationship.
• Estimate price change using duration.
• Identify when convexity is relevant.
• Compare yield measures.
• Recognize equity valuation method limitations.
• Interpret option and futures hedges.
• Distinguish active and passive management.
• Apply IPS constraints to investment recommendations.
• Recognize suitability issues.
• Explain rebalancing methods.
• Identify behavioural biases from client actions.

How to Use This With Practice Questions

For CSI IMT Exam 2: Investment Management Techniques review, do not stop at reading formulas. Convert each topic into original practice questions:

1. Start with topic drills for formulas and definitions.
2. Move to mixed question-bank sets to test topic recognition.
3. Review detailed explanations for every missed question.
4. Track mistakes by category: formula, concept, wording, or suitability judgment.
5. Re-test weak areas with fresh original practice questions.
6. Finish with timed mock exams to build speed and decision confidence.

A good final step is to work through an independent companion practice set for IMT Exam 2, focusing especially on fixed income, portfolio risk, valuation, derivatives, and performance measurement.