Portfolio Management introduces the theoretical framework for constructing and evaluating portfolios. At Level I the key areas are Modern Portfolio Theory (MPT) and the efficient frontier, the Capital Asset Pricing Model (CAPM), the Investment Policy Statement (IPS), and an introduction to behavioural finance. The topic accounts for 8–12% of the exam and underpins every other topic — understanding diversification and risk-return trade-offs is essential.
Efficient frontier and CML: the efficient frontier shows the maximum return for a given level of risk. Adding a risk-free asset creates the Capital Market Line (CML); the tangency point is the market portfolio. All investors hold a combination of the risk-free asset and the market portfolio.
Systematic vs. unsystematic risk: systematic (market) risk cannot be diversified away and is measured by beta. Unsystematic (specific) risk can be eliminated by diversification. CAPM rewards only systematic risk.
IPS components: the CFA curriculum identifies return objectives, risk objectives, time horizon, liquidity, taxes, legal/regulatory constraints, and unique circumstances (RRTTLLU) as the key IPS elements.
Behavioural finance biases: cognitive errors (overconfidence, conservatism, anchoring, availability, representativeness) vs. emotional biases (loss aversion, status quo, endowment, regret aversion). Loss aversion is typically cited as having losses weigh roughly twice as heavily as equivalent gains.
Confusing the CML (using total risk σ on the x-axis, applies to all portfolios) with the SML (Security Market Line — using beta on the x-axis, applies to individual securities and portfolios).
Forgetting that beta = 0 assets earn only the risk-free rate under CAPM — not a zero return. The market risk premium is the reward for bearing systematic risk above the risk-free rate.
Treating all behavioural biases as equally correctable. Cognitive errors are more amenable to education and correction; emotional biases are harder to overcome and often require portfolio structure solutions.
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