Investment Products and Portfolio Construction
Product landscape
Candidates must distinguish asset classes and vehicles: cash equivalents, bonds, equities, real assets, and alternatives; and wrappers such as mutual funds, exchange-traded funds, separately managed accounts, and annuities. Know the core distinctions - ETFs trade intraday and may have premiums or discounts to net asset value, while open-end mutual funds transact at end-of-day NAV. Understand active versus passive management, expense ratios, and the effect of costs on long-run returns.
Risk and return concepts
Know standard deviation as total volatility, beta as sensitivity to the market, correlation as the driver of diversification benefit, and the distinction between systematic (market) risk and unsystematic (company-specific) risk. A common trap is thinking diversification eliminates all risk; it reduces unsystematic risk only. Another trap is confusing alpha (excess return versus benchmark adjusted for risk) with raw outperformance.
Portfolio construction
Construction starts with the investment policy statement: objectives, constraints (liquidity, time horizon, tax, legal, unique), and risk budget. Asset allocation is the primary driver of return variability. Rebalancing to target weights enforces discipline and controls drift; know the difference between calendar and threshold rebalancing.
Worked rule of thumb
Two assets with equal expected returns but low correlation produce a portfolio with lower volatility than either alone - the lower the correlation, the larger the reduction, until correlation reaches negative one. If a question offers a portfolio with a higher return and lower risk than an alternative, it dominates and is the correct answer under mean-variance logic.