IME flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Investment Policy Statement

Written document stating the client's return and risk objectives, constraints (liquidity, horizon, tax, legal, unique), and governance rules that guide portfolio decisions and manager oversight.

Binding Risk Constraint

When risk willingness and risk ability differ, the lower of the two governs the portfolio's risk level; ability is financial, willingness is psychological.

Human Capital

Present value of a client's future earnings. It is an asset on the household balance sheet and is typically bond-like for stable earners, declining with age.

Goals-Based Sub-Portfolios

Funding each goal with a separate asset mix matched to its horizon and priority, so essential short-horizon goals use lower-risk assets than aspirational long-horizon goals.

Risk Capacity vs Attitude

Capacity is the objective financial ability to absorb losses without derailing the plan; attitude is subjective willingness. A questionnaire measures attitude, not capacity.

CAPM Required Return

E(Ri) = Rf + beta × (E(Rm) − Rf). Beta captures only systematic risk, so unsystematic risk earns no expected premium in equilibrium.

Building Block Equity Return

Expected equity return approximated as dividend yield plus expected earnings growth plus valuation repricing plus inflation, each stated over the same horizon.

Strategic vs Tactical Allocation

Strategic allocation is the long-horizon policy mix derived from objectives and capital market expectations; tactical allocation is a short-horizon deviation within policy bands.

Information Ratio

Active return divided by tracking error. It measures excess return per unit of active risk and allows comparison of strategies with different benchmarks.

Active Share

Percentage of portfolio holdings differing from the benchmark. High active share with low tracking error indicates diversified stock-specific bets rather than factor tilts.

Gordon Growth Model

P0 = D1 / (r − g). It values equity from next-period dividend, required return, and sustainable growth, and requires r greater than g.

Modified Duration

Macaulay duration divided by (1 + y/m). Approximate percentage price change for a small parallel yield shift equals negative modified duration times the yield change.

Convexity Adjustment

Percentage price change approximately equals negative modified duration times yield change plus one-half convexity times the squared yield change; convexity benefits both directions.

Immunization

Matching asset duration (and convexity) to liability duration so the portfolio funds liabilities despite rate changes, with rebalancing as durations drift apart.

Tax-Equivalent Yield

Municipal yield divided by (1 minus marginal tax rate). It converts a tax-exempt yield into the taxable yield needed to match it after tax.

Illiquidity Premium

Extra expected return compensating investors for lock-ups, capital calls, and limited exit. It is compensation for risk borne, not a riskless gain.

DPI and TVPI

DPI is distributions divided by paid-in capital; TVPI is total value (distributions plus residual) divided by paid-in capital. Both measure private fund performance.

Return Smoothing

Appraisal-based or stale alternative valuations understate reported volatility and autocorrelation, overstating diversification benefit and understating true risk.

Sharpe Ratio

Portfolio return minus risk-free rate, divided by portfolio standard deviation. It penalizes total risk and suits evaluation of an entire portfolio.

Jensen's Alpha

Portfolio return minus the CAPM-required return given its beta. Positive alpha means the manager beat the return justified by systematic risk taken.

Money-Weighted Return

Internal rate of return on actual cash flows, so it reflects the client's timing of contributions and withdrawals rather than manager skill alone.

Value at Risk

A loss threshold not expected to be exceeded at a stated confidence level and horizon; it says nothing about loss size beyond the threshold.

Asset Location

Placing tax-inefficient assets in tax-deferred accounts and tax-efficient assets in taxable accounts to reduce total tax drag on the household portfolio.

Tax Drag

Pre-tax return minus after-tax return. Even small annual drag compounds substantially over long horizons, reducing terminal wealth materially.

Wash-Sale Rule

Realizing a loss while buying a substantially identical security within a defined window disallows the loss; track basis and substitute securities carefully.

Roth Versus Traditional

Traditional contributions are often pre-tax with taxable withdrawals; Roth contributions are after-tax with tax-free qualified withdrawals and no lifetime RMDs for the owner.

ETF Creation and Redemption

Authorized participants exchange baskets of securities for ETF shares, keeping price near NAV and enabling in-kind, tax-efficient redemptions.

GIPS Compliance

Voluntary, firm-wide global performance reporting standard requiring defined composites and disclosures; third-party verification is optional, not required.

Fiduciary Duty

Obligation to act in the client's best interest with loyalty and care, disclose material conflicts, and follow the client's objectives and constraints.

Material Nonpublic Information

Information that could affect price and is not public. Trading on it or tipping others violates ethics rules; use restricted lists and information barriers.

Best Execution

Duty to seek the most favorable execution considering price, speed, and likelihood of execution, not simply the lowest stated commission.

Prudent Investor Standard

Process-based standard requiring documented analysis, consideration of reasonable alternatives, and consistency with the IPS; results alone do not prove prudence.