CAIA Level I cheat sheet

Fiduciary duty has three components: loyalty (client interests first), care (competence and diligence), and prudence (act as a prudent investor would).

Material nonpublic information: trading or tipping on it is prohibited; the permitted responses are to disclose it publicly or abstain from acting on it.

Conflicts of interest must be disclosed to clients and employer and managed so client interests prevail; disclosure alone does not always cure a conflict.

Gifts, entertainment, or benefits that could impair independence and objectivity should be declined or disclosed to the employer.

Performance must be presented fairly, accurately, and completely; simulated or backtested results must never be linked to actual results as if continuous.

A GIPS composite must include all actual, fee-paying, discretionary portfolios managed to the same strategy; non-discretionary and non-fee-paying portfolios are excluded.

Supervisors must take reasonable steps to detect and prevent violations by subordinates, including establishing and enforcing compliance procedures.

Suitability requires that a recommendation fit the client's objectives, constraints, risk tolerance, and financial knowledge and experience.

Ethical decision framework: identify relevant facts, stakeholders, duties owed, available alternatives, and consequences, then act and review the outcome.

Core alternative categories are hedge funds, private equity and private debt, real assets, and structured products; common traits are illiquidity, leverage, active management, and light regulation.

Typical fee structure is a management fee on assets (often 1-2%) plus an incentive fee on profits (often 20%), frequently with a high-water mark and sometimes a hurdle rate.

The J-curve describes early negative returns from fees and write-downs followed by rising returns as investments mature and exit.

Reported alternative returns are often smoothed or appraisal-based, which understates volatility and correlation and overstates diversification benefit.

Access is typically restricted to accredited or qualified investors, with minimum commitments, lockups, and limited redemption rights.

Common vehicles include limited partnerships, limited liability companies, offshore funds, fund-of-funds structures, and separately managed accounts.

Due diligence spans investment, operational, business, and legal review, with operational and fraud risk often dominating the analysis.

Alternatives can expand the efficient frontier when their correlation with traditional assets is low, but leverage and illiquidity raise tail and liquidity risk.

CAPM: E(Ri) = Rf + beta_i x [E(Rm) - Rf], where beta_i = Cov(i,m) / Var(m); only systematic risk is priced.

Gordon growth model: P0 = D1 / (r - g), valid only when the growth rate g is less than the required return r.

Bond prices and yields move inversely; percentage price change is approximated by -D_mod x change in yield + 0.5 x convexity x (change in yield)^2.

Modified duration = Macaulay duration / (1 + y/m); the duration of a zero-coupon bond equals its maturity.

Performance measures: Sharpe = (Rp - Rf)/sigma_p; Treynor = (Rp - Rf)/beta_p; Jensen's alpha = Rp - [Rf + beta_p(Rm - Rf)].

Portfolio variance = sum over i and j of w_i w_j sigma_ij; as the number of assets grows, covariance terms dominate and unsystematic risk becomes negligible.

Market efficiency forms: weak (past prices reflected, so technical analysis fails), semi-strong (all public information), strong (all information including private).

Credit spread compensates for expected default loss, risk premium, liquidity, and tax differences versus the benchmark government bond.

Longer maturity and lower coupon both increase a bond's duration and therefore its sensitivity to yield changes.

Value at Risk at confidence level c is the loss threshold such that losses exceed it with probability (1 - c); it says nothing about the size of losses beyond it.

Parametric VaR is approximately portfolio value x (z_c x sigma - mu) over the horizon; volatility scales with the square root of time.

Expected shortfall (CVaR) is the average loss conditional on exceeding VaR; unlike VaR it is subadditive and therefore a coherent risk measure.

Marginal contribution to risk: MCTR_i = w_i x (Sigma w)_i / sigma_p, and the MCTRs sum exactly to total portfolio risk sigma_p.

Risk parity allocates capital so that each holding contributes an equal share of total portfolio risk rather than an equal dollar weight.

Black-Litterman combines CAPM equilibrium returns with investor views through Bayesian updating, producing more stable weights than plain mean-variance optimization.

Stress testing and scenario analysis address tail, non-normal, and liquidity risks that VaR and standard deviation miss.

Tracking error is the standard deviation of active returns (Rp - Rb); the information ratio equals active return divided by tracking error.

Beta captures systematic risk that cannot be diversified; residual (idiosyncratic) risk can be reduced by adding assets with low correlation.

Core strategy families: long/short equity, event-driven (merger arbitrage, distressed), relative value (convertible arbitrage, fixed income arbitrage), macro, and managed futures/CTA.

Fees are typically a 1-2% management fee on net asset value plus a 20% incentive fee on profits above a high-water mark, sometimes subject to a hurdle rate.

Liquidity terms include lockup periods, redemption notice periods, gates, and side pockets for illiquid positions.

A 130/30 portfolio holds 130% long and 30% short, giving 100% net exposure with active extension of both sides.

Convertible arbitrage holds a long convertible bond against a short stock position, profiting from cheap implied volatility and credit mispricing.

Merger arbitrage buys the target and may short the acquirer in stock deals; returns are exposed to deal-break risk and deal-timeline risk.

Systematic trend-following managed futures exhibit low correlation with equities and positive skew, often called crisis alpha during equity drawdowns.

Hedge fund databases suffer survivorship, backfill, and self-selection biases, so reported index returns overstate actual investor experience.

Standard structure is a limited partnership: LPs commit capital, the GP calls capital over time, and earns a 2% management fee plus 20% carried interest, often with a hurdle and catch-up.

The J-curve arises because fees and unrealized write-downs dominate early years while gains appear later at exit.

Performance multiples: DPI = distributions / paid-in capital; RVPI = residual value / paid-in capital; TVPI = DPI + RVPI.

IRR assumes interim cash flows are reinvested at the IRR itself, so early distributions can overstate IRR relative to what the investor actually earns.

LBO return drivers are EBITDA growth, multiple expansion, debt deleveraging, and fee or leakage effects.

Exit routes include IPO, strategic trade sale, secondary buyout, recapitalization, and write-off.

Vintage-year diversification spreads commitments across market cycles, reducing timing risk in a portfolio of funds.

Private debt segments: senior secured floating-rate loans with covenants, subordinated mezzanine debt with warrants or equity kickers, and distressed debt.

A GP commitment of typically 1-5% of fund capital aligns interests, and blind-pool investing means capital is committed before specific deals are identified.

Capitalization rate = net operating income / property price; value = NOI / cap rate, so cap rates rise with perceived risk and with interest rates.

Real estate total return decomposes into income return plus capital appreciation; leverage amplifies both gains and losses.

Key real estate debt metrics: LTV = loan / value; DSCR = NOI / debt service; debt yield = NOI / loan amount.

Commodity futures return = spot return + roll yield + collateral yield; spot return is zero for a static spot position held without price change.

Contango (futures above spot) produces negative roll yield for long positions; backwardation produces positive roll yield.

Infrastructure assets typically feature long-lived, regulated or concession-based cash flows, high barriers to entry, and partial inflation linkage.

Timberland return combines biological growth, land value appreciation, and harvest revenue timing; farmland adds crop income to land appreciation.

Appraisal-based real estate indices smooth reported returns, understating volatility and correlation and overstating diversification benefits.

Real assets are commonly used as inflation hedges, but the hedging effectiveness varies widely by asset type and time horizon.

A structured product is a fixed-income base plus a derivative overlay; principal protection is typically created by combining a zero-coupon bond with an option position.

Capital-protected note at maturity = principal + participation rate x max(0, underlying return); upside may be capped and participation may be below 100%.

Securitized structures allocate losses bottom-up: the equity tranche absorbs first losses, then mezzanine, then senior, which is how subordination provides credit enhancement.

Cash CDOs hold actual underlying bonds or loans; synthetic CDOs gain credit exposure by selling protection through credit default swaps.

Mortgage-backed securities carry prepayment risk when rates fall (shortening duration, negative convexity) and extension risk when rates rise.

Barrier options are cheaper than vanilla options: a knock-in activates only when the underlying touches a level, and a knock-out terminates at that level.

Buffer structures absorb losses within a stated buffer before principal is impaired, while cap structures limit upside participation.

In a securitization cash flow waterfall, senior tranche interest and principal are paid before mezzanine and equity tranches receive distributions.