Investment Management and Trading
Investment Management and Trading
This domain tests portfolio construction, risk and return measurement, security trading mechanics, and market efficiency. Candidates must connect client objectives to asset allocation, interpret performance statistics, and know how orders behave in Canadian markets.
Risk, return and portfolio theory
- Total risk = systematic (market) + unsystematic (company-specific). Diversification reduces unsystematic risk; systematic risk remains and is measured by beta.
- CAPM: expected return = risk-free rate + beta × (market return − risk-free rate). Alpha is actual return minus CAPM expected return.
- Asset allocation explains most return variability; security selection and market timing are secondary.
- Time-weighted return removes cash-flow effects and suits manager evaluation; money-weighted return reflects the investor's actual experience.
- Real return ≈ nominal return − inflation; use compounding for exact values.
Trading mechanics
- Market order: immediate execution at best available price. Limit order: executes at the limit or better; a buy limit above the market fills immediately at the best ask.
- Stop order becomes a market order when the stop is triggered; stop-limit becomes a limit order, so it may not fill in a fast market.
- Short sales require borrowing shares; margin and buy-in风险 apply. Settlement in Canada is T+1 for equities and most fixed income.
- Bid-ask spread is a liquidity cost; market makers earn the spread and bear inventory risk.
Worked example
A portfolio has beta 1.20. The risk-free rate is 3.0% and the expected market return is 8.0%. CAPM expected return = 3.0% + 1.20 × (8.0% − 3.0%) = 9.0%. If the portfolio actually returned 10.5%, alpha = 10.5% − 9.0% = +1.5%. The 1.5% is not proof of skill; it may reflect style, sector or luck, and must be judged against the correct benchmark and over a full cycle.
Traps that cost marks
- Confusing beta (systematic risk) with standard deviation (total risk).
- Treating a stop-limit order as guaranteed execution; it can remain unfilled.
- Using money-weighted return to rank managers when client cash flows distorted the result.
- Quoting nominal return as real return, or ignoring compounding when comparing frequencies.
- Assuming semi-strong market efficiency means active management can never add value; it concerns publicly available information, not private information or risk premia.