CFA Level III cheat sheet

Standard I(B) Independence and Objectivity: analysts must not accept gifts, entertainment or travel that could reasonably impair objectivity; modest gifts must be disclosed to the employer.

Standard II(A) Material Nonpublic Information: information is material if disclosure would likely move the price or if reasonable investors would want it before deciding; trading or causing others to trade on it violates the standard.

Mosaic theory: combining public information with nonmaterial nonpublic information is permitted; acting on material nonpublic information is prohibited.

Standard III(B) Fair Dealing: recommendations must be disseminated to all clients fairly, and clients affected by a change in recommendation must be notified before the change is implemented.

Standard IV(B) Additional Compensation: written employer consent is required before accepting fees, bonuses or other benefits from third parties for services that conflict with the employer's interest.

Standard V(A) Diligence and Reasonable Basis: a recommendation must rest on thorough analysis and adequate research; model outputs are not a substitute for understanding the model's assumptions.

GIPS require firms to present at least five years of compliant performance (or since inception), building to ten years, using asset-weighted composite returns.

GIPS composite dispersion: annual ex-post standard deviation or interquartile range is required for composites holding six or more portfolios for the full year.

Sharpe ratio = (Rp - Rf)/sigma_p; the tangency portfolio maximizes Sharpe and is the optimal risky portfolio when a risk-free asset exists.

Roy's safety-first criterion: select the portfolio maximizing SFRatio = (E(Rp) - RL)/sigma_p, which minimizes the probability of falling below the threshold return RL.

Two-asset variance = w1^2sigma1^2 + w2^2sigma2^2 + 2w1w2rho12sigma1*sigma2; the diversification benefit rises as rho falls.

Systematic risk cannot be diversified away; as the number of assets grows, portfolio variance approaches the average covariance among assets.

Strategic asset allocation is long-term and IPS-driven; tactical asset allocation is a short-term deviation constrained by policy ranges.

Surplus = market value of assets - market value of liabilities; surplus risk is lowest when asset-liability correlation is high and asset volatility is low.

Rebalancing corridors should be wider when transaction costs are high, policy ranges in the IPS are wide, and the investor's risk tolerance is higher.

Goal-based allocation: the total portfolio's required return is the asset-weighted average of each goal's required return, and each sub-portfolio carries its own horizon and risk budget.

Active return is decomposed as sum of (w_p - w_b)r_b [allocation] plus sum of w_b(r_p - r_b) [selection] plus interaction term.

Fundamental law of active management: IR is approximately IC times the square root of breadth; adding independent decisions raises expected information ratio.

Contribution to risk of asset i = w_i * (marginal change in portfolio volatility with respect to w_i); capital weights diverge from risk weights when correlations are below one.

Duration immunization requires PV(assets) = PV(liabilities) and asset duration = liability duration; asset convexity should exceed liability convexity for large rate shifts.

Tracking error is the annualized standard deviation of (Rp - Rb); maximizing alpha subject to a tracking-error budget determines the optimal active weights.

Binding constraints in construction typically include issuer/sector concentration caps, liquidity limits, leverage limits, turnover caps and tracking-error budgets.

Core-satellite construction pairs a low-cost index core that supplies beta with active satellites, with total active risk controlled at the aggregate level.

Trade rule: expected alpha from a rebalancing trade must exceed round-trip trading costs plus market impact and any tax consequence it creates.

Time-weighted return geometrically links subperiod returns around external cash flows and removes the effect of cash-flow timing; GIPS require TWR except for private market investments.

Money-weighted return is the IRR of portfolio cash flows; it reflects the investor's actual experience and is heavily influenced by the size and timing of contributions.

Sharpe = (Rp - Rf)/sigma_p (total risk); Treynor = (Rp - Rf)/beta_p (systematic risk); Jensen's alpha = Rp - [Rf + beta_p(Rm - Rf)].

M-squared = Rf + (Sharpe_p * sigma_m) - Rm; it rescales portfolio return to the benchmark's volatility so the two are directly comparable.

Information ratio = active return / active risk; it measures the consistency of active management rather than its magnitude alone.

Brinson attribution: allocation effect = (w_p - w_b)(r_b - r_benchmark); selection effect = w_b(r_p - r_b); interaction = (w_p - w_b)(r_p - r_b).

Capture ratio = upside capture / downside capture; a value above 1 indicates the manager participated better in rising markets than in falling ones.

GIPS require firms to value portfolios at least monthly and on the date of all large external cash flows, and to present composite dispersion annually.

Put-call parity for European options on a non-dividend stock: c + X/(1+r)^T = p + S0; violations create arbitrage opportunities.

Value of a long forward at time t: Vt = St - F0/(1+r)^(T-t); the value is zero at initiation.

Covered interest rate parity: F (domestic per foreign) = S * (1 + r_domestic)/(1 + r_foreign); the higher-yielding currency trades at a forward discount.

Number of futures contracts to adjust equity beta = [(beta_target - beta_portfolio)/beta_futures] * (V_portfolio/V_futures).

Delta hedge ratio = portfolio delta / option delta; the hedge is dynamic because delta changes as the underlying price moves.

Parametric VaR = (mean return - z * sigma) * portfolio value; it understates risk for fat-tailed, illiquid or non-linear portfolios.

Expected shortfall (CVaR) is the average loss conditional on the loss exceeding VaR; it is a coherent risk measure that captures tail exposure.

Basis = spot price - futures price; basis risk arises when the hedging instrument differs from the exposure in underlying or maturity.

Institutional IPS components: governance, risk tolerance, return objective, liquidity needs, time horizon, tax, legal/regulatory and unique considerations.

Liability-driven investing for insurers targets surplus and regulatory capital, while for pension plans it targets funded status and contribution volatility.

Endowment spending policies apply a spending rate to a smoothed market value, reducing year-to-year spending volatility and supporting intergenerational equity.

Private market investments exchange liquidity and valuation certainty for an illiquidity premium; performance is judged by IRR plus TVPI and DPI multiples.

Hedge fund strategies: equity market neutral (low beta), global macro (directional), event driven (deal spreads) and relative value (spread convergence).

Factor-based construction tilts toward value, momentum, quality, size and low volatility; each tilt must be measured and monitored as a risk exposure.

Manager due diligence covers organizational stability, investment process, risk management, attribution evidence, fee structure and operational risk.