CFA Level III key terms

The practice of assembling public information, nonmaterial nonpublic information, and reasoned inference into an investment conclusion. Because no single piece is material and nonpublic, the resulting analysis may legitimately support a recommendation without breaching confidentiality.

Information a reasonable investor would consider important to an investment decision that has not yet been disseminated to the market. Trading on it, or causing others to trade, violates the standards even without direct communication of the facts.

The duty to keep professional judgment free of influences such as gifts, issuer-paid travel, bonus structures, or pressure from employers and clients, and to disclose or decline arrangements that a reasonable observer could see as compromising.

The obligation to give all clients an equitable opportunity to act on recommendations and changes, typically by disseminating investment actions broadly before the firm trades for its own account or for favored clients.

Compensation, fees, or non-monetary benefits paid to or received from another party for recommending products or services. Members must disclose these arrangements to their employer and to clients so the potential bias is visible.

The long-horizon target mix of asset classes chosen to satisfy an investor's return objective and risk tolerance. It becomes the policy benchmark against which tactical tilts and total portfolio results are judged.

Short- to medium-term deviations from policy weights that attempt to exploit perceived mispricing or shifting market conditions, kept within risk limits and permissible ranges defined by the governing policy document.

A written document recording an investor's return objective and risk tolerance together with constraints on liquidity, time horizon, taxes, legal and regulatory factors, and unique circumstances, plus governance rules for implementation and review.

A technique that chooses portfolio weights to maximize expected return for a given variance, tracing the efficient frontier. Outputs are highly sensitive to small changes in the return, risk, and correlation inputs.

A Bayesian method that starts from market-equilibrium implied returns and blends in the investor's views, each weighted by its confidence, producing expected returns that generate more diversified and stable portfolios than raw optimization.

An approach that selects assets by how they affect the surplus of assets over liabilities, first hedging the interest rate and inflation sensitivity of liabilities, then seeking return on the remaining surplus.

Tolerance bands set around policy weights so that trading occurs only when a weight drifts outside the range, balancing risk control against transaction costs and capital gains taxes.

The standard deviation of the difference between portfolio and benchmark returns. It measures how much active risk a manager takes and how tightly the portfolio is expected to follow its benchmark.

Active return divided by tracking error. It expresses the active return generated per unit of active risk and allows comparison of managers running benchmark-relative mandates with different risk budgets.

A model that explains security or portfolio returns through exposures to common factors such as value, size, momentum, or quality, plus security-specific effects. It is used for risk forecasting, return attribution, and portfolio construction.

A structure combining a large, low-cost, benchmark-like core portfolio with smaller actively managed satellite positions intended to add alpha, so that total active risk and total cost stay controlled.

Replicating a benchmark's risk characteristics, such as sector weights, duration, or credit quality, using a subset of its securities rather than all of them, common when full replication is costly or illiquid.

Allocating total portfolio risk rather than capital among asset classes, strategies, or managers, often measured by contribution to tracking error or to total variance, so risk limits align with intended return sources.

A return computed by chaining sub-period returns so that external cash flows do not influence the result. It isolates the manager's investment skill and is the standard basis for reporting under global performance standards.

The internal rate of return equating the present value of a portfolio's contributions and withdrawals with its ending value. It reflects the size and timing of client cash flows as well as the manager's decisions.

Decomposing active return into allocation effects from over- or underweighting segments, selection effects from security choices inside segments, and the interaction of the two, measured against the benchmark.

Globally recognized ethical standards for calculating and presenting investment results. They require fair representation, full disclosure, and firm-wide composites so prospective clients can compare firms on a consistent basis.

Two ratios comparing portfolio performance with the benchmark in rising and falling markets. Downside capture materially below upside capture indicates favorable asymmetric behavior over the measured period.

The approximate percentage change in a bond's price for a one percentage point change in yield. It measures interest rate sensitivity and is used to set hedge ratios and match assets to liabilities.

The curvature of a bond's price-yield relationship. Positive convexity means prices rise more when yields fall than they decline when yields rise, improving on duration-only estimates of price change.

Offsetting the delta of an option position using the underlying asset or other options so that small moves in the underlying produce little or no gain or loss. The hedge must be adjusted as delta changes.

The loss expected to be exceeded only with a stated small probability over a stated horizon. It summarises downside exposure in one number but reveals nothing about the severity of losses beyond it.

The average loss across the worst outcomes beyond the Value at Risk threshold. Because it averages the tail rather than cutting it off, it is a coherent risk measure that captures extreme loss severity.

Structuring a fixed-income portfolio so that its duration and convexity offset those of a liability, making the portfolio's value relatively insensitive to interest rate shifts over the relevant horizon.

The share of foreign currency exposure that is hedged. It is chosen by weighing hedging cost, the correlation of currency moves with the portfolio, and the investor's tolerance for base-currency volatility.

A contract in which the protection buyer pays a periodic premium and receives compensation if a referenced borrower defaults or a specified credit event occurs, used to hedge or to take credit exposure.

The present value of an individual's expected future labor income. Its risk resembles bonds for stable salaried workers and equity for variable earners, which shapes how financial capital should be invested.

Dividing wealth into separate sub-portfolios, each sized and invested to fund one specific goal with its own time horizon and risk level, instead of optimizing a single aggregate portfolio.

A whole-wealth view listing financial assets, pensions, and the value of human capital alongside explicit and implicit liabilities such as future consumption, giving a fuller picture of net worth and risk exposure.

A legal standard requiring fiduciaries to invest as a prudent person would, judging each holding within the context of the whole portfolio and permitting diversification, risk management, and delegation to qualified managers.

The pattern in which private market funds report negative net returns early, from fees and write-downs, before later realizations lift results, so measured performance depends heavily on how young the fund is.

The additional expected return investors require for holding assets that cannot be sold quickly without a price concession. It is a core rationale for allocating to private equity, real estate, and private credit.

Total value to paid-in capital compares cumulative distributions plus residual value with capital drawn, while distributions to paid-in capital counts only cash returned. The gap shows how much value remains unrealized.