Investment Advisor flashcards

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

Investment Policy Statement

A written document specifying client objectives, constraints, target asset allocation, and review procedures; it governs all subsequent investment decisions and is updated as circumstances change.

Risk tolerance

The combination of a client's willingness (psychological attitude) and ability (financial capacity) to bear risk; the effective tolerance is the lower of the two.

Time-weighted return

A return measure that eliminates the effect of external cash flows by geometrically linking sub-period returns; it is the standard for evaluating manager performance.

Money-weighted return

The internal rate of return on all portfolio cash flows, reflecting the investor's actual experience; it differs from time-weighted return when contributions and withdrawals are large.

Rebalancing threshold

A rule that triggers portfolio adjustment when an asset class deviates from its target weight by a preset amount, such as five percentage points, controlling risk and transaction costs.

Suitability versus fiduciary

Suitability requires a recommendation be appropriate for the client; fiduciary duty under the Advisers Act requires undivided loyalty and care, including disclosure of conflicts.

Advisory process cycle

The repeating sequence of establishing the relationship, gathering client data, analyzing needs, drafting the policy statement, implementing, monitoring, and reviewing the plan.

Bond duration

A measure of a bond's price sensitivity to yield changes; modified duration approximates the percentage price change for a one percent change in yield.

Convexity

The curvature of the price-yield relationship; positive convexity means duration underestimates price gains and overestimates price losses for large yield moves.

Put-call parity

For European options on a non-dividend stock, the call minus put price equals the stock price minus the present value of the strike; violations permit arbitrage.

Gordon growth model

A dividend discount model valuing a stock as next year's dividend divided by the difference between required return and constant growth; growth must be below required return.

Open-end versus closed-end funds

Open-end funds issue and redeem shares at net asset value; closed-end funds trade on exchanges and may trade at premiums or discounts to net asset value.

Treasury bill discount yield

A money market yield quoting the discount from face value annualized on a 360-day basis, using face value rather than purchase price as the denominator.

Primary and secondary markets

The primary market is where securities are first issued to raise capital; the secondary market is where existing securities trade among investors, providing liquidity and price discovery.

Duration and convexity adjustment

Estimated bond price change equals negative duration times yield change plus one-half convexity times the square of the yield change, improving accuracy for larger yield moves.

Geometric mean return

The compound annual growth rate over a period, computed as the nth root of the product of (1 plus each period return) minus one; it reflects actual wealth accumulation.

Coefficient of variation

Standard deviation divided by expected return; it measures risk per unit of expected return and allows comparison of investments with different return levels.

Capital asset pricing model

Expected return equals the risk-free rate plus beta times the market risk premium; beta measures sensitivity to market movements and captures systematic risk only.

Sharpe ratio

Excess return over the risk-free rate divided by standard deviation of returns; it measures reward per unit of total risk and is appropriate for fully diversified portfolios.

Jensen's alpha

The difference between a portfolio's actual return and the return predicted by the capital asset pricing model given its beta; positive alpha indicates outperformance.

Portfolio variance two assets

The sum of squared weights times variances plus twice the product of weights, standard deviations, and correlation; lower correlation reduces total portfolio risk.

Systematic versus unsystematic risk

Systematic risk affects all securities and cannot be diversified away; unsystematic risk is firm-specific and can be reduced through diversification. Only systematic risk is compensated.

Value at risk

The maximum loss expected over a given horizon at a specified confidence level; for normal returns it equals mean minus the z-score times standard deviation.

Security market line

A graph of expected return versus beta under the capital asset pricing model; securities plotting above the line are undervalued and below the line are overvalued.

Strategic asset allocation

The long-term target mix of asset classes chosen to meet the investor's objectives and constraints; it is the primary driver of long-run portfolio performance.

Tactical asset allocation

Short-term deviations from strategic target weights intended to exploit market opportunities, typically constrained by policy limits in the investment policy statement.

Human capital

The present value of a client's future earnings; combined with financial capital it forms total wealth and influences how much equity risk the client can bear.

Liquidity constraint

The need for cash or readily marketable assets to meet planned and unplanned expenses; an emergency reserve of three to six months of expenses is typically funded first.

Tax-deferred account placement

Holding high-turnover and income-producing assets in tax-deferred accounts while placing low-turnover equity and tax-exempt bonds in taxable accounts to improve after-tax returns.

Form ADV

The registration and disclosure document filed by investment advisers; Part 1 contains business and ownership data, and Part 2 is the narrative brochure delivered to clients.

Custody rule

Rule 206(4)-2 requiring client assets be held by a qualified custodian, with surprise examinations or account statement delivery, and an audit exemption for certain pooled vehicles.

Code of ethics

Rule 204A-1 requires advisers to adopt written standards of conduct, personal trading reporting, and pre-clearance of certain securities transactions to prevent conflicts.