CFA portfolio

Vocabulary practice flashcards covering Economics and Investment Markets, Active Portfolio Management, ETFs, Multifactor Models, Market Risk Measurement, and Backtesting/Simulation.

Break-Even Inflation Rate (BEI)

The difference between the yield on non-inflation-indexed bonds and the yield on inflation-indexed bonds ($\text{yield on non-inflation-indexed bonds} - \text{yield on inflation-indexed bonds}$), comprising expected inflation ($\pi$) and a risk premium for inflation uncertainty ($\theta$).

Credit Spread

The spread between corporate and benchmark bonds that tends to rise during economic downturns and shrink during expansions, widening considerably more for consumer cyclical issuers than for consumer non-cyclical issuers in downturns.

Cyclical Industries

Industries (such as durable goods manufacturers and consumer discretionary) that are extremely sensitive to the business cycle, with earnings that rise during economic expansions and fall during contractions.

Consumption-Hedging Properties of Equity

The characteristic of equities having higher values during good economic times and lower values during bad times, resulting in poor consumption-hedging properties and requiring a positive equity risk premium.

Active Return

The value added by active management, calculated as the active portfolio return minus the benchmark return ($R_A = R_P - R_B$), composed of asset allocation return plus security selection return.

Information Ratio (IR)

The ratio of active return to active risk ($IR = \frac{R_P - R_B}{\sigma(R_P - R_B)} = \frac{R_A}{\sigma_A}$), which measures excess return per unit of active risk.

Information Coefficient (IC)

A measure of an investment manager's forecasting skill, calculated for a market timer as $IC = 2 \times (\%\text{ correct}) - 1$.

Breadth (BR)

The number of independent active bets made by an active manager over a given time frame in the Fundamental Law of Active Management.

Transfer Coefficient (TC)

A metric measuring the degree of constraints placed on an active manager's portfolio construction, equaling $1$ for an unconstrained portfolio.

Fundamental Law of Active Portfolio Management

A framework that determines expected active return and information ratio using the formula $IR = (TC)IC\sqrt{BR}$ and $E(R_A) = (TC)IC\sqrt{BR}\sigma_A$.

Authorized Participants (APs)

Institutional entities authorized to create or redeem ETF shares in-kind through the delivery or receipt of underlying security baskets, keeping market prices near Net Asset Value (NAV).

Tracking Error (ETF)

The annualized standard deviation of the daily tracking difference between an ETF's returns and its underlying benchmark's returns.

ETF Premium (Discount) %

The percentage difference between an ETF's secondary market trading price and its Net Asset Value, calculated as $\frac{\text{ETF price} - \text{NAV}}{\text{NAV}}$.

Arbitrage Opportunity

An investment opportunity that bears no risk and requires no net investment cost, but generates a positive profit.

Arbitrage Pricing Theory (APT)

A multifactor equilibrium model that describes expected returns for well-diversified portfolios under three assumptions: unsystematic risk can be diversified away, returns are generated by a factor model, and no arbitrage opportunities exist.

Macroeconomic Factor Model

A multifactor model assuming that asset returns are explained by surprises or shocks (the difference between realized values and consensus expected values) in macroeconomic variables like GDP, interest rates, and inflation.

Fundamental Factor Model

A multifactor model that explains asset returns using returns from multiple firm-specific financial characteristics, such as P/E ratio, market capitalization, leverage ratio, and earnings growth rate.

Statistical Factor Model

A multifactor model that uses multivariate statistical techniques (such as factor analysis or principal components analysis) to identify factors explaining asset return covariation, often lacking straightforward economic interpretation.

Factor Portfolio

A portfolio engineered to have a factor sensitivity of $1$ to a single specified risk factor and a sensitivity of $0$ to all other factors, representing a pure bet on that factor.

Tracking Portfolio

A portfolio constructed with a specific set of factor sensitivities designed to replicate the factor exposures and performance of a target benchmark index.

Value at Risk (VaR)

An estimate of the minimum loss expected to occur with a given probability over a specified time horizon, stated either in currency units or as a percentage of portfolio value.

Parametric Method (VaR)

A method of estimating VaR that uses estimated variances and covariances of securities to model the distribution of portfolio values, typically assuming a normal distribution.

Conditional VaR (CVaR)

An extension of Value at Risk that measures the expected loss on a portfolio given that the loss exceeds the VaR threshold.

Incremental VaR (IVaR)

The estimated change in total portfolio VaR that results from a specific change in the size of an existing portfolio position.

Marginal VaR (MVaR)

The estimated change in portfolio VaR for a very small change in a position, used to measure that position's contribution to overall portfolio VaR.

Delta

An option risk measure that quantifies the sensitivity of an option's price to an incremental change in the price of the underlying asset.

Gamma

A second-order option risk measure that quantifies the sensitivity of an option's delta to changes in the price of the underlying asset.

Vega

An option risk measure that quantifies the sensitivity of an option's price to changes in the volatility of the underlying asset price.

Reverse Stress Test

A risk management process that identifies the specific combinations of adverse market events and scenarios that would cause a business or firm to fail.

Risk Budgeting

A risk management procedure that begins with determining an acceptable overall amount of risk and then allocates that risk across investment positions to maximize expected return.

Stop-Loss Limit

A market risk constraint requiring an investment position to be reduced or closed out entirely when losses exceed a pre-specified threshold over a designated time period.

Scenario Limit

A risk constraint requiring portfolio adjustments so that the estimated potential loss under a designated scenario will not exceed a set maximum amount.

Backtesting

The process of evaluating the historical risk and return of an investment strategy by simulating the investment process using historical data.

Rolling-Window Backtesting

A backtesting simulation technique that uses a walk-forward window to calibrate trade signals or factors, periodically rebalances the portfolio, and evaluates investment performance over time.

Survivorship Bias

A backtesting distortion that occurs when the historical analysis includes only entities that have survived to the present day, ignoring failed or liquidated entities.

Look-Ahead Bias

A backtesting error that occurs when data or information is used in the simulation that would not have been available at the actual point in time when the investment decision was made.

Data Snooping

The problematic practice of choosing a specific model or strategy because it generated favorable backtesting performance metrics, such as a high $t$-statistic or a low $p$-value.