Risk & Portfolio Management

Alpha

The return earned above what an asset's risk exposure would have predicted.

Alpha = Actual Return - [Risk-Free Rate + Beta x (Market Return - Risk-Free Rate)] %

Asset Allocation

The division of a portfolio between asset classes such as equity, debt, gold and cash.

Test: target weights are set per asset class and the portfolio is managed to those weights over time %

Risk & Portfolio Management

Averaging Down

Buying more of a holding after its price has fallen, reducing the average cost per unit.

New Average Cost = (Original Quantity x Original Price + New Quantity x New Price) / Total Quantity ₹

Risk & Portfolio Management

Benchmark

The index or standard against which a portfolio's performance is measured.

Excess Return = Portfolio Return - Benchmark Return over the same period %

Risk & Portfolio Management

Beta

A measure of how much an asset's return moves relative to the market's, on average.

Beta = Covariance of Asset and Market Returns / Variance of Market Returns ratio (x, times)

Risk & Portfolio Management

Black Swan

An event that is unpredicted, has extreme impact, and is rationalised as predictable only after it occurs.

Test: the event lay outside expectations, carried extreme consequences, and attracted retrospective explanation qualitative

Risk & Portfolio Management

Calmar Ratio

Annualised return divided by the maximum drawdown over the same period.

Calmar Ratio = Compound Annual Growth Rate / Maximum Drawdown ratio (x, times)

Risk & Portfolio Management

Capital Market Line

The line showing the risk-return combinations available by mixing the risk-free asset with the optimal risky portfolio.

Expected Return = Risk-Free Rate + [(Market Return - Risk-Free Rate) / Market Standard Deviation] x Portfolio Standard Deviation %

Risk & Portfolio Management

Concentration Risk

The exposure created when a large share of a portfolio sits in one holding, sector or risk factor.

Test: the largest position, sector or factor exposure is large enough that a normal adverse outcome in it would materially damage the portfolio %

Risk & Portfolio Management

Conditional Value at Risk

The average loss on the occasions when the value-at-risk threshold is exceeded.

CVaR = Average of all losses greater than the VaR threshold ₹

Risk & Portfolio Management

Correlation

A measure from -1 to +1 of how closely two assets' returns move together.

Correlation = Covariance of A and B / (Standard Deviation of A x Standard Deviation of B) ratio (x, times)

Risk & Portfolio Management

Counterparty Risk

The risk that the other party to a contract fails to perform its obligations.

Test: performance of the contract depends on a specific party's solvency, with no guarantor standing behind it qualitative

Risk & Portfolio Management

Covariance

A measure of how two assets' returns vary together, unscaled by their individual volatilities.

Covariance = Average of [(Return A - Mean A) x (Return B - Mean B)] %

Risk & Portfolio Management

Currency Risk

The risk that exchange rate movements change the value of an investment or cash flow measured in the home currency.

Return in Home Currency = (1 + Foreign Return) x (1 + Currency Change) - 1 %

Risk & Portfolio Management

Diversification

Spreading investments across assets whose returns do not move together, so that the portfolio's volatility falls below the average of its…

Portfolio Variance = Sum over all pairs of (Weight i x Weight j x Covariance of i and j) qualitative

Risk & Portfolio Management

Downside Risk

The dispersion of returns below a target level, ignoring variation above it.

Downside Deviation = square root of the average of squared shortfalls below the target return %

Risk & Portfolio Management

Drawdown

The decline in a portfolio's value from a previous peak to a subsequent trough, expressed as a percentage.

Drawdown = (Peak Value - Current Value) / Peak Value x 100 %

Risk & Portfolio Management

Efficient Frontier

The set of portfolios offering the highest expected return for each level of risk.

Test: no other portfolio offers a higher expected return at the same standard deviation, or the same return at a lower one qualitative

Risk & Portfolio Management

Emergency Fund

Money held in safe, immediately accessible instruments to cover unexpected expenses or loss of income.

Target Emergency Fund = Monthly Essential Expenses x Number of Months of Cover Required ₹

Risk & Portfolio Management

Equity Risk Premium

The additional return investors require for holding equities rather than the risk-free asset.

Equity Risk Premium = Expected Market Return - Risk-Free Rate %

Risk & Portfolio Management

Event Risk

The risk that a specific identifiable occurrence causes a sudden large move in a security's price.

Test: a scheduled or plausible discrete event exists whose outcome would materially change the security's value qualitative

Risk & Portfolio Management

Expectancy

The average result per trade of a strategy, combining win rate with the sizes of wins and losses.

Expectancy = (Win Rate x Average Win) - (Loss Rate x Average Loss) ₹

Risk & Portfolio Management

Hedging

Taking an offsetting position to reduce the loss an existing exposure would suffer from an adverse move.

Hedge Ratio = Value of Exposure x Beta / Contract Value of the Hedging Instrument ratio (x, times)

Risk & Portfolio Management

Inflation Risk

The risk that rising prices erode the purchasing power of an investment's returns.

Real Return = (1 + Nominal Return) / (1 + Inflation Rate) - 1 %