Risk & Portfolio Management

Information Ratio

Return above a benchmark per unit of tracking error.

Information Ratio = (Portfolio Return - Benchmark Return) / Tracking Error ratio (x, times)

Interest Rate Risk

The risk that changes in interest rates reduce the value of an investment or raise the cost of borrowing.

Approximate Price Change = -Modified Duration x Change in Yield %

Risk & Portfolio Management

Kelly Criterion

A formula giving the position size that maximises the long-run growth rate of capital.

Optimal Fraction = (Win Probability x Payoff Ratio - Loss Probability) / Payoff Ratio %

Risk & Portfolio Management

Leverage

The use of borrowed capital to increase the size of a position relative to the money committed.

Leverage = Total Position Value / Own Capital Committed ratio (x, times)

Risk & Portfolio Management

Liquidity Risk

The risk of being unable to exit a position at a reasonable price, or at all, when required.

Test: the position size is large relative to normal traded volume, or the security can become untradable under stress qualitative

Risk & Portfolio Management

Margin

Borrowed funds or collateral used to take a position larger than the cash available.

Margin Requirement = Position Value x Required Percentage; Leverage = Position Value / Margin Posted ₹

Risk & Portfolio Management

Margin Call

A demand from a broker for additional funds when losses reduce collateral below the required level.

Shortfall = Required Margin - Available Collateral, payable immediately ₹

Risk & Portfolio Management

Maximum Drawdown

The largest peak-to-trough decline a portfolio or strategy has experienced over a measured period.

Maximum Drawdown = the largest value of (Peak - Trough) / Peak observed across the period %

Risk & Portfolio Management

Mean Reversion

The tendency of a series to return toward its long-run average after moving far away from it.

Test: extreme deviations from a long-run mean are followed on average by moves back toward that mean qualitative

Risk & Portfolio Management

Modern Portfolio Theory

The framework holding that assets should be judged by their contribution to a portfolio's risk and return, not in isolation.

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

Risk & Portfolio Management

Portfolio

The complete collection of investments held by an individual or institution, considered as one unit.

Portfolio Return = Sum of (Weight of each Holding x Return of that Holding) ₹

Risk & Portfolio Management

Position Sizing

Deciding how much capital to commit to a single position, based on the loss that would be acceptable if it went wrong.

Position Size = (Account Value x Risk per Trade %) / Risk per Share shares

Risk & Portfolio Management

R-Squared

The proportion of a portfolio's return variation that is explained by movements in its benchmark.

R-Squared = Square of the Correlation between Portfolio and Benchmark Returns, expressed as a percentage %

Risk & Portfolio Management

Rebalancing

Restoring a portfolio to its target weights by selling what has grown beyond them and buying what has fallen below.

Test: weights are returned to target on a schedule, or whenever a weight drifts beyond a stated tolerance band %

Risk & Portfolio Management

Risk

The possibility that an investment's actual outcome differs from what was expected, including permanent loss of capital.

Test: the range of possible outcomes is wide, and at least some of those outcomes are materially worse than the expected one qualitative

Risk & Portfolio Management

Risk Capacity

How much loss an investor can absorb financially without their plans failing.

Test: the loss that could be sustained while still meeting known obligations from other resources and income %

Risk & Portfolio Management

Risk Management

The practice of identifying, measuring and limiting the losses a portfolio can suffer.

Test: a maximum acceptable loss is defined in advance, and position sizes are set so that it cannot be exceeded in normal conditions qualitative

Risk & Portfolio Management

Risk of Ruin

The probability that a series of losses reduces capital below the level needed to continue.

Rises with the fraction of capital risked per position, with the loss rate, and falls with the ratio of average win to average loss %

Risk & Portfolio Management

Risk Tolerance

How much volatility and loss an investor is emotionally willing to endure without abandoning their plan.

Test: the largest decline the investor would hold through without selling, judged by past behaviour rather than by stated intention %

Risk & Portfolio Management

Risk-Free Rate

The return available on an investment considered to carry no default risk, used as the baseline for all other returns.

Test: the instrument is a sovereign obligation in the domestic currency, with maturity matching the horizon being analysed %

Risk & Portfolio Management

Risk-Reward Ratio

The ratio of a position's intended gain to the loss that would be taken if the thesis fails.

Risk-Reward Ratio = (Target Price - Entry Price) / (Entry Price - Stop Price) ratio (x, times)

Risk & Portfolio Management

Sharpe Ratio

Return above the risk-free rate per unit of total volatility.

Sharpe Ratio = (Portfolio Return - Risk-Free Rate) / Standard Deviation of Portfolio Returns ratio (x, times)

Risk & Portfolio Management

Sortino Ratio

Return above a minimum acceptable return per unit of downside deviation only.

Sortino Ratio = (Portfolio Return - Target Return) / Downside Deviation ratio (x, times)

Risk & Portfolio Management

Standard Deviation

A measure of how far a set of returns typically sits from their average.

Standard Deviation = square root of the average of the squared deviations from the mean %