Risk & Portfolio Management — 60 Terms Defined

Alpha Risk & Portfolio Management % 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 Risk & Portfolio Management % 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

Averaging Down Risk & Portfolio Management ₹ 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

Benchmark Risk & Portfolio Management % The index or standard against which a portfolio's performance is measured. Excess Return = Portfolio Return - Benchmark Return over the same period

Beta Risk & Portfolio Management ratio (x, times) 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

Black Swan Risk & Portfolio Management qualitative 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

Calmar Ratio Risk & Portfolio Management ratio (x, times) Annualised return divided by the maximum drawdown over the same period. Calmar Ratio = Compound Annual Growth Rate / Maximum Drawdown

Capital Market Line Risk & Portfolio Management % 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

Concentration Risk Risk & Portfolio Management % 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

Conditional Value at Risk Risk & Portfolio Management ₹ The average loss on the occasions when the value-at-risk threshold is exceeded. CVaR = Average of all losses greater than the VaR threshold

Correlation Risk & Portfolio Management ratio (x, times) 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)

Counterparty Risk Risk & Portfolio Management qualitative 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

Covariance Risk & Portfolio Management % 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)]

Currency Risk Risk & Portfolio Management % 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

Diversification Risk & Portfolio Management qualitative Spreading investments across assets whose returns do not move together, so that the portfolio's volatility falls below the average of its parts. Portfolio Variance = Sum over all pairs of (Weight i x Weight j x Covariance of i and j)

Downside Risk Risk & Portfolio Management % 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

Drawdown Risk & Portfolio Management % 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

Efficient Frontier Risk & Portfolio Management qualitative 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

Emergency Fund Risk & Portfolio Management ₹ 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

Equity Risk Premium Risk & Portfolio Management % The additional return investors require for holding equities rather than the risk-free asset. Equity Risk Premium = Expected Market Return - Risk-Free Rate

Event Risk Risk & Portfolio Management qualitative 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

Expectancy Risk & Portfolio Management ₹ 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)

Hedging Risk & Portfolio Management ratio (x, times) 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

Inflation Risk Risk & Portfolio Management % The risk that rising prices erode the purchasing power of an investment's returns. Real Return = (1 + Nominal Return) / (1 + Inflation Rate) - 1