Capital Allocation Line (CAL) and Capital Market Line (CML)
We form a capital allocation line when we combine a risky asset portfolio with a risk-free asset. This represents the allocation between risk-free and risky assets based on investor risk preferences. The capital market line is a special case of…
Systematic and Non-systematic Risks
Systematic risk is inherent in the overall market and cannot be avoided. Non-systematic risk is limited to a particular asset class or security and can be avoided through appropriate portfolio diversification. Systematic Risk When you invest in a market, you face…
Return Generating Models
A return-generating model can provide investors with an estimate of the return of a particular security given certain input parameters. The most general form of a return-generating model is a multi-factor model. In its simplest form, the multi-factor model is…
Beta Explained
Beta is a measure of systematic risk. Statistically, it depends on the degree of correlation between a security and the market. Calculating Beta We begin with the single index model using realized returns constructed as follows: $$ R_i – R_f…
Capital Asset Pricing Model (CAPM)
The Capital Asset Pricing Model (CAPM) provides a linear relationship between the expected return for an asset and the beta. The Security Market Line (SML) represents CAPM on a graph. As opposed to the Capital Market Line (CML), where the…
Calculating Returns Using CAPM
Given as asset systematic risk, the expected return can be computed using the capital asset pricing model. The CAPM result is usually used as a first estimate of return. In addition, it is used in capital budgeting and the determination…
Applications of CAPM
CAPM can be extended to a number of areas. It provides additional applications beyond the estimation of security returns. A key area is in performance evaluation, where a number of commonly used metrics are employed. Performance Evaluation Various computable performance…
The Investment Policy Statement
[vsw id=”hh4LeaTMl5Q” source=”youtube” width=”611″ height=”344″ autoplay=”no”] Before constructing a client’s portfolio, an advisor should understand the client’s goals, resources, circumstances, and constraints. Portfolio planning is the process of constructing a portfolio to meet a client’s investment objectives. The written document…
Components of the IPS
There is no standard format to the Investment Policy Statement, but most conform to a basic structure. The two key sections are the investment objectives and the investment constraints. Typical IPS Structure The IPS document usually follows the structure below:…
Risk and Return Objectives
The investment objectives and investment constraints are arguably the key components of the IPS. The two elements outline the risk and return objectives. Return objectives and expectations must be consistent with the risk objectives and constraints that apply to a…
