Chapter 3: Portfolio Risk and Return – Part II

In this section

• Combining Risk-Free Assets with Risky Portfolios
  Discover how blending risk-free assets with risky portfolios shapes an investor’s complete portfolio and risk profile
• The Capital Market Line (CML) and the Separation Principle
  A deep dive into the Capital Market Line and Tobin’s Separation Principle, exploring their theoretical frameworks, assumptions, and practical implications for portfolio construction.
• Systematic Versus Nonsystematic Risk
  A deep dive into market-wide versus asset-specific risks, highlighting diversification principles, CAPM beta, and real-world applications.
• The Capital Asset Pricing Model (CAPM) and Beta
  Explore the essentials of CAPM and Beta, including theoretical foundations, assumptions, practical uses, and criticisms, in this comprehensive guide for CFA® candidates.
• Security Market Line (SML) and Applications
  An in-depth look at the Security Market Line, a keystone of the CAPM framework. Understanding the SML is essential for analyzing risk-return trade-offs, identifying mispriced assets, and applying performance evaluation methods in portfolio management.
• Performance Measures (Sharpe, Treynor, Jensen’s Alpha, M²)
  Explore comprehensive insights into Sharpe, Treynor, Jensen’s Alpha, and M² measures for critical risk-adjusted performance evaluation in portfolio management. This article covers theoretical underpinnings, practical applications, data considerations, and exam tips, helping CFA candidates excel in analyzing investment performance.
• Empirical Testing of CAPM in Different Markets
  Learn about foundational CAPM tests, anomalies in returns, multi-factor expansions, and how market structures affect CAPM results in both developed and emerging economies.
• Extensions of the CAPM and Multi-Factor Models
  Explore how multi-factor models build upon the Capital Asset Pricing Model by incorporating size, value, momentum, and quality factors to better capture asset returns.
• Practical Challenges in Beta Estimation
  Explore how non-stationary markets, thinly traded assets, and shifting relationships complicate beta estimation, and see how advanced techniques like Bayesian updates help manage evolving correlations in dynamic markets.
• Portfolio Performance Attribution Techniques
  Explore how portfolio returns can be dissected into allocation, selection, and interaction effects using the Brinson model and more advanced methods, shedding light on where managers truly add value.
• Jensen’s Alpha in Active Management
  Explore how Jensen’s Alpha helps measure portfolio performance relative to the Capital Asset Pricing Model (CAPM), and discover its applications, critiques, and best practices in active management.
• Incorporating Transaction Costs in Performance Analytics
  Explore how transaction costs affect performance measurement and attribution, learn about explicit and implicit cost components, and discover expert tips to manage costs effectively in portfolio management.
• Residual Risk and Factor Tilts
  Exploring how residual risk arises, how factor tilts can be used intentionally in active management, and ways to carefully monitor and balance these exposures for an optimized portfolio.
• Risk-Adjusted Portfolio Selection Approaches
  Discover how investors optimize portfolios by balancing returns with risk constraints using mean–variance optimization, risk parity, and robust methods.
• Hedging Systematic Risk with Derivatives
  Discover how index futures, swaps, and options can effectively hedge systematic market exposures, reduce portfolio beta, and manage risk during volatile market conditions.
• Limitations of Performance Measures in Extreme Markets
  An in-depth exploration of how traditional performance metrics can be inadequate during severe market stress, highlighting hidden tail risks, correlation breakdowns, and the need for robust risk oversight.