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Investments: Principles of Portfolio and Equity Analysis by Gerhard Van de Venter, CFA, Wendy L. Pirie, CFA, Jerald E. Pinto, CFA, Michael G. McMillan, CFA

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CHAPTER 7

BASICS OF PORTFOLIO PLANNING AND CONSTRUCTION

Alistair Byrne, CFA

Edinburgh, U.K.

Frank E. Smudde, CFA

Amsterdam, The Netherlands

LEARNING OUTCOMES

After completing this chapter, you will be able to do the following:

  • Explain the reasons for a written investment policy statement (IPS).
  • List and explain the major components of an IPS.
  • Discuss risk and return objectives, including their preparation.
  • Distinguish between the willingness and the ability (capacity) to take risk in analyzing an investor’s financial risk tolerance.
  • Describe the investment constraints of liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances and their implications for the choice of portfolio assets.
  • Explain the definition and specification of asset classes in relation to asset allocation.
  • Discuss the principles of portfolio construction and the role of asset allocation in relation to the IPS.

1. INTRODUCTION

To build a suitable portfolio for a client, investment advisers should first seek to understand the client’s investment goals, resources, circumstances, and constraints. Investors can be categorized into broad groups based on shared characteristics with respect to these factors (e.g., various types of individual investors and institutional investors). Even investors within a given type, however, will invariably have a number of distinctive requirements. In this chapter, we consider in detail the planning for investment success based on an individualized ...

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