Introduction

Welcome to Portfolio Theory and Asset Allocation: the unit that teaches you how to match investments to customers, build diversified portfolios, and evaluate performance using the foundational models of modern finance.

Exam Weight: Chapter 7 covers approximately 15 questions

What You'll Learn

In this unit, you'll cover:

• Customer-Specific Factors: How risk tolerance, time horizon, objectives, and liquidity needs drive security selection
• Portfolio and Account Analysis: Diversification, asset allocation, concentration risk, volatility, and tax ramifications
• Systematic and Unsystematic Risk: Market-wide risk vs. company-specific risk, and how correlation affects diversification
• Beta: Measuring a security's sensitivity to market movements and calculating portfolio beta
• Alpha: Evaluating whether a manager adds value beyond what market risk alone would predict
• Capital Asset Pricing Model (CAPM): The formula that connects risk-free rates, beta, and expected returns
• Modern Portfolio Theory (MPT): The efficient frontier, risk-return tradeoff, and optimal portfolio construction

Why This Matters

The Series 7 exam tests whether you can connect a customer's profile to appropriate investments and evaluate portfolio performance. This unit provides the theoretical backbone for those decisions. You need to know how to assess risk (beta), measure manager skill (alpha), calculate expected returns (CAPM), and construct portfolios that maximize return for a given level of risk (MPT). These concepts appear in suitability questions, portfolio analysis scenarios, and calculation problems across the exam.

Let's start with the foundation: the customer-specific factors that drive every investment recommendation.