The same portfolio can be a sound recommendation for one customer and a violation for another. Portfolio analysis settles which in two passes: first who the customer is, then what the holdings actually do.
Every recommendation starts with facts about the customer. The customer investment profile is the set of facts you gather to judge what fits. Financial Industry Regulatory Authority (FINRA) Rule 2111(a) and Securities and Exchange Commission (SEC) Regulation Best Interest (Reg BI), Rule 15l-1(b)(2), list the same items. They are age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance. Anything else the customer tells you counts too.
For a retail customer, Reg BI's care obligation governs. You need a reasonable basis to believe the recommendation is in that customer's best interest, given the profile and the product's risks, rewards and costs. Rule 2111.08 says Rule 2111 does not apply to recommendations covered by Reg BI. Rule 2111 suitability therefore governs the rest, such as recommendations to institutional customers.
Common mistakes
- Beta times the whole market return: Writing 3% + 1.2 × 10% = 15% misreads CAPM. Beta scales only the 7% premium, giving 11.4%.
- Alpha as return minus market: 12% − 10% = 2% is alpha only when beta is 1. At a 1.3 beta, the true alpha was −0.1%.
- Beta as total volatility: A 1.5 beta means about 1.5 times the market's move, not "50% more volatile." Standard deviation measures total volatility, while beta skips company-specific swings.
Bottom line
- Reg BI's care obligation governs retail recommendations and Rule 2111 the rest; both use the same profile, and when willingness and ability to take risk disagree, the lower one governs.
- Objectives in rising risk are preservation of capital, current income, growth and income, growth and speculation; higher expected return always means more risk.
- Every options recommendation must be not unsuitable; an opening transaction also needs a customer who can evaluate the risk and financially bear it (Cboe Rule 9.3, FINRA Rule 2360(b)(19)).
- Strategic allocation is the target mix restored by rebalancing; tactical allocation is a temporary, forecast-driven tilt; longer horizons and higher tolerance mean more stocks.
Exam shortcut
Work CAPM stems in a fixed order. Find the premium first (market minus risk-free), multiply by beta, then add the risk-free rate. If the stem adds an actual return, subtract the CAPM figure to get alpha. An answer equal to portfolio minus market is the trap unless beta is 1. If the stem gives standard deviation rather than beta, it wants the Sharpe ratio, and the highest ratio wins.
The full lesson (about 4,545 words, 30 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C11
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