investment

This course is designed to provide the student with both the theoretical understanding of how investment decisions are made under uncertainty and the practical applications of this theory. Specific attention is focused on the risk reduction strategies in the formation of investment portfolios. Lectures, readings in the text and class assignments are designed to provide the student with the skills needed to understand the theoretical framework of financial economics which underlie investment analysis and portfolio management as well as the practical understanding of how these theories are used by professional investment managers and corporations (as well as by individual investors). While emphasis will be placed on the development of the investment and portfolio theory and its applications, the student will also be exposed to the limitations of theory. The major goal is to enable the student to think like a professional investment analysis and to communicate effectively his or her understanding.

The topics covered in the class will include the organization of securities markets, modern portfolio theory, asset pricing models, efficient market theory, the pricing of fixed income securities, security analysis, and an introduction to derivatives. While most of the course will be focused on domestic (US) financial markets, some of the concepts will be illustrated using international and emerging markets.

Two items require particular emphasis. First, class attendance is important. Considerable material will be covered each week and the class builds rapidly on materials. It will be difficult for a student to keep up without attending all of the classes. Second, it is important that the student carefully read each assignment and workout the problems and quizzes at the end of each chapter. While selected problems will be assigned it is recommended that the student read through all problems and understand how they should be approached.

Students need to have access to the Internet and to Excel, as some assignments will use real data. These are available on the university computer labs.

This course acquaints MBA students with the theoretical and more practical aspects of investment analysis, for security selection and portfolio management purposes. The goal is to expose students to material that any participant in the investments industry – from private investor to pension fund consultant to portfolio manager – will find useful. Logically, the study of investment pricing techniques and of the institutional background in which investment professionals operate should precede the study of how these professionals do or ought to behave. The course, which consists of six main parts, is organized accordingly.

After an introduction and a brief review of general finance concepts, Part I of the course presents the institutional environment in which portfolio managers operate. We discuss participants; instruments and their markets; and the way that securities are traded.

Parts II and III deal with portfolio management. Part II is short. It starts with the basic elements of modern portfolio theory: return (both nominal and real), risk, and the trade-off that risk-averse investors must make between the two. It then covers portfolio mechanics. Part III tackles “top-down” portfolio management as well as the major pricing models for financial assets. Among those, we first study the CAPM (“capital asset pricing model”), building on and significantly extending the notions learned in previous finance courses. We then explain how to use the CAPM in practice, i.e., how to implement index pricing models and (time permitting) multi-factor models and hedge fund strategies.

Parts IV and V analyze the two categories of financial instruments that nowadays account for most trading activity: fixed income assets and interest-rate derivatives securities. Part IV deals with securities that provide fixed periodic income, such as municipal and other local government bonds, US Treasury Bills, Notes and Bonds, and mortgage-backed securities. The material includes the computation of bond yields, and the measurement of the term structure of interest rates. Part V discusses portfolio-management techniques that are specific to fixed-income securities. Topics include overviews of interest-rate risk measurement (including duration and convexity) and management, and credit risk (including credit spreads and credit crunches). Time permitting, yield-curve and spread-convergence trading techniques and bond-portfolio hedging shall be discussed. Credit derivatives and hedging techniques shall be introduced.

Part VI then presents the key elements of fundamental analysis for equities. The main items discussed in this part of the course are the elements of a “top-down” analysis of a firm’s prospects, from macroeconomic and industry analysis to company-specific items. Practitioners rely on three main methods to value individual equities: ratio analysis, discount models and “comparables.” We shall revisit dividend discount models, and cover in detail price/earnings ratio analysis.

Students attending this class will learn

1. Modern portfolio theory;
2. Fixed income securities;
3. Term structure of interest rate;
4. Interest rate risk measurement and management;
5. Fundamental analysis of for equities.

We will use only parts of the following text.

• Zvi Bodie, Alex Kane, Alan Marcus (2009), Investments, 8th Edition, McGraw-Hill (hereafter, BKM).
• Burton Malkiel (2007), A Random Walk Down Wall Street, 9th Edition, W.W. Norton & Company. (hereafter, BM)
• Carmen Reinhart and Kenneth Rogoff (2009) This Time is Different: Eight Centuries of Financial Folly, 1st Edition, Princeton University Press. (hereafter, RR)

Investments is an especially dynamic area, and students are urged to follow current developments in the press. This includes reading the following papers: The Wall Street Journal, The Economist (weekly, www.economist.com, mostly pay site) or The Financial Times. Barron’s, Euromoney and Value Line’s Investment Surveys are some of the other good sources of investment news. Other newspapers may also be useful for the purpose of the class, but often lack significant amounts of relevant information.

Discussion and exams will reward those who prepare in advance. The exams will draw heavily on the homework assignments, which are not going to be graded, given throughout the semester. Grading will be based on Reflection and Analysis Assignments (10 percent), reading from Random Walk Book (10 percent), two group assignments (30 percent), a midterm exam (25 percent) and a cumulative final exam (25 percent). Exams are take-home and open book. All homework should be typed and submitted to me by e-mail not later than specified due date (homework sent in late will not be accepted). For programming assignments, you should submit a working program file. For analytic and algebraic exercises, I prefer to receive them as a LaTeX format but also accept PDF files.

Reflection and Analysis Assignments (due each week by Monday evening 11:59 PM):

Every week, you will be required to submit two page review of an article related to investments or portfolio management found in the professional press (Wall Street Journal, Financial Times, Economist, standard business publications). Beyond a summary of the article, the student should critique based on readings and materials covered in class. Some weeks a specific article will be assigned for review. Be sure to provide a complete reference to the article (publication, author if available, title, date) and a brief summary (one paragraph) of the article. Include in your discussion the following 4 points. The assignment should be no more than 2 pages (with normal font and margins).

1. What did you learn (most significant points)?
2. What did it connect with that you knew previously and/or with what you have learned in this class?
3. What questions does the article raise in your mind (e.g., what is unresolved)?
4. How would this information impact you as an investor (either personally or professionally)?

Group Assignments

Since we wish to emphasize practical skills, students shall complete two sets of numerical problems that use actual asset returns. To reflect how most companies conduct business, students shall form groups to handle this assignment. Groups shall comprise four students -- no fewer, no more. Groups shall e-mail their composition to me by February 1 at the latest. Once groups have been formed, their composition is not allowed to change. I reserve the right to handle any and all group-related problems. Each group is to return an e-mail with its written answers and the supporting Excel spreadsheets by:

• Assignment #1 (group): by Monday, March 1 at 6 PM;
• Assignment #2 (group): by Monday, March 15 at 6 PM

Reading from A Random Walk Down Wall Street (due every other week by Monday evening 11:59 PM, only if your group is assigned to review the relevant chapters)

Each group will also be asked to review the following chapters of A Random Walk Down Wall Street. The review should be no more than 15 pages (with normal font and margins). Be sure to provide a brief summary (no more than five pages) of the relevant chapters. Then provide answers to the following questions:

1. What did you learn (most significant points)?
2. What did it connect with that you knew previously and/or with what you have learned in this class?
3. What questions does the article raise in your mind (e.g., what is unresolved)?
4. How would this information impact you as an investor (either personally or professionally)?