Investment management lecture notes ppt

investment analysis lecture notes and investment management lecture notes
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Investments Lecture Notes Prof. Doron Avramov The Jerusalem School of Business Administration The Hebrew University of JerusalemSyllabus: Course Description  In this course you will study the theory and practice of investment management in domestic and global financial markets.  The course comprehensively describes conceptual paradigms and their extensive applications in practice. 2 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementSyllabus: Contents  The following topics will be covered:  Asset allocation;  Security selection;  ETFs: an easy way to invest;  Computing rate of return on various investments;  Short selling and buying on margin;  The risk-return tradeoff;  The stock versus bond performance;  Constructing price weighted indexes (e.g., Dow Jones 30, Nikkei 225) as well as value weighted indexes (e.g., TA25, S&P500, NASDAQ);  Recovering key financial ratios from financial statements;  Debating market efficiency; 3 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementSyllabus: Contents  Analyzing performance of mutual funds;  Comparing mutual funds to hedge funds;  Examining evidence on market anomalies, especially, the size, value, price momentum, earnings momentum, and volatility effects in stock prices;  Diversification gain and portfolio volatility;  Forming optimal portfolios with constraints;  Investing in public and private equities, commodities, and bonds;  Understanding and pricing derivatives securities;  Valuing equities using the discounted cash flows approach and price multipliers. 4 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementSyllabus: Prerequisite  Make sure you have taken all the prerequisite courses.  The course requires adequate analytical skills.  Familiarity with statistics should extend through concepts of mean, standard deviation, covariance, correlation, the normal distribution, and regression analysis.  A good grounding in Excel is essential for solving the case studies as well as analyzing traditionally applied paradigms in financial economics. 5 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementSyllabus: Resources  Textbook: The class notes are fairly comprehensive. If you wish to enhance your knowledge, you can use the following textbooks:  Fundamentals of Investments Valuation and Management by Jordan & Miller.  Investments Bodie, Kane, and Marcus  TA: Lior Metzker; email: lior.metzker at mail.huji.ac.il 6 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementSyllabus: Grading  Assignments (36%): There are three case studies as well as frequent problem sets corresponding to end-of-chapter questions. You can form groups of up to (no more than) four students to prepare the cases. However, end-of-chapter questions must be solved individually. Each case accounts for 9% of the final grade. All problem sets combined also account for 9% of the final grade.  Final Exam (64%): The final exam will be based on the material covered in class (in letter and spirit), class handouts, class discussions, examples, case studies, and assigned readings. The exam is closed books and closed notes. However, you can bring in one piece of paper with handwritten or printed notes (double-sided, A4 size). You are not allowed to use any other notes. You can also use a calculator during the exam. 7 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementSyllabus: Class Attendance  To get credit for this course it is mandatory to attend all the sessions. You are responsible for any announcement (including due dates for the case studies and problem sets), discussion, and remarks made in class.  A nontrivial fraction of the final exam questions could be based on class discussion, coverage of recent events in financial markets, and examples which are uncovered in the lecture notes. 8 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementCase 1: Dimensional Fund Advisers (DFA) http://hbr.org/product/dimensional-fund-advisers-2002/an/203026-PDF-ENG  In 2002, the time when the case study was written, DFA was a 30 billion fund. Ever since there has been a phenomenal growth in assets managed by DFA. See updated figures in the DFA website.  You will find in the case study that several features make DFA an unusual family of mutual funds. In particular, DFA believes in market efficiency. It hence relies on passive strategies undertaking more of a buy- and-hold investment approach than active search for mispriced stocks. DFA uses academic research to form investments and assess their performance. It has also specialized in trading large blocks of small stocks at discount prices. 9 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementCase 1: Dimensional Fund Advisers (DFA)  The case covers several topical subjects in finance including efficient markets, models of capital market equilibrium (e.g., the CAPM), the Fama-French three-factor model, financial instruments, investment management, tax management, liquidity, and stock trading. 10 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementDFA - Questions  Q1. Are DFA investment management practices consistent with market efficiency?  Q2. What are the Fama-French (FF) findings? How do Fama and French explain the size and book to market effects in stock prices? Looking forward, should you expect small stocks to outperform large stocks? Value stocks to outperform growth stocks? Do FF findings hold in other financial markets beyond the US? What are the alternative (non-risk) explanations for the size and value effects?  Q3. Visit http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html Download returns on 25 size and book to market portfolios and then replicate the table in the class notes (the one in the value anomaly section) based on: a. The entire sample period starting from 1/70 b. The 1/1/90-31/12/1999 period c. The 1/1/2000-31/12/2010 period d. The period starting from 1/1/2011. Describe the size and book-to-market effects in all these periods. 11 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementDFA - Questions  Q4. What are liquidity constraints on trading? How does DFA deal with liquidity constraints, and what are the costs and benefits of implementing the DFA’s strategy? Has the DFA’s liquidity proving strategy been improving its performance over the years?  Q5. Who are the most prominent competitors of DFA in the mutual fund industry? How could you explain the impressive progress DFA has made over time in attracting new money relative to its peers?  Q6. Compare DFA performance to its major competitors. That is, pick at least two mutual funds managed by DFA (based on style or sector) and examine whether those funds have outperformed similar funds managed by at least two of DFA’s competitors. Also examine whether the DFA funds have outperformed their benchmarks. You can use yahoo finance at http://finance.yahoo.com/ to get real time data. 12 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementDFA – Guidelines  Q1: DFA has been closely affiliated with Eugene Fama - a Nobel price laureate from the University of Chicago. Fama has been a strong believer in market efficiency. It should be noted that also Robert Shiller won the Nobel Prize in 2013 along with Fama. Shiller believes that markets are inefficient and subject to behavioral biases. Who is right? This seems to be a philosophical question. The empirical evidence is not conclusive. Per Fama, if high book-to-market small-cap stocks earn more over the long run – they must be more risky and moreover the CAPM does not capture these additional risk sources. DFA claims to have adopted Fama’s beliefs. Based on the case study, is it really clear that the DFA management believes in market efficiency? 13 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementDFA – Guidelines  Q2: This question is about describing the Fama-French findings based on past evidence and future prospects. Here is some background. The Fama-French three-factor model (which extends the single-factor CAPM) has gained prominence in the industry and academia. Some folks do not accept that model. What could be the objections here? For one, the model followed the data and is not inspired by economic theory. There are also behavioral (non risk) explanations for the value premium. Here is one. Investors classify stocks to growth or value categories based on historical growth rates. Such investors are willing to pay high prices for growth stocks believing that the previously observed phenomenal growth rates will last for the very long run. But in reality, high growth rates are typically not long lasting – past high growth rate firms could become low growth rate firms in the future, and vice versa. Therefore, growth stocks earn less in the future once investors realize that growth firms perform poorly relative to prior expectations. That means the value premium could reflect investors’ incorrect extrapolation of past growth rates. There are other behavioral explanations. 14 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementDFA – Guidelines  Q3: This one is self-explanatory. Simply download the data and compute statistics similar to those displayed in the class notes. You are also requested to analyze patterns in the size and value effects during the distinct sample periods.  Q4: DFA has established an excellent reputation in the niche of liquidity providing. What is the liquidity providing strategy, how does it work and what are the pros and cons? If you have anything else to say about the important concept of liquidity please feel free to detail it in your submitted case.  Q5: Compare the growth of DFA to distinguished competitors (e.g., Vanguard, Fidelity, among other competitors) – has DFA attracted more inflows? If yes, how could you explain that.  Q6: Identify competing mutual funds and compare performance. 15 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementCase 2: AQR’s Momentum Funds (2012) Please note that there are 2 links. http://hbr.org/product/aqr-s-momentum-funds-a/an/211025-PDF-ENG http://hbr.org/product/aqr-s-momentum-funds-b/an/211075-PDF- ENG?Ntt=AQR%27s%2520Momentum%2520Funds This case study discusses the launch of several new retail mutual funds that offer investors the exposure to price momentum, a prominent investment style. While momentum strategies have been commonplace among hedge funds, the new AQR funds would become the first retail funds to focus on this strategy. 16 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementAQR’s Questions  Q1: Describe in general the momentum trading strategy. What are the common explanations for the existence of momentum in asset prices?  Q2: Identify one of AQR momentum funds. Compare performance of that fund relative to the market portfolio?  Q3: Describe potential reasons for the momentum crash during 2009. 17 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementAQR’s Questions  Q4: Can a retail investor easily imitate a momentum fund? Explain in detail whether a similar home-made strategy could be established.  Q5: Compare two momentum funds – one for small cap stocks while the other for large cap stocks. Which one you would favor and why?  Q6: There are also sector funds specializing in momentum. PTF implements momentum among technology stocks; PXI implements momentum among energy stocks. Explain the basic strategies of such funds (ETFs). Find other sector ETFs investing in momentum. What would be the benchmarks for assessing performance of such ETFs? Have momentum ETFs been able to beat their benchmarks?  Q7: What can you learn about market efficiency based on the performance of momentum funds? 18 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementCase 3: Harvard Management Company (HMC) http://hbr.org/product/harvard-management-company-2010/an/211004-PDF- ENG?Ntt=211004 The central issue in this case is to propose an asset allocation policy for Harvard Management Company using concepts of mean variance optimization and portfolio constraints studied in class. Let us start with the policy portfolio displayed in Exhibit 4. The policy portfolio is the long run asset mix of Harvard. It specifies the “neutral weighting” for each asset class. HMC was given a minimum and maximum range for each asset class within which they could trade. HMC made tactical asset allocation bets from time to time attempting to beat the policy portfolio in anticipation for short- term market moves. Some of the questions below involve using the Excel Solver for forming optimal portfolios under constraints for each of the asset classes under consideration. 19 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment ManagementHMC – Questions  Q1: Given figures in Exhibits 4 and 17 what is the expected return and volatility of the policy portfolio?  Q2: Find an efficient portfolio having the same expected return as the policy portfolio but lower volatility based on portfolio constraints displayed in Exhibit 18. Report the investment weights of this portfolio as well as its volatility.  Q3: Find an efficient portfolio having the same volatility as the policy portfolio but higher expected return based on the same portfolio constraints. Report the investment weights of this portfolio as well as its expected return.  Q4: Repeat questions 2 and 3 using the new set of constraints in Exhibit 19. 20 Prof. Doron Avramov, The Jerusalem School of Business Administration, The Hebrew University of Jerusalem, Investment Management