Modern Investment Theory

Basic Information

1. Course Type: Academic Core Course

2. Class Hours: 54 (45 minutes each class hour)

3. Credits: 3 credits

4. Suitable for: Graduate Students of Finance

Course Introduction

This course is focused on correctly guiding investment concepts in the context of the portfolio theory. The main contents of this course includes capital asset pricing model, arbitrage trading price, securities transaction prices, the exchange rate and stock management. The course also teaches students knowledge of the stock valuation, assessment of futures earnings and dividends, fixed-income market and so on. The course emphasizes unity of fundamentality and applicability, attaches importance not only to students' accumulation of investment knowledge and cultivation of basic investment operation ability, but also to the ability to prepare various investment products portfolios.

Course Objectives

By the end of this course, students are requested to grasp the related investment elementary theory, discover the opportunities for investment and the manage investment risk, combine investment theory and practice, utilize the knowledge to analyze related issues in modern investment environment, grasp the investment product innovation and the investment risk management trend, achieve the requested finance goal, discover the value of negotiable securities which are underestimated, avoid taxes as well as evaluate the investment performance.

Outline of Course Content

Chapter 1 Investment Environment

Overall Objective: to know the investment environment.1. Financial Markets

2. Asset Classes

Contents:

Section1. Financial Markets

1. Money market

(1) Treasury bills

(2)Bid and asked price (3)Bank discount method (4)Certificates of deposits (5)Commercial Paper (6)Bankers Acceptances (7)Eurodollars (8)Repurchase Agreements (RPs) and Reverse RPs (9)Brokers' Calls (10)Federal Funds (11)LIBOR Market2. Bond market (1)Treasury Notes and Bonds (2)Inflation-Protected Treasury Bonds (3)Federal Agency Debt (4)International Bonds  (5)Municipal Bonds (6)Corporate Bonds (7)Mortgages and Mortgage-Backed Securities

3. Equity securities

(1)Common stock(2)Residual claim(3)Limited liability(4)Preferred stock(4)Fixed dividends-limited(5)Priority over common(6)Tax treatment(7)Depository receipts

4. Indexes

5. Derivative markets  (1)Options

(2)Futures

Section2. Asset Classes

Chapter 2 Return and risk

Overall Objective: to know return and risk.1. Expected return

2. Standard deviation

Contents:

Section1. Expected return

Section2. Standard deviation

Chapter 3 Risk aversion and capital allocation to risky assetsOverall Objective: to know risk aversion and capital allocation to risky assets

1. Risk and risk aversion

2. Utility function

3. Capital allocation across risky and risk-free portfolios

4. Passive strategies: The Capital Market Line

Contents:

Section1. Risk and risk aversion

Section2. Utility function

Section3. Capital allocation across risky and risk-free portfolios

Section4. Passive strategies: The Capital Market Line

Chapter 4 Optimal risky portfolios

Overall Objective: to know optimal risky portfolios1. Diversification and portfolio risk

2. Covariance and correlation

3. Two-Security portfolio: return

4. Two-Security portfolio: risk

5. Three-Security portfolio

6 Markowitz Portfolio Selection Model

7 Risk pooling and the insurance principle

Contents:

Section 1. Diversification and portfolio risk

Section 2. Covariance and correlation

Section 3. Two-Security portfolio: return

Section 4. Two-Security portfolio: risk

Section 5. Three-Security portfolio

Section 6 Markowitz Portfolio Selection Model

Section 7 Risk Pooling and the insurance principle

Chapter 5 Index Models

Overall Objective: to know index models1. Advantages of the Single Index Model

2. Single Factor Model

3. Index Model and diversification

4. Alpha and security analysis

5. Optimal Risky Portfolio of the Single-Index Model

Contents:

Section 1. Advantages of the Single Index Model

Section 2. Single Factor Model

Section 3. Index model and diversification

Section 4. Alpha and security analysis

Section 5. Optimal risky portfolio of the single-index model

Chapter 6 Capital Asset Pricing ModelOverall Objective:to know The Capital Asset Pricing Model1. Assumptions

2. The Security Market Line

3. Extensions of the CAPM

Contents:

Section1. Assumptions

Section2. The Security Market Line

Section3. Extensions of the CAPM

Chapter 7Arbitrage Pricing Theory and multifactor models of risk and returnOverall Objective: to know Arbitrage Pricing Theory and multifactor models of risk and return 1. Single Factor Model

2. Multifactor Models

3. Arbitrage Pricing Theory

4. APT and CAPM Compared

5. Multifactor APT

Contents:

Section1. Single Factor Model

Section2. Multifactor Models

Section3. Arbitrage Pricing Theory

Section4. APT and CAPM Compared

Section5. Multifactor APT

Chapter 8 Efficient Market HypothesisOverall Objective: to know The Efficient Market Hypothesis.1. EMH and competition

2. Versions of the EMH

3. Active or passive management

4. Market efficiency and portfolio management

5. Event studies

Contents:

Section1. EMH and competition

Section2. Versions of the EMH

Section3. Active or passive management

Section4. Market efficiency and portfolio management

Section5. Event studies

Chapter 9 Bond Prices and yieldsOverall Objective: to know bond prices and yields.1. Bond characteristics

2. Different issuers of bonds

3. Bond pricing

4. Yield to maturity

Contents:

Section1. Bond characteristics

Section2. Different issuers of bonds

Section3. Bond pricing

Section4. Yield to maturity

Chapter 10 Term structure of interest ratesOverall Objective: to know the term structure of interest rates.1. Overview of term structure

2. Yield curve under certainty

3. Forward rates from observed rates

4. Interest rate uncertainty

5. Theories of term structure

Contents:

Section1. Overview of term structure

Section2. Yield curve under certainty

Section3. Forward rates from observed rates

Section4. Interest rate uncertainty

Section5. Theories of term structure

Chapter 11 Managing bond portfoliosOverall Objective: the goal here is to know managing bond portfolios 1. Duration

2. Convexity

3. Immunization

Contents:

Section1. Duration

Section2. Convexity

Section3. Immunization

Chapter 12 Equity valuation modelsOverall Objective: to know equity valuation models1. Dividend Discount Models

2. Price/Earning Ratios

3. Cash Flow Approach

Contents:

Section1. Dividend Discount Models

Section2. Price/Earning Ratios

Section3. Cash Flow Approach

Chapter 13 Options markets: IntroductionOverall Objective: to know options markets1. Option

2. Different types of options

3. Profits at expiration

4. Option strategies

Contents:

Section1. Option

Section2. Different types of options

Section3. Profits at expiration

Section4. Option strategies

Chapter 14 Option valuationOverall Objective: to know option valuation1. Option values

2. Binomial option pricing

3. Black-Scholes Option Valuation

4. Black-Scholes Model with dividends

5. Using the Black-Scholes Formula

6. Portfolio insurance

Contents:

Section1. Option values

Section2. Binomial Option Pricing

Section3. Black-Scholes Option Valuation

Section4. Black-Scholes Model with Dividends

Section5. Using the Black-Scholes formula

Section6. Portfolio insurance

Chapter 15 Futures marketsOverall Objective: know futures markets.1. Futures and forwards

2. Trading mechanics

3. Trading strategies

4. Basis risk

5. Futures pricing

6. Risk management

Contents:

Section1. Futures and forwards

Section2. Trading mechanics

Section3. Trading strategies

Section4. Basis risk

Section5. Futures pricing

Section6.Risk Management

Chapter 16 Portfolio Performance Evaluation

Overall Objective: to know portfolio performance evaluation.

1. Risk adjusted performance

2. Information ratio

3. M2 measure

4. Market timing

5. Style analysis

Contents:

Section1. Risk adjusted performance

Section2. Information ratio

Section3. M2 measure

Section4. Market timing

Section5. Style analysis

Class Hour Distribution

Week 1 Chapter 1, Chapter 2

Week 2 Chapter 3

Week 3 Chapter 4

Week 4 Chapter 5

Week 5 Chapter 6

Week 6 Chapter 7

Week 7 Chapter 8

Week 8 Chapter 9

Week 9 Chapter10

Week 10 Chapter11

Week 11 Chapter12

Week 10 Chapter11

Week 11 Chapter12

Week 12 Chapter13

Week 13 Chapter14

Week 14 Chapter15

Week 15 Chapter16

Week 16 Case Study

Week 17 Case Study

Week 18 Exercise

The total course hour is 54(45 minutes each class hour), which will be evenly distributed in 18weeks, that is every week will have 3 course hours.

Text book

Zvi Vodie. Investments (9th Edition), China Machine Press, 2012

Course requirements and grading

Grading Policy: Your grade for the course will be calculated as follows:

Regular Homework and Class Participation 30%

Final Exam 70%

Attendance: Regular attendance is an important requirement for successful performance in this course. If a student repeatedly misses classes, questions will be raised with the administration and suggesting the student withdrew from the course.

Homework problems: problem sets will be assigned regularly. All the students will get a chance to present homework solutions in class. At this point, it is not as important to have a correct solution as it is to demonstrate that you have worked on your homework seriously. Please, start looking at problems right away so that you can ask for help if you need it. In addition to my office hours and email, you can use the homework discussion board on Blackboard for homework help. Your homework problems will help you to understand the material and to systematically prepare for exams. Class participation and homework will account for 30% of your grade.