Last Update: Everything is now posted. Good luck on the finals!

Investment Challenge Update #6: “May you live in the time of changes” certainly does sound like a curse these days… Because the changes are almost all bad. The most recent wave of implosions in the financial sector last week determined the winner for the Investment Challenge: WM. On Tuesday (11/13), we’ll briefly discuss the current state of affairs in the markets, how we got here, and the challenges ahead.

 

Economics 282: Investment Finance
Fall 2007, 1:15—3:00, Willis 211

Instructor: Pavel Kapinos
Office: Willis 322
Office Hours: Mo 2-4; Tu 10-12, 4-5 or by appointment

Prefect: Hugh Cameron

 

 

Tentative Syllabus

Date

Lecture

References

September 11, 2007 (Tu)

Lecture 1: Course Overview: Introduction to the class and investment finance

BKM 1,2,5

September 13, 2007 (Th)

Lecture 2: Bond Prices and Yields

BKM 14 | lecture2.xls

September 18, 2007 (Tu)

Lecture 3: Term Structure of Interest Rates

BKM 15 | lecture3.xls | The Living Yield Curve | What Makes the Yield Curve Move

September 20, 2007 (Th)

Lecture 4: Managing Bond Portfolios

BKM 16.1-3 | lecture4.xls | Greenspan on the Daily Show

September 25, 2007 (Tu)

Lecture 5: Security Analysis

BKM 16.5; 17,18.1-2

September 27, 2007 (Th)

Lecture 6: Risk and Risk Aversion | Optimization | Equity Premium Puzzle

BKM 18.3-4 | Class Notes | Optimization Primer (3.2 is optional) | Notes on Risk Aversion

October 2, 2007 (Tu)

Lecture 7: Statistical Review

BKM Appendix A | Stats Review

October 4, 2007 (Th)

Midterm I

Lectures 1-6

October 9, 2007 (Tu)

Lecture 8: Capital Allocation between Risky and Risk-free Assets

BKM 6,7 | Quincunx

October 11, 2007 (Th)

Lecture 9: Optimal Risky Portfolios

BKM 8 | lecture9.xls

October 16, 2007 (Tu)

Lecture 10: Capital Asset Pricing Model (CAPM)

BKM 9

October 18, 2007 (Th)

Lecture 11: Single-index Model | Empirical Tests of the CAPM

BKM 10, notes | lecture11.xls

October 23, 2007 (Tu)

Lecture 12: Arbitrage Pricing Theory

BKM 11, 13 | lecture12.xls

October 25, 2007 (Th)

Lecture 13: Market Efficiency, Anomalies, and Behavioral Finance

BKM 12, notes

October 30, 2007 (Tu)

Lecture 14: Portfolio Performance Evaluation

BKM 24

November 1, 2007 (Th)

Midterm II

Lectures 1-13

November 6, 2007 (Tu)

Lecture 15: Options I—Strategies

BKM 20

November 8, 2007 (Th)

Lecture 16: Options II—Pricing

Class notes | BKM 21 | lecture16.xls

November 13, 2007 (Tu)

Lecture 17: Options III—American vs. European | Course Overview

Class notes | lecture17.xls

November 17, 2007 (Sa)

Final: 7-9:30pm

Everything

Problem Sets:
Problem Set 1, due Tu 9/18   | Solution, Excel Work
Problem Set 2, due Tu 9/25   | Solution, Excel Work
Problem Set 3, due Tu 10/2   | Solution
Problem Set 4, due Tu 10/16 | Solution, Excel Work
Problem Set 5, due Tu 10/23 | Solution, Excel Work
Problem Set 6, due Tu 10/30 | Solution, Excel Work
Problem Set 7, due Tu 11/13 | Solution, Excel Work

Financial Likbez:
The Winner’s Curse by Richard Thaler
Robert Haugen’s Quantitative Investment website and his trilogy: The Inefficient Stock Market: What Pays Off and Why, Beast on Wall Street: How Stock Volatility Devours Our Wealth, and The New Finance: Overreaction, Complexity, and Uniqueness
Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Taleb
T. F. Crack’s Heard on the Street: Quantitative Questions from Wall Street Job Interviews

Links:
Econ 110 (Winter 2006)
Macroeconomic updates: Global Economic Forum by Morgan Stanley
Financial and Economic News: CNN Money,  Economist, Wall Street Journal
Financial data and news: Yahoo! Finance, Google Finance, Morningstar.com
Macroeconomic data for the US: FRED II database by the Federal Reserve Bank of Saint Louis
Educational resources: Investopedia, Stock Market Game, Wall Street Prep, Beat the Market

Old Stuff:

Investment Challenge Update #1: The field is set and we’re off to the races! I gave each entry $100 and $1 for the S&P 500 index, so that comparisons between that index and the class portfolio can easily be made. So far we have one runaway leader: LDK. There are fairly compelling reasons for including this one in your portfolio. Selling solar wafers to manufacturers of solar cells in China may play to be a great bet, as the country try to recoup the environmental costs of its recent rapid growth and accepts the higher environmental standards pushed by the international community. I’m also encouraged by the signs of international diversification that are written all over this selection, especially EWZ (since I own a tiny number of its shares) and EEM, which seems to be a great diversification instrument.

Investment Challenge Update #2: LDK still stays ahead but slows down quite a bit, so let’s look at the runner-up: EWZ. Some argue that the recent cuts in the FFR target have affected the emerging markets more than the domestic economy. But, wait, there’s more: The latest reading of the manufacturing data suggests that the U.S. economy may be slowing down even more than previously anticipated, prompting investors to believe that the Fed will slash interest rates even further. This will continue to put downward pressure on the dollar, raising the dollar value of foreign assets. Moral of the story: diversify internationally.

 

Investment Challenge Update #3: LDK falters where it firmly trod (are you familiar with the inimitable Lord Tennyson?) but God (or whatever entity is responsible for the vagaries of the stock market) saves Brazil or, at the very least, its ETF, EWZ, which now becomes the leader of the pack. Close behind are FLIR, a company that produced a bunch of equipment that could be used in a Hollywood spy thriller and whose prospects have probably been boosted by the recent “War of Terror”, EEM (we’ve already discussed the benefits of international diversification), BBY (betting on consumer electronics in a potentially recessionary environment might be risky), and AMG (this financial management company with a stellar track record may get a further boost from the declining interest rates). What’s next? Gossip about the upcoming FOMC meeting and whether the Fed will cut rates again. Count the number of times when a 0.5% decrease in the FFR target has not been followed by another cut at the next meeting since Greenspan became chairman. It does look like the Fed likes to smooth interest rate fluctuations, doesn’t it? But the macroeconomic news has been fairly upbeat: the trade deficit is declining, as is the fiscal deficit, plus the real estate market is showing some signs of stability. So there are few real-side or financial reasons to lower the rates, aside from Greenspan’s dour forecast. On the other hand, if the spike in oil prices lasts, inflationary pressures may build up further, hence another interest rate cut may be ill-advised. The Fed’s stance in this tradeoff should be very telling about its true preferences…

 

Investment Challenge Update #4: At the first glance, it looks like WM has joined the list of entries in the red. But it’s a short entry, so it’s actually making a positive contribution to the class portfolio. Although naked shorts are potentially perilous (stock prices are expected to go up after all), this short certainly looks like a great idea right now. The stock got rattled this summer with the subprime backlash hitting it hard. Bernanke’s recent comments on the possibility of further real estates woes have sent this stock price even lower. Interestingly, with 5.9% of shares shorted (see the Key Statistics page for the company), WM isn’t even the one that investors seem to feel most pessimistic about: for AMG this share is 24.6% and BBW 33.6%! (XOM, on the other hand is under 1%--there are few takers to place bets against an oil giant.) On a totally unrelated note, here’s a little reminder from Bennett Surajat (’07) that math is—or, at least, can be—fun.

 

Investment Challenge Update #5: The Fed decided to cut the interest rates last week, expecting the housing market to dampen growth. The FOMC statement also indicated that “after this action, the upside risks to inflation roughly balance the downside risks to growth,” which means that investors shouldn’t hold their breath for additional rate cuts. A week after the cut, the SP500 has hardly moved and the class portfolio exhibited only a modest increase in value. Overall, the class is still beating the SP500, with most of the gains coming from the trio of leaders: FLIR, EWZ, and WM. The short on the latter, however, may get hurt by some investors’ sentiment that the worst in the credit markets may have passed—the stock certainly had a nice comeback on Tuesday. FLIR continues with its impressive gains, while EWZ is my pick to finish second.