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  3. University Of Leicester (LE)
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  5. Investment Management - EC3077 (EC3077)

Lecture notes

Investment Management, Portfolio management, bond and stock valuation
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Complete notes for the EC3077 Investment Management module. I achieved the highest overall mark, and highest exam mark for my class of ~120 students using these notes. There is no guarantee of your final mark included with the purchase of these notes however.

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  • April 11, 2022
  • 75
  • 2020/2021
  • Lecture notes
  • Unknown
  • All classes

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Investment Management CONTENTS


Contents

1 Valuation 2

1.1 Introduction to security valuation . . . . . . . . . . . . . . . . . . 2

1.2 Valuations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4


2 Bonds 4

2.1 Basic Features . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

2.2 Bond Characteristics . . . . . . . . . . . . . . . . . . . . . . . . 5

2.3 Rates of return on bonds . . . . . . . . . . . . . . . . . . . . . . 6

2.4 Global Bond Market Structure . . . . . . . . . . . . . . . . . . . 7

2.5 Who buys bonds? . . . . . . . . . . . . . . . . . . . . . . . . . 8

2.6 Bond Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

2.7 Alternative Bond Issues . . . . . . . . . . . . . . . . . . . . . . 10


3 The Fundamentals of Bond Valuation 13

3.1 Bond Duration . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

3.2 The Yield Model . . . . . . . . . . . . . . . . . . . . . . . . . . 16

3.3 Comparing Bond Yields . . . . . . . . . . . . . . . . . . . . . . 16

3.4 What determines an interest rate? . . . . . . . . . . . . . . . . . 18

3.5 Expectations Hypothesis . . . . . . . . . . . . . . . . . . . . . . 20


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,Investment Management CONTENTS


3.6 Liquidity Preference (Term Premium) Hypothesis . . . . . . . . . . 21

3.7 Segmented Market Hypothesis . . . . . . . . . . . . . . . . . . . 22

3.8 Yield Spreads . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

3.9 What Determines the Price Volatility for Bonds? . . . . . . . . . . 23

3.10 Trading Strategies . . . . . . . . . . . . . . . . . . . . . . . . . 24

3.11 Duration Measures and price changes . . . . . . . . . . . . . . . . 24


4 Efficient Market Hypothesis 28

4.1 Weak form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

4.2 Semi-strong form . . . . . . . . . . . . . . . . . . . . . . . . . . 30

4.3 Strong form . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30


5 Portfolio Management 30

5.1 Passive Management . . . . . . . . . . . . . . . . . . . . . . . . 33

5.2 Indexing Strategy . . . . . . . . . . . . . . . . . . . . . . . . . 33

5.3 Active Management Strategies . . . . . . . . . . . . . . . . . . . 34

5.3.1 Interest Rate Anticipation . . . . . . . . . . . . . . . . . . 34

5.4 Core-Plus Management Strategies . . . . . . . . . . . . . . . . . 36

5.5 Matched-Funding Management Strategies . . . . . . . . . . . . . . 38

5.6 Dedicated Portfolios . . . . . . . . . . . . . . . . . . . . . . . . 38




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,Investment Management CONTENTS


5.7 Immunisation Strategies . . . . . . . . . . . . . . . . . . . . . . 39


6 Security Market Indexes 41

6.1 Uses of Security-Market Indexes . . . . . . . . . . . . . . . . . . 41

6.2 Factors in Constructing Market Indexes . . . . . . . . . . . . . . . 41

6.3 Stock Market Indexes . . . . . . . . . . . . . . . . . . . . . . . 42

6.4 Value-Weighted Index . . . . . . . . . . . . . . . . . . . . . . . 43

6.5 Unweighted Index . . . . . . . . . . . . . . . . . . . . . . . . . 43

6.6 Fundamental Weighted Index . . . . . . . . . . . . . . . . . . . . 44


7 Stock Valuation 44

7.1 Why and when to use DCF . . . . . . . . . . . . . . . . . . . . . 45

7.2 Why and when to use the relative valuation techniques . . . . . . . 45

7.3 Valuation with Temporary Supernormal Growth . . . . . . . . . . 46

7.4 Relative Valuation Techniques . . . . . . . . . . . . . . . . . . . 46

7.5 Estimating the Inputs . . . . . . . . . . . . . . . . . . . . . . . 49

7.6 Estimating RR for Foreign Securities . . . . . . . . . . . . . . . . 49

7.7 Expected Growth Rates . . . . . . . . . . . . . . . . . . . . . . 50

7.8 Breakdown of ROE . . . . . . . . . . . . . . . . . . . . . . . . . 51

7.9 Estimating dividend growth for foreign stocks . . . . . . . . . . . . 52




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, Investment Management CONTENTS


7.10 Mathematical concepts . . . . . . . . . . . . . . . . . . . . . . . 52

7.11 Altman Z Score . . . . . . . . . . . . . . . . . . . . . . . . . . 53

7.12 Net Asset Value . . . . . . . . . . . . . . . . . . . . . . . . . . 55

7.13 Dividend Valuation Model . . . . . . . . . . . . . . . . . . . . . 56


8 Arbitrage Pricing Theory 58

8.1 Microeconomics based risk factor APT model . . . . . . . . . . . . 59


9 Technical Analysis 60

9.1 Stock Market Anomalies . . . . . . . . . . . . . . . . . . . . . . 61


10 Evaluating Portfolio Performance 62

10.1 Treynor Performance Measure . . . . . . . . . . . . . . . . . . . 63

10.2 Sharpe Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

10.3 Jensen Portfolio Measure . . . . . . . . . . . . . . . . . . . . . . 64


11 Portfolio Performance 65


12 Active vs Passive 65

12.1 Active Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . 67

12.2 Fundamental Strategies . . . . . . . . . . . . . . . . . . . . . . . 67

12.3 Technical Strategies . . . . . . . . . . . . . . . . . . . . . . . . 68



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