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Summary Complete & Concise - Investments

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*New* get it cheaper: . The Complete & Concise summary for the MSc F&I course Investments (BM01FI). Based on my tried and proven method, this summary provides you with all the theory you need to pass the exam, in just 11 pages. That means it's perfect for use together with exercises, practice quest...

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  • 12 december 2020
  • 14
  • 2020/2021
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Complete & Concise: Investments
By Thomas Konings

Use: examples and common abbreviations are included at the end of the summary.

Contents
Week 1: Financial Markets – Basics and Trends ..................................................................................... 2
Week 2: Portfolio Theory + Workshop 1 ................................................................................................ 3
Application of Portfolio Theory........................................................................................................... 4
Workshop 1: Application Portfolio Theory ......................................................................................... 4
Exercises .............................................................................................................................................. 4
Week 3: Asset Pricing Models & Testing + Workshop 2 ......................................................................... 4
Testing CAPM ...................................................................................................................................... 5
Workshop 2: Sustainable Finance ....................................................................................................... 6
Week 4: Arbitrage Pricing Theory + Workshop 3.................................................................................... 7
Workshop 3: Technical Analysis .......................................................................................................... 8
Week 5: Asset Pricing Tests & Market Efficiency.................................................................................... 9
Week 6: Behavioral, Arbitrage Limits, Fixed Income + Workshop 4 ..................................................... 10
Workshop 4: Article Stambaugh & Yuan (2017) ............................................................................... 11
Week 7: Interest Rate Risk + Workshop 5 ............................................................................................ 12
Workshop 5: Managing Sovereign Bond Portfolio ........................................................................... 12
Examples per Week............................................................................................................................... 13
Examples Week 1 .............................................................................................................................. 13
Examples Week 3 .............................................................................................................................. 13
Examples Week 6 .............................................................................................................................. 13
Abbreviations ........................................................................................................................................ 14




Check out the other summaries in the Complete & Concise series
Business Ethics & Financial Modelling and Analytics




© Thomas Konings – 2020 All rights reserved. Reproduction and distribution are prohibited.
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, Week 1: Financial Markets – Basics and Trends
Functions of financial markets: (1) Allocation of capital [put money to good use, traditionally done
by bankers] (2) enabling consumption timing/smoothing (3) separation of ownership and
management [pro: do not have to manage own company; con: agency problems]
(4) provision of liquidity [easy to convert to cash without taking money from company]
(5) allocation of risk (6) information aggregation [through prices]

Margin Trading: “purchase securities (in part) by borrowing money” → “margin”: capital put up by
investor (US: minimum 50%), if margin falls below threshold (“maintenance margin” 25% long, 30%
𝐸𝑞𝑢𝑖𝑡𝑦 𝑖𝑛 𝑎𝑐𝑐𝑜𝑢𝑛𝑡
short) investor gets a margin call, must put up extra capital. 𝑀𝑎𝑟𝑔𝑖𝑛 =
𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑐𝑐𝑜𝑢𝑛𝑡

Short sales: borrow stock through broker, sell it, deposit proceeds and margin in an account.
Closing position: buy stock, return to party you borrowed it from

Financial market types: (1) Dealer market [Fixed income, FX, some derivative markets]
(2) Agency markets (limit order book) → most stock, some derivative markets

Dealer market: buyers and seller trade not with each other but with dealers (usually banks). Dealers
act as stabilizers in the market, supplying immediacy = can always buy/sell at bid-ask of the bank
Note: bank is obliged to give you a bid-ask, it is also their compensation
Bid-ask spread: fixed costs, inventory risk (banks hold assets), costs of trading against better
informed (asym. information), counterparty risk → competition among deals = low spread
Agency markets: order flow meets in central place, buyers & sellers trade directly on limit order
book (example 1.1), typically one market maker or specialist for each stock
Note: as specialist you have to step in if order book does not match supply & demand, if
there are more buyers this indicates (possible) asym. Information, you want large inventory

Why do we care? → Type of market determines way of trading, which influences process and price
➔ Trading involves costs: investors are concerned about liquidity (ability to trade large quantities
quickly and at a low cost, and little impact on market price)

Three elements of liquidity: (1) Transaction costs [fixed, variable] (2) depth [how much demand &
supply there is, ease of trading] (3) price impact [large quantity transactions move price against you]

Three important recent trends: (1) Institutionalization: increasing % of stocks now held by
institutions, rather than retail investors. Mostly: [i] Mutual Fund MF [ii] Hedge Fund HF
Ad i: open-ended or closed-ended, open = not traded, can expand for new investors, active or
passive, long only, no derivatives. Fees: front-end/back-end load (on leave/enter), management fees
Ad ii: wealthy individuals, lockup period, long-short [“market-neutral”], arbitrage. Fees: management
+ performance (2%/20%)
Pro: diversification, specialization, economies of scale, monitoring of firms
Con: agency problems, herd behavior, additional costs

(2) Computerized/high-frequency trading [HFT]: debate on HFT, blamed for increased volatility
(flash crashes) and for exploiting retail investors (exploiting fragmentation, exchanges, platforms)
and predicting behavior (move price against them). Empirical evidence: HFT provides liquidity and
price discovery, minor role in flash crashes.

(3) Sustainable investing [ESGs]: UN principles, ESG factors [Environmental, Social, Governance]
Traditional (Friedman, 1970): business of business is business, maximize shareholder value
Modern (Porter & Kramer, Hart & Zingales): create shared value, shareholder welfare, not value

© Thomas Konings – 2020 All rights reserved. Reproduction and distribution are prohibited.
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