UNIVERSITY OF MARYLAND Robert H. Smith School of Business Investments Fall 2014 I. Information on Instructor Instructor: Professor Email: xiaohui@rhsmith.umd.edu (preferred method of contact) Office: 4426 Van Munching Mobile Phone: (240) 507 9877 Course Notes are on Canvas Office Hours: Tuesdays & Thursdays, 2pm to 3pm, and I am always available so always feel free to contact me. Class meeting venue and time: Section 0201 Tuesdays & Thursdays, 11am to 1215pm, VMH 1418 Section 0301 Tuesdays & Thursdays, 1230pm to 145pm, VMH 1418 Review sessions by the TA: some Thursdays, 5pm to 6pm, Review sessions by the instructor: some Fridays, 1245pm to 145pm, II. Course Description and Objectives Required Textbook Essentials of Investments, by Bodie, Kane, and Marcus, McGraw-Hill, 9 th edition Required Course packet Purchase the course packet at: https://cb.hbsp.harvard.edu/cbmp/access/27906209 The course packet contains four cases. Course Overview This course is an introductory course in investments. We cover the following topics (the chapters are from BKM): Note: The schedule given below is only tentative, and may be changed based on the progress of the class. It is a student s responsibility to read the assigned chapters, as information in them may be part of a quiz or an exam. Week Topic Reading Week 1 Introduction Chapter 1, 2, and 3 Week 2 Debt securities I Chapter 10 Week 3 Debt securities II Chapter 11
Week 4 Portfolio theory I - Risk and return Chapter 5 Week 5 Portfolio theory II Efficient diversification Chapter 6 Week 6 The capital asset pricing model (CAPM) Chapter 7.1 & 7.2 Week 7 Empirical tests of CAPM Chapter 7.3, 7.4, and 7.5 Week 8 Market efficiency Chapter 8 Week 9 Midterm review Midterm Exam: October 30, Thursday (tentative schedule) Week 10 Behavior finance Chapter 9 Week 11 Equity valuation Chapter 13 Week 12 Derivatives Options Chapter 15 Week 13 Derivatives Options Chapter 16 Week 14 Derivatives Futures Chapter 17 Week 15 Final exam review Note on Calculators This course involves the use of a financial calculator (Texas Instruments BA II Plus or HP 12C) and the development of Excel spreadsheets for solving complex problems. III Assessments Graded Components of the Course The following components will be used to determine a student s course grade: Component Weight Description Cases 30% Four Harvard Business School cases to be done in groups Exams 70% Two exams, both accumulative, a mid-term (worth 35%) and a final exam (worth 35%), given on assigned dates Cases Four cases are to be done in groups of five students. Students may choose their own groups, and must submit the names of group members to the instructor by the beginning of the third week of classes. Each case will be presented by a group.
Detailed instruction of submitting the group assignment: 1. Please email me a PDF file of the assignment. You can also email me the excel workbook if you deem it necessary. 2. Please include all your group members last names in the name of the PDF file. Also clearly put all your group members full names on the cover page of the PDF file. 3. Please email me the assignment no more than 12 hours before the due date. One of the goals of these assignments is to help students become familiar the finance industry, learn how to collect information from available resources, clearly present the idea, and communicate with the audience effectively. List of HBS Cases Topic Case title Case number Due 1 Bonds and bond valuation Note on Bond Valuation and Returns 9-205-008 2 Risk and Return Alex Sharpe's portfolio 908N20 3 CAPM Valuing Wal-mart - 2010 W11058 4 Options The Keller Fund's Option Investment Strategies 9-295-096 Homework (Optional) Several homework assignments will be assigned. The homework assignments are not graded, and you are strongly encouraged to work through all the problems to enhance your learning. Examinations Two exams will be given during the semester, a mid-term and a final. The final exam will be during the university-assigned time slot. Both exams will be quantitative in nature, consisting of multi-part questions, and financial calculators will be required to answer them. IV. Academic Conduct Academic Integrity The University's Code of Academic Integrity is designed to ensure that the principles of academic honesty and integrity are upheld. All students are expected to adhere to this Code. The Smith School does not tolerate academic dishonesty. All acts of academic dishonesty will be dealt with in accordance with the provisions of this code. Please visit the following website for more information on the University's Code of Academic Integrity: http://www.studenthonorcouncil.umd.edu/code.html. On each assignment you will be asked to write out and sign the following pledge. "I pledge on my honor that I have not given or received any unauthorized assistance on this exam/assignment"\\ "The University of Maryland, College Park has a nationally recognized Code of Academic Integrity, administered by the Student Honor Council. This Code sets standards for academic integrity at Maryland for all undergraduate and graduate students. As a student you are responsible for upholding these standards for this course. It is very important for you to be aware of the consequences of cheating, fabrication, facilitation, and plagiarism. For more information on the Code of Academic Integrity or the Student Honor Council, please visit http://www.studenthonorcouncil.umd.edu/whatis.html."
CASE 1: Note on Bond Valuation and Returns Student Assignment 1. Consider a bond with a par value of $1000 to be paid in 7 years, a coupon rate of 5%, and a required annual yield of 12%. Assume that coupon payments are made annually to bond holders, and that the next coupon payment is expected in twelve months. What is the current price of the bond? 2. For the bond described in Question 1, what is the new required annual yield if the bond price goes up 3%? If it goes down by 3%? 3. For the bond described in Question 1, assuming the same bond price, what are the annualized 1-month yield and the annualized 9-month yield for this bond? 4. What is the effective annual rate of a bond with a 2-month yield of 1.1%?
CASE 2: Alex Sharpe s Portfolio Student Assignment 1. Returns and Risk Estimate and compare the returns and variability (i.e. annual standard deviation over the past five years) of Reynolds and Hasbro with that of the S&P 500 Index. Which stock appears to be riskiest? 2. Portfolio Risk Suppose Sharpe s position had been 99 percent of equity funds invested in the S&P 500 and either one per cent in Reynolds over one percent in Hasbro. Estimate the resulting portfolio position. How does each stock affect the variability of the equity investment? How does this relate to your answer in question 1 above? 3. Regression Analysis to Calculate Beta Perform a regression of each stocks monthly returns on the Index returns to compute a beta for each stock. How does this relate to your answer in question 2 above? 4. Capital Asset Pricing Model (CAPM) How might the expected return of each stock relate to its riskiness? 5. In what stock(s) (if any) should Sharpe invest?
CASE 3: Valuing Wal-mart Student Assignment 1. As of February 2010, what is your assessment of the worth of Wal-Mart s stock? Utilize all of the methods discussed in the case to value the shares, including the following: a) The perpetual growth in dividends b) Forecasted dividends for the next several years plus sale of the stock in the future c) The three-stage dividend model d) The price/earnings approach Note: Clearly state any assumptions that you make. 2. Based on your analysis, as Sabrina Gupta, what recommendation would you make?
CASE 4: Keller Fund's Option Investment Strategies Student Assignment 5. To analyze the profit and loss possibilities inherent in the option investment strategies, please perform the following analyses for call and put options on Lotus s common stock that mature in February 1994 and that have an exercise price of $55 per share. a) Compute net profits and losses per share (actual dollar profits and losses, not rates of return) at expiration (February 19, 1994) for the following investment strategies: Buying a call option on Lotus s stock; Writing a call option on Lotus s common stock; Buying a put option on Lotus s common stock; Writing a put option on Lotus s common stock; b) For each of the option investment strategies listed above, draw a graph relating possible profits and losses per share to Lotus s stock price at the time of expiration. Put profits and losses per share on the vertical axis of your graph and stock prices on the horizontal axis. c) Compute profits and losses per share, and graph them against stock prices for the strategy of buying a share of Lotus s common stock at $55 per share and holding it until February 19, 1994. 6. Study the graph created in your answer to question 1. Which of the various strategies examined offers the greatest upside return? The least upside return? The greatest downside potential? The least downside potential? Which is likely to produce better investment returns more often? In your opinion, which strategy is the most aggressive? Which is the most conservative? In general, are investment strategies involving options risky or safe? 7. If you owned Lotus s stock, but were concerned about the possibility of bad news, how might you use options to protect yourself against the risk of a price decline? 8. Buying a share of Lotus s stock at $55 per share while simultaneously writing (selling) a call option with an exercise price of $55 per share is called a covered call (also a buywrite ) investment strategy. What is the relationship between covered call positions and selling put options? Do the quoted put and call option prices appear to be consistent with this relationship? 9. Suppose that on January 18, 1994, Lotus s stock was valued at $75.00 per share instead of $55.00. What is the very least you would expect to pay for the February 1994 call option exercisable at 55? What is the most? In general, what factors should enter into a determination of the appropriate price to pay?
10. Compare the prices of options on Lotus s stock and those on AT&T s. Why are options with identical exercise prices and maturity dates, and written on stocks with identical prices, selling for different prices? Do options on one of these two stocks provide investor with superior investment opportunities in some comparison to the other?\ 11. In general, what play would you make on AT&T s or Lotus s stock in January 1994?