I. Course Objectives Finance plays an important role in modern economies. Some of us have money to invest, others have ideas but no money, and others still (more fortunate and rare) have money and ideas. Finance can generally be defined as the field that studies ways to channel money from savers to entrepreneurs. It may be approached from three different perspectives: (1) How investors allocate savings among different assets (2) How capital markets function to clear the market for capital (Demand: Firms, Supply: Investors) (3) How firms raise and invest capital A course in investments focuses on (1) and (2). The focus of this course will be on the application of modern financial theory to understand portfolio selection and pricing of assets in capital markets. We will focus on asset allocation decisions, and how to choose among several investment opportunities. We will also examine valuation models for bonds, stocks and derivative securities. In addition, we will cover topics such as mutual funds, efficient markets and performance evaluation. The topics fit into six broad areas: (1) Fixed-Income Securities: Bond valuation, risk-free rate, term structure of interest rates, forward rates, credit risk, bond portfolio strategies, interest rate risk (2) Relationship between Risk and Return: diversification, risk reduction strategies, asset pricing models (3) Equity Securities: Stock valuation, multiples, industrial and macroeconomic analysis (4) Derivative Securities: Options and Futures, Risk Management, Hedging Strategies, Arbitrage in Financial Markets (5) Applications of Portfolio Management: Efficient markets, performance evaluation, asset allocation strategies, timing and selectivity, structured products (6) International Investments: Institutional Aspects, Global stock and bond markets, Foreign Exchange Markets, International diversification, Currency risk, Hedging strategies This course is essential for anyone who wants to make his/her career in investment banking, corporate treasury, research, consultancy or even set up its own private 1
business. In addition, it is very relevant for personal finance management. Soon you will have to manage your own wealth, and the tools learned here can be extremely valuable. After this course, you will be able to value almost any asset, create portfolios or manage funds. Also, you will learn how to deal with risk, what to do in a bear market, how to invest globally. To get there, we will take a hands-on approach. It is my belief that the best way to learn is by doing it. Thus, we will have several real-data projects throughout the term, to make sure the main points are well understood. Spreadsheets are the main instrument used in most financial institutions. These projects allow students to develop spreadsheet skills for financial modelling. To really understand the markets, one must invest! Budget constraints forbid us from doing that. The closest thing available is a simulator. We will play an investment game. In this game you will be able to invest in several assets, and your performance will be assessed relative to the rest of the class. The group should develop an investment strategy, and take it seriously. Finally, one of the main features of this course is the valuation project. Working as a group, you will experience the job of a professional analyst. You will learn the tricks and details of a complete valuation of a chosen European company. This will be a thorough task, which will hopefully integrate your knowledge of different areas: finance, strategy, accounting, economics, etc. II. Course Materials Textbook: Investments, by Bodie, Kane and Marcus (BKM), McGraw Hill, 6 th Edition. ISBN: 0071238204 Class Notes Website Problem Sets Website Additional reading material Website Financial Calculator (Get used to it before classes start) Excel Add-ins: Analysis Toolpak VBA; Solver. Don t ask me for these. They are available in any MS Office CD. III. Class Web page You should check the web page regularly for updates, course materials, additional readings, exercises and messages. 2
I will post the slides of each session online. This way you can concentrate on the discussions, and don t have to worry about taking notes of every slide. Additional readings and exercises will also be posted in the web page. IV. Grading Your grade will be a weighted average of the following: Final Exam (40%) Projects + Class Participation + Trading Game (60%) The main project for this course will be a complete valuation of a known European company. This valuation project, some exercises and the trading game will be completed by groups of students. I expect all students to organize in groups of THREE students. Two or four are not accepted. The group will prepare reports for each of the exercises, and should meet regularly (at the bar is fine!) to discuss investment strategies and management of their portfolio. V. Class Participation Students are expected to be prepared for class and participate in the discussions. Preparation includes reading all the required readings for each class. Please do not be shy to ask questions so long as they are relevant and constructive. VI. House Rules 1 - I will cold call. I expect you to read and be able to answer questions related to the assigned chapters for each lesson. Also, in the classes after each exercise was handed over, we will discuss it, and I expect each member of each group to be able to explain and support their methodology and results. Each group member should be prepared to discuss all aspects of the assignment. If you know in advance you will miss one of these classes, please let me know, and I will make sure not to penalize you for this (one time, for a very good reason). 2 - Cell phones, and laptop computers are not allowed in class. Please make sure that your cell phone is switched off before the class starts. No cell phone should be used as a calculator or as a watch (during exams). Bring a calculator and a watch to class! 3 - Please bring and use your name card in every single class, as this will help me learn your names. 3
4 - Any form of cheating during the course will not be tolerated. I will be very tough on cheating, copying results of exercises, free ride, etc. Believe me, it is easy to find out who worked and who didn t. 5 - Late submissions of the exercises will not be accepted. Viruses, printer jams, lost computers, etc, are actually very frequent events. You should incorporate them into your schedules, and make sure you have everything ready well in advance. VII. Trading Game You are endowed with $1,000,000 to start your own little investment company. Choose your partners; you should form a group of three people. You should come up with an investment philosophy that is clearly articulated in a paragraph or two and submit it to me before class 4. To trade go to http://www.stocksquest.com I have set-up a private competition. There is a handout on my website with instructions about registration in the competition. VIII. Contact Information Office hours for this course are on Tuesdays, from 17.30 to 18.30. The preferred mean of communication is email. Feel free to contact me with any doubts/problems, or to schedule an appointment outside these hours. Professor Nuno Fernandes Office: 5321 Email: nfernandes@fcee.ucp.pt Web Page: http://www.nunofernandes.com/ 4
IX. Course Content Tentative Class Date Contents Readings BKM 1 10-Fev Introduction to Financial Markets. Money Markets. 1-3 2 15-Fev Bonds - Valuation, Yield Curve 14, 15 3 17-Fev Bonds - Ratings, Spot, Forward 14, 15 4 Bonds - Portfolio Management - Duration 22-Fev - Immunization 16 5 Stock Valuation - Industrial and 24-Fev Macroeconomic Analysis 17 6 01-Mar Diversification - Efficient Set 5, 6, 7, 8 7 03-Mar CAPM - Estimation issues 9, 10 8 08-Mar APT - Other models for cost of capital 10, 11 9 10-Mar Options, Futures 20, 21 10 15-Mar Options, Futures 22, 23 11 17-Mar Options, Futures 22, 23 Stock Valuation - Industrial and freq Macroeconomic Analysis 12 12-Abr Stock Valuation - Multiples 18, 19, Damodaran 13 14-Abr Market Efficiency 12, 13 14 19-Abr Stock Valuation and Market Efficiency 12, 13 15 Portfolio Management - Performance 21-Abr Measures 4, 24 16 Portfolio Management - Asset Allocation, 26-Abr Timing, Style, Selection 24, 27 17 Portfolio Management - Structured 28-Abr Products 20, 21, 22, 23 18 Portfolio Management - Fund 03-Mai Management 24, 26, 27 + R&C fundos 19 05-Mai International Investments 25 20 10-Mai International Investments 25 21 12-Mai International Investments 25 22 17-Mai International Investments 25 23 19-Mai International Investments 25 24 24-Mai Valuation - Presentation of projects 25 5