LEONARDObDAbVINCI
TransferbofbInnovation
Kristina Levišauskait÷
b
Investment Analysis and Portfolio Management
b b b b
LeonardobdabVincibprogrammebproject
„Development and Approbation of Applied Courses
b b b b b b
Based on the Transfer of Teaching Innovations
b b b b b b
in Finance and Management for Further Education
b b b b b b
of Entrepreneurs and Specialists in Latvia, Lithuania and Bulgaria”
b b b b b b b b
VytautasbMagnusbUniversityb
Kaunas,bLithuania
2010
, InvestmentbAnalysisbandbPortfoliobManagement
Table of Contents
b b
Introduction .................................................................................................................... 4
1. Investmentbenvironmentbandbinvestmentbmanagementbprocess ................................ 7
1.1 Investingbversusbfinancing ................................................................................ 7
1.2. Directbversusbindirectbinvestment....................................................................... 9
1.3. Investmentbenvironment .................................................................................. 11
1.3.1. Investmentbvehicles ............................................................................... 11
1.3.2. Financialbmarkets ...................................................................................19
1.4. Investmentbmanagementbprocess ..................................................................... 23
Summary ..................................................................................................................26
Key-terms ................................................................................................................ 28
Questionsbandbproblems ...........................................................................................29
Referencesbandbfurtherbreadings .............................................................................. 30
Relevantbwebsites .................................................................................................... 31
2. Quantitativebmethodsbofbinvestmentbanalysis ........................................................... 32
2.1. Investmentbincomebandbrisk ............................................................................. 32
2.1.1. Returnbonbinvestmentbandbexpectedbratebofbreturn ................................ 32
2.1.2. Investmentbrisk.bVariancebandbstandardbdeviation ............................... 35
2.2. Relationshipbbetweenbriskbandbreturn............................................................... 36
2.2.1. Covariance ........................................................................................... 36
2.2.2. CorrelationbandbCoefficientbofbdetermination ........................................40
2.3. Relationshipbbetweenbthebreturnsbonbstockbandbmarketbportfolio...................... 42
2.3.1. CharacteristicblinebandbBetabfactor ..........................................................43
2.3.2. Residualbvariance ...................................................................................44
Summary ...................................................................................................................45
Key-terms ................................................................................................................. 48
Questionsbandbproblems ...........................................................................................48
Referencesbandbfurtherbreadings ............................................................................... 50
3. Theorybforbinvestmentbportfoliobformation ............................................................... 51
3.1. Portfoliobtheory ............................................................................................... 51
3.1.1. Markowitzbportfoliobtheory ................................................................... 51
3.1.2. Thebexpectedbratebofbreturnbandbriskbofbportfolio ................................... 54
3.2. CapitalbAssetbPricingbModel ............................................................................ 56
3.3. ArbitragebPricebTheory .................................................................................... 59
3.4. MarketbEfficiencybTheory ................................................................................ 62
Summary ...................................................................................................................64
Key-terms ................................................................................................................. 66
Questionsbandbproblems ............................................................................................67
Referencesbandbfurtherbreadings ............................................................................... 70
4. Investmentbinbstocks ................................................................................................. 71
4.1. Stockbasbspecificbinvestment ............................................................................. 71
4.2. Stockbanalysisbforbinvestmentbdecisionbmaking ................................................ 72
4.2.1. E-I-Cbanalysis ..................................................................................... 73
4.2.2. Fundamentalbanalysis .......................................................................... 75
4.3. Decisionbmakingbofbinvestmentbinbstocks.bStockbvaluation ............................... 77
4.4. Formationbofbstockbportfolios ........................................................................... 82
4.5. Strategiesbforbinvestingbinbstocks ...................................................................... 84
Summary ..................................................................................................................87
Key-terms ................................................................................................................ 90
2
, InvestmentbAnalysisbandbPortfoliobManagement
Questionsbandbproblems ..........................................................................................90
Referencesbandbfurtherbreadings .............................................................................. 93
Relevantbwebsites .................................................................................................... 93
5. Investmentbinbbonds................................................................................................. 94
5.1. Identificationbandbclassificationbofbbonds ........................................................ 94
5.2. Bondbanalysis:bstructurebandbcontents ............................................................... 98
5.2.1. Quantitativebanalysis ..............................................................................98
5.2.2. Qualitativebanalysis .............................................................................. 101
5.2.3. Marketbinterestbratesbanalysis ............................................................... 103
5.3. Decisionbmakingbforbinvestmentbinbbonds.bBondbvaluation............................. 106
5.4. Strategiesbforbinvestingbinbbonds.bImmunization............................................ 109
Summary ................................................................................................................113
Key-terms .............................................................................................................. 116
Questionsbandbproblems ......................................................................................... 117
Referencesbandbfurtherbreadings ............................................................................ 118
Relevantbwebsites .................................................................................................. 119
6. Psychologicalbaspectsbinbinvestmentbdecisionbmaking........................................... 120
6.1. Overconfidence ..............................................................................................120
6.2. Dispositionbeffect ...........................................................................................123
6.3. Perceptionsbofbinvestmentbrisk ........................................................................124
6.4. Mentalbaccountingbandbinvesting ................................................................... 126
6.5. Emotionsbandbinvestmentbdecisions ................................................................128
Summary ................................................................................................................130
Key-terms .............................................................................................................. 132
Questionsbandbproblems ......................................................................................... 132
Referencesbandbfurtherbreadings ............................................................................ 133
7. Usingboptionsbasbinvestments................................................................................... 135
7.1. Essentialsbofboptions ...................................................................................... 135
7.2. Optionsbpricing .............................................................................................. 136
7.3. Usingboptions.bProfitbandblossbonboptions....................................................... 138
7.4. Portfoliobprotectionbwithboptions.bHedging ................................................... 141
Summary ................................................................................................................143
Key-tems ................................................................................................................145
Questionsbandbproblems ......................................................................................... 146
Referencesbandbfurtherbreadings ............................................................................ 147
Relevantbwebsites .................................................................................................. 147
8. Portfoliobmanagementbandbevaluation ................................................................... 148
8.1. Activebversusbpassivebportfoliobmanagement ................................................ 148
8.2. Strategicbversusbtacticalbassetballocation .........................................................150
8.3. Monitoringbandbrevisionbofbthebportfolio ........................................................ 152
8.4. Portfoliobperformancebmeasures .................................................................... 154
Summary ................................................................................................................156
Key-terms .............................................................................................................. 158
Questionsbandbproblems ......................................................................................... 158
Referencesbandbfurtherbreadings ............................................................................ 160
Relevantbwebsites .................................................................................................. 161
Abbreviationsbandbsymbolsbused ................................................................................. 162
Bibliography................................................................................................................ 164
Annexes ...................................................................................................................... 165
3
, InvestmentbAnalysisbandbPortfoliobManagement
Introduction
MotivationbforbDevelopingbthebCourse
ResearchbbybthebmembersbofbthebprojectbconsortiumbEmployers’bConfederationbo
fbLatviabandbBulgarianbChamberbofbCommercebandbIndustrybindicatedbthebneedbforbfurthe
rbeducationbcourses.
InnovativebContentbofbthebCourse
Thebcoursebisbdevelopedbtobincludebthebfollowingbinnovativebcontent:
• Keybconceptsbofbinvestmentbanalysisbandbportfoliobmanagementbwhichbarebexplai
nedbfrombanbappliedbperspectivebemphasizingbthebindividualbinvestors‘decisionb
makingbissues.
• Appliedbexercisesbandbproblems,bwhichbcoverbmajorbtopicsbsuchbasbquantitativeb
methodsbofbinvestmentbanalysisbandbportfoliobformation,bstocksbandbbondsbanalys
isbandbvaluationbforbinvestmentbdecisionbmaking,boptionsbpricingbandbusingbasbinv
estments,bassetballocation,bportfoliobrebalancing,bandbportfoliobperformancebmea
sures.
• Summaries,bKey-
terms,bQuestionsbandbproblemsb arebprovidedbatbthebendbofbeverybchapter,bwhichba
idbrevisionbandbcontrolbofbknowledgebacquisitionbduringbself-study;
• Referencesbforbfurtherbreadingsbandbrelevantbwebsitesbforbbroadeningb knowledge
bandbanalyzingbrealbinvestmentbenvironmentbarebpresentedbatbthebendbofbeverybcha
pter.
InnovativebTeachingbMethodsbofbthebCourse
Thebcoursebisbdevelopedbtobutilizebthebfollowingbinnovativebteachingbmethods:
• Availabilityb onbthebelectronicbplatformbwithbinteractiveblearningbandbinteractiveb
evaluationbmethods;
• Activebusebofbcasebstudiesbandbparticipantbcenteredblearning;
• Availabilitybinbmodularbform;
• Utilizingbtwobformsbofblearningb-bself-studybandbtutorialbconsultations;
• Availabilitybinbseveralblanguagesbsimultaneously.
TargetbAudiencebforbthebCourse
Thebtargetbaudiencebis:bentrepreneurs,bfinancebandbmanagementbspecialistsbfromb
Latvia,bLithuaniabandbBulgaria.
4
TransferbofbInnovation
Kristina Levišauskait÷
b
Investment Analysis and Portfolio Management
b b b b
LeonardobdabVincibprogrammebproject
„Development and Approbation of Applied Courses
b b b b b b
Based on the Transfer of Teaching Innovations
b b b b b b
in Finance and Management for Further Education
b b b b b b
of Entrepreneurs and Specialists in Latvia, Lithuania and Bulgaria”
b b b b b b b b
VytautasbMagnusbUniversityb
Kaunas,bLithuania
2010
, InvestmentbAnalysisbandbPortfoliobManagement
Table of Contents
b b
Introduction .................................................................................................................... 4
1. Investmentbenvironmentbandbinvestmentbmanagementbprocess ................................ 7
1.1 Investingbversusbfinancing ................................................................................ 7
1.2. Directbversusbindirectbinvestment....................................................................... 9
1.3. Investmentbenvironment .................................................................................. 11
1.3.1. Investmentbvehicles ............................................................................... 11
1.3.2. Financialbmarkets ...................................................................................19
1.4. Investmentbmanagementbprocess ..................................................................... 23
Summary ..................................................................................................................26
Key-terms ................................................................................................................ 28
Questionsbandbproblems ...........................................................................................29
Referencesbandbfurtherbreadings .............................................................................. 30
Relevantbwebsites .................................................................................................... 31
2. Quantitativebmethodsbofbinvestmentbanalysis ........................................................... 32
2.1. Investmentbincomebandbrisk ............................................................................. 32
2.1.1. Returnbonbinvestmentbandbexpectedbratebofbreturn ................................ 32
2.1.2. Investmentbrisk.bVariancebandbstandardbdeviation ............................... 35
2.2. Relationshipbbetweenbriskbandbreturn............................................................... 36
2.2.1. Covariance ........................................................................................... 36
2.2.2. CorrelationbandbCoefficientbofbdetermination ........................................40
2.3. Relationshipbbetweenbthebreturnsbonbstockbandbmarketbportfolio...................... 42
2.3.1. CharacteristicblinebandbBetabfactor ..........................................................43
2.3.2. Residualbvariance ...................................................................................44
Summary ...................................................................................................................45
Key-terms ................................................................................................................. 48
Questionsbandbproblems ...........................................................................................48
Referencesbandbfurtherbreadings ............................................................................... 50
3. Theorybforbinvestmentbportfoliobformation ............................................................... 51
3.1. Portfoliobtheory ............................................................................................... 51
3.1.1. Markowitzbportfoliobtheory ................................................................... 51
3.1.2. Thebexpectedbratebofbreturnbandbriskbofbportfolio ................................... 54
3.2. CapitalbAssetbPricingbModel ............................................................................ 56
3.3. ArbitragebPricebTheory .................................................................................... 59
3.4. MarketbEfficiencybTheory ................................................................................ 62
Summary ...................................................................................................................64
Key-terms ................................................................................................................. 66
Questionsbandbproblems ............................................................................................67
Referencesbandbfurtherbreadings ............................................................................... 70
4. Investmentbinbstocks ................................................................................................. 71
4.1. Stockbasbspecificbinvestment ............................................................................. 71
4.2. Stockbanalysisbforbinvestmentbdecisionbmaking ................................................ 72
4.2.1. E-I-Cbanalysis ..................................................................................... 73
4.2.2. Fundamentalbanalysis .......................................................................... 75
4.3. Decisionbmakingbofbinvestmentbinbstocks.bStockbvaluation ............................... 77
4.4. Formationbofbstockbportfolios ........................................................................... 82
4.5. Strategiesbforbinvestingbinbstocks ...................................................................... 84
Summary ..................................................................................................................87
Key-terms ................................................................................................................ 90
2
, InvestmentbAnalysisbandbPortfoliobManagement
Questionsbandbproblems ..........................................................................................90
Referencesbandbfurtherbreadings .............................................................................. 93
Relevantbwebsites .................................................................................................... 93
5. Investmentbinbbonds................................................................................................. 94
5.1. Identificationbandbclassificationbofbbonds ........................................................ 94
5.2. Bondbanalysis:bstructurebandbcontents ............................................................... 98
5.2.1. Quantitativebanalysis ..............................................................................98
5.2.2. Qualitativebanalysis .............................................................................. 101
5.2.3. Marketbinterestbratesbanalysis ............................................................... 103
5.3. Decisionbmakingbforbinvestmentbinbbonds.bBondbvaluation............................. 106
5.4. Strategiesbforbinvestingbinbbonds.bImmunization............................................ 109
Summary ................................................................................................................113
Key-terms .............................................................................................................. 116
Questionsbandbproblems ......................................................................................... 117
Referencesbandbfurtherbreadings ............................................................................ 118
Relevantbwebsites .................................................................................................. 119
6. Psychologicalbaspectsbinbinvestmentbdecisionbmaking........................................... 120
6.1. Overconfidence ..............................................................................................120
6.2. Dispositionbeffect ...........................................................................................123
6.3. Perceptionsbofbinvestmentbrisk ........................................................................124
6.4. Mentalbaccountingbandbinvesting ................................................................... 126
6.5. Emotionsbandbinvestmentbdecisions ................................................................128
Summary ................................................................................................................130
Key-terms .............................................................................................................. 132
Questionsbandbproblems ......................................................................................... 132
Referencesbandbfurtherbreadings ............................................................................ 133
7. Usingboptionsbasbinvestments................................................................................... 135
7.1. Essentialsbofboptions ...................................................................................... 135
7.2. Optionsbpricing .............................................................................................. 136
7.3. Usingboptions.bProfitbandblossbonboptions....................................................... 138
7.4. Portfoliobprotectionbwithboptions.bHedging ................................................... 141
Summary ................................................................................................................143
Key-tems ................................................................................................................145
Questionsbandbproblems ......................................................................................... 146
Referencesbandbfurtherbreadings ............................................................................ 147
Relevantbwebsites .................................................................................................. 147
8. Portfoliobmanagementbandbevaluation ................................................................... 148
8.1. Activebversusbpassivebportfoliobmanagement ................................................ 148
8.2. Strategicbversusbtacticalbassetballocation .........................................................150
8.3. Monitoringbandbrevisionbofbthebportfolio ........................................................ 152
8.4. Portfoliobperformancebmeasures .................................................................... 154
Summary ................................................................................................................156
Key-terms .............................................................................................................. 158
Questionsbandbproblems ......................................................................................... 158
Referencesbandbfurtherbreadings ............................................................................ 160
Relevantbwebsites .................................................................................................. 161
Abbreviationsbandbsymbolsbused ................................................................................. 162
Bibliography................................................................................................................ 164
Annexes ...................................................................................................................... 165
3
, InvestmentbAnalysisbandbPortfoliobManagement
Introduction
MotivationbforbDevelopingbthebCourse
ResearchbbybthebmembersbofbthebprojectbconsortiumbEmployers’bConfederationbo
fbLatviabandbBulgarianbChamberbofbCommercebandbIndustrybindicatedbthebneedbforbfurthe
rbeducationbcourses.
InnovativebContentbofbthebCourse
Thebcoursebisbdevelopedbtobincludebthebfollowingbinnovativebcontent:
• Keybconceptsbofbinvestmentbanalysisbandbportfoliobmanagementbwhichbarebexplai
nedbfrombanbappliedbperspectivebemphasizingbthebindividualbinvestors‘decisionb
makingbissues.
• Appliedbexercisesbandbproblems,bwhichbcoverbmajorbtopicsbsuchbasbquantitativeb
methodsbofbinvestmentbanalysisbandbportfoliobformation,bstocksbandbbondsbanalys
isbandbvaluationbforbinvestmentbdecisionbmaking,boptionsbpricingbandbusingbasbinv
estments,bassetballocation,bportfoliobrebalancing,bandbportfoliobperformancebmea
sures.
• Summaries,bKey-
terms,bQuestionsbandbproblemsb arebprovidedbatbthebendbofbeverybchapter,bwhichba
idbrevisionbandbcontrolbofbknowledgebacquisitionbduringbself-study;
• Referencesbforbfurtherbreadingsbandbrelevantbwebsitesbforbbroadeningb knowledge
bandbanalyzingbrealbinvestmentbenvironmentbarebpresentedbatbthebendbofbeverybcha
pter.
InnovativebTeachingbMethodsbofbthebCourse
Thebcoursebisbdevelopedbtobutilizebthebfollowingbinnovativebteachingbmethods:
• Availabilityb onbthebelectronicbplatformbwithbinteractiveblearningbandbinteractiveb
evaluationbmethods;
• Activebusebofbcasebstudiesbandbparticipantbcenteredblearning;
• Availabilitybinbmodularbform;
• Utilizingbtwobformsbofblearningb-bself-studybandbtutorialbconsultations;
• Availabilitybinbseveralblanguagesbsimultaneously.
TargetbAudiencebforbthebCourse
Thebtargetbaudiencebis:bentrepreneurs,bfinancebandbmanagementbspecialistsbfromb
Latvia,bLithuaniabandbBulgaria.
4
