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.
Sold through Stuvia 1
, 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.
Sold through Stuvia 2
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.
Sold through Stuvia 1
, 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.
Sold through Stuvia 2
