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  • LEONARDO DA VINCI

    Transfer of Innovation

    Kristina Leviauskait

    Investment Analysis and Portfolio Management

    Leonardo da Vinci programme project

    Development and Approbation of Applied Courses Based on the Transfer of Teaching Innovations

    in Finance and Management for Further Education of Entrepreneurs and Specialists in Latvia, Lithuania and Bulgaria

    Vytautas Magnus University Kaunas, Lithuania

    2010

  • Investment Analysis and Portfolio Management

    2

    Table of Contents

    Introduction ...4

    1. Investment environment and investment management process...7 1.1 Investing versus financing7

    1.2. Direct versus indirect investment .9

    1.3. Investment environment..11

    1.3.1. Investment vehicles ..11

    1.3.2. Financial markets...19

    1.4. Investment management process.23

    Summary..26

    Key-terms28

    Questions and problems...29

    References and further readings..30

    Relevant websites31

    2. Quantitative methods of investment analysis...32 2.1. Investment income and risk.32

    2.1.1. Return on investment and expected rate of return...32

    2.1.2. Investment risk. Variance and standard deviation...35

    2.2. Relationship between risk and return..36

    2.2.1. Covariance36

    2.2.2. Correlation and Coefficient of determination...40

    2.3. Relationship between the returns on stock and market portfolio42

    2.3.1. Characteristic line and Beta factor.43

    2.3.2. Residual variance...44

    Summary...45

    Key-terms.48

    Questions and problems...48

    References and further readings...50

    3. Theory for investment portfolio formation...51

    3.1. Portfolio theory51

    3.1.1. Markowitz portfolio theory...51

    3.1.2. The expected rate of return and risk of portfolio..54

    3.2. Capital Asset Pricing Model56

    3.3. Arbitrage Price Theory59

    3.4. Market Efficiency Theory62

    Summary...64

    Key-terms.66

    Questions and problems67

    References and further readings...70

    4. Investment in stocks.....................................................................71

    4.1. Stock as specific investment.....71

    4.2. Stock analysis for investment decision making72

    4.2.1. E-I-C analysis.73 4.2.2. Fundamental analysis..75

    4.3. Decision making of investment in stocks. Stock valuation..77

    4.4. Formation of stock portfolios...82

    4.5. Strategies for investing in stocks..84

    Summary..87

    Key-terms90

  • Investment Analysis and Portfolio Management

    3

    Questions and problems..90

    References and further readings..93

    Relevant websites....93

    5. Investment in bonds.94

    5.1. Identification and classification of bonds94

    5.2. Bond analysis: structure and contents..98

    5.2.1. Quantitative analysis..98

    5.2.2. Qualitative analysis..101

    5.2.3. Market interest rates analysis...103

    5.3. Decision making for investment in bonds. Bond valuation...106

    5.4. Strategies for investing in bonds. Immunization...109

    Summary113

    Key-terms..116

    Questions and problems.117

    References and further readings... 118

    Relevant websites..119

    6. Psychological aspects in investment decision making..120

    6.1. Overconfidence..120

    6.2. Disposition effect...123

    6.3. Perceptions of investment risk...124

    6.4. Mental accounting and investing...126

    6.5. Emotions and investment decisions...128

    Summary....130

    Key-terms..132

    Questions and problems.132

    References and further readings133

    7. Using options as investments..135

    7.1. Essentials of options..135

    7.2. Options pricing..136

    7.3. Using options. Profit and loss on options..138

    7.4. Portfolio protection with options. Hedging...141

    Summary143

    Key-tems145

    Questions and problems.146

    References and further readings147

    Relevant websites..147

    8. Portfolio management and evaluation...148 8.1. Active versus passive portfolio management148

    8.2. Strategic versus tactical asset allocation150

    8.3. Monitoring and revision of the portfolio...152

    8.4. Portfolio performance measures154

    Summary156

    Key-terms..158

    Questions and problems.158

    References and further readings160

    Relevant websites..161

    Abbreviations and symbols used.162

    Bibliography164

    Annexes...165

  • Investment Analysis and Portfolio Management

    4

    Introduction Motivation for Developing the Course

    Research by the members of the project consortium Employers Confederation

    of Latvia and Bulgarian Chamber of Commerce and Industry indicated the need for

    further education courses.

    Innovative Content of the Course

    The course is developed to include the following innovative content:

    Key concepts of investment analysis and portfolio management which are

    explained from an applied perspective emphasizing the individual

    investorsdecision making issues.

    Applied exercises and problems, which cover major topics such as quantitative

    methods of investment analysis and portfolio formation, stocks and bonds

    analysis and valuation for investment decision making, options pricing and

    using as investments, asset allocation, portfolio rebalancing, and portfolio

    performance measures.

    Summaries, Key-terms, Questions and problems are provided at the end of

    every chapter, which aid revision and control of knowledge acquisition during

    self-study;

    References for further readings and relevant websites for broadening

    knowledge and analyzing real investment environment are presented at the end

    of every chapter.

    Innovative Teaching Methods of the Course

    The course is developed to utilize the following innovative teaching methods:

    Availability on the electronic platform with interactive learning and interactive

    evaluation methods;

    Active use of case studies and participant centered learning;

    Availability in modular form;

    Utilizing two forms of learning - self-study and tutorial consultations;

    Availability in several languages simultaneously.

    Target Audience for the Course

    The target audience is: entrepreneurs, finance and management specialists from

    Latvia, Lithuania and Bulgaria.

  • Investment Analysis and Portfolio Management

    5

    The course assumes little prior applied knowledge in the area of finance.

    The course is intended for 32 academic hours (2 credit points).

    Course Objectives

    Investment analysis and portfolio management course objective is to help

    entrepreneurs and practitioners to understand the investments field as it is currently

    understood and practiced for sound investment decisions making. Following this

    objective, key concepts are presented to provide an appreciation of the theory and

    practice of investments, focusing on investment portfolio formation and management

    issues. This course is designed to emphasize both theoretical and analytical aspects of

    investment decisions and deals with modern investment theoretical concepts and

    instruments. Both descriptive and quantitative materials on investing are presented.

    Upon completion of this course the entrepreneurs shall be able:

    to describe and to analyze the investment environment, different types of

    investment vehicles;

    to understand and to explain the logic of investment process and the

    contents of its each stage;

    to use the quantitative methods for investment decision making to

    calculate risk and expected return of various investment tools and the

    investment portfolio;

    to distinguish concepts of portfolio theory and apply its principals in the

    process of investment portfolio formation;

    to analyze and to evaluate relevance of stocks, bonds, options for the

    investments;

    to understand the psychological issues in investment decision making;

    to know active and passive investment strategies and to apply them in

    practice.

    The structure of the course

    The Course is structured in 8 chapters, covering both theoretical and analytical

    aspects of investment decisions:

    1. Investment environment and investment process;

    2. Quantitative methods of investment analysis;

    3. Theory of investment portfolio formation;

    4. Investment in stocks;

  • Investment Analysis and Portfolio Management

    6

    5. Investment in bonds;

    6. Psychological aspects in investment decision making;

    7. Using options as investments;

    8. Portfolio management and evaluation.

    Evaluation Methods

    As has been mentioned before, every chapter of the course contains

    opportunities to test the knowledge of the audience, which are in the form of questions

    and more involved problems. The types of question includ