PORTFOLIO MANAGEMENT

                                                                                                                             

PROGRAM OF THE COURSE

“PORTFOLIO MANAGEMENT”

Prof. Andriy Kaminsky

 

MODULE 1. A Framework for Portfolio Management

 

Topic 1. Portfolio Management as a Process

Notion of investment management • Definition of portfolio management • Three steps of portfolio management: the planning step, the execution step, the feedback step • Historical overview of portfolio management development • Main pillars of portfolio management: theoretical backgrounds, quantitative methods of analysis, data sources • Investment Policy Statement (IPS) and its structure • Principal-agent relationships in portfolio management •

 

Practical constituent. Goals of Portfolio Creation. Investment Policy Statement

• Development of Investment Policy Statement (IPS) for individual investors of different types.
• Development of Investment Policy Statement (IPS) for institutional investors of different types.

 

Proposed reading: [6], [15], [19], [35], [36], [43].

 

Topic 2. Investment Environment for Portfolio Management Process

How do the financial markets benefit society? • Financial assets versus real assets • Money market and capital market • Financial instruments and financial intermediators • Functions of financial intermediators • Infrastructure’s elements of capital markets • Marketplaces and transactions costs • Stock exchanges and their roles.

 

Practical constituent. Role of Capital Markets in Modern Economics: Portfolio Management Viewpoint

• Possibilities for investment without capital markets. Identifying characteristics of alternative (non-financial) investments.
• Benefits of capital market for economies. Efficient transfer of funds through the time period. Possibilities of portfolio creation on such markets.
• Infrastructure elements of modern capital market and their functions. Analysis of functions of stock exchange.

Proposed reading: [3], [4], [8], [25], [29], [31], [34].

 

Topic 3. Asset Classes and their Characteristics

General overview of asset classes for portfolio constructions • Loan-type class and it characteristics • Equity-type class and it characteristics • Hybrids asset classes and it characteristics • Derivatives and their using • Risk-return correspondence for different asset classes • Alternative for financial investments: their roles and functions • Real estate (including real estate investment trusts, land trusts etc.), commodities, precious metal, antiques and other objects for investments.

 

Practical constituent.  Asset Classes: their Advantages and Risks

• Advantages and risks of investments into equity-type instruments: capital protection, risk-return correspondence, liquidity problems, high volatility and other.
• Advantages and risks of investments into the government bond-type instruments.
• Characteristics of investments into corporative bonds. Inflation problems and index-linked bonds as instruments of hedging. Problem of reinvestment risk.
• Opportunities and risks of non-financial investments.
• Alternative (non-financial) investments in the Ukrainian market: opportunities, liquidity problems (spreads between ask and bid prices), prospects, regulations, and taxation.

Proposed reading: [3], [4], [6], [8], [34], [35], [41], [42].   

 

 

Topic 4. Information Support for Portfolio Decision-Making

Role of information in portfolio management process • Theoretical aspects of information: asymmetry information, adverse selection risk and moral hazard risk • Practical aspect of information using: what information really need and obtainable? • Raw information from the market: prices, trading volumes, spreads and others • Concept of market efficiency by Eugene Fama • Weak, semi-strong and strong market efficiency: definitions and verification tests • The Cowles-Jones test.

 

 

Practical constituent. Data Mining in Portfolio Management

• Data mining (or knowledge discovery) process for portfolio management: main sources of information for decision making. Data warehouses and their use.
• Representation of raw data and their characteristics. Transactional data and their transformation.
• The Cowles-Jones test application.

 

Proposed reading: [1], [7], [14], [28], [39].

 

Topic 5. Investment Risks: Identification, Analysis and Measurement

Notion of investment risks • Systematic and non-systematic investment risks • Procedure of risk measurement • Three conceptual approaches to risk measurement: variability, losses in negative situation, sensitivity • Incorporation of risk-attitude into risk measurement • Characteristics of risk-averse, risk-seeking and risk-neutral investors

 

Practical constituent. Investment Risk Measurement

• Notion of systematic and non-systematic risk.
• Three conceptual approaches to risk measurement. Strengths and weaknesses of each approach to risk measurement.
• Calculation of values of different risk measures for financial instruments. 

Proposed reading: [2], [16], [23], [26], [27], [35], [39], [44].

 

MODULE 2. Equities and Bonds Portfolio Management

 

Content of Module 2

 

Topic 6. Markowitz Approach to Portfolio Formation

Expected return and risk for stocks • Risk-return correspondence and its graphic presentation • Correlations between returns and their role for portfolio forming • Diversification concept • Mathematical backgrounds for diversification effect • Two-criteria model of portfolio optimization • Set of feasible portfolios and efficient frontier • Why is the efficient set concave? • Map of indifference curves and risk aversion interpretation • Choice of portfolio from effective set • Portfolio with minimum risk • Systematic and non-systematic risks • Naïve diversification portfolio • Economic and mathematic problems with the use of the Markowitz approach.

 

Practical constituent. Markowitz Approach to Portfolio Formation

• Expected return and variance of assets combinations: linearity expected return vs non-linearity variance.
• Correlations between returns and their role in portfolio optimization. Cases with positive and negative correlations. Economic interpretation of positive and negative correlation.
• Portfolio formation with two common stocks. Analysis of special cases with correlations between returns:  -1; 0; 1.
• Portfolio formation with minimum risk.

 

Proposed reading: [3], [6], [11], [15], [19], [26], [37], [38].

 

Topic 7. Portfolio Decision-Making Involving Risk-Free Asset 

Notion of free-risk asset • Combination of risky asset and risk-free asset • Impact of risk-free rate on efficiency set • Two-funds separation theorem and its application to portfolio management • Capital Market Line (CML) • Market price of investment risk • Passive strategy as application of two-funds separation theorem.   

 

Practical constituent. Mean-Variance Model Adding the Risk-Free Asset

• Analysis of the “risk-free asset” notion at the national stock market. What options should be considered?
• Finding the optimal portfolio based on two-fund theorem. Considerations for investors with different risk attitude. 
• Formation of optimal portfolio composed from risky and risk-free assets. Consideration of different economic situations (market growth/crisis).

 

Proposed reading: [6], [8], [11], [13], [15], [19], [26], [41].

 

Topic 8. Capital Asset Pricing Model and Market Portfolio

Basic assumptions for Capital Asset Pricing Model (CAPM) • Critical analysis of basic CAPM assumptions • Grounds for existence of market portfolio and analysis of its structure • Reward-to-risk ratio for securities in relation to that of the overall market • Security Market Line (SML) as benchmark for assessing investment performance • Underpriced and overpriced securities • Passive strategy of portfolio management.

 

Practical constituent. Capital Asset Pricing Model and Market Portfolio

• Critical analysis of CAPM assumptions. What assumptions are the furthest from reality?
• Using CAPM basic formula for estimating expected return of securities and their risks.
• Analysis of market portfolio and its application for the passive portfolio strategy.
• Choosing undervalued and overvalued securities. Portfolio management based on this approach.

 

Proposed reading: [6], [8], [11], [13], [15], [19], [26], [41].

 

Topic 9. Index model

Foundations of index models • Single Index Model • Systematic and non-systematic risks in the Single Index Model • • Characteristics of “beta” coefficients and their use for valuation of securities • Formation of market indices: arithmetic type, geometric type, capitalization-weighted type • Index as a benchmark for portfolio management

 

Practical constituent. Market Indices and Index Models

• Types of index constructions: Arithmetic, Geometric, Capitalization-weighted. Main components of stock index construction.
• Single Index Model for estimating stock risk and return. Interpretation of systematic and non-systematic risks in this model.
• Economic logic of beta-analysis. Composing portfolio on the basis of beta-approach.

 

Proposed reading: [1], [6], [13], [15], [18], [26].

 

 

Topic 10. Strategies of Bonds Portfolio Formation. Immunization Approach

Risks for investment into bonds: default risk, inflation risk, and interest rate risk • Passive strategies of investments into the bonds: “buy-and-hold” and “laddering” • Reinvestment risk and its appearance in bonds investment • Logic of immunization procedure • The Frederick Macaulay duration concept • The Paul Samuelson Theorem

 

Practical constituent. Bonds Portfolio Management

• Application of “buy-and-hold” and “laddering” passive strategies for portfolio creation for different financial institutions (banks, insurance companies, non-government pension funds).
• Calculation of duration and application of the Samuelson Theorem.
• Immunization bonds portfolio.

 

Proposed reading: [1], [11], [15], [25], [26].

 

Topic 11. Rating Approach in Bond Portfolio Management

Essence of modern understanding of “Rating” • Graded presentation of rating values • Investment and speculative grades of rating • Modern credit rating industry • Main world rating agencies: Standard & Poor`s, Moody`s, Fitch • Problems of using rating approach for investment management • Strategy of investments concentration into bonds with high rating • Strategy of diversification through bonds with speculative grades.

Practical constituent. Anatomy of Rating-Based Portfolio Approach

• Rating use for bonds portfolio management: advantages and disadvantages.
• Value distribution function for portfolios of bonds with different grades. Particularities of Value-at-Risk application.
• Analysis and estimation of risks in portfolios created using the strategy of concentration of investments into bonds with high rating.
• Analysis and estimation of risks in portfolios created using the diversification strategy through bonds with speculative grades.

 

Proposed reading: [13], [15], [25], [26], [44].

 

 

 

REFERENCES

 

 

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