FNCE30001 Investments

SUBJECT GUIDE
Semester 2, 2011

Prepared by Professor Rob Brown Department of Finance Faculty of Business and Economics

Contents
Subject Overview ................................................................................................................................. 3 Prerequisites .......................................................................................................................................... 3 Learning Outcomes ............................................................................................................................. 3 Subject Objectives .......................................................................................................................... 3 Generic Skills................................................................................................................................... 3 Awareness Issues ............................................................................................................................ 4 Contact Details ..................................................................................................................................... 4 Lecturer Contact Details ............................................................................................................... 4 Tutor Contact Details .................................................................................................................... 4 Email Protocol ................................................................................................................................ 4 Lectures and Tutorials ......................................................................................................................... 5 Lecture Times ................................................................................................................................. 5 Lecture and Tutorial Schedule ...................................................................................................... 5 Enrolling in Tutorials ..................................................................................................................... 6 Textbook.......................................................................................................................................... 6 Assessment ............................................................................................................................................ 6 Assessment Overview .................................................................................................................... 6 Policy on Calculators in Examinations........................................................................................ 7 Assignment Submission................................................................................................................. 7 Plagiarism and Collusion ............................................................................................................... 7 Late Submission .............................................................................................................................. 8 Standardisation Policy .................................................................................................................... 8 Special Consideration ..................................................................................................................... 8 Teaching and Learning Unit ......................................................................................................... 8 Other Information ............................................................................................................................... 9 Special Examinations ..................................................................................................................... 9 Student Responsibilities ...................................................................................................................... 9 Detailed Lecture and Reading Guide .............................................................................................. 10

Subject Overview
Welcome to FNCE30001 Investments. This subject is an introduction to investment analysis. The first half of the subject covers equities, while the second half covers fixed interest securities.

Prerequisites
The prerequisites for this subject are FNCE20001 (333-201) Business Finance and one of ECOM20001 (316-205) Introductory Econometrics, ECON20003 (316-206) Quantitative Methods 2 or MAST20005 (620-202) Statistics.

Learning Outcomes
Subject Objectives
On successful completion of this subject students should be able to: Discuss core concepts in finance, including risk, return, risk premium and risk aversion Analyse the portfolio selection problem, with emphasis on the mean variance framework Critically evaluate theories of asset pricing and their application in the pricing of securities Analyse issues in the pricing of fixed interest securities and the management of fixed interest portfolios Critically evaluate theories of the term structure of interest rates Discuss issues in the pricing of swaps and their application in risk management Develop techniques to evaluate the performance of money managers

Generic Skills
Generic Skills Development None Oral communication Written communication Collaborative learning Problem solving Team work Statistical reasoning Application of theory to practice Interpretation and analysis Critical thinking Synthesis of data and other information Evaluation of data and other information Use of computer software Accessing data and other information from a range of sources Activity level Some Moderate X X X X X X X X X X X X High

Awareness Issues
Awareness Issue None Financial market efficiency Current financial market conditions Tax effects on prices and decisions Market globalisation Government regulation Risk management Risk measurement Valuation issues Investor behaviour Corporate governance and business ethics Financial modelling Current corporate financial practice Activity level Some Moderate X X X X X X X X X X X High X

Contact Details
Lecturer Contact Details
The first 5 lectures will be given by Dr Joachim Inkmann. The following six lectures will be given by Professor Rob Brown. Their contact details are: Lecturer Room Phone email Dr Inkmann 11.028 The Spot 8345-8177 jinkmann@unimelb.edu.au Professor Brown 11.016 The Spot 8344 8015 rlbrown@unimelb.edu.au The lecturer-in-charge is Professor Brown. The tutor-in charge is Mr Allan Horsfall (email: akh@unimelb.edu.au). Dr Inkmanns consultation time is Friday 1.00 pm to 3.00 pm. Other times are available by appointment. Professor Browns consultation time is Tuesday 1.00 pm to 3.00 pm. Other times are available by appointment.

Tutor Contact Details

These details will be made available via the LMS.

Email Protocol
Given the size of the enrolment, please first direct your questions about the subject content to your assigned tutor. If your tutor is unable to provide the help you need, you should see the relevant lecturer.

While academic staff may address queries received via email, it is often more appropriate to resolve substantive questions face-to-face during normal consultation hours. We are only able to respond to student emails coming from a University email address. Please do not use personal email addresses such as Yahoo, Hotmail or even business email addresses. Emails from non-University email addresses may be filtered by the Universitys spam filter, which means that we may not receive your email. All correspondence relating to this subject will be sent only to your University email address. Note that you must first activate your University email address before you can send or receive emails at that address. You can activate your email account at http://accounts.unimelb.edu.au/.

Lectures and Tutorials

Lecture Times
There are two lecture streams. As far as possible, lectures in both streams will be identical, but some differences are inevitable. The Wednesday lectures are 12.00 noon 2.00 pm in The Spot Basement Theatre. The Friday lectures are 10.00 am 12.00 noon in The Spot Basement Theatre.

Lecture and Tutorial Schedule

Week 1 2 3 4 5 6 7 8 9 10 11 12 Lecture Lecture Topic Dates 27 & 29 July Risk Aversion and Capital Allocation 3 & 5 Aug Optimal Risky Portfolios 10 & 12 Aug Capital Asset Pricing Model 17 & 19 Aug Index Models 24 & 26 Aug Arbitrage Pricing Theory and Multifactor Models 31 Aug & 2 Fixed Income Fundamentals Sep 7 & 9 Sep MID-SEMESTER EXAM* 14 & 16 Sep Coupon Bonds MID-SEMESTER BREAK 5 & 7 Oct Managing Fixed Income Portfolios 12 & 14 Oct Term Structure of Interest Rates 19 & 21 Oct Floaters and Swaps 26 & 28 Oct Portfolio Performance Evaluation Tutorial Topic No Tutorial Risk Aversion and Capital Allocation Optimal Risky Portfolios Capital Asset Pricing Model Index Models Arbitrage Pricing Theory and Multifactor Models NO TUTORIAL CLASSES Fixed Income Fundamentals NO TUTORIAL CLASSES Coupon Bonds Managing Fixed Income Portfolios Term Structure of Interest Rates Floaters, Swaps and Portfolio Performance Evaluation

* Students enrolled in the Wednesday lectures will sit their exam on Wednesday 7 September from 12.30 pm to 1.30 pm in Wilson Hall. Students enrolled in the Friday lectures will sit their exam on Friday 9 September from 10.30 am to 11.30 am in Wilson Hall. No lectures or tutorials are held in the week of the midsemester exam. Students must sit the exam for the lecture in which they are enrolled. Copies of lecture slides, tutorial questions and important notices will be available for download from the LMS website at http://www.lms.unimelb.edu.au.

Enrolling in Tutorials
You must enrol in a tutorial for this subject as soon as possible. From the Student Portal on the Universitys website, click on the Admin tab; then, under Timetable, click on View my subject timetable and register in classes.

Textbook
The prescribed text is: Z. Bodie, M. Ariff, R. da Silva Rosa, A. Kane and A.J. Marcus, Investments, 1st edition, McGraw-Hill, 2007.

Assessment
Assessment Overview
One 3-hour end-of-semester examination (70%). The time and location of the final examination are decided by the Universitys central administration and will be provided during the semester. The final examination has an additional 15 minutes of reading time. A formula sheet will be provided. The final examination will cover the whole subject but will give greater weight to those topics not included in the mid-semester examination. One 1-hour mid-semester exam (20%). Note: The exam is on material covered in the first 5 lectures. Students enrolled in the Wednesday lectures will sit their exam on Wednesday 7 September from 12.30 pm to 1.30 pm in Wilson Hall. Students enrolled in the Friday lectures will sit their exam on Friday 9 September from 10.30 am to 11.30 am in Wilson Hall. No lectures or tutorials are held in the week of the mid-semester exam. Students must sit the exam for the lecture in which they are enrolled. Writing time is 1 hour; there is no reading time. A formula sheet will be provided. Two assignments (2 5% = 10%). The due dates are: Assignment 1: 4.00 pm on Tuesday 30 August Assignment 2: 4.00 pm on Friday 14 October

Following Faculty policy, all assignments must be submitted electronically through the Assignment Tool. Further details will be available via the LMS.

Policy on Calculators in Examinations

Any calculator that can be programmed and/or that can display a graph and/or that has a full alphabetic keyboard will not be permitted in any examination in this subject. The department website contains further information on complying and non-complying calculators. It is the responsibility of each student to ensure that the calculator they take into an examination complies with this rule. If any student in an examination is found in possession of a non-complying calculator, the calculator will be confiscated for the period of the examination. Note that it is not sufficient merely to switch off a calculators programming capacity. In addition, the student will be in breach of university regulations governing examinations, the penalties for which may include: exclusion from the university, either permanently or temporarily; imposition of a fine; deprivation of credit for the subject or for a component of assessment of the subject; termination of enrolment.

Assignment Submission
Faculty policy requires all assignments to be submitted electronically through the Assignment Tool. Assignment(s) that are attempted to be submitted elsewhere will not be marked.

Plagiarism and Collusion

Presenting material from other sources without full acknowledgement (referred to as plagiarism) is heavily penalised. Penalties for plagiarism can include a mark of zero for the piece of assessment or a fail grade for the subject. Plagiarism is the presentation by a student of an assignment identified as his or her own work even though it has been copied in whole or in part from another students work, or from any other source (eg. published books, web-based materials or periodicals), without due acknowledgement in the text. Collusion is the presentation by a student of an assignment as his or her own work when it is, in fact, the result (in whole or in part) of unauthorised collaboration with another person or persons. Both the student presenting the assignment and the student(s) willingly supplying unauthorised material are considered participants in the act of academic misconduct. See http://academichonesty.unimelb.edu.au/plagiarism.html for more information. The Teaching and Learning Unit has developed a web-based Academic Honesty Module that allows you to learn more about and test your knowledge of plagiarism and collusion. You are strongly encouraged to complete this module, which can be accessed at: http://academichonesty.unimelb.edu.au/

Late submission of an assignment is permitted only where an extension has been granted. Requests for an extension must be submitted to the Commerce Student Centre. Extensions can be granted only by the Commerce Student Centre. Contact details for undergraduate enquiries at the Commerce Student Centre are: Location: Phone: email: Fax: Upper ground floor, ICT Building, 111 Barry Street 13 MELB (13 63 52) 13melb@unimelb.edu.au 9347 3986

Unless an extension has been granted, a late assignment will NOT be marked.

Standardisation Policy
The final mark for this subject may be adjusted in accordance with the Facultys standardisation guidelines.

Special Consideration
Students who have been significantly affected by illness or other serious circumstances during the semester may be eligible to apply for Special Consideration. The following website contains detailed information relating to who can apply for Special Consideration and the process for making an application: http://www.ecom.unimelb.edu.au/students/special/

Teaching and Learning Unit

The Teaching and Learning Unit offers a wide range of support services to students. If you are having any difficulty in studying for this subject you could arrange a consultation with the Units learning skills specialist. The learning skills specialist can review your current approaches to study and offer advice on how to adjust to the demands of tertiary study. If you are a student from a non-English speaking background there is a specialist in English as a Second Language who is available to help with your written work. Both of these specialists are available for face-to-face consultations or electronically through email. Go to the Faculty office to arrange for consultations or contact the specialists electronically through the Teaching and Learning Unit web page. The web page also contains a wide variety of study skills topics and information sheets for students, and a timetable of upcoming events, including focussed workshops, designed to support Economics and Commerce students in their study. The Teaching and Learning Unit is located on the 5th floor of The Spot. Please visit the TLUs website (http://tlu.fbe.unimelb.edu.au/). Make use of the Teaching and Learning Unit. It is there to help.

Other Information
Special Examinations
There are no supplementary examinations in units taught by this Faculty, but the examiners may require candidates to be present for further written or oral tests to be held before the publication of results. Candidates are warned that only very short notice of these tests can be given and it is important that they can be reached at the address held by the University. The Department of Finance endeavours to give students a week's notice of their eligibility to sit a special test. However, where an exam has been held late in the examination period or where there is a heavy marking load, it may be possible to give only 48 hours notice. If a student fails to sit a special exam (for whatever reason) they should not expect to be offered another exam.

Student Responsibilities
The University is obliged to ensure that the information students need to plan their courses is accurate, timely and generally available. In turn, students have responsibilities that include the following: to be well informed about courses and course requirements; to plan a course which satisfies course requirements; to attend all set classes; to be aware of rights and obligations; and to abide by the University's rules and regulations.

Detailed Lecture and Reading Guide

Week 1 25 July to 29 July Risk Aversion and Capital Allocation
1. Introduction to Investments 2. Risk and risk aversion 2.1 Utility function 2.2 Indifference curves 3. Capital allocation across risky and risk-free portfolios 3.1 The complete portfolio 4. Portfolios of one risky asset and a risk-free asset 4.1 The capital allocation line 4.2 The Sharpe ratio 5. Risk tolerance and asset allocation 5.1 The optimal complete portfolio Reading: Bodie et al, Chapters 6 and 7. Note: There are no tutorial classes this week.

Week 2 1 August to 5 August Optimal Risky Portfolios

1. Diversification and portfolio risk 1.1 Systematic and nonsystematic risk 2. Portfolios of two risky assets 2.1 Perfectly positive and negative correlation 2.2 The minimum-variance portfolio 3. Asset allocation with risky and risk-free assets 3.1 The optimal risky portfolio 3.2 The optimal complete portfolio 4. The Markowitz portfolio selection model 4.1 The efficient frontier 4.2 Separation property Reading: Bodie et al, Chapter 8.

Week 3 8 August to 12 August The Capital Asset Pricing Model (CAPM)

1. The CAPM 1.1 The market portfolio 1.2 The capital market line 1.3 The security market line 2. The CAPM and the index model 3. Extensions of the CAPM Reading: Bodie et al, Chapter 9. 10

Week 4 15 August to 19 August Index Models

1. The single-factor model 1.1 Covariances 2. The single-index model 2.1 Regression model 2.2 Expected return and beta 2.3 Risk and covariance 2.4 Diversification 3. Estimating the single index model 3.1 Alpha 3.2 Beta 3.3 Variance 4. Portfolio construction and the single-index model 4.1 The information ratio 4.2 The optimal risky portfolio Reading: Bodie et al, Chapters 10 and 27.

Week 5 22 August to 26 August Arbitrage Pricing Theory (APT) and Multifactor Models
1. Multifactor models 1.1 Security returns 1.2 Security market line 2. The APT 2.1 Arbitrage 2.2 Betas and expected returns 2.3 One-factor security market line 3. Individual assets and the APT 3.1 The APT and the CAPM 4. Multifactor APT 5. Multifactor CAPM and the APT Reading: Bodie et al, Chapter 11.

Week 6 29 August to 2 September Fixed Income Fundamentals

Note: Assignment 1 is due this week. The deadline is 4.00 pm on Tuesday 30 August. 1. 2. 3. 4. 5. 6. 7. Fixed income securities: What and who? Bond types Pricing zero-coupon bonds Pricing money market securities The zero rate curve Using the zero rate curve to price securities Measuring the return on zeros Bodie et al, Chapter 14.

Reading:

11

Week 7 5 September to 9 September Mid-semester Exam

Students enrolled in the Wednesday lectures will sit their exam on Wednesday 7 September from 12.30 pm to 1.30 pm in Wilson Hall. Students enrolled in the Friday lectures will sit their exam on Friday 9 September from 10.30 am to 11.30 am in Wilson Hall. Students must sit the exam for the lecture in which they are enrolled. No lectures or tutorials are held in the week of the mid-semester exam.

Week 8 12 September to 16 September Coupon Bonds

1. 2. 3. 4. 5. 6. 7. 8. Review: Zeros and fixed-coupon bonds Yield-to-maturity (ytm) Bond pricing in practice (A): Australian conventions Bond pricing in practice (B): US conventions The yield curve The par yield curve Finding the zero rate curve: Bootstrapping The holding period return Bodie et al, Chapters 14 and 15. Reserve Bank of Australia, Pricing Formulae for Commonwealth Government Securities, available at http://www.rba.gov.au/mkt-operations/technotes/pricing-formulae.html

Reading:

Week 9 3 October to 7 October Managing Fixed Income Portfolios

1. 2. 3. 4. 5. 6. Overview of bond portfolio risks Some mathematical properties of bond prices Duration and convexity More properties of duration How duration is used in portfolio management Measuring portfolio yield Bodie et al, Chapter 16. How Duration Changes Over Time (available as a pdf on the LMS).

Reading:

12

Week 10 10 October to 14 October The Term Structure of Interest Rates

1. 2. 3. 4. 5. 6.

Note: Assignment 2 is due this week. The deadline is 4.00 pm on Friday 14 October. Zero rates, forward rates and actual rates What determines the forward rate? The term structure of interest rates (TSIR): Definition TSIR explanations (1): The expectations hypothesis TSIR explanations (2): The liquidity premium hypothesis Interpreting the slope of the TSIR Bodie et al, Chapter 15.

Reading:

Week 11 17 October to 21 October Floaters and Swaps

1. Floaters 1.1 What is a floater? 1.2 How much is a floater worth? 1.3 The duration of a floater 2. Interest rate swaps 2.1 What is an interest rate swap? 2.2 Why do interest rate swaps exist? 2.3 How much is an interest rate swap worth? 2.4 Interest rate swaps in practice Reading: Bodie et al, Chapter 16.

Week 12 24 October to 28 October Portfolio Performance Evaluation

1. 2. 3. 4. Steps in performance evaluation Performance measurement Performance appraisal Performance attribution Bodie et al, Chapter 24. Performance Measurement (available as a pdf on the LMS).

Reading:

13