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Unformatted text preview: Finance 512 Portfolio Analysis • • • • • Professor Hsiu-lang Chen 2425 UH; Phone: 355-1024 Email: Class Website: UICBlackboard My Office Hours: 2:00pm~5:00pm on Wednesdays or by appointments Hsiu-lang Chen Portfolio Analysis 1 Course Objectives Learn the concept of investing from the perspective of a portfolio manager rather than an individual investor Involve detailed quantitative analysis Focus on the investment strategies for large portfolios and in particular risk management issues Emphasize in both portfolio theory and investment practice (Real-Data-Oriented Homework) Update dynamics of market development Hsiu-lang Chen Portfolio Analysis 2 Reference Books Investments, Zvi Bodie, Alex Kane, and Alan J. Marcus, Irwin/McGraw-Hill, 9th edition. Modern Portfolio Theory and Investment Analysis, Edwin J. Elton, Martin J. Gruber, Stephen J. Brown, and William N. Goetzmann, John Wiley & Sons, Inc., 8th edition. Investment Analysis and Portfolio Management, Frank Reily and Keith Brown, Thomson/South-Western, 8th edition. Hsiu-lang Chen Portfolio Analysis 3 Evaluation Computer Project & Presentation 36% Done in groups Present the project at the end Grade determined by the interesting of the topics, the scope of the project, the completeness of the analysis, and the effectiveness of the presentation. Two Exams Hsiu-lang Chen 64% (32% each) Portfolio Analysis 4 Grades 86% + 76% to 85% 66% to 75% 56% to 65% 55% or below A B C D F Grading might be curved at the end, depending on the overall class performance. • Exception: students absent more than 3 class are excluded from such a curving. Students surfing over the web during the lecture are considered as absent students. Hsiu-lang Chen Portfolio Analysis 5 Hsiu-lang Chen Portfolio Analysis 6 World's Assets Hit Record Value Of $140 Trillion Hsiu-lang Chen By JOANNA SLATER; January 10, 2007; C8; WSJ Portfolio Analysis 7 Terminal Value 1927~2010 Small-Cap $29,947 Large-Cap $1,518 LT TBond $85 T-Bill $20 12 10 Log Scale 8 6 4 2 0 -2 Hsiu-lang Chen Portfolio Analysis 8 12-year Sample Correlations 1938~2010 Corr(S,B) Corr(L,B) Corr(S,L) 1.2 1 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 -0.8 -1 Hsiu-lang Chen Portfolio Analysis 9 Hsiu-lang Chen Portfolio Analysis 10 Course Outline I Consistency of mean-variance analysis and expected utility maximization [Chapter 1011, EGBG], [Chapter 6 & Appendix A&B , BKM] Are assets returns normally distributed? [Chapter 5, BKM] Does time diversification work? [Handouts; Chapter 7.5, BKM] Portfolio Theory & Portfolio Construction The Optimal Risky Portfolio, The Correlation Structure of Security Returns [Chapter 6-8, EGBG], [Chapter 7-10, BKM] Black-Litterman Model by Goldman, Sachs & Co. [Handouts; Chapter 27.3, BKM] Applications of Factor Models in Risk Management Risk Neutral and Index Mimicking [Handouts; Chapter 10 & 17, BKM] Hsiu-lang Chen Portfolio Analysis 11 Course Outline II Introduction to Mutual Fund Industry Mutual Fund Performance Evaluation and Style Classification [Ch24, BKM; Handouts] Returns-based approach: Sharpe, William F., 1992, Asset allocation: Management style and performance measurement, Journal of Portfolio Management (Winter), 7−19. Holdings-based approach: Chan, Louis K. C., Stephen G. Dimmock, and Josef Lakonishok, 2009, Benchmarking Money Manager Performance: Issues and Evidence, Review of Financial Studies 22, 4553-4599. Chan, Louis K. C., Hsiu-lang Chen, and Josef Lakonishok, 2002, On mutual fund investment styles, Review of Financial Studies 15, 1407-1437. Discussion: Fama, Eugene F. and Kenneth R. French, 2010, Luck versus Skill in the Cross-Section of Mutual Fund Returns, Journal of Finance 65, 1915~1947. Tax Issues in Fund Performance Evaluation Current Issues in Mutual Fund Industry/Hedge Fund Industry [Chapter 26 & 27, BKM; Wall Street Journal, Handouts] Equity Valuation Models [Chapter 18-19, BKM & EGBG, Wall Street Journal, Handouts] (if time is allowed) Hsiu-lang Chen Portfolio Analysis 12 The United States of Subprime Data Show Bad Loans Permeate the Nation; Pain Could Last Years By RICK BROOKS and CONSTANCE MITCHELL FORD; October 11, 2007; WSJ, Page A1 Year 2007 From 2004 to 2006, more than 2,500 banks, thrifts, credit unions and mortgage companies made a combined $1.5 trillion in high-interest-rate loans, carring interest rates of 3% or more over U.S. Treasurys of comparable durations. Hsiu-lang Chen Portfolio Analysis 13 Year 2008 Hsiu-lang Chen Portfolio Analysis 14 Year 2009 Hsiu-lang Chen Portfolio Analysis 15 Hsiu-lang Chen Portfolio Analysis 16 Law Remakes U.S. Financial Landscape Senate Passes Overhaul That Will Touch Most Americans; Bankers Gird for Fight Over Fine Print By DAMIAN PALETTA And AARON LUCCHETTI ; WSJ; JULY 16, 2010; A1 The Dodd–Frank Wall Street Reform and Consumer Protection Act Hsiu-lang Chen Portfolio Analysis 17 Meet the Supporting Cast Markets Continued to Benefit From Intervention in 2010; Now, the Question Is, Can the Fed and Others Exit Neatly? By TOM LAURICELLA; WSJ; 01/03/2011; R1 Hsiu-lang Chen Portfolio Analysis 18 Traditional Investment Instruments: Stocks, Bonds, Options, Futures, Real Estates, … Un-conventional Investment Instruments: Arts, Sports transferring rights, Credit-Default Swaps, CDOs, CLOs, SIVs, Auction-Rate Bonds, Death Bonds… Hsiu-lang Chen Portfolio Analysis 19 Default Fears Unnerve Markets Partners in Credit Deals Face Big Write-Downs As Bond Insurer Teeters By SUSAN PULLIAM and SERENA NG; January 18, 2008; WSJ, Page A1 ACA ($425m) kept its single-A rating and thus didn't require to post collateral even if the securities it insured slipped in value. If a hedge fund, which doesn't have a credit rating, is selling the insurance, the hedge fund may be asked to put up more collateral each time the security insured falls in value. Hsiu-lang Chen 20 ACA wrote $89b credit default swap as of Nov Portfolio downgraded to CCC on 12/19/2007 and was delisted. but was Analysis CDO (Collateralized Debt Obligations) Financial vehicles that bundle different kinds of debt-ranging from corporate bonds, to securities underpinned by mortgages, to debt backed by money owed on credit cards-and cut it into slices. An investment bank creates a CDO, which is really just a company running from $500m to $2b in size. These slices (tranches) are sold to investors in the form of bonds. While these slices contain the same debt, they differ in terms of which pay the most interest and which are least at risk of losing money. Hsiu-lang Chen Portfolio Analysis 21 Do lenders care much about credit quality of borrowers? WSJ, A1, 06/27/2007 Hsiu-lang Chen Portfolio Analysis WSJ, C3, 03/13/2007 22 Deal Fees Under Fire Amid Mortgage Crisis Guaranteed Rewards Of Bankers, Middlemen Are in the Spotlight By LIAM PLEVEN and SUSANNE CRAIG; January 17, 2008; WSJ,Page A1 Hsiu-lang Chen Portfolio Analysis 23 CLO (Collateralized Loan Obligations) Banks on a Bridge Too Far? As Risk Rises in LBOs, Investors Start to Balk; Warning From Overseas By ROBIN SIDEL, VALERIE BAUERLEIN and CARRICK MOLLENKAMP June 28, 2007; Page C1 Hsiu-lang Chen Portfolio Analysis 24 'Conduits' in Need of a Fix Subprime Hazards Lurk In Special Pipelines Held Off Bank Balance Sheets By DAVID REILLY and CARRICK MOLLENKAMP; WSJ, August 30, 2007; Page C1 Conduits helped banks generate revenue by creating a tool to finance highly rated investments, did not contribute to accounting volatility and did not need much regulatory capital. Globally, commercial-paper market is about $3 trillion while the amount of asset-backed commercial paper is about $1.3 trillion. Of this, $1.1 trillion is backed by funding lines from banks. Citigroup has $77B conduits; JP Morgan Chase has $54B. State Street has $28B. Hsiu-lang Chen Portfolio Analysis 25 Structured Investment Vehicles (SIV) Sossidis and Partridge-Hicks invented SIVs in London in the late 1980s. Banks use SIVs and conduits to issue short-dated commercial paper and medium-term notes, investing the proceeds in assets such as credit-card debt and mortgage securities. The vehicles profit by capturing the spread. SIVs differ from conduits because conduits have banksupported credit lines to carry them through if they can't roll over their commercial paper, while SIVs receive only limited support. SIVs can also issue longer-dated notes, can use leverage and have tended to have greater exposure to mortgage debt. Most off-balance-sheet vehicles, conduits and SIVs included, don't have "owners" in the traditional sense. Rather they are like corporate zombies and are typically set up in offshore tax havens Citigroup has nearly $100 billion in seven affiliated structured investment vehicles, or SIVs. Globally, SIVs had $400 billion in assets as of Aug. 28, according to Moody's. $49b SIVs was bailed out in 12/11/2007. WSJ, 10/13/2007, 10/15/2007, Page A1; Hsiu-lang Chen 10/16/2007, Page A1, C1, C14 Portfolio Analysis WSJ, 10/18/2007, Page A1 26 U.S. Investors Face An Age of Murky Pricing Values of Securities Tougher to Pin Down; Discord at Dillon Read By SUSAN PULLIAM, RANDALL SMITH and MICHAEL SICONOLFI; WSJ, October 12, 2007; Page A1 In March, John Niblo, a hedge-fund manager at the firm Dillon Read, twice slashed his fund's valuation of securities tied to "subprime" mortgages, knocking them down by about 20%, or nearly $100 million. But managers at UBS AG, the parent company, were irate. UBS later shut down the in-house hedge fund. Oct 1, UBS announced a $3.7 billion write-down on $23 billion of securities with mortgage exposure. Hsiu-lang Chen Portfolio Analysis 27 Pricing Probes On Wall Street Gather Steam SEC-Led Investigations Focus on Public Notice, In-House Discrepancies By SUSAN PULLIAM and KARA SCANNELL; December 21, 2007; WSJ, Page C1 Financial firms often use mathematical models with built-in assumptions in determining value, or "marks," which might differ if they had to sell the securities. Investigate whether Wall Street firms placed higher values on their own securities than those they placed on customer holdings. Citi wrote down subprime-mortgage investments by $18b, obtained $14.5b capital infusion in addition to $7.5b raised in Nov, and cut the Chen Hsiu-langquarterly dividend to 32 cents a share Portfolio Analysis from 54 cents. 01/15/2008 $16.7b SEC Aims to Let Firms Explain Crunch Thorns WSJ, 03/14/2008; Page C1 SEC Gives Firms More Leeway 28 In Pricing Asset-Backed Issues WSJ, 03/31/2008; Page C7 Trader Made Billions on Subprime John Paulson Bet Big on Drop in Housing Values; Greenspan Gets a New Gig, Soros Does Lunch By GREGORY ZUCKERMAN; January 15, 2008; WSJ, Page A1 Long: the credit-default swaps that complacent investors seemed to be pricing too low in 2005. Short: 1. Risky CDO slices by engaging complex debt contract with banks. 2. ABX, an index that reflects the value of a basket of subprime mortgages made over six months. An index of those made in the first half of 2006 appeared 100 in July 2006 but fell to 20s in Fall 2007. The upshot: The older Paulson credit funds rose 590% last year and the newer Chen 350%. one Hsiu-lang Portfolio Analysis 29 Auction-Rate Bonds WSJ, 02/15/08, C2; 02/16/08, B1; 02/19/08, C1; 02/21/08, D1; 03/29/08, B1 & B5; 08/09/08, A1 Auction-rate securities are initially sold as long-term bonds but are effectively turned into short-term securities through auctions typically held every seven, 28 or 35 days. Issuers reap the low financing costs associated with short-term debt, while investors gain liquidity through the frequent sales. Auction-rate securities generally paid higher yields than savings accounts or money-market funds. Portfolio Analysis Hsiu-lang Chen 30 UBS to Pay $19 Billion As Auction Mess Hits Wall Street By LIZ RAPPAPORT and RANDALL SMITH; WSJ, August 9, 2008; Page A1 Hsiu-lang Chen While the bulk of the market is municipal debt, student lenders and closed-end mutual funds also raise money in this market. Estimates on the breakdown vary, but the municipal sector is thought to be $200 billion to $250 billion, with student lending accounting for less than $100 billion. When all bonds being offered for sale fail to attract bids, the issuer's rate goes up, often markedly, until the next successful auction, when a new clearing rate goes into effect. In this case, investors are unable to sell their securities for cash but are paid a higher penalty rate of interest up to 20%. 31 Portfolio Analysis WSJ, C1, 02/21/2007 WSJ, A1, 11/26/2007 Hsiu-lang Chen Portfolio Analysis 32 Is a money manager a good career? Hsiu-lang Chen Portfolio Analysis 33 Hsiu-lang Chen Portfolio Analysis 34 Hsiu-lang Chen Portfolio Analysis 35 Hsiu-lang Chen Portfolio Analysis 36 The Charge by Money Managers Mutual funds: on average 1.35% management fee Hedge funds: in general, 2% management fee + 20% of profits Is it an easy job to be a persistently successful money manager? Hsiu-lang Chen Portfolio Analysis 37 10/15/04 Hsiu-lang Chen Portfolio Analysis 38 Resource of Financial Data members.cgi Username: uicfin11 Password: CRSP provides US historical stock information while Compustat provides historical accounting information. IBES provides consensus and detail forecasts on earnings from security analysts. TAQ contains intraday transactions data (trades and quotes) for all securities. Hsiu-lang Chen Portfolio Analysis 39 Resource of US Research Data ty/ken.french/ Factor returns and industry returns commonly used in research in Finance Historical returns on portfolios sorted by firm characteristics Hsiu-lang Chen Portfolio Analysis 40 How can be a successful money manager? Build a foundation in Finance —Theory, Data Analysis, Implementation Understand the market dynamics —Gleaning information insights —Connecting information dots Hsiu-lang Chen Portfolio Analysis 41 Hedge Fund Ospraie Gets Physical In Bid to Fine-Tune Commodity Bets By IANTHE JEANNE DUGAN; WSJ, June 28, 2008; Page B1 Now, Ospraie is looking to get a leg up. In a bid to get an inside look into what is moving commodities markets, the firm closed this week on a $2.8 billion purchase of ConAgra Foods Inc.'s commoditiestrading unit. The deal makes Ospraie one of the largest U.S. operators of grain elevators, which buy grain from farmers and sell it up the food chain. Ospraie already controls barges that move crops and will add railroad to transport more. It also gains a big Omaha commoditiestrading floor as part of the ConAgra operation, which it renamed Gavilon. The moves underscore how large investors increasingly are buying physical assets -- from farms to refineries -- as big institutions pour money into commodities. The owners have a major advantage over other investors, because they glean insights into the food chain. Hsiu-lang Chen Portfolio Analysis 42 Seeking an Edge, Big Investors Turn to Network of Informants Mark Gerson Assembles Web Of Moonlighting Managers; Applebee's Bars Practice Drawing a Line at 'Nonpublic' By LAURIE P. COHEN WSJ; 11/27/2006; Page A1 Hsiu-lang Chen Portfolio Analysis 43 U.S. in Vast Insider Trading Probe By SUSAN PULLIAM, MICHAEL ROTHFELD,JENNY STRASBURG and GREGORY ZUCKERMAN; WSJ;11/20&11/22/10;A1 Hsiu-lang Chen Portfolio Hint Insider Probe Will Broaden Big Consultant PayoutsAnalysis 44 By SUSAN PULLIAM, MICHAEL ROTHFELD And JENNY STRASBURG; WSJ; 01/10/2011; A1 Fund Titan Found Guilty Rajaratnam Convicted of Insider Trading; Jurors Cite Tapes: 'Just a Lot of Evidence’ WSJ; 05/12/2011; A1 Hsiu-lang Chen Portfolio Analysis 45 How to connect information dots? Is this easy? Ask Intelligence Agencies … President Obama said U.S. intelligence agencies knew that al Qaeda in Yemen was targeting the U.S. but "failed to connect those dots" to thwart a Christmas Day bombing attempt. Information may be shared but disparate pieces of data aren't being assembled. (President Says U.S. Missed Key Bomb Clues By JONATHAN WEISMAN, SIOBHAN GORMAN and EVAN PEREZ; WSJ; 01/06/2010; A1) Hsiu-lang Chen Portfolio Analysis 46 How to connect information dots? (foundation + 6th sense) Be “in” the markets! Read Wall Street Journal Everyday! After Tough 2007, Japan Stocks May Be the New Year's Bargains; By ANDREW MORSE; WSJ, 12/31/2007 Growing Reliance on Temps Holds Back Japan's Rebound Firms Increasingly Add Part-Time Workers; Spending Power Lags By YUKA HAYASHI; WSJ, 1/7/2008; Page A1 Hsiu-lang Chen Portfolio Analysis 47 "Why do the French kiss a woman's hand?“ (A Quote from Mario Draghi, the current Bank of Italy Governor and the next chief of the European Central Bank) (An Exception: Dominique Strauss-Kahn, former IMF chief) "You have to start somewhere." Hsiu-lang Chen Portfolio Analysis 48 Google Primes Patent Pump Looking Out for Android, Search Giant Arms Itself With Intellectual Property By Don Clark; WSJ; 08/16/2011; A4 Hsiu-lang Chen Portfolio Analysis 49 Changes of the Landscape Allies Rivals Dynamics of Comovement with Others Updates of Prior Information (Prior Estimations) Changes in fundamental risk Changes in expected returns Connection of Information Dots Google: Rivals Are Ganging Up By JOHN LETZING; WSJ; 08/04/2011; B6 Google accused rivals Oracle, Microsoft and Apple of waging an "organized, hostile campaign" against its Android mobile phone software, using questionable patents. Hsiu-lang Chen Portfolio Analysis Mobility's Benefits for Google Not Patently Obvious By ROLFE WINKLER And MARTIN PEERS; WSJ; 08/16/2011; C8 50 ...
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