CHAPTER13
THETERMSTRUCTUREOFINTERESTRATES
1. In general, the forward rate can be viewed as the sum of the markets expectation
of the future short rate plus a potential risk or liquidity premium. According to
the expectations theory of the term structure o

Lectures 1-10
Problem
and
Concept Check
Solutions
L1 Concept check
Why are money market instruments cash-like?
A: They are low risk, very liquid (can be sold easily on
the market) and have low maturity (value does not
fluctuate with interest rates).
Wha

Lecture 7 (Ch 7)
The Capital Asset
Pricing Model
Where we are
up to now:
how to allocate between risky and riskless assets
how to choose optimal risky portfolio
efficient minimum variance frontier
this lecture:
how much return to get for risk
CAPM

FNCE 443
Investments
About this course
PLEASE READ THE SYLLABUS AND THE TEXTBOOK
prerequisite: FNCE 317
no laptops and electronic devices with wireless
communication permitted in the classroom
regular attendance and active participation expected
ATTEND

Lecture 5 (Ch 6)
Diversification
Where we are
up to now:
goals regarding return and risk: utility
optimal allocation between risky and risk-free asset
this lecture:
how to combine risky assets in a portfolio?
diversification
covariance and correlat

Lecture 12
Midterm Review
Financial Markets
Roles:
informational role and capital allocation
consumption timing
allocation of risk
separation of ownership and management
Classes of assets and securities:
money market instruments (debt but like cash):

Lecture 14 (Ch 13)
The Term Structure of
Interest Rates
Chapter Overview
The yield curve
Interest rates under certainty
Interest rates under uncertainty
Theories of the term structure
The expectation hypothesis
Liquidity preference
Interpreting the ter

Lecture 16 (Ch 15)
Macroeconomic
and
Industry Analysis
Chapter Summary
Objective: To introduce aspects of
economic conditions that affect earnings.
The Global Economy
The Domestic Macroeconomy
Demand and Supply Shocks
Federal Government Policy
Busin

Lecture 6
Minimum-Variance Frontier
and
Efficient Diversification
Where we are
up to now:
how to combine risky portfolio with risk-free
how to combine two risky portfolios
diversification benefit depends on correlation
this lecture:
efficient mean-v

Lecture 18 (Ch 17)
Price-Earning Ratios
and
Statement Analysis
Where we are
Up to now:
linked E(r) to P
constant growth dividend discount model:
D0 (1 g) D1
V0
=
k-g
k-g
get k from CAPM expected return
This lecture:
more on the growth opportunities
r

Lecture 9 (Ch 8)
Arbitrage Pricing Theory
and
Multifactor Models
Where we are
up to now:
trade-off between risk and return
measure for priced risk is beta, CAPM
abnormal return alpha
this lecture:
Arbitrage Pricing Theory (APT)
limitations of the C

Lecture 8 (Ch 2 & 8)
Market Indexes
and
CAPM in Practice
Where we are
Up to now:
optimal diversification
CAPM: (under some specific assumptions)
optimal risky portfolio is the market portfolio
for every asset i:
ri,t rf ,t i rM ,t rf ,t i,t
This lectu

Lecture 3 (Ch 4)
Risk and Return
Outline
Determinants of interest rates
Rates of return for different holding periods
Risk and risk premiums
Estimations of return and risk
Normal distribution
Deviations from normality and risk estimation
Extreme events

Lecture 2 (Ch 2, 3)
Yield Calculation
and Security Market
Trading
Outline
Objectives:
1. To understand how yields on money market
instruments are computed. (Ch 2)
2. To explain the institutional details and
mechanics of investing in securities. (Ch 3)
2
M

CHAPTER6
OPTIMALRISKYPORTFOLIOS
1. (a) for sure.
(b) and (d) are firm-specific.
(c) and (e) can be either firm-specific or due to marketwide factors.
2. (a) and (c) enter into the portfolio variance and thus affect portfolio risk.
3. (a) is true by defini

Lecture 13 (Ch 12)
Bond Prices, Yields, and
Credit Risk
Accrued interest (p.421)
with semi-annual coupons:
Annual Coupon$ Days since last coupon payment
Accrued Interest
2
Days between coupon payments
invoice price = flat price +accrued interest
Example:

Lecture 22
Final Review
Where we are
First half of course:
risk and return, preference and utility
CAPM, SML, CAL, and efficient frontier
behavior finance and market efficiency
Second half of course:
bond pricing, yield curve, duration
equity valuati

Lecture 19
Derivatives Market
and
Options Basics
Where we are
Up to now:
priced equity but equity derivatives?
priced bonds but embedded options?
callable, puttable, convertible
value = (value of simple bond) + (value of options)
face options in real

Lecture 15 (Ch 14)
Bond Duration
And
Portfolio Management
Where we are
Up to now:
Bond Pricing and Yields
Term Structure and Yield Curve
This lecture:
Interest rate risks (i.g. Duration)
Bond Convexity
Portfolio Management
2
Chapter Summary
Objectiv

Lecture 10 (Ch 9)
Market Efficiency
Where we are
Up to now:
risk , return E(r), and
- CAPM, APT
no arbitrage implies =0
Fama-French and other multifactor models
This lecture:
Market Efficiency (Ch 9)
- forms of market efficiency
- evidence on market

Lecture 20 (Ch 19)
Option Pricing
Where we are
Last lecture:
intrinsic value: option value at expiration
put-call parity (from replicating portfolio):
This lecture:
how to find the put or call prices?
using replication strategy on a binomial tree
Bla

Lecture 21
Futures Pricing
Where we are
Up to now:
options
binomial option pricing
black-Scholes model
This lecture:
futures contracts
margins in futures contracts
hedging with futures
pricing futures
2
Futures and Forwards (20.1)
Forward: agreemen

Lecture 11 (Ch 10)
Behavioral Finance
and
Technical Analysis
Where we are
Up to now:
if markets efficient: no arbitrage (=0)
CAPM, Fama-French and APT
(in theory) do passive portfolio management
tests show markets are pretty efficient
This lecture:
h

Notes on
Linear regression :
Ri (t ) i i RM (t ) i ,t
Ri (t ) ri ,t r f ,t
where:
i
Cov(ri , rM )
M2
RM (t ) rM ,t r f ,t
i is the intercept from the regression. If the intercept is
positive, we have positive alpha. If the intercept is negative we
hav

Lecture 17 (Ch 16)
Equity Evaluation
Models
Where we are
Up to now:
Bond pricing, yield, and duration.
Macro and Industry Analysis
This lecture:
Valuing stocks
Dividend discount models in detail
2
Equity basics
Definition of equity:
issued by corpora

Lecture 13 (Ch 12)
Bond Prices, Yields, and
Credit Risk
1
Chapter Summary
Objective: To review the principles of
bond pricing and to examine the
determinants of credit risk.
Bond Characteristics(12.1)
Bond Pricing and YTM
Taxation Issues
Default Risk

Lecture 4 (Ch 5)
Capital Allocation to Risky
Assets
Where we are
up to now:
real vs. nominal return
distribution of returns: mean and variance
risk measures: STD, VaR
what exactly is risk?
this lecture:
risk aversion and utility
indifference curves