FE 445 – Investment Analysis and Portfolio

Management
Fall 2020

Farzad Saidi

Boston University | Questrom School of Business

Admin
Instructor

• Farzad Saidi
• E-mail: fsaidi@bu.edu
• Office: #522F and ZOOMland

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The basics

• We will meet Mondays and Wednesdays

• Prerequisites: FE323 (Financial Management)
• THE textbook: Essentials of Investments by Zvi Bodie, Alex Kane,
and Alan J. Marcus
• 11th , 10th , 9th , or 8th edition is fine
• No need to buy the access card
• Some lectures are not modeled after the book:
study materials = slides

2
Grading

• Midterm + final = 35% + 55% = 90%

• Participation = 10%
• LfA means participation is multidimensional ⇒ e.g., use the chat
function to ask questions!

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What is this course about?

• This course elective provides an introduction to, and elaborates on

some of, the following key topics:
• The investment management process
• Defining investment objectives and constraints
• Modern Portfolio Theory, CAPM, Fama-French factors, APT,
efficient markets, stock and bond valuation models
• Immunizing and managing interest-rate risk
• Active and passive investment strategies, fundamental analysis,
trading practices, and performance evaluation
• The role of futures and options in hedging and speculation
• Understanding the assumptions underlying the different approaches
and their limitations

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How to do well

• Read the slides and the accompanying textbook chapters (see

syllabus) before coming to class
• Think about the material
• Attend lectures – whatever works!
• Ask questions
• Ask more questions
• Review the material after class

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Lecture 1: Introduction and
investment process
What would you do? Buying vs. renting

• You just moved to Cupertino, California. You plan to live in this

area for about 5 years, and your family will give you enough money
for a down-payment on a home
• You found a condo with two bedrooms and two bathrooms
• If you rent it, it costs $3,000 per month
• If you buy it, it costs $1 million
• You are able to pay down 20% of the housing price
• Given your credit score, the 30-year fixed mortgage rate is 3%
• Would you rent it or buy it? What else do you need to consider to
make a decision?

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Investor objectives: individual investors

• Opportunity cost of capital depends on time preferences

• Balance risk and return: test your risk tolerance
• Life cycle is critical in determining risk/return trade-off
• Younger investors: most wealth in human capital ⇒ willing to bear
more risk for higher returns
• Older investors: most wealth in financial capital ⇒ want to plan
retirement: lower risk

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Investing for retirement

Example:
http://personal.vanguard.com/us/funds/vanguard/TargetRetirementList

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Investor constraints

• Liquidity
• Speed and ease of converting asset into cash
• Normally entails sacrifice in return
• Investment horizon
• Planned liquidation date
• Taxes: maximize after-tax returns
• Regulations
• Professional and institutional investors
• Unique needs

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Investor objectives: professional investors

• Personal trusts
• Mutual funds
• Pension funds: two types
1. Defined contribution pension fund:
• Employee and employer contribute a set amount
• Benefit depends on investment performance
• Risk borne by the individual
• Investment earnings are usually not taxed until the funds are
withdrawn, usually after retirement
2. Defined benefit pension fund:
• Retirement benefit depends on years and salary
• Return assumption important
• Risk borne by the company

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Investor objectives

• Non-life insurance companies (e.g., property & casualty insurers)

• Invest premiums to cover policyholders’ claims later
• Explains why we need capital regulation for insurance companies ⇒
safeguard solvency
• Hedge against potential claims
• Need liquidity in case of, for instance, natural disaster
• Life insurance companies
• Banks
• Endowment funds (2019)

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Investor objectives

• Non-life insurance companies (e.g., property & casualty insurers)

• Invest premiums to cover policyholders’ claims later
• Explains why we need capital regulation for insurance companies ⇒
safeguard solvency
• Hedge against potential claims
• Need liquidity in case of, for instance, natural disaster
• Life insurance companies
• Banks
• Endowment funds (2019)

Harvard $39.2bn
Yale $29.4bn
Texas $26.5bn
Stanford $26.5bn
Princeton $25.4bn
MIT $16.4bn
BU $2.19bn

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Investment process

1. Asset allocation: use portfolio theory

• Money market assets ⇒ liquidity needs
• Fixed-income securities (mostly bonds)
• Stocks: value, size, sector, dividend yield
• Real estate
• Commodities
Main determinant of risk-return profile
2. Security selection:
• What exactly to invest in, e.g., stock-picking

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U.S. insurance industry holds $3.6 trillion (2015) of fixed-
income assets

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Investment policy: active vs. passive

• Active
• Try to enhance performance
• Active asset/security allocation
• Must balance with costs
• Trading costs
• Time or paying advisors
• Passive (indexing)
• Trying to get average returns at low cost
• Mix of passive and active

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Active vs. passive investing

Active Funds Are Losing Capital

Figure. Cumulative Fund Flows1

Source: Investment Company Fact Book

I Large fund flows out of active funds and into passive funds (ETFs)

1 Source: Investment Company Fact Book

1 / 30

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Active vs. passive investing
Index Funds – New Kings on Wall Street

As of September 2019, for

the first time in history,
I passive funds
manage more capital

• Since September 2019, there is more passive investing than active

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Summary

This class:

• Asset-allocation decision is the main driver of the risk characteristic

Next class:

• Real vs. financial assets

• Roles of financial markets
• Classes of financial assets and securities
• Money market instruments
• Investment companies, e.g., mutual funds

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