UNIVERSITY OF SOUTHERN CALIFORNIAMARSHALL SCHOOL OF BUSINESS

FALL 2007

FBE 555: Investment Analysis and Portfolio ManagementDay-time MBA: TTh3:30p.m. - 4:50 p.m. Room JKP 210 (Section 15429R)PM-MBA section: Th 6:30p.m. - 9:30 p.m. Room JKP 212 (Section 15431R)

Contact InformationInstructor: Joe ChenOffice: HOH 412Office Hours: Thursdays, 1:30pm-3:00pm (or by appointment)e-mail: joe.chen@marshall.usc.edu Course website: on Blackboard (http://blackboard.usc.edu)

Course ObjectivesThe objective of the course is to study theory and empirical evidence relevant for portfolio management.An emphasis is placed on understanding how an investment professional would allocate funds in anhypothetical portfolio. Major topics include estimation of capital market parameters, trade-off between riskand return, optimal portfolio selection, equilibrium asset pricing models, and delegated portfoliomanagement. Emphasis will be put on development of techniques that should be part of the tool kit ofthose interested in becoming professional investors and/or researchers in finance. The course material istilted heavily towards equity markets since there are separate courses that cover fixed income markets andderivative securities. This course is designed to primarily address the needs of advanced students in anMBA program.

Prerequisites I will assume at least a good understanding of basic notions in finance: the time-value of money;

return, risk and portfolio diversification; net present value etc. These are materials covered basicCorporate Finance, GSBA 521 (a prerequisite course). I will discuss some of these topics in class, butI expect you to refresh your memory on them at the very beginning of the semester. Spending time inclass to review topics that are covered by more basic courses would be inefficient and, most important,would take time away from new and more exciting topics. I assume that you are in this class to learnnew material and get ready for the job market and I will teach the course accordingly.

Uncertainty is what makes the study of financial markets fascinating. If there were no uncertainty there

would be very few job opportunities on Wall Street! Unfortunately, uncertainty also makes our taskmore difficult. The good news is that you will finally understand why you had to study statistics. Noserious study of portfolio and risk management can be undertaken without a basic knowledge ofstatistics. You should have covered these materials in GSBA 524 . For this reason, I expect you tomake a serious effort to refresh your memory on some essential concepts such as descriptive statistics,inference techniques and basic regression analysis. Any introductory book in statistics should help youto get up to speed.

A mathematical approach is necessary to avoid superficiality for many of the topics covered by this

course. We will assume a good knowledge of basic algebra and calculus. I am not a fan oftechnicalities per se; however, I hope that by the end of the semester you will appreciate how the useof technical tools is important to make this a useful course.

I will assign problem sets that require the use of Microsoft Excel. If you are planning to work in thearea of investment management, it is essential that you develop your computer skills. I will assumethat you know how to use spreadsheets to perform some basic analysis.

Grading Criteria, Exams, Assignments and Course Policy

Grading CriteriaThe course grade is based on the following criteria:

1st Exam: October 4 (Thusday) 25%2nd Exam: November 15 (Thursday) 25%Course Project: due December 6 25%Assignments: 15%Participation: 10%

Course Groups Teamwork is a critical skill to be developed in investment management. Each class participants are to

form into groups of 4-6 students. If you have problems creating groups or finding enough members,one will be assigned for you.

Name your group with business name appropriate for an investment company. Eg. Marshall Invt Co.

All assignments and projects must be done in groups, with no exceptions.

Assignments, Exams, Course Policy, and Office Hours Assignments: I will assign homework problems on a regular basis, which are to be done in groups.

There will be a total of 6 assignments. Submit one write-up for the entire group, being careful tonote all the names of group members and the section number. Hard copies are preferred, butproperly formatted electronic copies in PDF may also be submitted via the course website. Anydocuments submitted electronically must be properly formatted for printing supporting documentsmaybe provided as separate non-printing pages. Unformatted MS Words or MS Excel files will not beaccepted. Late assignments are NOT acceptable.

Exams: The exams are closed book and closed notes . They are intended to take 1hour and 20minutes.You are not allowed to use any notes. We will allow the use of non-programmable calculators duringthe exams. There will be no additional class meetings during the weeks exams are given. There is nofinal exam for this course.

Makeup Exams: There will be no makeup exams. Any missed exam or assignment not turned in will

receive a credit of zero and included in the computation of the final grade. By registering for this classyou are committing, among other things, to take the exams on the scheduled dates.

Course Project: There will be one major project dealing with asset allocation. We will be workingon this project throughout the term, with sections due intermittently. We will apply the portfoliochoice and diversification theory from class to some actual real-life scenarios. Extensive use will bemade of Excel (or any other mathematical package). The project must be done in your groups. A finalversion of the project write-up must be submitted on December 6.

Furthermore, the project will involve presentation components. Each group must prepare an 8 to 10minute Powerpoint presentation for December 6. Each group must also prepare one additional 5minute Powerpoint presentation on a portion of the project due as the course progresses (in weeks 5,11 or 13). You may sign up for presentation slots as soon as groups are formed.

Return of Graded Paperwork: Returned paperwork, unclaimed by a student, will be discarded after 4weeks and, hence, will not be available should a grade appeal be pursued by a student following thereceipt of his/her course grade.

Additional Course Materials: Homework assignments, solutions, additional readings, and all otheradditional course materials will be posted on the course web page. You are responsible for timelydownloads of the materials from the course web page. We will also provide copies of my lecturenotes on the course web page. We can only guarantee that the lecture notes will be available after thelecture, but We will try to make the notes available by the evening before the lecture.

Office Hours: If you have any questions about the material covered in class please do not hesitate to

see me. Please send me an e-mail to schedule an appointment (but please do not ask for anappointment for a time within 24 hours). Dropping without an appointment outside of office hours ishighly discouraged (except in emergencies). If you have problems keeping up with the material, donot wait hoping that things will get better. They will probably get much worse. Remember that thereason why you enrolled in this course is to learn some finance, not to survive through the course.

Research Travel: Marshall School of Business is a world-renowned research institution. Theadvantage of studying under our faculty is that you will be exposed to up-to-date leading research infinance (materials not found in any textbook). The disadvantage is that the faculty is sometimesrequired to share the ideas developed here with other research institutions and will periodically beunavailable.

Calculators and Computers: The nature of the subject matter requires significant amount ofnumerical computations. Students are expected to bring a calculator to every class session and to allexaminations. Moreover, use of laptop computers in the classroom is highly encouraged.

Tent Cards: Classroom participation and interaction is an integral part of the learning experience. Tofacilitate this, students are expected to bring a tent card to every class session and place it visibly.

Disability: Any student requesting academic accommodations based on a disability is required toregister with Disability Services and Programs (DSP) each semester. A letter of verification forapproved accommodations can be obtained from DSP. Please be sure the letter is delivered to me asearly in the semester as possible. DSP is located in STU 301 and is open 8:30 a.m. - 5:00 p.m.Monday through Friday. The phone number for DSP is (213) 740-0776

Academic Dishonesty: We will strictly enforce the university rules on academic integrity: The use of unauthorized material, communication with fellow students during anexamination, attempting to benefit from the work of another student, and similar behaviorthat defeats the intent of an examination, or other class work is unacceptable to theUniversity. It is often difficult to distinguish between a culpable act and inadvertent behaviorresulting from the nervous tensions accompanying examinations. Where a clear violation hasoccurred, however, the instructor may disqualify the student's work as unacceptable andassign a failing mark on the paper. (SCampus)

For more detailed information, see the University Student Conduct Code in SCampus.

Textbooks and Additional Readings

Textbooks Required:

Managing Investment Portfolios, 3rd Edition (referred to as Mgmt Book hereafter)Authors: John L Maginn, Donald L Tuttle, Jerald E Pinto and Dennis W McLeaveyPublisher: Wiley (ISBN: 978-0-470-08014-6)

Quantitative Investment Analysis, 2nd Edition (referred to as Quant Book hereafter)Authors: Richard A DeFusco, D.W. McLeavey, J.E. Pinto, David E Runkle, and Mark JP AnsonPublisher: Wiley (ISBN: 978-0-470-05220-4)

Additional Readings Required:

A course reader with copies of HBS cases will be assigned.Additional required readings may be assigned and provided electronically.

Highly Recommended:1. Daily reading of the Wall Street Journal or the Financial Times.2. Weekly reading of the Economist.

Recommended:Articles from: Journal of Portfolio Management and Financial Analysts Journal.

Tentative Course Outline and Assigned ReadingsThis is a tentative course outline and assigned readings: topics and assigned readings are subject tochange.

1. Overview of Capital Markets and Portfolio ManagementWe classify the main types of financial markets, and introduce the basic securities traded on them. We thendiscuss the different exchanges in which securities are traded, the typical positions taken and the costsassociated with trading. We discuss some of the practical aspects of investment decision-making andintroduce the process of portfolio management. We also study the industry of active portfoliomanagement, such as mutual funds, pension funds and hedge funds. This section summarizes the basicinstitutional details we need to know when discussing the main themes of the investment process forequities.

Read: Mgmt Book, Chapters 1 and 2 (Optional: Mgmt Book, Chapter 3)

2. Quantitative Review, Historical Return Analysis and Portfolio MathematicsWe review some basic concepts of statistics and probability theory: namely, means, standard deviations,variances, covariances and correlations. We discuss estimating these statistical moments using historicalsamples, as well as running and interpreting regression analysis. We also consider how to mathematicallyrepresent returns and portfolio holdings as to account for cash deposits and loans, margin accounts andshort-selling.

Read: Mgmt Book, Chapter 4.1-4.3, Quant Book, Chapters 4.1-4.3Review: Quant Book, Chapters 3, 5.3, 6, 7.1-7.3

3. Optimal Portfolio Diversification and Portfolio ChoiceWe first introduce the notions of risk and portfolio diversification and discuss how to compute importantdescriptive statistics for portfolios of assets. We use Markowitzs approach to portfolio formation to showhow investors can take advantage of the correlation structure among assets to generate an investmentopportunity set that dominates (in a reward-to-risk sense) any of the individual assets taken in isolation.We show how to construct the best set of attainable portfolios and provide precise measures for the benefitsof portfolio diversification. We also discuss how different attitudes towards risk affect the composition ofthe portfolio held by each investor.

Read: Mgmt Book, Chapter 5, Quant Book, Chapters 11.1-11.3

4. Equilibrium Asset Pricing Models: CAPM and APTWe assume that the investors are rational and, therefore, optimize their portfolio holdings according to theirpreferences, subject to their budget (and possibly some institutional) constraints. Using this approach wederive the Capital Asset Pricing Model (CAPM) and discuss its implications for asset pricing andinvestment-decision making. We then assume that assets returns are generated by a finite number of factorsand all arbitrage opportunities are exploited, which lead to the Arbitrage Pricing Theory (APT).

Read: Quant Book, Chapters 11.4Review: Quant Book, Chapters 8 and 9

5. Empirical Validation of Asset Pricing Models and Market EfficiencyWe discuss some of the main tests carried out to investigate the empirical merits of the asset pricingmodels discussed so far. We then go on to approach the problem of market efficiency: we discuss thedifferent levels of efficiency (weak, semi-strong and strong) and analyze the basic empirical evidence thatsupports, or rejects, this notion. Anomalies to the asset pricing models and revised models are analyzed.Alternative approaches to managing assets are discussed in relation to market efficiency.

Read: Additional materials to be distributed

6. Portfolio Management Performance EvaluationWe discuss how to evaluate past performance of portfolio management by investment advisors in thecontext of the asset pricing models. Specific topics include measures of past performance, survivorshipbias, benchmarks and style drifts.

Read: Mgmt Book, Chapter 7 and 12

7. Additional TopicsIf time allows, additional topics relating to portfolio management will be covered. Some potential topicsmay include but not limited to CFA program, organization of mutual fund industry, internationalinvesting, fixed-income securities, derivative securities, tax-efficient portfolio management and behavioralfinance.

Tentative Course Schedule

(Due dates for student deliverables are in bold, at the beginning of the lecture for the week)

Week 1 (August 28/30) Lectures 1 and 2

Week 2 (September 4/6) Lectures 1 and 2Homework assignment #1 due

Week 3 (September 11/13) Lecture 3, part 1Homework assignment #2 due

Week 4 (September 18/20) Lecture 3, part 2Homework assignment #3 due

Week 5 (September 25/27) Course project presentation #1, feedback and discussionQ&A session in preparation for Midterm #1Project component part 1 dueFirst set of groups present course project presentation #1

Week 6 (October 4) No meeting on Tuesday October 2Midterm exam #1

Week 7 (October 9/11) Discussion of midterm exam #1Lecture 4

Week 8 (October 16/18) Lecture 5Homework assignment #4 due

Week 9 (October 23/25) Lecture 6Homework assignment #5 due

Week 10 (October 30/November 1) Lecture 7 (subject to change)Homework assignment #6 due

Week 11 (November 6/8) Course project presentation #2, feedback and discussion.Q&A session in preparation for Midterm #2Project component part 2 dueSecond set of groups present course project presentation #2

Week 12 (November 15) No meeting on Tuesday November 13Midterm exam #2

Thanksgiving week No meeting on Tuesday November 20, Thursday November 22

Week 13 (November 27/29) Discussion of midterm exam #2Course project presentation #3Feedback and discussion of course project presentation #3Q&A session for preparing final projectProject component part 3 dueLast set of groups present course project presentation #3

Week 14 (December 6) Final project write-up dueFinal project presentation