1. 1 Paul Redmond Portfolio Management – MGMT4017 Dublin Institute of Technology Semester 2 - Spring 2015 Dr Paul Redmond paul.redmond@dit.ie What will we learn in this course? The theory of combining securities to form optimal portfolios. How to apply this theory by creating and analyzing a portfolio of assets (using MS Excel). Texts 1. “Financial Modeling” by Simon Benninga. 2. “Modern Portfolio Theory and Investment Analysis” by Elton, Gruber, Brown and Goetzmann. 3. “Contemporary Portfolio Theory and Risk Management” by Tucker, Becker, Isimbabi, Ogden.”

2. 2 Paul Redmond Portfolio Management – MGMT4017 Dublin Institute of Technology Semester 2 - Spring 2015 Dr Paul Redmond paul.redmond@dit.ie Assessment Continuous assessment: 40% project 10% journal article review (including a presentation and written review) Final exam 50%

3. 3 Paul Redmond 1. Financial Securities and Financial Markets Money market instruments Short term debt instruments with a maturity of one year or less Sold by governments, financial institutions, companies. Treasury Bills (T-bills) Short term (1 year or less) IOU from US government. Least risky of all money market instruments Closest thing to a “risk free asset”.

4. 4 Paul Redmond Capital Market Securities Securities with maturities greater than one year or no designated maturity at all. Divided into the fixed income market and the equity market. Fixed income securities Treasury notes (1-10 years). Treasury bonds (maturity beyond 10 years) Corporate bonds (senior v subordinated debt)

5. 5 Paul Redmond Capital Market Securities Common stock (equity) Represents an ownership claim on the earnings and assets of a corporation. Riskier than debt When and where did it all start….. Vereenigde Oust Indische Compagnie

6. 6 Paul Redmond Derivative Instruments Security whose value is derived from the value of an underlying security. Also known as contingent claims. Options Forwards Futures

7. 7 Paul Redmond Indirect Investing Investment funds http://www.zurichlife.ie/servlet/EagleStarServletCo ntroller?controller=5star5Holdings&fund=40

8. 8 Paul Redmond Financial Securities As investors we like high return but don’t like high risk. Return and risk for different types of financial securities (1926-2007) Source: Modern Portfolio Theory and Investment Analysis, (Ibbotson and Associates 2008) AssetAverage ReturnStandard Deviation T-bills3.8%3.1% Treasury bonds5.8%9.2% Common Stocks (Large stocks) 12.3%20.0% Small Stocks17.0%32.8%

9. 9 Paul Redmond Trading Mechanics Types of orders Market orders Stop orders Short selling Investors sell securities they don’t own. At a future time the short seller repurchases the shares and replaces them. Reason is that seller expects the share price to decline. Short selling is not a recent innovation.

10. 10 Paul Redmond Trading Mechanics Margin Investors can buy securities with cash and part borrowing. This is called purchasing securities on margin.

11. 11 Paul Redmond Trading Mechanics Margin Example: 100 AT&T shares purchased at $50 per share and partially financed with loan $2000. The margin is 3000/5000 = 60% ASSETSLIABILITIES 100 AT&T shares $5000Loan $2000 Net worth $3000

12. 12 Paul Redmond Trading Mechanics Margin Initial margin Maintenance margin If margin drops below the maintenance margin the brokerage issues a margin call. If the security drops below a price P then a margin call will be issued. Suppose the maintenance margin is 25%.

13. 13 Paul Redmond Trading Mechanics Maintenance margin If the security drops below a price P then a margin call will be issued. Suppose the maintenance margin is 25%. P=26.67

14. 14 Paul Redmond Trading Mechanics Effects of margin on return Purchasing securities utilizing leverage accentuates gains and losses Example A $50 share increases by $5 in one year. The return is 10%

15. 15 Paul Redmond Trading Mechanics Effects of margin on return Example A $50 share increases by $5 in one year. The return is 10% Suppose you purchase the share with 50% margin. The annual interest rate on the borrowing is 3%.

16. 16 Paul Redmond Trading Mechanics Effects of margin on return Example cont’d Suppose instead there is a $5 (10%) decrease in share price.

17. 17 Paul Redmond Trading Mechanics Margin requirements for short sales An investor short sold $10,000 of shares and the initial margin requirement was 50%. The investor has to put up $5000 in cash

18. 18 Paul Redmond Trading Mechanics Margin requirements for short sales An investor short sold $10,000 of shares and the initial margin requirement was 50%. The investor has to put up $5000 in cash AssetsLiabilites Cash from short sale 10000Mkt value of securities sold short 10000 Cash from investor 5000Net worth 5000 15000

19. 19 Paul Redmond Question You want to buy 200 intel shares which cost $40 each. The initial margin requirement is 60%. What is the maximum amount you could borrow to leverage this position?

20. 20 Paul Redmond Question You purchased 100 Intel shares on margin with $2000 cash and $1000 borrowing. Suppose the maintenance margin is 20%. What would the share price have to fall to before the broker issues a margin call?

21. 21 Paul Redmond Question You purchased 1000 AT&T shares for $10 each. This was part financed by borrowing $4000 at an annual interest rate of 5%. One year later your shares are worth $11 each. What is your rate of return?

22. 22 Paul Redmond