LEONARDO DA VINCI

TRANSFER OF INNOVATION

Kristina Leviauskait

Investment Analysis and Portfolio Management

Leonardo da Vinci programme project

Development and Approbation of Applied Courses

Based on the Transfer of Teaching Innovations in
Finance and Management for Further Education
of Entrepreneurs and Specialists in Latvia, Lithuania and Bulgaria

Vytautas Magnus University

Kaunas, Lithuania

2010

Investment Analysis and Portfolio Management

Table of Contents
Introduction ...4
1. Investment environment and investment management process...7
1.1 Investing versus financing7
1.2. Direct versus indirect investment .9
1.3. Investment environment..11
1.3.1. Investment vehicles ..11
1.3.2. Financial markets...19
1.4. Investment management process.23
Summary..26
Key-terms28
Questions and problems...29
References and further readings..30
Relevant websites31
2. Quantitative methods of investment analysis...32
2.1. Investment income and risk.32
2.1.1. Return on investment and expected rate of return...32
2.1.2. Investment risk. Variance and standard deviation...35
2.2. Relationship between risk and return..36
2.2.1. Covariance36
2.2.2. Correlation and Coefficient of determination...40
2.3. Relationship between the returns on stock and market portfolio42
2.3.1. Characteristic line and Beta factor.43
2.3.2. Residual variance...44
Summary...45
Key-terms.48
Questions and problems...48
References and further readings...50
3. Theory for investment portfolio formation...51
3.1. Portfolio theory51
3.1.1. Markowitz portfolio theory...51
3.1.2. The expected rate of return and risk of portfolio..54
3.2. Capital Asset Pricing Model56
3.3. Arbitrage Price Theory59
3.4. Market Efficiency Theory62
Summary...64
Key-terms.66
Questions and problems67
References and further readings...70
4. Investment in stocks.....................................................................71
4.1. Stock as specific investment.....71
4.2. Stock analysis for investment decision making72
4.2.1. E-I-C analysis.73
4.2.2. Fundamental analysis..75
4.3. Decision making of investment in stocks. Stock valuation..77
4.4. Formation of stock portfolios...82
4.5. Strategies for investing in stocks..84
Summary..87
Key-terms90
2

Investment Analysis and Portfolio Management

Questions and problems..90

References and further readings..93
Relevant websites....93
5. Investment in bonds.94
5.1. Identification and classification of bonds94
5.2. Bond analysis: structure and contents..98
5.2.1. Quantitative analysis..98
5.2.2. Qualitative analysis..101
5.2.3. Market interest rates analysis...103
5.3. Decision making for investment in bonds. Bond valuation...106
5.4. Strategies for investing in bonds. Immunization...109
Summary113
Key-terms..116
Questions and problems.117
References and further readings... 118
Relevant websites..119
6. Psychological aspects in investment decision making..120
6.1. Overconfidence..120
6.2. Disposition effect...123
6.3. Perceptions of investment risk...124
6.4. Mental accounting and investing...126
6.5. Emotions and investment decisions...128
Summary....130
Key-terms..132
Questions and problems.132
References and further readings133
7. Using options as investments..135
7.1. Essentials of options..135
7.2. Options pricing..136
7.3. Using options. Profit and loss on options..138
7.4. Portfolio protection with options. Hedging...141
Summary143
Key-tems145
Questions and problems.146
References and further readings147
Relevant websites..147
8. Portfolio management and evaluation...148
8.1. Active versus passive portfolio management148
8.2. Strategic versus tactical asset allocation150
8.3. Monitoring and revision of the portfolio...152
8.4. Portfolio performance measures154
Summary156
Key-terms..158
Questions and problems.158
References and further readings160
Relevant
websites..161
Abbreviations and symbols used.162
Bibliography164
Annexes...165

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