Applied Fundamentals in Finance: Portfolio Management and Investments

Preface
About this Book
Contents
About the Author
List of Abbreviations
Part I: Portfolio Management
1: Return
1.1 Introduction
1.2 Simple (Discrete) Investment Return
1.3 Continuous Compounded Investment Return
1.4 Investment Return Over Several Periods
1.5 Arithmetic Mean Return
1.6 Geometric Mean Return
1.7 Money-Weighted Return
Example: Calculation of the Money-Weighted Return for the Stock of Zalando
1.8 Real Rate of Return
Example: Calculation of the Real Return After Taxes
1.9 Expected Return
1.10 Summary
1.11 Problems
1.12 Solutions
Microsoft Excel Applications
2: Risk
2.1 Introduction
2.2 Variance and Standard Deviation
Example: Calculation of the Volatility of the Mercedes-Benz Group Stock Based on Monthly Returns for 2016
2.3 Average Return and Standard Deviation
2.4 Downside Risk
Example: Calculation of the Semi-Standard Deviation of the Mercedes-Benz Group Stock Using Monthly Returns for 2016
2.5 Value at Risk
Example: Calculation of VAR
2.6 Summary
2.7 Problems
2.8 Solutions
Appendix: Standard Normal Distribution Table
Cumulative Probabilities for a Standard Normal Distribution
Cumulative Probabilities for a Standard Normal Distribution
Microsoft Excel Applications
3: Other Investment Characteristics
3.1 Introduction
3.2 Properties of a Distribution
3.2.1 Normal Distribution
3.2.2 Skewness
3.2.3 Kurtosis
Example: Calculation of the Expected Return, Standard Deviation, Skewness, and Excess Kurtosis of a Return Distribution
3.2.4 Lognormal Distribution
3.3 Market Characteristics
3.3.1 Information Efficiency of Financial Markets
3.3.2 The Random Walk
Example: Calculation of the Standard Deviation Over Several Time Periods with Different Autocorrelation
3.3.3 Behavioural Finance and Market Efficiency
3.3.4 Market Liquidity and Trading Costs
Example: Bid-Ask Spread
3.4 Summary
3.5 Problems
3.6 Solutions
Microsoft Excel Applications
References
4: Efficient Risky Portfolios
4.1 Introduction
4.2 Expected Return and Risk of a Two-Asset Portfolio
Example: Calculation of Expected Return and Risk of an Asset Using Prospective Scenario Analysis
Example: Calculation of Covariance with Prospective Scenario Analysis
Example: Expected Return of a Two-Asset Portfolio with a Risk of Zero
4.3 The Efficient Frontier
4.4 Expected Return and Risk of a Portfolio Consisting of Many Risky Assets
4.5 Diversification Effect
Example: Diversification Effect
4.6 Summary
4.7 Problems
4.8 Solutions
Microsoft Excel Applications
References
5: Optimal Portfolio
5.1 Introduction
5.2 Risk Aversion
5.2.1 Concept of Risk Aversion
5.2.2 Utility Theory and Indifference Curves
Example: Calculation of Utility
Example: Calculation of the Utility for Different Investments
5.3 The Optimal Risky Portfolio
5.4 The Risk-Free Investment: Capital Allocation Line Model
Example: Tangent Portfolio with Two Risky Assets
Example: Expected Return and Risk of a Portfolio on the Most Efficient Capital Allocation Line
Example: Calculation of Capital Allocation
Example: Adding an Asset Class to an Existing Portfolio
5.5 Homogeneous Expectations: Capital Market Line Model
Example: Calculation of Capital Allocation, Expected Return, and Risk in the Capital Market Line Model
5.6 Summary
5.7 Problems
5.8 Solutions
Microsoft Excel Applications
References
6: Capital Asset Pricing Model and Fama-French Model
6.1 Introduction
6.2 Capital Asset Pricing Model
6.2.1 Basics of the Model
6.2.2 Calculation and Interpretation of the Beta
Example: Calculation of Beta
6.2.3 The Security Market Line
Example: Calculation of Expected Return with the CAPM
Example: Expected Return and Beta of a Portfolio
6.2.4 Equilibrium Model
Example: Determining Overvalued and Undervalued Equity Securities with the CAPM
6.2.5 Applications of the CAPM in Corporate Finance
Example: Calculation of the Cost of Equity for Mercedes-Benz Group
Example: Calculation of the Weighted Average Cost of Capital for Mercedes-Benz Group
6.3 Fama-French Model
6.3.1 The Risk Premiums for Size and Value
6.3.2 Expected Rate of Return
Example: Expected Return Based on the CAPM and the FFM Using the Stock of Adidas AG
6.4 Summary
6.5 Problems
6.6 Solutions
Microsoft Excel Applications
References
Online Sources
7: Portfolio Management Process
7.1 Introduction
7.2 Planning
7.2.1 Investment Objectives and Constraints
7.2.1.1 Risk Objectives
Example: Determining Risk Tolerance
7.2.1.2 Return Objectives
7.2.1.3 Constraints
Example: Investment Policy Statement
7.2.2 Investment Policy Statement
7.2.3 Capital Market Expectations
7.2.4 Strategic Asset Allocation
7.3 Execution
7.4 Feedback
7.4.1 Monitoring the Investment Policy Statement
7.4.2 Monitoring Capital Market Expectations
7.4.3 Rebalancing the Portfolio
7.4.4 Performance Evaluation
Example: Sharpe Ratio and Information Ratio
7.5 Performance Attribution of an Active Portfolio
Example: Performance Attribution
7.6 Summary
7.7 Problems
7.8 Solutions
References
Part II: Equity Securities
8: Dividend Discount Model
8.1 Introduction
8.2 Fundamentals of Equity Valuation
Example: Calculation of the Intrinsic Share Value in the Event of a Company Liquidation in Four Years
8.3 Growth Rate
Example: Calculation of the Fundamental Growth Rate for the Stock of Mercedes-Benz Group AG
8.4 One-Stage Dividend Discount Model
Example: Valuation of the Linde Stock with the One-Stage Dividend Discount Model
8.5 Two-Stage Dividend Discount Model
Example: Valuation of the Mercedes-Benz Group Stock with the Two-Stage Dividend Discount Model
8.6 Summary
8.7 Problems
8.8 Solutions
References
9: Free Cash Flow Models
9.1 Introduction
9.2 Free Cash Flow to Equity Model
9.2.1 Overview
9.2.2 Definition and Calculation of the FCFE
9.2.3 Growth Rate of the FCFE
Example: Calculation of the Fundamental Free Cash Flow to Equity Growth Rate
9.2.4 One-Stage FCFE Model
Example: Calculation of the Intrinsic Share Value Using the One-Stage FCFE Model
9.2.5 Two-Stage FCFE Model
Example: Valuation of the Mercedes-Benz Group Stock with the Two-Stage FCFE Model
9.3 Free Cash Flow to Firm Model
9.3.1 Definition and Calculation of Free Cash Flow to Firm
9.3.2 Growth Rate of the FCFF
9.3.3 One-Stage FCFF Model
Example: Calculation of the Intrinsic Share Value With the One-Stage FCFF Model
9.3.4 Comparison Between FCFE and FCFF Models
9.4 Adjusted Present Value Model
Example: Calculation of Enterprise Value Using the APV Model for a Debt-Financed Acquisition
9.5 Summary
9.6 Problems
9.7 Solutions
References
10: Multiples
10.1 Introduction
10.2 Price-to-Earnings Ratio
10.2.1 Definition
Example: Comparables Method
10.2.2 P/E Ratio Based on Forecast Fundamentals
Example: Calculation of the Justified Trailing P/E Ratio and of the Intrinsic Share Value Using the Deutsche Telekom Stock
10.2.3 P/E Ratio Based on Comparable Companies
Example: Relative Valuation Analysis of the Mercedes-Benz Group Stock Based on the Comparables Method Using the Price-to-Earni...
10.3 Price/Earnings-to-Growth Ratio
Example: Relative Valuation Analysis of the Mercedes-Benz Group Stock Based on the Comparables Method Using the Price/Earnings...
Example: Calculation of the Justified Price/Earnings-to-Growth Ratio Using the Deutsche Telekom AG Stock
10.4 Price-to-Book Ratio
10.4.1 Definition
10.4.2 P/B Ratio Based on Forecast Fundamentals
Example: Calculation of the Justified Price-to-Book Ratio Using the Deutsche Telekom AG Stock
10.4.3 P/B Ratio Based on Comparable Companies
Example: Relative Valuation Analysis of the Mercedes-Benz Group Stock Based on the Comparables Method Using the Price-to-Book ...
10.5 Enterprise Value EBITDA Ratio
Example: Calculation of the Enterprise Value EBITDA Ratio
10.6 Summary
10.7 Problems
10.8 Solutions
References
Online Sources
Part III: Bonds
11: Bond Price and Yield
11.1 Introduction
11.2 Basic Features of a Bond
11.3 Different Types of Bonds
11.4 Pricing of Fixed-Rate Bonds
11.4.1 Pricing Fixed-Rate Bonds with a Fixed Risk-Adjusted Discount Rate
Example: Pricing of the Mercedes-Benz Group AG 2% 2019/2031 Bond on a Coupon Date
Example: Pricing of the Mercedes-Benz Group AG 2% 2019/2031 Bond between Two Coupon Dates
11.4.2 Pricing Fixed-Rate Bonds with Risk-Adjusted Discount Rates That Correspond to the Timing of the Cash Flows
Example: Pricing of the Mercedes-Benz Group AG 2% 2019/2031 Bond between Two Coupon Dates with Risk-Adjusted Discount Rates th...
11.4.3 Pricing of Zero-Coupon Bonds
Example: Pricing of the Mercedes-Benz Group AG 0% 2019/2024 Bond
11.5 Pricing of Floating-Rate Notes
Example: Pricing of the Mercedes-Benz Group AG 2016/2019 Floating-Rate Note
11.6 Yield Measures for Fixed-Rate Bonds
Example: Calculation of the Current Yield, the Yield to Maturity, and the Total Return of the Mercedes-Benz Group AG 2% 2019/2...
11.7 Summary
11.8 Problems
11.9 Solutions
Microsoft Excel Applications
References
Online Sources
12: Duration and Convexity
12.1 Introduction
12.2 Analysis of the Risk Factors
12.2.1 Overview
12.2.2 Interest Rate Risk
12.2.3 Credit Risk
12.2.4 Market Liquidity Risk
12.3 Duration-Convexity Approach
Example: Calculation of the Price Change of an Option-Free Fixed-Rate Bond Using the Taylor Series Expansion with a Second-Ord...
12.4 Duration
12.4.1 Modified Duration and Macaulay Duration
Example: Calculation of the Macaulay Duration and the Modified Duration Using the Mercedes-Benz Group AG 2% 2019/2031 Bond
12.4.2 Factors Affecting Duration and Price Volatility
Example: Assessing the Price Volatility of Option-Free Bonds
12.5 Convexity
Example: Calculation of the Modified Convexity and Approximate Price Change with the Duration-Convexity Approach for the Merce...
12.6 Applications
12.7 Summary
12.8 Problems
12.9 Solutions
Microsoft Excel Applications
References
Online Sources
Part IV: Derivatives
13: Futures, Forwards, and Swaps
13.1 Introduction
13.2 Use of Derivatives
13.3 Futures and Forwards
13.3.1 Futures Versus Forwards
13.3.2 Profit and Loss
13.3.3 Leverage Effect
13.3.4 Pricing
Example: Pricing of a West Texas Intermediate Oil Futures Contract
Example: Pricing of a DAX Forward and an SMI Forward
13.3.5 Valuation
13.3.6 Hedging
13.4 Swaps
13.5 Summary
13.6 Problems
13.7 Solutions
References
14: Options: Basics and Valuation
14.1 Introduction
14.2 Basic Characteristics
14.3 Profit and Loss
14.3.1 Call Option
Example: Profit/Loss Calculation of a Call Option
14.3.2 Put Option
Example: Profit/Loss Calculation of a Put Option
14.4 Intrinsic Value and Time Value
14.5 Binomial Option Pricing Model
14.6 Black-Scholes Option Pricing Model
Example: Calculation of the Call and Put Price with the Black-Scholes Model
14.7 Put-Call Parity
14.8 Leverage Effect
14.9 Option Price Sensitivities
14.9.1 Delta
14.9.2 Gamma
Example: Delta and Gamma
14.9.3 Vega
14.9.4 Rho
14.9.5 Theta
14.10 Summary
14.11 Problems
14.12 Solutions
Microsoft Excel Applications
References
Online Sources
15: Option Strategies
15.1 Introduction
15.2 Synthetic Equity
15.3 Synthetic Call and Put Option
15.4 Covered Call
15.4.1 Profit and Loss
Example: Covered Call Strategy
15.4.2 Objectives
15.5 Protective Put
Example: Protective Put Strategy
15.6 Collar
Example: Collar Strategy
15.7 Bull and Bear Spreads
15.7.1 Bull Spread
Example: Bull Call Spread Strategy
15.7.2 Bear Spread
Example: Bear Put Spread Strategy
15.7.3 Spread Strategy with Volatile Share Prices
15.8 Straddle
15.8.1 Long Straddle
15.8.2 Short Straddle
Example: Straddle Strategy
15.8.3 Breakeven Share Price and Volatility
15.9 Effects of Exercising Options on the Strategy
15.10 Selection of the Option Strategy
15.11 Summary
15.12 Problems
15.13 Solutions
References
Online Sources
Index