# Spring 2018 Course Announcement – Finance 4366: Options, Futures and Other Derivatives

Here’s the “prospectus” for my Spring 2018  Finance 4335 risk management course; if you click on the image, this will bring up a full-page PDF version.  If you have enjoyed Finance 4366 this semester, I hope you’ll tell your friends about the course and encourage them to enroll in it (and/or contact me if they have any further questions)!

# Synopsis of the Capital Market theory topic that we’ll cover during tomorrow’s Finance 4335 class meeting

The Capital Market Theory lecture note upon which last tomorrow’s Finance 4335 class discussion will be based provides the following important insights:

1. Borrowing and lending at the riskless rate of interest in combination with investing in (mean-variance efficient) risky portfolios makes it possible for investors to obtain superior risk-return trade-offs compared with investing only in mean-variance efficient risky portfolios. In the figure below (taken from page 13 of the Capital Market Theory lecture note), investors select portfolios along the Capital Market Line, which is given by the following equation: $E({r_p}) = {r_f} + \left[ {\displaystyle\frac{{E({r_m}) - {r_f}}}{{{\sigma _m}}}} \right]{\sigma _p}$.In the above figure, $\alpha$ corresponds to the optimal level of exposure to the market index which is labled as point M. When $\alpha = 0$, the investor is fully invested in the riskless asset. When $0 < \alpha < 1$, the investor is partially invested in the riskless asset and in the market index; such portfolios are referred to as “lending” portfolios. When $\alpha = 1$, the investor is fully invested in the market index. Finally, when $\alpha> 1$, the investor funds her investment in the market index with her initial wealth plus borrowed money; such portfolios are referred to as “borrowing” portfolios.
2. Given that investors select (based upon their level of tolerance for risk) portfolios that lie on the Capital Market Line, this behavior has implications for the pricing of risk for individual securities. Specifically, the Capital Market Line implies that for individual securities, the Security Market Line must hold. The equation for the Security Market Line (which is commonly referred to as the Capital Asset Pricing Model, or CAPM) is given by the following equation:$E({r_i}) = {r_f} + \left[ {E({r_m}) - {r_f}} \right]{\beta _i}$,where ${\beta _i} = {\sigma _{i,m}}/\sigma _m^2.$
3. According to the CAPM, the appropriate measure of risk for an individual stock is its beta, which indicates how much systematic risk the stock has compared with an average risk investment such as the market portfolio. Beta for security i (${\beta _i}$) is measured by dividing the covariance between i and the market (${\sigma _{i,m}}$) by market variance ($\sigma _m^2$). If the investor purchases an average risk security, then its beta is 1 and the expected return on such a security is the same as the expected return on the market. On the other hand, if the security is riskier (safer) than an average risk security, then it’s expected return is higher (lower) than the same as the expected return on the market.
4. If the expected return on a security is higher (lower) than the expected return indicated by the CAPM equation, this means that the security is under-priced (over-priced). Investors will recognize this mispricing and bid up (down) the under-priced (over-priced) security until its expected return conforms to the CAPM equation.
5. According to the CAPM, only systematic (i.e., non-diversifiable) risk is priced. Systematic risks are risks which are common to all firms (e.g., return fluctuations caused by macroeconomic factors which affect all risky assets). On the other hand, unsystematic (i.e., diversifiable) risk is not priced since its impact on a diversified asset portfolio is negligible. Diversifiable risks comprise risks that are firm-specific (e.g., the risk that a particular company will lose market share or go bankrupt).

# minimum variance portfolio spreadsheet from today’s class

Linked below, please find the minimum variance portfolio spreadsheet from today’s class. The learning objective is to showcase how differences in correlation give rise to different portfolio weightings for determining the minimum risk combination of two risky assets. The spreadsheet also decomposes portfolio variance into component parts – risk that originates from the variances of the assets which comprise the portfolio, as well as risk that originates from covariance.

4335 mvp.xlsx

# Overview:

Baylor has a student-managed investment fund comprised of large capitalization (large-cap) stocks which is now valued at approximately \$7.5 million.  Students in the class are directly responsible for managing the portfolio, while learning the techniques used by professionals to analyze and select individual stocks. Each student will also learn how to use Bloomberg, FactSet, Thomson Eikon and other resources commonly used in the investment management industry.

# The Class:

Time:              Mondays, 5:00-7:30pm
Location:         Hodges Financial Markets Center
Structure:        Designed after the operational format of a funds management firm and built around student participation.

The course primarily consists of market sector teams preparing and presenting to the class detailed reports on stocks in their sector.  Every class member is involved in the discussion of each stock.  Following the presentation and discussion, the team makes a recommendation on the stocks they presented.  The class votes and the decisions of the class are implemented.

For a better understanding of the course, you are welcome to sit through all or part of a class session this semester!  Just come to the Financial Markets Center before 5:00pm any Monday evening.

# Professors:

• Brandon Troegle, CFA®, is a Managing Director and portfolio manager with Hillcrest, focusing on the firm’s securities selections across various strategies. Before joining Hillcrest, Brandon was an equity analyst at Morningstar. Prior to Morningstar, he worked for Luther King Capital Management and Bank of America.
• Wesley Wright, CFA®, is a Portfolio Manager at Hillcrest Asset Management focusing on the firm’s International Value Strategy. Prior to joining Hillcrest, Wesley was a Portfolio Manager at Dreman Value Management in New York where he managed the firm’s International Value product and U.S. All Cap Value product.

How to Apply:  By 5:00pm, Monday, October 23, submit the following:

1. Cover letter stating why you wish to take the course
2. Unofficial transcript ( Note:  Applicants must have completed an investments course (e.g., FIN 4365 or FIN 5365) or take it concurrently with the Practicum.)
3. Resume

Submit documents to Dr. Bill Reichenstein, Department of Finance, Insurance & Real Estate, FOS 320.36.

Enrollment is limited to 15 graduate and undergraduate students with strong academic records and an interest in investments.  Applicants will be evaluated by a Finance faculty committee chaired by Dr. Bill Reichenstein, Professor of Finance and Chair of the Board of Trustees of the Phil Dorr Investment Fund.