A83010 Applied Financial Modelling

At the end of the course a student will be able

• to perform financial calculations
• and to carry out statistical and empirical procedures

that come in useful in the fields of financial analysis and portfolio management.

In addition, he/she will be

• familiar with the regularities of US financial markets
• and well informed about equity research and value investing.

This course, worth 8 ECTS credits, is about financial analysis and portfolio management. It deals with some validated quantitative models and processes that support decisions on

• the appraisal of companies;
• the management of portfolios according to the requirements in terms of liquidity, diversification, income/growth, risk/return, e.g. a private portfolio, an endowment, or a mutual fund.

Emphasis is placed on data, quantitative models, statistical and empirical estimation procedures that are used or taken into consideration by financial advisors, financial analysts, and portfolio managers, e.g. of mutual or hedge funds. Moreover, attention is devoted to equity research and value investing. As a consequence, students will learn which data to analyse and how to approach an evaluation or management problem, especially in connection with stocks, bonds, and exchange-traded funds. Students will also understand in depth

• how to diversify between asset classes, i.e. how to obtain the greatest possible long-term return from a financial portfolio with a given degree of risk;
• how to rotate groups of stocks within the S&P 500 stock index;
• how to pick mispriced stocks or bonds by relying on fundamental analysis.

All the relevant aspects of a financial problem are taken into account through a problem-oriented and hence multidisciplinary approach. Therefore,

• reference is made to the theoretical principles and practical notions of other related subjects, such as managerial accounting, industrial economics, and applied statistics;
• attention is paid to the empirical evidence on US financial markets, with historical data on their performance being appropriately classified. As investment decisions are assumed to be both rational and emotional, emphasis is placed on the occurrence of speculative bubbles caused by irrational exuberance;
• teaching includes practical sessions, where use is made of an electronic spreadsheet to display the most advanced procedures. Homework may involve the development of an electronic spreadsheet that processes real data.

The main findings of selected empirical studies are consistently reported by means of educated summaries. Different inspiring regularities of US financial markets are taken into consideration, including the relationship between current forward rates and future spot rates, the performance of corporate bonds, heteroskedasticity and mean reversion of stock returns (price-earnings ratios and dividend yields as predictors of long-term returns), the dissimilar behaviour of growth and value stocks, the effects exerted on stock prices by the most unexpected news in quarterly reports, the performance of equity mutual funds and its persistence. Such regularities lay the foundations for active portfolio management by individual and institutional investors alike.

To take this course, students must be familiar with mathematics (basics of calculus and optimisation), statistics (sample statistics and their distributions, hypothesis testing, multiple linear regression) and accounting (reclassified financial statements, main accounting ratios). Knowledge of the financial system (markets and intermediaries as institutions and their functions, financial contracts and their use) is very helpful.

Individual active learning is needed on the basis of 1-2 hours per week, so as to keep up with all lesson and practical sessions (8 ECTS credits, 50 contact hours or so). As personal advice is likely to be needed as well, each student should meet the lecturer at least once during office hours.

Teaching includes practical sessions, which are computer assisted. Class attendance and active involvement are strongly recommended and graded (6% of the best possible score).

After completing both individual and communal homework (21% of the best possible score) during the course, attenders will take a closed-book written exam (73%) at the end of the course. The exam for the remaining students is oral. Whether the final exam is written or oral, a pocket calculator is needed. Attenders can’t register for the exam, unless they have filled in an anonymous questionnaire on the course. Non-attenders may contact their lecturer for advice on how to go about this subject.