Objectives and Overview

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En provenance du cours de University of Illinois at Urbana-Champaign

Investments I: Fundamentals of Performance Evaluation

281 notes

University of Illinois at Urbana-Champaign

Investments I: Fundamentals of Performance Evaluation

281 notes

Cours 3 sur 7 dans Specialization Financial Management

In this course, we will discuss fundamental principles of trading off risk and return, portfolio optimization, and security pricing. We will study and use risk-return models such as the Capital Asset Pricing Model (CAPM) and multi-factor models to evaluate the performance of various securities and portfolios. Specifically, we will learn how to interpret and estimate regressions that provide us with both a benchmark to use for a security given its risk (determined by its beta), as well as a risk-adjusted measure of the security’s performance (measured by its alpha). Building upon this framework, market efficiency and its implications for patterns in stock returns and the asset-management industry will be discussed. Finally, the course will conclude by connecting investment finance with corporate finance by examining firm valuation techniques such as the use of market multiples and discounted cash flow analysis. The course emphasizes real-world examples and applications in Excel throughout. This course is the first of two on Investments that I am offering online (“Investments II: Lessons and Applications for Investors” is the second course). The over-arching goals of this course are to build an understanding of the fundamentals of investment finance and provide an ability to implement key asset-pricing models and firm-valuation techniques in real-world situations. Specifically, upon successful completion of this course, you will be able to: • Explain the tradeoffs between risk and return • Form a portfolio of securities and calculate the expected return and standard deviation of that portfolio • Understand the real-world implications of the Separation Theorem of investments • Use the Capital Asset Pricing Model (CAPM) and 3-Factor Model to evaluate the performance of an asset (like stocks) through regression analysis • Estimate and interpret the ALPHA (α) and BETA (β) of a security, two statistics commonly reported on financial websites • Describe what is meant by market efficiency and what it implies for patterns in stock returns and for the asset-management industry • Understand market multiples and income approaches to valuing a firm and its stock, as well as the sensitivity of each approach to assumptions made • Conduct specific examples of a market multiples valuation and a discounted cash flow valuation This course was previously entitled “Financial Evaluation and Strategy: Investments” and was part of a previous specialization entitled "Improving Business and Finances Operations", which is now closed to new learner enrollment. “Financial Evaluation and Strategy: Investments” received an average rating of 4.8 out of 5 based on 199 reviews over the period August 2015 through August 2016. You can view a detailed summary of the ratings and reviews for this course in the Course Overview section. This course is part of the iMBA offered by the University of Illinois, a flexible, fully-accredited online MBA at an incredibly competitive price. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

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Module 2: Motivating, Explaining, & Implementing the Capital Asset Pricing Model (CAPM)

In Module 2, we will develop the financial intuition that led to the Capital Asset Pricing Model (CAPM), starting with the Separation Theorem of Investments. We will understand that in a CAPM setting, only the market-wide risk of an asset is priced – securities with greater sensitivity to the market are required by investors to yield higher returns on average. We will also learn how to interpret regressions that provide us with both a benchmark to use for a security given its risk (determined by its beta), as well as a risk-adjusted measure of the security’s performance (measured by its alpha).

Objectives and Overview9:09

Rencontrer les enseignants

Scott Weisbenner
William G. Karnes Professor of Finance
Department of Finance, College of Business

[ Music ]

>> Hi. I'm Professor Scott Weisbenner at the University

of Illinois and this is module two of my course on investments.

So I thought I'd start out this module with a question for you.

So just take a step back and think, what location pops

up when you think of the cradle of western civilization?

The University of Illinois of course.

Alright, sorry for the plug, I'm mandated to say it.

Think back far, 2500 years farther in fact to Greece,

Greek civilization, and when we think of Greece

of course we think of the Parthenon in Athens, Socrates,

Plato, Aristotle, the Greek alphabet,

and within the Greek alphabet the two most important letters

were put in the most prominent position;

the first two slots, alpha and beta.

Fast forward 2500 years to the world of finance today,

alpha and beta still are very prominent.

Okay? You don't trust me?

Fine, just look here in the world of academics.

Everyone is trying to generate alpha or at least write

about people who are trying to generate alpha.

Mutual fund performance, an inventive to generate alpha.

Do hedge funds deliver alpha?

Alpha's front and center on financial screens,

so here this is taken from Morningstar.com, we're looking

at the Fidelity Magellan Fund, we're looking

at a regression analysis here with things like r squared beta,

alpha here, alpha -2.4, Fidelity Magellan Fund underperforming

its benchmark by -2.4% per year or the last 10 years.

Don't worry.

At the end of module two you'll be all on top of this.

Beta's front and center.

This was taken on the first screen of Finance.Yahoo

when you type in the Tesla Motor stock tickers.

Tesla's beta, 1.44, you can see this is a stock price

as of May 2015.

Whenever you look at this I don't know

if the price will be up or down.

Alright? Panera Bread, beta here much lower, 0.3.

Why the difference?

Panera way below one, Tesla greater than one

when it comes to beta.

Why is beta so provocative?

Are the reports of beta's death premature?

Is beta dead again?

If beta's dead where is the corpse?

Very mysterious.

And what? There's this thing called smart beta?

We're going to address all these topics

about the Capital Asset Pricing Model, developing it,

interpreting it and then implementing it in examples

in Excel to evaluate the performance

of various securities.

All of this is happening in module two.

We already got the objectives and overview done

by a trip back to Greece.

I'm sorry, I have to admit after being a finance professor,

I always wanted to be deep voice guy on a commercial

and I got my opportunity to kind of check that on the to do list.

Second topic, Separation Theorem of Investments.

So this you can view as like the John Vogel

of Vanguard view of the world.

The Separation Theorem of Investments very elegant says

that as an investor all you have to worry

about is breaking your portfolio between two funds;

a risk free asset fund like Treasury bills

and the market portfolio.

If you love risk you'll invest a lot in the market, if you don't

like risk you'll invest most in Treasury bills

but all investors are holding some combination

of the market portfolio and the risk free asset.

Examples of reducing portfolio risk,

how can you reduce a portfolio of adding,

can you reduce a portfolio by adding more assets to it?

And a key determination of whether the answer is yes

or no will be how correlated are these assets with each other

and we'll kind of go through a fun example

with a gambling trip to [inaudible].

And then finally we're getting to the development

of the Capital Asset Pricing Model, CAPM.

Dates back to the 1960's, still a gold standard at least

of an introduction to asset pricing models

and an introduction to more sophisticated asset

pricing models.

You really start with the CAPM

and for my money it still has the best economic intuition

behind it.

Maybe that's why a lot of Nobel Prizes in economics were awarded

for people's work developing the Capital Asset Pricing Model

in the 1960's.

In section 2-5 we're going to do applications

of the Capital Asset Pricing Model.

Let's look at the stock returns at Coca Cola.

Do a Capital Asset Pricing Model analysis of those returns

to determine what should investors have

as a benchmark return for Coca Cola.

How much is Coca Cola surpassed or fell short

of the benchmark established by the Capital Asset Pricing Model?

Evaluation of the famous small value stock investment strategy

over the last 88 years, 1927 to 2014.

So we're looking at a group of stocks representing firms

that are small in size, small market value of equity

but also have a high book to market ratio

like a small cement company.

How do we view that investment strategy

in a Capital Assets Pricing Model view of the world,

and then we'll introduce this Three Factor Model

as another way to evaluate the return's

and the performance's strategies.

And to build up on that we'll have our assignment

within this module, assignment three.

This is a mystery.

You have to put your detective cap on for this one.

I will give you three securities,

I'll give you their returns over the last 20 years, so 240 months

of returns, by doing a Capital Asset Pricing Model regression

analysis, by doing a Three Factor Model analysis you're

going to be able to tell at least the investment style,

the characteristics of this security and then maybe

by looking at its performance,

looking at the characteristics you can actually identify what

the mystery security is.

And as always I'll follow the assignment up with a discussion,

and then finally cap things off so we can look back,

see what we've accomplished, review in section 2-8.

For those of you who are taking this course for high engagement,

who are taking the course to get University of Illinois credit,

as always we have supplemental materials for you

in this module, further practice

with the Capital Asset Pricing Model and the Three Factor Model

by evaluating the performance even more mystery security.

So once you're done with this you're going to be very adept

at interpreting what's alpha, what's beta,

what are the various betas in the Three Factor Model represent

and how can we use them

to identify the securities, evaluate performance.

Practical knowledge and experiences

that you'll take away from module two,

understanding the Separation Theorem of Investment

and why people like John Vogel at Vanguard say this is really,

you know, kind of all you need to know, just keep life simple,

allocate assets across a couple funds, a risk free fund,

a stock market fund, let your risk aversion decide the

asset allocation.

Don't worry about trying to find the, you know, kind of needle

in the haystack of active management,

just do an allocation based on your risk aversion

between Treasury bills, risk free asset

and the stock market, the risky asset.

We'll get an in depth knowledge

of the Capital Asset Pricing Model,

what does alpha represent, what does beta represent?

They were the first two letters

in the Greek alphabet for a reason.

They're the first two letters in finance for a reason.

We'll be very adept at understanding what they mean

at the end of this module.

And then finally practice estimating

and analyzing regressions with real world data

and interpreting what the various regression coefficients

mean and imply about the security

or asset that we're analyzing.

[ Silence ]

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