COMM 371 - Investment Theory

The starting point of asset valuation is the present-value formula, and will be covered first. We will then proceed to fixed-income securities, focusing mainly on government bonds and emphasizing the relation between valuation and no-arbitrage. Next, we will move to stocks, starting with basic notions of risk, return, and diversification. We will formalize the trade-off between risk and return in the context of portfolio theory. We will then examine how risk is priced in equilibrium, via the Capital Asset Pricing Model (CAPM) and multi-factor models. While covering asset pricing models, we will also examine the models' implications for stock valuation, security selection, and performance evaluation. We will also ask whether the market values stocks efficiently, or whether there are “abnormal” returns leading to large profits. Finally, we will cover derivatives, especially futures and options. After an overview of the derivatives’ main uses, we will cover valuation methods, such as the binomial and the Black-Scholes model, emphasizing again the relation between valuation and no-arbitrage.

Learning objectives

While the main goal of the course is to familiarize students with the fundamental theoretical concepts, we will also emphasize the concepts’ practical applications. This will be done through case studies, Excel computer coursework, and homework assignments. Students will be exposed to real-life examples and applications using up-to-date data from financial markets. Lectures will also cover main empirical results from current academic research papers that are related to the course topics. Students will understand the relationship between risk and return and will be able to value fixed-income securities, stocks, and derivatives. Students will also know how to form a portfolio of financial assets.

Prerequisite: COMM 298.