Security Analysis and Portfolio Management Learning Journal_Finance
There are so many things that I learned from the course. I was introduced to different aspects of investment environment.
I learned about the basic investment process from saving, investing, forming a portfolio, asset allocation, and security selection. There are four broad components that comprise investment risk. Thus are purchasing power risk, business risk, interest rate risk and market risk. The expected return of an investment is defined as the sum of the possible outcome times the probability of occurrence. By calculating expected return, we are saying that given a set of probabilities and outcomes, we expect a certain return of our investment. Understanding and learning how to identify, measure and deal with investment risks and expected return is very important not only to financial professionals or business people but to everyone. The world is experiencing an economic downturn and in these times, people must learn how to save and invest their money. Having even just the basic knowledge in investment environment, risk and return can guide us.
One of the most memorable topics that we discussed in class is the modern portfolio theory suggested by Henry Markowitz. Markowitz began by assuming that all of us avoid risks but instead of measuring risk at the individual security level, he believed it should be measured at the portfolio level. Markowitz believed that portfolio diversification reduces risks. If diverse investments always moved together, there would be no diversification benefit. On the other hand, if they never moved together, there would be no risk. I find studying the history of financial management and the personalities that shaped the discipline very interesting.
There are two asset pricing models that I learned in the course. These are Capital Asset Pricing Model (CAPM) and Intertemporal Capital Asset Pricing Model (ICAPM). The CAPM, credited to Sharpe (1964) and Lintner (1965), is the first, most famous, and most widely used model in asset pricing. The CAPM indicates the expected or required rates of return on risky assets. CAPM is based on the assumption that investors prefer less risk and more return. It is also the assumption of CAPM that borrowing and lending rates are equal; that there are no transaction costs or taxes; that betas are stable and that the market portfolio chosen for comparison appropriate. Intertemporal Capital Asset Pricing Model (ICAPM), on the other hand, is credited to Merton (1973). The ICAPM recognizes that investors care about the market return, so that is the first risk factor. The extra factors are innovations to state variables that describe an investor’s consumption-portfolio decision. Other things being equal, investors prefer assets that pay off well when there is bad news that future returns will be lousy. Such assets provide insurance; they help to reduce the risk of long-term investments.
Another topic that we discussed in class in market efficiency. Market efficiency is a description of how prices in competitive markets react to new information. An efficient market is one in which prices adjust rapidly to new information and in which current prices fully reflect all available information. Contrary to popular view, market efficiency does not require that the market price be equal to true value at every point in time, All it requires is that errors in the market price is unbiased; prices can be greater than or less than true value, as long as these deviations are random. I also learned that definitions of market efficiency have to be specific not only about the market that is being considered but also the investor group that is covered. It is quite impossible that all market are efficient to all investors. Definitions of market efficiency are also linked up with assumptions about what information is available to investors and reflected in the price.
One of the most challenging topics that we discussed in class is the computation interest rates and their dynamics. Interest rates are important in pricing all other market securities since they are used in time discounting, Interest rates are important on corporate level since most investment decisions are based on some expectation regarding alternative opportunities and the cost of capital – both depend on the interest rates.
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