INVESTMENT ANALYSIS AND PORTFOLIO MANAGEMENT
Introduction ........................................................................................................................................................................... 3
Topic 1: General Concepts and Investment Process.............................................................................................................. 4
Topic 2: Investing Direct and Indirect .................................................................................................................................. 21
Topic 3: Return and Risk, and Portfolio Theory ................................................................................................................... 43
Topic 4: Efficient Diversification .......................................................................................................................................... 61
Topic 5: CAPM and Multifactor Models............................................................................................................................... 83
Topic 6: Market Efficiency and Behavioral Finance ........................................................................................................... 100
Topic 7: Equity Valuation ................................................................................................................................................... 114
Topic 8: Bond Valuation and Bond Portfolio Management ............................................................................................... 130
Topic 9: Portfolio Performance Evaluation ........................................................................................................................ 147
Topic 10: Applied portfolio management (guest lecture) ................................................................................................. 162
Topic 11: Investing using Derivatives................................................................................................................................. 177
,2
,Introduction
Goals of the course
- Know how to invest directly (individual stocks) and indirectly (ETFs)
- Never forget that lunches are (hardly) never free!
o High return requires taking higher risks
o Risk-Return Trade-Off
- Understand pricing principles on financial markets
o How can we determine price and (expected) return and risk of a financial asset?
o What is the fair value (Vt) of an asset? à the correct price
o Pt = the price of the asset if you buy the asset on the market
o We expect that Vt = Pt
§ Often, this is not true, but this can lead to investment opportunity (Pt < Vt)
- Understand how to construct portfolios
o How should we allocate our funds à Diversify
§ Diversifying reduces the risk (= s) of the portfolio
- Be able to evaluate investments (strategies)
o How do we know we did a good investment?
Why study investments?
- Most people make investment decisions sometime
o Need sound framework for managing and increasing wealth
o Retirement decisions:
§ Importance of making good decisions
- Essential part of a career in the field
o Security analyst
o Portfolio manager
o Stockbrokers
o Financial advisors/planners
- Power of compounding
o Reason why investing is important
o Becomes stronger the longer you invest à exponential increase
Example: Each year you invest $5000, you do this for 20 years. The total investment is thus $100.000
over 20 years. Suppose that each year you have a return of 5%. The total value of the investment after
20 years is $165.330.
The longer you invest, or the higher the interest rate, the stronger the effect of compounding.
3
,Topic 1: General Concepts and Investment Process
Introduction
Investment
- The current commitment of money or other resources in the expectation of reaping future benefits
Question: Which financial asset do you prefer to invest in nowadays?
- Cash
- Government bonds
- Corporate bonds
- Individual stocks
- Mutual funds / ETFs à You’re investing in a diversified portfolio
- Real estate
- Gold à increased a lot over the last years, but this doesn’t mean that it will keep increasing in the future
o Performs well if there’s a lot of uncertainty (war, …)
- Bitcoins
- Other
Some recent trends
Stock market and government/corporate bond market: Return index and return
expressed in Euro in 2025
- What factors explain the sharp global stock market decline in Feb–Mar 2025?
o Trump’s communication about import tariffs
o Geopolitical tension creates a lot of uncertainty
o If the tariffs would be implemented, companies would be affected by
this, and thus profits would go down
§ Leads to lower share prices
- Shows that stock market is much more risky/volatile than the bonds market
Stock markets worldwide: Returns (based on MSCI return index in Euro)
- US stock market performed well in $, but not in €
- Performance and Currency Risk:
o Question: From a European investor’s perspective, did the US stock
market perform well last year?
§ Yes, because the return was positive in USD.
§ No, because after converting to EUR the return was negative.
§ It depends, both A and B are correct.
o If you want to know you’re exact return, you should look at the
performance, after converting it to your currency
o From a European investor’s perspective, you lost more or less 2% on
your investment à negative return = bad investment
o Potential solution
§ Hedge the currency risk
Exchange Rates:
- USD depreciated by 11% against the EUR
- Currency risk:
o If you invest in financial instruments, you should take the exchange rate
into account
- Last year: € has appreciated against a lot of other currencies
o Disadvantage for EU investors that invest in other countries
4
,Return per sector (based on MSCI return index in Euro)
- Cyclical consumer goods sector did not perform well
o Goods of which the purchase is linked to economic situation
o Reasons: uncertainty about import tariffs that might lead to a recession
- Energy didn’t perform well
- Real estate didn’t perform well
o Interest rates are high à makes a loan more expensive
o Fear of inflation: central banks increase the interest rates
- Industry sector is performing well
o Defense is a large part of this sector, and there have been large investments in this sector
- Financial sector is performing well
o Higher interest rates
- Communication and IT sector are performing well
o Magnificent 7 (amazon, alphabet, …)
Government bond yields (maturity 10 year)
- Yield: return that you get on a yearly basis, if you hold the investment until
maturity
- Negative relation between yield and interest rate
- Interest rates are typically higher in US than in EU
o Explanations:
§ Growth is typically higher in US than in EU
§ US has a lot of debt: the higher the debt, the higher the interest
rate that you have to pay on your debt
- Germany: yields tend to go up
o Germany has decided to issue more debt to invest in infrastructure
Bond returns for different categories (different types of bonds):
- Bonds that are more risky, tend to give a higher return
o Bonds of emerging countries are more risky than bonds of EU
o Bonds of companies are more risky than government bonds
US real estate has performed well from a historical perspective, but …
- Financial crisis: real estate went down substantially
- Covid crisis: real estate went down substantially
- Real estate has become more risky than it was
o More fluctuations
o Markets can change: the past can’t predict the future
Bitcoins
- Substantial upward potential
- From time to time there are substantial crashes
- It’s not clear what the fair value of bitcoin is
o Sometimes prices are going up, without a clear reason
5
, Historical Perspective
Adjusted prices (accounting for stock splits, including dividends)
- Total return indexes: includes dividends
- Conclusion
o The best investment in 1980 would have been Apple
o Individual stocks have upward potential
o Putting all your money in one specific asset is not a good idea
§ Very risky à Reason to diversify
- Currency risk
o The risk is taken into account, because it is expressed in €
- Individual stocks have a lot of potential, but also higher risk for losses
- S&P500
o Fluctuates much less, stable over time and increasing
o Diversifying
§ The increase is much more stable
- Even if diversified, there’s still a risk for losses
o E.g. bad news about the economy
o Stock market
§ On the long term, it is more stable
§ Long term perspective is necessary
§ You will recover the losses over time
o Government bonds
§ Increases and is more stable compared to stock market
§ Leads to lower returns compared to stock market
Stylized facts:
- Individual stocks can fluctuate a lot
o Great potential for high gains, but also high risk of losing money
- Stock indexes in general do fluctuate less than individual stocks
o Less potential for high gains, but also less risk of losing money
o Diversification potential
- Bond indexes in general do fluctuate less than stock indexes
o Less potential for high gains, but also less risk of losing money
Basic concepts:
Return and risk
Return
- Why invest? → To earn a return
o Alternative of investing = not investing (holding your money as cash at home)
o Opportunity cost = not earning a return and losing purchasing power because of inflation
- Expected return = the return you anticipate for the future
o Et = (Rt+1)
o Expected return at time t = return at time t+1
- Realized return = the return you actually earn in the past
o Rt+1 = actual return
- Realized ≠ Expected → this is where risk comes in
Risk
- The chance/probability that realized return ≠ expected return
- Reflects uncertainty about the outcome of an investment à fluctuation
o More fluctuation = more uncertainty
6
Introduction ........................................................................................................................................................................... 3
Topic 1: General Concepts and Investment Process.............................................................................................................. 4
Topic 2: Investing Direct and Indirect .................................................................................................................................. 21
Topic 3: Return and Risk, and Portfolio Theory ................................................................................................................... 43
Topic 4: Efficient Diversification .......................................................................................................................................... 61
Topic 5: CAPM and Multifactor Models............................................................................................................................... 83
Topic 6: Market Efficiency and Behavioral Finance ........................................................................................................... 100
Topic 7: Equity Valuation ................................................................................................................................................... 114
Topic 8: Bond Valuation and Bond Portfolio Management ............................................................................................... 130
Topic 9: Portfolio Performance Evaluation ........................................................................................................................ 147
Topic 10: Applied portfolio management (guest lecture) ................................................................................................. 162
Topic 11: Investing using Derivatives................................................................................................................................. 177
,2
,Introduction
Goals of the course
- Know how to invest directly (individual stocks) and indirectly (ETFs)
- Never forget that lunches are (hardly) never free!
o High return requires taking higher risks
o Risk-Return Trade-Off
- Understand pricing principles on financial markets
o How can we determine price and (expected) return and risk of a financial asset?
o What is the fair value (Vt) of an asset? à the correct price
o Pt = the price of the asset if you buy the asset on the market
o We expect that Vt = Pt
§ Often, this is not true, but this can lead to investment opportunity (Pt < Vt)
- Understand how to construct portfolios
o How should we allocate our funds à Diversify
§ Diversifying reduces the risk (= s) of the portfolio
- Be able to evaluate investments (strategies)
o How do we know we did a good investment?
Why study investments?
- Most people make investment decisions sometime
o Need sound framework for managing and increasing wealth
o Retirement decisions:
§ Importance of making good decisions
- Essential part of a career in the field
o Security analyst
o Portfolio manager
o Stockbrokers
o Financial advisors/planners
- Power of compounding
o Reason why investing is important
o Becomes stronger the longer you invest à exponential increase
Example: Each year you invest $5000, you do this for 20 years. The total investment is thus $100.000
over 20 years. Suppose that each year you have a return of 5%. The total value of the investment after
20 years is $165.330.
The longer you invest, or the higher the interest rate, the stronger the effect of compounding.
3
,Topic 1: General Concepts and Investment Process
Introduction
Investment
- The current commitment of money or other resources in the expectation of reaping future benefits
Question: Which financial asset do you prefer to invest in nowadays?
- Cash
- Government bonds
- Corporate bonds
- Individual stocks
- Mutual funds / ETFs à You’re investing in a diversified portfolio
- Real estate
- Gold à increased a lot over the last years, but this doesn’t mean that it will keep increasing in the future
o Performs well if there’s a lot of uncertainty (war, …)
- Bitcoins
- Other
Some recent trends
Stock market and government/corporate bond market: Return index and return
expressed in Euro in 2025
- What factors explain the sharp global stock market decline in Feb–Mar 2025?
o Trump’s communication about import tariffs
o Geopolitical tension creates a lot of uncertainty
o If the tariffs would be implemented, companies would be affected by
this, and thus profits would go down
§ Leads to lower share prices
- Shows that stock market is much more risky/volatile than the bonds market
Stock markets worldwide: Returns (based on MSCI return index in Euro)
- US stock market performed well in $, but not in €
- Performance and Currency Risk:
o Question: From a European investor’s perspective, did the US stock
market perform well last year?
§ Yes, because the return was positive in USD.
§ No, because after converting to EUR the return was negative.
§ It depends, both A and B are correct.
o If you want to know you’re exact return, you should look at the
performance, after converting it to your currency
o From a European investor’s perspective, you lost more or less 2% on
your investment à negative return = bad investment
o Potential solution
§ Hedge the currency risk
Exchange Rates:
- USD depreciated by 11% against the EUR
- Currency risk:
o If you invest in financial instruments, you should take the exchange rate
into account
- Last year: € has appreciated against a lot of other currencies
o Disadvantage for EU investors that invest in other countries
4
,Return per sector (based on MSCI return index in Euro)
- Cyclical consumer goods sector did not perform well
o Goods of which the purchase is linked to economic situation
o Reasons: uncertainty about import tariffs that might lead to a recession
- Energy didn’t perform well
- Real estate didn’t perform well
o Interest rates are high à makes a loan more expensive
o Fear of inflation: central banks increase the interest rates
- Industry sector is performing well
o Defense is a large part of this sector, and there have been large investments in this sector
- Financial sector is performing well
o Higher interest rates
- Communication and IT sector are performing well
o Magnificent 7 (amazon, alphabet, …)
Government bond yields (maturity 10 year)
- Yield: return that you get on a yearly basis, if you hold the investment until
maturity
- Negative relation between yield and interest rate
- Interest rates are typically higher in US than in EU
o Explanations:
§ Growth is typically higher in US than in EU
§ US has a lot of debt: the higher the debt, the higher the interest
rate that you have to pay on your debt
- Germany: yields tend to go up
o Germany has decided to issue more debt to invest in infrastructure
Bond returns for different categories (different types of bonds):
- Bonds that are more risky, tend to give a higher return
o Bonds of emerging countries are more risky than bonds of EU
o Bonds of companies are more risky than government bonds
US real estate has performed well from a historical perspective, but …
- Financial crisis: real estate went down substantially
- Covid crisis: real estate went down substantially
- Real estate has become more risky than it was
o More fluctuations
o Markets can change: the past can’t predict the future
Bitcoins
- Substantial upward potential
- From time to time there are substantial crashes
- It’s not clear what the fair value of bitcoin is
o Sometimes prices are going up, without a clear reason
5
, Historical Perspective
Adjusted prices (accounting for stock splits, including dividends)
- Total return indexes: includes dividends
- Conclusion
o The best investment in 1980 would have been Apple
o Individual stocks have upward potential
o Putting all your money in one specific asset is not a good idea
§ Very risky à Reason to diversify
- Currency risk
o The risk is taken into account, because it is expressed in €
- Individual stocks have a lot of potential, but also higher risk for losses
- S&P500
o Fluctuates much less, stable over time and increasing
o Diversifying
§ The increase is much more stable
- Even if diversified, there’s still a risk for losses
o E.g. bad news about the economy
o Stock market
§ On the long term, it is more stable
§ Long term perspective is necessary
§ You will recover the losses over time
o Government bonds
§ Increases and is more stable compared to stock market
§ Leads to lower returns compared to stock market
Stylized facts:
- Individual stocks can fluctuate a lot
o Great potential for high gains, but also high risk of losing money
- Stock indexes in general do fluctuate less than individual stocks
o Less potential for high gains, but also less risk of losing money
o Diversification potential
- Bond indexes in general do fluctuate less than stock indexes
o Less potential for high gains, but also less risk of losing money
Basic concepts:
Return and risk
Return
- Why invest? → To earn a return
o Alternative of investing = not investing (holding your money as cash at home)
o Opportunity cost = not earning a return and losing purchasing power because of inflation
- Expected return = the return you anticipate for the future
o Et = (Rt+1)
o Expected return at time t = return at time t+1
- Realized return = the return you actually earn in the past
o Rt+1 = actual return
- Realized ≠ Expected → this is where risk comes in
Risk
- The chance/probability that realized return ≠ expected return
- Reflects uncertainty about the outcome of an investment à fluctuation
o More fluctuation = more uncertainty
6
