BA 233 Course Outline--Fall 1998

Walter A. Haas School of Business
U.C. Berkeley
Fall 1998
BA/E233: Securities Markets and Investment Policies

Professor Terry A. Marsh

Office: Faculty 651

Phone: (510) 642-1651

Course Description:
The topics covered in the course include Derivatives (options, futures, swaps, etc.); Fixed Income; Portfolio Management; Dynamic Trading Strategies; Trading (Market Microstructure).

The class meets on Wednesdays and Fridays, from 11:00 am-12:30 pm. E233 meets on Wednesdays from 6:00-9:00 pm.

Last Revised: August 21, 1998

Preface:

Three texts are listed below for each of the main topics: derivatives, fixed income, and portfolio analysis. Each of these texts provides serious depth in its respective area. If you don't intend to specialize in an area, please don't feel that you "have to" read the respective book thoroughly.

The emphasis of the course is on applications, and I promise that you'll never be asked for a 50K memory dump of the text, notes, or the like. The course is "immersion style" and will be relatively unstructured, in part reflecting the unstructured nature of the applications. If you like cut-and-dried "answers," lots of feedback (or, sin of sins, you are fixated on grades, etc.), this is NOT the course for you!

Classes will be a mixture of lecture and discussion. For the discussion, I may sometimes ask you to read one or two topical articles for the following class or week. Please be prepared to discuss them; you will probably learn most in arguing your point of view.

Grading:

There will be a mid-term and a final examination, each counting for 40% of the grade.
The discussion section will use the text Cases in Financial Engineering for the first five to six week.
Assignments from this text, plus a couple of other short assignments later in the semester, will count for 20% of the grade.

Cases Text:

Scott Mason, Robert Merton, Andre Perold, and Peter Tufano, Cases in Financial Engineering: Applied Studies of Financial Innovation, Prentice-Hall Inc., 1995.

Texts:

Options and Derivatives Section:

John Hull, Options, Futures, and other Derivative Securities, Prentice-Hall, Revised, 1997.

Fixed Income Section:

Bruce Tuckman, Fixed Income Securities, John Wiley & Sons, 1995.

Portfolio Section:

Edwin J. Elton and Martin J. Gruber, 1994, Modern Portfolio Theory and Investment Analysis, New York, Wiley.

References

Zvi Bodie, Alex Kane, and Alan Marcus, Investments, 3rd Edition.

Aswath Damodaran, 1996, Investments, John Wiley & Sons.

William Sharpe and Gordon Alexander, Investments, 4th Edition, Prentice-Hall, 1989.

Gerard Gennotte and Mark Latham, Asset Prices and the Theory of Investments, Unpublished Manuscript, U.C. Berkeley. In the Business Library.

Weeks 1-4: Introduction and Background Contingent Claims and Futures Markets

Terry Marsh and David Modest, Dynamic Replication: Options I. (In Course Reader, Vol. 1 (at Copy Central on Bancroft)

Terry Marsh and David Modest, Dynamic Replication: Options II. (In Course Reader, Vol. 2 (at Copy Central on Bancroft):

Hull, Chapters 1-3, 6-8, 10

Terry Marsh, "Valuation," Part IV: The Portable MBA in Investments, ed. by Peter Bernstein, John Wiley & Sons, New York, October 1995, 111-197 and 409-415.

Terry Marsh, "The Value of Flexibility in the Use of Assets," Unpublished Paper, 1995.

David Fite and Paul Pfleiderer, "Should Firms Use Derivatives to Manage Risk?," Graduate School of Business, Stanford University, 1994.

Avinash Dixit and Robert S. Pindyck, Investment under Uncertainty, ISBN: 0691034109

Background Reading:

Roger G. Ibbotson and Gary P. Brinson, Global Investing, McGraw-Hill, New York, 1993.

Peter Bernstein, Capital Ideas: The Improbable Origins of Modern Wall Street, Free Press, New York, 1992.

Week 5: Dynamic Trading Strategies

Forbes, "The Dollar Cost Fallacy," April 10, 1995, p. 59.

Philip Dybvig, "Inefficient Dynamic Portfolio Strategies or How to Throw away a Million Dollars in the Stock Market," The Review of Financial Studies 1(1), 1988, 67-88.

Weeks 6-8: Fixed Income/Term Structure

Brief Review of Concepts: Spot and Forward Rates, Yields, etc. Tuckman, Chs. 1-3. Convexity and Immunization Notes and Tuckman, Chs. 11-12.

Models for Interest Rates and Equilibrium Bond Price Dynamics Notes and Tuckman, Ch. 13

Term Structure Theories (Very Brief) Notes

Preference-Free Characterizations of the Term Structure of Interest Rates Notes Tuckman, Chs. 5-9.

Applications to Hedging Interest Rate Risk and Fixed Income Derivatives (Bond Options, Caps, Collars, etc.) Tuckman, Chs. 14-18.

Credit/Default Risk: Yield Premiums on Risky Corporate Bonds and Junk Bonds

Background Reading:

Terry Marsh, "Valuation," Part IV: The Portable MBA in Investments, ed. by Peter Bernstein, John Wiley & Sons, October 1995, 111-197 and 409-415.

Terry Marsh, "Term Structure of Interest Rates and the Pricing of Fixed Income Claims and Bonds," Handbook in Operations Research and Management Science, ed. by R. Jarrow, V. Maksimovic, and W. Ziemba, 1995.

Robert Litterman and Jose Scheinkman, "Common Factors affecting Bond Returns," Journal of Fixed Income, June 1991, 54-61.

Douglas Breeden and Michael Giarla, "Hedging Interest Rate Risks with Futures, Swaps, and Options," Working Paper No. 87-108, Fuqua School of Business, Duke University, 1987.

Weeks 9-13: Portfolio Management

Notes to be Distributed. Elton and Gruber.

Topics: Investment Criteria

Efficient Set Mechanics

Security Return Models

Market Efficiency, Security "Alphas"

International Portfolio Issues

Exchange Rates

Background Reading:

"Investment Management," The Economist, November 27, 1993, Survey: pp. 1-30. "Welcome to Bull Country," The Economist, July 18, 1998, pp. 21-23.

William Sharpe, "Asset Allocation: Management Style and Performance Measurement," Journal of Portfolio Management 18(2), Winter 1992, 7-19.

Richard Roll, "A Mean/Variance Analysis of Tracking Error," Journal of Portfolio Management 18(4), Summer 1992, 13-22.

William Sharpe, "Factor Models, CAPMs, and the ABT," Journal of Portfolio Management 11(1), Fall 1984, 21-25.

"The Mathematics of Markets," The Economist, October 9, 1993, Survey: pp. 1-22.

Gerard Gennotte and Hayne Leland, "Market Liquidity, Hedging, and Crashes," American Economic Review 80(5), December 1990, 999-1021. (First Look)

Week 14: Trading (Market Microstructure)

Notes to be Distributed.

Cases Text:

Texts:

References

Weeks 1-4: Introduction and Background Contingent Claims and Futures Markets

Background Reading:

Week 5: Dynamic Trading Strategies

Weeks 6-8: Fixed Income/Term Structure

Background Reading:

Weeks 9-13: Portfolio Management

Background Reading:

Week 14: Trading (Market Microstructure)

TAM:JW 9/4/98