Lecture Notes for Finance 1 (MiQE/F, MSc course at UNISG)
1 Mean-Variance Frontier 3
1.1 Portfolio Return: Mean, Variance, and the Effect of Diversification . . 3
1.2 Mean-Variance Frontier of Risky Assets . . . . . . . . . . . . . . . . 7
1.3 Mean-Variance Frontier of Riskfree and Risky Assets . . . . . . . . . 15
1.4 Examples of Portfolio Weights from MV Calculations . . . . . . . . . 17
A Some Matrix Algebra and Calculus 20
2 Index Models 23
2.1 The Inputs to a MV Analysis . . . . . . . . . . . . . . . . . . . . . . 23
2.2 Single-Index Models . . . . . . . . . . . . . . . . . . . . . . . . . . 24
2.3 Estimating Beta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
2.4 Multi-Index Models . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
3 Utility-Based Portfolio Choice 32
3.1 Utility Functions and Risky Investments . . . . . . . . . . . . . . . . 32
3.2 Utility Optimization and the Two-Fund Theorem . . . . . . . . . . . 38
3.3 Application of Normal Returns: Value at Risk and the Telser Criterion 50
3.4 Empirical Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
4 CAPM 55
4.1 Portfolio Choice with Mean-Variance Utility . . . . . . . . . . . . . . 55
4.2 Beta Representation of Expected Returns . . . . . . . . . . . . . . . 62
4.3 Market Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
45 CAPM Extensions 71
5.1 Nonmarketable Assets . . . . . . . . . . . . . . . . . . . . . . . . . 71
5.2 Heterogenous Investors . . . . . . . . . . . . . . . . . . . . . . . . . 77
5.3 CAPM without a Riskfree Rate . . . . . . . . . . . . . . . . . . . . 79
5.4 Multi-Factor Models . . . . . . . . . . . . . . . . . . . . . . . . . . 82
5.5 Joint Portfolio and Savings Choice . . . . . . . . . . . . . . . . . . . 83
6 Testing CAPM and Multifactor Models 88
6.1 Market Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
6.2 Several Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
6.3 Fama-MacBeth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
7 Performance Analysis 101
7.1 Performance Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . 101
7.2 Performance Attribution . . . . . . . . . . . . . . . . . . . . . . . . 109
7.3 Style Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110
8 Investment for the Long Run 114
8.1 Time Diversification . . . . . . . . . . . . . . . . . . . . . . . . . . 114
8.2 The Growth-Optimal Portfolio . . . . . . . . . . . . . . . . . . . . . 118
8.3 More General Utility Functions and Rebalancing . . . . . . . . . . . 122
9 Predicting Asset Returns 125
9.1 Asset Prices, Random Walks, and the Efficient Market Hypothesis . . 125
9.2 Autocorrelations . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130
9.3 Other Predictors and Methods . . . . . . . . . . . . . . . . . . . . . 137
9.4 Security Analysts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
9.5 Technical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
9.6 Empirical U.S. Evidence on Stock Return Predictability . . . . . . . . 145.4
An Application of MV Portfolio Choice: International Assets . . . . . 65

Lecture Notes for Finance 2 (MiQE/F, MSc course at UNISG)
8 Interest Rate Calculations 3
8.1 Zero Coupon (discount) Bonds . . . . . . . . . . . . . . . . . . . . . 3
8.2 Forward Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
8.3 Coupon Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
8.4 Estimating the Yield Curve . . . . . . . . . . . . . . . . . . . . . . . 13
8.5 Conventions on Important Markets . . . . . . . . . . . . . . . . . . 17
8.6 Inflation-Indexed Bonds . . . . . . . . . . . . . . . . . . . . . . . . 22
A More Details on Bond Conventions 24
A.1 Bond Equivalent Yields on US Bonds . . . . . . . . . . . . . . . . . 24
9 Bond Portfolios 28
9.1 Duration: Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . 28
9.2 Duration Matching . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
9.3 Yield Curve Models . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
9.4 Interest Rates and Macroeconomics . . . . . . . . . . . . . . . . . . 41
9.5 Forecasting Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . 45
10 Basic Option Pricing 49
10.1 European Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
10.2 Are Options Risky Assets? . . . . . . . . . . . . . . . . . . . . . . . 51
10.3 American Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
10.4 Forward-Spot Parity . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
10.5 Put-Call Parity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
10.6 Early Exercise of American Options . . . . . . . . . . . . . . . . . . 60
10.7 Pricing Bounds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63