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Investment Theory and Risk Management, + Website

Book Description

A unique perspective on applied investment theory and risk management from the Senior Risk Officer of a major pension fund

Investment Theory and Risk Management is a practical guide to today's investment environment. The book's sophisticated quantitative methods are examined by an author who uses these methods at the Virginia Retirement System and teaches them at the Virginia Commonwealth University. In addition to showing how investment performance can be evaluated, using Jensen's Alpha, Sharpe's Ratio, and DDM, he delves into four types of optimal portfolios (one that is fully invested, one with targeted returns, another with no short sales, and one with capped investment allocations).

In addition, the book provides valuable insights on risk, and topics such as anomalies, factor models, and active portfolio management. Other chapters focus on private equity, structured credit, optimal rebalancing, data problems, and Monte Carlo simulation.

  • Contains investment theory and risk management spreadsheet models based on the author's own real-world experience with stock, bonds, and alternative assets

  • Offers a down-to-earth guide that can be used on a daily basis for making common financial decisions with a new level of quantitative sophistication and rigor

  • Written by the Director of Research and Senior Risk Officer for the Virginia Retirement System and an Associate Professor at Virginia Commonwealth University's School of Business

Investment Theory and Risk Management empowers both the technical and non-technical reader with the essential knowledge necessary to understand and manage risks in any corporate or economic environment.

Table of Contents

  1. Cover
  2. Series Page
  3. Title Page
  4. Copyright
  5. Dedication
  6. Preface
  7. Acknowledgments
  8. Chapter 1: Discount Rates and Returns
    1. Estimating Returns
    2. Geometric and Arithmetic Averages
    3. Caveats to Return Extrapolation
    4. Discounting Present Values of Cash Flow Streams
    5. Internal Rate of Return and Yield to Maturity
    6. Real and Nominal Returns
    7. Summary
  9. Chapter 2: Fixed Income Securities
    1. Coupon-Bearing Bonds
    2. Infinite Cash Flow Streams (Perpetuities)
    3. General Pricing Formulas for Finite Cash Flow Streams
    4. Interest Rate Risk
    5. Analysis of Duration
    6. Interest Rate Risk Dynamics
    7. Immunization and Duration
    8. Applications—Liability Discounting and Cash Matching
    9. Pension Logic
    10. Risky Coupons
    11. Inflation Risk and TIPS
    12. A Bond Portfolio Strategy (Optional)
    13. Summary
    14. Appendix 2.1: Solving Infinite and Finite Power Series
    15. Reference
  10. Chapter 3: Term Structure
    1. Discounting Using Spot Rates
    2. Forward Rates
    3. NPV Revisited
    4. Short Rates
    5. The Bootstrap Method
    6. Duration Redux
    7. Summary
  11. Chapter 4: Equity
    1. The Determination of Stock Prices
    2. Discount Rates Redux
    3. Price and Dividend Multiples
    4. Extrapolating Multiples to Forecast Returns
    5. Pitfalls of Trend Analysis
    6. The Gordon Growth Model
    7. Sources of Return
    8. Summary
    9. References
  12. Chapter 5: Portfolio Construction
    1. Stochastic Returns and Risk
    2. Diversification
    3. The Efficient Frontier
    4. Markowitz Portfolio Selection Criteria
    5. Capital Market Line and the CAPM
    6. Performance Evaluation
    7. Summary
    8. Appendix 5.1: Statistical Review
    9. Appendix 5.2: Risk-Adjusted Performance
    10. Reference
  13. Chapter 6: Optimal Portfolios
    1. Portfolio 1: Minimum Variance Portfolio (Fully Invested)
    2. Portfolio 2: Minimum Variance Portfolios with Targeted Return
    3. Portfolio 3: Minimum Variance Portfolios with No Short Sales
    4. Portfolio 4: Minimum Variance Portfolios with Capped Allocations
    5. Portfolio 5: Maximum Risk-Adjusted Return
    6. Performance Attribution
    7. The Efficient Frontier (Again)
    8. Summary
    9. Appendix 6.1: Matrix Operations
  14. Chapter 7: Data and Applications
    1. Analyzing Returns on a 10-Asset Portfolio
    2. Performance Attribution
    3. Changing the Investment Horizon Returns Frequency
    4. Benchmarking to the Market Portfolio
    5. The Cost of Constraints
    6. A Bond Strategy
    7. Summary
  15. Chapter 8: Anomalies
    1. Deviations from the CAPM
    2. Behavioral Finance
    3. Summary
    4. References
  16. Chapter 9: Factor Models
    1. Arbitrage Pricing Theory (APT)
    2. Factor Selection
    3. Model Estimation
    4. Principal Components
    5. Applications and Examples
    6. Summary
    7. References
  17. Chapter 10: Active Portfolio Management
    1. Active Portfolio Construction and Attribution Analysis
    2. Performance Attribution
    3. Summary
    4. Appendix 10.1: Active Space
  18. Chapter 11: Risk
    1. The Failure of VaR
    2. Taxonomy of Risk
    3. Visualizing Risk
    4. Estimating Volatilities
    5. Maximum Likelihood Estimation (Optional)
    6. Credit Risk
    7. Adjusting for Leverage
    8. Adjusting for Illiquidity
    9. Other Risks
    10. Summary
    11. References
  19. Chapter 12: Monte Carlo Methods
    1. Non-Normal Distributions
    2. The Gaussian Copula
    3. Summary
    4. References
  20. Chapter 13: Systemic Risk
    1. Extreme Value Theory
    2. Estimating the Hazards of Downside Risks
    3. A Systemic Risk Indicator
    4. Summary
    5. References
  21. Chapter 14: Incorporating Subjective Views
    1. Methodological Concepts
    2. An Example Using Black-Litterman
    3. Active Space
    4. Risk Attribution
    5. Summary
    6. References
  22. Chapter 15: Futures, Forwards, and Swaps
    1. Institutional Detail and Futures Mechanics
    2. The Relationship between Spot Prices and Forward (Futures) Prices
    3. Hedging Basis Risk
    4. Hedging Portfolio Risk
    5. Futures Pricing
    6. Swaps
    7. Summary
    8. References
  23. Chapter 16: Introduction to Options
    1. Option Payoffs and Put-Call Parity
    2. Pricing European Call Options
    3. Pricing European Put Options
    4. Option Strategies
    5. Real Options
    6. Summary
    7. References
  24. Chapter 17: Models of Stock Price Dynamics
    1. Stock Price Dynamics
    2. Ito Processes
    3. Lognormal Stock Prices
    4. Deriving the Parameters of the Binomial Lattice
    5. Black-Scholes-Merton Model
    6. The Greek Letters
    7. Monte Carlo Methods
    8. Summary
    9. Appendix 17.1: Derivation of Ito's Lemma
  25. Chapter 18: Hedging Portfolio Risk
    1. Simple Hedging Strategies
    2. S&P 500 Index Puts
    3. Selling Volatility
    4. VIX Calls
    5. Liability-Driven Investment
    6. Summary
    7. References
  26. Chapter 19: Private Equity
    1. The Private Equity Model
    2. Return and Risk Methodology
    3. Summary
    4. Appendix 19.1: CAPM
    5. References
  27. Chapter 20: Structured Credit
    1. Securitization
    2. Credit Enhancement
    3. Basics of Pricing Interest Rate Derivatives
    4. Interest Rate Dynamics
    5. CMO Valuation
    6. The Crash of the Housing Bubble
    7. Summary
    8. Reference
  28. Chapter 21: Optimal Rebalancing
    1. Trigger Strategies and No-Trade Regions
    2. An Optimal Control Problem
    3. Implications
    4. Optimal Rebalancing in a Static Optimization Model
    5. The Comparative Statics of Transaction Costs
    6. Reference
  29. Chapter 22: Data Problems
    1. Covariance Estimation
    2. An Example
    3. Empirical Results
    4. Overlapping Observations
    5. Conclusions
    6. Appendix 22.1: Covariance Matrix Estimation
    7. References
  30. About the Author
  31. Index