Equity Portfolio Management 539
Revised October 2007
Prepared by Ryan Garvey, Ph.D.
Equity Portfolio Management is an elective for MBA students at Duquesne University. The
course introduces students to the theory behind constructing an optimal investment portfolio
and the implications this theory has for asset pricing. A second theme of the course is to
examine the theory behind why market prices are thought to be fairly priced or “efficient”
versus the opposing view (behavioral finance) that questions investor rationality and, therefore,
efficient market prices.
Equity Portfolio Management extensively uses the Investment Center at Duquesne University.
Students become proficient in using Bloomberg, Compustat, Morningstar/Ibbotson and other
financial databases in order to apply the theoretical material presented in this course.
The Hewlett Packard 12C Financial Calculator (or equivalent) is required for this course.
Prerequisite: Assessing the Financial Health of the Organization 514
After completing the course, students will understand:
• the interpretation, composition, and calculation process involved in commonly used
• the mechanics, risk, and calculations involved in both margin and short trading.
• the concept of risk aversion and utility.
• the process of allocating funds between a risky asset and a risk free asset and how
leverage could be used in this process.
• systematic and firm-specific risk, and how to reduce the amount of firm-specific risk in a
portfolio by combining securities with differing patterns of returns.
• how to quantify the risk-reduction process by being able to calculate and interpret
covariance and correlation coefficients.
• the development and the theory of the capital asset pricing model (CAPM) and how to
construct and use the security market line.
• the concept of market efficiency and how to make rational investment decisions based
upon the existence of market efficiency.
• the key errors made by individuals in processing information and the biases uncovered
The Investment Setting (Introductory Material)
a) distinguish among the composition and characteristics of the three predominant weighting
schemes used in constructing stock market series;
b) discuss the source and direction of bias exhibited by each of three predominant weighting
schemes used in constructing stock market series;
c) compute a price weighted, a market weighted, and an unweighted index series for three
d) compare and contrast major structural features of domestic and global stock indexes;
e) describe the process of buying a stock on margin;
f) compute the rate of return on a margin transaction;
g) define maintenance margin;
h) determine the stock price at which the investor would receive a margin call;
i) explain the concept of required rate of return and discuss the components of an
investor’s required rate of return;
j) differentiate between the real risk-free rate of return and the nominal risk-free rate of return
and, compute both return measures;
k) explain the risk premium;
a) define risk aversion and cite evidence that suggests that individuals are generally risk averse;
b) explain the capital allocation line.
c) list the assumptions about individuals’ investment behavior of the Markowitz Portfolio
d) compute expected return for an individual investment and for a portfolio;
e) compute the variance and standard deviation for an individual investment;
f) compute the covariance of rates of return, and show how it is related to the
g) compute and interpret the standard deviation of return for a risky asset, the covariance and
correlation coefficient between the returns for two assets, and the variance or standard
deviation of a two-asset portfolio;
h) list the components of the portfolio standard deviation formula, and explain which
component is most important to consider when adding an investment to a portfolio;
i) demonstrate the change in the risk–return tradeoff of a two-asset portfolio as
the correlation between the two assets changes in specified ways;
j) describe the efficient frontier and explain the implications for incremental returns as an
investor assumes more risk;
k) demonstrate the concept of the efficient frontier, and show, using utility
analysis, how a risk-averse investor selects the optimal portfolio.
l) Explain indifference curves
m) define optimal portfolio and show how each investor may have a different optimal portfolio.
Asset Pricing Theory
a) list the assumptions of the capital market theory;
b) discuss the assumptions of the capital market theory, explain how the presence of a risk-free
asset changes the portfolio possibilities relative to the Markowitz efficient frontier, describe the
market portfolio and the role it plays in the formation of the capital market line (CML), and
distinguish between systematic and unsystematic risk;
c) explain what happens to the expected return, the standard deviation of returns, and possible
risk-return combinations when a risk-free asset is combined with a portfolio of risky assets;
explain and illustrate the standard deviation of return as a function of the number of stocks in
d) identify the market portfolio, and describe the role of the market portfolio in the formation
of the capital market line (CML);
e) define systematic and unsystematic risk and explain why an investor should not expect to
receive additional return for assuming unsystematic risk;
f) describe the capital asset pricing model, diagram the security market line (SML), and define
g) discuss the security market line (SML) and how it differs from the CML, calculate the beta of
a risky asset, and calculate and interpret, based on the SML, the expected return for an asset; h)
determine whether the asset is undervalued, overvalued, or properly valued; and outline the
appropriate trading strategy;
h) calculate and interpret using the SML, the expected return on a security, and
evaluate whether the security is undervalued, overvalued, or properly valued;
i) evaluate the effect on the SML of relaxing each of the following assumptions: 1) differential
borrowing and lending rates, 2) transactions costs, 3) heterogeneous expectations and planning
periods, and 4) taxes;
j) explain how the systematic risk of an asset is estimated using the characteristic line;
k) discuss the stability of individual asset betas and portfolio betas over time;
l) discuss beta estimation problems and why published beta estimates may differ
m)describe the concept of benchmark error and its implications for testing the capital asset
pricing model (CAPM).
a) define an efficient capital market, discuss arguments supporting the concept of efficient
capital markets, describe and contrast the forms of the efficient market hypothesis (EMH):
weak, semistrong, and strong, and describe the tests used to examine the weak form, the
semistrong form, and the strong form of the EMH;
b) identify six market anomalies and explain their implications for the semistrong form of the
EMH, and explain the overall conclusions about each form of the EMH;
c) explain the implications of stock market efficiency for technical analysis and fundamental
analysis, discuss the implications of efficient markets for the portfolio management process and
the role of the portfolio manager, and explain the rationale for investing in index funds.
a) identify and evaluate “fundamental” and “noise trader” risk that may be present in
implementing a trade designed to profit from a mispricing of an asset;
b) discuss the costs of implementing a trade designed to profit from a mispricing of an asset;
c) explain what conditions are sufficient to limit arbitrage and allow deviations from
fundamental value to persist.
d) identify the key assumptions that have evolved in the field of finance, and discuss the
limitations of these assumptions;
e) formulate the problem of overestimating the precision and importance of information.
f) discuss the effect of overconfidence on investors’ trading;
g) describe how overconfidence may affect risk-taking behavior.
h) explain how the fear of regret and seeking of pride affects investors’ holding
periods of winning and losing investments;
i) discuss the disposition effect in relation to investor wealth and investor reaction to company-
specific versus general economic news;
j) justify how the concept of “reference point” may affect an investor’s trading behavior.
k) compare and contrast the “house money,” “snake bite,” “trying to break
even,” and “endowment” effects on investor decision-making behaviors;
l) explain how various events in the past may affect an investor’s future risk taking;
m) discuss how the avoidance of cognitive dissonance may affect an investors’ decision-making
n)explain how mental accounting may 1) result in investor decisions that are contrary to the
strategy of wealth maximization and 2) affect the diversification of an investor’s portfolio.
o) explain how mental accounting may lead both individual and institutional
investors to misperceive risk;
p) discuss how the concept of correlation is generally not implemented when investors affected
by mental accounting build portfolios;
q) explain how mental accounting can result in naive diversification as compared to the efficient
diversification that results from implementing MPT.
r) discuss how the concept of representativeness may cause investors to
incorrectly extrapolate a company’s past business operations or stock price performance into
s) identify and discuss the characteristics of a portfolio constructed by an investor affected by
the concept of familiarity;
t) discuss the investment decision problems of investors affected by the concept of familiarity.
The recommended time that should be allocated to each part of the course is as follows:
Introductory Material (20%)
Portfolio Theory (40%)
Asset Pricing Theory (10%)
Market Efficiency (15%)
Behavioral Finance (15%)
Instructors should follow the learning objectives in the order that they are presented on the
master syllabus. Instructors must cover up to at least the Behavioral Finance Section.
Recommended Teaching Procedure
The theoretical material covered in this course can be conceptually difficult for many students
to comprehend. Therefore, it is recommended that instructors apply the theoretical material
through the use of a series of course projects. The Investment Center at Duquesne University
provides a wealth of resources (e.g., Bloomberg, Compustat, Morningstar/Ibbotson, Reuters,
etc.) in order for instructors to develop course projects that correspond to the theoretical
material covered in this course.
Exam 1 – 20% of the final grade
Exam 2 – 20% of the final grade
Final Exam – 25% of the final grade
Assignments (Suggested - Investment Center Competency Project, Portfolio Project, Market
Efficiency and or Behavioral Finance Reading Assignments) – 30% of the final grade
Class participation – 5% of the final grade
*The plus/minus grading system is used in this course.
Textbooks and References
Required Textbook: Investments, Bodie, Kane, and Marcus, 7th edition.
Learning Outcomes Assessment
Instructors are encouraged to measure student learning through the use of exams and projects.
Please see attached examples.