The focus of this course is on the financial theory and empirical evidence that are useful for investment decisions. The topics covered in this course can be broadly categorized into five groups:
  • Financial Theories
    This includes portfolio theory, the capital asset pricing model and the arbitrage pricing theory, all of which have become an integrated part of the decision-making in investments.
  • Empirical Evidence in the Equity and Equity Options Markets
    This includes patterns in cross-sections of stock returns, the time-series behavior of stock returns time-varying expected returns and stochastic volatility, and further empirical evidence from the equity options market.
  • Introduction to Fixed-Income and Credit Sensitive Instruments
    This includes default-free as well as defaultable bonds, yield curve analysis, the effect of Fed target rates, fixed-income derivatives such as swaps, caps, floors, and swaptions, models of default and ratings transitions, and more recent development of credit derivatives.
  • Market Efficiency and "Active" Investments
    We start with the efficient market hypothesis, which is a useful framework for modeling financial markets. Like any model, the efficient market hypothesis is not a perfect description of reality: some prices are almost certainly "wrong". Hence there are reasons to believe that active management can have effective results. Topics in active investments include security analysis, active portfolio management, hedge funds, and risk management issues.
  • Brief Introduction to Behavioral Finance
    While traditional finance assumes investors act rationally to maximize a well-defined utility function, behavioral finance tries to use other theories of behavior, from psychology, sociology, and anthropology, to explain financial markets. This topic will be covered by just one lecture, the main purpose of which is to get you exposed to this active and fast growing field in Finance.
Course Objectives
A sound investment decision requires in-depth knowledge of the financial markets, rigorous analytical thinking and precise mathematical derivation. The main objective of this class is to teach you these three elements:
  • Analytical Tools
    Among others, an important analytical skill you should acquire from taking this class is the ability to transform a real life investment problem into an analytically tractable model. This modeling skill is an important aspect of this class, and will be emphasized throughout the course.
  • Quantitative Skills
    Modern finance has its quantitative aspect. Powerful mathematical techniques such as optimization, dynamic programming, probability theory and statistical analysis pave the way for many complex investment problems.
    In this class, you will be exposed to this quantitative aspect. You are not expected to be fluent in mathematics, but I hope to teach you the fundamentals, which are portable from one situation to another. Moreover, through 5 group assignments, you will have hands-on experiences with optimization, data analysis, Monte-Carlo simulation, etc.
  • Empirical Knowledge
    Essential to any investment decision is the knowledge of the investment environment. Broadly speaking, the financial instruments can be categorized into equity, debt, and derivatives. Important empirical evidence from all three types of financial markets will be examined in this class. Although I will emphasize concepts and the big picture a lot, please realize that 15.433 involves a fair bit of algebra, notation, and basic mathematics. So if you are uncomfortable with the above three notions, please talk to the course instructor about it.
Course Materials
Required Reading
Bodie, Zvi, Alex Kane, and Alan J. Marcus ("BKM"). Investments. 5th Edition. McGraw-Hill/Irwin, 2002.

Recommended Reading
P. Bernstein. Capital Ideals: The Improbable Origins of Modern Wall Street. New York: Free Press, 1992.

TA's and Review Sessions

The TA's for the course will hold weekly office hours, review sessions are announced in the class.


Regular attendance and class participation     10%
Five group assignments                                   20%
Mid-term examination                                       30%
Final examination                                             40%

Class Preparation and Participation

Both class preparation and participation are important. The classroom is a great place to test and enhance your understanding of the material by asking and answering questions. It will be hard to contribute to the discussions if you are unprepared. I strongly encourage you to prepare for class in study groups. For details, see Course Schedule and Reading List.

Class participation, from clarifying questions to creative and insightful comments, is greatly encouraged. Your active participation will transform this class into a great learning experience for everyone, including myself.

Group Assignments

There are five group assignments. Each is worth between 3 to 5 points toward your final grade. Group assignments are due at the beginning of class on the due date.

Please work in a group of three to five students when preparing these assignments. Each group should hand in only one set of answers. Each group member will receive the same grade on an exercise, and each is expected to make a significant contribution to the solution of every problem.

1 Capital Market Theory 3
2 Security Analysis 5
3 Futures Problem 4
4 Simulation Based Option Problem 5
5 Performance Attribution 3
Total 20
Both mid-term and final exams are in-class, closed-book and closed-notes. The mid-term will be given after lecture 11, and the final will be given during the scheduled final examination date (after lecture 24).

Unlike the group assignments, you may not work on the exams in groups. If you have to miss the exams due to medical reasons, please contact me before the exams.