Luca Ghezzi

Financial Modelling and Management – Part II concerns the application of scientific tools to investment and funding activities that are also represented in terms of random cash flows. More precisely, it deals with some validated models and procedures that support decisions on the appraisal of companies; the management of portfolios according to the requirements in terms of liquidity, diversification, income/growth, risk/return. The presentation is both qualitative and quantitative. Emphasis is placed on data and procedures that are used or taken into consideration by financial advisors, financial analysts, and portfolio managers, e.g. of mutual or pension funds. Although coverage is neither exhaustive nor entirely up-to-date, it is rigorous; a broad set of useful and consistent notions is explained in the clearest possible form. Accordingly, students will learn which data to analyse and how to go about financial analysis and discretionary portfolio management, especially in connection with stocks, bonds, and exchange-traded funds. After outlining the stages and tasks of a portfolio management process, students will learn how to choose a strategic asset allocation in line with household age, goals, and risk tolerance; spot social, technical, economic/ecological, or political trends by following a top-down approach; look for mispriced stocks by relying on fundamental analysis, a bottom-up approach. As for equity research and value investing, students will focus on whether a listed company benefits from a sustainable competitive advantage and whether stock price and fundamental value are consistent. In doing so, Benjamin Graham’s, Philip Fisher’s, and Warren Buffett’s guidelines will be mentioned. A problem-oriented and hence multidisciplinary approach is adopted so that reference is made to the theoretical principles and practical notions of other related subjects such as business economics and applied statistics; due attention is paid to economic science, the main findings of selected empirical studies being summarised in the simplest possible form. Different anomalies and regularities of US financial markets are taken into consideration, as they lay the foundations for proficient portfolio management by both individual and institutional investors. In other words, stress is put on a business practice that is consistent with empirical evidence; the informational and fundamental efficiency of US financial markets is examined, with attendant neoclassical and behavioural interpretations being contrasted. As investment decisions are both rational and emotional, emphasis is placed on bounded rationality and cognitive biases leading to irrational exuberance and speculative bubbles. The author shares the belief with other Italian colleagues that a fruitful theory rests on a solid and practical basis, and vice versa. Accordingly, learning and retaining Financial Modelling and Management – Part II should be made easier by a twofold course of reading the theoretical one, concerned with analytical processes or statistical inquiries and their peculiarities; the operational one, focused on financial contracts, financial transactions, and business practice.

In 1971 floating exchanged rates replaced fixed exchange rates, originally agreed upon in 1944 in Bretton Woods. Since then both financial modelling and financial management have undergone an unprecedented development, fed and facilitated by the liberalisation and globalisation of financial markets, the diffusion of information technologies, the progress made by financial information services. This electronic book is consistent with such a development. It allows a twofold course of reading: the theoretical one as well as the operational one. The former is about analytical processes or statistical enquiries, whereas the latter is about financial contracts, financial transaction, and business practice. The approach is rigorous yet both practical and multidisciplinary, reference being made to business economics, industrial economics, and financial economics.

A divergence-based procedure is applied to trading in the S&P 500 stock index. Such a procedure has previously and successfully been applied to trading in foreign currencies. Performance is tested against a benchmark, i.e. a passive portfolio replicating the S&P 500 stock index; its robustness is also checked in a few subperiods. According to our numerical evidence, higher annualised mean returns, i.e. higher final portfolio values, as well as lower annualised standard deviations can be obtained in all subperiods. However, basic Montecarlo tests are failed. The on-line extension of the present off-line implementation is taken into consideration, as it is more suited for an operational use.

An efficient frontier model is derived within a problem of passive management. An aggregate portfolio is rebalanced annually to restore the percent weights of its strategic asset allocation; its annual total returns are assumed to be independent and lognormally distributed. Expanding on previous theoretical results, it is shown how a minimum-variance set based on simple returns turns into a minimum-variance set based on logarithmic returns. According to the attendant theoretical results, which have a general validity, inefficient portfolios based on simple returns cannot turn into efficient portfolios based on logarithmic returns, whereas efficient portfolios based on simple returns can also turn into inefficient portfolios based on logarithmic returns. In the latter instance, there can be two different qualitative patterns, both of which are portrayed by using historical data. Moreover, the shortfall constraint approach is extended to the case of lognormal portfolio returns. Each threshold return can be turned into a threshold accumulation that has the same shortfall probability; coeteris paribus, the more distant the time horizon, the smaller the shortfall probability. As our procedure is analytically tractable, it might be operationally useful, especially to financial advisors and institutional investors.

A partire dal 1971, anno di transizione dal regime di cambi fissi di Bretton Woods al regime di cambi flessibili, sia la Matematica sia la Tecnica finanziaria hanno attraversato una stagione di straordinario sviluppo, alimentato e facilitato dalla liberalizzazione e globalizzazione dei mercati finanziari, dalla diffusione delle tecnologie informatiche e telematiche, dai progressi compiuti dai fornitori di informazione finanziaria. Pur non rinunciando al rigore delle tradizionali trattazioni, gli Appunti di matematica e tecnica finanziaria sono più decisamente orientati alle applicazioni. Coerentemente con lo sviluppo menzionato più sopra, essi offrono una duplice chiave di lettura della disciplina: quella logica, relativa ai procedimenti analitici o empirici, e quella operativa, relativa a contratti, operazioni e processi finanziari. L’approccio è non solo pragmatico ma anche multidisciplinare, con riferimenti alla contabilità, all’economia industriale, all’economia dei mercati e de gli intermediari finanziari.

Technology-related intangible assets are considered, with emphasis being placed on the 4 main evaluation methods, i.e. the cost, market, income, and real option method. A concise overview of those methods is provided, with their strengths and weaknesses being contrasted. This lays the foundations of a case study about the financial evaluation of a patent. Resort is made to the income approach only, suitably expanded by performing a sensitivity analysis. As few forecasts prove critical, a range of feasible values can be obtained for the net present value of the patent. In other words, the usual outcome of the evaluation process is reached without using and reconciling one another different evaluation methods.

A steady state economy is considered and the equilibrium of its capital market is studied. Demand and supply are represented by means of two trade offs between average return and risk; both are met when equilibrium is attained. Some well known results about average return and risk are more readily obtained and new results about capital asset pricing are achieved. When prices are other than equilibrium ones, investors know how to perform portfolio selection so that convergence to equilibrium is assured. Insights are also taken into the link between book and market rates of return. Although microeconomically founded, the resulting model is as simple as the CAPM by Sharpe, Lintner, and Mossin.