[MUSIC] Hi, I'm Professor Scott Weisbenner at the University of Illinois, and this is module 2 of my course on investments. So, I thought I'd start off this module with a question for you. So just take a step back and think, what location pops up when you think of the cradle of western civilization? The University of Illinois of course. All right, sorry for the plug. I'm mandated to say it. Think back farther, 2500 years farther in fact, to Greece, Greek civilization. And when we think of Greece, of course, we think of the Parthenon in Athens, Socrates, Plato, Aristotle, the Greek alphabet. And within the Greek alphabet, the two most important letters were put in the most prominent position, the first two slots, alpha and beta. Fast forward 2500 years to the world of finance today, alpha and beta still are very prominent. Okay, you don't trust me. Fine, just look here in the world of academics. Everyone is trying to generate alpha or at least write about people who are trying to generate alpha mutual fund performance and incentive to generate Alpha. Do hedge funds deliver alpha? Alpha is front and center on financial screen. So here, this is taken from Morningstar.com. We're looking at Fidelity Magellan Fund, we're looking at a regression analysis here with things like R-squared, beta, alpha here, alpha of- 2.4. Fidelity Magellan fund underperforming its benchmark by- 2.4% per year over the last ten years. Don't worry, the end of module 2, you'll be all on top of this. Beta is front and center. This was taken from the first screen on finance.yahoo. When you type in the Tesla motor stock sticker Tesla's beta 1.44, you can see this is a stock price as of May 2015. Whenever you look at this, I don't know if the price will be up or down, all right? Panera Bread, beta here much lower, 0.3. Why the difference? Panera way below 1. Tesla greater than 1 when it comes to beta. Why is beta so provocative? Are the reports of betas death premature? Is beta dead again? If beta is dead, where is the corpse? Very mysterious, and what? There's this thing called smart beta? We're going to address all these topics about the Capital Asset Pricing Model, developing it, interpreting it, and then implementing it in examples in Excel to evaluate the performance of various securities. All of this is happening in module 2. We already got the objectives and overview done by a trip back to Greece. I'm sorry, I have to admit after being a finance professor, I always wanted to be deep voice guy on a commercial, and I got my opportunity to kind of check that on the to-do list. Second topic, separation theorem of investments. So this you could view is like the John Bogle of Vanguard view of the world. The separation theorem of investments very elegant says that as an investor, all you have to worry about is breaking your portfolio between two funds, a risk-free asset fund like Treasury Bills and the market portfolio, okay? If you love risk, you'll invest a lot in the market. If you don't like risk, you'll invest most in Treasury Bills. But all investors are holding some combination of the market portfolio and the risk-free asset. Examples of reducing portfolio risk, how can you reduce the portfolio by adding more assets to it? And a key determination whether the answer is yes or no will be how correlated are these assets with each other? And we'll kind of go through a fun example with the gambling trip to Macau. And then finally, we're getting to the development of the Capital Asset Pricing Model, CAPM, dates back to the 1960s, still a gold standard at least of an introduction to asset pricing models and an introduction to more sophisticated asset pricing models. You really start with the CAPM, and for my money, it still has the best economic intuition behind it. Maybe that's why a lot of Nobel prizes in economics were awarded for people's work developing the Capital Asset Pricing Model in the 1960s. In section 2 to 5, we're going to do applications of the Capital Asset Pricing Model. Let's look at the stock returns at Coca-Cola, do a Capital Asset Pricing Model analysis of those returns to determine what should investors have as a benchmark return for Coca-Cola. How much has Coca-Cola surpassed or fell short of the benchmark established by the Capital Asset Pricing Model. Evaluation of the famous small-value stock investment strategy over the last 88 years, 1927 to 2014. So, we're looking at a group of stocks representing firms that are small in size, small market value of equity, but also have a high book to market ratio, like a small cement company. How do we view that investment strategy in a Capital Asset Pricing Model view of the world? And then we'll introduce this three-factor model as another way to evaluate the returns and the performance of strategies. And to build up on that, we'll have our assignment within this module. Assignment 3, this is a mystery, and you have to put your detective cap on for this one. I will give you three securities; I'll give you their returns over the last 20 years. So 240 months of returns by doing a Capital Asset Pricing Model regression analysis. By doing a three-factor model analysis, you're going to be able to tell at least the investment style the characteristics of this security and then maybe by looking at its performance, looking at the characteristics, you can actually identify what the mystery security is. And as always, I'll follow the assignment up with a discussion, and then finally, cap things off so we can look back, see what we've accomplished, review in section 28. For those of you who are taking this course for high engagement, who are taking the course to get University of Illinois credit, as always, we have supplemental materials for you in this module. Further practice with the Capital Asset Pricing Model and the three-factor model by evaluating the performance even more mystery security. So, once you're done with this, you're going to be very adept at interpreting what's alpha, what's beta? What are the various betas in the three-factor model represent, and how can we use them to identify the securities, evaluate performance? Practical knowledge and experiences that you'll take away from module 2, understanding the separation theorem of investments and why people like John Bogle at Vanguard say this is really kind of all you need to know, just keep life simple. Allocate assets across a couple funds, a risk-free fund, a stock market fund, let your risk aversion decide the asset allocation. Don't worry about trying to find the kind of needle in the haystack of active management, just do an allocation based on your risk aversion between Treasury Bills, risk-free asset in the stock market, the risky asset. We'll get an in-depth knowledge of the Capital Asset Pricing Model. What does alpha represent? What does beta represent? They were the first two letters in the Greek alphabet for a reason. They're the first two letters in finance for a reason. And we'll be very adept at understanding what they mean at the end of this module. And then finally, practice estimating and analyzing regressions with real-world data and interpreting what the various regression coefficients mean and employ about the security or asset that we're analyzing.