Investments, 10th Edition_2

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nvesmns

TENTH EDTION

ZVIBODE

Boston University

ALEX

KANE

University of California, San Diego

ALANJ.MARCUS

Boston

College

Mc

Graw

Hill

Education



Contents

4.1

4.2

3.3

The

Rise

of Electronic

Trading 68

3.4

U.S.

Markets 69

N AS D AQ

/Th e

N e w Yo r k S to c k E x c h a n g e / E C N s

3.5

New Trading

Strategie: 71

Algor i thmic T ra d in g H ig h - F req u en c y

T ra d in g

/

D a rk

Poo ls

/ B o n d

Tr ad i ng

3.6

Globalization

of

Stock Markets

74

3.7 Trading Costs

76

3.8 Buying on Margin 76

3.9 Short Sales

80

3.10 Regulation of

Secu rities M arkets 83

Sel f -Regu la t ion /

Th e S a r bane s -Ox l e y

Act / I n s i d e r T ra d in g

End of

Chapter M aterial 87 -91

CHARTER

4

Mutual

Funds and Other

Investment

Companies 92

Investment

Companies

92

Types

of

Investment

Companies 93

U n i t

Inves tment

Trust s

/

M a n a g e d I n v es tm en t C o m p a n i e s

/

Ot h e r

I n v es tm en t O r ga n i za t i o n s

C o m m i n g l ed F u n d s / Rea l Estate I n v es tm en t Trust s

( R EI Ts )

/ He d g e

F u n d s

Mutual Funds

96

Inves tment Pol ic ies

Mo n ey

M ar ke t F und s

/

Eq u i t y

F u n ds /

S e c t or F u n ds

B o n d F u n ds / I n t e r na t i ona l F u n ds /B a l a n c e d F u n ds

Assel

Al l oca t i on and

Flexible F u n ds / I n d e x F u n d s

H o n •

Funds Are

S o l d

Costs

of Investing in

Mutual

Funds 99

F e e

S truc ture

O p era t i n g Expe nse s /

F ro n t - E n d L o a d

/ Ba c k - E n d

L o a d

/ I 2 b- I Ch ar g e s

F e e s a n d Mu tu a l F und R e t u r ns

Taxation of Mutual Fund Income 103

Exchange-Traded Funds 103

Mu tual Fund Investm ent Performance:

A First Look

107

Information on Mu tual Funds

110

End

o f Chapter Material 112-116

4.3

4.4

4.5

4.6

4.7

4.8

P ART I I

Portfolio Theory

andPractica

117

5.1

Determinants of the Level of Interest Rates 118

Rea l a n d N o m i n a l R a t es

o f In teres t

/ T h e Equi l ib r in»

Rea l

Ra te

o f In teres t /The

E q u i l ib r iu m N o m in a l Rate

o f

In teres t / T a x es a n d th e Rea l

Ra te

o f

In teres t

5.2

Comparing

Rates of Return for Different Holding

Periods 122

Ar n u a l

Pe r c e n ta g e

Ra tes

/ Cont i nuous

C o m p o i m d i n g

5.3 Bills and Inflation, 1926-2012 125

5.4 Risk and Risk Premiums 127

H o ld in g - P er io d Re tu rn s

/ E xp ec t ed

Re tu rn a n d

Standard

D ev ia t i o n

/ Exce ss Re tu rn s a n d

Risk

P r e m i u m s

5.5 Time Series

Analysis of

Past Rates

of

Return

130

T im e

Ser ies v er s u s S c en a r io Analys i s / Expected

Returns

a n d

the Ar i thmet ic Average

/ T h e

G e ome t r i e

( T im e-

W e ig h ted )

Average Return

a r ia n c e a n d S ta n da rd

D ev ia t i o n /Mea n a n d S ta n da rd D ev ia t io n E s l im a te s

f r o m

H ig h er - F req u en c y

O b s erv a t i o n s T h e Reward- to -

Vola t i l i ty

( S h ar pe )

Ra t io

5.6

The N ormal Distribution 135

5.7 Deviations from

Normality

and Risk Measures 137

Value at Risk Expec ted Shor t fa l l L o w e r Par t ia l

S ta n da rd D ev ia t i o n a n d the S o r t i n o Ra t io / Rela t ive

Frequency o f L a r g e , N eg a t i ve 3 - S ig m a Re tu rn s

5.8 Historie Returns on Risky Portfolios 141

P o r t f o l i o

R e t u r ns /

A Glo b a l V iew o f

the

H is to r i c a l

Rec o rd

5.9

Long-Term

Investments

152

N o rm a l a n d L o g n o rm a l Re tu rn s / S i m u l a t i o n o f L o n i ; -

Term Future Ra tes o f R e tu rn / The Risk -Free

Rate

Rev is i ted

/

Wh e r e

Is

Res ea rc h o n Ra te s o f Re tu rn

H ea ded? / F or e cas t s f o r t h e Lo n g F l a u t

End of Chapter

Material 161-167

CH AP T E R 6

CHAPTER 5

Risk,

Return, and

the

Historical Record

117

Capital Allocation to Risky Assets 168

6.1 Risk and Risk Aversion 168

Risk, S pe cu l a t ion , a nd G a m b l i n g / R i s k A v ersio n a n d

Util i ty

Va lu es s t im a t in g Risk Avers ion

6.2 Capital Allocation across

Risky

and Risk-Free

Portfolios 175

6.3 The Risk-Free

Asset

177

6.4 Portfolios of One

Risky Asset

and a Risk-Free

Asset 178

6.5 Risk Tolerance

and

Asset

Allocation 182

N o n n o r m a l

R e t u r ns

6.6

Passive Strategies: The

Capital

Market Line

187

End of Chapter

Material

190-199

Appendix

A:

Risk Aversion, Expected Utility,

and

the

St.

Petersburg Paradox

199

I X



Contents

Appendix B:

Utility Functions and Equilibrium Prices

of

Insurance Contracts

203

Appendix C: The Kelly Criterion 203

CHAPTER7

Optimal

Risky

Portfolios

205

7.1

Diversiflcation and

Portfolio Risk

206

7.2

Portfolios ofTwo Risky Assets

208

7.3

Asset

Allocation with Stocks, Bonds, and

Bills

215

Asse t Al loca t ion wi th Two

Risky Asset Classes

7.4

The Markowitz Portfolio

Optirnization

Model 220

Secur i ty Se lec t ion / Ca p i t a l A l lo c a t i o n and the S ep a ra t i o n

Proper ty / The Power o f Divers i f lca t ion / Asset

Alloca t ion

a n d

Secur i ty S e l e c t i on /

O p t im a Por t fo l io s a n d

N o n n o r m a l R e tu r n s

7.5

Risk P ooling,

Risk Sharing, and the Risk

of Long-

Term Investments 230

Risk

Pool ing

a n d

t h e I n s u ra n c e P r in c ip l e

Risk

S h a r i n g

I n ve s tm e n t

fo r

the L o n g

R un

End of Chapter Material 234-244

Appendix A: A Spreadsheet Model for Efficient

Diversiflcation

244

Appendix

B:

Review

o f

Portfolio Statistics

249

CH AP T E R 8

Index Models 256

8.1

A Single-Factor

Security Market

257

T h e I n put

List o f t h e Markowi tz ,

M o d e l

/

N o r n n d i t x o f

Returns

a n d

Sys tema t ic

Risk

8.2 The

Single-Index

Model 259

The Regress ion Equa t ion

o f t h e S in g le - In dex M o d e l

/

T h e

Expec ted R e t u m - B e t a

Relatio n.ship / Risk

a n d

C o v a r ia n c e i n the S in g le - In dex M o de l

/ T h e

Se t o f

E s t lm a te s

N e e d e d f o r

the S in g le - In dex M o d e l I he Index

M o d e l a n d

Divers i f lca t ion

8.3 Estim ating the Single-Index Model

264

T h g

Sccun'fv

CfKircictcrisnc Line/or Hcwfrlf-Pm bird /

Power

o / V A e

6'CAJbr

/ff

//W/mw

o f Va r i a n ce

/ The Es t ima te

o f

A lp h a /

T h e E s t im a l e

o f

Be ta

Firm-Spec i j ic Risk / C o rre la l i o n and

C o v a r ia n c e

Matr ix

8.4

Portfolio

Construction and the Single-Index

Model

271

-Smg/e-Wgf-AWc'/ U.\r/

T h e

O p t im a l Risky Por t fo l io

in

the S ing le- Index Model /

Procedure

n

E xa m p le

/W

Premwm fbrecosW/TTif

OpfwW

8.5 Practica Aspects of Portfolio Management with the

Index

Model

278

/ / w

f/ir /

"//

( ,'i

M od e l ' . ' / Th e

Im lu s i r y Vers ion

o f l l i e

l nde\ M o di

I

•

l ' red ic l ing Betas /

Index M od e l \ a n d

I r a e k i n l ' o , t I » l i < "

End of Chapter

Material

284 -290

PART

III

Equilibrium

in

Capital

Markets

291

CHAPTER

9

The Capital

Asset

Pricinjj

Model 291

9.1 The Capital Asset

Pricing Model

291

W h v Do Al l Inves to rs I loh l the M a r l i

l

P . > / t < > l n

The Pass ive S l ra t eg v I s l . f f n i en t / /h e R i s k / ' / <

n n tn n

.

the Marke t l ' or t fo l ' t o /

.xpected R i

tu

m s

o n

I n d t i

id in ,

Sec t t r i t ies / The

S ec u r i t y

M a r k e t

l

. i n e

.

I

I n

( Al'\l

the S in g le - In dex M a r k e t

9.2 Assumptions

and Extension* ofthe

( AI'M

3 1 ) 2

AsMtnip t ions o f t h e C'A/'M / < h a l l e n \ a n , . ' I \ t,

> :

M . " -

to the

C 'A/ 'M /

I he / c r o - B c t a Mo,l , / I a h o i / < < ,

a n d

N o t u r a d e d . \s\et\

/

\

Mnli i /n no, I M o d •

i

,;na II, ,

l ' or t jo l ios

/ C o n s i n n / i u o n Bits,

d ( '

\l'\l I

n i m m : -

t h e CAPM

9.3 The CAPM and the Acadcmic

World

313

9.4

I

he CAPM

and

Ihe Investment

Iiidu.stry

315

End

of Chapter Material 316-323

CHAPTER 10

Arbitrage

Prieinj» Theoi-y

and

Multifactor Models

of Risk

and

Return

324

10.1 M ultil'actor M odels: An

()>er\ie« 325

l a c t o r M o d e l s o j

S < uri i \

Re t io n s

10.2

Arbitrage Pricing Theory 327

Arbi trage,

R i s k

Arh i trage, „ m l

I

, / « < / < / >

I I I I I J

U ,

, 7

Divers i j ied

l ' or t jo l ios

/

I

)t\ei

s i / n

- , / / / ,

> / ;

a n d

R ,

s

,'

,

in l ' rae l i ee /

Execu t ing Arb i trage

/

Ihe

A l b u i n e ,

Et/ t ini ion o f t l n -

AI'

I

10.3

The

API,

the CAPM .

and the

Index

Model

334

The

AI'

I ' a n d

th e

(

'AI 'M

/ I he

A I ' 1 a n d /»,</.*/..

O p th n i za t i o n in a S in g le l n dc \ M a i k e t

10.4

A Multifactor

APT

338

10.5 The Kama-French (11) Three-Iaclor

Model 3 4 1 )

End of Chapter

Material

342-348

X



Contents

CHARTER

11

The Efficient

Market

Hypothesis

349

11.1

Random

Walks

and

the Efficient Market

Hypothesis

350

C o m p e t i t i o n a s t h e S our ce o f E f f i c i en c y / Vers io n s o f the

Ef f ic ien t Marke t Hy po t h e s i s

11.2 Implications

of the EM H

354

Technica l

Anat y s i s F u n d a m e n t a l Anal y s i s / A c t i v e

versus Pass ive

P o r t f o l i o M a n a g e m e n t / Th e

R o l e

o f

P o n f o l i o M a n a g e m e n t

i n a n E f f i c i en t Ma rk e t / R e s o u r c e

Al l oca t i on

11.3

Event

Studies 359

11.4 Are

Markets Efficient?

362

The

Issues

T h e

Ma g n i tu de I s s u e / Th e S e l e e t i on Bios Issue

/

Th e

Luc k y E ve n t Issue

Wenk-Form Tes ts : Pat t e r ns

in

S to c k Re tu rn s

Re tu rn s

ove r S h or t H or i z ons /

R e t u r ns

ove r L o n g

H o r i zo n s

Pred ic to rs o f B r o a c l M a r k e t R e t u r ns /

S em is t ro n g T es t s :

Marke t A n o in a l i e s

The S mal l -F i r m- i n -Ja i mar y

Effec t

/

T h e

N e g l e c t e d -

F i r m

Effect a n d

Li q u i d i t y Effec ts / B ook- t o -M ar ke t

Ra t io s / P o s t - E a r n i n g s - A n n o u n c e m e n t Price Dri f t

S t r a n g - F o r m Tes ts : Ins ide

I n f o r m a t i o n / I n t e r p r e t i n g

the

Anoina l ies

R i s k P rem iu m s o r Ine f f i c iencies?

/ An o i n a l i e s

o r D a t a

Min ing ' . ' / Anoi na l i e s

o v e r

T i m e

Buhb les

a n d Ma rk e t

Ef f i c iency

11.5

Mutual

Fu nd and A nalyst

Performance

375

S t o c k Marke t Ani d vs t s

/ M u t ua l

F u n d

M a n a g e r s

/So,

Are

Marke ts

Efficient'.'

End

of

Chapter

Material 380-387

CHARTER 12

Behavioral Finance

and Technical

Analysis 388

12.1 The

Behavioral

Critique

389

I n fo rm a t io n P ro c es s in g

Forccas t ing E r r o r s / Ove r con j i d e nce / Con se r va t i sm /

Sample S ize

Neglec t and R e pr e se n t a t i v e ne ss

Behaviora l Bia s c s

F läm in g

/

Men ta l

Accoun t i ng /

Reg re t A v o ida n c e

P r o s p e c t Theory

Limi ts tu Arbi trage

F u n da m en ta l Risk / I m p l e m e n t a t i o n

Cos t s

/ M o d e l

/W

Limi ts

to

A rb i tra g e a n d th e La w

o f

O n e P r i c e

" S i ame se T w in " C o m p a n i e s /E q u i t y C a r v e - O u t s/

Cl ose d -End F u n ds

Bubb les a n d Beh a v io ra l

E c o n o m ic s

/

Evaluat ing the

Beh a v io ra l C r i t iq u e

12.2

Technical

Analysis and Behavioral Finance 400

Trends a n d C o rrec t i o n s

M O m e n t u m

a n d

M o v in g Ave r a g e s /

Rela t ive S treng th /

Brea d th

S en t im en t I n d ic a to r s

Tr in

Stat is t ic / C o n f iden c e

I n d e x / P u t / C a l l

Ra t io

A

W a r n in g

End

of Chapter

Material 407-413

CHAPTER13

Empirical Evidence on Security

Returns

414

13.1

The Index

Model

and

the

Single-Factor APT 415

The Expected

R e t u r n-B e t a

Re la t i o n s h ip

Set t ing U p

the

S a m p le D a ta

/

Est imat ing the

S C L /

E s t im a t in g

t h e SM L

Tests of the

C A P M

/ T h e Marke t Index / Mea s u rem en t

Error in Be ta

13.2

Tests of the Multifactor

CAPM

and APT

421

La b o r

I n c o m e

/

Priva te

( N o n t ra ded ) B u s in es s / Ear ly

Vers ions o f t h e

Mu l t i f a c to r

C A P M a n d

A P T /

A M a c r o

Fac tor Mo de l

13.3

Fama-French-Type

Factor Models 426

Size a n d B/M a s Risk Fac tors / Beha v i o r a l E x p la n a t i o n s /

M o m e n t u m :

A

Four th

Fac tor

13.4 Liquidity and Asset

Pricing

433

13.5 Consumption-Based

Asset

Pricing

and the

Equity

Premium

Puzzle 435

C o n s u m p ti o n G r o w t h a n d Marke t Rates

o f

Re tu rn

/

Expec ted versus

Real ized

Returns / Surv ivorsh ip Bias /

Extens ions

to

t h e C A P M

M a y R e s o l ve

the Equ i ty Pr e m ium

Puzzle

/ L i qu i d i t y

a n d th e Equi ty

Pr e m ium Puz z le /

B e h a v io r a l E x p la n a t i o n s o f t h e E q u i t y P rem iu m Puzzle

/

End

of Chapter

Material

442-444

PART

IV

Fixed-Income Securities 445

CH AP T E R 14

Bond

Prices and

Yields 445

14.1 Bond Characteristics

446

Treasury

Bo n ds

a n d

N o tes

X I



Contents

AccnW Meresf (W

ßwoW f nee.;

Cor por a t e B ond s

Cal l Provi s ions o n

Cor por a t e

B o n d s / Conver t ib le

B ond s

/

Put table

Bo n ds / Fl o a t i n g -Ra t e

B o n d s

fre/grWAoc* f A e f

Domesüc

nfemaOono/

B ond s

/

I nnova t i on

in the

B ond M ar ke t

Inverse Floaters

/Asse t - B acked

B o n d s

/

Cat as t r oph e

B o n d s /

Indexe

d B o n d s

14.2 Bond

Pricing

452

B ond Pr i c i ng be t we e n Coupo n D a t e s

14.3 Bond Y ields 458

Yield t o Ma tur i ty

/

Yield to Cal l

/

Real i zed C o m p o u n d

Re tu rn

versus

Yield

to Matur i t y

14.4 Bond

Prices over Tim e

463

Yield

t o M a t u r it y v e r sus Ho l d i ng -Pe r i od R e t u rn

/

Ze r o-

C o u p o n B o n d s a n d Treasury

Str ips /Af ter-Tax

R e t u r ns

14.5 Default Risk and Bond

Pricing

468

Junk B ond s

/

D e t e r m i na t u s

o f B o n d

Safe ty

/

B o n d

Indentures

S ink ing Funds /

S ubor d i na t i on

o f

Fur ther

D eb t /

Dividend Rest r i c t ions

/

Col l a t e r a l

Yield to Matur i t y a n d Defaul t Risk / Cred i t Defau l t

S waps

/

Cred i t R i sk and

Col la tera l i zed

Deb t O b l i ga t i o n s

End o f

Chapter

Material 479-486

C HA PTER

15

The

TermStructure

of

Interest

Rates 487

15.1

The

Yield

Curve

487

B o n d Pr icing

15.2 The

Yield

Curve

and Fu ture Interest

Rates 490

The Yield

Cur ve

u n der Cer t a i n ty /

Ho l d i ng -Pe r i od

Returns

/ F o rw a rd

R at e s

15.3 Interest Rate Uncertainty and

Forward

Rates 495

15.4 Theories

of

the Term Structure

497

The Expectat ions H ypothesi s / L iquid i t y Pre ference

15.5 Interpreting

the Term Structure 501

15.6

Forward Rates as Forward

Contracts

504

End o f Chapter Material

506-514

C HA PTER

16

Managing

Bond Portfolios

515

16.1 Interest

Rate

Risk 516

In teres t Rate Sen si t i v it y

/

D ur a t i on

/ W h a t

D e t e r m i ne s

D ur a t i on?

7

Dwrafion

w / e 2 /or D w r a w o n

w / c

j

/br Dwwf/o«

//Mf 4 /er

Dwraüo/z j or

D ur a t i on

16.2 Convexity 52 5

W h x

D o

Investors

L i k c Co n vex i t y ' /

D ur a t i on

a n d

Convexi ty o f C a l l a b l e B o n d s /

D ur a t i on

a n d ( ' onvc\ i t \

< > l

M o r t ga ge -Ba c k ed S e t - u

r i t te

16.3 Passive Bond

Management

533

Bo n d- I n dex Fu n ds / Imin i in iza t ion / C a s h H o ir Malchin ' :

a n d Ded i c a l i o n

/

Oll icr

Pr ob l e ms

will i

( ' o i i v cn l i ona l

I numi n i z a t i on

16.4

Active

Bond Management 543

S our ce s

o f

Potent ia l

Prof i t

/ Ho r i zon Ana l y s i s

End of

Chapter Material 545-556

PART V

Security

Analysis

557

CHAPTER 17

Macroeconomic and

Industry

Analysis

557

17.1

The

Global Ec onom y 558

17.2 The Domestic

Macroeconomy 560

17.3 Demand

and

Supply Shocks 562

17.4

Federal Government

Policy 563

Fisca l Pol icy / M o n e t a r y l ' o l i cv

/

Snppl\ S n h l ' o l i , i, s

17.5

Business Cycles 566

Th e Bu s i n es s Cyc l e / E c o n o m i c Im H c a to r s

/

O t h c r

I nd i ca t o r s

17.6

Industry

Analysis 571

D e f in i ng an Indus t ry / Sens i t iv i ty l o the B u s i n e ß ( I ,

S e c t or R o t a t i on

/ Indus t ry Li te

(

'vcles

Shir t -Up

S t e i g e / C o n s o l i d a l i o n

S ta^ c / M o n o il\ S ,

R e l a t iv e D e i Tme

Indust ry

Struc ture

a n d P e r f o r m a n c e

1

hreat

o f I j i t rv / Ri va l r v hc l w c en

I \isim( oin ju n

t or s / Pressure f r o m Subs t i tu te Product s / B a i •g ,a i im

P o w er o f l i uy c r s / Bargainini : P o w er , » /

S i ipph ,

i \

End o f


CHAPTER 18

Equity Valuation Models 591

18.1

Valuation

by

Comparables 591

L i m i t a t i o n s o f B o o k Vidue

18.2 Intrinsic

Value versus Market Price 593

18.3

Dividend Discount

Models 595

Th e C o n s l a n l - C r o w t h

D D M

/

Co n vc r gc n c e

o l

1 ' i n ,

t o In t r ins ic Va lu e / S tock Pr ices

< m d

I n ves t m en t

O p p o r t u n i t i e s

/ L i f e C y c les

a n d M u l t i s t a ge C n n M h

M o d e l s / M u l t is t ag e C r o w t h M o d e l s

xii



Contents

18.4 Price-E arnings Ratio 609

The P r i c e - E a m i n g s

R a t i o

a n d Growth Oppor tun i t i e s

/

P/E Ra t i o s a n d S t o c k R i s k /

Pi t fa l l s

in P / E Ana ly s i s /

C o m b i ni l ig

P/E A n a l y s i s

a n d t h e

D D M

/ Oth er

C o m p a r a t iv e V a l u a t io n

R a t i o s

P r i c e - t o -Bo o k R at io / Pr i ce - t o - C ash - F low R a t i o /

Price- to-Sa les R a t i o

18.5 Free Cash

Flow

Valuation

Approaches

617

C o m p u t i n g

the

V a l u a t i o n

M o d e l s / T h e P r o b l e m wi th

18.6

The A ggregate

Stock Market

622

End

of

Chapter

Material

623-634

CHAPTER

19

Financial Statement Analysis 635

19.1

The

M ajor Financial Statements

635

The

I n c o m e

S ta t emen t /

T h e

B a l a n c e S h e e t / T h e

S t a t e me n t o f

C a s h E l o w s

19.2

Measuring

Firm

Performance

640

19.3

Profitability

Measures 641

Re tu rn o n Assets, R OA / R e t u r n o n C ap i ta l , R O C /

Return

o n

E c / u i t y , R O E /

Fi n a n c i a l L eve r a ge

a n d R O E /

E c o n o m i c Va h te Added

19.4

Ratio

Analysis 645

Dec o m p o s i t i o n o f R O E / Turnov er and O th er Asse t

UtiUzat ion Ra t i o s / L iq u id i t y R a t i o s / M a r k e t P r i c e

Rat ios: Gr o w t h ve r s u s Va l u e / C h o o s i n g

a

B e n c h m a r k

19.5 An

Illustration of

Financial Statem ent

Analysis

655

19.6

Comparability Problems 658

I n ven t o n Va l u a t i o n / Deprec ia t i on /

I n f l a t i o n

a n d In teres t

Fxpense / F a i r V al ue Accoun t i ng / Qua l i t y o f E a r n i n g s

and

Accoun t i ng

Prac t i ces / I n t e rna t i ona l

Ac c o u n t i n g

Conve n t i ons

19.7 Value Investing:

The Graham Technique

665

End o f Chap ter Material

665-677

PART

V I

Options

Futuresand

Omer

Drivatives678

CHARTER 20

Options Markets: Introduction

678

20.1 The O ption Contract

679

Opt i ons

Trad ing

/ A m e r i c a n

a n d E u r o p ea n

O p t i o n s /

Adjus tments in

O p t i o n C o n t r a c t T e r m s / The

O p t i o n s

Cl e ar i ng

C o r p o r a t i o n

/

O t h e r

L i s t ed

O p t i o n s

Index O p t i o n s / Futures

Op t i ons

/ F o re ig n Cur r e ncy

O p t i o n s

/ In teres t Ra te

Opt i ons

20.2 Values

of Options

at Expiration 685

Cal l O p t i o n s / P u t O p t i o n s / O p t i o n versus S tock

Inves tments

20.3 Option

Strategie«

689

Protec t ive

Pu t

/

Cove r e d

Cal ls

/

St radd le

/

Sp r ea ds

/

Co l l a r s

20.4

The Put-Call Parity Relationship 698

20.5 Op tion-Like Secu rities 701

Ca l l a b le Bo n ds

/

Con ver t ib le Secur i t ies /

Wa r r an t s /

Col la tera l i zed Loans

/

Levered

Equi ty

a n d R i s k y Debt

20.6

Financial Engineering 707

20.7 Exotic Options 709

Asian

O p t i o n s

/ Ba r r i e r

O p t i o n s

/

Lookback O p t i o n s /

Cur r e ncy -Tr ans l a t e d

O p t i o n s / D i g i t a l O p t i o n s

End of Chapter Material

710-721

C H A P T E R

21

Option Valuation 722

21.1 Op tion V aluation:

Introduction

722

In t r ins ic and T i me V a l ues / Det e r m i n a n t s

o f

O p t i o n Vahles

21.2 Restrictions on Option Values 725

Res tr ic t ions on the Value

ofa

Cal l O p t i o n /

Ear l y

Exe re ise

and D i v i d end s

/

Ear ly Exe

re ise o f Am er i c a n Pit ts

21.3 Binomial Option Pricing 729

Two-State O p t i o n Pr i c i ng

/ Genera l i z ing

the Two-State

Appr oach

/

M a k i n g t h e V a l ua t i on M o d e l Pr ac t i ca l

21.4

Black-Scholes Option Valuation 737

The Black-Scholes F or mu l a / Di v i den ds a n d Ca l l O p t i o n

V al ua t i on

/ Put O p t i o n

V al ua t i on /

Dividends

a n d

Put

O p t i o n

V al ua t i on

21.5

Using the

Black-Scholes Formula

746

He d g e

Ra t i o s a n d

the B lack-Scholes

F o rm u la / Port fo l io

I n su r ance

/ O p t i o n Pr icing

and t h e

Cris i s o f 2008-2009 /

O p t i o n Pr i c i ng a n d Por t fo l io Theo r y

/

He d g i ng B e ts on

Mispr iced

O p t i o n s

21.6

Empirical

Evidence

on Option Pricing 758

End

of

Chapter

Material 759-769

C H A P T E R 22

Futures Markets 770

22.1

The Fu tures Contract 771

The Bas ics

of Futures Co n t r a c t s / Exis t ing Co n t r a c t s

22.2 Trading Mechanics 775

The C l ea r i n gho u s e

a n d

O p e n Interest / The

M a r g i n

Ac c o u n t a n d

M a r k i n g

to M a r k e t / Ca s h ve r s u s

Actual

Del ivery / Regu l a t i o n s /

Taxa t i on

xiii



Contents

22.3

Futures

Markets

Strategies 781

fWging (W ßo.m

'""V

22.4

Futures Prices 785

T h e Spot -Futures Par i ty T h e o r e m / S pr e ad s / Forward

versus Futures Pr ic ing

22.5 Futures

Prices

versus Expected

Spot Prices

791

Expe c t a t i ons H y po t h e s is

/

N o r m a l B u c k w a r d a t io n

/

C o n t a n g o /

Mo dern P o r t f o l i o Theo r y

End o f

Chapter Material

793-798

C H A P T E R 23

Futures, Swaps, and Risk Management

799

23.1 Foreign Exchange Futures 799

T h e

M ar ke t s

/ In teres t Rate Par i ty / Direc t versus Indirec t

Q uot e s /U si ng

Futures

to

M anag e Exch ang e Ra te R i s k

23.2 Stock-Index

Futures 806

T h e

Co n t r a c t s

/

Creat ing Synthe l i c S tock Posi t ions:

A n

Assel Al l oca t i on Too l / Index Arbi t rage / U s in g I n dex

Futures

to

He d g e M a r ke t Risk

23.3 Interest Rate Futures 813

Hedg ing In teres t Rate

Risk

23.4 Swaps 815

S waps an d B a l ance S h e e t R e s t r uc tu r i ng / Th e S wap

Dealer

/

Ot h e r

In teres t Rate

Cont r ac t s

/

Siva/i P r ic in g

/

Cred i t Risk

in

the S w a p Market /

Cred i t

Defaul t

S w a p s

23.5

Commodity Futures Pricing

822

Pric ing

wi th

S torage

Cos t s

/

D i scoun t e d Cash

F l o w

Anal y s is f o r C om mo d i ty F u t u r e s

End o f Chapter Material

825-834

PART VII

Applied

Portfolio

Management 835

C HA PTER 24

Portfolio Performance Evaluation 835

24.1 The Conventional

Theory

o f Performance

Evaluation

835

Average

Rates

o f

R e t u r n / T i m e - W e i g h t e d Returns versus

Dollar-Weigh ted

Returns

/ Dollar-

We i g h t e d R e t u rn an d

Investment P er fo rm a n c e /Ad j u s t i ng

R e t u r ns f o r

Risk /

T h e M

2

M e asur e o f Pe r f o r mance

/ Sharpe' s

R at i o I s

Cnfcnonyor

Overa// /X/ywpnoff

M e o a u re . ? rn T W o Sccfinno.?

Jane s

Por t fo l io Represent s Her

Ent ire

Risky

Inves t

me nt

Fund /

Jane

's

Choice Por t fo l io I s O n e

o f 'M a n x

Por t fo l ios

C o m b i n ed i n t o

a L a rg e

I nve s t me n t

F u n d

Th e

Ro le o f

Al ph a

in

P e r f o r m a n c e

Mcu.su rcs /Ae iua l

Pe r jor munce M ca sur e inc i i t:

A n l:.\ti/nplc

/

l ' c i lo i

i n t im

<

M a n i p u l a t i o n

and i h e

M o n u n g s t a r

l\i\k Adji tslci l

Riiiur,:

Retd izcd Re turns

v e r x i i . s l ' .xpected Ren a l i s

24.2 Performance Measurement for Hedge Funds

851

24.3

Performance Measurement with Changing

Portfolio

Compositum 854

24.4 Market Tuning

855

The P o l e n l ia l V a l u e o j M ar kc l I n n in g / \ a l m n e Ma rk e

' I imii lg a s ( I

Call

Opl iou / The

\ 'ulue o j

h n p e r l a /ore i ustm::

24 .5 Style Analysis 86 1

S l v le Ana l v s is a nd M i d t i j a c t o r

l ic i ichinarks

/ Sivlc

Anal y s i s

in Exce l

24.6 Performance

Attribution Proccdurcs

864

Asse t Alloca t ion

D e c i s i ons

/ S e i

l o r

u n d S t •c itrus S c l c c i w u

Decis ions / S un in i i ng U p

Coi i i pone n l

(

oi i i r i l 'u t ions

End of

Chapter Material

870-881

CHAPTER

25

International Diversiflcation 882

25.1

Global Vlarkets for Equ itics 883

D e ve l ope d

Co u n t r i e s / Frncrg ing Ma rk e t s / M a r k e

Ca p i t a l i z a t i o n

a n d

H D P / /Inn ie-Coi in t ry l l ias

25.2

Risk Factors in

International

Investing 887

Exch ang e

Rute R i s k /

l 'o l i l i ca l

R i s k

25.3 International

Investing: Risk,

Return, and Henellts

from

Diversifikation

895

Risk and R e t u rn : S u m m a r v

S t

U l i t

ii

v / Are

l n \es tn i en i s

in

E m erg in g M a r k e t s Riskier'. ' / Are Average Re turns

Hi g h e r

in E inerg ing Markets ' . '

/

I s

lAch u i i ^ e Rute R i s k

Impor ta l l t in I n t e r n a t i o n a l l ' o n j o l io s . '

/ l i cnc l i i s i r o m

Inlernul ionul

Divers i j ica l ion / Mislcut l ing R e p r e s e n h n n > n

o f

Divers i f l cat ion

U e u e j ' it s /

Reti l ist ic

l u m / i t s

I nun

I n t e r na t i ona l

Divers i j ica l ion

/ A r e

l ic i icfus I r u n i

I n t e r na t i ona l

Divcrs i j icu t ion

l ' i r . snvc t l

i n

l l ea r M ar k ,

t s '

25.4 Assessing the P otential o f International

Diversifikation 911

25.5

International

Investing and Performance

Attribution 916

Co n s l r u c t i n g

u

B e n c h m a r k

P o r t f o ho

o /

l o rc i ^ i i

Asseis

Per formance At t r ihut io i i

End

of


CHAPTER 26

Hedge Funds

926

26.1 Hedge

Funds versus

Mutual

Funds

927

26.2

Hedge Fund

Strategies 928

D i r e c ti ona l un d N o n d i r ec t i o n u l St rateg ies / Sta t i s t ica l

Ar b i t r ag e

X I V



Contents

26.3 Portable Alpha

931

An

Examp l e

of a Pure

P l a y

2 6 . 4

Style Analysis for Hedge Funds

933

26.5

Performance Measurement

for

Hedge Funds 935

Liquid i t y a n d He d g e F u n d P e r f o r m a n c e / H e d g e F u n d

Pe r f or mance a n d

S urv iv or s l i i p

Bi a s

/

H e d g e

F u n d

Pe r f or mance

a n d

C l u i n g in g F a c t o r L o a d i n g s

/

T a i I E ven t s

und He d g e F und P e r f o r m a n c e

2 6 . 6 Fee Structure

in Hedge

Funds 943

End

of


CHAPTER 27

The Theory of

Active

Portfolio

Management 951

2 7 . 1 Optimal

Portfolios

and Alpha Values 951

Eorccas ts o f Al p ha Va h l e s a n d

E x t r e m e

Por t fo l io

W e i gh t s

/

Rest riet

i on o f B e n c h m a r k Risk

2 7 . 2

The Treynor-BIack Mod el

and

Forecast Precision 958

Adj i t s t ing Forecast s

f o r

t h e P r ec i s i o n o f A l p h a /

Dist r ibut ion of Al p ha Va l u es

/

Or g an i z . a t i ona l S t r u c t u r e

u n d P e r fo r m a n c e

27.3

The

Black-Litterman

Model 962

Black-l . i tt er inan Asse l A l l o c a t i o n Dec i s i o n / S t e p 1 : The

Co va r i a n c e M a t r i x

f ron t

H is to r i ca l D a t a / S t ep

2:

Det e r m i n a t i o n

o f

a Hasel i ne F or e cas t / S tep 3: In tegra t ing

the M a n a ger ' s P r i va t e V i ew s /Step 4 : Rev i s ed

(Pos t er i o r )

Fxpectat ion s /

Step

5: P o r t f o l i o O p t i m i z a t i o n

2 7 . 4 Treynor-Black versus Black-Lit terman: Complements,

Not

Substitutes 968

The H l . M o d e l a s h i ng o n t he T B C a k e / W h y N ot Rep l a c e

the

Emi r e I

i i Ca k e w i t h t h e B E h

i ng

?

27.5 The Value of

Active

Management 970

A M od e l f o r the E s t i m a t i o n o f

Pot e n t i a l

Fees

/

Resu l t s

f r o n t

the

Di s t r i b u t i o n o f Act t ta l I n f o r m a t i o n R a t l o s /

Resu l ts f r o m Di s t r i b u t i o n o f

A l

l n a

F or e cas t s

/ Res u l t s

with Rc a s o n a b l c l o r e c a s t i n g R e c o r d s

2 7 . 6 Concluding

Remarks

on

Active Management 972

Knd of

Chapter

Material 973-974

Appendix A: Forecasts

and Realizations o f

Alpha

974

Appendix

B:

The General Black-L itterman

Model

975

C H A P T E R

28

Investment Policy and the Framework

of

the CFA

Institute 977

28.1 The Investment M anagement Process

978

Objec t ives / l n d i v i du a l Investors / P ers o n a l Trust s /

M ut ua l

F u n d s

/ P en s io n

F und s

/ E n d o w m e n t F u n ds / E i f c

I n su r ance

C o m p a n i e s

/ N o n - L i f e

Insurance C o m p a n i e s /

B a n k s

28.2 Constraints

983

Liquid i t y

/ nve s t me n t Ho r i zo n /Regulat ions /

Tax

Co n s i de r a t i o n s /

U ni q ue N e e d s

28.3 Policy

Statements 985

S a m p l e

Pol icy S t a t em en t s

f or Individuell Investors

28.4 Asset

Allocation 992

Taxes and Asse t Al locat ion

28.5 Managing Portfolios of lndividual

Investors 994

H u m a n C a p i ta l

a n d

I n su r ance

/ Inves tment

in

Resident

e

/

S av i ng

f or R e t i r e me n t

and t h e Assump t i on o f Risk /

R e t i re me n t P l ann i ng M o d e l s / M a n a g e Yo ur

O w n

Por t fo l io

o r

Rely o n Others? /T a x S h e h e r i ng

The Tax-Defer ral Opt ion

/ Tax-Deferred

Ret i rement

P l ans / D e f e r r e d Annui t i es

/ Va r ia b le

and U n i ve r sa l

Life

I n su r ance

28.6 Pension Funds 1000

Def ined Co n t r i b u t i o n Pl ans

/

Defined

Beneßt

Plans

/

P en s io n

Investment S t rateg ies

Inves t ing

i n Equi t i es

/ W r o n g R e a s o n s to luvest in

Equi t i es

28.7 Investments

for the

Long

Run

1003

Target

Inves t ing and t h e Term S truc ture

o f

Bo n ds /

M aki ng S i mp l e I nve s tme n t Ch o i ce s

/ Inf lat ion Risk

a n d

Long -Te r m I nve st o r s

End of Chapter Material 1004-1014

REFERENCES TO

CFA

PROBLEMS 1015

GLOSSARY G-l

N A ME INDEX 1-1

SUBJECT INDEX 1-4

Investments, 10th Edition_2

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