CONTENTS
PART Ⅰ ELEMENTS OF INVESTMENTS = 1
CHAPTER Ⅰ INVESTMENTS: BACKGROUND AND ISSUES = 2
1.1 Real Assets versus Financial Assets = 3
1.2 A Taxonomy of Financial Assets = 4
1.3 The Investment Process = 5
1.4 Markets Are Competitive = 6
The Risk-Return Tradeoff = 6
Efficient Markets = 7
1.5 The Players = 8
Financial Intermediaries = 9
Investment Bankers = 11
1.6 Markets and Market Structure = 11
Direct Search Markets = 11
Brokered Markets = 11
Dealer Markets = 12
Auction Markets = 12
1.7 Recent Trends = 12
Globalization = 13
Securitization = 14
Financial Engineering = 16
1.8 Outline of the Text = 16
Summary = 17
CHAPTER Ⅱ FINANCIAL MARKETS AND INSTRUMENTS = 20
2.1 The Money Market = 20
Treasury Bills = 21
Bank Discount Yields = 22
Certificates of Deposit = 25
Commercial Paper = 25
Bankers' Acceptances = 26
Eurodollars = 26
Repos and Reverses = 26
Brokers' Calls = 27
Federal Funds = 27
The LIBOR Market = 27
Yields on Money Market Instruments = 27
2.2 The Fixed-Income Capital Market = 28
Treasury Bonds and Notes = 28
Federal Agency Debt = 29
Municipal Bonds = 31
Corporate Bonds = 33
Mortgages and Mortgage-Backed Securities = 34
2.3 Equity Securities = 35
Common Stock as Ownership Shares = 35
Characteristics of Common Stock = 36
Stock Market Listings = 36
Preferred Stock = 37
2.4 Stock and Bond Market Indexes = 38
Stock Market Indexes = 38
Dow Jones Averages = 38
Standard & Poor's Indexes = 41
Other Market Value Indexes = 42
Equally Weighted lndexes = 44
Foreign and International Stock Market Indexes = 44
Bond Market Indicators = 45
2.5 Derivative Markets = 46
Options = 46
Futures Contracts = 47
Summary = 48
CHAPTER Ⅲ How SECURITIES ARE TRADED = 53
3.1 How Firms Issue Securities = 54
Investment Banking = 54
Shelf Registration = 55
Underpricing = 55
3.2 Where Securities Are Traded = 56
The Secondary Markets = 56
The Over-the-Counter Market = 58
The Third and Fourth Markets = 59
The National Market System = 59
3.3 Trading on Exchanges = 60
The Participants = 61
Types of Orders = 61
Specialists and the Execution of Trades = 62
Block Sales = 64
Settlement = 64
3.4 Trading on the OTC Market = 65
3.5 Trading Costs = 65
3.6 Buying on Margin = 67
3.7 Short Sales = 70
3.8 Regulation of Securities Markets = 72
Circuit Breakers = 73
Inside Trading = 73
3.9 Mutual Funds and Other Investment Companies = 75
Mutual Funds = 75
Management Companies and Mutual Fund Investment Policies = 77
Unit Investment Trusts = 81
Commingled Funds = 81
Real Estate Investment Trusts (REITs) = 81
Summary = 82
CHAPTER Ⅳ INVESTORS AND THE INVESTMENT PROCESS = 87
4.1 Investors = 88
Individual Investors = 88
Professional Investors = 89
Pension Funds = 89
Life Insurance Companies = 90
Nonlife Insurance Companies = 91
Banks = 91
Endowment Funds = 91
4.2 Investor Constraints = 92
4.3 Objectives and Constraints of Various Investors = 94
Objectives = 94
Constraints = 94
4.4 Investment Policies = 95
Top-Down Policies for Institutional Investors = 97
Active versus Passive Policies = 98
4.5 Taxes and Investment Strategy = 100
Tax-Shelter Options = 100
4.6 Monitoring and Revising Investment = 102
Portfolios = 102
Summary = 103
PART Ⅱ PORTFOLIO THEORY = 110
CHAPTER Ⅴ RISK AND RETURN: PAST AND PROLOGUE = 111
5.1 Risk and Risk Premiums = 112
5.2 The Historical Record = 114
Bills, Bonds, and Stocks, 1926-1993 = 114
5.3 Asset Allocation Across Risky and Risk-Free Portfolios = 119
The Risky Asset = 119
The Risk-Free Asset = 121
Portfolio Expected Return and Risk = 121
The Capital Allocation Line = 123
Risk Tolerance and Asset Allocation = 125
5.4 Passive Strategies and the Capital Market Line = 125
Summary = 127
CHAPTER Ⅵ EFFICIENT DIVERSIFICATION = 133
6.1 Diversification and Portfolio Risk = 134
6.2 Asset Allocation with Two Risky Assets = 135
Covariance and Correlation = 135
The Three Rules of Two-Risky-Asset Portfolios = 139
The Risk-Return Trade-Off with Two-Risky-Asset Portfolios = 140
6.3 The Optimal Risky Portfolio with a Risk-Free Asset = 144
6.4 Efficient Diversification with Many Risky Assets = 147
The Efficient Frontier of Risky Assets = 147
Choosing the Optimal Risky Portfolio = 148
The Preferred Complete Portfolio and the Separation Property = 149
6.5 A Single-Factor Asset Market = 149
Specification of a Single-Index Model of Security Returns = 150
Statistical and Graphical Representation of the Single-Index Model = 151
Diversification in a Single-Factor Security Market = 153
Summary = 154
CHAPTER Ⅶ CAPITAL ASSET PRICING AND ARBITRAGE PRICING THEORY = 164
7.1 The Capital Asset Pricing Model = 165
Why All Investors Hold the Market Portfolio = 166
The Passive Strategy Is Efficient = 167
The Risk Premium of the Market Portfolio = 168
Expected Returns on Individual Securities = 168
The Security Market Line = 171
Applications of the CAPM = 172
7.2 The CAPM and Index Models = 173
The Index Model, Realized Returns, and the Expected Return-Beta Relationship = 173
Estimating the Index Model = 174
Predicting Betas = 176
7.3 The CAPM and the Real World = 177
7.4 Arbitrage Pricing Theory = 180
Arbitrage Opportunities and Profits = 180
Well-Diversified Portfolios and the Arbitrage Pricing Theory = 183
The APT and the CAPM = 185
Multifactor Generalization of the APT and CAPM = 186
Summary = 187
CHAPTER Ⅷ THE EFFICIENT MARKET HYPOTHESIS = 194
8.1 Random Walks and the Efficient Market Hypothesis = 195
Competition as the Source of Efficiency = 196
Versions of the Efficient Market Hypothesis = 196
8.2 Implications of the EMH for Investment Policy = 197
Technical Analysis = 197
Fundamental Analysis = 197
Active versus Passive Portfolio Management = 198
The Role of Portfolio Management in an Efficient Market = 199
8.3 Are Markets Efficient? = 200
The Issues = 200
Tests of Predictability in Stock Market Returns = 202
Predictors of Broad Market Movements = 204
Portfolio Strategies and Market Anomalies = 205
Scientific and Computing Power in Search of Abnormal Returns = 216
So, Are Markets Efficient? = 217
Summary = 219
PART Ⅲ FIXED-INCOME SECURITIES = 224
CHAPTER Ⅸ BOND PRICES AND YIELDS = 225
9.1 Bond Characteristics = 226
Treasury Bonds and Notes = 226
Corporate Bonds = 228
Preferred Stock = 230
Other Issuers = 231
9.2 Default Risk = 231
Junk Bonds = 231
Determinants of Bond Safety = 233
Bond Indentures = 234
9.3 Bond Pricing = 236
Review of the Present Value Relationship = 236
Bond Pricing = 237
9.4 Bond Yields = 239
Yield to Maturity = 240
Yield to Call = 241
Yield to Maturity and Default Risk = 243
Realized Compound Yield versus Yield to Maturity = 244
Yield to Maturity versus Holding Period Return = 245
9.5 Bond Prices over Time = 245
Zero-Coupon Bonds = 246
9.6 The Yield Curve = 249
The Expectations Theory = 249
The Liquidity Preference Theory = 251
Market Segmentation Theory = 252
A Synthesis = 252
Summary = 254
CHAPTER Ⅹ MANAGING FIXED-INCOME INVESTMENTS = 262
10.1 Interest Rate Risk = 263
Interest Rate Sensitivity = 263
Duration = 264
10.2 Passive Bond Management = 269
Net Worth Immunization = 269
Target Date Immunization = 270
Cash Flow Matching and Dedication = 275
10.3 Active Bond Management = 276
Sources of Potential Profit = 276
An Example of a Fixed-Income Investment Strategy = 279
10.4 Interest Rate Swaps = 281
Summary = 283
PART Ⅳ SECURITY ANALYSIS = 290
CHAPTER XI MACROECONOMIC AND INDUSTRY ANALYSIS = 291
11.1 The Global Economy = 292
11.2 The Domestic Macroeconomy = 294
11.3 Interest Rates = 296
Real and Nominal Rates of Interest = 297
The Equilibrium Real Rate of Interest = 301
The Equilibrium Nominal Rate of Interest = 302
11.4 Demand and Supply Shocks = 302
11.5 Federal Government Policy = 304
Fiscal Policy = 304
Monetary Policy = 304
Supply-Side Policies = 305
11.6 Business Cycles = 306
The Business Cycle = 306
Economic Indicators = 308
11.7 Industry Analysis = 310
Defining an Industry = 311
Sensitivity to the Business Cycle = 312
Industry Life Cycles = 314
Industry Structure and Performance = 316
An Example = 317
Summary = 319
CHAPTER XII EQUITY VALUATION = 323
12.1 Balance Sheet Valuation Methods = 324
12.2 Intrinsic Value versus Market Price = 325
12.3 Dividend Discount Models = 326
The Constant Growth DDM = 327
Stock Prices and Investment Opportunities = 330
Life Cycles and the Constant Growth Model = 333
12.4 Price/Earnings Ratios = 337
The Price/Earnings Ratio and Growth Opportunities = 337
Pitfalls in P/E Analysis = 340
Combining P/E Analysis and the DDM = 342
12.5 The Aggregate Stock Market = 342
Summary = 345
CHAPTER XIII FINANCIAL STATEMENT ANALYSIS = 351
13.1 The Major Financial Statements = 352
The Income Statement = 352
The Balance Sheet = 353
The Statement of Cash Flows = 354
13.2 Accounting versus Economic Earnings = 356
13.3 Return on Equity = 358
Past versus Future ROE = 358
Financial Leverage and ROE = 358
13.4 Ratio Analysis = 360
Decomposition of ROE = 360
Turnover and Other Asset Utilization Ratios = 363
Liquidity and Coverage Ratios = 364
Market Price Ratios = 365
13.5 An Illustration of Financial Statement Analysis = 367
13.6 Comparability Problems = 369
Inventory Valuation = 370
Depreciation = 371
Inflation and Interest Expense = 372
International Accounting Conventions = 373
Inflation Accounting = 373
13.7 Value Investing: The Graham Technique = 373
Summary = 374
CHAPTER XIV TECHNICAL ANALYSIS = 383
14.1 Technical Analysis = 383
14.2 Charting = 384
The Dow Theory = 384
Other Charting Techniques = 387
A Warning = 390
14.3 Technical Indicators = 391
Market Volume = 391
Put/Call Ratio = 393
Moving Averages = 393
Breadth = 394
Short Interest = 395
Odd-Lot Trading = 395
Confidence Index = 395
Relative Strength = 396
14.4 The Value Line System = 396
14.5 Can Technical Analysis Work in Efficient Markets? = 398
Self-Destructing Patterns = 398
A New View of Technical Analysis = 400
Summary = 400
PART Ⅴ DERIVATIVE ASSETS: OPTIONS AND FUTURES = 405
CHAPTER XV OPTIONS MARKETS = 406
15.1 The Option Contract = 407
Options Trading = 408
American and European Options = 410
The Option Clearing Corporation = 410
Other Listed Options = 411
15.2 Values of Options at Expiration = 414
Call Options = 414
Put Options = 415
Options versus Stock Investments = 418
The Put-Call Parity Relationship = 419
Option Strategies = 422
15.3 Option-like Securities = 428
Callable Bonds = 428
Convertible Securities = 430
Warrants = 433
Collateralized Loans = 433
Levered Equity and Risky Debt = 435
Summary = 435
CHAPTER XVI OPTIONS VALUATION = 442
16.1 Options Valuation: Introduction = 442
Intrinsic and Time Values = 442
Determinants of Options Values = 443
16.2 Binomial Options Pricing = 445
Two-State Options Pricing = 445
Generalizing the Two-State Approach = 449
16.3 Black-Scholes Option Valuation = 451
The Black-Scholes Formula = 451
Put Option Valuation = 455
16.4 Using the Black-Scholes Formula = 456
Hedge Ratios and the Black-Scholes Formula = 456
Portfolio Insurance = 457
16.5 Empirical Evidence = 462
Summary = 462
CHAPTER XVII FUTURES MARKETS = 468
17.1 The Futures Contract = 469
The Basics of Futures Contracts = 469
Existing Contracts = 470
17.2 Mechanics of Trading in Futures Markets = 473
The Clearinghouse and Open Interest = 473
Marking to Market and the Margin Account = 475
Cash versus Actual Delivery = 477
Regulations = 477
Taxation = 478
17.3 Futures Markets Strategies = 478
Hedging and Speculation = 478
Basis Risk and Hedging = 480
17.4 The Determination of Futures Prices = 481
The Spot-Futures Parity Theorem = 481
Spreads = 484
17.5 Financial Futures = 485
Stock Index Futures = 486
Creating Synthetic Stock Positions = 486
Index Arbitrage and the Triple-Witching Hour = 487
Foreign Exchange Futures = 488
Interest Rate Futures = 489
Summary = 492
PART Ⅵ ACTIVE INVESTMENT MANAGEMENT = 497
CHAPTER XVIII PERFORMANCE EVALUATION = 498
18.1 Measuring Investment Returns = 498
Time-Weighted versus Dollar-Weighted Returns = 499
Arithmetic versus Geometric Averages = 500
18.2 Risk-Adjusted Returns = 502
Comparison Groups = 502
Risk Adjustments = 503
Risk Adjustments with Changing Portfolio Composition = 507
18.3 Market Timing = 508
18.4 Performance Attribution Procedures = 509
Asset Allocation Decisions = 512
Sector and Security Allocation Decisions = 512
Summing Up Component Contributions = 512
Summary = 513
CHAPTER XIX INTERNATIONAL DIVERSIFICATION = 520
19.1 International Investments = 521
The World Market Portfolio = 521
International Diversification = 522
Exchange Rate Risk = 526
Passive and Active International Investing = 532
Factor Models and International Investing = 534
Equilibrium in International Capital Markets = 536
Summary = 537
Appendix: Real Estate = 541
Precious Metals = 541
Other Nontraditional Assets = 544
CHAPTER XX ACTIVE PORTFOLIO MANAGEMENT = 545
20.1 The Lure of Active Management = 545
20.2 Objectives of Active Portfolio = 547
20.3 Market Timing = 550
Valuing Market Timing as an Option = 552
The Value of Imperfect Forecasting = 553
20.4 Security Selection: The Treynor-Black Model = 553
Overview of the Treynor-Black Model = 553
Portfolio Construction = 554
20.5 Multifactor Models and Active Portfolio Management = 556
Summary = 557
