Part 1 Background
1 Understanding Investments 1
An Overall Perspective on Investing 1
Establishing a Framework for Investing 3
A Perspective on Investing 4
The Importance of Studying Investments 5
Understanding the Investment Decision Process 9
Checking Your Understanding 14
Structuring the Decision Process 14
Important Considerations in the Investment Decision-Making Process 15
Checking Your Understanding 20
Organizing the Text 20
Summary 21
Questions 22
Spreadsheet Exercises 22
Checking Your Understanding 22
2 Investment Alternatives 24
Organizing Financial Assets 25
A Global Perspective 27
Nonmarketable Financial Assets 27
Money Market Securities 28
Checking Your Understanding 31
Capital Market Securities 31
Fixed-Income Securities 31
Checking Your Understanding 44
Equity Securities 44
Checking Your Understanding 50
Derivative Securities 51
A Final Note 53
Summary 53
Questions 54
Problems 55
Spreadsheet Exercises 55
Checking Your Understanding 56
3 Indirect Investing 57
Investing Indirectly 58
What is an Investment Company? 59
Three Major Types of Investment Companies 60
Checking Your Understanding 66
Types of Mutual Funds 66
Checking Your Understanding 72
The Net Asset Value per Share 72
The Details of Indirect Investing 73
Checking Your Understanding 78
Investment Company Performance 78
Investing Internationally through Investment Companies 83
The Future of Indirect Investing 84
Hedge Funds 85
Summary 86
Questions 87
Computational Problems 88
Spreadsheet Exercises 88
Checking Your Understanding 89
4 Securities Markets and Market Indexes 90
The Importance of Financial Markets 91
The Primary Markets 91
Checking Your Understanding 95
The Secondary Markets 95
Checking Your Understanding 101
Stock Market Indexes 101
Checking Your Understanding 108
Bond Markets 108
Derivatives Markets 109
The Globalization of Markets 109
Summary 110
Questions 110
Problems 111
Computational Problems 112
Spreadsheet Exercises 112
Checking Your Understanding 113
5 How Securities are Traded 114
Introduction 114
How Orders Work 118
Checking Your Understanding 122
Investor Protection in the Securities Markets 122
Checking Your Understanding 127
Margin 127
Short Sales 130
Checking Your Understanding 135
Summary 135
Questions 136
Problems 136
Computational Problems 137
Spreadsheet Exercises 137
Checking Your Understanding 138
Part 2 Portfolio and Capital Market Theory
6 The Risk and Return from Investing 139
An Overview 139
Return 140
Measuring Returns 141
A Global Perspective 147
Checking Your Understanding 150
Summary Statistics for Returns 150
Checking Your Understanding 154
Risk 154
Measuring Risk 156
Checking Your Understanding 160
Realized Returns and Risks from Investing 160
Compounding and Discounting 164
Summary 164
Questions 165
Demonstration Problems 166
Problems 167
Computational Problems 168
Spreadsheet Exercises 168
Checking Your Understanding 169
7 Portfolio Theory 171
Dealing with Uncertainty 171
Checking Your Understanding 176
Introduction to Modern Portfolio Theory 176
Portfolio Risk 179
Analyzing Portfolio Risk 179
Checking Your Understanding 181
The Components of Portfolio Risk 181
Checking Your Understanding 186
Calculating Portfolio Risk 186
Checking Your Understanding 189
Obtaining the Data 190
Summary 191
Questions 192
Problems 193
Computational Problems 194
Spreadsheet Exercises 194
Checking Your Understanding 195
8 Portfolio Selection and Asset Allocation 197
Building a Portfolio Using Markowitz Principles 198
The Global Perspective—International Diversification 201
Some Important Conclusions about the Markowitz Model 202
Checking Your Understanding 203
Selecting Optimal Asset Classes—The Asset Allocation Decision 203
Asset Allocation and the Individual Investor 211
Checking Your Understanding 216
The Impact of Diversification on Risk 216
The Implications of Reducing Risk by Holding Portfolios 219
Summary 219
Questions 220
Problems 220
Spreadsheet Exercises 221
Checking Your Understanding 223
9 Capital Market Theory and Asset Pricing Models 224
Capital Market Theory 225
Checking Your Understanding 229
The Capital Market Line 229
Checking Your Understanding 233
Systematic Risk and Beta 233
The Capital Asset Pricing Model (CAPM) 239
Checking Your Understanding 243
Arbitrage Pricing Theory 245
Checking Your Understanding 249
Other Prominent Factor Models 249
Some Conclusions about Asset Pricing 250
Summary 251
Questions 252
Demonstration Problems 253
Problems 254
Computational Problems 254
Spreadsheet Exercises 255
Checking Your Understanding 255
Part 3 Common Stocks: Analysis, Valuation, and Management
10 Common Stock Valuation 256
Overview 257
Discounted Cash Flow Models 258
The Dividend Discount Model 259
Checking Your Understanding 262
Growth Rate Cases for the DDM 262
Checking Your Understanding 273
Other Discounted Cash Flow Approaches 273
Checking Your Understanding 276
The Multiplier Approach 276
Other Multipliers 278
Relative Valuation Metrics 279
Which Approach to Use? 283
Bursting the Bubble on New Economy Stocks—A Lesson in Valuation 284
Checking Your Understanding 285
Some Final Thoughts on Valuation 285
Summary 286
Questions 287
Demonstration Problems 287
Problems 289
Computational Problems 290
Spreadsheet Exercises 291
Checking Your Understanding 291
11 Common Stocks: Analysis and Strategy 293
A Global Perspective 293
The Impact of the Overall Market on Stocks 294
Building Stock Portfolios 296
Checking Your Understanding 296
The Passive Strategy 296
Checking Your Understanding 301
The Active Strategy 301
Checking Your Understanding 311
Rational Markets and Active Strategies 311
A Simple Strategy: The Coffeehouse Portfolio 311
Summary 312
Questions 313
Problems 313
Computational Problems 313
Spreadsheet Exercises 314
Checking Your Understanding 314
12 Market Efficiency 315
Overview 315
The Concept of an Efficient Market 316
Checking Your Understanding 322
How to Test for Market Efficiency 322
Checking Your Understanding 327
Market Anomalies 327
Checking Your Understanding 335
Behavioral Finance 335
Checking Your Understanding 341
Some Conclusions about Market Efficiency 341
Summary 343
Questions 345
Problems 346
Checking Your Understanding 346
Part 4 Security Analysis
13 Economy/Market Analysis 347
Introduction 347
Taking a Global Perspective 348
Assessing the Economy 348
Checking Your Understanding 355
The Stock Market and the Economy 355
Checking Your Understanding 357
Understanding the Stock Market 357
Checking Your Understanding 360
Making Market Forecasts 360
Checking Your Understanding 363
Summary 367
Questions 367
Problems 368
Computational Problems 368
Spreadsheet Exercises 369
Checking Your Understanding 369
14 Sector/Industry Analysis 370
Introduction 371
What is an Industry? 372
The Importance of Sector/Industry Analysis 373
Checking Your Understanding 375
Analyzing Sectors/Industries 377
Checking Your Understanding 381
Using Sector/Industry Analysis as an Investor 383
Summary 387
Questions 387
Checking Your Understanding 388
15 Company Analysis 389
Fundamental Analysis 389
The Accounting Aspects of Earnings 390
Checking Your Understanding 397
The Problems with EPS 397
Checking Your Understanding 401
Using the Financial Statements to Analyze FCF, ROE, and EPS 401
Checking Your Understanding 406
Earnings Estimates 406
The Multiplier 410
Fundamental Security Analysis in Practice 414
Summary 416
Questions 417
Problems 418
Computational Problems 418
Spreadsheet Exercises 419
Checking Your Understanding 420
16 Technical Analysis 421
Introduction 422
What is Technical Analysis? 422
Checking Your Understanding 425
Stock Price and Volume Techniques 425
Checking Your Understanding 431
Technical Indicators 435
Testing Technical Analysis Strategies 437
The Ebb and Flow of Technical Analysis 439
Some Conclusions about Technical Analysis 439
Summary 441
Questions 442
Computational Problems 442
Checking Your Understanding 442
Part 5 Fixed-Income Securities: Analysis, Valuation, and Management
17 Bond Yields and Prices 443
Introduction 443
Bond Yields and Interest Rates 444
Measuring Bond Yields 451
Checking Your Understanding 457
Checking Your Understanding 459
Bond Prices 459
Bond Price Changes 461
Checking Your Understanding 465
Summary 465
Questions 466
Problems 467
Computational Problems 468
Spreadsheet Exercises 468
Checking Your Understanding 469
18 Bonds: Analysis and Strategy 470
Why Buy Bonds? 470
Important Considerations in Managing a Bond Portfolio 474
Checking Your Understanding 475
Bond Strategies and Techniques 475
Passive Management Strategies 476
Active Management Strategies 478
Managing Price Volatility 482
Checking Your Understanding 490
Immunization 490
Summary 494
Questions 495
Problems 496
Computational Problems 496
Spreadsheet Exercises 497
Checking Your Understanding 497
Part 6 Derivative Securities
19 Options 498
Why Have Derivative Securities? 499
Introduction to Options 499
Understanding Options 501
Checking Your Understanding 501
Checking Your Understanding 505
Payoffs and Profits from Basic Option Positions 505
Some Basic Options Strategies 510
Checking Your Understanding 513
Option Valuation 513
Checking Your Understanding 522
An Investor’s Perspective on Puts and Calls 522
Stock Index Options 524
Summary 527
Questions 528
Problems 529
Computational Problems 529
Spreadsheet Exercises 530
Checking Your Understanding 531
20 Futures Contracts 532
An Overview of Futures Markets 532
The Structure of Futures Markets 535
Checking Your Understanding 537
The Mechanics of Trading 537
Checking Your Understanding 542
Using Futures Contracts 542
Checking Your Understanding 545
Financial Futures 545
Single Stock Futures 553
Summary 554
Questions 555
Problems 556
Computational Problems 556
Checking Your Understanding 556
Part 7 Investment Management
21 Managing Your Financial Assets 557
A Perspective on Investing in Financial Assets 557
Managing Your Financial Assets 558
Checking Your Understanding 560
Formulate an Appropriate Investment Strategy 560
Investor Objectives 560
Checking Your Understanding 563
What Issues Do Investors Face in Their Financial Planning? 563
Investor Expectations as a Part of Financial Planning 566
Checking Your Understanding 567
Implementing Investing Strategies 568
Basic Investment Management Strategies 570
Financial Planning on an Ongoing Basis 571
Checking Your Understanding 573
Rebalancing a Portfolio of Financial Assets 573
Determining the Success of Your Financial Planning 574
Summary 574
Questions 575
Spreadsheet Exercises 577
Checking Your Understanding 578
22 Evaluation of Investment Performance 579
A Framework for Evaluating and Assessing Portfolio Performance 580
Performance Measurement Issues 580
Checking Your Understanding 586
Risk-Adjusted Measures of Performance 588
Checking Your Understanding 589
Checking Your Understanding 595
Measures of Downside Risk 596
Style Analysis and Performance Attribution 598
Money Managers and Performance Presentations 600
Checking Your Understanding 601
An Overview on Performance Evaluation 601
Summary 602
Questions 603
Problems 604
Computational Problems 605
Spreadsheet Exercises 606
Checking Your Understanding 607
Glossary G-1
Index I-1
