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 Brokerage Transactions 115 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 Return and Risk 177 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 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