Fundamentals of Investments

Cover Page......Page 1
Title Page......Page 6
Copyright Page......Page 7
Dedication......Page 8
About the Authors......Page 9
Preface......Page 10
Acknowledgments......Page 17
Brief Contents......Page 35
Contents......Page 36
1 A Brief History of Risk and Return......Page 46
1.1 Returns......Page 47
1.2 The Historical Record......Page 52
1.3 Average Returns: The First Lesson......Page 57
1.4 Return Variability: The Second Lesson......Page 62
1.5 More on Average Returns......Page 69
1.6 Risk and Return......Page 72
1.7 Summary and Conclusions......Page 73
2 Buying and Selling Securities......Page 82
2.1 Getting Started......Page 83
2.2 Brokerage Accounts......Page 85
2.3 Short Sales......Page 92
2.4 Investor Objectives, Constraints, and Strategies......Page 99
2.5 Forming an Investment Portfolio......Page 106
2.6 Summary and Conclusions......Page 108
3 Overview of Security Types......Page 116
3.2 Interest-Bearing Assets......Page 117
3.3 Equities......Page 121
3.4 Derivatives......Page 127
3.5 Option Contracts......Page 130
3.6 Summary and Conclusions......Page 134
4 Mutual Funds......Page 141
4.1 Advantages and Drawbacks of Mutual Fund Investing......Page 142
4.2 Investment Companies and Fund Types......Page 143
4.3 Mutual Fund Operations......Page 145
4.4 Mutual Fund Costs and Fees......Page 146
4.5 Short-Term Funds......Page 150
4.6 Long-Term Funds......Page 152
4.7 Mutual Fund Performance......Page 158
4.8 Closed-End Funds, Exchange-Traded Funds, and Hedge Funds......Page 163
4.9 Summary and Conclusions......Page 171
5 The Stock Market......Page 178
5.1 Private Equity Versus Selling Securitiesto the Public......Page 179
5.2 The New York Stock Exchange......Page 185
5.3 Operation of the New York Stock Exchange......Page 187
5.4 NASDAQ......Page 192
5.5 NYSE and NASDAQ Competitors......Page 194
5.6 Stock Market Information......Page 195
5.7 Summary and Conclusions......Page 203
6 Common Stock Valuation......Page 211
6.2 The Dividend Discount Model......Page 212
6.3 The Two-Stage Dividend Growth Model......Page 220
6.4 The Residual Income Model......Page 226
6.5 Price Ratio Analysis......Page 228
6.6 An Analysis of the McGraw-Hill Company......Page 233
6.7 Summary and Conclusions......Page 239
7 Stock Price Behavior and Market Effi ciency......Page 252
7.3 Foundations of Market Efficiency......Page 253
7.4 Forms of Market Effiency......Page 254
7.5 Why Would a Market Be Efficient?......Page 255
7.6 Some Implications of Market Efficiency......Page 256
7.7 Informed Traders and Insider Trading......Page 260
7.8 How Efficient Are Markets?......Page 262
7.9 Market Efficiency and the Performance of Professional Money Managers......Page 265
7.10 Anomalies......Page 268
7.11 Bubbles and Crashes......Page 272
7.12 Summary and Conclusions......Page 277
8 Behavioral Finance and the Psychology of Investing......Page 285
8.2 Prospect Theory......Page 286
8.3 Overconfidence......Page 290
8.4 Misperceiving Randomness and Overreacting to Chance Events......Page 291
8.5 Sentiment-Based Risk and Limits to Arbitrage......Page 296
8.6 Technical Analysis......Page 298
8.7 Summary and Conclusions......Page 312
9 Interest Rates......Page 322
9.1 Interest Rate History and MoneyMarket Rates......Page 323
9.2 Money Market Prices and Rates......Page 328
9.3 Rates and Yields on Fixed-Income Securities......Page 335
9.4 The Term Structure of Interest Rates......Page 339
9.5 Nominal versus Real Interest Rates......Page 342
9.6 Traditional Theories of the Term Structure......Page 346
9.7 Determinants of Nominal InterestRates: A Modern Perspective......Page 348
9.8 Summary and Conclusions......Page 351
10 Bond Prices and Yields......Page 359
10.1 Bond Basics......Page 360
10.2 Straight Bond Prices and Yieldto Maturity......Page 361
10.3 More on Yields......Page 367
10.4 Interest Rate Risk and Malkiel’s Theorems......Page 370
10.5 Duration......Page 374
10.6 Bond Risk Measures Based on Duration......Page 378
10.7 Dedicated Portfolios and Reinvestment Risk......Page 379
10.8 Immunization......Page 382
10.9 Summary and Conclusions......Page 384
11 Diversification and Risky Asset Allocation......Page 394
11.1 Expected Returns and Variances......Page 395
11.2 Portfolios......Page 398
11.3 Diversification and Portfolio
 Risk......Page 401
11.4 Correlation and Diversifi
cation......Page 405
11.5 The Markowitz Efficient Frontier......Page 412
11.6 Summary and Conclusions......Page 415
12 Return, Risk, and the Security Market Line......Page 425
12.1 Announcements, Surprises, and Expected Returns......Page 426
12.2 Risk: Systematic and Unsystematic......Page 428
12.3 Diversifi cation, Systematic Risk, and Unsystematic Risk......Page 430
12.4 Systematic Risk and Beta......Page 431
12.5 The Security Market Line......Page 434
12.6 More on Beta......Page 441
12.7 Extending CAPM......Page 446
12.8 Summary and Conclusions......Page 448
13 Performance Evaluationand Risk Management......Page 458
13.1 Performance Evaluation......Page 459
13.2 Comparing Performance Measures......Page 462
13.3 Investment Risk Management......Page 467
13.4 More on Computing Value-at-Risk......Page 471
13.5 Summary and Conclusions......Page 473
14 Futures Contracts......Page 481
14.1 Futures Contracts Basics......Page 482
14.2 Why Futures?......Page 488
14.3 Futures Trading Accounts......Page 493
14.4 Cash Prices versus Futures Prices......Page 495
14.5 Stock Index Futures......Page 498
14.6 Summary and Conclusions......Page 503
15 Stock Options......Page 512
15.1 Options on Common Stocks......Page 513
15.2 The Options Clearing Corporation......Page 517
15.3 Why Options?......Page 518
15.4 Stock Index Options......Page 520
15.5 Option “Moneyness”......Page 523
15.6 Option Payoffs and Profits......Page 524
15.7 Using Options to Manage Risk......Page 528
15.8 Option Trading Strategies......Page 530
15.9 Option Intrinsic Value......Page 534
15.10 Arbitrage and Option Pricing Bounds......Page 536
15.11 Put-Call Parity......Page 539
15.12 Summary and Conclusions......Page 543
16 Option Valuation......Page 553
16.1 A Simple Model to Value Options before Expiration......Page 554
16.2 The One-Period Binomial Option Pricing Model......Page 555
16.3 The Two-Period Binomial Option Pricing Model......Page 558
16.4 The Binomial Option Pricing Model with Many Periods......Page 562
16.5 The Black-Scholes Option Pricing Model......Page 564
16.6 Varying the Option Price Input Values......Page 567
16.7 Measuring the Impact of Stock Price Changes on Option Prices......Page 570
16.8 Hedging Stock with Stock Options......Page 572
16.9 Hedging a Stock Portfolio with Stock Index Options......Page 574
16.10 Implied Standard Deviations......Page 576
16.11 Employee Stock Options......Page 577
16.12 Summary and Conclusions......Page 581
17 Projecting Cash Flowand Earnings......Page 590
17.2 Financial Statements......Page 591
17.3 Financial Statement Forecasting......Page 598
17.4 Starbucks Corporation Case Study......Page 605
17.5 Summary and Conclusions......Page 615
18 Corporate Bonds......Page 626
18.1 Corporate Bond Basics......Page 627
18.2 Types of Corporate Bonds......Page 628
18.3 Bond Indentures......Page 629
18.4 Protective Covenants......Page 640
18.5 Event Risk......Page 641
18.7 Preferred Stock......Page 643
18.9 Corporate Bond Credit Ratings......Page 644
18.10 Junk Bonds......Page 646
18.11 Bond Market Trading......Page 649
18.12 Summary and Conclusions......Page 650
19 Government Bonds......Page 658
19.2 U.S. Treasury Bills, Notes, Bonds, and STRIPS......Page 659
19.3 U.S. Treasury Auctions......Page 667
19.4 U.S. Savings Bonds......Page 668
19.5 Federal Government Agency Securities......Page 669
19.6 Municipal Bonds......Page 671
19.7 Equivalent Taxable Yield......Page 678
19.8 Taxable Municipal Bonds......Page 679
19.9 Summary and Conclusions......Page 680
20 Mortgage-Backed Securities......Page 688
20.2 Fixed-Rate Mortgages......Page 689
20.3 Government National Mortgage Association......Page 697
20.4 Public Securities Association Mortgage Prepayment Model......Page 698
20.5 Cash Flow Analysis of GNMA Fully Modified Mortgage Pools......Page 700
20.6 Collateralized Mortgage Obligations......Page 704
20.7 Yields for Mortgage-Backed Securities and Collateralized Mortgage Obligations......Page 710
20.8 Summary and Conclusions......Page 711
Appendix A: Answers to Test Your Investment Quotient Question......Page 719
Appendix B: Answers to Selected Questions and Problems......Page 723
Appendix C: Key Equations......Page 725
Index......Page 729