Investment analysis and portfolio management

COPYRIGHT......Page 4
Part 1. THE INVESTMENT BACKGROUND......Page 21
  1.1. May You Live in Interesting Times......Page 23
  1.2. What Is an Investment?......Page 24
   1.3.1. Measures of Historical Rates of Return......Page 25
   1.3.2. Computing Mean Historical Returns......Page 27
   1.3.3. Calculating Expected Rates of Return......Page 29
   1.3.4. Measuring the Risk of Expected Returns......Page 31
   1.3.5. Risk Measures for Historical Returns......Page 33
  1.4. Determinants of Required Rates of Return......Page 34
   1.4.2. Factors Influencing the Nominal Risk-Free Rate (NRFR)......Page 35
   1.4.3. Risk Premium......Page 37
   1.4.4. Risk Premium and Portfolio Theory......Page 38
  1.5. Relationship between Risk and Return......Page 39
  1.6. Road Map for the Rest of the Book......Page 40
 Chapter 2. The Asset Allocation Decision......Page 45
   2.1.2. Life-Cycle New Worth and Investment Strategies......Page 46
   2.1.3. Life-Cycle Investment Goals......Page 48
  2.2. The Portfolio Management Process......Page 49
  2.3. The Need for a Policy Statement......Page 50
   2.3.1. Other Benefits......Page 51
   2.4.1. Investment Objectives......Page 52
   2.4.2. Investment Constraints......Page 56
   2.4.3. Some Common Mistakes......Page 59
  2.5. The Importance of Asset Allocation......Page 60
   2.5.1. Real Investment Returns after Taxes and Costs......Page 61
   2.5.2. Returns and Risks of Different Asset Classes......Page 62
  APPENDIX: CHAPTER 2: Objectives and Constraints of Institutional Investors......Page 67
 Chapter 3. Selecting Investments in a Global Market......Page 71
   3.1.1. Relative Size of Financial Markets......Page 72
   3.1.2. Return on Domestic and Foreign Securities......Page 73
   3.1.3. Risk of Combined Country Investments......Page 74
   3.2.1. Fixed-Income Investments......Page 78
   3.2.3. Equity Instruments......Page 80
   3.2.4. Special Equity Instruments: Options......Page 82
   3.2.6. Investment Companies......Page 83
   3.2.8. Low-Liquidity Investments......Page 85
  3.3. Historical Risk-Returns on Alternative Investments......Page 86
   3.3.1. World Portfolio Performance......Page 87
 Chapter 4. Securities Markets and the Economy......Page 91
   4.1.1. Characteristics of a Good Market......Page 92
   4.2.1. Government of Canada Bond Issues......Page 93
   4.2.4. Corporate Stock Issues......Page 94
   4.2.5. Private Placements......Page 95
   4.3.3. Financial Futures......Page 96
   4.3.4. Secondary Equity Markets......Page 97
   4.4.1. Primary Listing Markets......Page 98
   4.4.4. Alternative Trading Systems (ATSs)......Page 103
   4.5.1. Types of Orders......Page 104
   4.5.2. Exchange Market Makers......Page 107
   4.5.3. Where Do We Go from Here?......Page 108
   4.7.1. The Sample......Page 109
   4.8.1. Price-Weighted Index......Page 110
   4.8.2. Value-Weighted Index......Page 112
   4.8.3. Unweighted Index......Page 113
   4.8.4. Style Indices......Page 114
  4.9. Bond-Market Indices......Page 115
  4.11. Comparison of Indices Over Time......Page 116
Part 2. DEVELOPMENTS IN INVESTMENT THEORY......Page 123
  5.1. Why Should Capital Markets Be Efficient?......Page 125
   5.2.1. Weak-Form Efficient Market Hypothesis......Page 126
   5.3.1. Weak-Form Hypothesis: Tests and Results......Page 127
   5.3.2. Semistrong-Form Hypothesis: Tests and Results......Page 129
   5.3.3. Strong-Form Hypothesis: Tests and Results......Page 138
  5.4. Behavioural Finance......Page 141
   5.4.1. Explaining Biases......Page 142
  5.5. Implications of Efficient Capital Markets......Page 143
   5.5.2. Efficient Markets and Fundamental Analysis......Page 144
   5.5.3. Efficient Markets and Portfolio Management......Page 146
   6.1.1. Risk Aversion......Page 151
  6.2. Markowitz Portfolio Theory......Page 152
   6.2.2. Expected Return......Page 153
   6.2.3. Standard Deviation of Returns for an Individual Investment......Page 154
   6.2.4. Standard Deviation of Returns for a Portfolio......Page 155
   6.2.5. Standard Deviation of a Portfolio......Page 161
   6.2.6. A Three-Asset Portfolio......Page 169
   6.2.7. Estimation Issues......Page 170
  6.3. The Efficient Frontier and Investor Utility......Page 171
   6.3.1. The Efficient Frontier......Page 172
   A. Proof that Minimum Portfolio Variance Occurs with Equal Weights when Securities Have Equal Variance......Page 177
   B. Derivation of Weights that Will Give Zero Variance when Correlation Equals –1.00......Page 178
   C. Indifference Curves and Investor Utility......Page 179
   7.1.1. Background for Capital Market Theory......Page 181
   7.1.2. Developing the Capital Market Line......Page 183
   7.1.3. Risk, Diversification, and the Market Portfolio......Page 187
   7.1.4. Investing with the CML: An Example......Page 190
   7.2.1. A Conceptual Development of the CAPM......Page 192
   7.2.2. The Security Market Line......Page 193
   7.3.2. Zero-Beta Model......Page 198
   7.3.4. Heterogeneous Expectations and Planning Periods......Page 200
   7.3.5. Taxes......Page 201
   7.4.2. Comparability of Published Estimates of Beta......Page 202
   7.5.1. From CAPM to APT......Page 203
   7.5.2. Using the APT......Page 205
  7.6. Multifactor Models in Practice......Page 207
   7.6.1. Macroeconomic-Based Risk Factor Models......Page 209
   7.6.2. Microeconomic-Based Risk Factor Models......Page 210
   7.6.3. Extensions of Characteristic-Based Risk Factor Models......Page 213
Part 3. ANALYSIS AND MANAGEMENT OF COMMON SHARES......Page 219
 Chapter 8. Economic and Industry Analysis......Page 221
   8.2.1. General Economic Influences......Page 222
   8.2.2. Industry Influences......Page 224
   8.2.4. Does the Three-Step Process Work?......Page 225
   8.3.1. Understanding Business Cycles......Page 226
   8.3.2. Knowing Monetary Variables......Page 228
   8.3.3. Inflation and Interest Rates......Page 230
   8.3.4. Forecasting Performance of the Stock Market......Page 233
   8.4.1. What Is an Industry?......Page 235
   8.4.2. The Business Cycle and Industry Sectors......Page 237
   8.4.3. Structural Economic Changes and Alternative Industries......Page 241
   8.4.4. Evaluating the Industry Life Cycle......Page 243
   8.4.5. Analysis of Industry Competition......Page 245
  9.1. Company Analysis versus Stock Valuation......Page 251
   9.1.2. Defensive Companies and Stocks......Page 252
   9.2.1. Economic and Industry Influences......Page 253
   9.3.1. Firm Competitive Strategies......Page 254
   9.3.2. Focusing a Strategy......Page 255
   9.3.3. SWOT Analysis......Page 256
  9.4. Estimating Intrinsic Value......Page 257
   9.4.1. Present Value of Dividends......Page 258
   9.4.2. Present Value of Free Cash Flow to Equity......Page 262
   9.4.3. Present Value of Operating Free Cash Flow......Page 263
   9.4.4. Relative Valuation Ratio Techniques......Page 267
   9.5.1. Company Sales Forecast......Page 268
   9.6.1. The Internal Performance......Page 269
   9.6.2. Importance of Quarterly Estimates......Page 270
   9.7.2. Microanalysis of the Earnings Multiplier......Page 271
   9.7.3. Making the Investment Decision......Page 274
   9.8.1. Price/Book Value (P/BV) Ratio......Page 275
   9.8.2. Price/Cash Flow (P/CF) Ratio......Page 276
  9.9. Analysis of Growth Companies......Page 277
   9.9.3. Alternative Growth Models......Page 278
   9.9.4. The Real World......Page 282
   9.10.1. Economic Value Added (EVA)......Page 283
   9.10.3. Relationships between EVA and MVA......Page 285
  9.11. Site Visits and the Art of the Interview......Page 286
  9.12. When to Sell......Page 287
   9.13.2. Paralysis of Analysis......Page 288
  9.14. Global Company and Stock Analysis......Page 289
 Chapter 10. Technical Analysis......Page 293
  10.1. Underlying Assumptions of Technical Analysis......Page 294
  10.2. Advantages of Technical Analysis......Page 295
   10.3.2. Challenges to Technical Trading Rules......Page 296
  10.4. Technical Trading Rules and Indicators......Page 297
   10.4.1. Contrary-Opinion Rules......Page 298
   10.4.2. Follow the Smart Money......Page 300
   10.4.3. Momentum Indicators......Page 301
   10.4.4. Stock Price and Volume Techniques......Page 302
   10.5.1. Technical Analysis of Foreign Exchange Rates......Page 309
  10.6. Technical Analysis of Bond Markets......Page 310
Part 4. ANALYSIS AND MANAGEMENT OF BONDS......Page 315
  11.1. Basic Features of a Bond......Page 317
   11.1.1. Bond Characteristics......Page 318
  11.2. The Global Bond Market Structure......Page 320
   11.2.1. Bond Ratings......Page 321
   11.3.1. Domestic Government Bonds......Page 323
   11.3.2. Government Agency Issues......Page 325
   11.3.3. Municipal Bonds......Page 326
   11.3.4. Corporate Bonds......Page 327
   11.3.5. International Bonds......Page 333
   11.4.1. Interpreting Bond Quotes......Page 334
   12.1.1. The Present Value Model......Page 339
   12.1.2. The Yield Model......Page 340
  12.2. Computing Bond Yields......Page 341
  12.3. Calculating Future Bond Prices......Page 346
   12.3.1. Realized (Horizon) Yield with Differential Reinvestment Rates......Page 347
  12.4. What Determines Interest Rates?......Page 349
   12.4.2. Fundamental Determinants of Interest Rates......Page 350
  12.5. The Term Structure of Interest Rates......Page 354
   12.5.1. Expectations Hypothesis......Page 355
   12.5.2. Liquidity Preference (Term Premium) Hypothesis......Page 358
   12.5.4. Trading Implications of the Term Structure and Yield Spreads......Page 359
   12.6.1. Trading Strategies......Page 360
   12.6.2. Duration Measures......Page 361
   12.6.3. Modified Duration and Bond Price Volatility......Page 364
   12.6.4. Bond Convexity......Page 366
  APPENDIX: CHAPTER 12: Duration and Convexity with Semi-annual Cash Flows......Page 376
Part 5. DERIVATIVE SECURITY ANALYSIS......Page 377
 Chapter 13. An Introduction to Derivative Markets and Securities......Page 379
   13.1.1. The Language and Structure of Forward and Futures Markets......Page 380
   13.1.2. Interpreting Futures Price Quotations: An Example......Page 382
   13.1.3. The Language and Structure of Option Markets......Page 384
   13.1.4. Interpreting Option Price Quotations: An Example......Page 385
   13.2.1. The Basic Nature of Derivative Investing......Page 388
   13.2.2. Basic Payoff and Profit Diagrams for Forward Contracts......Page 389
   13.2.3. Basic Payoff and Profit Diagrams for Call and Put Options......Page 390
   13.2.4. Option Profit Diagrams: An Example......Page 394
   13.3.1. Put-Call-Spot Parity......Page 397
   13.3.2. Put-Call Parity: An Example......Page 399
   13.3.3. Creating Synthetic Securities Using Put-Call Parity......Page 400
   13.3.4. Adjusting Put-Call-Spot Parity for Dividends......Page 401
   13.3.5. Put-Call-Forward Parity......Page 402
   13.4.1. Restructuring Asset Portfolios with Forward Contracts......Page 404
   13.4.2. Protecting Portfolio Value with Put Options......Page 406
   13.4.3. An Alternative Way to Pay for a Protective Put......Page 408
   13.5.2. Covered Call Options......Page 410
   13.5.3. Straddles, Strips, and Straps......Page 412
   13.5.4. Strangles......Page 414
   13.5.5. Chooser Options......Page 415
   13.5.6. Spreads......Page 416
   13.5.7. Range Forwards......Page 419
  14.1. An Overview of Forward and Futures Trading......Page 427
   14.2.1. Hedging and the Basis......Page 430
   14.2.2. Understanding Basis Risk......Page 431
   14.3.1. The Cost to Carry Model......Page 432
   14.3.2. Contango and Backwardated......Page 433
   14.4.1. Interest Rate Futures......Page 434
   14.4.2. Stock Index Futures......Page 435
   14.5.1. Option Market Conventions......Page 438
   14.5.2. Price Quotations for Exchange-Traded Options......Page 439
   14.6.1. The Basic Binomial Approach......Page 446
   14.6.2. The Binomial Approach Expanded......Page 447
  14.7. The Black-Scholes Valuation Model......Page 450
   14.7.1. Properties of the Model......Page 451
   14.7.2. Estimating Volatility......Page 453
   14.7.3. Valuing European-Style Put Options......Page 456
   14.7.4. Problems with Black-Scholes Valuation......Page 457
   14.8.1. Interest Rate Swaps......Page 458
   14.8.2. Extensions of Swaps......Page 459
   14.9.1. Warrants......Page 461
   14.9.2. Convertible Bonds......Page 463
   14.9.3. Callable Bonds......Page 464
Part 6. PORTFOLIO MANAGEMENT......Page 471
  15.1. An Overview......Page 475
  15.2. Passive Equity Portfolio Management Strategies......Page 477
   15.2.1. Index Portfolio Construction Techniques......Page 478
   15.2.2. Tracking Error and Index Portfolio Construction......Page 479
  15.3. Active Equity Portfolio Management Strategies......Page 482
   15.3.1. Fundamental Strategies......Page 483
   15.3.2. Technical Strategies......Page 486
   15.3.3. Anomalies and Attributes......Page 488
   15.3.4. Benchmarking and Computer Screening......Page 490
   15.4.1. Value versus Growth Investing......Page 491
   15.4.2. Style Analysis......Page 494
  15.5. Asset Allocation Strategies......Page 498
   15.5.1. Integrated Asset Allocation......Page 499
   15.5.3. Tactical Asset Allocation......Page 502
   15.5.5. Selecting an Active Allocation Method......Page 504
  APPENDIX: CHAPTER 15: Canadian Mutual Fund Project......Page 508
  16.1. Bond Portfolio Performance, Style, and Strategy......Page 511
   16.2.1. Buy-and-Hold Strategy......Page 514
   16.2.2. Indexing Strategy......Page 515
   16.2.3. Bond Indexing in Practice: An Example......Page 516
  16.3. Active Management Strategies......Page 517
   16.3.1. Interest Rate Anticipation......Page 518
   16.3.3. Credit Analysis......Page 520
   16.3.4. Yield Spread Analysis......Page 524
   16.3.5. Implementing an Active Bond Transaction......Page 525
   16.3.6. Active Global Bond Investing......Page 526
  16.4. Core-Plus Management Strategies......Page 527
   16.5.1. Dedicated Portfolios......Page 528
   16.5.2. Immunization Strategies......Page 530
   16.5.3. Horizon Matching......Page 536
   16.6.1. Contingent Immunization......Page 538
  APPENDIX: CHAPTER 16: Bond Immunization and Portfolio Rebalancing......Page 548
 Chapter 17. Professional Money Management, Alternative Assets, and Industry Ethics......Page 551
  17.1. The Asset Management Industry: Structure and Evolution......Page 552
  17.2. Private Management and Advisory Firms......Page 553
   17.2.1. Investment Strategy at a Private Money Management Firm......Page 556
   17.3.1. Valuing Investment Company Shares......Page 557
   17.3.2. Closed-End versus Open-End Investment Companies......Page 558
   17.3.4. Investment Company Portfolio Objectives......Page 560
   17.3.7. Mutual Fund Organization and Strategy: An Example......Page 561
  17.4. Hedge Funds and Private Equity......Page 566
   17.4.2. Hedge Fund Strategies......Page 567
   17.4.3. Risk Arbitrage Investing: A Closer Look......Page 570
   17.4.4. Hedge Fund Performance......Page 572
   17.4.5. Private Equity......Page 573
   17.5.1. Regulation in the Asset Management Industry......Page 579
   17.5.2. Standards for Ethical Behaviour......Page 581
   17.5.3. Examples of Ethical Conflicts......Page 582
  17.6. What Do You Want from a Professional Asset Manager?......Page 583
  18.1. Peer Group Comparisons......Page 589
   18.2.1. Treynor Portfolio Performance Measure......Page 590
   18.2.2. Sharpe Portfolio Performance Measure......Page 593
   18.2.3. Jensen Portfolio Performance Measure......Page 594
   18.2.4. The Information Ratio Performance Measure......Page 597
   18.2.5. Comparing the Composite Performance Measures......Page 598
   18.2.6. Application of Portfolio Performance Measures......Page 600
   18.3.1. Performance Attribution Analysis......Page 607
   18.3.2. Measuring Market Timing Skills......Page 610
  18.4. The Challenges of Benchmarking......Page 611
   18.4.1. The Global Benchmark Problem......Page 612
   18.4.2. Implications of the Benchmark Problems......Page 613
  18.5. Evaluation of Bond Portfolio Performance......Page 614
   18.5.1. Returns-Based Bond Performance Measurement......Page 615
   18.6.1. Time-Weighted Returns......Page 616
   18.6.2. Dollar-Weighted Returns......Page 617
   18.6.3. Performance Presentation Standards......Page 618
Web Part 7. VALUATION PRINCIPLES AND PRACTICES......Page 625
Appendix A. CFA® Questions and Problems......Page 627
Appendix B. How to Become a CFA® Charterholder......Page 667
Appendix C. Code of Ethics and Standards of Professional Conduct......Page 669
Appendix D. Interest Tables......Page 673
Appendix E. Standard Normal Probabilities......Page 677
Comprehensive References List......Page 679
Glossary......Page 697
Index......Page 713