Investments

Cover
Title
Copyright
Contents
Preface
PART ONE: INTRODUCTION
	CHAPTER 1 The Investment Environment
		1.1 A Short History of Investing
		1.2 The Economic System and Investment
			Real Investment Versus Financial Investment
		1.3 The Participants: Individuals and Financial Intermediaries
			Individuals and Financial Objectives
			The Investment Process
			Financial Intermediaries
		1.4 Recent Trends
			Globalization
			Financial Engineering
			Securitization
			Information and Computer Networks
		1.5 The Agency Problem: Executives, Analysts, and Auditors
		1.6 Lessons to Learn
			Free Lunches
			Diversification, Information, and Patience
		1.7 Outline of the Text
	CHAPTER 2 Financial Markets and Instruments
		2.1 The Money Market
			Treasury Bills
			Certificates of Deposit and Bearer Deposit Notes
			Commercial Paper
			Bankers' Acceptances
			Eurodollars
			Repos and Reverses
			Federal Funds
			Brokers' Call Loans
			The LIBOR Market
			Yields on Money Market Instruments
		2.2 The Bond Market
			Government of Canada Bonds
			Provincial and Municipal Bonds
			Corporate Bonds
			International Bonds
			Mortgages and Mortgage-Backed Securities
		2.3 Equity Securities
			Common Stock as Ownership Shares
			Characteristics of Common Stock
			Stock Market Listings
			Preferred Stock
			Income Trusts
			Depository Receipts
		2.4 Stock and Bond Market Indices
			Stock Market Indices
			Foreign and International Stock Market Indices
			Bond Market Indicators
		2.5 Derivative Markets
			Options
			Futures Contracts
			Other Derivative Assets: Warrants, Swaps, and Hybrid Securities
	CHAPTER 3 Trading on Securities Markets
		3.1 How Firms Issue Securities
			Privately Held Firms
			Short Form Prospectus Distribution System (SFPDS)
			Initial Public Offerings
		3.2 Types of Markets and Orders
			Types of Markets
			Types of Orders
			Trading Mechanisms
			The Execution of Trades
			Settlement
			The Rise of Electronic Trading
		3.3 Securities Markets
			The Toronto Stock Exchange
			The Bond Market
			U.S. Markets
			New Trading Strategies
			Foreign Markets
			Derivatives Markets
		3.4 Trading Costs
			Internet Investing
		3.5 Trading with Margin
			Buying on Margin
			Short Sales
		3.6 Regulation of Securities Markets
			Regulatory Responses to Recent Scandals and the 2008–09 Financial Crisis
			Self-Regulation and Circuit Breakers
			Insider Trading
		Appendix 3A: A Detailed Margin Position
PART TWO: PORTFOLIO THEORY
	CHAPTER 4 Return and Risk: Analyzing the Historical Record
		4.1 Determinants of the Level of Interest Rates
			Real and Nominal Rates of Interest
			The Equilibrium Real Rate of Interest
			The Equilibrium Nominal Rate of Interest
			Taxes and the Real Rate of Interest
		4.2 Comparing Rates of Return for Different Holding Periods
			Annual Percentage Rates
			Continuous Compounding
		4.3 Bills and Inflation, 1957–2012
		4.4 Risk and Risk Premiums
			Holding-Period Returns
			Expected Return and Standard Deviation
			Excess Returns and Risk Premiums
		4.5 Time Series Analysis of Past Rates of Return
			Time Series Versus Scenario Analysis
			Expected Returns and the Arithmetic Average
			The Geometric (Time-Weighted) Average Return
			Variance and Standard Deviation
			Mean and Standard Deviation Estimates from Higher-Frequency Observations
			The Reward-to-Variability (Sharpe) Ratio
		4.6 The Normal Distribution
		4.7 Deviations from Normality and Risk Measures
			Value at Risk
			Expected Shortfall
			Lower Partial Standard Deviation and the Sortino Ratio
			Relative Frequency of Large, Negative 3-Sigma Returns
		4.8 The Historical Record
			Bills, Bonds, and Stocks, 1957–2012
			Stock Portfolios, Canada and U.S., 1950–2012
			A Global View of the Historical Record
		Appendix 4A: Long-Term Investments
			Normal and Lognormal Returns
			Simulation of Long-Term Future Rates of Return
			Where Is Research of Rates of Return Headed?
			Forecasts for the Long Haul
	CHAPTER 5 Capital Allocation to Risky Assets
		5.1 Risk and Risk Aversion
			Risk, Speculation, and Gambling
			Risk Aversion and Utility Values
			Estimating Risk Aversion
		5.2 Capital Allocation Across Risky and Risk-Free Portfolios
		5.3 The Risk-Free Asset
		5.4 Portfolios of One Risky Asset and One Risk-Free Asset
		5.5 Risk Tolerance and Asset Allocation
			Non-normal Returns
		5.6 Passive Strategies: The Capital Market Line
		Appendix 5A: Risk Aversion and Expected Utility
		Appendix 5B: Utility Functions and Equilibrium Prices of Insurance Contracts
	CHAPTER 6 Optimal Risky Portfolios
		6.1 Diversification and Portfolio Risk
		6.2 Portfolios of Two Risky Assets
		6.3 Asset Allocation with Stocks, Bonds, and Bills
			Asset Allocation with Two Risky Assets
		6.4 The Markowitz Portfolio Optimization Model
			Security Selection
			Capital Allocation and Separation Property
			The Power of Diversification
			Asset Allocation and Security Selection
			Optimal Portfolios and Non-normal Returns
		6.5 A Spreadsheet Model
			The Covariance Matrix
			Expected Returns
			The Bordered Covariance Matrix and Portfolio Variance
			Using the Excel Solver
			Finding the Minimum Variance Portfolio
			Charting the Efficient Frontier of Risky Portfolios
			Finding the Optimal Risky Portfolio on the Efficient Frontier
			The Optimal CAL
			The Optimal Risky Portfolio and the Short-Sales Constraint
		Appendix 6A: Risk Pooling, Risk Sharing, and the Risk of Long-Term Investments
			Risk Pooling and the Insurance Principle
			Risk Pooling
			Risk Sharing
			Investment for the Long Run
PART THREE: EQUILIBRIUM IN CAPITAL MARKETS
	CHAPTER 7 The Capital Asset Pricing Model
		7.1 The Capital Asset Pricing Model
			Why Do All Investors Hold the Market Portfolio?
			The Passive Strategy Is Efficient
			The Risk Premium of the Market Portfolio
			Expected Returns on Individual Securities
			The Security Market Line
		7.2 Assumptions and Extensions of the CAPM
			Assumptions of the CAPM
			Challenges and Extensions to the CAPM
			The Zero-Beta Model
			Labour Income and Nontraded Assets
			A Multiperiod Model and Hedge Portfolios
			A Consumption-Based CAPM
			Liquidity and the CAPM
		7.3 The CAPM and the Academic World
		7.4 The CAPM and the Investment Industry
	CHAPTER 8 Index Models and the Arbitrage Pricing Theory
		8.1 A Single-Factor Security Market
			The Input List of the Markowitz Model
			Normality of Returns and Systematic Risk
		8.2 The Single-Index Model
			The Regression Equation of the Single-Index Model
			The Expected Return–Beta Relationship
			Risk and Covariance in the Single-Index Model
			The Set of Estimates Needed for the Single-Index Model
			The Index Model and Diversification
		8.3 Estimating the Single-Index Model
			The Security Characteristic Line for XA Corporation
			The Explanatory Power of the SCL for XA
			Analysis of Variance
			The Estimate of Alpha
			The Estimate of Beta
			Firm-Specific Risk
			Correlation and Covariance Matrix
		8.4 Portfolio Construction and the Single-Index Model
			Alpha and Security Analysis
			The Index Portfolio as an Investment Asset
		8.5 Portfolio Management with the Single-Index Model
			Is the Index Model Inferior to the Full-Covariance Model?
			The Industry Version of the Index Model
			Company Beta Estimates
			Index Models and Tracking Portfolios
		8.6 Multifactor Models
			Factor Models of Security Returns
		8.7 Arbitrage Pricing Theory
			Arbitrage, Risk Arbitrage, and Equilibrium
			Well-Diversified Portfolios
			Diversification and Residual Risk in Practice
			Executing Arbitrage
			The No-Arbitrage Equation of the APT
		8.8 The APT, the CAPM, and the Index Model
			The APT and the CAPM
			The APT and Portfolio Optimization in a Single-Index Market
		8.9 A Multifactor APT
		8.10 Where Should We Look for Factors?
		8.11 The Multifactor Capm and the Apt
	CHAPTER 9 Market Efficiency
		9.1 Random Walks and the Efficient Market Hypothesis
			Competition as the Source of Efficiency
			Versions of the Efficient Market Hypothesis
		9.2 Implications of the EMH for Investment Policy
			Technical Analysis
			Fundamental Analysis
			Active Versus Passive Portfolio Management
			The Role of Portfolio Management in an Efficient Market
			Resource Allocation
		9.3 Event Studies
		9.4 Are Markets Efficient?
			The Issues
			Weak-Form Tests: Patterns in Stock Returns
			Returns over Long Horizons
			Semistrong Tests: Market Anomalies
			Strong-Form Tests: Inside Information
			Interpreting the Evidence
			Bubbles and Market Efficiency
			The "Noisy Market Hypothesis" and Fundamental Indexing
		9.5 Mutual Fund and Analyst Performance
			Stock Market Analysts
			Mutual Fund Managers
			Survivorship Bias in Mutual Fund Studies
			So Are Markets Efficient?
	CHAPTER 10 Behavioural Finance and Technical Analysis
		10.1 The Behavioural Critique
			Information Processing
			Behavioural Biases
			Limits to Arbitrage
			The Law of One Price
			Bubbles and Behavioural Economics
			Evaluating the Behavioural Critique
		10.2 The Appeal of Technical Analysis
		10.3 Trends and Charting
			Trends and Corrections
			A Warning
			Moving Averages
		10.4 Technical Indicators
			Sentiment Indicators
			Flow of Funds
			Market Structure
		10.5 Can Technical Analysis Work in Efficient Markets?
			Information and Signalling
	CHAPTER 11 Empirical Evidence on Security Returns
		11.1 The Index Model and the Single-Factor APT
			The Expected Return–Beta Relationship
			Tests of the CAPM
			Estimating Index Models for Canadian Stocks
			Thin Trading
			The Market Index
			Measurement Error in Beta
		11.2 Tests of the Multifactor CAPM and APT
			Labour Income
			Private (Nontraded)
		11.3 Early Versions of the Multifactor CAPM and APT
			A Macro Factor Model
		11.4 The Fama-French-Type Factor Models
			Size and B/M as Risk Factors
			Behavioural Explanations
			Momentum: A Fourth Factor
		11.5 Liquidity and Asset Pricing
		11.6 Consumption-Based Asset Pricing and the Equity Premium Puzzle
			Consumption Growth and Market Rates of Return
			Expected Versus Realized Returns
			Survivorship Bias
			Extensions to the CAPM May Resolve the Equity Premium Puzzle
			Liquidity and the Equity Premium Puzzle
			Behavioural Explanations of the Equity Premium Puzzle
PART FOUR: FIXED-INCOME SECURITIES
	CHAPTER 12 Bond Prices and Yields
		12.1 Bond Characteristics
			Canada Bonds
			Corporate Bonds
			Preferred Stock
			Other Issuers
			International Bonds
			Innovation in the Bond Market
		12.2 Bond Pricing
			Review of the Present Value Relationship
			Bond Pricing Between Coupon Dates
		12.3 Bond Yields
			Yield to Maturity
			Yield to Call
			Realized Compound Yield Versus Yield to Maturity
		12.4 Bond Prices over Time
			Yield to Maturity Versus Holding-Period Return
			Zero-Coupon Bonds
			After-Tax Returns
		12.5 Default Risk
			Junk Bonds
			Determinants of Bond Safety
			Bond Indentures
			Yield to Maturity and Default Risk
			Credit Default Swaps
			Credit Risk and Collateralized Debt Obligations
	CHAPTER 13 The Term Structure of Interest Rates
		13.1 The Yield Curve
			Bond Pricing
		13.2 The Yield Curve and Future Interest Rates
			The Yield Curve Under Certainty
			Holding-Period Returns
			Forward Rates
		13.3 Interest Rate Uncertainty and Forward Rates
		13.4 Theories of the Term Structure
			The Expectations Hypothesis
			Liquidity Preference
		13.5 Interpreting the Term Structure
		13.6 Forward Rates as Forward Contracts
	CHAPTER 14 Managing Bond Portfolios
		14.1 Interest Rate Risk
			Interest Rate Sensitivity
			Duration
		14.2 Convexity
			Why Do Investors Like Convexity?
		14.3 Passive Bond Management
			Bond Index Funds
			Immunization
			Cash Flow Matching and Dedication
			Other Problems with Conventional Immunization
		14.4 Active Bond Management
			Sources of Potential Profit
			Horizon Analysis
			Contingent Immunization
		14.5 Financial Engineering and Interest Rate Derivatives
		Appendix 14A: Duration and Convexity of Callable Bonds and Mortgage-Backed Securities
			Callable Bonds
			Mortgage-Backed Securities
PART FIVE: EQUITIES
	CHAPTER 15 Macroeconomic and Industry Analysis
		15.1 The Global Economy
		15.2 The Domestic Macroeconomy
		15.3 Demand and Supply Shocks and Government Policy
		15.4 Federal Government Policy
			Fiscal Policy
			Monetary Policy
			Supply-Side Policies
		15.5 Business Cycles
			The Business Cycle
			Economic Indicators
		15.6 Industry Analysis
			Defining an Industry
			Sensitivity to the Business Cycle
			Sector Rotation
			Industry Life Cycles
			Industry Structure and Performance
		15.7 The Aggregate Stock Market
	CHAPTER 16 Equity Evaluation Models
		16.1 Valuation by Comparables
			The Balance Sheet Approach
		16.2 Intrinsic Value Versus Market Price
		16.3 Dividend Discount Models
			Convergence of Price to Intrinsic Value
			Stock Prices and Investment Opportunities
			Life Cycles and Multistage Growth Models
			Multistage Growth Models
		16.4 Earnings, Growth, and Price-Earnings Ratios
			Growth or Value Investing
			P/E Ratios and Stock Risk
			Pitfalls in P/E Analysis
			Combining P/E Analysis and the DDM
			Other Comparative Valuation Ratios
		16.5 Free Cash Flow Valuation
			FCF Versus the DDM
			The Problem with DCF Models
		Appendix 16A: Derivation of the Dividend Discount Model
			The Constant-Growth DDM
	CHAPTER 17 Financial Statement Analysis
		17.1 The Major Financial Statements
			The Income Statement
			The Balance Sheet
			The Statement of Changes in Financial Position
		17.2 Measuring Firm Performance
		17.3 Profitability Measures and Their Analysis
			Past Versus Future ROE
			Financial Leverage and ROE
			Decomposition of ROE
		17.4 More Ratio Analysis
			Turnover and Other Asset Utilization Ratios
			Liquidity Ratios
			Market Price Ratios: Growth Versus Value
			Choosing a Benchmark
		17.5 Economic Value Added
		17.6 An Illustration of Financial Statement Analysis
		17.7 Comparability Problems
			Inventory Valuation
			Depreciation
			Inflation and Interest Expense
			Fair Value Accounting
			Quality of Earnings and Accounting Practices
			International Accounting Conventions
		17.8 The Value of Fundamental Analysis
			The Potential
			Value Investing: The Graham Technique
PART SIX: DERIVATIVE ASSETS
	CHAPTER 18 Options and Other Derivatives Markets: Introduction
		18.1 The Option Contract
			Options Trading
			American and European Options
			Adjustments in Option Contract Terms
			The Option Clearing Corporation
			Other Listed Options
		18.2 Values of Options at Expiration
			Call Options
			Put Options
			Options Versus Stock Investments
		18.3 Option Strategies
			Protective Put
			Covered Call
			Straddle
			Spreads
			Collars
		18.4 The Put–Call Parity Relationship
		18.5 Option-Like Securities
			Callable Bonds
			Convertible Securities
			Warrants
			Collateralized Loans
			Levered Equity and Risky Debt
		18.6 Financial Engineering
		18.7 Exotic Options
			Asian Options
			Barrier Options
			Lookback Options
			Currency-Translated Options
			Digital Options
	CHAPTER 19 Option Valuation
		19.1 Option Valuation: Introduction
			Intrinsic and Time Values
			Determinants of Option Values
		19.2 Restrictions on Option Values
			Restrictions on the Value of a Call Option
			Early Exercise and Dividends
			Early Exercise of American Puts
		19.3 Binomial Option Pricing
			Two-State Option Pricing
			Generalizing the Two-State Approach
			Making the Valuation Model Practical
		19.4 Black-Scholes Option Valuation
			The Black-Scholes Formula
			Dividends and Call Option Valuation
			Put Option Valuation
		19.5 Using the Black-Scholes Formula
			Hedge Ratios and the Black-Scholes Formula
			Portfolio Insurance
			Option Pricing and the Crisis of 2008–2009
			Option Pricing and Portfolio Theory
			Hedging Bets on Mispriced Options
		19.6 Stochastic Dominance Option Pricing
			Complete and Incomplete Markets
			Generalizing the Binomial Option Pricing Model
		19.7 Empirical Evidence
	CHAPTER 20 Futures, Forwards, and Swap Markets
		20.1 The Futures Contract
			The Basics of Futures Contracts
			Existing Contracts
		20.2 Mechanics of Trading in Futures Markets
			The Clearinghouse and Open Interest
			Marking to Market and the Margin Account
			Cash Versus Actual Delivery
			Regulations
			Taxation
		20.3 Futures Markets Strategies
			Hedging and Speculating
			Basis Risk and Hedging
		20.4 Futures Prices
			The Spot–Futures Parity Theorem
			Spreads
			Forward Versus Futures Pricing
		20.5 Commodity Futures Pricing
			Pricing with Storage Costs
			Discounted Cash Flow Analysis for Commodity Futures
			Futures Prices Versus Expected Spot Prices
			Expectations Hypothesis
			Normal Backwardation
			Contango
			Modern Portfolio Theory
		20.6 Stock Index Futures
			The Contracts
			Creating Synthetic Stock Positions: An Asset Allocation Tool
			Index Arbitrage
		20.7 Foreign Exchange Futures
			The Markets
			Interest Rate Parity
		20.8 Interest Rate Futures
			The Markets
			Hedging Interest Rate Risk
		20.9 Swaps
			Swaps and Balance Sheet Restructuring
			The Swap Dealer
			Other Interest Rate Contracts
			Swap Pricing
			Credit Risk in the Swap Market
			Credit Default Swaps
PART SEVEN: ACTIVE PORTFOLIO MANAGEMENT
	CHAPTER 21 Active Management and Performance Measurement
		21.1 The Objective of Active Management
			Performance Measurement Under Active Management
		21.2 Measuring Returns and Calculating Averages
			Average Rates of Return
			Time-Weighted Returns Versus Dollar-Weighted Returns
			Dollar-Weighted Return and Investment Performance
		21.3 Risk-Adjusted Performance Measures
			Risk Adjustment Techniques
			The M2 Measure of Performance
			The Sharpe Ratio as the Criterion for Overall Portfolios
			Appropriate Performance Measures in Two Scenarios
			The Role of Alpha in Performance Measures
			Actual Performance Measurement: An Example
			Performance Manipulation and the Morningstar Risk-Adjusted Rating
			Realized Returns Versus Expected Returns
		21.4 Style Analysis
			Style Analysis and Multifactor Benchmarks
			Style Analysis in Excel
			Other Performance Measures
		21.5 Market Timing
			The Potential Value of Market Timing
			The Value of Imperfect Forecasting
			Identifying Timing Ability
		21.6 Performance Evaluation
		21.7 Performance Attribution Procedures
			Asset Allocation Decisions
			Sector and Security Allocation Decisions
			Summing up Component Contributions
		Appendix 21A: Valuing Market Timing as a Call Option
	CHAPTER 22 Portfolio Management Techniques
		22.1 A Framework for Investment Policy
			Institutions and Their Objectives
			Constraints
			Unique Needs
		22.2 Indexing
			Index Strategies
		22.3 Hedging
			Hedging Systematic Risk
			Hedging Interest Rate Risk
		22.4 Asset Allocation
		22.5 Security Selection: The Treynor-Black Model
			Alpha and Security Analysis
			The Index Portfolio as an Investment Asset
			The Optimal Risky Portfolio in the Single-Index Model
			The Information Ratio
			Summary of Optimization Procedure
			An Example
		22.6 The Black-Litterman Model
			A Black-Litterman Asset Allocation Decision
			A Five-Step Process
		22.7 The Two Models: Complements, Not Substitutes
			Enhancement or Replacement of TB by BL
		22.8 The Value of Active Management
			The Contribution of the Information Ratio
			The Performance of Alternative Forecasts
		Appendix 22A: Refinements to Treynor-Black
			Forecasts of Alpha Values and Extreme Portfolio Weights
			Restriction of Benchmark Risk
			Imperfect Forecast and Adjustments to Alpha
			Adjusting Forecasts for the Precision of Alpha
			Distribution of Alpha Values
			Organizational Structure and Performance
		Appendix 22B: The General Black-Litterman Model
			Steps 1 and 2: The Covariance Matrix and Baseline Forecasts
			Step 3: The Manager's Private Views
			Step 4: Revised (Posterior) Expectations
			Step 5: Portfolio Optimization
	CHAPTER 23 Managed Funds
		23.1 Investment Companies
			Other Investment Organizations
			Private Equity and Hedge Funds
		23.2 Mutual Funds
			Investment Policies
			How Funds Are Sold
			Taxation of Mutual Fund Proceeds
		23.3 Hedge Funds: Strategies and Alpha
			Hedge Fund Strategies
			Statistical Arbitrage
			Portable Alpha
		23.4 Costs of Investing in Mutual and Hedge Funds
			Fee Structure
			Fees and Mutual Fund Returns
			Fee Structure in Hedge Funds
		23.5 Investment Performance of Managed Funds
			Mutual Fund Performance
			Persistence in Performance
			Hedge Fund Performance
		23.6 Exchange-Traded Funds
		23.7 Information on Mutual Funds
		Appendix 23A: Taxation and Tax Sheltering
			The Canadian Tax System
			Tax Deferral and Shelters
		Appendix 23B: Pension Funds
			Defined-Contribution Plans
			Defined-Benefit Plans
			Alternative Perspectives on Defined-Benefit Pension Obligations
			Pension Investment Strategies
			Pension Fund Appraisal
	CHAPTER 24 International Investing
		24.1 International Investments
			The World Equity Portfolio
			International Diversification
			Market Capitalization and GDP
			Home-Country Bias
			Techniques for Investing Internationally
		24.2 Risk Issues in International Investing
			Political Risk
			Exchange Rate Risk
			Using Futures to Manage Exchange Rate Risk
		24.3 Risk, Return, and Benefits from International Diversification
			Integration of Markets
			Risk and Return: Summary Statistics
			Are Investments in Emerging Markets Riskier?
			Are Average Returns in Emerging Markets Greater?
			The Home Bias
		24.4 Assessing the Potential of International Investing
		24.5 Assessment of International Investing
			Constructing a Benchmark Portfolio of Foreign Assets
Glossary
	A
	B
	C
	D
	E
	F
	G
	H
	I
	J
	K
	L
	M
	N
	O
	P
	Q
	R
	S
	T
	U
	V
	W
	Y
	Z
Index
	A
	B
	C
	D
	E
	F
	G
	H
	I
	J
	K
	L
	M
	N
	O
	P
	Q
	R
	S
	T
	U
	V
	W
	Y
	Z