PART ONE 1
BACKGROUND 1
1 Introduction to Modern Investment Theory 1
PART ONE 1
BACKGROUND 1
1 INTRODUCTION TO MODERN INVESTMENT THEORY 1
CHAPTER 1 The Function of Financial Markets 1
Savings-Investment Foundation 1
Efficiency of Financial Markets 2
THE DEVELOPMENT OF MODERN INVESTMENT THEORY 2
Stages of Efficiency 3
Financial Assets 3
WHY SHOULD YOU LEARN MODERN INVESTMENT THEORY? 4
The Role of Financial Intermediaries 5
2 SECURITIES AND MARKETS 6
Bank Discount Rate 6
2 Securities and Markets 6
Government Bonds 7
SECURITIES 7
Disintermediation and Securitization 8
Financial Innovation 9
Country Efficiency 9
The Catalyst for Change 10
Types of Innovations 11
The Implications of Savings 11
Corpotate Fixed Income Securities 11
Sensitivity of Price to Various Properties 12
Degrees of Moneyness 13
Interest Rates and Arbitrage Efficiency 14
Corporate Stock 14
Summary 15
Selected References 15
The Structure of the System 17
CHAPTER 2 The Flow-of-Funds System 17
Sectoring 18
The Preparation of a Matrix and Its Use 20
Forwrd and Futures Contracts 20
Options and Warrants 20
Federal Reserve Flow-of-Funds Data 21
The Shares of Investment Companies and Mutual Funds 22
Credit Flows 23
Market Pressure to Assume Equilibrium Prices 24
The Difference Between Primary and Secondary Markets 24
THE FINANCIAL MARKETS 24
Implications of Analysis 25
Organizde Exchanges for Common Stock and Bonds 25
Summary 27
Organized Exchanges for Futures Contracts 27
Organized Exchanges for Options 27
Selected References 28
The Individual Choice 29
The Interest Rate in an Exchange Economy 29
CHAPT ER 3 Foundations for Interest Rates 29
The Over-the -Counter Market 30
Computerized Trading Techniques 30
Optimum with Exchange 31
Combined Effect 33
SUMMARY 34
Market Equilibrium 35
3 Some Statistical Concepts 38
3 SOME STATISTICAL CONCEPTS 38
Behavior of Individual Economic Units 39
Interest Rates in a World with Risk 39
THE SIMPLE OR MARGINAL PROBABILITY DISTRIBUTION 39
The Population Expected Value and Variance 40
The Sample Mean and Variance 40
Utility for Financial Assets 40
THE JOINT PROBABILITY DISTRIBUTION 42
Utility for Other Assets 42
Utility for Financial Liabiliues 42
The Sample Covariance 43
Market Equilibrium 43
Maximizing Utility for the Economic Unit 44
The Action of All Economic Units 45
Summary 46
The Population Covariance 46
Appendix：The Equilibrium Prices of Financial Assets 47
The Correlation Coefficient 48
Market Equilibrium：Two Economic Units 50
The Coefficient of Detemination 50
THE RELATIONSHIP BETWEEN A STOCK AND THE MARKET PORTFOLIO 51
Market Equilibrium：Multiple Financial Assets 51
The Charaeteristie Line 52
The Beta Factor 53
Selected References 53
Residual Variance 54
CHAPTER 4 Prices and Yields for Bonds and Money Market Instruments 55
Review of Present Values 55
Present Value When Interest Is Compounded More Than Once a Year 56
Annuities 56
SUMMARY 57
Coupons and Principal Payments 57
The Price of a Bond 57
Continuous Compounding 57
Price When Next Coupon Payment Is Less Than Six Months Away 58
Zero-Coupon Bonds 60
Yield Calculations for Bonds 60
Holding Period Return 61
Current Yield 61
Implicit Reinvestment Rate Assumption 61
Yield for Perpetuilies 62
Yield-to-Maturity for Zero-Coupon Bonds 62
Money Market Instrument Returns 63
Summary 64
Implications 64
Selected References 65
CHAPTER 5 Inflation and Returns 66
PART TWO 66
PORTFOLIO MANAGEMENT 66
4 COMBINING INDIVIDUAL SECURITIES INTO PORTFOUOS 66
The Historical Record in Brief 66
4 Combining Individual Securities into Portfolios 66
PORTFOLIO MANAGEMENT 66
PART TWO 66
THE RISK AND EXPECTED RETURN OF A PORTFOLIO 68
The Portfolio s Rate of Return 68
The Portfolio s Expected Rate of Return 69
The Nature of Inflation Premiums 69
Unanticipated Inflation 70
The Portfolio s Variance 70
COMBINATION LINES 72
The Fisher Effect 72
Nominal Interest Rates and Inflation, Theoretically 73
Empirical Evidence on Nominal Interest Rates 74
Problems in Empirical Testing 74
Testing for the Effect of Inflation 75
The Cases of Perfect Positive and Negative Correlation 75
The Fisher Effect More Directly 77
A Summing Up 77
Nominal Contracting Effects 77
Debtor-Creditor Claims 78
Depreciation 78
Inventories 78
The Mechanics 79
Inflation Indexed Bonds 79
Empirical Testing 79
Corporate Value 79
Other Aspects 80
Summary 80
Borrowing and Lending at a Risk-Free Rate 80
SUMMARY 81
Selected References 81
APPENDIX1：FORMULAS FOR THE EXPECTED RATE OF RETURN AND VARIANCE OF A PORTFOLIO 82
Definition of Term Structure 83
CHAPTER 6 The Term Structure of Interest Rates 83
The Pure Expectations Theory 84
Forward Rates of Interest 85
Substitutability of Maturities 86
Technical Problems 87
Arbitruge and Market Efficiency 88
Uncertainty and Term Premiums 89
Market Segmentation 90
5 FINDING THE EFFICIENT SET 92
Term Structure Implications 92
General Equilibrium Notions 92
5 Finding the Efficient Set 92
Cox-Ingersoll-Ross Theory 92
THE MINIMUM VARIANCE AND EFFICIENT SETS 93
Other Models of the Term Structure 93
Multifactor Models 94
FINDING THE EFFICIENT SET WITH SHORT SELLING 94
Lattice-Type Models 95
The Isoexpected Return Lines 96
Summary 97
Empirical Evidence 97
Selected References 98
The Isovariance Ellipses 99
The Critical Line 101
The Coupon Effect 101
CHAPTER 7 Price Volatility, Coupon Rate, and Maturity 101
The Duration Measure and Its Changing Behavior 103
Relationship between Duration and Maturity 105
FINDING THE MINIMUM VARIANCE WITHOUT SHORT SELLING 106
Relationship between Duration and Changes in Interest Rates 106
Relationship between Duration and Coupon Payment 106
Volatility Duration 108
Modified Duration Formula 109
Convexity 109
TWO IMPORTANT PROPERTIES OF THE MINIMUM VARIANCE SET 109
The Convexity Measure 110
Illustration of Price-Change Estimates Using Modified Duration and Convexity 111
Further Observations on Convexity 112
Immunization of Bond Portfolios 113
Immunization with Coupon Issues 114
An Illustration 114
Fisher-Weil Duration 116
Mapping the Stochastic Process 116
Testing for Immunization Effectiveness 117
Additional Immunization Considerations 118
Equilibration between Coupon and Noncoupon Bond Markets 118
Coupon Stripping 119
SUMMARY 119
Term Structure of Pure Discount Bonds 120
APPENDIX2：A THREE-DIMENSIONAL APPROACH TO FINDING THE EFFICIENT SET 120
Arbitrage Efficiency between the Markets 120
Summary 122
Selected References 123
CHAPTER 8 The Default-Risk Structure of Interest Rates 125
Promised, Realized, and Expected Rates 125
Distribution of Possible Returns 126
APPENDIX3：USING LAGRANGIAN MULTIPLIERS TO FIND THE MINLMUM VARIANCE SET 128
Empirical Evidence on Default Losses 128
APPENDIX4：PROOF OF PROPERTY II 130
Credit Ratings and Risk Premiums 131
Some Studies of Bond Ratings 132
Cyclical Behavior of Risk Premiums 133
APPENDIX5：UTILITY AND RISK AVERSION 134
The Market Segmentation Effect 135
Issuers and Use in Acquisitions 137
Development of the Market 137
Speculative-Grade（Junk）Bonds 137
Risk versus Return 138
Event Risk 139
Empirical Evidence 141
Risk Structure and the Term Structure 141
Summary 143
Selected References 144
Introduction to Contract 146
CHAPTER 9 Derivative Securities：Interest-Rate Futures 146
Features of Futures Markets 148
Margin Requirements 148
Money Market Instruments 148
Quality Delivery Options 149
Longer-Term Instruments 149
Marking-to-Market and Price Movements 149
Hedging and Speculation 151
Some Hedging Fundumentals 151
Futures and Spot Prices 152
Long Hedges 152
6 FACTOR MODELS 152
6 Factor Models 152
FACTOR MODELS TO ESTIMATE VOLATILITY OF RETURN 153
The Single -Factor Model 153
Hedge Rations 154
Short Hedges 155
Basis Pisk 155
The Single-Factor Model s Simplified Formula for Portfolio Variance 155
More on Basis Risk 156
Sources of Basis Risk 158
Market Efficiency 158
Possible Reasons for Deviation of Forward and Futures Rates 159
Summary 160
An Example Where the Single-Factor Model Works 160
Selected References 161
An Example of a Potential Problem with the Single-Factor Model 163
CHAPTER 10 Derivative Securities：Options 163
Option Valuation 163
Expiration Date Value of an Option 164
Multifactor Models 165
Valuation Prior to Expiration 165
Estimating Portfolio Variance Using a Multifactor Model：An Example 167
Hedging with Options 168
Black -Scholes Option Model 169
MODELS FOR ESTIMATING EXPECTED RETURN 171
Debt Options 172
Features of Futures Options 172
Use of Debt Options 173
Caps, Floors, and Collars 174
Valuation of Debt Options 175
Firm Characteristics（Factors）That Induce Differentials in Expected Returns 176
Yield Curve Options 177
Estimating and Projecting Factor Payoffs 178
Debt Plus Option Characteristic 179
Conversion Price/Ratio 179
Convertible Securities 179
A Test of the Accuracy of Expected Return Factor Models 180
Value of Convertible Securities 180
Premiums 181
Simulating the Performance of the Expected Return Factor Model 182
Summary 183
Other Reasons for Premiums 183
SUMMARY 184
Appendix A：Put-Call Parity 184
Appendix B：Application of Option Pricing Concepts to Valuing Convertible Securities 186
Selected References 190
CHAPTER 11 Derivative Securities：Swaps 192
Swap Features 192
An Illustration 193
Valuation Issues 194
Comparative Advantage 194
Completing Markets 195
Default Risk 195
PART THREE 196
7 THE CAPITAL ASSET PRICING MODEL 196
RISK，EXPECTED RETURN，AND PERFORMANCE MEASUREMENT 196
Skirting Tax Laws and Regulations 196
PART THREE 196
RISK，EXPECTED RETURN，AND PERFORMANCE MEASUREMENT 196
7 The Capital Asset Pricing Model 196
THE ASSUMPTIONS OF THE CAPITAL ASSET PRICING MODEL 197
AssumptionⅠ：Investors Can Choose Between Portfolios on the Basis of Expected Return and Variance 197
Credit Risk, Maturity, and Systemic Risk 197
Swap Valuation：A Summing Up 197
Default Provisions 198
Value at Risk 199
Secondary Market Values 200
Assumption Ⅲ：There Are No Frictions in the Capital Market 201
AssumptionⅡ：All Investors Are in Agreement Regarding the Planning Horizon and the Distributions of 201
Summary 201
Swaptions 201
The Capital Market Line 202
THE CAPITAL ASSET PRICING MODEL WITH UNLIMITED BORROWING AND LENDING AT A RISK-FREE RATE 202
Selected References 202
Option-Adjusted Spreads 203
CHAPTER 12 Embedded Options and Option-Adjusted Spreads 203
An Illustration 204
The Basic Methodology 204
The Nature of the Call Feature 205
Forms of the Provision 206
The Relationship Between the Risk of an Asset and Its Expected Rate of Return 206
Putable Bonds 207
Redemption versus Callability 207
The Call Featrure s Valuation 208
The Positioning of Characteristic Lines under the Capital Asset Pricing Model 208
Interest-Rate Expectations 209
The Positions of Individual Assets in Expected Return, Standard Deviation Space 209
The Call Feature and Convexity 210
Valuation in an Option Pricing Context 211
Empirical Evidence on Call Valuation 212
The Sinking Fund 212
Characteristics of the Provision 213
Value of the Sinking Fund 214
Empirical Evidence 215
Summary 215
Selected References 216
THE CAPITAL ASSET PRICING MODEL WITH NO RISK-FREE ASSET 217
CHAPTER 13 Mortgage Securities and Prepayment Pisk 217
Some Features of Mortgages 217
Mortgage Pass-Through Security 218
Agency Pass-Throughs 218
Nonagency Pass-Throughs 219
Mortgage Derivatives 219
THE CAPITAL ASSET PRICING MODEL WHEN A RISK-FREE ASSET EXISTS BUT WE CAN T SELL IT 220
Collateralized Mortgage Obligations（CMOs） 220
Floaters and Inverse Floaters 221
Stripped Mortgage-Backed Securities 221
Planned Amortization Class（PAC）and Targeted Amorization Class（TAC）Securities 221
Prepayment Option and Its Valuation 222
Prepayment and Convexity 222
SUMMARY 222
Measures of Prepayment 223
Coupon Rate and Age 224
Additional Factors Explaining Prepayment 225
Modeling Prepayment Experience 226
Prepayment Behavior of Certain Derivatives 227
Planned Amortization Class Securities 227
Optiion-Adjusted Spread Approach 227
Other Asset-Backed Securities 230
Summary 230
Selected References 231
8 Empirical Tests of the Capital Asset Pricing Model 232
8 EMPIRICL TESTS OF THE CAPITAL ASSET PRICING MODEL 232
Risk and Return form Foreign Investment 233
The Black Jensen, and Scholes Test（1972） 233
CHAPTER 14 Controlling Currency Risk 233
EARLY TESTS OF THE CAPITAL ASSET PRICING MODEL 233
Exchange Rate Risk Management 234
Forward Exchange Market 235
The Fama-MacBeth Study（1974） 235
Illustration of Spot and Forward Exchage Rates 236
A Single European Currency（Euro） 236
Underlying Relationships 238
The Law of One Price 238
Purchasing Power Parity 238
ROLL S CRITIQUE OF TESTS OF THE CAPITAL ASSET PRICING MODEL 238
Previous Tests as Tautologies 239
Interest -Rate Parity 240
Interest-Rate Parity Approximation 242
Covered Interest Arbitrage 242
Can the Capital Asset Pricing Model Ever Be Tested? 243
Empirical Evidence Concerning Interest-Rate Parity（IRP） 243
Currency Options 244
Currency Futures 244
Other Ways to Shift Risk 244
Currency Swaps 245
THE OTHER SIDE OF THE ISSUE 245
Tautologies Can t Prediet the Future 245
Valuation Implications 246
Currency/Interest-Rate Swaps 246
Can You Reject the CAPM if You Find No Efficient Portfolios with Positive Portfolio Weights? 247
The Amount to Hedge 248
The Cost of Curreucy Hedging 248
Sensitivity Analysis to Alernative Market Indices 248
MORE RECENT TESTS OF THE CAPM 248
Testing a Contained CAPM 248
Black s Universal Hedging 249
Closing Thoughts 249
Currency-Option and Multiple-Currency Bonds 250
Some Institutional Characteristics 250
Euro and Foreign Bonds 250
Summary 251
Selected References 252
SUMMARY 254
CHAPTER 15 The Influence of Taxes 254
Tax Treatment of Capital Gains 255
Original Issue Discount（OID）Bonds 255
Capital Gains Treatment for Taxable Coupon Bonds 256
The De Minimis Rule 257
Capital Gains Treatment for Municipal Bonds 257
Tax Timing Options 257
9 The Arbitrage Pricing Theory 258
9 THE ARBITRAGE PRICING THEORY 258
Municipal Bonds and the Taxation of Interest Income 258
The Nature of the Municipal Market 259
Taxable versus Tax-Exempt Yields 259
DERIVING THE ARBITRAGE PRICING THEORY 259
The APT with an Infinite Number of Securities 260
Value of the Tax Exemption Feature 261
Variation of Implied Tax Rate 262
The Effect of Tax Reform and Supply 263
Implied Tax Rate and Maturity 263
Preferred-Stock Taxt Effects 264
Straight Preferred-Stock Investments 264
Auction-Rate Preferred Stock 265
The APT with a Finite Number of Securities 265
Summary 266
Selected References 266
EMPIRICAL TESTS OF THE APT 267
Intial Empirical Tests 267
The Issues Involved 268
CHAPTER 16 The Social Allocation of Capital 268
Is the APT Testable in Principle? 268
Ceilings on Borrowing Costs 269
The Effect of Usury Laws 270
THE CONSISTENCY OF THE APT AND THE CAPM 270
The Negatives of Interest-Rate Ceilings 271
SUMMARY 271
Government Guarntees and Insurance 272
The Transfer of Underlying Risk 273
Interest-Rate Subsidies 274
Option-Pricing Valuation 274
The Effect of the Subsidy 274
Effectiveness of the Subsidy 275
Financial Intermediation Through Borrowing and Relending 276
The Situation Illustrated 277
Regulations Affecting Investor and Borrowet Behavior 278
The Effect of Government Intermediation 278
The Effectiveness of This Approach 279
The Costs to Society 279
Qualificatiion for Tax-Exempt Financing 280
10 THE TRACKING POWER OF MARKOWITZ PORTFOLIO OPTIMIZATION 281
10 The Tracking Power of Markowitz Portfolio Optimization 281
Policy Implications 281
Benefits, Costs, and Externalities 281
CONDITIONS REQUIRED FOR THE EFFICIENCY OF CAP-WEIGHTED PORTFOLIOS 282
WHEN CAP-WEIGHTED PORTFOLIOS ARE EFFICIENT 282
Summary 283
Selected References 284
WHEN CAP-WEIGHTED PORTFOLIOS ARE INEFFICIENT 284
What If We Disagree? 284
Index 285
What If Some of Us Can t Sell Short? 285
Tax Avoidance 286
Foreign Investors 287
Human Capital 287
The Benefits of Portfolio Optimization 287
Interest Only（IOs）, Principal Only (POs), and Residual Class Securities 288
A SIMPLE TEST OF THE EFFICIENCY OF THE CAP-WEIGHTED INDEX 288
TRACKING TARGETS WITH STOCK PORTFOLIOS 291
Tracking Targets with Factor Models 293
Tracking a Target with the Markowitz Bullet 294
TRACKING THE RATE OF INFLATION WITH THE MARKOWITZ BULLET 297
SUMMARY 299
APPENDIX 6：FINDING THE PORTFOLIO WITH THE MINIMUM VOLATILITY OF DIFFERENCES 300
11 Measuring Portfolio Performance 305
11 MEASURING PORTFOLIO PERFORMANCE 305
MEASURING THE RATE OF RETURN TO A PORTFOLIO 306
THE NEED FOR RISK-ADJUSTED PERFORMANCE MEASURES 307
RISK-ADJUSTED PERFORMANCE MEASURES BASE D ON THE CAPITAL ASSET PRICING MODEL 309
The Jensen Index 311
The Treynor Index 314
The Sharpe Index 315
Misspecifying the Market Pricing Structure 317
PITFALLS IN MEASURING PERFORMANCE WITH THE JENSEN, TREYNOR, AND SHARPE INDICES 317
Misspecification of the Market Index 321
MEASURING PERFORMANCE USING THE ARBITRAGE PRICING THEORY 324
MEASURING PERFORMANCE WITHOUT THE USE OF AN ASSET PRICING MODEL 327
SUMMARY 330
PART FOUR 341
INTEREST RATES AND BOND MANAGEMENT 341
PART FOUR 341
INTEREST RATES AND BOND MANAGEMENT 341
12 The Level of Interest Rates 341
12 THE LEVEL OF INTEREST RATES 341
THE REAL AND NOMINAL RATES OF INTEREST 342
INTEREST RATES AND THE SUPPLY AND DEMAND FOR MONEY 343
The Transactions Demand for Money 343
The Speculative Demand for Money 344
The Total Demand for Money 346
The Supply of Money and the Equilibrium Interest Rate 348
INVESTMENT, SAVING, AND NATIONAL INCOME 350
THE INTEREST RATES 353
A Tax Cut 355
THE EFFECT OF A CHANGE IN FISCAL POLICY 355
Monetizing the Deficit 359
SUMMARY 360
13 THE TERM STRUCTURE OF INTEREST RATES 367
13 The Term Structure of Interest Rates 367
THE NATURE AND HISTORY OF THE TERM STRUCTURE 368
DRAWING THE TERM STRUCTURE 371
METHODS OF COMPUTING THE YIELD TO MATURITY 375
The Arithmetie Mean Yield to Maturity 375
The Geometric Mean Yield to Matruity 376
The Internal Yield to Maturity 376
A BRIEF OVERVIEW OF THE THREE THEORIES OF THE TERM STRUCTURE 376
THE MARKET EXPECTATIONS THEORY OF THE TERM STRUCTURE 377
THE LIQUIDITY PREFERENCE THEORY OF THE TERM STRUCTURE 380
THE MARKET SEGMENTATION THEORY OF THE TERM STRUCTURE 383
DERIVING THE MARKET S ORECAST OF FUTURE INTEREST RATES FROM THE TERM STRUCTURE 386
Finding the Market s Forecast from Arithmetic Mean Yields 386
Finding the Market s Forecast with Internal Yields 388
SUMMARY 392
APPENDIX 7：AVERAGING MULTIPLE RATES OF RETURN 393
14 Bond Portfolio Management 407
14 BOND PORTFOLIO MANAGEMENT 407
ESTIMATING THE EXPECTED RETURN OF A BOND FOR PORTFOLIO ANALYSIS 408
Forecasting Expected Returns on Treasury Bonds 408
Forecasting Expected Returns on Corporate Bonds 411
A DURATION-BASED APPROACH TO ESTIMATING THE RISK OF A BOND PORTFOLIO 413
A MARKOWITZ APPROACH TO BOND RISK MANAGEMENT 414
DIVIDING THE PORTFOLIO BETWEEN BONDS AND STOCK 416
SUMMARY 416
15 INTEREST IMMUNIZATION 422
15 Interest Immunization 422
CASH MATCHING AND INTEREST IMMUNIZATION 423
ALTERNATIVE MEASURES OF DURATION 425
Macaulay s Duration 425
Fisher-Weil Duration 426
Duration and Yield Elasticity 426
Duration and the Response of the Value of a Stream of Payments or Receipts to a Change in Discount R 427
Cox, Ingersoll, Ross Duration 430
IMMUNIZING WITH MACAULAY S DURATION：THE CASE OF A SINGLE-PAYMENT LIABILITY 431
The Effect of Interest Rate Changes on Present Values 432
The Effect of Interest Rate Changes on Terminal Values 433
COMPUTING THE MACAULAY DURATION AND INTERNAL YIELD OF A BOND PORTFOLIO 435
Combination Lines for Internal Yield and Duration 439
IMMUNIZING WITH THE MACAULAY DURATION：THE CASE OF A MULTIPLE-PAYMENT LIABILITY 439
A TEST OF THE RELATIVE EFFECTIVENESS OF THE THREE DURATION MEASURES 441
SUMMARY 445
16 EUROPEAN OPTION PRICING 454
THE PRICING OF DERIVATIVE SECURITIES 454
16 European Option Pricing 454
PARY FIVE 454
PART FIVE 454
THE PRICING OF DERIVATIVE SECURITIES 454
PRICING OPTIONS UNDER RISK NEUTRALITY AND UNIFORM PROBABILITY DISTRIBUTIONS 455
Valuing a Call Option 455
Valuing a Put Option 457
The Relationship Between Option Values and Stock Values 459
The Effect of a Change in Stock Variance on Option Values 463
BINOMIAL OPTION PRICING 465
Binomial Call Option Pricing over a Single Period 466
Binomial Put Option Pricing over a Single Period 469
Binomial Option Pricing over Multiple Periods 470
VALUING OPTIONS USING THE BLACK-SCHOLES FRAMEWORK 474
The Black-Scholes Value for a Call Option 478
Estimating the Variance of the Stock sReturn 481
The Relationship Between Black-Scholes Put and Call Values and Underlying Stock Pritces 482
The Black-Scholes Value for a Put Option 482
PUT-CALL PARITY 484
Using the Black-Scholes Framework to Value Options on Stocks That Pay Dividends 484
APPENDIX 8：PROOF THAT αVc/αVs IS THE PROBABILITY OF EXERCISE FOR A CALL OPTION ON A STOCK WITH A 487
SUMMARY 487
17 AMERICAN OPTION PRICING 497
17 American Option Pricing 497
THE LOWER LIMITS TO THE VALUE OF AMERICAN OPTIONS 498
Market forces Supporting the Hard Floor 498
Floors Supporting American Call Options 498
Market Forces Supporting the Soft Floor 499
Floors Supporting American Put Options 501
When the Right to Exercise Early Has No Value 502
THE VALUE OF EARLY EXERCISE 502
How Dividend Payments May Induce Early Exercise of American Call Options 503
Early Exercise of American Put Options 504
THE BINOMIAL MODEL AS AN AMERICAN OPTION-PRICING MODEL 504
SUMMARY 506
APPENDIX 9：THE GESKEROLL-WHALEY AMERICAN OPTION-PRICING MODEL 507
18 Additional Issues in Option Pricing 512
18 ADDITIONAL ISSUES IN OPTION PRICING 512
USING THE OPTION-PRICING FORMULAS TO FIND THE MARKET S ESTIMATE OF THE STOCK S VARIANCE 513
BIAS PROBLEMS IN OPTION-PRICING MODELS 514
Changing Volatility as a Source of Bias in Option-Pricing Models 516
Bias from Using European Models to Value American Options 518
Pricing Bias Resulting from Error in the Model s Inputs 519
OPTION STRATEGIES 520
The Straddle 520
The Butterfly Spread 522
Computing the Expected Return on an Option Strategy 523
Delta, Gamma, and Theta 524
Getting Delta Neutral 526
Portfolio Insurance 530
COMPLEX SECURITIES AS PORTFOLIOS OF OPTIONS 533
Common Stock as an Option 533
Bonds as Portfolios of Options and Option Complements 535
SUMMRY 536
19 Financial Forward and Futures Contracts 541
19 FINANCIAL FORWARD AND FUTURES CONTRACTS 541
CHARACTERISTICS OF FORWARD AND FUTURES CONTRACTS 542
THE DETERMINATION OF FORWARD PRICES 543
The Relationship Between the Forward Price and the Current Commodity Price 544
The Relationship Between the Forward Price and the Expected Commodity Price 548
The Consistency of the Two Expressions for the Forward Price 551
Market Value of Previously Issued Forward Contracts 552
DETERMINATION OF FUTURES PRICES 553
The Sign of the Premiums for Various Financial Futures 556
The Significance of the Premiums to Investors and Financial Managers 556
THE SECURITY UNDERLYING A FUTURES CONTRACT TO BUY TREASURY BONDS 557
HEDGING WITH BOND FUTURES CONTRACTS 562
USES OF STOCK INDEX FUTURES 563
FULL COVARIANCE APPROACH TO CONSTRUCTING A FUTURES OVERLAY 564
SUMMARY 566
ISSUES IN INVESTMENT MANAGEMENT 573
PART FIVE 573
20 The Effect of Taxes on Investment Strategy and Securities Prices 573
ISSUES IN INVESTMENT MANGEMENT 573
20 THE EFFECT OF TAXES ON INVESTMENT STRATEGY AND SECURITIES PRICES 573
PART SIX 573
THE TAX STRUCTURE 574
What Investment Income Is Taxed? 574
Capital Gains and Losses 575
TAXES AND INVESTMENT STRATEGY 575
Computing After-Tax Rates of Return 575
The Locked-In Effect 577
Dividend Clienteles 579
THE EFFECT OF TAXES ON SECURITIES PRICES 581
The Effiect of Dividends on Expected Stock Returns 581
Relative Expected Returns on Taxable and Tax-Exempt Securities 584
SUMMARY 587
21 STOCK VALUATION 594
21 Stock Valuation 594
A FRAMEWORK FOR VALUING COMMON STOCKS 595
Dividends versus Earnings 596
The Constant Growth Model 596
The Multistage Growth Model 597
COMPUTERIZED THREE-STAGE STOCK VALUATION 601
PRICE-EARNINGS RATIO 607
What Determines the Level of the Price-Earnings Ratio? 608
Changes That Can Be Expected in the Price-Earnings Ration over Time 608
SUMMARY 609
22 Issues in Estimating Future Earnings and Dividends 612
22 ISSUES IN ESTIMATING FUTURE EARNINGS AND DIVIDENDS 612
PAYING IN ADVANCE FOR GROWTH 613
THE LINK BETWEEN GROWTH AND STOCK VALUATION AND RISK AND EXPECTED RETURN 619
THE ACCURACY OF PREDICTIONS OF GROWTH IN EARNINGS AND DIVIDENDS 623
Is Past Growth a Reliable Guide to Future Growth? 623
The Accuracy of Short-Term Professional Forecasts 625
The Accuracy of Growth Forecasts Made by Protessional Analysts 625
The Accuracy of Long-Term Professional Forecasts 628
The Accuracy of Market Forecasts of the Growth in Earnings Per Share 629
IMPLICATIONS FOR INVESTMENT STRATEGY 634
SUMMARY 637
23 Market Efficiency：The Concept 641
23 MARKET EFFICIENCY：THE CONCEPT 641
FORMS OF THE EFFICIENT MARKET HYPOTHESIS 642
THE SIGNIFICANCE OF THE EFFICIENT MARKET HYPOTHESIS 645
RISK AND EXPECTED RETURN IN AN EFFICIENT MARKET 647
QUICK AND ACCURATE RESPONSE TO NEW INFORMATION 650
SYSTEMATIC PATTERNS IN STOCK PRICES RELATED ONLY TO TIME-VARYING INTEREST RATES AND RISK PREMIA 651
FAILURE OF SIMULATED TRADING STRATEGIES 653
MEDIOCRITY IN THE PERFORMANCE OF INFORMED INVESTORS 655
SUMMARY 656
24 MARKT EFFICIENCY：THE EVIDENCE 661
24 Market Efficiency：The Evidence 661
Measuring Stock Price Response 662
DO SECURITY PRICES RESPOND RAPIDLY AND ACCURATIELY TO THE RECEIPT OF NEW INFORMATION? 662
The Response of Stock Prices to the Announcement of a Stock Split 665
The Pesponse of Stock Prices to Quarterly Earnings Reports 667
Further Evidence on the Reaction of Stock Prices to Positive and Negative Events 669
THE BEHAVIOR OF CHANGES IN STOCK PRICES 673
Studies of Serial Correlation 673
Studies of Seasonality 677
The Day-of-the -Week Effect 677
DO TRADING RULES FAIL UNDER SIMULATION? 693
SUMMARY 710
APPENDIX10：ADDITIONAL PROPERTIES OF THE MINIMUM VARIANCE SET 718
Appendix10：Additional Properties of the Minimum Variance Set 718
Appendix11：Invest Software 727
APPENDIX11：INVEST SOFTWARE 727
Glossary 729
GLOSSARY 729
Index 737
INDEX 737