PART ONE BACKGROUND 1
1 Understanding Investments 1
An Overall Perspective on Investing 2
Establishing a Framework for Investing 3
Some Definitions 3
A Perspective on Investing in Financial Assets 4
Why Do We Invest? 4
The Importance of Studying Investments 5
The Personal Aspects 5
Investments as a Profession 7
Understanding the Investment Decision Process 8
The Basis of Investment Decisions—Return and Risk 9
Structuring the Decision Process 12
Important Considerations in the Investment Decision Process for Today's Investors 13
The Great Unknown 13
The Global Investments Arena 14
The Importance of the Internet 15
Individual Investors Versus Institutional Investors 15
Ethics in Investing 16
Organizing the Text 17
Summary 18
2 Investment Alternatives 21
Organizing Financial Assets 22
Direct Investing 23
An International Perspective 24
Nonmarketable Financial Assets 24
Money Market Securities 26
The Treasury Bill 26
Money Market Rates 27
Fixed-Income Securities 28
Bonds 28
Types of Bonds 31
Asset-Backed Securities 37
Rates on Fixed-Income Securities 37
Equity Securities 38
Preferred Stock 38
Common Stock 39
Investing Internationally in Equities 42
Derivative Securities 43
Options 43
Futures Contracts 44
A Final Note 45
Summary 45
3 Indirect Investing 49
Investing Indirectly 50
What Is an Investment Company? 51
Types of Investment Companies 53
Unit Investment Trusts 53
Exchange-Traded Funds(ETFs) 53
Closed-End Investment Companies 54
Open-End Investment Companies(Mutual Funds) 55
Types of Mutual Funds 57
Money Market Funds 58
Equity Funds,Bond Funds,and Hybrid Funds 59
The Mechanics of Investing Indirectly 63
Closed-End Funds 63
Mutual Funds 64
Exchange-Traded Funds 69
Investment Company Performance 69
Measures of Fund Performance 70
Morningstar Ratings 71
Benchmarks 72
How Important are Expenses in Affecting Performance? 72
Some Conclusions About Fund Performance 72
Investing Internationally Through Investment Companies 74
Fund Categories for International Investing 75
The Future of Indirect Investing 76
Fund Supermarkets 76
Separately Managed Accounts 76
Hedge Funds 77
Summary 77
4 Securities Markets 82
The Importance of Financial Markets 83
The Primary Markets 83
Initial Public Offerings(IPOs) 84
The Investment Banker 84
Global Investment Banking 86
Private Placements 86
The Secondary Markets 87
U.S. Securities Markets for the Trading of Equities 87
The New York Stock Exchange 89
American Stock Exchange 92
The NASDAQ Stock Market 93
Comparisons of the Three Major Equity Markets 94
Regional Exchanges 95
Over-the-Counter Stocks 95
Electronic Communications Networks(ECNs) 96
In-House Trading 97
Foreign Markets 97
Stock Market Indexes 98
The Dow Jones Averages 98
Standard ＆ Poor's Stock Price Indexes 100
Understanding a Capitalization-Weighted Index 101
NASDAQ Indexes 102
Other Indexes 103
Relationships Between Domestic Stock Indexes 103
Foreign Stock Market Indicators 104
Bond Markets 105
Treasury Bonds 105
Agency Bonds 105
Municipal Bonds 106
Corporate Bonds 106
The Changing Bond Market 106
Derivatives Markets 107
The Changing Securities Markets 107
The National Market System(NMS) 107
The Intermarket Trading System(ITS) 108
Changes in U.S. Markets 108
The Globalization of Securities Markets 108
Summary 109
5 How Securities Are Traded 113
Brokerage Transactions 114
Brokerage Firms 114
Brokerage Accounts 118
Commissions 118
Investing Without a Broker 119
How Orders Work 120
Orders on the Organized Exchanges 120
Orders in the NASDAQ Stock Market 122
Decimalization of Stock Prices 122
Types of Orders 122
Clearing Procedures 124
Investor Protection in the Securities Markets 124
Government Regulation 124
Self-Regulation 126
Other Investor Protections 128
Margin 129
How Margin Accounts Can be Used 129
Margin Requirements and Obligations 130
Margin Requirements on Other Securities 131
Some Misconceptions About Margin 132
Short Sales 132
Selling Short as an Investor 134
Summary 136
PART TWO PORTFOLIO AND CAPITAL MARKET THEORY 136
6 Returns and Risks from Investing 140
An Overview 141
Return 142
The Two Components of Return 142
Risk 143
Sources of Risk 143
Measuring Returns 145
Total Return 145
Return Relative 147
Cumulative Wealth Index 149
Taking a Global Perspective 150
International Returns and Currency Risk 151
Summary Statistics for Returns 153
Arithmetic Mean 153
Geometric Mean 154
Arithmetic Mean Versus Geometric Mean 154
Inflation-Adjusted Returns 155
Measuring Risk 157
Variance and Standard Deviation 158
Risk Premiums 159
Realized Returns and Risks from Investing 161
Total Returns and Standard Deviations for the Major Financial Assets 161
Cumulative Wealth Indexes 163
The Components of Cumulative Wealth 164
Compounding and Discounting 165
Summary 165
7 Portfolio Theory 173
Dealing with Uncertainty 174
Using Probabilities 175
Probability Distributions 175
Calculating Expected Return for a Security 177
Calculating Risk for a Security 177
Introduction to Modern Portfolio Theory(MPT) 179
Portfolio Return and Risk 179
Portfolio Expected Return 180
Portfolio Risk 180
Analyzing Portfolio Risk 181
Risk Reduction—The Insurance Principle 181
Diversification 182
The Components of Portfolio Risk 184
The Correlation Coefficient 184
Covariance 187
Relating the Correlation Coefficient and the Covariance 188
Calculating Portfolio Risk 188
The Two-Security Case 188
The n-Security Case 191
The Importance of Covariance 192
Obtaining the Data 192
Simplifying the Markowitz Calculations 193
Summary 194
8 Portfolio Selection 201
Building a Portfolio Using Markowitz Principles 202
Identifying Optimal Risk-Return Combinations 202
Selecting an Optimal Portfolio of Risky Assets 204
The Global Perspective—International Diversification 206
Some Important Conclusions About the Markowitz Model 207
Alternative Methods of Obtaining the Efficient Frontier 207
The Single-Index Model 208
Multi-Index Models 211
Selecting Optimal Asset Classes—The Asset Allocation Decision 211
Some Major Asset Classes 212
Combining Asset Classes 214
Asset Allocation and the Individual Investor 215
Owning Stocks and Bonds 216
Return and Risk Combinations 217
Life-Cycle Analysis 219
The Impact of Diversification on Risk 219
Systematic and Nonsystematic Risk 219
How Many Securities are Enough to Diversify Properly? 220
The Implications of Reducing Risk by Holding Portfolios 222
Summary 222
9 Asset Pricing Models 228
Capital Market Theory 229
Capital Market Theory Assumptions 229
Introduction of the Risk-Free Asset 230
Risk-Free Borrowing and Lending 231
The Equilibrium Return-Risk Trade-off 232
The Capital Market Line 233
The Security Market Line 237
Beta 238
The CAPM's Expected Return—Beta Relationship 239
Over-and-Undervalued Securities 240
Estimating the SML 242
Estimating Beta 242
Tests of the.CAPM 245
Arbitrage Pricing Theory 246
The Law of One Price 246
Assumptions of APT 247
Factor Models 247
Understanding the APT Model 248
Identifying the Factors 249
Using APT in Investment Decisions 250
Some Conclusions about Asset Pricing 251
Summary 251
PART THREE COMMON STOCKS:ANALYSIS,VALUATION,AND MANAGEMENT 251
10 Common Stock Valuation 259
Overview 260
Discounted Cash Flow Techniques 260
Two DCF Approaches 261
The Dividend Discount Model 262
Dividends Dividends—What about Capital Gains? 271
The Dividend Discount Model in Practice 272
Other Discounted Cash Flow Approaches 273
Intrinsic Value and Market Price 275
Relative Valuation Techniques 276
The P/E Ratio or Earnings Multiplier Approach 277
Price/Book Value 281
Price/Sales Ratio(PRS) 281
Economic Value Added 283
Which Approach to Use? 283
Bursting the Bubble on New Economy Stocks—A Lesson in Valuation 284
Some Final Thoughts on Valuation 286
Summary 286
11 Common Stocks:Analysis and Strategy 296
Taking a Global Perspective 297
Analyzing Some Important Issues Involving Common Stocks 297
The Impact of the Overall Market on Individual Stocks 298
The Required Rate of Return 299
Building Stock Portfolios 301
The Passive Strategy 302
Buy-and-Hold Strategy 302
Index Funds 303
The Active Strategy 305
Security Selection 305
Sector Rotation 311
Market Timing 313
Rational Markets and Active Strategies 315
A Simple Strategy—The Coffeehouse Portfolio 316
Summary 316
12 Market Efficiency 320
Overview 321
The Concept of an Efficient Market 321
What is an Efficient Market? 321
Why The U.S. Stock Market can be Expected to be Efficient 323
The International Perspective 323
Forms of Market Efficiency 324
How to Test for Market Efficiency 327
Weak-Form Tests 328
Semistrong-Form Tests 330
Strong-Form Evidence 331
Behavioral Finance and Market Anomalies 334
Earnings Announcements 336
Low P/E Ratios 338
The Size Effect 338
The January Effect 339
The Value Line Ranking System 340
Other Anomalies 342
Some Conclusions about Market Efficiency 343
Data Mining 344
Some Remaining Issues 345
Behavioral Finance and Efficient Markets 345
A Final Argument for Market Efficiency 347
Summary 347
PART FOUR SECURITY ANALYSIS 347
13 Economy/Market Analysis 352
Taking a Global Perspective 353
Assessing the Economy 354
The Business Cycle 354
Forecasts of the Economy 358
Understanding the Stock Market 361
What Do We Mean by the "Market"? 361
Making Market Forecasts 365
Focus on the Important Variables 365
Using the Business Cycle to Make Market Forecasts 369
Other Approaches to Assessing the Market's Direction 370
Summary 374
14 Sector/Industry Analysis 377
What Is an Industry? 378
Classifying Industries 379
A New Classification System—NAICS 379
Other Industry Classifications 379
The Importance of Sector/Industry Analysis 380
Why Industry Analysis is Important Over the Long Run 380
Industry Performance Over Shorter Periods 381
How One Industry Can Have a Major Impact on Investors—The Telecom Industry 382
Cross-Sectional Volatility Has Increased 383
Analyzing Sectors/Industries 383
The Industry Life Cycle 383
Qualitative Aspects of Industry Analysis 385
Using Sector/Industry Analysis as an Investor 387
Sector Rotation 387
Evaluating Future Industry Prospects 387
Business Cycle Analysis 388
Picking Industries for Next Year 390
Summary 392
15 Company Analysis 395
Fundamental Analysis 396
The Accounting Aspects of Earnings 397
The Financial Statements 397
The Problems with EPS 404
Has the Situation Improved? 405
The Global Arena—International Accounting 409
Analyzing a Company's Profitability 409
Analyzing Return on Equity(ROE) 410
Analyzing Return on Assets(ROA) 411
Using ROE—Estimating the Internal(Sustainable)Growth Rate 412
Earnings Estimates 413
A Forecast of EPS 414
The Accuracy of Earnings Forecasts 414
Earnings Surprises 415
Earnings Guidance 416
The Earnings Game 417
Useful Information for Investors about Earnings Estimates 418
Sales Growth—An Alternative to Earnings 418
The P/E Ratio 419
Which P/E Ratio is Being Used? 419
Determinants of the P/E Ratio 419
Why P/E Ratios Vary Among Companies 420
The PEG Ratio 421
Fundamental Security Analysis in Practice 421
Summary 424
16 Technical Analysis 431
What Is Technical Analysis? 432
A Framework for Technical Analysis 434
Stock Price and Volume Techniques 435
The Dow Theory 435
Charts of Price Patterns 436
Moving Averages 441
Relative Strength 443
Using the Computer for Technical Analysis 444
Technical Indicators 445
Breadth Indicators 445
Sentiment Indicators 445
Testing Technical Analysis Strategies 447
The EBB and Flow of Technical Analysis 449
Some Conclusions about Technical Analysis 449
Summary 452
PART FIVE FIXED-INCOME SECURITIES:ANALYSIS, VALUATION,AND MANAGEMENT 452
17 Bond Yields and Prices 455
Bond Yields 456
The Basic Components of Interest Rates 457
Measuring Bond Yields 458
Bond Prices 467
The Valuation Principle 467
Bond Valuation 468
Bond Price Changes 469
Bond Price Changes Over Time 469
Bond Price Changes as a Result of Interest Rate Changes 470
Measuring Bond Price Volatility: Duration 473
Summary 480
18 Bonds:Analysis and Strategy 488
Why Buy Bonds? 489
Buying Foreign Bonds 490
Important Considerations in Managing a Bond Portfolio 491
Understanding the Bond Market 491
The Term Structure of Interest Rates 492
The Risk Structure of Interest Rates—Yield Spreads 497
Bond Strategies 499
Passive Management Strategies 500
Immunization—A Structured Portfolio Strategy 502
Active Management Strategies 505
Building a Fixed-Income Portfolio 507
Conservative Investors 508
Aggressive Investors 508
The International Perspective 509
Summary 510
PART SIX DERIVATIVE SECURITIES 510
19 Options 514
Why Have Derivative Securities? 515
Why Options Markets? 515
Introduction to Options 516
Understanding Options 517
Options Terminology 517
How Options Work 518
The Mechanics of Trading 519
Payoffs and Profits from Basic Option Positions 521
Calls 521
Puts 523
Some Basic Options Strategies 525
Covered Calls 526
Protective Puts 529
Portfolio Insurance 531
Option Valuation 532
A General Framework 532
Intrinsic Values and Time Values 532
Boundaries on Option Prices 534
The Black-Scholes Model 536
Put Option Valuation 539
Summarizing the Factors Affecting Options Prices 539
Hedge Ratios 540
Using the Black-Scholes Model 540
An Investor's Perspective on Puts and Calls 541
What Puts and Calls Mean to Investors 541
The Evolutionary Use of Options 541
Stock-Index Options 542
The Basics of Stock-Index Options 542
Strategies with Stock-Index Options 543
The Popularity of Stock-Index Options 545
Summary 545
20 Futures 552
Understanding Futures Markets 553
Why Futures Markets ? 553
Current U.S. Futures Markets 554
Foreign Futures Markets 555
Futures Contracts 555
The Structure of Futures Markets 556
Futures Exchanges 556
The Clearinghouse 556
The Mechanics of Trading 557
Basic Procedures 557
Margin 559
Using Futures Contracts 562
Hedgers 562
How to Hedge with Futures 563
Speculators 564
Financial Futures 564
Interest Rate Futures 565
Stock-Index Futures 568
Single Stock Futures 573
Summary 574
PART SEVEN INVESTMENT MANAGEMENT 574
21 Portfolio Management 579
Portfolio Management as a Process 580
Individual Investors Versus Institutional Investors 582
Formulate an Appropriate Investment Policy 584
Objectives 584
Constraints and Preferences 586
Determine and Quantify Capital Market Expectations 589
Forming Expectations 589
Rate of Return Assumptions 590
Developing and Implementing Investing Strategies 593
Asset Allocation 593
Portfolio Optimization 595
Monitor Market Conditions and Investor Circumstances 596
Monitoring Market Conditions 596
Changes in Investor's Circumstances 596
Rebalancing the Portfolio 596
Performance Measurement 598
Summary 599
22 Evaluation of Investment Performance 602
A Framework for Evaluating and Assessing Portfolio Performance 603
Performance Measurement Issues 604
Three Questions to Answer in Measuring Portfolio Performance 604
Return Calculations 605
Risk Considerations 607
Performance Benchmarks and Performance Universes 608
Performance Universes 608
Performance Benchmarks 609
Risk-Adjusted Measures of Performance 610
The Sharpe Performance Measure 610
The Treynor Performance Measure 612
Jensen's Differential Return Measure 615
M2 617
Style Analysis and Performance Attribution 619
Style Analysis 619
Performance Attribution 620
Money Managers and Performance Presentations 621
An Overview on Performance Evaluation 622
Summary 622