Contents

Preface xvi and Reverses / Federal Funds / Brokers’ Calls /

The LIBOR Market / Yields on Money Market
PART I Instruments
2.2 The Bond Market 33
Introduction 1 Treasury Notes and Bonds / Inflation-Protected Treasury
Bonds / Federal Agency Debt / International Bonds /
Chapter Municipal Bonds / Corporate Bonds / Mortgages and
Mortgage-Backed Securities
The Investment Environment 1
2.3 Equity Securities 40
1.1 Real Assets versus Financial Assets 2
Common Stock as Ownership Shares / Characteristics of
1.2 Financial Assets 3 Common Stock / Stock Market Listings / Preferred Stock /
1.3 Financial Markets and the Economy 5 Depositary Receipts
The Informational Role of Financial Markets / 2.4 Stock and Bond Market Indexes 43
Consumption Timing / Allocation of Risk / Separation of Stock Market Indexes / Dow Jones Industrial Average /
Ownership and Management / Corporate Governance The Standard & Poor’s 500 Index / Other U.S. Market-
and Corporate Ethics Value Indexes / Equally Weighted Indexes / Foreign
1.4 The Investment Process 8 and International Stock Market Indexes / Bond Market
1.5 Markets Are Competitive 9 Indicators
The Risk–Return Trade-Off / Efficient Markets 2.5 Derivative Markets 50
1.6 The Players 11 Options / Futures Contracts
Financial Intermediaries / Investment Bankers / Venture End of Chapter Material 52–56
Capital and Private Equity
1.7 The Financial Crisis of 2008 15
Chapter
Antecedents of the Crisis / Changes in Housing Finance /
Mortgage Derivatives / Credit Default Swaps / The Rise of How Securities Are Traded 57
Systemic Risk / The Shoe Drops / The Dodd-Frank Reform Act 3.1 How Firms Issue Securities 57
1.8 Outline of the Text 23 Privately Held Firms / Publicly Traded Companies /
End of Chapter Material 23–26 Shelf Registration / Initial Public Offerings
3.2 How Securities Are Traded 62
Chapter Types of Markets
Asset Classes and Financial Instruments 27 Direct Search Markets / Brokered Markets / Dealer
2.1 The Money Market 27 Markets / Auction Markets
Treasury Bills / Certificates of Deposit / Commercial Types of Orders
Paper / Bankers’ Acceptances / Eurodollars / Repos Market Orders / Price-Contingent Orders

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Trading Mechanisms PART II

Dealer Markets / Electronic Communication Networks
(ECNs) / Specialist Markets Portfolio Theory
3.3
3.4
The Rise of Electronic Trading 66
U.S. Markets 68
and Practice 117
NASDAQ / The New York Stock Exchange / ECNs
Chapter
3.5 New Trading Strategies 70
Algorithmic Trading / High-Frequency Trading / Dark
Risk, Return, and the Historical Record 117
Pools / Bond Trading 5.1 Determinants of the Level of Interest Rates 118
3.6 Globalization of Stock Markets 73 Real and Nominal Rates of Interest / The Equilibrium
3.7 Trading Costs 74 Real Rate of Interest / The Equilibrium Nominal Rate of
Interest / Taxes and the Real Rate of Interest
3.8 Buying on Margin 75
5.2 Comparing Rates of Return for Different Holding
3.9 Short Sales 78
Periods 121
3.10 Regulation of Securities Markets 82
Annual Percentage Rates / Continuous Compounding
Self-Regulation / The Sarbanes-Oxley Act / Insider
5.3 Bills and Inflation, 1926–2015 124
Trading
5.4 Risk and Risk Premiums 126
End of Chapter Material 86–90
Holding-Period Returns / Expected Return and Standard
Deviation / Excess Returns and Risk Premiums
Chapter 5.5 Time Series Analysis of Past Rates of Return 129
Time Series versus Scenario Analysis / Expected Returns
Mutual Funds and Other Investment and the Arithmetic Average / The Geometric (Time-
Companies 91 Weighted) Average Return / Variance and Standard
4.1 Investment Companies 91 Deviation / Mean and Standard Deviation Estimates
4.2 Types of Investment Companies 92 from Higher-Frequency Observations / The Reward-to-
Volatility (Sharpe) Ratio
Unit Investment Trusts / Managed Investment Companies /
Other Investment Organizations 5.6 The Normal Distribution 134
Commingled Funds / Real Estate Investment Trusts 5.7 Deviations from Normality and Alternative Risk
(REITs) / Hedge Funds Measures 136
4.3 Mutual Funds 95 Value at Risk / Expected Shortfall / Lower Partial
Standard Deviation and the Sortino Ratio / Relative
Investment Policies
Frequency of Large, Negative 3-Sigma Returns
Money Market Funds / Equity Funds / Sector
5.8 Historic Returns on Risky Portfolios 140
Funds / Bond Funds / International Funds / Balanced
Funds / Asset Allocation and Flexible Funds / A Global View of the Historical Record
Index Funds 5.9 Normality and Long-Term Investments 147
How Funds Are Sold Short-Run versus Long-Run Risk / Forecasts for the
4.4 Costs of Investing in Mutual Funds 98 Long Haul
Fee Structure End of Chapter Material 151–156
Operating Expenses / Front-End Load / Back-End
Load / 12b-1 Charges Chapter
Fees and Mutual Fund Returns Capital Allocation to Risky Assets 157
4.5 Taxation of Mutual Fund Income 102 6.1 Risk and Risk Aversion 158
4.6 Exchange-Traded Funds 103 Risk, Speculation, and Gambling / Risk Aversion and
4.7 Mutual Fund Investment Performance: Utility Values / Estimating Risk Aversion
A First Look 106 6.2 Capital Allocation across Risky and Risk-Free
4.8 Information on Mutual Funds 109 Portfolios 164
End of Chapter Material 112–116 6.3 The Risk-Free Asset 166

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6.4 Portfolios of One Risky Asset and a Risk-Free 8.4 The Industry Version of the Index Model 259
Asset 167 Predicting Betas
6.5 Risk Tolerance and Asset Allocation 170 8.5 Portfolio Construction Using the Single-Index Model 262
Non-Normal Returns Alpha and Security Analysis / The Index Portfolio as an
6.6 Passive Strategies: The Capital Market Line 176 Investment Asset / The Single-Index Model Input List /
End of Chapter Material 178–187 The Optimal Risky Portfolio in the Single-Index Model /
Appendix A: Risk Aversion, Expected Utility, and the The Information Ratio / Summary of Optimization Proce-
St. Petersburg Paradox 187 dure / An Example / Correlation and Covariance Matrix

Appendix B: Utility Functions and Risk Premium Forecasts / The Optimal Risky Portfolio / Is
Risk Premiums 191 the Index Model Inferior to the Full-Covariance Model?
End of Chapter Material 271–276
Chapter
Optimal Risky Portfolios 193 PART III
7.1
7.2
Diversification and Portfolio Risk 194
Portfolios of Two Risky Assets 195
Equilibrium in Capital
7.3 Asset Allocation with Stocks, Bonds, and Bills 203 Markets 277
Asset Allocation with Two Risky Asset Classes
7.4 The Markowitz Portfolio Optimization Model 208 Chapter
Security Selection / Capital Allocation and the Separa- The Capital Asset Pricing Model 277
tion Property / The Power of Diversification / Asset
9.1 The Capital Asset Pricing Model 277
Allocation and Security Selection / Optimal Portfolios
and Non-Normal Returns Why Do All Investors Hold the Market Portfolio? / The
Passive Strategy Is Efficient / The Risk Premium of the
7.5 Risk Pooling, Risk Sharing, and the Risk
Market Portfolio / Expected Returns on Individual
of Long-Term Investments 217
Securities / The Security Market Line / The CAPM and
Risk Pooling and the Insurance Principle / Risk Sharing / the Single-Index Market
Diversification and the Sharpe Ratio / Time Diversifica-
9.2 Assumptions and Extensions of the CAPM 288
tion and the Investment Horizon
Identical Input Lists / Risk-Free Borrowing and the
End of Chapter Material 222–232
Zero-Beta Model / Labor Income and Nontraded
Appendix A: A Spreadsheet Model for Efficient Assets / A Multiperiod Model and Hedge Portfolios /
Diversification 232 A Consumption-Based CAPM / Liquidity and the CAPM
Appendix B: Review of Portfolio Statistics 237 9.3 The CAPM and the Academic World 298
9.4 The CAPM and the Investment Industry 299
Chapter
End of Chapter Material 300–308
Index Models 245
8.1 A Single-Factor Security Market 246 Chapter
The Input List of the Markowitz Model / Systematic ver- Arbitrage Pricing Theory and Multifactor
sus Firm-Specific Risk Models of Risk and Return 309
8.2 The Single-Index Model 248
10.1 Multifactor Models: A Preview 310
The Regression Equation of the Single-Index Model / The
Factor Models of Security Returns
Expected Return–Beta Relationship / Risk and Covari-
ance in the Single-Index Model / The Set of Estimates 10.2 Arbitrage Pricing Theory 312
Needed for the Single-Index Model / The Index Model Arbitrage, Risk Arbitrage, and Equilibrium / Well-
and Diversification Diversified Portfolios / The Security Market Line of the APT
8.3 Estimating the Single-Index Model 255 Individual Assets and the APT
The Security Characteristic Line for Ford / The Explana- Well-Diversified Portfolios in Practice
tory Power of Ford’s SCL / The Estimate of Alpha / The 10.3 The APT, the CAPM, and the Index Model 319
Estimate of Beta / Firm-Specific Risk The APT and the CAPM / The APT and Portfolio
Typical Results from Index Model Regressions Optimization in a Single-Index Market

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10.4 A Multifactor APT 321 Limits to Arbitrage and the Law of One Price
10.5 The Fama-French (FF) Three-Factor Model 324 “Siamese Twin” Companies / Equity Carve-Outs /
End of Chapter Material 326–332 Closed-End Funds
Bubbles and Behavioral Economics / Evaluating the
Chapter Behavioral Critique
The Efficient Market Hypothesis 333 12.2 Technical Analysis and Behavioral Finance 384
11.1 Random Walks and the Efficient Market Trends and Corrections
Hypothesis 334 Momentum and Moving Averages / Relative Strength /
Competition as the Source of Efficiency / Versions of the Breadth
Efficient Market Hypothesis Sentiment Indicators
11.2 Implications of the EMH 339 Trin Statistic / Confidence Index / Put/Call Ratio
Technical Analysis / Fundamental Analysis / Active versus A Warning
Passive Portfolio Management / The Role of Portfolio End of Chapter Material 391–396
Management in an Efficient Market / Resource Allocation
11.3 Event Studies 343 Chapter
11.4 Are Markets Efficient? 347 Empirical Evidence on Security
The Issues Returns 397
The Magnitude Issue / The Selection Bias Issue / The 13.1 The Index Model and the Single-Factor SML 398
Lucky Event Issue
The Expected Return–Beta Relationship
Weak-Form Tests: Patterns in Stock Returns
Setting Up the Sample Data / Estimating the SCL /
Returns over Short Horizons / Returns over Long Horizons Estimating the SML
Predictors of Broad Market Returns / Semistrong Tests: Tests of the CAPM / The Market Index / Measurement
Market Anomalies Error in Beta
The Small-Firm Effect / The Neglected-Firm Effect 13.2 Tests of the Multifactor Models 403
and Liquidity Effects / Book-to-Market Ratios / Post–
Labor Income / Private (Nontraded) Business / Early Tests
Earnings-Announcement Price Drift
of the Multifactor CAPM and APT / A Macro Factor Model
Strong-Form Tests: Inside Information / Interpreting the
13.3 Fama-French-Type Factor Models 407
Anomalies
Size and B/M as Risk Factors / Behavioral Explanations /
Risk Premiums or Inefficiencies? / Anomalies or Data
Momentum: A Fourth Factor
Mining? / Anomalies over Time
13.4 Liquidity and Asset Pricing 414
Bubbles and Market Efficiency
13.5 Consumption-Based Asset Pricing and the Equity
11.5 Mutual Fund and Analyst Performance 359
Premium Puzzle 416
Stock Market Analysts / Mutual Fund Managers / So, Are
Expected versus Realized Returns / Survivorship Bias /
Markets Efficient?
Extensions to the CAPM May Resolve the Equity Premium
End of Chapter Material 365–372 Puzzle / Liquidity and the Equity Premium Puzzle /
Behavioral Explanations of the Equity Premium Puzzle
Chapter
End of Chapter Material 422–424
Behavioral Finance and Technical
Analysis 373
PART IV
12.1 The Behavioral Critique 374
Information Processing
Forecasting Errors / Overconfidence / Conservatism /
Fixed-Income Securities 425
Sample Size Neglect and Representativeness Chapter
Behavioral Biases
Bond Prices and Yields 425
Framing / Mental Accounting / Regret Avoidance /
Affect / Prospect Theory 14.1 Bond Characteristics 426
Limits to Arbitrage Treasury Bonds and Notes
Fundamental Risk / Implementation Costs / Model Risk Accrued Interest and Quoted Bond Prices

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Corporate Bonds 16.2 Convexity 505

Call Provisions on Corporate Bonds / Convertible Why Do Investors Like Convexity? / Duration and
Bonds / Puttable Bonds / Floating-Rate Bonds Convexity of Callable Bonds / Duration and Convexity of
Preferred Stock / Other Domestic Issuers / International Mortgage-Backed Securities
Bonds / Innovation in the Bond Market 16.3 Passive Bond Management 513
Inverse Floaters / Asset-Backed Bonds / Catastrophe Bond-Index Funds / Immunization / Cash Flow Match-
Bonds / Indexed Bonds ing and Dedication / Other Problems with Conventional
14.2 Bond Pricing 432 Immunization
Bond Pricing between Coupon Dates 16.4 Active Bond Management 522
14.3 Bond Yields 438 Sources of Potential Profit / Horizon Analysis
Yield to Maturity / Yield to Call / Realized Compound End of Chapter Material 525–536
Return versus Yield to Maturity
14.4 Bond Prices over Time 444
PART V
Yield to Maturity versus Holding-Period Return / Zero-
Coupon Bonds and Treasury Strips / After-Tax Returns
14.5 Default Risk and Bond Pricing 449
Security Analysis 537
Junk Bonds / Determinants of Bond Safety / Bond Chapter
Indentures
Sinking Funds / Subordination of Further Debt /
Macroeconomic and Industry Analysis 537
Dividend Restrictions / Collateral 17.1 The Global Economy 537
Yield to Maturity and Default Risk / Credit Default Swaps / 17.2 The Domestic Macroeconomy 540
Credit Risk and Collateralized Debt Obligations Key Economic Indicators
End of Chapter Material 460–466 Gross Domestic Product / Employment / Inflation /
Interest Rates / Budget Deficit / Sentiment
Chapter 17.3 Demand and Supply Shocks 542
17.4 Federal Government Policy 542
The Term Structure of Interest Rates 467
Fiscal Policy / Monetary Policy / Supply-Side Policies
15.1 The Yield Curve 467
17.5 Business Cycles 545
Bond Pricing
The Business Cycle / Economic Indicators / Other Indicators
15.2 The Yield Curve and Future Interest Rates 470
17.6 Industry Analysis 550
The Yield Curve under Certainty / Holding-Period
Defining an Industry / Sensitivity to the Business Cycle /
Returns / Forward Rates
Sector Rotation / Industry Life Cycles
15.3 Interest Rate Uncertainty and Forward Rates 475
Start-Up Stage / Consolidation Stage / Maturity Stage /
15.4 Theories of the Term Structure 477 Relative Decline
The Expectations Hypothesis / Liquidity Preference Industry Structure and Performance
Theory
Threat of Entry / Rivalry between Existing Competitors /
15.5 Interpreting the Term Structure 480 Pressure from Substitute Products / Bargaining Power
15.6 Forward Rates as Forward Contracts 484 of Buyers / Bargaining Power of Suppliers
End of Chapter Material 486–494 End of Chapter Material 560–568

Chapter Chapter

Managing Bond Portfolios 495 Equity Valuation Models 569

16.1 Interest Rate Risk 496 18.1 Valuation by Comparables 569
Interest Rate Sensitivity / Duration / What Determines Limitations of Book Value
Duration? 18.2 Intrinsic Value versus Market Price 571
Rule 1 for Duration / Rule 2 for Duration / Rule 18.3 Dividend Discount Models 573
3 for Duration / Rule 4 for Duration / Rule 5 for The Constant-Growth DDM / Convergence of Price
Duration to Intrinsic Value / Stock Prices and Investment

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Opportunities / Life Cycles and Multistage Growth Index Options / Futures Options / Foreign Currency
Models / Multistage Growth Models Options / Interest Rate Options
18.4 The Price–Earnings Ratio 587 20.2 Values of Options at Expiration 663
The Price–Earnings Ratio and Growth Opportunities / Call Options / Put Options / Option versus Stock
P/E Ratios and Stock Risk / Pitfalls in P/E Analysis / Investments
Combining P/E Analysis and the DDM / Other 20.3 Option Strategies 667
Comparative Valuation Ratios Protective Put / Covered Calls / Straddle / Spreads / Collars
Price-to-Book Ratio / Price-to-Cash-Flow Ratio / 20.4 The Put-Call Parity Relationship 675
Price-to-Sales Ratio
20.5 Option-Like Securities 678
18.5 Free Cash Flow Valuation Approaches 595
Callable Bonds / Convertible Securities / Warrants /
Comparing the Valuation Models / The Problem with Collateralized Loans / Levered Equity and Risky Debt
DCF Models
20.6 Financial Engineering 684
18.6 The Aggregate Stock Market 599
20.7 Exotic Options 686
End of Chapter Material 601–612
Asian Options / Barrier Options / Lookback Options /
Currency-Translated Options / Digital Options
Chapter
End of Chapter Material 687–698
Financial Statement Analysis 613
19.1 The Major Financial Statements 613 Chapter
The Income Statement / The Balance Sheet / The State- Option Valuation 699
ment of Cash Flows
21.1 Option Valuation: Introduction 699
19.2 Measuring Firm Performance 618
Intrinsic and Time Values / Determinants of Option
19.3 Profitability Measures 619 Values
Return on Assets, ROA / Return on Capital, ROC / 21.2 Restrictions on Option Values 703
Return on Equity, ROE / Financial Leverage and ROE /
Restrictions on the Value of a Call Option / Early Exer-
Economic Value Added
cise and Dividends / Early Exercise of American Puts
19.4 Ratio Analysis 623
21.3 Binomial Option Pricing 706
Decomposition of ROE / Turnover and Other Asset
Two-State Option Pricing / Generalizing the Two-State
Utilization Ratios / Liquidity Ratios / Market Price
Approach / Making the Valuation Model Practical
Ratios: Growth versus Value / Choosing a Benchmark
21.4 Black-Scholes Option Valuation 714
19.5 An Illustration of Financial Statement Analysis 633
The Black-Scholes Formula / Dividends and Call Option
19.6 Comparability Problems 636
Valuation / Put Option Valuation / Dividends and Put
Inventory Valuation / Depreciation / Inflation and Interest Option Valuation
Expense / Fair Value Accounting / Quality of Earnings and
21.5 Using the Black-Scholes Formula 722
Accounting Practices / International Accounting Conventions
Hedge Ratios and the Black-Scholes Formula / Portfolio
19.7 Value Investing: The Graham Technique 642
Insurance / Option Pricing and the Crisis of 2008–2009 /
End of Chapter Material 643–656 Option Pricing and Portfolio Theory / Hedging Bets on
Mispriced Options
PART VI 21.6 Empirical Evidence on Option Pricing 734

Options, Futures, and Other End of Chapter Material 735–746

Derivatives 657 Chapter

Futures Markets 747
Chapter
22.1 The Futures Contract 747
Options Markets: Introduction 657 The Basics of Futures Contracts / Existing Contracts
20.1 The Option Contract 657 22.2 Trading Mechanics 753
Options Trading / American and European Options / The Clearinghouse and Open Interest / The Margin
Adjustments in Option Contract Terms / The Options Account and Marking to Market / Cash versus Actual
Clearing Corporation / Other Listed Options Delivery / Regulations / Taxation

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