Investments / Zvi Bodie, Alex Kane, Alan J. Marcus.

Includes bibliographical references and index.

C O N T E N T S


PART ONE 1
INTRODUCTION
CHAPTER 1 3
THE INVESTMENT ENVIRONMENT
1.1 Real Assets versus Financial Assets 4
1.2 Financial Markets and the Economy 6 Consumption Timing 6 Allocation of Risk
6 Separation of
Ownership and Management 7 A Crisis in Corporate Governance 8
Accounting Scandals 8 Analyst Scandals 10 Initial Public Offerings 11
1.3 Clients of the Financial System 11 The Household Sector 12 The Business
Sector 12 The
Government Sector 13
1.4 The Environment Responds to Clientele Demands 14
Financial Intermediation 14 Investment Banking 16 Financial Innovation and
Derivatives 17
Response to Taxation and Regulation 18
1.5 Markets and Market Structure 20
1.6 Ongoing Trends 21 Globalization 21 Securitization 22 Financial Engineering
24 Computer
Networks 25 Summary 25 Key Terms 26 Websites 26 Problems 27 Standard and Poor?s
29 E-
Investments: Track Your Portfolio 29 Solutions to Concept Checks 30
CHAPTER 2 31
FINANCIAL INSTRUMENTS
2.1 The Money Market 32 Treasury Bills 32 Certificates of Deposit 33 Commercial
Paper 33 Bankers?
Acceptances 33 Eurodollars 34 Repos and Reverses 34 Federal Funds 34 Brokers?
Calls 35 The LIBOR
Market 35 Yields on Money Market Instruments 35
2.2 The Bond Market 35 Treasury Notes and Bonds 36 Federal Agency Debt 36
International Bonds 38
Municipal Bonds 39 Corporate Bonds 41 Mortgages and Mortgage-Backed Securities
42
2.3 Equity Securities 44 Common Stocks as Ownership Shares 44 Characteristics of
Common Stock 45
Stock Market Listings 46 Preferred Stock 47
2.4 Stock and Bond Market Indexes 47 Stock Market Indexes 47 Dow Jones Averages
48 Standard &
Poor?s Indexes 51 Other U.S. Market-Value Indexes 52 Equally Weighted Indexes 52
Foreign and
International Stock Market Indexes 53 Bond Market Indicators 53
2.5 Derivative Markets 54 Options 54 Futures Contracts 57


Summary 58 Key Terms 59 Websites 59 Problems 60 Standard and Poor?s 63 E-
Investments:
Security Prices and Returns 63 Solutions to Concept Checks 63
CHAPTER 3 65
HOW SECURITIES ARE TRADED
3.1 How Firms Issue Securities 66 Investment Bankers and Underwriting 66 Shelf
Registration 68 Private
Placements 68 Initial Public Offerings 68
3.2 Where Securities Are Traded 71 The Secondary Markets 72 The Over-the-Counter
Market 73 The
Third and Fourth Markets 75 The National Market System 76 Bond Trading 77
3.3 Trading on Exchanges 77 The Participants 77 Types of Orders 78
Market Orders 78 Limit Orders 78 Specialists and the Execution of Trades 80
Block Sales 81 The
SuperDOT System 82 Settlement 82
3.4 Trading on the OTC Market 82 Market Structure in Other Countries 84
London 84 Euronext 84 Tokyo 85 Globalization of Stock Markets 85
3.5 Trading Costs 86
3.6 Buying on Margin 88
3.7 Short Sales 91
3.8 Regulation of Securities Markets 94 Government Regulation 94 Regulatory
Responses to
Recent Scandals 95 Self-Regulation and Circuit Breakers 96 Insider Trading 98
Summary 99 Key
Terms 100
Websites 100 Problems 101 Standard and Poor?s 105 E-Investments: Short Sales 105
Solutions to
Concept Checks 105

CHAPTER 4 107
MUTUAL FUNDS AND OTHER INVESTMENT COMPANIES
4.1 Investment Companies 108
4.2 Types of Investment Companies 109 Unit Investment Trusts 109 Managed
Investment Companies 109
Other Investment Organizations 111
Commingled Funds 111 Real Estate Investment Trusts (REITS) 111 Hedge Funds 111
4.3 Mutual Funds 112 Investment Policies 112
Money Market Funds 112 Equity Funds 112 Bond Funds 113 International Funds 113
Balanced
and Income Funds 113 Asset Allocation and Flexible Funds 113 Index Funds 113 How
Funds Are
Sold 115
4.4 Costs of Investing in Mutual Funds 116 Fee Structure 116
Front-End Load 116 Back-End Load 116 Operating Expenses 116 12b-1 Charges 116
Fees and
Mutual Fund Returns 117
4.5 Taxation of Mutual Fund Income 119
4.6 Exchange-Traded Funds 120
4.7 Mutual Fund Investment Performance: A First Look 122
4.8 Information on Mutual Funds 125 Summary 129 Key Terms 129 Websites 130
Problems 131
Standard and Poor?s 133 E-Investments: Choosing a Mutual Fund 133 Solutions to
Concept
Checks 133
PART TWO 135
PORTFOLIO THEORY
CHAPTER 5 137
HISTORY OF INTEREST RATES AND RISK PREMIUMS
5.1 Determinants of the Level of Interest Rates 138
Real and Nominal Rates of Interest 138 The Equilibrium Real Rate of Interest 139
The
Equilibrium Nominal Rate of Interest 140 Bills and Inflation, 1963?2002 141
Taxes and the Real
Rate of Interest 142
5.2 Risk and Risk Premiums 142
5.3 The Historical Record 144 Bills, Bonds, and Stocks, 1926?2002 144
5.4 Real Versus Nominal Risk 150
5.5 Return Distributions and Value at Risk 151
5.6 A Global View of the Historical Record 154
5.7 Forecasts for the Long Haul 154 Summary 156 Key Terms 157 Websites 157
Problems 158
Standard and Poor?s 162 E-Investments: Analytics Tutorial 162 Solutions to
Concept Checks 162
Appendix: Continuous Compounding 162

CHAPTER 6 165
RISK AND RISK AVERSION
6.1 Risk and Risk Aversion 166 Risk with Simple Prospects 166 Risk, Speculation,
and Gambling 167 Risk
Aversion and Utility Values 168
6.2 Portfolio Risk 173 Asset Risk versus Portfolio Risk 173 A Review of
Portfolio Mathematics 174
Rule 1 174 Rule 2 174 Rule 3 175 Rule 4 175 Rule 5 178 Summary 179 Key Terms 179
Websites
179 Problems 180 Standard and Poor?s 182 E-Investments: Risk and Return 182
Solutions to
Concept Checks 182 Appendix A: A Defense of Mean-Variance Analysis 184 Appendix
B: Risk
Aversion, Expected Utility, and the St. Petersburg Paradox 191

CHAPTER 7 197
CAPITAL ALLOCATION BETWEEN THE RISKY ASSET AND THE RISK-FREE ASSET
7.1 Capital Allocation across Risky and Risk-Free Portfolios 198
7.2 The Risk-Free Asset 200
7.3 Portfolios of One Risky Asset and One Risk-Free Asset 201
7.4 Risk Tolerance and Asset Allocation 205
7.5 Passive Strategies: The Capital Market Line 210 Summary 214 Key Terms 214
Websites 215 Problems
215 Standard and Poor?s 219 E-Investments: The S&P 500 219 Solutions to Concept
Checks 219

CHAPTER 8 223
OPTIMAL RISKY PORTFOLIOS
8.1 Diversification and Portfolio Risk 224
8.2 Portfolios of Two Risky Assets 225
8.3 Asset Allocation with Stocks, Bonds, and Bills 234
The Ultimate Risky Portfolio with Two Risky Assets and a Risk-Free Asset 235
8.4 The Markowitz Portfolio Selection Model 240 Security Selection 240
8.5 The Spreadsheet Model 246 Calculation of Expected Return and Variance 246
Capital
Allocation and the Separation Property 251 Asset Allocation and Security
Selection 253
8.6 Optimal Portfolios with Restrictions on the Risk-Free Asset 254 Summary 258
Key Terms 259
Websites 259 Problems 260 E-Investments: Risk Comparisons 266 Solutions to
Concept Checks 266
Appendix A: The Power of Diversification 269 Appendix B: The Insurance
Principle: Risk-sharing versus
Risk-Pooling 272 Appendix C: The Fallacy of Time Diversification 274

PART THREE 279
EQUILIBRIUM IN CAPITAL MARKETS
CHAPTER 9 281
THE CAPITAL ASSET PRICING MODEL
9.1 The Capital Asset Pricing Model 281 Why Do All Investors Hold the Market
Portfolio? 283 The
Passive Strategy Is Efficient 285 The Risk Premium of the Market Portfolio 285
Expected Returns on
Individual Securities 286 The Security Market Line 289
9.2 Extensions of the CAPM 292 The CAPM with Restricted Borrowing: The Zero-Beta
Model 293
Lifetime Consumption and the CAPM 297
9.3 The CAPM and Liquidity 297 Summary 303 Key Terms 304 Websites 304 Problems
304 Standard and
Poor?s 309 E-Investments: Beta Comparisons 309 Solutions to Concept Checks 310
Appendix: Demand for
Stocks and Equilibrium Prices 311


CHAPTER 10 317
INDEX MODELS
10.1 A Single-Index Security Market 318 Systematic Risk versus Firm-Specific
Risk 318
Estimating the Index Model 321 The Index Model and Diversification 324
10.2 The CAPM and the Index Model 326 Actual Returns versus Expected Returns 326
The Index
Model and Realized Returns 326 The Index Model and the Expected Return?Beta
Relationship
327
10.3 The Industry Version of the Index Model 329 Predicting Betas 333
10.4 Index Models and Tracking Portfolios 334 Summary 336 Key Terms 336 Websites
336
Problems 336 Standard and Poor?s 340 E-Investments: Comparing Volatilities and
Beta
Coefficients 340 Solutions to Concept Checks 341


CHAPTER 11 343
ARBITRAGE PRICING THEORY AND MULTIFACTOR MODELS OF RISK AND RETURN
11.1 Multifactor Models: An Overview 344 Factor Models of Security Returns 344 A
Multifactor Security
Market Line 346
11.2 Arbitrage Pricing Theory 348 Arbitrage, Risk Arbitrage, and Equilibrium 349
Well-Diversified
Portfolios 350 Beta and Expected Returns 351 The One-Factor Security Market Line
353
11.3 Individual Assets and the APT 355 The APT and the CAPM 356
11.4 A Multifactor APT 356
11.5 Where Should We Look for Factors? 358
11.6 A Multifactor CAPM 361 Summary 362 Key Terms 363 Websites 363 Problems 363
Standard and
Poor?s 367 E-Investments: APT versus CAPM 368 Solutions to Concept Checks 368
CHAPTER 12 369
MARKET EFFICIENCY AND BEHAVIORAL FINANCE
12.1 Random Walks and the Efficient Market Hypothesis 370
Competition as the Source of Efficiency 372 Versions of the Efficient Market
Hypothesis 373
12.2 Implications of the EMH 373 Technical Analysis 373 Fundamental Analysis 377
Active
versus Passive Portfolio Management 378 The Role of Portfolio Management in an
Efficient
Market 380 Resource Allocation 380
12.3 Event Studies 381
12.4 Are Markets Efficient? 384 The Issues 384
The Magnitude Issue 384 The Selection Bias Issue 385 The Lucky Event Issue 385
Weak-Form
Tests: Patterns in Stock Returns 386
Returns over Short Horizons 386 Returns over Long Horizons 387 Predictors of
Broad Market
Returns 388 Semistrong Tests: Market Anomalies 388
The Small-Firm-in-January effect 389 The Neglected-Firm Effect and Liquidity
Effects 391 Book-
to-Market Ratios 391 Post?Earnings-Announcement Price Drift 392 Strong-Form
Tests: Inside
Information 394 Interpreting the Evidence 394
Risk Premiums or Inefficiencies? 394 Anomalies or Data Mining? 396
12.5 A Behavioral Interpretation 396 Information Processing 397
Forecasting Errors 397 Overconfidence 397 Conservatism 398 Sample-Size Neglect
and
Representativeness 398 Behavioral Biases 398
Framing 398 Mental Accounting 398
Regret Avoidance 399 Limits to Arbitrage 399
Fundamental Risk 399 Implementation Costs 400 Model Risk 400 Evaluating the
Behavioral
Critique 400
12.6 Mutual Fund Performance 401 So, Are Markets Efficient? 405 Summary 405 Key
Terms 406
Websites 406 Problems 407 Standard and Poor?s 413 E-Investments: Efficient
Markets and
Insider Trading 413 Solutions to Concept Checks 413
CHAPTER 13 415
EMPIRICAL EVIDENCE ON SECURITY RETURNS
13.1 The Index Model and the Single-Factor APT 416
The Expected Return?Beta Relationship 416
Setting Up the Sample Data 417 Estimating the SCL 417 Estimating the SML 417
Tests of the
CAPM 418 The Market Index 419 Measurement Error in Beta 422 The EMH and the CAPM
424
Accounting for Human Capital and Cyclical Variations in Asset Betas 424
13.2 Tests of Multifactor CAPM and APT 426 A Macro Factor Model 426
13.3 The Fama-French Three-Factor Model 429
13.4 Time-Varying Volatility 432
13.5 The Equity Premium Puzzle 435 Expected versus Realized Returns 435
Survivorship Bias
437
13.6 Survivorship Bias and Tests of Market Efficiency 438 Summary 441 Key Terms
441
Websites 441 Problems 442 Standard and Poor?s 444 E-Investments: Portfolio
Theory 444
Solutions to Concept Checks 444
PART FOUR 445
FIXED-INCOME SECURITIES
CHAPTER 14 447
BOND PRICES AND YIELDS
14.1 Bond Characteristics 448 Treasury Bonds and Notes 448
Accrued Interest and Quoted Bond Prices 450 Corporate Bonds 450
Call Provisions on Corporate Bonds 451 Convertible Bonds 452 Puttable Bonds 452
Floating-Rate
Bonds 452 Preferred Stock 452 Other Issuers 453 International Bonds 453
Innovation in the Bond
Market 453
Inverse Floaters 454 Asset-Backed Bonds 454 Catastrophe Bonds 454 Indexed Bonds
454
14.2 Bond Pricing 455 Bond Pricing between Coupon Dates 458
14.3 Bond Yields 459 Yield to Maturity 459 Yield to Call 462 Realized Compound
Yield
versus Yield to Maturity 464
14.4 Bond Prices over Time 466 Yield to Maturity versus Holding-Period Return
468 Zero-
Coupon Bonds 468 After-Tax Returns 469
14.5 Default Risk and Bond Pricing 471 Junk Bonds 471 Determinants of Bond
Safety 471
Bond Indentures 474
Sinking Funds 474 Subordination of Further Debt 475 Dividend Restrictions 475
Collateral 476
Yield to Maturity and Default Risk 477 Summary 478 Key Terms 479 Websites 479
Problems 480
Standard and Poor?s 485 E-Investments: Credit Spreads 485 Solutions to Concept
Checks 485

CHAPTER 15 487
THE TERM STRUCTURE OF INTEREST RATES
15.1 The Term Structure Under Certainty 488 Bond Pricing 488 Bond Stripping and
Pricing of Coupon
Bonds 491 Holding-Period Returns 492 Forward Rates 493
15.2 Interest Rate Uncertainty and Forward Rates 495
15.3 Theories of the Term Structure 497 The Expectations Hypothesis 497
Liquidity Preference 497
15.4 Interpreting the Term Structure 498
15.5 Forward Rates as Forward Contracts 503
15.6 Measuring the Term Structure 505 Summary 509 Key Terms 509 Websites 509
Problems 510 E-
Investments: Expectations and Term Spreads 516 Solutions to Concept Checks 516

CHAPTER 16 519
MANAGING BOND PORTFOLIOS
16.1 Interest Rate Risk 520 Interest Rate Sensitivity 520 Duration 523 What
Determines Duration? 527
Rule 1 for Duration 528 Rule 2 for Duration 528 Rule 3 for Duration 528 Rule 4
for Duration
529 Rule 5 for Duration 529 Rule 6 for Duration 530 Rule 7 for Duration 530 Rule
8 for
Duration 530
16.2 Convexity 531 Why Do Investors Like Convexity? 534 Duration and Convexity
of
Callable Bonds 534
16.3 Passive Bond Management 536 Bond-Index Funds 537 Immunization 538 Cash Flow
Matching and
Dedication 546 Other Problems with Conventional Immunization 546
16.4 Active Bond Management 547 Sources of Potential Profit 547 Horizon Analysis
548
Contingent Immunization 549
16.5 Interest Rate Swaps 551 Swaps and Balance Sheet Restructuring 552 The Swap
Dealer 552
16.6 Financial Engineering and Interest Rate Derivatives 553 Summary 555 Key
Terms 556
Websites 556 Problems 557 Standard and Poor?s 566 E-Investments: Bond
Calculations 566
Solutions to Concept Checks 566

PART FIVE 569
SECURITY ANALYSIS
CHAPTER 17 571
MACROECONOMIC AND INDUSTRY ANALYSIS
17.1 The Global Economy 572
17.2 The Domestic Economy 574
17.3 Demand and Supply Shocks 576
17.4 Federal Government Policy 576 Fiscal Policy 577 Monetary Policy 578 Supply-
Side Policies 579
17.5 Business Cycles 579 The Business Cycle 579 Economic Indicators 581
17.6 Industry Analysis 585 Defining an Industry 586 Sensitivity to the Business
Cycle 587 Sector Rotation
590 Industry Life Cycles 591
Start-Up Stage 592 Consolidation Stage 592
Maturity Stage 592 Relative Decline 593 Industry Structure and Performance 594
Threat of Entry 594 Rivalry between Existing Competitors 594 Pressure from
Substitute Products 594
Bargaining Power of Buyers 594 Bargaining Power of Suppliers 595 Summary 595 Key
Terms 595
Websites 595 Problems 596 Standard and Poor?s 602 E-Investments: The
Macroeconomy 602 Solutions to
Concept Checks 602

CHAPTER 18 605
EQUITY VALUATION MODELS
18.1 Valuation by Companies 606 Limitations of Book Value 607
18.2 Intrinsic Value versus Market Price 608
18.3 Dividend Discount Models 609 The Constant-Growth DDM 611 Convergence of
Price to Intrinsic
Value 614 Stock Prices and Investment Opportunities 615 Life Cycles and
Multistage Growth Models 618
Multistage Growth Models 622
18.4 Price-Earnings Ratio 622 The Price-Earnings Ratio and Growth Opportunities
622 P/E Ratios and
Stock Risk 626 Pitfalls in P/E Analysis 627 Combining P/E Analysis and the DDM
631 Other Comparative
Valuation Ratios 632
Price-to-Book Ratio 632 Price-to-Cash-Flow Ratio 632 Price-to-Sales Ratio 633
18.5 Corporate Finance and the Free Cash Flow Approach 634
18.6 Inflation and Equity Valuation 636
18.7 The Aggregate Stock Market 639 Explaining Past Behavior 639 Forecasting the
Stock
Market 640
PART SIX 695
OPTIONS, FUTURES, AND OTHER DERIVATIVES
CHAPTER 20 697
OPTIONS MARKETS: INTRODUCTION
20.1 The Option Contract 698 Options Trading 700 American and European Options
702 Adjustments in
Option Contract Terms 702 The Option Clearing Corporation 702 Other Listed
Options 703
Index Options 703 Futures Options 705 Foreign Currency Options 705 Interest Rate
Options
705
20.2 Values of Options at Expiration 705 Call Options 705 Put Options 707 Option
versus
Stock Investments 709
20.3 Option Strategies 711 Protective Put 711 Covered Calls 713 Straddle 715
Spreads 716
Collars 716
20.4 The Put-Call Parity Relationship 719
20.5 Optionlike Securities 721 Callable Bonds 721 Convertible Securities 723
Warrants 725
Collateralized Loans 726 Levered Equity and Risky Debt 727
20.6 Financial Engineering 728
20.7 Exotic Options 731 Asian Options 731 Barrier Options 731 Lookback Options
731
Currency-Traded Options 731 Binary Options 732 Summary 732 Key Terms 732
Websites 732
Problems 733 Standard and Poor?s 740 E-Investments: Options and Straddles 740
Solutions to
Concept Checks 740
Summary 642 Key Terms 643 Websites 643 Problems 644 Standard and Poor?s 651 E-
Investments: Equity
Valuation 652 Solutions to Concept Checks 652


CHAPTER 19 655
FINANCIAL STATEMENT ANALYSIS
19.1 The Major Financial Statements 656 The Income Statement 656 The Balance
Sheet 657 The
Statement of Cash Flows 658
19.2 Accounting versus Economic Earnings 659
19.3 Return on Equity 660 Past versus Future ROE 661 Financial Leverage and ROE
662
19.4 Ratio Analysis 664 Decomposition of ROE 664 Turnover and Other Asset
Utilization Ratios 665
Liquidity and Coverage Ratios 667 Market Price Ratios 667 Choosing a Benchmark
670
19.5 Economic Value Added 671
19.6 An Illustration of Financial Statement Analysis 672
19.7 Comparability Problems 674 Inventory Valuation 674 Depreciation 675
Inflation and Interest Expense
676 Quality of Earnings 676 International Accounting Conventions 679
19.8 Value Investing: The Graham Technique 680 Summary 681 Key Terms 682
Websites 682 Problems
683 Standard and Poor?s 692 E-Investments: Financial Statement Analysis 693
Solutions to Concept
Checks 693
CHAPTER 21 745
OPTION VALUATION
21.1 Option Valuation: Introduction 746 Intrinsic and Time Values 746
Determinants of Option Values 747
21.2 Restrictions on Option Values 748 Restrictions on the Value of a Call
Option 749 Early Exercise and
Dividends 751 Early Exercise of American Puts 751
21.3 Binomial Option Pricing 752 Two-State Option Pricing 752 Generalizing the
Two-State Approach
755
21.4 Black-Scholes Option Valuation 758 The Black-Scholes Formula 759 Dividends
and Call Option
Valuation 765 Put Option Valuation 766
21.5 Using the Black-Scholes Formula 767 Hedge Ratios and the Black-Scholes
Formula 767 Portfolio
Insurance 770 Hedging Bets on Mispriced Options 774
21.6 Empirical Evidence on Option Pricing 778 Summary 779 Key Terms 780 Websites
780 Problems 781
Standard and Poor?s 787 E-Investments: Black-Scholes Option Pricing 788
Solutions to Concept Checks
788

CHAPTER 22 791
FUTURES MARKETS
22.1 The Futures Contract 792 The Basics of Futures Contracts 792 Existing
Contracts 796
22.2 Mechanics of Trading in Futures Markets 796 The Clearinghouse and Open
Interest 796 Marking to
Market and the Margin Account 799 Cash versus Actual Delivery 801 Regulations
802 Taxation 802
22.3 Futures Markets Strategies 802 Hedging and Speculation 802 Basis Risk and
Hedging 805
22.4 The Determination of Futures Prices 806 The Spot-Futures Parity Theorem 806
Spreads 809 Forward
versus Futures Pricing 810
22.5 Futures Prices versus Expected Spot Prices 811
Expectation Hypothesis 811 Normal Backwardation 812 Contango 812 Modern
Portfolio Theory 812
Summary 813 Key Terms 814 Websites 814 Problems 815 Standard and Poor?s 817 E-
Investments:
Contract Specifications for Financial Futures and Options 818 Solutions to
Concept Checks 818

CHAPTER 23 821
FUTURES AND SWAPS: A CLOSER LOOK
23.1 Foreign Exchange Futures 822 The Markets 822 Interest Rate Parity 822
Direct versus Indirect Quotes
826 Using Futures to Manage Exchange Rate Risk 826
23.2 Stock Index Futures 829 The Contracts 829 Creating Synthetic Stock
Positions: An Asset Allocation
Tool 830 Empirical Evidence on Pricing of Stock-Index Futures 832 Index
Arbitrage and the Triple-
Witching Hour 834 Using Index Futures to Hedge Market Risk 835
23.3 Interest Rate Futures 837 Hedging Interest Rate Risk 837 Other Interest
Rate Futures 839
23.4 Commodity Futures Pricing 840 Pricing with Storage Costs 840 Discounted
Cash Flow Analysis for
Commodity Futures 843
23.5 Swaps 844 Swap Pricing 846 Credit Risk in the Swap Market 847 Swap
Variations 848
Summary 849 Key Terms 850 Websites 850 Problems 851 Standard and Poor?s 856 E-
Investments:
Describing Different Swaps 856 Solutions to Concept Checks 857

PART SEVEN 859
ACTIVE PORTFOLIO MANAGEMENT
CHAPTER 24 861
PORTFOLIO PERFORMANCE EVALUATION
24.1 Measuring Investment Returns 862 Time-Weighted Returns versus Dollar-
Weighted Returns 862
Arithmetic versus Geometric Averages 863
24.2 The Conventional Theory of Performance Evaluation 866
The M2 Measure of Performance (M 2) 869
Sharpe?s Measure as the Criterion for Overall Portfolios 870 Appropriate
Performance Measures
in Three Sections 871
Jane?s Portfolio Represents Her Entire Risky Investment Fund 871 Jane?s
Portfolio Is an Active
Portfolio and Is Mixed with a Passive Market Index 872 Jane?s Choice Portfolio
Is One of Many
Portfolios Combined into a Large Investment Fund 872 Relationships among the
Various
Performance Measures 874 Actual Performance Measurement: An Example 875 Realized
Returns
versus Expected Returns 875
24.3 Performance Measurement with Changing Portfolio Composition 877
24.4 Market Timing 879
24.5 Performance Attribution Procedures 881 Asset Allocation Decisions 883
Sector and Security
Selection Decisions 884 Summing Up Component Contributions 885
24.6 Style Analysis 886
24.7 Morningstar?s Risk-Adjusted Rating 889
24.8 Evaluating Performance Evaluation 890 Summary 892 Key Terms 893 Websites
893
Problems 894 Standard and Poor?s 901 E-Investments: Performance of Mutual Funds
902
Solutions to Concept Checks 902

CHAPTER 25 905
INTERNATIONAL DIVERSIFICATION
25.1 Global Markets for Equities 906 Developed Countries 906 Emerging Markets
906 Market
Capitalization and GDP 908 Home-Country Bias 910
25.2 Risk Factors in International Investing 910 Exchange Rate Risk 910 Country-
Specific Risk 914
25.3 International Investing: Risk, Return, and Benefits from Diversification
917
Risk and Return: Summary Statistics 918 Are Investments in Emerging Markets
Riskier? 918 Are
Average Returns in Emerging Markets Greater? 918 Is Exchange Rate Risk Important
in
International Portfolios? 920 Benefits from International Diversification 921
Misleading
Representation of Diversification Benefits 922 Realistic Benefits from
International
Diversification 925 Are Benefits from International Diversification Preserved in
Bear Markets?
927
25.4 International Investing and Performance Attribution 927
Constructing a Benchmark Portfolio of Foreign Assets 928 Performance Attribution
929 Summary
932 Key Terms 932 Websites 933 Problems 933
Standard and Poor?s 937 E-Investments: International Diversification 937
Solutions to Concept Checks 937

CHAPTER 26 939
THE PROCESS OF PORTFOLIO MANAGEMENT
26.1 Making Investment Decisions 940 Objectives 940 Individual Investors 942
Personal Trusts 942
Mutual Funds 942 Pension Funds 942 Endowment Funds 942 Life Insurance Companies
942 Non?Life
Insurance Companies 943 Banks 943
26.2 Constraints 943 Liquidity 944 Investment Horizon 944 Regulations 944 Tax
Considerations 944
Unique Needs 944
26.3 Asset Allocation 946 Policy Statements 947 Taxes and Asset Allocation 947
26.4 Managing Portfolios of Individual Investors 948
Human Capital and Insurance 948 Investment in Residence 949 Saving for
Retirement and the
Assumption of Risk 949 Retirement Planning Models 950 Manage Your Own Portfolio
or Rely on
Others? 950 Tax Sheltering 952
The Tax-Deferral Option 952 Tax-Deferred Retirement Plans 953 Deferred Annuities
953
Variable and Universal Life Insurance 954
26.5 Pension Funds 955 Defined Contribution Plans 955 Defined Benefit Plans 956
Alternative
Perspectives on Defined Benefit Pension Obligations 956
Pension Investment Strategies 957
Investing in Equities 958 Wrong Reasons to Invest in Equities 959
26.6 Future Trends in Portfolio Management 960 Summary 961 Key Terms 962
Websites 962
Problems 963 E-Investments: Personal Diversification 973 Solutions to Concept
Checks 973
Appendix: A Spreadsheet Model for Long-Term Investing 974

CHAPTER 27 981
THE THEORY OF ACTIVE PORTFOLIO MANAGEMENT
27.1 The Lure of Active Management 982
27.2 Objectives of Active Portfolios 983
27.3 Market Timing 984 Valuing Market Timing as an Option 986 The Value of
Imperfect Forecasting 987
27.4 Security Selection: The Treynor-Black Model 988
Overview of the Treynor-Black Model 988 Portfolio Construction 989
27.5 Multifactor Models and Active Portfolio Management 995
27.6 Imperfect Forecasts of Alpha Values and the Use of the Treynor-Black Model
in Industry
996 Summary 998 Key Terms 999 Problems 999 Solutions to Concept Checks 1002

APPENDIX A 1005
Quantitative Review
APPENDIX B 1043
References to CFA Questions
APPENDIX C 1047
Glossary

NAME INDEX 1061
SUBJECT INDEX 1065

300-399