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Part 1 THE INVESTMENTBACKGROUND 2

THE INVESTMENT SETTING 4

What Is an Investment? 4

Investment Defined 5

Measures of Return and Risk 6

Measures of Historical Rates of Return 6

Computing Mean Historical Returns 8

Calculating Expected Rates of Return 10

Measuring the Risk of Expected Rates of Return 13

Risk Measures for Historical Returns 15

Determinants of Requid Rates of Return 15

The Real RiskFree Rate 16

Factors Influencing the Nominal RiskFreeRate (NRFR) 17

Risk Premium 19

Risk Premium and Portfolio Theory 21

Fundamental Risk versus Systematic Risk 22

Summary of Required Rate of Return 22

Relationship between Risk and Return 23

Movements along the SML 24

Changes in the Slope of the SML 24

Changes in Capital Market Conditions orExpected Ination 26

Summary of Changes in the RequiredRate of Return 27

Investments Online 27

STANDARD DEVIATION 31

THE ASSET ALLOCATION DECISION 36

Individual Investor Life Cycle 37

The Preliminaries 37

Life Cycle Net Worth and Investment Strategies 38

Life Cycle Investment Goals 39

The Portfolio Management Process 39

The Need for a Policy Statement 41

Understand and Articulate RealisticInvestor Goals 41

Standards for Evaluating PortfolioPerformance 42

Other Benefits 43

Input to the Policy Statement 43

Investment Objectives 44

Investment Constraints 47

Constructing the Policy Statement 53

The Importance of Asset Allocation 53

Real Investment Returns after Taxes and Costs 54

Returns and Risks of Different Asset Classes 55

Asset Allocation Summa 57

Asset Allocation and Cultural Diffences 58

Investments Online 60

INSTITUTIONAL INVESTORS 63

SELECTING INVESTMENTSIN A GLOBAL MARKET 68

The Case for Global Investments 69

Relative Size ofU.S.Financial Markets 70

Rates of Return onU.S.and ForeignSecurities 71

Individual Country Risk and Return 72

Risk of Combined Country Investments 73

Global Investment Choices 78

FixedIncome Investments 79

International Bond Investing 82

Equi Instruments 83

Special Equi Instruments: Options 85

Futures Contracts 86

Investment Companies 86

Real Estate 88

LowLiquidi Investments 89

Historical Risk/Returns onAlternative Investments 90

Stocks, Bonds, and T Bills 91

World Portfolio Performance 92

Art and Antiques 95

Real Estate 96

Investments Online 99

Chapter 3 AppendrrCOVARIANCE AND CORRELATION 103

Chapter 4 ORGANIZATION AND FUNCTIONINGOF SECURITIES MARKETS 106

What Is a Market？ 107

Characteristics of a Good Market 107

Organization of the Securities Market 109

Primary Capital Markets 109

Government Bond Issues 109

Municipal Bond Issues 109

Corporate Bond and Stock Issues 110

Private Placements and Rule 144A 112

Secondary Financial Markets 112

Why Secondary Markets Are Important 112

Secondarv Bond Markets 113

Financial Futures 114

Secondary Equi Markets 114

Regional Exchanges and theOvertheCounter Market 122

Detailed Analysis of ExchangeMarkets 128

Exchange Membership 128

Types of Orders 129

Exchange Market Makers 133

Changes in the Securities Markets 136

Evidence and Effect of Institutionalization 136

Negotiated Commission Rates 137

The Impact of Block Trades 138

Institutions and Stock Price Volatili 139

National Market System (NMS) 139

New Trading Systems 142

Global Market Changes 142

Future Developments 144

Investments Online 145

Chapter 4 AppendixCHARACTERISTICS OF DEVELOPEDAND DEVELOPING MARKETSAROUND THE WORLD 149

Chapter 5SECURITYMARKETINDICATOR SERIES 153

Uses of SecurityMarket Indexes 154

Diffentiating Factors in ConstructingMarket Indexes 155

The Sample 155

Weighting Sample Members 155

Computational Procedure 155

StockMarket Indicator Series 155

PriceWeighted Series 156

ValueWeighted Series 158

Unweighted Price Indicator Series 161

Global Equity Indexes 162

BondMarket Indicator Series 165

Investment-Grade Bond Indexes 168

High-Jield Bond Indexes 168

Global Government Bond Market Indexes 168

Composite Stock-Bond Indexes 170

Merrill Lynch-Wilshire U.S. Capital MarketsIndex (ML-WCMI) 170

Brinson Partners Global Security MarketIndex (GSMI) 170

Comparison of Indexes over Time 171

Correlations among Monthly EquityPrice Changes 171

Correlations among Monthly Bond Indexes 173

Mean Annual Stock Price Changes 173

Annual Bond Rates of Return 173

Investments Online 175

Chapter S AppendxFOREIGN STOCK-MARKET INDEXES 178

Chapter 6SOURCES OF INFORMATION ONGLOBAL INVESTMENTS 180

Aggregate Economic Analysis 181

U.S. Government Sources 181

Bank Publications 182

Non-U.S. Economic Data 183

Agggate Security-Market Analysis 185

Government Publications 185

Commercial Publications 185

Brokerage Firm Reports 188

Industry Analysis 190

Industry Publications 190

Industry Magazines 190

Individual Stock and Bond Analysis 192

Company-Generated Information 192

Commercial Publications 193

Brokerage Firm Reports 196

Investment Magazines 196

Obtaining Information on Bonds 199

Required Information 199

Sources of Bond Quotes 200

Sources of Information on Mutual Funds 200

Theoretical and Empirical Analysis 202

Academic Journals 202

Computerized Data Sources 204

Data Banks 204

Online Databases 205

Investments Online 206

2DEVELOPMENTS ININVESTMENT THEORY 210

Chapter 7EFFICIENT CAPITAL MARKETS 212

Why Should Capital Markets Be Efficient? 213

Alternative Efficient Market Hypotheses 214

Expected Return or Fair Game Model 214

Weak-Fm Efcient Market Hypothesis 215

Semistrong-Form Efficient Market Hypothesis 215

Strong-Form Efcient Market Hypothesis 216

Tests and Results of Alternative EfficientMarket Hypotheses 216

Weak-Form Hypothesis: Tests and Results 216

Semistrong-Form Hypothesis: Tests and Results 219

Strong-Form Hypothesis: Tests and Results 240

Implications of Efficient Capital Markets 247

Eicient Markets and Technical Analysis 247

Efficient Markets and Fundamental Analysis 247

Efficient Markets and Portfolio Management 249

Efficiency in European Equity Markets 252

Investments Online 253

Chapter 8AN INTRODUCTION TOPORTFOLIO MANAGEMENT 258

Some Background Assumptions 259

Risk Aversion 259

Definition of Risk 260

Markowitz Portfolio Theory 260

Alternative Measures of Risk 260

Expected Rates of Return 261

Variance (Standard Deviation) of Returns foran Individual Investment 262

Variance (Standard Deviation) of Returns fora Portfolio 262

Standard Deviation of a Portfolio 267

A Three-Asset Portfolio 275

Estimation Issues 276

The Efficient Frontier 277

The Efficient Frontier and Investor Utility, 278

Investments Online 279

Chapter 8 AppendixA PROOF THAT MINIMUM PORTFOLIOVARIANCE OCCURS WITH EQUALWEIGHTS WHEN SECURITIES HAVEEQUAL VARIANCE 283

B DERIVATION OF WEIGHTS THATWILL GIVE ZERO VARIANCE WHENCORRELATION EQUALS -1.00 284

Chapter 9AN INTRODUCTION TO ASSETPRICING MODELS 285

Capital Market Theory: An Overview 286

Background for Capital Market Theo 286

Risk-Free Asset 288

The Market Portfolio 291

The Capital Asset Pricing Model: ExpectedReturn and Risk 295

The Security Market Line (SML) 296

Arbitrage Pricing Theory (APT) 302

Empirical Tests of the APT 307

Investments Online 307

Chapter IoEXTENSIONS AND TESTING OFASSET PRICING THEORIES 313

Relaxing the Assumptions 314

Differential Borrowing and Lending Rates 314

Zero-Beta Model 315

Transaction Costs 316

Heterogeneous Expectations and PlanningPeriods 317

Taxes 317

Empirical Tests of the CAPM 318

Stability of Beta 318

Comparabili of Published Estimates of Beta 319

Relationship between Systematic Risk andReturn 320

Effect of Skewness on the Relationship 321

Effect of Size, PE, and Leverage 322

Effect of Book-to-Market Value: TheFama-French Study 322

Summary of CAPM Risk-Return EmpiricalResults 323

The Market Portfolio: Theory versusPractice 325

Arbitrage Pricing Theory (APT) 329

Empirical Tests of the APT 332

Roll-Ross Study, 332

Extensions of the Roll-Ross Tests 333

The APT and Anomalies 334

The Shanken Challenge to Testability of the APT 336

Investments Online 337

Chapter IAN INTRODUCTION TODERIVATIVE MARKETS ANDSECURITIES 341

Overview of Derivative Markets 342

The Language and Structure of Forward andFutures Markets 343

Interpreting Futures Price Quotations:An Example 344

The Language and Structure of Option Markets 346

Interpreting Option Price Quotations:An Example 348

Investing with Derivative Securities 349

The Basic Nature of Derivative Investing 350

Basic Payoff Diagrams for Forward Contracts 352

Basic Payoff Diagrams for Call and Put Options 353

Option Payoff Diagrams: An Example 356

The Relationship between Forward andOption Contracts 358

Put-Call-Spot Pari 359

Put-Call-Pari: An Example 360

Creating Synthetic Securities Using Put-CallPari 361

Adjusting Put-Call Spot Parity for Dividends 363

Put-Call-Forward Pari 364

An Intduction to the Use of Derivativesin Portfolio Management 365

Restructuring Asset Portfolios with ForwardContracts 366

Protecting Portfolio Value with Pat Options 367

Investments Online 370

3 VALUATION PRINCIPLESAND PRACTICES 380

Chapter 12ANALYSIS OF FINANCIALSTATEMENTS 382

Major Financial Statements 382

Generally Accepted Accounting Principles 383

Balance Sheet 383

Income Statement 383

Statement of Cash Flows 383

Alternative Measures of Cash Flow 387

Purpose of Financial Statement Analysis 388

Analysis of Financial Ratios 388

Importance of Relative Financial Ratios 388

Computation of Financial Ratios 389

Common Size Statements 390

Evaluating Internal Liquidity 391

Internal Liquidi Ratios 391

Evaluating Operating Performance 395

Operating Efficiency Ratios 395

Operating Protabili Ratios 397

Risk Analysis 404

Business Risk 404

Financial Risk 406

Proportion of Debt (Balance Sheet)Ratios 406

Earnings Flow Ratios 408

Cash Flow Ratios 410

Analysis of Growth Potential 412

Importance of Growth Analysis 412

Determinants of Growth 412

External Market Liquidity 414

Market Liquidi Dened 414

Determinants of Market Liquidi 414

Comparative Analysis of Ratios 415

Internal Liquidi 417

Operating Performance 417

Financial Risk 417

Growth Analysis 417

Analysis of Non-U.S. Financial Statements 417

Accounting Statement Format Dierences 418

Dierences in Accounting Principles 419

International Ratio Analysis 422

The Quality of Financial Statements 424

Balance Sheet 424

Income Statement 424

The Value of Financial Statement Analysis 424

Uses of Financial Ratios 425

Stock Valuation Models 425

Financial Ratios and Systematic Risk 426

Financial Ratios and Bond Ratings 426

Financial Ratios and Insolvency (Bankruptcy) 427

Limitations of Financial Ratios 428

Investments Online 428

Chapter 13AN INTRODUCTION TO SECURITYVALUATION 436

An Overview of the Valuation Process 437

Why a Three-Step Valuation Process? 438

General Economic influences 438

Indust Influences 440

Company Analysis 441

Does the Three-Step Process Work? 441

Theory of Valuation 442

Stream of Expected Returns (Cash Flows) 442

Required Rate of Return 443

Investment Decision Process: A Comparison ofEstimated Values and Market Prices 443

Valuation of Alternative Investments 443

Valuation of Bonds 443

Valuation of Preferred Stock 445

Approaches to the Valuation of Common Stock 445

Why and When to Use the Discounted Cash-FlowValuation Approach 446

Why and When to Use the Relative ValuationTechniques 447

Discounted Cash-Flow Valuation Techniques 447

Infinite Period DDM and Growth Companies 452

Valuation with Tempora Supernormal Growth 453

Present Value of Operating Cash Flows 454

Present Value of Free Cash Flows to Equi 456

Relative Valuation Techniques 456

Earnings Multiplier Model 457

The PricelCash Flow Ratio 459

The PricelBook Value Ratio 460

The PricelSales Ratio 460

Estimating the Inputs: The Requid Rateof Return and the Expected Gwth Rate ofValuation Variables 461

Required Rate of Return (k) 461

Estimating the Required Return for ForeignSecurities 463

Expected Growth Rate of Dividends 466

Estimating Dividend Growth for Foreign Stocks 469

Investments Online 470

Chapter 13 AppendixDERIVATION OF CONSTANT GROWTHDIVIDEND DISCOUNT MODEL (DDM) 473

Chapter 14THE ANALYSIS OF ALTERNATIVEECONOMIES AND SECURITYMARKETS: THE GLOBAL ASSETALLOCATION DECISION 475

Economic Activity and Security Markets 476

Cyclical Indicator Appach to Forecastingthe Economy 478

Cyclical Indicator Categories 478

Analytical Measures of Performance 480

Limitations of the Cyclical Indicator Approach 482

Leading Indicators and Stock Prices 482

Other Leading Indicator Series 483

Monetary Variables, the Economy, andStock Prices 484

Money Supply and the Economy 485

Money Supply and Stock Prices 485

Other Economic Variables and Stock Prices 487

Inflation, Interest Rates, and Security Prices 488

Summary of Macroeconomic Analysis 491

Analysis of World Security Markets 491

Inflation and Exchange Rates 492

Correlations among Returns 492

Individual Count Stock Price Changes 492

Individual Count Analysis 493

World Asset Allocation 494

Investments Online 499

4ANALYSIS AND MANAGEMENTOF BONDS 504

Chapter 15BOND FUNDAMENTALS 506

Basic Featus of a Bond 506

Bond Characteristics 507

Rates of Return on Bonds 509

The Global Bond-Market Structure 510

Participating Issuers 511

Participating Investors 513

Bond Ratings 513

Alternative Bond Issues 515

Domestic Government Bonds 516

Government Agency Issues 519

Municipal Bonds 522

Corporate Bonds 524

International Bonds 532

Obtaining Information on Bond Prices 533

Interpreting Bond Quotes 534

Investments Online 539

Chapter 16THE ANALYSIS AND VALUATIONOF BONDS 542

The Fundamentals of Bond Valuation 543

The Present Value Model 543

The Yield Model 545

Computing Bond Yields 546

Nominal Yield 547

Current yield 547

Promised Yield to Maturi 547

Promised Yield to Call 551

Realized (Horizon) Yield 552

Calculating Future Bond Prices 553

Realized (Horizon) ield with DifferentialReinvestment Rates 555

Price and Yield Determination on NoninterestDates 557

Yield Adjustments for Tax-Exempt Bonds 557

Bond Vield Books 558

Bond Valuation Using Spot Rates 558

What Determines Interyst Rates? 560

Forecasting Interest Rates 561

Fundamental Determinants of Interest Rates 562

Term Structure of Interest Rates 565

Calculating Forward Rates fm theSpot Rate Curve 570

Term Structu Theories 573

Yield Spreads 577

What Determines the Price Volatilityfor Bonds? 578

Trading Strategies 581

Duration Measures 581

Modied Duration and Bond Price Volatility 585

Bond Convexity 586

Duration and Convexi for Callable Bonds 591

Limitations of Macaulay and Modied Duration 595

Yield Spreads with Embedded Options 603

Static Yield Spreads 604

Option-Adjusted Spread 604

Investments Online 606

Chapter 16 Appendix 621

Chapter 17BOND PORTFOLIO MANAGEMENTSTRATEGIES 622

Alternative Bond Portfolio Strategies 622

Passive Management Strategies 623

Active Management Strategies 624

A Global Fixed-Income Investment Strategy 637

Matched-Funding Techniques 639

Contingent Procedures 648

Implications of Capital Market Theory andthe EMH on Bond Portfolio Management 654

Bonds and Total Portfolio Theo 655

Bonds and Capital Market Theo 655

Bond Price in a CAPM Framework 656

Bond-Market Efciency 659

Investments Online 660

SANALYSIS OF COMMONSTOCKS 676

Chapter 18STOCK-MARKET ANALYSIS 678

Applying the DDM Valuation Model tothe Market 679

Market Valuation Using the Reduced Form DDM 680

Estimating the Gwth Rate of Dividends (g) 684

Market Valuation Using the Free Cash Flow toEquity (FCFE) Model 688

Valuation Using the Relative ValuationAppach 690

Two-Part Valuation Procedure 690

Importance of Both Components of Value 691

Estimating Expected Earnings per Share 693

Estimating Gross Domestic Product 694

Estimating Sales per Share for a Market Series 694

Alternative Estimates of Corporate Net Profits 695

Estimating Aggregate Operating Prot Margin 696

Estimating Depreciation Expense 700

Estimating Interest Expense 703

Estimating the Tax Rate 704

Calculating Earnings per Share: An Example 705

Estimating the Earnings Multiplier for aStock-Market Series 706

Determinants of the Earnings Multiplier 707

Estimating the Required Rate of Return (k) 707

Estimating the Growth Rate of Dividends (g) 707

Estimating the Dividend-Payout Ratio (D1lEd 708

Estimating an Earnings Multiplier: An Example 708

Calculating an Estimate of the Value for theMarket Series 712

Calculating the Expected Rate of Return onCommon Stocks 712

Other Relative Valuation Ratios 713

Analysis of World Markets 717

Individual Country Analysis 717

Investments Online 721

Chapter 19INDUSTRY ANALYSIS 726

Why Do Industry Analysis? 727

Cross-Sectional Indust Performance 728

Industry Performance over Time 728

Performance of the Companies within an Indust 728

Differences in Industry Risk 730

Summa of Research of Industry Analysis 730

The Business Cycle and Industry Sectors 730

Ination 732

Interest Rates 732

International Economics 733

Consumer Sentiment 733

Structural Economic Changes andAlternative Industries 733

Demographics 733

Lifestyles 733

Technology 734

Politics and Regulations 734

Estimating Industry Rates of Return 735

Valuation using the Reduced Form DDM 736

Industry Valuation Using the Free Cash Flow toEquity (FCFE) Model 744

Industry Analysis Using the RelativeValuation Approach 746

The Earnings Multiple Technique 746

Competition and Expected Indust Returns 751

Other Relative Valuation Ratios 764

The PricelBook Value Ratio 764

The PricelCash Flow Ratio 764

The PricelSales Ratio 764

Global Industry Analysis 766

The European Chemical Industry 769

Investments Online 771

Chapter 19 AppendixA. PREPARING AN INDUSTRY ANALYSIS 777

B. DATA NEEDS FOR AN INDUSTRYANALYSIS 779

C. INSIGHTS ON ANALYZING INDUSTRYROAs 780

Chapter 20COMPANY ANALYSIS ANDSTOCK SELECTION 782

Company Analysis versus the Selectionof Stock 783

Growth Companies and Growth Stocks 783

Defensive Companies and Stocks 784

Cyclical Companies and Stocks 785

Speculative Companies and Stocks 785

Value versus Growth Investing 785

Economic, Industry, and Structural Links toCompany Analysis 785

Economic and Indust Influences 786

Structural Influences 786

Company Analysis 787

Firm Competitive Strategies 787

Focusing a Strategy 789

SWOTAnalysis 790

Some Lessons om Lynch 790

Estimating Intrinsic Value 792

Present Value of Dividends 792

Present Value of Dividends Model (DDM) 796

Present Value of Free Cash Flow to Equity 797

Present Value of Operating Free Cash Flow 798

Relative Valuation Ratio Techniques 802

Estimating Company Earnings per Sha 802

Company Sales Forecast 802

Estimating the Company Profit Margin 807

Walgen Competitive Strategies 808

The Internal Performance 808

Estimating Company Earnings Multipliers 810

Macroanalysis of the Earnings Multiplier 810

Microanalysis of the Earnings Multiplier 811

Making the Investment Decision 817

Additional Measus of Relative Value 819

PricelBook Value (PIBV) Ratio 819

PricelCash Flow (PICF) Ratio 821

PricelSales (PIS) Ratio 821

Summary of Relative Valuation Ratios 823

Analysis of Growth Companies 824

Growth Company Defined 824

Actual Returns above Expected Returns 824

Growth Companies and Growth Stocks 825

Growth Companies and the DividendDiscount Model 825

Alternative Growth Models 826

No-Growth Firm 826

Long-Run Growth Models 826

The Real World 830

Measures of Value-Added 830

Economic Value-Added (EVA) 830

Market Value-Added (MVA) 832

Relationships between EVA and MVA 834

The Franchise Factor 834

Growth Duration 835

A Flexible Growth Stock Valuation Model 839

An Example 841

Site Visits and the Art of the Interview 843

When to Sell 844

Inuences on Analysts 844

Efficient Markets 844

Paralysis ofAnalysis 845

Forces Pulling on the Analyst 845

Global Company Analysis 845

Earnings per Share Analysis 846

Common Stock Statistics 846

Share Price Performance 846

Individual Company Analysis 848

Investments Online 850

Chapter 21TECHNICAL ANALYSIS 869

Underlying Assumptions ofTechnical Analysis 870

Advantages of Technical Analysis 871

Challenges to Technical Analysis 873

Challenges to Technical Analysis Assumptions 873

Challenges to Technical Trading Rules 873

Technical Trading Rules and Indicators 874

Contra-Opinion Rules 875

Follow the Smart Money 879

Other Market Environment Indicators 882

Stock Price and Volume Techniques 886

Technical Analysis of Foreign Markets 894

Technical Analysis of Bond Markets 895

Investments Online 897

Chapter 22EQUITY PORTFOLIO MANAGEMENTSTRATEGIES 901

Passive versus Active Management 902

An Overview of Passive Equity PortfolioManagement Strategies 903

Index Fund Construction Techniques 904

An Overview of Active Equity PortfolioManagement Strategies 905

Value versus Growth Investing:A Closer Look 908

An Overview of Style Analysis 913

Asset Allocation Strategies 917

I ntegrated Asset Allocation 917

Strategic Asset Allocation 922

Tactical Asset Allocation 922

Insured Asset Allocation 924

Selecting an Allocation Method 924

Using Futures and Options in EquityPortfolio Management 924

Modifying Portfolio Risk and Return:A Review 924

The Use of Futures in Asset Allocation 927

The Use of Derivatives in Equi Portfolios 927

Hedging Portfolio Inflows and Outflows 928

Using Futures in Passive Equi PortfolioManagement 928

Using Futures in Active Equi PortfolioManagement 928

Modifying the Characteristics of an InternationalEqui Portfolio 929

Investments Online 930

6 DERIVATIVE SECURITYANALYSIS 936

Chapter 23FORWARD AND FUTURESCONTRACTS 938

An Overview of Forward andFutures Trading 939

Hedging with Forwards and Futus 943

Hedging and the Basis 943

Calculating the Optimal Hedge Ratio 945

Forward and Futus Contracts:Basic Valuation Concepts 946

Valuing Forwards and Futures 946

The Relationship between Spot andForward Prices 948

Financial Forwards and Futures:Applications and Strategies 949

Interest Rate Forwards and Futures 950

Long-Term Interest Rate Futures 950

Short-Term Interest Rate Futures 955

Stock Index Futures 962

Currency Forwards and Futures 967

Investments Online 974

Chapter 23 Appendix A.CLOSED-FORM EQUATION FORCALCULATING DURATION 981

B. CALCULATING MONEY MARKETIMPLIED FORWARD RATES 982

Chapter 24OPTION CONTRACTS 985

An Overview of Option Markets andContracts 986

Option Market Conventions 986

Price Quotations for Exchange-TradedOptions 987

The Fundamentals of Option Valuation 994

The Basic Approach 994

Improving Forecast Accuracy 996

The Binomial Option Pricing Model 1001

The Black-Seholes Valuation Model 1004

Estimating Volatili 1007

Problems with Black-Seholes Valuation 1009

Option Valuation: Extensions andAdvanced Topics 1011

Valuing European-Sle Put Options 1011

Valuing Options on Dividend-BearingSecurities 1012

Valuing American-Sle Options 1013

Other Extensions of the Black-ScholesModel 1015

Exotic Options 1017

Option Trading Strategies 1021

Protective Put Options 1022

Covered Call Options 1023

Straddles, Strips, and Straps 1024

Strangles 1026

Chooser options 1027

Spreads 1028

Range Forwards 1031

Investments Online 1033

Chapter 25SWAP CONTRACTS, CONVERTIBLESECURITIES, AND OTHEREMBEDDED DERIVATIVES 1041

OTC Interest Rate Agreements 1042

Forward-Based Interest Rate Contracts 1042

Forward Rate Agreements 1042

Interest Rate Swaps 1044

Option-Based Interest Rate Contracts 1051

Caps and Floors 1051

Collars 1052

Swap Options (“Swaptions”) 1054

Swap Contracting Extensions 1056

Currency Swaps 1056

Equity Index-Linked Swaps 1060

Commodity Swaps 1062

Warrants and Convertible Securities 1064

Warrants 1065

Convertible Securities 1066

Convertible Preferred Stock 1067

Convertible Bonds 1067

Other Embedded Derivatives 1071

Dual Currency Bonds 1072

Equity Index YinkedNotes 1073

Commodi-Linked Bull and Bear Bonds 1077

Swap-Linked Notes 1079

Investments Online 1082

7INVESTMENT COMPANIESAND EVALUATINGPORTFOLIO PERFORMANCE 1092

Chapter 26PROFESSIONAL ASSETMANAGEMENT 1094

The Asset Management Industry:Structure and Evolution 1095

Private Management and Advisory Firms 1098

Management of Investment Companies 1099

Valuing Investment Company Shares 1101

Closed-End versus Open-End InvestmentCompanies 1101

Closed-End Investment Companies 1101

Open-End Investment Companies 1104

Fund Management Fees 1105

pes of Investment Companies Based onPortfolio Makeup 1106

Common Stock Funds 1106

Balanced Funds 1106

Bond Funds 1106

Money Market Funds 1106

Breakdown by Fund Characteristics 1107

Global Investment Companies 1108

Sources of Information 1110

Ethics and Regulation in the ProfessionalAsset Management Industry 1118

Performance of Investment Companies 1120

Analysis of Overall Performance 1120

Impact of Fund Objectives 1122

Consistency of Performance 1122

What Performance Studies Mean to You 1123

Investments Online 1125

Chapter 27EVALUATION OF PORTFOLIOPERFORMANCE 1132

What Is Required of a Portfolio Manager? 1133

Composite Portfolio PerformanceMeasures 1134

Portfolio Evaluation before 1960 1134

Peer Group Comparisons 1134

Treynor Portfolio Performance Measure 1135

Sharpe Portfolio Performance Measure 1139

Jensen Portfolio Performance Measure 1141

The Information Ratio Performance Measure 1143

Application of Portfolio PerformanceMeasures 1144

Components of Investment Performance 1149

Performance Attribution Analysis 1154

Asset Class Attribution Analysis: An Example 1155

Performance Attribution Extensions 1156

Measuring Market Timing Skills 1158

Factors That Affect Use of PerformanceMeasures 1159

Benchmark Errors and Global Investing 1160

A Demonstration of the Global BenchmarkProblem 1161

Implications of the Benchmark Problems 1162

Required Characteristics of Benchmarks 1164

Evaluation of Bond Portfolio Performance 1165

A Bond Market Line 1165

Decomposing Portfolio Returns 1168

Analyzing Sources of Return 1170

Consistency of Performance 1171

Reporting Investment Performance 1171

Time-Weighted and Dollar-Weighted Returns 1172

Performance Presentation Standards 1173

Investments Online 1177

Appendix AHOW TO BECOME A CHARTERFINANCIAL ANALYST 1187

Appendix BCODE OF ETHICS AND STANDARDS OFPROFESSIONAL CONDUCT 1189

Appendix CINTEREST TABLES 1191

Appendix DSTANDARD NORMAL PROBABILITIES 1196

Glossary 1197

Name and Company Index 1215

Subject Index 1223