Table of contents for Investments / Zvi Bodie, Alex Kane, Alan J. Marcus.

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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

Library of Congress Subject Headings for this publication:

Investments.
Portfolio management.