Finance Course: Investment s and Portfolio Volume Instructor: Tatyana Zabotina University of Illinois at Springfield =>? McGraw-Hill/Irwin McGraw−Hill Primis ISBN: 0−390−48886−0 Text: Investments, Sixth Edition Bodie−Kane−Marcus This book was printed on recycled paper Finance http://www.mhhe.com/primis/online/ Copyright ©2003 by The McGraw−Hill Companies, Inc All rights reserved Printed in the United States of America Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without prior written permission of the publisher This McGraw−Hill Primis text may include materials submitted to McGraw−Hill for publication by the instructor of this course The instructor is solely responsible for the editorial content of such materials 111 FINA ISBN: 0−390−48886−0 Finance Volume Bodie−Kane−Marcus • Investments, Sixth Edition Front Matter Preface I Introduction 14 Financial Instruments The Investment Environment How Securities are Traded Mutual Funds and Other Investment Companies 14 48 76 118 II Portfolio Theory 146 History of Interest Rates and Risk Premiums Risk and Risk Aversion Capital Allocation Between the Risky Asset and the Risk−Free Asset Optimal Risky Portfolios 146 III Equilibrium in Capital Markets 286 The Capital Asset Pricing Model 10 Index Models 11 Arbitrage Pricing Theory and Multifactor Models of Risk and Return 12 Market Efficiency and Behavioral Finance 13 Empirical Evidence on Security Returns 286 322 348 374 174 206 231 420 IV Fixed−Income Securities 450 14 Bond Prices and Yields 15 The Term Structure of Interest Rates 16 Managing Bond Portfolios 450 490 521 V Security Analysis 571 17 Macroeconomic and Industry Analysis 18 Equity Valuation Models 19 Financial Statement Analysis 571 604 653 VI Options, Futures, and Other Derivatives 693 20 Options Markets: Introduction 21 Option Valuation 22 Futures Markets 23 Futures and Swaps: A Closer Look 693 741 786 815 iii VII Active Portfolio Management 853 24 Portfolio Performance Evaluation 25 International Diversification 853 896 iv Bodie−Kane−Marcus: Investments, Sixth Edition Front Matter Preface © The McGraw−Hill Companies, 2004 P R E F A C E xviii We wrote the first edition of this textbook more than 15 years ago The intervening years have been a period of rapid and profound change in the investments industry This is due in part to an abundance of newly designed securities, in part to the creation of new trading strategies that would have been impossible without concurrent advances in computer technology, and in part to rapid advances in the theory of investments that have come out of the academic community In no other field, perhaps, is the transmission of theory to real-world practice as rapid as is now commonplace in the financial industry These developments place new burdens on practitioners and teachers of investments far beyond what was required only a short while ago Investments, Sixth Edition, is intended primarily as a textbook for courses in investment analysis Our guiding principle has been to present the material in a framework that is organized by a central core of consistent fundamental principles We make every attempt to strip away unnecessary mathematical and technical detail, and we have concentrated on providing the intuition that may guide students and practitioners as they confront new ideas and challenges in their professional lives This text will introduce you to major issues currently of concern to all investors It can give you the skills to conduct a sophisticated assessment of current issues and debates covered by both the popular media as well as more-specialized finance journals Whether you plan to become an investment professional, or simply a sophisticated individual investor, you will find these skills essential Our primary goal is to present material of practical value, but all three of us are active researchers in the science of financial economics and find virtually all of the material in this book to be of great intellectual interest Fortunately, we think, there is no contradiction in the field of investments between the pursuit of truth and the pursuit of money Quite the opposite The capital asset pricing model, the arbitrage pricing model, the efficient markets hypothesis, the option-pricing model, and the other centerpieces of modern financial research are as much intellectually satisfying subjects of scientific inquiry as they are of immense practical importance for the sophisticated investor In our effort to link theory to practice, we also have attempted to make our approach consistent with that of the Institute of Chartered Financial Analysts (ICFA), a subsidiary of the Association of Investment Management and Research (AIMR) In addition to fostering research in finance, the AIMR and ICFA administer an education and certification program to candidates seeking the title of Chartered Financial Analyst (CFA) The CFA curriculum represents the consensus of a committee of distinguished scholars and practitioners regarding the core of knowledge required by the investment professional This text also is used by the CAIA Association, a nonprofit association that provides education concerning nontraditional investment vehicles and sponsors the Chartered Alternative Investment Analyst designation There are many features of this text that make it consistent with and relevant to the CFA curriculum The end-of-chapter problem sets contain questions from past CFA exams, and, for students who will be taking the exam, Appendix B is a useful tool that lists each CFA question in the text and the exam from which it has been taken Chapter includes excerpts from the “Code of Ethics and Standards of Professional Conduct” of the ICFA Chapter 26, which discusses investors and the investment process, is modeled after the ICFA outline In the Sixth Edition, we have further extended our systematic collection of Excel spreadsheets that give tools to explore concepts more deeply than was previously possible Bodie−Kane−Marcus: Investments, Sixth Edition Front Matter Preface © The McGraw−Hill Companies, 2004 PREFACE xix These spreadsheets are available on the website for this text (www.mhhe.com/bkm), and provide a taste of the sophisticated analytic tools available to professional investors UNDERLYING PHILOSOPHY Of necessity, our text has evolved along with the financial markets In the Sixth Edition, we address many of the changes in the investment environment At the same time, many basic principles remain important We believe that attention to these few important principles can simplify the study of otherwise difficult material and that fundamental principles should organize and motivate all study These principles are crucial to understanding the securities already traded in financial markets and in understanding new securities that will be introduced in the future For this reason, we have made this book thematic, meaning we never offer rules of thumb without reference to the central tenets of the modern approach to finance The common theme unifying this book is that security markets are nearly efficient, meaning most securities are usually priced appropriately given their risk and return attributes There are few free lunches found in markets as competitive as the financial market This simple observation is, nevertheless, remarkably powerful in its implications for the design of investment strategies; as a result, our discussions of strategy are always guided by the implications of the efficient markets hypothesis While the degree of market efficiency is, and always will be, a matter of debate, we hope our discussions throughout the book convey a good dose of healthy criticism concerning much conventional wisdom Distinctive Themes Investments is organized around several important themes: The central theme is the near-informational-efficiency of well-developed security markets, such as those in the United States, and the general awareness that competitive markets not offer “free lunches” to participants A second theme is the risk–return trade-off This too is a no-free-lunch notion, holding that in competitive security markets, higher expected returns come only at a price: the need to bear greater investment risk However, this notion leaves several questions unanswered How should one measure the risk of an asset? What should be the quantitative trade-off between risk (properly measured) and expected return? The approach we present to these issues is known as modern portfolio theory, which is another organizing principle of this book Modern portfolio theory focuses on the techniques and implications of efficient diversification, and we devote considerable attention to the effect of diversification on portfolio risk as well as the implications of efficient diversification for the proper measurement of risk and the risk–return relationship This text places greater emphasis on asset allocation than most of its competitors We prefer this emphasis for two important reasons First, it corresponds to the procedure that most individuals actually follow Typically, you start with all of your money in a bank account, only then considering how much to invest in something riskier that might offer a higher expected return The logical step at this point is to consider other risky asset classes, such as stock, bonds, or real estate This is an asset allocation decision Second, in most cases, the asset allocation choice is far more important in determining overall investment performance than is the set of security selection decisions Asset allocation is the primary determinant of the risk-return profile of the investment portfolio, and so it deserves primary attention in a study of investment policy Bodie−Kane−Marcus: Investments, Sixth Edition xx Front Matter Preface © The McGraw−Hill Companies, 2004 PREFACE This text offers a much broader and deeper treatment of futures, options, and other derivative security markets than most investments texts These markets have become both crucial and integral to the financial universe and are the major sources of innovation in that universe Your only choice is to become conversant in these markets—whether you are to be a finance professional or simply a sophisticated individual investor NEW IN THE SIXTH EDITION Following is a summary of the content changes in the Sixth Edition: The Investment Chapter contains extensive new material on failures in corporate goverEnvironment nance in the boom years of the 1990s and the conflicts of interest that gave (Chapter 1) rise to the many scandals of those years How Securities We have added new material on securities trading including initial public Are Traded (Chapter 3) offerings, electronic trading, and regulatory reforms in the wake of recent corporate scandals to Chapter History of Interest We have extended the historical evidence on security returns to include Rates and Risk international comparisons as well as new approaches to estimating the mean Premiums (Chapter 5) market return We also have added an introduction to value at risk using historic returns as a guideline Arbitrage Pricing Theory and Multifactor Models of Risk and Return (Chapter 11) We have largely rewritten this chapter There is now greater focus on the use of factor models as a means to understand and measure various risk exposures The intuition for the multifactor risk–return relation has been enhanced, and the comparison between the multifactor APT and CAPM has been further developed Market Efficiency and We have fully reworked our treatment of behavioral finance by adding more Behavioral Finance careful development of behavioral hypotheses, their implications for secu(Chapter 12) rity pricing, and their relation to the empirical evidence on security pricing Empirical Evidence on We have updated our discussion of the value and size effects, with an emSecurity Returns phasis on competing interpretations of these premiums (Chapter 13) Bond Prices and Yields We have added new spreadsheet material helpful in analyzing bond prices (Chapter 14) and yields This new material enables students to price bonds between coupon dates Equity Valuation We have added new material on quality of earnings, earnings management, Models (Chapter 18) and the use of accounting data in valuation analysis to this chapter Bodie−Kane−Marcus: Investments, Sixth Edition Front Matter Preface © The McGraw−Hill Companies, 2004 xxi PREFACE Financial Statement We have added new material related to the accounting scandals of the last Analysis (Chapter 19) few years to this chapter It discusses ways in which accounting rules were skirted in the 1990s and ongoing reforms in accounting standards Option Valuation We have extended the binomial option pricing model to a multiperiod exam(Chapter 21) ple to illustrate how the model may be used to obtain realistic prices International We have fully rewritten this chapter, which now contains considerably more Diversification evidence on global financial markets and security returns (Chapter 25) In addition to these changes, we have updated and edited our treatment of topics wherever it was possible to improve exposition or coverage The Process of We have added to this chapter an appendix containing an extensive spreadPortfolio Management sheet model for sophisticated financial planning The spreadsheets (available (Chapter 26) as well at the course website) allow students to study the interaction of taxes and inflation on long-term financial strategies ORGANIZATION AND CONTENT The text is composed of seven sections that are fairly independent and may be studied in a variety of sequences Since there is enough material in the book for a two-semester course, clearly a one-semester course will require the instructor to decide which parts to include Part I is introductory and contains important institutional material focusing on the financial environment We discuss the major players in the financial markets, provide an overview of the types of securities traded in those markets, and explain how and where securities are traded We also discuss in depth mutual funds and other investment companies, which have become an increasingly important means of investing for individual investors The material presented in Part I should make it possible for instructors to assign term projects early in the course These projects might require the student to analyze in detail a particular group of securities Many instructors like to involve their students in some sort of investment game and the material in these chapters will facilitate this process Parts II and III contain the core of modern portfolio theory Chapter is a general discussion of risk and return, making the general point that historical returns on broad asset classes are consistent with a risk–return trade-off We focus more closely in Chapter on how to describe investors’ risk preferences In Chapter we progress to asset allocation and then in Chapter to portfolio optimization After our treatment of modern portfolio theory in Part II, we investigate in Part III the implications of that theory for the equilibrium structure of expected rates of return on risky assets Chapters and 10 treat the capital asset pricing model and its implementation using index models, and Chapter 11 covers multifactor descriptions of risk and the arbitrage pricing theory We complete Part II with a chapter on the efficient markets hypothesis, including its rationale as well as the behavioral critique of the hypothesis, the evidence for and against it, and a chapter on empirical evidence concerning security returns The empirical evidence chapter in this edition follows the efficient markets chapter so that the student can use the perspective of efficient market theory to put other studies on returns in context Part IV is the first of three parts on security valuation This Part treats fixed-income securities—bond pricing (Chapter 14), term structure relationships (Chapter 15), and interestrate risk management (Chapter 16) The next two Parts deal with equity securities and derivative securities For a course emphasizing security analysis and excluding portfolio theory, one may proceed directly from Part I to Part III with no loss in continuity Bodie−Kane−Marcus: Investments, Sixth Edition Front Matter Preface © The McGraw−Hill Companies, 2004 Walkthrough This book contains several features designed to make it easy for the student to understand, absorb, and apply the concepts and techniques presented New and Enhanced Pedagogy Concept Check A unique feature of this book is the inclusion of Concept Checks in the body of the text These self-test questions and problems enable the student to determine whether he or she has understood the preceding material Detailed solutions are provided at the end of each chapter CONCEPT CHECK QUESTION ☞ a Suppose the real interest rate is 3% per year and the expected inflation rate is 8% What is the nominal interest rate? b Suppose the expected inflation rate rises to 10%, but the real rate is unchanged What happens to the nominal interest rate? Bills and Inflation, The Fisher equation predicts a close connection between inflation and the 1963–2002 rate of return on T-bills This is apparent in Figure 5.2, which plots both time series on the same set of axes Both series tend to move together, which is consistent with our previous statement that expected inflation is a significant force determining the nominal rate of interest For a holding period of 30 days, the difference between actual and expected inflation is not large The 30-day bill rate will adjust rapidly to changes in expected inflation induced by observed changes in actual inflation It is not surprising that we see nominal rates on bills move roughly in tandem with inflation over time SOLUTIONS TO CONCEPT CHECKS $2,885.9 Ϫ $2.3 ϭ $7.79 370.4 The net investment in the Class A shares after the 4% commission is $9,600 If the fund earns a 10% return, the investment will grow after n years to $9,600 ϫ (1.10)n The Class B shares have no front-end load However, the net return to the investor after 12b-1 fees will be only 9.5% In addition, there is a back-end load that reduces NAV ϭ Bodie−Kane−Marcus: Investments, Sixth Edition Front Matter © The McGraw−Hill Companies, 2004 Preface Current Event Boxes Short articles from business periodicals are included in boxes throughout the text The articles are chosen for relevance, clarity of presentation, and consistency with good sense SPUN GOLD DID WALL STREET FIRMS BRIBE BOSSES WITH SHARES? Back in 1997, reports that Robertson Stephens, a Silicon Valley investment bank, was “spinning” IPO shares to executives who rewarded them with banking mandates prompted an SEC probe into the practice The probe was soon abandoned The practice boomed, becoming one of the more lucrative ways in which executives combined with Wall Street to abuse ordinary shareholders On August 30th Citigroup told congressional investigators that in 1997–2000 it had allocated IPO shares to Bernie Ebbers that had generated profits of $11m for the former boss of WorldCom, a telecoms firm which was a big Citigroup client, and is now bust thanks to fraud Other WorldCom executives had also benefited Citi claims that these investment-banking business in return Its “host of benign” explanations for why some shares were allocated retrospectively, giving executives a risk-free gain, seems thin So does its claim that Jack Grubman, until last month the bank’s top telecoms analyst, played no part in allocating shares to executives Among the documents that Citigroup sent to Congress was a memo copied to Mr Grubman that listed executives at several telecoms firms who had expressed interest in shares in IPOs Regulators and the courts will have to decide whether allocations of shares to executives were, in effect, bribes If so, the punishment could be severe Nor is Citi the only firm at risk Credit Suisse First Boston gave shares in IPOs Excel Applications The Sixth Edition has expanded the boxes featuring Excel Spreadsheet Applications A sample spreadsheet is presented in the E X C E L A P P L I text with an interactive version and related questions available on the book website at www.mhhe.com/bkm C A T I O N S SHORT SALE This Excel spreadsheet model was built using the text example for DotBomb The model allows you to analyze the effects of returns, margin calls, and different levels of initial and maintenance margins The model also includes a sensitivity analysis for ending stock price and return on investment You can learn more about this spreadsheet model using the interactive version available at our Online Learning Center at www.mhhe.com/bkm A 10 Initial Investment Initial Stock Price Number of Shares Sold Short Ending Stock Price Cash Dividends Per Share Initial Margin Percentage Maintenance Margin Percentage B $50,000.00 $100.00 1,000 $70.00 $0.00 50.00% 30.00% C Action or Formula for Column B Enter data Enter data (B4/B9)/B5 Enter data Enter data Enter data Enter data D Ending St Price $170.00 160.00 150.00 140.00 130.00 120.00 E Return on Investment 58.33% -133.33% -116.67% -100.00% -83.33% -66.67% -50.00% 1062 Bodie−Kane−Marcus: Investments, Sixth Edition Back Matter © The McGraw−Hill Companies, 2004 Index 1077 Subject Index International diversification, 905–906 bear markets, 927 benefits from, 921–922, 925–927 global equity markets, 906–910 misleading representation of benefits, 922–925 performance attribution and, 927–931 risk factors in, 910–917 risk, return, and benefits from, 917–927 International funds, 113 International investing, 910–917 benchmark portfolio, 928–929 cash/bond selection, 931 country selection, 930–931 country-specific risk, 914–917 currency selection, 929–930 Excel application, 932 exchange rate risk, 910–913, 920–921 historical record, 154–155 performance attribution and, 927–931 risk factors in, 910–917 risk, return, and benefits, 917–927 stock selection, 931 International Monetary Fund (IMF), 573 International Monetary market, 822 International Securities Exchange, 700 International stock market indexes, 53 Internet firms, 25 e-brokers, 87 investment banking, 25 valuation of, 626 Internet IPO, 71 Interquartile range, 1010, 1022 Intertemporal CAPM (ICAPM), 361–362 Interval closed-end funds, 111 Intrinsic value, 312, 609 market price vs., 608–609 options, 746 Inventory turnover ratio, 665–666 Inventory valuation, 674–675 Inventory valuation adjustment (IVA), 675 Inverse floaters, 454, 553–555 Investment bankers, 16, 66–68 Investment banking, 16–17, 66–68 Investment companies, 16, 108 closed-end funds, 109–110 commingled funds, 111 functions performed, 108 hedge funds, 111–112 managed investment companies, 109–111 open-end funds, 109 other organizations, 111–112 real estate investment trusts (REITs), 111 types of, 109–112 unit investment trusts, 109 Investment Companies (Wiesenberger), 125 Investment Company Act of 1940, 109 Investment Company Institute, 125 Investment constraints, 943–945 investment horizon, 944–945 liquidity, 944 matrix of constraints, 943 regulations, 944 tax considerations, 944 unique needs, 944–945 Investment decisions, 940–943 banks, 943 endowment funds, 942 individual investors, 942 life insurance companies, 942–943 mutual funds, 942 non-life insurance companies, 943 objectives, 940 pension funds, 942 personal trusts, 942 Investment environment; see Financial environment Investment-grade bonds, 471 Investment horizon, 300, 944–945 Investment losses, 151–152 Investment management companies, 112 Investment opportunity set, 203 one risky asset and one risk-free asset, 201–205 Investment performance of mutual funds, 117–119, 122–125 rewards for incremental performance, 372 Investment policies, for mutual funds, 112–115 Investment process; see Portfolio management process Investment returns arithmetic vs geometric averages, 863–865 forecasting future returns, 865–866 M measure, 869–870 measurement of, 862–866 time-weighted vs dollar-weighted returns, 862–863 Invoice price, 450, 458 IPOs (initial public offerings), 11, 13, 66, 68–71 IRAs, 953 Island/Instinet, 75–76, 83 J Jaganathan and Wang (JW), 425 January effect, 389–391 Jensen’s measure, 868 Joint tests, 389 Junior debtholders, 475 Junk bonds, 113, 471 K Kandel and Stambaugh (KS), 420–421 Keogh plans, 953 “Kinked” CAL, 204 Knock-out/knock-in options, 731 Kondratieff wave theory, 374–375 Bodie−Kane−Marcus: Investments, Sixth Edition 1078 Back Matter © The McGraw−Hill Companies, 2004 Index Subject Index L Lagging indicators, 581–583 Large stocks, historical record (1926-2002), 144–149, 152–153 Law of One Price, 349, 606 Lazard, 11 Leading economic indicators, 581–583, 641 Leakage of information, 98, 382–383 LEAPS (Long-Term Equity AnticiPation Securities), 701, 771 Lehman Aggregate Bond Index, 537 Lehman Brothers, 53 Lending, 255–258 Leverage, 203–204 degree of operating leverage (DOL), 589–590 financial leverage, 590 operating leverage, 588–590 return on equity (ROE) and, 660–662 Leverage ratio, 472, 664 Leveraged buyouts, 471 Levered equity, risky debt and, 727–728 LIBOR market (London Interbank Offered Rate), 35, 551, 840 Life cycle financial planning, 949–952 Life cycles, multistage growth models and, 618–622 Life insurance, 948 Life insurance companies, 942 Lifetime consumption, CAPM and, 297 LIFO (last-in first-out), 674 Limit-buy order, 78 Limit orders, 78–80 Limit-sell order, 78 Limited liability, 45 Lipper Analytical Services, 871 Liquid-yield option note (LYON), 729 Liquidation costs, 299n Liquidation date, 944 Liquidation value, 607 Liquidity, 297, 496n, 944 CAPM and, 297–303 Liquidity effects, 391 Liquidity preference theory, 497–498 Liquidity premium, 496–497 Liquidity ratios, 472, 667 Liquidity risk, 77, 297, 946 Listing requirements, 73 Lloyd’s of London, 20 Load, 111 Lognormal distribution, 187–190, 1014–1017, 1020–1021 London Interbank Offered Rate (LIBOR), 35, 551, 840 London International Financial Futures Exchange (LIFFE), 85, 822 London Stock Exchange, 84 Long hedge, 804 Long position, 57, 792 Long-short strategy, 335 Long Term Capital Management, 35, 573 Long-Term Equity AnticiPation Securities (LEAPS), 701, 771 Long-term investing, spreadsheet model for, 974–979 Long-term T-bonds, historical record (1926–2002), 144–149 Lookback option, 731 Low-load funds, 116 Lower partial standard deviation (LPSD), 153 Lower transactions costs, 108 Lucky event issue, 384–386 LYON (liquid-yield option note), 729 M M measure of performance, 869, 871 Macaulay’s duration, 523–524, 535 Macroeconomic analysis business cycles, 579–585 demand shocks, 576 domestic macroeconomy, 574–575 federal government policy, 576–579 global economy, 572–574 supply shocks, 576 MAD (mean absolute deviation), 185 Magnitude issue, 384 Maintenance margin, 90–91, 204n, 800 Making markets, 74, 80 Malkiel’s bond-pricing relationships, 520–521, 528, 531 Managed investment companies, 109–111 Management, ownership and, 7–8 Margin, 88–91 defined, 89 Excel Worksheet for, 89 maintenance margin, 90–91, 800 turnover vs., 664–665 Margin accounts, 204, 799–801 Margin call, 90, 93, 204n, 703 Margin purchases, 204n Margin of safety, 668 Marginal tax rates, 579 Marginal utility of wealth, 192 Market anomalies, 388–393; see also Efficient market hypothesis (EMH) behavioral interpretation, 396–401 book-to-market ratios, 391–392 data mining, 396 inside information, 394 mutual fund performance, 401–405 neglected-firm and liquidity effects, 391 post-earnings-announcement price drift, 392–393 risk premiums vs inefficiencies, 394–395 semistrong tests, 388–393 small-firm-in-January effect, 389–391 strong-form tests, 394–396 Market-book-value ratio (P/B), 667 Market capitalization, 907–910 GDP and, 908–910 1063 1064 Bodie−Kane−Marcus: Investments, Sixth Edition Back Matter Index © The McGraw−Hill Companies, 2004 1079 Subject Index Market capitalization rate, 609, 621, 636, 668 Market conversion value, 452 Market efficiency, 384–396; see also Efficient market hypothesis (EMH broad market returns, 388 issues of, 384 lucky event issues, 385–386 magnitude issues, 384–385 portfolio strategies and market anomalies, 388–393 random walk and, 370–372 returns over long horizons, 387–388 returns over short horizons, 386–387 selection bias issue, 385 stock market returns, 386–388 survivorship bias, 438–440 Market index (Roll’s critique), 419–420 “Market Index Target-Term Securities” (MITTS), 961 Market-indexed certificate of deposit, 729 Market making, 74, 80 Market model, 329 Market neutral, 112, 334 Market orders, 78 Market portfolio (M), 283–284 risk premium of, 285 Market price, intrinsic value vs., 608–609 Market price ratios, 667–668 Market price of risk, 287 Market psychology, 369 Market risk, 224, 320, 835–837, 946 Market structure, 20–21 Market timers, 830 Market timing, 254, 879–881, 984–988 imperfect forecasting, 987–988 stock-index futures and, 830 valuing as an option, 986–987 Market-value-weighted index, 51 Markets, 20–21 Markets and instruments bond market, 35–44 derivative markets, 54–58 equity securities, 44–47 fixed-income capital market, 35–44 money market, 32–35 stock and bond market indexes, 47–54 Marking to market, 799–801 Markowitz portfolio selection model, 240–246, 284, 317–318, 321, 981, 983 security selection, 240–246 Maturity stage, 592–593 May Day, 75 “Me-first rule,” 475 Mean, 185 Mean absolute deviation (MAD), 185 Mean-variance analysis, 184–190, 272 Mean-variance (M-V) criterion, 172 Mean-variance theory, 983–984 Measures of dispersion, 1010–1012 Median, 184 Memory bias, 397 Mental accounting, 398–399 Merrill Lynch, 9–10, 16, 53, 76–77, 170, 329–332, 729, 961 Merrill Lynch Domestic Master Index, 537 Microsoft, 11, 51, 73, 606–607 Minimum-variance frontier, 240 Minimum-variance portfolio, 232 Minor trends, 374 Misappropriation theory, 98 Mispriced options, 774–778 Mispricing, arbitrage and, 357–358 Mode, 185 Model risk, 400 Modern portfolio theory (MPT), futures prices and, 812–813 Modified duration, 526, 837 Modigliani and Miller (MM), 634 Momentum effect, 387 Monetary policy, 578 Money illusion, 639 Money market, 18, 31–35, 946 bankers’ acceptances, 33–34 brokers’ calls, 35 certificates of deposit, 33 commercial paper, 33 Eurodollars, 34 federal funds, 34 LIBOR market, 35 major components of, 33 repos and reverses, 34 treasury bills, 32–33 yields on, 35 Money market funds, 112, 200 Money market mutual funds, 112 Money spread, 716 Money supply, 582 Moody’s Industrial Manual, 476 Moody’s Investor Services, 471–472 Morgan Stanley, 70, 76, 869 Morgan Stanley Capital International (MSCI) indexes, 52–54, 921 Morningstar, 125–129, 213 Morningstar Mutual Funds, 228 Morningstar’s Mutual Fund Sourcebook, 107, 116, 125 Morningstar’s Risk Adjusted Rating (RAR), 889–890 Mortality tables, 954 Mortgage-backed securities, 17, 42–44, 454 Mortgage bond, 476 Mortgage markets, 17, 23 Mortgage pass-through securities, 17, 24, 43–44, 453 Mortgage trusts, 111 Mortgages, 17, 42–44 Moving averages, 375 MSCI (Morgan Stanley Capital International), 53–54 Multifactor APT, 356–358 Bodie−Kane−Marcus: Investments, Sixth Edition 1080 Back Matter © The McGraw−Hill Companies, 2004 Index Subject Index Multifactor CAPM, 361–362 macro factor model, 426–429 test of, 426–429 Multifactor models, 344–348 active portfolio management, 995–996 determination of factors, 358–360 Fama and French three-factor model, 360 mispricing and arbitrage, 357–358 multifactor security market line, 346–348 risk assessment using, 346 Multifactor SML, 346–348, 357 Multiple regression analysis, 360, 1035–1036 Multiplier, 729 Multistage growth models, 618, 622 Excel application, 635 life cycles and, 618–622 Multivariate statistics, 1028–1036 Municipal bonds, 39–40 Mutual fund, risk measurement of, 871 Mutual Fund Letter, 234 Mutual fund performance, 117–119, 122–125, 401–405 Mutual Fund Sourcebook (Morningstar), 107, 116, 125 Mutual fund theorem, 285 Mutual funds, 16, 107, 109, 112–116, 942 asset allocation and flexible funds, 113 back-end load, 116 balanced and income funds, 113 bond funds, 113 classification of, 112–115 correlation, 228 costs of investing in, 116–119 emerging country funds, 918 equity funds, 112–113 exchange-traded funds (ETFs), 120–122 fee structure, 116–117 fixed-income funds, 113 front-end load, 116 how sold, 115–116 index funds, 113–115, 379 information on, 125–128, 130 international funds, 113 investment performance, 117–119, 122–125, 401–405 investment policies, 112 money market funds, 112 net asset value (NAV), 108 net returns, 118–119 operating expenses, 116 performance presentation, 892 returns and fees, 117–119 single-country funds, 917 soft dollars, 118–119 specialized sector funds, 113 survivorship bias, 439–440 tax efficiency, 120, 128 taxation of income on, 119–120 turnover rates, 120 12b-1 charges, 116–117 types of, 112–115 N NAICS codes (North American Industry Classification System), 586–587 Naked option writing, 713 Naked puts, 708 Nasdaq market (NASDAQ), 52, 72n, 73, 76, 120 initial listing requirements, 74 level of subscribers, 74 Small Order Execution System (SOES), 83 trading on, 83 Nasdaq National Market System, 74 Nasdaq SmallCap Market, 74 National Association of Securities Dealers (NASD), 52, 72n, 74–75, 96 National Association of Securities Dealers Automated Quotation system (Nasdaq), 73 National exchanges, 72–73 National Market System, 76–77 National wealth, Negative convexity, 534 Negative correlation, 177–178, 228, 233 Negative dividend (storage costs), 841 Neglected-firm effect, 391 Net asset value (NAV), 108 Net hedging hypothesis, 812 Net profit, 698 Neutral diversification strategy, 211 Neutral weights, 883 New York Stock Exchange (NYSE), 20–21, 46, 72 block transactions on, 82 bond trading, 77 circuit breakers, 96–98 competitors of, 72–73 composite index, 52 listing requirements, 72–73, 679 national market system, 76–77 seat prices on, 72 as secondary market, 72 specialist, 80 Nikkei Index, 48, 53, 154 No-arbitrage condition, 343–344, 349–350, 356 No-load funds, 116 Noise, 876, 982 Nominal income, 142 Nominal interest rate, 138–139 equilibrium nominal rate of interest, 140–141 Nominal rate of return, 150, 454 Non-life insurance companies, 943 Nondiversifiable risk, 224 Nonfinancial business sector, balance sheet of, 13 Nonrecourse loan, 726 Nonrecurring items, 677 Nonstandard normal distributions, 1017–1018 Nonsystematic risk, 224, 351 Nonvoting stock, 45n Nordic Country Alliance, 85 Normal backwardation, 812 1065 1066 Bodie−Kane−Marcus: Investments, Sixth Edition Back Matter Index © The McGraw−Hill Companies, 2004 1081 Subject Index Normal distribution, 148, 151–153, 187–190 Normal and lognormal distributions, 187–190, 1014–1018 North American Free Trade Association (NAFTA), 573, 587 North American Industry Classification System (NAICS), 586–587 Notional principal, 551 NSC (Nouveau Système de Cotation), 84 Null hypothesis, 1036 O Objectives, 940 October 19, 1987 market crash, 772, 928 Odd lots, 47 Off-balance-sheet assets and liabilities, 677–678 Official Summary of Insider Trading (SEC), 394 Official Summary of Securities Transactions and Holdings (SEC), 98 Oil shocks, 35, 576 Omnibus Budget Reconciliation Act (OBRA) of 1987, 957 On the run, 492 One Up on Wall Street (Lynch), 593, 625 OneSource program (Schwab), 115 Online brokers/trading, 25, 86 Online information, 25 Open-end funds, 109; see also Mutual funds Open-end investment companies, 107, 112 Open interest, 704, 796–799 Open market operations, 578 Open orders, 80 Open outcry system, 797 OpenIPO, 71 Operating earnings, 628 Operating expenses, 116 Operating income, 656 Operating leverage, 588–590 Optimal complete portfolio, 238–240 Optimal risky portfolio, 223, 237–238, 981 lending/borrowing and, 255–258 spreadsheet model, 251 two risky assets and a risk-free asset, 235–237 Optimization process, 988, 990–991 Optimization program, 246, 253 Option Clearing Corporation (OCC), 702–703 Option contract, 56, 698, 702 Option elasticity, 769 Option-type contracts, 19 Optionlike securities, 721–728 callable bonds, 721–722 collateralized loans, 726–727 convertible securities, 723–725 levered equity and risky debt, 727–728 warrants, 725–726 Options, 19, 54–56 adjustments in contract terms, 702 American options, 702, 751–752 collars, 716–719 Options—Cont covered calls, 713–715 European options, 702 Excel spreadsheet for, 715 financial engineering, 728–730 foreign currency options, 705 futures options, 705 index options, 703–705 interest rate options, 705 levered equity and risk debt, 727–728 LYONs, 729 management payoffs, 10 other listed options, 703–705 protective put, 711–712 put-call parity relationship, 719–721 spreads, 716 stock investments vs., 709–710 straddles, 715–716 strategies, 711–719 trading options, 700–701 values at expiration, 705–710 Options valuation, 745–779 binomial model, 752–758 Black-Scholes model, 758–767 dividends and call options, 765–766 empirical evidence on, 778–779 hedge ratios, 767–770 portfolio insurance, 770–771 pricing formula, 759–765 put option valuation, 766–767 synthetic protective put options, 771–774 call option, 748–750 determinants of, 747–748 early exercise and dividends, 751 empirical evidence on, 778–779 hedging bets on mispriced options, 774–778 intrinsic value, 746 introduction to, 746–748 market timing as option, 986–987 mispriced options, 774–778 restrictions on option values, 748–752 call option, 749–750 early exercise of American puts, 751–752 early exercise and dividends, 751 time value, 746 two-state option pricing, 752–755 Oracle, 10 Original-issue junk (junk bonds), 471 Original issues discount (OID) bonds, 468–470 OTC Bulletin Board, 74 Out of the money, 699 Over-the-counter (OTC) Bulletin Board, 74 Over-the-counter (OTC) firms, 52 Over-the-counter (OTC) market, 20, 73–74 Level (making markets), 75 options trading, 700–701 trading on, 82–83 Overconfidence, 397 Bodie−Kane−Marcus: Investments, Sixth Edition 1082 Back Matter Index © The McGraw−Hill Companies, 2004 Subject Index Overheated economies, 575 Ownership, management and, 7–8 P P/E effect, 389 P/E ratio; see Price-earnings (P/E) ratio P/E to g (PEG ratio), 625 Pacific Stock Exchange, 72, 76, 700n Par value, 448 Participation rate, 729 Pass-through security, 17, 22–23, 37, 43–44, 43n Pass-through status (tax code), 119 Passive bond management, 536–547 bond-index funds, 537–538 cash flow matching and dedication, 546 immunization, 538–544 rebalancing, 544–545 Passive core, 379 Passive investment strategy, 113, 378–379, 519 Passive portfolio, 989 Passive strategy, 210, 983 capital market line, 210–213 as efficient, 285 performance measurement, 883 Payer swaption, 849 Paying for order flow, 87 Payout stage, 954 Peak, 579 PEG ratio, 625 Penn Central bankruptcy, 35 Penn Square Bank, 35 Pension funds, 678, 863, 942, 955–959 defined benefit pension obligations, 956–957 defined benefit plans, 942, 956 defined contribution plans, 942, 955 equity investments, 958–959 immunization, 958 investment strategies, 957–958 Pension plan, 955–956 Percentage margin, 89 Performance attribution procedures, 881–886 asset allocation decisions, 883–884 cash/bond selection, 931 component contributions, 885–886 country selection, 930–931 currency selection, 929–930 Excel application for, 886 international investing and, 927–931 sector and security selection, 884–885 stock selection, 931 Performance measurement; see Portfolio performance evaluation Perpetuity, 47, 453, 529 Personal funds, 960 Personal trusts, 942 Philadelphia Stock Exchange, 76 Pink sheets, 73 Plain vanilla securities, 17 Plan sponsor, 956 Plowback ratio, 615 Policy statements, 947 Political risk, 914–917, 946 Pooling of assets, 108 Portability problem, 957 Portfolio allocation lending/borrowing and, 254–258 Markowitz portfolio selection model, 240–246 optimal risky portfolio, 235–238 passive strategies, 210–213 risky asset vs risk-free asset, 198–200 stocks, bonds, and bills, 234–240 two risky assets, 225–234 well-diversified portfolios, 350–351 Portfolio alpha, 868 Portfolio construction, 989–995 Portfolio insurance, 711, 770–771, 774 Portfolio management; see also Active portfolio management active vs passive, 378–380 asset allocation, 883–884, 946–947 constraints of, 943–945 determination of portfolio practices, 940 future trends in, 960–961 futures and hedging, 804–805 for individual investors’ portfolios, 948–955 investment decisions, 940–943 market timing, 984–988 matrix of objectives, 943 multifactor models, 995–996 objectives of, 940, 983–984 pension investment strategies, 957–959 portfolio construction, 989–995 rewards for incremental performance, 372 role in efficient market, 380 security/sector selection, 884–885, 988–995 synthetic stock positions, 830–832 Portfolio management process asset allocation, 946–948 banks, 943 constraints, 943–946 endowment funds, 942 future trends in, 960–961 individual investors, 948–955 investment decisions, 940–943 investment horizon, 944 life insurance companies, 942–943 liquidity, 944 mutual funds, 942 non-life insurance companies, 943 objectives, 940–941 pension funds, 942, 955–959 personal trusts, 942 policy statements, 947 1067 1068 Bodie−Kane−Marcus: Investments, Sixth Edition Back Matter Index © The McGraw−Hill Companies, 2004 1083 Subject Index Portfolio management process—Cont regulations, 944 tax considerations, 944, 947–948 unique needs, 944–945 Portfolio mathematics, 174–178 Portfolio objectives, 940 Portfolio opportunity set, 232 Portfolio performance evaluation, 861–892 active and market-index portfolio mix, 972 AIMR Performance Presentation Standards, 891–892 appraisal ratio, 868, 992 arithmetic vs geometric averages, 863–865 asset allocation decisions, 883–884 cash/bond selection, 931 changing portfolio composition, 877–879 country selection, 930–931 currency selection, 929–930 dollar-weighted returns, 862–863 evaluating performance, 890–892 example of, 875 Excel example, 875 forecasting future returns, 865–866 investment fund, 872–873 Jensen’s measure, 868 M measure of performance, 869 market timing, 879–881 measuring returns, 862–866 Morningstar’s risk-adjusted rating, 889–890 performance attribution procedures, 881–886 performance evaluation, 890–892 realized returns vs expected returns, 875–877 relationship among performance measures, 874 risk-adjusted measures, 868–873 risky investment fund, 871–872 sector and security decisions, 884–885 Sharpe’s measure, 868, 870–871, 984, 992 stock selection, 931 style analysis, 886–889 theory of, 866–877 three scenarios of, 871–873 time-weighted returns, 862–863 Treynor’s measure, 868, 872–874 Portfolio risk, 122, 173–178 asset risk vs., 173–174 diversification and, 174, 224–225 performance measurement and, 878–879 portfolio mathematics, 174–178 return and, 229–233 Portfolio strategies, market anomalies and, 388–393 Portfolio theory, 165 asset risk vs portfolio risk, 173–174 certainty equivalent rate, 169 correlation coefficient, 177 covariance, 176–178 expected rate of return, 174–177 mean-variance analysis, 184–190 minimum-variance portfolio, 232 Portfolio theory—Cont normal and lognormal distributions, 187–190 portfolio mathematics, 174–178 risk and risk aversion, 166–173, 191–195 speculation, and gambling, 167–168 standard deviation, 175 utility values, 168–169 variance, 174 Portfolio variance, calculating of, 178 Portfolios, of two risky assets, 225–234 Positive correlation, 177 Post-earnings-announcement price drift, 392–393 Power of the test, 1037 Preferred stock, 47, 452–453 DDM and, 612 Preliminary prospectus, 66 Premium, 58, 698 Premium bonds, 461 Present value of growth opportunities (PVGO), 616 Price continuity, 81, 187 Price discovery, 83 Price-earnings analysis DDM and, 631–632 pitfalls in, 627–631 Price-earnings multiple, 622 Price-earnings (P/E) ratio, 47, 668 growth opportunities and, 622–625 growth rate vs., 625–626 stock risk and, 626–627 Price fixing agreements, 19 Price priority, 83 Price risk, 70, 496n, 539–540 Price-to-book ratio, 632, 668–669 Price-to-cash-flow ratio, 632 Price-to-sales ratio, 633 Price value of a basis point (PVBP), 838 Price Waterhouse, 19 Price-weighted average, 48 splits and, 49–51 Primary market, 20, 66 Primary trend, 374 Primex, 76 Primitive security, 17, 350 Principal Financial Group, Inc., 66–67 Principal-only (PO) strip, 554–555 Private placement, 66, 68 Pro-forma accounts, 678 Pro forma earnings, 628 Probability distributions, 184–187, 1007–1021 Procter & Gamble, 555 Product decision, 983 Productive capacity, Professional management, 108, 952 Profit margin, 663 Profitability ratios, 473 Program trading, 82, 834 Projected benefit obligation (PBO), 957 Bodie−Kane−Marcus: Investments, Sixth Edition 1084 Back Matter Index © The McGraw−Hill Companies, 2004 Subject Index Prospectus, 66, 95 Protective covenants, 474 Protective put, 711–713, 770 Proxy, 45 Proxy contest, PRS Group (Political Risk Services), 914–917 Prudent man rule, 942, 944 Pseudo-American call option value, 766 Public offering, 66 Purchasing power, 138–139, 150–151 Purchasing power risk, 946 Pure play, 335 Pure yield curve, 492, 506 Pure yield pickup swap, 548 Purely passive strategy, 983 Put bond, 452 Put-call parity relationship, 719–721 Put-call parity theorem, 720 Put options, 55, 699 Black-Scholes put valuation, 766–767 early exercise of American put, 751–752 naked puts, 708 profits and losses on, 699–700 protective put, 711–712 synthetic protective put, 771–774 values at expiration, 707–708 Put swaption, 849 Putnam, 112 Puttable bonds, 452 PV factor, 456 Q Quality of earnings, 676–677 Quanto, 731–732 Qubes (QQQ), 120 Quick ratio, 472, 667 Qwest Communications, 8–9 R Random variable, 184, 1007 Random walk, 370–372 Range, 1010 Rate anticipation swap, 548 Rate of return complete portfolio, 201 historical record (1926–2002), 144–149, 864 measuring investment returns, 862–866 real vs nominal risk, 150–151 required rate of return, 291 standard deviation (as measure of risk), 143 Rate of return analysis, 273 Ratio analysis, 619, 662–670 benchmark for, 670 decomposition of ROE, 662–664 as default risk predictors, 471–473 Ratio analysis—Cont liquidity and coverage ration, 667 margin vs turnover, 664–665 market price ratios, 667–668 price-to-book and investment opportunities, 668–669 turnover and other asset utilization ratios, 665–666 Raytheon, 619–621 Real assets, 4–6 Real consumption, 976 Real estate investment trusts (REITs), 12, 111 Real interest rate, 138–141 approximation of, 139 equilibrium real rate of interest, 139–140 taxes and, 142 Real vs nominal risk, 150–151 Realism, 676 Realized compound yield, 464–466 Realized return, index model and, 326–327 vs expected return, 435–437, 875–877 Rebalancing immunized portfolios, 543–545 Record keeping and administration, 108 Red herring, 66 Redeemable preferred stock, 47 Redeemable trust certificates, 109 Refunding, 451 Regional exchanges, 72 Regional funds, 113 Registered bonds, 451 Regression analysis, 1033–1034 Regression coefficients, 1034 Regression equation, 322, 1034 Regret avoidance, 399 Regulation Q, 14, 18 Regulation of securities market, 94–99; see also Securities and Exchange Commission (SEC) circuit breakers, 96–98 financial environment response to, 18–19 futures market, 802 government regulation, 94–95 insider trading, 98–99 prudent man rule, 944 responses to recent scandals, 95–96 self-regulation, 96–98 state regulations, 95 Reinvestment rate, 460n Reinvestment rate risk, 539–540 Relative decline, 593 Relative strength approach, 375 Remaindermen, 942 Replacement cost, 608 Replication, 753 Representativeness, 398 Repurchase agreements (repos/RPs), 34 Required rate of return, 291, 988 Reserve requirements, 18, 578 Reserving practices, 679 Residual claim, 45 1069 1070 Bodie−Kane−Marcus: Investments, Sixth Edition Back Matter © The McGraw−Hill Companies, 2004 Index 1085 Subject Index Residual income, 671 Residuals, 322 Resistance levels, 375–377 Resource allocation, 380–381 Retirement annuity, 974 Retirement assets; see Individual investors; Pension funds Retirement planning models, 950 spreadsheet model for long-term investing, 974–979 Retirement savings, 949 Return on assets (ROA), 473, 661 Return distributions, 151–153 Return on equity (ROE), 473, 660–662 decomposition of, 662–664 financial leverage and, 660–662 past vs future ROE, 660 Return requirements, 940 Return on sales (ROS), 663 Revenue bonds, 39 Revenue recognition, 677–678 Reversal effect, 388 Reverse repo, 34 Reversing trade, 798 Reward-to-variability ratio, 203, 207, 235–236, 868, 984, 991 Risk, 142–144; see also Portfolio risk allocation of, 6–7 assessing risk tolerance, 168–171 bond price/reinvestment rate, 539 business cycle risk, 224 commodity hedging, 812–813 country-specific risk, 914–917 credit risk in swap market, 847–848 default risk, 471–474 derivatives for risk management, 711 diversifiable risk, 224, 325 exchange rate risk, 910–914, 920–921 financial engineering, 24 historical risk premiums, 144–149 household sector, 12 interest rate risk, 520–531, 946 liquidity risk, 77, 297, 946 market price of risk, 287 market risk, 224, 320, 946 Morningstar’s risk-adjusted rating, 889–890 mutual funds, 127–128, 871 P/E ratios and stock risk, 626–627 political risk, 914–917, 946 portfolio risk; see Portfolio risk price risk, 70 real vs nominal risk, 150–151 risk-adjusted performance measures, 868–874 risk aversion and, 166–173 risk premiums; see Risk premiums simple prospects, 166–167 speculation and gambling, 167–168 standard deviation (as measure of), 143 Risk—Cont systematic risk vs firm-specific, 318–321 value at risk, 151–153 volatility risk, 778 Risk-adjusted performance measures, 868–870 Risk arbitrage, 349–350 Risk assessment, using multifactor models, 346 Risk averse investors, 168–169, 205 Risk aversion, 144, 166–173, 191–195, 210, 233n, 252 expected utility, 191–195 utility values and, 168–169 Risk-free asset, 150, 178, 200 lending/borrowing and, 254–258 optimal risky portfolio and, 235–237 Risk-free rate, 144 Risk lover, 170 Risk management derivative securities, 711 exchange rate risk, 826–828 hedging market risk, 835–837 interest rate risk hedge, 837–840 Risk Management Association (RMA), 670 Risk motives, 12 Risk-neutral investors, 170 Risk-pooling, 272–274 Risk preferences, 12 Risk premiums, 142–144, 165, 167, 201, 436 historical record, 144–149, 156 individual assets, 283 inefficiencies and, 394–395 market portfolio, 285 Risk questionnaires, 170–171 Risk-return trade-off, 172, 198, 201, 917–919, 940 Risk-sharing vs risk-pooling, 272–274 Risk structure of interest rates, 477 Risk tolerance, 205–210, 940–941 asset allocation and, 205–210 questionnaire for, 941 Risky assets, 198 efficient frontier of, 241, 245 two-security model, 242–243 Risky portfolio, 199–200 Rivalry, 594 Road shows, 68 Robertson Stephens, 70 Roll’s critique, 419–422, 424 Round lots, 47 Rule 10b-5, 373 Rule 144A, 68 Rule 415, 68 S St Petersburg Paradox, 191–195 Saitori, 85 Sallie Mae, 44 Salomon Smith Barney, 9–10, 53, 76, 627 Bodie−Kane−Marcus: Investments, Sixth Edition 1086 Back Matter Index © The McGraw−Hill Companies, 2004 Subject Index Salomon Smith Barney Broad Investment Grade (BIG) Index, 379, 537 Sample size neglect, 398 Sample statistics, 1026–1028 Samurai bonds, 38, 453 Sarbanes-Oxley Act (2001), 95 SBC Communications, 51 Scatter diagram, 321 Scenario analysis, 1008 Scudder Kemper Investments Inc., 170 Sears Roebuck, 51 Seasoned new issues, 66 Seats, 72 Second central moment, 185–186 Second-pass regression, 417–418 Secondary markets, 20–21, 66, 72–73, 458 fourth market, 75–76 national market system, 76–77 over-the-counter market, 73–74 stock exchanges, 72–73 third market, 75 Secondary trend, 374 Sector decisions, 884–885 Sector funds, 113 Sector rotation, 590–591 Secured bonds, 41 Securities how issued, 66–71 mutual funds; see Mutual funds plain vanilla securities, 17 primitive vs derivative, 17 trading; see Securities trading Securities Act Amendments of 1975, 76 Securities Act of 1933, 94–95 Securities Exchange Act of 1934, 94, 373 Securities and Exchange Commission (SEC), 14, 33, 66, 88, 373 consolidated tape, 76 EDGAR website, 606 history of, 95 insider trading, 98, 394 preliminary prospectus, 66 prospectus disclosure, 125 Regulation FD (Fair Disclosure), 96 Rule 144A, 68 Rule 415, 68 12b-1 fees, 116–117 Securities Investor Protection Act of 1970, 95 Securities Investor Protection Corporation (SIPC), 95 Securities markets; see Markets and instruments Securities trading block sales, 81–82 bond trading, 77 circuit breakers, 96–98 Euronext, 84–85 execution of trades, 80–81 fourth market, 75–76 Securities trading—Cont globalization of, 85 inside information, 98 insider trading, 98–99, 394 London Stock Exchange, 84 margin buying, 88–91 mechanics of, 77–82 National Market system, 76–77 over-the-counter (OTC) market, 73–74, 82–84 participants in, 77–78 regulation of markets, 94–99 secondary markets, 72–73 self-regulation and circuit breakers, 96–98 settlement and, 82 short sales, 91–94 specialists and, 80–81 SuperDOT system, 82 third market, 75 Tokyo Stock Exchange, 85 types of orders, 78–80 where traded, 71–77 Securitization, 17, 22–23, 43 Security Analysis (Graham and Dodd), 681 Security characteristic line (SCL), 323, 877 estimating of, 417 Security issuance, 13 Security market line (SML), 289–292 arbitrage and, 353–355 estimating of, 417–418 multifactor SML, 346–348, 357 one-factor SML, 353 Security Risk Evaluation (beta book), 329–331 Security selection, 197 asset allocation and, 253–254 attribution analysis, 884–885 Markowitz portfolio selection model, 240–246 Treynor-Black model, 988–995 Security selection decision, 197 Selection bias issue, 384–385 Self-regulation, 96–98 Sell discipline, 713 Semistrong-form EMH, 373 Sentiment, 575 Separation property, 251–253 Serial bond, 475 Serial correlation, 386 SETS (Stock Exchange Electronic Trading Service), 84 Settlement, 82 Shareholders, 45 Shareholders’ equity, 657 Shares, Sharpe’s measure, 868–872, 874, 878, 984, 992 Shelf registration, 68 Short hedging, 803 Short interest rate, 488–490 Short position, 57, 792 margin calls on, 93–94 1071 1072 Bodie−Kane−Marcus: Investments, Sixth Edition Back Matter Index © The McGraw−Hill Companies, 2004 1087 Subject Index Short sales, 91–94, 229n, 241n, 246, 250 cash flows from, 92 Excel worksheet for, 94 SIC (Standard Industry Classification) codes, 586–587 Siebel Systems, 10 Significance level, 876, 1036 Simple prospect, 166 Simple regression, 1034 Single-country funds, 917 Single-factor APT, index model and, 416–425 Single-factor model, 319, 344 Single-index model, 319, 424–425, 872 Single-index security market, 318–326 CAPM and, 326–329 estimating the index model, 321–324 index model and diversification, 324–326 systematic vs firm-specific risk, 318–321 Sinking funds, 474–475 Skewed probability distributions, 186 Skewness, 153, 186, 986, 1011–1012 Slow growers, 593 Small-firm effect, 389 Small-firm-in-January effect, 389–391 Small Order Execution System (SOES), 83 Small stocks, historical record (1926-2002), 144–149, 152–153, 864 Smallness problem, 16 Socially responsible investing, 246 Societal risk, 946 Soft dollars, 118–119 Special purpose entities, 8, 678 Specialists, 77, 80–81 Specialist’s post, 77 Specialized sector funds, 113 Speculation, 167–168 on the basis, 805–806 hedging and, 802 on mispriced options, 775–778 on the spread, 806 T-bond futures, 803 Speculative-grade bonds, 471 Spiders (SPDR), 120 Spinning IPOs, 70, 96 Splining techniques, 508n Spot-futures parity theorem, 806–807 Spot rate, 489–490 Spot yields, Excel application, 506 Spreads, 35, 450–451, 716, 718, 809–810 Spring Street Brewing Company, 25, 71 Stability, 1015 Stalwarts, 593 Standard & Poor’s Composite (S&P 500), 51, 113, 120, 211–213, 378, 703, 764 Standard & Poor’s Corporation bond ratings, 471–473 indexes, 51 industry analysis, 587 Standard & Poor’s Corporation—Cont Market Insight service, 606, 670 market outlook (2003), 577 Outlook, 681 Standard & Poor’s Depository Receipt (SPDR), 120 Standard & Poor’s Market Insight, 29 Standard deviation, 153, 166, 175, 1011 lower partial standard deviation (LPSD), 153 Standard error, 1038 Standard Industry Classification (SIC) codes, 586–587 Standard normal distribution, 1014–1019 Start-up stage, 592 State regulation, 95 Statement of cash flows, 658–660 Stern Stewart & Co., 671 Stock Exchange Automated Quotations (SEAQ), 84 Stock exchanges, 72 Stock-index futures, 829–837 contracts, 829–830 empirical evidence on pricing, 832–833 hedging market risk, 835–837 index arbitrage, 834–835 major contracts, 829 synthetic stock positions, 830–832 triple-witching hour, 834–835 Stock investments, vs options, 709–710 Stock market aggregate stock market, 639–641 explaining past behavior, 639–640 forecasting, 640–641 globalization of, 85 as leading indicator, 641 Stock market indexes, 47–53 Dow Jones averages, 48 equally weighted indexes, 52–53 foreign and international indexes, 53 other U.S market-value indexes, 52 price-weighted average, 48–51 Standard & Poor’s indexes, 51 value-weighted indexes, 51–52 Stock market listings, 46–47 Stock market returns over long horizons, 387–388 over short horizons, 386–387 predictors of broad market returns, 388 Stock options, 7, 10–11, 677–678, 697, 726 Stock prices intrinsic value and, 614–615 investment opportunities, 615–617 options and, 747 Stock risk, P/E ratios and, 626–627 Stock selection, 931 Stock splits, price-weighted averages and, 49–51 Stockholders, Stockholders’ equity, 657 Bodie−Kane−Marcus: Investments, Sixth Edition 1088 Back Matter Index © The McGraw−Hill Companies, 2004 Subject Index Stocks, bonds, and bills asset allocation with, 234–240 historical rates of return (1926–2002), 144–149 Stop-buy orders, 79 Stop-loss orders, 79 Storage costs, 840–841 Straddle, 715–717 Straight bond, 722–723 Straps, 716 Street name, 82 Strike price, 54, 698, 700 Strips, 18, 469, 716 STRIPS (Separate Trading of Registered Interest and Principal of Securities), 469 Strong-form EMH, 373 Structured investment products, 961 Student Loan Marketing Association (SLMA), 44 Style analysis, 886–889 Subordinated debentures, 41 Subordination clauses, 475 Substitute products, 594 Substitution swap, 547–548 Sun Microsystems, 73 Sunbeam, 10, 677 SuperDOT system, 82, 834 SuperMontage, 76, 83 Suppliers, 595 Supply shock, 576 Supply-side policies, 579 Support levels, 375 Survivorship bias, 438 market efficiency and, 438–440 Swap dealer, 552–553 Swaps, 19, 697, 844–849 balance sheet restructuring and, 552, 845–848 credit risk in, 847–848 pricing of, 846–847 swap variations, 848–849 Swaptions, 849 Syndicate, 66 Synthetic protective put options, 771–774 Synthetic stock positions, 830–831 Systematic risk, 224, 269, 302, 320, 325n, 874 factor models, 343, 345 firm-specific risk vs., 318–321 T T ϩ requirement, 82 T-bills; see Treasury bills T-bond futures, speculating/hedging with, 803–805 T Rowe Price Associates Inc., 170 T-statistic, 154 T-Test, 1039–1040 Takeover attempts, 371–372, 383 Takeover threat, 8, 45 Tax anticipation notes, 39 Tax-burden ratio, 663 Tax consideration, 380, 944 Tax-deferral option, 952 Tax-deferred retirement plans, 953, 960 Tax efficiency, 120, 128 Tax policy, 579 Tax-qualified defined contribution plans, 953 Tax Reform Act of 1986, 39, 142 Tax sheltering, 952–953 deferred annuities, 953–954 tax-deferral option, 952–953 tax-deferred retirement plans, 953 variable and universal life insurance, 954–955 Tax swap, 548 Tax-timing options, 508 Taxes after-tax yield, 39–40 asset allocation and, 947–948 financial environment response to, 18–19 futures and, 802 household sector and, 12 investment considerations and, 380, 944 of mutual fund income, 119–120 OID bonds, 469–470 real rate of interest and, 142 tax sheltering, 952–955 Technical analysis, 373–376 Templeton Funds, 405 Term insurance, 943 Term premiums, 502 Term repo, 34 Term structure of interest rates, 487 bond pricing, 488–491 bond stripping and pricing of coupon bonds, 491–492 certainty conditions, 488–494 expectations hypothesis, 497 forward rates and, 495–497 interpretation of, 498–503 liquidity preference, 497–498 measurement of, 505–508 theories of, 497–498 uncertainty and, 495–497 Tertiary trends, 374 Third market, 75 Third moment of the distribution, 153, 186, 1012 Threat of entry, 594 Three-factor model of APT (Fama and French), 395 Tick test, 97 Time diversification, fallacy of, 274–277 Time series plots, 1026 Time spread, 716 Time value, 746 Time-varying volatility, 432–434 Time-weighted returns, 862–863 Times-interest-earned ratio, 472, 667 Timing risk, 946 TIPS (Treasury Inflation Protected Securities), 151n Tobin’s q, 608 Tokyo Stock Exchange (TSE), 85 1073 1074 Bodie−Kane−Marcus: Investments, Sixth Edition Back Matter © The McGraw−Hill Companies, 2004 Index 1089 Subject Index Tombstone advertisements, 66–67 Top-down approach, 197–198 Total International Stock Index Fund, 108 Total return, 46 Total Stock Market Portfolio (Vanguard), 52, 122 Tracking error, 868 Tracking portfolio, 334–336, 357 Trading costs, 86–87 bid-asked spread, 86–87 commission schedules, 86 Trading halts, 97 Trading pit, 796–797 Trading through, 83 Trading volume, 376 Transportation costs, 800n Treasury bills, 32–33, 35, 469 historical record (1926-2002), 144–149 inflation (1963-2002) and, 141 rates of return (1926-2002), 144–149 as risk-free asset, 150, 200 Treasury bonds, 36, 448–450 Treasury Inflation Protected Securities (TIPS), 454–455 Treasury notes, 36, 448–450 Treasury strips, 469 Treynor-Black model, 988–995 industry use, 996–998 overview of, 988–989 portfolio construction, 989–995 Treynor’s measure, 868, 872–874 Trin statistic, 376 Triple-witching hour, 834–835 Trough, 579 TSX (Canada), 53 Turnarounds, 593 Turnover, 664–666 Turnover rate, 120 12b-1 charges, 116–117 Two-state option pricing, 752–755 Two-tailed test, 1037 Tyco, Type I errors, 1037 Type II errors, 1037 U Unbundling, 24 Underwriters, 66 Underwriting, 66–68 Underwriting syndicate, 66 Unemployment rate, 575 Uniform Securities Act, 95 Union Carbide, 51 Unique needs, 944–945 Unique risk, 224 Unit investment trusts, 109 U.S business, balance sheet of, 13 U.S Department of Commerce, 670, 675 U.S government, balance sheet of, 14 U.S households, balance sheet of, U.S Internal Revenue Code, 952 Units, 109 Universal life insurance, 943, 954 University of Chicago, Center for Research in Securities Prices (CRSP), 211 Unmanaged trusts, 109 Unsecured bonds, 41, 476 Utility, 168, 205–207 Utility function, 165, 192n, 206 Utility scores, evaluating investments by, 169–173 Utility values, risk aversion and, 168–169, 186 V VA Linux, 69–70 Valuation by comparables, 606–608 Valuation ratios, 632–633 Value at Risk (VaR), 151–153 Value investing (Graham technique), 680–681 Value Line, 128, 329n Value Line Investment Survey, 587, 619–620n, 681 Value stocks, 127, 433 Value-weighted index, 51–52 Vanguard 500 Index Fund, 113, 212, 378–379 Vanguard Group, 52, 108–109, 112–115, 122, 170, 198, 212, 378, 917 Vanguard Windsor Fund, 405 Variable annuities, 954 Variable costs, 588 Variable life, 943 Variable life insurance, 954 Variance, 166, 174–175, 178, 187, 287, 1010 Volatility risk, 778 Volatility value, 746 W Wall Street Journal closed-end mutual funds, 110 corporate bond listings, 42, 451 currency futures listing, 823 Eurodollar futures contracts, 839 foreign exchange rates, 823 futures listings, 57, 793–795, 842 government agency issues, 38 index options listings, 704 market diaries, 376 money market securities listings, 32 mutual fund quotations, 115 options market listings, 56 performance of stock indexes, 53 stock market listings, 46 stock options listings, 701 Treasury listings, 32, 37, 449 Walt Disney, 10, 454 Warrants, 725–726 Waste Management, 729 Bodie−Kane−Marcus: Investments, Sixth Edition 1090 Back Matter © The McGraw−Hill Companies, 2004 Index Subject Index Weak-form EMH, 373, 386–388 Wealth indexes of investments, 148–149 Weather derivatives, 796 WEBS (World Equity Benchmark Shares), 21, 120, 251, 921 Well-diversified portfolios, 350–351 APT and, 350–351 defined, 350 Wellington Management, 109 Whole-life insurance policy, 943 Wiesenberger Investment Companies Services, 113, 116, 125 Wilshire 5000 index, 52, 122–123, 213, 379 Window dressing, 891 Wit Capital, 71 Workout period, 547 World equity benchmark shares (WEBS), 921 World Wide Web, 25, 71 for IPOs, 71 WorldCom, 8–9, 70, 471 Write calls, 698 X Xerox, 10 Y Yahoo! website, 582, 584 Yankee bonds, 38, 453, 537 Yield curve, 489, 500–501 forward rates and, 499–503 Yield to call, 462–464 Yield to maturity (YTM), 36, 450, 459–462 default risk and, 477 Excel function for, 462 expected vs promised YTM, 477–478 holding period return vs., 468 realized compound yield vs., 464–466 Yields after-tax yield, 39–40 forward rates on coupon bonds, 507–508 money market instruments, 35 taxable vs tax-exempt, 41 Z Z-scores, 473–474 Zero-beta model, 293–297 Zero-coupon bonds (zeros), 18, 448, 468–469, 729 holding period return on, 492 Zero-plus tick, 97 Zero risk premium, 170 1075 ... yield on the tax-free municipal r (1 Ϫ t) ϭ rm (2 . 1) r ϭ rm /(1 Ϫ t) (2 . 2) or Bodie Kane Marcus: Investments, Sixth Edition 40 I Introduction 23 © The McGraw−Hill Companies, 2004 Financial Instruments... mortgage-related agencies are the Federal Home Loan Bank (FHLB), the Federal National Mortgage Association (FNMA, or Fannie Mae), the Government National Mortgage Association (GNMA, or Ginnie Mae), and... pass-throughs have since become popular These are sponsored by FNMA (Federal National Mortgage Association, or Fannie Mae) and FHLMC (Federal Home Loan Mortgage Corporation, or Freddie Mac) As of late 2002,