Investments bodie kane marcus

finance Less managing More teaching Greater learning STUDENTS INSTRUCTORS Want to get better grades? (Who doesn’t?) Would you like your students to show up for class more prepared? Prefer to your homework online? (After all, you are online anyway…) Need a better way to study before the big test? (A little peace of mind is a good thing…) (Let’s face it, class is much more fun if everyone is engaged and prepared…) Want an easy way to assign homework online and track student progress? (Less time grading means more time teaching…) Want an instant view of student or class performance? (No more wondering if students understand…) Need to collect data and generate reports required for administration or accreditation? 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INSTRUCTORS GET: • A Self-Quiz and Study tool that assesses your knowledge and recommends specific readings, supplemental study materials, and additional practice work.* • Auto-graded assignments, quizzes, and tests • Simple assignment management, allowing you to spend more time teaching • Detailed Visual Reporting where student and section results can be viewed and analyzed *Available with select McGraw-Hill titles • Sophisticated online testing capability • A filtering and reporting function that allows you to easily assign and report on materials that are correlated to accreditation standards, learning outcomes, and Bloom’s taxonomy • An easy-to-use lecture capture tool • The option to upload course documents for student access ISBN: 9780073530703 Author: Bodie/Kane/Marcus Title: Investments, 9e Front endsheets Color: 4c Pages: 2,3 finance Less managing More teaching Greater learning STUDENTS INSTRUCTORS Want to get better grades? (Who doesn’t?) Would you like your students to show up for class more prepared? Prefer to your homework online? (After all, you are online anyway…) Need a better way to study before the big test? (A little peace of mind is a good thing…) (Let’s face it, class is much more fun if everyone is engaged and prepared…) Want an easy way to assign homework online and track student progress? (Less time grading means more time teaching…) Want an instant view of student or class performance? (No more wondering if students understand…) Need to collect data and generate reports required for administration or accreditation? (Say goodbye to manually tracking student learning outcomes…) With McGraw-Hill's Connect Plus Finance, ™ STUDENTS GET: Want to record and post your lectures for students to view online? • Easy online access to homework, tests, and quizzes assigned by your instructor • Immediate feedback on how you’re doing (No more wishing you could call your instructor at a.m.) With McGraw-Hill's Connect Plus Finance, ™ • Quick access to lectures, practice materials, eBook, and more (All the material you need to be successful is right at your fingertips.) INSTRUCTORS GET: • A Self-Quiz and Study tool that assesses your knowledge and recommends specific readings, supplemental study materials, and additional practice work.* • Auto-graded assignments, quizzes, and tests • Simple assignment management, allowing you to spend more time teaching • Detailed Visual Reporting where student and section results can be viewed and analyzed *Available with select McGraw-Hill titles • Sophisticated online testing capability • A filtering and reporting function that allows you to easily assign and report on materials that are correlated to accreditation standards, learning outcomes, and Bloom’s taxonomy • An easy-to-use lecture capture tool • The option to upload course documents for student access ISBN: 9780073530703 Author: Bodie/Kane/Marcus Title: Investments, 9e Front endsheets Color: 4c Pages: 2,3 Want an online, searchable version of your textbook? Wish your textbook could be available online while you’re doing your assignments? Connect™ Plus Finance eBook If you choose to use Connect™ Plus Finance, you have an affordable and searchable online version of your book integrated with your other online tools Connect™ Plus Finance eBook offers features like: • Topic search • Direct links from assignments • Adjustable text size • Jump to page number • Print by section Want to get more value from your textbook purchase? Think learning finance should be a bit more interesting? Check out the STUDENT RESOURCES section under the Connect™ Library tab Here you’ll find a wealth of resources designed to help you achieve your goals in the course Every student has different needs, so explore the STUDENT RESOURCES to find the materials best suited to you ISBN: 9780073530703 Author: Bodie/Kane/Marcus Title: Investments, 9e Front endsheets Color: 4c Page: 4, Insert Want an online, searchable version of your textbook? Wish your textbook could be available online while you’re doing your assignments? Connect™ Plus Finance eBook If you choose to use Connect™ Plus Finance, you have an affordable and searchable online version of your book integrated with your other online tools Connect™ Plus Finance eBook offers features like: • Topic search • Direct links from assignments • Adjustable text size • Jump to page number • Print by section Want to get more value from your textbook purchase? Think learning finance should be a bit more interesting? Check out the STUDENT RESOURCES section under the Connect™ Library tab Here you’ll find a wealth of resources designed to help you achieve your goals in the course Every student has different needs, so explore the STUDENT RESOURCES to find the materials best suited to you ISBN: 9780073530703 Author: Bodie/Kane/Marcus Title: Investments, 9e Front endsheets Color: 4c Page: 4, Insert Confirming Pages Investments bod30700_fm_i-xxviii.indd i 7/23/10 4:37 PM Confirming Pages The McGraw-Hill/Irwin Series in Finance, Insurance and Real Estate Stephen A Ross, Franco Modigliani Professor of Finance and Economics, Sloan School of Management, Massachusetts Institute of Technology, Consulting Editor Financial Management Adair Excel Applications for Corporate Finance First Edition Ross, Westerfield, Jaffe, and Jordan Corporate Finance: Core Principles and Applications Third Edition Saunders and Cornett Financial Institutions Management: A Risk Management Approach Seventh Edition Block, Hirt, and Danielsen Foundations of Financial Management Fourteenth Edition Ross, Westerfield, and Jordan Essentials of Corporate Finance Seventh Edition Saunders and Cornett Financial Markets and Institutions Fourth Edition Brealey, Myers, and Allen Principles of Corporate Finance Tenth Edition Ross, Westerfield, and Jordan Fundamentals of Corporate Finance Ninth Edition International Finance Brealey, Myers, and Allen Principles of Corporate Finance, Concise Edition Second Edition Shefrin Behavioral Corporate Finance: Decisions that Create Value First Edition Brealey, Myers, and Marcus Fundamentals of Corporate Finance Sixth Edition White Financial Analysis with an Electronic Calculator Sixth Edition Brooks FinGame Online 5.0 Investments Bruner Case Studies in Finance: Managing for Corporate Value Creation Sixth Edition Chew The New Corporate Finance: Where Theory Meets Practice Third Edition Cornett, Adair, and Nofsinger Finance: Applications and Theory First Edition DeMello Cases in Finance Second Edition Grinblatt (editor) Stephen A Ross, Mentor: Influence through Generations Bodie, Kane, and Marcus Essentials of Investments Eighth Edition Real Estate Hirschey and Nofsinger Investments: Analysis and Behavior Second Edition Ling and Archer Real Estate Principles: A Value Approach Third Edition Hirt and Block Fundamentals of Investment Management Ninth Edition Financial Planning and Insurance Jordan and Miller Fundamentals of Investments: Valuation and Management Fifth Edition Higgins Analysis for Financial Management Ninth Edition Sundaram and Das Derivatives: Principles and Practice First Edition Kellison Theory of Interest Third Edition Financial Institutions and Markets bod30700_fm_i-xxviii.indd ii Robin International Corporate Finance First Edition Brueggeman and Fisher Real Estate Finance and Investments Fourteenth Edition Stewart, Piros, and Hiesler Running Money: Professional Portfolio Management First Edition Ross, Westerfield, and Jaffe Corporate Finance Ninth Edition Kuemmerle Case Studies in International Entrepreneurship: Managing and Financing Ventures in the Global Economy First Edition Bodie, Kane, and Marcus Investments Ninth Edition Grinblatt and Titman Financial Markets and Corporate Strategy Second Edition Kester, Ruback, and Tufano Case Problems in Finance Twelfth Edition Eun and Resnick International Financial Management Fifth Edition Rose and Hudgins Bank Management and Financial Services Eighth Edition Rose and Marquis Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace Eleventh Edition Allen, Melone, Rosenbloom, and Mahoney Retirement Plans: 401(k)s, IRAs, and Other Deferred Compensation Approaches Tenth Edition Altfest Personal Financial Planning First Edition Harrington and Niehaus Risk Management and Insurance Second Edition Kapoor, Dlabay, and Hughes Focus on Personal Finance: An Active Approach to Help You Develop Successful Financial Skills Third Edition Kapoor, Dlabay, and Hughes Personal Finance Ninth Edition 7/23/10 4:37 PM Confirming Pages Investments N I N T H E D I T I O N ZVI BODIE Boston University ALEX KANE University of California, San Diego ALAN J MARCUS Boston College bod30700_fm_i-xxviii.indd iii 7/23/10 4:37 PM Confirming Pages INVESTMENTS Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020 Copyright © 2011, 2009, 2008, 2005, 2002, 1999, 1996, 1993, 1989 by The McGraw-Hill Companies, Inc All rights reserved 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 the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper WVR/WVR ISBN 978-0-07-353070-3 MHID 0-07-353070-0 Vice president and editor-in-chief: Brent Gordon Publisher: Douglas Reiner Executive editor: Michele Janicek Director of development: Ann Torbert Development editor II: Karen L Fisher Vice president and director of marketing: Robin J Zwettler Senior marketing manager: Melissa S Caughlin Vice president of editing, design, and production: Sesha Bolisetty Project manager: Dana M Pauley Senior buyer: Michael R McCormick Interior designer: Laurie J Entringer Lead media project manager: Brian Nacik Media project manager: Joyce J Chappetto Typeface: 10/12 Times Roman Compositor: Laserwords Private Limited Printer: Worldcolor Library of Congress Cataloging-in-Publication Data Bodie, Zvi Investments / Zvi Bodie, Alex Kane, Alan J Marcus.—9th ed p cm.—(The McGraw-Hill/Irwin series in finance, insurance and real estate) Includes index ISBN-13: 978-0-07-353070-3 (alk paper) ISBN-10: 0-07-353070-0 (alk paper) Investments Portfolio management I Kane, Alex II Marcus, Alan J III Title HG4521.B564 2011 332.6—dc22 2010018924 www.mhhe.com bod30700_fm_i-xxviii.indd iv 7/23/10 4:37 PM Confirming Pages About the Authors ZVI BODIE ALEX KANE ALAN J MARCUS Boston University University of California, San Diego Boston College Zvi Bodie is the Norman and Adele Barron Professor of Management at Boston University He holds a PhD from the Massachusetts Institute of Technology and has served on the finance faculty at the Harvard Business School and MIT’s Sloan School of Management Professor Bodie has published widely on pension finance and investment strategy in leading professional journals In cooperation with the Research Foundation of the CFA Institute, he has recently produced a series of Webcasts and a monograph entitled The Future of Life Cycle Saving and Investing Alex Kane is professor of finance and economics at the Graduate School of International Relations and Pacific Studies at the University of California, San Diego He has been visiting professor at the Faculty of Economics, University of Tokyo; Graduate School of Business, Harvard; Kennedy School of Government, Harvard; and research associate, National Bureau of Economic Research An author of many articles in finance and management journals, Professor Kane’s research is mainly in corporate finance, portfolio management, and capital markets, most recently in the measurement of market volatility and pricing of options Alan Marcus is the Mario J Gabelli Professor of Finance in the Carroll School of Management at Boston College He received his PhD in economics from MIT Professor Marcus has been a visiting professor at the Athens Laboratory of Business Administration and at MIT’s Sloan School of Management and has served as a research associate at the National Bureau of Economic Research Professor Marcus has published widely in the fields of capital markets and portfolio management His consulting work has ranged from new-product development to provision of expert testimony in utility rate proceedings He also spent years at the Federal Home Loan Mortgage Corporation (Freddie Mac), where he developed models of mortgage pricing and credit risk He currently serves on the Research Foundation Advisory Board of the CFA Institute v bod30700_fm_i-xxviii.indd v 7/23/10 4:37 PM Confirming Pages Subject Index Farm Credit agencies, 444 Fast growers, 572 Federal agency debt, 35 Federal Deposit Insurance Corporation (FDIC), 30 Federal funds (fed funds), 32, 555 Federal government policy, 554–557 fiscal policy, 554 monetary policy, 554–556 supply-side policies, 556–557 Federal Home Loan Bank (FHLB), 35, 444 Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), 35, 39, 523, 652 failure of, 40 financial crisis of 2008, 17–18, 21 Federal National Mortgage Association (FNMA or Fannie Mae), 35, 39, 444, 523 failure of, 40 financial crisis of 2008, 17–18, 21 Federal Reserve Bank of St Louis, 158 Federal Reserve Board federal funds rate targeting, 555 margin limits, 77 monetary policy, 555 Federal Savings and Loan Insurance Corporation (FSLIC), 979 Fedwire, 459 Feedback, 953 Feeder funds, 919 Fees active management, 945–946 hedge funds, 919–921 mutual funds, 99–102 Fibonacci numbers, 393 Fidelity’s Magellan Fund, 111, 841–482 FIFO (first-in first-out), 648 Financial Accounting Standards Board (FASB) Statement No 87, 977 Statement No 157, 650 Financial assets, 2, 4–5 balance sheet of U.S households, derivatives, equity, fixed-income or debt securities, real assets vs., 2–3 separation of ownership/management, 6–7 Financial crisis of 2008, 14–23, 309 antecedents of, 15–17 changes in housing finance, 17–18 credit default swaps, 19–20, 470 money market for short-term lending, 22, 33 mortgage derivatives, 18–19, 471 peak of crisis, 21–22 real economy and, 22–23 systemic risk, 20–23 Financial engineering, 696–698; see also Derivative assets index-linked CDs, 696–697 Financial Industry Regulatory Authority (FINRA), 84 Financial instruments bond market, 34–41 derivative markets, 51–53 equity securities, 41–44 money market, 28–33 stock and bond market indexes, 44–51 Financial intermediaries, 11–14 investment bankers, 13–14 investment companies, 12 role of, 11–14 Financial leverage business cycle sensitivity, 566–569 ROE and, 633–635 Financial markets allocation of risk, 5–6 capital markets, 28 as competitive, 9–11 consumption timing, corporate governance/ethics, 7–8 economy and, 5–8 as efficient, 10–11 financial intermediaries in, 11–13 firms as net borrowers, 11 government’s role in, 11 households as net savers, 11 information role of, investment bankers and, 13–14 major players in, 11–14 money markets, 28 risk-return trade-off, 9–10 separation of ownership and management, 6–7 Financial planning, 991 Financial ratio analysis; see Ratio analysis Financial statement analysis, 627 accounting vs economic earnings, 627, 632 balance sheet, 628–630 comparability problems, 648–654 depreciation, 649 economic value added, 644–654 fair value accounting, 650–651 financial leverage and ROE, 633–635 illustration of use, 646–647 income statement, 627–628 inflation and interest expense, 650 international accounting conventions, 653–654 inventory valuation, 648–649 profitability measures, 632–635 quality of earnings, 652–653 ratio analysis; see Ratio analysis return on equity, 633–635 statement of cash flows, 630–632 value investing (Graham technique), 654–655 Financial supermarkets, 99 Firm commitment, 60 Firm-specific risk, 197–198, 258 First-pass regression, 408 Fiscal policy, 554 Fitch Investors Services, 19, 442, 461 Fixed annuities, 974 Fixed asset, 630 Fixed-asset turnover, 636, 643 Fixed-charge coverage ratio, 463 Fixed-income arbitrage, 905 Fixed-income capital market, 34; see also Bonds; Money market; Treasury bills corporate bonds, 38–39, 441–442 federal agency debt, 35 inflation-protected Treasury bonds, 35 international bonds, 35 mortgages and mortgage-backed securities, 39–41 municipal bonds, 35–38, 444 preferred stock, 443–444 Treasury notes and bonds, 34, 440–441 Fixed-income portfolio management; see Active bond management Fixed-income securities, 4, 439; see also Bonds; Money market bond market innovation, 444–445 collateralized loan, 694–695 convertible bonds, 442–443 corporate bonds, 441–442 floating-rate bonds, 443 innovations in, 444–445 international bonds, 444 levered equity and risky debt, 696 preferred stock, 443–444 puttable bonds, 443 Treasury bonds and notes, 440–441 Flash trading, 72–73 Flat prices, 449 Flexible funds, 98 Float securities, 59 Floating-rate bonds, 4, 443 Floor broker, 69–70 Forecasting active portfolio management, 946–948 long horizons, 153–154 risk premium forecasts, 246, 267 stock market, 614–615 value of imperfect forecasting, 839–840 Forecasting errors, 383 Forecasting record, 934 Foreign bonds, 444 Foreign currency options, 673 Foreign exchange futures, 760, 784–791, 817 covered interest arbitrage, 786–788 direct vs indirect quotes, 788 interest rate parity, 786–788 managing exchange rate risk, 788–791 the markets, 784–786 Foreign exchange swap, 800 Foreign stock market indexes, 49 Foreign stocks; see Global equity markets Forward contract, 755–756 forward rates as, 497–499 futures pricing vs., 775–776 swaps vs., 805 synthetic forward loan, 498 Forward interest rate, 486–487 as forward contracts, 497–499 interest rate risk, 489 interest rate uncertainty and, 488–490 slopes of yield curve, 494 Forward interest rate contract, 497 Framing, 384 Freddie Mac; see Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) Free cash flow for the firm (FCFF), 609–612 Free cash flow to equityholders (FCFE), 609 Free cash flow valuation approaches, 609–613 Free float, 48 Free-rider benefit, 180 Front-end load, 100 FTSE (Financial Times) index (UK), 44, 49, 74, 864 Full-covariance model; see also Markowitz portfolio selection model index model vs., 268–269 Full-service brokers, 76 Fully diluted earnings per share, 693 Fund of funds, 905, 919–921 Fundamental analysis, 349–350, 548 Fundamental analysts, 583 Fundamental risk, 386–387 Futures contracts, 53, 667, 755–760, 782 basics of, 756–759 cash vs actual delivery, 765 existing contracts, 759–760 leverage and, 767 I-9 bod30700_sidx_I4-I20.indd 8/17/10 3:27 PM Confirming Pages Subject Index Futures contracts—Cont maintenance margin, 763–764 margin account, 763–764 marking to market, 763–765 oil futures, 766–769 profit to buyers/sellers, 759 sample of, 760 as zero-sum game, 757 Futures markets, 755, 784 arbitrage, 771–772 basis risk and hedging, 769–770 clearinghouse, 760–763 currency futures, 785 exchange rate risk, 788–791 foreign exchange futures, 760, 817, 874–791 forward vs futures pricing, 775–776 future vs expected spot price, 776–778 hedging and speculation, 766–770 interest rate futures, 760, 798–800 interest rate parity, 786–788, 871 leverage and, 767 mechanics of trading in, 760–766 open interest, 760–763 presidential/other prediction futures, 760–761 regulations, 765–766 spot-futures parity theorem, 770–773 stock-index futures, 791–797 strategies for, 766–770 taxation, 766 trading mechanics, 760–770 Futures options, 673 Futures prices, 756, 770–776 contango, 777 cost-of-carry relationship, 772 expectations hypothesis, 776 expected spot prices vs., 776–778 forward vs., 775–776 future market arbitrage, 771–772 modern portfolio theory and, 777–778 normal backwardation, 776–777 parity and spreads (Excel), 775 spot-futures parity theorem, 770–771 spreads, 773–774 G Galleon Group insider-trading case, 347 Gambling, 161–162 Gamma, 741 General Electric (GE), 42–43 General obligation bonds, 36 Generally accepted accounting principles (GAAP), 648, 654 Geometric (time-weighted) average return, 131–132 arithmetic average vs., 132 Ginnie Mae; see Government National Mortgage Association (GNMA or Ginnie Mae) Glass-Steagall Act, 14 Global Crossing, Global economy, 549–551 Global equity markets, 864–868; see also International investing developed countries, 864 emerging markets, 864–867 home-country bias, 867–868 market capitalization and GDP, 867 market capitalization of world stock exchanges, 74 stock market return (2009), 549 Global funds, 97 Global macro style, 905 Global tactical asset allocation, 795 Globalization, of stock markets, 75 Globex, 761–762, 792n Goldman Sachs, 14, 73 Goodwill, 630 Gordon model, 588–591 Government, in financial markets, 11; see also Federal government policy Government National Mortgage Association (GNMA or Ginnie Mae), 35, 444 Graham technique, 654–655 Great Moderation, 16, 556 Gross domestic product (GDP), 551, 558 market capitalization and, 867 Growth funds, 97 Growth opportunities, 595 present value of growth opportunities (PVGO), 594 price-earnings ratio and, 601–604 price to book, 641 Growth rate of dividends, 593 Growth stocks, 112 Guaranteed investment contract (GIC), 529 H Hang Seng (Hong Kong) index, 49 HealthSouth, Hedge fund performance, 830–832, 912–918 changing factor loadings, 915–916 liquidity and, 904, 913–914 Long-Term Capital Management example, 918 problems in evaluation, 832 survivorship bias and, 915 tail events and, 916–918 Hedge fund strategies, 274, 904–907 directional strategies, 905 long-short strategy, 274 market neutral, 905, 906 market-neutral positions, 903, 905, 906, 908 nondirectional strategies, 905–906 portable alpha, 908–910 pure play, 906 statistical arbitrage, 907 styles of, 905, 924 Hedge funds, 96, 903 compensation structure, 904–905 fee structure in, 919–921 investors in, 904 liquidity issues in, 904 long-short strategy, 906 mutual funds vs., 96, 904–905 performance measurement for, 830–832, 912–918 portable alpha, 908 strategies of, 904 style analysis for, 910–912 transparency, 904 Hedge portfolios, 303–304 Hedge ratio, 733, 742 Black-Scholes formula and, 733–735 call option value, 734 dynamic hedging, 724, 737 exchange rate risk, 789–790 stock price fluctuations, 737 two-state option, 718–720 Hedging, 766, 784 basis risk and, 769 cross-hedging, 769, 800 dynamic hedging, 724, 737 exchange rate risk, 871 factor betas and, 321 futures markets and, 766–770 index futures and market risk, 795–797 interest rate risk, 798–800 long/short hedge, 768 mispriced options and, 739–743 oil futures, 767–768 profit on hedged put portfolio, 740 speculation and, 766–769 Heterogeneous expectations, 161 Hewlett-Packard balance sheet, 629 DuPont decomposition for, 644 income statement, 628 moving average chart (2009), 395–396 security characteristic line (SCL), 255–256 statement of cash flows, 631 High water mark, 919 High-yield bonds, 4, 461–463 Historic returns on risky portfolios, 139–146 diversified portfolio, 140–143 excess returns, 141–144 expected shortfall (ES), 144–145 global view of, 145–146 performance, 144–145 total return, 141 U.S large stocks, 139, 141–143 U.S long-term government bonds, 131, 139–143 U.S small stocks, 139, 141–143 U.S T-bills, 141–143 value at risk (VaR), 144–145 world large stocks, 139, 141–143 Holding-period return (HPR), 127–128, 457, 819 after-tax holding-period return, 968 expected holding period return, 586 original-issues discount bonds, 460 simulation of long-term future rates of return, 150–152 yield to maturity vs., 458 zero-coupon bonds, 485–486 Home bias, 879 Home-country bias, 867–868 Homogeneous expectations, 281 Horizon analysis, 456, 537 “Hot hands” phenomenon, 371 House money effect, 385 Households balance sheet of (2009), domestic net worth, household wealth, as net savers, 11 Housing finance, changes in, 17–18 Human capital, 969 asset betas, 414–416 insurance and, 969–970 Hurdle rate, 290–291, 407 I Illiquidity, 306, 426–427, 913 asset pricing and, 306–309 average returns and, 309 Immunization, 528–534 cash flow matching and dedication, 534–535 constructing a portfolio, 533 holding period immunization, 532 I-10 bod30700_sidx_I4-I20.indd 10 8/17/10 3:27 PM Confirming Pages Subject Index pension liability, 529, 978 problems of, 535 rebalancing portfolios, 532–534 Implementation costs, 388 Implied volatility, 728, 730 In the money, 669 In-sample data, 256 Incentive fee, 904, 919, 920–921 Income beneficiaries, 954 Income funds, 97 Income statement, 627–628 common-size income statement, 628 Hewlett-Packard example, 628 Indenture; see Bond indentures Index arbitrage, 794–795 Index funds, 49, 98, 351 bond-index funds, 527 criticisms of, 181 to hedge market risk, 795–797 Index futures; see also Stock-index futures to hedge market risk, 795–797 Index-linked CDs, 696–697 Index model, 246; see also Single-index model betas and, 272 CAPM and, 293–296 diversification and, 252–254 example of, 266–268 expected return-beta relationship, 250, 294–296, 408 full-covariance model vs., 268–269 implementation of, 260 industry version of, 269–272 as investment asset, 262–263 market model, 295–296 mutual funds and, 437 portfolio management with, 268–274 realized returns and, 293–294 single-factor APT and, 408–417 single-factor security market, 247–249 tracking portfolios, 273–274 Index options, 673 Indexed bonds, 445–446 Indifference curve, 165, 176–178 Indirect quotes, 778 Indirect security analysis, 179n Individual investors, 969–975; see also Behavioral finance deferred annuities, 974 human capital and insurance, 969–970 life cycles and, 954 managing portfolios of, 969–975 professional services or self-management, 972 residence as investment, 970 retirement planning models, 970–972 risk tolerance, 970 saving for retirement, 970 tax-deferral option, 972–973 tax-deferred retirement plans, 973 tax sheltering, 972–973 variable and universal life insurance, 974–975 Industrial development bond, 36, 36n Industrial production, 551 Industrial production index, 558 Industry analysis, 562–573 bargaining power of buyers/suppliers, 573 business cycle sensitivity, 566–567 defining an industry, 564–566 degree of operating leverage (DOL), 567–568 industry cyclicality (example), 567 industry stock price performance (2009), 565 Porter’s competitive analysis, 573 return on equity by industry (2009), 564 rivalry between competitors, 573 sector rotation, 569–570 structure and performance, 573 substitute products, 573 threat of entry, 573 Industry life cycles, 570–572 asset plays, 572 consolidation stage, 571 cyclicals, 572 fast growers, 572 maturity stage, 571 relative decline, 571–572 slow growers, 572 stalwarts, 572 start-up stage, 571 turnarounds, 572 Inflation, 158, 552 interest expense and, 650 long-term investing and, 981 real income and, 650 T-bills (1926–2009) and, 125–127 unanticipated inflation, 342 Inflation-linked bonds, 57 Inflation-protected treasury bonds, 35, 445–446 Inflation rate, forward rates and expectations hypothesis, 491 Information asymmetric information, 307 insider/outsider trading, 347 leakage of, 354 on mutual funds, 109–112 role of financial markets, Information processing, 382–384 conservatism, 383 forecasting errors, 383 overconfidence, 383 sample size neglect/representativeness, 383–384 Information ratio, 264–266, 822, 831, 946 Informational asymmetry, 307n Initial public offerings (IPOs), 59, 61 average initial returns, 62 long-term relative performance of, 63 pricing of, 62 Input list, 214, 247–248 Inside information, 85, 364–365 Inside quotes, 65, 69 Inside spread, 307 Insider trading, 85–86, 347–348, 355 Insurance, 969–970 Insurance contracts, equilibrium prices of, 194–195 Insurance principle, 197, 220–221 diversification and, 197 risk-pooling and, 220–221 risk-sharing and, 222–224 Intangible fixed asset, 630 Intangibles, 653 Intel Corp., 52, 65 Intercommodity spread, 769n Interest-burden ratio, 636, 643 Interest coverage ratio, 636, 643 Interest expense, inflation and, 650 Interest rate futures, 760, 798–800 Interest rate options, 673–674 Interest rate parity, 786–788, 871 Interest rate risk, 509–518, 525, 968 bond prices and forward rates, 489 duration, 512–518 hedging of, 798–800 maturity and, 510 sensitivity to, 509–518 Interest rate swap, 800, 803 balance sheet restructuring, 801–802 other contracts, 803–804 swap dealer, 802 Interest rates; see also Term structure of interest rates approximating the real rate, 119 determinants of level of, 118–121 equilibrium nominal rate, 120–121 equilibrium real rate, 119–120 factors that determine, 118 inflation and (1926–2009), 127 macroeconomy and, 552 nominal rate, 118–119 real interest rate, 118–119 risk structure of interest rates, 468 taxes and, 121 yield curve and future rates, 483–487 Intermarket spread swap, 536 Intermediate trends, 394 Internal rate of return (IRR), 291 International accounting conventions, 653–654 depreciation, 653 intangibles, 653 reserving practices, 653 International bonds, 35, 444 International diversification, 863 assessing potential of, 888–893 bear markets and, 886–888 benefits from, 881–886 efficient diversification, 196, 199 exchange rate risk, 868–871 global equity markets, 864–867 home-country bias, 867–868 market capitalization and GDP, 867 misleading representation of benefits, 884–885 performance attribution and, 893–897 political risk, 871–875 risk factors in, 868–875 risk, return, and benefits from, 875–880 spreadsheet model for, 235 International financial reporting standards (IFRS), 654 International funds, 97 International investing cash/bond selection, 896 country selection, 896 country-specific risk, 874 currency selection, 895–896 emerging market risk, 876 Excel application, 896 exchange rate risk, 868–871 performance attribution and, 893–897 political risk, 871–875 risk factors in, 868–875 risk, return, and benefits of diversification, 875–876 stock selection, 896 International Monetary Fund, 549 International Securities Exchange, 70 International stock market indexes, 49 Intertemporal capital asset pricing model (ICAPM), 304, 429 Intrade, 761 Intrinsic value, 586, 711–712 convergence of price to, 592 market price vs., 586–587 Inventory turnover ratio, 639, 643 Inventory valuation, 648–649 I-11 bod30700_sidx_I4-I20.indd 11 8/17/10 3:27 PM Confirming Pages Subject Index Inverse floaters, 444 Inverted yield curve, 481 Investing; see Investment decisions; Investment process Investment, 1, 8–9 Investment bankers, 13–14; see also Financial crisis of 2008 Investment banking, 60 Investment companies, 12–13, 92–93; see also Mutual funds closed-end funds, 94 commingled funds, 95 functions performed, 92–93 hedge funds, 96 managed investment companies, 94–95 open-end funds, 94 other organizations, 95–96 real estate investment trusts (REITs), 95 types of, 93–96 unit investment trusts, 93–94 Investment Company Act of 1940, 93, 904 Investment Company Institute, Directory of Mutual Funds, 110 Investment constraints, 957–959 investment horizon, 958 liquidity, 958 matrix of constraints, 958 regulations, 958 tax considerations, 959 unique needs, 959 Investment decisions; see also Long-term investments banks, 957 endowment funds, 956–957 individual investors; see Individual investors life insurance companies, 957 mutual funds, 956 non-life insurance companies, 957 objectives, 953–954, 956 pension funds, 956 personal trusts, 954–956 Investment environment, validity of CAPM, 299–300 Investment-grade bonds, 461 Investment horizon, 958 Investment management process, 953–957 banks, 957 components of, 955 constraints, 957–959 endowment funds, 956–957 execution, 953 feedback, 953 individual investors, 954 investments for long run, 979–981 life insurance companies, 957 mutual funds, 956 non-life insurance companies, 957 objectives of, 953–954, 956 pension funds, 956 personal trusts, 954–956 planning, 953 risk tolerance questionnaire, 954 Investment opportunities, stock prices and, 592–595 Investment opportunity set, 172 Investment performance business cycle sensitivity, 566–569 fees and mutual fund returns, 101–102 international investments, 893–897 mutual funds, 106–109 Investment policy statements, 953, 959–967 components of, 955, 960 governance, 960–966 investment, return, and risk, 960 risk management, 960, 966–967 sample statement, 960–967 scope and purpose, 960–961 Investment process, 8–9; see also Portfolio management asset allocation decisions, bottom-up strategy, security analysis, security selection decision, top-down portfolio construction, Investor fear gauge, 730–731 Invoice price, 441, 449 Iowa Electronic Markets, 761 IPOs; see Initial public offerings Irrational exuberance, 367n iShares, 106, 875 J Japanese Yen, 551 Jensen’s measure, 822 J.P Morgan, 739 JPMorgan Chase, 14, 21 Junk bonds, 4, 98, 461–463 K Kondratieff waves, 394–395 Kurtosis, 137, 143n L Labor income, 302–303 Lagging indicators, 559–561 Late trading, 103 LavaFlow, 72 Law of one price, 324, 388–390, 482 closed-end funds, 389–390 equity carve-outs, 388–389 limits to arbitrate and, 388–390 “Siamese Twin” companies, 388 Leading economic indicators, 559–561 Leakage of information, 354 LEAPS (Long-Term Equity AnticiPation Securities), 671 Lehman Brothers, 14, 20–22, 33, 83, 97n, 469 Lemons problem, 307 Level of significance, 257 Leverage, 172, 643 compound leverage factor, 643 degree of operating leverage (DOL), 568 financial leverage and business cycle, 566–569 futures and, 767 key financial ratios, 643 operating leverage, 567–568 return on equity (ROE) and, 634 Leverage ratio, 14n, 463, 636 Levered equity and risky debt, 696 LIBOR; see London Interbank Offered Rate (LIBOR) Life-cycle funds, 97 Life-cycles, 434; see also Industry life cycles multistage growth models, 595–599 Life expectancy, 970 Life insurance companies, 957 LIFO (last-in first-out), 648–649 Limit order book, 65 Limit orders, 65 Limited liability, 42 Liquidation value, 585 Liquidity, 20, 306–307, 489n, 643 asset pricing and, 426–428 CAPM and, 306–310 efficient market anomalies and, 428 equity premium puzzle, 434 hedge funds and, 904, 913–914 as investment constraint, 958 Liquidity beta, 309 Liquidity effects, 362 Liquidity preference theory, 491–493 Liquidity premium, 489, 491 Liquidity ratios, 463, 639–640 Liquidity risk, 309–310, 968 Liquidity traders, 307 Lloyd’s of London, 63 Load, 95 Loadings, 911 Lock-up periods, 96, 904, 913 Lognormal distribution, 147 risk in the long run, 148–149 London Interbank Offered Rate (LIBOR), 15, 32, 800 TED spread (1988–2009), 15, 22, 33 London International Financial Futures Exchange, 785 London Stock Exchange, 74 SEAQ (Stock Exchange Automated Quotations), 74 SETS (Stock Exchange Electronic Trading Service), 74 Long hedge, 768 Long position, 53, 756 Long-short equity hedge, 905 Long-short strategy, 274 Long-Term Capital Management, 32, 140, 309, 550, 730, 832, 910, 918 Long-term investments, 147–154, 223–224 advice from mutual fund industry, 980 forecasts for, 153–154 inflation risk and, 981 lognormal distribution, 147–149 risk in long run, 148–149 Sharpe ratio and, 150 simulation of future rates of return, 150–152 target date retirement fund (TDRF), 981 Lookback options, 698 Loss aversion, 385–386 Low-load funds, 100 Lower partial standard deviation, 139 Lucky event issue, 356–357 M M2 measure of performance, 823–824, 927 Macaulay’s duration, 512, 522 Macroeconomic analysis budget deficit, 552–553 business cycles, 557–559 demand shocks, 553–554 domestic macroeconomy, 551–553 economic indicators, 559–562 I-12 bod30700_sidx_I4-I20.indd 12 8/17/10 3:27 PM Confirming Pages Subject Index employment/unemployment rate, 552 federal government policy, 554–557 global economy, 549–550 gross domestic product (GDP), 551 inflation, 552 interest rates, 552 sentiment, 553 supply shocks, 553–554 Madoff scandal, 920 Magnitude issue, 356 Maintenance margin, 77–78, 173n, 763–764 Malkiel’s bond-pricing relationships, 510 Managed futures, 905 Managed investment companies, 94–95 Margin, 20, 76–79, 173, 756 example of, 77 Excel applications, 78 maintenance margin, 77–78 margin call, 77, 82, 173n turnover vs., 637 Margin account, 763–764 Margin call, 77, 82, 173n Mark-to-market accounting, 650–651 Market anomalies, 360, 381; see also Efficient market hypothesis (EMH) book-to-market ratios, 363 data mining, 367, 381 inside information, 364–365 interpretation of, 365–366 mutual fund and analyst performance, 369–373 neglected-firm and liquidity effects, 362 P/E effect, 361 post-earnings-announcement price drift, 363–364 risk premiums vs inefficiencies, 365–355 semistrong tests, 360–361 small-firm-in-January effect, 361–362 strong-form tests, 364–365 Market-book-value ratio (P/B), 640–641, 643 Market capitalization, 867 developed countries, 875 emerging markets, 866 Market capitalization rate, 587, 599 Market conversion value, 442 Market efficiency; see also Efficient market hypothesis (EMH) broad market returns, 359–360 bubbles and, 367–368 competition as source of, 345–347 lucky event issues, 356–357 magnitude issues, 356 market anomalies, 360–361 portfolio management in, 351–352 random walk and, 344–345 returns over long horizons, 358–359 returns over short horizons, 358 selection bias issue, 356 semistrong tests, 360–364 strong-form tests, 364–365 weak-form tests of, 358–360 Market index (Roll’s critique), 410–412 Market model, 295–296, 353 Market neutral, 274, 796, 903, 905, 906, 908 Market-neutral active stock selection, 797 Market orders, 65 Market portfolio (M), 281–283, 298, 410 reward-to-risk ratio, 286–287 risk premium of, 282, 284–285 Market price ratios, 643 Market price of risk, 287 Market psychology; see Behavioral finance Market risk, 197, 968 hedging with index futures, 795–797 Market timing, 834–840 imperfect forecasting, 839–840 mutual funds, 103 potential value of, 836–837 security characteristics lines, 834–835 valuing as a call option, 837–839 Market value added (MVA), 665 Market-value-weighted index, 48 Markets auction markets, 64 brokered markets, 64 as competitive, 9–11 dealer markets, 64 direct search markets, 64 efficient markets, 10–11, 356–357 risk-return trade-off, 9–10 types of, 63–64 Markets and instruments bond market, 34–41 derivative markets, 51–53 equity securities, 41–44 money market, 28–33 stock and bond market indexes, 44–51 Marketwide liquidity risk, 309 Marking to market, 763–765 Markowitz portfolio selection model, 211–220, 264, 281 asset allocation and security selection, 219 capital allocation and separation property, 214–216 diversification, power of, 217–219 drawbacks of, 246 efficient frontier with index model, 267 index model vs., 268–269 input list of, 214, 247–248 optimal portfolios and nonnormal returns, 219–220 security selection, 211–214 Maturity stage, 571 Mean absolute deviation (MAD), 240n Mean-variance (M-V) criterion, 165 Memory bias, 383 Mental accounting, 384–385 Merrill Lynch, 14, 20–21, 73 Merrill Lynch Domestic Master Index, 527 Metal and energy futures, 760 Microsoft Corporation, 7, 584, 739 Minimum-variance portfolio, 204, 211, 236–237 Minor trends, 394 Model investor, 954 Model risk, 388 Modern portfolio theory, 10, 777–778 Modified duration, 514, 798 Modified index model, 249n Momentum effect, 358, 425–426 Monetary policy, 554–556 Money market, 4, 28–33 bankers’ acceptances, 31 brokers’ calls, 32 certificates of deposit (CD), 30 commercial paper, 30–31 crisis of 2008, 22, 33 Eurodollars, 31 federal funds, 32 LIBOR market, 32 major components of, 30 repos and reverses, 31 Treasury bills, 29–30 yields on, 32–33 Money market funds, 33, 96–97 Money spread, 684 Moody’s Investor Services, 19, 442, 461 Moody’s Industrial Manual, 466 Morgan Stanley Capital International (MSCI), 893 country indexes, 49–50 EAFE index, 893–894 Morgan Stanley Global Economic Forum (GEF), 901 Morningstar’s Mutual Fund Sourcebook, 99, 110–111, 831 Morningstar’s Risk-Adjusted Rating (RAR), 844–845 Mortality tables, 974 Mortgage-backed securities; see Mortgages and mortgage-backed securities Mortgage bond, 466 Mortgage derivatives, 18–19 Mortgage pass-through security, cash flows in, 17 Mortgage trusts, 95 Mortgages and mortgage-backed securities, 38–41 adjustable-rate mortgage (ARMs), 18 callable corporate bonds vs., 525 conforming/conventional mortgages, 18, 39 duration and convexity of, 523–526 failures of Freddie Mac and Fannie Mae, 40 housing finance changes pre-2008 crisis, 17–18 price-yield curve, 524 securities outstanding (1979–2009), 39 subprime mortgages, 18, 39–40 Moving averages, 395–397 Multi-index model, 252 Multifactor APT, 331–333, 336 Multifactor benchmarks, style analysis and, 842–843 Multifactor CAPM APT and, 336 macro factor model, 418–419 test of, 417–419 Multifactor models, 318–843 determination of factors, 333–335 factor models of security returns, 319–320 Fama and French (FF) three-factor model, 335, 419–420 mispricing and arbitrage, 332 multifactor security market line, 321–323, 332 overview of, 319–323 risk assessment using, 321 two-factor model, 320, 322 Multifactor security market line, 321–323 Multiperiod CAPM model, 303–304 Multiplier, 697 Multistage growth models, 595–600 Excel application, 600 life cycles and, 595–599 Multistrategy style, 905 Municipal bonds, 35–38, 444 equivalent taxable yield, 37 general obligation bonds, 36 industrial development bond, 36 ratio of yields vs corporate debt (1953–2009), 38 revenue bonds, 36 tax anticipation notes, 36 tax-exempt debt outstanding (1979–2009), 36 Mutual fund fees, 99–102 Mutual fund managers, 369–373, 831 Mutual fund theorem, 283 I-13 bod30700_sidx_I4-I20.indd 13 8/17/10 3:27 PM Confirming Pages Subject Index Mutual funds, 13, 92, 96–99, 903, 956 asset allocation and flexible funds, 98 back-end load, 100 balanced funds, 97 basic investing rules, 980 bond funds, 97 costs of investing in, 99–103 equity funds, 97 exchange-traded funds (ETFs), 104–106 fee structure, 99–102 front-end load, 100 hedge funds vs., 96, 904–905 how sold, 99 index funds, 98 index model and, 437 information on, 109–112 international funds, 97 investment performance, 106–109 investment policies, 96–98 late trading and market timing, 103 money market funds, 33, 96–97 net asset value (NAV), 93, 103 130/30 funds, 904 operating expenses, 99 performance of, 368–373, 851 returns and fees, 101–102 sector funds, 97 soft dollars, 102 survivorship bias, 433 taxation of income on, 103–104 turnover, 104 12b-1 charges, 100–101 N NAFTA (North American Free Trade Agreement), 564n, 566 NAICS codes, 564 Naked access, 72–73 Naked option writing, 680 Naked puts, 675 Naked short-selling, 80n NASDAQ Stock Market (NASDAQ), 66, 68–69, 75 level of subscribers, 69 listing requirements, 69 Nasdaq Market Center, 69, 72 Pink Link, 68–69 National Association of Securities Dealers Automatic Quotations System (NASDAQ), 66–68 National market system, 72–73 National wealth, Negative convexity, 521n, 522 Negative correlation, 201 Neglected-firm effect, 362 Net asset value (NAV), 93, 103 New York Stock Exchange (NYSE), 43, 64, 66, 69–72 block sales, 71 Direct Plus/Direct+, 71 listing requirements, 70 NYSE Euronext, 70 program trade, 71 self-regulation of, 84 settlement, 71–72 specialist, 67, 70 SuperDot and electronic trading, 71 Nikkei Average (Tokyo), 44, 49, 75 No-load funds, 100 Noise traders, 307 Nominal interest rate, 118–119, 446 equilibrium nominal rate of interest, 120–121 Non-life insurance companies, 957 Non-normal distributions conditional tail expectation (CTE), 138 expected shortfall, 138 lower partial standard deviation (LPSD), 139 Sortino ratio, 139 value at risk (VaR), 138 Nonconforming “subprime” loans/mortgages, 18, 524 Nondirectional strategies, 905–906 Nondiversifiable risk, 197–198 Nonnormal returns, 178, 219–220 Nonrecurring items, 652 Nonsystematic risk, 197, 326 Nontraded assets, 302–303 Nontraded business, 416–417 Nonvoting stock, 41n Normal backwardation, 776–777 Normal distribution, 134–136; see also Non-normal distributions deviations from, 136–139 in Excel, 136 skewed distributions and, 137 North American Industry Classification System (NAICS codes), 564, 566 Notional principal, 800 O Off-balance-sheet assets/liabilities, 652–653 Oil futures, 766–767 Omnibus Budget Reconciliation Act (OBRA) of 1987, 977 On-the-run yield curve, 483 One-factor security market line, 328–330 130/30 mutual funds, 904 One Up on Wall Street (Lynch), 572, 603 OneChicago, 759 Open-end funds, 94 Open-end investment companies, 92 Open interest, 760–763 Operating expenses, mutual funds, 99 Operating income, 628 Operating leverage, 567–568 Optimal complete portfolio, 168, 171, 209 determination of, 210 indifference curves and, 177 proportions of, 210 Optimal risky portfolio, 196, 208–209 alpha values and, 926–933 construction and properties of, 927 diversification and portfolio risk, 197–198 nonnormal returns, 219–220 optimization procedure, 266 short sales and, 238–239 single-index model, 263–264, 268 spreadsheet (Excel) model, 215, 238, 267–268 two risky assets, 206–210 two risky assets and a risk-free asset, 206–210 Optimization example using Excel Solver, 236 portfolio optimization, 942 summary of procedure, 266 Option elasticity, 734 Option-like securities, 690–696 bonds with embedded options, 522 callable bonds, 39, 690 collateralized loans, 694–695 convertible bonds, 39, 690–693 convertible securities, 690–683 levered equity and risky debt, 696 warrants, 693–694 Option smirk, 744 Options, 51–52 adjustments in contract terms, 671–672 American options, 671 call options; see Call options collars, 684, 687 covered calls, 680–683 embedded options, 522 European option, 671 exercise (strike) price, 51 exotic options; see Exotic options foreign currency options, 673 futures options, 673 index options, 673 interest rate options, 673–674 levered equity and risk debt, 696 option contract, 668–674 other listed options, 672–674 protective put, 678–680 put-call parity relationship, 687–689 put options; see Put options spreads, 683–684, 686 stock investments vs., 676–678 straddles, 683–685 strategies, 678–687 trading options, 670–671 values at expiration, 674–678 Options Clearing Corporation (OCC), 672, 706 Options valuation, 611–712 binomial option pricing, 718–724 Black-Scholes model, 724–733 assumptions of, 728 dividends and call/put options, 731–733 empirical evidence on, 743–744 Excel model for, 729, 735 formula for, 724–730 hedge ratios and, 733–734, 737 hedging bets on mispriced options, 739–743 implied volatility, 728 portfolio insurance, 735–736 pricing formula, 725 pseudo-American call option value, 732 put option valuation, 732–733 synthetic protective put options, 736–737 Black-Scholes model, example of, 726 call option, 674–675 determinants of, 712–714 early exercise and dividends, 716 empirical evidence on, 743–744 hedging bets on mispriced options, 739–743 intrinsic and time values, 711–712 profits on delta-neutral portfolio, 742 put options, 675–676, 732–733 restrictions on option values, 714–717 call option, 715–716 early exercise of American puts, 717 early exercise and dividends, 716 time value, 712 two-state option pricing, 718–721 volatility and, 714n Order types, 64–66 limit orders, 65 market orders, 65 price-contingent orders, 65–66 stop orders, 66 I-14 bod30700_sidx_I4-I20.indd 14 8/17/10 3:27 PM Confirming Pages Subject Index Organizational structure and performance, 936–937 Oriental Land Company, 445 Original-issue discount bonds, 459–460 Original-issue junk (junk bonds), 461 Out of the money, 669 Out-of-sample data, 256 Outsider trading, 347 Over-the-counter (OTC) market, 66 Overconfidence, 383 P P-value, 257–258 P/E effect, 361 P/E ratio; see Price-earnings (P/E) ratio Pairs trading, 907 Par value, 440 Parmalat, Participation rate, 697 Pass-throughs, 18, 39, 103, 523 Passive bond management, 508, 526–535 bond-index funds, 527 cash flow matching and dedication, 534 immunization, 528–534 rebalancing, 532–534 Passive core, 351 Passive management, 10 Passive market index portfolio, 927 Passive portfolio, 264 Passive strategy, 179–180, 508 active vs., 350–351 capital market line and (CML), 179–183 as efficient, 283 index funds, 98, 351 Peak, 557 PEG ratio, 603 Penn Square bank, 32 Pension funds, 956, 975–979 defined benefit pension obligations, 976–977 defined benefit plans, 956, 976 defined contribution plans, 956, 975–976 equity investments, 978–979 immunization, 978 investment strategies, 977–978 portability problem, 977 Pension liability, 529 Performance attribution procedures, 846–851, 896–897 asset allocation decisions, 848–849 cash/bond selection, 896 component contributions, 850–851 country selection, 896 currency selection, 895–896 Excel application for, 851, 896 international investing and, 897 sector and security selection, 850 stock selection, 896 Performance measurement; see Portfolio performance evaluation Personal residence, 970 Personal trusts, 954–956 Physical settlement, 468 Piggyback loans, 18 Pink Link, 68 Pinksheets.com, 68 Planning, 953 Plowback ratio, 593 Political risk, 871–875, 968 Ponzi schemes, 919–920 Portability problem, 977 Portable alpha, 908–910 Porter’s competitive analysis, 573 Portfolio, complete portfolio, 209–210 hedge portfolios, 303–304 market portfolio (M), 281–283 one risky and a risk-free asset, 170–173 replicating portfolio, 718–719 tracking portfolio, 273–274 well-diversified portfolio, 325–326 Portfolio allocation Markowitz portfolio selection model, 211–220 minimum-variance portfolio, 204 one risky asset and risk-free asset, 170–173 two risky assets, 199–205 well-diversified portfolios, 325–326 Portfolio insurance, 680, 735–739 Portfolio management; see also Active portfolio management index model and, 268–274 individual investors, 954 investment decisions; see Investment decisions organizational chart for, 937 role in efficient market, 351–352 Portfolio opportunity set, 205 Portfolio performance evaluation, 819–830 alpha and, 827 average rates of return, 819–820 changing portfolio composition, 833 dollar-weighted returns, 820 equalizing beta, 826 evaluating performance, 845–846 example of, 825–829 Excel example, 827 hedge funds, 830–832, 912–918 historic returns on risky portfolios, 144–145 information ratio, 822, 946 international investing, 893–897 Jensen’s measure, 822 M2 measure of performance, 823–824 market timing, 834–840 Morningstar’s Risk Adjusted Rating (RAR), 844–845 mutual funds, 368–373, 861 performance attribution procedures, 846–851 realized return vs expected return, 829–830 risk-adjusted measures, 821–822 Sharpe’s measure, 822, 824 style analysis, 840–844 time-weighted returns, 820 Treynor’s measure, 822, 826 two scenarios for, 825–826 value of imperfect forecasting, 839–840 Portfolio risk, 285 diversification and, 197–198 performance measurement and, 833 return and, 202 Portfolio statistics, 199n correlation coefficient, 243–244 covariance, 242–243 expected returns, 239–240 portfolio rate of return, 240 portfolio variance, 245 review of, 239–245 variance and standard deviation, 240–241 Portfolio theory; see also Capital allocation risk and risk aversion, 161–166 Portfolio variance, 200, 245 border-multiplied covariance matrix, 200, 236 bordered covariance matrix, 200 spreadsheet model, 236 Post-earnings-announcement price drift, 363–364 Posterior distribution, 933 Prediction markets, 760–61 Preferred stock, 43–44, 443–444 cumulative dividends, 43 DDM and, 589 redeemable preferred stock, 44 Premium, 668; see also Equity premium; Risk premiums Premium bonds, 452 Present value, 446–447 Present value of growth opportunities (PVGO), 594 Price-contingent orders, 65–66 Price continuity, 68 Price-earnings (P/E) ratio, 43, 601–609, 641, 643, 653 DDM and, 607 earnings management and, 605–606 effect of ROE and plowback, 602 growth opportunities and, 601–604 growth rate vs (PEG ratio), 603 industry comparisons, 608 pitfalls in analysis, 604–607 stock risk and, 604 Price risk, 529–530 Price-to-book ratio, 608, 640–642 growth options and, 641 Price-to-cash-flow ratio, 608 Price-to-sales ratio, 608 Price value of a basis point (PVBP), 798 Price-weighted average, 44–46 splits and, 45–46 Primary market, 14, 59, 64 Primary trend, 394 Primitive securities, 324 Prior distribution, 933 Private placement, 60–61 Pro forma earnings, 605–606 Profit margin, 635 Profitability measures, 632–635, 643 financial leverage and ROE, 633–635 key financial ratios of, 643 past vs future ROE, 6533 Profitability ratios, 643 Program trade, 71 Program trading, 795 Projected benefit obligation (PBO), 977 Prospect theory, 385–386 Prospectus, 60 Protectionism, 550 Protective covenants, 464 Protective put, 678–680, 736 stock investment vs., 680 Proxy, 42 Proxy contest, PRS Group (Political Group Services) International Country Risk Guide, 872–875 Prudent investor rules, 955, 958 Pseudo-American call option value, 732 Public offering, 60 Purchasing power risk, 968 Pure plays, 322 examples of, 908–909 risks of, 910 Pure yield curve, 482–483 I-15 bod30700_sidx_I4-I20.indd 15 8/17/10 3:27 PM Confirming Pages Subject Index Pure yield pickup swap, 536 Put bond, 443 Put-call parity relationship, 687–689 Put/call ratio, 398–399 Put options, 51, 669 Black-Scholes put valuation, 732 current stock price and, 717 dividends and, 733 early excise of American put, 717 naked puts, 675 profits and losses on, 669 protective put, 678–680, 736 synthetic protective put, 736–737 values at expiration, 675–676 Putman Prime Money Market Fund, 33 Puttable bonds, 443 PV factor, 447 Q Quanto, 698 Quartile of a distribution, 138 Quick ratio, 463, 640, 643 Qwest Communications, R Random walk, 344–345, 392 Rate anticipation swap, 536 Rate of return; see also Historic returns on risky portfolio annual percentage rates (APRs), 123 annualized rates of return, 122 consumption growth and market rates of return, 429–431 continuous compounding, 123–125 different holding periods, 122–125 effective annual rate (EAR), 122 expected returns and arithmetic average, 130–131 geometric (time-weighted) average return, 131–132 nominal and real rate of return (bond), 446 normality of returns and systematic risk, 248–249 portfolio rate of return, 240 required rate of return, 291, 587, 810 reward-to-volatility (Sharpe) ratio, 172, 206–209, 407 simulation of long-term future rates, 150–152 time series vs scenario analysis, 130 Ratio analysis, 635–644; see also Price-earnings (P/E) ratio asset utilization, 638–639 benchmark for, 642 comparative valuation ratios, 607–608 decomposition of ROE, 635–637 as default risk predictors, 463 economic value added, 644–645 leverage, 636 liquidity ratios, 639–640 major industry groups, 644 margin vs turnover, 637 market price ratios, 640–642 market valuation statistics (1955–2005), 609 price-to-book ratio, 608 price-to-cash-flow ratio, 608 price-to-sales ratio, 608 profitability, 643 summary of key ratios, 643 turnover/other utilization ratios, 638–639 two-industry comparison, 596 Real assets, financial assets vs., 2–3 Real estate, 5, 970 Real estate investment trusts (REITs), 95 Real income, inflation and, 650 Real interest rate, 118–119 approximation of, 119 equilibrium real rate of interest, 119–120 taxes and, 121 Realized compound return, 455 yield to maturity vs., 454–455 Realized return expected return vs., 431–432, 829–830 index model and, 293–294 Rebalancing, 532–534 Red herring, 60 Redeemable preferred stock, 44 Redeemable trust certificates, 94 Redemption fees, 100 Refunding, 442 Regional funds, 97 Regression equation, 249 Regret avoidance, 385 Regulation of securities market, 82–86; see also Securities and Exchange Commission (SEC) futures market, 765–766 insider trading, 85–86 as investment constraint, 958 prudent investor rule, 955, 958 Sarbanes-Oxley Act, 84–85 self-regulation, 84 Reinvestment rate risk, 456, 529–530 Relative decline stage, 571–572 Relative strength approach, 348 Relative value positions, 906 Remaindermen, 954 Replacement cost, 585 Replicating portfolio, 718–719 Repos (repurchase agreements), 31 Representativeness, 383–384 Repurchase agreements (repos), 31 Required rate of return, 291, 587, 810 Reserve Primary Money Market Fund, 22, 33, 97n Reserving practices, 653 Residual, 250 Residual claim, 42 Residual claimants, 585 Residual income, 645 Resistance levels, 349 Resource allocation, 352–353 Retirement assets; see Individual investors; Pension funds Retirement planning models, 970–972 Retirement savings, 970 Return on assets (ROA), 463, 632–633, 643 Return on equity (ROE), 463, 632–635, 642–643 decomposition of, 635–637 financial leverage and, 633–634 industry comparison (2009), 564 major software development firms (example), 566 past vs future ROE, 633 Return requirements, 953 Return on sales (ROS), 635, 643 Revenue bonds, 36 Revenue recognition, 652 Revenue sharing, 99 Reversal effect, 359 Reverse repo, 31 Reversing trade, 762 Reward-to-risk ratio for market portfolio (M), 286–287 Reward-to-volatility ratio, 172, 206–209, 407; see also Sharpe ratio Risk; see also Portfolio risk adjusting returns for, 821–822 allocation of, 5–6 basis risk, 769 benchmark risk, 931–933 consumption risk, 305 counterparty risk, 785 country-specific risk, 874 credit risk, 461, 525n, 805–806 default risk; see Default risk diversifiable risk, 197 exchange rate risk, 868–871 firm-specific, 197–198, 258 fundamental risk, 386–387 individual investors, 970 interest rate risk; see Interest rate risk international investing and, 868–875 investment risk, 117 liquidity risk, 309–310, 968 in long run, 148–149 market price of risk, 287 market risk, 197, 795–797, 968 model risk, 388 Morningstar’s risk-adjusted rating, 844–845 nondiversifiable risk, 197–198 nonsystematic risk, 197, 326 political risk, 871–875, 968 portfolio risk; see Portfolio risk price risk, 529–530 purchasing power risk, 968 pure play, 910 reinvestment rate risk, 456, 529–530 risk aversion and, 161–166 risk premiums; see Risk premiums risk–return trade-off, 9–10 shortfall risk, 149 single-index model, 250 societal risk, 968 speculation and gambling, 1161–162 stock risk, 604 systematic risk, 197 systemic risk, 15 time vs., 153, 968 unique risk, 197 value at risk (VaR), 99, 138, 140, 144–145, 178, 219–220 volatility risk, 743 Risk arbitrage, 324 Risk assessment, multifactor models, 321 Risk aversion, 129, 162, 187, 205 estimation of, 165–166 expected utility, 191–194 speculation and, 161 utility values and, 162–165 Risk-free asset, 169–170 risky asset and, 206–210 two risky assets and, 206–210 Risk-free portfolios, capital allocation and, 167–169 Risk-free rate, 129 Risk lover, 164 I-16 bod30700_sidx_I4-I20.indd 16 8/17/10 3:27 PM Confirming Pages Subject Index Risk management, 680 multifactor models in, 321 Risk Management Association (RMA) Annual Statement Studies, 642 Risk-neutral, 164 Risk pooling, 220–222 insurance principle and, 220–221 investment for the long run, 223–224 Risk premiums, 127–130, 161, 333 excess returns and, 129–130 expected return and standard deviation, 128–129, 202, 205 forecasts of, 246, 267 holding-period returns, 127–128 inefficiencies vs., 365–366 market portfolio, 282, 284 Risk-return trade-off, 9–10, 164 emerging markets, 876 international investing, 876–878 portfolio objectives, 953–954, 956 Risk sharing, 222–224 Risk structure of interest rates, 468 Risk tolerance, 953 asset allocation and, 174–178 questionnaire for, 166–167, 187, 954 Risky assets capital allocation and, 167–169 efficient frontier of, 211–213 leverage position in, 172 levered equity and risky debt, 696 optimal risky portfolio with, 206–210 portfolios of two risky assets, 199–205 risk-free asset and, 206–210 two-security Excel model, 212 variance of, 241 Risky portfolios, 169; see also Optimal risky portfolio charting the efficient frontier of, 237 historic returns on, 139–146 Rite Aid, Rivalry between competitors, 573 Road shows, 61 Roll’s critique, 298n, 410–412 Royal Dutch Petroleum, 388–389 S Safe investing; see Bond safety St Petersburg Paradox, 191–193 Salomon Broad Investment Grade (BIG) Index, 527 Sample size neglect, 383–384 Samurai bonds, 35, 444 Santa effect, 914 Sarbanes-Oxley Act, 8, 84 Savings, 8–9 Scatter diagram, 255–256 Scenario analysis, 130, 161, 241 Seasoned equity offerings, 59 Second-pass regression, 408–409 Secondary market, 14, 59 Secondary trend, 394 Sector funds, 97 Sector rotation, 569–570 Sector selection decisions, 850 Secured bonds, 38 Securities; see also Convertible securities; Equity securities how firms issue, 59–63 initial public offerings, 61–63 investment banking and, 60 private placements, 61 shelf registration, 60 trading; see Securities trading Securities Act of 1933, 82, 84, 904 Securities Act Amendments of 1975, 72 Securities Exchange Act of 1934, 82, 348 Securities and Exchange Commission (SEC), 83 consolidated tape, 72 EDGAR Web site, 583–584 electronic communication networks, 67, 72 insider trading, 355 national market system, 72 Official Summary of Securities Transactions and Holdings, 86, 365 prospectus disclosure, 109 public offerings, 60 Rule 10b-5, 348 Rule 144A (private placements), 61 Rule 415 (shelf registration), 60 soft dollar arrangements, 102 trade-through rule, 72–73 12b-1 charges, 100–101 Securities Investor Protection Act of 1970, 83 Securities Investor Protection Corporation (SIPC), 83 Securities markets; see also Markets and instruments bond trading, 73 as competitive, 9–11 electronic communication networks (ECNs), 72 globalization and consolidation of, 75 insider trading, 85–86 Nasdaq, 68–69 national market system, 72–73 New York Stock Exchange, 69–70 in other countries, 74–75 regulation of, 82–86 Sarbanes-Oxley Act, 84–85 self-regulation of, 84 trading mechanisms, 66–68 types of markets, 63–64 types of orders, 64–66 U.S securities markets, 68–73 Securities trading, 59, 63–68 auction markets, 64 block sales, 64, 71 bond trading, 73 brokered markets, 64 dealer markets, 64, 66–67 direct search markets, 64 electronic communication networks (ECNs), 67, 71–72 Euronext, 74 globalization and consolidation, 75 insider trading, 85–86 late trading in mutual funds, 103 London Stock Exchange, 74 margin buying, 76–79 market orders, 65 naked access, 73 National Market system, 72–73 in other countries, 74–75 over-the-counter (OTC) market, 66 price-contingent orders, 65–66 program trade, 71, 795 regulation of markets, 82–86 self-regulation, 84 settlement and, 71–72 short sales, 66, 79–83 specialists markets, 67–68 stop orders, 66 SuperDOT system, 71 Tokyo Stock Exchange, 75 trading costs, 76 trading mechanisms, 66–68 types of markets, 63–64 types of orders, 64–66 Securitization, 17, 41 Security analysis, Security Analysis (Graham and Dodd), 654 Security characteristic line (SCL), 255, 334 analysis of variance, 256–257 estimation of, 408–409 explanatory power of, 255–256 Hewlett-Packard example, 255–256 market timing and, 834–935 Security market line (SML), 289–293, 407 arbitrage and, 329 estimation of, 409 multifactor SML, 321–323, 332 one-factor SML, 328–330 positive-alpha stock and, 292 style analysis vs., 841–482 Security returns beta and, 316 empirical evidence on, 407–408 factor models of, 319–321 Security selection, 8, 28, 196 asset allocation and, 219 efficient frontier of risky assets, 211–213 Markowitz portfolio selection model, 211–214 Security selection decisions, 850 Selection bias issue, 356 Self-regulation in securities market, 84 Semistrong-form hypothesis, 348 Semistrong tests, 360–365 Sentiment/sentiment indicators, 397–399, 553 confidence index, 398 put/call ratio, 398–399 trin statistic, 397–398 Separation of ownership/management, 6–7 Separation property, 214–216 Serial bond issue, 466 Serial correlation, 358, 913 Settlement, 71–72 Shareholders, 628 Shareholders’ equity, 628 Sharpe ratio, 133, 136, 172, 206–209, 263, 822–823 hedge funds and, 913–914 historical record of, 144–145 long-term horizon, 150 overall portfolios, 824 Shelf registration, 60 Shell Transport, 388–389 Short hedge, 768 Short position, 53, 756 Short rate, 484–485 Short sales, 66, 79–83 cash flows from purchasing vs., 80 example of, 81 Excel application, 80 margin calls on, 82 optimal risky portfolio and, 238–239 “Siamese Twin” companies, 388 Significance level of the test, 297n Single-factor model, 319 I-17 bod30700_sidx_I4-I20.indd 17 8/17/10 3:27 PM Confirming Pages Subject Index Single-factor security market, 247–249 input list of Markowitz model, 247–248 normality of returns and systematic risk, 248–249 Single-index model, 249–254 analysis of variance, 256–257 correlation and covariance matrix, 258–261 diversification and, 252–254 estimate of alpha, 257–258 estimate of beta, 258 estimates needed for, 251–252 estimating the model (example), 254–261 expected return-beta relationship, 250 firm-specific risk, 258 human capital and cyclical asset betas, 414–416 nontraded business, 416–417 portfolio construction and, 261–268 alpha and security analysis, 261–262 example of, 266–268 information ratio, 264–266 input list, 263 optimal risky portfolio, 263–264 optimization summary, 266 risk premium forecasts, 267 regression equation of, 249–250 risk and covariance in, 250 security characteristic line, 255–256 Single-stock futures, 759 Sinking funds, 465–466 Skew, 137 Slow growers, 572 Small-firm effect, 361 Small-firm-in-January effect, 361–362 Socially responsible investing, 214 Societal risk, 968 Soft dollars, 102 Sortino ratio, 139 SPDR (Standard & Poor’s Depository Receipt), 104 Special-purpose entities, Specialist, 67, 70 Specialist markets, 67–68 Speculation, 161–162 on the basis, 769–770 hedging and, 766–767 mispriced options, 740 oil futures, 766 on the spread, 770 Speculative-grade bonds, 461 Spinning IPOs, 62 Spot-futures parity theorem, 770–773 Spot rate, 484, 486, 488 Spreads, 684, 773–774 bullish spread, 684, 686 Excel application, 683 futures, 769 parity and, 775 speculating on, 770 spread pricing, 774 Stalwarts, 572 Standard & Poor’s 500 stock price index, 98, 179–180, 351 average annual returns, 180 cash-to-futures spread (Oct 19 and 20), 738 cumulative returns (1980–2009), 16 earnings per share vs (1970–2009), 552 earnings yield vs 10-year Treasury yield (1955–2009), 614 implied volatility and exercise price, 744 as market-value-weighted index, 48 monthly dividend yield, 773 Standard & Poor’s Corporation bond ratings, 442, 461, 463 credit ratings, 19 indexes, 48–49 Market Insight service, 584 Outlook, 655 Standard deviation expected return and, 128–129, 202, 205 historical record of returns, 145 international portfolios by diversification, 890–891 investment proportions and, 203 lower partial standard deviation (LPSD), 139 minimum-variance portfolio, 204 variance and, 132–133, 240–242 Start-up stage, 571 Statement of cash flows, 630–632 Hewlett-Packard example, 631 Statistical arbitrage, 907 Stern Stewart, 645 Stochastic volatility models, 730 Stock exchange, 69 Stock-index futures, 791–797 contracts, 791–792 hedging market risk, 795–797 index arbitrage, 704–795 major contracts, 792 synthetic stock positions, 792–794 Stock investments, option vs., 676–678, 680 Stock market aggregate stock market, 613–615 consolidation of, 75 explaining past behavior, 613–614 forecasting of, 614–615 globalization of, 75 listing standards, 90 as self-regulating, 84 Stock market analysts, 368–369 Stock market bubble, 368, 391 Stock market indexes, 44–50 correlations among major, 793 Dow Jones averages, 44–47 equally weighted indexes, 49 foreign and international indexes, 49 market-value-weighted indexes, 48 other U.S market-value indexes, 49 price-weighted average, 44–46 Standard & Poor’s indexes, 48–49 value-weighted index, 48 Stock market listings, 42–43 Stock prices convergence to intrinsic value, 592 convertible bond and, 692 industry stock price performance (2009), 565 investment opportunities and, 592–595 random walk argument, 344–345, 392 Stock risk, P/E ratios and, 604 Stock selection, 896 Stop-buy orders, 66 Stop-loss orders, 66 Stop orders, 66 Storage costs, 807–808 Straddles, 683–685 Straight bond, 690 Straps, 684 Stratified sampling (cellular approach), 527–528 Street name, 72 Strike price, 51, 668 Strips, 684 STRIPS (Separate Trading of Registered Interest and Principal of Securities), 459, 481–482 Strong-form hypothesis, 348 Strong-form tests, 364–365 Structure Investment Vehicle (SIV), 470 Structured products, 19n Stub value, 389 Style analysis, 840–844 in Excel, 843–844 Fidelity’s Magellan Fund (example), 841–842 hedge funds, 910–912 multifactor benchmarks, 842–843 security market line (SML) vs., 841–842 Style drift, 904 Style portfolios, 365–366, 421 Subordinated debentures, 38 Subordination clauses, 466 Subprime mortgages, 18, 39–40 Substitute products, 573 Substitution swap, 536 Sunbeam, 652 SuperDot, 71 Supply shock, 553 Supply-side policies, 556–557 Support levels, 349 Survivorship bias, 295n, 393, 433, 821n, 915 Swap dealer, 802 Swaps, 667, 800–806 balance sheet restructuring and, 801–802 bond swap, 536–537 credit default swaps (CDS), 19–20, 806 credit risk in, 805–806 foreign exchange swap, 800 forward contract vs., 805 interest rate swap, 800–801, 803 other interest rate contracts, 803–804 pricing of, 804–805 swap dealer, 802 Synthetic forward loan, 498 Synthetic protective put, 736–737 Synthetic stock positions, 792–794 Systematic risk, 197–198, 250, 254, 826 factor models, 327 normality of returns and, 248–249 Systemic risk, 15, 21, 470 financial crisis of 2008, 20–21 real economy and, 22–23 T T-statistic, 257n Tail events, hedge fund performance and, 916–918 Tailing the hedge, 908n Tangible fixed assets, 630 Target-date retirement fund (TDRF), 981 Target investing, 980 Targeted-maturity funds, 97 Tax anticipation notes, 36 Tax-burden ratio, 636 Tax-deferral option, 972–973 Tax-deferred retirement plans, 973 Tax-exempt debt outstanding (1979–2009), 36 Tax policy, 557 Tax Reform Act of 1986, 121 Tax sheltering, 972–975 deferred annuities, 974 tax-deferral option, 972–973 I-18 bod30700_sidx_I4-I20.indd 18 8/17/10 3:27 PM Confirming Pages Subject Index tax-deferred retirement plans, 973 variable and universal life insurance, 974–975 Tax swap, 537 Taxes asset allocation and, 968–969 futures and, 766 investment considerations and, 959 mutual fund income, 103–104 OID bonds, 460 real rate of interest and, 121 tax sheltering, 972–975 taxable vs tax-exempt yields, 38 Technical analysis, 381, 406 behavioral finance and, 392–400 breadth, 396–397 cautions on use of, 399–400 confidence index, 398 Dow theory, 394–395 implications of EMH, 348–349 moving averages, 395–396 put/call ratio, 398–399 resistance/support levels, 349 sentiment indicators, 397–399 trends and corrections, 393 trin statistic, 397–398 TED (Treasury-Eurodollar) spread, 15, 22, 33 Term insurance, 957 Term premiums, 496 Term repo, 31 Term spread, 497 Term structure of interest rates, 480, 490–493, 980 expectations hypothesis, 490–491 forward inflation rates and, 491 interpretation of, 494–497 liquidity preference, 491–493 theories of, 490–493 uncertainty and forward rates, 488–490 Tertiary trends, 394 Threat of entry, 573 3Com, 388–389 Time diversification, 220 Time series analysis expected returns and arithmetic average, 130–131 geometric (time-weighted) average return, 131–132 reward-to-volatility (Sharpe) ratio, 133 scenario analysis vs., 130 variance and standard deviation, 132–133 Time spread, 684 Time value, 711–712 Time-weighted (geometric) average return, 131–132, 819 Time-weighted returns vs dollar-weighted returns, 820 Times-interest-earned, 463, 636, 643 Timing risk, 968 TIPS (Treasury Inflation-Protected Securities), 35 Tobin’s q, 585 Tokyo Stock Exchange (TSE), 75 Too big to fail, 223 Top-down portfolio construction, 9, 196 Total asset turnover (ATO), 636, 643 Tracking error, 822, 931, 949 Tracking portfolios, 273–274, 331 Trade policy, 550 Trade-through rule, 72–73 Trading costs, 76 Trading mechanisms, 66–68; see also Securities trading dealer markets, 66–67 electronic communication networks (ECNs), 67 futures markets, 760–766 options trading, 670–671 specialist markets, 67–68 Trading pit, 760 Tranches, 19, 470, 525–526 Transactions costs, 426 Transparency, 23, 904 Treasury bills (T-bills), 4, 29, 459 asset allocation with, 206–210 bank-discount method, 29 bond-equivalent yield, 30 inflation and (1926–2009), 125–127 nominal and real wealth indexes (1968–2009), 126 as risk-free asset, 170 statistics for (1926–2009), 125 three-mo CD spread vs (1970–2009), 33 Treasury Inflation Protected Securities (TIPS), 445, 981 Treasury notes and bonds, 34, 440–441 inflation-protected Treasury bonds, 35 Treasury strips, 459–460, 481–482 Trends and corrections, 393 Treynor-Black model, 926, 933–937 Black-Litterman vs., 943–945 distribution of alpha values, 935–936 forecast precision of alpha, 934–935 organizational structure and performance, 936–937 Treynor’s measure, 822, 826 Trin statistic, 397–398 Trough, 557 TSX (Canada), 49 Tulip mania, 367 Turnarounds, 572 Turnover, 104, 637–639 12b-1 charges, 100–102 Two-state option pricing, 718–721 Tyco, 83 Type I and Type II errors, 297n U Unanticipated inflation, 342 Underwriters, 13, 60 Unemployment rate, 552 Uniform Securities Act (1956), 84 Unique needs, 959 Unique risk, 197 Unit investment trusts, 93–94 U.S Department of Commerce, 642 Units, 95 Universal banks, 14 Universal life insurance, 957, 974–975 Unmanaged trusts, 94 Unsecured bonds, 466 Utility, 162, 205, 385 Utility function, 160, 386 allocation to risky asset, 174–178 expected utility, 191–194 insurance contracts, 194–195 prospect theory and, 385–386 Utility rate-making and CAPM, 292 Utility scores, evaluating investments by, 163 Utility values, risk aversion, 162–166 V VA Linux, 61, 61n Value at risk (VaR), 138, 140, 144–145, 178, 219–220 Value investing (Graham technique), 654–655 Value Line Investment Survey, 565, 598, 655 Value stocks, 110 Value-weighted indexes, 48 Vanguard Group, 96, 98, 168, 351 Vanguard 500 Index Fund, 98, 351 Vanguard Total Stock Market Index portfolio, 107 Variable annuities, 974 Variable life, 957 Variable life insurance, 974–975 Variance portfolio variance, 200, 245 risky asset, 241 standard deviation and, 132–133, 240–242 Vega, 743 Views, 937 Volatility, 714n CBOE’s VIX index as fear gauge, 730–731 dynamic hedging and, 724 implied volatility, 728 Volatility risk, 743 W Wall Street Journal Online CBOT corn futures, 53 closed-end mutual funds, 94 corporate bonds, 442 foreign exchange futures, 786 futures listings, 758 interest rate futures, 803 market diaries, volume, advancers, decliners, 397 spot/forward prices in foreign exchange, 785 stock market listings, 43 stock options on IBM, 670 trading on Intel options, 52 Treasury bill yields, 29 Treasury bonds and notes, 34 Treasury issues, 440 Walmart, 645 Walt Disney, 444 Warrants, 693–694 Weak-form tests, 347, 358–360 Wealth, 305n Wealth index, 126 Wealthcare Capital Management, 216n Weather derivatives, 759 Well-diversified portfolio, 325–326 Whole-life insurance policy, 957 Wiesenberger’s Investment Companies, 110 Wilshire 5000 index, 49, 107–108, 181, 351 diversified equity funds vs (1971–2009), 108 Window dressing, 846 Winterthur, 445 Workout period, 536 WorldCom, 7, 83, 461 W.R Grace, 652 Y Yahoo!, 7, 110, 115, 563 Yankee bonds, 35, 444 I-19 bod30700_sidx_I4-I20.indd 19 8/17/10 3:27 PM Confirming Pages Subject Index Yield curve, 480–483, 492–493, 505 bond pricing, 481–482 forward rates, 486–485 future interest rates and, 483–487 holding-period returns, 485–486 inverted yield curve, 481 on-the-run yield curve, 483, 488 pure yield curve, 482–483 slopes of, 492–494 spot and forward yields, 488 Treasury yield curves, 481 under certainty, 483–485 Yield to call, 453–454 Yield to maturity (YTM), 34, 451 default risk and, 467 Excel function for, 452 expected vs promised YTM, 467 holding period return vs., 458 realized compound return vs., 454–455 Yields, 29, 439; see also Bond yields bank-discount method, 29 bond-equivalent yield, 30, 34 equivalent taxable yield, 37 money market instruments, 32–33 spread between 10-year Treasury and Baa-rated corporate, 799 taxable vs tax-exempt, 38 Z Z-score, 464 Zero-beta model, 301–302 Zero-coupon bonds (zeros), 440, 459–460 Zero-sum game, 757 I-20 bod30700_sidx_I4-I20.indd 20 8/17/10 3:27 PM Commonly Used Notation b Retention or plowback ratio C Call option value CF rM Cash flow D Duration E Exchange rate E(x) rf Expected value of random variable x F Futures price e 2.718, the base for the natural logarithm, used for continuous compounding ROE Sp t Return on equity, incremental economic earnings per dollar reinvested in the firm Reward-to-volatility ratio of a portfolio, also called Sharpe’s measure; the excess expected return divided by the standard deviation Time Tp Treynor’s measure for a portfolio, excess expected return divided by beta f Forward rate of interest V g Growth rate of dividends Intrinsic value of a firm, the present value of future dividends per share H Hedge ratio for an option, sometimes called the option’s delta X Exercise price of an option y Yield to maturity i Inflation rate k Market capitalization rate, the required rate of return on a firm’s stock ln Natural logarithm function M The market portfolio Rate of return beyond the value that would be forecast from the market’s return and the systematic risk of the security Systematic or market risk of a security ij N(d) Cumulative normal function, the probability that a standard normal random variable will have value less than d p Probability P Put value PV Present value P/E Price-to-earnings multiple r Back endsheets Color: 4/C Page: The rate of return on the market portfolio The firm-specific return, also called the residual return, of security i in period t ei t ISBN: 0073530700 Author: Zvi Bodie, Alex Kane, Alan J Marcus Title: Investments, 9/e The risk-free rate of interest Rate of return on a security; for fixed-income securities, r may denote the rate of interest for a particular period Correlation coefficient between returns on securities i and j Standard deviation Cov(ri , rj) Variance Covariance between returns on securities i and j ISBN: 0073530700 Author: Zvi Bodie, Alex Kane, Alan J Marcus Title: Investments, 9/e Back endsheets Color: 4/C Pages: 2,3 ISBN: 0073530700 Author: Zvi Bodie, Alex Kane, Alan J Marcus Title: Investments, 9/e Back endsheets Color: 4/C Pages: 2,3 ... best suited to you ISBN: 9780073530703 Author: Bodie/ Kane/ Marcus Title: Investments, 9e Front endsheets Color: 4c Page: 4, Insert Confirming Pages Investments bod30700_fm_i-xxviii.indd i 7/23/10... A Ross, Mentor: Influence through Generations Bodie, Kane, and Marcus Essentials of Investments Eighth Edition Real Estate Hirschey and Nofsinger Investments: Analysis and Behavior Second Edition... Printer: Worldcolor Library of Congress Cataloging-in-Publication Data Bodie, Zvi Investments / Zvi Bodie, Alex Kane, Alan J Marcus. —9th ed p cm.—(The McGraw-Hill/Irwin series in finance, insurance