Using proven, field-tested technology, auto-graded Excel Projects allow instructors to seamlessly integrate Microsoft Excel® content into their course without having to manually grade spreadsheets Students have the opportunity to practice important finance skills in Excel, helping them to master key concepts and gain proficiency with the program “I like how the ‘give me an example’ option works with the homework—it is nice to run through an example with guidance to learn how to solve these problems.” — Student, Virginia Polytechnic Institute and State University 89% 86% 84% eText Study Plan Dynamic Study Modules Dynamic Study Modules use the latest developments in cognitive science and help students study chapter topics by adapting to their performance in real time % of students who found learning aid helpful Pearson eText enhances student learning with engaging and interactive lecture and example videos that bring learning to life The Gradebook offers an easy way for you and your students to see their performance in your course 85% of students would tell their instructor to keep using MyLab Finance For additional details visit: www.pearson.com/mylab/finance This page intentionally left blank Fundamentals of Investing Fourteenth Edition Global Edition SCOTT B SMART Ind i a n a U n i v e r s i t y CHAD J ZUTTER Univ e r s i t y o f P i t t s b u r g h Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney • Dubai • Singapore • Hong Kong Tokyo • Seoul • Taipei • New Delhi • Cape Town • Sao Paulo • Mexico City • Madrid • Amsterdam • Munich • Paris • Milan Vice President, Business, Economics, and UK Courseware: Donna Battista Director of Portfolio Management: Adrienne D’Ambrosio Editorial Assistant: Catherine Cinque Acquisitions Editor, Global Edition: Ananya Srivastava Assistant Project Editor, Global Edition: Jyotis Elizabeth Jacob Vice President, Product Marketing: Roxanne McCarley Product Marketer: Kaylee Carlson Product Marketing 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Education Limited KAO Two KAO Park Hockham Way Harlow Essex CM17 9SR United Kingdom and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsonglobaleditions.com © Pearson Education Limited 2020 The rights of Scott B Smart and Chad J Zutter to be identified as the authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988 Authorized adaptation from the United States edition, entitled Fundamentals of Investing, 14th Edition, ISBN 978-0-13-517521-7 by Scott B Smart and Chad J Zutter, published by Pearson Education © 2020 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a license permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS All trademarks used herein are the property of their respective owners The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners For information regarding permissions, request forms, and the appropriate contacts within the Pearson Education Global Rights and Permissions department, please visit www.pearsoned.com/permissions/ This eBook is a standalone product and may or may not include all assets that were part of the print version It also does not provide access to other Pearson digital products like MyLab and Mastering The publisher reserves the right to remove any material in this eBook at any time British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library ISBN 10: 1-292-31697-7 ISBN 13: 978-1-292-31697-0 eBook ISBN 13: 978-1-292-31703-8 Typeset in Times NR MT Pro by Integra Software Services, Inc Dedicated to our friends and mentors, Dr Lawrence J Gitman and Michael D Joehnk, who trusted us as coauthors and successors of Fundamentals of Investing SBS CJZ This page intentionally left blank Brief Contents Detailed Contents Preface 19 Part One Preparing to Invest The Investment Environment Securities Markets and Transactions Investment Information and Securities Transactions Part Two Important Conceptual Tools 4A Return and Risk The Time Value of Money Modern Portfolio Concepts Part Three Investing in Common Stocks Common Stocks Analyzing Common Stocks Stock Valuation Market Efficiency and Behavioral Finance Part Four Investing in Fixed-Income Securities 10 11 Fixed-Income Securities Bond Valuation Part Five Portfolio Management 12 13 Mutual Funds and Exchange-Traded Funds Managing Your Own Portfolio Part Six Derivative Securities 14 15 Options: Puts and Calls Futures Markets and Securities 35 72 116 158 194 210 257 293 335 374 418 463 506 549 588 631 Glossary 665 Index 679 Web Chapters 16 17 18 (at www.pearsonglobaleditions.com) Investing in Preferred Stocks Tax-Advantaged Investments Real Estate and Other Tangible Investments Contents Part One Preparing to Invest Chapter The Investment Environment 35 FAMOUS FAILURES IN FINANCE Ethical Failure— Massaging the Numbers 55 Opening Vignette 35 FAMOUS FAILURES IN FINANCE A Run for the Money 57 Investments and the Investment Process 36 Attributes of Investments 36 / The Structure of the Investment Process 39 Types of Investments 41 Short-Term Investments 41 / Common Stock 41 / Fixed-Income Securities 43 / Mutual Funds 44 / Exchange-Traded Funds 45 / Hedge Funds 45 / Derivative Securities 46 / Other Popular Investments 47 Making Your Investment Plan 47 Writing an Investment Policy Statement 47 / Considering Personal Taxes 49 / Investing over the Life Cycle 53 / Investing over the Business Cycle 54 Meeting Liquidity Needs with Short-Term Investments 56 The Role of Short-Term Investments 56 Common Short-Term Investments 58 / Investment Suitability 60 Careers in Finance 61 Developing Skills for Your Career 64 Summary 66 / Discussion Questions 68 / Problems 69 / Case Problem 1.1 70 / Case Problem 1.2 71 Chapter Securities Markets and Transactions 72 FAMOUS FAILURES IN FINANCE Short Sellers Tip 60 Minutes 104 Opening Vignette 72 Securities Markets 73 Types of Securities Markets 73 / Broker Markets and Dealer Markets 80 / Electronic and High-Frequency Trading 86 / General Market Conditions: Bull or Bear 88 Contents Globalization of Securities Markets 89 Growing Importance of International Markets 90 / International Investment Performance 90 / Ways to Invest in Foreign Securities 90 / Risks of Investing Internationally 91 Trading Hours and Regulation of Securities Markets 93 Trading Hours of Securities Markets 93 / Regulation of Securities Markets 93 Basic Types of Securities Transactions 95 Long Purchase 96 / Margin Trading 96 / Short Selling 102 Summary 106 / Discussion Questions 109 / Problems 109 / Case Problem 2.1 114 / Case Problem 2.2 115 Chapter Investment Information and Securities Transactions 116 FAMOUS FAILURES IN FINANCE Robbing Shareholders to Pay Paul 140 Opening Vignette 116 Investment Research and Planning 117 Getting Started in Investment Research 117 / A Word of Caution About Internet Trading 120 Types and Sources of Investment Information 121 Types of Information 123 / Sources of Information 123 Understanding Market Averages and Indexes 132 Stock Market Averages and Indexes 132 / Bond Market Indicators 136 Making Securities Transactions 137 The Role of Stockbrokers 137 / Basic Types of Orders 141 / Online Transactions 143 / Transaction Costs 144 / Investor Protection: SIPC and Arbitration 145 Investment Advisors and Investment Clubs 147 Using an Investment Advisor 147 / Investment Clubs 148 Summary 149 / Discussion Questions 152 / Problems 153 / Case Problem 3.1 156 / Case Problem 3.2 157 Part Two Important Conceptual Tools Chapter Return and Risk 158 FAMOUS FAILURES IN FINANCE Fears of Deflation Worry Investors 162 Opening Vignette 158 The Concept of Return 159 Components of Return 159 / Why Return Is Important 160 / Level of Return 161 / Historical Returns 163 / The Time Value of Money and Returns 163 INDEX feasible set (attainable set), 231–232, 233f holding period return calculation, 563t measurement, 562–563 immunization, case problem, 503 income, 50 investment amount, measurement, 560 investor characteristics/objectives, 550 management, formula plans, 567–571 marriage, impact, 550 measures, examples, 563–566 objectives, 211, 550–551 optimal portfolio, 232–233 performance, assessment, 559–566, 582–583 planning, principles, 211–222 policies, 550–551 rebalancing actions, 568 replicating portfolios, 601 return, measurement, 560–563 revision, 566 risk, 234f sets, 231–232 standard deviation, 220 equation, 217e tracking, 120 traditional portfolio management, modern portfolio management (contrast), 230–236 unrealized gains, example, 562t volatility panel, correlation (effect), 216f Portfolio betas, 233–236 calculation, 234–235 equation, 234e interpretation, 235–236 returns, changes (association), 236t Portfolio return, 211–214 Century Casinos Inc (CNTY), 212t, 218t equation, 211e Walmart Stores Inc (WMT), 212t, 218t Post-earnings announcement drift (momentum), 384–386, 385f Poston, Daniel (accounting problems), 309 Preferred stock, 43 Preliminary prospectus, 75–76 Premium, 595 equation, 533e occurrence, 533 Premium bonds, 427 Premium discount brokers, 139 Prepayment risk See Call risk Present value (PV), 358 annuity, present value, 204 calculations, usage, 539 calculator/spreadsheet use, 202 equation, 201e future value extension, 200–202 relationship, 201f return streams, present value, 202–204 Pretax HPR, calculation, 557t, 558t Prices See Stock prices bond prices behavior, principles, 426–428, 427f history, 419–424 forecast, 338–342 information, 123, 128–129 price effect, 490 price-relative procedures, 359–361 risk, behavior, 485 target prices, 343 volatility, bond duration (relationship), 488–489 Price-to-book value (P/BV) equation, 320 ratio, 359, 360–361 Price-to-cash-flow (P/CF) procedure, 360 ratio, 359 equation, 360e Price-to-earnings (P/E) approach, 355, 358–359 multiples, 318, 339–341 Price-to-earnings (P/E) ratio, 317–318, 343, 522 average P/E ratio, 339f calculation, 318 equation, 317e estimation, 338–339 future P/E ratio, 338 problem, 340 Price to earnings to growth (PEG) ratio, 318, 318e Price-to-sales (P/S) ratio, 359, 360–361 equation, 361 Primary market, 73–80, 85 Principal, 43 bonds, principal, 425–426 Principal at maturity, 472–473 Problem investments, isolation, 559 Procter & Gamble, 2051 stockholder report, 126f Producer prices, 299t Profitability, 310 movement, 597 picture, 322 ratios, 315–316 Profit protection protective puts, usage, 609–611 put hedge, usage, 610t Profits forecast, 336–338 magnification, 97–99 potential, 596–598 takeouts, 493 Progressive tax, 50 Property investment issuance, 36–37 REIT, 520 Prospectus, 127 cover, 75f final prospectus, 76 Protective puts, 609–611 Prudent Speculator, The, 128 Public offerings, 73, 74–77 direct listing process, 79–80 investment bank role, 78–79 IPO process, 74–77 Public utilities (corporate bond market), 440 Public Utilities Fortnightly, 124 Pump-and-dump scams, 130 Purchasing power risk, 424 Put-call parity, 599–602 example, 601e holds, 601 usage, 602 Put hedge, usage, 610t Put options (puts), 589–596 features, 589–592 function, 591–592 intrinsic value, equation, 598e leverage, 591 price, equation, 602e profit potential, 596–598 691 692 INDEX Put options (puts), (continued) usage, 608–609 valuation properties, 597f value, 598 Put transactions, 595–596 Pyramiding, principle, 102 Quarterly Financial Report, 124 Quick ratio, 310–311 equation, 311e Quiet period, 75 Quotation system, usage, 639 Quotes, reading, 266 Raging Bull, 130 Rapid expansion (industry growth cycle), 303 Rate of return See Return RBC Capital optimism, 293 report, 295 Real estate bubble, 260 Real Estate Investment Trust Act (1960), 520 Real estate investment trusts (REITs), 519–520, 525, 536 Real property, 36–37 Real rate of return (r*), 464 Rebalancing actions, 568 Recessions signs, 465 stocks, performance, 55t Redemption fee, 45 Red Hat (RHT) stock, analysis, 335 Red herring, 76 Regular income, 529 Regulation FD, 125 Regulation NMS Rule 612, 88 Reinvested dividends, 273t HPR, usage, 537–538 Reinvestment automatic reinvestment plans, 528–529 effect, 490 risk, behavior, 485 REITs See Real estate investment trusts Relative strength index (RSI), 402 Replicating portfolios, 601 Report on Digital Investment Advice (FINRA), 148 Representativeness, 390–393 Required rate of return, 345 Required return, 345–346 Research and development (R&D), 303–304 Reserve Fund, 525 Retention rate (rr), equation, 354 Retirement programs, 529 saving, initiation, 197 Return bond returns, history, 419–424 changes, association, 135t chasing, 391 comparative returns, 278–279 data, usage, 421, 555 enhancement, 611–614 excess return, 565 global returns measurement, 280–281 perspectives, 279–280 historical returns, 421–422 long-term returns, measuring, 538–539 market measures, comparison, 563–566 measures, 477–484, 537–539 portfolio standard deviation, 564 rate, 101 risk, balance, 558 sources, 535–537 standard deviation, 212t stream, present value, 202–204 Return correlations, 215f economic factors, impact, 221 Return on assets (ROA), 315, 315e breakdown, 316–317 Return on equity (ROE), 315–316, 341 breakdown, 316–317 equation, 316e expanded equation, 317, 317e Return on invested capital (ROIC), 101–102, 640–641 equation, 101e, 641e Revenue bonds, 436–437 Revenue, decline (example), 98 Rights, 589 offering, 73 Risk, 539–540 business/financial risk, 424 call risk (prepayment risk), 425 characteristics, 57–58 credit risk, 424 default risk, 58, 424 differential, 470 diversifiable risk, 233 diversification, 233–234 exposure, 424–425 interest rate risk, 424 liquidity risk, 425 management, 550 modification, 609–611 portfolio risk, 234f purchasing power risk, 424 return, balance, 558 risk-adjusted required return, excess, 565 risk-free bond, 601 undiversifiable risk, 233 Risk-free interest rate, increase, 604 Risk-free rate, 464 Risk premium (RP), 464 Road show, 76 Robo-advisors, 147–148 Robots, efficient markets (relationship), 381 Rolling-over process, 492–493 Roth IRA, 53, 529 Round-lot transactions, 141 Round-trip commissions, 635 Rudy Nutrition, 131 Russell 2000 Index (RUT), 615, 646 Sales forecast, 336–338 load, 45, 510 report, 338 Sarbanes-Oxley Act (2002), 93–94 Savers, return, 194–196 Savings account balance data, 195t, 196t Scams, avoidance, 130–131 Seasoned equity offerings (SEOs), 73–74 Secondary market (aftermarket), 80 Sector funds, 525–526 Secured debt, 430 Securities buying, 85 INDEX convertible securities, 43, 446–452 debt securities, market, 433–446 derivative securities, 38, 46 federal securities laws, 94t fixed-income securities, 43–45 foreign securities, investment process, 90–91 hybrid securities, 446 investment issuance, 36–37 large security issue, selling process, 78f lenders, identification, 103 long purchase, 96 margin trading, 96–102 market basket, alteration, 525 mispricing, 295 portfolio, inheritance (example), 252 primary market, 73–80 returns, margin trading (effect), 97t stock symbol, verification, 144 synthetic securities, 612 types, initial margin requirements, 99t Securities Acts Amendments (1975), 144–145 Securities, analysis, 294–296 behavioral finance, implications, 395 necessity, 295–296 principles, 294–295 top-down approach, 294–295 Securities and Exchange Commission (SEC), 73 financial statement filing, 305 transactions, report, 381 Securities Exchange Act (1934), Section 6, 95 Securities Investor Protection Act (1970), 145 Securities Investor Protection Corporation (SIPC), 145 Securities markets, 39, 72, 73–88 globalization, 89–92 regulation, 93–95 trading hours, 93 types, 73–80 Securities prices, 387–395 decline, money (making), 103 increase, 101 Securities transactions, 72, 116, 137–146 types, 95–105 Security Market Line (SML), 229f Self-attribution bias, overconfidence (relationship), 388 Self-directed retirement plans (SEPs), 529 SEP-IRAs, 53 Self-regulatory organization (SRO), 95 Semiannual compounding, 475–476 usage, 479–481 Senior subordinated issues, 440 SEPs See Self-directed retirement plans Serial obligations, 436 Shanghai Stock Exchange, 90 Shareholders, theft, 140 Share prices, 134 behavior, 344 estimation, 342 impact, assessment, 300 Share repurchases, 265 Sharpe’s measure (SM), 563–564 Sharpe, William F., 563 Short hedge, usage, 650 Shorting-against-the-box, 102 Short interest, 398–399 Short sale margin positions, 104t mechanics, 103t Short seller position coverage, 635 price decline, 105 tip, 104 Short selling, 102–105 advantages/disadvantages, 105 essentials, 102–105 margin requirements, relationship, 103–105 uses, 105 Short straddle, 614 Short-term investments, 39, 41 advantages/disadvantages, 58 interest, 57 risk characteristics, 57–58 role, 56–58 scorecard, 60t types, 58–60, 59t–60t usage, 56–65 Short-term trading, speculation (relationship), 283, 531 Simple average, 403 Simple interest, 194 Single bond, duration, 486–487 Single brokerage account, 140 Single stock futures, 645 Sinking funds, 429–430 commonness, 440 provisions, call/refunding protection features (contrast), 429–430 Size effect, 384 Small Business Administration, 435 Small-cap stocks, 276–277 Small-firm effect (size effect), 384 Smart Investors, 515 SmartMoney, 120 Smart money, trend, 397 Socially responsible funds, 526 Social media, 130 Southwest Airlines balance sheet, example, 268 stock, market price, 268 SPDR See Standard & Poor’s Depositary Receipt Special subscription services, 124 Specialty issues, 441–444 Speculating, 641–642 Speculation buying, 607–609 call options, usage, 607–608, 608t put options, usage, 608–609 short-term trading, relationship, 283, 531 Speculative stocks, 54, 276 Speculators, 634 S&P Industry Surveys, 303 Spitzer, Eiliot, 512 Spreading, 641–642 Spreadsheets, usage, 197 Spreads, types, 612 Stability/decline (industry growth cycle), 303 Standard deviation, 211–214 Century Casinos Inc (CNTY), 218t equation, 217e Walmart Stores Inc (WMT), 218t Standard normal distribution, 606f Standard of performance See Performance standard Standard & Poor’s 100 Index (OEX), 615 Standard & Poor’s 500 Index (S&P 500 Index), 506, 646 movements, tracking, 514 option, value, 615 693 694 INDEX Standard & Poor’s Corporation (S&P) bond rating agency, 129, 430 ExxonMobil (XOM) downgrade, 418 financial reports/services, 127 research, 296 types, 134 Standard & Poor’s Corporation 500 (S&P 500), 210 historical average annual returns, 259t Stock Index, 44–45 stocks, average P/E ratio, 339f Standard & Poor’s Corporation (S&P) Index, 133–135, 257 DJIA average, comparison, 135f equation, 134e shares, counting, 134 Standard & Poor’s Depositary Receipt (SPDR), 507 State income tax rate, example, 440 Statement of cash flows See Cash flows State Street Global Advisors, impact, 507 Stockbrokers role, 137–141 selection, 139 StockCharts, 120 Stockholders equity, 306 reports, 125, 127 Stock indexes, 261f, 645–646 puts/calls, trading, 589 Stock index futures, 645–646, 648 case problem, 661–662 hedging, 650–651 trading, 650–651 Stock market averages/indexes, 132–136 economic variables, relationship, 301t economy, relationship, 297 entry, case problem, 290–291 Stock options, 38, 593–596 provisions, 593–594 trading (CBOE), 589 trading strategies, 607–614 Stock ownership, 37 advantages, 260–261 disadvantages, 261–262 pros/cons, 260–262 Stock prices behavior, perspective, 258–260 daily stock price reactions, 380f decline, example, 142 equation, 359e movement, 396 present value, 353 Stocks analysis, case problem, 372–373 beta level, 378 blue-chip stocks, 274 bonds comparative performance, 423f contrast, 422–424 book value, 268 common stock, 41–43 correlation coefficient, 219 current income, 262f cyclical stocks, 276 defensive stocks, 276 dividends, 272–273 drift, 384 exchanges, 83 foreign stocks, investment, 277–281 future cash flows, estimates, 294 growth stocks, 275 income stocks, 275 investment, 395 case problem, 333–334 return, measures, 556 investor purchase, 351 issue, preliminary prospectus (cover), 75f management, aggressiveness, 283 new stock issues, announcement, 264f offerings, 258–262 performance, 55t preferred stock, 43 price, equation, 602e purchase/sale, 266–267 quotes, 120 Netflix example, 267f reading, 266 returns, 130 average annual stock returns, 278f risk, 509 share, value (equations), 347e, 349e, 352e, 356e speculative stocks, 276 spin-offs, 263, 265, 271 stock-index options, 614–621 valuation, 616 stock-price behavior over time, 351 symbol, verification, 144 technical measures, case problem, 413–414 tech stocks, 275 transaction costs, 266–267 Treasury stock, 265 types, 274–277 value stocks, price-to-book ratios, 361 Stocks analysts ethical conflicts, 348 recommendations, bias (absence), 127 Stock splits, 265 example, 265 Stocks valuation, 335 approaches, 355–359 models, 346–362 Stop-limit order, 142–143 Stop-loss order, 142–143 usage, 571 Street-name accounts, 103 Strike price, 589–590, 593–594, 603, 620 Student Loan Marketing Association, 435–436 Subcription services, 127 Subordinated debentures, 430, 440, 444 Substitution swaps, 493 Summary of Income and Capital Changes, 535 Survey of Current Business, 124 Survivorship bias, 509 Suspended orders, 142 Sweeteners, 589 Swiss Exchange, 90 Switch Inc IPO, 116–117 stock, trading, 117 Synthetic securities, 612 Tactical asset allocation, 552 Taiwan Stock Exchange Corp., 90 Tangible personal property, 37 Target prices, 343 INDEX Taxable equivalent yields, 438–440, 439t equations, 439 Taxable income, examples, 51, 52 Tax-advantaged retirement savings plans, 53 Taxation, sources, 49–50 Tax Cuts & Jobs Act (2017), 49, 298, 536 Taxes consequences, 572 efficiency, 532 investments, relationship, 53 planning, 53 reduction, 53, 550 tax swaps, 493–494 Tax-exempt money funds, 524 Tax-exempt municipal bonds, interest rates, 464 Tax-exempt returns, taxable equivalent yields, 439 Tax-free interest, 438 Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act (2010), 298 Technical analysis, 396–406 Technical measures, case problem, 413–414 Tech stocks, 275 Term to maturity, 426 Thaler, Richard, 374 Ticker symbols, confusion, 144 Times interest earned, 314–315, 314e Time to expiration, 602–603 Time value, 602–603 calculations, computational aids (usage), 196–197 computers/spreadsheets, usage, 197 Time value of money, 194 Tokyo Stock Exchange, 90 Toronto Stock Exchange, 90 Total asset turnover, 313, 313e Total returns, 352, 537 equation, 280e, 445e Total transaction costs, calculation, 82 Trading mechanics, 635 rules/measures, 399–402 strategies, 607–614 technical/service problems, 143–144 techniques, 649–652 volume, loss aversion (relationship), 389 Trading index (TRIN), 400–401 equation, 400e Traditional portfolio management approach, 230–231 modern portfolio management, contrast, 230–236, 250–251 MPT, reconciliation, 236 Trailing earnings, 359 Tranches, 442 Transactions costs, 144–145, 266–267 timing, 567–573 Transfer agent, role, 512 Transportation (corporate bond market), 440 Treasury bills (T-bills), 57 Treasury bonds, 434–435 active trading, 425 auction results, 434f historical annual yields/total returns, 422t Treasury Inflation-Protected Securities (TIPS), 435 Treasury issues, yield curves, 469f Treasury notes, 434 Treasury securities default risk, absence, 424, 468 rates, 464 Treasury stock, 265 Treynor equation, 564e Treynor, Jack L., 564 Treynor’s measure, 554–565, 563 Triangular averages, 403 Triple witching day, 650 Trump, Donald, 298 Two and twenty rule, 46 Two-plus-two schedule, 594 Tyco International, 91 Underreaction, 392–393 Undiversifiable risk, 233 United Press International (UPI), 124 United States annual IPO data, 74t housing indexes, 261f indexes, examples, 646 mutual funds, assets under management, 508f securities markets, viewpoint, 91–92 stock indexes, 261f United States stock market doubling, 257 milestone, 88 Unit investment trusts, 519 Universal Office Furnishings (UVRS) common-size income statement, 337t competitors, 323t dollar-based statement, 337t financial performance, forecast (development), 343–345 forecast statistics, 344t historical financial data, 344t Unlisted securities, 80 Unrealized capital gains, 537 Unrealized gains, example, 562t Unsecured debt, 430 Up-front fee, 510 U.S.-pay bonds, foreign-pay bonds (contrast), 444–445 Valuation, 336–346 models, 335 process, 345–346 properties, 597f Value effect, 386 funds, 522 phenomenon, behavioral explanation, 391–392 sources, 449 storehouse, 530 Value Line financial analysis source, 303 indexes, 135–136 Value Line Investment Survey, 127, 135, 532 Value stocks, price-to-book ratios, 361 Vanguard 500 Index fund, 506 Vanguard ETF, design, 217 Vanguard Global Equity Fund, securities, 508–509 Vanguard Group, 506 Vanguard S&P 500 Index fund, 509 Variable growth, 352–353 free cash flow, 357–358 model, 347 695 696 INDEX Variable-growth DVM application, 353 usage, 354t Variable-ratio plan, 570–571, 584 example, 570t Varner Industries, 96 Vertical spreads, 612 Volatility Index (VIX), 605 Volatility, option prices (relationship), 603–604 Voya Corporate Leaders Trust Fund (LEXCX), 525 Wall Street Journal (usage), 35, 123, 129, 136, 299, 359, 555 Walmart Stores Inc (WMT) correlation, 215 earnings per share, dividend payment, 272 individual/portfolio returns, 212t portfolios, 219f returns, 218t quarterly revenues, 375f retail sales percentage, 376 returns, standard deviation, 212t standard deviations, 218t stock price, 376f random behavior, 377 Warrants, 589 Wealth accumulation, 530, 572 investment, case problem, 371–372 Weather futures, 639 Weighted averages, 403 life, 486 Weil, Richard, 464 Wikinvest, 120 Window dressing, 231 Wise Bread (investment education site), 117 Wrap account (managed account), 140–141 Yahoo! Finance, 120, 555 report, example, 122f Yankee bonds, 91, 222 Yield curves, 467–472 inversion, example, 470 plotting, 468 shape, 470–471 steepness, 471–472 theories, 468–471 Treasury issue yield curves, 469f types, 467, 468f usage, 471–472 Yields current yield, 478 finding, 480–481 increase, 467 measures, 477–484 Yield spread, 420–421 records, 435 Yield to call (YTC), 481–484 precision, 482–483 Yield to maturity (YTM), 478–484, 487 precision, 482–483 York Water Company, dividend (raising), 269 YTC See Yield to call Zacks Equity Research report, 210 Zacks stock screener, 120f Zero-coupon bonds, 441–442 build-in price appreciation, 448 yield, finding, 480–481 Zero-coupon securities, 441 Zero growth, 347–348 model, 347 Key Equations Equation 2.1 Equation 2.1a Equation 2.2 Margin = = Value of securities - Debit balance Value of securities V - D V Total Total Market Market current interest value of value of + income paid on securities securities Return on received margin loan at sale at purchase invested capital = from a margin Amount of equity at purchase transaction Equation 4.1 Required return Real rate Expected inflation Risk premium = + + on investment j of return premium for investment j Equation 4.2 Risk@free rate = Equation 4.3 Required return Risk@free Risk premium = + on investment j rate for investment j Equation 4.4 Equation 4.5 Equation 4.6 Equation 5.1 Real rate Expected inflation + of return premium Income Capital gain (or loss) + during period during period Holding period return = Beginning investment value Capital gain (or loss) Ending Beginning = during period investment value investment value n Return for Average or a a outcome t - expected return b t=1 Standard deviation = Total number - b of outcomes Proportion of , portfolio s total Return Portfolio = • dollar value * on asset µ Return invested in asset + Proportion of , portfolio s total Return • dollar value * on asset µ + Á + invested in asset Proportion of Proportion of , , portfolio s total Return portfolio s total Return n • dollar value * on asset = a ã dollar value * on asset µ j=1 invested in n invested in j asset n asset j Equation 5.2 Equation 5.3 Total risk = Diversifiable risk + Undiversifiable risk Expected return Beta for Expected market Risk@free = Risk@free + c * a bd on investment j investment j return rate rate Key Equations Equation 5.4 Proportion of Beta , Portfolio portfolio s total = ± * for ≤ beta dollar value asset in asset + Proportion of Beta , portfolio s total ± * for ≤ + Á + dollar value asset in asset Proportion of Proportion of Beta Beta , , n portfolio s total portfolio s total ± * for ≤ = a ± * for ≤ dollar value dollar value j=1 asset n asset j in asset n in asset j Equation 6.1 Net profit - Preferred dividends after taxes EPS = Number of shares of common stock outstanding Annual dividends received per share Current market price of the stock Equation 6.2 Dividend yield = Equation 6.3 Dividend payout ratio = Equation 6.4 Equation 6.5 Dividends per share Earnings per share Total returns Current income Capital gains Changes in currency = + { 1in U.S dollars 1dividends 1or losses exchange rates Returns from current Returns from Total return = income and capital gains { changes in currency 1in U.S dollars 1in local currency2 exchange rates Equation 6.6 Exchange rate Ending value of Amount of dividends at end of stock in foreign + received in holding period currency foreign currency Total return W -1 = G * (in U.S dollars) Beginning value of stock Exchange rate in foreign currency at beginning of holding period Equation 7.1 Current ratio = Equation 7.2 Quick ratio = Equation 7.3 Net working capital = Current assets - Current liabilities Equation 7.4 Accounts receivable turnover = Equation 7.5 Inventory turnover = Current assets Current liabilities Current assets - inventory Current liabilities Sales revenue Accounts receivable Sales revenue Inventory Key Equations Sales revenue Total asset Equation 7.6 Total asset turnover = Equation 7.7 Debt@equity ratio = Long@term debt Stockholders’ equity Equation 7.8 Equity multiplier = Total assets Stockholders’ equity Equation 7.9 Times interest earned = Equation 7.10 Net profit margin = Equation 7.11 ROA = Net profit after taxes Total assets Equation 7.12 ROE = Net profit after taxes Stockholders’ equity Equation 7.13 ROA = Net profit margin * Total asset turnover Equation 7.14 ROE = ROA * Equity multiplier Equation 7.15 ROE = ROA * Equity multiplier = 1Net profit margin * Total asset turnover * Equity multiplier Equation 7.16 P>E = Earnings before interest and taxes Interest expense Net profit after taxes Sales revenue Price of common stock EPS Stock’s P > E ratio Equation 7.17 PEG ratio = Equation 7.18 Dividends per share = Equation 7.19 Dividend payout ratio = Equation 7.20 Book value per share = Equation 7.21 Price@to@book@value = Equation 8.1 Future after@tax earnings in year t 3@ to 5@year growth rate in earnings = Annual dividends paid to common stock Number of common shares outstanding Dividends per share Earnings per share Stockholders’ equity Number of common shares outstanding Market price of common stock Book value per share Estimated sales in year t * Net profit margin expected in year t Key Equations Equation 8.2 Future after@tax earnings in year t Estimated EPS = in year t Number of shares of common stock outstanding in year t Equation 8.3 EPS = Equation 8.4 Estimated dividends Estimated EPS Estimated = * per share in year t for year t payout ratio Equation 8.5 Estimated share price Estimated EPS Estimated P/E = * at end of year t in year t ratio Equation 8.6 , Required Risk@free Stock s Market Risk@free bd = + c * a rate of return rate rate beta return After@tax earnings Book value of equity * = ROE * Book value per share Book value of equity Shares outstanding Equation 8.7 Value of a Annual dividends = Required rate of return share of stock Equation 8.8 , Next year s dividends Value of a = Required rate Dividend growth share of stock of return rate Equation 8.9 Value of a share = of stock Equation 8.10 Present value of Present value of the price future dividends + of the stock at the end of during the initial the variable@growth period variable@growth period , g = ROE * The firm s retention rate, rr Equation 8.10a rr = - Dividend payout ratio Equation 8.11 Value of a share of stock = Equation 8.12 Stock price = EPS * P>E ratio Equation 8.13 P/CF ratio = Equation 8.14 P/S ratio = Equation 9.1 Abnormal return (or alpha) = Actual return - Expected return Equation 9.3 present value of future free cash flows going to equity shares outstanding Free cash flow = after@tax earnings + depreciation - investments in working capital - investments in fixed assets Market price of common stock Cash flow per share Market price of common stock Sales per share Average yield on 10 high - grade corporate bonds Confidence = index Average yield on 10 intermediate - grade bonds Key Equations Number of up stocks Volume in up stocks , Number of down stocks Volume in down stocks Equation 9.4 TRIN = Equation 9.5 MFCR = Mutual fund cash position , Total assets under management Equation 9.6 RSI = 100 - c 100 , a1 + Equation 10.1 Taxable equivalent yield = Equation 10.2 Average price change on up days bd Average price change on down days Yield on municipal bond - Marginal federal tax rate Taxable equivalent yield Municipal bond yield for both federal and = - 3Federal tax rate + State tax rate (1 - Federal tax rate) state taxes Equation 10.3 Exchange rate Ending value of Amount of interest at end of bond in foreign + received in holding period currency foreign currency Total return * = G W - 1.00 Beginning value of bond Exchange rate (in U S dollars) in foreign currency at beginning of holding period Equation 10.4 Conversion value = Conversion ratio * Current market price of the stock Equation 10.5 Conversion equivalent = Equation 10.6 Conversion premium (in +) = Equation 10.7 Conversion premium (in ,) = Equation 10.8 Payback period = Equation 11.2 BPi = Current market price of the convertible bond Conversion ratio Current market price Conversion of the convertible bond value Conversion premium (in +) Conversion value Conversion premium (in $) Annual dividend Annual interest income from the income from the convertible bond underlying common stock Present value of Present value of + coupon payments bond>s par value Equation 11.2a N PVN C BPi = a t + (1 + ri)N t = (1 + ri) Equation 11.4 Bond price (with semi@ Present value of the annuity of Present value of the = + annual compounding) semiannual coupon payments bond>s par value Equation 11.4a BPi = C>2 a1 + ri b + C>2 a1 + ri b 2 + g + C>2 a1 + ri b 2N + +1,000 ri 2N a1 + b Key Equations Equation 11.5 Current yield = Annual interest income Current market price of the bond Equation 11.6 BPi = +1,204 = +105 +105 +105 +105 +105 +1085 + + + + + (1 + ri) (1 + ri)5 (1 + ri) (1 + ri) (1 + ri) (1 + ri) Equation 11.7 Present value of the bond>s Present value of the bond>s Bond price = annual coupon payments + future price at the end over the holding period of the holding period Equation 11.7a BPi = Equation 11.8 Duration = a c Equation 11.9 Modified duration = Equation 11.10 Percent change = -1 * Modified duration * Change in interest rates in bond price Equation 11.11 ED = Equation 12.1 Premium (or discount) = (Share price - NAV) , NAV Equation 12.2 Equation 13.1 C C C FV + + g + + (1 + ri)N (1 + ri)N (1 + ri)1 (1 + ri)2 N t=1 (Macaulay) Duration in years + Yield to maturity BP(ri T) - BP(ri c ) * BP * ∆ri Holding period return = Number of Number of Ending Initial ° shares at end * ¢ - ° shares at beginning * ¢ price price of period of period Number of shares Initial ° at beginning of * ¢ price period Current income Capital gain (or loss) + during period during period Holding period return = Beginning investment value Equation 13.1a HPR = Equation 13.2 PV(Ct) * td BP C + CG V0 Capital gain (or loss) Ending Beginning = during period investment value investment value Equation 13.2a CG = Vn - V0 Equation 13.3 Dividends and Realized Unrealized Holding interest + + gain gain period received = Number of Number of months return for Initial months in Withdrawn a portfolio equity +± ≤ - ± ≤ portfolio form portfolio investment New Withdrawn * * funds 12 funds 12 Key Equations Equation 13.3a HPRp = Equation 13.4 Sharpe>s measure = Equation 13.4a SM = Equation 13.5 Total portfolio return - Risk@free rate Standard deviation of portfolio return rp - rf sp Treynor>s measure = Equation 13.5a TM = Equation 13.6 C + RG + UG ip wp E0 + aNF * b - aWF * b 12 12 Total portfolio return - Risk@free rate Portfolio beta rp - rf bp Jensen>s measure = 1Total portfolio return - Risk@free rate2 3portfolio beta * (Market return - Risk@free rate) Equation 13.6a JM = (rp - rf) - 3bp * (rm - rf) Equation 14.1 Intrinsic value of a call = (Stock price - Strike price) * 100 or 0, whichever is greater Equation 14.2 Intrinsic value of a put = (Strike price - Stock price) * 100 or 0, whichever is greater Equation 14.3 Price of a put option + Price of a stock = Price of a call option + Price of a risk@free bond Equation 14.4 Call price = SN(d1) - PV(X)N(d2) Ina Equation 14.4a d1 = S s2 b + ar + bT X s2T Equation 14.4b d2 = d1 - s2T Equation 15.1 Return on invested capital = Selling price of Purchase price of commodity contract commodity contract Amount of margin deposit This page intentionally left blank GLOBAL EDITION This is a special edition of an established title widely used by colleges and universities throughout the world Pearson published this exclusive edition for the benefit of students outside the United States and Canada If you purchased this book within the United States or Canada, you should be aware that it has been imported without the approval of the Publisher or Author In the turbulent post-2008 financial environment, the importance of understanding the risks of investing and answering the fundamental questions that help shape a sound investment strategy is more crucial than ever The fourteenth edition of Fundamentals of Investing continues to deconstruct the mechanics of assessing prices in order to make informed investment decisions This textbook first makes students conversant in the language of investing by breaking down essential concepts It then builds on this foundation by guiding students into developing investment strategies, assessing the risk and return of different types of portfolios as well as individual securities, and tracking their performance New to This Edition • Revised chapter openers and related end-of-chapter problems help students see the real-world application of chapter content • Expanded use of real-world data in examples, tables, figures, and end-of-chapter problems helps students learn skills that can be used in both their personal and professional lives • New and updated Investor Facts boxes provide depth and breadth to investment concepts and reinforce their importance in the real world • Revised end-of-chapter problems using interest rates, stock prices, and other values better reflect market conditions Also available for purchase is MyLab Finance, a collection of online homework, tutorial, and assessment products designed to improve results It includes author videos that introduce the main ideas of each chapter, all end-of-chapter problems for practice and assignment, auto-graded Excel projects, and other learning tools ... States edition, entitled Fundamentals of Investing, 14th Edition, ISBN 978-0-13-517521-7 by Scott B Smart and Chad J Zutter, published by Pearson Education © 2020 All rights reserved No part of this... is reshaping the world of investing is the growing globalization of securities markets As a result, Fundamentals of Investing continues to stress the global aspects of investing We initially... aspects of investing Building on that foundation, they can learn how to make informed decisions in the highly dynamic investment environment This fourteenth edition of Fundamentals of Investing