Fundamentals of Investments: Valuation and Management, 8th Edition PDF by Bradford D. Jordan, Thomas W. Miller Jr. and Steven D. Dolvin

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Fundamentals of Investments: Valuation and Management, Eighth Edition

By Bradford D. Jordan, Thomas W. Miller Jr. and Steven D. Dolvin

Fundamentals of Investments 8th Edition

Contents:

PART ONE Introduction 1

1. A Brief History of Risk and Return 1

1.1 Returns 2

Dollar Returns 2

Percentage Returns 4

A Note on Annualizing Returns 5

1.2 The Historical Record 7

A First Look 7

A Longer Range Look 8

A Closer Look 9

2008: The Bear Growled and Investors

Howled 12

1.3 Average Returns: The First Lesson 14

Calculating Average Returns 15

Average Returns: The Historical

Record 15

Risk Premiums 15

The First Lesson 16

1.4 Return Variability: The Second Lesson 17

Frequency Distributions and Variability 17

The Historical Variance and Standard

Deviation 18

The Historical Record 20

Normal Distribution 20

The Second Lesson 22

1.5 More on Average Returns 24

Arithmetic Versus Geometric

Averages 24

Calculating Geometric Average

Returns 25

Arithmetic Average Return or Geometric

Average Return? 27

Dollar-Weighted Average Returns 28

1.6 Risk and Return 30

The Risk-Return Trade-Off 30

A Look Ahead 31

1.7 Summary and Conclusions 31

  1. The Investment Process 41

2.1 The Investment Policy Statement 42

Objectives: Risk and Return 42

Investor Constraints 42

Strategies and Policies 45

2.2 Investment Professionals 47

Choosing a Broker/Advisor 47

Online Brokers 48

Investor Protection 48

Broker–Customer Relations 49

2.3 Types of Accounts 50

Cash Accounts 50

Margin Accounts 50

Annualizing Returns on a Margin

Purchase 54

Hypothecation and Street Name

Registration 55

Retirement Accounts 56

2.4 Types of Positions 57

Basics of a Short Sale 57

Short Sales: Some Details 58

Short-Sale Constraints 61

2.5 Forming an Investment Portfolio 63

Some Risk Tolerance Scores 63

Risk and Return 63

Investor Constraints 64

Strategies and Policies 64

More on Asset Allocation 65

Reits 65

2.6 Summary and Conclusions 66

  1. Overview of Security Types 75

3.1 Classifying Securities 76

3.2 Interest-Bearing Assets 76

Money Market Instruments 76

Fixed-Income Securities 78

3.3 Equities 80

Common Stock 80

Preferred Stock 81

Common Stock Price Quotes 82

3.4 Derivatives 85

Futures Contracts 85

Futures Price Quotes 86

Gains and Losses On Futures Contracts 88

3.5 Option Contracts 88

Option Terminology 88

Options Versus Futures 89

Option Price Quotes 89

Gains and Losses on Option

Contracts 90

Investing In Stocks Versus Options 91

3.6 Summary and Conclusions 92

  1. Mutual Funds and Other Investment

Companies 100

4.1 Advantages and Drawbacks of Mutual

Fund Investing 101

Advantages 101

Drawbacks 102

4.2 Investment Companies and Fund

Types 102

Open-End Versus Closed-End Funds 102

Net Asset Value 103

4.3 Mutual Fund Operations 104

Mutual Fund Organization and

Creation 104

Taxation of Investment Companies 105

The Fund Prospectus and Annual

Report 105

Mutual Fund Transactions 105

4.4 Mutual Fund Costs and Fees 106

Types of Expenses And Fees 106

Expense Reporting 108

Why Pay Loads and Fees? 110

The Impact of Fees on Portfolio

Values 110

4.5 Short-Term Funds 111

Money Market Mutual Funds 111

Money Market Deposit Accounts 113

4.6 Long-Term Funds 113

Stock Funds 113

Taxable and Municipal Bond Funds 115

Stock and Bond Funds 117

Mutual Fund Objectives: Recent

Developments 118

4.7 Mutual Fund Performance 121

Mutual Fund Performance

Information 121

How Useful Are Fund Performance

Ratings? 121

4.8 Closed-End Funds, Exchange-Traded

Funds, and Hedge Funds 124

Closed-End Funds Performance

Information 124

The Closed-End Fund Discount

Mystery 125

Exchange-Traded Funds 125

Hedge Funds 130

4.9 Summary and Conclusions 133

PART TWO Stock Markets 142

  1. The Stock Market 142

5.1 Private Equity versus Selling Securities

to the Public 143

Private Equity 143

The Structure of Private Equity Funds 143

Types of Private Equity Funds 144

Selling Securities to The Public 145

The Primary Market for Common

Stock 145

The Secondary Market for Common

Stock 148

Dealers and Brokers 148

5.2 The New York Stock Exchange 151

NYSE Membership History 151

Designated Market Makers 151

Other NYSE Participants 152

The NYSE Hybrid Market 152

NYSE-Listed Stocks 153

5.3 Operation of the New York Stock

Exchange 153

NYSE Floor Activity 154

Special Order Types 155

5.4 NASDAQ 158

Nasdaq Operations 159

Nasdaq Participants 159

5.5 NYSE and NASDAQ Competitors 160

5.6 Stock Market Information 160

The Dow Jones Industrial Average 160

Stock Market Indexes 162

More on Price-Weighted Indexes 166

The Dow Jones Divisors 167

More on Index Formation: Base-Year

Values 167

5.7 Summary and Conclusions 168

  1. Common Stock Valuation 177

6.1 Security Analysis: Be Careful Out

There 178

6.2 The Dividend Discount Model 178

Constant Perpetual Growth 179

Historical Growth Rates 181

The Sustainable Growth Rate 183

Analyzing Roe 184

6.3 The Two-Stage Dividend Growth

Model 186

Nonconstant Growth in the First Stage 188

The H-Model 190

Discount Rates for Dividend Discount

Models 190

Observations on Dividend Discount

Models 191

6.4 The Residual Income Model 191

Residual Income 192

The Rim versus the Constant Growth

Ddm 192

6.5 The Free Cash Flow Model 194

Free Cash Flow 194

The FCF Model versus the Constant

Growth Ddm 195

6.6 Price Ratio Analysis 197

Price-Earnings Ratios 197

Price-Cash Flow Ratios 198

Price-Sales Ratios 198

Price-Book Ratios 198

Applications of Price Ratio Analysis 199

Enterprise Value Ratios 200

6.7 An Analysis of the E. I. du Pont Company 201

Using the Dividend Discount Model 202

Using the Residual Income Model 204

Using the Free Cash Flow Model 204

Using Price Ratio Analysis 206

6.8 Summary and Conclusions 208

  1. Stock Price Behavior and Market Efficiency 220

7.1 Introduction to Market Efficiency 221

7.2 What Does “Beat the Market” Mean? 221

7.3 Foundations of Market Efficiency 221

7.4 Forms of Market Efficiency 222

7.5 Why Would a Market Be Efficient? 223

7.6 Some Implications of Market

Efficiency 224

Does Old Information Help Predict Future

Stock Prices? 224

Random Walks and Stock Prices 224

How Does New Information Get Into Stock Prices? 225

Event Studies 225

7.7 Informed Traders and Insider

Trading 228

Informed Trading 228

Insider Trading 228

7.8 How Efficient Are Markets? 230

Are Financial Markets Efficient? 230

Some Implications of Market

Efficiency 231

7.9 Market Efficiency and the Performance

of Professional Money Managers 232

7.10 Anomalies 235

The Day-of-the-Week Effect 235

The Amazing January Effect 235

Turn-of-the-Year Effect 238

Turn-of-the-Month Effect 238

The Earnings Announcement Puzzle 239

The Price-Earnings (P/E) Puzzle 239

7.11 Bubbles and Crashes 239

The Crash of 1929 239

The Crash of October 1987 241

The Asian Crash 243

The “Dot-Com” Bubble and Crash 243

The Crash of October 2008 244

7.12 Summary and Conclusions 246

  1. Behavioral Finance and the Psychology

of Investing 254

8.1 Introduction to Behavioral Finance 255

8.2 Prospect Theory 255

Frame Dependence 256

Loss Aversion 257

Mental Accounting and House

Money 258

8.3 Overconfidence 259

Overconfidence and Trading

Frequency 259

Overtrading and Gender: “It’s (Basically) a Guy Thing” 260

What Is a Diversified Portfolio to the

Everyday Investor? 260

Illusion of Knowledge 260

Snakebite Effect 261

8.4 Misperceiving Randomness and

Overreacting to Chance Events 262

The “Hot-Hand” Fallacy 264

The Gambler’s Fallacy 265

 

8.5 More on Behavioral Finance 266

Heuristics 266

Herding 266

How Do We Overcome Bias? 267

8.6 Sentiment-Based Risk and Limits to

Arbitrage 268

Limits to Arbitrage 268

The 3Com/Palm Mispricing 268

The Royal Dutch/Shell Price Ratio 269

8.7 Technical Analysis 270

Why Does Technical Analysis Continue

to Thrive? 270

Dow Theory 271

Elliott Waves 272

Support and Resistance Levels 272

Technical Indicators 273

Relative Strength Charts 275

Charting 276

Fibonacci Numbers 281

Other Technical Indicators 282

8.8 Summary and Conclusions 283

PART THREE Interest Rates and Bond

Valuation 295

  1. Interest Rates 295

9.1 Interest Rate History and Money Market

Rates 296

Interest Rate History 296

Money Market Rates 298

9.2 Money Market Prices and Rates 301

Bank Discount Rate Quotes 302

Treasury Bill Quotes 303

Bank Discount Yields versus Bond

Equivalent Yields 304

Bond Equivalent Yields, APRs, and

EARs 306

9.3 Rates and Yields on Fixed-Income

Securities 308

The Treasury Yield Curve 308

Rates on Other Fixed-Income

Investments 309

9.4 The Term Structure of Interest Rates 312

Treasury Strips 312

Yields For U.S. Treasury Strips 314

9.5 Nominal versus Real Interest Rates 315

Real Interest Rates 315

The Fisher Hypothesis 315

Inflation-Indexed Treasury Securities 316

9.6 Traditional Theories of the Term

Structure 317

Expectations Theory 317

Maturity Preference Theory 320

Market Segmentation Theory 320

9.7 Determinants of Nominal Interest Rates:

A Modern Perspective 321

Problems with Traditional Theories 321

Modern Term Structure Theory 321

Liquidity and Default Risk 323

9.8 Summary and Conclusions 323

  1. Bond Prices and Yields 332

10.1 Bond Basics 333

Straight Bonds 333

Coupon Rate and Current Yield 333

10.2 Straight Bond Prices and Yield to

Maturity 334

Straight Bond Prices 334

Premium and Discount Bonds 336

Relationships among Yield

Measures 338

A Note on Bond Price Quotes 338

10.3 More on Yields 340

Calculating Yields 340

Yield to Call 341

Using a Financial Calculator 343

10.4 Interest Rate Risk and Malkiel’s

Theorems 345

Promised Yield And Realized Yield 345

Interest Rate Risk and Maturity 345

Malkiel’s Theorems 346

10.5 Duration 348

Macaulay Duration 348

Modified Duration 348

Calculating Macaulay Duration 349

Properties of Duration 351

10.6 Bond Risk Measures Based on

Duration 352

Dollar Value of An 01 352

Yield Value of A 32nd 352

10.7 Dedicated Portfolios and Reinvestment

Risk 353

Dedicated Portfolios 353

Reinvestment Risk 354

10.8 Immunization 356

Price Risk versus Reinvestment Rate

Risk 356

Immunization by Duration Matching 356

Dynamic Immunization 357

10.9 Summary and Conclusions 358

PART FOUR Portfolio Management 368

  1. Diversification and Risky Asset

Allocation 368

11.1 Expected Returns and Variances 369

Expected Returns 369

Calculating the Variance of Expected

Returns 371

11.2 Portfolios 372

Portfolio Weights 372

Portfolio Expected Returns 373

Portfolio Variance of Expected

Returns 374

11.3 Diversification and Portfolio Risk 375

The Effect of Diversification: Another

Lesson From Market History 375

The Principle of Diversification 377

The Fallacy of Time Diversification 377

11.4 Correlation and Diversification 380

Why Diversification Works 380

Calculating Portfolio Risk 381

The Importance of Asset Allocation,

Part 1 383

More On Correlation and the Risk-Return

Trade-Off 385

11.5 The Markowitz Efficient Frontier 387

The Importance of Asset Allocation,

Part 2 387

11.6 Summary and Conclusions 390

  1. Return, Risk, and the Security Market

Line 401

12.1 Announcements, Surprises, and Expected

Returns 402

Expected and Unexpected Returns 402

Announcements and News 402

12.2 Risk: Systematic and Unsystematic 404

Systematic and Unsystematic Risk 404

Systematic and Unsystematic Components

Of Return 405

12.3 Diversification, Systematic Risk, and

Unsystematic Risk 406

Diversification and Unsystematic

Risk 406

Diversification and Systematic Risk 406

12.4 Systematic Risk and Beta 407

The Systematic Risk Principle 407

Measuring Systematic Risk 407

Portfolio Betas 409

12.5 The Security Market Line 410

Beta And The Risk Premium 410

The Reward-To-Risk Ratio 411

The Basic Argument 411

The Fundamental Result 413

The Security Market Line 415

12.6 More on Beta 417

A Closer Look At Beta 418

Where Do Betas Come From? 419

Another Way to Calculate Beta 421

Why Do Betas Differ? 423

12.7 Extending CAPM 424

A (Very) Brief History of Testing

CAPM 424

The Fama-French Three-Factor

Model 425

12.8 Summary and Conclusions 426

  1. Performance Evaluation and Risk

Management 435

13.1 Performance Evaluation 436

Performance Evaluation Measures 436

The Sharpe Ratio 437

The Treynor Ratio 438

Jensen’s Alpha 438

Another Method to Calculate Alpha 439

Information Ratio 442

R-Squared 442

13.2 Comparing Performance Measures 443

Global Investment Performance

Standards 445

Sharpe-Optimal Portfolios 446

13.3 Investment Risk Management 448

Value-at-Risk 449

13.4 More on Computing Value-at-Risk 450

13.5 Summary and Conclusions 452

PART FIVE Futures and Options 460

  1. Futures Contracts 460

14.1 Futures Contracts Basics 461

Modern History of Futures

Trading 461

Futures Contract Features 462

Futures Prices 463

14.2 Why Futures? 466

Speculating with Futures 466

Hedging with Futures 467

14.3 Futures Trading Accounts 471

14.4 Cash Prices versus Futures Prices 473

Cash Prices 473

Cash-Futures Arbitrage 473

Spot-Futures Parity 475

More on Spot-Futures Parity 476

14.5 Stock Index Futures 477

Basics of Stock Index Futures 477

Index Arbitrage 478

Hedging Stock Market Risk With

Futures 479

Hedging Interest Rate Risk With

Futures 480

Futures Contract Delivery Options 481

14.6 Summary and Conclusions 482

  1. Stock Options 491

15.1 Options on Common Stocks 492

Option Basics 492

Option Price Quotes 493

15.2 The Options Clearing Corporation 495

15.3 Why Options? 496

15.4 Stock Index Options 497

Index Options: Features and

Settlement 498

Index Option Price Quotes 498

15.5 Option Intrinsic Value and

“Moneyness” 499

Intrinsic Value for Call Options 499

Intrinsic Value for Put Options 500

Time Value 500

Three Lessons About Intrinsic Value 501

Show Me The Money 501

15.6 Option Payoffs and Profits 502

Option Writing 502

Option Payoffs 503

Option Payoff Diagrams 503

Option Profit Diagrams 504

15.7 Using Options to Manage Risk 506

The Protective Put Strategy 506

Credit Default Swaps 507

The Protective Put Strategy and Corporate

Risk Management 508

Using Call Options in Corporate Risk

Management 508

15.8 Option Trading Strategies 509

The Covered Call Strategy 509

Spreads 510

Combinations 511

15.9 Arbitrage and Option Pricing Bounds 512

The Upper Bound for Call Option

Prices 512

The Upper Bound for Put Option

Prices 512

The Lower Bounds for Call and Put Option

Prices 513

15.10 Put-Call Parity 515

Put-Call Parity with Dividends 517

What Can We Do with Put-Call

Parity? 517

15.11 Summary and Conclusions 519

PART SIX Topics in Investments 529

  1. Option Valuation 529

16.1 A Simple Model to Value Options before

Expiration 530

16.2 The One-Period Binomial Option Pricing

Model 531

The One-Period Binomial Option Pricing

Model—The Assumptions 531

The One-Period Binomial Option Pricing

Model—The Setup 531

The One-Period Binomial Option Pricing

Model—The Formula 532

What Is Delta? 534

16.3 The Two-Period Binomial Option Pricing

Model 534

Step 1: Build a Price Tree for Stock Prices

Through Time 535

Step 2: Use the Intrinsic Value Formula

to Calculate the Possible Option Prices at

Expiration 535

Step 3: Calculate The Fractional Share

Needed to Form Each Risk-Free Portfolio

at the Next-to-Last Date 536

Step 4: Calculate All Possible Option

Prices at the Next-to-Last Date 537

Step 5: Repeat This Process by Working

Back to Today 537

16.4 The Binomial Option Pricing Model with

Many Periods 538

16.5 The Black-Scholes Option Pricing

Model 540

16.6 Varying the Option Price Input Values 542

Varying the Underlying Stock Price 543

Varying the Option’s Strike Price 543

Varying the Time Remaining Until Option

Expiration 543

Varying the Volatility of the Stock

Price 544

Varying the Interest Rate 544

16.7 Measuring the Impact of Stock Price

Changes on Option Prices 545

Interpreting Option Deltas 546

16.8 Hedging Stock with Stock Options 547

Hedging Using Call Options—The

Prediction 548

Hedging Using Call Options—The

Results 548

Hedging Using Put Options—The

Prediction 548

Hedging Using Put Options—The

Results 549

16.9 Hedging a Stock Portfolio with Stock

Index Options 549

16.10 Implied Standard Deviations 551

CBOE Implied Volatilities for Stock

Indexes 552

16.11 Employee Stock Options 553

ESO Features 553

ESO Repricing 553

ESOs at the Gap, Inc. 554

Valuing Employee Stock Options 554

16.12 Summary and Conclusions 555

  1. Projecting Cash Flow and Earnings 565

17.1 Sources of Financial Information 566

17.2 Financial Statements 566

The Balance Sheet 567

The Income Statement 569

The Cash Flow Statement 570

Performance Ratios and Price Ratios 571

17.3 Financial Statement Forecasting 573

The Percentage of Sales Approach 573

The Pro Forma Income Statement 573

The Pro Forma Balance Sheet 574

Scenario One 576

Scenario Two 576

Projected Profitability and Price

Ratios 579

17.4 Starbucks Corporation Case Study 579

Pro Forma Income Statement 581

Pro Forma Balance Sheet 582

Valuing Starbucks Using Ratio

Analysis 585

Valuing Starbucks Using a Two-Stage

Dividend Growth Model 586

Valuing Starbucks: What Does the Market

Say? 587

17.5 Summary and Conclusions 587

  1. Corporate and Government Bonds 599

18.1 Corporate Bond Basics 600

18.2 Corporate Bond Indentures 601

Bond Seniority Provisions 602

Call Provisions 602

Put Provisions 605

Bond-to-Stock Conversion Provisions 605

Graphical Analysis of Convertible Bond

Prices 607

Bond Maturity and Principal Payment

Provisions 608

Sinking Fund Provisions 609

Coupon Payment Provisions 609

Protective Covenants 610

Adjustable-Rate Bonds 610

18.3 Government Bond Basics 611

18.4 U.S. Treasury Bills, Notes, Bonds,

and STRIPS 612

Treasury Bond and Note Prices 615

Treasury Inflation-Protected

Securities 617

18.5 U.S. Treasury Auctions 619

18.6 Federal Government Agency

Securities 619

18.7 Municipal Bonds 621

Municipal Bond Features 622

Types of Municipal Bonds 622

Municipal Bond Insurance 624

Equivalent Taxable Yield 624

Taxable Municipal Bonds 625

18.8 Bond Credit Ratings 625

Why Bond Ratings Are Important 627

An Alternative to Bond Ratings 627

Junk Bonds 628

18.9 Summary and Conclusions 630

  1. Global Economic Activity and Industry

Analysis 640

19.1 Top-Down Analysis 641

19.2 Global Macroeconomic Activity 642

Real GDP 642

Business Cycles 643

Economic Indicators 645

The Global Economy and Stock Return

Correlations 645

The Effects of Exchange Rates on Global

Investments 646

19.3 Monitoring Jobs and the Price Level 647

Labor Market Indicators 647

The Consumer Price Index 648

19.4 Monetary and Fiscal Policy 649

Monetary Policy 649

Fiscal Policy 651

19.5 Industry Analysis 652

Identifying Sectors 652

Porter’s Five Forces 655

19.6 Summary and Conclusions 656

  1. Mortgage-Backed Securities 663

20.1 A Brief History of Mortgage-Backed

Securities 664

20.2 Fixed-Rate Mortgages 664

Fixed-Rate Mortgage Amortization 665

Fixed-Rate Mortgage Prepayment

and Refinancing 667

20.3 Government National Mortgage

Association 671

GNMA Clones 671

20.4 Public Securities Association Mortgage

Prepayment Model 672

20.5 Cash Flow Analysis of GNMA Fully

Modified Mortgage Pools 674

Macaulay Durations for GNMA

Mortgage-Backed Bonds 675

20.6 Collateralized Mortgage Obligations 677

Interest-Only and Principal-Only Mortgage

Strips 678

Sequential Collateralized Mortgage

Obligations 680

Protected Amortization Class Bonds 682

20.7 Yields for Mortgage-Backed Securities and

Collateralized Mortgage Obligations 684

20.8 Summary and Conclusions 685

APPENDICES

A Answers to Test Your Investment Quotient

Questions 693

B Answers to Selected Questions and

Problems 697

C Key Equations 699

Name Index 703

Equations Index 705

Subject Index 708

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