## Investments, Eleventh Edition

By Zvi Bodie, Alex Kane and Alan J. Marcus

**Contents:**

Preface xvi

Part-I

Introduction 1

Chapter 1

The Investment Environment 1

1.1 Real Assets versus Financial Assets 2

1.2 Financial Assets 3

1.3 Financial Markets and the Economy 5

The Informational Role of Financial Markets /

Consumption

Timing / Allocation of Risk / Separation of

Ownership and Management / Corporate Governance

and Corporate Ethics

1.4 The Investment Process 8

1.5 Markets Are Competitive 9

The Risk–Return Trade-Off / Efficient Markets

1.6 The Players 11

Financial Intermediaries / Investment Bankers / Venture

Capital and Private Equity

1.7 The Financial Crisis of 2008 15

Antecedents of the Crisis / Changes in Housing Finance /

Mortgage Derivatives / Credit Default Swaps / The Rise of

Systemic Risk / The Shoe Drops / The Dodd-Frank Reform Act

1.8 Outline of the Text 23

End of Chapter Material 23–26

Chapter 2

Asset Classes and Financial Instruments 27

2.1 The Money Market 27

Treasury Bills / Certificates of Deposit / Commercial

Paper / Bankers’ Acceptances / Eurodollars / Repos

and Reverses / Federal Funds / Brokers’ Calls /

The LIBOR Market / Yields on Money Market

Instruments

2.2 The Bond Market 33

Treasury Notes and Bonds / Inflation-Protected Treasury

Bonds / Federal Agency Debt / International Bonds /

Municipal Bonds / Corporate Bonds / Mortgages and

Mortgage-Backed Securities

2.3 Equity Securities 40

Common Stock as Ownership Shares / Characteristics of

Common Stock / Stock Market Listings / Preferred Stock /

Depositary Receipts

2.4 Stock and Bond Market Indexes 43

Stock Market Indexes / Dow Jones Industrial Average /

The Standard & Poor’s 500 Index / Other U.S. Market-

Value Indexes / Equally Weighted Indexes / Foreign

and International Stock Market Indexes / Bond Market

Indicators

2.5 Derivative Markets 50

Options / Futures Contracts

End of Chapter Material 52–56

Chapter 3

How Securities Are Traded 57

3.1 How Firms Issue Securities 57

Privately Held Firms / Publicly Traded Companies /

Shelf Registration / Initial Public Offerings

3.2 How Securities Are Traded 62

Types of Markets

Direct Search Markets / Brokered Markets / Dealer

Markets / Auction Markets

Types of Orders

Market Orders / Price-Contingent Orders

Trading Mechanisms

Dealer Markets / Electronic Communication Networks

(ECNs) / Specialist Markets

3.3 The Rise of Electronic Trading 66

3.4 U.S. Markets 68

NASDAQ / The New York Stock Exchange / ECNs

3.5 New Trading Strategies 70

Algorithmic Trading / High-Frequency Trading / Dark

Pools / Bond Trading

3.6 Globalization of Stock Markets 73

3.7 Trading Costs 74

3.8 Buying on Margin 75

3.9 Short Sales 78

3.10 Regulation of Securities Markets 82

Self-Regulation / The Sarbanes-Oxley Act / Insider

Trading

End of Chapter Material 86–90

Chapter 4

Mutual Funds and Other Investment

Companies 91

4.1 Investment Companies 91

4.2 Types of Investment Companies 92

Unit Investment Trusts / Managed Investment Companies /

Other Investment Organizations

Commingled Funds / Real Estate Investment Trusts

(REITs) / Hedge Funds

4.3 Mutual Funds 95

Investment Policies

Money Market Funds / Equity Funds / Sector

Funds / Bond Funds / International Funds / Balanced

Funds / Asset Allocation and Flexible Funds /

Index Funds

How Funds Are Sold

4.4 Costs of Investing in Mutual Funds 98

Fee Structure

Operating Expenses / Front-End Load / Back-End

Load / 12b-1 Charges

Fees and Mutual Fund Returns

4.5 Taxation of Mutual Fund Income 102

4.6 Exchange-Traded Funds 103

4.7 Mutual Fund Investment Performance:

A First Look 106

4.8 Information on Mutual Funds 109

End of Chapter Material 112–116

Part-II

Portfolio Theory

and Practice 117

Chapter 5

Risk, Return, and the Historical Record 117

5.1 Determinants of the Level of Interest Rates 118

Real and Nominal Rates of Interest / The Equilibrium

Real Rate of Interest / The Equilibrium Nominal Rate of

Interest / Taxes and the Real Rate of Interest

5.2 Comparing Rates of Return for Different Holding

Periods 121

Annual Percentage Rates / Continuous Compounding

5.3 Bills and Inflation, 1926–2015 124

5.4 Risk and Risk Premiums 126

Holding-Period Returns / Expected Return and Standard

Deviation / Excess Returns and Risk Premiums

5.5 Time Series Analysis of Past Rates of Return 129

Time Series versus Scenario Analysis / Expected Returns

and the Arithmetic Average / The Geometric (Time-

Weighted) Average Return / Variance and Standard

Deviation / Mean and Standard Deviation Estimates

from Higher-Frequency Observations / The Reward-to-Volatility

(Sharpe) Ratio

5.6 The Normal Distribution 134

5.7 Deviations from Normality and Alternative Risk

Measures

136

Value at Risk / Expected Shortfall / Lower Partial

Standard

Deviation and the Sortino Ratio / Relative

Frequency

of Large, Negative 3-Sigma Returns

5.8 Historic Returns on Risky Portfolios 140

A Global View of the Historical Record

5.9 Normality and Long-Term Investments 147

Short-Run versus Long-Run Risk / Forecasts for the

Long Haul

End of Chapter Material 151–156

Chapter 6

Capital Allocation to Risky Assets 157

6.1 Risk and Risk Aversion 158

Risk, Speculation, and Gambling / Risk Aversion and

Utility Values / Estimating Risk Aversion

6.2 Capital Allocation across Risky and Risk-Free

Portfolios 164

6.3 The Risk-Free Asset 166

6.4 Portfolios of One Risky Asset and a Risk-Free

Asset 167

6.5 Risk Tolerance and Asset Allocation 170

Non-Normal Returns

6.6 Passive Strategies: The Capital Market Line 176

End of Chapter Material 178–187

Appendix A: Risk Aversion, Expected Utility, and the

St. Petersburg Paradox 187

Appendix B: Utility Functions and

Risk Premiums 191

Chapter 7

Optimal Risky Portfolios 193

7.1 Diversification and Portfolio Risk 194

7.2 Portfolios of Two Risky Assets 195

7.3 Asset Allocation with Stocks, Bonds, and Bills 203

Asset Allocation with Two Risky Asset Classes

7.4 The Markowitz Portfolio Optimization Model 208

Security Selection / Capital Allocation and the Separation

Property / The Power of Diversification / Asset

Allocation and Security Selection / Optimal Portfolios

and Non-Normal Returns

7.5 Risk Pooling, Risk Sharing, and the Risk

of Long-Term Investments 217

Risk Pooling and the Insurance Principle / Risk Sharing /

Diversification and the Sharpe Ratio / Time Diversification

and the Investment Horizon

End of Chapter Material 222–232

Appendix A: A Spreadsheet Model for Efficient

Diversification 232

Appendix B: Review of Portfolio Statistics 237

Chapter 8

Index Models 245

8.1 A Single-Factor Security Market 246

The Input List of the Markowitz Model / Systematic versus

Firm-Specific Risk

8.2 The Single-Index Model 248

The Regression Equation of the Single-Index Model / The

Expected Return–Beta Relationship / Risk and Covariance

in the Single-Index Model / The Set of Estimates

Needed for the Single-Index Model / The Index Model

and Diversification

8.3 Estimating the Single-Index Model 255

The Security Characteristic Line for Ford / The Explanatory

Power of Ford’s SCL / The Estimate of Alpha / The

Estimate of Beta / Firm-Specific Risk

Typical Results from Index Model Regressions

6.4 Portfolios of One Risky Asset and a Risk-Free

Asset 167

6.5 Risk Tolerance and Asset Allocation 170

Non-Normal Returns

6.6 Passive Strategies: The Capital Market Line 176

End of Chapter Material 178–187

Appendix A: Risk Aversion, Expected Utility, and the

St. Petersburg Paradox 187

Appendix B: Utility Functions and

Risk Premiums 191

Chapter 7

Optimal Risky Portfolios 193

7.1 Diversification and Portfolio Risk 194

7.2 Portfolios of Two Risky Assets 195

7.3 Asset Allocation with Stocks, Bonds, and Bills 203

Asset Allocation with Two Risky Asset Classes

7.4 The Markowitz Portfolio Optimization Model 208

Security Selection / Capital Allocation and the Separation

Property / The Power of Diversification / Asset

Allocation and Security Selection / Optimal Portfolios

and Non-Normal Returns

7.5 Risk Pooling, Risk Sharing, and the Risk

of Long-Term Investments 217

Risk Pooling and the Insurance Principle / Risk Sharing /

Diversification and the Sharpe Ratio / Time Diversification

and the Investment Horizon

End of Chapter Material 222–232

Appendix A: A Spreadsheet Model for Efficient

Diversification 232

Appendix B: Review of Portfolio Statistics 237

Chapter 8

Index Models 245

8.1 A Single-Factor Security Market 246

The Input List of the Markowitz Model / Systematic versus

Firm-Specific Risk

8.2 The Single-Index Model 248

The Regression Equation of the Single-Index Model / The

Expected Return–Beta Relationship / Risk and Covariance

in the Single-Index Model / The Set of Estimates

Needed for the Single-Index Model / The Index Model

and Diversification

8.3 Estimating the Single-Index Model 255

The Security Characteristic Line for Ford / The Explanatory

Power of Ford’s SCL / The Estimate of Alpha / The

Estimate of Beta / Firm-Specific Risk

Typical Results from Index Model Regressions

8.4 The Industry Version of the Index Model 259

Predicting Betas

8.5 Portfolio Construction Using the Single-Index Model 262

Alpha and Security Analysis / The Index Portfolio as an

Investment Asset / The Single-Index Model Input List /

The Optimal Risky Portfolio in the Single-Index Model /

The Information Ratio / Summary of Optimization Procedure

/ An Example / Correlation and Covariance Matrix

Risk Premium Forecasts / The Optimal Risky Portfolio / Is

the Index Model Inferior to the Full-Covariance Model?

End of Chapter Material 271–276

PART III

Equilibrium in Capital

Markets 277

Chapter 9

The Capital Asset Pricing Model 277

9.1 The Capital Asset Pricing Model 277

Why Do All Investors Hold the Market Portfolio? / The

Passive Strategy Is Efficient / The Risk Premium of the

Market Portfolio / Expected Returns on Individual

Securities / The Security Market Line / The CAPM and

the Single-Index Market

9.2 Assumptions and Extensions of the CAPM 288

Identical Input Lists / Risk-Free Borrowing and the

Zero-Beta Model / Labor Income and Nontraded

Assets / A Multiperiod Model and Hedge Portfolios /

A Consumption-

Based CAPM / Liquidity and the CAPM

9.3 The CAPM and the Academic World 298

9.4 The CAPM and the Investment Industry 299

End of Chapter Material 300–308

Chapter 10

Arbitrage Pricing Theory and Multifactor

Models of Risk and Return 309

10.1 Multifactor Models: A Preview 310

Factor Models of Security Returns

10.2 Arbitrage Pricing Theory 312

Arbitrage, Risk Arbitrage, and Equilibrium / Well-

Diversified Portfolios / The Security Market Line of the APT

Individual Assets and the APT

Well-Diversified Portfolios in Practice

10.3 The APT, the CAPM, and the Index Model 319

The APT and the CAPM / The APT and Portfolio

Optimization

in a Single-Index Market

10.4 A Multifactor APT 321

10.5 The Fama-French (FF) Three-Factor Model 324

End of Chapter Material 326–332

Chapter 11

The Efficient Market Hypothesis 333

11.1 Random Walks and the Efficient Market

Hypothesis 334

Competition as the Source of Efficiency / Versions of the

Efficient Market Hypothesis

11.2 Implications of the EMH 339

Technical Analysis / Fundamental Analysis / Active versus

Passive Portfolio Management / The Role of Portfolio

Management in an Efficient Market / Resource Allocation

11.3 Event Studies 343

11.4 Are Markets Efficient? 347

The Issues

The Magnitude Issue / The Selection Bias Issue / The

Lucky Event Issue

Weak-Form Tests: Patterns in Stock Returns

Returns over Short Horizons / Returns over Long Horizons

Predictors of Broad Market Returns / Semistrong Tests:

Market Anomalies

The Small-Firm Effect / The Neglected-Firm Effect

and Liquidity Effects / Book-to-Market Ratios / Post–Earnings-

Announcement Price Drift

Strong-Form Tests: Inside Information / Interpreting the

Anomalies

Risk Premiums or Inefficiencies? / Anomalies or Data

Mining? / Anomalies over Time

Bubbles and Market Efficiency

11.5 Mutual Fund and Analyst Performance 359

Stock Market Analysts / Mutual Fund Managers / So, Are

Markets Efficient?

End of Chapter Material 365–372

Chapter 12

Behavioral Finance and Technical

Analysis 373

12.1 The Behavioral Critique 374

Information Processing

Forecasting Errors / Overconfidence / Conservatism /

Sample Size Neglect and Representativeness

Behavioral Biases

Framing / Mental Accounting / Regret Avoidance /

Affect / Prospect Theory

Limits to Arbitrage

Fundamental Risk / Implementation Costs / Model Risk

Limits to Arbitrage and the Law of One Price

“Siamese Twin” Companies / Equity Carve-Outs /

Closed-End Funds

Bubbles and Behavioral Economics / Evaluating the

Behavioral Critique

12.2 Technical Analysis and Behavioral Finance 384

Trends and Corrections

Momentum and Moving Averages / Relative Strength /

Breadth

Sentiment Indicators

Trin Statistic / Confidence Index / Put/Call Ratio

A Warning

End of Chapter Material 391–396

Chapter 13

Empirical Evidence on Security

Returns 397

13.1 The Index Model and the Single-Factor SML 398

The Expected Return–Beta Relationship

Setting Up the Sample Data / Estimating the SCL /

Estimating the SML

Tests of the CAPM / The Market Index / Measurement

Error in Beta

13.2 Tests of the Multifactor Models 403

Labor Income / Private (Nontraded) Business / Early Tests

of the Multifactor CAPM and APT / A Macro Factor Model

13.3 Fama-French-Type Factor Models 407

Size and B/M as Risk Factors / Behavioral Explanations /

Momentum: A Fourth Factor

13.4 Liquidity and Asset Pricing 414

13.5 Consumption-Based Asset Pricing and the Equity

Premium

Puzzle 416

Expected versus Realized Returns / Survivorship Bias /

Extensions to the CAPM May Resolve the Equity Premium

Puzzle / Liquidity and the Equity Premium Puzzle /

Behavioral Explanations of the Equity Premium Puzzle

End of Chapter Material 422–424

PART IV

Fixed-Income Securities 425

Chapter 14

Bond Prices and Yields 425

14.1 Bond Characteristics 426

Treasury Bonds and Notes

Accrued Interest and Quoted Bond Prices

Corporate Bonds

Call Provisions on Corporate Bonds / Convertible

Bonds / Puttable Bonds / Floating-Rate Bonds

Preferred Stock / Other Domestic Issuers / International

Bonds / Innovation in the Bond Market

Inverse Floaters / Asset-Backed Bonds / Catastrophe

Bonds / Indexed Bonds

14.2 Bond Pricing 432

Bond Pricing between Coupon Dates

14.3 Bond Yields 438

Yield to Maturity / Yield to Call / Realized Compound

Return versus Yield to Maturity

14.4 Bond Prices over Time 444

Yield to Maturity versus Holding-Period Return / Zero-

Coupon Bonds and Treasury Strips / After-Tax Returns

14.5 Default Risk and Bond Pricing 449

Junk Bonds / Determinants of Bond Safety / Bond

Indentures

Sinking Funds / Subordination of Further Debt /

Dividend

Restrictions / Collateral

Yield to Maturity and Default Risk / Credit Default Swaps /

Credit Risk and Collateralized Debt Obligations

End of Chapter Material 460–466

Chapter 15

The Term Structure of Interest Rates 467

15.1 The Yield Curve 467

Bond Pricing

15.2 The Yield Curve and Future Interest Rates 470

The Yield Curve under Certainty / Holding-Period

Returns / Forward Rates

15.3 Interest Rate Uncertainty and Forward Rates 475

15.4 Theories of the Term Structure 477

The Expectations Hypothesis / Liquidity Preference

Theory

15.5 Interpreting the Term Structure 480

15.6 Forward Rates as Forward Contracts 484

End of Chapter Material 486–494

Chapter 16

Managing Bond Portfolios 495

16.1 Interest Rate Risk 496

Interest Rate Sensitivity / Duration / What Determines

Duration?

Rule 1 for Duration / Rule 2 for Duration / Rule

3 for Duration / Rule 4 for Duration / Rule 5 for

Duration

16.2 Convexity 505

Why Do Investors Like Convexity? / Duration and

Convexity

of Callable Bonds / Duration and Convexity of

Mortgage-Backed Securities

16.3 Passive Bond Management 513

Bond-Index Funds / Immunization / Cash Flow Matching

and Dedication / Other Problems with Conventional

Immunization

16.4 Active Bond Management 522

Sources of Potential Profit / Horizon Analysis

End of Chapter Material 525–536

PART V

Security Analysis 537

Chapter 17

Macroeconomic and Industry Analysis 537

17.1 The Global Economy 537

17.2 The Domestic Macroeconomy 540

Key Economic Indicators

Gross Domestic Product / Employment / Inflation /

Interest Rates / Budget Deficit / Sentiment

17.3 Demand and Supply Shocks 542

17.4 Federal Government Policy 542

Fiscal Policy / Monetary Policy / Supply-Side Policies

17.5 Business Cycles 545

The Business Cycle / Economic Indicators / Other Indicators

17.6 Industry Analysis 550

Defining an Industry / Sensitivity to the Business Cycle /

Sector Rotation / Industry Life Cycles

Start-Up Stage / Consolidation Stage / Maturity Stage /

Relative Decline

Industry Structure and Performance

Threat of Entry / Rivalry between Existing Competitors /

Pressure from Substitute Products / Bargaining Power

of Buyers / Bargaining Power of Suppliers

End of Chapter Material 560–568

Chapter 18

Equity Valuation Models 569

18.1 Valuation by Comparables 569

Limitations of Book Value

18.2 Intrinsic Value versus Market Price 571

18.3 Dividend Discount Models 573

The Constant-Growth DDM / Convergence of Price

to Intrinsic Value / Stock Prices and Investment

Opportunities / Life Cycles and Multistage Growth

Models / Multistage Growth Models

18.4 The Price–Earnings Ratio 587

The Price–Earnings Ratio and Growth Opportunities /

P/E Ratios and Stock Risk / Pitfalls in P/E Analysis

/

Combining P/E Analysis and the DDM / Other

Comparative

Valuation Ratios

Price-to-Book Ratio / Price-to-Cash-Flow Ratio /

Price-to-Sales Ratio

18.5 Free Cash Flow Valuation Approaches 595

Comparing the Valuation Models / The Problem with

DCF Models

18.6 The Aggregate Stock Market 599

End of Chapter Material 601–612

Chapter 19

Financial Statement Analysis 613

19.1 The Major Financial Statements 613

The Income Statement / The Balance Sheet / The Statement

of Cash Flows

19.2 Measuring Firm Performance 618

19.3 Profitability Measures 619

Return on Assets, ROA / Return on Capital, ROC /

Return on Equity, ROE / Financial Leverage and ROE /

Economic

Value Added

19.4 Ratio Analysis 623

Decomposition of ROE / Turnover and Other Asset

Utilization

Ratios / Liquidity Ratios / Market Price

Ratios: Growth versus Value / Choosing a Benchmark

19.5 An Illustration of Financial Statement Analysis 633

19.6 Comparability Problems 636

Inventory Valuation / Depreciation / Inflation and Interest

Expense / Fair Value Accounting / Quality of Earnings and

Accounting Practices / International Accounting Conventions

19.7 Value Investing: The Graham Technique 642

End of Chapter Material 643–656

PART VI

Options, Futures, and Other

Derivatives 657

Chapter 20

Options Markets: Introduction 657

20.1 The Option Contract 657

Options Trading / American and European Options /

Adjustments in Option Contract Terms / The Options

Clearing Corporation / Other Listed Options

Index Options / Futures Options / Foreign Currency

Options / Interest Rate Options

20.2 Values of Options at Expiration 663

Call Options / Put Options / Option versus Stock

Investments

20.3 Option Strategies 667

Protective Put / Covered Calls / Straddle / Spreads / Collars

20.4 The Put-Call Parity Relationship 675

20.5 Option-Like Securities 678

Callable Bonds / Convertible Securities / Warrants /

Collateralized Loans / Levered Equity and Risky Debt

20.6 Financial Engineering 684

20.7 Exotic Options 686

Asian Options / Barrier Options / Lookback Options /

Currency-Translated Options / Digital Options

End of Chapter Material 687–698

Chapter 21

Option Valuation 699

21.1 Option Valuation: Introduction 699

Intrinsic and Time Values / Determinants of Option

Values

21.2 Restrictions on Option Values 703

Restrictions on the Value of a Call Option / Early Exercise

and Dividends / Early Exercise of American Puts

21.3 Binomial Option Pricing 706

Two-State Option Pricing / Generalizing the Two-State

Approach / Making the Valuation Model Practical

21.4 Black-Scholes Option Valuation 714

The Black-Scholes Formula / Dividends and Call Option

Valuation / Put Option Valuation / Dividends and Put

Option Valuation

21.5 Using the Black-Scholes Formula 722

Hedge Ratios and the Black-Scholes Formula / Portfolio

Insurance / Option Pricing and the Crisis of 2008–2009 /

Option Pricing and Portfolio Theory / Hedging Bets on

Mispriced Options

21.6 Empirical Evidence on Option Pricing 734

End of Chapter Material 735–746

Chapter 22

Futures Markets 747

22.1 The Futures Contract 747

The Basics of Futures Contracts / Existing Contracts

22.2 Trading Mechanics 753

The Clearinghouse and Open Interest / The Margin

Account and Marking to Market / Cash versus Actual

Delivery / Regulations / Taxation

22.3 Futures Markets Strategies 757

Hedging and Speculation / Basis Risk and Hedging

22.4 Futures Prices 761

The Spot-Futures Parity Theorem / Spreads / Forward

versus Futures Pricing

22.5 Futures Prices versus Expected Spot Prices 768

Expectations Hypothesis / Normal Backwardation /

Contango / Modern Portfolio Theory

End of Chapter Material 770–774

Chapter 23

Futures, Swaps, and Risk Management 775

23.1 **Foreign Exchange Futures** 775

The Markets / Interest Rate Parity / Direct versus Indirect

Quotes / Using Futures to Manage Exchange Rate Risk

23.2 Stock-Index Futures 783

The Contracts / Creating Synthetic Stock Positions: An

Asset Allocation Tool / Index Arbitrage / Using Index

Futures to Hedge Market Risk

23.3 Interest Rate Futures 788

Hedging Interest Rate Risk

23.4 Swaps 790

Swaps and Balance Sheet Restructuring / The Swap

Dealer / Other Interest Rate Contracts / Swap Pricing /

Credit Risk in the Swap Market / Credit Default Swaps

23.5 Commodity Futures Pricing 797

Pricing with Storage Costs / Discounted Cash Flow

Analysis for Commodity Futures

End of Chapter Material 801–810

PART VII

Applied Portfolio

Management 811

Chapter 24

Portfolio Performance Evaluation 811

24.1 The Conventional Theory of Performance

Evaluation 811

Average Rates of Return / Time-Weighted Returns versus

Dollar-Weighted Returns / Adjusting Returns for Risk /

The Sharpe Ratio for Overall Portfolios

The M2 Measure and the Sharpe Ratio

The Treynor Ratio

The Information Ratio

The Role of Alpha in Performance Measures / Implementing

Performance Measurement: An Example / Realized

Returns versus Expected Returns

24.2 Style Analysis 823

24.3 Performance Measurement with Changing Portfolio Composition 826

Performance Manipulation and the Morningstar Risk-

Adjusted Rating

24.4 Market Timing

The Potential Value of Market Timing / Valuing Market

Timing

as a Call Option / The Value of Imperfect Forecasting

24.5 Performance Attribution Procedures 835

Asset Allocation Decisions / Sector and Security Selection

Decisions / Summing Up Component Contributions

End of Chapter Material 841–852

Chapter 25

International Diversification 853

25.1 Global Markets for Equities 853

Developed Countries / Emerging Markets / Market

Capitalization and GDP / Home-Country Bias

25.2 Exchange Rate Risk and International

Diversification 857

Exchange Rate Risk / Investment Risk in International

Markets / International Diversification / Are Benefits from

International Diversification Preserved in Bear Markets?

25.3 Political Risk 868

25.4 International Investing and Performance

Attribution 871

Constructing a Benchmark Portfolio of Foreign Assets /

Performance Attribution

End of Chapter Material 875–880

Chapter 26

Hedge Funds 881

26.1 Hedge Funds versus Mutual Funds 882

Transparency / Investors / Investment Strategies /

Liquidity / Compensation Structure

26.2 Hedge Fund Strategies 883

Directional and Nondirectional Strategies / Statistical

Arbitrage

26.3 Portable Alpha 886

An Example of a Pure Play

26.4 Style Analysis for Hedge Funds 889

26.5 Performance Measurement for Hedge Funds 891

Liquidity and Hedge Fund Performance / Hedge Fund

Performance and Survivorship Bias / Hedge Fund

Performance and Changing Factor Loadings / Tail

Events and Hedge Fund Performance

26.6 Fee Structure in Hedge Funds 899

End of Chapter Material 902–906

Chapter-27

The Theory of Active Portfolio

Management 907

27.1 Optimal Portfolios and Alpha Values 907

Forecasts of Alpha Values and Extreme Portfolio Weights /

Restriction of Benchmark Risk

27.2 The Treynor-Black Model and Forecast

Precision 914

Adjusting Forecasts for the Precision of Alpha / Distribution

of Alpha Values / Organizational Structure and

Performance

27.3 The Black-Litterman Model 918

Black-Litterman Asset Allocation Decision / Step 1: The

Covariance Matrix from Historical Data / Step 2: Determination

of a Baseline Forecast / Step 3: Integrating the

Manager’s Private Views / Step 4: Revised (Posterior)

Expectations / Step 5: Portfolio Optimization

27.4 Treynor-Black versus Black-Litterman:

Complements, Not Substitutes 923

The BL Model as Icing on the TB Cake / Why Not

Replace the Entire TB Cake with the BL Icing?

27.5 The Value of Active Management 925

A Model for the Estimation of Potential Fees / Results

from the Distribution of Actual Information Ratios / Results from Distribution of Actual Forecasts

27.6 Concluding Remarks on Active Management 927

End of Chapter Material 927–928

Appendix A: Forecasts and Realizations of

Alpha 928

Appendix B: The General Black-Litterman

Model 929

Chapter 28

Investment Policy and the Framework of the

CFA Institute 931

28.1 The Investment Management Process 932

Objectives / Individual Investors / Personal Trusts /

Mutual Funds / Pension Funds / Endowment Funds / Life

Insurance Companies / Non–Life Insurance Companies / Banks

28.2 Constraints 937

Liquidity / Investment Horizon / Regulations / Tax Considerations / Unique Needs

28.3 **Policy Statements** 939

Sample Policy Statements for Individual Investors

28.4 Asset Allocation 943

Taxes and Asset Allocation 944

28.5 Managing Portfolios of Individual Investors 945

Human Capital and Insurance / Investment in Residence /

Saving for Retirement and the Assumption of Risk /

Retirement Planning Models / Manage Your Own Portfolio

or Rely on Others? / Tax Sheltering

The Tax-Deferral Option / Tax-Protected Retirement

Plans / Deferred Annuities / Variable and Universal

Life Insurance

28.6 Pension Funds 951

Defined Contribution Plans / Defined Benefit Plans /

Pension Investment Strategies

Investing in Equities / Wrong Reasons to Invest in

Equities

28.7 Investments for the Long Run 954

Making Simple Investment Choices / Inflation Risk and

Long-Term Investors

End of Chapter Material 956–966

REFERENCES TO CFA PROBLEMS 967

GLOSSARY G-1

NAME INDEX I-1

SUBJECT INDEX I-4

FORMULAS F-1