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INVESTMENT
PORTFOLIO MANAGEMENT
INVESTMENT ANALYSIS &
BE UNSTOPPABLE ANALYSIS &
The up-to-date content in this book
PORTFOLIO
MANAGEMENT
helps you to get the knowledge
you need to succeed.
Prepares you for working in a global environment

with discussion of how investment theory or
practice is influenced by the globalisation of
investments and capital markets
Coverage of data specific to the Asia–Pacific

region gives you an understanding of the nuances
and practices of this region’s markets
Helps you learn about current investment

alternatives and develop ways of analysing
future investment opportunities
ASIA–PACIFIC
EDITION
STUDY HACK #23

Switch your study location each day – go to
the library, sit at the kitchen table or study
in a café. This stops you getting bored!
Jess, student, Melbourne
ISBN 978-0170416030
Asia–Pacific Edition
9 7 8 01 7 0 4 1 6 03 0
Copyright 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-202
vii
CONTENTS
Guide to the text xvi
Guide to the online resources xviii
Preface xix
About the authors xxiii
Acknowledgements xxvi
PART 1 THE INVESTMENT BACKGROUND 2

CHAPTER 1 Standards for evaluating portfolio performance .......... 45
THE INVESTMENT SETTING ..................................... 4 Other benefits ...................................................................... 45
What is an investment? ................................................... 4 Inputs into the investment policy statement ........ 47
Investment defined .............................................................. 6 Investment objectives ....................................................... 47
Measures of return and risk ........................................... 7 Investment constraints ..................................................... 51
Measures of historical rates of return .............................. 7 Constructing the policy statement ........................... 54
Computing mean historical returns ................................. 9 General guidelines ............................................................. 54
Calculating expected rates of return .............................. 12 The importance of asset allocation .......................... 54
Measuring the risk of expected rates of return ........... 15 Investment returns after taxes and inflation ................ 56
Risk measures for historical returns ............................... 17 Returns and risks of different asset classes ................. 59
Determinants of required rates of return .............. 17 Asset allocation summary ................................................ 60
The real risk-free rate ........................................................ 19 Chapter 2 Appendix:
Factors influencing the nominal risk-free Objectives and constraints of institutional
rate (NRFR) ........................................................................... 19 investors ............................................................................... 67
Risk premium ...................................................................... 22 Institutional investment summary ................................. 70
Risk premium and portfolio theory ................................. 24
CHAPTER 3
Fundamental risk versus systematic risk ..................... 25 SELECTING INVESTMENTS IN A
Summary of required rate of return ................................ 25 GLOBAL MARKET ........................................................ 71
Relationship between risk and return ...................... 26 The case for global investments ................................ 72
Movements along the SML .............................................. 27 Relative size of global financial markets ....................... 73
Changes in the slope of the SML .................................... 27 Rates of return on domestic and foreign securities ....... 73
Changes in capital market conditions or Risk of combined country investments ......................... 76
expected inflation ............................................................... 29
Global investment choices ........................................... 81
Summary of changes in the required rate of return ...... 29
Fixed-income investments ............................................... 81
Chapter 1 Appendix:
International bond investing ............................................ 85
Computation of variance and standard deviation ...... 34
Equity instruments ............................................................ 86
Coefficient of variation ...................................................... 35
Special equity instruments: options .............................. 87
CHAPTER 2 Futures contracts ............................................................... 88
THE ASSET ALLOCATION DECISION ................ 37 Investment companies ...................................................... 88
Individual investor life cycle ........................................ 38 Real estate ............................................................................ 90
The preliminaries ............................................................... 38 Low-liquidity investments ............................................... 92
Investment strategies over an investor’s lifetime ....... 38 Recent risk–return performance of
Life cycle investment goals .............................................. 41 alternative investments ................................................. 93
The portfolio management process ......................... 42 Chapter 3 Appendix:
The need for an investment policy statement ..... 43 Covariance ........................................................................... 99
Understand and articulate realistic investor goals ..... 44 Correlation ............................................................................ 99
viii CONTENTS
CHAPTER 4 Special orders .................................................................... 121

ORGANISATION AND FUNCTIONING Margin transactions ......................................................... 121
OF SECURITIES MARKETS .................................... 101
Short sales .......................................................................... 123
What is a market? ......................................................... 101
Exchange market-makers ............................................... 125
Characteristics of a good market .................................. 102
Exchange merger mania ................................................. 125
Organisation of the securities market ......................... 103
CHAPTER 5
Primary capital markets .............................................. 103
SECURITY-MARKET INDICES ............................... 129
Australian Government Securities (AGS) ................... 104
Uses of security-market indices .............................. 130
Treasury Notes and Treasury Indexed Bonds ............ 104
Differentiating factors in constructing
Corporate bond issues ..................................................... 104 market indices ................................................................ 131
Corporate share issues .................................................... 105 The sample ......................................................................... 131
Private placements ........................................................... 106 Weighting sample members .......................................... 131
Secondary financial markets ..................................... 107 Computational procedure ............................................... 131
Why secondary markets are important ....................... 107 Share-market indices ................................................... 132
Secondary bond markets ................................................ 107 Price-weighted index ...................................................... 132
Financial futures ............................................................... 108 Value-weighted index ..................................................... 135
Secondary equity markets .............................................. 108 Equal-weighted (unweighted) index ........................... 136
Trading services available on the Fundamental weighted index ....................................... 137
Australian Securities Exchange (ASX) ................... 110
Australian equity indices ............................................... 138
Product issuance .............................................................. 110
Style indices ...................................................................... 139
Trading services ............................................................... 111
Global equity indices ....................................................... 140
Order types and control .................................................. 111
Bond-market indices .................................................... 142
Classification of US secondary equity markets ...... 112
Australian investment-grade bond
Primary listing markets ................................................... 112 indices and maturity ........................................................ 143
Regional share exchanges .............................................. 116 Australian bond indices and default risk .................... 143
The third market ............................................................... 116 Global government bond indices .................................. 144
The significant transition of the Comparison of indices over time ........................... 144
US equity markets ............................................................ 117
Correlations between monthly equity
Alternative types of orders available price changes .................................................................... 144
in US markets ................................................................. 120
Correlations between monthly bond index returns ...... 145
Market orders .................................................................... 120
Chapter 5 Appendix:
Limit orders ........................................................................ 120
Share market indices ....................................................... 149
PART 2 DEVELOPMENTS IN INVESTMENT THEORY 152

CHAPTER 6 Semi-strong form hypothesis: tests
EFFICIENT CAPITAL MARKETS ........................... 154 and results .......................................................................... 161
Why should capital markets be efficient? ........... 155 Strong-form hypothesis: tests and results .................. 173
Alternative efficient market hypotheses ............. 156 Behavioural finance ...................................................... 177
Weak-form efficient market hypothesis ....................... 156 Explaining biases ............................................................. 178
Semi-strong form efficient market hypothesis .......... 157 Fusion investing ............................................................... 179
Strong-form efficient market hypothesis .................... 157 Implications of efficient capital markets .............. 179
Tests and results of efficient market Efficient markets and technical analysis .................... 180
hypotheses ...................................................................... 157 Efficient markets and fundamental analysis .............. 180
Weak-form hypothesis: tests and results .................... 158 Efficient markets and portfolio management ............. 182
CONTENTS ix
CHAPTER 7 Developing the capital market line .............................. 220

AN INTRODUCTION TO Risk, diversification and the market portfolio ............ 224
PORTFOLIO MANAGEMENT ............................... 190
Investing with the CML: an example .......................... 227
Understanding risk aversion ..................................... 190
The capital asset pricing model .............................. 228
Risk aversion ..................................................................... 190
A conceptual development of the CAPM ................... 229
Definition of risk ................................................................ 191
The security market line ................................................. 230
Markowitz portfolio theory ....................................... 191
Relaxing the assumptions .......................................... 238
Alternative measures of risk .......................................... 192
Differential borrowing and lending rates .................... 239
Expected rates of return ................................................. 192 Zero-beta model ................................................................ 239
Variance (standard deviation) of returns Transaction costs ............................................................. 240
for an individual investment .......................................... 193
Heterogeneous expectations and
Covariance and correlation of returns planning periods ............................................................... 241
for a portfolio ...................................................................... 194
Taxes ................................................................................... 242
Standard deviation of a portfolio ................................... 200
Additional empirical tests of the CAPM .............. 242
A three-asset portfolio ..................................................... 208
Stability of beta ................................................................. 242
Estimation issues ............................................................. 209
Relationship between systematic risk and return ........ 243
The efficient frontier ........................................................ 210
Summary of CAPM risk–return empirical results ......... 245
The efficient frontier and investor utility .................... 211
The market portfolio: theory versus practice ....... 245
Chapter 7 Appendix:
CHAPTER 9
Proof that minimum portfolio variance occurs
MULTIFACTOR MODELS OF RISK
with equal weights when securities have
AND RETURN ............................................................... 254
equal variance ................................................................... 217
Arbitrage pricing theory ............................................ 254
Derivation of weights that will give zero
variance when correlation equals −1.00 ..................... 217 Using the APT ................................................................... 257
Security valuation with the APT: an example ........... 259
CHAPTER 8
Empirical tests of the APT .............................................. 260
AN INTRODUCTION TO ASSET
PRICING MODELS ..................................................... 218 Multifactor models and risk estimation ............... 263
Capital market theory: an overview ...................... 218 Multifactor models in practice ...................................... 264
Background for capital market theory ......................... 218 Estimating risk in a multifactor setting:
examples ............................................................................. 270
PART 3 VALUATION PRINCIPLES AND PRACTICES 284

CHAPTER 10 Common size statements ............................................... 295
ANALYSIS OF FINANCIAL Evaluating internal liquidity .......................................... 297
STATEMENTS ............................................................... 286
Evaluating operating performance ............................... 302
Major financial statements ........................................ 287
Operating profitability ratios .......................................... 304
Generally accepted accounting principles ................. 287 Risk analysis ...................................................................... 311
Balance sheet .................................................................... 287 External market liquidity risk ........................................ 323
Statement of profit or loss ............................................... 289 Analysis of growth potential .......................................... 324
Statement of cash flows .................................................. 290 Comparative analysis of ratios ................................ 327
Measures of cash flow ..................................................... 291 Internal liquidity ............................................................... 327
Purpose of financial statement analysis ...................... 293 Operating performance ................................................... 328
Analysis of financial ratios ......................................... 293 Risk analysis ...................................................................... 329
Importance of relative financial ratios ......................... 294 Growth analysis ................................................................ 329
Calculation of financial ratios ................................... 295 Analysis of foreign financial statements ..................... 329
x CONTENTS
The quality of financial statements ........................ 330 Valuation of bonds ............................................................ 352
Balance sheet .................................................................... 330 Valuation of preference shares ...................................... 353
Statement of profit or loss ............................................... 330 Approaches to the valuation of ordinary shares ....... 354
Footnotes ............................................................................ 330 Why and when to use the discounted
The value of financial statement analysis ............ 331 cash flow valuation approach ........................................ 355
Specific uses of financial ratios ................................ 331 Why and when to use the relative
valuation techniques ....................................................... 356
Share valuation models ................................................... 332
Discounted cash flow valuation techniques .............. 356
Estimating the ratings on bonds .................................. 332
Infinite period DDM and growth companies .............. 362
Predicting insolvency (bankruptcy) ............................. 333
Valuation with temporary supernormal growth ........ 362
Limitations of financial ratios ........................................ 334
Present value of operating free cash flows ................. 364
Chapter 10 Appendix:
Present value of free cash flows to equity .................. 365
Adjusting volatility measure for growth ...................... 342
Relative valuation techniques .................................. 366
Measuring operating leverage ...................................... 342
Earnings multiplier model .............................................. 366
CHAPTER 11
The price/cash flow ratio ................................................ 369
AN INTRODUCTION TO SECURITY
VALUATION ................................................................... 344 The price/book value ratio .............................................. 369
An overview of the valuation process .................. 345 The price/sales ratio ........................................................ 370
Why a three-step valuation process? .................... 347 Implementing the relative valuation technique ........ 371
General economic influences ........................................ 347 Estimating the inputs: the required
rate of return and the expected growth
Industry influences ........................................................... 348
rate of valuation variables ......................................... 372
Company analysis ............................................................ 349
Required rate of return (k) .............................................. 372
Does the three-step process work? .............................. 349
Estimating the required return for
Theory of valuation ...................................................... 350 foreign securities .............................................................. 374
Stream of expected returns (cash flows) ..................... 350 Expected growth rates .................................................... 376
Required rate of return .................................................... 351 Estimating dividend growth for foreign shares ......... 379
Investment decision process: a comparison Chapter 11 Appendix:
of estimated values and market prices ........................ 351
Derivation of constant-growth dividend
Valuation of different types of investments ....... 352 discount model (DDM) .................................................... 383
PART 4 ANALYSIS AND MANAGEMENT OF ORDINARY SHARES 384

CHAPTER 12 CHAPTER 13
MACROANALYSIS AND MICROVALUATION INDUSTRY ANALYSIS ............................................... 411
OF THE SHARE MARKET ....................................... 386 Why do industry analysis? ......................................... 412
Introduction to market analysis................................ 387 Cross-sectional industry performance ......................... 412
Aggregate market analysis (macroanalysis)........ 390 Industry performance over time .................................... 414
Leading, coincident and lagging indicators................ 390 Performance of the companies within
Sentiment and expectations surveys............................. 393 an industry ......................................................................... 414
Interest rates........................................................................ 394 Differences in industry risk ............................................ 415
Microvaluation analysis................................................. 400 Summary of research on industry analysis ................. 415
FCFE to value the market................................................. 400 Industry analysis process ............................................... 415
Multiplier approach............................................................ 404 The business cycle and industry sectors ............. 416
Shiller P/E ratio.................................................................... 405 Inflation ............................................................................... 418
Macrovaluation and microvaluation of Interest rates ...................................................................... 418
world markets...................................................................... 406
CONTENTS xi
International economics ................................................. 418 Some lessons from Peter Lynch....................................... 474
Consumer sentiment ....................................................... 419 Tenets of Warren Buffett................................................... 474
Structural economic changes ................................... 419 Tenets of Howard Marks................................................... 475
Demographics ................................................................... 419 CHAPTER 15
Lifestyles ............................................................................. 420 TECHNICAL ANALYSIS ............................................ 478
Technology ......................................................................... 421 Underlying assumptions of technical analysis ......... 479
Politics and regulations ................................................... 421 Advantages of technical analysis ............................ 480
Evaluating the industry life cycle ............................ 422 Challenges to technical analysis ............................. 482
Analysis of industry competition ............................ 424 Challenges to the assumptions of
Competition and expected industry returns .............. 424 technical analysis ............................................................. 482
Estimating industry rates of return ........................ 426 Challenges to technical trading rules .......................... 482
Valuation using the reduced form dividend Technical trading rules and indicators .................. 483
discount model (DDM) .................................................... 427 Contrary-opinion rules ..................................................... 484
Industry valuation using the free cash flow Follow the smart money .................................................. 486
to equity (FCFE) model ................................................... 434 Momentum indicators ..................................................... 487
Industry analysis using the relative Share price and volume techniques ............................ 488
valuation approach ....................................................... 437
Technical analysis of other markets ............................. 494
The earnings multiple technique ................................. 437
Other relative valuation ratios ....................................... 449
Market Technicians Association (MTA) ..................... 497
The price/book value ratio .............................................. 452
Chartered Market Technician (CMT) program .......... 497
The price/cash flow ratio ................................................ 452
CHAPTER 16
The price/sales ratio ........................................................ 453
EQUITY PORTFOLIO MANAGEMENT
Summary of industry/market ratios ............................. 453
STRATEGIES .................................................................. 498
Global industry analysis ............................................. 455
Passive versus active management ....................... 499
An overview of passive equity portfolio
Preparing an industry analysis: management strategies ............................................. 501
What is an industry? ........................................................ 459
Index portfolio construction techniques ..................... 501
Insights on analysing industry ROAs .......................... 460
Tracking error and index portfolio construction ........ 502
CHAPTER 14 Methods of index portfolio investing ........................... 505
COMPANY ANALYSIS AND SHARE
An overview of active equity portfolio
VALUATION ................................................................... 462
management strategies ............................................. 507
Company analysis........................................................... 462 Fundamental strategies .................................................. 508
Growth companies and growth shares......................... 463 Technical strategies ......................................................... 512
Defensive companies and shares.................................... 463 Factors, anomalies and attributes ................................ 514
Cyclical companies and shares....................................... 464 Forming momentum-based share portfolios:
Speculative companies and shares................................ 464 two examples .................................................................... 517
Value versus growth investing........................................ 464 Tax efficiency and active equity management ......... 519
Connecting industry analysis to Value versus growth investing: a closer look ..... 521
company analysis............................................................ 465 An overview of style analysis ................................... 526
Competitive strategies for companies........................... 465 Asset allocation strategies ........................................ 530
SWOT analysis.................................................................... 467 Integrated asset allocation ............................................. 530
Calculating intrinsic value............................................ 468 Strategic asset allocation ................................................ 532
Some additional insights on valuation – for Tactical asset allocation .................................................. 534
individual companies......................................................... 468
Insured asset allocation .................................................. 535
Analysing growth companies.......................................... 469
Selecting an active allocation method ........................ 535
Lessons from some legends....................................... 474
xii CONTENTS
PART 5 ANALYSIS AND MANAGEMENT OF BONDS 540

CHAPTER 17 Term structure theories .............................................. 602
BOND FUNDAMENTALS ........................................ 542 Expectations hypothesis ................................................ 602
Basic features of a bond ............................................ 542 Liquidity preference (term premium)
Bond characteristics ........................................................ 543 hypothesis .......................................................................... 604
The global bond market structure ......................... 546 Segmented market hypothesis ..................................... 605
Participating issuers ........................................................ 546 Trading implications of the term structure ................ 605
Participating investors .................................................... 548 Yield spreads ..................................................................... 606
Bond ratings ...................................................................... 549 What determines the price volatility
Government bonds ...................................................... 551 for bonds? ....................................................................... 607
Treasuries ........................................................................... 552 Trading strategies ............................................................ 610
Treasury Indexed Bonds (TIBs) ..................................... 553 Duration measures ........................................................... 610
Semi-government bonds ................................................ 554 Modified duration and bond price volatility ............... 614
Foreign government bonds ............................................ 556 Bond convexity ................................................................. 615
Government agency issues ............................................ 558 Duration and convexity for callable bonds ................. 621
Corporate bonds .......................................................... 560 Limitations of Macaulay and modified duration ....... 625
Interpreting bond quotes ................................................ 560 Yield spreads with embedded options ................ 632
High-yield bonds .............................................................. 562 Static yield spreads .......................................................... 633
Structured products and securitised claims .............. 563
Option-adjusted spread .................................................. 634
International bonds .......................................................... 569
Chapter 18 Appendix ................................................. 643
CHAPTER 18
CHAPTER 19
THE ANALYSIS AND VALUATION
BOND PORTFOLIO MANAGEMENT
OF BONDS ..................................................................... 573
STRATEGIES .................................................................. 644
The fundamentals of bond valuation .................... 574
Bond portfolio performance, style
The present value model ................................................ 574 and strategy .................................................................... 644
The yield model ................................................................. 577 Passive management strategies ............................. 646
Computing bond yields .............................................. 578 Buy-and-hold strategy ..................................................... 646
Coupon yield ...................................................................... 578 Indexing strategy ............................................................. 647
Running yield .................................................................... 579 Active management strategies ............................... 648
Promised yield to maturity ............................................. 579 Interest rate anticipation ................................................ 649
Promised yield to call ....................................................... 582 Valuation analysis ............................................................. 652
Realised (horizon) yield ................................................... 583 Credit analysis ................................................................... 652
Calculating future bond prices ................................ 584 Yield spread analysis ....................................................... 657
Realised (horizon) yield with differential
Implementing an active bond transaction ................. 657
reinvestment rates ........................................................... 585
Active global bond investing: an example ................. 660
Price and yield determination on
Core-plus management strategies ........................ 662
non-interest dates ............................................................ 586
Matched-funding management strategies ......... 664
Bond valuation using spot rates ............................. 587
Dedicated portfolios ......................................................... 665
What determines interest rates? ............................ 590
Forecasting interest rates ............................................... 590 Immunisation strategies ................................................. 666
Fundamental determinants of interest rates .............. 591 Horizon matching ............................................................. 674
The term structure of interest rates ............................. 594 Contingent and structured management
strategies ......................................................................... 675
Calculating forward rates from the
spot rate curve .............................................................. 599 Contingent immunisation .............................................. 675
CONTENTS xiii
PART 6 DERIVATIVE SECURITY ANALYSIS 688

CHAPTER 20 Valuing forwards and futures ......................................... 738
AN INTRODUCTION TO DERIVATIVE The relationship between spot and
MARKETS AND SECURITIES ................................. 690 forward prices .................................................................... 740
Overview of derivative markets .............................. 691 Financial forwards and futures:
The language and structure of forward applications and strategies ....................................... 741
and futures markets ......................................................... 692 Interest rate forwards and futures ................................ 742
Interpreting futures price quotations: Long-term interest rate futures ..................................... 742
an example ......................................................................... 694
Short-term interest rate futures .................................... 745
The language and structure of option markets ......... 696
Share index futures .......................................................... 746
Interpreting option price quotations:
Currency forwards and futures ...................................... 750
an example ......................................................................... 697
Investing with derivative securities ....................... 700
A closed-form equation for calculating
The basic nature of derivative investing .................... 700
duration ............................................................................... 761
Basic payoff and profit diagrams for
Calculating money market implied
forward contracts ............................................................. 703
forward rates ...................................................................... 761
Basic payoff and profit diagrams for call
and put options ................................................................. 704 CHAPTER 22
OPTION CONTRACTS ............................................. 763
Option profit diagrams: an example ............................. 707
An overview of option markets
The relationship between forward and
and contracts .................................................................. 764
option contracts ............................................................ 710
Option market conventions ........................................... 764
Put-call-spot parity ........................................................... 710
Price quotations for exchange-traded options .......... 765
Put-call parity: an example ............................................. 711
The fundamentals of option valuation ................. 771
Creating synthetic securities using
put-call parity .................................................................... 713 The basic approach ......................................................... 771
Adjusting put-call-spot parity for dividends .............. 714 Improving forecast accuracy ......................................... 774
Put-call-forward parity ..................................................... 715 The binomial option pricing model .............................. 778
An introduction to the use of derivatives The Black-Scholes valuation model ............................. 781
in portfolio management ........................................... 717 Estimating volatility ......................................................... 785
Restructuring asset portfolios with Problems with Black-Scholes valuation ...................... 787
forward contracts ............................................................. 717 Option valuation: extensions and
Protecting portfolio value with put options ................ 719 advanced topics ............................................................ 788
An alternative way to pay for a protective put .......... 721 Valuing European-style put options ............................. 788
CHAPTER 21 Valuing options on dividend-paying securities ......... 789
FORWARD AND FUTURES CONTRACTS ...... 730 Valuing American-style options .................................... 790
An overview of forward and futures trading ..... 730 Other extensions of the Black-Scholes model ........... 792
Futures contract mechanics .......................................... 733 Option trading strategies .......................................... 794
Comparing forward and futures contracts ................. 734 Protective put options ..................................................... 794
Hedging with forwards and futures ...................... 735 Covered call options ......................................................... 796
Hedging and the basis .................................................... 735 Straddles, strips and straps ............................................ 797
Understanding basis risk ................................................ 736 Strangles ............................................................................. 799
Calculating the optimal hedge ratio ............................. 737 Chooser options ................................................................ 800
Forward and futures contracts: Spreads ............................................................................... 801
basic valuation concepts ............................................ 738 Range forwards ................................................................. 804
xiv CONTENTS
CHAPTER 23 Credit-related swaps ....................................................... 823

SWAP CONTRACTS, CONVERTIBLE Warrants and convertible securities ...................... 827
SECURITIES AND OTHER EMBEDDED
Warrants ............................................................................. 827
DERIVATIVES ................................................................ 811
Convertible securities ...................................................... 829
OTC interest rate agreements ................................ 812
Convertible preference shares ....................................... 829
Forward-based interest rate contracts ........................ 812
Convertible bonds ............................................................ 830
Option-based interest rate contracts ........................... 819
Valuing flexibility: an introduction
Swap contracting extensions ................................... 822
to real options ................................................................ 831
Equity index-linked swaps ............................................. 822 Company valuation with real options .......................... 832
PART 7 SPECIFICATION AND EVALUATION OF ASSET MANAGEMENT 840

CHAPTER 24 Regulation in the asset management industry ......... 885
PROFESSIONAL MONEY MANAGEMENT, Standards for ethical behaviour .................................... 887
ALTERNATIVE ASSETS AND
Examples of ethical conflicts ......................................... 889
INDUSTRY ETHICS ..................................................... 842
What do you want from a professional
The asset management industry:
asset manager? ............................................................. 890
structure and evolution .............................................. 843
Structure and evolution .................................................. 843 CHAPTER 25
EVALUATION OF PORTFOLIO
Private management and advisory firms .................... 847
PERFORMANCE .......................................................... 898
Investment strategy at a private money
What is required of a portfolio manager? .......... 899
management firm ............................................................. 849
Early performance measurement
Organisation and management of
techniques ....................................................................... 900
investment companies ................................................ 851
Portfolio evaluation before 1960 .................................... 900
Valuing investment company shares ........................... 851
Peer group comparisons ................................................. 900
Closed-end versus open-end investment
companies .......................................................................... 852 Composite portfolio performance
measures .......................................................................... 901
Fund management fees .................................................. 855
Treynor portfolio performance measure ...................... 902
Investment company portfolio objectives ................... 855
Sharpe portfolio performance measure ....................... 904
Breakdown by fund characteristics ............................. 860
Jensen portfolio performance measure ....................... 905
Global investment companies ....................................... 861
The information ratio performance measure ............. 908
Investing in alternative asset classes .................... 861
Comparing the composite performance
Hedge funds ...................................................................... 865
measures ............................................................................ 909
Characteristics of a hedge fund .................................... 865
Performance measurement with downside risk ....... 912
Hedge fund strategies ..................................................... 867
Holdings-based performance measurement ..... 914
Risk arbitrage investing: a closer look ......................... 869
Grinblatt-Titman (GT) performance measure ............ 915
Hedge fund performance ................................................ 870
Characteristic selectivity (CS) performance
Private equity .................................................................... 874 measure .............................................................................. 917
Development and organisation of the
Components of investment performance ........... 919
private equity market ...................................................... 875
Decomposing the return: Fama .................................... 919
The private equity investment process ...................... 878
Performance attribution analysis .................................. 921
Returns to private equity funds .................................... 880
Measuring market timing skills .................................... 924
Real estate investment trusts ........................................ 882
Factors that affect use of performance
Ethics and regulation in the professional
measures .......................................................................... 925
asset management industry ..................................... 885
CONTENTS xv
Demonstration of the global benchmark Returns-based bond performance measurement ..... 929
problem ............................................................................... 926 Bond performance attribution ....................................... 930
Implications of the benchmark problems ................... 927 Reporting investment performance ...................... 933
Required characteristics of benchmarks .................... 928 Time-weighted and money-weighted returns ........... 933
Evaluation of bond portfolio performance ......... 929 Performance presentation standards ........................... 935
Appendix A How to become a CFA® charterholder 944

Appendix B Code of ethics and standards of professional conduct 945
Appendix C Interest tables 948
Appendix D Standard normal probabilities 952
Answers to concept check questions 953
References 974
Glossary 991
Index 1009
xvi
Guide to the text

As you read this text you will find a number of features in
every chapter to enhance your study of investment analysis
and portfolio management and help you understand how
the theory is applied in the real world.
PART OPENING FEATURES
PART 1
Part openers introduce
each of the chapters
within the Part and give
The investment an overview of how the
background chapters in the text

relate to each other.
A Chapter list outlines
the chapters contained
CHAPTER
CHAPTER
1 THE INVESTMENT SETTING
2 THE ASSET ALLOCATION DECISION
in each Part for easy
CHAPTER
CHAPTER
3 SELECTING INVESTMENTS IN A GLOBAL MARKET
4 ORGANISATION AND FUNCTIONING OF SECURITIES MARKETS
reference.
CHAPTER 5 SECURITY-MARKET INDICES
The chapters in Part 1 will provide a background for your study of investments by answering the
following questions:
• Why do people invest?
• How do you measure the returns and risks for various or different investments?
• What factors should you consider when you make asset allocation decisions?
• What investments are available?
• How do securities markets function?
CHAPTER-OPENING FEATURES • How and why are securities markets around the world changing?
• What are the major uses of security-market indices?
• How can you evaluate the market behaviour of shares and bonds?
• What factors cause differences among share and bond-market indices?
In the first chapter, we consider why an individual would invest, how to measure the rates of return
and risk for various or different investments, and what factors determine an investor’s required rate
1
of return on an investment. The latter point will be important in subsequent analyses when we work
4 to understand investor behaviour, the markets for alternative securities and the valuation of various
investments.
Because the ultimate decision facing an investor is the makeup of his or her portfolio, Chapter 2
deals with the all-important asset allocation decision. This includes specific steps in the portfolio
management process and factors that influence the makeup of an investor’s portfolio over his or her
life cycle.
Identify the key
The investment setting concepts that the
After you read this chapter, you will be able to: chapter will cover with
1
2
Explain what an investment is, and why individuals invest
Recognise how investors measure the rate of return on an investment
the Introduction and list
BK-CLA-REILLY_BROWN_1E-190039-Chp01.indd 2 05/07/19 4:49 PM
3 Understand the factors that contribute to the rates of return that investors require on
different investments
of Learning objectives
4 Appreciate the difference between risk and return.
at the start of each
chapter, which are
This initial chapter discusses several topics basic to the subsequent chapters. We begin by defining the
term investment and discussing the returns and risks related to investments. This leads to a presentation
linked to each topic
of how to measure the expected and historical rates of returns for an individual asset or a portfolio of
assets. In addition, we consider how to measure risk not only for an individual investment but also for an heading in the chapter.
investment that is part of a portfolio.
The third section of the chapter discusses the factors that determine the required rate of return for
an individual investment. The factors discussed are those that contribute to an asset’s total risk. Because
most investors have a portfolio of investments, it is necessary to consider how to measure the risk of
an asset when it is a part of a large portfolio of assets. The risk that prevails when an asset is part of a
diversified portfolio is referred to as its systematic risk (this is the residual risk that cannot be diversified
away).
The final section deals with what causes changes in an asset’s required rate of return over time.
Notably, changes occur because of both macroeconomic events that affect all investment assets and
microeconomic events that affect the specific asset.
1.1 WHAT IS AN INVESTMENT?

Copyright 2020 Cengage Learning.
For most ofAll
yourRights Reserved.
life, you will be earning and May not
spending beRarely,
money. copied,
though,scanned,
will your currentor duplicated, in whole or in part. WCN 02-200-202
income
exactly balance with your consumption desires. Sometimes, you may have more money than you want
to spend; at other times, you may want to purchase more than you can afford based on your current
income. These imbalances will lead you either to borrow or to save to maximise the long-run benefits
the investor is trading a known dollar amount today for some expected future stream of payments that
should be greater than the current dollar amount today.
At this point, we have answered the questions about why people invest and what they want from
their investments. They invest to earn a return from savings due to their deferred consumption. They
want a rate of return that compensates them for the time period of the investment, the expected rate
of inf lation and the uncertainty of the future cash f lows. This return, the investor’s required rate
of return, is discussed throughout this book. A central question of this book is how investors select
GUIDE TO THE TEXT xvii
xvii
investments that will give them their required rates of return.
This rate is often annualised, to allow easy comparisons between different rates of return for
competing investments, since rates are commonly quoted in annual terms.
The next section of this chapter describes how to measure the expected or historical rate of return
on an investment and also how to quantify the uncertainty (risk) of expected returns. You need to
6 PART 1 THE understand
INVESTMENT these techniques for measuring the rate of return and the uncertainty of these returns to
BACKGROUND
FEATURES WITHIN CHAPTERS evaluate the suitability of a particular investment. Although our emphasis will be on financial assets,
such as bonds and shares, we will refer to other assets, such as art and antiques. Chapter 3 discusses the
range of financial assets and also considers some non-financial assets.
2 per cent during the period of investment, he or she will increase the required interest rate by 2 per cent.
Check your progress through In our example, the investor would require $106 in the future to defer the $100 of consumption during
CONCEPT
an inf lationary period (a 6 per cent nominal, risk-free interest rate will be required instead of 4 per cent).
CHECK
each section by answering the Further, if the future payment from the investment is not certain, the investor will demand an
interest rate thatinherit
You suddenly exceeds$10the
000nominal
and arerisk-free
decidinginterest
what to rate. Theit.uncertainty
do with Which of theoffollowing
the payments from
options an
could
Concept check questions as you be considered
investment is the investments? Explain
investment risk. The why, or whyreturn
additional not, you would
added to consider them risk-free
the nominal, to be investments.
interest rate is
a Organise and pay for an all expenses trip around Australia for your family
progress through the chapter. called a risk premium. In our previous example, the investor would require more than $106 one year
b Purchase shares in Qantas
from today to compensate for the uncertainty. As an example, if the required amount were $110, $4
c Purchase open-ended Qantas tickets for use at a date of your choosing
(4 per cent) would be considered a risk premium.
d Pay your university fees
e Buy units in an education fund for your MBA or PhD
Important Key terms are bolded 1.1.1 Investment defined

in the text. A full list of key From our discussion, we can specify a formal definition of an investment. Specifically, an investment
is the current commitment of dollars for a period of time in order to derive future payments that will
terms is available in the compensate the investor for (1) the time the funds are committed, (2) the expected rate of inf lation during
this time period, and (3) the uncertainty of the future payments. The ‘investor’ can be an individual, a
glossary, which can be found at BK-CLA-REILLY_BROWN_1E-190039-Chp01.indd 6
government, a pension fund or a corporation. Similarly, this definition includes all types of investments,
05/07/19 4:50 PM
the back of the book. including investments by corporations in plant and equipment and investments by individuals in shares,
bonds, commodities or real estate. This text emphasises investments by individual investors. In all cases,
the investor is trading a known dollar amount today for some expected future stream of payments that
should be greater than the current dollar amount today.
At this point, we have answered the questions about why people invest and what they want from
their investments. They invest to earn a return from savings due to their deferred consumption. They
END-OF-CHAPTER FEATURES want a rate of return that compensates them for the time period of the investment, the expected rate
of inf lation and the uncertainty of the future cash f lows. This return, the investor’s required rate
of return, is discussed throughout this book. A central question of this book is how investors select
investments that will give them their required rates of return.
At the end of each chapter you will find several tools to help you to review, practise and extend
This rate is often annualised, to allow easy comparisons between different rates of return for
your knowledge of the key learning outcomes. 96 competingBACKGROUND
PART 1 THE INVESTMENT investments, since rates are commonly quoted in annual terms.
The next section of this chapter describes how to measure the expected or historical rate of return
on an investment and also how to quantify the uncertainty (risk) of expected returns. You need to
Review your understanding understand these techniques for measuring the rate of return and the uncertainty of these returns to
SUMMARY
evaluate the suitability of a particular investment. Although our emphasis will be on financial assets,
of the key chapter topics • Investors whosuch
wantas
thebonds
broadestand shares,
range we will
of choices in refer to other
1 assets, such
A positive as art and
relationship antiques.
typically Chapter
holds between 3 discusses the
the rate
with the Summary. investments range of financial

must consider assets and
foreign equities andbonds
also considers someofnon-financial
in addition to their domestic counterparts. Many foreign
return earned on assets.
an asset and the variability of its
historical rate of return. This is expected in a world of
98 PART 1 THE INVESTMENT BACKGROUND
securities offer investors higher risk-adjusted returns risk-averse investors who require higher rates of return
than do domestic securities. In addition, the low positive
CONCEPT to compensate for more uncertainty.
CHECK between foreign and domestic
or negative correlations 2 The correlation among rates of return for selected
securities make them ideal for building a diversified alternative investments can be quite low, especially for
PROBLEMS
portfolio.
You suddenly inherit $10 000 and are deciding what to do with it. Which of the following options could
Exhibit 3.10 summarises the risk and return characteristics CHAPTER 3 SELECTING INVESTMENTS
domestic and foreign equities and bonds and between
IN A GLOBAL MARKET 97
•
be considered investments? Explain why, or whythese not,financial assets
you would and alternative
consider them investments, such
to be investments.
1 Using
of the ainvestment
source of alternatives
internationaldescribed
statistics,incompare the
this chapter. Investment
as commodities Arithmetic Geometric
and real estate. Standard
These correlations
percentage a Organise and pay for an all expenses trip around
category
Australia for yourmean
family
mean (%)of diversification
(%) among
deviation of
Some of the change in the
differences arefollowing economic
due to unique data
factors that confirm the advantage
for
we Australia,
b Purchase
discussed.Japan,
Foreign Germany, shares
Canada
equities and bonds
in
and Qantas
the
are United
considered different asset classes on a global basis. return (%)
a
Test your knowledge and QUESTIONS

States
riskier than c Purchase
for adomestic
recent year. Whatand
equities open-ended
were Qantas
the differences,
bonds because the tickets •for In
of and use at a date
Equities
addition of yourmany
to describing choosing
10.28 8.81
direct investments, such16.9
d Pay your university fees
which country
unavoidable or countries
uncertainty duediffered most from
to exchange theand
rate risk United as Treasury
equities bills
and bonds, we 3.54
also discussed3.49investment 3.2
consolidate your learning States?

a
country
What arerisk.
1
stamps
theSuch
Aggregate output
e investments
Buy units
advantages inart,
as
of investing anantiques,
education
in coinsfund
the equities
(GDP) risk premiums. You should
and for your MBA
rather companies ortoPhD
Long-term
stamps
government
that
be moreallow investors
liquid to buy investments
5.10 antiques
than 4.91
and art? What 6.4
than therequire
corporate heavybondsliquidity
of a company? Compare the indirectly.
must These can
an investor be important
typically do to selltoa investors
collectionwho want
of art and
through the end-of-chapter
bonds
bdivideConsumer
consideration Price Index
ofareal estate
certainty of returns for bond withinvestments between
those for equities. Draw to take advantage
antiques?
Long-term Briefly of professional
contrast this
5.95
management
procedure 5.65to the sale but of
also a9.6
cyourMoney supply growth
a linepersonal
graph tohome, on which
demonstrate the you do not
pattern ofexpect
returnsas high
you want instant
corporate
portfolio diversification
bonds
of equities listed on with a limitedor
a national amount of funds.
international
Questions and Problems. 2 Using

awould
change
2 real Discuss
online
returnenvision
in the
estate,three
resources,
becauseforofeach
share
which
factors
examine
non-monetary
marketaindices
requires
that cause much
the
of these assets
weekly
factors,
overandpercentage
for Australia,
higher
domestic rate
commercial
time.
Japan,due
of return
investors
With Real$10
exchange.
12 equities
You have
000, you may not9.49
estate
ora bonds,
fairly large
be able to buy 9.44many individual
but you could acquire shares in a
4.5
a
Based on arithmetic mean.portfolio of US equities and bonds.
Germany,
to United Kingdom andand the United States. For each
to cash
considerflow uncertainty
including various illiquidity.
global securities in their mutual
You meet fund or an ETF,
a financial which at
planner would
a socialgivegathering
you a share whoof a
• of thesedata
Recent
portfolios.
weeks, which
on the foreign indices
risk–return profile ofmoved
various most closely
investment a Explain
diversified
suggests why
portfolio
that you the geometric
that
diversify yourand
might containarithmetic
portfolio 100 mean
bytoinvesting
150 returns
different
in
with the Australian
BK-CLA-REILLY_BROWN_1E-190039-Chp01.indd market
6 equities, index? Whichcommodities,
series diverged are not equal and whether one or orthe other may be 05/07/19 4:50 PM
3 alternatives, including
Discuss why international bonds,
diversification reduces portfolio domestic
emerging and
marketinternational
equities. equities bonds.
most from the andAustralian market index? Discusstwo these
98 PART
real
risk. estate
1Specifically,
THE INVESTMENT
foreign
why would securities,
you expect
BACKGROUND
point low
toward correlation in 13 Themore useful for investment
superannuation plan for Joey decision
Ltd has making.
historically
results as they relate to international diversification. For the timeshares
period
generalisations:
the rates of return for domestic and foreign securities? binvested in the ofindicated,
only Australianrank these investments
companies.
3 Using online sources, look up the exchange rate for the on a relative basis
4 Discuss why you would expect a difference in the Recently, the fund has using
decided theto coefficient
add internationalof variation
Australian dollar with the Japanese yen for each of the from most toplan
leastportfolio.
desirable. Explainand your rationale.
correlation of returns between securities from Australia and exposure to the Identify briefly discuss
EXHIBIT
past 103.10 yearsAlternative
(you can useinvestment
an average for riskthe and return
year or a characteristics Assume theproblems
arithmeticthat mean
from other countries, such as the US, Japan, Canada and cthree potential thereturns
plan may in these
confrontseriesin are
PROBLEMS
specific time period each year). Based on these exchange
South Africa.
Rate of return
rates, compute and discuss the yearly exchange rate
normally
selecting distributed.
international
that andomestic
investor equities.
Calculate
equities thatthe range
it did
would have expected to achieve
not offacereturns
in
5 Discuss whether you would expect any change in the choosing
Using on
1 effect a source of international
an investment in Japanese statistics, compare
equities by an the Investment Arithmetic
time from Geometric Standard
correlations between domestic and foreign equities. For 14 AVI 95 per cent
Capital of the
has been experiencing holding
increasingequities.demand
percentage
Australian changeDiscuss
investor. in the following
the impact economic data
of this exchange 5 You category mean (%)long-run meanannual(%) rates deviation of
example, discuss whether you would expect the correlation fromare its given the following
institutional clients for information andreturn of return
assistance
a
(%)
for Australia,
rate effect on Japan, the riskGermany,
of Japanese Canada andfor
equities theanUnited for alternative investment instruments:
between Australian and Japanese share returns to change related to international investment management.
States for a
Australian recent year. What were the differences, and
investor. Equities Futures 10.28 8.81 16.9
over time. If so, why? Recognising
Government that this
T-notes
Art andis an area of growing importance,
antiques the
3.50%
4 The which countryinformation
following or countriesis differed
availablemost from the
concerning theUnited Treasury bills 3.54 3.49 3.2
6 When you invest in Japanese or German bonds, what Coins and stamps firm has hired
Large-cap an experienced
Warrants
equities and optionsanalyst/portfolio manager 11.75
States? risk and return relationships in the capital market
historical Long-term 5.10 4.91 6.4
major additional risks must you consider besides yield specialising incorporate
Long-termreal
international
bonds
equities and market strategy. 5.50
of Aggregate
a Asiatica over output
the past(GDP) five years: government
Commercial estate
changes within the country? Domestic equities Hisbonds
Foreign first assignment is to represent AVI Capital before a
equities
b Consumer Price Index Long-term government bonds 4.90
7 Some investors believe that international Foreign corporateinvesting
bonds Real estate client
(personal company’s
Long-term home) investment 5.95committee5.65 to discuss the 9.6
c Money supply growth Small-capitalisation equities 13.10
introduces additional risks. Discuss these risks and how corporate
possibility bonds
of changing their present ‘Australian securities
2 Using online resources, examine the weekly percentage Domestic corporate bonds
they can affect your return. Give an example. only’Real
The estate
investment
annual rate approach 9.49
to one
of inflation including
during 9.44 period
this was 4.5
international
change in the share market indices for Australia, Japan,
Foreign government bonds
8 You can acquire convertible bonds from a rapidly growing 3investments.
per
a
Based cent. He ismean.
Calculate
on arithmetic toldthethat
realtheratecommittee
of return on wants
thesea
Germany, United Kingdom and the Unitedgovernment
Domestic States. Forbonds
each
company or from a utility. Speculate on which convertible presentation
investment that fully and objectively examines the basic,
alternatives.
of these weeks, which foreignT-bills indices moved most closely a Explain why the geometric and arithmetic mean returns
bond would have the lower yield and discuss the reason substantive considerations on which the committee should
with the Australian market index? Which series diverged are not equal and whether one or the other may be
Extend your understanding for this difference.
SUGGESTED READINGS
most from the Australian market index? Discuss these
9 Compare the liquidity of an investment in raw land with
results as they relate to international diversification.
focus its attention, including both theory and evidence.
more useful for investment decision making.
The company’s pension plan has no legal or other barriers
Risk
b For the time period indicated, rank these investments
through the Suggested
that of an investment in equities. Be specific as to why and to adoption of an international approach; no foreign
3 Using
Grabbe, online1996. sources, look up the
International exchange
Financial rate for
Markets. the on a relative
Karthik,basis using the coefficient of variation
how J.the Orlin.
liquidity differs. (Hint: Begin by defining New
liquidity.) Ramanathan,
pension liabilities Frank
currently Fabozzi,
exist. and
IdentifyJames and Gerand.
briefly 2012.
York: Australian
Elsevier dollar with the Japanese yen for each of the from most to least desirable. Explain In your rationale. of
The Handbook
are Science Publishing. ‘International Bondreasons
Portfolio forManagement.’
Readings list relevant to each
10 What share warrants and call options? How do they discuss three adding international securities to
past 10 years (you can use an average for the year or a c Assume
Fixed-Income the arithmetic
Securities, 8th ed.,mean returns
ed. Frank in theseNew
J. Fabozzi. series are
York:
Lessard,
differDonald
from each R. 1988.
other? ‘International Diversification.’ In The the pension portfolio and three problems associated with
specific time period each year). Based on these exchange McGraw-Hill. normally distributed. Calculate the range of returns
Financial
11 Discuss Analyst’s Handbook,
why financial 2nd ed.,
analysts ed. Sumner
consider antiques N.and
Levine.
art to such an approach.
chapter. rates, compute and discuss the yearly exchange rate
Homewood,
be illiquid IL:investments.
Dow Jones-Irwin. Why do they consider coins and
effect on an investment in Japanese equities by an
that an investor
Siegel, Laurence
Bills, and95Inflation
B., and would
per centAround
Paul D.have
of the the timeWorld.’
expected
Kaplan.
from holding
1990. to
In Managing
achieve
‘Stocks,
equities.
Bonds,
Institutional
Malvey, Jack. 2012. ‘Global Credit, Bond Portfolio
Australian investor. Discuss the impact of this exchange 5 You
Assets, ed.are given
Frank J. the following
Fabozzi. New long-run
York: Harper annual rates of return
& Row.
Management.’ In The Handbook
BK-CLA-REILLY_BROWN_1E-190039-Chp03.indd 96 of Fixed-Income Securities, 8th 05/07/19 6:48 PM
rate effect on the risk of Japanese equities for an for alternative investment instruments:
ed., ed. Frank J. Fabozzi. New York: McGraw-Hill. Solnik, Bruno, and Dennis McLeavey. 2012. International
Australian investor.
Ramanathan, Karthik. 2012. ‘International Bond Markets and Investments, 6th ed.T-notes
Government Reading, MA: Addison-Wesley. 3.50%
4 The following information is available concerning the
Instruments.’ In The Handbook of Fixed-Income Securities, Large-cap equities 11.75
historical risk and return relationships in the capital market
8th ed., ed. Frank J. Fabozzi. New York: McGraw-Hill. Long-term corporate bonds 5.50
of Asiatica over the past five years:
Long-term government bonds 4.90
Small-capitalisation equities 13.10
The annual rate of inflation during this period was

BK-CLA-REILLY_BROWN_1E-190039-Chp03.indd 98 3 per cent. Calculate the real rate of return on these 05/07/19 6:48 PM
investment alternatives.
SUGGESTED READINGS
BK-CLA-REILLY_BROWN_1E-190039-Chp03.indd 97 05/07/19 6:48 PM
Grabbe, J. Orlin. 1996. International Financial Markets. New Ramanathan, Karthik, Frank Fabozzi, and James Gerand. 2012.
York: Elsevier Science Publishing. ‘International Bond Portfolio Management.’ In The Handbook of
xviii
Guide to the online resources

FOR THE INSTRUCTOR
Cengage is pleased to provide you with a selection of resources

that will help you prepare your lectures and assessments.
These teaching tools are accessible via cengage.com.au/instructors
for Australia or cengage.co.nz/instructors for New Zealand.
SOLUTIONS MANUAL
The Solutions Manual provides detailed solutions to every question in the text.
TEST BANK
This bank of questions has been developed in conjunction with the text for creating quizzes,
tests and exams for your students. Deliver these through your LMS and in your classroom.
POWERPOINT™ PRESENTATIONS
Use the chapter-by-chapter PowerPoint presentations to enhance your lecture presentations
and handouts in order to reinforce the key principles of your subject.
ARTWORK FROM THE TEXT

Add the digital files of graphs, exhibits and flow charts into your course management system,
use them in student handouts, or copy them in your lecture presentations.
xix
PREFACE
The pleasure of authoring a textbook comes from writing about a subject that we enjoy and find exciting.
As authors, we hope that we can pass on to the reader not only knowledge but also the excitement that we
feel for the subject. In addition, writing about investments brings an added stimulant because the subject
can affect the reader during his or her entire business career and beyond. We hope that what readers derive
from this course will help them enjoy better lives through managing their financial resources properly.
The purpose of this book is to help you learn how to manage your money so you will derive the
maximum benefit from what you earn. To accomplish this purpose, you need to learn about the many
investment alternatives that are available today and, what is more important, to develop a way of analysing
and thinking about investments that will remain with you in the years ahead when new and different
investment opportunities become available.
Because of its dual purpose, the book mixes description and theory. The descriptive material
discusses available investment instruments and considers the purpose and operation of capital markets
around the world. The theoretical portion details how you should evaluate current investments and
future opportunities to develop a portfolio of investments that will satisfy your risk-return objectives.
Preparing this Asia Pacific edition has been challenging for three reasons. First, most traditional
texts focus on issues specific to the US market. Whilst these continue to be important and relevant
in a global context, given the US market’s dominance and influence on our region, there are certain
nuances and practices that make our markets unique. We have explored these differences by including
discussions of issues specific to our markets and through including relevant Asia Pacific examples.
Secondly, we continue to experience rapid changes in the securities markets in terms of theory,
new financial instruments, innovative trading practices, and the fallout from the significant credit
and liquidity disruption and the numerous regulatory changes that followed. Thirdly, capital markets
continue to become very global in nature. Consequently, early in the book we present the compelling case
for global investing. Subsequently, to ensure that you are prepared to function in a global environment,
almost every chapter discusses how investment practice or theory is influenced by the globalisation of
investments and capital markets. This completely integrated treatment is to ensure that you develop a
broad mindset on investments that will serve you well in the future.
Intended market
This text is addressed to both graduate and advanced undergraduate students who are looking for an
in-depth discussion of investments and portfolio management. The presentation of the material is
intended to be rigorous and empirical, without being overly quantitative. A proper discussion of the
modern developments in investments and portfolio theory must be rigorous. The discussion of numerous
empirical studies reflects the belief that it is essential for alternative investment theories to be exposed
to the real world and be judged on the basis of how well they help us understand and explain reality.
Key features of the Asia Pacific edition

When planning this edition of Investment Analysis and Portfolio Management, we wanted to retain its
traditional strengths and capitalise on new developments in the investments area to make it the most
comprehensive investments textbook available. The text has been updated for currency and relevance to
the Asia Pacific region.
xx PREFACE
This edition maintains its unparalleled international coverage. Investing knows no borders, and
although the total integration of domestic and global investment opportunities may seem to contradict the
need for separate discussions of international issues, it, in fact, makes the need for specific information
on non-US markets, instruments, conventions and techniques even more compelling.
Both technology and regulations have caused more significant changes during the last decade in
the functioning and organisation of global security markets than during the prior 40 years. Chapter 4
contains a detailed discussion of this evolution and the results for global markets.
Today’s investing environment includes derivative securities not as exotic anomalies, but as standard
investment instruments. We felt that Investment Analysis and Portfolio Management must reflect that
reality. Consequently, our four chapters on derivatives are written to provide the reader with an intuitive,
clear discussion of the different instruments, their markets, valuation, trading strategies, and general use
as risk management and return enhancement tools.
We have added many new questions and problems to the end-of-chapter material to provide more
student practice on executing computations concerned with more sophisticated, and Asia Pacific-related,
investment problems.
Chapter 3 The updated evidence of returns (through 2018) continues to support global diversification,
and an updated study on global assets supports the use of a global measure of systematic risk to explain
asset returns. Also, we consider new investment instruments available for global investors, including
global index funds and the continued growth of exchange-traded funds (ETFs) for numerous countries
and sectors.
Chapter 4 This chapter focuses on the continuing growth in trading volume handled by electronic
communications networks (ECNs) and provides details on the significant changes in global security
markets. We also consider the rationale for the continuing consolidation of global exchanges across asset
classes of stocks, bonds and derivatives. In addition, we note that the corporate bond market continues
to experience major changes in how and when trades are reported, and the number of bond issues
involved.
Chapter 5 This chapter shows the three major methods for constructing an index of the share market.
We discuss the many uses of indices, especially the benchmarking of a portfolio and the importance of
selecting an appropriate index for the benchmark. We examine the great variety of indices for shares
and bonds. These typically focus on specific parts of the market, such as the size of a company and style
of investing for shares, or credit quality and maturity for bonds. The chapter shows many of the leading
indices in the world as well as indices in Australia.
Chapter 6 This chapter provides the evidence that both supports the efficient market hypothesis but
also provides the evidence of anomalies. We discuss behavioural finance and how it may explain many
of the anomalies. Further, we discuss the implications of changes in the cost of trading (considered in
Chapter 4) on some of the empirical results of prior studies.
Chapter 8 This chapter has been revised to enhance the presentation of the important transition
between modern portfolio theory and the Capital Asset Pricing Model (CAPM) in a more intuitive
way, including a section on industry-specific characteristic lines. The discussion contains several
examples of how the CAPM is measured and used in practice, in both the Asia Pacific region and
global markets.
Chapter 9 The discussion of the theory and practice of using multifactor models of risk and expected
return has been updated and expanded. The connection between the Arbitrage Pricing Theory (APT)
and empirical implementations of the APT continues to be stressed conceptually.
PREFACE xxi
Chapter 10 This chapter contains a detailed comparison of alternative cash flow specifications and
how they are used in valuation models and credit analysis. When we apply the extensive ratio analysis
to Woolworths Group Limited, it uncovers several changes in the performance by Woolworths, which
highlights the usefulness of the analysis.
Chapter 11 Here we emphasise the two alternative approaches to valuation (present value of cash flows
and relative valuation) as applied to the Asia Pacific region. An updated presentation of the yield spread
(to 2018) enforces the importance of the changing risk premium.
Chapter 12 This chapter both considers the macroeconomic variables that affect capital markets
and demonstrates the microvaluation of these markets. The demonstration was very challenging and
insightful due to the economic and market environment during, and since, the global financial crisis of
2007–2009.
Chapter 13 We continue to emphasise the importance of the macroanalysis of an industry and the large
impact this has on the subsequent valuation of the industry.
Chapter 14 We advocate a two-part analysis that first involves an in-depth analysis of a company to
understand both its business and financial risk and its growth outlook. The second part of the analysis is a
share valuation component that depends upon the company analysis for inputs. The result is two decisions
– one on the company and the second on the share. It is emphasised that these decisions do not have to be
the same (e.g., the shares of a good company may be a poor investment as they may be overvalued).
Chapter 15 This chapter provides an overview of technical analysis – an analytical technique that
examines price patterns and trading volume of securities, particularly shares. We discuss the logic and
reasoning of technical analysis and then demonstrate the popular trading rules, which can be classified
into four categories. The chapter contrasts technical analysis with the efficient markets hypothesis,
previously examined in Chapter 6.
Chapter 16 This chapter contains an enhanced discussion of the relative merits of passive versus active
management techniques for equity portfolio management focusing on the important role of tracking
error. Expanded material on measuring the tax efficiency of an equity portfolio has been introduced,
along with additional analysis of equity portfolio investment strategies, including fundamental and
technical approaches, as well as a detailed description of equity style analysis.
Chapter 17 This chapter introduces the key features of bonds. There are a great many types of bonds
varying in the timing of payments, the tax implications, the likelihood of default and the liquidity
of their markets. We survey the world bond market and find that Australian bonds constitute an
important investment opportunity for world investors. The chapter examines the many securities
created out of promised or anticipated cash flows. Examples include payments from mortgage-backed
securities (MBS), asset backed securities (ABS) and collateralised debt obligations (CDO).
Chapter 18 This chapter prices bonds using a single discount rate, as well as spot rates throughout the
yield curve. We distinguish and calculate five different measures of yield. We discuss the yield curve
and theories regarding their shapes. The chapter presents four specifications of duration including the
strengths and problems for each of them. Similarly, we consider three yield spreads – traditional spreads,
static yield spreads and option adjusted spreads (OAS) – and the relationships among them.
Chapter 19 This chapter presents material on how the investment style of a fixed-income portfolio is
defined and measured in practice. We discuss and compare active and passive fixed-income strategies,
as well as examples of liability-asset matching and how the bond immunisation process functions. We
examine real world strategies such as core-plus and contingent immunisation that combine passive and
active management.
xxii PREFACE
Chapter 20 Expanded discussions of the fundamentals associated with using derivative securities
(e.g., interpreting price quotations, basic payoff diagrams, basic strategies) are included in this chapter.
We also provide updated examples of both basic and intermediate risk management applications using
derivative positions, as well as new material on how these contracts trade in the marketplace.
Chapter 21 New and updated examples and applications are provided throughout the chapter,
emphasising the role that forward, and futures contracts play in managing exposures to equity, fixed-
income and foreign exchange risk. Also included is an enhanced discussion of how futures and forward
markets are structured and operate.
Chapter 22 Here we expand the discussion linking valuation and applications of call and put options in
the context of investment management. The chapter contains both new and updated examples designed
to illustrate how investors use options in practice, as well as a discussion of the recent changes to options
markets.
Chapter 23 This chapter includes a revised discussion of several advanced derivative applications
(e.g., swap contracting, convertible securities, structured notes, real options), as well as updated examples
and applications of each of these applications. An extensive discussion of how credit default derivatives
are used in practice has also been updated.
Chapter 24 Contained in this chapter is a revised and updated discussion of the organisation and
participants in the professional asset management industry. Of particular note is an extensive update of
the structure and strategies employed by hedge funds as well as enhanced analysis of how private equity
funds function.
Chapter 25 This chapter provides an expanded examination of the performance measures for a portfolio
manager, including their development and shortcomings. We cover a number of performance techniques
in addition to the four major performance measures. The discussion examines not only measures that
focus on the portfolio’s return, but also techniques that focus on the security holdings of the portfolio.
We show how the concept of downside risk can be incorporated into the performance measure. Finally,
we present acceptable methods for calculating and reporting results.
For educational purposes only

Please note this independent textbook is intended for educational purposes only and should not be
construed as investment advice in any way.
This textbook was not prepared for inclusion in, or in connection with any Product Disclosure
Statement or other offer document and should not be relied upon to provide all the necessary information
for investment decisions. Although great care has been taken to ensure the accuracy of this text, the
authors give no warranties in relation to the statements and information contained herein and disclaim
all liability arising from any persons acting on the information and statements in this text. The text
provides general opinion and not personal securities recommendations. All investors are strongly advised
to consult professional financial advisers whose role it is to provide appropriate investment advice, taking
into account an individual investor’s investment objectives, financial situation and particular needs.
xxiii
ABOUT THE AUTHORS

Frank K. Reilly
Frank K. Reilly is the Bernard J. Hank Professor of Finance and former dean of the Mendoza College of
Business at the University of Notre Dame. Holding degrees from the University of Notre Dame (BBA),
Northwestern University (MBA) and the University of Chicago (PhD), Professor Reilly has taught at
the University of Illinois, the University of Kansas and the University of Wyoming in addition to the
University of Notre Dame. He has several years of experience as a senior securities analyst, as well as
experience in share and bond trading. A chartered financial analyst (CFA), he has been a member of
the Council of Examiners, the Council on Education and Research, the grading committee, and was
chairman of the board of trustees of the Institute of Charted Financial Analysts and chairman of the
board of the Association of Investment Management and Research (AIMR; now the CFA Institute).
Professor Reilly has been president of the Financial Management Association, the Midwest Business
Administration Association, the Eastern Finance Association, the Academy of Financial Services and
the Midwest Finance Association. He is or has been on the board of directors of the First Interstate
Bank of Wisconsin, Norwest Bank of Indiana, the Investment Analysts Society of Chicago, UBS Global
Funds (chairman), Fort Dearborn Income Securities (chairman), Discover Bank, NIBCO, Inc., the
International Board of Certified Financial Planners, Battery Park High Yield Bond Fund, Inc., Morgan
Stanley Trust FSB, the CFA Institute Research Foundation (chairman), the Financial Analysts Seminar,
the Board of Certified Safety Professionals and the University Club at the University of Notre Dame.
As the author of more than 100 articles, monographs, and papers, his work has appeared in numerous
publications including Journal of Finance, Journal of Financial and Quantitative Analysis, Journal of
Accounting Research, Financial Management, Financial Analysts Journal, Journal of Fixed Income and
Journal of Portfolio Management. In addition to Investment Analysis and Portfolio Management, 10th ed.,
Professor Reilly is the co-author of another textbook, Investments, 7th ed. (South-Western, 2006) with
Edgar A. Norton. He is editor of Readings and Issues in Investments, Ethics and the Investment Industry,
and High Yield Bonds: Analysis and Risk Assessment.
Professor Reilly was named on the list of Outstanding Educators in America and has received the
University of Illinois Alumni Association Graduate Teaching Award, the Outstanding Educator Award
from the MBA class at the University of Illinois and the Outstanding Teacher Award from the MBA
class and the senior class at Notre Dame. He also received from the CFA Institute both the C. Stewart
Sheppard Award for his contribution to the educational mission of the Association and the Daniel J.
Forrestal III Leadership Award for Professional Ethics and Standards of Investment Practice. He also
received the Hortense Friedman Award for Excellence from the CFA Society of Chicago and a Lifetime
Achievement Award from the Midwest Finance Association. He was part of the inaugural group selected
as a fellow of the Financial Management Association International. He is or has been a member of the
editorial boards of Financial Management, The Financial Review, International Review of Economics and
Finance, Journal of Financial Education, Quarterly Review of Economics and Finance and the European
Journal of Finance. He is included in Who’s Who in Finance and Industry, Who’s Who in America, Who’s
Who in American Education and Who’s Who in the World.
Keith C. Brown
Keith C. Brown holds the position of University Distinguished Teaching Professor of Finance and Fayez
Sarofim Fellow at the McCombs School of Business, University of Texas. He received his BA in economics
from San Diego State University, where he was a member of the Phi Beta Kappa, Phi Kappa Phi and
xxiv ABOUT THE AUTHORS
Omicron Delta Epsilon honour societies. He received his MS and PhD in financial economics from the
Krannert Graduate School of Management at Purdue University. Since leaving school in 1981, he has
specialised in teaching investment management, portfolio management and security analysis, capital
markets and derivatives courses at the undergraduate, MBA and PhD levels, and has received numerous
awards for teaching innovation and excellence, including election to the university’s prestigious Academy
of Distinguished Teachers. In addition to his academic responsibilities, he also serves as President and
Chief Executive Officer of The MBA Investment Fund, L.L.C., a privately funded investment company
managed by graduate students at the University of Texas.
Professor Brown has published more than 40 articles, monographs, chapters and papers on topics
ranging from asset pricing and investment strategy to financial risk management. His publications have
appeared in such journals as Journal of Finance, Journal of Financial Economics, Review of Financial
Studies, Journal of Financial and Quantitative Analysis, Review of Economics and Statistics, Journal of
Financial Markets, Financial Analysts Journal, Financial Management, Journal of Investment Management,
Advances in Futures and Options Research, Journal of Fixed Income, Journal of Applied Corporate Finance
and Journal of Portfolio Management. In addition to his contributions to Investment Analysis and Portfolio
Management, 10th edition, he is a co-author of Interest Rate and Currency Swaps: A Tutorial, a textbook
published through the Association for Investment Management and Research (AIMR; now the CFA
Institute). He received a Graham and Dodd Award from the Financial Analysts Federation as an author
of one of the best articles published by Financial Analysts Journal in 1990 and a Smith- Breeden Prize
from the Journal of Finance in 1996.
In August 1988, Professor Brown received his Chartered Financial Analyst designation from the
CFA Institute, and he has served as a member of that organisation’s CFA Candidate Curriculum
Committee and Education Committee and on the CFA Examination Grading staff. For five years, he
was the research director of the Research Foundation of the CFA Institute, from which position he
guided the development of the research portion of the organisation’s world-wide educational mission.
For several years, he was also associate editor for Financial Analysts Journal and currently holds that
position for Journal of Investment Management and Journal of Behavioral Finance. In other professional
service, Professor Brown has been a regional director for the Financial Management Association and has
served as the applied research track chairman for that organisation’s annual conference.
Professor Brown is the cofounder and senior partner of Fulcrum Financial Group, a portfolio
management and investment advisory firm located in Austin, Texas and Las Vegas, Nevada, that
currently oversees portfolios holding a total of $60 million in fixed-income securities. From May
1987 to August 1988 he was based in New York as a senior consultant to the Corporate Professional
Development Department at Manufacturers Hanover Trust Company. He has lectured extensively
throughout the world on investment and risk management topics in the executive development programs
for such companies as Fidelity Investments, JP Morgan Chase, Commonfund, BMO Nesbitt Burns,
Merrill Lynch, Chase Manhattan Bank, Chemical Bank, Lehman Brothers, Union Bank of Switzerland,
Shearson, Chase Bank of Texas, The Beacon Group, Motorola, and Halliburton. He is an advisor to the
boards of the Teachers Retirement System of Texas and the University of Texas Investment Management
Company and serves on the Investment Committee of LBJ Asset Management Partners.
Asjeet S. Lamba
Asjeet S. Lamba is an Associate Professor with the Department of Finance at the University of
Melbourne. He has a BA (Honours) in Economics from the University of Delhi, an MBA in Finance from
the University of Michigan and a PhD in Finance from the University of Washington. His main research
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intelligence and earnestness of the whites, we find the problem
simplifying. So far from the future bringing trouble, we feel confident
that another decade or so, confirming the experience of the past ten
years, will furnish the solution to be accepted of all men.
Let us examine briefly what the South has been doing, and study
the attitude of the races toward each other. Let us do this, not so
much to vindicate the past as to clear the way for the future. Let us
see what the situation teaches. There must be in the experience of
fifteen years something definite and suggestive. We begin with the
schools and school management, as the basis of the rest.
Every Southern State has a common-school system, and in every
State separate schools are provided for the races. Almost every city
of more than five thousand inhabitants has a public-school system,
and in every city the schools for whites and blacks are separate.
There is no exception to this rule that I can find. In many cases the
law creating this system requires that separate schools shall be
provided for the races. This plan works admirably. There is no friction
in the administration of the schools, and no suspicion as to the
ultimate tendency of the system. The road to school is clear, and
both races walk therein with confidence. The whites, assured that
the school will not be made the hot-bed of false and pernicious
ideas, or the scene of unwise associations, support the system
cordially, and insist on perfect equality in grade and efficiency. The
blacks, asking no more than this, fill the schools with alert and eager
children. So far from feeling debased by the separate-school system,
they insist that the separation shall be carried further, and the few
white teachers yet presiding over negro schools supplanted by negro
teachers. The appropriations for public schools are increased year
after year, and free education grows constantly in strength and
popularity. Cities that were afraid to commit themselves to free-
schools while mixed schools were a possibility commenced building
school-houses as soon as separate schools were assured. In 1870
the late Benjamin H. Hill found his matchless eloquence unable to
carry the suggestion of negro education into popular tolerance. Ten
years later nearly one million black children attended free-schools,
supported by general taxation. Though the whites pay nineteen-
twentieths of the tax, they insist that the blacks shall share its
advantages equally. The schools for each race are opened on the
same day and closed on the same day. Neither is run a single day at
the expense of the other. The negroes are satisfied with the
situation. I am aware that some of the Northern teachers of negro
high-schools and universities will controvert this. Touching their
opinion, I have only to say that it can hardly be considered fair or
conservative. Under the forcing influence of social ostracism, they
have reasoned impatiently and have been helped to conclusions by
quick sympathies or resentments. Driven back upon themselves and
hedged in by suspicion or hostility, their service has become a sort of
martyrdom, which has swiftly stimulated opinion into conviction and
conviction into fanaticism. I read in a late issue of Zion’s Herald a
letter from one of these teachers, who declined, on the conductor’s
request, to leave the car in which she was riding, and which was set
apart exclusively for negroes. The conductor, therefore, presumed
she was a quadroon, and stated his presumption in answer to the
inquiry of a young negro man who was with her. She says of this:
“Truly, a glad thrill went through my heart—a thrill of pride. This great
autocrat had pronounced me as not only in sympathy, but also one in
blood, with the truest, tenderest, and noblest race that dwells on earth.”
If this quotation, which is now before me, over the writer’s name,
suggests that she and those of her colleagues who agree with her
have narrowed within their narrowing environment, and acquired
artificial enthusiasm under their unnatural conditions, so that they
must be unsafe as advisers and unfair as witnesses, the sole
purpose for which it is introduced will have been served. This
suggestion does not reach all Northern teachers of negro schools.
Some have taken broader counsels, awakened wider sympathies,
and, as a natural result, hold more moderate views. The influence of
the extremer faction is steadily diminishing. Set apart, as small and
curious communities are set here and there in populous States,
stubborn and stiff for a while, but overwhelmed at last and lost in the
mingling currents, these dissenting spots will be ere long blotted out
and forgotten. The educational problem, which is their special care,
has already been settled, and the settlement accepted with a
heartiness that precludes the possibility of its disturbance. From the
stand-point of either race the experiment of distinct but equal schools
for the white and black children of the South has demonstrated its
wisdom, its policy, and its justice, if any experiment ever made plain
its wisdom in the hands of finite man.
I quote on this subject Gustavus J. Orr, one of the wisest and best
of men, and lately elected, by spontaneous movement, president of
the National Educational Association. He says: “The race question in
the schools is already settled. We give the negroes equal
advantages, but separate schools. This plan meets the reason and
satisfies the instinct of both races. Under it we have spent over five
million dollars in Georgia, and the system grows in strength
constantly.” I asked if the negroes wanted mixed schools. His reply
was prompt: “They do not. I have questioned them carefully on this
point, and they make but one reply: “They want their children in their
own schools and under their own teachers.” I asked what would be
the effect of mixed schools. “I could not maintain the Georgia system
one year. Both races would protest against it. My record as a public-
school man is known. I have devoted my life to the work of
education. But I am so sure of the evils that would come from mixed
schools that, even if they were possible, I would see the whole
educational system swept away before I would see them
established. There is an instinct that gathers each race about itself. It
is as strong in the blacks as in the whites, though it has not asserted
itself so strongly. It is making itself manifest, since the blacks are
organizing a social system of their own. It has long controlled them in
their churches, and it is now doing so in their schools.”
In churches, as in schools, the separation is perfect. The negroes,
in all denominations in which their membership is an appreciable
percentage of the whole, have their own churches, congregations,
pastors, conferences, bishops, and their own missionaries. There is
not the slightest antagonism between them and the white churches
of the same denomination. On the contrary, there is sympathetic
interest and the utmost friendliness. The separation is recognized as
not only instinctive but wise. There is no disposition to disturb it, and
least of all on the part of the negro. The church is with him the center
of social life, and there he wants to find his own people and no
others. Let me quote just here a few sentences from a speech
delivered by a genuine black negro at the General Conference of the
Methodist Episcopal Church (South), in Atlanta, Georgia, in 1880. He
is himself a pastor of the African Methodist Church, and came as a
fraternal delegate. This extract from a speech, largely extempore, is
a fair specimen of negro eloquence, as it is a fair evidence of the
feeling of that people toward their white neighbors. He said:
“Mr. Chairman, Bishops, and Brethren in Christ: Let me here state a

circumstance which has just now occurred. When in the vestry, there we
were consulting your committee, among whom is your illustrious Christian
Governor, the Honorable A. H. Colquitt [applause], feeling an unusual
thirst, and expecting in a few moments to appear before you,
thoughtlessly I asked him if there was water to drink. He, looking about
the room, answered, ‘There is none; I will get you some.’ I insisted not;
but presently it was brought by a brother minister, and handed me by the
Governor. I said: ‘Governor, you must allow me to deny myself this
distinguished favor, as it recalls so vividly the episode of the warrior king
of Israel, when, with parched lips, he cried from the rocky cave of
Adullam, ‘Oh! that one would give me drink of water of the well of
Bethlehem that is at the gate.’ And when three of his valiant captains
broke through the host of the enemy, and returned to him with the water
for which his soul was longing, regarding it as the water of life, he would
not drink it, but poured it out to the Lord.’ [Applause.] So may this
transcendent emblem of purity and love, from the hand of your most
honored co-laborer and friend of the human race, ever remain as a
memorial unto the Lord of the friendship existing between the Methodist
Episcopal Church South and the African Methodist Episcopal Church
upon this the first exchange of formal fraternal greeting. [Applause.]
“In the name of the African Methodist Episcopal Church,—and I declare
the true sentiments of thousands,—I say, that for your Church and your
race we cherish the kindliest feelings that ever found a lodgment in the
human breast. [Applause.] Of this you need not be told. Let speak your
former missionaries among us, who now hold seats upon this floor, and
whose hearts have so often burned within them as they have seen the
word sown by them in such humble soil burst forth into abundant
prosperity. Ask the hundred thousand of your laymen who still survive the
dead, how we conducted ourselves as tillers of the soil, as servants about
the dwelling, and as common worshipers in the temple of God! Ask your
battle-scarred veterans, who left their all to the mercy of relentless
circumstances, and went, in answer to the clarion call of the trumpet, to
the gigantic and unnatural strife of the second revolution! Ask them who
looked at their interests at home [great cheering]; who raised their
earthworks upon the field; who buried the young hero so far away from
his home, or returned his ashes to the stricken hearts which hung
breathless upon the hour; who protected their wives and little ones from
the ravages of wild beasts, and the worse ravages of famine! And the
answer is returned from a million heaving bosoms, as a monument of
everlasting remembrance to the benevolence of the colored race in
America. [Immense applause.] And these are they who greet you to-day,
through their chief organization, the African Methodist Episcopal Church
in the United States of America. [Loud and continued applause.]
“And now, though the yoke which bound the master and the slave
together in such close and mutual responsibility has been shivered by the
rude shock of war, we find ourselves still standing by your side as natural
allies against an unfriendly world.” [Applause.]
In their social institutions, as in their churches and schools, the

negroes have obeyed their instinct and kept apart from the whites.
They have their own social and benevolent societies, their own
military companies, their own orders of Masons and Odd Fellows.
They rally about these organizations with the greatest enthusiasm
and support them with the greatest liberality. If it were proposed to
merge them with white organizations of the same character, with
equal rights guaranteed in all, the negroes would interpose the
stoutest objection. Their tastes, associations, and inclinations—their
instincts—lead them to gather their race about social centers of its
own. I am tempted into trying to explain here what I have never yet
seen a stranger to the South able to understand. The feeling that, by
mutual action, separates whites and blacks when they are thrown
together in social intercourse is not a repellent influence in the harsh
sense of that word. It is centripetal rather than centrifugal. It is
attractive about separate centers rather than expulsive from a
common center. There is no antagonism, for example, between
white and black military companies. On occasions they parade in the
same street, and have none of the feeling that exists between
Orangemen and Catholics. Of course the good sense of each race
and the mutual recognition of the possible dangers of the situation
have much to do with maintaining the good-will between the distinct
races. The fact that in his own church or society the negro has more
freedom, more chance for leadership and for individual development,
than he could have in association with the whites, has more to do
with it. But beyond all this is the fact that, in the segregation of the
races, blacks as well as whites obey a natural instinct, which, always
granting that they get equal justice and equal advantages, they obey
without the slightest ill-nature or without any sense of disgrace. They
meet the white people in all the avenues of business. They work side
by side with the white bricklayer or carpenter in perfect accord and
friendliness. When the trowel or the hammer is laid aside, the
laborers part, each going his own way. Any attempt to carry the
comradeship of the day into private life would be sternly resisted by
both parties in interest.
We have seen that in churches, schools, and social organizations
the whites and blacks are moving along separately but harmoniously,
and that the “assortment of the races,” which has been described as
shameful and unjust, is in most part made by the instinct of each
race, and commands the hearty assent of both. Let us now consider
the question of public carriers. On this point the South has been
sharply criticised, and not always without reason. It is manifestly
wrong to make a negro pay as much for a railroad ticket as a white
man pays, and then force him to accept inferior accommodations. It
is equally wrong to force a decent negro into an indecent car, when
there is room for him or for her elsewhere. Public sentiment in the
South has long recognized this, and has persistently demanded that
the railroad managers should provide cars for the negroes equal in
every respect to those set apart for the whites, and that these cars
should be kept clean and orderly. In Georgia a State law requires all
public roads or carriers to provide equal accommodation for each
race, and failure to do so is made a penal offense. In Tennessee a
negro woman lately gained damages by proving that she had been
forced to take inferior accommodation on a train. The railroads have,
with few exceptions, come up to the requirements of the law. Where
they fail, they quickly feel the weight of public opinion, and shock the
sense of public justice. This very discussion, I am bound to say, will
lessen such failures in the future. On four roads, in my knowledge,
even better has been done than the law requires. The car set apart
for the negroes is made exclusive. No whites are permitted to
occupy it. A white man who strays into this car is politely told that it is
reserved for the negroes. He has the information repeated two or
three times, smiles, and retreats. This rule works admirably and will
win general favor. There are a few roads that make no separate
provision for the races, but announce that any passenger can ride on
any car. Here the “assortment” of the races is done away with, and
here it is that most of the outrages of which we hear occur. On these
roads the negro has no place set apart for him. As a rule, he is shy
about asserting himself, and he usually finds himself in the meanest
corners of the train. If he forces himself into the ladies’ car, he is apt
to provoke a collision. It is on just one of these trains where the
assortment of the passengers is left to chance that a respectable
negro woman is apt to be forced to ride in a car crowded with negro
convicts. Such a thing would be impossible where the issue is fairly
met, and a car, clean, orderly, and exclusive, is provided for each
race. The case could not be met by grading the tickets and the
accommodations. Such a plan would bring together in the second or
third class car just the element of both races between whom
prejudice runs highest, and from whom the least of tact or restraint
might be expected. On the railroads, as elsewhere, the solution of
the race problem is, equal advantages for the same money,—equal
in comfort, safety, and exclusiveness,—but separate.
There remains but one thing further to consider—the negro in the
jury-box. It is assumed generally that the negro has no
representation in the courts. This is a false assumption. In the United
States courts he usually makes more than half the jury. As to the
State courts, I can speak particularly as to Georgia. I assume that
she does not materially differ from the other States. In Georgia the
law requires that commissioners shall prepare the jury-list for each
county by selection from the upright, intelligent, and experienced
citizens of the county. This provision was put into the Constitution by
the negro convention of reconstruction days. Under its terms no
reasonable man would have expected to see the list made up of
equal percentage of the races. Indeed, the fewest number of
negroes were qualified under the law. Consequently, but few
appeared on the lists. The number, as was to be expected, is
steadily increasing. In Fulton County there are seventy-four negroes
whose names are on the lists, and the commissioners, I am
informed, have about doubled this number for the present year.
These negroes make good jurymen, and are rarely struck by
attorneys, no matter what the client or cause may be. About the
worst that can be charged against the jury system in Georgia is that
the commissioners have made jurors of negroes only when they had
qualified themselves to intelligently discharge a juror’s duties. In few
quarters of the South, however, is the negro unable to get full and
exact justice in the courts, whether the jury be white or black.
Immediately after the war, when there was general alarm and
irritation, there may have been undue severity in sentences and
extreme rigor of prosecution. But the charge that the people of the
South have, in their deliberate and later moments prostituted justice
to the oppression of this dependent people, is as false as it is
infamous. There is abundant belief that the very helplessness of the
negro in court has touched the heart and conscience of many a jury,
when the facts should have held them impervious. In the city in
which this is written, a negro, at midnight, on an unfrequented street,
murdered a popular young fellow, over whose grave a monument
was placed by popular subscription. The only witnesses of the killing
were the friends of the murdered boy. Had the murderer been a
white man, it is believed he would have been convicted. He was
acquitted by the white jury, and has since been convicted of a
murderous assault on a person of his own color. Similarly, a young
white man, belonging to one of the leading families of the State, was
hanged for the murder of a negro. Insanity was pleaded in his
defense, and so plausibly that it is believed he would have escaped
had his victim been a white man.
I quote on this point Mr. Benjamin H. Hill, who has been
prosecuting attorney of the Atlanta, Ga., circuit for twelve years. He
says: “In cities and towns the negro gets equal and exact justice
before the courts. It is possible that, in remote counties, where the
question is one of a fight between a white man and a negro, there
may be a lingering prejudice that causes occasional injustice. The
judge, however, may be relied on to correct this. As to negro jurors, I
have never known a negro to allow his lawyer to accept a negro
juror. For the State I have accepted a black juror fifty times, to have
him rejected by the opposing lawyer by order of his negro client. This
has incurred so invariably that I have accepted it as a rule.
Irrespective of that, the negro gets justice in the courts, and the last
remaining prejudice against him in the jury-box has passed away. I
convicted a white man for voluntary manslaughter under peculiar
circumstances. A negro met him on the street and cursed him. The
white man ordered him off and started home. The negro followed
him to his house and cursed him until he entered the door. When he
came out, the negro was still waiting. He renewed the abuse,
followed him to his store, and there struck him with his fist. In the
struggle that followed, the negro was shot and killed. The jury
promptly convicted the slayer.”
So much for the relation between the races in the South, in
churches, schools, social organizations, on the railroad, and in
theaters. Everything is placed on the basis of equal
accommodations, but separate. In the courts the blacks are admitted
to the jury-box as they lift themselves into the limit of qualification.
Mistakes have been made and injustice has been worked here and
there. This was to have been expected, and it has been less than
might have been expected. But there can be no mistake about the
progress the South is making in the equitable adjustment of the
relations between the races. Ten years ago nothing was settled.
There were frequent collisions and constant apprehensions. The
whites were suspicious and the blacks were restless. So simple a
thing as a negro taking an hour’s ride on the cars, or going to see a
play, was fraught with possible danger. The larger affairs—school,
church, and court—were held in abeyance. Now all this is changed.
The era of doubt and mistrust is succeeded by the era of confidence
and good-will. The races meet in the exchange of labor in perfect
amity and understanding. Together they carry on the concerns of the
day, knowing little or nothing of the fierce hostility that divides labor
and capital in other sections. When they turn to social life they
separate. Each race obeys its instinct and congregates about its own
centers. At the theater they sit in opposite sections of the same
gallery. On the trains they ride each in his own car. Each worships in
his own church, and educates his children in his schools. Each has
his place and fills it, and is satisfied. Each gets the same
accommodation for the same money. There is no collision. There is
no irritation or suspicion. Nowhere on earth is there kindlier feeling,
closer sympathy, or less friction between two classes of society than
between the whites and blacks of the South to-day. This is due to the
fact that in the adjustment of their relations they have been practical
and sensible. They have wisely recognized what was essential, and
have not sought to change what was unchangeable. They have
yielded neither to the fanatic nor demagogue, refusing to be misled
by the one or misused by the other. While the world has been
clamoring over their differences they have been quietly taking
counsel with each other, in the field, the shop, the street and cabin,
and settling things for themselves. That the result has not astonished
the world in the speediness and the facility with which it has been
reached, and the beneficence that has come with it, is due to the fact
that the result has not been freely proclaimed. It has been a
deplorable condition of our politics that the North has been
misinformed as to the true condition of things in the South. Political
greed and passion conjured pestilential mists to becloud what the
lifting smoke of battle left clear. It has exaggerated where there was
a grain of fact, and invented where there was none. It has sought to
establish the most casual occurrences as the settled habit of the
section, and has sprung endless jeremiades from one single
disorder, as Jenkins filled the courts of Christendom with
lamentations over his dissevered ear. These misrepresentations will
pass away with the occasion that provoked them, and when the truth
is known it will come with the force of a revelation to vindicate those
who have bespoken for the South a fair trial, and to confound those
who have borne false witness against her.
One thing further need be said, in perfect frankness. The South
must be allowed to settle the social relations of the races according
to her own views of what is right and best. There has never been a
moment when she could have submitted to have the social status of
her citizens fixed by an outside power. She accepted the
emancipation and the enfranchisement of her slaves as the
legitimate results of war that had been fought to a conclusion. These
once accomplished, nothing more was possible. “Thus far and no
farther,” she said to her neighbors, in no spirit of defiance, but with
quiet determination. In her weakest moments, when her helpless
people were hedged about by the unthinking bayonets of her
conquerors, she gathered them for resistance at this point. Here she
defended everything that a people should hold dear. There was little
proclamation of her purpose. Barely did the whispered word that
bespoke her resolution catch the listening ears of her sons; but for all
this the victorious armies of the North, had they been rallied again
from their homes, could not have enforced and maintained among
this disarmed people the policy indicated in the Civil Rights bill. Had
she found herself unable to defend her social integrity against the
arms that were invincible on the fields where she staked the
sovereignty of her States, her people would have abandoned their
homes and betaken themselves into exile. Now, as then, the South is
determined that, come what may, she must control the social
relations of the two races whose lots are cast within her limits. It is
right that she should have this control. The problem is hers, whether
or not of her seeking, and her very existence depends on its proper
solution. Her responsibility is greater, her knowledge of the case
more thorough than that of others can be. The question touches her
at every point; it presses on her from every side; it commands her
constant attention. Every consideration of policy, of honor, of pride,
of common sense impels her to the exactest justice and the fullest
equity. She lacks the ignorance or misapprehension that might lead
others into mistakes; all others lack the appalling alternative that, all
else failing, would force her to use her knowledge wisely. For these
reasons she has reserved to herself the right to settle the still
unsettled element of the race problem, and this right she can never
yield.
As a matter of course, this implies the clear and unmistakable
domination of the white race in the South. The assertion of that is
simply the assertion of the right of character, intelligence and
property to rule. It is simply saying that the responsible and steadfast
element in the community shall control, rather than the irresponsible
and the migratory. It is the reassertion of the moral power that
overthrew the scandalous reconstruction governments, even though,
to the shame of the Republic be it said, they were supported by the
bayonets of the General Government. Even the race issue is lost at
this point. If the blacks of the South wore white skins, and were
leagued together in the same ignorance and irresponsibility under
any other distinctive mark than their color, they would progress not
one step farther toward the control of affairs. Or if they were
transported as they are to Ohio, and there placed in numerical
majority of two to one, they would find the white minority there
asserting and maintaining control, with less patience, perhaps, than
many a Southern State has shown. Everywhere, with such
temporary exceptions as afford demonstration of the rule,
intelligence, character, and property will dominate in spite of
numerical differences. These qualities are lodged with the white race
in the South, and will assuredly remain there for many generations at
least; so that the white race will continue to dominate the colored,
even if the percentages of race increase deduced from the
comparison of a lame census with a perfect one, and the omission of
other considerations, should hold good and the present race majority
be reversed.
Let no one imagine, from what is here said, that the South is
careless of the opinion or regardless of the counsel of the outside
world. On the contrary, while maintaining firmly a position she
believes to be essential, she appreciates heartily the value of
general sympathy and confidence. With an earnestness that is little
less than pathetic she bespeaks the patience and the impartial
judgment of all concerned. Surely her situation should command this
rather than indifference or antagonism. In poverty and defeat,—with
her cities destroyed, her fields desolated, her labor disorganized, her
homes in ruins, her families scattered, and the ranks of her sons
decimated,—in the face of universal prejudice, fanned by the storm
of war into hostility and hatred—under the shadow of this sorrow and
this disadvantage, she turned bravely to confront a problem that
would have taxed to the utmost every resource of a rich and
powerful and victorious people. Every inch of her progress has been
beset with sore difficulties; and if the way is now clearing, it only
reveals more clearly the tremendous import of the work to which her
hands are given. It must be understood that she desires to silence
no criticism, evade no issue, and lessen no responsibility. She
recognizes that the negro is here to stay. She knows that her honor,
her dear name, and her fame, no less than her prosperity, will be
measured by the fulness of the justice she gives and guarantees to
this kindly and dependent race. She knows that every mistake made
and every error fallen into, no matter how innocently, endanger her
peace and her reputation. In this full knowledge she accepts the
issue without fear or evasion. She says, not boldly, but conscious of
the honesty and the wisdom of her convictions: “Leave this problem
to my working out. I will solve it in calmness and deliberation, without
passion or prejudice, and with full regard for the unspeakable
equities it holds. Judge me rigidly, but judge me by my works.” And
with the South the matter may be left—must be left. There it can be
left with the fullest confidence that the honor of the Republic will be
maintained, the rights of humanity guarded, and the problem worked
out in such exact justice as the finite mind can measure or finite
agencies administer.
THE LITTLE BOY IN THE BALCONY.
M Y special amusement in New York is riding on the elevated

railway. It is curious to note how little one can see on the
crowded sidewalks of this city. It is simply a rush of the same people
—hurrying this way or that on the same errands—doing the same
shopping or eating at the same restaurants. It is a kaleidoscope with
infinite combinations but the same effects. You see it to-day, and it is
the same as yesterday. Occasionally in the multitude you hit upon a
genre specimen, or an odd detail, such as a prim little dog that sits
upright all day and holds in its mouth a cup for pennies for its blind
master, or an old bookseller with a grand head and the deliberate
motions of a scholar moldering in a stall—but the general effect is
one of sameness and soon tires and bewilders.
Once on the elevated road, however, a new world is opened, full of
the most interesting objects. The cars sweep by the upper stories of
the houses, and, running never too swiftly to allow observation,
disclose the secrets of a thousand homes, and bring to view people
and things never dreamed of by the giddy, restless crowd that sends
its impatient murmur from the streets below. In a course of several
months’ pretty steady riding from Twenty-third Street, which is the
station for the Fifth Avenue Hotel, to Rector, which overlooks Wall
Street, I have made many acquaintances along the route—and on
reaching the city my first curiosity is in their behalf.
One of these is a boy about six years of age—akin in his fragile
body and his serious mien, a youngster that is very precious to one. I
first saw this boy on a little balcony about three feet by four,
projecting from the window of a poverty-stricken fourth floor. He was
leaning over the railing, his white, thoughtful head just clearing the
top, holding a short round stick in his hand. The little fellow made a
pathetic picture, all alone there above the street, so friendless and
desolate, and his pale face came between me and my business
many a time that day. On going up town that evening just as night
was falling, I saw him still at his place, white and patient and silent.
Every day afterwards I saw him there, always with the short stick in
his hand. Occasionally he would walk around the balcony rattling the
stick in a solemn manner against the railing, or poke it across from
one corner to another and sit on it. This was the only playing I ever
saw him do, and the stick was the only plaything he had. But he was
never without it. His little hand always held it, and I pictured him
every morning when he awoke from his joyless sleep, picking up his
plaything and going out to his balcony, as other boys go to play. Or
perhaps he slept with it, as little ones do with dolls and whip-tops.
I could see that the room beyond the window was bare. I never
saw any one in it. The heat must have been terrible, for it could have
had no ventilation. Once I missed the boy from the balcony, but saw
his white head, moving about slowly in the dusk of the room.
Gradually the little fellow become a burden to me. I found myself
continually thinking of him, and troubled with that remorse that
thoughtless people feel even for suffering for which they are not in
the slightest degree responsible. Not that I ever saw any suffering on
his face. It was patient, thoughtful, serious, but with never a sign of
petulance. What thoughts filled that young head—what
contemplation took the place of what should have been the ineffable
upbringing of childish emotion—what complaint or questioning were
living behind that white face—no one could guess. In an older
person the face would have betokened a resignation that found
peace in the hope of things hereafter. In this child, without hope or
estimation, it was sad beyond expression.
One day as I passed I nodded at him. He made no sign in return. I
repeated the nod on another trip, waving my hand at him—but
without avail. At length, in response to an unusually winning
exhortation, his pale lips trembled into a smile—but a smile that was
soberness itself. Wherever I went that day that smile went with me.
Wherever I saw children playing in the parks, or trotting along with
their hands nestled in strong fingers that guided and protected, I
thought of that tiny watcher in the balcony—joyless, hopeless,
friendless—a desolate mite, hanging between the blue sky and the
gladsome streets—lifting his wistful face now to the peaceful heights
of the one, and now looking with grave wonder on the ceaseless
tumult of the other. At length—but why go any further? Why is it
necessary to tell that the boy had no father, that his mother was
bedridden from his birth, and that his sister pasted labels in a drug-
house, and he was thus left to himself all day? It is sufficient to say
that I went to Coney Island yesterday, and forgot the heat in the
sharp saline breezes—watched the bathers and the children—
listened to the crisp, lingering music of the waves as they sang to the
beach—ate a robust lunch on the pier—wandered in and out among
the booths, tents, and hubbub—and that through all these manifold
pleasures, I had a companion that enjoyed them with a gravity that I
can never hope to emulate, but with a soulfulness that was touching
—and that as I came back in the boat, the breezes singing through
the cordage, music floating from the fore-deck, and the sun lighting
with its dying rays the shipping that covered the river, there was
sitting in front of me a very pale but very happy bit of a boy, open-
eyed with wonder, but sober and self-contained, clasping tightly in
his little fingers a short battered stick. And finally that whenever I
pass by a certain overhanging balcony now, I am sure of a smile
from an intimate and esteemed friend who lives there.
POEMS
BY VARIOUS HANDS.
GRADY.
I.
S UNS rise and set, stars flash and darken:

To-day I stand alone and hearken
Unto this counsel, old and wise:
“As shadows still we flee.” The blossom
May hide the rare fruit in its bosom,
But in the core the canker lies.
II.
To-day I stand alone and listen—

While on my cheek the teardrops glisten
And a strange blindness veils my sight,
Unto the story of his dying
And how, in God’s white slumber lying,
His laureled brow is lulled to-night.
III.

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Investment Analysis & Portfolio Management 11th Edition

(eBook PDF) Fixed Income Analysis (CFA Institute

(eBook PDF) Damodaran on Valuation: Security Analysis

Advances in Active Portfolio Management: New

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Prepares you for working in a global environment

Coverage of data specific to the Asia–Pacific

Helps you learn about current investment

STUDY HACK #23

PART 1 THE INVESTMENT BACKGROUND 2

CHAPTER 4 Special orders .................................................................... 121

PART 2 DEVELOPMENTS IN INVESTMENT THEORY 152

CHAPTER 7 Developing the capital market line .............................. 220

PART 3 VALUATION PRINCIPLES AND PRACTICES 284

PART 4 ANALYSIS AND MANAGEMENT OF ORDINARY SHARES 384

PART 5 ANALYSIS AND MANAGEMENT OF BONDS 540

PART 6 DERIVATIVE SECURITY ANALYSIS 688

CHAPTER 23 Credit-related swaps ....................................................... 823

PART 7 SPECIFICATION AND EVALUATION OF ASSET MANAGEMENT 840

Appendix A How to become a CFA® charterholder 944

Guide to the text

PART OPENING FEATURES

background chapters in the text

1.1 WHAT IS AN INVESTMENT?

Important Key terms are bolded 1.1.1 Investment defined

with the Summary. investments range of financial

Test your knowledge and QUESTIONS

consolidate your learning States?

Questions and Problems. 2 Using

The annual rate of inflation during this period was

Guide to the online resources

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ARTWORK FROM THE TEXT

Key features of the Asia Pacific edition

For educational purposes only

ABOUT THE AUTHORS

“Mr. Chairman, Bishops, and Brethren in Christ: Let me here state a

In their social institutions, as in their churches and schools, the

M Y special amusement in New York is riding on the elevated

S UNS rise and set, stars flash and darken:

To-day I stand alone and listen—

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