### Solution Manual for Investment Analysis and Portfolio Management 11th Edition by Frank K. Reilly

#### Solution Manual for Investment Analysis and Portfolio Management 11th Edition by Frank K. Reilly

Learn to manage your money to maximize your earning potential with Reilly/Brown/Leeds’ INVESTMENT ANALYSIS AND PORTFOLIO MANAGEMENT, 11th Edition. Extremely reader friendly in a succinct 18 chapters, this text equips you with a solid understanding of investment instruments, capital markets, behavioral finance, hedge funds, international investing and much more. Real-world examples and hands-on applications bring chapter concepts to life as you learn to use the same tools as investment professionals. The 11th edition’s unparalleled international coverage provides specific information on non-U.S. markets, instruments, conventions and techniques. New detailed discussions explain the impact of changes in both technology and regulations on global security markets. In addition, three chapters are devoted to derivatives securities–which are now standard investment instruments.

Title page

Copyright page

Brief Contents

Contents

Preface

Acknowledgments

About the Authors

Part 1: The Investment Background

Chapter 1: The Investment Setting

What Is an Investment?

Investment Defined

Measures of Return and Risk

Measures of Historical Rates of Return

Computing Mean Historical Returns

Calculating Expected Rates of Return

Measuring the Risk of Expected Rates of Return

Risk Measures for Historical Returns

Determinants of Required Rates of Return

The Real Risk-Free Rate

Factors Influencing the Nominal Risk-Free Rate (NRFR)

Risk Premium

Risk Premium and Portfolio Theory

Fundamental Risk versus Systematic Risk

Summary of Required Rate of Return

Relationship between Risk and Return

Movements along the SML

Changes in the Slope of the SML

Changes in Capital Market Conditions or Expected Inflation

Summary of Changes in the Required Rate of Return

Chapter 1 Appendix: Computation of Variance and Standard Deviation

Chapter 2: Asset Allocation and Security Selection

Individual Investor Life Cycle

The Preliminaries

Investment Strategies over an Investor’s Lifetime

Life Cycle Investment Goals

The Portfolio Management Process

The Need for a Policy Statement

Understanding and Articulating Realistic Investor Goals

Standards for Evaluating Portfolio Performance

Other Benefits

Input to the Policy Statement

Investment Objectives

Investment Constraints

Constructing the Policy Statement

General Guidelines

Some Common Mistakes

The Importance of Asset Allocation

Investment Returns after Taxes and Inflation

Returns and Risks of Different Asset Classes

Asset Allocation Summary

The Case for Global Investments

Relative Size of U.S. Financial Markets

Rates of Return on U.S. and Foreign Securities

Risk of Diversified Country Investments

Historical Risk-Returns on Alternative Investments

World Portfolio Performance

Art and Antiques

Real Estate

Chapter 2 Appendix:

A. Covariance

B. Correlation

Chapter 3: Organization and Functioning of Securities Markets

What Is a Market?

Characteristics of a Good Market

Decimal Pricing

Organization of the Securities Market

Primary Capital Markets

Government Bond Issues

Municipal Bond Issues

Corporate Bond Issues

Corporate Stock Issues

Private Placements and Rule 144A

Secondary Financial Markets

Why Secondary Markets Are Important

Secondary Bond Markets

Financial Futures

Secondary Equity Markets

Exchange Market-Makers

Classification of U.S. Secondary Equity Markets

Primary Listing Markets

The Significant Transition of the U.S. Equity Markets

Alternative Types of Orders Available

Market Orders

Limit Orders

Special Orders

Margin Transactions

Short Sales

Exchange Merger Mania

Chapter 4: Security Market Indexes and Index Funds

Uses of Security Market Indexes

Differentiating Factors in Constructing Market Indexes

The Sample

Weighting Sample Members

Computational Procedure

Stock Market Indexes

Price-Weighted Index

Value-Weighted Index

Unweighted Index

Fundamental Weighted Index

Style Indexes

Global Equity Indexes

Bond Market Indexes

U.S. Investment-Grade Bond Indexes

High-Yield Bond Indexes

Global Government Bond Indexes

Composite Stock–Bond Indexes

Comparison of Indexes over Time

Correlations between Monthly Equity Price Changes

Correlations between Monthly Bond Index Returns

Investing in Security Market Indexes

Chapter 4 Appendix: Stock Market Indexes

Part 2: Developments in Investment Theory

Chapter 5: Efficient Capital Markets, Behavioral Finance, and Technical Analysis

Efficient Capital Markets

Why Should Capital Markets Be Efficient?

Alternative Efficient Market Hypotheses

Tests and Results of Efficient Market Hypotheses

Behavioral Finance

Explaining Biases

Fusion Investing

Implications of Efficient Capital Markets

Efficient Markets and Fundamental Analysis

Efficient Markets and Portfolio Management

Technical Analysis

Underlying Assumptions of Technical Analysis

Advantages of Technical Analysis

Challenges to Technical Analysis

Challenges to the Assumptions of Technical Analysis

Challenges to Specific Trading Rules

Technical Trading Rules and Indicators

Contrary-Opinion Rules

Follow the Smart Money

Momentum Indicators

Stock Price and Volume Techniques

Efficient Markets and Technical Analysis

Chapter 6: An Introduction to Portfolio Management

Some Background Assumptions

Risk Aversion

Definition of Risk

The Markowitz Portfolio Theory

Alternative Measures of Risk

Expected Rates of Return

Variance (Standard Deviation) of Returns for an Individual Investment

Variance (Standard Deviation) of Returns for a Portfolio

Standard Deviation of a Portfolio

A Three-Asset Portfolio

Estimation Issues

The Efficient Frontier

The Efficient Frontier: An Example

The Efficient Frontier and Investor Utility

Capital Market Theory: An Overview

Background for Capital Market Theory

Developing the Capital Market Line

Risk, Diversification, and the Market Portfolio

Investing with the CML: An Example

Chapter 6 Appendix:

A. Proof That Minimum Portfolio Variance Occurs with Equal Investment Weights When Securities Have

B. Derivation of Investment Weights That Will Give Zero Variance When Correlation Equals 1.00

Chapter 7: Asset Pricing Models

The Capital Asset Pricing Model

A Conceptual Development of the CAPM

The Security Market Line

Empirical Tests of the CAPM

Stability of Beta

Relationship between Systematic Risk and Return

Additional Issues

Summary of Empirical Results for the CAPM

The Market Portfolio: Theory versus Practice

Arbitrage Pricing Theory

Using the APT

Security Valuation with the APT: An Example

Empirical Tests of the APT

Multifactor Models and Risk Estimation

Multifactor Models in Practice

Estimating Risk in a Multifactor Setting: Examples

Part 3: Valuation and Management of Common Stocks

Chapter 8: Equity Valuation

Important Distinctions

Fairly Valued, Overvalued, and Undervalued

Top-Down Approach versus Bottom-Up Approach

An Introduction to Discounted Cash Flow and Relative Valuation

The Foundations of Discounted Cash Flow Valuation

The Constant Growth Model

The No-Growth Model

Multistage (or Two-Stage) Growth Assumption

Discounted Cash Flow

Method #1: The Dividend Discount Model

Method #2: Free Cash Flow to Equity—The Improved DDM

Method #3: Discounted Cash Flow (FCFF)

Relative Valuation

Implementing Relative Valuation

Relative Valuation with CSCO

Advantages of Multiples

Disadvantages of Multiples

Ratio Analysis

Growth Rate of Sales

Gross Margins

Operating Margins

Net Margins

Accounts Receivable Turnover

Inventory Turnover

Net PP&E Turnover

Debt as a Percentage of Long-Term Capital

Changes in Reserve Accounts

Operating Earnings/GAAP Earnings

The Quality of Financial Statements

Balance Sheet

Income Statement

Footnotes

Moving on to Chapter 9

Chapter 8 Appendix: Derivation of Constant-Growth Dividend Discount Model (DDM

Chapter 9: The Top-Down Approach to Market, Industry, and Company Analysis

Introduction to Market Analysis

Aggregate Market Analysis (Macroanalysis)

Leading, Coincident, and Lagging Indicators

Sentiment and Expectations Surveys

Interest Rates

Microvaluation Analysis

FCFE to Value the Market

Multiplier Approach

Shiller P/E Ratio

Macrovaluation and Microvaluation of World Markets

Introduction to Industry Analysis: Why Industry Analysis Matters

Industry Analysis

The Business Cycle and Industry Sectors

Structural Economic Changes Impact the Industry(Noncyclical Factors)

Industry Life Cycle

Industry Competition

Estimating Industry Rates of Return

Estimating the Cost of Capital

Sales Growth Estimates

Other Considerations

Global Industry Analysis

Company Analysis

Growth Companies and Growth Stocks

Defensive Companies and Stocks

Cyclical Companies and Stocks

Value versus Growth Investing

Connecting Industry Analysis to Company Analysis

Firm Competitive Strategies

SWOT Analysis

Calculating Intrinsic Value

Some Additional Insights on Valuation—For Individual Companies

Analyzing Growth Companies

Lessons from Some Legends

Some Lessons from Lynch

Tenets of Warren Buffett

Tenets of Howard Marks

Chapter 10: The Practice of Fundamental Investing

Initial Public Offerings

Why Go Public

The IPO Process

Underpricing

Market Stabilization

Reasons for Underpricing

Bookbuilt Offering versus Auction

Longer-Term Performance of IPOs

Buy-Side Analysts and Sell-Side Analysts

Sell-Side Analysts

Buy-Side Analysts

Financial Analyst Forecasting Literature

Snap Inc. IPO and Analysts

Capital Allocation

The Seven Places That Capital Can Be Allocated

Dividends versus Repurchases

What Do Investors Want to See?

Corporate Governance

The Board of Directors

Anti-Takeover Provisions

Compensation

Creating a Stock Pitch

Air Lease Pitch

A Few Closing Points Concerning Stock Pitches

Chapter 10 Appendix:

A Few Closing Points Concerning Stock Pitches

The Plane Truth

Chapter 11: Equity Portfolio Management Strategies

Passive versus Active Management

An Overview of Passive Equity Portfolio Management Strategies

Index Portfolio Construction Techniques

Tracking Error and Index Portfolio Construction

Methods of Index Portfolio Investing

An Overview of Active Equity Portfolio Management Strategies

Fundamental Strategies

Technical Strategies

Factors, Attributes, and Anomalies

Forming Momentum-Based Stock Portfolios: Two Examples

Tax Efficiency and Active Equity Management

Active Share and Measuring the Level of Active Management

Value versus Growth Investing: A Closer Look

An Overview of Style Analysis

Asset Allocation Strategies

Integrated Asset Allocation

Strategic Asset Allocation

Tactical Asset Allocation

Insured Asset Allocation

Part 4: Valuation and Management of Bonds

Chapter 12: Bond Fundamentals and Valuation

Basic Features of a Bond

Bond Characteristics

The Global Bond Market Structure

Participating Issuers

Participating Investors

Bond Ratings

Survey of Bond Issues

Domestic Government Bonds

Government Agency Issues

Municipal Bonds

Corporate Bonds

Nontraditional Bond Coupon Structures

High-Yield Bonds

International Bonds

Bond Yield Curves

The Determinants of Bond Yields

Yield Curves and the Term Structure of Interest Rates

Par versus Spot Yield Curves

Yield Curves for Credit-Risky Bonds

Determining the Shape of the Term Structure

Bond Valuation

Par versus Spot Bond Valuation

Bond Valuation and Yields with Semiannual Coupons

Relationship between Bond Yields, Coupon Rates, and Bond Prices

Bond Valuation between Coupon Dates

Computing Other Bond Yield Measures

Chapter 13: Bond Analysis and Portfolio Management Strategies

Bond Analysis Tools

Implied Forward Rates

Bond Duration

Bond Convexity

Bonds with Embedded Options

Yield Spread Analysis

An Overview of Bond Portfolio Management: Performance, Style, and Strategy

Passive Management Strategies

Buy-and-Hold Strategy

Indexing Strategy

Bond Indexing in Practice: An Example

Active Management Strategies

Interest Rate Anticipation

Credit Analysis

Implementing an Active Bond Transaction

Active Global Bond Investing: An Example

Core-Plus Management Strategies

Matched-Funding Management Strategies

Dedicated Portfolios

Immunization Strategies

Horizon Matching

Contingent and Structured Management Strategies

Chapter 13 Appendix: Closed-Form Equation for Calculating Macaulay Duration

Part 5: Derivative Security Analysis

Chapter 14: An Introduction to Derivative Markets and Securities

Overview of Derivative Markets

The Language and Structure of Forward and Futures Markets

Interpreting Futures Price Quotations: An Example

The Language and Structure of Option Markets

Interpreting Option Price Quotations: An Example

Investing with Derivative Securities

The Basic Nature of Derivative Investing

Basic Payoff and Profit Diagrams for Forward Contracts

Basic Payoff and Profit Diagrams for Call and Put Options

Option Profit Diagrams: An Example

The Relationship between Forward and Option Contracts

Put–Call–Spot Parity

Put–Call Parity: An Example

Creating Synthetic Securities Using Put–Call Parity

Adjusting Put–Call–Spot Parity for Dividends

Put–Call–Forward Parity

An Introduction to the Use of Derivatives in Portfolio Management

Restructuring Asset Portfolios with Forward Contracts

Protecting Portfolio Value with Put Options

An Alternative Way to Pay for a Protective Put

Chapter 15: Forward, Futures, and Swap Contracts

An Overview of Forward and Futures Trading

Futures Contract Mechanics

Comparing Forward and Futures Contracts

Hedging with Forwards and Futures

Hedging and the Basis

Understanding Basis Risk

Calculating the Optimal Hedge Ratio

Forward and Futures Contracts: Basic Valuation Concepts

Valuing Forwards and Futures

The Relationship between Spot and Forward Prices

Financial Forwards and Futures: Applications and Strategies

Interest Rate Forwards and Futures

Long-Term Interest Rate Futures

Short-Term Interest Rate Futures

Stock Index Futures

Currency Forwards and Futures

OTC Forward Contracts

Interest Rate Contracts

Equity Index-Linked Swaps

Chapter 15 Appendix: Calculating Money Market Implied Forward Rates

Chapter 16: Option Contracts

An Overview of Option Markets and Contracts

Option Market Conventions

Price Quotations for Exchange-Traded Options

The Fundamentals of Option Valuation

The Basic Approach

Improving Forecast Accuracy

The Binomial Option Pricing Model

The Black–Scholes Valuation Model

Estimating Volatility

Problems with Black–Scholes Valuation

Option Valuation: Extensions

Valuing European-Style Put Options

Valuing Options on Dividend-Bearing Securities

Valuing American-Style Options

Option Trading Strategies

Protective Put Options

Covered Call Options

Straddles, Strips, and Straps

Strangles

Spreads

Range Forwards

Other Option Applications

Convertible Bonds

Credit Default Swaps

Part 6: Analysis and Evaluation of Asset Management

Chapter 17: Professional Portfolio Management, Alternative Assets, and Industry Ethics

The Asset Management Industry: Structure and Evolution

Private Management and Advisory Firms

Investment Strategy at a Private Money Management Firm

Organization and Management of Investment Companies

Valuing Investment Company Shares

Closed-End versus Open-End Investment Companies

Fund Management Fees

Investment Company Portfolio Objectives

Breakdown by Fund Characteristics

Global Investment Companies

Mutual Fund Organization and Strategy: An Example

Investing in Alternative Asset Classes

Hedge Funds

Characteristics of a Hedge Fund

Hedge Fund Strategies

Risk Arbitrage Investing: A Closer Look

Hedge Fund Performance

Private Equity

Ethics and Regulation in the Professional Asset Management Industry

Regulation in the Asset Management Industry

Standards for Ethical Behavior

Examples of Ethical Conflicts

What Do You Want from a Professional Asset Manager?

Chapter 18: Evaluation of Portfolio Performance

The Two Questions of Performance Measurement

Simple Performance Measurement Techniques

Peer Group Comparisons

Portfolio Drawdown

Risk-Adjusted Portfolio Performance Measures

Sharpe Portfolio Performance Measure

Treynor Portfolio Performance Measure

Jensen Portfolio Performance Measure

Information Ratio Performance Measure

Sortino Performance Measure

Summarizing the Risk-Adjusted Performance Measures

Application of Portfolio Performance Measures

Holdings-Based Portfolio Performance Measures

Grinblatt–Titman Performance Measure

Characteristic Selectivity Performance Measure

The Decomposition of Portfolio Returns

Performance Attribution Analysis

Fama Selectivity Performance Measure

Factors That Affect Use of Performance Measures

Demonstration of the Global Benchmark Problem

Implications of the Benchmark Problems

Required Characteristics of Benchmarks

Reporting Investment Performance

Time-Weighted and Money-Weighted Returns

Performance Presentation Standards

Appendix A The CFA® Charter

Appendix B Code of Ethics and Standards of Professional Conduct

Appendix C Interest Tables

Appendix D Standard Normal Probabilities

Comprehensive References List

Glossary

Index

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