INVESTMENT SCIENCE GBV

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PREFACE xxi,Chapter 1 INTRODUCTION 1,1 1 Cash Flows 2. 1 2 Investments and Markets 3,The Comparison Principle 4. Arbitrage 4,Dynamics 5,Risk Aversion 5,1 3 Typical Investment Problems 6. Risk Assessment and Management 8,Pure Investment 8. Other Problems 9,1 4 Organization of the Book 9,Deterministic Cash Flow Streams 9.
Single Period Random Cash Flow Streams 10,Derivative Assets 10. General Cash Flow Streams 11,Part I DETERMINISTIC CASH FLOW STREAMS. Chapter 2 THE BASIC THEORY OF INTEREST 15,2 1 Principal and Interest 15. Simple Interest 15,Compound Interest 16,Compounding at Various Intervals 17. Continuous Compounding 18,Money Markets 19,2 2 Present Value 20.
2 3 Present and Future Values of Streams 21,The Ideal Bank 21. Future Value 21,Present Value 22,x CONTENTS,Frequent and Continuous Compounding 23. Present Value and an Ideal Bank 23,2 4 Internal Rate of Return 24. 2 5 Evaluation Criteria 26,Net Present Value 27,Internal Rate of Return 28. Discussion of the Criteria 28,2 6 Applications and Extensions 30.
Net Flows 30,Cycle Problems 31,Inflation 34,2 7 Summary 36. Exercises 37,References 41,Chapter 3 FIXED INCOME SECURITIES 42. 3 1 The Market for Future Cash 43,Savings Deposits 43. Money Market Instruments 44,U S Government Securities 44. Other Bonds 45,Mortgages 46,Annuities 46,3 2 Value Formulas 46.
Perpetual Annuities 47,Finite Life Streams 48,Running Amortization 50. Annual Worth 51,3 3 Bond Details 52,Quality Ratings 53. 3 4 Yield 54,Qualitative Nature of Price Yield Curves 55. Other Yield Measures 58,3 5 Duration 59,Interest Duration 60. Macaulay Duration 60,Explicit Formula 61,Qualitative Properties of Duration 61.
Duration and Sensitivity 62,Duration of a Portfolio 64. 3 6 Immunization 65,3 7 Convexity 68,3 8 Summary 69. Exercises 71,References 74,CONTENTS xi,Chapter 4 THE TERM STRUCTURE OF INTEREST RATES 76. 4 1 The Yield Curve 76,4 2 The Term Structure 78,Spot Rates 78. Discount Factors and Present Value 79,Determining the Spot Rate 81.
4 3 Forward Rates 82,4 4 Term Structure Explanations 85. Expectations Theory 85,Liquidity Preference 86,Market Segmentation 87. Discussion 87,4 5 Expectations Dynamics 88,Spot Rate Forecasts 88. Discount Factors 89,Short Rates 90,Invariance Theorem 91. 4 6 Running Present Value 92,4 7 Floating Rate Bonds 95.
4 8 Duration 96,Fisher Weil Duration 96,Discrete Time Compounding 97. 4 9 Immunization 98,4 10 Summary 100,Exercises 102. References 106,Chapter 5 APPLIED INTEREST RATE ANALYSIS 107. 5 1 Capital Budgeting 108,Independent Projects 108. Interdependent Projects 111,5 2 Optimal Portfolios 113.
The Cash Matching Problem 114,5 3 Dynamic Cash Flow Processes 116. Representation of Dynamic Choice 117,Cash Flows in Graphs 119. 5 4 Optimal Management 120,Running Dynamic Programming 120. Examples 123,5 5 The Harmony Theorem 128,5 6 Valuation of a Firm 130. Dividend Discount Models 130,Free Cash Flow 132,5 7 Summary 134.
Exercises 136,References 139,xii CONTENTS,Part II SINGLE PERIOD RANDOM CASH FLOWS. Chapter 6 MEAN VARIANCE PORTFOLIO THEORY 143,6 1 Asset Return 144. Short Sales 144,Portfolio Return 146,6 2 Random Variables 147. Expected Value 148,Variance 149,Several Random Variables 150. Covariance 150,Variance of a Sum 152,6 3 Random Returns 152.
Mean Standard Deviation Diagram 155,6 4 Portfolio Mean and Variance 156. Mean Return of a Portfolio 156,Variance of Portfolio Return 156. Diversification 157,Diagram of a Portfolio 159,6 5 The Feasible Set 161. The Minimum Variance Set and the Efficient Frontier 162. 6 6 The Markowitz Model 164,Solution of the Markowitz Problem 165. Nonnegativity Constraints 168,6 7 The Two Fund Theorem 168.
6 8 Inclusion of a Risk Free Asset 171,6 9 The One Fund Theorem 173. Solution Method 173,Explicit Solution 175,6 10 Summary 175. Exercises 176,References 179,Chapter 7 THE CAPITAL ASSET PRICING MODEL 180. 7 1 Market Equilibrium 180,7 2 The Capital Market Line 182. 7 3 The Pricing Model 184,Betas of Common Stocks 187.
Beta of a Portfolio 187,7 4 The Security Market Line 187. Systematic Risk 189,7 5 Investment Implications 190. 7 6 Performance Evaluation 191,7 7 CAPM as a Pricing Formula 194. Linearity of Pricing and the Certainty Equivalent Form 196. 7 8 Project Choice 198,CONTENTS xiii,7 9 Projection Pricing 200. Minimum Norm Pricing 202,7 10 Correlation Pricing 203.
7 11 Summary 206,Exercises 207,References 211,Chapter 8 OTHER PRICING MODELS 213. 8 1 Introduction 213,8 2 Factor Models 213,Single Factor Model 214. Portfolio Parameters 215,Multifactor Models 219,Selection of Factors 219. 8 3 The CAPM as a Factor Model 220,The Characteristic Line 221. 8 4 Arbitrage Pricing Theory 223,Simple Version of APT 223.
Well Diversified Portfolios 225,General APT 226,APT and CAPM 227. 8 5 Projection Pricing with Factors 227,8 6 A Multiperiod Fallacy 229. 8 7 Summary 230,Exercises 232,References 234,Chapter 9 DATA AND STATISTICS 235. 9 1 Basic Estimation Methods 235,Period Length Effects 236. Mean Blur 238,9 2 Estimation of Other Parameters 240.
Estimation of cr 240,a Blur 241,9 3 The Effect of Estimation Errors 242. Three Views 243,Maximum Tangent 245,Compounding Effect 248. 9 4 Conservative Approaches 248,Better Estimates 249. 9 5 Tilting Away From Equilibrium 250,9 6 Summary 252. Exercises 253,References 255,Chapter 10 RISK MEASURES 257.
10 1 Value at Risk 258,xiv CONTENTS,Properties of VaR 260. Capital Requirement 260,10 2 Computation of Value at Risk 261. Model Based Method 261,Other Models 264,Shortcut for Discrete Distributions 264. Empirical Approach for Market Risk 265,10 3 Criticisms of VaR 266. Diversification Failure 266,Poor Assessment of Risk 267.
Discontinuous Value 268,10 4 Coherent Risk Measures 269. 10 5 Conditional Value at Risk 270,10 6 Coherent Characterization 272. 10 7 Convexity 274,10 8 Summary 275,Exercises 275,References 277. Chapter 11 GENERAL PRINCIPLES 279,11 1 Introduction 279. 11 2 Utility Functions 279,Equivalent Utility Functions 281.
11 3 Risk Aversion 282,Derivatives 284,Risk Aversion Coefficients 284. Certainty Equivalent 284,11 4 Specification of Utility Functions 285. Direct Measurement of Utility 285,Parameter Families 287. Questionnaire Method 288, 11 5 Utility Functions and the Mean Variance Criterion 288. Quadratic Utility 288,Normal Returns 290,11 6 Linear Pricing 291.
Type A Arbitrage 291,Portfolios 292,Type B Arbitrage 292. 11 7 Portfolio Choice 293,11 8 Arbitrage Bounds 296. 11 9 Zero Level Pricing 297,11 10 Log Optimal Pricing 299. 11 11 Finite State Models 301,Completeness 302,State Prices 302. Positive State Prices 302,CONTENTS xv,11 12 Risk Neutral Pricing 304.
11 13 Summary 306,Exercises 308,References 311,Part III DERIVATIVE SECURITIES. Chapter 12 FORWARDS FUTURES AND SWAPS 315,12 1 Pricing Principles 316. 12 2 Forward Contracts 318,Forward Interest Rates 319. 12 3 Forward Prices 319,Costs of Carry 322,Tight Markets 324. Investment Assets 325,12 4 The Value of a Forward Contract 326.
12 5 Swaps 327,Value of a Commodity Swap 327,Value of an Interest Rate Swap 329. 12 6 Basics of Futures Contracts 329,12 7 Futures Prices 332. 12 8 Relation to Expected Spot Price 335,12 9 The Perfect Hedge 336. 12 10 The Minimum Variance Hedge 336,12 11 Optimal Hedging 340. 12 12 Hedging Nonlinear Risk 341,12 13 Summary 345.
Exercises 346,References 349,Chapter 13 MODELS OF ASSET DYNAMICS 350. 13 1 Binomial Lattice Model 351,13 2 The Additive Model 353. i Normal Price Distribution 354,13 3 The Multiplicative Model 355. Lognormal Prices 355,Real Stock Distributions 356,13 4 Typical Parameter Values 357. 13 5 Lognormal Random Variables 358,13 6 Random Walks and Wiener Processes 359.
Generalized Wiener Processes and Ito Processes 361. 13 7 A Stock Price Process 362,Lognormal Prices 363. Standard Ito Form 363,Simulation 365,13 8 Ito s Lemma 366. xvi CONTENTS,13 9 Binomial Lattice Revisited 368,13 10 Summary 370. Exercises 370,References 373,Chapter 14 BASIC OPTIONS THEORY 374. 14 1 Option Concepts 375,14 2 The Nature of Option Values 377.
Time Value of Options 379,Other Factors Affecting the Value of Options 379. 14 3 Option Combinations and Put Gall Parity 380,Put Call Parity 381. 14 4 Early Exercise 382,14 5 Single Period Binomial Options Theory 383. 14 6 Multiperiod Options 386,No Early Exercise 389. 14 7 More General Binomial Problems 389,Put Options 389.
Dividend and Term Structure Problems 391,Futures Options 391. 14 8 Evaluating Real Investment Opportunities 393,Real Options 397. Linear Pricing 399,14 9 General Risk Neutral Pricing 401. 14 10 Three principle Power 402,Decomposition of the Pricing Principles 403. 14 11 Summary 403,Exercises 404,References 408,Chapter 15 ADDITIONAL OPTIONS TOPICS 410.
15 1 Introduction 410,15 2 The Black Scholes Equation 410. Proof of the Black Scholes Equation 412,Self Financing Strategies 414. 15 3 Call Option Formula 414,15 4 Risk Neutral Valuation 416. 15 5 Delta 417, 15 6 Replication Synthetic Options and Portfolio Insurance 419. 15 7 Volatility Smiles 422,Equality of Implied Volatilities 423.
Risk Neutral Probability Density 424,15 8 Computational Methods 425. Monte Carlo Simulation 426,Finite Difference Methods 427. Binomial and Trinomial Lattices 429,CONTENTS xvii,15 9 Exotic Options 431. Pricing 433,15 10 Comparison of Methods 434,15 11 Storage Costs and Dividends 435. Binomial Form 435,Brownian Motion Form 436,15 12 Martingale Pricing 437.
15 13 Axioms and Black Scholes 438,Market Price of Risk 440. 15 14 Summary 440,Exercises 442,References 446,Chapter 16 INTEREST RATE DERIVATIVES 448. 16 1 Examples of Interest Rate Derivatives 448,16 2 The Need for a Theory 450. 16 3 The Binomial Approach 451,Implied Term Structure 452. No Arbitrage Opportunities 454,16 4 Pricing Applications 455.
Bond Derivatives 455,Forwards and Futures 455,Futures 457. 16 5 Leveling and Adjustable Rate Loans 457,Adjustable Rate Loans 458. 16 6 The Forward Equation 461,16 7 Matching the Term Structure 464. The Ho Lee Model 464,The Black Derman Toy Model 465. Matching Implied Volatilities 465,16 8 Immunization 467.
16 9 Collateralized Mortgage Obligations 469,16 10 Models of Interest Rate Dynamics 473. 16 11 Continuous Time Solutions 474,The Backward Equation 475. Affine Processes 476,Risk Neutral Pricing Formula 477. 16 12 Extensions 477,16 13 Summary 478,Exercises 479. References 482,Chapter 17 CREDIT RISK 483,17 1 The Classic Merton Model 484.
Probability of Default 486,Credit Spread 486,xviii CONTENTS. 17 2 First Passage Times 487,Lattice Methods 488,Early Default 490. Coupons 491,17 3 Rating Methods 492,17 4 Intensity Reduced Form Model 493. Poisson Processes 493,Inhomogeneous Process 495,17 5 Stochastic Intensity Model 495. 17 6 Intermediate Receipts 496,17 7 Analytically Tractable Cox Processes 497.
Model Fitting 497,17 8 Simulation 498,Direct Simulation 498. A Better Way 499,17 9 Lattice Methods 500,17 10 Correlated Defaults 503. 17 11 Credit Derivatives 505,Bonds and Loans 506,Credit Default Swaps CDS s 506. Forwards and Options on CDS s 508,Total Return Swaps TRS s 508. Collateralized Debt Obligations CDO s 509,17 12 Summary 511.
Exercises 512,References 513,Part IV GENERAL CASH FLOW STREAMS. Chapter 18 OPTIMAL PORTFOLIO GROWTH 517,18 1 The Investment Wheel 517. Analysis of the Wheel 519,18 2 The Log Utility Approach to Growth 519. Log Utility Form 521,Examples 521,18 3 Properties of the Log Optimal Strategy 525. 18 4 Alternative Approaches 526,Other Utility 526,18 5 Continuous Time Growth 528.
Dynamics of Several Stocks 528,Portfolio Dynamics 529. Implications for Growth 530,The Portfolio of Maximum Growth Rate 530. 18 6 The Feasible Region 531,CONTENTS xix,The Efficient Frontier 531. Inclusion of a Risk Free Asset 532,18 7 The Log Optimal Pricing Formula 536. Market Data 539,18 8 Log Optimal Pricing and the Black Scholes.
Equation 540,18 9 Summary 541,Exercises 542,References 546. Chapter 19 GENERAL INVESTMENT EVALUATION 547,19 1 General Present Value 547. Projects and Opportunities 548,19 2 Multiperiod Securities 548. Assets 549,Portfolio Strategies 549,Arbitrage 550,Short Term Risk Free Rates 550. 19 3 Risk Neutral Pricing 550,19 4 Optimal Pricing 552.
The Single Period Problem 552,Applications 553,19 5 The Double Lattice 555. 19 6 Pricing in a Double Lattice 557,19 7 Investments with Private Uncertainty 560. General Approach 562,19 8 Buying Price Analysis 566. INVESTMENT SCIENCE SECOND EDITION DAVID G LUENBERGER STANFORD UNIVERSITY New York Oxford OXFORD UNIVERSITY PRESS CONTENTS PREFACE xxi Chapter 1 INTRODUCTION 1 1 1 Cash Flows 2 1 2 Investments and Markets 3 The Comparison Principle 4 Arbitrage 4 Dynamics 5 Risk Aversion 5 1 3 Typical Investment Problems 6 Pricing 6 Hedging 7 Risk Assessment and Management 8 Pure Investment 8 Other Problems

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