Finance

Preface 9

Chapter 1    Finance 13

Chapter 2    Financial Institutions and Markets 19

2.1        Financial Institutions 20

2.2        Financial Markets 28

2.3        Summary 35

Key Points 36

Chapter 3    Financial Arithmetic 39

3.1        Asset Returns 40

3.2        Future Value Calculation – Compounding 41

3.3        Present Value Calculation – Discounting 44

3.4        Effective Annual Interest Rates 45

3.5        Risky and Non-Risky Future Cash Flows 48

3.6        Summary 50

Key Points 50

Chapter 4    Financial Instruments: Prices and Risks 53

4.1        The Law of One Price – Arbitrage 54

4.2        Financial Risk – Important Concepts 58

4.3        Financial Risk Measurement 60

4.4        Financial Risk Management 65

4.5        Summary 70

Key Points 70

Chapter 5    Bonds (Debt) 75

5.1        Annuities 76

5.2        Zero-Coupon Bonds 79

5.3        Coupon Bonds 81

5.4        Bond Prices, Time and Interest Rates 83

5.5        Government Bonds versus Corporate Bonds 88

5.6        Summary 91

Key Points 91

Chapter 6    Stocks (Equity) 97

6.1        Dividends 98

6.2        Pricing Stocks 99

6.3        Stock Prices and Psychology – The Beauty Contest 104

6.4        Fundamental Analysis versus Technical Analysis 107

6.5        Summary 110

Key Points 110

Chapter 7    Forwards and Futures 113

7.1        Forwards and Futures – The Basics 114

7.2        Forwards and Futures – Risk Management Tools 118

7.3        Forward (Futures) Pricing 119

7.4        Forwards and Futures – Predictors of Spot Prices? 123

7.5        Summary 125

Key Points 126

Chapter 8    Options 129

8.1        Some Background 130

8.2        Options and Forwards – Similar but Different 132

8.3        Basic Option Terminology 133

8.4        Payoff Diagrams 139

8.5        Put-Call Parity 146

8.6        What Determines the Option Price? 149

8.7        Option Pricing – The Black-Scholes Formula 153

8.8        Summary 156

Key Points 157

Chapter 9    Investment Portfolio Choice I: The Mean-Variance Framework 163

9.1        Investment Portfolio Choice – The Basics 164

9.2        Portfolio Returns, Risks and Correlations 165

9.3        The Mean-Variance Framework 169

9.4        Two-Fund Separation 179

9.5        Summary 180

Key Points 181

Chapter 10  Investment Portfolio Choice II: …|The Capital Asset Pricing Model (CAPM) 187

10.1     CAPM – The Basics 188

10.2     General Implications 190

10.3     Risk Premiums on Risky Assets 193

10.4     Portfolio Choice 196

10.5     Stock Pricing 197

10.6     Summary 199

Key Points 200

Chapter 11  Market Efficiency 205

11.1     Are Markets Efficient? 206

11.2     Weak Market Efficiency 209

11.3     Semi-Strong Market Efficiency 213

11.4     Strong Market Efficiency 213

11.5     Stock Market Anomalies 215

11.6     Summary 218

Key Points 219

Chapter 12  Credit 221

12.1     Corporate Bonds 222

12.2     Credit Rating Agencies 226

12.3     The Basel II Regulatory Framework 229

12.4     Credit Risk Models 232

12.5     Credit Derivatives 234

12.6     Summary 238

Key Points 239

Appendix      Basic Mathematical Statistics 241

A.1       Random Variables 241

A.2       Probability Distributions 242

A.3       Means and Variances 244

A.4       Correlation 245

A.5       Just Another Example 246

References 249

Index 251