cowore 1 cunoren 2 CONTENTS Preface Acknowledgements ‘About the Authors Tre Time VALUE OF MONEY 1 INTRODUCTION 2 INTEREST RATES: INTERPRETATION 3 THE FUTURE VALUE OF A SINGLE CASH FLOW 347 The Frequency of Compounding 32 Continuous Compounding 3.3 Stated and Elective Rates 4 THE FUTURE VALUE OF A SERIES OF CASH FLOWS 4.1. Equal Cash Flows—Ordinary Annuity 42. Unequal Cash Flows 5. THE PRESENT VALUE OF A SINGLE CASH FLOW 5.1. Finding the Present Value ofa Single Cash Flow 5.2, The Frequency of Compounding 6 7A PRESENT VALUE OF A SERIES OF CASH FLOWS 5.1. The Present Value of a Series of Equal Cash Flows 62. The Present Value of an Infinite Series of Equal Cash Flows—Perpetuity 6.3. Present Values Indexed at Times Other Than 6.4. The Present Value ofa Series of Unequal Cash Flows 7 SOLVING FOR RATES, NUMBER OF PERIODS, OR SIZE OF ANNUITY PAYMENTS 7.1. Solving for interest Rates and Growth Rates 7.2. Solving forthe Number of Periods 7.3 Solving forthe Size of Annuity Payments 7.4. Review of Present and Future Value Equivalence 7.5. The Cash Flow Adcitivty Principle 8 SUMMARY PROBLEMS SOLUTIONS Discounted CasH Flow APPLICATIONS 1 INTRODUCTION 2 NET PRESENT VALUE AND INTERNAL RATE OF RETURN 2.1. Net Present Value and the Net Present Value Rule 22 The intemal Rate of Retum and the Internal Rate of Return Rule 2.3. Problems with the IRR Rule 3 PORTFOLIO RETURN MEASUREMENT 3.1 Money-Weighted Rate of Return 3.2 Time-Weighted Rate of Return 4 MONEY MARKET YIELDS 57 37 58 58 60 a 65 6 6 n xixii Contents cunmrer 3 5 SUMMARY PROBLEMS. SOLUTIONS ‘STATISTICAL CONCEPTS AND MARKET RETURNS 1 INTRODUCTION 2. SOME FUNDAMENTAL CONCEPTS 2.1. The Nature of States 2.2. Populations and Samples 23° Measurement Scales 3. SUMMARIZING DATA USING FREQUENCY DISTRIBUTIONS 4 THE GRAPHIC PRESENTATION OF DATA 4.1. The Histogram 42 The Frequency Polygon and the Cumulative Frequency Distribution 8 MEASURES OF CENTRAL TENDENCY 5.1. The Arithmetic Mean 5.2 The Median 5.3. The Mode 5.4 Other Concepts of Mean 6 OTHER MEASURES OF LOCATION: QUANTILES 6.1 Quarles, Quiles, Decies, and Percentiles 62. Quantiles in Investment Practice MEASURES OF DISPERSION 7.1 The Range 7.2. The Mean Absolute Deviation 7.3. Population Variance and Population Standard Deviation 74 Sample Variance and Sample Standard Deviation 7.5. Semivariance, Semideviation, and Related Concepts 7.6 Chebyshev’ inequality 7.7 Coefcient of Variation 7.8 The Sharpe Ratio 8 SYMMETRY AND SKEWNESS IN RETURN DISTRIBUTIONS, 9 KURTOSIS IN RETURN DISTRIBUTIONS 10 USING GEOMETRIC AND ARITHMETIC MEANS 1 SUMMARY PROBLEMS SOLUTIONS. conrter 4 Prosasuiry Concerts 1 INTRODUCTION 2. PROBABILITY, EXPECTED VALUE, AND VARIANCE 3. PORTFOLIO EXPECTED RETURN AND VARIANCE OF RETURN 4 TOPICS IN PROBABILITY 41 Bayes Formula 42 Principles of Counting 5 SUMMARY PROBLEMS SOLUTIONS CHAPTER s} Common Prosasitity DistRiBUTIONS 1 INTRODUCTION n n 8 87 cy 8 8 8 89 3 99 99 100 103 103 108 no m2 120 120 14 126 126 7 129 12 135 137 139 ut 9 153 155 158 164 179 180 180 202 an an 215 219 2m 26 231 232Contents cuarrer 6 cunoren 7” 2 DISCRETE RANDOM VARIABLES 2.1. The Discrete Uniform Distribution 2.2. The Binomial Distribution 3 CONTINUOUS RANDOM VARIABLES 3.1 Contiowous Uniform Distribution 3.2. The Normal Distribution 3.3. Applications ofthe Normal Distribution 34 The LognonmalDistibution 4 MONTE CARLO SIMULATION SUMMARY PROBLEMS SOLUTIONS ‘SAMPLING AND ESTIMATION 1 INTRODUCTION 3 SAMPLING 2.1. Simple Random Sampling 2.2. Stratified Random Sampling 23. Time-Series and Cross-Sectional Data 3. DISTRIBUTION OF THE SAMPLE MEAN 3.1. The Centra Limit Theorem 4 POINT AND INTERVAL ESTIMATES OF THE POPULATION MEAN 4.1. Point Estimators 42 Confidence Intervals forthe Population Mean 4.3. Selection of Sample Size 5 MORE ON SAMPLING 5.1 DatarMining Bias 5.2. Sample Selection Bias 5.3 Look-Ahead Bias 5.4 Time-Period Bi 6 SUMMARY PROBLEMS SOLUTIONS HyporHesis TESTING 1 INTRODUCTION 2. HYPOTHESIS TESTING 3 HYPOTHESIS TESTS CONCERNING THE MEAN 3.1. Tests Conceming a Single Mean 3.2. ‘Tests Conceming Diferences Between Means 3.3. Tests Concerning Mean Differences 4 HYPOTHESIS TESTS CONCERNING VARIANCE 4.1, Tests Concerning a Single Variance 42. Tests Concerning the Equality (Inequaliy) of Two Variances 5 OTHER ISSUES: NONPARAMETRIC INFERENCE 5.1. Tests Concerning Corelaton: The Spearman Rank Corelation Coefcient ‘5.2 Nonparametric Inference: Summary 6 SUMMARY PROBLEMS SOLUTIONS 232 234 236 246 246 250 257 260 266 2m 25 179 285 285 286 286 288 289 201 292 295 295 297 308 305 306 308 309 310 an 314 317 323 304 325 335 335 342 347 351 351 353 356 357 360 360 363 368