Quantitative Investment Analysis (CFA Institute... (PDF) (2024)

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QUANTITATIVEINVESTMENTANALYSISSecond EditionRichard A. DeFusco, CFADennis W. McLeavey, CFAJerald E. Pinto, CFADavid E. Runkle, CFAJohn Wiley & Sons, Inc.

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QUANTITATIVEINVESTMENTANALYSIS

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CFA Institute is the premier association for investment professionals around the world,with over 85,000 members in 129 countries. Since 1963 the organization has developedand administered the renowned Chartered Financial Analyst Program. With a rich historyof leading the investment profession, CFA Institute has set the highest standards in ethics,education, and professional excellence within the global investment community, and is theforemost authority on investment profession conduct and practice.Each book in the CFA Institute Investment Series is geared toward industry practitionersalong with graduate-level finance students and covers the most important topics in theindustry. The authors of these cutting-edge books are themselves industry professionals andacademics and bring their wealth of knowledge and expertise to this series.

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QUANTITATIVEINVESTMENTANALYSISSecond EditionRichard A. DeFusco, CFADennis W. McLeavey, CFAJerald E. Pinto, CFADavid E. Runkle, CFAJohn Wiley & Sons, Inc.

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Copyright ⃝c 2004, 2007 by CFA Institute. All rights reserved.Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, orauthorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com.Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons,Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online athttp://www.wiley.com/go/permissions.Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparingthis book, they make no representations or warranties with respect to the accuracy or completeness of the contents ofthis book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. Nowarranty may be created or extended by sales representatives or written sales materials. The advice and strategiescontained herein may not be suitable for your situation. You should consult with a professional where appropriate.Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including butnot limited to special, incidental, consequential, or other damages.For general information on our other products and services or for technical support, please contact our CustomerCare Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax(317) 572-4002.Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not beavailable in electronic formats. For more information about Wiley products, visit our Web site at www.wiley.com.Library of Congress Cataloging-in-Publication Data:Quantitative investment analysis / Richard A. DeFusco . . . [et al.].—2nd ed.p. cm.—(The CFA Institute investment series)Includes bibliographical references.ISBN-13 978-0-470-05220-4 (cloth)ISBN-10 0-470-05220-1 (cloth)1. Investment analysis—Mathematicalmodels. I.DeFusco,RichardArmand.HG4529.Q35 2006332.601’5195—dc222006052578Printed in the United States of America.10 9 8 7 6 5 4 3 2 1

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To Margo, Rachel, and RebekahR.A.D.To Jan, Christine, and AndyD.W.M.In memory of Irwin T. Vanderhoof, CFAJ.E.P.To Patricia, Anne, and SarahD.E.R.

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CONTENTSForeword xiiiAcknowledgments xviiIntroduction xixCHAPTER 1The Time Value of Money 11 Introduction 12 Interest Rates: Interpretation 13 The Future Value of a Single Cash Flow 33.1 The Frequency of Compounding 83.2 Continuous Compounding 103.3 Stated and Effective Rates 124 The Future Value of a Series of Cash Flows 134.1 Equal Cash Flows—Ordinary Annuity 134.2 Unequal Cash Flows 155 The Present Value of a Single Cash Flow 155.1 Finding the Present Value of a Single Cash Flow 155.2 The Frequency of Compounding 176 The Present Value of a Series of Cash Flows 196.1 The Present Value of a Series of Equal Cash Flows 196.2 The Present Value of an Infinite Series of Equal Cash Flows—Perpetuity 236.3 Present Values Indexed at Times Other Than t = 0 246.4 The Present Value of a Series of Unequal Cash Flows 267 Solving for Rates, Number of Periods, or Size of Annuity Payments 277.1 Solving for Interest Rates and Growth Rates 277.2 Solving for the Number of Periods 307.3 Solving for the Size of Annuity Payments 307.4 Review of Present and Future Value Equivalence 357.5 The Cash Flow Additivity Principle 36vii