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Investment Science

by
ISBN13:

9780195108095

ISBN10:
0195108094
Format:
Hardcover
Pub. Date:
7/3/1997
Publisher(s):
Oxford University Press
List Price: $159.94

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Summary

Fueled in part by some extraordinary theoretical developments in finance, an explosive growth of information and computing technology, and the global expansion of investment activity, investment theory currently commands a high level of intellectual attention. Recent developments in the field are being infused into university classrooms, financial service organizations, business ventures, and into the awareness of many individual investors. Modern investment theory using the language of mathematics is now an essential aspect of academic and practitioner training. Representing a breakthrough in the organization of finance topics,Investment Sciencewill be an indispensable tool in teaching modern investment theory. It presents sound fundamentals and shows how real problems can be solved with modern, yet simple, methods. David Luenberger gives thorough yet highly accessible mathematical coverage of standard and recent topics of introductory investments: fixed-income securities, modern portfolio theory and capital asset pricing theory, derivatives (futures, options, and swaps), and innovations in optimal portfolio growth and valuation of multiperiod risky investments. Throughout the book, he uses mathematics to present essential ideas of investments and their applications in business practice. The creative use of binomial lattices to formulate and solve a wide variety of important finance problems is a special feature of the book. In moving from fixed-income securities to derivatives, Luenberger increases naturally the level of mathematical sophistication, but never goes beyond algebra, elementary statistics/probability, and calculus. He includes appendices on probability and calculus at the end of the book for student reference. Creative examples and end-of-chapter exercises are also included to provide additional applications of principles given in the text. Ideal for investment or investment management courses in finance, engineering economics, operations research, and management science departments,Investment Sciencehas been successfully class-tested at Boston University, Stanford University, and the University of Strathclyde, Scotland, and used in several firms where knowledge of investment principles is essential. Executives, managers, financial analysts, and project engineers responsible for evaluation and structuring of investments will also find the book beneficial. The methods described are useful in almost every field, including high-technology, utilities, financial service organizations, and manufacturing companies.

Author Biography


David G. Luenberger, Professor in Engineering-Economics Systems & Operations Research, Stanford University. He has written several successful books with Addison-Wesley and John Wiley publishers.

Table of Contents

Preface xiii
1 INTRODUCTION
1(12)
1.1 Cash Flows
2(1)
1.2 Investments and Markets
3(3)
1.3 Typical Investment Problems
6(2)
1.4 Organization of the Book
8(5)
Part I DETERMINISTIC CASH FLOW STREAMS 13(124)
2 THE BASIC THEORY OF INTEREST
13(27)
2.1 Principal and Interest
13(5)
2.2 Present Value
18(1)
2.3 Present and Future Values of Streams
19(3)
2.4 Internal Rate of Return
22(2)
2.5 Evaluation Criteria
24(4)
2.6 Applications and Extensions(*)
28(6)
2.7 Summary
34(1)
Exercises
35(3)
References
38(2)
3 FIXED-INCOME SECURITIES
40(32)
3.1 The Market for Future Cash
41(3)
3.2 Value Formulas
44(5)
3.3 Bond Details
49(3)
3.4 Yield
52(5)
3.5 Duration
57(5)
3.6 Immunization
62(3)
3.7 Convexity(*)
65(1)
3.8 Summary
66(2)
Exercises
68(3)
References
71(1)
4 THE TERM STRUCTURE OF INTEREST RATES
72(30)
4.1 The Yield Curve
72(1)
4.2 The Term Structure
73(4)
4.3 Forward Rates
77(3)
4.4 Term Structure Explanations
80(3)
4.5 Expectations Dynamics
83(5)
4.6 Running Present Value
88(2)
4.7 Floating Rate Bonds
90(1)
4.8 Duration
91(3)
4.9 Immunization
94(2)
4.10 Summary
96(1)
Exercises
97(4)
References
101(1)
5 APPLIED INTEREST RATE ANALYSIS
102(35)
5.1 Capital Budgeting
103(5)
5.2 Optimal Portfolios
108(3)
5.3 Dynamic Cash Flow Processes
111(3)
5.4 Optimal Management
114(7)
5.5 The Harmony Theorem(*)
121(3)
5.6 Valuation of a Firm(*)
124(4)
5.7 Summary
128(2)
Exercises
130(4)
References
134(3)
Part II SINGLE-PERIOD RANDOM CASH FLOWS 137(126)
6 MEAN-VARIANCE PORTFOLIO THEORY
137(36)
6.1 Asset Return
137(4)
6.2 Random Variables
141(5)
6.3 Random Returns
146(4)
6.4 Portfolio Mean and Variance
150(5)
6.5 The Feasible Set
155(2)
6.6 The Markowitz Model
157(5)
6.7 The Two-Fund Theorem(*)
162(3)
6.8 Inclusion of a Risk-Free Asset
165(1)
6.9 The One-Fund Theorem
166(3)
6.10 Summary
169(1)
Exercises
170(2)
References
172(1)
7 THE CAPITAL ASSET PRICING MODEL
173(24)
7.1 Market Equilibrium
173(2)
7.2 The Capital Market Line
175(2)
7.3 The Pricing Model
177(4)
7.4 The Security Market Line
181(2)
7.5 Investment Implications
183(1)
7.6 Performance Evaluation
184(3)
7.7 CAPM as a Pricing Formula
187(3)
7.8 Project Choice(*)
190(2)
7.9 Summary
192(1)
Exercises
193(2)
References
195(2)
8 MODELS AND DATA
197(31)
8.1 Introduction
197(1)
8.2 Factor Models
198(7)
8.3 The CAPM as a Factor Model
205(2)
8.4 Arbitrage Pricing Theory(*)
207(5)
8.5 Data and Statistics
212(5)
8.6 Estimation of Other Parameters
217(1)
8.7 Tilting Away from Equilibrium
218(3)
8.8 A Multiperiod Fallacy
221(1)
8.9 Summary
222(2)
Exercises
224(3)
References
227(1)
9 GENERAL PRINCIPLES
228(35)
9.1 Introduction
228(1)
9.2 Utility Functions
228(3)
9.3 Risk Aversion
231(3)
9.4 Specification of Utility Functions(*)
234(3)
9.5 Utility Functions and the Mean-Variance Criterion(*)
237(3)
9.6 Linear Pricing
240(2)
9.7 Portfolio Choice
242(3)
9.8 Log-Optimal Pricing(*)
245(2)
9.9 Finite State Models
247(4)
9.10 Risk-Neutral Pricing(*)
251(1)
9.11 Pricing Alternatives(*)
252(2)
9.12 Summary
254(1)
Exercises
255(3)
References
258(5)
Part III DERIVATIVE SECURITIES 263(154)
10 FORWARDS, FUTURES, AND SWAPS
263(33)
10.1 Introduction
263(1)
10.2 Forward Contracts
264(2)
10.3 Forward Prices
266(7)
10.4 The Value of a Forward Contract
273(1)
10.5 Swaps(*)
273(2)
10.6 Basics of Futures Contracts
275(3)
10.7 Futures Prices
278(3)
10.8 Relation to Expected Spot Price(*)
281(1)
10.9 The Perfect Hedge
282(1)
10.10 The Minimum-Variance Hedge
283(2)
10.11 Optimal Hedging(*)
285(2)
10.12 Hedging Nonlinear Risk(*)
287(4)
10.13 Summary
291(1)
Exercises
291(4)
References
295(1)
11 MODELS OF ASSET DYNAMICS
296(23)
11.1 Binomial Lattice Model
297(2)
11.2 The Additive Model
299(1)
11.3 The Multiplicative Model
300(3)
11.4 Typical Parameter Values(*)
303(1)
11.5 Lognormal Random Variables
304(1)
11.6 Random Walks and Wiener Processes
305(3)
11.7 A Stock Price Process
308(4)
11.8 Ito's Lemma(*)
312(1)
11.9 Binomial Lattice Revisited
313(2)
11.10 Summary
315(1)
Exercises
316(2)
References
318(1)
12 BASIC OPTIONS THEORY
319(32)
12.1 Option Concepts
320(2)
12.2 The Nature of Option Values
322(3)
12.3 Option Combinations and Put-Call Parity
325(2)
12.4 Early Exercise
327(1)
12.5 Single-Period Binomial Options Theory
327(3)
12.6 Multiperiod Options
330(3)
12.7 More General Binomial Problems
333(4)
12.8 Evaluating Real Investment Opportunities
337(7)
12.9 General Risk-Neutral Pricing(*)
344(1)
12.10 Summary
345(1)
Exercises
346(4)
References
350(1)
13 ADDITIONAL OPTIONS TOPICS
351(31)
13.1 Introduction
351(1)
13.2 The Black-Scholes Equation
351(4)
13.3 Call Option Formula
355(2)
13.4 Risk-Neutral Valuation(*)
357(1)
13.5 Delta
358(2)
13.6 Replication, Synthetic Options, and Portfolio Insurance(*)
360(2)
13.7 Computational Methods
362(6)
13.8 Exotic Options
368(3)
13.9 Storage Costs and Dividends(*)
371(2)
13.10 Martingale Pricing(*)
373(2)
13.11 Summary
375(1)
Appendix: Alternative Black-Scholes Derivation(*)
376(2)
Exercises
378(3)
References
381(1)
14 INTEREST RATE DERIVATIVES
382(35)
14.1 Examples of Interest Rate Derivatives
382(2)
14.2 The Need for a Theory
384(1)
14.3 The Binomial Approach
385(4)
14.4 Pricing Applications
389(2)
14.5 Leveling and Adjustable-Rate Loans(*)
391(4)
14.6 The Forward Equation
395(2)
14.7 Matching the Term Structure
397(3)
14.8 Immunization
400(2)
14.9 Collateralized Mortgage Obligations(*)
402(4)
14.10 Models of Interest Rate Dynamics(*)
406(2)
14.11 Continuous-Time Solutions(*)
408(2)
14.12 Summary
410(1)
Exercises
411(2)
References
413(4)
Part IV GENERAL CASH FLOW STREAMS 417(58)
15 OPTIMAL PORTFOLIO GROWTH
417(27)
15.1 The Investment Wheel
417(2)
15.2 The Log Utility Approach to Growth
419(6)
15.3 Properties of the Log-Optimal Strategy(*)
425(1)
15.4 Alternative Approaches(*)
425(2)
15.5 Continuous-Time Growth
427(3)
15.6 The Feasible Region
430(5)
15.7 The Log-Optimal Pricing Formula(*)
435(3)
15.8 Log-Optimal Pricing and the Black-Scholes Equation(*)
438(2)
15.9 Summary
440(1)
Exercises
441(2)
References
443(1)
16 GENERAL INVESTMENT EVALUATION
444(31)
16.1 Multiperiod Securities
444(3)
16.2 Risk-Neutral Pricing
447(1)
16.3 Optimal Pricing
448(4)
16.4 The Double Lattice
452(2)
16.5 Pricing in a Double Lattice
454(4)
16.6 Investments with Private Uncertainty
458(5)
16.7 Buying Price Analysis
463(6)
16.8 Continuous-Time Evaluation(*)
469(2)
16.9 Summary
471(1)
Exercises
472(2)
References
474(1)
Appendix A BASIC PROBABILITY THEORY 475(4)
A.1 General Concepts 475(1)
A.2 Normal Random Variables 476(1)
A.3 Lognormal Random Variables 477(2)
Appendix B CALCULUS AND OPTIMIZATION 479(5)
B.1 Functions 479(1)
B.2 Differential Calculus 480(1)
B.3 Optimization 481(3)
Answers to Exercises 484(5)
Index 489


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