Preface

he purpose of this book is to provide a concise coverage of 20 of the most important topics in investments. Investment Analytics is written for those professionals who are pursuing a career in investments. Although it is mostly intended for those individuals who are aiming at an MBA in Finance or are contemplating the CFA (Chartered Financial Analyst) program it will undoubtedly be of interest and accessible to other graduate students and advanced business undergraduates. Investment Analytics has also been designed as a revision and reference tool. It is organised as follows. We begin with a comprehensive quiz of 60 questions to test your knowledge in investments. We then move to a discussion of some basic concepts in Chapter 1. Please note that the endnotes are an integral part of the book and should be treated as such. Also, suggested references appear at the end of every chapter for those who want to delve deeper. The second chapter is devoted to the review of the different types of yield measures encountered when dealing with common stocks and fixed income securities. These include the earnings yield and the concept of yield-to-worst. Chapter 3 discusses the use of simple and multiple regression techniques in investments including hypothesis testing, model selection, problems commonly encountered in practice and their related solutions. Dummy variables are also explained and possible refinements are proposed. This chapter also contains a general algorithm for regression analysis. Chapter 4 contains a description as well as an interpretation of 24 popular ratios. These ratios are grouped into 6 distinct categories that capture particular aspects of a companys financial health. This chapter ends with a comprehensive problem involving the reviewed ratios. The next chapter takes a close look at the statement of cash flows. This is a very important financial statement as it is central to the idea of earnings quality and inevitably to concepts such as cash-flow-at-risk. Indeed there are ways through which management can artificially improve the earnings of a firm. Chapter 6 is devoted to the analysis of one such method, namely the choice of the inventory valuation formula, and on its impact on valuation and financial ratios. Chapter 7 is devoted to the important topic of asset allocation. Popular studies have highlighted the determining influence of the asset allocation decision in generating portfolio returns. Global portfolios and implementation issues are also analysed. Bond valuation, in the domestic context, is reviewed in Chapter 8. So is the relationship between price and yield for bonds of different maturities. Foreign bonds are taken up in the following chapter. Chapter 10 discusses the concept of the term structure of interest rates which can be thought of as an arbitrage-based bond pricing technique. The concepts of spot and forward rates are derived via the bootstrapping method and popular theories about the term structure are visited. Chapter 11 contrasts the method of horizon return analysis with the one based on yield-tomaturity. Its use as a screening device is highlighted. Chapter 12 develops a framework for analysing convertible bonds. Chapter 13 is devoted to six stock valuation models all of which are easily stored in a programmable calculator. The notion of expected return, risk and correlation are taken up in the ensuing chapter. These concepts underpin what has become an industry standard in risk management: Value-at-Risk. Beta is exposed in chapter 15. Its place in investments and the current state of the debate are emphasised. Richer models like those based on arbitrage assumptions are brushed upon in attempting to model the return-generating process of equities. Chapter 16 contains a discussion of the concept of duration and convexity as

Preface
approximations to expected rates of return on fixed income securities. The properties of duration are enumerated. Convexity is examined in some greater detail in Chapter 17. Derivatives are taken up in chapter 18. Stock options are analysed to some depth. The famous Black and Scholes formula and the binomial model are considered, the behaviour of option prices is analysed and optimal exercise rules are inventoried. Furthermore we take a look at some option strategies and the important concept of implied standard deviation. At the end of the day, month or quarter one would like to know how well a particular strategy performed. Chapter 19 deals with the measurement of the performance of investment portfolios. The notions of dollar-weighted rate of return and time-weighted rate of return are described and contrasted. Chapter 20 carries the process of distinguishing managers skill from luck one step further. Indeed this last chapter is entirely devoted to the topic of performance attribution which can be thought of a method of breaking down portfolio return into a few useful components. Chapter 20 is followed by the answers to the Investment IQ and Ratio-Quiz. At the end of most chapters there are a series of problems which the reader can use to test her mastery of the topics covered in this book. An extensive glossary that also serves as an index completes Investment Analytics. Hope you like it. Your comments are welcomed at density@intnet.mu. Sanjay Jagatsingh, CFA Mauritius, November 1999 Acknowledgements I am indebted to many people for making this book a reality. First mentors and colleagues who have contributed significantly to my knowledge of investments and econometrics such as Marc Gaudry and Tran Cong Liem (Universit de Montral), the late Lise Salvas and Vihang Errunza (McGill University). Next, the myriad of executives and MBA students from both hemispheres that were taught using material from earlier drafts of this book. They offered precious feedback. I am grateful to Vinod Chidambaram (Air Mauritius Ltd) who took time out of his busy schedule to offer helpful comments on the overall project. I also wish to thank the team at Daiichi Process (Mauritius) Ltd particularly Ibrahim Ayoub for walking me through the world of pre-press and printing. Finally I pay tribute to my family especially to Lady Radhika Jagatsingh who helped in more ways than one and to Nastassia Jagatsingh for offering invaluable suggestions from day one. About the author Sanjay Jagatsingh is an econometrician and the Managing Director of Mascarenhas Analytica Ltd, an organisation based in sunny Mauritius, which specialises in Executive Training, Publishing and offers an array of Advisory Services to investment professionals. In addition to being a CFA charterholder, he holds an MBA in Finance from McGill University and a M. Sc. Economics (Universit de Montral). Sanjay also taught Investments and Portfolio Management at McGill University.
CFA is a licensed service mark of AIMR.

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