Equity Readings - Harvard University



AIMR Suggested Equity Readings

Section I. Equity Valuation Approaches

Section II. Growth Analysis and Measurement

Section III. Risk

Section IV. Equity Derivatives and Strategies

Section V. Equity Portfolio Management

Section VI. Selected Topics in Financial Statement Analysis

STUDY SESSION 1

Framework for Equity Valuation Analysis-The Basic Dividend Discount Model and the Importance of Cash Flow/Free Cash Flow

READING 1: "Dividend-Discount Models," Ch. 6, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 98-126. This reading discusses the strengths, weaknesses, and best uses of key forms of the dividend discount model for valuing growth. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 2: "Company Value and the Manager's Mission," Part I , Valuation: Measuring and Managing the Value of Companies, University Edition (Second Edition), Tom Copeland, Tim Koller, and Jack Murrin (John Wiley & Sons, 1994), pp. 3-131. The overall focus of this reading is on exploring the managerial (internal) implications of valuation (external) methodology. The authors identify the so-called value drivers of a company and relate them to return on invested capital "trees." They present a rationale and defense of a discounted cash flow/long-term free cash flow valuation approach, and they show that accounting-based valuation approaches (e.g., those based on earnings per share) are value destroying. An approach to valuing strategic investments is presented, and the effects of tying managerial compensation to cash-flow-based valuation metrics are discussed. Level of difficulty: Not difficult. Estimated study time: 2.5 hours.

READING 3: "Cash Flow Valuation: A Practitioner's Guide," Part II, Valuation: Measuring and Managing the Value of Companies, University Edition (Second Edition), Tom Copeland, Tim Koller, and Jack Murrin (John Wiley & Sons, 1994), pp. 135-246 and 285-324. These readings present, apply, interpret, and critically evaluate two major frameworks for valuation: the entity DCF model and the economic profit model. The authors conduct historical analysis of net operating profit less adjusted taxes, invested capital, ROC, and FCF by using a comprehensive, integrative case study (Preston Corporation). Performance forecasting is illustrated, and the strategic position of a company and its industry is evaluated and then used to estimate continuing value. Level of difficulty: Moderately difficult. Estimated study time: 2.5 hours.

READING 4: "Multi-Business Valuation," Ch. 11, Valuation: Measuring and Managing the Value of Companies, University Edition (Second Edition), Tom Copeland, Tim Koller, and Jack Murrin (John Wiley & Sons, 1994), pp. 327-58. The process of valuing a company involved in multiple businesses is conducted by first comparing the company's "as is" DCF value with its current market value, then considering potential value-enhancing restructuring moves. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 5: "Free-Cash-Flow-to-Equity Discount Models," Ch. 7, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 127-43. The author critically evaluates, defines, defends, illustrates the free-cash-flow-to-equity (FCFE) model in several forms: the single-stage or constant-growth/infinite-horizon, two-stage, and three-stage (the so-called E-model) models. The various forms of the FCFE model are compared and contrasted with the ways in which the dividend discount model is implemented. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 6: "Valuing a Firm-The Free-Cash-Flow-to-Firm Approach," Ch. 8, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 144-72. The author defines, defends, illustrates, and critically evaluates the free-cash-flow-to-firm (FCFF) approach in the same forms as considered for the FCFE model. He compares and contrasts the FCFE and FCFF models and explores the relative merits of each approach. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

STUDY SESSION 2

EVA™ Valuation Models and Alternative Measures of Added Value

READING 1: "The EVA Financial Management System," Ch. 4, The Quest for Value, G. Bennett Stewart III (Harper Business, 1991), pp. 118-78. The author describes the economic value added (EVA) approach, which involves a residual economic income measure that subtracts the cost of capital from the operating profits generated by a business, and explains its rationale. He uses numerous archetypal companies to illustrate how to calculate and interpret EVA. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 2: "Valuation Concepts," Ch. 7, The Quest for Value, G. Bennett Stewart III (Harper Business, 1991), pp. 250-305. This chapter relates EVA valuation methodology to the conceptual underpinnings of Miller and Modigliani's seminal work. The author presents the value-driver model and extols the virtues of judicious financial leverage-whether funds are "needed" or not. The relationship between the degree of debt used and the cost of debt is discussed, and valuation is correlated with the industrial life cycle. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 3: "A Recipe for Reviving the Campbell Soup Company," Ch. 15, The Quest for Value, G. Bennett Stewart III (Harper Business, 1991), pp. 673-739. This reading presents a comprehensive case analysis of the Campbell Soup Company that shows how EVA can be used to evaluate and enhance the operating performance and market value of a firm. The difference between the static and dynamic uses of debt is emphasized. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 4: "Measures of Value Added," Ch. 3, Company Performance and Measures of Value Added, Pamela P. Peterson and David R. Peterson (Research Foundation of the Institute of Chartered Financial Analysts, 1996), pp. 11-31. This reading analyzes the differences between economic and accounting profit and evaluates the various ways in which economic profit can be calculated. The authors examine the relationship between market value added (MVA) and measures of economic value added. They also describe and critically evaluate Holt's cash flow return on investment (CFROI). Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 5: "Comparison of Alternative Performance Measures," Ch. 4, and "Conclusions," Ch. 5, Company Performance and Measures of Value Added, Pamela P. Peterson and David R. Peterson (Research Foundation of the Institute of Chartered Financial Analysts, 1996), pp. 33-45 and p. 47. The authors construct and evaluate empirical tests of the relationship between companies' equity market performance and both traditional and value-added measures. The evidence shows that, for numerous reasons, market value added measures may not be superior to stock returns as measures of performance. Level of difficulty: Not difficult. Estimated study time: 0.5 hour

STUDY SESSION 3

Issues in Applying the Dividend Discount Model and the Role of P/E, P/B, and P/S Valuation Models

READING 1: "Some Evidence on the Value of Dividend Discount Models (Available Online)," Eric H. Sorensen and David A. Williamson, Financial Analysts Journal, Association for Investment Management and Research (November/December 1985), pp. 60-69. This study uses I/B/E/S consensus earnings growth rate forecasts to test the usefulness of several common discounted cash flow (DCF) valuation models: price-to-earnings (P/E), constant growth/single-stage, two-stage, and three-stage. The authors show that greater model complexity enhances the efficacy of valuation analysis. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 2: "Price/Earnings Ratios," Ch. 10, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 197-222. The nature and challenges of applying the P/E valuation approach are explained and illustrated for stable firms and high-growth firms. The reading addresses the issues involved in using financial fundamentals to predict P/Es and gives evaluations of the relative merits of common variants of P/E, such as price/free cash flow to equity (P/FCFE) and value of firm/free cash flow to firm (Firm/FCF). The usefulness of various P/E-based investment strategies is also considered. Level of difficulty: Moderately difficult. Estimated study time: 1 hour

READING 3: "Price/Book Value Ratios," Ch. 11, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 223-43. This reading discusses the advantages and disadvantages of the price-to-book-value (P/B) valuation approach, especially relative to market-based approaches. The author considers problems associated with comparing the P/B of a company with comparable firms' P/Bs, the issues associated with estimating P/Bs from financial fundamentals, and common variants of the P/B ratio. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 4: "Price/Sales Ratios," Ch. 12, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 244-62. This reading discusses the advantages and disadvantages of the price-to-sales (P/S) approach relative to the P/E and P/B valuation methods. The relationship between profit margins and the P/S ratio is explored, with emphasis on strategic valuation implications. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 5: "P/E, P/B and the Present Value of Future Dividends," Patricia M. Fairfield, Financial Analysts Journal, Association for Investment Management and Research (July/August 1994), pp. 23-31. This reading identifies and seeks to adjust for problems stemming from the DDM's implicit assumptions about the relationship between accounting numbers and dividend policy. In this approach, the author restates the DDM without making any assumptions about the relationship between accounting data and future dividends or dividend policy. The focus of the analysis is on estimating a firm's future profitability by considering how different combinations of P/E and P/B are associated with distinct patterns of future profitability. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

STUDY SESSION 4

Inflation Effects on the Valuation Process and Option-Pricing-Based Valuation Models

READING 1: "Inflation and World Equity Selection," Claude B. Erb, Campbell R. Harvey, and Tadas E. Viskanta, Financial Analysts Journal, Association for Investment Management and Research (November/December 1995), pp. 28-42. This reading examines the relationships among inflation, asset expected returns, and asset risks. It confirms prior researchers' findings that within a given country, monthly inflation and asset returns are negatively related. However, the authors do not find a positive relationship between long-term inflation and long-term asset returns. Furthermore, they find that inflation exposure helps explain differences in volatility in different markets globally and that a significant relationship exists between country credit risk and inflation. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 2: "The Effects of Inflation," Ch. 8, Franchise Value and the Price/Earnings Ratio, Martin L. Leibowitz and Stanley Kogelman (Research Foundation of the Institute of Chartered Financial Analysts, 1994), pp. 119-38. The primary argument of this reading is that those companies that can increase earnings to keep pace with inflation will tend to be more valuable than comparable companies without this flow-through capacity. The authors evaluate and discuss the specific effects of inflation flow-through ability on P/E, the effect of inflation on earnings horizons, and the effect of stable and unstable inflation on P/E are discussed. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 3: "Using Option Pricing Methods to Value Flexibility," Ch. 15, Valuation: Measuring and Managing the Value of Companies, University Edition (Second Edition), Tom Copeland, Tim Koller, and Jack Murrin (John Wiley & Sons, 1994), pp. 464-95. This reading surveys the use of option-pricing models to value asset and liability options commonly faced by corporate financial managers. Emphasis is on developing a useful framework for evaluating and responding to the need for financial flexibility in decision making. The authors develop event trees to illustrate the practical application of binomial option-pricing models; and they estimate the cost of capital is estimated given callability and convertibility options. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 4: "Applications of Option-Pricing Theory to Valuation," Ch. 16, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 340-65. The emphasis of the presentation is on valuing equity as an option. The author explores the implications of this view of equity by valuing natural resource assets and product patents as options. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 5: "Overview and Conclusion," Ch. 17, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 366-75. This reading provides an integrative framework for choosing the right model for a given valuation situation. The author distinguished among discounted cash flow, relative-value, and option-pricing valuation approaches and develops model choice criteria, such as level of earnings, current growth, sources of growth, dividends vs. free cash flows and the stability of leverage. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

II. Growth Analysis and Measurement

Section II Study Guides

STUDY SESSION 5

Defining, Measuring, Estimating, and Valuing Relevant Growth

READING 1: "Growth Companies vs. Growth Stocks," Peter L. Bernstein, Harvard Business Review, Harvard Business School Publishing (September 1956), pp. 87-98. This reading addresses the question: What is a growth company? The article develops a framework for defining growth and for distinguishing between "growth companies" and "growth stocks." Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 2: "Growth Opportunities vs. Growth Stocks," Meir Statman, Journal of Portfolio Management, Institutional Investor (Spring 1984), pp. 70-74. This reading extends the ideas developed in the Bernstein classic article (Session 4, Reading 1) by examining the difference between sustainable growth and transitory growth. The author argues that the distinction is particularly important because only sustainable growth is worth a stock price premium. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 3: "Introduction," Ch. 1; "The Franchise Factor," Ch. 2; and "The Franchise Portfolio," Ch. 3, Franchise Value and the Price/Earnings Ratio, Martin L. Leibowitz and Stanley Kogelman (Research Foundation of the Institute of Chartered Financial Analysts, 1994), pp. 1-6, 7-28, and 29-46. These monograph chapters explore the factors affecting P/Es-in particular, the growth factor. First, the authors contrast the franchise value (FV) approach to the dividend discount model framework. In addition, they discuss and illustrate the elements of FV analysis. Level of difficulty: Moderately difficult. Estimated study time: 1.5 hours.

READING 4: "Franchise Value and the Growth Process," Ch. 6; "The Growth Illusion: The P/E 'Cost' of Earnings Growth," Ch. 7; "Resolving the Equity Duration Paradox," Ch. 9; and "Theoretical Price/Earnings Ratios and Accounting Variables," Ch. 10, Franchise Value and the Price/Earnings Ratio, Martin L. Leibowitz and Stanley Kogelman (Research Foundation of the Institute of Chartered Financial Analysts, 1994), pp. 81-100, 101-18, 139-65, and 167-94. These chapters focus on the nature, dimensions, and duration of a company's franchise opportunities. Level of difficulty: Moderately difficult. Estimated study time: 1.5 hours.

READING 5: Sales-Driven Franchise Value, Martin L. Leibowitz (Research Foundation of the Institute of Chartered Financial Analysts, 1997), pp. 1-40. This monograph extends the value-added valuation concepts developed in Franchise Value and the Price/Earnings Ratio (see Reading 4). The refinement bases the franchise value measure on sales growth rather than earnings growth, the focus of the earlier work. A sales-based franchise margin is developed that takes into account the cost of capital required to develop and maintain new sales. Companies are evaluated on their ability to generate new sales, the ultimate source of earnings growth, and their ability to maintain their profit margins on those sales. Only those companies that possess some form of monopolistic power in the form of intellectual property or barriers to entry will be in a position to reap the franchise rewards of new investment. To the company that is able to maintain both sales growth and franchise margins, however, the reward will be a higher market value of equity. Level of difficulty: Moderately difficult. Estimated study time: 2 hours.

READING 6: "Estimation of Growth Rates," Ch. 5, Damodaran on Valuation, Aswath Damodaran (John Wiley & Sons, 1994), pp. 67-97. This reading examines basic techniques for estimating growth rates for equity valuation modeling. Numerous illustrations of the techniques are provided. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 7: "Company Analysis and Stock Selection," Ch. 20, Investment Analysis and Portfolio Management, Fifth Edition, Frank K. Reilly and Keith C. Brown (Dryden Press, 1997), pp. 747-63. This reading incorporates the notion of growth duration, which is developed extensively in the franchise value framework (see Session 4, Readings 3 and 4) into a readily applied model for valuing companies. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 8: "Accounting- and Finance-Based Measures of Risk," Ch. 18, and "Empirical Research: Implications for Financial Statement Analysis," Ch. 5, The Analysis and Use of Financial Statements, Second Edition, Gerald I. White, Ashwinpaul C. Sondhi, and Dov Fried (John Wiley & Sons, 1997), pp. 983-91, 1021-25, 215-37, and 244-51. This reading provides an updated and in-depth examination of topics bearing on growth and growth forecasts. The techniques and measures introduced can be used to refine expectations of growth rates and duration. Also, the authors provide a critical review of the existing empirical literature that considers factors associated with market returns and valuation behavior for companies. Level of difficulty: Moderately difficult. Estimated study time: 1.5 hour.

READING 9: "Value versus Growth Stocks: Book-to-Market, Growth, and Beta," Robert S. Harris and Felicia C. Marston, Financial Analysts Journal, Association for Investment Management and Research (September/October 1994), pp. 18-24. This reading contains an empirical examination of the role of growth in the market valuation of equity. The article investigates specifically, the links among B/MV, beta, and forecasted growth in earnings. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

III. Risk

Section III Study Guides

STUDY SESSION 6

Risk Concepts and Measurement; Time Diversification

READING 1: "Risk of Equity Securities and Portfolios (Available Online)," Dan diBartolomeo, Northfield Information Services (February 22, 1997), pp. 1-10. The author provides a broad introduction to several important equity risk topics: a definition of risk, measures of risk, modeling equity risks with simple and multiple common risk factors, types of multiple factor models, and estimation error in equity portfolio construction. Each of the sections includes a discussion of relative strengths and weaknesses of the topic. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 2: "Global Risk Management: Are We Missing the Point?" Richard Bookstaber, Journal of Portfolio Management, Institutional Investor (Spring 1997), pp. 102-07. The reading discusses risk-management problems arising from the methods used to define and measure uncertainty and risk. Six key considerations for risk management highlight the limitations of volatility as a measure of risk. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 3: "Financial Decision-Making in Markets and Firms: A Behavioral Perspective," Ch. 13, Werner F.M. De Bondt and Richard H. Thaler, Handbooks in Operations Research and Management Science, Finance, vol. 9, Robert Jarrow, Vojislav Maksimovic, and William T. Ziemba, eds. (Elsevier-North Holland, 1995), pp. 385-410. Behavioral finance attempts to model the actual behavior of individuals and companies in the market. The authors provide a selective review of recent work in behavioral finance. They describe well-known psychological tendencies and illustrate the relevance of the tendencies to investment theory and corporate finance. Level of difficulty: Not difficult. Estimated study time: 2 hours.

READING 4: "The Peculiar Persistence of Catastrophic Trading Strategies (Available Online)," David Emanuel, presented at the Chicago Board of Trade Fall Research Seminar (February 1996), pp. 1-9. The author argues that conventional performance measures overstate the performance and understate the risk of potentially catastrophic trading strategies. For example, "doubling-up" strategies that eventually lose everything may exhibit little volatility in the short run. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 5: "The Long-Term Case for Equities," Paul A. Samuelson, Journal of Portfolio Management, Institutional Investor (Fall 1994), pp. 15-24. This reading considers issues of time diversification, the concept that the standard deviation of equity returns will decline over time. The author provides a critique of fallacies that led to acceptance of time diversification and arguments that favor the concept. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 6: "What Practitioners Need to Know about Time Diversification," Mark Kritzman, Financial Analysts Journal, Association for Investment Management and Research (January/February 1994), pp. 14-18. This reading, also currently assigned in the CFA Program, is an excellent extension of Paul A. Samuelson's article, "The Long-Term Case for Equities," Journal of Portfolio Management (Fall 1994), pp. 15-24. After reviewing the intuition behind time diversification, the author demonstrates that if risk aversion is invariant to changes in wealth, if risky returns are random, and if future wealth depends only on investment results, the investment horizon is irrelevant to portfolio choice. The article concludes with reasons investors might still condition their risk on their investment horizon. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 7: "Time Diversification: Perspectives from Option Pricing Theory," Craig Merrill and Steven Thorley, Financial Analysts Journal, Association for Investment Management and Research (May/June 1996), pp. 13-19. This reading demonstrates that securities with option-like features that guarantee a minimum return have greater equity market participation as the investment horizon increases. If the cost of insurance is defined as forgone market participation, then increased market participation implies a lower cost of insurance. This lower cost suggests that risk itself is lower, which is consistent with the concept of time diversification. Level of difficulty: Not difficult. Estimated study time: 1 hour.

STUDY SESSION 7

APT Factor Models

READING 1: "A Practitioner's Guide to Arbitrage Pricing Theory (Available Online)," Edwin Burmeister, Richard Roll, and Steven Ross, A Practitioner's Guide to Factor Models (Research Foundation of the Institute of Chartered Financial Analysts, 1994), pp. 1-30. This reading provides a review of the development and advantages of a multi-factor model developed from the postulates of a linear factor returns model and no-arbitrage condition. The authors define and examine the macroeconomic factors found to influence asset returns. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 2: "Multi-Index Models Using Simultaneous Estimation of All Parameters," A Practitioner's Guide to Factor Models, Edwin Elton and Martin Gruber (Research Foundation of the Institute of Chartered Financial Analysts, 1994), pp. 31-57. The authors review the methodology for identifying asset risk factors and estimating an asset's sensitivities. They provide examples of the use of factor analysis to empirically identify the risk factors in a multifactor model of returns and discuss estimation issues and the strengths and weaknesses of factor models. Level of difficulty: Moderately difficult. Estimated study time: 1.5 hours.

READING 3: "BARRA's Risk Models (Available Online)," Aamir Sheikh, BARRA Research Insights (1996), pp. 1-24. The author addresses the techniques employed in the construction of different types of factor models and the relative costs and benefits of the various models used to estimate the risk of equity securities and portfolios. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 4: "United States Equity Version3 (E3) (Available Online)," BARRA Risk Model Handbook (1998), pp. 7-9, 41-43, and 74-84. This reading defines the risk-factor indexes used by BARRA, a consulting firm that supplies risk models, in its E3 United States Equity Model. The industry and sector classification schemes are also described. Level of difficulty: Not difficult. Estimated study time: 0.5 hour

READING 5: "The Salomon Brothers U.S. Stock Risk Attribute Model (Available Online)," Quantitative Strategy, Eric Sorensen, Joseph Mezrich, and Chee Thum (Salomon Brothers, 1989), pp. 1-17. The authors describe the estimation and application of a multifactor model of individual stock returns. In this application of the APT, the factors are defined a priori as the difference between the actual and expected values of seven macroeconomic series. The applications include scenario analysis of stock and portfolio selection. Level of difficulty: Moderately difficult. Estimated study time: 2 hours.

STUDY SESSION 8

How Stable Is Risk?

READING 1: "Investment Risk and Uncertainty at the End of History (Available Online)," Letter 121, Keith Ambachtsheer, The Ambachtsheer Letter, KPA Advisory Services (January 30, 1996), pp. 1-4. The author explores the distinction between risk (known future states and probabilities) and uncertainty (unknown states and probabilities). He suggests that markets undergo regime shifts and that it is these shifts that investors should consider. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 2: "Is the Stock Market More Stable Than It Used to Be?" Edward Renshaw, Financial Analysts Journal, Association for Investment Management and Research (November/December 1995), pp. 81-88. The author presents evidence from annual trading ranges, financial return distributions, and fluctuations in the S&P 500 Index that supports the hypothesis that the U.S. market is more stable now than it used to be. Possible reasons are a more stable U.S. economy, changing structure of the U.S. economy, portfolio investment strategies, and the globalization of securities markets. He posits that markets dominated by inexperienced investors often boom and then crash. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 3: "Daily Stock Market Volatility: 1928-1989," Andrew L. Turner and Eric J. Weigel, Management Science, Institute for Operations Research and Management Sciences (November 1992), pp. 1586-1609. The authors examined the daily return variability of the S&P 500 index and Dow Jones average for the 1928-89 period. Although the 1980s were the third most volatile decade, in standard deviation terms, for U.S. stock returns, the primary reason was the sharp drop in prices in the fourth quarter of 1987. Nevertheless, returns in the 1980s displayed far more skewness and kurtosis than in other decades, and the frequency of extreme-return events increased, although it was dramatically lower than in the 1920s and 1930s. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 4: "Peapods and Perils," Ch. 10, Against the Gods: The Remarkable Story of Risk, Peter L. Bernstein (John Wiley & Sons 1996), pp. 172-86. The author argues that markets display mean reversion. Investors, following the representativeness heuristic, expect the future to look like the present, and therefore, they overweight current information at the expense of long-run information. This behavior serves as a rationale for contrarian (value) investing and against the serial independence of returns. Forecasting is complicated, however, by either a slow reversion that is interrupted by shocks, or a strong reversion that overshoots, or an unstable mean. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 5: "A Mean-Reverting Walk Down Wall Street," Werner F.M. De Bondt and Richard H. Thaler, Journal of Economic Perspectives, American Economic Association (Winter 1989), pp. 189-202. This reading reviews the evidence of mean reversion in equity indexes and the ability of contrarian strategies to earn excess returns. A behavioral model of investor behavior is proposed to explain the results. Level of difficulty: Not difficult. Estimated study time: 2 hours.

STUDY SESSION 9

Risk Measures and Applications

READING 1: "Value-at-Risk (1): Understanding the Various Ways to Calculate VAR," Charles Smithson with Lyle Minton, Risk (January 1996). Extracted from Canadian Imperial Bank of Commerce Class Notes. The authors define value at risk (VAR) as the maximum an institution can lose over a specified time horizon at a specified probability level. The article describes the concept and reviews different methods of calculating VAR. The authors compare the VARs produced by three different common methods and assess the strengths and weakness of each method. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 2: "Value-at-Risk (2): The Debate on the Use of VAR," Charles Smithson with Lyle Minton, Risk (February 1996). Extracted from Canadian Imperial Bank of Commerce Class Notes. The authors discuss the extent to which VAR is used by various market participants. Key issues concerning which firms should use VAR and the best way to calculate the risk measure are considered. The article also surveys and evaluates the various ways in which the analytic method can be used to incorporate options into the calculation of VAR using. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 3: "VAR: Seductive but Dangerous," Tanya Styblo Beder, Financial Analysts Journal, Association for Investment Management and Research (September/October 1995), pp. 12-24. The author uses techniques common among market participants to calculate eight measures for three hypothetical portfolios. The calculations are extremely dependent on the parameters, data, assumptions, and methodology used. The author concludes that, although they are necessary for effective risk management, quantitative techniques for the measurement and control of risk are not sufficient. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 4: "Dividend Yield and Equity Duration," Ch. 7, Richard Bernstein, Style Investing (John Wiley & Sons, 1995), pp. 120-41. The author examines ways to measure interest rate sensitivity for equities, how interest rates affect different styles of investing, and how differences in companies' ability to pass inflation through to customers can offset the interest rate sensitivity of certain investment styles. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 5: "On the Use and Misuse of Downside Risk," Frank A. Sortino and Hal J. Forsey, Journal of Portfolio Management, Institutional Investor (Winter 1996), pp. 35-42. The authors agree that downside deviation, the deviation of return below some set value that must be earned, is a valuable measure of risk. Their intent is to caution against its misuse and its assumed completeness. The correct calculation of downside deviation requires that attention be paid to abnormal returns and measurement errors. They conclude that no single risk measure is sufficient. Level of difficulty: Not difficult. Estimated study time: 0.5 hour

READING 6: "Business Conditions, Monetary Policy and Expected Security Returns," Gerald R. Jensen, Jeffrey M. Mercer, and Robert R. Johnson, Journal of Financial Economics, Elsevier-North Holland (February 1996), pp. 213-37. The authors reconsider the evidence that expected returns can be forecast by the term premium, default premium, and dividend yield. They find that the monetary policy environment influences investors' required rates of return in the United States. Level of difficulty: Moderately difficult. Estimated study time: 2 hours.

READING 7: "Size and Book-to-Market Factors in Earnings and Returns," Eugene F. Fama and Kenneth R. French, Journal of Finance, American Finance Association (March 1995), pp. 131-55. This reading provides empirical support for the proposition that size and the book-to-market ratio are proxies for a company's profitability. Level of difficulty: Moderately difficult. Estimated study time: 2 hours.

READING 8: "Making Sense of Beta, Size and Book-to-Market," Hersh Shefrin and Meir Statman, Journal of Portfolio Management, Institutional Investor (Winter 1995), pp. 26-34. Using Fortune magazine surveys, the authors examine the relationship between "good" companies and "good" stocks. Level of difficulty: Not difficult. Estimated study time: 1 hour.

IV. Equity Derivatives and Strategies

Section IV Study Guides

STUDY SESSION 10

Equity Derivatives and Strategies:

READING 1: "Adding Value with Equity Derivatives: Part I," Gary L. Gastineau, Derivative Strategies for Managing Portfolio Risk, Keith C. Brown, ed. (Association for Investment Management and Research, 1993), pp. 54-61. Derivatives are useful in implementing strategic and tactical portfolio management and are often more flexible and cheaper than moving in and out of the underlying securities, especially in global applications. Strategic applications include statistical arbitrage and market making, portfolio insurance, and asymmetrical asset allocation. Tactical applications include tax arbitrage in general (and dividend capture in particular), regulatory arbitrage, yield enhancement, equity collars, and symmetrical international

diversification. Portfolio performance measurement and evaluation is difficult with such applications because of the challenges of measuring risk in derivatives positions. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 2: "Adding Value with Equity Derivatives: Part II," Joanne M. Hill, Derivative Strategies for Managing Portfolio Risk, Keith C. Brown, ed. (Association for Investment Management and Research, 1993), pp. 62-73. Equity derivatives allow the equity portfolio manager to achieve a number of different investment objectives at relatively low cost. They can be used to participate in global equity markets and are useful in risk management, asset allocation, and active portfolio management. The primary applications Hill explores are obtaining equity exposure to a particular non-U.S. market using futures and managing risk using equity index options. The author considers the various ways in which futures can be used to own an index fund and examines the primary differences between futures and swaps and between listed and OTC option markets. She argues that futures are most useful in managing symmetrical (i.e., upside and downside or untruncated) equity exposure to a given country market whereas index options are most effective in risk management. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 3: "The Uses and Risks of Derivatives," Joanne M. Hill, Investing Worldwide VI, Association for Investment Management and Research (January 1996), pp. 46-58. This presentation traces the history and market-driven evolution of equity derivatives and portfolio strategies. The author presents the various ways in which an international index can be replicated with futures, evaluates their relative merits, and discusses issues in the implementation of these futures strategies. Index option strategies discussed include overwriting, tailored hedges, option sales in tactical asset allocation, and return enhancement with volatility trading. The author compares OTC and listed options and surveys the use of structured notes to capture index returns. The reading concludes with a discussion of risk management and derivatives, sources of risk, and the need for internal risk controls. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 4: "Advanced Derivatives and Strategies," Ch. 15, An Introduction to Derivatives, Fourth Edition, Don M. Chance (Dryden Press, 1998), pp. 625-33. This chapter describes equity derivatives, analyzes their risk-return characteristics, and discusses common uses of equity forwards, break forwards, equity swaps, and equity collars. The author provides practical examples of the derivatives' use in managing equity portfolios. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 5: "Using Swaps in Equity Portfolios," Gary L. Gastineau, Derivative Strategies for Managing Portfolio Risk, Keith C. Brown, ed. (Association for Investment Management and Research, 1993), pp. 74-77. Equity swaps have been a small part of the overall swap market, but portfolio managers do use them to overcome such constraints as taxes and regulations that make direct ownership of equity expensive or inaccessible in many markets. The four key issues related to equity swaps that Gastineau discusses are U.S. Internal Revenue Service (IRS) swap regulations, the significance of swaps for industry structure, the use of swaps to extend the efficient frontier portfolio, and the importance of credit risk.

The author also explores the implications of the ability of plan sponsors to swap portfolio benchmarks. This ability can have a significant effect on how plan sponsors allocate funds among competing portfolio managers. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 6: "Application of Derivative Strategies in Managing Global Portfolios," Roger G. Clarke, Derivative Strategies for Managing Portfolio Risk, Keith C. Brown, ed. (Association for Investment Management and Research, 1993), pp. 78-91. This reading examines the use of derivative strategies in effecting asset allocations in global portfolios. Derivatives can be used to create new market exposure, protect existing exposure, and enhance returns. The benefits of using futures include the ability to leave most or all of the underlying assets in place and the separation of allocation duties and taking risks. That is, the assets can be handled by one set of managers and the derivative position can be handled by an overlay manager. The issues that must be evaluated in using futures include tracking error, liquidity, mispricing, and rollover risk. The reading discusses a variety of options-related strategies designed to create new market exposure, to protect existing market exposure, or to enhance portfolio returns. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 7: "The Comparison of Strategies Using Derivatives," Maarten L. Nederlof, Derivative Strategies for Managing Portfolio Risk, Keith C. Brown, ed. (Association for Investment Management and Research, 1993), pp. 113-19. This reading discusses the nature and portfolio management implications of options' asymmetrical return distributions. The asymmetrical outcome of options offers useful ways to alter the risk-return complexion of a portfolio. Asymmetry leads to distorted risk measures, however, and can lead to missed opportunities. The author illustrates the potential effects of adding derivatives to a portfolio by using protective put and covered call strategies. He also presents, a general framework for evaluating whether an option strategy is appropriate for a particular portfolio. He emphasizes that options are attractive because they can be focused to lock in a particular scenario and because they can be customized. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 8: "Advanced Derivatives and Strategies," Ch. 15, An Introduction to Derivatives, Fourth Edition, Don M. Chance (Dryden Press, 1998), pp. 633-35. This chapter excerpt provides an overview of exchange-listed warrants based on foreign stock indexes (equity warrants) and debt with interest payments linked to a stock market index (equity-linked debt). The author presents payoff structures and valuation issues and describes common variations of these securities. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 9: "Equity Swap Agreement and Synthetic Equity (Available Online)" and "Warrants and Covered Warrants," Gary L. Gastineau, Tina R. Ruygrok, Sian O'Shea, Margaret A. Shergalis, and Caroline A. Wilkinson, A Compendium of Equity Instruments (S.G. Warburg, 1995), pp. 34-38 and 43-55. These readings describe several equity warrants and equity-linked debt securities. Emphasis is on the rationales for their use, the structure of the markets in which the securities are traded, valuation issues, and strategic applications. The specific securities are equity swap agreements and synthetic equity, warrants and covered warrants, and equity-linked notes. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 10: "Advanced Derivatives and Strategies," Ch. 15, An Introduction to Derivatives, Fourth Edition, Don M. Chance (Dryden Press, 1998), pp. 646-59. This material describes the characteristics and payoff structures of a wide variety of so-called exotic options-a category that includes virtually any option that is not traded on an exchange and is not essentially identical to one traded on an exchange. The exotic options, which are analyzed and illustrated using market data include asset-or-nothing, cash-or-nothing, chooser, and Asian options. Numerous other exotic options are described, although the author does not develop examples of them. These include compound, installment, barrier, down-and-out, up-and-out, multi-asset, rainbow, outperformance, look-back, and forward-start options. Level of difficult: Moderately difficult. Estimated study time: 1 hour.

V. Equity Portfolio Management

Section V Study Guides

Study Session 11

Equity Style Management: What Is It and How Is It Used?

READING 1: "Equity Style: What It Is and Why It Matters," Ch. 1, Jon A. Christopherson and C. Nola Williams, The Handbook of Equity Style Management, Second Edition, T. Daniel Coggin, Frank J. Fabozzi, and Robert D. Arnott, eds. (Frank J. Fabozzi Associates, 1997), pp. 1-19. This reading introduces the topic of equity style portfolio management. Style management is defined and issues associated with the various styles and benchmarks are explored. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 2: . "Is Equity Style Management Worth the Effort? Some Critical Issues for Plan Sponsors," Ch. 20, Charles Trzcinka, The Handbook of Equity Style Management, Second Edition, T. Daniel Coggin, Frank J. Fabozzi, and Robert D. Arnott, eds. (Frank J. Fabozzi Associates, 1997), pp. 301-308 (through the top paragraph) and p. 312 of chapter "Summary and Conclusion." The author examines the purposes of style management from the plan sponsor's perspective. While the primary purpose must be to increase portfolio return, other important purposes include enhancing communication with the money manager, evaluating performance, and diversifying funds under management. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 3: "Understanding the Differences and Similarities of Equity Style Indexes," Ch. 2, Melissa R. Brown and Claudia E. Mott, The Handbook of Equity Style Management, Second Edition, T. Daniel Coggin, Frank J. Fabozzi, and Robert D. Arnott, eds. (Frank J. Fabozzi Associates, 1997), pp. 21-53. This reading examines the construction and behavior of a number of style benchmarks that are widely used for performance assessment and asset allocation. The authors consider what the benchmarks reveal regarding the nature of the styles and how the indexes for the same style differ from one another. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 4: "Asset Allocation: Management Style and Performance Measurement," William F. Sharpe, Journal of Portfolio Management, Institutional Investor (Winter 1992), pp. 7-19. The author presents an overview of return-based style analysis using a factor model regression approach to identify the style(s) of a manager. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 5: "Equity Style Classifications," Jon A. Christopherson, Journal of Portfolio Management, Institutional Investor (Spring 1995), pp. 32-43. The article discusses the relative strengths and weaknesses of two methods for determining a portfolio manager's investment style: 1) analysis of equity characteristics, and 2) analysis of return patterns (correlation analysis). Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

STUDY SESSION 12

Returns to Style: Implications for Investment Management

READING 1: "The Earnings Expectations Life Cycle," Richard Bernstein, Financial Analysts Journal, Association for Investment Management and Research (March/April 1993), pp. 90-93. The author develops a graphical framework that links investors' earnings expectations and stock prices to equity style management. Key problems associated with the implementation of equity style strategies, which are based on expectations, are discussed. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 2: "Making Sense of Beta, Size, and Book-to-Market," Hersh Shefrin and Meir Statman, Journal of Portfolio Management, Institutional Investor (Winter 1995), pp. 26-34. This article relates Fortune magazine survey data on the "quality" of companies to returns to style and risk factors. The study updates earlier literature that explores the differences between "good companies" and "good stocks." Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 3: "Historical Tendencies of Equity Style Returns and the Prospects for Tactical Style Allocation," Ch. 12, Douglas W. Case and Steven Cusimano, Equity Style Management, Robert A. Klein and Jess Lederman, eds. (Irwin Professional Publishing, 1995), pp. 259-87. This chapter examines the gains from forecasting style and implementing an intra-asset-class style allocation system for equity portfolio management. Level of difficulty: Moderately difficult. Estimated study time: 1.5 hours.

READING 4: "Value, Relative Strength, and Volatility in Global Equity Country Selection," Rosemary Macedo, Financial Analysts Journal, Association for Investment Management and Research (March/April 1995), pp. 70-78. This article extends style investing to country selection in global equity portfolios using relative value and relative strength (growth). Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

READING 5: "Part II-International Equity Style Management," Part 2 of Ch. 5, David Umstead, Equity Style Management, Robert A. Klein and Jess Lederman, eds. (Irwin Professional Publishing, 1995), pp. 118-41. This chapter examines the same issue addressed by Macedo (Reading 6), but assumes a fixed style tilt in the analysis: growth or value. The author finds that value outperforms growth in all periods examined. Level of difficulty: Not difficult. Estimated study time: 1 hour.

VI. Selected Topics in Financial Statement Analysis

Section VI Study Guides

STUDY SESSION 13

Earnings Quality and International Financial Statement Analysis

READING 1: "Managing Earnings (Available Online)," Pat McConnell and Janet Pegg, Accounting Issues, Bear, Stearns & Company (September 10, 1996), pp. 1-37. This reading provides a structured, comprehensive framework for analyzing, evaluating, and comparing the quality of earnings for individual companies over time and for more than one company. Examples of recent SEC enforcement actions illustrate how managers may attempt to manage reported earnings. Level of difficulty: Not difficult. Estimated study time: 1 hour

READING 2: "The Quality of Reported Earnings Has Improved, But . . . Pointers on What to Look for in Company Reports (Available Online)," Gabrielle Napolitano and Abby Joseph Cohen, U.S. Research (Goldman, Sachs & Company, January 2, 1997) pp. 1-10. Napolitano and Cohen discuss why the quality of earnings may have improved in recent years. In addition, they discuss continuing sources of quality of earnings problems, including timing of revenue recognition, changes in depreciation schedules, use of loss reserves, capitalization of costs, recurring use of restructuring charges, and use of the deferred tax asset valuation allowance. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 3: "Earnings-Based Analysis and Valuation," Ch. 13, Financial Statement Analysis: Theory, Application, and Interpretation, Sixth Edition, Leopold A. Bernstein and John J. Wild (Irwin/McGraw-Hill, 1998), pp. 621-53. This reading considers the importance of earnings quality and persistence in valuation, individual adjustments to recast earnings and earnings components of financial statements for analysis, and the role of earning power in forecasting and valuation. Numerous examples of real companies' reporting practices are provided to illustrate the analysis. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 4: "Corporate Financial Disclosure: A Global Assessment," Ch. 18, Carol A. Frost and Kurt P. Ramin, International Accounting and Finance Handbook, Second Edition, Frederick D.S. Choi, ed. (John Wiley & Sons, 1997), pp. 18.1-18.33. This reading presents a descriptive analysis of selected annual report disclosures for 200 companies from five countries: France, Germany, Japan, the United Kingdom, and the United States. Forty companies were selected for each country, and the reports were analyzed with particular attention to disclosures in the following areas: forward-looking information, industry and geographical segment information, accounting policies, cash and funds flow statements, and special information for nondomestic financial statement users. The items were selected for analysis on the basis of their importance to financial analysts and other users of financial statements. Striking differences were observed among the countries in items disclosed and in the extent of disclosure. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 5: "Corporate Disclosure and Transnational Financial Reporting in Selected Countries," Ch. 4, Shahrokh M. Saudagaran, International Accounting and Finance Handbook, Second Edition, Frederick D.S. Choi, ed. (John Wiley & Sons, 1997), pp. 4.6-4.22. This reading surveys the diversity in financial statement reporting and disclosure practices in Canada, Germany, Japan, the United Kingdom, and the United States. Attention is paid to the primary aspects of statements that are likely to be of interest to a nondomestic user of the information. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 6: "International Financial Statement Analysis," Ch. 8, Ronald Sherman and Rebecca Todd, International Accounting and Finance Handbook, Second Edition, Frederick D.S. Choi, ed. (John Wiley & Sons, 1997), pp. 8.1-8.61. This reading provides discussion of the various motivations for performing international financial statement analysis, the factors affecting cross-border analysis, systems for classifying and categorizing countries' accounting and disclosure practices, and sources of financial information. Techniques for transforming and analyzing statements to compare cross-border companies are introduced. The techniques are illustrated with a comparative analysis of a U.S. company and an Italian company. Level of difficulty: Moderately difficult. Estimated study time: 1.5 hour.

READING 7: "Achieving Comparability of U.S. and Japanese Price-Earnings Ratios," Ch. 7, Paul R. Brown, Virginia E. Soybel, and Clyde P. Stickney, International Accounting and Finance Handbook, Second Edition, Frederick D.S. Choi, ed. (John Wiley & Sons, 1997), pp. 7.1-7.18. This reading examines the body of research into the question of why Japanese P/Es have historically been much higher than those in other countries, such as the United States. The question revolves around the distinction between accounting disclosure differences and cultural differences that may lead to higher or lower risk tolerances, amounts of equity used, and so on. The reasons for some of the differences are explained in the reading. Level of difficulty: Moderately difficult. Estimated study time: 0.5 hour.

STUDY SESSION 14

Special Topics: Intellectual Property and Other Intangible Assets and Financial Services Operations

READING 1: "Overview: Intellectual Property-The New Global Currency," Colleen Spring Zimmerman and Leslie J. Dunlop, The New Role of Intellectual Property in Commercial Transactions, Melvin Simensky and Lanning G. Bryer, eds. (John Wiley & Sons, 1994), pp. 1-24. Zimmerman and Dunlop review current trends and issues that illustrate the increasing value and importance of intellectual property as an economic asset and an essential tool in business. They examine the pressures that these trends exert on the traditional legal dimensions of the global economy. First, they outline the basic ways in which intellectual property is created and protected and the basic rationale underlying such protection. Next, they discuss various trends in the markets and courts that reflect the extension and exploitation of the value of intellectual property. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 2: "Intangible Assets," Ch. 7, The Analysis and Use of Financial Statements, Second Edition, Gerald I. White, Ashwinpaul C. Sondhi, and Dov Fried (John Wiley & Sons, 1998), pp. 331-34 and 342-47. For many companies, intellectual property and other intangible assets are the major source of revenue, profitability, and high growth. This reading focuses on the different accounting techniques applied to the various types of intangibles and on the implications for financial statement analysis of the accounting methods. The article discusses transformations an analyst may wish to make to financial statements to enhance comparability among companies and provide a better basis for valuing the companies. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 3: "Quantitative Methods of Valuing Intellectual Property," Ch.1, Russell L. Parr and Gordon V. Smith, The New Role of Intellectual Property in Commercial Transactions, Melvin Simensky and Lanning G. Bryer, eds. (John Wiley & Sons, 1994), pp. 39-68. Parr and Smith discuss ways in which intellectual properties contribute to corporate value and methods by which intellectual property values can be quantified. They present the roles of active and passive intellectual property in business value creation and explore strategic alliances as a mechanism for controlling development time, cost, and risk. They present three general methods for valuing intellectual property, and they compare and contrast the strengths and weaknesses of these methods. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

READING 4: "Risk and Return in R&D-Intensive Industries," Stewart C. Myers, Corporate Financial Decision Making and Equity Analysis, Randall S. Billingsley, ed. (Association for Investment Management and Research, 1995), pp. 26-33. Myers addresses four problems in the valuation of R&D-intensive companies-accounting disclosure distortion, risk and the related cost of capital, the risk-return "staircase" (i.e., the pattern of return and risk in the various phases of development), and valuing R&D investments that display severely skewed return patterns. The conclusion is that techniques used for investment and risk management in venture capital partnerships capture the essence of R&D investments. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 5: "The Financial Services Industry: Depository Institutions," Ch. 1, Financial Institutions Management, Second Edition, Anthony Saunders (Irwin/McGraw-Hill, 1997), pp. 1-22. This reading provides a general introduction to the primary operations and activities of financial institutions, with a focus on commercial banks and thrifts. After reviewing the general business environment for these companies, Saunders examines the types of financial reports issued by banks and thrifts and considers regulatory factors affecting these institutions. He then analyzes trends in the operations of the institutions and the implications of changes for future operations and changes in the institutions. Level of difficulty: Not difficult. Estimated study time: 1 hour.

READING 6: "The Financial Services Industry: Other Financial Institutions," Ch. 3, Financial Institutions Management, Second Edition, Anthony Saunders (Irwin/McGraw-Hill, 1997), pp. 41-54. This chapter covers a number of intermediaries other than commercial banks: investment banks, finance companies (including manufacturing companies' finance subsidiaries), securities firms, and mutual funds. Saunders compares and contrasts the nature of the firms' activities, their asset and liability portfolios, the services they provide, and the customers they serve. Level of difficulty: Not difficult. Estimated study time: 0.5 hour.

READING 7: "Evaluating the Performance of Financial Intermediaries," Ch. 8, Marcia M. Cornett, Fundamentals of Financial Institutions Management, Anthony Saunders, ed. (Irwin/McGraw-Hill, forthcoming in 1999), pp. 145-75. Cornett provides a framework for analyzing the financial statements of financial institutions, including finance company subsidiaries of manufacturing companies. As an example of the kind of financial statement analysis required of analysts, she provides an in-depth analysis of the financial statements of one type of financial firm, the commercial bank. Level of difficulty: Moderately difficult. Estimated study time: 1 hour.

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