- The revised 13th edition of Foundations for Scientific Investing is now available (paperback ISBN 978-1991155474; eBook ASIN B0CVN59SQW),
along with the seventh edition of Foundations for Scientific Investing: Multiple-Choice, Short-Answer, and Long-Answer Test Questions
in paperback (ISBN 9780995117358) and eBook (ASIN B08R76VWF4). The latter book contains 700+ class-tested exam/assignment questions and answers to reinforce the
material in the book. Letter answers to the multiple-choice questions appear in the book and online (below). Ordering details.
Note that extended suggested solutions to the more difficult multiple-choice
questions can now be found online.
- Highlighted Points of difference: What makes this book different from other investments books? (PDF file; 6 pages; January 2022)
- This revised 13th edition is the product of 25+ years of investment research and experience (academic, personal, and professional), and
20+ painstaking years of destructive testing in university classrooms. Although the topic is applied investments, the integration of finance,
economics, accounting, pure mathematics, statistics, numerical techniques, and spreadsheets (or programming) make this an ideal capstone
course at the advanced undergraduate or masters/MBA level. The book has a heavily scientific/quantitative focus, but the material
should be accessible to a motivated practitioner or talented individual investor with (for the most part) only high school level
mathematics or intermediate level university mathematics. Although aimed at the advanced undergraduate or masters/MBA level, the
careful explanations of a wide range of advanced capital markets topics makes this an excellent book for a U.S.
PhD student in need of an easily accessible foundation course in capital markets theory and practice.
- There are literature reviews of multiple advanced areas, and more than 30 unanswered research questions are identified;
these research questions would be ideal for a master's thesis or a chapter of a PhD. The applied nature of the book also makes
it ideal for capital markets practitioners. For example, in one exercise, the reader is taken by the hand and walked through
construction of a worked spreadsheet example of an active alpha optimization using actual stock market data.
(The reader gets to build ex-ante alphas, and feed them into an optimization that weighs returns, risk,
and transaction costs. A portfolio is rebalanced based on the optimization, and ultimately a backtest is conducted to
measure ex post alpha.)
- Other practitioner material includes advanced time value of money exercises,
a review of retirement topics, extensive discussions of dividends, P/E ratios, transaction costs,
the CAPM, value versus growth versus glamour versus income, and a review of more than 100 years
of stock market performance and more than 200 years of interest rates.
- Option trading is discussed, and the implicit leverage in a call option is compared with
the explicit leverage in a margin trade. There is also a careful discussion of the active versus
passive debate, including reasons why you might want to hold an active fund even if it underperforms
its benchmark after fees.
- The book contains 72 "Quant Quizzes," containing over 100 individual questions. Each is designed to reinforce key ideas.
There are also more than 10 "You Need to Know" boxes, each of which focuses on a very important point that is often taught poorly
or overlooked completely in university courses. Special attention is paid to more difficult topics like construction of Student-t statistics,
the Roll critique, smart beta, factor-based investing, the Fama-French critique, and Grinold-Kahn versus Black-Litterman models
(note that a hybrid Grinold-Kahn/Black-Litterman model is introduced). A key diagram shows how the following models are related
to each other: Martingale, Random Walk, ABM, GBM, APT, CAPM, Markowitz, Tobin, Zero-Beta CAPM, Black-Scholes, Bachelier, etc.
Another key diagram identifies participants in securities lending transactions that stand behind any short sale of stock.
Also, the Roll Critique and the Black Zero-Beta CAPM are both generalized to reference portfolios that are not necessarily
fully invested. The list of references has over 1,000 items from the academic and practitioner literature and the extensive
index has over 9,500 entries. Finally, note that a separate book with more than 600 classroom-tested questions exists to accompany this book.
- Every investor needs capital markets intuition and critical thinking skills to conduct confident,
deliberate, and skeptical investment. The overarching goal of this book is to help investors build these skills.
- The book is broken into four main sections:
- Foundations I: Quantitative
(The Perfect Foresight Example, Maths and Stats, Classroom Experiments, etc).
- Foundations II: Financial Economics
(Returns, TVM, Fundamental/Technical Analysis, Transaction Costs, Dividends and DDMs,
Passive Return and Risk and Markowitz, Active Return and Risk, P/E ratios, Enterprise Value and Enterprise Ratio, Retirement Topics, etc).
- Financial Theories and Empirical Evidence
(Random Walk, Efficient Markets,
Modern Technical Analysis, CAPM Fama-French and Ferguson-Shockley, etc).
- Active Investment Topics
(ETFs, Value vs Growth, Hedge and Long-Short Funds, Option Trading versus Margin Trading,
Securities Lending Diagram and Short Selling Diagram, History and Stock Prices and Interest Rates, DB/DC Plans, Accruals, Absolute Returns, Fundamental Indexation, Low-Beta Strategies,
Smart Beta, Factor-Based Investing, LDI, Portable Alpha, Personal Trading, etc).
- Do you want to see a detailed table of contents? If so, follow the "How to Buy the Books" link above until you get to the Amazon page
for the eBook. Then click on the "Look Inside" icon at the top of the cover image. You will be able to see the
first 30 (or more) pages, including a detailed table of contents.
- Click here to see front cover image.
- Dr. Timothy Falcon Crack did PhD coursework at MIT and Harvard, and graduated with a PhD in Financial Economics from MIT.
He has degrees in Mathematics (with a lot of Statistics), Finance, and Financial Economics and a diploma in Accounting/Finance.
He also holds the Investment Management Certificate from the UK Society of Investment Professionals.
He has won six university teaching awards and been nominated for at least five others.
- Dr. Crack has published in the top academic journal in Finance (The Journal of Finance), the top
practitioner-oriented journals in Finance (The Financial Analysts Journal and The Journal of Futures Markets),
and the top pedagogical journal in Finance (The Journal of Financial Education).
He has also published in what was the top interdisciplinary Business journal (The Journal of Business).
He has written seven sole-authored finance books (the following links direct you to the latest editions for sale at Amazon.com
and Amazon.co.uk):
- Dr. Crack taught at the university level from 1985 to 2000, and again from 2004 onwards, including four
years as a front line teaching assistant for MBA students at MIT, and five years teaching undergraduate,
MBA and PhD courses at Indiana University's Kelley School of Business.
He is now a chaired full professor of Finance at the oldest university in New Zealand.
- Dr. Crack has worked as an independent consultant to the New York Stock Exchange and to a foreign
government body investigating wrong doing in the financial markets. His most recent practitioner job was as
the head of quantitative active equity research for the UK and Continental Europe in the London office of
what was the world's largest institutional asset manager.
Click here to be directed to the latest edition(s)
for sale at Amazon.com and Amazon.co.uk (as part of a list containing every book I have written plus some other favorites).
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Download Spreadsheets and Solutions....
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LEFT click on Spreadsheet names and choose "Save."
Be patient; it may take a full minute to download if the server is busy.
Note that some files differ with the edition of the book.
A padlock symbol here indicates that the file is password protected.
Look up "password" in the index of the book to find the password for any
password-protected files.
None of these spreadsheets uses VBA, or any macros, or has any embedded links to other
sheets (the Osborne-2010 spreadsheet is an exception). Approximate file sizes are given.
Sometimes Google Chrome refuses to download a file from here, saying "insecure download blocked."
Then I click on the download symbol and I click on "keep" and the file downloads OK.
- 53-PERCENT-COIN-TOSS-GAME-REVISED.xlsx (24KB)
- Averaging-PE-Ratios-to-get-Index-PE.xlsx (14KB)
Which average should you use (quadratic, arithmetic, geometric, harmonic, cap-weighted, or weighted-harmonic) when
averaging P/E ratios to get the P/E ratio of an index? See Section 2.3.8 of the 13th edition.
- ACTIVE-ALPHA-DATA.xls (1st, 2nd, or 3rd Edition)
(375KB) ACTIVE-ALPHA-DATA.xls (4th-13th Edition) (1105KB)
- BACK-TEST.xls (1st, 2nd, or 3rd Edition) (400KB) BACK-TEST.xls (4th-13th Edition) (927KB)
- bbsGREEKS-ACTIVEX.xlsm For readers of Basic Black-Scholes. Password from that book may be required.
- bbsGREEKS-REVISED.xls For readers of Basic Black-Scholes. Password from that book may be required.
- bbs-revised.xls For readers of Basic Black-Scholes. Password from that book may be required.
- COCO-2021-SHEET-1-VARIANCE-t-DECOMPOSITION-20210218 (3,030KB)
- COCO-2021-SHEET-2-INDEPENDENCE-AND-STUDENT-t-20210218 (3,840KB)
- DAILY-YIELD-CURVE-MOVIE-20210622.xlsm A yield curve movie for the classroom.
- US Daily Data (14,000+ observations; 1962:01-2019:03)
- UK Daily Data (9,800+ observations; 1979:01-2019:03)
- NZ Daily Data (8,200+ observations; 1985:01-2019:03)
When you load it up, you need to "enable content" when asked.
Then you use the mouse to click on the spinner. After that first click you can use the mouse or the arrow keys to change the spinner.
You can also use a piece of sticky tape to hold down the arrow keys or mouse button. It is a "movie" only if you press the mouse button or
arrow key and hold it down.
- DIVERSIFICATION-MYTH.xls beta version (252KB)
Arnott (FAJ, 62(5), 2006) argues that the classic 60/40 portfolio does not provide true diversification (FFSI, 13th Ed., p. 82).
This spreadsheet allows the user to demonstrate/visualize diversification benefits from combining stocks and bonds.
It also allows the user to show the circumstances under which there is little diversification benefit from adding
bonds to a portfolio of stocks. It ties in with Section 1.3.13 on understanding correlation and covariance (see p. 82 of 13th Ed.),
Section 2.6.1 on the parameterization of risk and return in a multi-asset portfolio
(see p. 256 of 13th Ed.), and Section 4.1.9 on the correlation between returns to stocks
and bonds (see p. 475 of 13th Ed.).
- DIVIDEND-IMPUTATION-EXAMPLE.xls (890KB)
- Debt-Banana-Crack-Roberts-2015.xls (378KB)
- dog.xlsm (dog and circular field spreadsheet)
- DYNAMIC-GRAPH.xls (200KB)
- DYNAMIC-MULTIPLE-REGRESSION-WITH-COLUMN-CONCATENATION.xls
(717KB) I needed to run a multiple linear regression in Excel, but the data on the
variables were not contiguous. So, I needed to concatenate columns from different locations and then
run the regression using matrix algebra. There are few if any instructions in the sheet (it was part of
a large research project and this part is taken completely out of context). You will need to spend quite
some time to figure out what I did.
- DYNAMIC-REGRESSION.xls (60KB)
- DYNAMIC-TEXT.xls (30KB)
- EXTRACT-DIAGONAL.xlsx (How to extract diagonal of a square matrix in Excel) (15KB)
- GameStop-Options.xlsx When GameStop/GME stock price rocketed upwards in January 2021,
$10-strike puts on GME quadrupled in value. How do put option prices rise when stock price rises? I have included analysis of long stock
(margined and unmargined), short stock (margined), long put, short put (margined), long call, and short call (margined) positions. (25KB)
- GEARING-NEUTRAL-RATIOS.xls (41KB)
- INVARIANCE-UNDER-ORTHOGONALIZATION-2019.xls (2,078KB)
Dating back to at least the 1960s, some finance researchers attempted to address the effects of multicollinearity on an OLS
regression by pulling out an offending independent variable, regressing that variable on the other independent variables
(i.e., a first-pass regression), and then replacing the offending variable in the original regression with the residuals from
the first-pass regression. In fact, this is a waste of time. The key regression characteristics
(coefficient of the offending variable, its standard error, the t-statistic of the offending variable's coefficient,
the residuals, the R-Squared, the adjusted R-squared, the SSE, the standard error of the regression, and
the F-stat for the regression) are all immune to this transformation. My spreadsheet demonstrates these properties.
This spreadsheet is based on the paper: Mitchell, Douglas W., 1991, "Invariance of Results Under a Common Orthogonalization,"
Journal of Economics and Business, Vol. 43, pp. 193--196.
Note new comments regarding Section 8 of Fama-French (2015, JFE 116(1), pp.1-22) (Five-Factor Model paper).
- LOW-RSQUARED-HIGH-TSTAT.xlsx (69KB)
Accompanying discussion on p.86 of the 10th--13th editions. What
does it mean if you get a low R-squared but a high t-stat on the coefficient of an OLS?
- LUMP-SUM-AVERAGE-RETURNS-AND-WEALTH.xlsx You invest $1,000 lump sum and
hold the investment for 100 years. The continuously-compounded returns are IID normally distributed (or scaled Student-t, if selected).
How does your geometric average return to date vary over time? How does your accumulated wealth vary over time?
- MARKOWITZ-DATA.xls (1st, 2nd, or 3rd Edition) (790KB) MARKOWITZ-DATA.xls (4th-13th Edition) (1037KB)
- MAX-UTIL-OBJ.xls (30KB)
- MIN-VAR-OBJ.xls and associated bat-wing plot: Bat-Wing-Min-Var-Obj.pdf (30KB)
- MONTE-CARLO-EXERCISES-2020.xlsx (5,576KB)
- MONTE-CARLO-STD-CAUCHY.xls (2,314KB)
- MORTGAGE-PREPAYMENT-EXERCISE.xlsx (57KB) Assuming
a 30-year fixed-rate mortgage, this spreadsheet shows the effect of a double-principal prepayment of
mortgage principal on the total interest paid and the term of the loan. The TVM properties of principal prepayments
is very interesting! There are 10 challenge questions in the Excel spreadsheet.
- NZX-CLOB-OPENING-AUCTION-ALGORITHM.xls (592 KB) How does the New Zealand Stock Exchange
execute their opening auction algorithm? The worked example in this spreadsheet shows how the NZX algorithm determines
a market-clearing price in a centralised limit order book. There is also a similar closing-auction algorithm.
- normal-pdf-discretization-2021.xlsx (970KB)
- OSBORNE-2010-A-RESOLUTION-TO-THE-NPV-IRR-DEBATE.xls (313KB)
My spreadsheet is based on Osborne, Michael J., 2010, "A Resolution to the NPV-IRR Debate?," The Quarterly Review of Economics and
Finance, Vol. 50 No. 2, (May), pp. 234--239. I take his examples and make them dynamic here using spinners. This spreadsheet
is one of my favorites. It led me to a dual space solution to a
difficult statistics problem with Mike Osborne as a co-author.
- PE-GREPS-OEX-2019.pdf (74KB) This OLS line of best fit shows that P/E and
forecast g(EPS) are related. So, thinking about P/E as a reflection
of forecast growth rates in EPS is justified. R^2=44% implies correlation 66%. [Details: Plot drawn May 5, 2019 showing
Bloomberg's BEst_PE_RATIO versus BEST_EST_LONG_TERM_GROWTH for the OEX (S&P100)
stocks, where BEST_EST_LONG_TERM_GROWTH is described thus "Long Term Growth Forecasts are received
directly from contributing analysts, they are not calculated by BEst. While different analysts apply different
methodologies, the Long Term Growth Forecast generally represents an expected
annual increase in operating earnings per share over the company's next full business
cycle. In general, these forecasts refer to a period of
between three to five years."]
- P-ever-ITM.xlsm (1,272 KB) Probability that an option ever trades in the money.
Probability that an option is ever in the money. Arguably, because 60% of CBOE option positions are closed out prior to
maturity, an option trader buying an out-of-the-money option cares more about the probability
that an option ever trades in the money than about the probability that it ends its life in the money.
- Q62-Q113-20200610-REVISED.xlsx (Q63 and Q113 from the 6th and 7th Editions of the Q&A Book) Showing that
returns can be positively correlated while prices diverge.(595KB)
- Pricing-NZDX-Bonds-Using-Excel.xlsx How to find the transaction price
for an NZX (NZDX) bond trade using Excel's =PRICE function. I use Excel to price two corporate bond trades on the NZX (NZDX) from March 2023.
I price both bond transactions perfectly, to the penny, accounting for positive accrued interest in the first case, and an ex-coupon period
in the second case. (The latter case is similar to accounting for negative accrued interest.) See also the next spreadsheet.
- Pricing-30-Year-T-Bonds-Macaulay-Duration.xlsx How to find the Macaulay
duration of a 30-year US Treasury bond (T-Bond) using Excel. I use Excel's =DURATION function and the closed-form formula for duration
from Heard on The Street. I perform the calculation for two actual US T-Bonds (CUSIP 912810TN8; CUSIP 912810SN9). You can also vary coupon rate and yield and find the
Macaulay duration of a hypothetical 30-year US T-Bond. See also the previous spreadsheet.
- PUSHING-Z-TO-GET-T.xlsm A demonstration of the relative excess kurtosis of the Student-t distribution.
You can adjust the degrees of freedom of the Student-t and see the pdf compared with a standard normal and a non-standard normal with the same variance.
- Q257-Q320-20200610.xlsx (Q257 and Q320 [6th Edition] or Q285 and Q348 [7th Edition] of the Q&A Book) (56KB)
- Semi-Annual-vs-Annual-Coupon-Bonds-with-same-YTM.pdf Is a semi-annual coupon
bond worth more or less than an annual coupon bond if they have the same maturity and the same quoted YTM? The answer depends solely
upon whether the bonds are premium, par, or discount bonds, as shown in the algebra in the pdf file.
- Shreve-2004-CTSF-Proof PDF (193KB) Steven Shreve (2004)
Stochastic Calculus for Finance II: Continuous-Time Models gives a continuous-time self-financing condition (4.10.15)
that I use here to re-derive the Black-Scholes-Merton PDE. Shreve argues that because the delta is time varying,
there are extra terms in the derivation that Merton overlooks. We use Shreve Corollary 4.6.3 (Ito Product Rule),
and his 4.10.17 and 4.10.18. The end result (the Black-Scholes-Merton PDE) is the same, but the intermediary steps are different and more
detailed.
- TRADING-OPTIONS-VERSUS-TRADING-STOCKS.xlsx (18KB) Following a scenario in the book, stock, levered stock, and call options are compared to each other.
- VCV-INVERTIBLE-DEMO.xls (180KB)
- VCV-INVERTIBLE-DEMO-II-CONSEQUENCES.xls (200KB)
RIGHT click on PDF file names and choose "Save As."
1st, 2nd, and 3rd Edition of FFSI and 1st Edition of Q&A Book
4th or 5th Edition of FFSI and 2nd Edition of Q&A Book
6th-13th Editions of FFSI and 3rd-7th Edition of Q&A Book
Last Updated: April 16, 2024
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