Introduction to Finance Markets, Investments, and Financial Management 16th Edition RONALD W MELICHER Professor of Finance University of Colorado at Boulder EDGAR A NORTON Professor of Finance Illinois State University To my parents, William and Lorraine, and to my wife, Sharon, and our children, Michelle, Sean, and Thor Ronald W Melicher To my best friend and wife, Becky; our son Matthew and his wife, Angie; our daughter Amy and her husband, Jake Edgar A Norton EDITORIAL DIRECTOR EDITORIAL MANAGER SENIOR PRODUCTION EDITOR SENIOR CONTENT MANAGER DESIGNER ACQUISITIONS EDITOR DEVELOPMENT EDITOR EDITORIAL ASSISTANT DIRECTOR OF MARKETING MARKETING MANAGER MARKETING ASSISTANT PRODUCT DESIGNER Michael McDonald Karen Staudinger Suzie Pfister Dorothy Sinclair Thomas Nery Emily McGee Courtney Jordan Anna Durkin Kevin Witt Lauren Harrell Ashley Migliaro Matthew Origoni This book was set in 10/12 Stix by Aptara Corp and printed and bound by LSI This book is printed on acid free paper ∞ Founded in 1807, John Wiley & Sons, Inc has been a valued source of knowledge and understanding for more than 200 years, helping people around the world meet their needs and fulfill their aspirations Our company is built on a foundation of principles that include responsibility to the communities we serve and where we live and work In 2008, we launched a Corporate Citizenship Initiative, a global effort to address the environmental, social, economic, and ethical challenges we face in our business Among the issues we are addressing are carbon impact, paper specifications and procurement, ethical conduct within our business and among our vendors, and community and charitable support For more information, please visit our website: www.wiley.com/go/citizenship Copyright © 2017 John Wiley & Sons, Inc All rights reserved No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978)750-8400, fax (978)750-4470 or on the web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, (201)748-6011, fax (201)748-6008, or online at http://www.wiley.com/go/permissions EPUB: 978-1-119-32111-8 The inside back cover will contain printing identification and country of origin if omitted from this page In addition, if the ISBN on the back cover differs from the ISBN on this page, the one on the back cover is correct Printed in the United States of America 10 Preface The sixteenth edition of Introduction to Finance: Markets, Investments, and Financial Management builds upon the successes of its earlier editions while maintaining fresh and upto-date coverage of the field of finance This edition introduces several new electronic features to assist with student access to the textbook and with learning Our text is designed to present a more-balanced first course in finance, one that offers students perspectives on financial markets, investing, and financial management We use a successful pedagogy that reviews, first, markets and institutions; then, the world of investments; and finally, the concepts and applications of business financial management Unlike other textbooks with a singular “corporate finance” focus, our text offers a balanced first course in finance Eighteen chapters cover the three major financial areas involving the financial system, investments, and business finance For the student who does not plan to take additional courses in finance, this book provides a valuable overview of the discipline’s major concepts For the student who wants to take additional courses in finance, the overview presented provides a solid foundation upon which future courses can build Introduction to Finance is meant to be used in a course whose purpose is to survey the foundations of the finance discipline As such, it is designed to meet the needs of students in various programs Specifically, Introduction to Finance can be used in any of the following four ways: As the first course in finance at a college or university where the department wants to expose students to a broad foundational survey of the discipline As the first and only course in finance for nonfinance business students As an appropriate text to use at a school that seeks to provide liberal arts majors with a business minor or business concentration The writing level is appropriate to provide students with a good foundation in the basics of our discipline As a “lower division” service course whose goal is to attract freshmen and sophomores to business and to attract them to become finance majors The philosophy behind the book is threefold First, we believe that a basic understanding of the complex world of finance should begin with a survey course that covers an introduction to financial markets, investments, and financial management or business finance Students can gain an integrated perspective of the interrelationships among these three areas They will appreciate how businesses and individuals are affected by markets and institutions, as well as of how markets and institutions can be used to meet the goals of individuals or firms Given the events in the financial markets and the economy in 2007–2009 and the financial implications of the United Kingdom’s 2016 decision to withdraw from the European Union (known as “Brexit”), this integrated perspective adds value to student learning and an understanding of the field Second, we wrote the book as an introductory survey of finance with a readable and user-friendly focus in mind We seek to convey basic knowledge, concepts, and terms that will serve the nonfinance major into the future and that will form a foundation upon which the finance major can build Some finer points, discussions of theory, and complicated topics are reserved for “Learning Extensions” in selected chapters We aim to make students using our text financially literate and cognizant of the richness of finance The book provides a good foundation for students to build upon in later courses in financial management, investments, or financial markets Third, we focus on the practice of finance in the settings of markets, investments, and financial management We focus on the descriptive in each of these fields We don’t want students to be unable to see the forest of finance because the trees of quantitative methods obscure their view or scare them away When we introduce equations and mathematical concepts that are applicable to finance, we will show step-by-step solutions By learning about markets (including gaining knowledge about institutions), investments, and management as the three major strands of finance, students will finish their course with a greater understanding of how these three fields interrelate Financial markets will be seen as the arena to which businesses and financial institutions go to raise funds, and as the mechanism through which individuals can invest their savings to meet their future goals The topic of investments is important in facilitating the savings–investment process Understanding the trade-off of risk and return, as well as the valuation of bonds and stocks, is essential to investors and businesses raising financial capital Understanding how securities markets work is equally important Financial management uses information it obtains from securities and other financial markets to efficiently and profitably manage assets and to raise needed funds in a cost-efficient manner A broad exposure to the discipline of finance will meet the needs of nonmajors who should know the basics of finance so they can read the The Wall Street Journal, visit businessrelated Internet sites, and analyze other business information sources intelligently It will help the nonfinance major work as a member of a cross-functional work team, a team that will include finance professionals In addition, this overview of finance will start the finance major off on the right foot Rather than receiving a compartmentalized idea of finance—often viewed through the corporate finance lens that many texts use—the finance major will receive a practical introduction to the different disciplines of finance, and will better appreciate the relationships among them Part of the book contains six chapters on the financial system, with primary emphasis on financial markets and the tools and skills necessary to better understand how such markets work We begin with an overview of the three main subfields iv PRE FACE of finance, identify the “six principles of finance,” and discuss career opportunities The principles of finance are the following: Money has a time value Higher returns are expected for taking on more risk Diversifying one’s investments can reduce risk Financial markets are efficient in pricing securities The objectives of managers and stockholders may differ Reputation matters We discuss finance and the role and functions of the financial system to a nation’s economy The role of banks, other financial intermediaries, and the Federal Reserve are reviewed, as are their functions in the financial system Part introduces the international role of finance and how modern economies are affected by exchange rates, trade, and the flow of global funds Following this introduction to the financial system, Part focuses on investments We review the role of savings in an economy and the ways in which funds flow to and from different sectors Interest rates are introduced, and the discussion centers on making the student aware of the different influences on interest rate levels and why the rates change over time Because interest rates measure the cost of moving money across time, this section reviews basic time-value-of-money concepts with many worked-out examples, including the keystrokes that students can use when working with financial calculators Next, after reviewing the characteristics of bonds and stocks, students will learn to apply time-value-of-money concepts to find the prices of these securities Continuing our overview of investments, we discuss investment banking basics and the operations of securities markets, as well as the fundamentals of investment risks and returns, to conclude Part Advanced classes may want to review the financial derivatives basics, which are explained in a Learning Extension of Chapter 11’s discussion of securities and markets The raising of funds by businesses in the institutional and market environments is covered in Parts and Next, in Part 3, the final six chapters of the text introduce students to financial management The discussion begins with the different ways in which to organize a business, and the financial implications of each organizational form We introduce accounting concepts, such as the balance sheet, income statement, and statement of cash flows, with simple examples We discuss financial ratios, which assist in the process of analyzing a firm’s strengths and weaknesses We review their use as a means of helping managers plan ahead for future asset and financing needs Strategies for managing a firm’s current assets and current liabilities are examined, as are the funding sources firms use to tap the financial markets for short-term financing Finally, we introduce students to capital budgeting basics and capital structure concepts New and Improved Many new pedagogical features are included in the textbook, including the following: • An e-book format for electronic and “cloud” access to the textbook and related learning material A black-and-white, binder-ready version is available as well for those preferring a paper copy • Coordinated chapter learning objectives, chapter summaries, and end-of-chapter review questions Each chapter learning objective is numbered; the expanded chapter summaries review each individual learning objective and each review question is keyed to a specific learning objective number • Every chapter contains or Discussion Questions that can be used in class, assigned to students, or used by the instructor on learning management systems such as Blackboard, Moodle, Sakai, and others to form the basis of graded or ungraded class participation and critical thinking • The e-book version presents, at the end of each section (corresponding to each learning objective) several multiple choice questions for students to use as a review of chapter concepts • Some of the tables, charts, and graphics include interactive features that allow students to sort, categorize, or focus on a single graph feature at a time as it changes values over time Other downloadable spreadsheets allow students to practice some of the chapter’s calculations • Excel templates have been updated and revised to reflect the book’s content • Existing test bank items were re-examined and new questions added to reflect the many content changes and to better test student knowledge The content of Introduction to Finance has been updated to incorporate many of the economic and financial events of the past few years The financial crisis of 2007–2008, the subsequent recession and recovery—along with the behavior of the Federal Reserve and securities markets—provide a means to highlight causes, effects, and the integration of finance into our everyday lives, as well as the implications for markets, investments, and business finance A financial crisis colored label, denoting a “Focus Point,” is placed next to relevant text material We continue with our innovation found in previous editions, featuring a real firm (Walgreens, the retail drugstore chain) in many of the chapters on investments and financial management as a means of presenting and analyzing data In addition to these broad improvements, all chapters have been updated and revised to reflect recent events and data Specific notable changes in this sixteenth edition include the following: Chapter 1, The Financial Environment, provides an overview of the financial system and environment including economic and financial developments during the 2007–2008 financial crisis and the 2008–2009 Great Recession The chapter has been reorganized with “careers in finance” being presented near the end of the chapter after students have been introduced to basic finance terms and concepts Chapter 2, Money and the Monetary System, discusses the process of moving savings into investments and provides an overview of the monetary system While physical money P REFAC E (coin and paper currency) in the United States continues to be our focus, we recognize possible growth in the use of digital currencies including bitcoin The relationship between money supply and economic activity is discussed in light of continued easy monetary policies Chapter 3, Banks and Other Financial Institutions, covers the types and roles of financial institutions During the 2007–09 period, falling housing prices, mortgage loan defaults, and declining values on mortgage-backed securities that resulted in many financial institutions not having adequate equity capital to continue to operate, and, thus, needing to merge or be “bailed out.” The ability of banks to maintain sound balance sheets, including adequate capital ratios, continues to be of concern to regulators, politicians, and others Chapter 4, Federal Reserve System, describes the current structure and operations of the Federal Reserve (the Fed) The Fed’s response to the recent financial crisis and economic downturn as well as its efforts to stimulate economic growth through quantitative easing and other means is covered The Fed used quantitative easing, among other things, to stimulate economic growth and is finding it difficult to move towards more-traditional interest rate levels Janet Yellen, the current chair of the Fed’s board of governors, is faced with the difficult task of simultaneously maintaining economic growth raising interest rates that are near zero Chapter 5, Policy Makers and the Money Supply, describes how the four policy maker groups (Federal Reserve System, the president, Congress, and the U.S Treasury) are responsible for carrying out the national economic policy objectives of economic growth, high employment, and price stability We cover the U.S government’s response to the perfect financial storm involving the financial crisis and the subsequent Great Recession New material on the current size of the national debt and the efforts of the U.S Treasury to manage the national debt are presented Chapter 6, International Finance and Trade, covers the evolution of the international monetary system and efforts by European countries to achieve unification, although the recent decision by the United Kingdom to withdraw from the European Union has caused concern about the future economic and financial viability of the European Union Material on currency exchange rates and the factors that affect currency exchange rates have been substantially rewritten We discuss the use of hedging, forward contracts, and forward rates in the section that covers managing currency exchange risk We also have added a Learning Extension that discusses the use of forward contracts in international business transactions Chapter 7, Savings and Investment Process, discusses the relationship between gross domestic product and capital formation, and covers the major sources of income and outlays involved in the annual federal budget Recent data on personal and corporate savings are presented and discussed The role played by individuals in the 2007–09 financial crisis and the Great Recession is also covered v Chapter 8, Interest Rates, discusses the supply and demand for loanable funds and the components of market interest rates This chapter was substantially rewritten and uses current interest rates when examining interest rates The relationship between interest rates and the maturity of comparable-quality debt remains at historically low levels and is due, in part, to the Fed’s easy monetary policy Recent default risk premium levels are also presented and discussed Chapter 9, Time Value of Money, conveys the importance of compounding (earning interest on interest) in building wealth over time We continue to present examples of how to perform time value calculations using formulas, interest factor tables, step-by-step financial calculator keystrokes, and Excel spreadsheets While historically low interest rates make it attractive to finance the purchase of homes and other durable goods, low rates also make it difficult for individuals to build wealth over time Chapter 10, Bond and Stocks: Characteristics and Valuations, has its bond valuation section rewritten to use the “annual percentage rate” (APR) approach as opposed to the “effective interest rate” (EAR) approach The chapter contains updated data and improved discussions of bonds and stocks We have revised the discussion of the risks facing investors in the low interest rate environment sustained by the Fed since the Great Recession Spreadsheet examples show how to apply time value concepts to calculate bond prices and stock prices Chapter 11, Securities and Markets, incorporates changes in securities trading, including high-frequency trading and events such as the New York Stock Exchange and Intercontinental Exchange (NYSE–ICE) merger, as well as an overview of the Facebook initial public offering (IPO) and some of its issues This chapter’s Learning Extension on futures and options has been revised to reflect reviewer suggestions Chapter 12, Financial Returns and Risk Concepts, is one of the more mathematical chapters; it shows how to calculations with step-by-step calculator keystrokes and spreadsheet functions Its content is updated, especially evidence regarding the difficulty in “beating the market” by active investors Chapter 13, Business Organization and Financial Data, features data from Walgreens’ financial statements, with highlights about the merger with Boots Alliance We maintain that a firm’s goal is to maximize shareholder wealth, and we discuss “sustainability” in light of this goal Chapter 14, Financial Analysis and Long-Term Financial Planning, uses updated data from Walgreens and the retail drugstore industry in a practical example of financial ratio analysis using industry averages We focus on changes in Walgreens’ financial ratios following its merger with Boots Alliance to form Walgreens Boots Alliance Chapter 15, Managing Working Capital, expands the discussion of managing cash in a difficult business environment with low interest rates We discuss a new reason why firms hold large amounts of cash, with the tax cost of repatriating the funds back to the home country vi PRE FACE Chapter 16, Short-Term Business Financing, contains information on real firms’ working capital financing strategies and on the implications of the financial crisis on a firm’s ability to obtain short-term financing, including the role of “supply chain financing” by some banks and suppliers We include a section on the American Energy and Infrastructure Jobs Act of 2012 (JOBS Act of 2012), a tool to help small firms obtain financing, including the use of “crowdfunding.” Chapter 17, Capital Budgeting Analysis, relates the cash flow estimation process for a project to the firm’s statement of cash flows found in Chapter 13 and reviews standard capital budgeting analysis tools, such as net present value (NPV), internal rate of return (IRR), profitability index (PI), and modified internal rate of return (MIRR) Chapter 18, Capital Structure and the Cost of Capital, contains updated discussions of trends in the use of debt by corporations and the use of debt financing in the low interest rate environment that has existed since the Great Recession We include information of how managers compute capital costs from the Cost of Capital Survey issued by the Association of Finance Professionals Spreadsheet Illustrations: We show how to use spreadsheets to solve problems, and to teach students about the power of spreadsheet functions and analysis Boxed Features: Throughout the book, boxes are used to focus on current topics or applications of interest They are designed to illustrate concepts and practices in the dynamic field of finance • Small Business Practice boxes highlight aspects of the chapter topics relating directly to small businesses and entrepreneurship • Career Opportunities in Finance boxes provide information about various careers in finance and appear in many chapters • Personal Financial Planning boxes provide insight into how the chapter’s content can be applied to an individual’s finances Learning Extensions: Chapter appendixes, called Learning Extensions, are included in many chapters Learning Extensions provide additional in-depth coverage of topics related to their respective chapters, and many challenge students to use their mathematical skills End-of-Chapter Materials: Each chapter provides the Learning and Teaching Aids The sixteenth edition of Introduction to Finance offers the following aids for students and instructors: Chapter Openers: Each chapter begins with the following: • Chapter Learning Objectives, which students can use to review the chapter’s main points and which instructors can use as a basis for in-class lecture or discussion; • Where We Have Been statements that remind students of what was covered in the previous chapters; • Where We Are Going, which are previews of chapters to come; • How This Chapter Applies To Me that explain how the content of the chapter, no matter how technical or business specific, has applications to the individual student Applying Finance To: These boxes show how the topic of each chapter relates to the finance fields of institutions and markets, investments, and financial management Learning Activities: We direct the student to relevant websites at different points in each chapter Margin Definitions: Margin definitions of key terms are provided to assist students in learning the language of finance Focus Icons: Icons are placed by relevant text to indicate discussions of finance principles, implications of the recent financial crisis, financial or business ethical issues, and global or international discussions following: • Review Questions, keyed to specific chapter learning objectives that review chapter material • Exercises for students to solve and exercise their mathematical skills • Problems that are more difficult and that should be solved by using spreadsheets Downloadable templates are available for each problem Companion Website: The text’s website at www.wiley com/college/melicher contains a myriad of resources and links to aid learning and teaching Instructor’s Manual and Test Bank: The Instructor’s Manual is available to adopters of this text It features detailed chapter outlines, lecture tips, and answers to end-of-chapter review questions and problems Computerized Test Bank: There is a test bank for the text A Test-Generating Program that allows instructors to customize their exams also is provided Powerpoint Presentations: Created by the authors, a PowerPoint presentation is provided for each chapter of the text Slides include outline notes on the chapter, additional presentation topics, and figures and tables from the text Spreadsheet Templates: Excel-compatible templates, developed by Robert Ritchey of Texas Tech University, are available on the text website Students can use the financial analysis tools worksheets and templates to help apply what they’ve learned in the text and solve some of the end-of-chapter problems and challenge problems P REFAC E vii Acknowledgments We would like to thank the Wiley Publishing team of Acquisitions Editor, Emily McGee, Senior Production Editor, Suzie Pfister, Development Editor, Courtney Jordan, and Product Designer, Matthew Origoni for their role in preparing and publishing the sixteenth edition of Introduction to Finance In addition, we are especially grateful to the reviewers for their comments and constructive criticisms of this and previous editions: Saul W Adelman, Miami University, Ohio Tim Alzheimer, Montana State University Allan Blair, Palm Beach Atlantic College Stewart Bonem, Cincinnati State Technical and Community College Linda K Brown, St Ambrose University Joseph M Byers, Community College of Allegheny County, South Campus Robert L Chapman, Orlando College William Chittenden, Texas State University Sara J Conroy, Community College of Allegheny County Will Crittendon, Bronx Community College David R Durst, University of Akron Sharon H Garrison, Florida Atlantic University Asim Ghosh, Saint Joseph’s University Stephen S Gray, Western Illinois University Lester Hadsell, University of Albany Irene M Hammerbacher, Iona College Kim Hansen, Mid-State Technical College Jeff Hines, Davenport College Jeff Jewell, Lipscomb University Lisa Johnson, Centura College Ed Krohn, Miami Dade Community College Jessica Lancaster, McCann School of Business and Technology P John Limberopoulos, University of Colorado Boulder Leslie Mathis, University of Memphis Michael B McDonald, Fairfield University John K Mullen, Clarkson University Michael Murray, Winona State University Napoleon Overton, University of Memphis Michael Owen, Montana State University Marco Pagani, San Jose State University Jason Powers, Strayer University Barbara L Purvis, Centura College Alan Questell, Richmond Community College Ernest Scarbrough, Arizona State University Raymond Shovlain, St Ambrose University Amir Tavakkol, Kansas State University Jim Washam, Arkansas State University Howard Whitney, Franklin University Lawrence Wolken, Texas A&M University K Matthew Wong, St John’s University David Zalewski, Providence College Likewise, we appreciate the comments from students and teachers, who have used previous editions, and the assistance from the dozens of reviewers, who have commented about the early editions Special recognition goes to Carl Dauten, who coauthored the first four editions, and Merle Welshans, who was a coauthor on the first nine editions of the book Finally, and perhaps most importantly, we wish to thank our families for their understanding and support during the writing of the sixteenth edition RONALD W MELICHER, Boulder, Colorado EDGAR A NORTON, Normal, Illinois Author Bios RON M ELIC H ER is professor emeritus of finance and previously served three different terms as chair of the Finance Division, Leeds School of Business, University of Colorado, Boulder He is a past president of the Financial Management Association Ron earned undergraduate, M.B.A., and doctoral degrees from Washington University in St Louis, Missouri While at the University of Colorado, he received several distinguished teaching awards and was designated a university-wide President’s Teaching Scholar Ron has taught corporate finance and financial strategy and valuation in M.B.A and Executive M.B.A programs in addition to entrepreneurial finance and investment banking to undergraduate students He also has taught financial management materials in executive education courses and in in-house corporate programs His research has been published in major finance journals, including the Journal of Finance, Journal of Financial and Quantitative Analysis, and Financial Management He is also the coauthor of Entrepreneurial Finance, fifth edition (Cengage Learning, 2015) viii E D GA R A NORT ON is professor of finance and director of the Institute for Financial Planning and Analysis in the College of Business at Illinois State University He holds a double major in computer science and economics from Rensselaer Polytechnic Institute and received his M.S and Ph.D from the University of Illinois at Urbana–Champaign A Chartered Financial Analyst (CFA), he regularly receives certificates of achievement in the field of investments He has consulted with COUNTRY Financial, Maersk, and the CFA Institute; does pro bono financial planning; and is a past president of the Midwest Finance Association His research has appeared in numerous journals, such as Financial Review, Journal of Business Venturing, and Journal of Business Ethics He has coauthored four textbooks, including Introduction to Finance 622 INDEX Consumer finance companies, loans (provision), 51 Consumer Leasing Act, 94f Consumer Price Index (CPI), 209f Consumer price index (CPI), exclusion, 209 Consumption spending, GDP proportion, 288 Contractual savings defined, 175 Contractual savings organization careers, 16 defined, 47–48 role of, 48–50, 59f Contribution margin, defined, 446 Controller, defined, 409 Control of the firm, 593 Control phase, 546 Conversion ratio, defined, 263 Conversion value, defined, 263 Convertible bond, defined, 263 Convertible preferred stock, defined, 269 Corporate bond default risk premium (DRP), 213t defined, 182 yields, 577f statistical data, 577t Corporate debt GDP percentage, 568f markets, orientation, 257 Corporate equity capital, 266–270 defined, 266 Corporate governance, 405–409 agency problems, reduction, 407–409 principal-agent problem, 406–407 Corporate responsibilities, enhancement, 408 Corporate rtention rate, 176 Corporate savings, 176–177 Corporate stockholders, advantages, 387 Corporate tax rate, changes, 112 Corporations, 384, 387–388 defined, 387 equity securities, classes, 266 financial instruments/securities, issuance, 181–182 life stages, 180–181 profits, production, 176 savings process, 176–177 security analyst study, 408–409 taxable income, payment (example), 418–419 Correlation, defined, 360 Cost analyst, career, 16 Cost of capital, 569–574 business use, 576–578 calculations, current data (usage), 577 defined, 528, 566 requirement, 569–570 Cost of common equity, 572–573 Cost of debt, 571 Cost of going public, 308–311 Cost of goods sold (COGS), 392 increase, 460–461 sales increase, impact, 462t usage, 459 Cost of new common stock, 573–574 Cost of preferred stock, 572 Cost of retained earnings constant dividend growth model, 572–573 security market line (SML) approach, 572–573 Cost-push inflation, defined, 210 Cost-saving project, cash flow estimation, 558–561 total outlays, 559t Cost-volume-profit analysis, 445–446 defined, 445 Cost-volume-profit relationships, 446f Council of Economic Advisors (CEA), fiscal policy formulation, 107 Countries, initial returns, 309t Coupon interest, impact, 281 Covenants, defined, 257 Credibility, issue, 386 Credit analysis, 479 Credit analyst, career, 16 Credit bureaus, defined, 479 Credit cards, defined, 37 Credit (default) risk, defined, 68 Credit money, defined, 32 Credit policy, change (analysis), 482t Credit ratings, 184 defined, 184 Credit-reporting agencies, 479–480 Credit risk (default risk) absence, 281–282 annual spreads, 281f defined, 65, 281 impact, 281–282 spreads, fluctuation, 281 Credit scores, 184 defined, 184 Credit terms, 481–482 Credit transfer, 97 Credit union defined, 49 saving with, 56 Cross-sectional analysis, defined, 424 Crowdfunding, 503 Crowding out, defined, 113 Cumulative preferred stock, defined, 268 Currency anti-counterfeiting efforts, 32 counterfeiting, 31–32 debasing (Greek city-states), 207 demand, changes, 121–122 design changes, 31, 31f floating, 39, 40 flow, 121 index, U.S dollar value (relationship), 143f payments mechanism, 95–97 Currency appreciation, 137 Currency depreciation, 137 Currency exchange markets defined, 135 exchange rate determination, 139f Currency exchange rate, 136 appreciation/depreciation, 137–138 defined, 40, 136 factors, 138–142 Currency exchange rate risk, defined, 143–144 Current account, defined, 152 Current account balance, defined, 152 Current assets components, 492 composition, change, 467f defined, 395 fixed assets, mixture, 495–496 management, 468–476 partial financing, 491f Current assets to total assets ratio, 456f Current liabilities amounts owed, 396 defining, 395 Current liabilities to total assets ratio, 496f Current price/par value, difference (straightline amortization), 280 Current ratio, calculation, 427 CV See Coefficient of variation Cyclical variations, impact, 498 D DaimlerChrysler, 361 Dartmouth College v Woodward (Supreme Court decision), 387 DCF See Discounted cash flow Dealer, defined, 312 Dealer system, defined, 200 Debenture bonds, defined, 262 Debit cards, defined, 33 Debt after-tax cost, calculation, 571 concentration, 202 corporate use, trends, 567–568 cost, 571 financing, 172–173 issuance, 181 management, 113–114 defined, 113 management’s attitude toward, 593 monetization, defined, 107 national, defined, 113 obligations, risk-free securities, 198–203 ratios example, 584f WACC, differences, 589f rollover, 494 securities, maturity distribution, 202–203 variations, 592 Debt securities, defined, 15 Default rate, 183 Default risk (credit risk), 68, 212, 281–282 defined, 281 Default risk premium (DRP), 212–214, 218 defined, 197 demand, 281 Defensive activities, defined, 86 Deficit economic unit, defined, 23 Deficit financing defined, 113 effects, 113–114 Deficits budget, 171 powers, 110–112 reserves, defined, 121 U.S operation, 169 Degree of combined leverage (DCL) defined, 586 equation, example, 586–587 INDEX Degree of financial leverage (DFL), defined, 586 Degree of operating leverage (DOL), 446–448 calculation, 587 defined, 447 Delivery float, 476 Demand, supply (relationship), 138–139 Demand deposits, 32 checking accounts, 36 impact, 122 Demand-pull inflation, 210–211 defined, 210 Dent, Jr., Harry, 179 Deposit insurance, existence, 61 Deposit money, defined, 32–33 Depositors, funds (protection), 59 Depository financial institutions, careers, 16 Depository institutions cash/balances due, 63–64 defined, 47 deposits, expansion, 195 deregulation, 57–59 transactions, 122–123 Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA), 57, 88 Deposits, 66 acceptance, 53 contraction, 115, 120–121 creation, 115–116 expansion, 115, 195 FSLIC insurance, 60 multiple expansion, 20 percent reserve ratio, 119t offsetting/limiting factors, 119–120 Depreciation basics, 419–421 capital consumption adjustment, defined, 176 defined, 395 expense, impact, 545 methods, 420–421 noncash expense, 543 tax shield, 545–546 defined, 546 value reduction, 392 Derivative deposit, 115 defined, 115 Derivatives, existence (reasons), 334–335 Derivative securities defined, 182, 334 markets, defined, 15 Derivative securities markets, defined, 15 Designated market makers (DMMs), 320 defined, 315 Development capital, flow (impact), 174 Development stage, defined, 524 Deviations, defined, 345 Digital currency, defined, 40 Direct quotation method, defined, 136 Disbursement float, 476 components, reduction methods, 478t Discount bond, defined, 279 Discount brokerages, usage, 324 Discounted cash flow (DCF) managerial flexibility/options, 540 techniques, conflicts, 538–540 Discounted loan, defined, 501 Discounting defined, 225 financial calculator solution, 227 frequency (increase), 241–242 spreadsheet solution, 227–228 table-based solution, 228 usage, 225–228 Discount loan, calculation, 65 Discount operations, open-market operations (differences), 91 Discount rate, 570 defined, 89 net present value (NPV), relationship, 531f policy, intention, 89 Discount rate policy, 89–90 Discount window borrowing, 89 Discretaionary spending, defined, 171 Dispersion, measures, 352 Dissaving, defined, 178 Distribution channels, access (differences), 524 Distribution (normal distribution), 347f Diversification, 358 decision, 359–360 defined, 360 example, 362t Dividend-paying common stock, current price, 284 Dividend payout ratio calculation, 271 defined, 271, 580 Dividend reinvestment plans (DRIPs), defined, 270 Dividends, 270–274 dollar amount, corporate decision, 271–272 growth rates, knowledge, 287 payment strategies, problems, 271–272 timing, 272 policy, 581 DMMs See Designated market makers Documentary draft, defined, 145 Dodd-Frank Wall Street Reform and Consumer Protection Act (2010), 52, 71, 109 defined, 59 Dollar, adoption, 28 Dollar return, calculation, 343–344 Domestic economies, linkage, 151 Double taxation, escape, 388 Dow Jones Industrial Average (DJIA) basis, 324–325 levels change, 320 decrease, 352–353 stocks, 325t Draft (bill of exchange), defined, 145 Drafts acceptance Board of Governors, authorization, 149 example, 149–150 clean draft, 146 collection, bank assistance, 146–147 documentary draft, 145 types, 145–146 623 Drexel Burnham Lambert, bankruptcy, 214 DRP See Default risk premium Dual banking system, defined, 61 Dual-listed stocks, 314 Due diligence, defined, 300 Dun & Bradstreet (D&B), 480, 509 information, 25 DuPont analysis, defined, 440 Dutch auction, defined, 307 Dynamic actions, defined, 86 E Early chartered banks, 55 Earning power, 166, 179 Earnings before income and taxes (EBIT), 585 Earnings per share (EPS), 286, 393 example, 584f EBIT/eps analysis, 582–584 defined, 582 example, 583t EBIT/TA, 583 Economic activity constraint, 204 fiscal policy, impact, 111–112 money supply, relationship, 37–39 restraint, 112 stimulation, legislative efforts (usage), 107 Economic cycles, 179 Economic decisions, making, Economic expansion, 193 development capital, impact, 174 Economic expectations, 178 Economic growth, 98, 104 variability, 141 Economic policy objectives, 106f Economic risk, 141 defined, 141 Economic Stabilization Act of 2008, 112 Economic units, balance, 23 Economic unit savings, 174 Economic value (reduction), depreciation (representation), 392 Economies of scale, 523 Economy cyclical movements, 179 government, impact, 107–108 yield curves, relationship, 205 Effective annual rate (EAR) annual percentage rate (APR), difference, 243 calculation, 501 defined, 243 Effective cost (EC), calculation, 504–505 Efficient capital markets, 355–357 Efficient market (informationally efficient market) defined, 355 price reaction, 355f Electronic check clearing mechanisms, usage, 54 Electronic communications networks (ECNs), 321 Electronic data interchange defined, 477 Electronic exchange rate quotes, usage, 137 Electronic funds transfers (ETFs), 94 624 INDEX Electronic Fund Transfer Act, 94f Electronic payment mechanism, usage, 478 Emergency Economic Stabilization Act of 2008, 109 Emerging growth companies, 503 Employment Act 1946, 103 Employment levels, 104 Enhancement, defined, 541 Entrepreneurial finance, defined, Equal Credit Opportunity Act, 84, 94f Equilibrium exchange rate, 138 Equipment trust certificate, defined, 262 Equity defined, 393 examination, 397 issuance, 181 multiplier, calculation, 433 private placements, 306 variations, 592 Equity capital defined, 387 ratio, calculation, 69–70 Equity securities, defined, 15 Equity securities markets, defined, 15 Estimated spread, 261 Ethical behavior, defined, 10 Ethics, importance, 404–405 Euro, 133 defined, 40, 134 free float, 133 paper currency, design (difficulty), 134 percentage change, calculation, 138 value, decline, 138 Euro-denominated debt investments, debt investment conversion, 139 Eurodollar bonds, defined, 259 Eurodollar deposit liabilities, origin, 473 Eurodollar market, U.S bank entry, 473 Eurodollars, 473 Europe, unification, 133–135 European Central Bank (ECB), 135 bond purchases, 134 defined, 98 European Community (EC), 133 European Economic Community (EEC), 133 European Economic Union, policy makers, 106–107 European Monetary Union (EMU), 106 euro, free float, 133 European Union (EU), 106 defined, 133 financial crises, 134 Eurozone members defined, 134 goods/services, demand (increase), 139 Ex ante, defined, 350 Excel built-in financial functions, 223 NPER financial function, usage, 238 Excess reserves, defined, 87, 121 Exchage rate movements, 160–161 Exchange rate risk, 349 defined, 283, 349 Exchange rate risks, global business, 158–161 Exchange rates behavior, impact, 288 developments, 142–143 large-scale arbitrage activities, impact, 141 quotations, 136–137 Exchange rate system fixed exchange rate system, 132–133 flexible exchange rate system, 133 Exchanges, competition, 322 Exercise price (strike price), defined, 336 Expectations theory, defined, 205 Expected cash disbursements, 465 Expected future cash flows, present value, 284 Expected rate of return, calculation, 359 Expected return calculation, 352–353 expected risk, trade-off, 364 Exporter bank, financing, 147 borrowing amount, 147 financing, 147 Export-Import Bank, 150 defined, 150 Extendable notes, defined, 264 Extensible markup language (XML), usage, 484 External financing requirements, 444–445 External funds, amount (requirement), 444 ExxonMobil, stock price (changes), 577, 578f F Facebook IPO, 303–306 lock up provisions, 304–305 road show, 304 Face value (par value), defined, 255, 267 Factor, defined, 508 Factoring, usage, 509–511 Fair Credit Billing Act, 94f Fair Credit Reporting Act, 94f Fallen angels, 259 Family business/venture, 194, 386 FCPA See Foreign Corrupt Practices Act Federal budget defined, 107, 171 powers, 110–112 Federal debt functioning, 171 management, 108 Federal Deposit Insurance Corporation (FDIC), 71, 93 creation, 60 Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), 60 Federal funds, 471–472 defined, 35 example, 472t rates, 472f defined, 92 Federal government dollar (fiscal year 2011), 172f receipts/expenditures, 171–173 tax revenue reliance, 171 Federal Home Loan Bank Board (FHLBB), 60 Federal Home Loan Mortgage Corporation (FHLMC) (Freddie Mac), 108 creation, 184 defined, 78 Federal income taxation, 417–419 Federal National Mortgage Association (FNMA) (Fannie Mae), 108 creation, 185 defined, 78 Federal obligations, tax status, 200 Federal Open Market Committee (FOMC), 84, 90, 92, 93 liquidity, provision, 92 Federal Reserve Act of 1913, 30, 57 compromise, 80 Federal Reserve Bank of New York, year-end interest rates, 91 Federal Reserve Note See also United States changes, 31 Federal Reserve System (Fed), 12, 13, 105 advisory committees, 80, 81f, 84 Board of Governors, 82f chair, role, 83, 84–86 defined, 83 draft acceptance authorization, 149 branch banks, 83 check clearance, 96 characteristics, 77–78 components, 80 consumer, relationship, 94 consumer protection responsibilities, 94f defined, 77 discount rate, defined, 89 district banks, 80, 82–83 directors/officers, 82–83 districts, check clearance, 93–94 establishment, 57 float, 123–124 impact, 115 lending rate, bank prime rate changes (differences), 90f map, 82f notes, circulation, 122 open-market operations, 224 operations, public discussions, 86 organization, 81f policy instruments, 87 problems, 100–101 quantitative easing, 224 Regulation Q, 57 regulatory responsibilities, 94 reserve requirements, 61 service functions, 95–99 structure, 80–86 supervisory/regulatory functions, 93–94 supervisory responsibilities, 93–94 transactions, 122–124, 122f U.S banking system, 77–78 Federal Savings and Loan Insurance Corporation (FSLIC), deposits (insuring), 60 Federal statutory debt limits, defined, 173 Federal Trade Commission Improvement Act, 94f Fiat money, 132 defined, 30 paper currency, 30 usage, reliance, 31 Fiat U.S paper currency, example, 30f Field warehouse, defined, 513 INDEX Finance areas, 148 careers, 16–18 opportunities, 17, 120 defined, distinctions/separations, examination, 3–6 organization chart, 409–411 principles, 8–11 study areas, 1–2 plan, 18 reasons, 6–7 themes, 5–6 Finance companies, defined, 51 Finance firms defined, 48, 51 role of, 51 Financial account, defined, 152 Financial Accounting Standards Board (FASB), 389 Financial advisor, career, 353 Financial analysis DuPont system, 441f Financial analyst, career, 16 Financial assets defined, 26, 253 demand, change, 139 historical return/risk, 343–345 marketing, 13–14 short-term accumulation, 177 transfer, 14 Financial calculators, programming, 221–222 Financial contracts, 225 Financial crisis (2007–2008), 6, 22–23, 71 borrowing-related cultural shift, 185–186 development, 143 examination, 185–186 factors, 185 financial institution distress, 46–47 U.S central bank response, 77–78 Financial crisis-related activities, 112 Financial environment, 3–20 defined, elements of, illustration, 5f valuation, relationship, 287–289 Financial flexibility, 593 Financial goals, 383 Financial Industry Regulatory Authority (FINRA), formation, 321 Financial institutions career opportunities, 66 defined, distress, 46–47 economies, markets, and, financial system and, 12 roles, 47–51 types, 47–51, 48f Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), passage, 60 Financial intermediation, defined, 47 Financial leverage ratios, 425, 432 analysis, 432–435 defined, 432 Financial management careers, 16 Financial markets characteristics, 14–16 conditions, 593 defined, information efficient characteristic, interest rate determination, 192f securities pricing efficiency, finance principle, 8, types, 15–16 Financial officers, compensation, 409–410 Financial planner assistant, career, 17 career, 353 Financial plans, strategy (linkage), 404 Financial ratios, types, 425 Financial return and risk concepts Financial risk defined, 350 effects, 585t Financial statements, 399–401 analysis, 423–424 automobile bailout, relationship, 400–401 provision, 391 Financial storm, government reaction, 108–109 Financial system characteristics, 11–12 collapse, Fed avoidance, 204 components, 12–14, 12f defined, 11 financial assets marketing, 13–14 transfer, 14 financial functions, 12–14, 12f graphic view, 11f money creation, 13 transfer, 13 overview, 12–14 requirements, 11–12 savings accumulation, 13 lending/investing, 13 Financing See also Internally generated financing activities, cash flows, 544 approaches, 493–494 attraction/acquisition, 383 costs, weighted average, 570 exporter, usage, 147 exporter bank, usage, 147 importer bank, usage, 147–148 example, 148–149 mix, sales trend (impact), 497–498 net percent, 254f requirements (See External financing requirements) short-term sources, 469 sources, 573 cost, 272 strategies example, 493f guidelines, 592–593 625 Firm assets, 590–591 commitment underwriting, flowchart, 301f control of, 593 delaying tactics, 407 financial strategy, execution, 404 financing policy, 590–591 goals, 402–405 income statement, risk sources, 349t owner/managers, 404 receivables, examination, 508–509 size/age, impact, 496 value, example, 584f Firm-specific risk, 363, 364t First Bank of the United States, 55 First USA Inc., Merrill Lynch ownership, 303 Fiscal policy defined, 105 determination, 171–172 economic effects, 111–112 formulation, 107 impact, 111 makers, 171–172 stimulation, 185 Fixed assets current assets, mixture, 495–496 explanation, 395 management, 522 partial financing, 492f turnover, 429–430 Fixed assets turnover ratio, 429 Fixed capital, consumption, 170t Fixed charged coverage, calculation, 434–435 Fixed costs, 585 Fixed-rate mortgages defined, 183 holders, benefits, 183 Flexible exchange rate, 151 defined, 133 system (1973-present), 133 Float defined, 476 processing, 484 types, 476–477 Floor brokers, 315 Flotation, defined, 299 Flotation costs, defined, 308, 573 Follow-up stage, defined, 524 Ford, Gerald, 85 Ford Motor Company balance sheet, 401t common stock, 260–261 insolvency, 401 Foreign assets, U.S government ownership, 150 Foreign central banks, deposit levels (change), 124 Foreign Corrupt Practices Act (FCPA), 144, 145 Foreign Credit Insurance Association (FCIA), credit insurance policies provision, 135 Foreign currency, change (calculation), 138 Foreign customers, finding, 135 626 INDEX Foreign exchange (FOREX) crossrates, 137t currencies, 169 markets, defined, 16, 135 rates, examples, 136t risk, management, 143–144 Foreign exchange markets, 135–136 Foreign firms, preferred stock issuance, 268–269 Foreign ownership changes, 152–153 increase (public debt securities), 200–201 Foreign securities, 326–327 Foreign stocks, SEC registration, 326 Foreign systems, international banking, 71–72 Forward contract, 144 Forward exchange rate, defined, 144 Forward rate (FR), defined, 144 Fourth market, defined, 321 Fractional reserve system, defined, 87, 115 Fraudulent behavior, examples, 10 Free cash flow, increase, 181 French Revolution, inflation, 208 Front running, occurrence, 316 Full-bodied money, 132 defined, 28 Full-bodied U.S coins, examples, 29f Full Employment and Balanced Growth Act of 1978, 103 Funds transfer, electronic methods, 33 Future cash flows (future CF), 274 Future dividends, knowledge, 287 Futures, 335–336 contracts, 335 defined, 335 U.S exchanges, 335t Future value (FV) See also Annuity calculation/computation, 220–221, 535–536 defined, 220 determination, compounding (usage), 221–225 equating, 228–229 interest rate/time period, relationship, 224f spreadsheet solution, 222–224 table-based solution, 223 Future value interest factor (FVIF) example, 224t value, location, 232 Future value interest factor of an annuity (FVIFA), example, 234t Future value of an annuity due (FVAD), 248–249 Future value of an annuity (FVA), 232–235 Future value of an ordinary annuity (FVA), calculation, 233 G Garn-St Germain Depository Institutions Act of 1982, 58 GDR See Global depository receipt Generally accepted accounting principles (GAAP) defined, 389 home country accounting standards, differences, 390t General Motors (GM) balance sheet, 400t common stocks, classes, 267–268 profitability, 401 General partnership, liability risks, 387 Generation waves, 179 Germany, universal banking, 71–72 Glass-Steagall Act of 1933, 57, 313 defined, 52 Global bonds defined, 260 market, 259–260 Global business, exchange rate risks, 158–161 Global depository receipt (GDR), defined, 327 Global monetary system, 131–133 Going public, cost, 308–311 Gold certificates, issuance, 30 coins, production, 29 reserves, 169 standard criticism, 132 defined, 132 usage, history, 131 Goods/services direct exchange, absence, 151 imports, 168 net exports (NE), 167 nominal GDP, 38 prices, increase, 38 Goodwill, defined, 395 Google capital project, 525 mission, 383 Gordon model (constant dividend growth model), defined, 286 Government borrowing, impact, 196 ethical behavior, 106 funds, raises, 107 influence on economy, 107–109 loanable fund role, 196 organizations, 120 policy, impact, 524 securities, credit risk (absence), 281 spending, Congress increase, 111–112 unethical behavior, 106 Government expenditures (GE), defined, 167 Government National Mortgage Association (GNMA) (Ginnie Mae) creation, 184 defined, 78 Government-sponsored enterprise (GSE), 78 Gramm-Leach-Bliley Act of 1999 (GLBA), 58, 313 defined, 52 Great Depression Banking Act of 1933, passage, 52 financial crises, impact, 132 in the 1930s, Great Recession (2008–2009), trends/events, impact, 22 U.S central bank response, 77–78 U.S entry, 104 Greece, European Union and, 40 Greenspan, Alan, 85 Gross domestic product (GDP) calculation, 167 capital formation, 166–171 components, 167–168 consumption (2006/2009/2012/2015), 168t consumption spending, impact, 288 corporate debt percentage, 568f defined, 38, 104 government budget deficits, relationship, 106 impact, 92 money supply, relationship, 125–126 nominal GDP, expression, 38 Gross domestic product investment (GPDI), 167 defined, 167 Gross investment, gross savings (impact), 169 Gross savings, impact, 169, 170t Growth, changes (impact), 581 Growth rates internal growth rates, 579–580 planning, 579–581 sustainable growth rate, 580–581 H Hamilton, Alexander, 55 HealthSouth Corporation executives, indictment, 144 Hedge, defined, 334 Hedging, defined, 144 Hedging cash flows, 159–160 High crimes and misdemeanors, 172 High employment, 104 High frequency trading (HFT), defined, 322 High-tech IPOs, share price performance, 305f High-yield bonds (junk bonds), defined, 213–214, 259 Historical annual returns, examination, 347–348 Historical international price movements, 207–208 Historical return, 343–345 See also Assets Holding period returns, 295–296 Home country accounting standards, U.S GAAP (differences), 390t Home currency (HC), percentage change (calculation), 137 Home Mortgage Disclosure Act, 84 Home mortgage loans, combination, 22 Home mortgages, 203 Home mortgages, interest rates, 203 Horizon risk premium, 282 Horizon spreads (time spreads), 282 See also U.S Treasury securities Hot IPO markets, 310 House brokers (commission brokers), defined, 315 Housing prices, peak, 143 Humphrey-Hawkins Act, 103 I Identification stage, definition, 524 Illegal unethical behavior, examples, 10 Impeachment, 172 INDEX Implementation stage, defined, 524 Implicit agency costs, 407 Importer bank, financing, 147–148 example, 148–149 financing, 147–149 goods payment arrangement, 147 Income increase, 178 levels, 178 employment levels, association, 178 tax rates, increase, 111 Income statement, 391–393 business risk, effects, 585t defined, 391 example, depreciation expense (impact), 545 financial risk, effects, 585t leverage, effects, 587t project income statement, 543t ratio analysis, 424–425 risk sources, 349t Incremental after-tax cash flows, 541 estimation, 541 Incremental after-tax operating cash flows, 557, 559 example, 560t Incremental cash flows, defined, 541 Independent brokers, defined, 315 Independent projects, defined, 522 Indifference level, 582–583 Indirect quotation calculation, 136 method, defined, 136 Indirect transfers, usage, 24 Individual net worth, defined, 27 Individual retirement accounts (IRAs), 265 savings placement, 195 Individuals, savings level, 179–180 Individual saver, life stages, 179–180 Industrial senior debt ratings (US), distribution, 589t Industry comparative analysis, defined, 424 Industry-specific risk, 363 Inefficient markets, price reactions, 355f Inflation causes, 210–211 control, 142 defined, 27, 105, 207 double-digit inflation, impact, 193 implications, 225 increase, anticipation (absence), 192 rate (See Compound inflation rate) types, 210–211 Inflationary bias, 211 Inflation premium (IP), 207–211 defined, 197 expectation, 207 Informationally efficient market (efficient market), defined, 355 Initial margin, defined, 319, 335 Initial outlays, example, 557t Initial public offering (IPO), 229 average first-day returns (underpricing), 311t cold IPO markets, 310 defined, 299 Facebook IPO, 303–306 going public, cost, 308–311 high-tech IPOs, share price performance, 305f hot IPO markets, 310 investment bank advice, 300 lock up provisions, 304–305 offerings, number, 311t studies, 308–311 Initial returns, 309t Inside information, 327–328 Insider trading law, clarity (absence), 328 Instantaneous settlement, 266 Insurance agent, career, 17 Intangible assets, 593 IntercontinentalExchange (ICE), NYSE bid, 314 Interdistrict settlement, 96 Interest annual real rate, 198 coverage, calculation, 433–434 quarterly compounding, 243–244 real rate, defined, 197 risk-free rate, defined, 197 Interest-bearing federal obligations, average length/maturity distribution, 202t Interest rate (r) See also Short-term interest rates annuities, 237–239 bond prices, relationship, 282f calculation/computation, 197, 501 cashing in, 568–569 changes, 196 defined, 191 determination, 230–232 example, 192f effect, 195 equilibrium level, change, 192 financial calculator solution, 230 future value/time period, relationship, 224f international factors, 196 levels, historical changes, 193 maturity structure, 203–206 present value/time period, relationship, 229f solving, 230–231, 237–238 spreadsheet solution, 230 table-based solution, 230–231 term structure, 203–206 ranking, 204t Interest rate risk defined, 69, 197, 282, 350 impact, 282–283 Intermediate-term federal obligations, commercial bank holding, 199 Internal financing, external financing (proportion), 254 Internal funds, long-term financing, 254 Internal growth rate, defined, 579 Internally generated financing, 444 Internal rate of return (IRR), 527, 530–535 misconception, 534 net present value (NPV), relationship, 534–535 required by investors, 572 Internal rate of return (IRR) method defined, 531 627 Internal Revenue Code (IRC), 419 International banking defined, 71 foreign systems, 71–72 International Banking Act (IBA) of 1978, 71 International bond market, national boundaries, 260 International business, 151 ethical considerations, 144–145 International components, example (2006/2009/2012/2015), 168t International finance development, 131–132 International Fisher effect (IFE), 140 International Monetary Fund (IMF), 97 defined, 132 evolution, 131–132 reserves credit, 169 International monetary system, 39–40, 131–133 defined, 131 International payment imbalances, implications, 168–169 International trade aids, 150 balances, factors, 152 financing, 145–150 International transactions balance, 105–106 currency exchange/checkable deposits, involvement, 39–40 financing cost, 149–150 goal, balance, 151–153 handling, 151–153 problem, characteristics, 152 Internet bubble, 185 usage, 484 Interstate banking, regulations (liberalization), 62 In-the-money, defined, 339 Intradistrict settlement, 96 Intrinsic value, 277 Inventories investment amount, calculation, 461 Inventory collateral function, 513 conversion period, calculation, 458–459 loans, 513–514 management, 482–483 period, 458–459 usage, 470 sales increase, impact, 462t tracking, 485 turnover, calculation, 430–431 Inventory turnover ratio, 430 Investing cash flows, example, 544–545 Investing decisions, 161 Investing overseas, 142 Investment activities, cash flows, 544 bank, defined, 52 companies, classification, 358 defined, discounting, example, 227–228 example (2006/2009/2012/2015), 168t 628 INDEX Investment (continued ) firms, careers, 17 introduction to, 163–164 research analyst, career, 16 return, calculation, 221 saving, relationship, 169–170 savings, movement, 23–25 United States, 170t Investment bankers (underwriters) competitive bidding, 307–308 defined, 299 originating, 299–300 primary market functions, 299–303 rights offerings, 306–307 selling, function, 301–303 shelf registration, 306 underwriting, 300–301 Investment banking analysis, career, 17 houses, competitive bidding (advantages/ disadvantages), 307 intermediation activities, 52f regulation, 312–313 Investment banking firms defined, 50 functions, 312 innovations, 312, 313–314 Investment companies, defined, 50 Investment-grade bonds, 259 Investment grade bonds, defined, 213 Investors accredited investors, 306 angel investors, survey, 313 diversification, 358 ladder strategy, 260 over-optimism, 287 rates of return, determination, 229 risk averse characteristic, 212 yields, attainment, 568–569 Invoice processing, 484 IOUs, sale, 473 IPO See Initial public offering IPO questions, 300t Irrelevant cash flows, 542 Irrevocable commercial letter of credit example, 148f J Jackson, Andrew, 55 Japanese monetary systems, 40 JOBS Act, 503 Johnson, Andrew (impeachment), 172 JPMorgan Chase & Co., Bear Stearns (acquisition), 47, 108, 112 Jumpstart Our Business Startups (JOBS) Act (2012), 503 Junk bonds (high-yield bonds), defined, 213–214, 259 Just-in-time (JIT) inventory control system, 483 systems, 527 K Keynesians, 38–39 Korean War, wholesale prices (increase), 209 L Labor specialization methods, efficiency, Ladders, investing, 260 Large-scale arbitrage activities, impact, 141 Law, John, 207 Lehman Brothers bankruptcy, 47, 475 failure, 299 Lenders, unethical behavior, 242–243 Level production impact, 467f seasonal production, differences, 466–468 Leverage, effects, 587t Liability(ies), 66 balance sheet, 395–396 defined, 393 examination, 397 insurance, 47, 50 management, 69 management, impact, 69 Life cycle patterns, 170 Life insurance loans, 514 Limited branch banking, defined, 61 Limited liability company (LLC), defined, 388 Limited partners, defined, 387 Limited partnership, defined, 387 Limit order, defined, 317 Line of credit, defined, 499 Liquidity See also Banks attitudes, 195–196 defined, 27 management, 67–68 preference, 196 preference theory, defined, 206 ratios, 425, 427 analysis, 427–428 risk, defined, 67 Liquidity preference theory, defined, 206 Liquidity premium (LP), defined, 197 Liquidity ratios, defined, 427 Loanable funds demand, 192 interest rates, effect, 195 interest rates, impact, 196 sources, 194–195 supply, 192 factors, 195–196 theory, 194–195 defined, 194 Loan amortization schedule defined, 240 example, 240t Loan analyst, career, 16 Loans, 64–65 request, calculation, 501 secured loan, defined, 64 securing, stocks/bonds (usage), 514 types, 514 unsecured loan, defined, 64 Local currency, savings/personal power, 33 Local retail credit bureaus, establishment, 480 Lockbox system, defined, 477 London Stock Exchange, 326, 327 Longer-term shareholders, reason, 274 Long-run inflationary bias, continuation, 211 Long-term corporate debt securities, categories, 256 Long-term debt instruments (bonds), 181, 197 Long-term debt to total assets ratio, 579f Long-term financial planning, 442–445 Long-term financing patterns, 497f short-term financing, mix decisions, 496 sources, usage, 491f Long-term funds, 196 obtaining, 254 Long-term government bonds, return/risk measures, 354 Long-term interest rates, 193 changes, 196 Losses (magnification), margin (impact), 319 LP See Liquidity premium M Maastricht Treaty (1991) (Treaty on European Union), 106, 134 Macroeconomic events, asset returns (sensitivity), 364 MACRS See Modified accelerated cost recovery system Madoff, Bernie (unethical behavior), 10 Magnetic ink character recognition (MICR), 96 Maintenance margin, defined, 319 Major currencies index, U.S dollar value (relationship), 143f Major money market securities, characteristics, 34f Maloney Act of 1938, 321 Managers honesty, 546–547 objectives, differences (finance principle), 8, 10 Mandatory spending, defined, 171 Margin, defined, 318 Marginal tax rates, 417, 418, 419 Margin call, defined, 319 Margin trading, risk, 319 Marketable debt securities, maturity distribution, 202–203 Marketable government securities, defined, 198 Marketable interest-bearing federal obligations, average length/maturity distribution, 202t Marketable issues, 198 Marketable obligations, 198–199 Marketable securities management, 470–476 qualification, 469–470 Market-based weights, 574–575 Market interest rate, defined, 197 Market order, defined, 317 Market risk (systematic risk), 363–364 defined, 364 Markets characteristics, 322–324 discussion questions, 341 efficiency, 357 interest rates, determinants, 197 INDEX portfolio beta, 366 defined, 365 problems, 341 quality, identification, 322–323 stabilization, defined, 303 Market segmentation theory, defined, 206 Market timing, 591–592 hypothesis, defined, 591 Market value added (MVA), defined, 403 Market value ratios, 425 analysis, 437–439 defined, 437 Marshall, John, 387 Martin, Jr., William McChesney, 84, 85 Maturities, risk, 498–499 Maturity factoring, defined, 509 Maturity-matching approach, 492–493, 494 defined, 492 Maturity risk premium (MRP) defined, 197 requirement, 200 Maturity stage, 180 MBHCs See Multibank holding companies Medicare, primary expenditures, 171 Medium of exchange, defined, 27 Member banks (Fed component), 80–82 Merchandise trade balance, defined, 152 Merck & Company capital project, 525 mission, 383 Merger and acquisition (M&A) activities, impact, 312 Merrill Lynch, sale, 47 Mexican War, 208 Microeconomic risk, 364 Microsoft data, application, 347 dividend payout ratio, 271 historical variance, 346 returns distribution, 348t plot, 374f variance computation, 346t stock prices, 344f behavior, 344f Middle Ages, historical international price movements, 207–208 Miller, G William, 84, 85 Millionaire, attainment (process), 234 MIRR See Modified internal rate of return Mission, Objectives, Goals, and Strategies (MOGS), defined, 522 Mission, usage, 383 Mission statement, defined, 383 MMDA See Money market deposit account MMMFs See Money market mutual funds M1 money supply, 35–36 defined, 35–36 M2 money supply, 36–37 defined, 36 Modified accelerated cost recovery system (MACRS), 420 Modified internal rate of return (MIRR), 527, 535 decision rule, 536 example, 533f method, defined, 535 MOGS See Mission, Objects, Goals, and Strategies Monetarists, beliefs, 38 Monetary base (MB), defined, 125 Monetary Control Act, 58 Monetary policy defined, 86 discount rate policy, 89–90 functions/instruments, 86–93 implementation, 92–93 importance, 151 open-market operations, 90–91 quantitative easing (QE), 91–92 reserve requirements, 87–89 responsibilities, overview, 86–87 Monetary system exercises, 42–43 flowchart, 26f international monetary system, 39–40 overview, 25–26, 26f payments mechanism, 95–97 Monetizing the debt, defined, 107 Money creation, 13 credit money, defined, 32 defined, 27 deposit money, 32–33 devaluation (Punic Wars), 207 development, 28–33 fiat money, defined, 30 importance/functions, 26–27 representative full-bodied money, defined, 30 standard, history, 207 transfer, 13 velocity, defined, 38 Money market deposit account (MMDA) balances, 36–37 savings account components, 66 Money market mutual funds (MMMFs) defined, 37 money, flow, 58 usage, 39 Money markets, 181 defined, 14 Money market securities, 33–35, 34f, 181 characteristics, 34f defined, 33–34 types, 34f Money multiplier (m), 124–126 defined, 125 Money supply (MS) change, 115–121 price changes, impact, 210–211 decrease, 86 definition, broadening, 36 economic activity psychological factor, impact, 39 relationship, 37–39 exclusions, 36, 37 expansion, 54 increase, 86, 211 impact, 210–211 629 Monthly cash budget example, 468t level production, 467t Monthly cash inflows, example, 464t Monthly cash outflows example, 465t level production, 467t Morris, Robert, 55 Mortgage-backed security, 108 default rates, increase, 183 defined, 46, 183 types, 183–184 Mortgage banking firms, defined, 51 Mortgage bonds defined, 262 securing, absence, 262 types, 262–263 Mortgage loans default rates, increase, 183 origination, 182–183 underwater characteristic, 47 Mortgage markets, 182–184 defined, 15, 182 developments, 186 Mortgages analyst, career, 17 defined, 46, 181 types, 183–184 MS See Money supply Multibank holding companies (MBHCs), defined, 62 Multinational corporations, risk reduction/ speculation opportunities, 144 Municipal bond, defined, 181 Municipal securities, 474 Mutual funds, defined, 50 Mutual funds (open-ended funds), 358 underperformance, 357t Mutually exclusive projects, defined, 522 MVA See Market value added N National Association of Securities Dealers Automated Quotation (NASDAQ) impact, 322 trading, 269, 320 National Banking Act of 1864, 57 National Banking Acts payments system, 78–79 weakness, 78 National Banking System, weaknesses, 77–78 National Credit Union Administration (NCUA), 93 National Credit Union Share Insurance Fund (NCUSIF), deposit protection, 60 National debt amount, 113 defined, 113, 172 National economic policy objectives, 103–105 Nations, exporting/importing, 105 NAV See Net asset value Near-cash accounts, usage, 39 Negative correlation, defined, 360 Negative obligation, 316 630 INDEX Negotiable certificate of deposit (negotiable CD), 88, 473 defined, 34 Negotiable order of withdrawal (NOW) accounts, 36 authorization, 58 Net asset value (NAV), 358 Net exports (NE), 167 defined, 167 Net income (reduction), depreciation (impact), 545–546 Net monthly cash flows, level production, 468t Net present value (NPV), 527–528, 527–530 calculations, examples, 522, 528t, 533t, 558t computation methods, 529–530 defined, 522 discount rates, relationship, 531f internal rate of rate (IRR), relationship, 534–535 managerial flexibility/options, 540 profile, defined, 530 projects, origin, 522 safety margin, 539–540 spreadsheet functions, usage, 530 Net proceeds, example, 507 Net profit margin, calculation, 436 Net settlement facilities, 95 Net working capital calculation, 491 defined, 427, 491 question, 411 Net working capital to total assets ratio, 495f New common stock, cost, 573–574 Newspaper exchange rate quotes, usage, 137 New York Stock Exchange (NYSE) buying on margin, 318–319 going public, 314 limit order, 316 market order, 315 members, types, 315 NYSE-Euronext, 314 program trading, 320 record keeping, 319–320 securities listing, 316 transactions, 316 short sale, 318 stop-loss order, 317 structure, 315–316 transactions, consolidated report, 319 Nixon, Richard, 106 Nominal GDP, expression, 38 Nominal interest rate, defined, 197 Nominal risk-free interest rate, 274 Noncumulative preferred stock, defined, 268 Nondebt tax shields, 588, 593 Nondomestic bonds, risks, 283 Nonfinancial corporate savings (United States), 177t Nonmarketable government securities, defined, 201–202 Nonpublic firms, criterion, 404 Normal distribution, 347f Note payable, 396 Not-for-profit organizations, 120 NPER (Excel) function, usage, 238 NPV See Net present value NWC recovery, 555–556 O Odd lot, defined, 319 Offer price, defined, 300 Office of the Comptroller of the Currency (OCC), 93 Office of Thrift Supervision (OTS), 93 S&L regulation, 60 One-bank holding companies (OBHCs), 62 One-year government interest rates, 157 One-year investment, present value level, 226–227 Open-ended funds (mutual funds), 358 Open-end mortgage bond, defined, 262 Open-market operations, 90–91, 123, 224 defined, 91 Federal Reserve Act of 1913, impact, 91 Operating cash flows, example, 544–545 Operating cycle, 457, 459–460 calculation, 459 defined, 457 diagrams, 458f length, determination, 458–459 timeline, depiction, 457 Operating effects, financial leverage effects (combination), 584–588 Operating leverage, degree, 447 Operating profit margin, calculation, 436 Operating return on assets, calculation, 436 Operations question, 411 Opportunity cost, defined, 541 Optimum debt/equity mix, defined, 566 Option premium, defined, 337 Options, 336–339 contracts, 336–337 defined, 336 profit/loss diagrams, 339–340 Option writer, defined, 337 Order bill of lading defined, 145 example, 146f Ordinary annuity, defined, 232 Ordinary taxable income, 418 Organization corporate form, 388 proprietorship form, 385 Organizational forms/financial characteristics, 385t Organization chart, finance impact, 409–411 position, 410f Organization for Economic Cooperation and Development (OECD), recommendations, 409 Originating, 299–300 Out-of-the-money, defined, 339 Overseas funds, borrowing, 254 Overseas investing, 142 Over-the-counter (OTC) exchange, 269 market, 314, 320–322 regulation, 321 stocks, trading, 321 Overvalued investment opportunities, 220 Owners capital, 66 equity, 396, 503 Ownership equity, 194 liquidity, 385 P Paper checks, physical transfer, 54 Paper currency (physical money), 28–32 evolution/usage, 29 fiat money, 36 Paper money, usage, 207–208 Participating preferred stock, defined, 269 Partnership, 384, 386–387 defined, 387 liability risks, 387 life, 386 Par value (face value) defined, 255, 267 excess, 279 Paulson, Henry, 112 Payables, sales increase (impact), 462t Pay-as-you-go progressive income tax, 111 Payback period, 527, 537 calculation, 537 method, defined, 537 Payment balance, defined, 151–152 electronic forms, 95 Pecking order hypothesis, defined, 591 Pension fund payments, 179 Pension funds, defined, 50 Percentage of sales technique, 442–443 Percentage return, calculation, 343–344 Percent annual rate, calculation, 65 Periodic annuity payments determination, 239–241 annual payments, involvement, 239–240 real estate mortgage loans, monthly payments (involvement), 240–241 financial calculator solution, 239 spreadsheet solution, 239 table-based solution, 239–240 Periodic equal payment (PMT), 233, 275 Periodic interest charge (r), 243 Perpetuities, maturity dates, 255 Perpetuity, defined, 285 Personal consumption expenditures (PCE), defined, 167 Personal consumption expenditures (PCE), GDP percentage, 167 Personal current taxes, change, 175 Personal finance defined, planning, career opportunities, 353 Personal financial plan, development, 180 Personal financial planning, 14 Personal income, components, 175 Personal investment decisions, making, Personal saving, 174–176 calculation, 174 defined, 174 historical rates in the United States, 175t INDEX level, 169 rate, defined, 175 United States (2006/2009/2012/2015), 176t Personal taxable income, examination, 418 Person-to-business (P2B) transactions, 477 Physical money (coin/paper currency), 28–32 Pink sheet, 323 Pledging (pledge), 508–509 defined, 508 PMT See Periodic equal payment Poison pills, defined, 407 Policy makers economic policy objectives, 106f European Economic Union, 106–107 groups, 105–107 impact, 12 Political risk, defined, 141, 283 Ponzi scheme, 10 Portfolio defined, 358 diversification, risk (relationship), 363f expected return, 359 investments, number, 362–363 returns, 358–359 standard deviation, 359–360 risk, 262–264 variance, 359–360 Positive correlation, defined, 360 Positive net cash flow, example, 466 Post-audit phase, 499 Postwar inflation, 193 Post-World War II, inflation, 208–209 Pre-authorized checks, defined, 477 Precautionary motives, defined, 469 Preferred stock, 268–269 cost, 572 defined, 268 elements, 268t nonvoting status, 268 valuation, 285 Premium bond, defined, 279 Present value interest factor of an annuity (PVIFA) calculation, 529–530 example, 237t Present value interest factor (PVIF), 528 example, 228t values, 228 Present value of an annuity, 235–237 calculation, 485 financial calculator solution, 236 spreadsheet solution, 236 table-based solution, 236 Present value of an annuity due (PVAD), 249–250 Present value (PV) See also Annuity calculation, examples, 226–227 defined, 220 determination (See Bonds) discounting, usage, 225–228 equating, 228–229 financial calculators, usage, 227 interest rate/time period, relationships, 229f Pre-tax interest cost estimate, 571 Price changes impact, 210–211 initiation, 210–211 stability, 105 “Price bubble,” for technology stocks, Price-earnings (P/E) ratio, 438 Price/EPS ratio, 270 Price level (PL), 38 increase, expectations, 178 Price movements, 207–208 historical international price movements, 207–208 Price-variable cost margin, 585 PricewaterhouseCoopers, 388 Primary credit, rate, 89 Primary deposit, defined, 115 Primary markets, defined, 15, 299 Primary reserves, defined, 68 Primary securities markets, issuance, 299–303 Prime mortgage, defined, 184 Prime rate, defined, 64, 499 Principal-agent problem, 10, 406–407 defined, 406 result, 407 Principal payment streams, 183 Principals, defined, 406 Private borrowers, crowding out (threat), 113 Private equity sales, occurrence, 306 Private party, securities (sale), 306 Private placement, defined, 300 Processing float, 476 Product differentiation, 523 Production methods, efficiency, Profitability, 593 Profitability index (PI) (benefit/cost ratio), 536–536 defined, 536 Profitability ratios analysis, 435–437 defined, 435 Profits, comparison, 390t Program trading, defined, 320 Progressive tax rates, 417 Project analysis, data requirements, 526t income statement, 543t example, 558t operating life, cash flows, 555 rate of return, minimum, 569–570 safety margin, 539–540 stages, 554–556 statement of cash flows, firm statement of cash flows (differences), 543t termination, salvage value/NWC recovery, 555–556 Project cash flows estimation, 540–542, 554 approaches, 542–546 initial outlay, 554–555 example, 557t irrelevant cash flows, 542 isolation, 540–542 relevant cash flows, 540–542 return, 543 shareholder benefit, 557 631 Proprietorship (sole proprietorship), 384–386 defined, 384 financial capital, 385 Prospectus, defined, 300 Public borrowing, 171 Public Company Accounting Oversight Board (PCAOB), creation, 408 Public debt ownership, 201t securities, ownership, 200–201 Public Debt Act of 1941, 200 Public offering defined, 299 process, SEC regulation, 300 securities, sale amount, 301 Public transportation, developments, 173 Punic Wars (monetary devaluation), 207 Purchasing power, implications, 225 Purchasing power parity (PPP), defined, 140 Purchasing power risk, defined, 349 Putable bonds (retractable bonds), defined, 264 Put option defined, 336 payoff profiles from buying/writing, 340 PV See Present value PVIF See Present value interest factor PVIFA See Present value interest factor of an annuity Q Quantitative easing (QE), 91–92, 568 defined, 91 monetary policy tool, 224 Quick ratio, calculation, 427 R Radio frequency identification (RFID), usage, 485 RADR See Risk-adjusted discount rate Random walk, defined, 356 Rapid growth stage, 180 Rates of return See also Arithmetic average annual rates of return annualization, 295–296 determination, 229 minimum, 569 requirement, 569–570 Ratio analysis defined, 424 DuPont method, 440–442 Raw materials, ownership cost, 483 Reagan, Ronald, 103 Real assets, defined, 26 Real estate agent (broker), career, 17 Real estate mortgage loans financial calculator solution, 240 monthly payments, involvement, 240–241 spreadsheet solution, 242 Real Estate Settlement Procedures Act, 94f Realized capital gains, 418 Real output (RO), 38 Real property loans, origination, 48, 51 Real property organizations, careers, 16–17 Real rate of interest, defined, 197 632 INDEX Receivables factoring, 466 investment amount, calculation, 459 sales increase, impact, 462t Receivables turnover, 430 Recession, control/prediction (absence), 350 Record keeping, 319–320 Refunding, types (determination), 114 Registered bonds, defined, 256 Registered traders, defined, 315 Regulation FD, 328 Regulation Q, 58 Regulation Z, defined, 94 Reinvestment rate risk (rollover risk), 283 Relevant cash flows, 540–542 Remote capture, defined, 477 Representative full-bodied money, 132 defined, 30 Representative full-bodied paper currency, example, 30f Repurchase agreement, defined, 35 Reputation destruction, 10 importance, finance principle, 8, 10–11 Request for proposal (RFP), usage, 561 Required rate of return, 569–570 Required reserves defined, 87, 121 ratio, defined, 87, 121 Research analyst, career, 17 Reserve requirements, 58, 87–89 change, 87, 88, 122–123 Residual dividend policy, defined, 272 Resolution Trust Corporation (RTC), creation, 60 Restricted stocks, defined, 408 Retained earnings, 572–573 account, 396 Retained earnings, cost constant dividend growth model, 573 security market line (SML) approach, 572–573 Retention rate (RR), 580 defined, 580 Retirement outlays, primary expenditures, 171 Retractable bonds (putable bonds), defined, 264 Return on equity (ROE), calculation, 436–437, 440 Return on total assets, calculation, 436–437, 440 Returns distribution, example, 348t expected measures, 350–353 Revenue expanding project, cash flow estimation, 556–558 Reverse split, 273 Revolutionary War expenditures, financing, 55 inflation, 208 Revolving credit agreement (revolver), 501–502 defined, 502 effective cost, computation, 502 Rights offerings, 306–308 Risk business, 584, 593 categories, example, 548t considerations, 547–549 diversification, finance principle, 8–9 examples, 364t expected measures, 350–353 management’s attitude toward, 593 measure, standard deviation, 346–349 origin, 348–350 portfolio diversification, relationship, 363f return, difference (finance principle), sources, 349t Risk-adjusted discount rate (RADR), defined, 548 Risk averse investors, 212 Risk-free financial instrument, 197 Risk-free interest rate, defined, 197 Risk-free rate of interest, defined, 197 Risk-free return (RFR), 572–573 Risk-free securities, 198–203 Risk-weighted assets, usage, 70 Risky assets, presence, 365 Rollover risk (reinvestment rate risk), defined, 283 Rome, historical international price movements, 207 Round lot, 266 defined, 319 Rule of 72, defined, 232 Rule 415 (SEC), 306 S Sales data, example, 464f forecasts, impact, 464 terms, 504 trend, impact, 497–498 Sales finance companies, installment loan finance, 51 Salvage value, 555–556 Sarbanes-Oxley (SOX), impact, 409 Saving credit union, impact, 58 investment, relationship, 169–170 tax structure, impact, 112 United States, 170t Savings accumulation, 13 corporation, life stages, 180–181 creation, 174 current income, relationship, 178 deficit, defined, 174 defined, 174 domestic supply, 174 economic cycles, 178 economic expectations, 178 factors, 177–181 foreign sources, 174 historical role, 173 individual saver, life stages, 179–180 interest rate, example, 220 lending/investing, 13 local currency, 33 maintenance, media (usage), 176 movement, 23–25 rate, increase, 175 sources, 173–174 supply, origination, 194 surplus, defined, 174 total amount, factors, 177–178 volume, 195 Savings and loan (S&L) crisis, 56, 214 defined, 49 deposit protection, 60 development, 49 managements, preparation (problem), 59 OTS regulation, 60 Savings Association Insurance Fund (SAIF), 60 Savings banks appearance, 47 defined, 48–49 state chartering, 61 Savings deficit unit, 174 Savings-investment process defined, 24 focus, 25 individual savers to business firms, 24f Savings surplus unit, 174 Scenario analysis, usage, 583t SDRs See Special drawing rights Seasonal production example, 466t level production, differences, 466–468 Seasonal sales, impact, 467f Seasonal variation, impact, 497 Seasoned equity offerings (SEOs), 310 Secondary markets, defined, 15, 299 Secondary mortgage markets, participants, 184 Secondary reserves, defined, 68 Secondary securities markets, 314–316 Second Bank of the United States, 55 Secured lending (asset-based lending), 508 Secured loan, defined, 64 Secured obligations, 256 Securities, 64 analyst, career, 17 discussion questions, 341 ethical issues, 328–329 exchanges, 314–315 financial markets pricing efficiency, finance principle, 8, foreign investor purchases, 174 issuance, 300–302 listing, 316 management (See Marketable securities, management) offering announcement (tombstone), example, 302f problems, 341 safekeeping/transfer, 95 sale, 306 trading, 314–316 transactions, 317–320 Securities Act of 1933, 312 Securities and Exchange Commission (SEC) establishment, 312 foreign stocks, registration, 326 Rule 415, 306 INDEX Securities Exchange Act of 1934, 303, 312 Securities firms defined, 48 functions of, 50 Securities markets, 321 careers, 17 opportunities, 328–329 indexes, 324–327 issuance (See Primary securities markets.) Securitization defined, 183 usage, 262 Security market line (SML), 375–376 approach, 572–573, 576 example, 376f usage, 572–573 Seesaw effect, 260, 567 Selection stage, defined, 524 Semiannual compounding, usage, 241–242 Semi-annual interest rate, calculation, 277–278 Semistrong-form efficient market, defined, 357 SEOs See Seasoned equity offerings Settlement price, defined, 336 Shareholder value, focus, 402 Shareholder wealth calculation, 402–403 increase, employees (impact), 403t measurement, 402–403 Shelf registration, defined, 306 Short sale, defined, 318 Short seller, margin requirements, 318 Short-term credit, availability, 195 Short-term debt instruments, 34, 197 Short-term debt security, repurchase agreement, 35 Short-term finances, management, 457 Short-term financing advantages, 498 consideration, example, 515 cost, 515 factors, 495–499 influences, 498–499 long-term financing, mix decisions, 496 operating characteristics, 495–498 patterns, 497f providers, 499–503 sources, usage, 492f varieties, 508–512 Short-term funds, 196 Short-term interest rates, 471f Short-term investment policy guidelines, 474t statement, defined, 474 Short-term loans, federal funds, 35 Short-term maturities, concentration, 202 Short-term obligations, credit ratings, 474 Sight draft defined, 145 example, 145f Simple interest, defined, 221 Sinking fund, defined, 264 Sinking fund payments, defined, 434 SLPs See Supplemental Liquidity Providers Small Business Administration (SBA), 499, 502 loan guarantees, 508 Small Business Development Centers (SBDCs), 109 Small businesses bank financing, 503 credit, commercial bank provision, 81 credit types, usage, 51 government financing assistance, 109 government financing assistance for, 109 starting, 25 venture capital, financing source, 570 working capital management, importance, 470 Small business investment companies (SBICs), 109 Small Business Resource Center, 538 Small companies, success (habits), 384 Small firms, importance of, Small investor, diversification, 358 Small-size silver certificates, switch (occurrence), 30 Small venture firm, life cycle patterns, 170 SML See Security market line Social Security federal pension plan, 50 primary expenditures, 171 Sole proprietorship (proprietorship), defined, 384 Special dividend, defined, 271 Special drawing rights (SDRs), 169 defined, 133 Speculative inflation, defined, 211 Speculative motives, defined, 469 Speculative value of an option, defined, 339 Spending discretionary, defined, 171 mandatory, defined, 171 Spending power, local currency, 33 Spontaneous financing, 494 Spot exchange rate, defined, 137 Spot market, defined, 334 Spot rate (SR), 137–138, 160 Spread, defined, 301, 317 Spreadsheet functions, usage, 530 Spreadsheet programs availability, 227 built-in financial functions, 223 Stand-alone principle, defined, 540 Standard and Poor’s 500 (S&P500), 469 futures contract, listing, 336f index, 325 returns, plot, 374f Standard deviation, 346–348 defined, 316 usage, problem, 348 Standard loan, calculation, 65 Standard of value, defined, 27 Start-up firm, financing sources, 256 Startup stage, 180 State-chartered banks, 61 Statement of cash flows, 391, 396–398 defined, 397 sources, 397 uses, 397 Statement of income (statement of operations), 391 633 Statewide branch banking, defined, 61 Static trade-off hypothesis WACC, debt ratio (differences), 589f Static trade-off hypothesis, defined, 589 Stockbroker, career, 17 Stockholder objectives, differences (finance principle), 8, 10 Stockholders’ equity, 65–66, 66–67 Stock market indexes, 323 investing, 253 Stock options defined, 407 goal, 408 quotations, 337f Stocks betas, examples, 367t certificate defined, 266 example, 266f dividend, defined, 272 dual-listed stocks, 315 hyping, accusations, 406 options, defined, 407 portfolio, stocks/Treasury bond returns/ returns (example), 360f prices peak, 143, 185 reactions, 357 quotation, information, 269f quotes, reading, 269–270 repurchases, 270–274 restricted, defined, 408 returns, 359f reverse split, 273 share repurchases, 274 split, defined, 273 U.S Treasury bonds, relationship, 360 valuation, 284–289 constant dividend growth rates, usage, 285–287 constant dividends, usage, 285–286 risk, 287 Stop-loss order, defined, 317 Store of value, defined, 27 Straight through processing (STP), 266 Strategic plan, vision/mission (usage), 383 Strategy, financial plans (linkage), 404 Street name, 320 defined, 266, 318 Strengths, Weaknesses, Opportunities, and Threats (SWOT) analysis, 523 Strike price (exercise price), defined, 337 Strong-form efficient market, defined, 356 Subchapter S corporation, defined, 388 Subordinated debenture, defined, 262 Subprime mortgage, defined, 184 Sunk cost, defined, 542 Supplemental Liquidity Providers (SLPs), defined, 316 Suppliers, trade credit, 504 Supply, demand (relationship), 138–142 Surplus economic unit, defined, 23 Surpluses, powers, 110–112 Survival stage, 180 634 INDEX Sustainable growth rate, 580–581 defined, 580 SWOT See Strengths, Weaknesses, Opportunities, and Threats Syndicate, defined, 302 Systematic risk (market risk), 363–364 defined, 364 measure, process, 375t T Tangible assets, 593 Target capital structure, 575 Target dividend payout policy, defined, 271 Target weights, measurement, 574–576 Taxable investors, drawback, 264–265 Tax analyst, career, 16 Tax-free federal obligations, issuance (termination), 200 Tax motives, defined, 470 Tax policy, defined, 112 Tax rates, 417–418 Tax risk, defined, 350 Tax shields, 588, 593 Technicians (chartists), defined, 357 Technology, working capital management (relationship), 484–485 Technology stocks, price bubble, Tech-oriented stocks, 185 Terminal cash flows, 559–560 Term structure defined, 203 theories, 205–206 Term to maturity, lengthening, 282 Third market, defined, 321 Thrift institutions defined, 48 entry, 56 Tier capital, tier capital (sum), 70 Tier ratio, calculation, 70, 71 Time draft, defined, 145 Time horizons, differences, 538 Time period financial calculator solution, 231, 238 future value/interest rate, relationship, 224f present value/interest rate, relationship, 229f solving, 231, 238–239 spreadsheet solution, 231, 238 table-based solution, 231, 238 Time requirements annuities, 237–239 determination, 230–232 Time series analysis (trend analysis), defined, 424 Time spreads (horizon spreads) See U.S Treasury securities Time to maturity, 263–264 Time value of money defined, 220 finance principle, Time value (specualtive value of an option), 339 Title XIII (Pay It Back Act), 109 Token coins, defined, 28 Token (copper-nickel-clad) U.S coins, examples, 29f Token money, coins, 36 Tombstones defined, 301 example, 302f Too big to fail (TBTF), 112 Total assets turnover, calculation, 429 Total capital ratio, calculation, 70–71 Total debt to total assets, calculation, 432–433 Total outlays, 559t Total risk, 586–588 components, 364 Toxic assets, 71, 112 Trade balance, defined, 152 Trade credit cost, 504–505 defined, 481 establishment, 504 supplier source, 504–505 terms, 504 Trade discounts, defined, 504 Trades, execution accuracy, 323 Transactions motive, defined, 469 Transfer payments, defined, 111 Transmission float, 476 Traveler’s checks, 150 Traveler’s letter of credit, defined, 150 Treasurer, defined, 409 Treasury bill, defined, 34 Treasury bonds, defined, 199 Treasury Inflation Protected Securities (TIPS), 265 Treasury note/bond, 181 Treaty on European Union (Maastricht Treaty), 106, 134 Trend analysis (time series analysis), defined, 424 Troubled Asset Relief Program (TARP), 108, 112 Troubled assets, 71, 108 Trustee, defined, 257 Trust indenture, defined, 257 Trust-preferred securities, 70 Trust receipt, defined, 149, 513 Truth in Lending, 94f Truth in Lending Act (TILA), 84 U Underpricing, 301 defined, 308 Undervalued investment opportunities, 220 Underwriters (investment bankers), defined, 299 Underwriting, 300–301 agreement, defined, 300 firm commitment underwriting, flowchart, 301f Undistributed profits, 174 Undistributed profits (earnings retained in the business), defined, 174 Unemployment insurance program, funding, 111 Unethical managers, decisions (problems), 405 Unit banking, defined, 61 United Kingdom, banking in, 72 United States balance of payments (2011), 151–153 bank, foreign account balance (impact), 137 banking system historical development, 54–56 pre-Fed actions, 77–78 business organization, forms, 384–388 central bank response, 77–78 coins, 28–32 currencies, counterfeiting, 31–32 economy, small firms (importance), Federal Reserve Note, designs, 31f fiat U.S paper currency, example, 30f financial system graphic view, 11f operation, 23–24 full-bodied U.S coins, examples, 29f futures exchanges, 335t GAAP, home country accounting standards (differences), 390t industrial senior debt ratings, distribution, 589t inflation, 208–210 control, 142 rates, 225 interest rates, 196 levels, historical changes, 193 investment, 170t monetary system, flowchart, 26f money, development, 28–33 money supply, measures, 35–37 national income, goods sale, 151 nonfinancial corporate savings, 177t personal savings (2006/2009/2012/2015), 176t representative full-bodied paper currency, example, 30f saving, 170t Small Business Administration (SBA), 499, 502 stock market data, usage, 362–363 token (copper-nickel-clad) U.S coins, examples, 29f unemployment rate, increase, 104 United States dollar (U.S dollar) appreciation, 143 equivalence, 136 exchange example, 169 exchange rate developments, 142–143 strength pessimism, 142 renewal, 143 value, major currencies index (relationship), 143f United States Travel Act, 145 Unit volume variability, 585 Universal bank, defined, 52 Universal banking, 51–52, 71–72 Unrealized capital gains, 418 Unsecured loan, defined, 64 Unsecured obligations, 256 Unsystematic risk, 363–364 defined, 363 U.S economy, importance of small firms in, U.S Treasury accounts, balances, 110 bonds, active markets (dealer maintenance), 199–200 cash balances, management, 109 INDEX debt instruments, risk-free securities, 198–203 financing, dealer capacity, 200 funds, deposit, 124 income payment, 110 interest costs, restraint, 114 loan accounts, 110 notes, defined, 199 policy instruments, 108 receipts/outlays, 110 tax accounts, 110 Tax and Loan Accounts, 110 transactions, 124 U.S Treasury bills defined, 34, 199 interest rates, 204 purchase, short-term return, 365 rates commercial paper rates, differences, 475f example, 472f sale, 470–471 U.S Treasury bonds defined, 181, 199–200 returns, 360f stocks, relationship, 360 U.S Treasury securities horizon spreads (time spreads), 283f interest rates, term structure, 201t public debt ownership, 201t yield curves, 204f Usury, defined, 242 Utilization ratio, 429 V Valuation See also Bonds; Stocks domestic economic influences, 288 financial environment (relationship), 287–289 global economic influences, 287–288 industry/competition, 288–289 principles, 274–276 Variable-rate mortgages, 203 Variance See also Portfolio computation, examples, 346t, 351–352 defined, 345 measures, 352–353 risk measure, 345–346 Velocity of money (VM), 125 defined, 38, 125 increase, 38–39 Venture capital, financing source, 570 Venture capitalists, rates of return (determination), 229 Vision, usage, 383 Volcker, Paul, 84, 85 Voluntary savings, defined, 175 W Wachovia Bank, purchase, 47 Walgreens arithmetic average annual rate of return, 344–345 asset management ratios, 432f balance sheet, 394t, 426t data, application, 347 DuPont analysis, 441t financial data, 458t financial leverage ratios, 435f historical variance, 346 income statement, 392t, 426t liquidity ratios, 428f market value ratios, 438f percent-of-sales balance sheets, 443t profitability ratios, 437f ratio analysis, summary, 439 returns distribution, 348t variance computation, 346t statement of cash flows, 398t stock prices, 344f Wall Street Journal, The, 149, 269 Warehouse receipt, defined, 513 War of 1812, inflation, 208 Washington Mutual, failure, 47 Weak-form efficient market, defined, 357 Weighted average cost of capital (WACC), 574–578 debt ratio, differences, 589f target weights, measurement, 574–576 usage, 574 635 Weighted average cost of capital (WACC), defined, 574 Welfare payments, 111 Wells Fargo Bank capital project, 525 mission, 383 Wildcat banking, 56 Window dressing, occurrence, 456 Working capital defined, 395, 491 financing, strategies, 491–495 management importance, 470 technology, relationship, 484–485 reduction, 455 requirements, 460–463 World Bank, defined, 132 World War I, inflation, 208 World War II, inflation, 208–209 Y Yankee bonds, defined, 260 Yearly operating cash flows, estimation, 562 Year 2000 (Y2K) problem, 185 Yield curve, 186f construction, U.S government securities (usage), 203 defined, 203 differentiation, 205 economy, relationship, 205 examples, 472f flat characteristic, 205 riding, 471 upward slope, 205 Yield to maturity (YTM), 571 calculation, 280–281 defined, 279 Z Zero-balance account, defined, 477 Zero-coupon bond, defined, 264 Zero-coupon bonds, interest (absence), 264–265 Zero-coupon securities, 283 WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley’s ebook EULA ... Jake Edgar A Norton EDITORIAL DIRECTOR EDITORIAL MANAGER SENIOR PRODUCTION EDITOR SENIOR CONTENT MANAGER DESIGNER ACQUISITIONS EDITOR DEVELOPMENT EDITOR EDITORIAL ASSISTANT DIRECTOR OF MARKETING... Introduction to Finance Markets, Investments, and Financial Management 16th Edition RONALD W MELICHER Professor of Finance University of Colorado at Boulder EDGAR A NORTON Professor of Finance. .. future courses can build Introduction to Finance is meant to be used in a course whose purpose is to survey the foundations of the finance discipline As such, it is designed to meet the needs of students