Preface xiii
About the Authors xv
Part One Background 1
Chapter 1 What is Finance? 3
Capital Markets and Capital Market Theory 4
Financial Management 5
Investment Management 7
Summary 8
Chapter 2 Mathematics of Finance 11
The Importance of the Time Value of Money 11
Determining the Future Value 13
Determining the Present Value 20
Determining the Unknown Interest Rate 22
Determining the Number of Compounding Periods 23
The Time Value of a Series of Cash Flows 24
Valuing Cash Flows with Different Time Patterns 34
Loan Amortization 40
The Calculation of Interest Rates and Yields 46
Principles of Valuation 51
Summary 55
Chapter 3 Basics of Financial Analysis 57
Financial Ratio Analysis 58
Cash Flow Analysis 87
Usefulness of Cash Flows in Financial Analysis 99
Summary 105
Part Two Capital Markets and Capital Market Theory 109
Chapter 4 The Financial System 111
Financial Assets/Financial Instruments 111
Financial Markets 113
Financial Intermediaries 114
Regulators of Financial Actitivies 118
Classification of Financial Markets 122
Market Participants 131
Summary 150
References 154
Chapter 5 Interest Rate Determination and the Structure of Interest Rates 155
Theories About Interest Rate Determination 155
The Federal Reserve System and the Determination of Interest Rates 157
The Structure of Interest Rates 163
Term Structure of Interest Rates 168
Summary 178
References 179
Chapter 6 Basics of Derivatives 181
Futures and Forward Contracts 181
Options 194
Swaps 206
Cap and Floor Agreements 209
Summary 211
Appendix: Black-Scholes Option Pricing Model 212
References 219
Chapter 7 Asset Valuation: Basic Bond and Stock Valuation Models 221
Valuing Bonds 221
Valuation of Common Stock Using Dividend Discount Models 235
Summary 246
Appendix: Valuing Convertible Bonds 247
References 252
Chapter 8 Asset Valuation: The Theory of Asset Pricing 255
Characteristics of an Asset Pricing Model 255
Capital Asset Pricing Model 256
Arbitrage Pricing Theory Model 270
Summary 279
References 281
Part Three Financial Management 283
Chapter 9 Financial Management 285
Forms of Business Enterprise 286
The Objective of Financial Management 291
The Agency Relationship 296
Dividend and Dividend Policies 302
Special Considerations in International Financial Management 314
Summary 322
References 325
Chapter 10 Financial Strategy and Financial Planning 327
Strategy and Value 328
Financial Planning and Budgeting 331
Importance of Financial Planning 332
Budgeting Process 332
Sales Forecasting 334
Seasonal Considerations 337
Budgeting 338
Pro Forma Financial Statements 346
Long-Term Financial Planning 352
Financial Modeling 355
Performance Evaluation 362
Strategy and Value Creation 369
Summary 372
References 373
Chapter 11 The Corporate Financing Decision 375
Debt vs. Equity 375
The concept of leverage 378
Capital Structure and Financial Leverage 381
Financial Leverage and Risk 384
Capital Structure and Taxes 388
Capital Structure and Financial Distress 393
The Cost of Capital 397
The Agency Relationship and Capital Structure 399
Optimal Capital Structure: Theory and Practice 400
A Capital Structure Prescription 403
Summary 404
Appendix: Capital structure: Lessons from Modigliani and Miller 405
References 415
Chapter 12 Financial Engineering, Asset Securitization, and Project Financing 417
Creation of Structured Notes 419
Asset Securitization 427
Project Financing 438
Summary 446
References 448
Chapter 13 Capital Budgeting: Process and Cash Flow Estimation 449
Investment Decisions and Owners’ Wealth Maximization 450
Capital Budgeting Process 452
Classifying Investment Projects 454
Estimating Cash Flows of Capital Budgeting Projects 458
Summary 477
References 477
Chapter 14 Capital Budgeting Techniques 479
Evaluation Techniques 479
Net Present Value 481
Profitability Index 485
Internal Rate of Return 487
Modified Internal Rate of Return 491
Payback Period 495
Discounted Payback Period 496
Issues in Capital Budgeting 497
Comparing Techniques 500
Capital Budgeting Techniques in Practice 503
Capital Budgeting and the Justification of New Technology 504
Incorporating Risk into Capital Budgeting Analysis 506
Summary 523
References 524
Chapter 15 Managing Current Assets 525
Management of Cash and Marketable Securities 526
Cash Management 527
Marketable Securities 533
Management of Accounts Receivable 534
Inventory Management 545
Summary 553
References 554
Chapter 16 Financial Risk Management 555
Risk Defined 555
Enterprise Risk Management 558
Managing Risks 563
Risk Transfer 565
Summary 572
References 574
Part Four Investment Management 575
Chapter 17 The Basic Principles of Investment Management 577
The Investment Management Process 577
The Theory of Portfolio Selection 582
Tracking Error 604
Measuring and Evaluating Performance 607
Summary 622
References 624
Chapter 18 Equity Portfolio Management 625
Stock Market Indicators 625
Top-Down vs. Bottom-up Approaches 629
Fundamental vs. Technical Analysis 629
Popular Stock Market Strategies 631
Passive Strategies 643
Equity-Style Management 643
Types of Stock Market Structures 646
The U.S. Stock Markets: Exchanges and OTC Markets 649
Trading Mechanics 656
Summary 664
References 665
Chapter 19 Bond Portfolio Management 669
Sectors of the Bond Market 669
Features of Bonds 679
Yield Measures 686
Risks Associated with Investing in Bonds 693
Measuring Interest Rate Risk 702
Bond Indexes 710
Active Bond Portfolio Strategies 711
Passive Bond Portfolio Strategies 716
Summary 719
References 720
Chapter 20 Use of Stock Index Futures and Treasury Futures Contracts in
Portfolio Management 721
Using Stock Index Futures in Equity Portfolio Management 722
Using Treasury Bond and Note Futures Contracts in Bond Portfolio Management 736
Using Stock Index Futures and Treasury Bond Futures to Implement an Asset Allocation Decision 744
Summary 746
References 746
Chapter 21 Use of Options in Portfolio Management 747
Using Stock Options and Index Options in Equity Portfolio Management 747
Using Interest Rate Options in Bond Portfolio Management 761
Summary 771
Appendix: Pricing Models on Options on Physicals and Futures Options 771
References 773
Index 775
