Introduction to Finance: Markets, Investments, and Financial Management, 16th Edition PDF by Edgar Norton and Ronald Melicher

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Introduction to Finance: Markets, Investments, and Financial Management, 16th Edition
by Edgar Norton and Ronald Melicher
Introduction to Finance: Markets, Investments, and Financial Management, 16th Edition
Contents

Part 1 Institutions and Markets 1
1 The Financial Environment 3
1.1 What Is Finance? 4
Two Themes 5
1.2 Why Study Finance? 6
1.3 Six Principles of Finance 8
Time Value of Money 8
Risk Versus Return 8
Diversification of Risk 8
Financial Markets Are Eff icient 9
Management Versus Owner Objectives 10
Reputation Matters 10
1.4 Overview of the Financial System 11
Characteristics and Requirements 11
Financial System Components and Financial
Functions 12
Creating Money 13
Transferring Money 13
Accumulating Savings 13
Lending and Investing Savings 13
Marketing Financial Assets 13
Transferring Financial Assets 14
1.5 Financial Markets: Characteristics
and Types 14
Money and Capital Markets 14
Primary and Secondary Markets 15
Major Types of Financial Markets 15
1.6 Careers in Finance 16
1.7 The Plan of Study 18
Applying Finance To... 19
Summary 19
Key Terms 19
Review Questions 19
Exercises 20
2 Money and the Monetary System 21
2.1 The 2007–2008 Financial Crisis 22
2.2 Process of Moving Savings Into Investments 23
2.3 Overview of the Monetary System 25
2.4 Importance and Functions of Money 26
2.5 Development of Money in the United
States 28
Physical Money (Coin and Paper Currency) 28
Credit Money and Deposit Money 32
2.6 Money Market Securities 33
2.7 Measures of the U.S. Money Supply 35
M1 Money Supply 35
M2 Money Supply 36
Exclusions from the Money Supply 37
2.8 Money Supply and Economic Activity 37
2.9 International Monetary System 39
Applying Finance To... 40
Summary 41
Key Terms 42
Review Questions 42
Exercises 42
Problems 43
3 Banks and Other Financial
Institutions 45
3.1 Financial Institution Problems During the
Financial Crisis 46
3.2 Types and Roles of Financial Institutions 47
Depository Institutions 48
Contractual Savings Organizations 49
Securities Firms 50
Finance Firms 51
3.3 Overview of the Banking System 51
Commercial, Investment, and Universal Banking 51
Functions of Banks and the Banking System 53
3.4 Historical Development of the U.S. Banking
System 54
Before the Civil War 55
Entry of Thrift Institutions 56
3.5 Regulation of the Banking System 56
General Banking Legislation 57
The Savings and Loan Crisis 59
Protection of Depositors’ Funds 60
3.6 Structure of Banks 61
Bank Charters 61
Degree of Branch Banking 61
Bank Holding Companies 62
3.7 The Bank Balance Sheet 62
Assets 63
Liabilities and Stockholders’ Equity 65
3.8 Bank Management 67
Liquidity Management 67
Capital Management 69
3.9 International Banking and Foreign
Systems 71
Applying Finance To... 72
Summary 72
Key Terms 73
Review Questions 73
Exercises 74
Problems 74
4 Federal Reserve System 76
4.1 U.S. Central Bank Response to the Financial
Crisis and Great Recession 77
4.2 The U.S. Banking System Prior to the Fed 78
Weaknesses of the National Banking System 79
The Movement to Central Banking 80
4.3 Structure of the Federal Reserve System 80
Member Banks 80
Federal Reserve District Banks 82
Board of Governors 83
Federal Open Market Committee 84
Advisory Committees 84
Role of the Chair of the Fed Board of Governors 84
4.4 Monetary Policy Functions and Instruments 86
Overview of Responsibilities 86
Reserve Requirements 87
Discount Rate Policy 89
Open-Market Operations 90
Quantitative Easing 91
Implementation of Monetary Policy 92
4.5 Fed Supervisory and Regulatory Functions 93
Specific Supervisory Responsibilities 93
Specific Regulatory Responsibilities 94
4.6 Fed Service Functions 95
The Payments Mechanism 95
Transfer of Credit 97
Other Service Activities 97
4.7 Central Banks in Other Countries 98
Applying Finance To... 98
Summary 99
Key Terms 99
Review Questions 99
Exercises 100
Problems 100
5 Policy Makers and the Money
Supply 102
5.1 National Economic Policy Objectives 103
Economic Growth 104
High Employment 104
Price Stability 105
Domestic and International Implications 105
5.2 Four Policy Maker Groups 105
Ethical Behavior in Government 106
Policy Makers in the European Economic Union 106
5.3 Government Influence on the Economy 107
Government Reaction to the Perfect Financial Storm 108
5.4 Treasury Cash and General Management
Responsibilities 109
Managing the Treasury’s Cash Balances 110
Powers Relating to the Federal Budget and to Surpluses
or Deficits 110
Recent Financial Crisis Related Activities 112
5.5 Treasury Deficit Financing and Debt Management
Responsibilities 113
5.6 Changing the Money Supply 115
Checkable Deposit Expansion 115
Off setting or Limiting Factors 119
Contraction of Deposits 120
5.7 Factors Aff ecting Bank Reserves 121
Changes in the Demand for Currency 121
Federal Reserve System Transactions 122
5.8 The Monetary Base and the Money Multiplier 124
Applying Finance To... 126
Summary 126
Key Terms 127
Review Questions 127
Exercises 128
Problems 128
6 International Finance
and Trade 130
6.1 International Monetary System 131
Development of International Finance 131
How the International Monetary System Evolved 132
6.2 European Unification 133
European Union 133
Eurozone Members 134
The Euro 134
European Union Financial Crises 134
6.3 Currency Exchange Markets and Rates 135
Currency Exchange Markets 135
Exchange Rate Quotations 136
Currency Exchange Rate Appreciation and
Depreciation 137
6.4 Factors that Aff ect Currency Exchange Rates 138
Arbitrage 141
6.5 Conducting Business Internationally 142
Exchange Rate Developments for the U.S. Dollar 142
Managing Currency Exchange Risk 143
Ethical Considerations 144
6.6 Financing International Trade 145
Financing by the Exporter 145
Financing by the Importer 147
Banker’s Acceptance 149
Other Aids to International Trade 150
6.7 Developments in U.S. International Transactions 151
International Business Issues 151
Balance-of-Payments Accounts 151
Applying Finance To... 154
Summary 154
Key Terms 154
Review Questions 155
Exercises 155
Problems 156
6.8 Exchange Rate Risks in Global Business 158
Hedging Cash Flows 159
Speculating or Taking Educated Guesses on Exchange
Rate Movements 160
Where to Invest? 161
Summary 162
Review Questions 162
 
Part 2 Investments 163
7 Savings and Investment
Process 165
7.1 Gross Domestic Product and Capital
Formation 166
GDP Components 167
Implications of International Payment
Imbalances 168
Saving and Investment 169
7.2 Federal Government Receipts and
Expenditures 171
The Budget 171
Fiscal Policy Makers 171
Debt Financing 172
7.3 Role and Major Sources of Savings 173
Historical Sources 173
Creation of Savings 174
Personal Savings 174
Corporate Savings 176
7.4 Factors Aff ecting Savings 177
Levels of Income 178
Economic Expectations 178
Economic Cycles 179
Life Stages of the Individual Saver 179
Life Stages of the Corporation and Other Business
Firms 180
7.5 Capital Market Securities 181
7.6 Mortgage Markets 182
Types of Mortgages and Mortgage-Backed
Securities 183
Credit Ratings and Scores 184
Major Participants in the Secondary Mortgage
Markets 184
7.7 Role of the Individual in the 2007–08 Financial
Crisis 185
Early Factors 185
A Borrowing-Related Cultural Shift 185
Applying Finance To... 186
Summary 186
Key Terms 187
Review Questions 187
Exercises 188
Problems 188
8 Interest Rates 190
8.1 Supply and Demand for Loanable Funds 191
Historical Changes in U.S. Interest Rate Levels 193
Loanable Funds Theory 194
8.2 Components of Market Interest Rates 197
8.3 Default Risk-Free Securities: U.S. Treasury Debt
Instruments 198
Marketable Obligations 198
Dealer System 200
Tax Status of Federal Obligations 200
Ownership of Public Debt Securities 200
Maturity Distribution of Marketable Debt
Securities 202
8.4 Term or Maturity Structure of Interest Rates 203
Relationship Between Yield Curves and the
Economy 205
Term Structure Theories 205
8.5 Inflation Premiums and Price Movements 207
Historical International Price Movements 207
Inflation in the United States 208
Types of Inflation 210
8.6 Default Risk Premiums 212
Applying Finance To... 214
Summary 214
Key Terms 215
Review Questions 215
Exercises 216
Problems 216
9 Time Value of Money 218
9.1 Basic Time Value Concepts 219
9.2 Compounding to Determine Future Values 221
Inflation or Purchasing Power Implications 225
9.3 Discounting to Determine Present Values 225
Equating Present Values and Future Values 228
9.4 Finding Interest Rates and Time
Requirements 230
Solving for Interest Rates 230
Solving for Time Periods 231
Rule of 72 231
9.5 Future Value of an Annuity 232
9.6 Present Value of an Annuity 235
9.7 Interest Rates and Time Requirements for
Annuities 237
Solving for Interest Rates 237
Solving for Time Periods 238
9.8 Determining Periodic Annuity Payments 239
Examples Involving Annual Payments 239
Real Estate Mortgage Loans with Monthly Payments 240
9.9 More Frequent Time Intervals and The Cost of
Consumer Credit 241
More Frequent Than Annual Compounding or
Discounting 241
Cost of Consumer Credit 242
Applying Finance To... 244
Summary 244
Key Terms 245
Review Questions 245
Exercises 245
Problems 246
9.10 Annuity Due Problems 248
Future Value of an Annuity Due 248
Present Value of an Annuity Due 249
Interest Rates and Time Requirements for Annuity
Due Problems 250
Summary 251
Questions and Problems 251
10 Bonds and Stocks: Characteristics
and Valuations 252
10.1 Long-Term External Financing Sources for
Businesses 253
10.2 Bonds 255
Who Buys Bonds? 256
Bond Covenants 257
Bond Ratings 257
Global Bond Market 259
Reading Bond Quotes 260
10.3 Diff erent Types of Bonds 262
Time to Maturity 263
Income From Bonds 264
10.4 Corporate Equity Capital 266
Common Stock 266
Preferred Stock 268
Reading Stock Quotes 269
10.5 Dividends and Stock Repurchases 270
How Do Firms Decide on the Dollar Amount of
Dividends? 271
Stock Dividends and Stock Splits 272
Share Repurchases 273
10.6 Valuation Principles 274
10.7 Valuation of Bonds 276
Determining a Bond’s Present Value 277
Calculating the Yield to Maturity 279
Risk in Bond Valuation 281
Interest Rate Risk 282
10.8 Valuation of Stocks 284
Valuing Stocks with Constant Dividends 285
Valuing Stocks with Constant Dividend Growth Rates 285
Risk in Stock Valuation 287
Valuation and the Financial Environment 287
Global Economic Influences 287
Domestic Economic Influences 288
Industry and Competition 288
Applying Finance To... 289
Summary 289
Key Terms 290
Review Questions 290
Problems 291
10.9 Holding Period Returns 295
Annualized Rates of Return 295
Summary 297
Problems 297
11 Securities and Markets 298
11.1 Issuing Securities: Primary Securities
Markets 299
Primary Market Functions of Investment Bankers 299
11.2 The Facebook IPO 303
11.3 Other Ways to Assist Issuing Firms 306
Shelf Registration 306
Sell Securities to a Private Party 306
Rights Off erings 306
Competitive Bidding 307
11.4 Cost of Going Public 308
11.5 Investment Banking Firms: Other Functions,
Innovations, Regulations 312
Investment Banking Regulation 312
Innovations among Investment Banking Firms 313
11.6 Trading Securities—Secondary Securities
Markets 314
Organized Security Exchanges 314
Structure of The New York Stock Exchange 315
11.7 Security Transactions 317
Market Order 317
Limit Order 317
Stop-Loss Order 317
Short Sale 318
Buying on Margin 318
Record Keeping 319
Program Trading 320
11.8 Over-The-Counter Market 320
Third and Fourth Security Markets 321
High Frequency Trading 321
11.9 What Makes a Good Market? 322
A Word on Commissions 324
11.10 Security Market Indexes and Trading Foreign
Securities 324
Indexes 324
Foreign Securities 326
11.11 Inside Information and Other Ethical Issues 327
Ethics and Job Opportunities in Investments 328
Applying Finance To... 330
Summary 330
Key Terms 331
Review Questions 331
Problems 332
11.12 Why Do Derivatives Exist? 334
Futures Contracts 335
Options 336
Option Profit/Loss Diagrams 339
Summary 341
Key Terms 341
Discussion Questions 341
Problems 341
12 Financial Return and Risk
Concepts 342
12.1 Historical Return for a Single Financial Asset 343
Arithmetic Average Annual Rates of Return 344
12.2 Historical Risk Measures for a Single Financial
Asset 345
Standard Deviation as a Measure of Risk 346
12.3 Where Does Risk Come From? 348
12.4 Expected Measures of Return and Risk 350
12.5 Historical Returns and Risk of Diff erent Assets 354
12.6 Eff icient Capital Markets 355
12.7 Portfolio Returns 358
Expected Return on a Portfolio 359
12.8 Variance and Standard Deviation of Return on a
Portfolio 359
To Diversify or Not to Diversify? 361
12.9 Portfolio Risk and the Number of Investments
in the Portfolio 362
Systematic and Unsystematic Risk 363
12.10 Capital Asset Pricing Model 364
Applying Finance To... 368
Summary 368
Key Terms 369
Review Questions 369
Problems 370
12.11A Estimating Beta 373
12.11B Security Market Line 375
Summary 376
Problems 376
 
Part 3 Financial Management 379
13 Business Organization and
Financial Data 381
13.1 Starting a Business 382
Strategic Plan with a Vision or Mission 383
Business and Financial Goals 383
13.2 Forms of Business Organization in the United
States 384
Proprietorship 384
Partnership 386
Corporation 387
13.3 Accounting Principles 389
The Annual Report 391
13.4 Income Statement 391
13.5 The Balance Sheet 393
Assets 394
Liabilities 395
Owners’ Equity 396
13.6 Statement of Cash Flows 396
13.7 Financial Statements of Diff erent Companies 399
Common-Size Financial Statements 399
The Auto Bailout and Financial Statements 400
13.8 Goal of a Firm 402
Measuring Shareholder Wealth 402
Linking Strategy and Financial Plans 404
Criterion for Nonpublic Firms 404
What About Ethics? 404
13.9 Corporate Governance 405
Principal-Agent Problem 406
Reducing Agency Problems 407
13.10 Finance in the Organization Chart 409
Applying Finance To... 411
Summary 411
Key Terms 412
Review Questions 412
Problems 413
13.11A Income Tax 417
13.11B Depreciation Basics 419
A Few Words on Depreciation Methods 420
Summary 421
Review Questions and Problems 421
14 Financial Analysis and Long-Term
Financial Planning 422
14.1 Financial Statement Analysis 423
Ratio Analysis of Balance Sheet and Income
Statement 424
Types of Financial Ratios 425
14.2 Liquidity Ratios and Analysis 427
14.3 Asset Management Ratios and Analysis 429
14.4 Financial Leverage Ratios and Analysis 432
14.5 Profitability Ratios and Analysis 435
14.6 Market Value Ratios and Analysis 437
Summary of Ratio Analysis for Walgreens 439
14.7 DuPont Method of Ratio Analysis 440
14.8 Long-Term Financial Planning 442
Percentage of Sales Technique 442
Asset Investment Requirements 443
14.9 Cost-Volume-Profit Analysis 445
14.10 Degree of Operating Leverage 446
Applying Finance To... 448
Summary 449
Key Terms 450
Review Questions 450
Problems 450
15 Managing Working Capital 454
15.1 Importance of Working Capital 455
15.2 Operating and Cash Conversion Cycles 457
Operating Cycle 457
Cash Conversion Cycle 457
Determining the Length of the Operating Cycle and
Cash Conversion Cycle 458
15.3 Investments in Receivables, Inventory,
and Payable Financing 460
15.4 Cash Budgets 463
Minimum Desired Cash Balance 463
Estimated Cash Inflows 464
Estimated Cash Outflows 465
Constructing the Cash Budget 465
Seasonal Versus Level Production 466
15.5 Management of Current Assets 468
Cash Management 468
Marketable Securities 470
15.6 Getting—and Keeping—the Cash 476
15.7 Accounts Receivable Management 479
Credit Analysis 479
Credit-Reporting Agencies 479
Credit Terms and Collection Eff orts 481
15.8 Inventory Management 482
15.9 Technology and Working Capital
Management 484
Cash Management 484
Processing Invoices and Float 484
Tracking Inventory 485
Applying Finance To... 485
Summary 485
Key Terms 486
Review Questions 486
Problems 487
16 Short-Term Business Financing 490
16.1 Strategies for Financing Working Capital 491
Maturity-Matching Approach 492
Aggressive Approach 493
Conservative Approach 494
16.2 Factors Aff ecting Short-Term Financing 495
Operating Characteristics 495
Other Influences in Short-Term Financing 498
16.3 Providers of Short-Term Financing 499
Bank Lines of Credit 499
Computing Interest Rates 501
Revolving Credit Agreements 501
Small Business Administration 502
16.4 Nonbank Short-Term Financing Sources 504
Trade Credit from Suppliers 504
Commercial Finance Companies 505
Commercial Paper 506
16.5 Additional Varieties of Short-Term
Financing 508
Accounts Receivable Financing 508
Acceptances 511
16.6 Inventory Financing and Other Secured
Loans 512
Inventory Loans 513
Loans Secured by Stocks and Bonds 514
Other Forms of Security for Loans 514
16.7 The Cost of Short-Term Financing 515
Applying Finance To... 515
Summary 516
Key Terms 516
Review Questions 517
Problems 517
17 Capital Budgeting Analysis 520
17.1 Mission, Vision, and Capital Budgeting 521
Identifying Potential Capital Budget Projects 522
17.2 Capital Budgeting Process 524
17.3 Capital Budgeting Techniques—Net Present
Value 527
Using Spreadsheet Functions 530
17.4 Capital Budgeting Techniques—Internal Rate
of Return 530
NPV and IRR 534
17.5 Capital Budgeting Techniques—Modified Internal
Rate of Return 535
17.6 Capital Budgeting Techniques—Profitability
Index 536
17.7 Capital Budgeting Techniques—Payback
Period 537
17.8 Conflicts Between Discounted Cash Flow
Techniques 538
Diff erent Cash Flow Patterns 538
Diff erent Time Horizons 538
Diff erent Sizes 539
Diff erence Between Theory and Practice 539
17.9 Estimating Project Cash Flows 540
Isolating Project Cash Flows 540
Approaches to Estimating Project Cash Flows 542
17.10 Keeping Managers Honest 546
17.11 Risk-Related Considerations 547
Applying Finance To... 549
Summary 549
Key Terms 550
Review Questions 550
Problems 551
17.12 Project Stages and Cash Flow Estimation 554
Initial Outlay 554
Cash Flows During the Project’s Operating Life 555
Salvage Value and NWC Recovery at Project
Termination 555
17.13 Applications 556
Cash Flow Estimation for a Revenue Expanding
Project 556
Cash Flow Estimation for a Cost-Saving Project 558
Setting a Bid Price 561
Summary 563
Review Questions 563
Problems 563
18 Capital Structure and The Cost of
Capital 565
18.1 Why Choose a Capital Structure? 566
Trends in Corporate Use of Debt 567
Cashing in on Low Interest Rates 568
18.2 Required Rate of Return and The Cost of
Capital 569
18.3 Cost of Capital 571
Cost of Debt 571
Cost of Preferred Stock 572
Cost of Common Equity 572
Cost of New Common Stock 573
18.4 Weighted Average Cost of Capital 574
Capital Structure Weights 574
Measuring The Target Weights 574
What Do Businesses Use as Their Cost of Capital? 576
Diff iculty of Making Capital Structure Decisions 578
18.5 Planning Growth Rates 579
Internal Growth Rate 579
Sustainable Growth Rate 580
Eff ects of Unexpectedly Higher (or Lower) Growth 581
18.6 EBIT/Eps Analysis 582
Indiff erence Level 582
Implications of EBIT/Eps Analysis 583
18.7 Combined Operating and Financial Leverage
Eff ects 584
Unit Volume Variability 585
Price-Variable Cost Margin 585
Fixed Costs 585
Degree of Financial Leverage 586
Total Risk 586
18.8 Insights From Theory and Practice 588
Taxes and Nondebt Tax Shields 588
Bankruptcy Costs 588
Agency Costs 590
A Firm’s Assets and Its Financing Policy 590
The Pecking Order Hypothesis 591
Market Timing 591
Beyond Debt and Equity 592
Guidelines for Financing Strategy 592
Applying Finance To... 594
Summary 594
Key Terms 595
Review Questions 595
Problems 596
APPENDIX 599
GLOSSARY 609
INDEX 619

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