Suggestions For Further Reading Wdn
Boyle, P. P., and D. Emanuel, Discretely Adjusted Option Hedges, Journal of Financial Economics, 8 1980 , 259-82. Dillman, S., and J. Harding, Life after Delta the Gamma Factor, Euromoney, Supplement February 1985 , pp. 14-17. Figlewski, S., Options Arbitrage in Imperfect Markets, Journal of Finance 44 December 1989 , 1289-1311. Galai, D., The Components of the Return from Hedging Options Against Stocks, Journal of Business, 56 January 1983 , 45-54. Hull, J., and A. White, Hedging the Risks...
Components Of A Financial Planning Model
A completed financial plan for a large company is a substantial document. A smaller corporation's plan would have the same elements but less detail. For the smallest, youngest businesses, financial plans may be entirely in the financial managers' heads. The basic elements of the plans will be similar, however, for firms of any size. Financial plans include three components inputs, the planning model, and outputs. The relationship among these components is represented in Figure 1.16. Let's look...
Pricing of Treasury Bonds
As mentioned earlier in the text, a Treasury bond pays semiannual interest over its life. In addition, the face value of the bond is paid at maturity. Consider a 20-year, 8-percent coupon bond that was issued on March 1. The first payment is to occur in six months, that is, on September 1. The value of the bond can be determined as 10In addition, since futures contracts are marked-to-the-market daily, gains and losses on the first contract must be settled each day over the first year. If oil...
Ranking Proposals
In ranking proposals, upper management will rely heavily on the recommendations made by managers who have a keen knowledge of their decision units. Quantitative and qualitative factors must be considered. A cost benefit analysis should be performed for each decision unit. The ranking of decision packages goes in the order of decreasing benefit. The manager must identify those products or services that are the most crucial. The highest priority should be assigned to the minimum increment of...
NPV Profiles
See Ch 07 Tool Kit.xls for A graph that plots a project's NPV against the cost of capital rates is defined as all calculations. the project's net present value profile profiles for Projects L and S are shown in Figure 7-4. To construct NPV profiles, first note that at a zero cost of capital, the NPV is simply the total of the project's undiscounted cash flows. Thus, at a zero cost of capital NPVS 300, and NPVL 400. These values are plotted as the vertical axis intercepts in Figure 7-4. Next, we...
Dividends versus Capital Gains What Do Investors Prefer
An excellent source of recent dividend news for major corporations is available at the web site of Corporate Financials Online at http www.cfonews. com scs. By clicking the down arrow of the News Category box to the left of the screen, students may select Dividends to receive a list of companies with dividend news. Click on any company, and you will see its latest dividend news. When deciding how much cash to distribute to stockholders, financial managers must keep in mind that the firm's...
How do firms assess the probability that a customer will pay
Credit analysis is the process of deciding which customers are likely to pay their bills. There are various sources of information your own experience with the customer, the experience of other creditors, the assessment of a credit agency, a check with the customer's bank, the market value of the customer's securities, and an analysis of the customer's financial statements. Firms that handle a large volume of credit information often use a formal system for combining the various sources into an...
Combining Complementary Resources
Many small firms are acquired by large firms that can provide the missing ingredients necessary for the firm's success. The small firm may have a unique product but lack the engineering and sales organization necessary to produce and market it on a large scale. The firm could develop engineering and sales talent from scratch, but it may be quicker and cheaper to merge with a firm that already has ample talent. The two firms have complementary resources each has what the other needs so it may...
Strategic Planning
Strategic plans are long-term, broad plans ranging from 2 to 30 years, with 5 to 10 years being most typical. Strategic planning is continuous and looks where the company is going. It is done by upper management and divisional managers. Most of the information used is external to the company. The strategic plan is the mission of the company and looks to existing and prospective products and markets. Strategic plans are designed to direct the company's activities, priorities, and goals. They try...
Questions And Problems Gaa
14.1. Which of the following can be estimated for an American option by constructing a single binomial tree delta, gamma, vega, theta, rho 14.2. Calculate the price of a 3-month American put option on a non-dividend-paying stock when the stock price is 60, the strike price is 60, the risk-free interest rate is 10 per annum, and the volatility is 45 per annum. Use a binomial tree with a time interval of 1 month. 14.3. Explain how the control variate technique is implemented when a tree is used...
Excess Capacity Adjustments
Consider again the MicroDrive example set forth in Tables 11-2 and 11-3, but now assume that excess capacity exists in fixed assets. Specifically, assume that fixed assets in 2002 were being utilized to only 96 percent of capacity. If fixed assets had been used to full capacity, 2002 sales could have been as high as 3,125 million versus the 3,000 million in actual sales This suggests that MicroDrive's target fixed assets sales ratio should be 32 percent rather than 33.3 percent Target fixed...
The Expected Return On Common Stock
Estimates Based on the Capital Asset Pricing Model. Earlier we showed you how to use the capital asset pricing model to estimate the expected rate of return on common stock. The capital asset pricing model tells us that investors demand a higher rate of return from stocks with high betas. The formula is Expected return risk-free stock's expected market on stock interest rate beta risk premium Financial managers and economists measure the risk-free rate of interest by the yield on Treasury...
The Value of Interest Tax Shields
In Table 19.1, we boldly assume that the firm can fully capture interest tax shields of .35 on every dollar of interest. We also treat the interest tax shields as safe cash inflows and discount them at a low 8 percent rate. The true present value of the tax shields is almost surely less than 576,000 You can't use tax shields unless you pay taxes, and you don't pay taxes unless you make money. Few firms can be sure that future profitability will be sufficient to use up the interest tax shields....
Motives for Merging
Firms merge to fulfill certain objectives. The overriding goal for merging is maximization of the owners' wealth as reflected in the acquirer's share price. More specific motives include growth or diversification, synergy, fund raising, increased managerial skill or technology, tax considerations, increased ownership liquidity, and defense against takeover. These motives should be pursued when they are believed to be consistent with owner wealth maximization. 'Companies that desire rapid growth...
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15.1 Flotation Costs. The L5 Corporation is considering an equity issue to finance a new space station. Atotal of 10 million in new equity is needed. If the direct costs are estimated at 6 percent of the amount raised, how large docs the issue need to be What is the dollar amount of the flotation cost Answer to Chapter Review and SeHF-Test Ps-o amp Benni 15.1 The firm needs to net 10 million after paying the 6 percent flotation costs. So the amount raised is given by Amount raised X .06 10...
Multinational Capital Budgeting
Up to now, we have discussed the general environment in which multinational firms operate. In the remainder of the chapter, we will see how international factors affect key corporate decisions. We begin with capital budgeting. Although the same basic principles of capital budgeting analysis apply to both foreign and domestic operations, there are some key differences. First, cash flow estimation is more complex for overseas investments. Most multinational firms set up separate subsidiaries in...
Going For Broke
The start of the new millennium has been a tough one for companies and their investors, creditors, and employees. Recently WorldCom, Enron, and Kmart all declared bankruptcy. WorldCom, for example, is the largest company ever to declare bankruptcy, with Enron and Kmart not far behind. Industries like telecom, retail, and steel are in serious financial difficulty. And the trend seems to be continuing. In 2000, 176 publicly traded companies filed for bankruptcy. In 2001, 257 companies did so. And...
Example 223 AlliedSignal Takes Over AMP
Poison pill Measure taken by a target firm to avoid acquisition for example, the right for existing shareholders to buy additional shares at an attractive price if a bidder acquires a large holding. AMP was the world's largest producer of cables for computers and other electronic equipment. Its performance had disappointed investors, and the company was widely viewed as ripe for change in operations and management. AlliedSignal believed that it could make these changes faster and better than...
Pricing American And Bermudan Bond Options In A Term Structure Model
By way of introducing arbitrage-free pricing, Chapter 9 described the pricing of European bond options. Basically, either 19.2 or 19.4 is used to determine the value of the option at expiration and then the standard tree methodology is used to determine the value of the option on FIGURE 19.3 Value of a 99-18.25 Straddle on the 5s of February 15, 2011, at Expiration FIGURE 19.3 Value of a 99-18.25 Straddle on the 5s of February 15, 2011, at Expiration earlier dates. This section, therefore,...
Cash Budget 1
The budget preparation process normally begins with the sales budget and continues through the preparation of pro forma financial statements. The last schedule prepared before the financial statements is the cash budget. The cash budget is a schedule of estimated cash collections and payments. The various operating budgets and the capital budget are inputs to the cash budgeting process. The cash budget is prepared for the purpose of cash planning and control. It presents the expected cash...
Analysis of Mixed Semivariable Costs
For forecasting, planning, and budgeting, mixed costs need to be separated into their variable and fixed components. Because the mixed costs contain both fixed and variable elements, the analysis takes this mathematical form, which is called a cost-volume formula or flexible budget formula Where Y the mixed cost to be broken up X any given measure of activity such as direct labor hours, machine hours, or production volume a the fixed cost component b the variable rate per unit of X Separating...
Budget Manual
A budget manual describes how a budget is to be prepared. Items usually included in a budget manual are a planning calendar and distribution instructions for all budget schedules. Distribution instructions are important because, once a sched- ule is prepared, other departments within the organization will use the schedule to prepare their own budgets. Without distribution instructions, someone who needs a particular schedule may be overlooked. The budget manual communicates throughout the...
Definition of Variables
Fundamental to the specification of a financial model is the definition of the variables to be included. Basically, the three types of variables are policy variables Z , external variables X , and performance variables Y . Policy variables often called control variables are those over which management can exert some degree of control. Examples of financial variables are cash management, working capital, debt management, depreciation, tax, merger-acquisition decisions, the rate and direction of...
Two Pragmatic Methods
A forecast of cash collections and potential write-offs of accounts receivable is essential in cash budgeting and in judging the appropriateness of current credit and discount policies. The critical step in making such a forecast is estimating the cash collection and bad debt percentages to be applied to sales or accounts receivable balances. This chapter discusses two pragmatic methods of estimating cash collection rates or payment proportions and illustrates how these rates are used for cash...
The Cash Budget
The cash budget shows the firm's projected cash inflows and outflows over some specified period. Generally, firms use a monthly cash budget forecasted over the next year, plus a more detailed daily or weekly cash budget for the coming month. The monthly cash budgets are used for planning purposes, and the daily or weekly budgets for actual cash control. The cash budget provides more detailed information concerning a firm's future cash flows than do the forecasted financial statements. In...
Discount Nominal Cash Flows by the Nominal Cost of Capital
The distinction between nominal and real cash flows and interest rates is crucial in capital budgeting. Interest rates are usually quoted in nominal terms. If you invest 100 in a bank deposit offering 6 percent interest, then the bank promises to pay you 106 at the end of the year. It makes no promises about what that 106 will buy. The real rate of interest on the bank deposit depends on inflation. If inflation is 2 percent, that 106 will buy you only 4 percent more goods at the end of the year...
Spreadsheet Problem Agc
Start with the partial model in the file Ch 16P18 Build a Model.xls from the textbook's web site. Helen Bowers, owner of Helen's Fashion Designs, is planning to request a line of credit from her bank. She has estimated the following sales forecasts for the firm for parts of 2003 and 2004 Collection estimates obtained from the credit and collection department are as follows collections within the month of sale, 10 percent collections the month following the sale, 75 percent collections the...
Capital Structure and Corporate Strategy
After reading this chapter you should be able to 1. Describe how a firm's financial situation is likely to affect its sales and its ability to attract employees and suppliers. 2. Understand how financial distress can benefit some firms by inducing employees, suppliers, and governments to make financial concessions to the firm. 3. Explain how a firm's financial condition affects the way its competitors price their products. 4. Describe how the past profitability of a firm affects its current...
Risk in a Portfolio Context
In the preceding section, we considered the risk of assets held in isolation. Now we analyze the risk of assets held in portfolios. As we shall see, an asset held as part of a portfolio is less risky than the same asset held in isolation. Accordingly, most financial assets are actually held as parts of portfolios. Banks, pension funds, insurance companies, mutual funds, and other financial institutions are required by law to hold diversified portfolios. Even individual investors at least those...
Interest rate Hamiltonian and option theory
The Hamiltonian is a differential operator that acts on an underlying state space To .1 A Hamiltonian formulation of option theory is discussed and shown to be equivalent to the Black-Scholes approach. In particular, it is shown that the Black-Scholes equation is mathematically identical to the imaginary time Schrodinger equation of quantum mechanics 7o . The Hamiltonian formulation of quantum field theory is equivalent to, and independent of, the framework based on the Feynman path integral...
Security Selection Categorization
Each index has published rules for security selection so that an investor can gain a working knowledge of how each index is maintained. Some index providers detail information on how their indexes are constructed. Other providers release woefully inadequate information about their methodology, so be prepared to dig deep for data. In general, the more complex the selection methodology, the less disclosure is provided about the selection rules. Index providers that use a passive security...
Appendix A
We show that for the economy laid out in Equations 3-6 , there is an equilibrium in which the risk-free rate is constant and given by -fy exP ysc - 5 y2 c gt and in which the price-dividend ratio is a constant , and satisfies exp gD - Ygc Od y1o1c - 2yocaDo . In this equilibrium, returns are therefore given by To see this, start from the Euler equations of optimality, obtained through the usual perturbation arguments, Computing the expectation in Equation 21 gives Equation 18 . We conjecture...
Appendix A Proof of the Thinning Algorithm
Consider the problem of generating samples of a counting process N t i gt 11 r lt t with possibly random intensity X s . This amounts to sampling jump times ti, i gt 1, from the knowledge of X s . The thinning method requires to 1 select X as an upper bound for X s on its domain 2 sample jump times t of a Poisson process N with constant intensity X 3 perform an acceptance-rejection test on each t , which consists of sampling the random variable 1 X Ui lt a. t. , where U U 0, 1 4 accept t as a...
Swiss Portfolio Bond
The Swiss portfolio bond, or insurance wrapper, is a customized variable endowment policy combining the benefits of offshore banking and investing to create a unique holding structure. The best jurisdictions for this type of structure are Switzerland and Liechtenstein. This device affords the best asset protection with Swiss bank secrecy and is the perfect umbrella under which to safely keep your banking and investments from the prying eyes of your government or anyone else while you quietly...
Admission of a New Partner
The admission of a new partner requires the approval of the existing partners, although a partner's interest may be assigned to someone outside the partnership without the consent of the other partners. However, assigning an interest does not dissolve the partnership, and it does not allow the assignee to participate in the management of the partnership or to review transactions and records of the partnership. The assignee receives only the agreed-upon portion of the assigning partner's profit...
Capital Structure Decisions
For updates on a company's ratio, go to http finance. yahoo.com, enter the ticker symbol for a stock quote, and select Profile after the quote comes up. Click on Ratio Comparisons on the left side of the Profile sheet for updates on the sector ratio. A company can obtain long-term financing in the form of equity, debt, or some combination. The accompanying table shows the long-term debt ratios for different business sectors and selected individual companies within those industries.1 There are...
Review Questions Tjy
1. What is binomial about the binomial model In other words, how does the model get its name 2. If a stock price moves in a manner consistent with the binomial model, what is the chance that the stock price will be the same for two periods in a row Explain. 3. Assume a stock price is 120 and in the next year it will either rise by 10 percent or fall by 20 percent. The risk-free interest rate is 6 percent. A call option on this stock has an exercise price of 130. What is the price of a call...
Limitations of cost accounting and traditional management accounting
Even in the industrial age, financial or general accounting was not sufficient to provide useful and relevant information for management. This led to the invention of cost accounting at the beginning of the 20th century, mainly in the 1920s. Its main purpose was to allocate expenses and costs - which up to then had only been reported on a total basis for the entire company through the general ledger - to single products and to allow management to calculate more adequately product costs and to...
Volatility 1
If Black-Scholes BS is the correct option pricing model, then there can only be one BS implied volatility regardless of the strike price of the option, or whether the option is a call or a put. BS implied volatility smile and skew are clear evidence that market option prices are not priced according to the BS formula. This raises the important question about the relationship between BS implied volatility and the true volatility. The BS option price is a positive function of the volatility of...
Stocks and Bonds as Options
How does the two-state option model work What is the formula for the Black-Scholes option-pricing model The previous material in this chapter described, explained, and valued publicly traded options. This is important material to any finance student because much trading occurs in these listed options. The study of options has another purpose for the student of corporate finance. You may have heard the one-liner about the elderly gentleman who was surprised to learn that he had been speaking...
The Taxation of Dividends and Capital Gains
Many of these attempts to measure the effect of dividends are of more historical than current interest, for they look back at the years before 1986 when there was a dramatic difference between the taxation of dividends and capital gains.36 Today, the tax rate on capital gains for most shareholders is 20 percent, while for taxable incomes above 65,550 the tax rate on dividends ranges from 30.5 to 39.1 percent.37 Tax law favors capital gains in another way. Taxes on dividends have to be paid...
Diversification
Diversification often is mentioned as a benefit of one firm acquiring another. Earlier in this chapter, we noted that U.S. Steel included diversification as a benefit in its acquisition of Marathon Oil. In 1982 U.S. Steel was a cash-rich company over 20 percent of its assets were in the form of cash and marketable securities . It is not uncommon to see firms with surplus cash articulating a need for diversification. However, we argue that diversification, by itself, cannot produce increases in...
Minicase US Steels Acquisition of Marathon Oil
In the summer of 1981, Marathon Oil Company commissioned the First Boston Corporation to prepare an analysis of the underlying asset value of Marathon based solely on publicly available information. Before First Boston could complete the study, Mobil Corporation announced a tender offer for Marathon's common equity, thus launching one of the most eventful takeover stories in American corporate history. Ross-Westerfield-Jaffe VIII. Special Topics On October 30,1981, Mobil bid 85 per share for up...
Summary and Conclusions Juf
Earlier chapters of this text showed how to calculate net present value for projects of all-equity firms. We pointed out in the last two chapters that the introduction of taxes and bankruptcy costs changes a firm's financing decisions. Rational corporations should employ some debt in a world of this type. Because of the benefits and costs associated with debt, the Ross-Westerfield-Jaffe I IV. Capital Structure and I 17. Valuation and Capital I I The McGraw-Hill Corporate Finance, Sixth Dividend...
The Return and Risk for Portfolios
Suppose that an investor has estimates of the expected returns and standard deviations on individual securities and the correlations between securities. How then does the investor choose the best combination or portfolio of securities to hold Obviously, the investor would like a portfolio with a high expected return and a low standard deviation of return. It is therefore worthwhile to consider Ross-Westerfield-Jaffe I III. Risk I 10. Return and Risk The I I The McGraw-Hill Figure 10.1 Examples...
Cpt Pv
Because the bonds make semiannual payments, we must halve the coupon payment 8.25 2 4.125 gt 41.25 . halve the YTM 7.10 - 2 gt 3,55 , and double the number of periods 10 years remaining X 2 20 periods . Then, the current bond price is S1,08 .35. Vasicek Co. has 12.5 percent coupon bonds on She market with eight years left to maturity. The bonds make annua payments. If one of these bonds currently sells for 1,145.68. what is its YTM
Investment
Because bond prices fall when market interest rates rise and rise when market rates fall, the rate of return that you earn on a bond also will fluctuate with market interest rates. This is why we say bonds are subject to interest rate risk. Do not confuse the bond's rate of return over a particular investment period with its yield to maturity. The yield to maturity is defined as the discount rate that equates the bond's price to the present value of all its promised cash flows. It is a measure...
Organizational Structure
One of the most challenging tasks of a business may be organizing the people who perform its work. A business may begin with one person doing all the necessary tasks. As the business becomes successful and grows, however, there is generally more work, and more people are needed to perform various tasks. Through this division of work, individuals can become specialists at a specific job. Because there are several people often in different locations working toward a common objective, there must...
Foreign Corrupt Practices Act Of 1977
The Foreign Corrupt Practices Act of 1977 FCPA evolved from investigations by the Office of the Special Prosecutor that provided evidence of illegal acts perpetrated by U.S. firms in foreign lands. More than 400 U.S. companies admitted to making questionable payments to various foreign governments and political parties as part of an amnesty program U.S. Department of Justice http www.usdoj.gov . Given the environment of the 1970s and the proliferation of white-collar crimes e.g., insider...
Info Yxz 1
Firm Value Market Value of Equity Book Value of Debt Firm Value Market Value of Equity Book Value of Debt Once these data have been collected, we can then estimate the sensitivity of firm value to changes in the macroeconomic variables by regressing changes in firm value each year against changes in each of the individual variables. I. Sensitivity to changes in interest rates As we discussed earlier, the duration of a firm's projects provides useful information for determining the maturity of...
