Finance

FRANK J. FABOZZI, PHD, CFA, CPA, is Professor in the Practice of Finance and Becton Fellow at Yale University's School of Management, Editor of the Journal of Portfolio Management, and Associate Editor of the Journal of Structured Finance and the Journal of Fixed Income. PAMELA PETERSON DRAKE, PHD, CFA, is the J. Gray Ferguson Professor of Finance and Department Head of Finance and Business Law at James Madison University.

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