Description
Find a company that is within the United States. I choose DollsKill, a fashion retail company.Find the last three years of financial statements. Define who the company is, what they do, and then forecast the financials for the organization to 2030. What policies would need to change financially? What would be different for cash flow and budget? With forecasting, you will need to use NPV, FV, and more. Show your work and define clearly how you used the equations and came up with the data that you have. Essential Activities: Reading Chapter 6, 12, 14 and 15 in the text will assist you. (textbook attached)Watching the video Budgets (4:27 minutes) (LO1) (LO2)(LO3)(LO4) will assist you with this paper.This assignment should be no less than 4 pages, not including title and references. 3 or more reference are required.This paper must be formatted in APA Style 7th edition.Be very detailed in your explanation. Please make it not detected as AI writing.
Unformatted Attachment Preview
Final PDF to printer
finance
applications & theory
cor01589_fm_i-1.indd i
10/09/21 03:03 PM
Final PDF to printer
The McGraw-Hill Series in Finance, Insurance and Real Estate
FINANCIAL MANAGEMENT
Block, Hirt, and Danielsen
Foundations of Financial Management
Eighteenth Edition
Brealey, Myers, and Allen
Principles of Corporate Finance
Fourteenth Edition
Brealey, Myers, and Marcus
Fundamentals of Corporate Finance
Eleventh Edition
Brooks
FinGame Online 5.0
Bruner
Case Studies in Finance: Managing
for Corporate Value Creation
Eighth Edition
Cornett, Adair, and Nofsinger
Finance: Applications and Theory
Sixth Edition
Cornett, Adair, and Nofsinger
M: Finance
Fifth Edition
DeMello
Cases in Finance
Third Edition
Higgins
Analysis for Financial Management
Thirteenth Edition
Ross, Westerfield, Jaffe, and Jordan
Corporate Finance
Thirteenth Edition
Ross, Westerfield, Jaffe, and Jordan
Corporate Finance: Core Principles and
Applications
Sixth Edition
Ross, Westerfield, and Jordan
Essentials of Corporate Finance
Eleventh Edition
cor01589_fm_i-1.indd ii
Ross, Westerfield, and Jordan
Fundamentals of Corporate Finance
Thirteenth Edition
Shefrin
Behavioral Corporate Finance: Concepts and
Cases for Teaching Behavioral Finance
Second Edition
INVESTMENTS
Bodie, Kane, and Marcus
Essentials of Investments
Twelfth Edition
Bodie, Kane, and Marcus
Investments
Twelfth Edition
INTERNATIONAL FINANCE
Eun and Resnick
International Financial Management
Ninth Edition
REAL ESTATE
Brueggeman and Fisher
Real Estate Finance and Investments
Seventeenth Edition
Ling and Archer
Real Estate Principles: A Value Approach
Fifth Edition
FINANCIAL PLANNING AND
INSURANCE
Jordan, Miller, and Dolvin
Fundamentals of Investments: Valuation and
Management
Ninth Edition
Allen, Melone, Rosenbloom, and Mahoney
Retirement Plans: 401(k)s, IRAs, and Other
Deferred Compensation Approaches
Eleventh Edition
Sundaram and Das
Derivatives: Principles and Practice
Second Edition
Altfest
Personal Financial Planning
Second Edition
FINANCIAL INSTITUTIONS AND
MARKETS
Kapoor, Dlabay, and Hughes
Focus on Personal Finance: An Active
Approach to Help You Develop Successful
Financial Skills
Seventh Edition
Rose and Hudgins
Bank Management and Financial Services
Ninth Edition
Rose and Marquis
Financial Institutions and Markets
Eleventh Edition
Saunders and Cornett
Financial Institutions Management: A Risk
Management Approach
Tenth Edition
Kapoor, Dlabay, and Hughes
Personal Finance
Fourteenth Edition
Walker and Walker
Personal Finance: Building Your Future
Second Edition
Saunders and Cornett
Financial Markets and Institutions
Eighth Edition
10/09/21 03:03 PM
Final PDF to printer
finance
applications & theory
sixth edition
Marcia Millon Cornett
Bentley University
Troy A. Adair Jr.
Lehigh University
John Nofsinger
University of Alaska Anchorage
cor01589_fm_i-1.indd iii
10/09/21 03:03 PM
Final PDF to printer
FINANCE: APPLICATIONS AND THEORY, SIXTH EDITION
Published by McGraw Hill LLC, 1325 Avenue of the Americas, New York, NY 10019. Copyright ©2023 by McGraw
Hill LLC. All rights reserved. Printed in the United States of America. Previous editions ©2020, 2018, and 2015.
No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or
retrieval system, without the prior written consent of McGraw Hill LLC, including, but not limited to, in any network
or other electronic storage or transmission, or broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to customers outside the United
States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 LWI 27 26 25 24 23 22
ISBN 978-1-264-10158-0 (bound edition)
MHID 1-264-10158-9 (bound edition)
ISBN 978-1-266-49456-7 (loose-leaf edition)
MHID 1-266-49456-1 (loose-leaf edition)
Portfolio Director: Charles Synovec
Senior Product Developer: Christina Kouvelis
Executive Marketing Manager: Trina Maurer
Lead Content Project Managers: Ann Courtney (core) and Jamie Koch (assessment)
Buyer: Susan K. Culbertson
Design: Beth Blech
Content Licensing Specialist: Jacob Sullivan
Cover Image: ©Shutterstock/Lucky Team Studio
Compositor: Straive
All credits appearing on page are considered to be an extension of the copyright page.
Library of Congress Cataloging-in-Publication Data
Names: Cornett, Marcia Millon, author. | Adair, Troy A. (Troy Alton), 1964author. | Nofsinger, John R., author.
Title: Finance : applications & theory / Marcia Millon Cornett, Bentley
University, Troy A. Adair, Jr., Lehigh University, John Nofsinger,
University of Alaska Anchorage.
Description: Sixth edition. | New York, NY : McGraw Hill, [2023] | Series:
The McGraw-Hill education series in finance, insurance, and real estate
| Includes index.
Identifiers: LCCN 2021045971 | ISBN 9781264101580 (hardcover)
Subjects: LCSH: Finance.
Classification: LCC HG173 .C679 2023 | DDC 332–dc23
LC record available at https://lccn.loc.gov/2021045971
The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not
indicate an endorsement by the authors or McGraw Hill, and McGraw Hill does not guarantee the accuracy of the
information presented at these sites.
mheducation.com/highered
cor01589_fm_i-1.indd iv
10/09/21 03:03 PM
Final PDF to printer
dedicated
to my parents, Tom and Sue—Marcia Millon Cornett
to Max, my son and my inspiration—Troy A. Adair Jr.
to Anna, my wife and best friend—John Nofsinger
cor01589_fm_i-1.indd v
10/09/21 03:03 PM
Final PDF to printer
about the authors
Marcia Millon Cornett Robert A. and Julia E. Dorn Professor of Finance at Bentley
Courtesy of Marcia
Millon Cornett
University. She received her BS degree in economics from Knox College in Galesburg,
Illinois, and her MBA and PhD degrees in finance from Indiana University in Bloomington, Indiana. Dr. Cornett has written and published several articles in the areas of bank
performance, bank regulation, corporate finance, and investments. Articles authored by
Dr. Cornett have appeared in such academic journals as the Journal of Finance; Journal of
Money, Credit, and Banking; Journal of Financial Economics; Financial Management;
and Journal of Banking and Finance. She was recently ranked the 124th most published
out of more than 17,600 authors and the number five female author in finance literature over the last 50 years. Along with Anthony Saunders and Otgontsetseg Erhemjamts,
Dr. Cornett has recently completed work on the tenth edition of Financial Institutions
Management (McGraw Hill Education) and the seventh edition of Financial Markets
and Institutions (McGraw Hill Education). Professor Cornett serves as an associate editor for the Journal of Banking and Finance, Journal of Financial Services Research,
Review of Financial Economics, Financial Review, and Multinational Finance Journal.
Dr. Cornett has served as a member of the board of directors, the executive committee,
and the finance committee of the SIU Credit Union. Dr. Cornett has also taught at Southern Illinois University at Carbondale, the University of Colorado, Boston College, and
Southern Methodist University. She is a member of the Financial Management Association, the American Finance Association, and the Western Finance Association.
Troy Alton Adair Jr. Professor of Practice at Lehigh University and Founder and CEO
Courtesy of Troy
Alton Adair Jr
of dataDicts, Inc. He received his BS degree in computers/information science from the
University of Alabama at Birmingham, his MBA from the University of North Dakota,
and his PhD in finance from Indiana University. Dr. Adair serves Lehigh as the Co-Director of the Computer Science and Business (CSB) Program, the FinTech Minor, and the
Business Analytics Certificate Program. He also manages a data science consulting business specializing in providing customized data analytics assessments and training. He
previously managed research computing infrastructure and support services for Harvard
Business School and has written articles on bank regulator self-interest, analyst earnings
per share forecasting, and capital budgeting in continuous time. He is the author of Corporate Finance Demystified, Excel Applications in Corporate Finance, and Excel Applications in Investments (all McGraw Hill Education). He has also served as a consultant on
financial data information systems and business intelligence to a number of international
banks and insurance companies and as the faculty representative to the board of trustees
investments committee at Alma College. Dr. Adair has also taught at the University of
Michigan, Alma College, Hofstra University, Indiana University, and the University of
North Carolina at Chapel Hill. He is a member of the Financial Management Association,
the American Finance Association, and the Southern Finance Association.
vi
cor01589_fm_i-1.indd vi
10/09/21 03:03 PM
Final PDF to printer
John Nofsinger Dean, Professor, and William H. Seward Endowed Chair of Inter-
national Finance at the University of Alaska Anchorage. He earned his BS degree in
electrical engineering from Washington State University, his MBA degree from Chapman University, and his PhD degree in finance from Washington State University. Dr.
Nofsinger has written over 70 articles in the areas of investments, corporate finance,
and behavioral finance. These papers have appeared in the scholarly journals Journal of
Finance, Journal of Business, Journal of Financial and Quantitative Analysis, Financial
Management, Journal of Corporate Finance, Journal of Banking and Finance, and Journal of Behavioral Decision Making, among others. Dr. Nofsinger has also authored (or
coauthored) fourteen trade books, scholarly books, and textbooks that have been translated into eleven different languages. The most prominent of these books is the industry
book The Psychology of Investing. Dr. Nofsinger is a leading expert in behavioral finance
and is a frequent speaker on this topic at industry conferences, universities, and academic
conferences. He is frequently quoted or appears in the financial media, including The
Wall Street Journal, Financial Times, Fortune, Bloomberg Business Week, Smart Money,
The Washington Post, and CNBC, and other media from The Dolans to The Street.com.
Courtesy of John
Nofsinger
vii
cor01589_fm_i-1.indd vii
10/09/21 03:03 PM
Final PDF to printer
a note from the authors
“There is a lot to cover in this course so I focus on the core concepts, theories, and
problems.”
“I like to teach the course by using examples from their own individual lives.”
“My students come into this course with varying levels of math skills.”
How many of these quotes might you have said while teaching the undergraduate corporate finance course? Our many years of teaching certainly reflect such sentiments, and, as
we prepared to write this book, we conducted many market research studies that confirm
just how much these statements—or ones similar—are common across the country. This
critical course covers so many crucial topics that instructors need to focus on core ideas
to ensure that students are getting the preparation they need for future classes—and for
their lives beyond college.
We did not set out to write this book to change the way finance is taught, but rather
to parallel and support the way that instructors from across the country currently teach
finance. Well over 600 instructors teaching this course have shared their class experiences and ideas via a variety of research methods that we used to develop the framework
for this text. We are excited to have authored a book that we think you will find fits your
classroom style perfectly.
KEY THEMES
This book’s framework emphasizes three themes. See the next section in this preface for
a description of features in our book that support these themes.
• Finance is about connecting core concepts. We all struggle with fitting so many
topics into this course, so this text strives to make it easier for you by getting back
to the core concepts, key research, and current topics. We realize that today’s
students expect to learn more in class from lectures than in closely studying their
textbooks, so we’ve created brief chapters that clearly lead students to crucial
material that they need to review if they are to understand how to approach core
financial concepts. The text is also organized around learning goals, making it
easier for you to prep your course and for students to study the right topics.
• Finance can be taught using a personal perspective. Most long-term finance
instructors have often heard students ask “How is this course relevant to me?”
on the first day of class. We no longer teach classes dedicated solely to finance
majors; many of us now must teach the first finance course to a mix of business
majors. We need to give finance majors the rigor they need while not overwhelming class members from other majors. For years, instructors have used individual
examples to help teach these concepts, but this is the first text to integrate this personal way of teaching into the chapters.
• Finance focuses on solving problems and decision making. This isn’t to say that
concepts and theories aren’t important, but students will typically need to solve
some kind of mathematical problem—or at least understand the impact of different
viii
cor01589_fm_i-1.indd viii
10/09/21 03:03 PM
Final PDF to printer
numerical scenarios—to make the right decision on common finance issues. If
you, as an instructor, either assign problems for homework or create exams made
up almost entirely of mathematical material, you understand the need for good
problems (and plenty of them). You also understand from experience the number
of office hours you spend tutoring students and grading homework. Students have
different learning styles, and this text aims to address that challenge to allow you
more time in class to get through the critical topics.
CHANGES IN THE SIXTH EDITION
The global pandemic greatly impacted business and global trade. As a financial response,
central banks around the world eased monetary policy and made money more easily available. The resulting impact on a firm’s cost of capital affected the estimation of project
cash flows, valuations, and more. As capital budgeting is an important part of this book,
we have quickly incorporated the new environment into our theory and applications. In
addition, we have updated every chapter. Below are the changes we made for this sixth
edition, broken out by chapter.
Overall
• Increased the focus on using spreadsheets to solve financial problems
• Added Spreadsheet Tip boxes where appropriate
• Increased the number of spreadsheet-oriented end-of-chapter problems
• Updated data, company names, and scenarios to reflect the latest available data
and real-world changes
• Removed the Research It! assignments in all chapters
• Removed the “twin” problems in the End of Chapter Problem sets as they duplicate online assessment assignments. These deleted problem twins are still available as assignable content via McGraw Hill Connect.
Chapter 1: Introduction to Financial Management
• Updated the Personal Application with information on firms that have filed for
bankruptcy more recently
• Updated the data in Example 1-2 on executive compensation
• Edited Section 1.7: Big Picture Environment to discuss the ramifications of
COVID-19 and the Tax Cuts and Jobs Act of 2017
Chapter 2: Reviewing Financial Statements
• Added Spreadsheet Tip box for working with cells
• Added Excel to some examples
• Added Excel problems
• Deleted the second twin in the Problems
• Deleted Research It!
Chapter 3: Analyzing Financial Statements
• Added Spreadsheet Tip box for using functions
• Added Excel problems
• Added Chapter Spreadsheet Functions section to the end-of-chapter material
• Deleted the second twin in the Problems
cor01589_fm_i-1.indd ix
a note from the authors
ix
10/09/21 03:03 PM
Final PDF to printer
Chapter 4: Time Value of Money 1: Analyzing Single Cash Flows
• Added Spreadsheet Tip box for TVM Functions
• Updated the data in Figure 4.5 on gold prices
• Increased the number of Excel problems and added Excel to Examples
• Added Chapter Spreadsheet Functions section
• Included a short paragraph to mention the TVM tables
• Added Excel Solutions to Self-Test problems
• Deleted the second twin in the Problems
• Deleted Research It!
• Updated the gold return data in the Mini-Case
Chapter 5: Time Value of Money 2: Analyzing Annuity Cash Flows
• Added Spreadsheet Tip box for principal and interest portions of a payment
• Added Excel to examples and in text
• Updated Finance at Work box
• Added Chapter Spreadsheet Functions section
• Added Excel Solutions to Self-Test problems
• Added Excel problems
• Deleted the second twin in the Problems
• Deleted Research It!
Chapter 6: Understanding Financial Markets and Institutions
• Added Spreadsheet Tip box for creating a line graph
• Increased the number of Excel problems and added Excel to examples
• Updated Figures 6.4, 6.5, 6.8, 6.9, 6.13, 6.14
• Added Excel Solutions to Self-Test problems
• Deleted the second twin in the Problems
• Deleted Research It!
Chapter 7: Valuing Bonds
• Changed a Math Coach to a Spreadsheet Tip box
• Updated Figures 7.1–7.5 on bond issuance, interest rate path, yield to maturities,
new bond quotes, and a summary of the bond market
• Updated Table 7.2, Time Out 7.2, and associated discussions
• Changed the subject of a Finance at Work box to negative interest rates
• Changed the subject of a Finance at Work box to COVID-19 and the credit market
• Increased the number of Excel problems and added Excel to examples
• Added Excel Solutions to Self-Test problems
• Deleted the second twin in the Problems
• Deleted Research It!
Chapter 8: Valuing Stocks
• Updated all table and figure values in the body of the chapter
• Added a Spreadsheet Tip box on using the NPV function for stock valuation
• Rewrote the introduction of the Variable-Growth Technique section
x
a note from the authors
cor01589_fm_i-1.indd x
10/09/21 03:03 PM
Final PDF to printer
• Updated market and stock index discussions
• Changed Finance at Work box on psychology to focus on the GameStop event
• Revised examples to include new McDonald’s and Coca-Cola’s firm data and figures
• Increased the number of Excel problems and added Excel to examples
• Added Excel Solutions to Self-Test problems
• Deleted the second twin in the Problems
• Deleted Research It!
• Changed Mini-Case to Walmart valuation
Chapter 9: Characterizing Risk and Return
• Added a Spreadsheet Tip box on using statistics functions
• Updated all table and figure values in the body of the chapter
• Updated Time Out 9.1 and 9.2
• Added ETF popularity discussion to motivate diversification
• Updated the International Finance at Work box
• Updated the Google and GE text running examples
• Increased the number of Excel problems and added Excel to examples
• Added Chapter Spreadsheet Functions section
• Added Excel Solutions to Self-Test problems
• Deleted the second twin in the Problems
• Deleted Research It!
• Updated the data in the Mini-Case problem
Chapter 10: Estimating Risk and Return
• Added a Spreadsheet Tip box on using SLOPE to estimate beta
• Updated values and data in Tables 1.01 to 10.3
• Changed discussion and Figure 10.2
• Added discussion in Behavioral Finance section about market reaction and
COVID
• Updated data for end-of-chapter Excel problem
• Increased the number of Excel problems and added Excel to examples
• Added Chapter Spreadsheet Functions section
• Added Excel Solutions to Self-Test problems
• Deleted the second twin in the Problems
• Deleted Research It!
• Updated the data in the Mini-Case problem
Chapter 11: Calculating the Cost of Capital
• Updated Viewpoints example to use a streaming device rather than MP3
• Added a Spreadsheet Tip box on calculating weighted average cost of capital
• Added a Spreadsheet Tip box on calculating an average
• Increased the number of Excel problems and added Excel to most examples
• Added Chapter Spreadsheet Functions section
• Deleted the second twin in the Problems
• Deleted Research It!
cor01589_fm_i-1.indd xi
a note from the authors
xi
10/09/21 03:03 PM
Final PDF to printer
Chapter 12: Estimating Cash Flows on Capital Budgeting Projects
• Added a Spreadsheet Tip box on calculating straight-line depreciation
• Added a Spreadsheet Tip box on calculating OCF
• Added a Spreadsheet Tip box on calculating FCF
• Added a Spreadsheet Tip box on using tables to reference depreciation
• Added a Spreadsheet Tip box on calculating EAC
• Added Chapter Spreadsheet Functions section
• A majority of the Problems were turned into Excel problems
• Deleted Research It!
Chapter 13: Weighing Net Present Value and Other Capital Budgeting Criteria
• Added Excel to most of the examples
• Added a Spreadsheet Tip box on calculating the crossover rate
• Added Chapter Spreadsheet Functions section
• Deleted the second twin in the Problems and added more Excel problems
• Deleted Research It!
Chapter 14: Working Capital Management and Policies
• Added Excel to the examples
• Added Chapter Spreadsheet Functions section
• Deleted the second twin in the Problems and added more Excel problems
• Deleted Research It!
Chapter 15: Financial Planning and Forecasting
• Added Excel to most of the examples
• Added Chapter Spreadsheet Functions section
• Deleted the second twin in the Problems and added more Excel problems
• Deleted Research It!
Chapter 16: Assessing Long-Term Debt, Equity, and Capital Structure
• Added Excel to most of the examples
• Added Chapter Spreadsheet Functions section
• Most of the end-of-chapter Problems were turned into Excel problems
• Deleted Research It!
Chapter 17: Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts
• Added Excel to the examples
• Added Chapter Spreadsheet Functions section
• Deleted the second twin in the Problems and added more Excel problems
• Deleted Research It!
Chapter 18: Issuing Capital and the Investment Banking Process
• Added Excel to the examples
• Added material on the CARES Act passed into law in April 2020 as a response to
the COVID-19 pandemic
xii
a note from the authors
cor01589_fm_i-1.indd xii
10/09/21 03:03 PM
Final PDF to printer
• Added Chapter Spreadsheet Functions section
• Deleted the second twin in the Problems and added more Excel problems
• Deleted Research It!
Chapter 19: International Corporate Finance
• Revised the chapter running discussion of Starbucks
• Updated Tables 19.1, 19.2, 19.3, 19.4, and discussion
• Updated Figures 19.1, 19.2, 19.3, 19.4, and discussion
• Triangular arbitrage example shown in spreadsheet
• Increased the number of Excel problems and added Excel to examples
• Added Excel Solutions to Self-Test problems
• Deleted the second twin in the Problems
• Deleted Research It!
Chapter 20: Mergers and Acquisitions and Financial Distress
• Added Excel to the examples
• Added Chapter Spreadsheet Functions section
• Deleted the second twin in the Problems
• Deleted Research It!
cor01589_fm_i-1.indd xiii
a note from the authors
xiii
10/09/21 03:03 PM
Final PDF to printer
Stuart Monk/Shutterstock
W
Unique Features
e explained basic timevalue computations in the
previous chapter. Those
TVM equations covered moving a
single cash flow from one point in
time to another. While this circumCONNECTING CORE CONCEPTS
stance does describe some problems
that businesses and individuals face,
most debt and investment applications of time value of money feature multiple cash flows. In fact,
most situations require many equal
payments over time. Since these
situations require a bit more compliLearning Goals appear at thecated
beginning
of each
chapanalysis, this
chapter
continues the
ter and are indicated throughout
theTVM
texttopic
nextfortoapplications
headthat require many equal payments
ings, examples, summary, andover
end-of-chapter
problems
time. For example,
car loans
to which they relate. These outcomes
help instructors
and home mortgage
loans require
the borrower
to make
the same
structure their classes and assign
readings
and homemonthly payment for many months
work. The accompanying testorbank
instructors
years.provides
People save
for the future
with hundreds of questions organized
by levelcontributions
and learn- to
through monthly
theireven
pension
portfolios. People in
ing goals to make customization
easier!
retirement must convert their savings
into monthly income. Companies
also make regular payments.
Johnson & Johnson (ticker: JNJ)
will pay level semiannual interest
payments through 2033 on money
it borrowed. The Boeing Company
(ticker: BA) paid a $2.055 per share
quarterly dividend to stockholders
in 2020, an increase from the $1.71
quarterly dividend paid in 2018.
These examples require payments
(and compounding) over different
time intervals (monthly for car loans
and semiannually for company debt).
How are we to value these payments
into common or comparable terms?
In this chapter, we illustrate how to
value multiple cash flows over time,
including equal and uneven payments, and how to incorporate different compounding frequencies.
Learning Goals
LG5-1
Compound multiple cash
flows to the future.
LG5-7
Discount multiple cash
flows to the present.
Explain the impact of
compound frequency and
the difference between the
annual percentage rate and
the effective annual rate.
LG5-2
Compute the future value of
frequent, level cash flows.
LG5-3
LG5-8
LG5-4
Compute the present value
of an annuity.
Compute the interest rate of
annuity payments.
LG5-9
LG5-5
Figure cash flows and present value of a perpetuity.
Compute payments and
amortization schedules for
car and mortgage loans.
LG5-6
Adjust values for beginningof-period annuity payments.
LG5-10
Calculate the number of
payments on a loan.
145
Confirming Pages
cor01589_ch05_144-183.indd
finance at work
145
07/31/21 10:20 PM
markets
JP MORGAN’S $9 BILLION BLUNDER
To this day, possibly one of the largest derivative trading
losses was endured by JP Morgan Chase & Co. A huge trading bet backfired and left the bank with at least $9 billion in
losses from the bad trade. The bank’s chief investment officer
(CIO), responsible for managing the New York company’s risk,
placed a series of risky bets and trades. An article published
in The Wall Street Journal reported that “large positions taken
in that office by a trader nicknamed ‘the London whale’ had
roiled a sector of the debt markets. The bank, betting on a
continued economic recovery with a complex web of trades
tied to the values of corporate bonds, was hit hard when
prices moved against it starting last month, causing losses in
many of its derivatives positions. The losses occurred while
J.P. Morgan tried to scale back that trade.”
In April of 2012, The Wall Street Journal reported that
investors and hedge funds were trying to take advantage
of trades made by Chase’s London whale, Bruno Iksil, who
worked out of the CIO, by making bets in the market on credit
default swaps (CDSs). The CIO group previously had stopgaps
in place to protect and prevent the company from significant
losses during periods of downturn in the economy. However,
the Journal reports that earlier in 2012, “it began reducing
that position, [taking] a bullish stance on the financial health of
certain companies and selling protection that would compensate buyers if those companies defaulted on debts. Mr. Iksil
was a heavy seller of CDS contracts tied to a basket, or index,
!
Want to Know More?
of companies.” In April of 2012, these protection costs began
to go up, which further contributed to the bank’s losses.
According to JP Morgan Chase company filings, Mr. Iksil’s
group had approximately $350 billion in investment securities, about 15% of the bank’s total assets, on December 31,
2011. Mr. Dimon (the CEO) said the bank has an extensive
review under way of what went wrong. “These were grievous mistakes, they were self-inflicted, we were accountable
and we happened to violate our own standards and principles
by how we want to operate the company. This is not how we
want to run a business.”
Mr. Dimon held a conference call with investors and analysts on May 10, stating, “In hindsight, the . . . strategy was
flawed, complex, poorly reviewed, poorly executed, and poorly
monitored. The portfolio has proven to be riskier, more volatile and less effective . . . than we thought.” Dimon resolves,
“We will learn from it, we will fix it, we will move on, hopefully in
the end, it will make us a better company.” Though JP Morgan
Chase came through the financial crisis better off than many
other financial institutions, this trading loss certainly tarnishes
its reputation. Mr. Dimon reported that the loss is “slightly more
than $2 billion” in the second quarter of this year. Less than two
months later, losses were estimated to be as much as $9 billion.
Source: Dan Fitzpatrick, Gregory Zuckerman, and Liz Rappaport,
“J.P. Morgan’s $2 Billion Blunder,” The Wall Street Journal Online, May 11,
2012. JP Morgan Chase & Co. Business Update Call, May 10, 2012.
Key Words to Search for Updates: JPMorgan, London whale, derivative
trading losses
Derivative securities traders can be either users of derivative contracts (for hedging
and other purposes) or dealers (such as banks) that act as counterparties in customer
trades for fees. An example of hedging involves commodities such as corn, wheat, or soybeans. For example, suppose you run a flour mill and will need to buy either soft wheat
(Chicago) or hard red winter wheat (Kansas City) in the future. If you are concerned
that the price of wheat will rise, you might lock in a price today to meet your needs six
months from now by buying wheat futures on a commodities exchange. If you are correct
and wheat prices rise over the six months, you may purchase the wheat by closing out
your futures positions, buying the wheat at the futures price rather than the higher market
price. Likewise, if you know that you will be delivering a large shipment to, say, Europe
in three months, you might take an offsetting position in euro futures contracts to lock
in the exchange rate between the dollar and the euro as it stands today—and (you hope)
eliminate foreign exchange risk from the transaction.
Derivative securities markets are the newest—and potentially the riskiest—of the
financial security markets. Losses associated with off-balance-sheet mortgage-backed
securities created and held by FIs were at the very heart of the financial crisis. Signs
of significant problems in the U.S. economy first appeared in late 2006 and early 2007
when home prices plummeted and defaults began to affect the mortgage lending industry
as a whole, as well as other parts of the economy noticeably. Mortgage delinquencies,
particularly on subprime mortgages, surged in the last quarter of 2006 through 2008 as
homeowners who had stretched themselves to buy or refinance a home in the early 2000s
Time Out boxes, featured at the end of sections, test students’ understanding of the key terms and core concepts
just presented. Answers to the Time Out questions appear
at the end of each chapter.
192
part four
Valuing of Bonds and Stocks
1.25 times
$24m
Sales toCash
working
capital
ratio
= ______ = 0.20 times
Total asset turnover
4.00 times
Industry average
= 0.15 times
$123m
0.50 times
Capital intensity
2.00
All three liquidity ratios show that DPH Tree Farm, Inc., has more liquidity
ontimes
its balance
Debt ratio
sheet than the industry average (we discuss the process used to develop 50.00%
an industry aver1.00 times
age in section 3.8). Thus, DPH Tree Farm has more cash and other liquid assets
(or current
times
assets) available to pay its bills (or current liabilities) as they come due than2.00
does
the averTimes interest earned
7.25 times
age firm in the tree farm industry.
Debt-to-equity
Equity multiplier (common equity)
Cash coverage
8.00 times
ProfitSimilar
marginto Problems 3-1, 3-13, Self-Test Problem 1
18.75%
Gross profit margin
49.16%
Operating profit margin
42.02%
Basic earnings power
19.90%
ROA
9.38%
TIME OUT
ROE
18.75%
Dividend payout
35.00%
Market-to-book
ratio
times
3-1
What
are the three major liquidity ratios used in evaluating financial 1.30
statements?
PE ratio
4.10 times
3-2
How do the three major liquidity ratios used in evaluating financial statements differ?
3-3
Does a firm generally want to have high or low liquidity ratios? Why?
•
TIME OUT
3.2ANSWERS
AssetTO
Management
Ratios
LG3-2
AssetThe
management
ratios measure
howratios
efficiently
a firmratio,
usesthe
itsquick
assets
3-1
three most commonly
used liquidity
are the current
(or (inventory,
