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    Bodie Z., Merton R.C., Cleeton D.L. - Financial Economics

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    Lê Hồng Nhung

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    | Tbennecrere. 0 IKCONOMICS Zvi Bodie sis C oe | NIM PR OCcaCn FINANCIAL ECONOMICS Second Edition Zvi Bodie | Robert C. Merton | David L. Cleeton ‘This significant new finance text has a broader scope and greater empha than most other introductory finance texts, which typically focus exclu ere ornon Noe erent OU ee eC eee eT authors offer an approach balanced among the three analytical “pillars” of finance—optimization over time, asset valuation, and risk management. The book encompasses all subfields of finance Sr eee nn This text incorporates corporate finance, investmen onceptuai framework, and offers the “big picture” of resource allocation over time under conditions of uncertainty. Read their biographies inside the text, and visit www.prenhall.com/bodie for the textbook’s renee Tae Cea ed err cen ieceeernn ral Financial Economics ET Zvi Bodie Norman and Adele Barron Professor of Management School of Managemen Boston University Robert C. Merton John and Naity McArthur University Professor Harvard University David L. Cleeton Associate Provost and Professor of Economics Oberlin College IIUSToN Beene ra Upper Saddle River, New Jersey 07458 Library of Congress Cataloging in-Publication Data Botie, Zvi Financial economies /Zvi Bodie, Robert C. Mestor, David L. Cleefon.—2nd ed P. cm. Rev, ed, of: Finance. €2000, ISBN 0-13-185615-4 1. Finance, I. Merton,RobertC, M1 Cleeton, David L. Ill. Bodie, Zvi, Finance. W. Tite. HGI73.B38 2009 332der 2007049192 Executive Editor: Donna Batista Eitor in Chief: Dense Clinton “Manager, Product Development: Ashley Sartor Editorial Project Manager: Mary Kate Mure Permissions Projet Manager: Chares Mort Permissions Specialist: Sue Brekka Marketing Manager: Andrew Watts Batvoriat Assistant: Kerri McQueen Senior Managing Editor: Judy Leale Production Project Manager: Debbie Ryan Senior Operations Supervisor: Amold Vila (Operations Specialist: Michelle Klein Ant Director: Steve Fim Cover Designer: Bruce Kenselaar Cover Art Argosy Interior Designer: Jodi Nowowitz ‘Composition: TexTech International Fall‘Service Project Management: Bharath Parthasarathy Printed Binder: awards Brothers ‘Typeface: Times 10/12 (Credits and acknowledgments borrowed from other sources and reproduced, with permission, Jn this textbook appear on appropriate page within text Copyright © 2009, 2000 Pearson Education, Inc, Upper Saddle River, New Jersey, 07488. Pearson Prentice Hall, All ight reserved. Printed inthe United States of America. Tis publication i protected by Copyright and perinision should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form ‘ory ary means, electronic, mechanical, photocopying, ecardiag, 2 likewise. For information regarding permissions), write to: Righs and Permissions Department ‘Pearson Prentice Hall" isa trademark of Pearson Education, Ine earson® is aregisteed trademark of Pearson ple Prentice Hall” sa registered trademark of Pearson Education, Ine Pearson Education LID, Pearson Education Australia PTY, Limited Pearson Education Singapore, Po. Cd Pearson Education Nort Asia Lad Pearson Education, Canada, Ltd Pearson Educacin de Mexico, S.A. de CY. Pearson Education Japan Pearson Edvcation Malaysia, Pe. Lid aa avn as 10987654321 cen ISBN-13: 978-0-13-185615-8 ISBN-10:0:13-185615-4 \ dedicate this book to my wife, Judy, and my daughters, Lara and Moriya, without whose patient love and encouragement could never have brought it to completion. ~ .—Zvi Bodie To Samantha; Robert F, and Paul, my ineffable three and to Gweneth; Ellie, Archer, and Tess, their ineffable four. — Robert C. Merton To the memory of my father, Sam Cleeton, Jr. — David L. Cleeton Foreword Every year dozens of new textbooks are published. No wonder. As Willie Sutton told the judge about why he robbed banks: “That's where the money is.” But only every other decade does there arrive an innovative new work that sets a new pattern of excellence and pedagogy. This edition of Financial Economics has long been expected. And it proves to be ‘well worth the wait. Good teachability like good wine, requires much deliberate time. In the meanwhile, Robert Merton shared the 1997 Nobel Prize in Economics. His was never a case of “if” but only a case of “when,” for it has been well said that Merton is the Isaac Newton of modern finance theory. And ever since their graduate student days at MIT, Rodie and Merton have made a productive team. Speaking as one of their teachers, I hail their demonstrating that water can indeed rise above its source. The kind of finance that matters for modem experts oes beyond the tools that have been revolutionizing Wall Street: the pricing of options and other contingent derivatives. Yes, all that is important practically and theoretically. But as this book’s coverage shows, itis the Main Street econ- omy of production, capital budgeting, personal finance, and rational accouriing tha is best illuminated by this overdue breakthrough in teaching. I moan to myself, “Where were these authors back when I was a student?” Well, the future is longer than the past, and future students will reap the harvest that these innovative teachers have sown, Enjoy! Paul A. Samuelson Massachusetts Institute of Technology PARTI PART Il PART Ill PART IV PART V PART VI Brief Contents FINANCE AND THE FINANCIAL SYSTEM = 1 Chapter 1 Financial Economics 1 Chapter 2_ Financial Markets and Institutions 23 Chapter 3. Managing Financial Health and Performance 71 TIME AND RESOURCE ALLOCATION 107 Chapter 4 Allocating Resources Over Time 107 Chapter 5 Household Saving and Investment Decisions Chapter 6 The Analysis of Investment Projects 170 VALUATION MODELS 197 Chapter 7 Principles of Market Valuation 197 Chapter 8 Valuation of Known Cash Flows: Bonds 222 Chapter 9 Valuation of Common Stocks 244 RISK MANAGEMENT AND PORTFOLIO THEORY Chapter 10 Principles of Risk Management 267, Chapter 11 Hedging, Insuring, and Diversifying 296 Chapter 12. Portfolio Opportunities and Choice 333 ASSET PRICING 359 Chapter 13 Capital Market Equilibrium 359 Chapter 14 Forward and Futures Markets 377 Chapter 15 Markets for Options and Contingent Claims CORPORATE FINANCE 433 Chapter 16 Financial Structure of the Firm 433 Chapter 17 Real Options 465 148, 267 400 Contents Preface xxi PARTI FINANCE AND THE FINANCIAL SYSTEM 1 Chapter 1 Financial Economics 1 1.1 Defining Finance 2 1.2. Why Study Finance? 3 1.3. Financial Decisions of Households 4 1.4 Financial Decisions of Firms 6 1.5. Forms of Business Organi 8 1.6 Separation of Ownership and Management 9 1.7 TheGoal of Management 11 1.8 Market Discipline:Takeovers 14 1.9 The Role of the Finance Specialist in a Corporation 15 Summary 17 Questions and Problems 20 Chapter 2 Financial Markets and Institutions 23 24 Whatis the Financial System? 24 22 TheFlowofFunds 24 23. The Functional Perspective 26 Function 1: Transfering Resources acrossTime and Space 26 Function 2: Managing Risk 27 Function 3: Clearing and Setting Payments 29 Function 4: Pooling Resources and Subcividing Shares 29 Function 5: Providing Information 30 Function 6: Dealing with Incentive Problems 31 2.4 Financial Innovation and the “Invi 2.5 Financial Markets 36 2.6 Financial Market Rates 37 InterestRates 37 Ratesof Retum on Risky Assets 40 Market Indexes and Market Indexing 41 Rates of Retum in Historical Perspective 46 Inflation and Real Interest Rates 52 Interest Rate Equalization 56 ‘he Fundamental Determinants of Rates ofRetun 56 xi CONTENTS QI 28 29 Financial intermediaries 58 Banks 58 Other Depository Savings Institutions 58 Insurance Companies 59 Persion and Retirement Funds 59 Mutual Funds 59 Investment Banks 59 Venture Capital ims 60 Asset Management Fims 60 Information Services 60 Financial Infrastructure and Regulat Rules forTading — 61 Accounting Systems 61 Governmental and Quasi-Governmental Organizations 61 Central Barks 61 Special Purpose intermediaries 62 Regional and World Organizations 62 Summary 63 Questions and Problems 67 60 Chapter 3 Managing Financial Health 34 32 33 34 3S 36 37 38 39 3.10 3.1 and Performance 71 Functions of Financial Statements 72 Review of Financial Statements 73 The Balance Sheet 73 Thelncome Statement 75 The Cosh Flow Statement 76 Notes to Fnanral statements 78 Market Values versus Book Values 80 ‘Accounting versus Economic Measures ofincome 82 Returns to Shareholders versus Return ‘on Book Equity 83 ‘Analysis Using Financial Ratios 83 TheRelations among Ratios 85 Theéffectof Financial Leverage 87 Limitations of Ratio Analysis 88 The Financial Planning Process 88 Constructing a Financial Planning Model 89 Growth and the Need for External Financing 92 The Firm’ Sustainable Growth Rate 92 Working Capital Management 94 Liquidity and Cash Budgeting 96 Summary 96 Questions and Problems 99 CONTENTS XIII PART Il TIME AND RESOURCE ALLOCATION 107 Chapter 4 Allocating Resources Over Time 107 44 42 43 44 45 46 ar 48 49 4.10 aM Compounding 108 CCakulating FutureValues 110 Savingfor OldAge 112 Reinvesting ata Different Rate 112 Paying Backaloan 113, The Frequency of Compounding 113 Present Value and Discounting 114 When a $100 Gifts NotReally $100 117 Discounting with Compounding More Fequently Than Annually 117, Alternative Discounted Cash Flow Decision Rules 118 Investing intand 121 (thers People Money 122 Multiple Cash Flows 123, Timelines 123, FutureValue ofa Stream of CashFlows 123 Present Value ofa Stream of Cash Flows 124 Investing with Mutiple Cash Flows 124 Annuities 126 FutureValue of Annuities 124 PresentValue ofAnnities 125 Buying an Aneuity 126 Taking a Mortgage Loan 127 Perpetual Annuities 128 Investingin Prefered Stock 128 Investing in Common stock 129 Loan Amortization 129 ABargainCarloan? 130 Exchange Rates and Time Value of Money 131 ‘Computing NPV in Different Curencies 131 Inflation and Discounted Cash Flow Analysis. 132 Infation and Future Values 132 SavingforCollege:1 133, Investing in infation-Proof CDs 134 Why Debtors Gain from Unantnated Inflation 134 Infation and PresentValues 134 Saving for Colege:2. 135 Inflation and Savings Plans 135 Saving or Colege:3 135 Inflation and Investment Decisions 137 Taxes and investment Decisions. 138 Invest in Tax-Exempt Bonds? 138 Summary 139 Questions and Problems 142 XIV CONTENTS Chapter 5 Household Saving 5a 52 53 54 55 and Investment Decisions 148 Alife-Cycle Model of Saving 149 ‘Approach Target Replacement Rat of Prertirement income 149 ‘Approach 2: Maintain the Same Level of Consumption Spending 151 Taking Account of Social Security 157 Deferring Taxes Through Voluntary Retirement Plans 158 ‘Should You Invest in a Professional Degree? 159 ‘Should You Buy or Rent? 160 Summary 161 Questions and Problems 165 Chapter 6 The Analysis of Investment Projects 170 64 62 63 64 65 66 67 68 69 6.10 The Nature of Project Analysis 171 Where Do Investment Ideas Come From? 172 ‘The Net Present Value Javestment Rule 172 Estimating a Project's Cash Flows 174 Cost of Capital 176 Sensitivity Analysis Using Spreadsheets 178 Break-Even Point 178 Sensitivity of NPV to Sales Growth 181 ‘Analyzing Cost-Reducing Projects 181 Projects with Different Lives 183, Ranking Mutually Exclusive Projects 184 Inflation and Capital Budgeting 184 Summary 186 Questions and Problems 190 PART Ill VALUATION MODELS 197 Chapter 7 7A 72 73 74 75 16 1 78 79 7.40 7M iples of Market Valuation 197 The Relation between an Asset's Value and Its Price 198 Value Maximization and Financial Decisions 198 The Law of One Price and Arbitrage 200 Arbitrage and the Prices of Financial Assets 201 Interest Rates and the Law of One Price 202 Exchange Rates and Triangular Arbitrage 203 Valuation Using Comparables 205 Valuation Models 206 Valuing Real Estate 206 Valuing shares of Stock 207 ‘Accounting Measures of Value 207 How Information Is Reflected in Security Prices. 208 The Efficient Markets Hypothesis 209 Summary 212 Questions and Problems 215, ‘CONTENTS Chapter 8 Valuation of Known Cash Flows: Bonds 222 84 a2 a3 84 a5 86 Using Present Value Factors to Value Known Cash Flows 223 The Basic Building Blocks: Pure Discount Bonds 225 ‘Coupon Bonds, Current Yield, and Yield to Maturity 227 Beware of “High-Yield” US Treasury Bond Funds 230 Reading Bond Listings 230 Why Yields for the Same Maturity May Differ 231 The ffectofthe Couponfate 232 ‘he ectof Default isk andTaxes 233 Other Effects on Bond Yields 233 The Behavior of Bond Prices overTime 234 TheEfectof the Passage ofTime 234 Interest RateRisk 236 Summary 237 Questions and Problems 240 Chapter 9 Valuation of Common Stocks 244 94 92 93 94 95 Reading Stock Listings 245 The Discounted Dividend Model 245, The Constant-Growh-Rate, Discounted Dividend Model 247 Earnings and investment Opportunities 248 ‘AReconsideration of the Price/Earnings Multiple ‘Approach 252 Does Dividend Policy Affect Shareholder Wealth? 253 Cash Dividends and Share Repurchases 253, StockDividends 254 Dividend Policy ina Fictioniess Environment 256 Dividend Policy inthe Real World 257 Summary 259 Questions and Problems 261 PARTIV RISK MANAGEMENT AND PORTFOLIO THEORY 267 Chapter 10 Principles of Risk Management 267 10.1 10.2 10.3 What Is Risk? 268 Risk Management 269 Risk posure 270 Risk and Economic Decisions 270 Risks Facing Households 271 Risks Facing Firms 271 ‘The Role of Governmentin isk Management 272 The Risk-Management Process 273, Risk entiation 273 Risk Assessment 274 Selection of Risk Management Techniques 275 Implementation 275 Review 275 xv xv CONTENTS: 104 105 106 107 108 109 The Three Dimer Transfer 276 Hedging 276 Insuring — 276 Dwesifying 277 Risk Transfer and Economic Efficiency 278 Etfcient Beaing of Existing Risks 279 Risk and Resource location 279 Institutions for Risk Management 280 Portfolio Theory: Quantitative Analysis for Optimal Risk Management 282 Probability Distributions of Returns 283, Standard Deviation as a Measure of Risk 285, Summary 287 Questions and Problems 290 Chapter 11. Hedging, Insuring, and Diversifying 296 m4 112 113 14 15 16 1.7 118 119 11.10 wa Using Forward and Futures Contracts to Hedge Risk 297 Hedging Foreign-Exchange Risk with Swap Contracts 302 Hedging Shortiall Risk by Matching Assets to Liabilities 303 Minimizing the Cost of Hedging 303 Insuring versus Hedging 304 Basic Features of Insurance Contracts 306 Exclusions and Caps 306 Dediuctibies 306 Copayments 306 Financial Guarantees 307 Caps and Floors on interest Rates 307 Options as insurance 307 Put Optionson Stocks 308 Put Options on Bonds 309 The Diversification Principle 310 Diversification with Uncorelated Risks 310 Nondivrsifabe Risk 312 Diversification and the Cost of Insurance 313 Summary 315 Questions and Problems 317 Chapter 12 Portfolio Opportunities and Choice 333 124 122 Tne Process of Personal Portfolio Select Thelitecyde 334 Time Horizons 335, RiskTolerance 337 The Role of Professional Asset Managers 337 The Trade-Off between Expected Return and Risk 338, What IstheRskless Asset? 338 Combining the Riskess Asset anda Single Risky Asset 339 334 123 CONTENTS XNII ‘Achieving afarget Expected Return: 342 Portfolio Efciency 342 Efficient Diversification with Many Risky Assets 343 Portfolios fTwo Risky Assets 343 The Optimal Combination ofRiskyAssets 346 Selecting the Preferred Portolio 347 Achieving Target Expected Retur:2 349 Portfolios of Many Risky Assets 350 Summary 351 Questions and Problems 353 PARTV ASSETPRICING 359 Chapter 13 Capital Market Equilibrium 359 Ba 13.2 33 Ba BS Be The Capital Asset Pricing Model in Brief 360 Determinants of the Risk Premium on the Market Portfolio 362 Beta and Risk Premiums on Individual Securities 364 wing the CAPM in Portfolio Selection 366 Valuation and Regulating Rates of Return 368 Piscounted Cash Flow Valuation Models 369 Cost of Capital 369 Regulation and Cost Plusricing 370 Modifications and Alternatives to the CAPM 370 Summary 371 Questions and Problems 372 Chapter 14 Forward and Futures Markets 377 144 142 143 144 145 146 147 148 “9 14.10 14.11 14.12 14.13 Distinctions between Forward and Futures Contracts 378 The Economic Function of Futures Markets 380 The Role of Speculators. 381 Relation between Commodity Spot and Futures Prices. 382 Extracting Information from Commodity Futures Prices 383, Forward-Spot Price Parity for Gold 383, The “Implied” Cost of Cary 385 Financial Futures 386 The “Implied” Riskless Rate 388 The Forward Price Is Not a Forecast ofthe Future Spot Price 389 Forward-Spot Price-Parity Relation With Cash Payouts 390 “Implied” Dividends 391 The Foreign-Exchange Parity Relation 391 The Role of Expectations in Determining Exchange Rates 392 Summary 393 Questions and Problems 396 XVII CONTENTS Chapter 15 Markets for Options and Contingent 154 15.2 153 15.4 155 15.6 15.7 15.8 15.9 15.10 15.11 Claims 400 How Options Work 401 Index Options 403, Investing with Options 404 The Put-Call Parity Relation 407 Volatility and Option Prices 411 ‘Two-State (Binomial) Option Pricing 412 Dynamic Replication and the Binomial Model 414 The Black-Scholes Model 416 Implied Volatility 418 Contingent Claims Analysis of Corporate Debt and Equity 420 Credit Guarantees 422 Atypothetical ample 424 Other Applications of Option-Pricing Methodology 425 Summary 426 Questions and Problems 429 PART VI CORPORATE FINANCE 433 Chapter 16 Financial Structure of the Firm 433 16.1 162 163 16.4 165 16.6 16.7 168 16.9 16.10 Internal versus External Financing 434 Eq incing 435 Debt Financing 435 Secured Debt 436 Long-Term Leases 436, Pension ibis 437 The irrelevance of Capital Structure ina Frictionless Environment 439, Creating Value through Financing Decisions 442 Reducing Costs 443 Tawws and Subsidies 443, Costs of Financial Distress 446 Dealing with Conflicts of interest 447 Incentive Problems: Free Cash Flow 447 Conflicts between Shareholders and Creditors 448 a9 TheFive Companies 449 The Five Financing Methods 450 How to Evaluate Levered Investments 451 ThreeValuation Methods Compared 451 Summary 454 Questions and Problems 457 CONTENTS XIX Chapter 17 RealOptions 465 7A 172 173 Investing in Real Options 466 ‘Types Real Options 466 An txample 467 The Case of Uncertainty ity 469 SenstvtyAnalyss 471 Valuing the Deferal Option Using the Binomial Option Pricing Model 472 Applying the Black-Scholes Formula toValue Real Options 474 Summary 477 Questions and Problems 478 Suggested Readings 481 Glossary 484 Index 491 Preface Ten years have gone by since the publication of the first edition of this text book. That is three times the normal revision cycle time fora college text book in finance. To get the job done, it took the addition of a third coauthor, David Cleeton. But here it is. "We wrote the first edition because we strongly believed that there was a need for an intro-

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