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 Introduction to

Finance 15th
Edition

Ronald W. Melicher
Edgar A. Norton
vi PREFACE

and stocks. We have revised the discussion of the risks facing investors in a low interest rate
environment sustained by the Fed since the Great Recession. Spreadsheet examples show how to
apply time value concepts to calculate bond prices and stock prices.
Chapter 11, Securities and Markets, incorporates changes in securities trading, including the
New York Stock Exchange and IntercontinentalExchange (NYSE–ICE) merger as well as an
overview of the Facebook initial public offering (IPO) and some of its problems.
Chapter 12, Financial Returns and Risk Concepts, is one of the more mathematical chapters; it
shows how to do calculations with step-by-step calculator keystrokes and spreadsheet functions.
Chapter 13, Business Organization and Financial Data, features data from Walgreens’ financial
statements. We maintain that a firm’s goal is to maximize shareholder wealth, and we discuss
“sustainability” in light of this goal. In response to the financial crisis, we review problems with
using stock options as an incentive mechanism for managers and the balance sheet implications
of the government bailout for some U.S. auto companies.
Chapter 14, Financial Analysis and Long-Term Financial Planning, uses updated data from
Walgreens and the retail drugstore industry in a practical example of financial ratio analysis
using industry averages.
Chapter 15, Managing Working Capital, expands the discussion of managing cash in a difficult
business environment with low interest rates. We discuss a new reason why firms hold large
amounts of cash, with the tax cost of repatriating the funds back to the home country.
Chapter 16, Short-Term Business Financing, was revised to improve pedagogy and to update the
material. It contains information on real firms’ working capital financing strategies and on the
implications of the financial crisis on a firm’s ability to obtain short-term financing. We include
a section on the American Energy and Infrastructure Jobs Act of 2012 (JOBS Act of 2012), a tool
to help small firms obtain financing, including the use of “crowdfunding.”
Chapter 17, Capital Budgeting Analysis, relates the cash flow estimation process for a project
to the firm’s statement of cash flows from Chapter 13 and reviews standard capital budgeting
analysis tools such as net present value (NPV), internal rate of return (IRR), profitability index
(PI), and modified internal rate of return (MIRR).
Chapter 18, Capital Structure and the Cost of Capital, contains updated discussions of trends
in the use of debt by corporations and the use of debt financing in the low interest rate environ-
ment that has existed since the Great Recession.

LEARNING AND TEACHING AIDS

The fifteenth edition of Introduction to Finance offers the following aids for students and instructors:
CHAPTER OPENERS: Each chapter begins with the following:
• Chapter Learning Objectives, which students can use to review the chapter’s main points
and which instructors can use as a basis for in-class lecture or discussion;
• Where We Have Been statements that remind students of what was covered in the
previous chapters;
• Where We Are Going, which are previews of chapters to come;
• How This Chapter Applies To Me that explain how the content of the chapter, no matter
how technical or business specific, has applications to the individual student.

APPLYING FINANCE TO: These boxes show how the topic of each chapter relates to the finance
fields of institutions and markets, investments, and financial management.
INTERNET MARGIN NOTES: We direct the student to relevant Web sites at different points in
each chapter.
MARGIN DEFINITIONS: Margin definitions of key terms are provided to assist students in
learning the language of finance.
 PREFACE vii

CONCEPT CHECKS: These features appear in the margins near the end of every section to quiz
students on what they have learned and how well they have learned it. Concept Checks reinforce
the topical material and help students determine what they need to review.
MARGIN ICONS: These are placed in the margin to indicate discussions of finance principles,
implications of the recent financial crisis, financial or business ethical issues, and global or inter-
national discussions.
SPREADSHEET ILLUSTRATIONS: We show how to use spreadsheets to solve problems and to
teach students about the power of spreadsheet functions and analysis.
BOXED FEATURES: Throughout the book, boxes are used to focus on current topics or applications
of interest. They are designed to illustrate concepts and practices in the dynamic field of finance.
• Small Business Practice boxes highlight aspects of the chapter topics relating directly to
small businesses and entrepreneurship.
• Career Opportunities in Finance boxes provide information about various careers in
finance and appear in many chapters.
• Personal Financial Planning boxes provide insight into how the chapter’s content can be
applied to an individual’s finances.
LEARNING EXTENSIONS: Chapter appendixes, called Learning Extensions, are included in
many chapters. Learning Extensions provide additional in-depth coverage of topics related to
their respective chapters, and many challenge students to use their mathematical skills.
END-OF-CHAPTER MATERIALS: Each chapter provides the following:
• Discussion Questions that review chapter material
• Exercises for students to solve and exercise their mathematical skills
• Problems that are more difficult and that should be solved by using spreadsheets
COMPANION WEB SITE: The text’s Web site at www.wiley.com/college/melicher contains a
myriad of resources and links to aid learning and teaching.
INSTRUCTOR’S MANUAL AND TEST BANK: The Instructor’s Manual is available to adop-
ters of this text. It features detailed chapter outlines, lecture tips, and answers to end-of-chapter
questions and problems. The manual includes an extensive test bank of true/false and multi-
ple choice questions with answers, revised and expanded for this edition by Kevin Cochrane of
College of the Desert.
COMPUTERIZED TEST BANK: This program is for use on a PC running Windows. The
Computerized Test Bank contains content from the test bank provided within a Test Generating
Program that allows instructors to customize their exams.
POWERPOINT PRESENTATIONS: Created by the authors, a PowerPoint presentation is
provided for each chapter of the text. Slides include outline notes on the chapter, additional
presentation topics, and figures and tables from the text.
STUDENT PRACTICE QUIZZES: A set of quizzes, revised by Leslie Mathis of University of
Memphis, allows students to practice their knowledge and understanding of each chapter.
These multiple-choice quizzes are auto-graded to provide students with instant feedback on
their work.
SPREADSHEET SOFTWARE: A set of Excel-compatible templates, developed by Robert
Ritchey of Texas Tech University, are available on the text’s Web site. Students can use the
templates to help solve some of the end-of-chapter problems and challenge problems.

ACKNOWLEDGMENTS
We would like to thank the Wiley Publishing team of Executive Editor Joel Hollenbeck, Assistant
Editor Courtney Luzzi, and Senior Editorial Assistant Erica Horowitz for their role in preparing
and publishing the fifteenth edition of Introduction to Finance.
viii PREFACE

In addition, we are especially grateful to the reviewers for their comments and constructive
criticisms of this and previous editions:
Saul W. Adelman, Miami University, Ohio
Linda K. Brown, St. Ambrose University
Lisa Johnson, Centura College
Barbara L. Purvis, Centura College

Tim Alzheimer, Montana State University

Allan Blair, Palm Beach Atlantic College
Stewart Bonem, Cincinnati State Technical and Community College
Joseph M. Byers, Community College of Allegheny County, South Campus
Robert L. Chapman, Orlando College
William Chittenden, Texas State University
Will Crittendon, Bronx Community College
David R. Durst, University of Akron
Sharon H. Garrison, Florida Atlantic University
Asim Ghosh, Saint Joseph’s University
Lester Hadsell, University of Albany
Irene M. Hammerbacher, Iona College
Kim Hansen, Mid-State Technical College
Jeff Hines, Davenport College
Jeff Jewell, Lipscomb University
Ed Krohn, Miami Dade Community College
P. John Limberopoulos, University of Colorado Boulder
Leslie Mathis, University of Memphis
John K. Mullen, Clarkson University
Michael Murray, Winona State University
Napoleon Overton, University of Memphis
Michael Owen, Montana State University
Marco Pagani, San Jose State University
Alan Questell, Richmond Community College
Ernest Scarbrough, Arizona State University
Raymond Shovlain, St. Ambrose University
Amir Tavakkol, Kansas State University
Jim Washam, Arkansas State University
Howard Whitney, Franklin University
David Zalewski, Providence College
Likewise, we appreciate the comments from students and teachers, who have used previous
editions, and the assistance from the dozens of reviewers, who have commented about the early
editions. Special recognition goes to Carl Dauten, who coauthored the first four editions, and
Merle Welshans, who was a coauthor on the first nine editions of the book. Finally, and perhaps
most importantly, we wish to thank our families for their understanding and support during the
writing of the fifteenth edition.
Ronald W. Melicher, Boulder, Colorado
Edgar A. Norton, Normal, Illinois
 PREFACE ix

FEATURES OF THIS BOOK

Chapter Openers
• Chapter Learning Objectives that students can use to review the chapter’s main points and instructors can use as a
basis for in-class lecture or discussion.
• Where We Have Been briefly summarizes material from previous chapters.
• Where We Are Going briefly previews coverage in future chapters.
• How This Chapter Applies to Me briefly outlines personally relevant issues.

Concept Checks appear in the margins near the end of every section to quiz students on what they have just learned and
how well they have learned it. Concept checks reinforce the topical material and help students determine what they need
to review.

Boxed Features throughout the book are used to focus on current topics or applications of interest. They are designed to
illustrate concepts and practices in the dynamic field of finance.

• Small Business Practice boxes highlight aspects of the chapter topics relating directly to small businesses and
entrepreneurship.
• Personal Financial Planning boxes incorporate relevant information on how the chapter’s content can be applied to
an individual’s finances.
• Career Opportunities in Finance boxes appear in several chapters and provide information about various careers in
finance.
• Applying Finance To boxes show how the chapter relates to the finance fields of institutions and markets, investments,
and financial management.

Spreadsheet Illustrations explain how to use spreadsheets to solve problems while showing students the powers of
spreadsheet function and analysis.

Learning Extensions are chapter appendices, which provide additional in-depth coverage of topics related to their respec-
tive chapters. Many challenge students to use their mathematical skills.

End-of-Chapter Materials provide discussion questions, exercises, and special challenge problems that present students
with more difficult questions that should be solved using Excel spreadsheets.

Icons:

Concept Check Internet Activity Ethics Global Finance Financial Crisis

CONCEPT CHECK INTERNET ACTIVITY ETHICAL ISSUES GLOBAL DISCUSSION FINANCE PRINCIPLE FINANCIAL CRISIS
 • AUTHOR BIOS •
Ron Melicher is a professor of finance and previously served three different terms as chair
of the Finance Division, Leeds School of Business, University of Colorado Boulder. He is
a past president of the Financial Management Association. Ron earned undergraduate,
M.B.A., and doctoral degrees from Washington University in St. Louis, Missouri. While
at the University of Colorado, he has received several distinguished teaching awards
and was designated a university-wide President’s Teaching Scholar. Ron teaches corpo-
rate finance and financial strategy and valuation in the M.B.A. and Executive M.B.A.
programs, in addition to entrepreneurial finance and investment banking to undergradu-
ate students. His research has been published in major finance journals, including the
Journal of Finance, Journal of Financial and Quantitative Analysis, and Financial Manage-
ment. He is also the coauthor of Entrepreneurial Finance, fourth edition (South-Western/
Cengage Learning).

Edgar A. Norton is professor of finance in the College of Business at Illinois State Univer-
sity. He holds a double major in computer science and economics from Rensselaer
Polytechnic Institute and received his M.S. and Ph.D. from the University of Illinois at
Urbana–Champaign. A Chartered Financial Analyst (CFA), he regularly receives certificates
of achievement in the field of investments. He has consulted with COUNTRY Financial,
Maersk, and the CFA Institute; does pro bono financial planning; and is a past president
of the Midwest Finance Association. His research has appeared in numerous journals, such
as Financial Review, Journal of Business Venturing, and Journal of Business Ethics. He has
coauthored four textbooks, including Introduction to Finance.

x
 • BRIEF CONTENTS •
Preface iii

PART 1: INSTITUTIONS AND MARKETS 2

Chapter 1: The Financial Environment 4
Chapter 2: Money and the Monetary System 21
Chapter 3: Banks and Other Financial Institutions 43
Chapter 4: The Federal Reserve System 73
Chapter 5: Policy Makers and the Money Supply 97
Chapter 6: International Finance and Trade 123
PART 2: INVESTMENTS 148
Chapter 7: Savings and the Investment Process 150
Chapter 8: Interest Rates 173
Chapter 9: Time Value of Money 199
Chapter 10: Bonds and Stocks: Characteristics and Valuations 231
Chapter 11: Securities and Markets 275
Chapter 12: Financial Returns and Risk Concepts 313

PART 3: FINANCIAL MANAGEMENT 346

Chapter 13: Business Organization and Financial Data 348
Chapter 14: Financial Analysis and Long-Term Financial Planning 385
Chapter 15: Managing Working Capital 415
Chapter 16: Short-Term Business Financing 447
Chapter 17: Capital Budgeting Analysis 475
Chapter 18: Capital Structure and the Cost of Capital 515

Appendix 547
Glossary 556
Index 570

xi
 • CONTENTS •

PART 1 CHAPTER 2
INSTITUTIONS AND MARKETS 2 MONEY AND THE MONETARY SYSTEM 21
THE 2007–2008 FINANCIAL CRISIS 22
CHAPTER 1 PROCESS OF MOVING SAVINGS INTO
THE FINANCIAL ENVIRONMENT 4 INVESTMENTS 23
HOW HAS THE FINANCIAL ENVIRONMENT OVERVIEW OF THE MONETARY SYSTEM 24
CHANGED? 5
IMPORTANCE AND FUNCTIONS OF MONEY 26
WHAT IS FINANCE? 5
DEVELOPMENT OF MONEY IN THE UNITED
TWO THEMES 7 STATES 27
WHY STUDY FINANCE? 7 PHYSICAL MONEY (COIN AND PAPER
CAREERS IN FINANCE 8 CURRENCY) 27
SIX PRINCIPLES OF FINANCE 10 DEPOSIT MONEY 32
TIME VALUE OF MONEY 10 MONEY MARKET SECURITIES 33
RISK VERSUS RETURN 10 MEASURES OF THE U.S. MONEY SUPPLY 34
DIVERSIFICATION OF RISK 10 M1 MONEY SUPPLY 34
FINANCIAL MARKETS ARE EFFICIENT 11 M2 MONEY SUPPLY 35
MANAGEMENT VERSUS OWNER OBJECTIVES 11 EXCLUSIONS FROM THE MONEY SUPPLY 36
REPUTATION MATTERS 12 MONEY SUPPLY AND ECONOMIC ACTIVITY 36
OVERVIEW OF THE FINANCIAL SYSTEM 13 INTERNATIONAL MONETARY SYSTEM 38
CHARACTERISTICS AND REQUIREMENTS 13 SUMMARY 39
FINANCIAL SYSTEM COMPONENTS AND FINANCIAL KEY TERMS 40
FUNCTIONS 14 DISCUSSION QUESTIONS 40
EXERCISES 41
FINANCIAL MARKETS CHARACTERISTICS 16 PROBLEMS 41
MONEY AND CAPITAL MARKETS 16
PRIMARY AND SECONDARY MARKETS 16 CHAPTER 3
MAJOR TYPES OF FINANCIAL MARKETS 16 BANKS AND OTHER FINANCIAL
INSTITUTIONS 43
THE PLAN OF STUDY 17
SUMMARY 18 FINANCIAL INSTITUTION DISTRESS DURING
KEY TERMS 19 THE FINANCIAL CRISIS 44
DISCUSSION QUESTIONS 19 TYPES AND ROLES OF FINANCIAL
EXERCISES 19 INSTITUTIONS 45

xii
 CONTENTS xiii

DEPOSITORY INSTITUTIONS 46 MEMBER BANKS 77

CONTRACTUAL SAVINGS ORGANIZATIONS 46 FEDERAL RESERVE DISTRICT BANKS 78
SECURITIES FIRMS 47 BOARD OF GOVERNORS 80
FINANCE FIRMS 48 FEDERAL OPEN MARKET COMMITTEE (FOMC) 80
OVERVIEW OF THE BANKING SYSTEM 48 ADVISORY COMMITTEES 80
COMMERCIAL, INVESTMENT, AND UNIVERSAL ROLE OF THE CHAIR OF THE FED BOARD OF
BANKING 48 GOVERNORS 80
FUNCTIONS OF BANKS AND THE BANKING MONETARY POLICY FUNCTIONS AND
SYSTEM 50 INSTRUMENTS 82
HISTORICAL DEVELOPMENT OF THE U.S. OVERVIEW OF RESPONSIBILITIES 82
BANKING SYSTEM 51 RESERVE REQUIREMENTS 83
BEFORE THE CIVIL WAR 51 DISCOUNT RATE POLICY 85
ENTRY OF THRIFT INSTITUTIONS 53 OPEN-MARKET OPERATIONS 86
REGULATION OF THE BANKING SYSTEM 53 QUANTITATIVE EASING 87
GENERAL BANKING LEGISLATION 53 IMPLEMENTATION OF MONETARY POLICY 88
THE SAVINGS AND LOAN CRISIS 55 FED SUPERVISORY AND REGULATORY
PROTECTION OF DEPOSITORS’ FUNDS 56 FUNCTIONS 88
STRUCTURE OF BANKS 57 SPECIFIC SUPERVISORY RESPONSIBILITIES 88
BANK CHARTERS 57 SPECIFIC REGULATORY RESPONSIBILITIES 89
DEGREE OF BRANCH BANKING 57 FED SERVICE FUNCTIONS 89
BANK HOLDING COMPANIES 58 THE PAYMENTS MECHANISM 90
THE BANK BALANCE SHEET 59 TRANSFER OF CREDIT 92
ASSETS 60 OTHER SERVICE ACTIVITIES 92
LIABILITIES AND OWNERS’ CAPITAL 63 CENTRAL BANKS IN OTHER COUNTRIES 92
BANK MANAGEMENT 63 SUMMARY 94
KEY TERMS 95
LIQUIDITY MANAGEMENT 64 DISCUSSION QUESTIONS 95
CAPITAL MANAGEMENT 65 EXERCISES 95
INTERNATIONAL BANKING AND FOREIGN PROBLEMS 96
SYSTEMS 67
SUMMARY 68 CHAPTER 5
KEY TERMS 69 POLICY MAKERS AND THE MONEY
DISCUSSION QUESTIONS 69 SUPPLY 97
EXERCISES 70
PROBLEMS 70 NATIONAL ECONOMIC POLICY
OBJECTIVES 98
ECONOMIC GROWTH 98
CHAPTER 4 HIGH EMPLOYMENT 99
THE FEDERAL RESERVE SYSTEM 73
PRICE STABILITY 99
U.S. CENTRAL BANK RESPONSE TO
THE FINANCIAL CRISIS AND GREAT BALANCE IN INTERNATIONAL TRANSACTIONS 99
RECESSION 74 FOUR POLICY MAKER GROUPS 100
THE U.S. BANKING SYSTEM PRIOR ETHICAL BEHAVIOR IN GOVERNMENT 100
TO THE FED 75 POLICY MAKERS IN THE EUROPEAN ECONOMIC
WEAKNESSES OF THE NATIONAL BANKING UNION 101
SYSTEM 75 GOVERNMENT REACTION TO THE PERFECT
THE MOVEMENT TO CENTRAL BANKING 76 FINANCIAL STORM 101
STRUCTURE OF THE FEDERAL RESERVE GOVERNMENT INFLUENCE ON THE
SYSTEM 77 ECONOMY 102
xiv CONTENTS

POLICY INSTRUMENTS OF THE U.S. CONDUCTING BUSINESS

TREASURY 104 INTERNATIONALLY 134
MANAGING THE TREASURY’S CASH BALANCES 104 MANAGING FOREIGN EXCHANGE RISK 134
POWERS RELATING TO THE FEDERAL BUDGET AND ETHICAL CONSIDERATIONS 135
TO SURPLUSES OR DEFICITS 105 FINANCING INTERNATIONAL TRADE 135
RECENT FINANCIAL CRISIS-RELATED FINANCING BY THE EXPORTER 136
ACTIVITIES 106
FINANCING BY THE IMPORTER 138
AMOUNT OF NATIONAL DEBT AND DEBT
BANKER’S ACCEPTANCES 140
MANAGEMENT 107
OTHER AIDS TO INTERNATIONAL TRADE 140
CHANGING THE MONEY SUPPLY 108
BALANCE IN INTERNATIONAL
CHECKABLE DEPOSIT EXPANSION 108
TRANSACTIONS GOAL 141
OFFSETTING OR LIMITING FACTORS 112
NATURE OF THE PROBLEM 142
CONTRACTION OF DEPOSITS 112
BALANCE-OF-PAYMENTS ACCOUNTS 142
FACTORS AFFECTING BANK RESERVES 113 SUMMARY 144
CHANGES IN THE DEMAND FOR CURRENCY 113 KEY TERMS 144
FEDERAL RESERVE SYSTEM TRANSACTIONS 114 DISCUSSION QUESTIONS 145
EXERCISES 145
THE MONETARY BASE AND THE MONEY PROBLEMS 146
MULTIPLIER 117
SUMMARY 119
KEY TERMS 119
DISCUSSION QUESTIONS 119 PART 2
EXERCISES 120 INVESTMENTS 148
PROBLEMS 120
CHAPTER 7
SAVINGS AND THE INVESTMENT
CHAPTER 6 PROCESS 150
INTERNATIONAL FINANCE AND GROSS DOMESTIC PRODUCT AND CAPITAL
TRADE 123 FORMATION 151
GLOBAL OR INTERNATIONAL MONETARY GDP COMPONENTS 151
SYSTEM 124
IMPLICATIONS OF INTERNATIONAL PAYMENT
DEVELOPMENT OF INTERNATIONAL FINANCE 124 IMBALANCES 153
HOW THE INTERNATIONAL MONETARY SYSTEM LINK BETWEEN SAVING AND INVESTMENT 153
EVOLVED 124
FEDERAL GOVERNMENT RECEIPTS AND
EUROPEAN UNIFICATION 126 EXPENDITURES 155
EUROPEAN UNION 126 THE BUDGET 155
EUROZONE MEMBERS 126 FISCAL POLICY MAKERS 156
THE EURO 126 DEBT FINANCING 157
EUROPEAN UNION FINANCIAL CRISES 127 HISTORICAL ROLE AND CREATION OF
CURRENCY EXCHANGE MARKETS AND SAVINGS 158
RATES 127 FOREIGN SOURCES OF SAVINGS 158
CURRENCY EXCHANGE MARKETS 127 DOMESTIC SUPPLY OF SAVINGS 158
EXCHANGE RATE QUOTATIONS 128 CREATION OF SAVINGS 158
FACTORS THAT AFFECT CURRENCY EXCHANGE MAJOR SOURCES OF SAVINGS 159
RATES 129
PERSONAL SAVINGS 159
CURRENCY EXCHANGE RATE APPRECIATION AND
DEPRECIATION 132 CORPORATE SAVINGS 160
ARBITRAGE 133 FACTORS AFFECTING SAVINGS 161
EXCHANGE RATE DEVELOPMENTS FOR THE U.S. LEVELS OF INCOME 161
DOLLAR 133 ECONOMIC EXPECTATIONS 162
 CONTENTS xv

ECONOMIC CYCLES 162 DEFAULT RISK PREMIUMS 193

LIFE STAGES OF THE INDIVIDUAL SAVER 163 SUMMARY 195
KEY TERMS 195
LIFE STAGES OF THE CORPORATION 163
DISCUSSION QUESTIONS 195
CAPITAL MARKET SECURITIES 164 EXERCISES 196
MORTGAGE MARKETS 165 PROBLEMS 196
TYPES OF MORTGAGES AND MORTGAGE-BACKED
SECURITIES 165 CHAPTER 9
TIME VALUE OF MONEY 199
CREDIT RATINGS AND SCORES 166
PRINCIPLES OF FINANCE 200
MAJOR PARTICIPANTS IN THE SECONDARY
MORTGAGE MARKETS 167 BASIC CONCEPTS 201
A FURTHER LOOK AT THE 2007–2008 COMPOUNDING TO DETERMINE FUTURE
FINANCIAL CRISIS 167 VALUES 201
EARLY FACTORS 167 INFLATION OR PURCHASING POWER
IMPLICATIONS 205
A BORROWING-RELATED CULTURAL SHIFT 168
SUMMARY 168 DISCOUNTING TO DETERMINE PRESENT
KEY TERMS 169 VALUES 206
DISCUSSION QUESTIONS 169 EQUATING PRESENT VALUES AND FUTURE
EXERCISES 170 VALUES 209
PROBLEMS 170
FINDING INTEREST RATES AND TIME
REQUIREMENTS 210
CHAPTER 8 SOLVING FOR INTEREST RATES 210
INTEREST RATES 173 SOLVING FOR TIME PERIODS 211
SUPPLY AND DEMAND FOR LOANABLE RULE OF 72 212
FUNDS 174
FUTURE VALUE OF AN ANNUITY 212
HISTORICAL CHANGES IN U.S. INTEREST RATE
LEVELS 175 PRESENT VALUE OF AN ANNUITY 214
LOANABLE FUNDS THEORY 176 INTEREST RATES AND TIME REQUIREMENTS
FOR ANNUITIES 216
DETERMINANTS OF MARKET INTEREST
RATES 179 SOLVING FOR INTEREST RATES 216
RISK-FREE SECURITIES: U.S. TREASURY SOLVING FOR TIME PERIODS 217
DEBT OBLIGATIONS 180 DETERMINING PERIODIC ANNUITY
MARKETABLE OBLIGATIONS 181 PAYMENTS 218
DEALER SYSTEM 182 EXAMPLES INVOLVING ANNUAL PAYMENTS 218
TAX STATUS OF FEDERAL OBLIGATIONS 182 REAL ESTATE MORTGAGE LOANS WITH MONTHLY
PAYMENTS 219
OWNERSHIP OF PUBLIC DEBT SECURITIES 183
MATURITY DISTRIBUTION OF MARKETABLE DEBT MORE FREQUENT COMPOUNDING OR
SECURITIES 184 DISCOUNTING INTERVALS 220

TERM OR MATURITY STRUCTURE OF COST OF CONSUMER CREDIT 221

INTEREST RATES 185 UNETHICAL LENDERS 221
RELATIONSHIP BETWEEN YIELD CURVES AND THE APR VERSUS EAR 222
ECONOMY 186 SUMMARY 223
TERM STRUCTURE THEORIES 186 KEY TERMS 223
DISCUSSION QUESTIONS 223
INFLATION PREMIUMS AND PRICE
EXERCISES 224
MOVEMENTS 188
PROBLEMS 224
HISTORICAL INTERNATIONAL PRICE
MOVEMENTS 188 LEARNING EXTENSION 9
INFLATION IN THE UNITED STATES 189 ANNUITY DUE PROBLEMS 226
TYPES OF INFLATION 191 FUTURE VALUE OF AN ANNUITY DUE 226
xvi CONTENTS

PRESENT VALUE OF AN ANNUITY DUE 227 DISCUSSION QUESTIONS 268

EXERCISES 269
INTEREST RATES AND TIME REQUIREMENTS
FOR ANNUITY DUE PROBLEMS 228
PROBLEMS 229 LEARNING EXTENSION 10
ANNUALIZING RATES OF RETURN 272
HOLDING PERIOD RETURNS 272
CHAPTER 10 ANNUALIZED RATES OF RETURN 272
BONDS AND STOCKS: CHARACTERISTICS
PROBLEMS 274
AND VALUATIONS 231
LONG-TERM EXTERNAL FINANCING SOURCES
CHAPTER 11
FOR BUSINESSES 232
SECURITIES AND MARKETS 275
DEBT CAPITAL 234
ISSUING SECURITIES: PRIMARY SECURITIES
WHO BUYS BONDS? 235 MARKETS 276
BOND COVENANTS 236 PRIMARY MARKET FUNCTIONS OF INVESTMENT
BOND RATINGS 237 BANKERS 276
BONDHOLDER SECURITY 238 COST OF GOING PUBLIC 281
TIME TO MATURITY 240 THE FACEBOOK IPO 284
INCOME FROM BONDS 241 OTHER FUNCTIONS OF INVESTMENT BANKING
FIRMS 286
GLOBAL BOND MARKET 242
INVESTMENT BANKING REGULATION 287
READING BOND QUOTES 242
TRADING SECURITIES—SECONDARY
CORPORATE EQUITY CAPITAL 244
SECURITIES MARKETS 288
COMMON STOCK 245
ORGANIZED SECURITY EXCHANGES 288
PREFERRED STOCK 246
STRUCTURE OF THE NEW YORK STOCK
READING STOCK QUOTES 248 EXCHANGE 289
DIVIDENDS AND STOCK REPURCHASES 249 WHAT MAKES A GOOD MARKET? 294
HOW DO FIRMS DECIDE ON THE DOLLAR AMOUNT A WORD ON COMMISSIONS 296
OF DIVIDENDS? 249
SECURITY MARKET INDEXES 296
STOCK DIVIDENDS AND STOCK SPLITS 251
FOREIGN SECURITIES 297
SHARE REPURCHASES 252
INSIDE INFORMATION AND OTHER ETHICAL
VALUATION PRINCIPLES 252
ISSUES 298
VALUATION OF BONDS 255
CHANGES IN THE STRUCTURE OF THE STOCK
DETERMINING A BOND’S PRESENT VALUE 255 MARKET 299
CALCULATING THE YIELD TO MATURITY 258 SUMMARY 301
RISK IN BOND VALUATION 259 KEY TERMS 301
DISCUSSION QUESTIONS 302
VALUATION OF STOCKS 262
PROBLEMS 302
VALUING STOCKS WITH CONSTANT
DIVIDENDS 263 LEARNING EXTENSION 11
VALUING STOCKS WITH CONSTANT DIVIDEND INTRODUCTION TO FUTURES
GROWTH RATES 263 AND OPTIONS 305
RISK IN STOCK VALUATION 265 WHY DO DERIVATIVES EXIST? 305
VALUATION AND THE FINANCIAL FUTURES CONTRACTS 306
ENVIRONMENT 265
OPTIONS 307
GLOBAL ECONOMIC INFLUENCES 265
OPTION PAYOFF DIAGRAMS 308
DOMESTIC ECONOMIC INFLUENCES 266
SUMMARY 310
INDUSTRY AND COMPETITION 266 KEY TERMS 310
SUMMARY 267 DISCUSSION QUESTIONS 311
KEY TERMS 267 PROBLEMS 311
 CONTENTS xvii

CHAPTER 12 PARTNERSHIP 352

FINANCIAL RETURNS AND RISK CORPORATION 353
CONCEPTS 313
THE ANNUAL REPORT 355
HISTORICAL RETURN AND RISK FOR A SINGLE
FINANCIAL ASSET 314 ACCOUNTING PRINCIPLES 355
ARITHMETIC AVERAGE ANNUAL RATES OF INCOME STATEMENT 357
RETURN 315 THE BALANCE SHEET 359
VARIANCE AS A MEASURE OF RISK 316 ASSETS 359
STANDARD DEVIATION AS A MEASURE LIABILITIES 360
OF RISK 316 OWNERS’ EQUITY 361
WHERE DOES RISK COME FROM? 319 STATEMENT OF CASH FLOWS 361
EXPECTED MEASURES OF RETURN FINANCIAL STATEMENTS OF DIFFERENT
AND RISK 320 COMPANIES 363
HISTORICAL RETURNS AND RISK OF THE AUTO BAILOUT AND FINANCIAL
DIFFERENT ASSETS 323 STATEMENTS 364
EFFICIENT CAPITAL MARKETS 324 GOAL OF A FIRM 365
PORTFOLIO RETURNS AND RISK 327 MEASURING SHAREHOLDER WEALTH 366
EXPECTED RETURN ON A PORTFOLIO 327 LINKING STRATEGY AND FINANCIAL PLANS 367
VARIANCE AND STANDARD DEVIATION OF CRITERION FOR NONPUBLIC FIRMS 368
RETURN ON A PORTFOLIO 328
WHAT ABOUT ETHICS? 368
TO DIVERSIFY OR NOT TO DIVERSIFY? 329
CORPORATE GOVERNANCE 369
PORTFOLIO RISK AND THE NUMBER OF
INVESTMENTS IN THE PORTFOLIO 330 PRINCIPAL-AGENT PROBLEM 369
SYSTEMATIC AND UNSYSTEMATIC RISK 331 REDUCING AGENCY PROBLEMS 370

CAPITAL ASSET PRICING MODEL (CAPM) 332 FINANCE IN THE ORGANIZATION

ETHICS AND JOB OPPORTUNITIES IN
INVESTMENTS 335
SUMMARY 337
KEY TERMS 337
DISCUSSION QUESTIONS 337
PROBLEMS 338
LEARNING EXTENSION 12
ESTIMATING BETA 341
SECURITY MARKET LINE 342
QUESTIONS AND PROBLEMS 344
PART 3
FINANCIAL MANAGEMENT
CHAPTER 13
BUSINESS ORGANIZATION AND
FINANCIAL DATA 348
STARTING A BUSINESS 349
STRATEGIC PLAN WITH A VISION OR MISSION
BUSINESS AND FINANCIAL GOALS 350
FORMS OF BUSINESS ORGANIZATION IN THE
UNITED STATES 350
PROPRIETORSHIP 351
CHART 372
SUMMARY 374
KEY TERMS 375
DISCUSSION QUESTIONS 375
PROBLEMS 375
LEARNING EXTENSION 13
FEDERAL INCOME TAXATION 379
DEPRECIATION BASICS 381
A FEW WORDS ON DEPRECIATION
METHODS 382
QUESTIONS AND PROBLEMS 382
346
CHAPTER 14
FINANCIAL ANALYSIS AND LONG-TERM
FINANCIAL PLANNING 385
FINANCIAL STATEMENT ANALYSIS 386
RATIO ANALYSIS OF BALANCE SHEET AND
349 INCOME STATEMENT 386
TYPES OF FINANCIAL RATIOS 387
LIQUIDITY RATIOS AND ANALYSIS 388
ASSET MANAGEMENT RATIOS AND ANALYSIS 390
FINANCIAL LEVERAGE RATIOS AND ANALYSIS 392
xviii CONTENTS
PROFITABILITY RATIOS AND ANALYSIS 396
MARKET VALUE RATIOS AND ANALYSIS 398
SUMMARY OF RATIO ANALYSIS FOR
WALGREENS 400
DUPONT METHOD OF RATIO ANALYSIS
LONG-TERM FINANCIAL PLANNING
PERCENTAGE OF SALES TECHNIQUE
COST-VOLUME-PROFIT ANALYSIS 405
DEGREE OF OPERATING LEVERAGE 407
SUMMARY 409
KEY TERMS 410
DISCUSSION QUESTIONS 410
PROBLEMS 410
CHAPTER 15
MANAGING WORKING CAPITAL
OPERATING AND CASH CONVERSION
CYCLES 417
OPERATING CYCLE 417
CASH CONVERSION CYCLE 418
DETERMINING THE LENGTH OF THE OPERATING
CYCLE AND CASH CONVERSION CYCLE 419
WORKING CAPITAL REQUIREMENTS
CASH BUDGETS 423
MINIMUM DESIRED CASH BALANCE
ESTIMATED CASH INFLOWS 423
ESTIMATED CASH OUTFLOWS 424
CONSTRUCTING THE CASH BUDGET
SEASONAL VERSUS LEVEL PRODUCTION
MANAGEMENT OF CURRENT ASSETS
CASH AND MARKETABLE SECURITIES
MANAGEMENT 428
GETTING AND KEEPING THE CASH
ACCOUNTS RECEIVABLE MANAGEMENT
CREDIT ANALYSIS 437
CREDIT-REPORTING AGENCIES 437
CREDIT TERMS AND COLLECTION EFFORTS
INVENTORY MANAGEMENT 440
TECHNOLOGY AND WORKING CAPITAL
MANAGEMENT 441
CASH MANAGEMENT 441
PROCESSING INVOICES AND FLOAT
TRACKING INVENTORY 442
SUMMARY 443
KEY TERMS 443
DISCUSSION QUESTIONS 443
PROBLEMS 444
CHAPTER 16
SHORT-TERM BUSINESS FINANCING 447
STRATEGIES FOR FINANCING WORKING
CAPITAL 448
400 MATURITY-MATCHING APPROACH 449
AGGRESSIVE APPROACH 451
402
CONSERVATIVE APPROACH 451
403
FACTORS AFFECTING SHORT-TERM
FINANCING 452
OPERATING CHARACTERISTICS 452
OTHER INFLUENCES IN SHORT-TERM
FINANCING 454
PROVIDERS OF SHORT-TERM FINANCING 456
COMMERCIAL BANK LENDING 456
TRADE CREDIT FROM SUPPLIERS 460
415
COMMERCIAL FINANCE COMPANIES 461
COMMERCIAL PAPER 462
ADDITIONAL VARIETIES OF SHORT-TERM
FINANCING 464
ACCOUNTS RECEIVABLE FINANCING 464
INVENTORY LOANS 467
LOANS SECURED BY STOCKS AND BONDS 468
420
OTHER FORMS OF SECURITY FOR BANK LOANS 469
THE COST OF SHORT-TERM FINANCING 469
423
SUMMARY 470
KEY TERMS 471
DISCUSSION QUESTIONS 471
425 PROBLEMS 471
426
428 CHAPTER 17
CAPITAL BUDGETING ANALYSIS 475
MANAGEMENT OF FIXED ASSETS 476
434 IDENTIFYING POTENTIAL CAPITAL BUDGET
436 PROJECTS 476
CAPITAL BUDGETING PROCESS 478
CAPITAL BUDGETING TECHNIQUES 481
438 NET PRESENT VALUE 481
INTERNAL RATE OF RETURN 484
NPV AND IRR 487
MODIFIED INTERNAL RATE OF RETURN 488
PROFITABILITY INDEX 490
442
CONFLICTS BETWEEN DISCOUNTED
CASH FLOW TECHNIQUES 490
DIFFERENT CASH FLOW PATTERNS 490
DIFFERENT TIME HORIZONS 490
DIFFERENT SIZES 491
 CONTENTS xix

PAYBACK PERIOD 491 COST OF CAPITAL 520

DIFFERENCE BETWEEN THEORY AND COST OF DEBT 520
PRACTICE 492 COST OF PREFERRED STOCK 521
SAFETY MARGIN 492 COST OF COMMON EQUITY 521
MANAGERIAL FLEXIBILITY AND OPTIONS 493 COST OF NEW COMMON STOCK 523
ESTIMATING PROJECT CASH FLOWS 493 WEIGHTED AVERAGE COST OF CAPITAL 523
ISOLATING PROJECT CASH FLOWS 493 CAPITAL STRUCTURE WEIGHTS 524
APPROACHES TO ESTIMATING PROJECT MEASURING THE TARGET WEIGHTS 524
CASH FLOWS 495 WHAT DO BUSINESSES USE AS THEIR COST OF
CASH FLOW FROM OPERATIONS 495 CAPITAL? 525
CASH FLOW FROM INVESTMENT ACTIVITIES 497 DIFFICULTY OF MAKING CAPITAL
CASH FLOW FROM FINANCING ACTIVITIES 497 STRUCTURE DECISIONS 527
AN EXAMPLE 497 PLANNING GROWTH RATES 528
DEPRECIATION AS A TAX SHIELD 498 INTERNAL GROWTH RATE 529
KEEPING MANAGERS HONEST 499 SUSTAINABLE GROWTH RATE 529
RISK-RELATED CONSIDERATIONS 500 EFFECTS OF UNEXPECTEDLY HIGHER (OR LOWER)
SUMMARY 501 GROWTH 530
KEY TERMS 502 EBIT/EPS ANALYSIS 531
DISCUSSION QUESTIONS 502 INDIFFERENCE LEVEL 531
PROBLEMS 503
COMBINED OPERATING AND FINANCIAL
LEVERAGE EFFECTS 534
LEARNING EXTENSION 17
ESTIMATING PROJECT CASH FLOWS 505 UNIT VOLUME VARIABILITY 534
PRICE-VARIABLE COST MARGIN 534
PROJECT STAGES AND CASH FLOW
ESTIMATION 505 FIXED COSTS 534
INITIAL OUTLAY 505 DEGREE OF FINANCIAL LEVERAGE 535
CASH FLOWS DURING THE PROJECT’S TOTAL RISK 535
OPERATING LIFE 506 INSIGHTS FROM THEORY AND PRACTICE 537
SALVAGE VALUE AND NWC RECOVERY AT TAXES AND NONDEBT TAX SHIELDS 537
PROJECT TERMINATION 506
BANKRUPTCY COSTS 537
APPLICATIONS 507
AGENCY COSTS 539
CASH FLOW ESTIMATION FOR A REVENUE
A FIRM’S ASSETS AND ITS FINANCING POLICY 540
EXPANDING PROJECT 507
THE PECKING ORDER HYPOTHESIS 540
CASH FLOW ESTIMATION FOR A COST-SAVING
PROJECT 509 MARKET TIMING 540
SETTING A BID PRICE 511 BEYOND DEBT AND EQUITY 541
SUMMARY 513 GUIDELINES FOR FINANCING STRATEGY 541
DISCUSSION QUESTIONS 513 SUMMARY 543
PROBLEMS 513 KEY TERMS 543
DISCUSSION QUESTIONS 543
CHAPTER 18 PROBLEMS 544
CAPITAL STRUCTURE AND
THE COST OF CAPITAL 515 APPENDIX 547
WHY CHOOSE A CAPITAL STRUCTURE? 516 GLOSSARY 556
TRENDS IN CORPORATE USE OF DEBT 517 INDEX 570
CASHING IN ON LOW INTEREST RATES 518
REQUIRED RATE OF RETURN
AND THE COST OF CAPITAL 519
INTRODUCTION TO FINANCE

Markets, Investments, and Financial Management

 PA RT 1
INSTITUTIONS AND MARKETS

INTRODUCTION
Ask someone what he or she thinks “finance” is about. You’ll probably get a variety of responses: “It
deals with money.” “It is what my bank does.” “The New York Stock Exchange has something to do
with it.” “It’s how businesses and people get the money they need—you know, borrowing and stuff
like that.” And they’d all be correct!
Finance is a broad field. It involves national and international systems of banking and financing
business. It also deals with the process you go through to get a car loan and what a business does
when planning for its future needs.
It is important to understand that while the U.S. financial system is complex, it generally operates
efficiently. However, on occasion, imbalances can result in economic, real estate, and stock market
“bubbles,” which when bursts cause havoc on the workings of the financial system. The decade of
the 2000s began with the bursting of the “tech” or technology bubble and the “dot.com” bubble.
Then in mid-2006, the real estate bubble in the form of excessive housing prices burst. This was
followed by the peaking of stock prices in 2007 followed by a steep decline that continued into early
2009. Economic activity began slowing in 2007 and progressed into an economic recession begin-
ning in mid-2008, which was accompanied by double-digit unemployment rates. The result was the
2007–2008 financial crisis and the 2008–2009 Great Recession that produced the most financial
distress on the U.S. financial system since the Great Depression years of the 1930s.
Within the general field of finance, there are three areas of study: financial institutions and
markets, investments, and financial management. These areas are illustrated in the accompanying
diagram. Financial institutions collect funds from savers and lend them to or invest them in busi-
nesses or people that need cash. Examples of financial institutions are commercial banks, investment
banks, insurance companies, and mutual funds. Financial institutions operate as part of the financial
system. The financial system is the environment of finance. It includes the laws and regulations that
affect financial transactions. The financial system encompasses the Federal Reserve System, which
controls the supply of money in the U.S. economy. It also consists of the mechanisms that have been
constructed to facilitate the flow of money and financial securities among countries. Financial
markets represent ways for bringing together those that have money to invest with those that need
funds. Financial markets, which include markets for mortgages, securities, and currencies, are neces-
sary for a financial system to operate efficiently. Part 1 of this book examines the financial system
and the role of financial institutions and financial markets in it.
Securities markets play important roles in helping businesses and governments raise new funds.
Securities markets also facilitate the transfer of securities between investors. A securities market can
be a central location for the trading of financial claims, such as the New York Stock Exchange. It may
also take the form of a communications network, as with the over-the-counter market, which is
another means by which stocks and bonds can be traded. When people invest funds, lend or borrow
money, or buy or sell shares of a company’s stock, they are participating in the financial markets. Part
2 of this book examines the role of securities markets and the process of investing in bonds and stocks.
The third area of the field of finance is financial management. Financial management studies how
2
a business should manage its assets, liabilities, and equity to produce a good or service. Whether or
not a firm offers a new product or expands production, or how it invests excess cash, are
examples of decisions that financial managers are involved with. Financial managers are
constantly working with financial institutions and watching financial market trends as they
make investment and financing decisions. Part 3 discusses how financial concepts can help
managers better manage their firms.
There are few clear distinctions or separations between the three areas of finance. The
diagram intentionally shows institutions and markets, investments, and financial manage-
ment overlapping one another. Financial institutions operate in the environment of the
financial markets and work to meet the financial needs of individuals and businesses. Finan-
cial managers do analyses and make decisions based on information they obtain from the
financial markets. They also work with financial institutions when they need to raise funds
and when they have excess funds to invest. Participants investing in the financial markets use
information from financial institutions and firms to evaluate different investments in secu-
rities such as stocks, bonds, and certificates of deposit. A person working in one field must
be knowledgeable about all three. Thus, this book is designed to provide you with a survey
of all three areas of finance.
Part 1, Institutions and Markets, presents an overview of the financial system and its
important components of policy makers, a monetary system, financial institutions, and
financial markets. Financial institutions operate within the financial system to facilitate the
work of the financial markets. For example, you can put your savings in a bank and earn
interest. But your money doesn’t just sit in the bank: The bank takes your deposit and the
money from other depositors and lends it to Kathy, who needs a short-term loan for her
business; to Ron for a college loan; and to Roger and Maria, who borrow the money to help
buy a house. Banks bring together savers and those who need money, such as Kathy, Ron,
Roger, and Maria. The interest rate the depositors earn and the interest rate that borrowers
pay are determined by national and even international economic forces. Just what the bank
does with depositors’ money and how it reviews loan applications is determined to some
extent by bank regulators and financial market participants, such as the Federal Reserve
Board. Decisions by the president and Congress relating to fiscal policies and regulatory laws
may also directly influence financial institutions and markets and alter the financial system.
Chapter 2 presents an overview of the role of money in the operation of the U.S. mone-
tary and financial systems, including discussion of how funds are transferred among indi-
viduals, firms, and countries. Depository institutions, such as banks and savings and loans,
as well as other financial institutions, involved in the financial intermediation process are
the topic of Chapter 3. The Federal Reserve System, the U.S. central bank that controls the
money supply, is discussed in Chapter 4. Chapter 5 places the previous chapters in perspec-
tive, discussing the role of the Federal Reserve and the banking system in helping meet
national economic goals for the United States, such as economic growth, low inflation, and
stable exchange rates. Part 1 concludes with an explanation of international trade and the
topic of international finance in Chapter 6. 3
Another random document with
no related content on Scribd:
272
Samar 5,040
13,054
Saranguani 36
93
Semerara 23
60
Siargao 134
347
Sibuyan 131
339
Siquijor 83
215
Sulu, or Jolo 241
624
Tablas 250
648
Ticao 94
243
Ybayat, or Ibayat 22
57
Ylin 24
62

GROUPS.

Alabat 76
197
Jomalig

Banton 44
114
Simara
 Romblon

Daram 41
106
Buad

Camotes group: 74
192
Ponson
Poro
Pasijan

Calaguas group:
Tinagua 19
49
Guintinua

Cuyos group: 28
73
Cuyos
Cugo
Agutaya
Hamipo
Bisukei

Laguan 23
60
Batag

Limbancauyan 184
477
Mesa, or Talajit
Maripipi
 Balupiri
Biliran

Lubang 53 163
Ambil
Golo

San Miguel 82 212

Batan
Cacraray
Rapurrapu

Tawi Tawi group: 183 414

Tawi Tawi
Tabulinga
Tandubato

Others of the
Tawi Tawi group. 54 140

Total measured 118,542 307,025

Estimated area of
unmeasured islands 1,000 2,500

Total area 119,542 309,615

{368}

Length of general shore line.

Name. Miles
Kilometers
 Bohol 161
259
Cebu 310
499
Jolo Archipelago 858
1,381
Kalamines 126
203
Leite 363
584
Luzon 2,144
3,450
Masbate 244
393
Mindanao 1,592
2,562
Mindoro 322
518
Negros 386
621
Palawan 644
1,036
Panay 377
607
Samar 412
663
Minor islands 3,505
5,641

Total 11,444
18,417
"The following [as to population] is a quotation from an
article by W. F. Wilcox, of the United States Census Bureau.
It is well to notice that the last official census was in 1887
and that the figures of that census, though probably
underestimating the population of the islands, are the ones
which, in default of better, we are obliged to take as final.
It is probable that these are an understatement of the true
population of the Philippines for several reasons, among which
is one not observed by Mr. Wilcox, and which is therefore
mentioned. It is, of course, only supposition, but is at least
suggestive. For every adult counted in the census the
officials were obliged to return a poll tax. Thus, for
instance, if 100,000 persons were counted 100,000 pesetas
would have to be returned to the treasury. It has therefore
been supposed that the officials counted, say, 150,000 and
returned only 100,000 pesetas and 100,000 names. Mr. Wilcox
says (American Statistical Association Publ., September,
1899): 'The population of the islands in 1872 was stated in a
letter to Nature (6:162), from Manila, by Dr. A. B. Meyer, who
gives the latest not yet published statistics as his
authority. The letter gives the population of nine islands, as
follows:

Luzon 4,467,111
Panay 1,052,586
Cebu 427,356
Leite 285,495
Bohol 283,515
Negros 255,873
Samar 250,062
Mindanao 191,802
Mindoro 70,926

"It also gives the population of each of the 43 provinces of

the islands. The population was not counted, but estimated.
The number who paid tribute was stated as 1,232,544. How this
 was ascertained we are not informed. The total population,
7,451,352, was approximated 'on the supposition that about the
sixth part of the whole has to pay tribute.' In reality this
population is 6.046 times the assigned tribute-paying
population. But Dr. Meyer adds: 'As there exist in all the
islands, even in Luzon, independent tribes and a large number
in Mindanao, the number of 7,451,352 gives no correct idea of
the real population of the Philippines. This is not known at
all and will not be known for a long time to come.'

"Since 1872 there have been actual enumerations of the

Philippines, but authorities differ as to the time when they
occurred and the detailed results. These enumerations were
usually confined to the subject and Catholic population, and
omitted the heathen, Mohammedan, and independent tribes. Four
reports of the entire population have been printed:

1. A report made by the religious orders in 1876 or 1877, in

which the nationalities and creeds of the population were
distinguished.

2. A manuscript report to Professor Blumentritt of the

enumeration made by the religious orders in December, 1879.

3. The official report of the civil census of December 31,

1877, contained in Reseña geog. y estad. de España, 1888, p.
1079.

4. The official report upon the census taken by the civil

officers December 31, 1887, and printed in the first volume of
Censo de la Poblacion de España, at Madrid, in 1891.

The first two may be compared, and tend somewhat to

corroborate each other, as follows:

1. Tribute-paying natives.
5,501,356
 2. Army
14,545
3. Navy
2,924
4. Religious officers (Geistlichkeit)
1,962
5. Civil officers
5,552
6. Other Spaniards
13,265

Total Spaniards
38,248

1876-77.
1879.
Total Catholics 5,539,604
5,777,522
Heathen and Mohammedan natives 602,853
632,640
Foreigners (In 1876 there were:
British, 176; German, 109;
Americans, 42; French, 30) 378
592
Chinese 30,797
39,054

Total 6,173,632
6,449,813
"The third enumeration reported 5,567,685 as the
tribute-paying population. To this number should be added the
estimated number of the independent tribes, 'Indios no
sometidos'; this according to the missionaries' count was
about 600,000, making a total of 6,167,685. Most experts agree
that this official report is untrustworthy and involves
serious omissions, but believe that the facts are so
imperfectly known that they are unable to correct it. One
author, del Pac, writing in 1882, started from the
missionaries' census of 1876-77, viz, 6,173,632, assumed that
this omitted as many as 600,000 members of independent tribes
and that the increase of 1876-1882 would be 740,000. In this
way he got 7,513,632. A second writer, Sanciano, estimated the
population in 1881 as 10,260,249. The missionaries made an
estimate of their own in 1885 which showed 9,529,841.
Seat of War in the Island of Luzon.

{369}

"The fourth enumeration of those mentioned above showed a

population of 5,985,123 in 1887, and the totals both for the
group as a whole and for the fifty odd provinces tend to
confirm and to be confirmed by the civil count of 1877. This
number, however, represents only the nominally Catholic or
tribute-paying population. To it must be added the Mohammedan
or heathen tribes set down by clerical authorities as about
600,000. Perhaps the highest authority in this field,
Professor Blumentritt, is confident that this number does not
include all the independent tribes, but only those in the
mountains who have a special arrangement freeing them from all
the dues of the subject tribes. On the whole, therefore, Prof.
H. Wagner is inclined to estimate these omissions of
independent or non-Christian tribes at about 1,000,000 and the
population of the group at about 7,000,000. This result is
indorsed by the latest German authority, Hübner's
Geographisch-Statistische Tabellen for 1898, which gives the
population as
5,985,124 + 1,000,000 = 6,985,124, as follows:

Spanish
Estimated number
census.
not counted.

Luzon and adjacent islands 3,443,000

150,000
Mindoro and Masbate 126,000
100,000
Visayas Archipelago 2,181,000
200,000
 Mindanao 209,000
400,000
Calamianes and Palawan 22,000
50,000
Jolo (Sulu) Islands 4,000
100,000

Total 5,985,000
1,000,000

"Personally I am disposed to suspect that this number,

although called by Professor Wagner an outside estimate, is
below rather than above the truth. In favor of this position
it may be urged that Professor Wagner's estimate makes no
allowance either for the natural increase of population,
1887-1898, or for the fact that the first careful census of
densely populated regions, like India and Japan, usually
reveals a larger population than had been previously
estimated. This analogy might reasonably be applied to Luzon
and the Visayas."

United States, 56th Congress, 1st Session,

Senate Document Number 171, pages 4-7.

PHILIPPINE ISLANDS:
The native inhabitants.

"The inhabitants of the Philippines belong to three sharply

distinct races—the Negrito race, the Indonesian race, and the
Malayan race. It is universally conceded that the Negritos of
to-day are the disappearing remnants of a people which once
populated the entire archipelago. They are, physically,
weaklings of low stature, with black skin, closely-curling
hair, flat noses, thick lips, and large, clumsy feet. In the
matter of intelligence they stand at or near the bottom of the
human series, and they are believed to be incapable of any
considerable degree of civilization or advancement. Centuries
ago they were driven from the coast regions into the wilder
interior portions of the islands by Malay invaders, and from
that day to this they have steadily lost ground in the
struggle for existence, until but a few scattered and
numerically insignificant groups of them remain. … It is
believed that not more than 25,000 of them exist in the entire
archipelago, and the race seems doomed to early extinction. …

"So far as is at present known, the Philippine tribes

belonging to the Indonesian race are confined to the great
island of Mindanao, the surface of which constitutes about
one-third of the total land area of the archipelago. … The
Philippine representatives of this race are physically
superior not only to the Negritos, but to the more numerous
Malayan peoples as well. They are tall and well developed,
with high foreheads, aquiline noses, wavy hair, and often with
abundant beards. The color of their skins is quite light. Many
of them are very clever and intelligent. None of the tribes
have been Christianized. Some of them have grown extremely
fierce and warlike as a result of their long struggle with
hostile Malayan peoples. Others, more happy in their
surroundings, are pacific and industrious.

"The great majority of the inhabitants of the Philippines are

of Malayan extraction, although the race is not found pure in
any of the islands, but is everywhere more or less modified
through intermarriage with Chinese, Indonesians, Negritos,
Arabs, and, to a limited extent, Spaniards and other
Europeans. The individuals belonging to these Malayan tribes
are of medium size, with straight black hair. As a rule the
men are beardless, and when they have a beard it is usually
straggling, and appears late in life. The skin is brown and
distinctly darker than that of the Indonesians, although very
much lighter than that of the Negritos. The nose is short and
frequently considerably flattened. The representatives of
these three races are divided into numerous tribes, which
 often differ very greatly in language, manners, customs, and
laws, as well as in degree of civilization. …

"Any estimate of the total population must manifestly depend

on the number of inhabitants assigned to the various wild
tribes, of which there are no less than 69. For the purposes
of this report the commission has adopted as the total figure
8,000,000, considering this a conservative estimate. Baranera,
whose figures are believed to be carefully prepared, places
the total at 9,000,000. The extent of territory occupied in
whole or in part by each of the more important civilized
tribes can be estimated with a greater degree of accuracy, and
is approximately as follows: Visayans (occupying 28,100 square
miles) 2,601,600; Tagalogs (15,380 sq. miles) 1,663,900;
Bicols (6,900 sq. miles) 518,100; Ilocanos (6,170 sq. miles)
441,700; Pangasinaus (1,950 sq. miles) 365,500; Pampangas
(1,950 sq. miles) 337,900; Moros (12,860 sq. miles) 268,000;
Cagayans(11,500 sq. miles) 166,300. All of these peoples,
although ignorant and illiterate, are possessed of a
considerable degree of civilization, and, with the exception
of the Mohammedan Moros, are Christianized."

Philippine Commission,
Report, January 31, 1900, volume 1, pages 11-15.

PHILIPPINE ISLANDS: A. D. 1896-1898.

The Katipunan and the rising against Spanish rule.
Appearance of Aguinaldo as a leader.
Dr. José Rizal.
The Treaty of Biac-na-bato.
Departure of Aguinaldo and his return with
the American forces.

The Philippine Islands, discovered in 1521 by Magellan (or

Maghallanes or Magalhaes), and occupied by the Spaniards in
1565, seems, for a long period, to have interested that people
more as a missionary than as a commercial field. Indeed, the
 doings of the church and of the religious orders, and the
acceptance of Roman teachings of Christianity by the greater
part of the native population, make up the essential history
of the Philippines until quite recent times. If the islands
had offered gold mines, or pearl fisheries, or spice forests
to their European discoverers, the story would certainly have
been different. As it was, the Spaniards were not moved to
much eagerness in exploiting such resources of commerce as
they found; and so, through fortunate circumstances, the
natives were made converts instead of slaves.
{370}
By missionaries, more than by soldiers, they were subdued; by
the church, more than by the Spanish state, they were ruled.
It is certain that there were great corruptions and
oppressions in the government, and it follows that a large
share of responsibility for them rests on those who controlled
the affairs of the church. For the past hundred years, at
least, the more spirited part of the native population has
been restive under the misrule and its burdens, and frequent
attempts at insurrection have been made. Such an outbreak in
1872 was suppressed and punished with a vengefulness, in
executions and banishment, which rankled ever afterwards in
the hearts of the people.

A secret society, called the "Katipunan," or League, was then

formed, which became a revolutionary organization, and from
which sprang the most serious of Filipino rebellions, in 1896.
The province of Cavite was the center of revolt, and it was
there that Emilio Aguinaldo, then the schoolmaster at Silan,
came into prominence as a leader. Mr. John Foreman, who was in
the Philippines at the time of the insurrection, states that
Aguinaldo was personally humane, but fearful atrocities were
committed in the first months of the rising by some of the
insurgents of his band. One captured priest, according to Mr.
Foreman's account, "was cut up piecemeal; another was
saturated with petroleum and set on fire; and a third was
bathed in oil and fried on a bamboo spit run through the
length of his body." The Spaniards, on their side, were
equally inhuman in their treatment of captured rebels and
"suspects." Says Mr. Foreman: "About 600 suspects were
confined in the dungeons of Fort Santiago at the mouth of the
Pasig River. Then occurred a frightful tragedy. The dungeons
are below water-mark at high tide; the river filtered in
through the crevices in the ancient masonry; thus twice a day
these unfortunates were up to their waists or necks in water,
according to the height of the men. The Spanish sergeant on
duty threw his rug over the only light and ventilating shaft,
and, in a couple of days, carts were seen by many citizens
carrying away the dead, calculated to number 70. Provincial
governors and parish priests seemed to regard it as a duty to
supply the capital with batches of 'suspects' from their
localities. In Vigan, where nothing had occurred, many of the
heads of the best families and monied men were arrested and
brought to Manila in a steamer. They were bound hand and foot,
and carried like packages of merchandise in the hold. I
happened to be on the quay when the steamer discharged her
living freight, with chains and hooks to haul up and swing out
the bodies like bales of hemp. …

"Thousands of peaceful natives were treated with a ferocity

which would have shocked all Europe. … Within three months of
the outbreak, hundreds of the richest natives and half-castes
in Manila were imprisoned for a few days and released
conditionally"—the condition being a payment of ransom,
sometimes said to be as high as $40,000. But General Blanco,
the then Governor-General, was not vigorous enough in his
measures to satisfy the all-powerful clerical party in the
islands, and he was replaced by General Polaveja, who received
large reinforcements from Spain, and who succeeded in breaking
the strength of the rebellion to a great extent. But the
character of Polaveja's administration is thus described by
Mr. Foreman: "Apart from the circumstances of legitimate
warfare, in which probably neither party was more merciful
than the other, he initiated a system of striking terror into
the non-combatant population by barbarous tortures and
wholesale executions. … Men were escorted to the prisons by
pure caprice and subjected to horrible maltreatment. Many of
them were liberated in the course of a few days, declared
innocent, but maimed for life and forever unable to get a
living. … The only apparent object in all this was to
disseminate broadcast living examples of Spanish vengeance."
The most notable victim at this period was Dr. José Rizal, a
physician, highly educated in Europe, distinguished as an
oculist, and the author of certain novels in which the
condition of things in his native country was set forth. On
his return to the Islands, Dr. Rizal incurred the enmity of
the friars by opposing them, and was pursued by their
hostility. From 1893 to 1896 he was kept in banishment,
closely watched, at a small town in the island of Mindanao.
Then he sought and obtained permission to go to Cuba in the
medical staff of the Spanish army; but, just as he arrived at
Manila, on his way to Spain, the insurrection of 1896 broke
out, and though he was suffered to depart, his enemies pursued
him with accusations of complicity in the rising and caused
him to be brought back. Says Mr. Foreman, who was an
eye-witness of what occurred: "Not a few of us who saw the
vessel leave wished him 'God speed.' But the clerical party
were eager for his extermination. … The lay authorities always
had to yield to the monks, and history herein repeated itself.
Dr. Rizal was cabled for to answer certain accusations, and so
on his landing in the Peninsula he was incarcerated in the
celebrated fortress of Montjuich (the scene of so many
horrors), pending his re-shipment by the returning steamer. He
reached Manila as a state prisoner in the Colon, isolated from
all but his jailors. It was materially impossible for him to
have taken any part in the rebellion, whatever his sympathies
may have been." Nevertheless, he was tried by court-martial
for sedition and rebellion, condemned and shot; and his memory
is cherished in the islands as that of a martyred patriot.
"The decree of execution was one of Polaveja's foulest acts."
 Having scotched but not killed the insurrection, Polaveja went
home, with broken health, in the spring of 1897, and was
succeeded by General Primo de Rivera, who, after some months
of continued warfare, opened negotiations with Aguinaldo, the
recognized leader of the revolt. The result was a treaty,
known as the "Pacto de Biac-na-bato, signed December 14. By
this treaty "the rebels undertook to deliver up their arms and
ammunition of all kinds to the Spaniards; to evacuate the
places held by them; to conclude an armistice for three years
for the application and development of the reforms to be
introduced by the other part, and not to conspire against
Spanish sovereignty in the Islands, nor aid or abet any
movement calculated to counteract the reforms.
{371}
Emilio Aguinaldo and 34 other leaders undertook to quit the
Philippine Islands, and not to return to them until so
authorised by the Spanish Government. On behalf of the Spanish
Government it was agreed to pay, through the medium of Pedro
A. Paterno, to the rebels the sum of $1,000,000, and to the
families who had sustained loss by reason of the war $700,000,
in instalments and conditionally,"—the condition being that no
renewal of rebellion or conspiracy occur. Aguinaldo and other
chiefs of the insurrection left the Islands, accordingly; but
they are said to have been utterly duped. One instalment, only
($400,000), of the promised money was ever paid; the promised
reforms were not carried out, and persecution of those who had
been in sympathy with the rising was renewed.

J. Foreman,
The Philippine Islands,
chapter 26 (New York: Charles Scribner's Sons).

"Aguinaldo and his associates went to Hongkong and Singapore.

A portion of the money, $400,000, was deposited in banks at
Hongkong, and a lawsuit soon arose between Aguinaldo and one
of his subordinate chiefs named Artacho, which is interesting
on account of the very honorable position taken by Aguinaldo.
 Artacho sued for a division of the money among the insurgents
according to rank. Aguinaldo claimed that the money was a
trust fund, and was to remain on deposit until it was seen
whether the Spaniards would carry out their promised reforms,
and if they failed to do so, it was to be used to defray the
expenses of a new insurrection. The suit was settled out of
court by paying Artacho $5,000. No steps have been taken to
introduce the reforms, more than 2,000 insurgents, who had
been deported to Fernando Po and other places, are still in
confinement, and Aguinaldo is now using the money to carry on
the operations of the present insurrection."

F. V. Greene,
Memorandum concerning the Situation in the Philippines,
August 30, 1898 (Treaty of Peace and Accompanying Papers:
55th Congress, 3d Session,
Senate Document Number 62, part 1, page 421.

PHILIPPINE ISLANDS: A. D. 1897.

Refusal of United States Government to negotiate
with the insurgent republic.

See (in this volume)

UNITED STATES OF AMERICA: A. D. 1897 (NOVEMBER).

PHILIPPINE ISLANDS: A. D. 1898 (April-May).

Circumstances in which Aguinaldo was brought to
Manila to co-operate with American forces.

See (in this volume)

UNITED STATES OF AMERICA:
A. D. 1898 (APRIL-MAY: PHILIPPINES).

PHILIPPINE ISLANDS: A. D. 1898 (April-July).

Destruction of the Spanish fleet in Manila Bay.
Blockade and siege of the city.
Co-operation of insurgents under Aguinaldo.
 See (in this volume)
UNITED STATES OF AMERICA: A. D. 1898 (APRIL-JULY).

PHILIPPINE ISLANDS: A. D. 1898 (May-August).

Conduct of English and German naval officers at Manila.

See (in this volume)

UNITED STATES OF AMERICA: A. D. 1898 (MAY-AUGUST).

PHILIPPINE ISLANDS: A. D. 1898 (July-August).

Correspondence between the American commander and Aguinaldo.

This is fully given (showing the relations between the

American and Filipino forces, before the capture of Manila),
in the general account of the Spanish-American War.

See (in this volume)

UNITED STATES OF AMERICA:
A. D. 1898 (JULY-AUGUST: PHILIPPINES).

PHILIPPINE ISLANDS: A. D. 1898 (July-September).

American capture of Manila.
Relations with the Filipino insurgents.
General Merritt's report.
Aguinaldo declared President of the Philippine Republic.

See (in this volume)

UNITED STATES OF AMERICA: A. D. 1898 (JULY-SEPTEMBER).

PHILIPPINE ISLANDS: A. D. 1898 (August).

Suspension of hostilities between the United States and Spain.
Manila held by the former pending the conclusion
of a treaty of peace.

See (in this volume)

UNITED STATES OF AMERICA: A. D. 1898 (JULY-DECEMBER).
PHILIPPINE ISLANDS: A. D. 1898 (August).
Losses of the American army during the war with Spain.

See (in this volume)

UNITED STATES OF AMERICA: A. D. 1900 (JUNE).

PHILIPPINE ISLANDS: A. D. 1898 (August-December).

The state of things following the occupation of Manila
by American forces.
Growing distrust and unfriendliness of the Tagalos.
General Otis's report.

Of the state of things which followed the departure of General

Merritt, August 30, General Otis, who succeeded him in
command, reported subsequently as follows:

"Until October 14 [1898], the United States troops in the

Philippines remained stationed at Manila and Cavite, as
provided in General Merritt's orders of August 23, with very
slight exceptions, Major-General Anderson retaining
supervision of the district of Cavite and Major-General
MacArthur of the troops stationed in Manila, the three
organizations composing the provost guard continuing, however,
under the control of Brigadier-General Hughes. They were most
bountifully supplied with subsistence and medicines, but light
clothing suited to the climate and facilities necessary for
occupying and messing in barracks were needed. These were soon
obtained through contract and purchase from the merchants of
Hongkong and Manila and by shipment from the United States.
The troops received tactical instructions daily, but the
weather was too hot for much physical exertion, and time hung
heavily upon them. They entertained the impression that the
Spanish war had terminated, and the volunteers appeared to
believe that they should be recalled to the United States at
once and regular troops sent out to perform the monotonous
garrison duties which were about to follow the victory of