The AMA Handbook of Financial Risk Management

320 Pages·2011·1.56 MB·English

by  John J. Hampton

The AMA Handbook of
Financial Risk Management
This page intentionally left blank
The AMA Handbook of
Financial Risk Management
John J. Hampton
American Management Association
New York * Atlanta * Brussels * Chicago * Mexico City * San Francisco
Shanghai * Tokyo * Toronto * Washington, D.C.
Bulk discounts available. For details visit:
www.amacombooks.org/go/specialsales
Or contact special sales:
Phone: [phone]
Email: [email protected]
View all the AMACOM titles at: www.amacombooks.org
This publication is designed to provide accurate and authoritative information in regard
to the subject matter covered. It is sold with the understanding that the publisher is not
engaged in rendering legal, accounting, or other professional service. If legal advice or
other expert assistance is required, the services of a competent professional person should
be sought.
Library of Congress Cataloging-in-Publication Data
Hampton, John J., 1942-
The AMA handbook of financial risk management / John J. Hampton.
p. cm.
Includes index.
ISBN-13: 978-0-8144-1744-7
ISBN-10: 0-8144-1744-2
1. Financial risk management. 2. Risk management. I. Title. II. Title: Handbook of
financial risk management.
HD61.H314 2011
658.15’5—dc22
2010048291
© 2011 John J. Hampton.
All rights reserved.
Printed in the United States of America.
This publication may not be reproduced, stored in a retrieval system, or transmitted in
whole or in part, in any form or by any means, electronic, mechanical, photocopying,
recording, or otherwise, without the prior written permission of AMACOM, a division of
American Management Association, 1601 Broadway, New York, NY 10019
About AMA
American Management Association (www.amanet.org) is a world leader in talent develop-
ment, advancing the skills of individuals to drive business success. Our mission is to sup-
port the goals of individuals and organizations through a complete range of products and
services, including classroom and virtual seminars, webcasts, webinars, podcasts, confer-
ences, corporate and government solutions, business books and research. AMA’s approach
to improving performance combines experiential learning—learning through doing—with
opportunities for ongoing professional growth at every step of one’s career journey.
Printing number
10 9 8 7 6 5 4 3 2 1
To the MBA and MS in Accountancy candidates and the high-quality graduate business
instructors at Saint Peter’s College
This page intentionally left blank
Contents
Preface xi
Introduction xv
Part 1. Introduction to Financial Risk 1
Chapter 1. Categorizing Financial Risks 3
The Enterprise Risk Management Framework 3
Risk Categories 5
Financial Risk Management 14
Conclusion 16
Part 2. Accounting, Cash Flow, and Budget Exposures 17
Chapter 2. Risks from Financial Accounting 19
Overview of Accounting 19
Accounting Principles 19
Categories of Accounts 21
Trial Balance 24
Financial Statements 25
Conclusion 28
Chapter 2 Appendixes 28
Chapter 3. Managing Operating Cash Flows 33
The Cash Flow Statement 33
Cash Flow Exposures 37
Conclusion 40
Chapter 3 Appendixes 40
Chapter 4. Operating Budgets 53
Nature of Budgeting 53
Forecasting Revenues 54
Life-Cycle Stages in Budgeting 57
Risks in Revenue Forecasting 60
Expense Allocations 63
Accounting Budgets 66
Cash Budgeting 67
Details of Budgeting 70
Conclusion 72
Chapter 4 Appendixes 73
vii
American Management Association
www.amanet.org
viii Contents
Part 3. Analyzing Operating Risks 85
Chapter 5. Profit Planning 87
Planning 87
Breakeven Analysis 89
Profit-Volume Analysis 92
Marginal Analysis 93
Future Earnings per Share 95
Conclusion 99
Chapter 5 Appendixes 99
Chapter 6. Leverage 111
Return on Investment Leverage 111
Operating Leverage 116
Financial Leverage 118
Weaknesses of Profit Planning 121
Conclusion 121
Chapter 6 Appendixes 122
Chapter 7. Financial Analysis 129
Ratio Analysis 129
Liquidity Ratios 132
Profitability Ratios 136
Other Ratios 138
Determining Financial Norms 142
Conclusion 142
Chapter 7 Appendixes 143
Part 4. Relationship of Risk and Return 149
Chapter 8. Time Value of Money 151
Short-Term Financing 151
Intermediate-Term Financing 155
The Amortization Schedule 157
Conclusion 161
Chapter 8 Appendixes 162
Chapter 9. Risk and Required Return 171
Nature of Risk 171
Capital Asset Theory 178
Risk and Required Return 181
Financial and Operational Risks 183
Conclusion 186
Chapter 9 Appendixes 186
Part 5. Nature of a Capital Investment Decision 193
Chapter 10. Capital Budgeting Cash Flows 195
Foundation of Capital Budgeting 196
Cash Flows 201
Conclusion 207
Chapter 10 Appendix 208
American Management Association
www.amanet.org
Contents ix
Chapter 11. Capital Budgeting Returns 211
Payback Method 211
Present Value Techniques 212
Internal Rate of Return Method 213
Net Present Value (NPV) Method 215
Midyear Discount Factors for Cash Flows 217
Conclusion 221
Chapter 11 Appendixes 221
Part 6. Factors That Affect the Value of a Firm 233
Chapter 12. Valuation of Common Stock 235
Common Stock and Equity Markets 235
Valuation Concepts 237
Value of Common Stock 240
Comparative Approaches to Valuation 244
Conclusion 245
Chapter 12 Appendixes 245
Chapter 13. Capital Structure of the Firm 253
Capital Structure 253
Weighted Average Cost of Capital (WACC) 254
Required Return at the Margin 257
Contribution of Miller and Modigliani 260
Optimal Capital Structure 263
Conclusion 266
Chapter 13 Appendixes 266
Chapter 14. Valuation of Business Combinations 271
Business Combinations 271
Pyramiding 273
Takeover Strategies 276
Conclusion 280
Chapter 14 Appendixes 280
Index 293
American Management Association
www.amanet.org