The Jones Family, Incorporated

The Scene: Early evening in an ordinary family room in Manhattan, Modern furniturewith old copies of The Wall Street Journal and the Financial Times scattered around. Autographed photos of Alan Greenspan and George Soros are prominently displayed. A picture window reveals a distant view of lights on the Hudson River. John Jones sits at a computer terminal, glumly sipping a glass of chardonnay and trading Japanese yen over the Internet. His wife Marsha enters.

Marsha: Hi, honey. Glad to be home. Lousy day on trading floor, through. Dullsville. No volume. But I did manage to hedge next years production from our copper mine. I couldnt get a good quote on the right package of futures contracts, so I arranged a commodity swap.

John doesnt reply.

Marsha: John, whats wrong? Have you been buying yen again? Thats been a losing trade for weeks.

John: Well, yes. I shouldnt have gone to Goldman Sachss foreign exchange brunch. But Ive got to get out of the house somehow. Im cooped up here all day calculating covariances and efficient risk-return trade-offs while youre out trading commodity futures. You get all the glamour and excitement.

Marsha: Dont worry dear, it will be over soon. We only recalculate our most efficient common stock portfolio once a quarter. Then you can go back to leveraged leases.

John: You trade, and I do all the worrying. Now theres a rumor that our leasing company is going to get a hostile takeover bid. I knew the debt ratio was too low, and you forgot to put on the poison pill. And now youre made a negative-NPV investment!

Marsha: What investment?

John: That fancy new Mercedes horse transporter. The caretaker on our Connecticut estate told me it arrived today. He said it cost $35000! Sometimes I think you love that horse Kosak more than you love me!

Marsha: There, there, dont you believe it. You always come first. But after all, Kosak is a champion Hanoverian gelding. We cant show up at the dressage competitions in a ratty rented horsebox.

John and Marshas teenage son Johnny bursts into the room.

Johnny: Hi, Dad! Hi, Mom! Guess what? Ive made the junior varsity derivatives team! That means I can go on the field trip to the Chicago Board Options Exchange. (Pauses. ) Whats wrong?

John: Your mother has made another negative-NPV investment. A horse transporter.

Johnny: Thats OK, Dad. Mom told me about it. Well save on the rentals. Remember, Mom goes to dressage every other week, and a rented transporter costs $200 per day plus $1.00 per mile. Most of the trips are 40 or 50 miles one-way. And then we usually give the driver a $40 tip. With the new transporter, well only have to pay for diesel fuel and maintenance-probably only about $.45 per mile.

John: What about insurance? What about depreciation?

Marsha: Insurance is only $1200 per year. And by the way, the transporter isnt new, its reconditioned. Its a Troja horsebox on a Mercedes truck chassis. Itll hold its value pretty well. The salesman said we could probably resell it for $15000 after eight years, when Kosak will be ready to retire-and that assumes no inflation. I think inflation will be at least 4 percent per year.

John: Operating costs will inflate too. So whats the NPV?

Marsha: Well, I didnt calculateconvenience is worth something, you know.

Johnny: Ill do the calculation, Dad. I was going to do it yesterday, but my corporate finance teacher asked us to calculate default probabilities for a sample of junk bonds. Is a 9 percent nominal cost of capital OK?

Marsha: Sure, Johnny.

John: I just wish we could make your horse into a tax shelter.(Takes a deep breath and stands up.) Anyway, how about a nice family dinner? Ive reserved our usual table at the Four Seasons.

Everyone exits.

Announcer: Was the horse transporter really negative-NPV? Will John and Marsha have to fight a hostile takeover? Will Johnnys derivatives team use Black-Scholes or the binomial method? Find out in the next episode of The Jones Family, Incorporated.

You may not aspire to the Jones familys way of life, but you will learn about all their activities, from futures contracts to binomial option pricing, later in this book. Meanwhile, you may wish to replicate Johnnys NPV analysis.