Knowledge that Transforms

In the evaluation of investment opportunities risk is often a primary consideration. Risk is usually not a factor of such importance, however, in the evaluation of borrowing opportunities. But when the borrowing opportunities include the borrowing of foreign currencies, then the possibility of exchange rate fluctuations during the loan period may introduce a significant component of risk. It is our purpose to develop a method for evaluating and selecting international borrowing sources in the face of exchange rate uncertainties.

George M. Frankfurter, Herbert E. Phillips, Efficient Algorithms for Conducting Stochastic Dominance Tests on Large Numbers of Portfolios: A Comment, The Journal of Financial and Quantitative Analysis, Vol. 10, No. 1 (Mar., 1975), pp. 177-179

Two prominent views pertaining to measures of risk aversion can be found in the literature. First, Arrow [2] and Pratt [3]developed risk aversion measures based on the curvature characteristics of the individual investor's utility for wealth function. If the investor's utility for wealth function is given by V(W), thenare the Arrow-Pratt measures of absolute and relative risk aversion, respectively. The investor is risk averse or a risk lover as r(W) and r* (W) are positive or negative. The investor exhibits increasing, constant, or decreasing absolute risk aversion as while he exhibits increasing, constant, or decreasing relative risk aversion as .

The Stable (or Pareto-Lévy) distribution has been of considerable interest in describing the behavior of security prices ever since the important work by Mandelbrot [6], [7] and Fama [1]. The aforementioned contributions focused on the empirical hypothesis that security price data are better fitted by theoretical distributions with infinite variance rather than finite variance. Specifically, in the case of Stable distributions, the “characteristic exponent” is less than two, and the data are not adequately fitted by a normal distribution. Remarkably, however, although almost the entire body of literature addressing empirical questions with respect to the distribution of security prices investigages the behavior of the (natural) logarithm of security price relatives, to this author's knowledge no paper exists which analyzes the portfolio choice implications of the assumption that the logarithm of the asset returns has a symmetric Stable distribution with infinite variance. Thus, in Fama [2], Samuelson [10], and Ziemba [12], where the problem of selecting an optimal portfolio in Stable markets is the object of concern, one finds that it is assumed that the price-relatives (returns) have a Stable distribution; this rather than the logarithm of the price relatives. And it should be noted that none of these authors suggests that the untransformed price-relatives are better-fitted by a symmetric Stable distribution as compared with the logarithm of the price-relatives.

Early studies on the effect of holding company affiliation on bank performance yield some curious results (see [9], [11], [12]). Specifically, these studies did not find that holding company affiliation results in changes in capital-asset ratios or bank profitability.

More than twenty years ago the portfolio selection problem was stated as a parametric quadratic programming problem [3]. Since that time there has been an ongoing search for methods that would allow reductions in both the data and the computational effort required to implement the Markowitz formulation. Markowitz himself developed a special algorithm for the problem [4] Sharpe followed with his famous diagonal model [6], a linear programming approximation for the special case of mutual funds [7], and a linear programming approximation for the general problem [0]. And during this period there were substantial advances in quadratic programming computer codes. A very fast code is now widely available [1], but the size of the code itself (a listing of the annotated program runs to more than 3, 000 lines) makes its everyday use for portfolio selection somewhat unattractive.

At any point in time a firm must decide both the level of working capital consistent with its productive assets and how to finance these assets. Academic theorists in business administration have traditionally approached decision making of the firm on a segmented rather than on a global basis and have been satisfied with developing suboptinizing decision rules. Thus there has been concern about managing working capital and concern about choosing the optimum capital structure, but traditionally the two decisions have not been made jointly. And even if they were made jointly, decisions would still remain in the working capital area involving inventories, credit granting, and marketable securities. This paper is an attempt to interrelate working capital and capital structure decisions with working capital used not only as a buffer to avoid ruin but also to affect sales via changing inventory levels and credit policies. The possibility of ruin introduces a discontinuity that precludes perfect elimination of leverage effects via a market.

William W. Reints, Pieter A. Vandenberg, The Impact of Changes in Trading Location on a Security's Systematic Risk, The Journal of Financial and Quantitative Analysis, Vol. 10, No. 5 (Dec., 1975), pp. 881-890

A financial decision model of the firm, in which most prior deterministic decision models' assumptions were relaxed, was developed and solved for its policy and state variables' time-optimal trajectories. In particular, the three alternative modes of corporate financing, with their respective explicit and implicit costs, were treated as distinct, time-variant decision variables. In addition, their dynamic interdependent relationship with the firm's investment-possibilities schedule was clearly delineated. Besides eliminating the usual constant returns assumption, our model further introduced a dividends discount factor which was an explicit function of the firm's debt-equity ratio.Furthermore, despite the generality of the model solutions, valuable economic implications were determined; namely, (1) conditions for the existence of a steady-state equilibrium were established with the critical role of nonproportional external equity flotation costs being observed; (2) the firm's dynamic equilibrium path was locally unstable in the initial, high-growth phase of its life cycle and was locally stable in its declining-growth stage–a result consistent with the growth literature in security valu ation theory; and (3) the usual assumptions of the balanced-growth path models are sufficient for the optimality of their decision policies.

The growing sensitivity of savings deposits to flow in response to changes in interest rate differentials has become so commonplace in the past decade that the term “disintermediation” has become a part of the economists' vocabulary. It is a major conclusion of this paper that the volatility of savings deposits began to increase as early as 1950 for savings and loan associations and credit unions and as early as 1945 for mutual savings banks. As an indication of this, we proxy changes in the competitive environment for savings deposits by making yearly estimates of the elasticity of savings deposits with respect to deposit rates at savings and loan associations, mutual savings banks, and credit unions.