Knowledge that Transforms

In a recent paper Lloyd and Shick (LS) [4] report empirical results of tests of Stone's [7] two-factor model. Based on a sample of 60 banks and the 30 Dow Jones stocks, LS conclude that their findings generally support Stone's model. That is, an “interest rate risk” proxy appears to explain an additional portion of the variability of the sampled security returns over and above the variability due to an equity market proxy.

Throughout the finance and economics literature, it is widely recognized that taxation can significantly alter individual behavior and market equilibrium conditions. Yet, in the area of bonds, the impacts of taxation upon bond pricing have generally been ignored. The primary purpose of this paper is to trace out the impact of differential taxation of regular income and capital gains upon the pricing of coupon-bearing bonds.

This paper is concerned with costs of capital in mathematical programming formulations of the problem of capital budgeting under capital rationing. It shows that there is a serious error in the method outlined by previous authors for converting the shadow prices from the solution of the dual into measures of the firm's marginal internal opportunity rates. In addition to demonstrating that the traditional approach leads to erroneous and nonsensical results, this paper presents a correct procedure for determining these rates.

It Is commonplace within the confines of finance literature to explain variations in the firm's residual income stream via the dichotomy of business risk and financial risk. On an ex-post basis the business risk of the enterprise is a direct result of the firm's investment decision and is, thereby, embodied in its asset structure. It follows that the company's cost structure, product demand characteristics, intra-industry competitive position, and managerial talent all affect its business risk posture.

In a recent paper, the author [8] has derived the equilibrium bond pricing equation in a world of uncertain future interest rates assuming that capital gains and losses will be taxed at maturity at capital gains tax rates. In the case of premium bonds (i.e., bonds selling above par), the U.S. tax law allows bondholders to elect to amortize the premium on a straight line basis as a deduction from regular taxable income. For those paying positive tax rates, the amortization option will generally be advantageous compared to taking a capital loss at maturity.

Richard B. Kearns, Richard C. Burgess, An Effective Algorithm for Estimating Stochastic Dominance Efficient Sets, The Journal of Financial and Quantitative Analysis, Vol. 14, No. 3 (Sep., 1979), pp. 547-552

Robert Capettini, Richard A. Grimlund, Howard R. Toole, Comment: The Unique, Real Internal Rate of Return, The Journal of Financial and Quantitative Analysis, Vol. 14, No. 5 (Dec., 1979), pp. 1091-1094

Avner Kalay, Comment: Haugen and Senbet Paper, The Journal of Financial and Quantitative Analysis, Vol. 14, No. 4, Proceedings of 14th Annual Conference of the Western Finance Association, June 21-23, 1979 (Nov., 1979), pp. 711-714

The existence of risk aversion in portfolio theory can be explained by positing a concave utility function of wealth. In some cases it is useful to construct some measure of risk aversion rather than merely accept its existence.

The concept of a relationship between assumed risk and realized return is intuitively pleasing and has become widely accepted in the field of finance. Until recently this acceptance was anchored largely in what Hirschleifer [11] has called the “notorious fact” that stocks yield more in the long run than bonds and Hickman's finding [10] (since challenged by Fraine [7]) that over the years 1900–1943 the average ex post yield on publicly issued corporate debt was higher the lower the initial quality rating. However, with the advent of the capital asset pricing model of Sharpe [21], Lintner [16], and Mossin [19] the risk-return tradeoff concept has grown in importance and scope. The capital asset pricing model itself has weathered the years well, but has been theoretically and empirically revised, extended, and otherwise altered. Little remains of the original formulation except the proposition that in equilibrium more risk leads to more return--where “risk” for common stocks now means the nondiversified component as measured by the “Beta” coefficient of return volatility vis-à-vis the general market. As Modigliani and Pogue [18] observe after a review of the “more important” empirical tests of the capital asset pricing model: “Obviously, we cannot claim that the CAPM is absolutely right. On the other hand, the empirical tests do support the view that beta is a useful risk measure and that high beta stocks tend to be priced so as to yield correspondingly high rates of return.”