Knowledge that Transforms

The certainty-equivalent method of evaluating risky investments has been widely discussed in the literature ([2], [5], [14, p. 356], [19], [20]) and consists of applying a multiplicative factor, αt, to each period's expected cash flow, μt, to produce a certainty-equivalent flow, αtμt. The certainty-equivalent flow is then discounted with the riskless rate of interest, αtμt/(l + i)t. Although there has been much discussion of αt, researchers have not derived explicit expressions for αt, relying instead on ad hoc graphs [24, p. 328] or arguments involving mean-variance indifference curves [2] which may not even exist ([4], [12], [22], [23]). In this paper, I will (1) provide a rigorous definition of αt, (2) derive formal expressions for a for αt three special cases, (3) discuss relationships between αt and σt, the standard deviation of the period t cash flow, (4) formally derive the period t risk-adjusted discount rate, kt, from assumptions concerning the decision maker's (d. m.'s) risk preferences and cash flow distribution, and (5) apply the preceding results to a specific problem involving calculation of the risk-adjusted present value of an uncertain cash flow stream.

In this paper we confront two well-known models for pricing options. It shows how the two models, one derived in a discrete time framework by Boness, the other derived in a continuous time framework by Black and Scholes, can be made consistent. In doing so, we find the implicit, discrete period, discount factor for the call option. Several characteristics of the discount factor are analyzed and compared to the characteristics of the instantaneous expected rate of return on the call.

Dennis W. Draper, James W. Hoag, Financial Intermediation and the Theory of Agency, The Journal of Financial and Quantitative Analysis, Vol. 13, No. 4, Proceedings of Thirteenth Annual Conference of the Western Finance Association, June 20-26, 1978 (Nov., 1978), pp. 595-611

Rajnish Mehra, On the Financing and Investment Decisions of Multinational Firms in the Presence of Exchange Risk, The Journal of Financial and Quantitative Analysis, Vol. 13, No. 2 (Jun., 1978), pp. 227-244

Following Markowitz's [11] pioneering work on portfolio selection, it is customary to consider an individual's choice among several risky assets as a two-step procedure. First, given some general characteristics concerning his preferences, the decision maker chooses an efficient set of portfolios independent of his specific preference assessment. Secondly, an optimal portfolio is chosen from the efficient set given the individual's specific preferences.

In response to the many issues raised by Altman and Eisenbeis (A&E) [2], we will use their three-part outline. Before turning to their comments, however, we would like to take this opportunity to correct a typo in footnote 10 from our original paper [4]. The denominator of the formula is incorrect as shown, and should be .

The literature on leasing has generally concentrated on providing management with a selection criterion for the lease-versus-purchase decision; over the years, a variety of recommendations have been advanced ([1], [3], [6], [8], [16], and [18]). More recent papers, however, have shown that the terms of leasing contracts in a transaction-costless competitive capital market will inevitably be such as to render the stockholders of value-maximizing firms indifferent to that decision ([11] and [12]). Simply put, competition among potential lessors-together with the mandates of securities-price-equilibrating trading activities of investors in lessee and lessor firms—will necessarily drive the present values of the cash flows associated with lease arrangements to parity with direct asset purchase prices.

Since call option trading started on the Chicago Board Options Exchange (CBOE) in April 1973, the interest shown by both the investment and academic communities has grown as rapidly as the volume of option trading. In May 1973, the first full month of trading on the CBOE, a total of 34,599 contracts were traded; during 1976, the monthly volume reached 1.5 million contracts on the CBOE and 800,000 contracts on the American Stock Exchange. At present the New York Stock Exchange and certain regional exchanges are evaluating the feasibility of adapting option trading for their respective exchanges.

One of the innovative and successful new markets developed in recent years has been the registered exchange for the trading of option contracts. Key innovations provided by the option exchanges include the standardization of some contractual terms and the creation of a central clearing corporation to serve as issuer and obligor of each option contract, thus severing the contractual link between a specific option writer and buyer. These changes have facilitated the trading of existing call options in the secondary market and have provided increased liquidity, continuous public reporting of prices, better information on trading volume and open positions, and reduced transaction costs.

Numerous studies have already examined the investment performance of mutual fund management with data from the 1950s and 1960s. Although the previous studies differed in the time period and evaluation method, they generally agreed that mutual funds, on the average, had failed to outperform the market over time. Thus they rendered a strong support to the efficient market hypothesis. Yet there is a need for an investigation of the data of the past several years. This study evaluates the quarterly investment performance of mutual funds in the period 1969–1975, using the weighted index benchmark portfolio approach.