elements Of Finance.netÓ
Shareable Resources for Teaching
& Learning
Especially but not exclusively for learners of arts &
Sciences, Technology, Engineering, Mathematics, and financial economics
(aSTEMfe)
Writings by prof-td@elementsOfFinance.net
The elements Of Finance book: http://elementsoffinance.net/elements.pdf
An active project: http://elementsoffinance.net/palette.pdf
The
list includes both manuscripts published in journals and a selection of
unpublished manuscripts
1. Learn how penny stocks and extreme outcomes
provide evidence for the share market lottery premium that Allan Greenspan
predicted.
http://elementsoffinance.net/support/jpm_lottery.pdf
This
article with then Ph.D. Finance student coauthor Quan Wen at the University of
Alabama shows that the supermajority of extreme positive stock returns occur most commonly for stocks with a price less than $7 a
share. Stocks in low price deciles return less on average than medium and
higher priced stocks even though expectations are that rates of returns
distribute independently of the share price. Those investors seeking extreme
returns behaviorally respond as if to willingly sacrifice expected return for
their chance to own the winning ticket, however remote. The lottery premium is larger
in up markets than down markets and has become more costly as the decades roll
on.
2. Learn that the ex ante rate of return required to induce investment
generally equals the risk free rate of return plus a
risk premium whereas the expected rate of return depends on information and
information alone. The expected value of future flows sustains the expected
rate of return in a model of capitalized economic value described centuries ago,
never abandoned, made stronger ever since.
http://elementsoffinance.net/support/average_period_user_cost_and_term_structure.pdf
.
This unpublished manuscript models the economic
intrinsic value of a balance sheet from environmental parameters within the
user cost of capital, a measurable akin to the gross profit margin of financial
accounting. John Keynes writes in The General Theory (1936) that the
user cost constitutes a link between the present and future. The user cost also
is known as the rental price of capital and accounts for many real phenomena
besides the financial cost of money such as physical depreciation in productive
capacity and the effects of inflation and taxation. It’s all about time and
it’s often said that time is money. Many people spend many moments with their
mind on their money and their money on their mind!
3. Learn that variation in risk-sharing (risk-aversion)
between creditors and shareholders affects the shape of the yield curve.
http://elementsoffinance.net/support/neoclassical_term_structure.pdf
This
unpublished paper introduces diversification benefits from investment as a
source of wealth for the risk premium that sustains the growth of financial
markets.
4.
See that a complex modeling and measuring of the intrinsic value for a balance
sheet enables mapping intrinsic value to public policy in general and to tax
policy in particular.
http://elementsoffinance.net/support/aer_stock_prices.pdf
A
fundamental finding is that the responsiveness of balance sheet intrinsic value
to a change in the cost of capital (also known as the discount rate) may be
positive or negative and depends on a ratio of percentage changes, that is an interest
elasticity (a.k.a., duration) of the return streams for marginal investments
relative to that for total assets. When the ratio of elasticities exceeds
unity, a plausible scenario in some market settings, then company intrinsic
value rises with a rising cost of capital and falls with a falling cost of
capital, an observation otherwise unseen in the literature. An increase in the
cost of capital is commonly thought to unidirectionally depress intrinsic value
– wrong! Thanks to Boston College co-author Hassan Tehranian that handed me the
excess stock return numbers in this article that fortuitously aligned with my
predicted changes to intrinsic value for the 3 industries selected. I vividly
recall him comparing his numbers to my predictions while stating “but how did
you know” – priceless. I am even more
grateful to HT for the introduction outside my BC office door to Professor
Billy Helms visiting momentarily from the University of Alabama who, unbeknownst
at the time, would very soon offer me more than a quarter century of guidance
and growth opportunities within the Department of Economics, Finance, and Legal
Studies in sweet home Tuscaloosa.
5. This study, co-authored with Patric
Hendershott, Head of my dissertation committee at Purdue University examines
effects on the intrinsic value of U.S. Nonfinancial corporate fixed capital
stocks from policy changes enacted through federal tax law.
http://elementsoffinance.net/support/ntj_tax_policy.pdf
An
early draft of the study was presented by me at the National Bureau of Economic
Research Summer Workshop Series on Mass Ave Cambridge in the strip between MIT
and Harvard. A dozen distinguished profs seated around an ovoid table included
moderator Martin Feldstein, then the NBER President at one end and the
presenter (me) momentarily at the other end, with side chairs seating Mervyn
King, Jonathan Leape, Alan Auerbach, some others, and of course Pat
Hendershott! No side chair for me as post presentation discussion, especially
by Profs. Leape and Feldstein, kept me on my feet! Finishing
and exiting to the hallway revealed the next presenter, Lawrence Summers (with
David Cutler, I think), were preparing to enter the room and present next. That
gave opportunity for me to acknowledge the fantastic informative discussions on
economic income in Feldstein and Summers (1979).
Three
months after the summer workshop I answered the home phone about 8:30am to hear
“Hello, this is Fischer Black,” then a Goldman-Sachs VP and forevermore the MIT
prof that laid a firm foundation for standardized option markets. Though
answering the phone with a poopy baby diaper in-hand before heading to my BC
office, the 45-minute conversation with Fischer prompted by his read of this
study that later finalized with Daniel Holland, then editor of the National Tax
Journal at MIT, remains a cherished & inspirational event in my half
century with universities of higher learning. The phone conversation with
Fischer Black was so engrossing that I didn’t think to mention that as a Ph.D.
student in Fi617 Seminar in Investments at Purdue (the only FI designated course
in my history as student), Profs. Stroyny and Kracow assigned me to present the Black zero beta model
with restricted borrowing (1972). I regret not sharing with Fischer Black my
bewilderment and wonder, as the 7 page handout I
distributed in class showed in writing, that the asset allocation weight for risky
asset j he denotes as Wj in the publication, generalizes for the entire portfolio of risky assets
in matrix notation as “Wtranspose I
W” where I denotes the Identity matrix and W contains the allocation
weights for all risky assets. The matrix representation of the Black Zero Beta formula
appears an analogue to the formula “sigma transpose I sigma” that forms statistics.
6.
Learn about three financial accounting methods for valuing fixed asset
stocks that extend from the same fundamental specification. The historical replacement cost method measures
historical investment flows net of accumulated depreciation. The current replacement cost method extends
to account for incremental information on cumulative specific price inflation. The intrinsic value method in this article
accounts for inflation, taxes, capital accumulation histories, and capacity
depreciation schedules.
http://elementsoffinance.net/support/jar_fundamental_value.pdf
Thanks
to co-author Keith Shriver for questioning how my intrinsic value computations
compare to his data for actual used fixed corporate asset prices. I presented
our findings at the University of Chicago Graduate School of Business annual conference
hosted by the Institute for Professional Accounting. Actual used corporate
fixed asset prices track intrinsic valuations better than historical cost or
current cost measurements. A happy
learning moment occurred when discussant prof Ralph Sansing (Yale) having said
that the intrinsic valuation method “lacks a decision making
context” received a reply from Editor Katherine Schipper (UChicago) that “the
method is immune to this criticism because the intrinsic value specification
has a dimension of timelessness”. That dimension of timelessness forms the
concrete bond between the number and the real underlier! A scary learning
moment occurred when Aussie audience member Richard Leftwich (UChicago)
requested from me clarification for the effects on intrinsic value of asset
specific price inflation versus aggregate inflation. I knew not the answer but
only its event horizon. The answer forms the interstitial zone between (a) consumer
theory of utility specifications by Chipman and Moore (1972) that in the
absence of polymorphic household wants and needs, domestic tranquility begins
at home and accumulates into the wealth of a nation, and (b) producer theory of
value specifications from Dale Jorgenson (1983) that measure flow of funds
matrices, capacity utilization rates, and gross profit margins that accumulate
into the wealth of the nation throughout the complex economic web forming an
exchange economy . Sadly significant is that there
exists limited connectivity between domestic tranquility and a nation’s Gross
National Product or its Standing Army.
7.
Learn that the demand price for real capital embodies expected returns
based upon economic information about discounted cash flows.
http://elementsoffinance.net/support/producer_theory_of_value_and_equilibrium_stock_returns.pdf
When
properly discounted expected cash flows provide an intrinsic value measurement
then market competition assures that required risk premia measurements from the
consumer theory of value vibrate randomly and unpredictably around the
information-based expected returns (Bachelier 1893, 1906 and Paul Samuelson
1965). Burton Malkiel writes in A Random Walk Down Wall Street (1968)
that risk and risk alone determines the level of equilibrium rates of
return. Correction: Risk and risk alone
determine the required risk premium added to the risk-free rate, a societal
rate with concrete components independent of preferences. Risk determines only
the required rate of return and not its dual, the expected rate of return. Information and information alone determine
the expected rate of return. Efficient markets force the spread between
required and expected returns to narrow down to the core (Stoll 1989) thereby revealing
the overlapping of interest on interest.
8. This
unpublished study incorporates debt maturity structure into intrinsic value by
focusing on the zero net present value equilibrium condition in the market for
real assets. Market equilibria implies that the net
present value of the marginal investment is independent of the financing method
therefore user costs for alternative debt contracts equilibrate. The user cost
specification therefore implies a determinate relationship between interest
rates on alternative debt contracts. .
http://elementsoffinance.net/support/embodied_equity_theory_of_term_structure.pdf
Analysis
of the user cost specification reveals that the equilibrium interest rate is an
increasing function of the debt contract's loan-to-value ratio and debt
duration (its elasticity a.k.a. average period). The basic reason why the
interest rate increases with average period is this: the equity financing rate exceeds
the interest rate, a lengthening debt average period
reduces to equity the discounted cost of debt and the financing rate increases
to re-establish equilibrium. The “embodied equity” hypothesis advanced herein
joins the expectations hypothesis, the liquidity preference hypothesis, and the
market segmentation hypothesis as fundamental explanations for the normal
upward slope on the yield curve.
9. This study models and measures industry
level intrinsic values, an approach that focuses on the asset side of the
balance sheet. The ratio of industry
market capitalization to intrinsic value, dubbed the overvalue ratio, leverages
rates of return independently of required risk premia measures focused on the
liability side of the balance sheet.
Namely, for a $1 change in intrinsic value the resultant shareholder
rate of return is smaller for an overvalued industry (or company) and bigger
for an undervalued company irrespective of risk factors or preferences.
http://elementsoffinance.net/support/jpm_asset_valuation.pdf
I was invited to present this publication at the Wall
Street Quantitative Investment workshop hosted annually by Institutional
Investor, a prestigious trade journal.
Two profs presented to the attendees, say 400 diverse workers in
finance, already seated for lunch in this 1-day program at the then famous Helmsley
Hotel. Prof Ken French (Dartmouth) was the keynote speaker presenting the
Fama-French (1991) seminal work on Book-to-Market ratios and multi-factor risk
models. Then I spoke and sat back down for lunch beside Martin Leibowitz, then
at TIAA-CREF, grateful to praise his book Investing (1992) for its enduring
lessons, especially the “riding the yield curve” and the “barbell” investment
strategies, that I used in class and for cognition. In a brief back-stage chat
after lunch before attendees went to break-out sessions and speakers skedaddled
i conjectured to Ken French that the explanatory
power of the Book-to-Market ratio (=Stockholders’ equity divided by market cap)
likely has little to do with being a risk factor and more with being
mechanically connected by concrete numeracy to the Overprice ratio (=market cap
divided by intrinsic value).
10.
This unpublished paper analyzes a specification for the user cost of capital
that reveals fundamental implications for interpretation and measurement of
marginal effective income tax rates.
http://elementsoffinance.net/support/marginal_effective_tax_rates.pdf
A
novel and surprising finding is that the marginal effective income tax rate is
invariant to asset characteristics such as service life and capacity
depreciation through equilibration by the user cost of capital that maintains a
zero net present value for marginal investments. Maybe the findings echo Paul Samuelson (1963)
regarding the invariance of asset intrinsic value to the marginal income tax
rate.
11. This study, inspired and coauthored
with the then Head of the UA School of Accountancy Robert Ingram replicates the
Fama-French research relating the cross-section of stock returns to firm size,
beta, and total risk. Fama-French find that size relates positively with
average returns, and beta doesn’t, a result we replicate. Extending the
analysis, however, finds that as the extreme 2% of stock returns are censored
with trimmed least squares that the explanatory power of firm size persists
only in flat to falling markets. Systematic risk relates positively in
up-markets and negatively in down-markets, an outcome consistent with the
Sharpe-Lintner-Black capital asset pricing model for beta. We also find that
average returns relate negatively with total risk. The reduction in average
return associated with an increase in total risk presumably reflects the tradeoff
that investors willingly sacrifice for a chance at an extreme albeit unlikely return.
http://elementsoffinance.net/support/jfr_risk_return.pdf
The
43 associate editors at Journal of Financial Research selected this
article as the Best of the Year and kindly sent us two a $5,000 prize to share.
12.
This study is one of just a handful in the literature that model the
economic value of nonfinancial corporate assets to establish that the
well-known Tobin’s Q-ratio (= market cap to current replacement cost) may
systematically and routinely deviate from unity due to differences in the
timing of expected after-tax cash flows.
Still, empirical evidence shows little incremental explanatory power
from using tax-adjusted Q-ratios instead of standard unadjusted Q-ratios.
http://elementsoffinance.net/support/jpub_tax_bias.pdf
13.
This unpublished paper, coauthored with then Ph.D. student Cűneyt Demirgűreş, examines country funds
trading on the NYSE or AMEX comprised of common stocks trading on foreign
exchanges. We find high positive
correlation among premiums for country funds and conclude a "foreign-fund
investor sentiment" is systematic to all country funds. Premiums and domestic market indexes correlate
positively for funds investing in developed-economies (which largely
concentrate in the hands of individual investors) and negatively for funds
investing in developing-economies (which primarily are held by institutions). Returns on country funds and domestic indexes
correlate positive irrespective of ownership structure. These results suggest that foreign and
domestic investors use different information in setting asset prices thus
giving support to the investor sentiment hypothesis.
http://elementsoffinance.net/support/investor_sentiment_closed_end_country_funds.pdf
14.
Learn how market capitalizations for public utility industries relate to
measurements of underlying asset values.
Current replacement cost measurements (CC) of those assets contain
specifiable biases of economic value that depend on capital accumulation histories,
capacity depreciation schedules, tax depreciation schedules, and cost of
capital components. An intrinsic value
model provides estimates that show the bias contains incremental information
beyond that inherent with the CC measurements.
http://elementsoffinance.net/support/ntj_utility_valuation.pdf
This
study was awarded the $5,000 prize sponsored by the National Tax Association and
the Public Utility and Railroad Workshop at Wichita State University for the
annual Distinguished Award in Applied Research.
15.
Another unpublished nonclassical study that endogenizes debt maturity
into the intrinsic value of a hypothetical balance sheet shows different
recognizable formulations therein for the financial cost of capital.
http://elementsoffinance.net/support/debt_maturity_and_cost_of_capital.pdf
16.
My first publication in a journal that has “Finance” in the journal
title is pedagogic, maybe useful for teachers or students alike.
http://elementsoffinance.net/support/tfr_capital_budgeting.pdf
17.
The study below extends the sample from item #4 in this list, the AER
paper on stock prices and tax policy changes tracking intrinsic value, to 10
industries (2-digit SIC code) rather than the 3 industries (2-digit SIC code)
in the former study. The time required for collecting the information on price to
book ratios for debt securities compelled settling on 3 heavily capitalized industries
for the AER study. No other industries were examined as we lacked key data. The
additional evidence for all 10 industries showed quite a bit of noise in the
conclusions which was little disheartening, for sure.
http://elementsoffinance.net/support/tfr_tax_reform.pdf
18.
The important issue of government tax shields squeezing out private
investment is significant.
http://elementsoffinance.net/support/tfr_tax_shields.pdf
19.
My first journal acceptance after graduate school appears below. This is the only writing that uses continuous
time calculus. All other manuscripts and the book use discrete period
mathematics. The manuscript below is the most downloaded writing in this list besides
the book which tops all.
http://elementsoffinance.net/support/jecb_user_cost.pdf
20.
My doctoral dissertation from Purdue University approved December 1982, “The
Effects of Inflation and Taxation on the Value of Capital” is item=8310819 at
ProQuest. Therein the differential effect of LIFO versus FIFO inventory
accounting method on intrinsic value is specified and accounted for though no
later manuscripts utilize that particular reality check! Committee members
included Prof Patric Hendershott (Head), eventual Minister without Portfolio
for the Republic of China (Taiwan) Prof Hu Sheng Cheng, Prof Gary Schlarbaum, and
Prof James Moore.
The
Effects of Inflation and Taxation on the Value of Capital
21.
http://elementsoffinance.net/AlgorithmicDocumentGenerator.pdf
The free add-in below for Microsoft Excel can create a new
algorithmic document in MS Word
useful for nearly any topic or purpose.
Package personalized learning content into algorithmic setups
embodying random redraws of worksheet cells.
Cells might contain a number, word, or an alphanumeric
phrase/sentence/paragraph made from other cells! Endless options to uniquely redraw
algorithmic scenario setups give teachers and students alike lots of choices.
Click http://elementsoffinance.net/Algogen.xla to download the add-in for Excel.
Better yet, first peruse this documentation below then download the
add-in! http://elementsoffinance.net/AlgorithmicDocumentGenerator.pdf
Installation Instruction #3 in the above pdf describes how to activate two Excel add-ins
– the free Algogen add-in above and the Analysis Tool-Pak add-in from Microsoft. Completing that step (only) empowers Word
& Excel with Algogen wizards that help package your content into
algorithmic scenario setups, a potentially high return on invested time that
enhances teaching and learning effectiveness and efficiency. Find examples, hints, and more in the
documentation. For example, the first
pages present an analysis of student learning outcomes with multiple attempt
algorithmic online quizzes, multiple attempt algorithmic paper exams submitted
in class and/or online. The sample
includes thousands of students with varied teachers and course formats
(traditional, hybrid & online registrants).
All students populated one common undergraduate core course learning
community. All were challenged by the
same set of algorithmic assessments.
All software
resources listed herein are authored by prof-td@elementsOfFinance.net
and are available “as-is” subject to terms in the End User License agreement (EULA).
No liability nor benefit accrues to prof-td or elementsOfFinance.net
LLC by your use of these resources.
No harm is intended, either.
Hopefully you find unbelievably huge reductions in exam preparation time – for me the 18 hours per exam dropped down to
2 hours, a savings that accrued 4 times a semester (more than a complete
workweek)! The Algogen
app that prof-td uses even analyzes scantron results, transfers course
data, and makes a Standings page showing all student scores, publicly viewable
and anonymous, from 1st rank to last. Everyone knows the performance outcomes of
everyone else, anonymously. With a
handful of clicks Algogen made the prof a
complete 25-question exam with 4 unique versions ready for duplication onto
paper for classroom use. The procedure
also transfers the 25 answers for the 4 exam versions into the gradebook.xlsx
ready for the eventual Algogen click that
processes the scantron data, no matter how large or small the class. One semester more than 1,200 students
populated one common core course learning community with prof-td.
Not
every teacher wants to make easy tests
but
every teacher wants to easily make tests.
Get the free Algogen
app that allows you to select finance scenario setups from documents in an
algorithmic content collection and make countless new versions for purposes
like quizzes, exams, assignments, presentation examples, or for making
algorithmic online practice scenarios or assessments, at http://elementsOfFinance.net/Algogen.zip
Documentation provides installation instructions and
more: http://elementsoffinance.net/AlgorithmicDocumentGenerator.pdf .
Get the free algorithmic content collection written
for the elements Of Finance book at http://elementsoffinance.net/elements.zip