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unpublished manuscripts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. Those investors seeking extreme returns willingly
sacrifice expected return for their chance to own the winning ticket, however unlikely.
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This unpublished manuscript models the economic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. Prof JM Keynes
writes in The General Theory (1936) that the user cost constitutes a
link between the present and future.
It’s all about time and it’s well known that time is money. For many
people many moments may be spent 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unpublished paper introduces diversification benefits from investment as a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 know 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, a
proof otherwise unknown 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. 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. Non-financial
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 prof-td 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 participating included
moderator Martin Feldstein (NBER President), Mervyn King, Jonathan Leape, Alan
Auerbach, Larry Summers, and of course prof-Pat! A few months later prof-td
picked up the ringing home phone to hear the voice “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 remains a
cherished & inspirational event in my half century with universities of
higher learning.
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 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 declaration of timelessness
is keen! A scary learning moment occurred when audience member Richard Leftwich
(UChicago) requested from me clarification for the effects on intrinsic value
of asset specific price inflation versus aggregate inflation. The explanation
for that insightful question likely links the consumer theory of utility
insights from Chipman and Moore (1972) that the wealth of the nation accumulates
from the domestic tranquility that begins at home with insights from the Dale
Jorgenson derivations of National Wealth (1982) from flow of funds matrices,
capacity utilization rates, and gross profit margins throughout the economic
web of the exchange economy.
7.
Learn that the consumer theory of value initially described more than a
century ago supports specifications of asset return generating processes. Namely, the supply price of financial capital
embeds the well-known required risk premium as compensation to capitalists for
bearing risk. Learn that the other half
of the process is the producer theory of value described initially more than a
century ago that supports specifications of intrinsic value. Namely, 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 Samuelson
1965). Prof-B.Malkiel wrongly 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. Thus it
is that risk determines only the required 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 1976).
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 Helmsly
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
(TIAA-CREF) grateful to praise his book Investing for its enduring
lessons that I used in class and research. In a brief back-stage chat after
lunch before attendees went to break-out sessions and speakers departed i conjectured to prof-Ken 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
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 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. The findings echo Prof-Samuelson (1963)
regarding the invariance of intrinsic value to the marginal income tax rate.
11. This study, inspired and coauthored
with UA School of Accountancy (then) Head Robert Ingram, replicates the seminal
Fama-French research that relates 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 price investors willingly pay for a chance at an
unlikely extreme 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 prof-td and prof-Rob 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 classic that endogenizes debt maturity into the
intrinsic value of a hypothetical balance sheet.
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.
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 industries for the AER
study that I felt were heavily capitalized. The additional evidence showed quite
a bit of noise in the conclusions.
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 publication is the only manuscript that uses continuous time
calculus. All other manuscripts and the book use discrete period mathematics. The
manuscript below is the most downloaded writing 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 andTaxation on the Value of Capital”
is item=8310819 at ProQuest. 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, 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