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Finance and Financial Management

Finance Faculty Publications

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Full-Text Articles in Business

Applying Altman's Z-Score In The Classroom, Tom Arnold, John H. Earl Jr. Jul 2006

Applying Altman's Z-Score In The Classroom, Tom Arnold, John H. Earl Jr.

Finance Faculty Publications

Altman's Z-score is introduced in an Excel framework to produce a quick calculation of the Z-score with actual financial data available through the Internet. The lesson plan developed is easily introduced with topics covering ratio analysis, financial risk, bond rating changes, and bankruptcy. Given the wide use of the Z-score in practice to evaluate credit risk (or bankruptcy risk), the lesson plan produces a skill set that is very marketable.

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Adding Depth To The Discussion Of Capital Budgeting Techniques, Tom Arnold, Terry D. Nixon Jul 2006

Adding Depth To The Discussion Of Capital Budgeting Techniques, Tom Arnold, Terry D. Nixon

Finance Faculty Publications

The subject of capital budgeting generally encompasses a significant percentage of any beginning finance course with net present value (NPV) often receiving the most attention. Even after this substantial time allotment, critical assumptions and comparisons of the different techniques (such as payback period, discounted payback period, NPV and IRR) are frequently glossed over due to time constraints. Consequently, the goal of this paper is to present these non-NPV techniques in a manner that allows the beginning finance student to expeditiously see the intuition, inherent assumptions, and any connection with the more popular NPV calculation. A small portion of this paper …

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Getting More Out Of Two Asset Portfolios, Tom Arnold, Terry D. Nixon Apr 2006

Getting More Out Of Two Asset Portfolios, Tom Arnold, Terry D. Nixon

Finance Faculty Publications

Two-asset portfolio mathematics is a fixture in many introductory finance and investment courses. However, the actual development of the efficient frontier and capital market line are generally left to a heuristic discussion with diagrams. In this article, the mathematics for calculating these attributes of two-asset portfolios are introduced in a framework intended for the undergraduate classroom.

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Using Gmm To Flatten The Option Volatility Smile, Tom Arnold Mar 2006

Using Gmm To Flatten The Option Volatility Smile, Tom Arnold

Finance Faculty Publications

By using an over-identified Generalized Method of Moments (GMM) estimation procedure with careful consideration for data biases existing in the previous literature, parameters are estimated for a stochastic volatility jump diffusion option pricing (SVJ) model. The estimated parameters indicate a statistically significant highly negative infrequent jump process in the underlying security return distribution consistent with market crashes. When comparing to a stochastic volatility (SV) option pricing model, the SVJ is more robust but not always the superior model. The robustness of the models is further gauged by evaluating performance up to a year beyond the estimation data.

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Do Option Markets Substitute For Stock Markets?, Tom Arnold, Gayle Erwin, Lance Nail, Terry D. Nixon Jan 2006

Do Option Markets Substitute For Stock Markets?, Tom Arnold, Gayle Erwin, Lance Nail, Terry D. Nixon

Finance Faculty Publications

Using a sample of cash tender offers occurring between 1993 and 2002, we find evidence that the options market has become the preferred venue for traders attempting to profit on anticipated announcements. Options offer advantages relative to stocks. Traders gain leverage by trading in options and multiple options contracts on an individual stock. The results of our study indicate that a substitution effect does exist. Abnormal volume in the option market replaces abnormal volume in the stock market prior to cash tender offer announcements, and this abnormal option volume precedes abnormal stock volume for targets with or without traded options.

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Divergent Opinions And Value Stock Performance, John A. Doukas Jan 2006

Divergent Opinions And Value Stock Performance, John A. Doukas

Finance Faculty Publications

Those who believe that capital markets—that is, markets for stocks and bonds—operate efficiently and asset prices fully reflect all publicly available information are engaged in an ongoing debate about the exact interpretation of the “value premium” with those who reject this view. Value premium refers to the superior returns generated by the purchase of value stocks relative to growth, or glamour, stocks. Rationalists, the group believing in market efficiency, argue that because value stocks are fundamentally riskier than growth stocks, the value premium is compensation for bearing risk. Behavioralists, the group arguing that market asset prices don’t reflect all publicly …

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Improving Pro Forma Analysis Through Better Terminal Value Estimates, Tom Arnold, David S. North, Roy A. Wiggins Oct 2005

Improving Pro Forma Analysis Through Better Terminal Value Estimates, Tom Arnold, David S. North, Roy A. Wiggins

Finance Faculty Publications

Basic pro forma analysis often estimates the terminal value input using a simple growing perpetuity assumption. While this assumption is easy to implement, it potentially creates an upward bias in some inputs leading to lower firm or project value outputs. The purpose of this paper is to demonstrate a more accurate way to estimate the terminal value input. Further, by allowing for multiple sales growth rates and by not restricting other input variables to necessarily grow at these same rates, a more accurate, flexible, compact, and thorough analysis is possible.

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An Excel Application For Valuing European Options With Monte Carlo Analysis, Tom Arnold, Stephen C. Henry Apr 2005

An Excel Application For Valuing European Options With Monte Carlo Analysis, Tom Arnold, Stephen C. Henry

Finance Faculty Publications

By developing the basic intuition of how Monte Carlo simulation works within an Excel spreadsheet framework, this paper allows the undergraduate student to use Monte Carlo simulation techniques to price European style options without additional sophisticated software. Further, the skills and intuition developed provide the basis for much more complex simulation techniques.

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Is Fed Policy Still Relevant For Investors?, C. Mitchell Conover, Gerald R. Jensen, Robert R. Johnson, Jeffrey M. Mercer Jan 2005

Is Fed Policy Still Relevant For Investors?, C. Mitchell Conover, Gerald R. Jensen, Robert R. Johnson, Jeffrey M. Mercer

Finance Faculty Publications

Using 38 years of data, we show that U.S. monetary policy has had, and continues to have, a strong relationship with security returns. Specifically, we find that U.S. stock returns are consistently higher and less volatile during periods when the Federal Reserve is following an expansive monetary policy. Further, firms considered to be more sensitive to changes in monetary conditions, such as small firms and cyclicals, exhibit monetary-policy-related return patterns that are much more pronounced than average. Lastly, the influence of U.S. monetary policy is shown to be a global phenomenon, as international indices have return patterns similar to those …

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Using The Wacc To Value Real Options, Tom Arnold, Timothy Falcon Crack Nov 2004

Using The Wacc To Value Real Options, Tom Arnold, Timothy Falcon Crack

Finance Faculty Publications

We present a real option valuation using the weighted average cost of capital (WACC). This is an alternative to risk-neutral real option valuation. Using the WACC involves a marginal increase in mathematical complexity, but it is easy to implement in a spreadsheet, and it is easy to present to management. Our analysis reveals, however, that because the real option valuation is immune to choices of admissible discount rates (as per Arnold and Crack 2003a), the critical issue is correct estimation of volatility, not choice of discount rate. We also point out that the natural and conservative tendency to overestimate risk …

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Interest Rate Parity In Excel, Tom Arnold, Bonnie Buchanan Oct 2004

Interest Rate Parity In Excel, Tom Arnold, Bonnie Buchanan

Finance Faculty Publications

This paper develops interest rate parity in a framework that is easily implemented in Excel. The student can either be given the paper to see how the code is developed using the intuition of the interest rate parity framework or the student can be taught the interest rate parity framework and develop the Excel code as an assignment. Using either teaching method or the other exercises suggested in the paper, the student is able to understand how traders exploit violations of interest parity and become more comfortable with basic concepts, such as direct quotes and indirect quotes.

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Understanding The Impact Of Financial Decisions On Financial Statements: A Pedagogical Note, Tom Arnold, Leroy Brooks, Terry D. Nixon Apr 2004

Understanding The Impact Of Financial Decisions On Financial Statements: A Pedagogical Note, Tom Arnold, Leroy Brooks, Terry D. Nixon

Finance Faculty Publications

Viable financial planning requires financial managers' understanding of the consequences of impending decisions on their company's financial performance and position. Understanding the impact of prior decisions on their financial statements also enables future decisions aimed at improving their shareholders' wealth. This note intends to contribute to developing this capacity in finance students. We provide a presentation format directly connecting financial decisions to financial statement impacts. Bridging material covered in accounting courses and a finance student's needs as a possible future manager or analyst, this classroom pedagogy supplements and reinforces the objectives of the financial planning component of a finance course.

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Divergent Opinions And The Performance Of Value Stocks, John A. Doukas, Chansog Francis Kim, Christos Pantzalis Jan 2004

Divergent Opinions And The Performance Of Value Stocks, John A. Doukas, Chansog Francis Kim, Christos Pantzalis

Finance Faculty Publications

Divergence of opinions among investors, manifested in the dispersion of analysts' earnings forecasts, may play an important role in asset pricing. This article reports tests of whether disagreement can explain the cross-sectional return difference between value and growth (or "glamour") stocks in the U.S. market over the 1983-2001 period. Consistent with the theoretical proposition that stocks subject to greater investor disagreement earn higher returns, the tests found value stocks to be exposed to greater investor disagreement than growth stocks. This finding suggests that the return advantage of value strategies is a reward for the greater disagreement about their future growth …

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Intuitive Black-Scholes Option Pricing With A Simple Table, Tom Arnold, Terry D. Nixon, Richard L. Shockley Jr. Apr 2003

Intuitive Black-Scholes Option Pricing With A Simple Table, Tom Arnold, Terry D. Nixon, Richard L. Shockley Jr.

Finance Faculty Publications

The Black-Scholes option pricing model (1973) can be intimidating for the novice. By rearranging and combining some of the variables, one can reduce the number of parameters in the valuation problem from five to two: 1) the option's moneyness ratio and 2) its time-adjusted volatility. This allows the computationally complex Black-Scholes formula to be collapsed into an easy-to-use table similar to those in some popular textbooks. The tabular approach provides an excellent tool for building intuition about the comparative statics in the Black-Scholes equation. Further, the pricing table can be used to price options on dividend-paying stocks, commodities, foreign exchange …

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Impact: What Influences Finance Research?, Tom Arnold, Alexander W. Butler, Timothy Falcon Crack, Ayca Altintig Jan 2003

Impact: What Influences Finance Research?, Tom Arnold, Alexander W. Butler, Timothy Falcon Crack, Ayca Altintig

Finance Faculty Publications

Which journal articles have had the most impact on finance research? Which journals dominated finance research in the 1990s? We answer these and similar questions using a comprehensive sample of journals, an extensive time period, and a new ranking method that avoids problems inherent in the existing literature. Among our findings: six of the 10 articles most highly cited by finance journals were published in econometrics or economics journals; Journal of Finance has the most citations, but it accounts for only one of the top 10 articles; and Journal of Financial Economics has the highest impact per article.

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Finding Firm Value "Quickly" With An Analysis Of Debt, Tom Arnold, Jerry James Jan 2003

Finding Firm Value "Quickly" With An Analysis Of Debt, Tom Arnold, Jerry James

Finance Faculty Publications

A firm value calculator (FVC) is introduced that is much faster and less tedious than its pro forma counter-part. The additional benefit of this FVC over what is available in the existing literature is a direct analysis of the effect of leverage. The debt analysis is captured within both the firm's cash flow and the discount rate for the firm's cash flow. The calculator can be implemented on a hand-held calculator or on an Excel spreadsheet making the analysis very amenable to the classroom.

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Diversification Benefits From Foreign Real Estate Investment, C. Mitchell Conover, H. Swint Friday, G. Stacy Sirmans Jan 2002

Diversification Benefits From Foreign Real Estate Investment, C. Mitchell Conover, H. Swint Friday, G. Stacy Sirmans

Finance Faculty Publications

Previous research has questioned the stability of international equity diversification. This study examines whether foreign real estate exists in a more segmented market and whether foreign real estate provides any diversification benefit beyond that obtainable from foreign stocks. Using data encompassing the stock market crash of 1987, foreign real estate was found to have a lower correlation with U.S. stocks than foreign stocks. This lower correlation is shown to be stable through time as foreign real estate has a lower correlation in nearly the entire time period. Foreign real estate was also found to have a significant weight in efficient …

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Adr Risk Characteristics And Measurement, Tom Arnold, Lance Nail, Terry D. Nixon Jan 2002

Adr Risk Characteristics And Measurement, Tom Arnold, Lance Nail, Terry D. Nixon

Finance Faculty Publications

While a healthy empirical literature exists on international diversification and its benefits, surprisingly few studies have examined the risk characteristics and efficacy of asset pricing models for one avenue of international diversification – investments in American Depository Receipts (ADRs). Originating in approximately 1927, ADRs provide an opportunity for investors to indirectly purchase shares of foreign firms. ADRs represent a claim to a given number of shares of a foreign firm held by a U.S. financial institution (e.g., Bank of New York). With the increasingly significant presence of ADR trading in the American stock markets – increasing six-fold between 1990 and …

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An Analysis Of The Cross Section Of Returns For Ereits Using A Varying-Risk Beta Model, C. Mitchell Conover, H. Swint Friday, Shelly W. Howton Apr 2000

An Analysis Of The Cross Section Of Returns For Ereits Using A Varying-Risk Beta Model, C. Mitchell Conover, H. Swint Friday, Shelly W. Howton

Finance Faculty Publications

A dual-beta asset pricing model is employed to examine the cross-section of realized equity real estate investment trust (EREIT) returns over bull and bear markets. No significant relationship is found between EREIT returns and a constant beta. However, beta explains cross-sectional returns when betas are allowed to vary across bull markets. This positive relationship exists for both January and non-January months. During bear-market months, no significant relationship is found between REIT betas and returns. But, during such months, size and book-to-market ratio are found to be negatively related to returns.

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How Much Is Purchasing Power Parity Worth?, Stefan C. Norrbin, C. Mitchell Conover Apr 1998

How Much Is Purchasing Power Parity Worth?, Stefan C. Norrbin, C. Mitchell Conover

Finance Faculty Publications

Updating Bilson 's (1984) investment strategy using an out-of-sample forecast procedure, we find much smaller profits from a trading strategy based on purchasing power parity. Though the total profit is significant at a 5 percent level, it is substantially lower than what Bilson found. Our results suggest Bilson's excess profits are due to the sample of data used and the in-sample nature of the tests. Hence, this paper demonstrates that the simple investment strategy leads to the same conclusion that econometric testing does; namely, that purchasing power parity is only marginally useful in forecasting exchange rates.

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Reverse Lbo Underpricing: Information Asymmetry Or Price Support, Gregory Noronha, Kenneth Yung Jan 1997

Reverse Lbo Underpricing: Information Asymmetry Or Price Support, Gregory Noronha, Kenneth Yung

Finance Faculty Publications

Most studies attribute the underpricing of initial public offerings of equity securities to the ex ante uncertainty resulting from the information differential between the firm going public and the market. Ruud (1991, 1993), however, proposes that underpricing could result from underwriter price support in the early after-market. A paper examines firms that were once public, went private via leveraged buyout, and then went public again. It is reasonable to expect that since these reverse LBOs (RLBO) were once publicly traded, they should have less of an information differential with the market than firms going public for the 1st time. Tests …

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