Volume 27 CONTENTS SPRING 2001
#1 - THE RELATIVE ACCURACY OF THE MODIFIED BLACK-SCHOLES MODEL
FOR OPTIONS ON UNDERLYING STOCKS WITH DIVIDENDS
The Black-Scholes model continues to be the standard option pricing model discussed in virtually all corporate finance and investments texts. A recent article in this journal discussed how sensitive the calculated option value is to roundoffs made during the calculations and to how the normal probability is calculated. Another concern is that the original model assumes no dividends on the underlying stock. The model has been modified to allow for dividends, but the modification does not lead to values as precise as other models that specifically account for dividends. This paper is concerned with how large the errors are associated with using the BS approximation rather than a more complicated model that specifically accounts for dividends. The paper also shows when the errors can be expected to be relatively large. This should help instructors explain to students when a more sophisticated pricing model is necessary and why.
#2 - SIMILARITY BETWEEN THE FISHER SEPARATION THEOREM
AND THE TWO-FUND SEPARATION THEOREM
Chee K. Ng
In the teaching of NPV maximization, the Fisher separation theorem is used to separate the real-asset investment decision from the financing decision. The managerial implication of the Fisher separation theorem is that shareholders, despite their differences in utility functions, will let the firm’s management make value-maximizing decision while individual investors maximize utility by using borrowing or lending to adjust to the timing of consumption. Application of the Fisher separation theorem results in an equilibrium where all investors agree on the interest rate for postponing consumption, and managers can use the interest rate to make investment decisions. In the teaching of the capital asset pricing model, the two-fund separation theorem is used to separate the determination of investment in the market portfolio (the optimal portfolio of the risky assets) from the individual investors’ utility maximizing decisions by either lending or borrowing at the risk-free interest rate to manage the risk of their portfolios. Application of the two-fund separation theorem results in an equilibrium where all investors agreeing on the price for bearing risk, and the managers can use the price for risk-bearing to evaluate investment choices. This paper exposits schematically the intrinsic similarities between the two theorems. Students’ comprehension of the two theorems, and instructors’ pedagogical efficacy are expected to increase after realizing the intimate similarities between the Fisher separation theorem and the two-fund separation theorem.
#3 - A SYNTHESIS OF RISK MANAGEMENT WITHIN A FINANCIAL FRAMEWORK
Thomas A. Aiuppa
This article presents a synthesis of risk management within a financial framework. As risk management expands its scope, a coherent overview is needed to improve the understanding of risk, including the types of risk, the methods of managing risk and the impact of risk and its treatments on shareholder wealth. This synthesis highlights the pervasiveness of risk; it demonstrates how the classic risk management process can be used for more than just pure risks; and it places risk management in a wealth maximization paradigm.
#4 - MANAGING CURRICULUM CONVERGENCE IN RISK MANAGEMENT AND FINANCIAL SERVICES
Ryan B. Lee, Anne E. Kleffner and Norma L. Nielson
This article describes how the University of Calgary has increased the flexibility offered to students in a curriculum that directly reflects the convergence occurring in the financial services marketplace. This design uses elements from existing programs in finance, risk management and insurance, as well as a few specific courses from accounting, economics, and other departments. The result is a double concentration that provides students a better understanding of financial services and of the career paths offered in the financial services industry. Students are able to select a career path early, which in turn benefits them and their future employers.
#5 - MARKOWITZ AND THE SPREADSHEET: COMMENT
Don B. Panton
A segment of an article published in this journal [Stephens, 1998] provides an algorithm for determining the composition of the market (tangency) portfolio when short selling is allowed. I contend that a portion of the analysis (specifically, the development of equations 11 and 13 on pages 36 and 37) is in error. The current paper presents the analysis and equations I believe to be correct.
#6 - SUB-FIELD SPECIFIC RANKINGS OF FINANCE JOURNALS
Susan Christoffersen, Fred Englander, Augustine C. Arize, and John Malindretos
We examine the results of a survey taken of university finance faculty regarding their perceptions of the relative quality of journals within ten sub-disciplines of finance. The literature review outlines strengths and weaknesses of the citations approach and survey approach to journal ranking. We argue that both methods need to be utilized. There is a significant positive relation between the survey ranks and ranks obtained from the citations methods in Accounting and Finance, Corporate Finance, Insurance, and Public Finance. Serious concern arises within Applied Finance where the correlation is negative and significant. In other fields, no correlation is established.
#7 - FINANCE STUDENTS AND FINANCE EXECUTIVES: VALUES AND PRIORITIES
Pamela L. Hall and Terrell G. Williams
Chief Financial Officers (CFOs) from the largest U.S. business firms were surveyed concerning their personal values, stakeholder importance, organizational objectives, organizational strategies/tactics and competitive strengths. The results were then compared with perceptions of upper-division finance students in a four-year university. It is apparent from the results that financial factors are of high importance to both students and CFOs, but both groups see a balance in professional values, including a balanced concern for owners, customers and employees as the primary focal groups that a company must seek to satisfy.
#8 - FINANCE CHAIR PROFESSORSHIPS IN THE UNITED STATES
Ali M. Metwalli and Roger Y. W. Tang
This paper provides a profile of the 287 Finance Chair Professorships in the United States from 1992 to 1999. It shows that the number of finance chair professorships has increased 8.5% from 1992 to 1997 but has increased only minimally from 1997 to 1999. Schools that have trained a large number of graduates now serving as chairholders are often listed among the best business schools in the Business Week directory of top 25 MBA programs and the U.S. News and World Report directory of top 25 business schools. Examples include Chicago, MIT, Pennsylvania and Harvard. About 95% of the 287 chairholders in 1999 were full professors who preferred to teach corporate finance, financial institutions and markets, or investments and preferred to research the areas of commercial banking and capital structure. The original data and statistics were obtained from Hasselback’s Guide to Finance Faculty from 1992 to 1999. Critical questions that can be considered for future research topics are provided.
#9 - A COMMERCIAL BANK MANAGEMENT SPREADSHEET MODEL
Harry M. Davis
The Commercial Bank Management class covers numerous asset/liability management issues that affect bank performance. However, students often have a difficult time gauging the impact of operating and capital management decisions on the performance of a bank. This paper describes a spreadsheet model that can be used in the commercial bank management class to address this deficiency. Specifically, an instructor can use the model to show the impact of asset growth, asset composition, costs/yields on assets and deposits, loan/deposit ratio, net burden, and capital management decisions on various performance measures. Several strategies are covered as possible classroom examples.
#10 - TEACHING ABOUT THE ASIAN FINANCIAL CRISIS
Kenneth A. Kim and Suk H. Kim
The Asian financial crisis provides many important lessons to finance and economics students. For those professors who would like to cover this topic in their classroom, we provide an easy-to-follow guide to teaching about the crisis. Our instructions will be especially useful to those professors who are not experts on the Asian crisis, or who have not yet put together lecture material on this very important and timely topic. By following our teaching notes, any professor can provide a straight-forward, comprehensive, and easy-to-understand lecture on the crisis to almost any finance or economics class. To further assist the professor, we also provide sample transparencies.
#11 - A GENERAL MODEL FOR EPS AND FIRM GROWTH
Robert J. Angell and Betty L. Brewer
In most business finance and investments textbooks, growth of earnings per share is presented as a simple calculation of the product of the return on equity and the retention rate of earnings. This paper presents a more general model of growth that takes into consideration potential external sources and shows that the familiar model in most textbooks is a special case of the more general model.
#12 - EFFECTS OF FINANCIAL LEVERAGE: A SIMPLER PEDAGOGICAL APPROACH
Bing Liang and Ajai K. Singh
The effect of financial leverage is discussed in all corporate finance textbooks. The customary approach is to juxtapose the earnings per share (EPS) [or the return on equity (ROE)] against the earnings before interest and taxes (EBIT), with and without corporate debt. The break-even EBIT is accordingly determined. We offer a simpler and more intuitive approach to study the effect of financial leverage. We show that a firm benefits from leverage only if its operating return on investment (operating ROI) exceeds the interest rate on borrowed funds.
#13 - MASSACHUSETTS CARNEGIE BANK: THE EURO CROSS
Jonathan B. Welch
The Senior Vice President of Capital Markets at Massachusetts Carnegie Bank
has sold one of the bank’s customers a six month, 50,000,000 Swiss franc
forward contract, creating a short position at the bank in Swiss francs. The
bank’s objective is to make money with this opportunity while managing its
downside risk. As a backdrop to the case, the bank is under some pressure to
replace its traditional currency trading opportunities that have been eliminated
by the introduction of the Euro in January, 1999 as the new, unified currency
for most of Europe. However, a limiting factor to developing new business for
the bank is its conservative culture.
One alternative is for the bank, in a matter of minutes, to enter into a six month forward contract on more favorable terms than it has offered its customer and earn a guaranteed $25,000-$30,000. Another more profitable alternative involves the bank borrowing in the U.S. and creating a Swiss franc asset to offset the underlying risk. Although this would neutralize the bank’s currency risk position and guarantee a profit in the $65,000-$70,000 range, the CFO of the bank is concerned about placing low margin business on the bank’s balance sheet at a time when it is being scrutinized by credit rating agencies and security analysts. The third alternative of using the Euro as a proxy for the Swiss franc in a cross currency hedge has substantially more profit potential, possibly in the $200,000-$700,000 range, but with conjectural downside risk, including the possibility of a loss. The profit and risk calculations depend, in part, on the bank’s ability to forecast the Euro/Swiss franc cross rate six months forward using fundamental and technical analysis. Going "naked" is an alternative as well.
Students have an opportunity to calculate the profit potential, assess the risk of each alternative and recommend a decision to the Senior Vice President at the bank, who is under pressure to increase currency trading revenue subject to several constraints. Furthermore, students can learn about the new currency alignment in Europe and the role of the Euro.
The case can be used as part of the international component of financial management courses at the MBA level or upper level business finance courses at the undergraduate level. The case is rich enough so that it could also be used in international finance and management of financial institutions courses.
#14 - RIDGETOP FAMILY RESTAURANT ASSOCIATES:
VALUING A CLOSELY HELD BUSINESS
Bennie H. Nunnally, Jr.
In early 1999, Ridgetop Family Restaurant Associates wished to know the economic value of its 16-restaurant franchise. This need arose out of disagreements between the franchisor, the Overbrook Corporation, and franchisee over franchise growth prospects. The task of placing a value on the franchise fell to the franchise’s Chief Financial Officer.
#15 - COBBLEtm HOUSE LOAN CASE STUDY
Stephen P. Keef and Melvin L. Roush