Volume 31 CONTENTS Summer 2005
#1 - Mathematical Probability Theory and Finance: Connecting the Dots
Don M. Chance
Over the last four hundred years, mathematicians have developed a well-defined formal theory of probability. In spite of the fact that most financial economists are trained in probability theory, the mathematical terminology can be cryptic and difficult to understand. The financial economist encounters even more difficulty in trying to link formal concepts of mathematical probability theory with settings more familiar in models of markets and assets. This paper provides a straight-forward and clear explication of mathematical probability theory, illustrating it first with a simple example and second by connecting it to the familiar framework of the binomial model of asset price evolution. This paper should provide financial economists with a better foundation for reading the literature in mathematical finance.
#2 - Online and In-Class Student Evaluations
R. Phil Malone, Bonnie F. Van Ness and Robert A. Van Ness
Beginning in the fall 2003 semester, the University of Mississippi began administering faculty teaching evaluations online. There was an immediate and large decline in the percentage of students responding to the voluntarily online evaluation. Moreover, we find that the responding students are less likely to be satisfied with their instructor and likely to rate the class as more difficult than during previous semesters. These findings suggest the possibility that adversarial selection may bias the evaluation results and that voluntarily self-selection may result in a disproportionately high percentage of unhappy students participating in the online evaluations.
#3 - Some Evidence Regarding Computer-Based
Trading Simulations and Their Use as an Assessment Tool
Brent J. Lekvin
Improvements in computing capabilities have made it possible to bring sophisticated computer-based trading simulations into the classroom. Two related questions are addressed in this educational research. First, is there any evidence that students’ abilities can be effectively measured by computer-based simulations? Second, is there is any relationship between relative trading performance as measured by the simulations, and traditional measures of academic knowledge pertaining to the same financial instruments used in the simulations? Evidence presented suggests that performance in trading simulations is not random—students’ abilities appear to have a persistent affect on the outcomes. However, performance on computer-based simulations does not appear to be related to traditional academic measures of knowledge even though both types of assessment relate to the same sets of financial instruments. The main conclusion is that the use of computer-based simulations may be a necessity in order to effectively assess certain skills that are not well-assessed by traditional performance measures.
#4 - Duration: A Pedagogical Tool for Interest Rate Risk Analysis
Eldon C. Johnson
The high and volatile interest rates of the 1970s gave purpose to duration—it became a proxy for interest rate risk and portfolio immunization became widely accepted as a risk minimizing strategy. Duration is a present-value measure with unique properties that make it pedagogically useful for teaching the principles of valuation. Duration can be as conceptually simple as Macaulay’s original measure or as complex as the more recent and sophisticated multi-factor polynomial vector models. Macaulay’s duration, while simple, is an excellent tool for teaching the principles of valuation, if its limitations are understood. The purpose of this study is to review the history of duration, illustrate its value as a tool of interest-rate risk management, and introduce the "duration ratio" as a measure of the term-volatility of interest rates.
#5 - It's a Wonderful Life: A Case in Financial Institutions Management and History
James Philpot and Rodney Oglesby
The popular holiday movie, It’s a Wonderful Life, provides a useful in-class case that illustrates various topics in financial institutions history and management. We discuss our use of the film and provide questions and notes corresponding to relevant sequences in the film that stimulate classroom discussion and student thought. Students respond positively to the film in terms of its usefulness and appropriateness.
#6 - FRICTO Analysis: A Framework for Making Capital Structure and Financing Decisions
George W. Kester and Scott A. Hover
This paper discusses FRICTO analysis, a framework for making debt-versus-equity decisions and comparing financing alternatives that takes into account risk, income, control, flexibility, timing, and other considerations. The paper includes a decision tree to help students and practitioners understand how the elements of FRICTO analysis can be incorporated into the decision-making process.
#7 - Using Trading Simulations to Teach Market Microstructure Concepts
Asli Ascioglu and Lynn Phillips Kugele
This paper describes an equity trading simulation case designed to demonstrate fundamental microstructure concepts such as the price discovery process, the difference between quote-driven and order-driven markets, and the role of the specialist and market maker. In addition, the case provides a simplified framework for clarifying the importance of liquidity (or, conversely, the effects of illiquidity), and illustrating currently newsworthy topics such as "front-running." Survey results from students participating in the Trading Simulation Case average above 4 (on a 5-point Likert scale) with regard to their enjoyment of the exercise as well as in response to questions regarding their understanding of the trading process, the function and operation of the limit order book, market making activity and how front-running can occur.
#8 - Proctor & Gamble's Profit Sharing Plan: A Classroom Exercise in Ethics
Philip W. Glasgo and Clinton B. Schertzer
This class exercise involves a min-case that discusses the Procter & Gamble Profit Sharing Plan, and raises the issue of whether the plan, which results in a very high percentage of employees’ retirement benefits being in P&G stock, is consistent with the company’s high standard of ethics. The case uses a chronological approach to lead the reader through a series of events which alternately caused fear and joy among Procter & Gamble stakeholders.
#9 - Case Study: County Line Markets
Lou D'Antonio and Ron Rizzuto
County Line Markets (CLM) is a regional grocery chain with 67 stores located in the Midwest region of the United States. The company was founded in 1905 and is still operated by the Lloyd family. William Lloyd, the great grandson of founder Michael Lloyd, is president of the company. CLM is a private corporation and is owned by the Lloyd family. The company’s growth has been primarily organic. As the region expanded in population, CLM opened up new stores. Approximately 10 years ago it bought out a competitor that owned five stores in the northern part of the largest city in the state.
#10 - Case Study: TeleCom Red Flags
Hugh Grove, Tom Cook and Jon Goodwin
By mid 2002, the credibility of research provided by sell-side" analysts had become increasingly questioned in the wake of the major accounting scandals in the late 1990s. For example, one big firm fired an analyst for changing his rating to a "sell" recommendation on Enron at $38 per share, and another firm told its analysts to maintain a "buy" recommendation for Enron no matter what. The Securities and Exchange Commission (SEC) had begun pushing for the separation of investment banking and research functions. The negative publicity from the New York Attorney General fining Merrill Lynch $100 million and investigating other big Wall Street firms for questionable business practices could help smaller investment banking firms who were interested in expanding their research services.