An important maintained hypothesis in financial economics states that the average interest rate on a firm's debt is positively related to its leverage. This hypothesis has a long history going back at least to the work of Kalecki [4] where it was used to derive a determinate size for the competitive firm when the production function is homogeneous of degree one. The upward sloping interest rate-leverage relationship has also played an important role in the theory of finance. In this connection, it is somewhat interesting to find both Modigliani-Miller [5] and their many critics in complete agreement on the nature of this relationship. In particular, their statement on this subject conveys the impression that this relationship is governed by an unalterable law when they write: “Economic theory and market experience both suggest that the yields demanded by lenders tend to increase with the debt-equity ratio of the borrowing firm” [5, p. 273].

A set of theorems was derived based on the following set of axioms: (1) financial management seeks to maximize the wealth of existing shareholders; (2) all projects being considered at period 0 are of one period duration and possess the attribute that their adoption or rejection by the firm will not affect the business risk of the firm's asset portfolio; and (3) the ratio of debt to total book capital is given as α, and r and k reflect the firm's business and financial risk however perceived by investors.

It was shown that the NPV of any project satisfying the above conditions could be evaluated for accept-reject purposes with a CC involving book weights. This CC yielded an NPV numerically equal to the NPV using market value weights under special circumstances, namely, when k = r (1 − λ) or when M0/V0 = 1 − α, a special case of which is M0 = (1 −α)c0, i.e., if the firm were at its investment margin. After determining the book value CC, which is denoted as β, it was shown that it can be applied repeatedly for testing period 0 projects satisfying our axioms, even if these projects are unknown to management at the outset of the period. A market value CC, denoted as γ, was derived which gives identical accept-reject signals as the procedure.

Consider a productive investment project (or financial security), which would yield a stream of cash flows, positive and negative, over time. A major index of the acceptability of such a project is its internal rate of return, i.e., that rate of interest which discounts all the cash flows from the project to a present worth of zero. Soper [8] has developed a sufficient condition for the internal rate to be unique in the interval, (−1,∞), along the real line. Then, if the project requires an initial outlay, if Soper's condition holds, and if the unique internal rate exceeds the market rate of interest in each period of the project's life, the project's present worth is positive, and hence, other things being equal, it is worth undertaking.

This paper is an analytic treatment of the abandonment decision in capital investment analysis. It provides a methodology which has application in obtaining better estimates for project value and risk.

In this paper, possible factors affecting the second-pass regression results in capital asset pricing are investigated in detail. First, the true functional form used to test the risk-return relation is determined by using Box and Cox's [2] generalized functional form technique. Secondly, Box and Cox's residual analysis and transformation technique are used to show the importance of the skewness effect in capital asset pricing. Finally, some other factors affecting the results of second-pass regression coefficient in capital asset pricing also are explored. From these analyses, it is found that the functional form, the skewness effect, and the change of market condition are the most important factors in affecting the empirical conclusions in testing the bias of composite performance measures and the risk-return relation.

In our theoretical work on DSD ([17], [18], [19]), specially constructed examples were used to demonstrate that DSD is stronger than TSD. The results of the present paper imply that similar examples also arise naturally from realworld data. They also suggest that such examples are rare. In the specific cases studied here, the differences between these two stochastic orderings are real, but small, and TSD would likely be a suitable approximation to DSD for practical purposes. The differences between the resulting efficient subsets seem relatively less important as the size of the initial portfolio universe increases. For example, the percentage reduction in the efficient TSD subset for a 1000-portfolio problem is smaller than for a typical 100-portfolio problem. This was found to be true throughout the preliminary phases of the study, as well as in the final phase reported here. The (to us) disappointing performance of DSD resulted primarily from the left-tail problem, which became increasingly prevalent as the initial portfolio set expanded. This suggests that DSD would be most useful in problems of choice among relatively few alternatives, perhaps of the capital budgeting type. In addition, there are numerous nonfinancial problems in which DSD could prove to be useful in ranking alternative management policies. Finally, the greater strength of DSD may remain important in theoretical investigations, especially for situations in which the left-tail problem is absent.

A stock purchase warrant gives the owner the option to buy some predetermined number of shares of the associated common stock at a specified price over a stipulated time period. The specified price is called the exercise price of the warrant. The stipulated time period is quite variable, though the life of a typical warrant will exceed five years.

This paper analyzed the issue of why large commodity futures traders hold a large percentage of their portfolios in straddle positions where, for the most part, such behavior implies that they are holding assets with negative expected returns. It showed that an earlier paper by Schrock [2], which suggested that such behavior provided a means by which investors could enhance their risk-return tradeoffs, provided only a partial explanation for this behavior which, in a world of positive interest rates, held only under fairly restrictive conditions. Thus, it went on to develop a more general result which strongly suggests that differentially low margin requirements on straddle positions provide a strong incentive in a world of positive interest rates for investors to hold commodity straddle positions. With some modification the model developed in this paper can be used to derive similar conclusions for certain classes of transactions in the stock options market.

The relationship between an investor's attitude toward risk and the shape of his preference functions has long been recognized in both the general portfolio problem and the mean-variance model. By contrast, the literature has largely ignored the connection between general measures of an investor's attitude toward risk and the shape of his mean-variance or mean-standard deviation indifference curves. Yet this relationship is significant. Through general measures of risk aversion, assumptions about an investor's behavior under uncertainty imply restrictions on indifference curves. Conversely, assumptions about indifference curves impose restrictions on an investor's behavior under uncertainty. The development of this relationship and its implications is the objective of this note.

The academic research has produced a series of contributions on optimal portfolio strategies (Bradley and Crane [1], Crane [4], Cheng [3], Fisher and Weil [5], Watson [9], Wolf [10]). Several of these studies--Bradley and Crane, Watson, and Wolf--conclude that an optimal strategy for bank portfolios would be a “dumbbell” strategy. Such a dumbbell strategy invests only in the shortest and longest maturities, ignoring the intermediate maturities. The logic is straightforward: liquidity risk is lowest in the shortest maturities and yield is generally highest in the longest maturities. The risk/return superiority of such a strategy was empirically verified by Watson, with subsequent confirmation by the Bradley and Crane tests via a stochastic dynamic programming formulation.

In an earlier paper [1] a model of securities markets was introduced which implies that the ratio of transaction volume to price change is greater for transactions on which price rises than for those on which price falls. Examination of individual transactions data for a sample of corporate bonds showed that price changes and transaction volumes for those securities appears to behave in a manner consistent with the theory. However, the paper raised the question of whether the same is true for stocks. The positive dependence on share price of broker commissions for stocks could easily eliminate, or even reverse the sign of, the predicted positive difference between the absolute values of slopes of buyers' and sellers' reservation demand functions; and it is this difference which leads the model to predict the inequality of the ratios of volume to price change on upticks and downticks. This note records the results of tests of the model with stock data, using volumes and price changes pertaining both to individual transactions and to trading days. The tests indicate that the ratios of volume to price change exhibit the predicted relationship, when one of the two possible measures of volume is employed.