Showing papers on "Financial risk published in 1978"

Perceived risk and capital asset pricing

Abstract: work in stock valuation theory shows that investment risk can be depicted by several firm-determined measures such as financial and operating leverage, size, and variability of earnings per share.3 Proponents of this now traditional approach to asset pricing maintain that investment risk can be a multidimensional concept. Recently, several "connecting links" between these two views of risk and asset pricing have appeared in the literature. Hamada [25] and Beaver, Kettler and Scholes [1] have shown that a stock's beta coefficient is positively related to the amount of the firm's financial leverage. In addition, Myers [39], Turnbull [48] and Pettit and Westerfield [40] have demonstrated that beta is directly related to the firm's earnings covariance. These results, and others discussed in the next section, indicate that beta could be the sole measure of investment risk because the firm-determined risk measures espoused by stock valuation proponents may be determinants of beta. The purpose of this paper is to test empirically the relationships among these three approaches to risk and asset valuation. More specifically, two null hypotheses are tested. The first null hypothesis asserts that investment risk is unidimensional and equivalent to the beta coefficient. The second null hypothesis posits that beta is directly related to the firm's financial leverage. Viewed together, these two null hypotheses assert that investment risk is unidimensional and securities are priced solely on the basis of their market-related risk and only indirectly on the basis of financial leverage via its relation to beta.

Rate regulation, capital structure, and the sharing of interest rate risk in the electric utility industry†

Abstract: AS A CONSEQUENCE of increased volatility in the level of rates, interest rate risk has assumed greater significance as a determinant of the systematic risk associated with holding common stock. The purpose of this paper is to assess the interest rate risk associated with the assets of public utility companies and to analyze the extent to which it is shared between three groups: (a) the consumer;' (b) the firm's stockholders; and (c) the firm's debtholders. The paper attempts to empirically estimate the division of the risk in the recent past, and its relationship to the unique risk characteristics associated with public utility stocks. We shall also discuss the roles played by financial management and regulatory policy in risk allocation. As an aside, the empirical analysis also serves as a limited test of the relationships between financial leverage and risk proposed by Haugen and Wichern in [3]. Section I of this paper provides some descriptive statistics that support the contention that Electric Utility Stocks are indeed unique in their risk characteristics. We then attempt to explain why this is true. Section II sets forth the design of a cross-section regression experiment used to (a) estimate the interest rate risk associated with the assets of an electric utility, and (b) provide results used in measuring the division of this risk among the three groups. Section III sets forth the procedures used to estimate the variables contained in the cross-section regression analysis, and Section IV provides the results of the regression, as well as estimates of the relative risk shares taken by debt and equity. The share shifted to consumers through regulatory policy is estimated independently in Section V. Finally, a discussion of the relationship between risk sharing and financial management and rate regulation is provided in Section VI. I. THE RELATIVE RISK CHARACTERISTICS OF ELECTRIC UTILITY STOCKS In this section, the common stocks of public utilities and of nonregulated firms are compared with respect to the nondiversifiable risk that can be associated with (a) changing interest rates, and (b) other market based factors. In doing so, we assume

The Fundamental Determinants of Risk in Banking

Abstract: This study is concerned with establishing the determinants of banks' exposure to risk and with predicting risk in banking. Using the COMPUSTAT data base, prediction rules have been developed for two aspects of risk: systematic risk (risk that is related to covariance with the market portfolio) and residual risk (the aggregate of specific risk and extra-market covariance). For each type of risk, several models have bean estimated: one model employs only measures of the asset and liability characteristics of the bank; a second employs these characteristics and other data taken from annual reports; a third model adds the history of the behavior of the price at the bank's common stock. The central conclusion of the study is that systematic and residual risk in banks can be predicted from predetermined data. Prediction rules estimated in this way can serve a useful function in monitoring bank risk. Further, the predictive significance of each variable serves as a measure of the appropriateness of that variable as an indicator of risk, and hence as a target for regulation.

A model for long-range university budget planning under uncertainty

Abstract: A linear control model of a university budget is presented as an aid to developing optimal strategies for dealing with major exogenous uncertainties The specific uncertainties treated are those associated with inflation, endowment returns, and fund-raising The model seeks to stabilize budget growth by adhering as closely as possible to prescribed limits for certain critical financial ratios, such as the ratio of the budget to the endowment Sample runs for Stanford University are given, along with an analysis of the financial effects of varying the level of investment risk carried by the endowment

The Impact of Replacement Cost Accounting on Financial Performance

Abstract: (1978). The Impact of Replacement Cost Accounting on Financial Performance. Financial Analysts Journal: Vol. 34, No. 2, pp. 48-54.

Investment risk analysis with a simple utility function

Abstract: This study suggests an approach to investment risk analysis which provides a useful complement to more detailed analyses. The analyst specifies an appropriate distribution of cash flows and associated utility function from one of the four models suggested. Next, the risk adjusted present value of the investment stream is calculated using the simplified procedure outlined in the paper. Sensitivity analysis is then performed on the results to determine whether a more extensive analysis of the decision maker's risk preferences is called for.

Investment Portfolios and Regulation of Private Mortgage Insurance

Abstract: The purpose of this paper is to examine the regulations that govern the investment activities of private mortgage insurers. These firms are unlike other non-life insurers in several respects that have a bearing on investment policy. Although some states have regulations that reflect the uniqueness of mortgage insurers, the effectiveness of these regulations in controlling risk absorption is limited. The nature of the insurance contract and underwriting risk assumed by mortgage insurers is sufficient to justify more conservative regulatory guidelines than presently exist. The need for such guidelines is even more compelling in light of recent changes in the mortgage and financial markets. This paper examines potential regulatory problems associated with the investment activities of private mortgage insurers (hereafter referred to as MIICs). These firms insure mortgage lenders against both normal or day-to-day losses as well as the potentially catastrophic losses that could result from major economic adversity. The relationship between these large-scale losses and the investment policies of MICs has regulatory implications. Although a number of specific restrictions seemingly protect policyowners, their effectiveness is questionable because the regulations do not reflect all aspects of the unique relationship between the investment risk and the underwriting risk of MICs. To the extent that this unique relationship is not reflected in the present regulatory framework, the transfer of risk from a mortgage lender to the insurer may be negated by an investment policy inconsistent with the risk bearing function of the firm. In order to reflect the financial realities of mortgage insurance, the regulation of investments should focus not only on specific issues such as interest coverage or the continuity of dividend payments, but investment policy as well. Investment policy is a much broader issue and encompasses such matters as maturity composition, portfolio quality, diversification, and the mix of fixed income and equity securities. When the present John 1H. Brick, Ph.D., C.F.A., is an Assistant Professor, Department of Accounting aind Financial Administration, Michigan State University. Howard E. Thompson is Mary Rennebohn Professor, School of Business, University of Wisconsin, Madison. Professor Thompson has published extensively with articles appearing in the Journal of Risk and Insurance, Journal of Finance, Journal of Business, The Bell Joturnal of Economics and Management Science, Management Science, Operations Research, The Financial Analyst Journal, and Decision Science.

Default Risk and the Theory of the Firm

Abstract: The dynamic behavior of the corporation has been examined in recent literature, by a number of authors, notably, Krouse [4, 5], Elton-Gruber [2], and Senchak [8]. These efforts, however, although attempting to characterize the firm's optimal financing program have neglected to incorporate the threat of bankruptcy associated with these decisions. The thrust of this paper is to address this deficiency in the theoretical literature by explicitly recognizing the uncertainty of financial ruin attributable to the firm's choice of capital