Pricing firms on the basis of fundamentals

Determining the right or fair price of a stock is one of the oldest problems in finance. Business mergers and acquisitions rely on this information, but only in the last several decades have formal models been developed to address the question. This article focuses on fundamental valuation, a technique that determines the right price by forecasting cash flows from a stock market investment and calculating what that income is worth. ; The author first provides an overview of the literature and an illustration of commonly used fundamental valuation techniques based on relative valuation and the Gordon growth model and then discusses a valuation approach he developed in 2001. His work incorporates the proceeds from share liquidation into the cash flows that are used to value the firm, accounting for the reduction in future growth of cash flows from this liquidation of shares. The author demonstrates these methods by applying them to pricing BellSouth shares, the S&P 500 index, and some new-economy stocks. The discussion also looks at prices and estimated fundamental values during severe market turndowns. ; Pricing BellSouth using sales and sales growth is consistent with its dramatic rise and recent decline in price, the author finds; this method is also appropriate for a small group of high-growth stocks. Fundamental models, however, have more trouble explaining the price movements of the overall market. The author concludes that algorithmic valuation techniques provide, at best, a rough starting point for firm valuation.Asset pricing

Volatility forecasts, trading volume, and the ARCH versus option-implied volatility trade-off

Market expectations of future return volatility play a crucial role in finance; so too does our understanding of the process by which information is incorporated in security prices through the trading process. The authors seek to learn something about both of these issues by investigating empirically the role of trading volume in predicting the relative informativeness of volatility forecasts produced by ARCH models versus the volatility forecasts derived from option prices and in improving volatility forecasts produced by ARCH and option models and combinations of models. Daily and monthly data are explored. The authors find that if trading volume was low during period $t – 1$ relative to the recent past, then ARCH is at least as important as options for forecasting future stock market volatility. Conversely, if volume was high during period $t – 1$ relative to the recent past, then option-implied volatility is much more important than ARCH for forecasting future volatility. Considering relative trading volume as a proxy for changes in the set of information available to investors, their findings reveal an important switching role for trading volume between a volatility forecast that reflects relatively stale information (the historical ARCH estimate) and the option-implied forward-looking estimate.

The Case for Trills: Giving Canadians and their Pension Funds a Stake in the Wealth of the Nation

This study proposes that the Government of Canada issue a new debt security, the “Trill,” which would essentially offer Canadian investors an equity stake in the Canadian economy. The Trill is so-named because its coupon payment would be one-trillionth of Canada’s GDP. Similar to shares issued by corporations paying a fraction of corporate earnings in dividends, the Trill would pay a fraction of the “earnings” of Canada. Coupon payments would rise and fall with the GDP.pension papers, governance and public institutions

Stare down the barrel and center the crosshairs: Targeting the ex ante equity premium

The equity premium of interest in theoretical models is the extra return investors anticipate when purchasing risky stock instead of risk-free debt. Unfortunately, we do not observe this ex ante premium in the data; we only observe the returns that investors actually receive ex post, after they purchase the stock and hold it over some period of time during which random economic shocks affect prices. Over the past century U.S. stocks have returned roughly 6 percent more than risk-free debt, which is higher than warranted by standard economic theory; hence the "equity premium puzzle." In this paper we devise a method to simulate the distribution from which ex post equity premia are drawn, conditional on various assumptions about investors' ex ante equity premium. Comparing statistics that arise from our simulations with key financial characteristics of the U.S. economy, including dividend yields, Sharpe ratios, and interest rates, suggests a much narrower range of plausible equity premia than has been supported to date. Our results imply that the true ex ante equity premium likely lies very close to 4 percent.Bonds ; Investments ; Stock market ; Rate of return

The Case for Trills: Giving the People and Their Pension Funds a Stake in the Wealth of the Nation

We make the case for the U.S. government to issue a new security with a coupon tied to the United States’ current dollar GDP. This security might pay, for example, a coupon of one-trillionth of the GDP, and we propose the name "Trill" be used to refer to this new security. This new debt instrument should be of great interest to the Government for its stabilizing influence on the budget (as coupon payments fall in a recession with declining tax revenues) and for its yield, based on our valuation. Standard asset pricing analysis also suggests that Trills would enable important new portfolio diversification strategies and, in contrast to available assets that protect relative standards of living in retirement, Trills would have virtually no counterparty risk. We believe there would be a lively appetite for the Trill from institutional investors, public and private pension funds, as well as the individual investor.GDP-linked bonds, Aggregate risk, Income risk, Inflation-indexed bonds, MacroShares, U.S. Treasury, Treasury Inflation Protection Securities (TIPS), Intergenerational risk sharing, International risk sharing, Hedging, Portfolio diversification, Market portfolio

The Condensation of Phenols with Maleic Anhydride

The condensation of phenols with phthalic anhydride to give acid-base indicators is well known. The preparation of phenolphthalein was first reported by Baeyer in 1871 (1) using concentrated sulfuric acid as the catalyst. Baeyer reported the successful use of sulfuric chloride as the catalyst for the preparation of phenolphthalein in 1880 (2). Early reports of the condensation of resorcinol (3), p-chlorophenol(4) and o-cresol (5) with phthalic anhydride have also been made. The reaction of phenols with coumarin (11), with diphenic acid anhydride (8) and with succinic anhydride (6) to form compounds comparable in structure to the phthaleins has been reported. Very little work was done however toward establishing the indicator properties of the products. Sisson (13) attempted to prepare a number of maleins and succineins from phenols and maleic anhydride and succinic anhydride respectively. While indicator properties were evident he obviously did not isolate pure compounds or study them in detail. Similar results were reported by Doss and Tewari (7) who could not have had pure products. It seemed of interest therefore to repeat some of this work with the hope of obtaining the phenomaleins in a pure condition and of making a more comprehensive study of their indicator properties