Fred D. Arditti

Another Look at Mutual Fund Performance

Recent studies of mutual funds have all arrived at the same conclusion: mutual fund performance has been inferior to the performance of the market indices. One of the most prominent of these studies was conducted by William F. Sharpe. He showed that if his measure of mutual fund performance, the reward-to-variability ratio, is calculated net of management expenses for each fund in his sample of thirty-four, then the average value of this ratio over the thirty-four funds is significantly less than the same measure applied to the Dow Jones Industrials over the 1954–1963 period. From this evidence, Sharpe concluded that average mutual fund performance was distinctly inferior to an investment in the Dow Jones Industrial Average. It is the intent of this paper to show that if another variable, namely the third moment of the funds annual rate of return, is introduced into the investors decision process, Sharpes conclusion must be altered.

Spanning the State Space with Options

In the Arrow-Debreu approach to uncertainty it has been recognized that an inadequate number of markets in contingent claims would be a source of inefficiency. Several researchers have studied the allocative inefficiencies resulting from incomplete markets, i.e., when the number of independent securities is less than the number of states and therefore the state-space cannot be “spanned†by those securities. In a situation where the number of primitive assets is inadequate to span the state-space, the new spanning opportunities opened up by derived assets written on the primitives is an interesting question.

DISTRIBUTION MOMENTS AND EQUILIBRIUM: A COMMENT

Using the mean-variance model, Sharpe [5] and Lintner [4] have derived an equilibrium model for price determination under uncertainty. Jean [2] has tried to generalize this model so that other moments of the distribution will be taken into account. The purpose of this note is to show that unlike the Sharpe-Lintner model, Jeans results make no economic sense.

THREE WAYS TO PRESENT THE MARGINAL COST OF CAPITAL

Textbooks, courses, Some Associate I and teachersinelementary large of the Finan economics consistently ciation have expres of Financial Manag, teach that profits for a tutorial articles. Al tutorial articles. Alt firm are at a maximum to preempt space b when marginal cost equals tinuous publication, marginal revenue. Many of Arditti and Tys teachers in finance, howPresent the Margin , ., * . . ,nifies our willingnes ever, neglect this principle tifes on a seleines ev r, 0 i r ~~tidcles on a selective b in the teaching of capital budgeting. Perhaps this is partly because a firms capital may be a mix of funds from a number of sources; debt, preferred stock, common stock etc., at varying costs, and, even if a firms optimal capital mix is known, additional funds are not raised simultaneously in the same proportions. Then, to avoid the obviously unsupportable position that the capital budgeting cut-off rate should be at the cost of debt this year because this is the year to raise debt, and at the equity rate next year, because next year is the year to raise equity some have used weighted average cost of capital. (For additional discussion of the use of the weighted average cost of capital, see [1].) A cursory review of a dozen current textbooks confirms this. Our interpretation is that only five Editc cial

OPTIMAL COUPON RATE, TAXES, AND COLLUSION BETWEEN BORROWER AND LENDER

Publisher Summary This chapter explains how to determine the optimal coupon payment for a firm striving to minimize post-tax payments to bondholders, and describes that the actions of the firm acting to minimize its post-tax debt payment, in the face of potential bond buyers who act in their own self-interest as wealth-maximizers, result in a market issue price that is identical to that obtained if both firm and buyers were to collude in selecting a coupon rate that minimizes the sum of tax payments of the coalitions participants. The analysis is restricted to single-period bonds and is initially conducted in a deterministic system under two different tax systems.

The Theory of Finance.

This module presents the fundamental concepts of modern finance theory. This will form the foundation for other modules in finance and is primarily designed for finance students. This material is reinforced by the specialist (Group A) finance options available in the spring term. Although this module is open to economics students, our experience is that they find this difficult without the support of the specialist modules and only the best economics students do well. Much of modern finance is technically demanding as it makes considerable use of mathematics. This is particularly true of derivatives and option pricing, an area central to modern finance that employs stochastic calculus instead of ordinary calculus.