Encyclopedia of finance - springer (2013) - cheng few lee, alice c.lee

Encyclopedia of Finance


The Editors
Cheng-Few Lee, Rutgers University, USA
Alice C. Lee, Boston, MA, USA*

ADVISORY BOARD
James R. Barth, Auburn University and Milken Institute, USA
Ivan Brick, Rutgers University, USA
Chun-Yen Chang, National Chiao Tung University, Taiwan, Republic of China
Wayne Ferson, Boston College, USA
Joseph E. Finnerty, University of Illinois, USA
Martin J. Gruber, New York University, USA
Hyley Huang, Wintek Corporation, Taiwan, Republic of China
George Kaufman, Layola University, USA
John Kose, New York University, USA
Robert A. Schwartz, City University of New York, USA

*Disclaimer: Any views or opinions presented in this publication are solely those of the authors and do not necessarily represent those of State
Street Corporation. State Street Corporation is not associated in any way with this publication and accepts no liability for the contents of this
publication.


Cheng-Few Lee • Alice C. Lee
Editors

Encyclopedia of Finance
Second Edition

Editors
Cheng-Few Lee
Department of Finance
Rutgers University,
New Brunswick, NJ, USA

Alice C. Lee
State Street,
Boston, MA, USA

ISBN 978-1-4614-5359-8
ISBN 978-1-4614-5360-4 (eBook)
DOI 10.1007/978-1-4614-5360-4
Springer New York Heidelberg Dordrecht London
Library of Congress Control Number: 2012952929
# Springer Science+Business Media New York 2013
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Springer is part of Springer Science+Business Media (www.springer.com)


Preface to the Second Edition

Since the first edition was published in 2006, this encyclopedia has been very popular in both
academic and practitioner professions. It has been the most downloaded book in the area of
finance and economics, which was published by Springer.
In this new edition, we have revised Part I, Part II and Appendices extensively. In Part I, we
added more than 200 terminologies and essays. In Part II, we added 24 new chapters. Finally,
we added four new appendices. The new chapters and appendices can be found in the table
content.
Seventy-four papers included in Part II can be classified into eight groups as follows:
(a) Investment analysis and portfolio management (chapters 4, 8, 11, 13, 20, 22, 30, 32, 35,
41, 46, 49, 55, 62, and 66)
(b) Financial management and corporate finance (chapters 12, 19, 23, 27, 28, 29, 33, 40, 43,
52, 57, 64, 68, 69, 70, 71, 72, and 73)
(c) International finance (chapters 5, 7, 16, 31, 34, 42, 43, 48, 51, 53, and 67)
(d) Microstructure (chapters 17, 18, 21, 31, 36, 37, 38, 39, and 45)
(e) Asset pricing (chapters 9, 10, 11, 13, 35, 58, and 63)
(f ) Financial institutions and markets (chapters 2, 3, 14, 25, 47, and 54)
(g) Derivatives (chapters 6, 29, 44, and 65)
(h) Real estate finance (chapters 15, 26, 59, and 50)
(i ) Risk management (chapters 5, 6, 7, 23, 24, 25, 40, 56, 60, 61, 74, and 75)
For both undergraduate and graduate students, this encyclopedia is a good supplementary
material for the above-listed finance courses. In addition, this encyclopedia can be a good
supplementary material for financial accounting courses. We believe that this encyclopedia

will not only be useful to students but also for professors and practitioners in the field of
finance as a reference.
We would like to thank the contributors for willingness to share their expertise and their
thoughtful essays in Part II. We would like to thank Mr. Brian J. Foster of Springer for his
coordination and suggestions to this book. Finally, we would also like to express our gratitude
to our secretary and assistant, Ms. Miranda Mei-Lan Luo and Tzu Tai, for their efforts in
helping us pull together this tremendous repository of information.
We hope that the readers will find the encyclopedia to be an invaluable resource.
NJ, USA
MA, USA

Cheng-Few Lee
Alice C. Lee

v



Preface to the First Edition

Finance has become one of the most important and popular subjects in management school
today. This subject has progressed tremendously in the last 40 years, integrating models and
ideas from other areas such as physics, statistics, and accounting. The financial markets have
also rapidly expanded and changed extensively because of improvement in technology and the
ever changing regulatory and social environment. For example, there has been a rapid
expansion of financial concepts, instruments, and tools due to increased computing power
and seemingly instantaneous information sharing through networks. The internationalization
of businesses and economies will continue to impact the field of finance. With all this progress
and expansion in finance and society, we thought that it would be useful to put together an
updated comprehensive encyclopedia as a reference book for both students and professionals

in an attempt to meet the demand for a key source of fundamental finance terminology and
concepts.
This Encyclopedia of Finance contains five parts. Part I includes finance terminology and
short essays. Part II includes 50 important finance chapters by well-known scholars and
practitioners, such as James R. Barth, Ren-Raw Chen, Thomas C. Chiang, Quentin C. Chu,
Wayne E. Ferson, Joseph E. Finnerty, Thomas S.Y. Ho, C.H. Ted Hong, Cheng Hsiao, JingZhi Huang, Mao-wei Hung, John S Jahera Jr., Haim Levy, Wilbur G. Lewellen, Joseph P.
Ogden, Fai-nan Peng, Gordon S. Roberts, Robert A. Schwartz, K.C. John Wei, and Gillian
Yeo, among others. Topics covered in both Part I and Part II include fundamental subjects
such as financial management, corporate finance, investment analysis and portfolio management, options and futures, financial institutions, international finance, and real estate finance.
Part III contains appendices which discuss and derive some fundamental finance concepts and
models, Part IV lists references, and Part V provides both subject and author indexes.
Fifty papers included in Part II can be classified into eight groups as follows:
(a) Investment analysis and portfolio management (chapters 3, 7, 10, 12, 19, 21, 29, 31, 34,
40, 45, and 48)
(b) Financial management and corporate finance (chapters 11, 18, 22, 26, 27, 28, 32, 39, and 42)
(c) International finance (chapters 4, 6, 15, 30, 33, 41, 42, 47, and 50)
(d) Microstructure (chapters 16, 17, 20, 30, 35, 36, 37, 38, and 44)
(e) Asset pricing (chapters 8, 9, 10, 12, and 34)
(f ) Financial institutions and markets (chapters 1, 2, 13, 24, and 46)
(g) Derivatives (chapters 5, 28, and 43)
(h) Real estate finance (chapters 14, 25, and 49)
(i ) Risk management (chapters 4, 5, 6, 22, 23, 24, and 39)
For both undergraduate and graduate students, this encyclopedia is a good supplementary
material for the above-listed finance courses. In addition, this encyclopedia can be a good
supplementary material for financial accounting courses. We believe that this encyclopedia
will not only be useful to students but also for professors and practitioners in the field of
finance as a reference.
We would like to thank the contributors for willingness to share their expertise and their
thoughtful essays in Part II. We would like to thank Ms. Judith L. Pforr, of Springer, for her
coordination and suggestions to this book. Finally, we would also like to express our gratitude

vii


viii

Preface to the First Edition

to our secretaries Ms. Miranda Mei-Lan Luo, Ms. Sue Wang, Ms. Ting Yen, and Ms. Meetu
Zalani for their efforts in helping us pull together this tremendous repository of information.
We hope that the readers will find the encyclopedia to be an invaluable resource.
NJ, USA
MA, USA

Cheng-Few Lee
Alice C. Lee


About the Editors

Cheng-Few Lee is a distinguished professor of finance at Rutgers Business School, Rutgers
University, and was chairperson of the Department of Finance from 1988 to 1995. He has also
served on the faculty of the University of Illinois (IBE professor of finance) and the University
of Georgia. He has maintained academic and consulting ties in Taiwan, Hong Kong, China and
the United States for the past three decades. He has been a consultant to many prominent
groups including, the American Insurance Group, the World Bank, the United Nations, The
Marmon Group Inc., Wintek Corporation and Polaris Financial Group.
Professor Lee founded the Review of Quantitative Finance and Accounting (RQFA) in
1990 and the Review of Pacific Basin Financial Markets and Policies (RPBFMP) in 1998, and
serves as managing editor for both journals. He was also a co-editor of the Financial Review
(1985–1991) and the Quarterly Review of Economics and Business (1987–1989).

In the past 39 years, Dr. Lee has written numerous textbooks ranging in subject matter from
financial management to corporate finance, security analysis and portfolio management to
financial analysis, planning and forecasting, and business statistics. Dr. Lee has also published
more than 200 articles in more than 20 different journals in finance, accounting, economics,
statistics, and management. Professor Lee has been ranked the most published finance
professor worldwide during 1953–2008. Professor Lee has written many textbooks ranging
in subject matter from financial management to corporate finance, security analysis and
portfolio management to financial analysis, planning and forecasting, and business statistics.
Alice C. Lee is currently a vice president in finance at State Street Corporation, heading up
a group that provides analytics and valuations in support to the corporate Chief Accounting
Officer. She was also previously a Vice President in the Model Validation Group, Enterprise
Risk Management, at State Street Corporation. Her career spans over 20 years of experience,
with a diverse background that includes academia, engineering, sales, and management
consulting. Her primary areas of expertise and research are corporate finance and financial
institutions. She is coauthor of Statistics for Business and Financial Economics, 2e and 3e
(with Cheng F. Lee and John C. Lee), Financial Analysis, Planning and Forecasting, 2e
(with Cheng F. Lee and John C. Lee), and Security Analysis, Portfolio Management, and
Financial Derivatives (with Cheng F. Lee, Joseph Finnerty, John C. Lee and Donald Wort).
In addition, she has coedited other annual publications including Advances in Investment
Analysis and Portfolio Management (with Cheng F. Lee).

ix



Contents

Part I
1

Terms and Essays . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Terms and Essays . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Part II

3

Papers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205

2

Deposit Insurance Schemes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
James R. Barth, Cindy Lee, and Triphon Phumiwasana

3

Gramm-Leach-Bliley Act: Creating a New Bank for a New Millenium . . . . . 213
James R. Barth and John S. Jahera

4

Pre-funded Coupon and Zero-Coupon Bonds: Cost of Capital Analysis . . . . . 219
Suresh Srivastava and Ken Hung

5

Intertemporal Risk and Currency Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227
Jow-Ran Chang and Mao-Wei Hung

6

Credit Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237
Ren-Raw Chen and Jing-Zhi Huang

7

International Parity Conditions and Market Risk . . . . . . . . . . . . . . . . . . . . . 243
Thomas C. Chiang

8

Treasury Inflation-Protected Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257
Quentin C. Chu and Deborah N. Pittman

9

Asset Pricing Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263
Wayne E. Ferson

10

Conditional Asset Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273
Wayne E. Ferson

11

Conditional Performance Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279
Wayne E. Ferson

12

Working Capital and Cash Flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287
Joseph E. Finnerty

13

Evaluating Fund Performance Within the Stochastic
Discount Factor Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297
J. Jonathan Fletcher

14

Duration Analysis and Its Applications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305
Iraj J. Fooladi, Gady Jacoby, and Gordon S. Roberts

15

Loan Contract Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315
Aron A. Gottesman
xi


xii

Contents

16

Chinese A and B Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321

Yan He

17

Decimal Trading in the U.S. Stock Markets . . . . . . . . . . . . . . . . . . . . . . . . . . 325
Yan He

18

The 1997 NASDAQ Trading Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329
Yan He

19

Reincorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333
Randall A. Heron and Wilbur G. Lewellen

20

Mean Variance Portfolio Allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341
Cheng Hsiao and Shin-Huei Wang

21

Online Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347
Chang-Tseh Hsieh

22

A Critical Evaluation of the Portfolio Performance Indices

Under Rank Transformation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351
Ken Hung, Chin-Wei Yang, Matthew Brigida, and Dwight B. Means, Jr.

23

Corporate Failure: Definitions, Methods, and Failure
Prediction Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 357
Jenifer Piesse, Cheng-Few Lee, Hsien-Chang Kuo, and Lin Lin

24

Risk Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 367
Thomas S.Y. Ho and Sang Bin Lee

25

Term Structure: Interest Rate Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377
Thomas S.Y. Ho and Sang Bin Lee

26

Review of REIT and MBS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387
Cheng-Few Lee and Chiuling Lu

27

Experimental Economics and the Theory of Finance . . . . . . . . . . . . . . . . . . . 395
Haim Levy

28

Merger and Acquisition: Definitions, Motives, and Market Responses . . . . . . 411
Jenifer Piesse, Cheng-Few Lee, Lin Lin, and Hsien-Chang Kuo

29

Multistage Compound Real Options: Theory and Application . . . . . . . . . . . . 421
William T. Lin, Cheng-Few Lee, and Chang-Wen Duan

30

Market Efficiency Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445
Melody Lo

31

The Microstructure/Micro-Finance Approach to Exchange Rates . . . . . . . . . 449
Melody Lo

32

Arbitrage and Market Frictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453
Shashidhar Murthy

33

Fundamental Tradeoffs in the Publicly Traded Corporation . . . . . . . . . . . . . 459
Joseph P. Ogden

34

The Mexican Peso Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 465
Fai-Nan Perng

35

Portfolio Performance Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 471
Lalith P. Samarakoon and Tanweer Hasan


Contents

xiii

36

Call Auction Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477
Robert A. Schwartz and Reto Francioni

37

Market Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483
Robert A. Schwartz and Lin Peng

38

Market Makers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487
Robert A. Schwartz and Lin Peng

39

Structure of Securities Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491
Robert A. Schwartz and Lin Peng

40

Accounting Scandals and Implications for Directors:
Lessons from Enron . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495
Pearl Tan and Gillian Yeo

41

Agent-Based Models of Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . 501
Nicholas S.P. Tay

42

The Asian Bond Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507
Khairy Tourk

43

Cross-Border Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515
Geraldo M. Vasconcellos and Richard J. Kish

44

Jump Diffusion Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525
Shin-Huei Wang

45

Networks, Nodes, and Priority Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535
Daniel G. Weaver

46

The Momentum Trading Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 545
K.C. John Wei

47

Equilibrium Credit Rationing and Monetary Nonneutrality
in a Small Open Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549
Ying Wu

48

Policy Coordination Between Wages and Exchange
Rates in Singapore . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557
Ying Wu

49

The Le Chatelier Principle of the Capital Market Equilibrium . . . . . . . . . . . 565
Chin W. Yang, Ken Hung, and John A. Fox

50

MBS Valuation and Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569

C.H. Ted Hong and Wen-Ching Wang

51

The Impacts of IMF Bailouts in International Debt Crises . . . . . . . . . . . . . . . 581
Zhaohui Zhang and Khondkar E. Karim

52

Corporate Governance: Structure and Consequences . . . . . . . . . . . . . . . . . . 587
Bikki Jaggi

53

A Survey Article on International Banking . . . . . . . . . . . . . . . . . . . . . . . . . . 607
James Winder

54

Hedge Funds: Overview, Strategies, and Trends . . . . . . . . . . . . . . . . . . . . . . 621
John M. Longo


xiv

Contents

55

An Appraisal of Modeling Dimensions for Performance

Appraisal of Global Mutual Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 633
G.V. Satya Sekhar

56

Structural Credit Risk Models: Endogenous Versus
Exogenous Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 645
Michael B. Imerman

57

Arbitrage Opportunity Set and the Role of Corporations . . . . . . . . . . . . . . . . 659
James S. Ang and Yingmei Cheng

58

Equity Premium Puzzle: The Distributional Approach . . . . . . . . . . . . . . . . 675
Nadezhda Safronova

59

Understanding Ginnie Mae Reverse Mortgage H-REMICs:
Its Programs and Cashflow Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 691
C. H. Ted Hong and George H. Lee

60

An Analysis of Risk Treatment in the Field of Finance . . . . . . . . . . . . . . . . . . 705
´
´

Fernando Gomez-Bezares and Fernando R. Gomez-Bezares

61

The Trading Performance of Dynamic Hedging Models:
Time Varying Covariance and Volatility Transmission Effects . . . . . . . . . . . 713
Michael T. Chng and Gerard L. Gannon

62

Portfolio Insurance Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 727
Lan-chih Ho, John Cadle, and Michael Theobald

63

Time-Series and Cross-Sectional Tests of Asset Pricing Models . . . . . . . . . . . 745
Kyung-Jin Choi, Dongcheol Kim, and Soon-Ho Kim

64

Alternative Methods for Estimating Firm’s Growth Rate . . . . . . . . . . . . . . . 755
Ivan E. Brick, Hong-Yi Chen, and Cheng-Few Lee

65

A Comparison of Formulas to Compute Implied Standard Deviation . . . . . . 765
James S. Ang, Gwoduan David Jou, and Tsong-Yue Lai

66

Securities Transaction Taxes: Literature and Key Issues . . . . . . . . . . . . . . . . 777
Anna Pomeranets

67

Financial Control and Transfer Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 783
Savita A. Sahay

68

Alternative Models for Evaluating Convertible Bond:
Review and Integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 795
Lie-Jane Kao, Cheng-Few Lee, and Po-Cheng Wu

69

A Rationale for Hiring Irrationally Overconfident Managers . . . . . . . . . . . . . 803
Oded Palmon and Itzhak Venezia

70

The Statistical Distribution Method, the Decision-Tree Method
and Simulation Method for Capital Budgeting Decisions . . . . . . . . . . . . . . . . 813
Cheng-Few Lee and Tzu Tai

71

Valuation of Interest Tax Shields . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 825
Michael Dothan

72

Usefulness of Cash Flow Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 835
Savita A. Sahay


Contents

xv

73

Nonlinear Models in Corporate Finance Research: Review, Critique,
and Extensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851
Sheng-Syan Chen, Kim Wai Ho, Cheng-Few Lee, and Keshab Shrestha

74

Futures Hedge Ratios: A Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871
Sheng-Syan Chen, Cheng-few Lee, and Keshab Shrestha

75

Credit Risk Modeling: A General Framework . . . . . . . . . . . . . . . . . . . . . . . . 891
Ren-Raw Chen

Appendix A Derivation of Dividend Discount Model . . . . . . . . . . . . . . . . . . . . . . . 911
Appendix B

Derivation of DOL, DFL and DCL . . . . . . . . . . . . . . . . . . . . . . . . . . . 913

Appendix C

Derivation of Crossover Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 915

Appendix D

Capital Budgeting Decisions with Different Lives . . . . . . . . . . . . . . . . 917

Appendix E

Derivation of Minimum-Variance Portfolio . . . . . . . . . . . . . . . . . . . . . 919

Appendix F

Derivation of an Optimal Weight Portfolio Using
the Sharpe Performance Measure . . . . . . . . . . . . . . . . . . . . . . . . . . . . 921

Appendix G Applications of the Binomial Distribution
to Evaluate Call Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 923
Appendix H Derivation of Modigliani and Miller (M&M) Proposition I
and II with Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 929
Appendix I

Derivation of Capital Market Line (CML) . . . . . . . . . . . . . . . . . . . . . 931

Appendix J

Derivation of Capital Market Line (SML) . . . . . . . . . . . . . . . . . . . . . . 933

Appendix K Derivation of Black-Scholes Option Pricing Model . . . . . . . . . . . . . . . 935
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 937
Subject Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 977
Author Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1003



List of Contributors

James S. Ang Department of Finance, Florida State University, Tallahassee, FL, USA
James R. Barth Auburn University and Milken Institute, Auburn, Alabama, USA
Moshe Ben-Horin Ono Academic College, Israel
Ivan E. Brick Department of Finance and Economics, Rutgers University,
Newark and New Brunswick, USA
Matthew Brigida Clarion University of Pennsylvania, Clarion, PA, USA
John Cadle University of Birmingham, Birmingham, UK
Jow-Ran Chang National Tsing Hua University, Taiwan, Republic of China
Hong-Yi Chen National Central University, Taiwan, Republic of China
Ren-Raw Chen Fordham Univrsity, New York, NY, USA
Sheng-Syan Chen Department of Finance, College of Management,
National Taiwan University, Taipei, Taiwan, Republic of China
Yingmei Cheng Department of Finance, Florida State University, Tallahassee, FL, USA
Thomas C. Chiang Drexel University, Philadelphia, PA, USA
Rhodes College, Memphis, Tennessee, Philadelphia, PA, USA
Michael T. Chng Deakin University, Australia
Kyung-Jin Choi Korea University Business SchoolAnam-dong, Sungbuk-ku, Seoul,
South Korea
Quentin C. Chu University of Memphis, Memphis, Tennessee, USA
Michael Dothan Atkinson Graduate School of Management, Willamette University, USA
Chang-wen Duan Tamkang University, Taiwan, Republic of China

Wayne E. Ferson University of Southern California, Los Angeles, CA, USA
Joseph E. Finnerty University of Illinois, Champaign, IL, USA
J. Jonathan Fletcher University of Strathclyde, Glasgow, UK
Iraj J. Fooladi Dalhousie University, Halifax, Canada
John A. Fox Matthew Brigida, Clarion University of Pennsylvania, Clarion, PA, USA
Reto Francioni Swiss Stock Exchange, Switzerland
Gerard L. Gannon School of Accounting, Economics and Finance,
Deakin University, Melbourne, VIC, Australia

xvii


xviii

´
Fernando Gomez-Bezares Deusto Business School, Bilbao, Spain
´
Fernando R. Gomez-Bezares The Boston Consulting Group, Madrid, Spain
Aron A. Gottesman Pace University, New Albany, IN, USA
Tanweer Hasan Roosevelt University, USA
Yan He Indiana University Southeast, New Albany, IN, USA
Randall A. Heron Indiana University, Indianapolis, IN, USA
Kim Wai Ho Nanyang Technological University, Singapore
Lan-Chih Ho Central Bank of the Republic of China, Taiwan, Republic of China
Thomas S.Y. Ho Thomas Ho Company, Ltd, New York, NY, USA
C.H. Ted Hong BeyondBond, Inc., New York, NY, USA
Cheng Hsiao University of Southern California, Los Angels, CA, USA
Chang-Tseh Hsieh University of Southern Mississippi, Hattiesbury, MS, USA
Jing-Zhi Huang Penn State University, USA
Ken Hung Texas A&M International University, Laredo, TX, USA

Mao-Wei Hung National Taiwan University, Taiwan, Republic of China
Michael B. Imerman Princeton University, USA
Gady Jacoby University of Manitoba, Winnipeg, Manitoba, Canada
Bikki Jaggi School of Business, Rutgers University, Newark-New Brunswick, USA
John S. Jahera Auburn University, USA
Gwoduan David Jou CFO, Taikang life insurance co., Beijing, China
Lie-Jane Kao Kainan University, Taiwan, Republic of China
Khondkar E. Karim Rochester Institute of Technology, USA
Dongcheol Kim Korea University, Anam-dong, Sungbuk-ku, Seoul, South Korea
Soon-Ho Kim Korea University, Anam-dong, Sungbuk-ku, Seoul, South Korea
Richard J. Kish Lehigh University, Bethlehem, PA, USA
Hsein-Chang Kuo National Chi-Nan University, Taiwan, Republic of China
Tsong-Yue Lai Department of Finance, California State University-Fullerton, Fullerton,
CA, USA
Alice C. Lee State Street, Boston, MA, USA
Cheng-Few Lee Department of Finance and Economics, Rutgers University,
Newark and New Brunswick, USA
Rutgers Business School, Rutgers University, New Brunswick, USA
Cindy Lee China Trust Bank, USA
George H. Lee BeyondBond, Inc., New York, NY, USA
Sang Bin Lee Hanyang University, South Korea

List of Contributors


List of Contributors

xix

Haim Levy Hebrew University, Jerusalem, Israel

Wilbur G. Lewellen Purdue University, Indianapolis, IN, USA
Lin Lin National Chi-Nan University, Taiwan, Republic of China
William T. Lin Tamkang University, Taiwan, Republic of China
Melody Lo University of Texas at San Antonio, San Antonio, TX, USA
John M. Longo Rutgers University, New Brunswick, NJ, USA
Chiuling Lu Yuan Ze University, Taiwan, Republic of China
Dwight B. Means, Jr. Clarion University of Pennsylvania, Clarion, PA, USA
Shashidhar Murthy Indian Institute of Management Bangalore, Bangalore, India
Joseph P. Ogden State University of New York at Buffalo, Buffalo, NY, USA
Oded Palmon Rutgers Business, Rutgers University, Piscataway, NJ, USA
Rutgers Business, Rutgers University, Newark and New Brunswick, NJ, USA
Lin Peng Baruch College of the City, University of New York, New York, NY, USA
Fai-nan Perng Central Bank of the Republic of China (Taiwan), Taipei,
Taiwan, Republic of China
Triphon Phumiwasana Milken Institute, USA
Jenifer Piesse University of London, London, England, UK
Deborah N. Pittman Rhodes College, Memphis, Tennessee, USA
Anna Pomeranets Bank of Canada, Ottawa, Canada
Svetlozar T. Rachev Stony Brook University, SUNY, USA
Gordon S. Roberts York University, Toronto, ON, Canada
Nadezhda Safronova Institute of Econometrics, Statistics and Mathematical Finance,
School of Economics and Business Engineering, University of Karlsruhe, Karlsruhe, Germany
Savita A. Sahay Department of Accounting and Information Systems, Rutgers Business
School, Rutgers University, Janice Levin Building, Piscataway, NJ, USA
Lalith P. Samarakoon University of St. Thomas, Minneapolis, MN, USA
Robert A. Schwartz Baruch College of the City University of New York, NY, USA
G.V. Satya Sekhar Gandhi Institute of Technology and Management Studies, GITAM,
University, Visakhapatnam, India
Keshab Shrestha Risk Management Institute, National University of Singapore, Singapore,
Singapore

Suresh Srivastava University of Alaska Anchorage, AK, USA
Tzu Tai Rutgers University, New Brunswick, NJ, USA
Pearl Tan Singapore Management University, Singapore
Nicholas S.P. Tay University of San Francisco, San Francisco, CA, USA
Michael Theobald University of Birmingham, Birmingham, UK
Khairy Tourk Illinois Institute of Technology, Evanston, IL, USA


xx

Geraldo M. Vasconcellos Lehigh University, Bethlehem, PA, USA
Itzhak Venezia School of Business, The Hebrew University, Jerusalem, Israel
Shin-Huei Wang University of Southern California, Los Angsles, CA, USA
Wen-Ching Wang Robeco Investment Management, USA
Daniel G. Weaver Rutgers University, New Brunswick, NJ, USA
K.C. John Wei Hong Kong University of Science and Technology, Hong Kong, China
James Winder Rutgers University, New Brunswick, USA
Po-Cheng Wu Kainan University, Taiwan, Republic of China
Ying Wu Salisbury University, Salisbury, MD, USA
Chin-Wei Yang Clarion University of Pennsylvania, Clarion, PA, USA
National Chung cheng University, Chia-yi, Taiwan, Republic of China
Gillian Yeo Singapore Management University, Singapore
Zhaohui Zhang Long Island University, Brookville, NY, USA

List of Contributors


Part I
Terms and Essays

1

Terms and Essays

A
1. Abnormal Return
Return on a stock beyond what would be the expected
return that is predicted by market movements alone.
[See also Cumulative abnormal return (CAR)]
2. Absolute Cost Advantage
Absolute cost advantages can place competitors at a
cost disadvantage, even if the scale of operations is
similar for both firms. Such cost advantages can arise
from an advanced position along the learning curve,
where average costs decline as cumulative output rises
over time. This differs from economies of scale, which
involves the relationship between average costs and the
output level per period of time. A firm that enters a
market segment early can learn about the production
and distribution process first and make more efficient
use of assets, technology, raw inputs, and personnel
than its competitors. In such cases, the firm can frequently reduce costs and prices and maintain market
leadership. Similar advantages can result from
possessing proprietary technology that is protected by
patents.
Some firms seek to maintain absolute cost advantages
by entering foreign market. Early entry can allow the
firm to gain experience over its competitors, as it can
more efficiently track foreign market trends and

technologies and disseminate new methods throughout
the firm.
3. Absolute Priority of Claims
In cases of liquidation of a firm’s assets, the rule requires
satisfaction of certain claims prior to the satisfaction of
other claims. The priority of claims in liquidation or
reorganization typically takes the following order:
1. Special current debt, which includes trustee
expenses, unpaid wages that employees have earned
in the 90 days preceding bankruptcy (not to exceed
$2,000 for any one case), and contributions to
employee benefit plans that have fallen due within
the 180 days preceding bankruptcy.

2. Consumer claims on deposits not exceeding $900
per claim.
3. Tax claims.
4. Secured creditors’ claims, such as mortgage bonds
and collateral trust bonds, but only to the extent of
the liquidating value of the pledged assets.
5. General creditors’ claims, including amounts
owed to unsatisfied secured creditors and all unsecured creditors, but only to the extent of their
proportionate interests in the aggregate claims of
their classes.
6. Preferred stockholders’ claims, to the extent
provided in their contracts, plus unpaid dividends.
7. Residual claims of common stockholders.
The priority of claims order and amounts are arbitrary
and no conclusions should be drawn about the relative
merits of how workers, consumers, the government,

creditors, and owners are treated.
4. Absolute Priority Rule (APR)
Establishes priority of claims under liquidation. Once
the corporation is determined to be bankrupt, liquidation takes place. The distribution of the proceeds of the
liquidation occurs according to the following priority:
(1) Administration expenses; (2) Unsecured claims
arising after the filing of an involuntary bankruptcy
petition; (3) Wages, salaries, and commissions; (4)
Contributions to employee benefit plans arising within
180 days before the filing date; (5) Consumer claims;
(6) Tax claims; (7) Secured and unsecured creditors’
claims; (8) Preferred stockholders’ claims; (9) Common stockholders’ claims. APR is similar to absolute
priority of claims.
5. Absolute Purchasing Power Parity
Absolute purchasing power parity states that exchange
rates should adjust to keep purchasing power constant
across currencies. In general, however, absolute purchasing power parity does not hold, in part because of
transportation costs, tariffs, quotas, and other free trade
restrictions. A more useful offshoot of absolute

C.-F. Lee and A.C. Lee (eds.), Encyclopedia of Finance, DOI 10.1007/978-1-4614-5360-4_1,
# Springer Science+Business Media New York 2013

3


4

1

6.

7.

8.

9.

10.

11.

12.

13.

purchasing power parity is relative purchasing power
parity. [See also Relative purchasing power parity.]
Accelerated Cost Recovery System (ACRS)
A system used to depreciate accelerated assets for tax
purposes. The current system, enacted by the 1986 Tax
Reform Act, is very similar to ACRS established in
1981. The current modified cost recovery system
specifies the depreciable lives (recovery periods) and
rates for each of several classes of property. It should
be noted that this higher level of depreciation is offset
by reclassifying individual assets into categories with
longer life. [See Modified cost recovery system]
Accelerated Depreciation
A method of computing depreciation deductions for

income taxes that permits deductions in early years
greater than those under straight line depreciation.
It includes sums of year’s digits, units of production
and double decline methods. [See these three methods
discussed later is sections S, U and D]
Account Activity
Transactions associated with a deposit account, including home debits, transit checks, deposits, and account
maintenance.
Account Analysis
An analytical procedure for determining whether a
customer’s deposit account or entire credit-deposit
relationship with a bank is profitable. The procedure
compares revenues from the account with the cost of
providing services.
Account Executive
A representative of a brokerage firm who processes
orders to buy and sell stocks, options, etc. for a
customer’s account.
Account Maintenance
The overhead cost associated with collecting information and mailing periodic statements to depositors.
Accounting, Relationship to Finance
The accounting function, quantifies, to a certain extent,
the economic relationships within the firm and
provides data on which management bases its
planning, controlling, and operating decisions. Like
accounting, finance deals with value and the monetary
resources of the organization. [See Finance]
Accounting-Based Beta Forecasting
Elgers (1980, Accounting Review, pp. 389–408)
proposed

accounting-based
beta
forecasting.
Accounting-based beta forecasts rely upon the relationship of accounting information such as the growth rate of
the firm, earning before interest and tax (EBIT), leverage, and the dividend pay-out as a basis for forecasting
beta. To use accounting information in beta forecasting,
the historical beta estimates are first cross-sectionally
related to accounting information such as growth rate,
variance of EBIT, leverage, accounting beta, and so on:

Terms and Essays

bi ẳ a0 ỵ a1 X1i ỵ a2 X2i ỵ aj Xji ỵ Á am Xmi
where bi is the beta coefficient for i th firm which is
estimated in terms of market model.Xji is the jth
accounting variables for ith firm, and aj is the regression coefficient.
14. Accounting-Based Performance Measures
To evaluate firm performance we can use accountingbased measure such as sales, earnings per share,
growth rate of a firm. However, accounting performance measures are vulnerable to distortion by
accounting principles, whose application may be
somewhat subjective (such as when to recognize revenue or how quickly to depreciate assets). Rather than
present an unbiased view of firm performance,
accounting statements may be oriented toward the perspective that management wants to present. Additionally, accounting-based performance measures are
always historical, telling us where the firm has been.
15. Accounting Analytic
The use of financial ratios and fundamental analysis to
estimate firm specific credit quality examining items
such as leverage and coverage measures, with an evaluation of the level and stability of earnings and cash
flows. [See Credit scoring model]
16. Accounting Beta

Project betas can be estimated based on accounting
beta. Accounting measures of return, such as EBIT/
Total Assets, can be regressed against a profitability
index that is based on data for the stocks in the S&P
500 or some other market index:
EBIT
TA

!
project;i;t

EBIT
¼ ai þ Abi
TA

!
þ ei;t
market;t

where the slope estimate, Abi is the accounting beta.
Accounting information by product line or division is
available in various Securities and Exchange Commission (SEC) filings that are required of publicly
traded firms. Although a firm’s multidivisional structure may disqualify it from being a pure play comparable, it may include divisional data in its public SEC
filing that would be useful for estimating an accounting beta.
17. Accounting Break-Even
Accounting break-even occurs when accounting
revenues equal accounting expenses so that pretax
income (and hence net income) equals zero. It tells us
how much product must be sold so that the firm’s
overall accounting profits are equal to accounting

expenses. Ignoring working capital effects,
OCF ẳ NI ỵ Depreciation.


1

Terms and Essays

5

At accounting break-even, net income (NI) is zero,
so Operating Cash Flow (OCF) equals the periodic
depreciation expense. Substituting this into the general
break-even (Q*) formula, we obtain accounting breakeven quantity (Q*accounting) as:
Q
accounting ẳ

FC ỵ Dep
;
p vc

Where
FC ẳ xed cost;
vc ¼ variable cost per unit;
p ¼ price per unit;
Dep ¼ depreciation.
The denominator, (p À vc), is called the contribution margin. The accounting break-even quantity is
given by the sum of the fixed cost and depreciation
divided by the contribution margin. Accounting breakeven tells us how much product must be sold so that the
firm’s overall accounting profits are not reduced.

18. Accounting Earnings
Earnings of a firm as reported on its income statement.
Accounting earnings are affected by several conventions
regarding the valuation of assets such as inventories
(e.g., LIFO versus FIFO treatment) and by the way
some expenditures such as capital investments are
recognized over time (such as depreciation expenses).
19. Accounting Income
Income described in terms of accounting earnings,
based upon records of transactions in company books
kept according to generally accepted principles
(GAAP). Accountants generally measure revenues
and expenses based on accruals and deferrals rather
than cash flows and in turn, measure the net income of
the firm by matching its revenues with the costs it
incurred to generate those revenues.
Theoretically, financial analysis should consider
economic income rather than accounting earnings to
determine the value of the firm, since economic
income represents the firm’s true earnings and cash
flows. [See also economic income.] However, since
economic income is not directly observable, analysts
generally use accounting earnings as a proxy.
The relationship between economic income and
accounting earnings can be related by the following
equation:
Accounting Income ẳ Economic Income
permanent componentị ỵ ErrorTransitory componentị

20. Accounting Insolvency

Total book liabilities exceed total book value of assets.
A firm with negative net worth is insolvent on the
books.

21. Accounting Liquidity
The ease and quickness with which assets can be
converted to cash. Current assets are the most liquid
and include cash and those assets that will be turned
into cash within a year from the date of the balance
sheet. Fixed assets are the least liquid kind of assets.
22. Accounts Payable
Money the firm owes to suppliers. These are payments
for goods or services, such as raw materials. These
payments will generally be made after purchases.
Purchases will depend on the sales forecast. Accounts
payable is an unfunded short-term debt.
23. Accounting Rate of Return (ARR)
The accounting rate of return (ARR) method (which is
one of the methods for capital budgeting decision)
computes a rate of return for a project based on a
ratio of average project income to investment outlay
(usually either the total initial investment or the average investment is used). Projects with accounting
returns exceeding a management-determined minimum return are accepted; those with returns below
the cutoff are rejected. To compute the accounting
rate of return, we use the following ratio:
ARR ¼

Average annual net income
Total initial investment

Similar to the payback method, the accounting rate of
return method has none of the four desired selection
method characteristics. [See also payback method.]
First, it doesn’t even use cash flows; it relies on
accounting income. Second, it ignores time value of
money concepts. Third, it states no clearly defined,
objective decision criterion; like the payback method,
its cutoff depends on the discretion of management.
Fourth, ARR tells us absolutely nothing about the
impact of a project on shareholder wealth.
24. Accounts Receivable
Money owed to the firm by customers; the amounts not
yet collected from customers for goods or services sold
to them (after adjustment for potential bad debts).
25. Accounts Receivable Financing
A secured short-term loan that involves either the
assigning of receivables or the factoring of receivables.
Under assignment, the lender has a lien on the receivables and recourse to the borrower. Factoring involves
the sale of accounts receivable. Then the purchaser, call
the factor, must collect on receivables. [See Factoring]
26. Accounts Receivable Turnover
Credit sales divided by average accounts receivable. In
general, a higher accounts receivable turnover ratio
suggests more frequent payment of receivables by
customers. The accounts receivable turnover ratio is
written as:


6

1

Accounts Receivable Turnover ¼

27.

28.

29.

30.

31.

Sales
Accounts Receivable

Thus, if a firm’s accounts receivable turnover ratio is
larger than the industry average; this implies that the
firm’s accounts receivable are more efficiently managed that the average firm in that industry.
Accreting Swap
A swap where the notional amount increases over the
life of the swap. It is used to hedge interest rate risk or
agreements with a rising principal value, such as a
construction loan.
Accrual
The accumulation of income earned or expense
incurred, regardless of when the underlying cash flow
is actually received or paid.
Accrual Bond

A bond that accrues interest but does not pay interest to
the investor until maturity when accrued interest is
paid with the principal outstanding.
Accrual Swap
An interest rate swap where interest on one side
accrues only when the floating reference rate is within
certain range. The range can be maintained, fixed, or
reset periodically during the entire life of swap.
Accrued Interest
Interest income that is earned but not yet received.
Alternatively, it refers to pro-rated portion of a
bond’s coupon payment (c) since the previous coupon
date with (m À d) days have been passed since last
coupon payment, the accrued interest is cðm À dÞ=m
where m and d represent total days and days left to
receive coupon payment respectively. In a semiannual
coupon, if m ¼ 182 days, d ¼ 91 days and c ¼ $60
then the accrued interest is


182 À 91
$30ị
ẳ $15
182

32. Accumulated Benet Obligation (ABO)
FASB Statement 87 species that the measure of corporate pension liabilities to be used on the corporate
balance sheet in external reports is the accumulated
benefit obligation (ABO), which is the present value
of pension benefits owed to employees under the plan’s

benefit formula absent any salary projections and
discounted at a nominal rate of interest.
33. Accumulation Phase
During the accumulation phase, the investor
contributes money periodically to one or more openend mutual funds and accumulates shares. [See also
Variable annuities.]

Terms and Essays

34. Acid-Test Ratio
A measure of liquidity from reported balance sheet
figures with targeted minimum value of one. Calculated as the sum of cash, marketable securities, and
accounts receivable divided by current liabilities. [See
also Quick ratio]
35. Acquisition
Assuming there are two firms, Firm A and Firm B.
Acquisition is a form of business combination in
which Firm B buys Firm A and they both remain in
existence, Firm B as the parent and Firm A as the
subsidiary.
Mergers or acquisitions are also ways for a private
firm to raise equity capital by selling all or part of the
firm to another corporation. [See also merger.]
Another firm may pay an attractive price for the equity
of the private firm, especially if the private firm has a
good strategic fit with the buyer’s products and plans,
or if the purchase offers a foreign corporation easy
entry into the U.S. market. Acquisitions can be
negotiated to allow the firm’s managers to retain their
current positions or to receive lucrative consulting

contracts.
Another advantage to a merger or acquisition is
when the investor is a large corporation with deep
pockets and a willingness to help the firm grow.
Such a situation can provide financing for the firm’s
present and foreseeable future needs. Rather than
spending time canvassing banks and equity investors
for capital, management can concentrate on doing
what it presumably does best: managing the firm to
make it grow and succeed.
The drawback to a merger or acquisition is a loss of
control. Although a seemingly straightforward consequence, this can be a large stumbling block for a
business with a tradition of family ownership or for a
group of founding entrepreneurs who consider the firm
their “baby.” Unless the private equity owners get an
exceptional deal from the new owner, a merger or sale
causes them to give up the return potential of their
business. If the company does grow and succeed after
the sale, someone else – the new investor – will reap
the benefits. If the original owners stay with the new
owner, they may become frustrated by the lack of
attention from their new partners if the firm is only a
small part of the acquirer’s overall business.
36. Active Bond Portfolio Management
An investment policy whereby managers buy and sell
securities prior to final maturity to speculate on future
interest rate movements. In addition, managers can
also identify the relative mispricing within the fixedincome market.