Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 EXCHANGE RISK: A CAPITAL ASSET PRICING MODEL FRAMEWORK Conway L. Lackman Duquesne University INTRODUCTION It should not be surprising that in times of international monetary instability, there is renewed interest in the definition and analysis of exchange risk. One analytical framework that seems particularly suited to the analysis of the problem of exchange risk is the well-known Capital Asset Pricing Model (CAPM). CAPM is a two parameter, single period model focusing on the expected return of an asset and the asset’s riskiness. Risk is measured by the variance of the asset’s rate of return over time measured by ex-post data. Generalizing this framework to handle assets denominated in different currencies (with an added element of risk due to the presence of foreign exchange and so the possibility of devaluation) appeared to be a straightforward extension of the CAPM in its domestic context. This view was advanced by Grubel who pointed out that the models of portfolio balance developed by Markowitz and Tobin explain the real world phenomenon of diversified asset holdings elegantly and properly. However, their analysis has not yet been applied explicitly to the explanation of long-term asset holdings that include claims denominated in foreign currency. The purpose of this paper is to present the development of the treatment of exchange risk in the CAPM framework in such a way as to be a useful introduction to the theory, as well as to provide some insight into the questions the theory must address and the problems it poses.

Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 DEVELOPMENT OF PREDICTION MODELS FOR HORIZONTAL AND VERTICAL MERGERS Anna Lee Meador Marshall University Pamela H. Church Rhodes College L. Gayle Rayburn Memphis State University Abstract During the five-year period of 1981-1985 the largest number of business mergers in American history were consummated. This study examines the accounting, financial, and market variables which predict merger and acquisition target companies for this active time of business combinations. A sample of firms which experienced combinations during this period was matched with nonmerged companies similar in industry and asset size. Logit binary regression analysis was used to determine the factors which predict merger and acquisition target companies for the total sample and then for the horizontal and vertical subsamples of merged companies. The model for horizontal acquisitions showed the strongest predictive ability, with the variables long-term debt/total assets, long-term debt/market value, market value/book value, asset growth, and sales growth showing significance. The results support the contention that the wave of horizontal mergers during the 1980s was possibly the result of undervaluation of assets due to previous high inflation and the conservatism dictated by accounting principles, coupled with the laissez-faire attitude of the government during the period.

Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 THE EFFECT OF PUBLISHED REPORTS OF ENVIRONMENTAL POLLUTION ON STOCK PRICES Spuma M. Rao University of Southwestern Louisiana Abstract This study adds to the empirical evidence supporting a significant connection between ethics and profitability by examining the connection between published reports of unethical behavior—in terms of environmental pollution—by publicly traded U.S. and multinational firms and the performance of their stock. Using reports of environmental pollution—air, or water pollution or environmental cleanup—published in the Wall Street Journal from 1989 to 1993, the analysis shows that the actual stock performance for those companies was lower than the expected market adjusted returns. Unethical conduct by firms which is discovered and publicized does impact on the shareholders by lowering the value of their stock for an appreciable period of time. Whatever their views on whether ethical behavior is profitable, managers should be able to see a definite connection between unethical behavior and the worth of their firm’s stock. Stockholders, the press and regulators should find this information important in pressing for greater corporate and managerial accountability.

Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 EQUITY MUTUAL FUND HISTORICAL PERFORMANCE RATINGS AS PREDICTORS OF FUTURE PERFORMANCE Thomas S. Howe Illinois State University Ralph A. Pope California State University The authors would like to thank Dan DiBartolomeo of Northfield Information Services, Boston, MA, for graciously providing the return data used in this study. Abstract This study investigates the usefulness of Forbes equity fund performance ratings in predicting future mutual fund returns. Specifically, this study examines the relationships between (1) a fund’s Forbes equity fund rating and its performance during subsequent periods and (2) the predictive ability of Forbes equity fund ratings and the investment horizon. Results suggest that Forbes up-market ratings would have helped predict betas but would have been of little use in predicting future fund performance. Forbes down-market ratings may have helped predict fund returns over the following year and fund risk-adjusted returns over periods greater than one year.

Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 IS ACQUISITION OF MARKET POWER A DETERMINANT OF HORIZONTAL MERGERS? Maneesh Sharma Northeast Louisiana University Paul D. Thistle Western Michigan University Abstract Most studies on mergers and acquisitions are not sample selective. This study directly examines the motives of horizontal mergers by utilizing a sample of acquiring firms based on same SIC codes. A three factor Arbitrage pricing model was utilized, with Tobin’s q ratio as a measure of market power, to study the performance of the firms involved in the mergers. The results indicate the acquisition of market power not to be a significant motive for the mergers.

Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 UNSYSTEMATIC FUTURES PROFITS WITH TECHNICAL TRADING RULES: A CASE FOR FLEXIBILITY Nauzer Balsara Northeastern Illinois University Kathleen Carlson Northeastern Illinois University Narendar V. Rao Northeastern Illinois University Abstract This paper studies the behavior of a fixed-parameter technical trading rule as applied to four commodity futures contracts. The evidence suggests that fixed-parameter rules are inflexible, leading to wide swings in performance both across commodities and time periods. Consequently, the paper recommends the use of flexible-parameter trading rules which adapt to changes in market conditions, instead of expecting the market to operate within the specifications of an unalterable set of rules.

Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 HEDGING FOREIGN CURRENCY TRANSACTION EXPOSURE: THE IMPORTANCE OF REAL RATES OF INTEREST Glen A. Larsen, Jr. The University Of Tulsa Gary R. Freeman The University Of Tulsa Abstract Increasingly, U.S. firms are involved in global transactions which expose them to foreign currency fluctuations and potential adverse financial effects. Hedging forward exchange rates has become commonplace, but at a cost. Thus, information is needed by managers regarding forward exchange rates. Forward exchange rates are believed to contain two expectational components which vary through time: the expected premium, and the expected future spot exchange rate. Pooled time series analysis is employed in this study to empirically test a relationship which equates the expected premium to the difference in expected real interest rates for six major European Currency Unit (ECU) countries. The empirical tests confirm that differences in the level of expected real interest rates between the U.S. and the six major ECU countries over the study period are statistically equal to the expected forward premiums. The implication of this finding is that firms should use all available information on differences between real rates of interest when making forward hedge decisions.

Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 THE IMPACT OF INFLATION ON CAPITAL BUDGETING AND WORKING CAPITAL Geofrey T. Mills University of Northern Iowa INTRODUCTION A major impact on both financial theory and the practice of financial decision making has been the economic instability, especially in prices, evidenced in the U.S. economy since the mid 1960’s. Inflation in the past few years has not been a major macro economic problem, but its spectere, as demonstrated by the Fed’s recent increases in interest rates, is never for the agendas of financial decision makers. Macro economic instability has necessitated that expectations about the future rate of inflation be taken into consideration in making decision(s) about which capital projects will be undertaken by a firm. Nominal cash flows determine its degree of profitability. However, in making the capital budgeting decision both real and nominal concepts must be considered. The purpose of this paper is to continue the discussion of the role of inflation in capital budgeting, and to focus on the individual components of the process to draw specific conclusions with respect to the interaction between the cost of capital, inflation, and the cash flow variables within a DCF - IRR framework.

Journal of Financial and Strategic Decisions Volume 9, Number 1   Spring 1996 CREDIT UNION SAFETY AND PARENT ORGANIZATION EMPLOYMENT STABILITY Roy P. Patin, Jr. Midwestern State University Douglas W. McNiel McNeese State University INTRODUCTION Credit unions are unique among financial institutions because they provide saving and lending services almost exclusively to their owners. The owner/members must be linked together by a "common bond" which may lead to a concentration of risks that could affect the safety of the credit unions.1 The objective of this paper is to determine whether instability risks associated with a "common bond" affect the safety and performance of credit unions. Aspects of credit union safety examined include reserves, loan portfolio composition, and loan delinquency rates. Also examined are the effects of parent organization instability risks on credit union member benefits and the relative treatment of borrowers and savers.

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