Working Papers Abstracts – 1974

Working Papers Abstracts – 1974

The Demand for Risky Assets
Irwin Friend and Marshall E. Blume

Some New Bond Indexes
John S. Bildersee

Options and Efficiency
Stephen A. Ross

On Corporate Debt Maturity Strategies
James A. Morris

The Behavior of Risk and Return: An Econometric Study
Marshall E. Blume

Short-Run Asset Effects on Household Saying and Consumption
Irwin Friend and Charles Lieberman

The Monetary Sector in an Open Economy: An Empirical Analysis for Canada and Germany
Richard J. Herring

Working Capital, Risk, Growth and Diversification
John S. Bildersee

In some areas of finance there are many popular, sometimes conflicting and controversial theories. However, there are relatively few theories of working capital and its effects on the firm. Moreover, most of these theories do not consider the interactions between working capital, short term assets and the rest of the firm. Instead, studies in the working capital area are often programming models or case studies which, while informative, may be primarily problem oriented. Alternatively, some analyses apply inventory theory, but consider sectors of the firm rather than the entire firm.

In this paper, a theory is developed depicting working capital as a liquid buffer stock protecting the permanent, risky activities of the firm and absorbing the fluctuations of the firm associated with deviations of returns from expectations. As an integral part of the theory a firm’s working capital position is related to the firm’s long term asset position and to the risk-return relationship that the firm has accepted. In addition, it will be shown that the model of working capital developed here is consistent with some of the more popular theories of dividend policy and the use of leverage. Finally, the implications of growth and diversification due to investments on the margin are examined with respect to working capital policies.

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A large number of articles in the popular financial press have highlighted the substantial differences in the returns from equal-weighted and value-weighted indexes over the last several years. Thus, an equal-weighted Value Line Composite Index declined 64.8 percent from March 11, 1968, to September 30, 1974, while the value-weighted New York Stock Exchange (NYSE) Composite Index declined only 33.2 percent over this same period.

In trying to explain these differences, many observers have postulated the existence of the two, or even more, tiers in the market place. According to these observers, different types of stockholders confine their investments to specific tiers. The argument goes on that in recent years institutions have been channeling their huge amounts of new funds into a limited number of so-called favored stocks and thereby supporting their prices. Since these stocks, which constitute the upper tier, are generally stocks with larger market values, the recent differences in returns between equal-weighted indexes are said to be explained.

An alternative explanation, but not the only alternative, is that equal-weighted indexes are inherently more risky than value-weighted indexes and that the observed differences in returns on these two kinds of indexes in recent years are consistent with their differences in risk. The purpose of this paper is to analyze the risk and return characteristics of indexes of NYSE stocks under various weighting schemes starting in 1928. Following this analysis is a discussion of the implications for portfolio management.


Important elements in almost every financial market are the dealers who stand ready to trade for their own accounts and thereby provide to the public the convenience of being able to trade immediately. Today the structure of securities markets is in the process of major change; and as part of this restructuring, a major issue is the way in which dealer services ought to be provided and what the appropriate balance between regulation and competition ought to be.

In this paper the quality of dealer services in the over-the-counter (OTC) market as reflected in the nature and degree of dealer inventory changes is examined using NASDAQ (National Association of Securities Dealers Automated Quotation) system data on closing prices and dealer purchases and sales for each stock for each of six trading days between July 9, 1973 (Monday) and July 16, 1973. Appendix I contains a detailed discussion of the data.