This book provides innovative solutions to fundamental problems in finance, such as the valuation of bond and equity, the pricing of debt, equity and total asset, the determination of optimal capital structure, etc., which are unsolved or poor-solved so far.
The solutions in this book all have the following features:
Based on essential assumptions in line with reality, the final solutions are analytical solutions with closed-form models, the forms and variables of the models are determined by strict and objective logic processes rather than chosen or presumed subjectively, such as the new growth model for stock valuation, the new CAPM accounting for total risk rather than only systematic risk, the real solution to optimal capital structure based on the trade-off between tax shield and bankruptcy cost. In addition, these basic solutions or models are adjusted easily to various application scenarios.
Author(s): Zhiqiang Zhang
Series: Contributions to Finance and Accounting
Publisher: Springer
Year: 2023
Language: English
Pages: 434
City: Singapore
Preface
About This Book
Contents
Part I Asset Valuation
Finance and Its Fundamental Problems
1 Financial Theory and Business Practice
2 Finance in Academic Knowledge Spectrum
3 Fundamental Problems in Finance
3.1 The Objects of Financial Research
3.2 Fundamental Problems in Finance
3.3 Fundamental Problems Remain Unsolved
Discounting and Bond Valuation
1 The Methods of Valuation
1.1 Absolute Valuation
1.2 Relative Valuation
2 Bond Valuation I
2.1 Types of Bonds
2.2 Basic Model for Bond Valuation
2.3 Fundamental Problems Remain Unsolved
3 Bond Valuation II
3.1 The Accrued Interest
3.2 The Frequency of the Interest Payment
3.3 The Comprehensive Model for Bond Valuation
Further Readings
Stock and Equity Valuation: Where Discounting Does Not Work
1 The Gordon Growth Model
1.1 Basics of Stock and Equity Valuation
1.2 The Gordon Growth Model
1.3 Variations of the Model
2 Does a Positive Perpetual Growth Rate Exist?
2.1 The Surprises Resulted from Positive Perpetual Growth
2.2 Arithmetic or Geometric Average Growth Rate
2.3 Does a Positive Perpetual Growth Rate Exist?
3 The Feasibility of Gordon Growth Model
3.1 The Illusive Positive Perpetual Growth
3.2 The Feasibility of Gordon Growth Model
4 Where Is a Qualified Model for Stock Valuation?
4.1 The Potential of Ratio Method
4.2 The Potential of Discounting Method
4.3 The Stage of Finance as a Science
5 A New Absolute Valuation Beyond Discounting
5.1 New Criterion Other Than the Discount Rate
5.2 Solutions Based on ZZ Growth Model
5.3 Comparison of the Gordon Growth Model and ZZ Growth Model
6 The Theoretical Ratio Models
6.1 ZZ P/E Model
6.2 ZZ P/B Model
6.3 ZZ P/S Model
7 Some Applications of ZZ Ratio Models
7.1 Calculating the Fair-Priced Ratios
7.2 Measuring the Market Bubble
7.3 Predicting the Change of Stock Price
8 Summary of the Chapter
Further Readings
Further Discussion: Is Practice Ahead of Theory? —Based on the Case of Finance
1 Introduction
2 Some Basic Facts
3 The Roles of Theory and Practice
4 Difficulty of Theory
5 Usefulness of Theory
6 Evaluation or Assessment
7 Conclusions
Further Discussion: On the Basic Classification of Social Science—Decisional Science and Descriptive Science
1 Foreword
2 Science and Art: Similarities and Differences
3 Natural Science and Social Science: Differences in Objects and Methods
4 Basic Classification of Social Sciences: Descriptive Science and Decisional Science
4.1 The Difference Between Descriptive Science and Decisional Science
4.2 The Relationship Between Descriptive Science and Decisional Science
5 Research Methods of Social Sciences: Amateur and Professional Methods
6 Conclusion
Part II Asset Pricing
Option Pricing and Valuation of Contingent Cash Flow
1 Option and Its Value
1.1 Concepts About Option
1.2 The Intrinsic Value of Option
1.3 The Value of an Option
2 The History of Options
2.1 Options Before 1973
2.2 Options After 1973
2.3 The Role of Options
3 Option Pricing Method
3.1 The Early Research on Option Pricing
3.2 Black–Scholes Model
3.3 Other Methods
4 Real Options and Their Value
4.1 Source of Value
4.2 Types of Real Options
4.3 Map of Valuation Method
Further Readings
Certainty Equivalent, Risk Premium and Asset Pricing
1 The Relation Between Risk and Return
1.1 Basic Concepts
1.2 Return in Finance
1.3 Risk in Finance
2 Alternatives to Determine a Discount Rate
2.1 The Industrial Average Rate of Return
2.2 The Opportunity Cost of Capital
2.3 The Cost or Average Cost of Capital
3 The Capital Asset Pricing Model
3.1 Portfolio Theory
3.2 Sharpe’s Capital Asset Pricing Model
3.3 Defects of Sharpe CAPM
4 Certainty Equivalent and Risk Equivalent
4.1 On Certainty Equivalent
4.2 Risk Equivalent Model
4.3 Certainty Equivalent Model
4.4 A Numeric Example
5 Risk Premium and a New CAPM
5.1 Modeling Risk Premium and a New CAPM
5.2 Comparison Between Sharpe CAPM and ZZ CAPM
5.3 A Numeric Example
6 Summary
References
Debt/Loan Risk, Bankruptcy Cost and Debt/Loan Pricing
1 Debt/Loan Risk
1.1 The Description of Debt/Loan Risk
1.2 The Composition of Interest Rate
1.3 Debt Cost and Bankruptcy Cost
2 Valuation of Debt Guarantee
2.1 Valuing Debt Guarantee: Simple Cases
2.2 Valuing Debt Guarantee: Complex Cases
3 Bankruptcy Cost: Concept and Measurement
3.1 Discussion: Decisional Concept Versus Statistical Concept
3.2 Valuing Bankruptcy Cost: An Option Pricing Method
4 Debt/Loan Pricing
4.1 The Solution to Debt/Loan Pricing
4.2 Mutual Corroboration with Merton Model
4.3 Initial Numerical Test
5 Application Issues of the Model
5.1 Incremental Debt Consideration
5.2 Transaction Cost Consideration
5.3 The Safe-Guard Line
6 Determine Incremental Leverage
6.1 Logic of Incremental Leverage
6.2 Numerical Illustration of Incremental Leverage
7 Summary
References
Capital Asset Pricing: An Easy and Unified Solution
1 Systematic Risk and Total Risk
1.1 Equity Pricing with Sharpe CAPM
1.2 Systematic, Nonsystematic and Total Risk
1.3 Debt, Equity and Company Volatility
2 Equity Pricing and Total Asset Pricing
2.1 Based on the ZZ CAPM
2.2 Based on the ZZ Debt Pricing Model
2.3 The Unified Solution to Asset Pricing
3 The Solutions to Some Related Problems
3.1 The Comprehensive Application of ZZ Growth Model and ZZ CAPM
3.2 The Relationships Among the Three Discount Rates
3.3 The Long Run Tendency of the Discount Rates
Further Readings
Part III Leverage and Risks
Tax Shield, Bankruptcy Cost and Optimal Capital Structure
1 Firm’s Goal and Its Capital Structure
2 The Potential Benefits and Costs of Debt Financing
2.1 General Analyses
2.2 MM Model I
3 Efforts to Value Tax Shield and Bankruptcy Cost
3.1 MM Model II
3.2 The Trade-Off Model
3.3 The Pecking Order Theory
3.4 Other Efforts
3.5 Some Comments
4 Decision-Oriented Valuation of Tax Shield and Bankruptcy Cost
4.1 The Time Horizon
4.2 Value the Tax Shield
4.3 Value the Bankruptcy Cost
5 Decision-Oriented Optimal Capital Structure Model
5.1 Derivation of the Model
5.2 Basic Features of the Model
5.3 Basic Insights from the Model
6 Explanations to Some Capital Structure Puzzles
6.1 Why Financial Conservatism
6.2 Why No Leverage Target
6.3 Why Averse-Change with Profitability
6.4 Why Over Stable Leverage
6.5 Why Pecking Order
6.6 Why Market Timing
6.7 Dynamic Consideration?
6.8 Why Not 0% Debt in Absence of Corporate Tax
7 Summary
References
Some Extensive Discussions of ZZ Leverage Model
1 Problem Solving and Research Assumptions
1.1 Theory and Problem Solving
1.2 Universal Premise Assumptions
1.3 Assumptions of the ZZ Leverage Model
2 Some Application Extensions
2.1 Abnormal Growth
2.2 Bankruptcy Expectancy
2.3 Market Value Versus Book Value
2.4 Guaranteed Debt
2.5 Transaction Costs
2.6 Personal Income Tax
2.7 Inter-Firm’s Investments
3 A Case Study Based on ZZ Leverage Model Series
3.1 Haier and Its Leverage
3.2 The Optimal Leverage Based on ZZ Leverage Model
3.3 The Adjustments Based on the Application Extensions
3.4 The Trade-Off Value Analysis
4 Summary
Further Readings
Bankruptcy Probability and Firm Life Expectancy
1 Bankruptcy Risk
1.1 The Concept of Bankruptcy Risk
1.2 The Current Bankruptcy and Overall Bankruptcy
1.3 The Annual and Cumulative Bankruptcy Probability
2 Modelling of Bankruptcy Probability
2.1 The Related Research in Main Stream
2.2 Modelling of Bankruptcy Probability
2.3 The Probability of Current and Overall Bankruptcy
3 Bankruptcy Risk Analysis—Case Illustration
3.1 The Volatilities of the Case Companies
3.2 The Overall Bankruptcy Risk
3.3 The Current Bankruptcy Risk
4 Firm Life Expectancy Prediction
4.1 General Understandings and Perspectives
4.2 The Bankruptcy Probability and Firm Life Expectancy
4.3 The Firm Life Expectancies Based on Moody’s Rating Data
4.4 The Firm Life Expectancies Based on Empirical Volatilities
References
Further Discussion: A Novel—The Falling Apples
1 The Carefree Childhood
2 Initial Involvement in Scientific Research
3 Some Advice from John
4 The Data Business of Little Sam
5 Further Advice from John
6 The Reviewing Comments from Professional Journals
7 The Reviewing Comments from Scientific Research Funds
8 The Alchemy
9 The Models of Scientific Research
10 The First Ray of Dawn
Further Discussion: Why Financial Theory Stagnates Over Decades?
1 Financial Theory: 1950–1980
1.1 Portfolio Theory
1.2 MM Model
1.3 Capital Asset Pricing Model
1.4 Black–Scholes Model
2 Reasons for Stagnation of Financial Theory
2.1 Some Specious Reasons
2.2 Financial Research Content in Recent Decades
2.3 Financial Research Methods in Recent Decades
3 Relevant Policy Suggestions
3.1 Research Performance Assessment
3.2 Anonymous Review of Manuscripts
3.3 Looking Forward to “Dawn Light”
