Associate Professor Of Finance Research Articles

HOLDING‐PERIOD YIELDS ON HIGHEST‐GRADE CORPORATE BONDS

Financial ReviewVolume 1, Issue 4 p. 227-240 HOLDING-PERIOD YIELDS ON HIGHEST-GRADE CORPORATE BONDS DONALD L. TUTTLE, DONALD L. TUTTLE Dr. Tuttle is Associate Professor of Business Administration at the University of North Carolina at Chapel Hill and Dr. Wilbur is Associate Professor of Economics at East Tennessee State University (after June 1969, Associate Professor of Finance at Northern Illinois University). The authors wish to acknowledge the valuable suggestions and assistance offered by Dr. Henry A. Latané in connection with preparation of this paper. They wish also to express their appreciation for programming assistance provided by W. E. Young and R. H. Trent and the technical support of G. W. Adkins and others of the University of North Carolina Computation Center Staff.Search for more papers by this authorWILLIAM L. WILBUR, WILLIAM L. WILBUR Dr. Tuttle is Associate Professor of Business Administration at the University of North Carolina at Chapel Hill and Dr. Wilbur is Associate Professor of Economics at East Tennessee State University (after June 1969, Associate Professor of Finance at Northern Illinois University). The authors wish to acknowledge the valuable suggestions and assistance offered by Dr. Henry A. Latané in connection with preparation of this paper. They wish also to express their appreciation for programming assistance provided by W. E. Young and R. H. Trent and the technical support of G. W. Adkins and others of the University of North Carolina Computation Center Staff.Search for more papers by this author DONALD L. TUTTLE, DONALD L. TUTTLE Dr. Tuttle is Associate Professor of Business Administration at the University of North Carolina at Chapel Hill and Dr. Wilbur is Associate Professor of Economics at East Tennessee State University (after June 1969, Associate Professor of Finance at Northern Illinois University). The authors wish to acknowledge the valuable suggestions and assistance offered by Dr. Henry A. Latané in connection with preparation of this paper. They wish also to express their appreciation for programming assistance provided by W. E. Young and R. H. Trent and the technical support of G. W. Adkins and others of the University of North Carolina Computation Center Staff.Search for more papers by this authorWILLIAM L. WILBUR, WILLIAM L. WILBUR Dr. Tuttle is Associate Professor of Business Administration at the University of North Carolina at Chapel Hill and Dr. Wilbur is Associate Professor of Economics at East Tennessee State University (after June 1969, Associate Professor of Finance at Northern Illinois University). The authors wish to acknowledge the valuable suggestions and assistance offered by Dr. Henry A. Latané in connection with preparation of this paper. They wish also to express their appreciation for programming assistance provided by W. E. Young and R. H. Trent and the technical support of G. W. Adkins and others of the University of North Carolina Computation Center Staff.Search for more papers by this author First published: March 1969 https://doi.org/10.1111/j.1540-6288.1969.tb01725.xRead the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinkedInRedditWechat Volume1, Issue4March 1969Pages 227-240 RelatedInformation

HOLDING‐PERIOD YIELDS ON HIGHEST‐GRADE CORPORATE BONDS

Financial ReviewVolume 4, Issue 1 p. 227-240 HOLDING-PERIOD YIELDS ON HIGHEST-GRADE CORPORATE BONDS DONALD L. TUTTLE, DONALD L. TUTTLE Dr. Tuttle is Associate Professor of Business Administration at the University of North Carolina at Chapel Hill and Dr. Wilbur is Associate Professor of Economics at East Tennessee State University (after June 1969, Associate Professor of Finance at Northern Illinois University). The authors wish to acknowledge the valuable suggestions and assistance offered by Dr. Henry A. Latané in connection with preparation of this paper. They wish also to express their appreciation for programming assistance provided by W. E. Young and R. H. Trent and the technical support of G. W. Adkins and others of the University of North Carolina Computation Center Staff.Search for more papers by this authorWILLIAM L. WILBUR, WILLIAM L. WILBUR Dr. Tuttle is Associate Professor of Business Administration at the University of North Carolina at Chapel Hill and Dr. Wilbur is Associate Professor of Economics at East Tennessee State University (after June 1969, Associate Professor of Finance at Northern Illinois University). The authors wish to acknowledge the valuable suggestions and assistance offered by Dr. Henry A. Latané in connection with preparation of this paper. They wish also to express their appreciation for programming assistance provided by W. E. Young and R. H. Trent and the technical support of G. W. Adkins and others of the University of North Carolina Computation Center Staff.Search for more papers by this author DONALD L. TUTTLE, DONALD L. TUTTLE Dr. Tuttle is Associate Professor of Business Administration at the University of North Carolina at Chapel Hill and Dr. Wilbur is Associate Professor of Economics at East Tennessee State University (after June 1969, Associate Professor of Finance at Northern Illinois University). The authors wish to acknowledge the valuable suggestions and assistance offered by Dr. Henry A. Latané in connection with preparation of this paper. They wish also to express their appreciation for programming assistance provided by W. E. Young and R. H. Trent and the technical support of G. W. Adkins and others of the University of North Carolina Computation Center Staff.Search for more papers by this authorWILLIAM L. WILBUR, WILLIAM L. WILBUR Dr. Tuttle is Associate Professor of Business Administration at the University of North Carolina at Chapel Hill and Dr. Wilbur is Associate Professor of Economics at East Tennessee State University (after June 1969, Associate Professor of Finance at Northern Illinois University). The authors wish to acknowledge the valuable suggestions and assistance offered by Dr. Henry A. Latané in connection with preparation of this paper. They wish also to express their appreciation for programming assistance provided by W. E. Young and R. H. Trent and the technical support of G. W. Adkins and others of the University of North Carolina Computation Center Staff.Search for more papers by this author First published: February 1969 https://doi.org/10.1111/j.1540-6288.1969.tb01724.x-i1Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinkedInRedditWechat Volume4, Issue1February 1969Pages 227-240 RelatedInformation

Optimum Liquidity Levels for Multiple Line Insurance Companies

This paper illustrates how rules for deciding upon optimum inventory levels may be applied to cash balances. If the cost of holding excessive balances and also the cost of negative balances and having to borrow or liquidate some assets can be determined then these costs may be combined with the distribution of net incomes to determine the balance which will minimize the expected costs involved. Property-liability insurance companies Richard M. Duvall, Ph.D., is Associate Professor of Statistics in the University of Tennessee. His earlier teaching experience included service in the College of Business at the University of Texas and University of Michigan. In addition to other articles in this Journal, Dr. Duvall has had articles in the Journal of Finance, Accounting Review, Journal of American Statistical Association, Management Science, Journal of Financial and Quantitative Analysis, and in the 1965 Proceedings of the Business and Economics section of the American Statistical Association. Alfred E. Hofflander, Jr., Ph.D., C.L.U., C.P.C.U. is Assistant Professor of Insurance in the University of California at Los Angeles. His earlier teaching experience included service at Florida State University and the University of Texas. He was a Fellow in the Huebner Foundation. Dr. Hofflander is Assistant Editor of this Journal and is Associate Editor of The Annals of the Society of C.P.C.U. Eugene W. Lambert, Jr., Ph.D., C.F.A., is Associate Professor of Finance in the University of Tennessee. Before going to his present position, Dr. Lambert taught at the University of Alabama and the University of Texas, was a member of the Board of Directors of the Lubbock Savings and Loan Association, and was Assistant Cashier and Assistant Manager of the investment department of the Bank of the Southwest, N.A., in Houston. Dr. Lambert received one of the NAII Journal Awards in 1966. The statistical rules presented in this paper have been used by manufacturing firms for many years to determine optimal inventory levels. The purpose of this paper is to show the appropriateness of this technique to determining the correct level of cash balances in a property-liability insurance company. The authors wish to thank the referees for their valuable suggestions for improving the paper. are constantly faced with the need to determine the size of the cash balance' they should hold to meet expected current obligations. If they maintain large balances relative to their obligations, they incur an opportunity cost since the funds could be employed elsewhere in some profit producing manner. The opportunity cost of holding cash balances is considered to be the return which could be earned on high quality, short-term marketable assets such as U.S. Treasury Bills or Certificates of Deposit of commercial banks.2 If, on the other hand, the balances This paper was submitted in December, 1966. 1 Cash balances, for the purposes of this article, are defined as liquid non-earning assets, i.e., demand deposits. 2 Cash balances could be defined to include short-term earning assets in which case the opportunity cost would become the return earned on the firm's investment portfolio or, if there is no investment portfolio (as in a manufacturing firm), the return earned on the firm's invested capital. Because of the high current level of interest rates, the cost of holding cash versus shortterm securities is high. At the same time, since the interest yield curve is relatively flat, there is little or no sacrifice involved in buying short-term rather than long-term issues. Thus, the opportunity cost is much greater when considered as cash versus the return on short-term securities than when defined as the difference between the return on short-term versus long-term securities. This relationship will change over time as interest rates fluctuate. The choice of definitions of cash balances and opportunity cost does not affect the validity of the model to be presented. ( 199 ) This content downloaded from 207.46.13.53 on Thu, 01 Sep 2016 05:12:03 UTC All use subject to http://about.jstor.org/terms 200 The Journal of Risk and Insurance are small relative to their obligations, they will incur a cost of borrowing. This cost of borrowing to meet their obligations may also include a cost associated with the embarrassment of having to borrow. In the case of certain financial institutions, this psychic cost may render borrowing unacceptable. The alternative to borrowing is to sell a portion of the firm's portfolio. The costs associated with this type of transaction can be treated in a manner identical to the cost of borrowing, but they are more difficult to estimate in practice since they include market expectations.

ABANDONMENT VALUE AND CAPITAL BUDGETING*

The Journal of FinanceVolume 22, Issue 4 p. 577-589 Article ABANDONMENT VALUE AND CAPITAL BUDGETING* Alexander A. Robichek, Alexander A. Robichek The authors are, respectively, Professor of Business Administration and Associate Professor of Finance, Graduate School of Business, Stanford University. The assistance and helpful suggestions of W. David Neibuhr and Stewart C. Myers are gratefully acknowledged.Search for more papers by this authorJames C. Van Horne, James C. Van Horne The authors are, respectively, Professor of Business Administration and Associate Professor of Finance, Graduate School of Business, Stanford University. The assistance and helpful suggestions of W. David Neibuhr and Stewart C. Myers are gratefully acknowledged.Search for more papers by this author Alexander A. Robichek, Alexander A. Robichek The authors are, respectively, Professor of Business Administration and Associate Professor of Finance, Graduate School of Business, Stanford University. The assistance and helpful suggestions of W. David Neibuhr and Stewart C. Myers are gratefully acknowledged.Search for more papers by this authorJames C. Van Horne, James C. Van Horne The authors are, respectively, Professor of Business Administration and Associate Professor of Finance, Graduate School of Business, Stanford University. The assistance and helpful suggestions of W. David Neibuhr and Stewart C. Myers are gratefully acknowledged.Search for more papers by this author First published: December 1967 https://doi.org/10.1111/j.1540-6261.1967.tb00293.xCitations: 23 † This study was supported, in part, by funds made available by the Ford Foundation to the Graduate School of Business, Stanford University. The conclusions, opinions and other statements in this paper are those of the authors and are not necessarily those of the Ford Foundation. Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinked InRedditWechat Citing Literature Volume22, Issue4December 1967Pages 577-589 RelatedInformation

TAXES, CORPORATE FINANCIAL POLICY AND RETURN TO INVESTORS

IN [1] A SERIES and [2], of Franco papers Modigliani beginning with and [1] an [2], Franco Modi liani an Merton Miller unsettled both practitioners and students of corporate financial policy by demonstrating that, in the absence of distortions to market processes due to the existence of taxes, the cost of capital to a firm could not be affected by purely financial operations. In a series of subsequent papers [3], [4] and [5], Modigliani and Miller (hereafter abbreviated simply as M-M) expanded their earlier thesis to measure the impact on optimal corporate financial policies and capital costs of certain specific aspects of the U.S. tax structure. Throughout M-M's treatment, however, there runs an assumption that the basic arguments established in [1] and [2] are self-evident, and that taxes represent nothing beyond an unwelcome imperfection in otherwise efficiently functioning market processes. Experience teaching this material to a broad range of students convinces the present authors that the concepts embodied in M-M's analysis are quite subtle and difficult to communicate at an abstract level. They also are difficult to embody in a (more complex and realistic) corporate and individual income tax structure. Surprisingly, such pedagogic * The authors who are, respectively, Associate Professor of Finance in the Sloan School of Management, Massachusetts Institute of Technology, and Assistant Professor of Business Administration in the College of Business Administration, Boston University, wish to acknowledge support from the Ford Foundation's grant to the Sloan School for research in business ?nance. success as the authors have enjoyed usually arises from discussions of the impact on M-M's argument of the very tax induced distortions that appear most unwelcome to their basic propositions. Accordingly, an attempt will be made here to acomplish two fairly limited objectives: first, the effect on investment value of different tax structures will be used pedagogically to illustrate the basic theses propounded by Modigliani and Miller; and second, an attempt will be made to broaden this structure to one that more closely approximates the combination of corporate, personal income and capital gains taxes encountered in the U.S. today. The paper proceeds by developing a series of increasingly complex tax structures and examining their impact on a hypothetical corporation's optimal debt and dividend policies. Case 1 discusses the no-tax world laid out in [ 1 ] by Modigliani and Miller. Case 2 examines the impact on their propositions of corporate income taxes alone; essentially the argument presented by M-M in [3]. Case 3 considers the impact on rational debt and dividend decisions of differential personal income and capital gains taxes; considered partially by M-M in [2]. And Case 4 integrates the preceding material by considering corporate, personal income and capital gains taxes simultaneously. A summary completes the exposition. As always, rational behavior by both corporate and private investors, operat-

Multicollinearity in Regression Analysis: The Problem Revisited

T O MOST economists, the single equation least-squares regression model, like an old friend, is tried and true. Its properties and limitations have been extensively studied and documented and are, for the most part, wellknown. Any good text in econometrics can lay out the assumptions on which common versions of the model are based and provide a reasonably coherent perhaps even a lucid discussion of problems that arise as particular assumptions are violated. A short bibliography of definitive papers on such classical problems as non-normality, heteroscedasticity, serial correlation, feedback, etc., completes the job. As with most old friends, however, the longer one knows least squares, the more one learns about it. An admiration for its robustness under departures from many assumptions is sure to grow. The admiration must be tempered, however, by an appreciation of the model's sensitivity to certain other conditions. The requirement that explanatory variables be truly independent of one another is one of these. Proper of the model's classical problems ordinarily involves two separate stages: detection and correction. The DurbinWatson test for serial correlation, combined with Cochrane and Orcutt's suggested first differencing procedure, is an obvious example.' Bartlett's test for variance heterogeneity followed by a data transformation to restore homoscedasticity is another.2 No such treatment has been developed, however, for problems that arise as multicollinearity is encountered in regression analysis. Attention will focus here on what we consider to be the first step in a proper of the multicollinearity problem its detection, or diagnosis. Economists are coming more and more to agree that the second step, correction, requires the generation of additional information.3 Just how this information is to be obtained depends largely on the tastes of an investigator and on the specifics of a particular problem. It may involve additional primary data collection, the use of extraneous parameter estimates from secondary data sources, or the application of subjective information through constrained regression, or through Bayesian estimation procedures. Whatever its source, however, selectivity and thereby efficiency in generating the added information requires a systematic procedure for detecting its need i.e., for detecting the existence, measuring the extent, and pinpointing the location and causes of multicollinearity within a set of independent variables. Measures are proposed here that, in our opinion, fill this need. The paper's basic organization can be outlined briefly as follows. In the next section the multicollinearity problem's basic, formal nature is developed and illustrated. A discussion of historical approaches to the problem follows. With this as background, an attempt is made to define multicollinearity in terms of departures from a hypothesized statistical condition, and * The authors are Associate Professor of Finance at the Sloan School of Management, M.I.T., and Assistant Professor of Business Administration at the Harvard Business School, respectively. We are indebted to Professor John R. Meyer for introducing us to the multicollinearity problem and for advice and encouragement during the present effort to place it in perspective, and to Professors John Lintner and Robert Schlaifer for their comments and criticisms. Responsibility for specific interpretations, especially erroneous ones, remains our own. This research was supported by the Institute of Naval Studies, of which both authors were members at the time the work was conducted, and by grants from the Ford Foundation to both the Sloan School of Management and the Harvard Business School. Computation time and facilities were provided by the Computation Centers of Harvard and M.I.T. 1J Durbin and G. S. Watson, Testing for Serial Correlation in Least Squares Regression, Biometrika, 37-38, (1950-1951); and C. Cochrane and G. H. Orcutt, Application of Least Squares Regression to Relationships Containing Autocorrelated Error Terms Journal of the American Statistical Association, 44 (1949). 2F. David and J. Neyman, Extension of the Markoff Theorem on Least Squares, Statistical Research Memoirs, II (London, 1938). 'J. Johnston, Econometric Methods (McGraw-Hill, 1963), 207; J. Meyer and R. Glauber, Investment Decisions, Economic Forecasting, and Public Policy (Division of Research, Graduate School of Business Administration, Harvard University, 1964), 181 ff.

IMPUTED YIELDS OF A SINKING FUND BOND AND THE TERM STRUCTURE OF INTEREST RATES

annually with the trustee of the bond certain sums of money so long as a part of the issue is still outstanding. Such sums of money are known-as sinking funds and represent generally a fixed or variable percentage of the face amount of the issue outstanding originally. This paper first studies the true or imputed yield(s) to an investor on such a corporate bond. It then studies the relationship between the true yield(s) and the yield(s) as defined customarily under a variety of bond prices and sinking fund provisions. It further explores the practical applicability of the analytical models for- investors and suggests how the models can be modified to meet other requirements. It finally concludes by discussing the limitations of this paper and by explaining how the models can be used by an issuer. Sinking fund bonds can be classified into two types according to how the fund should be used: Type One: Upon receipt of the fund, the trustee must use it to retire immediately a part of the bonds of the issue then outstanding by either purchasing at market or exercising the right to call.' Type Two: In addition to the choice of retiring the bonds then outstanding, the trustee can use the sinking fund to invest in some securities. The trustee may also be allowed to accept, in lieu of sinking funds, some mortgageable properties as additional collateral to the issue to fulfill the sinking fund requirement. In practice, most industrial2 and many utility bonds are type one sinking fund bonds (hereafter type one bond) while most utility mortgage bonds are of the type two variety. The principal characteristic of an issue of type one bonds can also be considered as similar to that of a serial issue because in both cases, some bonds mature each year instead of all on a single date.' Neverthe* Associate Professor of Finance and Management Science, and Manufacturers & Traders Trust Co. Professor of Finance, respectively, State University of New- York at Buffalo. Completion of this paper was facilitated by the first author's participation in the Workshop in Research in Business Finance held at Harvard University in the Summer, 1965, and sponsored by the Ford Foundation. We also wish to express our appreciation to the Computer Center of the State University of New York at Buffalo for the computing time, Thomas E. Dewey of Kuhn Loeb & Co. for -supplying various information, Alan Savery, John Reid and Judith Matasar for statistical assistance.

Cloos on Reference Dates and Leading Indicators: A Comment

THE rejoinder by George W. Cloos to my paper On Dating of Business Cycles' repeats some of his allegations made earlier in January issue of this Journal; introduces fresh batch of quotations bearing on current interpretation of leading indicators by business press, though not on original issue of accuracy of NBER reference dates; protests number of my statements, hardly ever bothering to document their incorrectness; and ends up on note of skepticism regarding date of December, 1854, peak in Bureau's chronology.2 Since Cloos's new paper does not produce any new evidence pertinent to main point in debate, that issue can be left for reader to judge on its merits. However, paper contains some mistaken interpretations of Bureau's procedures and of my own views and some misstatements of fact. The following comments are addressed solely to these selected points. 1. My paper On Dating of Business Cycles3 is not publication of National Bureau and is in no sense an official NBER statement (p. 352). 2. I am not at all sure that my article reinforces Cloos's views on 1949 and 1954 revivals (p. 352). What much too late means is not well defined, but I do not believe to have implied that Bureau's dates for these turns are to be so described. Further may, of course, demonstrate need to shift back by few months one or both of these dates. If so, this will be due mainly to revision of old and appearance of new data, factor which Cloos continues to gloss over. 3. I did not suggest that inspection of clusters is a basic principle or 'concept' (p. 353) but that there exists a basic view of business that underlies Bureau's measurements.4 One may wish to regard NBER method as but, so, it is proxy for an ideal (a single precise measure of aggregate economic activity) which is not obtainable. 4. The limitations of for purpose of reference dating were, I think, sufficiently discussed in my paper in April issue of this Journal. They have nothing to do with fact, of which I hope everyone is aware, that includes change in inventories. Although Cloos admits that GNP and its components must be supplemented by other data in analysis (p. 354), he still believes that movements of should be accepted as the cycle (p. 353). In doing so, he largely ignores my argument and evidence, except when asking if quarterly peaks and troughs remain uncertain, what reliance can be placed upon monthly dates? (p. 353). But it is surely possible that sufficiently large and representative sample of monthly series may give more dependable information on turning point than quarterly GNP, and Cloos never proved contrary. * Associate professor of finance, Graduate School of Business, University of Chicago, and member of research staff, National Bureau of Economic Research.

Valuation of Closely-Held Stock for Federal Tax Purposes: Approach to an Objective Method

* Research Assistant in Statistics, The School of Business, The University of Chicago. ** Associate Professor of Finance, The School of Business, The University of Chicago. ***Member of the Ohio Bar. 1. This excludes unlisted stock which is traded over-the-counter. 2. U.S. Treas. Reg. 105, ?81.10(c) (1944); U.S. Treas. Reg. 108, ?86.19(c) (1943). There is no assurance the market would have absorbed additional shares on a given date at then prevailing prices; the market might have been broken under the weight of further offerings. The judge-made blockage rule is a response to this difficulty. This rule, applicable only in respect of large blocks of stock, Mott v. Commissioner, 139 F.2d 317 (6th Cir. 1943), permits the stock to be valued at the lowerthan-market figure which could have been realized, according to the testimony of experts, by means of a special offering or secondary distribution, that is, off-theexchange merchandising by specialists over a period of time. Havemeyer v. United States, 59 F. Supp. 537 (Ct. Cl. 1949), cert. denied, 326 U.S. 759 (1945); Groff v. Munford, 150 F.2d 825 (2d Cir. 1945); Thomas A. Standish, 8 T.C. 1204 (1947), Acq. 1947-2 CuM. BULL. 4. Thus blockage substitutes unverifiable estimates for the objective criterion of actual sales or bona fide bid and asked prices. But, in contrast with the procedure followed in valuing closely-held stocks, the issue is sharply defined (What could have been realized by means of a special offering or secondary distribution?) and relevant considerations are correspondingly delimited. The regulations themselves leave the door open for escape in hard cases from the objective market-price-equals-value rule: In cases in which it is established that the value per bond or share of any security determined on the basis of selling or bid and asked prices as herein provided does not reflect the fair market value thereof, then some reasonable modification of such basis or other relevant facts and elements of value shall be considered in determining fair market value. U.S. Treas. Reg. 105, ? 81.10(c) (1944); U.S. Treas. Reg. 108, ?86.19(c) (1943). MONTGOMERY, FEDERAL TAXES-ESTATES, TRUSTS AND GIFTs 626 (1949-1950), lists 16 cases in which the value of stock was determined to be less than the quoted market price. Such cases, however, may fairly be considered exceptions and, aside from cases involving very large blocks of stock, the courts are not easily persuaded to depart from market quotations. E.g., Estate of Caroline McCulloch Spencer, 5 T.C. 904, Aca. 1946-1 CUM. BULL. 4. (166)

Devaluation Procedures and the Role of the International Monetary Fund

PRIOR knowledge of the intention to devalue the currency of a country inevitably leads to a desire to export c-apital directly or indirectly in the form of goods, usually underinvoiced,3 or in the urge to purchase from abroad as much as is possible before the devaluation becomes effective.4 The result of any or all of these activities is to aggravate the deficit already present in the nation's international accounts. It is conceivable that such a drain may further endanger the position of the currency in such a way that the subsequent devaluation might not bring the desired relief.5 The purpose of this note is to examine the rules and laws of member countries relating to devaluation of their respective currencies and the provisions for devaluation made by the Fund and to assess whether the national legal requirements co-ordinate with the Fund's regulations. Since one of the major requirements for an effective devaluation is a swift and sudden announcement of the move, we shall attempt to evaluate whether a swift move can be accomplished by member countries at this time. The International Monetary Fund's resources are available to assist member countries by providing financial assistance to overcome temporary disequilibriums in their balance of payments and so to help them avoid policies that re,,Associate professor of finance, University of Chicago. 2 New York City. 3 The following observations refer to the French experience. Part of the external deficit is undoubtedly only apparent. So long as the rise in prices destroys confidence in the national currency, exporters will try to build up holdings in stable currency and the simplest way to do this is to undervalue exports in their declarations to the authorities and leave the balance abroad. It is noteworthy that the average unit value of exports in I947 was steadily falling while the index of wholesale price was continuing to rise.... It may be assumed that clandestine French holdings of foreign assets have increased considerably more than known French holdings of such assets have declined (M. Pierre Uri, quoted in United Nations Economic Commission for Europe, Economic Survey of Europe in I948, p. I39, n. 2). A similar observation is reported in the Economist (London), December 25, I948, p. I052: the first half of I948 exports were i5 per cent lower than the previous year by dollar value, but 36 per cent higher by weight. Though there are some other partial explanations of this paradox, the main explanation is that French exports are underinvoiced. In other words there is a large flight of capital, which unofficial estimates put at $500 million, a sum equal to half the American aid extended to France this year.