Financial Analysis, Planning and Forecasting Theory and Application - PowerPoint PPT Presentation

Loading...

PPT – Financial Analysis, Planning and Forecasting Theory and Application PowerPoint presentation | free to download - id: 50a424-NGI2O



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Financial Analysis, Planning and Forecasting Theory and Application

Description:

Financial Analysis, Planning and Forecasting Theory and Application Chapter 4 Application of Discriminant Analysis and Factor Analysis in Financial Management – PowerPoint PPT presentation

Number of Views:256
Avg rating:3.0/5.0
Slides: 38
Provided by: centerforp6
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Financial Analysis, Planning and Forecasting Theory and Application


1
Financial Analysis, Planning and
Forecasting Theory and Application
Chapter 4
Application of Discriminant Analysis and Factor
Analysis in Financial Management
  • By
  • Alice C. Lee
  • San Francisco State University
  • John C. Lee
  • J.P. Morgan Chase
  • Cheng F. Lee
  • Rutgers University

2
Outline
  • 4.1 Introduction
  • 4.2 Credit analysis
  • 4.3 Bankruptcy and financial distress analysis
  • 4.4 Applications of factor analysis to select
    useful financial ratios
  • 4.5 Bond ratings forecasting
  • 4.6 Bond quality ratings and the change of
    quality ratings for the electric utility
    industry
  • 4.7 Ohlsons and Shumways methods for Estimating
    Default Probability
  • 4.8 Summary
  • Appendix 4A. Jackknife method and its application
    in MDA analysis
  • Appendix 4B. Multi-period Logistic Regression

3
4.2 Credit analysis

  • (4.1)
  • where
  • Yi Index value for the ith account
  • ith firms quick ratio
  • ith firms total sales/inventory ratio
  • and A and B are the parameters or weights to be
    determined.

4
4.2 Credit analysis
  • (4.2)
  • (4.3)
  • (4.4a)

5
4.2 Credit analysis

  • (4.4b)
  • Where
  • Variance of X1
  • Variance of X2
  • Covariance between X1 and X2
  • Difference between the average of X1s for
    good accounts
  • and the average of X1s for bad accounts and
  • Difference between the average of X2 for
    good accounts
  • the average of X2 for bad accounts.

6
4.2 Credit analysis
  • TABLE 4.1 Status and index values of the
    accounts

Account Number Account Status Yi
7 Bad 0.81
10 Bad 0.89
2 Bad 1.30
3 Bad 1.45
6 Bad 1.64
12 Good 1.77
11 Bad 1.83
4 Good 1.96
1 Good 2.25
8 Good 2.50
5 Good 2.61
9 Good 2.80
7
4.2 Credit analysis
8
4.2 Credit analysis
9
4.3 Bankruptcy and financial distress analysis
  • Discriminant Model (Y is the value of z-score)
  • (4.5)
  • TABLE 4.2 Mean ratios of bankrupt / nonbankrupt
    firms
  • From Altman, E. I., Financial ratios,
    discriminant Analysis, and the prediction of
  • corporate bankruptcy, Journal of Finance 23
    (1968), p. 596, Table I. Reprinted
  • by Permission of Edward I. Altman and Journal of
    Finance.
  • Z-score gt2.99 non-bankrupt sector Z-score lt
    1.81 bankruptcy Z-score between 1.81 and 2.99
    gray area.

Ratio Definition Bankrupt Group Mean Nonbankrupt Group Mean
X1 Working capital / total assets -0.061 0.414
X2 Retained earnings / total assets -0.626 0.355
X3 EBIT/ total assets -0.318 0.153
X4 Market value of equity / book value of total debt 0.401 2.477
X5 Sales / total assets 1.500 1.900
10
Empirical
  • When we apply Equation (4.5) to calculate
    financial Z-score, the model should be defined as
  • Here we use JNJ in 2005 as an example,
  • Then, the z-score for JNJ is 1.2(0.3233)1.4(0.71
    47)3.3(0.2353)0.6(8.8683)1.0(0.8706) 8.3567

Ratio Definition JNJ
X1 Net Working capital / total assets ( current asset current liability ) / total assets 0.3233
X2 Retained earnings / total assets 0.7147
X3 EBIT/ total assets 0.2353
X4 Market value of equity / book value of total debt 8.8683
X5 Sales / total assets 0.8706
11
4.3 Bankruptcy and financial distress analysis
Class Size of Sample Definition
1. PPO 2(1.8) Serious problem-potential payoff. An advanced problem bank that has at least 50 percent chance of requiring financial assistance in the near future.
2. SP 14(12.7) Serious problem. A bank whose financial condition threatens ultimately to obligate financial outlay by the FEIC unless drastic changes occur.
3. OP 94(85.5) Other problem. A bank with some significant weakness, with vulnerability less than class 2, but still calling for aggressive supervision and extraordinary concern by the FEIC.
Total 110(100)
From Sinkey, J.F., A multivariate statistical analysis of the characteristics of problem banks, Journal of Finance 30 (1975), Table 2. Reprinted by permission. From Sinkey, J.F., A multivariate statistical analysis of the characteristics of problem banks, Journal of Finance 30 (1975), Table 2. Reprinted by permission. From Sinkey, J.F., A multivariate statistical analysis of the characteristics of problem banks, Journal of Finance 30 (1975), Table 2. Reprinted by permission.
12
4.3 Bankruptcy and financial distress analysis
  • TABLE 4.3 Profile analysis for problem banks

Financial Ratio 1969 1970 1971 1972
Loans/Assets
1. Problem bank 53.9 55.4 56.9 56.0
2. Nonproblem bank 49.3 48.9 47.8 47.8
Loans/Capital plus Reserves
1. Problem bank 648.3 692.2 768. 9 838.6
2. Nonproblem bank 564.5 562.5 562.4 577.5
Operating Expense/Operating Income
1. Problem bank 83.9 85.5 89.3 94.1
2. Nonproblem bank 78.5 78.6 81.8 82.4
Loan Revenue/Total Revenue
1. Problem bank 64.7 65.8 68.8 69.8
2. Nonproblem bank 59.3 59.2 59.9 59.6
Other Expenses/Total Revenue
1. Problem bank 15.8 16.0 16.3 16.4
2. Nonproblem bank 12.3 13.0 13.2 13.7
13
4.3 Bankruptcy and financial distress analysis
Year Type I Error Type II Error Total Error
1969 46.36 25.45 35.91
1970 42.73 27.27 35.00
1971 38.18 24.55 31.36
1972 28.15 21.36 24.76
14
4.3 Bankruptcy and financial distress analysis

  • (4.6)
  • where
  • 0 Unsecured loan,
  • 1 Secured loan
  • 0 Past interest payment due,
  • 1 Current loan
  • 0 Not audited firm,
  • 1 Audited firm
  • 0 Net loss firm
  • 1 Net profit firm
  • Working Capital/Current Assets
  • 0 Loan criticized by bank examiner,
  • 1 Loan not criticized by bank examiner.

15
4.3 Bankruptcy and financial distress analysis

  • (4.7)
  • where
  • Agents balances/Total assets a measure
    of the firms accounts receivable
    management
  • Stocks at cost (preferred and
    common)/Stocks at market
    (preferred and common) measures investment
    management
  • Bonds at cost/Bonds at market measures the
    firms age
  • (Loss adjustment expenses paid
    underwriting expenses paid) /
    Net premiums written a measure of a firms funds
    flow from insurance operations
  • Combined ratio traditional measure of
    underwriting profitability and
  • Premiums written direct/Surplus
    a measure of the firms sales
    aggressiveness.

16
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 1?Return on Investment Factor 1?Return on Investment Factor 1?Return on Investment Factor 1?Return on Investment Factor 1?Return on Investment Factor 1?Return on Investment
4 Earnings/Sales .88 .63 .75 .81
7 Earnings/Net Worth .79 .94 .95 .95
12 Earnings/Total Assets .93 .89 .85 .87
13 Cash Flow/Total Assets .92 .85 .84 .84
14 Cash Flow/Net Worth .50 .88 .79 .93
15 EBIT/Total Assets .89 .85 .77 .84
16 EBIT/Sales .89 .61 .70 .77
17 Cash Flow/Total Capital .94 .90 .85 .93
17
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms (Cont.)

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 1?Return on Investment Factor 1?Return on Investment Factor 1?Return on Investment Factor 1?Return on Investment Factor 1?Return on Investment Factor 1?Return on Investment
18 Earnings/Total Capital .94 .90 .88 .94
19 Cash Flow/Sales .79 .59 .87 .74
41 EBIT/Net Worth .79a .92 .95 .97
47 Cash Flow/Total Debt .81 .73 .84 .70
48 Earnings/Total Debt .87 .78 .86 .73
53 Operating Funds/Total Assets .88 .82 .45 .82
54 Operating Funds/Net Worth .25 .75 .63a .86
55 Operating Funds/Total Capital .83 .81 .33 .88
18
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms (Cont.)

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 2?Financial Leverage Factor 2?Financial Leverage Factor 2?Financial Leverage Factor 2?Financial Leverage Factor 2?Financial Leverage Factor 2?Financial Leverage
2 Net Worth/Total Assets -.80 -.85 -.82 -.69a
5 Long-Term Debt/Total Assets .87 .85 .85 .87
11 Long-Term Debt/Net Worth .88 .90 .91 .93
29 Long-Term Debt/Net Plant .85 .81 .80 .81
30 Long-Term Debt/Total Capital .89 .92 .94 .91
31 Total Debt/Net Worth .79 .85 .83 .71a
32 Total Debt/Total Assets .81 .85 .79 .74
50 Total Debt and Preferred Stock/Total Assets .79 .85 .78 .68
19
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms (Cont.)

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 3?Capital Intensiveness Factor 3?Capital Intensiveness Factor 3?Capital Intensiveness Factor 3?Capital Intensiveness Factor 3?Capital Intensiveness Factor 3?Capital Intensiveness
3 Sales/Net Worth .66 .85 .70a .78
6 Sales/Total Assets .78a .81 .75 .79
19 Cash Flow/Sales -.44 -72a ? ?
20 Current Liabilities/Net Plant .81 .49 .81 .43a
22 Current Assets/Total Assets .88 .46 .84 .41
26 Sales/Net Plant .94 .78 .91 .79
27 Sales/Total Capital .85 .91 .86 .83
20
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms (Cont.)

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 4?Inventory Intensiveness Factor 4?Inventory Intensiveness Factor 4?Inventory Intensiveness Factor 4?Inventory Intensiveness Factor 4?Inventory Intensiveness Factor 4?Inventory Intensiveness
1 Working Capital/Sales .72a .44 .69a .81
20 Current Liabilities/Net Plant .33 .71 ? ?
21 Working Capital/Total Assets .40 .76 .46 .85
22 Current Assets/Total Assets .39 .83 .45 .84
24 Current Assets/Sales .92 .74 .92 .74
25 Cost of Goods Sold/Inventory -.91 -.92 - .94 -.93
28 Inventory/Sales .87 .93 . 94 .93
21
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms (Cont.)

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 5?Cash Position Factor 5?Cash Position Factor 5?Cash Position Factor 5?Cash Position Factor 5?Cash Position Factor 5?Cash Position
42 Cash/Total Assets .91 .93 .89 .81
43 Cash/Current Liabilities .84 .88 .83 .87
44 Cash/Sales .93 .86 .88 .89
46 Cash/Fund Expenditures .91 .86 .88 .89
22
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms (Cont.)

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 6?Receivables Intensiveness Factor 6?Receivables Intensiveness Factor 6?Receivables Intensiveness Factor 6?Receivables Intensiveness Factor 6?Receivables Intensiveness Factor 6?Receivables Intensiveness
23 Quick Assets/Total Assets .52 .89 .68a .89
33 Receivables/Inventory .94 .84 .80a .82
34 Inventory/Current Assets -.75a -.70 -.64 -.76
35 Receivables/Sales .72a .83 .81 .83
37 Quick Assets/Sales .58 .86 .78 .88
40 Quick Assets/Current Liabilities .40 .76 .46 .81
45 Quick Assets/Fund Expenditures .55 .85 .75 .87
23
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms (Cont.)

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 7?Short-Term Liquidity Factor 7?Short-Term Liquidity Factor 7?Short-Term Liquidity Factor 7?Short-Term Liquidity Factor 7?Short-Term Liquidity Factor 7?Short-Term Liquidity
21 Working Capital/Total Assets ? ? .73 -.35
36 Inventory/Working Capital ? ? -.79 .16
38 Current Liabilities/Net Work ? ? -.55a .80
39 Current Assets/Current Liabilities .91 .64 .90 -.61
40 Quick Assets/Current Liabilities .77 .37 .76 -.31
49 Current Liabilities/Total Assets ? ? -.64a .78
51 Net Defensive Assets/Fund Expenditures .55 .74 .75 -.52a
24
4.4 Applications of factor analysis to select
useful financial ratios
  • TABLE 4.4a Cross-sectional comparison of
    financial ratios and factor loadings
    defining eight financial ratio categories for
    industrial firms (Cont.)
  • From Johnson, W.B., The cross-sectional
    stability of financial ratio patterns, Journal
    of Financial and Quantitative
  • Analysis 14 (1979), Table 2. Reprinted by
    permission of W. Bruce Johnson and JFQA.
  • a Indicates variables having a within-sample
    cross-loading of between 0.50 and 0.70 on one
    other factor.

Factor Loadings Factor Loadings Factor Loadings Factor Loadings
1972 1972 1974 1974
Primary Primary Primary Primary
Ratio Number Ratio Name Mfg. Retail Mfg. Retail
Factor 8?Decomposition Measures Factor 8?Decomposition Measures Factor 8?Decomposition Measures Factor 8?Decomposition Measures Factor 8?Decomposition Measures Factor 8?Decomposition Measures
56 Asset Decomposition .68 .74 ? ?
58 Equity Decomposition .84 .84 .86 .87
60 Noncurrent Items Decompostion .83 .78 .87 .85
61 Time Horizon Decompostion ? ? .62 .70
25
4.5 Bond ratings forecasting
  • TABLE 4.4b Cross-sectional congruency
    coefficients for eight financial-ratio dimensions
    for 1974

Factor Retail Firms Factor Retail Firms Factor Retail Firms Factor Retail Firms Factor Retail Firms Factor Retail Firms Factor Retail Firms Factor Retail Firms
Factor Primary Manufacturing Firms One Two Three Four Five Six Seven Eight
One ? Return on Investment .95 ?.41 ?.13 ?.05 .14 .05 ?.25 ?.26
Two ? Financial Leverage ?.40 .95 .11 ?.17 ?.17 ?.05 .45 .07
Three ? Capital Intensiveness ?.15 ?.00 .84 .28 ?.14 ?.16 .55 .04
Four ? Inventory Intensiveness ?.13 ?.02 ?.27 .87 ?.01 .15 .08 .08
Five ? Cash Position .20 ?.15 ?.21 .00 .88 .46 ?.29 .15
Six ? Receivables Intensiveness .01 ?.06 ?.42 .11 .29 .92 ?.24 .10
Seven ? Short-term Liquidity .19 ?.34 ?.17 .30 .38 .39 .76 ?.01
Eight ? Decomposition Measures ?.20 .16 .06 .06 .01 .05 .27 .84
From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA. From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA. From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA. From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA. From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA. From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA. From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA. From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA. From Johnson, W.B., The cross-sectional stability of financial ratio patterns, Journal of Financial and Quantitative Analysis 14 (1979), Table 3. Reprinted by permission of W. Bruce Johnson and JFQA.
26
4.5 Bond ratings forecasting
27
4.5 Bond ratings forecasting
  • (5) Defensive Interval QA/Operating Expense
    Minus Depreciation, Depletion, Amortization (6)
    Capital Expenditure/Sales

28
4.5 Bond ratings forecasting
  • From Chen, K. H., and T. A.
  • Shimerda, An empirical analysis
  • of useful financial ratios, Financial
  • Management (Spring 1981),
  • Exhibit 5. Reprinted by permission.
  • Ratio not included in the final factors of the
    PEMC studies.
  • Ratio not in the 48 ratios included in the
    PEMC study.

29
4.5 Bond ratings forecasting



30
4.5 Bond ratings forecasting
  • TABLE 4.7 Variable means, test of significance,
    and important ranks

Bond Rating Bond Rating Bond Rating Bond Rating Bond Rating Function Ranks Function Ranks Function Ranks
Variable AA A BAA BA B F-Ratio One Two Three
X1 0.000 0.077 0.520 1.000 1.000 ? 1 6 2
X2 1.634 1.581 1.260 1.058 0.486 25.45 2 2 5
X3 1.869 1.657 1.275 1.354 1.250 13.97 3 3 1
X4 1.138 0.606 0.560 0.511 0.707 6.05 6 1 6
X5 0.091 0.162 0.154 0.151 0.215 4.06 5 4 4
KX6 0.099 0.075 0.066 0.075 0.069 2.68 4 5 3
From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level. From Pinches, G.E., and K.A. Mingo, A multivariate analysis of industrial and bond ratings, Journal of Finance 28 (March 1973), Table 3. Reprinted by permission. Significant at 0.001 level Significant at 0.01 level Significant at 0.05 level.
31
4.6 Bond quality ratings and the change of
quality ratings for the electric utility industry
  • The multivariate-analysis technique
    developed by Pinches and Mingo for analyzing
    industrial bond ratings has also been used to
    determine bond quality ratings and their
    associated changes for electric utilities.
    Pinches, Singleton, and Jahakhani (1978) (PSJ)
    used this technique to determine whether fixed
    coverages were a major determinant of electric
    utility bond ratings. Bhandari, Soldofsky, and
    Boe (1979) (BSB) investigate whether or not a
    multivariate discriminant model that incorporates
    the recent levels, past levels, and the
    instability of financial ratios can explain and
    predict the quality rating changes of electric
    utility bonds.
  • PSJ (1978) found that fixed coverage is the
    only (and not the dominant) financial variable
    that apparently influences the bond ratings
    assigned to electric utility firms. Other
    important variables are the climate of
    regulation, total assets, return on total assets,
    growth rate or net earnings, and construction
    expenses/total assets.2 The major finding of
    BSBs study is that the MDA method can be more
    successful in predicting bond rating changes than
    it had been predicting the bond ratings
    themselves. These results have shed some light
    for the utility regulation agency on the
    determinants of bond ratings and the change of
    bond ratings for electric utility industries.

32
4.7 Ohlsons and Shumways methods for Estimating
Default Probability
  • X1 Natural log of (Total Assets/ GNP Implicit
    Price Deflator Index). The index assumes a
    base value of 100 for 1968
  • X2 (Total Liabilities/Total Assets)
  • X3 (Current Assets Current
    Liabilities)/Total Assets
  • X4 Current Assets/ Current Liabilities
  • X5 One if total liabilities exceeds total
    assets, zero otherwise
  • X6 Net income/total assets
  • X7 Funds provided by operations/total
    liabilities
  • X8 One if net income was negative for the last
    two years, zero otherwise and
  • X9 (Net income in year t Net income in t1) /
    (Absolute net income in year t Absolute
    net income in year t1).

33
4.7 Ohlsons and Shumways methods for Estimating
Default Probability


  • (4.8)
  • Where , P the
    probability of bankruptcy.

34
4.7 Ohlsons and Shumways methods for Estimating
Default Probability


  • (4.9)
  • Where , P the
    probability of bankruptcy
  • X1 Net Income/Total Assets
  • X2 (Total Liabilities/Total Assets)
  • X3 The logarithm of (each firms market
    capitalization at the end of year prior
    to the observation year / total market
    capitalization of NYSE and AMEX market)
  • X4 Past excess return as the return of the
    firm in year t-1 minus the value-weighted
    CRSP NYSE/AMEX index return in year t - 1 and
  • X5 idiosyncratic standard deviation of each
    firms stock returns. It is defined as the
    standard deviation of the residual of a
    regression which regresses each stocks
    monthly returns in year t 1 on the
    value-weighted NYSE/AMEX index return for the
    same year.

35
4.8 Summary
  • In this chapter, we have discussed
    applications of two multivariate statistical
    methods in discriminant analysis and factor
    analysis. Examples of using two-group
    discriminant functions to perform credit
    analysis, predict corporate bankruptcy, and
    determine problem banks and distressed P-L
    insurers were discussed in detail. Basic
    concepts of factor analysis were presented,
    showing their application in determining useful
    financial ratios. In addition, the combination
    of factor analysis and discriminant analysis to
    analyze industrial bond ratings was discussed.
    Finally, Ohlsons and Shumways methods for
    estimating default probability were discussed.
  • In sum, this chapter shows that multivariate
    statistical methods can be used to do practical
    financial analysis for both managers and
    researchers.

36
Appendix 4A. Jackknife method and its application
in MDA analysis
  • (4.A.1)
  • (4.A.2)
  • (4.A.3)

37
Appendix 4A. Jackknife method and its application
in MDA analysis
TABLE 4.A.1 Original and jackknifed (standardized) discriminant functions TABLE 4.A.1 Original and jackknifed (standardized) discriminant functions TABLE 4.A.1 Original and jackknifed (standardized) discriminant functions TABLE 4.A.1 Original and jackknifed (standardized) discriminant functions TABLE 4.A.1 Original and jackknifed (standardized) discriminant functions TABLE 4.A.1 Original and jackknifed (standardized) discriminant functions TABLE 4.A.1 Original and jackknifed (standardized) discriminant functions
Discriminant Function Discriminant Function Discriminant Function Discriminant Function Discriminant Function Discriminant Function
1 1 2 2 3 3
Variable Coefficient Jackknifed Coefficient Coefficient Jackknifed Coefficient Coefficient Jackknifed Coefficient
X1 ?.936 ?.882 .131 .102 ?.365 ?.361
X2 .528 .461 1.073 .863 ?.216 ?.017
X3 .360 .352 ? .758 ?.541 ?.493 ?.516
X4 .023 .041 ?1.284 ?.888 .006 .012
X5 ?.283 ?.171 ?.529 ?.544 .335 .421
X6 .327 .302 ?.280 ?.067 ?.340 ?.320
About PowerShow.com