Papers Published in Journals

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Papers Published in Journals

Interpreting SIGNs

On January 28, 1991, the Republic of Austria publicly offered $100 million principal amount of stock index growth notes (SIGN) in the US. SIGNs may be characterized as a package consisting of a 5.5-year zero coupon note, plus a 5.5-year European call option, or warrant, on the S&P 500 with a strike price of 336.69. The prospectus for the SIGNs suggests that they will be taxed as so-called contingent interest notes. The tax discussion of the prospectus suggests that tax arbitrage may be a possible motivation behind the creation of SIGNs. The creation of a new security can benefit investors if it reduces the impact of market imperfections or makes the capital markets more complete. The price behavior of the SIGNs in relation to the predicted price suggests that investors may have initially overvalued the SIGNs but that mispricing was eliminated within 2 months.

John D. Finnerty, Financial Management, pp. 34-47. 1993 Summer

Indexed Sinking Fund Debentures: Valuation and Analysis

In July 1988, the Federal National Mortgage Association (FNMA) issued $500 million principal amount of 8.7% indexed sinking fund debentures (ISFD). Five additional issues of ISFDs totaling $3.175 billion followed over the next 14 months. ISFDs contain an interest-rate-contingent sinking fund. The contingency feature works to the issuer's advantage because sinking fund payments accelerate when market interest rates drop and decelerate when interest rates rise. A contingent claims model is developed to value the ISFDs for each trading day between July 30, 1990 and August 31, 1991. ISFDs and similar financial instruments with contingent sinking funds represent an effective tool for financial institution asset-liability management. Issuing such instruments permits a financial institution that invests in fixed-rate mortgages to match more closely the durations of its assets and liabilities.

John D. Finnerty, Financial Management, pp. 76-93. 1993 Summer

How Often Will the Firemen Get Their Sleep?

We calculate the expected additional fire protection cost to a city implied by the 1974 amendments to the Fair Labor Standards Act. Under the amendments, if a city chooses not to pay its men who are on duty for more than 24 hours at a time for sleep and meal time, it may exclude up to eight hours of sleep time, but must compensate them at overtime rates for the entire sleep period if one or more alarms prevent them from obtaining at least five uninterrupted hours of sleep in that period. Interalarm times are modeled as a Poisson process, and both point and interval estimates of the additional annual overtime cost are computed for the city of Monterey by estimating the annual number of interrupted sleep periods. A model that permits the rate at which alarms are received and the length of the designated sleep period to be varied is developed for computing the proportion of nights in the year during which the firemen get five uninterrupted hours of sleep. A procedure for adjusting the model to allow for the time spent in response to an alarm is also described.

John D. Finnerty, Management Science, pp. 1169-1173. 1977 July

Financial Engineering in Corporate Finance: An Overview

Financial engineering allows the creation of innovative financial instruments and processes and the formulation of creative solutions to complex financial problems. A new security is innovative only if it: 1. enables an investor to realize a higher aftertax-risk-adjusted rate of return without adversely affecting the issuer's aftertax cost of funds, and/or 2. lets an issuer realize a lower aftertax cost of funds without adversely affecting investors. The basic causal factors reflected in innovative financial processes are: 1. efforts to reduce transaction costs, 2. steps to reduce idle cash balances in response to higher interest rates, and 3. the availability of relatively inexpensive computer technology that facilitates quicker financial transactions. Creative solutions to corporate finance problems have concentrated on developing the most efficient strategy for calling high-coupon debt when interest rates decline.

John D. Finnerty, Financial Management, pp. 14-33. Reprinted in Clifford W. Smith, Jr., and Charles W. Smithson, eds., The Handbook of Financial Engineering. Harper & Row, New York, 1990, ch. 3, and in Robert W. Kolb, ed., The Financial Derivatives Reader. Kolb, Miami, 1992, ch. 2. 1988 Winter

Extending the Black-Scholes-Merton Model to Value Employee Stock Options

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John D. Finnerty, Journal of Applied Finance, pp. 25-54. 2005 Fall/Winter

Exact Formulas for Pricing Bonds and Options When Interest Rate Diffusions Contain Jumps

I develop Heath-Jarrow-Morton extensions of the Vasicek and Jamshidian pure-diffusion models, extend these models to incorporate Poisson-Gaussian interest rate jumps, and obtain closed-form models for valuing default-free, zero-coupon bonds and European call and put options on default-free, zero-coupon bonds in a market where interest rates can experience discontinuous information shocks. The jump-diffusion pricing models value the instrument as the probability-weighted average of the pure-diffusion model prices, each conditional on a specific number of jumps occurring during the life of the instrument. I extend the models to coupon-bearing instruments by applying Jamshidian's serial-decomposition technique.

John D. Finnerty, Journal of Financial Research, pp. 319-341. 2005 Fall

Evaluating the Economics of Refunding High-Coupon Sinking-Fund Debt

The procedure described leads to the maximum amount of bonds an issuer can refund immediately at a profit. However, it does not state how much the issuer should actually call for immediate redemption. The decomposition approach permits the application of the methodology described by Boyce and Kalotay (1979). While there are a number of possible situations where refunding an entire issue would be less than optimal, there are at least 2 situations where a partial refunding could be more beneficial to a firm's shareholders than refunding the entire issue immediately. When a company tenders for an outstanding high-coupon issue, it may not be best to set the price as high as would be required in order to reacquire the whole issue. Also, due to the uncertainty of future interest rates, the reacquisition of only a part of a non-sinking fund issue might lead to greater expected utility of refunding savings than refunding the whole issue immediately when the issuer is risk averse because of the hedging implicit in a partial refunding.

John D. Finnerty, Financial Management, pp. 5-10. 1983 Spring

Determinants of the Settlement Amount in Securities Fraud Class Action Litigation

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John D. Finnerty and Gautam Goswami, Hastings Business Law Journal, forthcoming.

Designing an Efficient Investment Strategy for Hedging the Future Cost of a College Education

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John D. Finnerty, Iftekhar Hasan, and Yusif Simaan, Journal of Investing, pp. 47-58. 1996 Spring

Credit Derivatives, Infrastructure Finance, and Emerging Market Risk

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John D. Finnerty, Financier, pp. 64-75. 1996 February