Financial Education

Many have characterized Chinese stock markets as inefficient, casino-like and speculative. In the November 2007 Pacific Basin Finane Journal Eun and Huang show that China’s markets may be more rational than many credit.

China’s markets, more than others, are characterized by small investors with undiversified portfolios. Only 37% of shares are publicly tradable, and only 10% of listed companies can offer the B- or H- class shares available to foreign investors. In studying various preferences, the authors find the following:

1. Stocks are priced according to company-specific rather than systematic risk. There are strong size and value effects, similar to the results found in U.S. markets.
2. Investors will pay a premium for more liquid stocks.
3. Investors will pay a premium for dividend paying stocks, possibly because dividends may reduce the ability of managers to expropriate funds.
4. Investors require lower returns for A-share companies that also issue B- or H-shares, possibly because such companies must meet more stringent disclosure requirements.

Many studies have questioned the ability of mutual funds and pension funds to time the market. In an article published in the December 2007 Journal of Financial and Quantitative Analysis, Chen and Liang examine the returns of 221 hedge funds self-identified as market timers. They find that, for the 1994-2005 period, evidence supports timing ability – especially in volatile or bear markets.

The results are robust to model specification and volatility timing. They do not appear to result primarily from option-like trading or luck.

The authors conclude that the flexible strategies associated with hedge funds are useful for professional market timers, and that funds promising market-timing results are likely to deliver them.

Various studies have documented that the four-day period starting with the last trading day of a month and ending on the third trading day of the subsequent month accounts for the bulk of stock market returns. In the March/April 2008 Financial Analysts Journal McConnell and Xu show that this effect has persisted, and is not confined to small capitalization or low priced stocks. It occurs in 31 of the 35 countries they examined and does not appear to be caused by month-end buying pressure as measured by trading volume or equity fund money flows.

Portfolio monitoring includes monitoring changes in the characteristics of individual securities or asset classes. Over time, underlying average returns, volatility and correlations with other asset classes can change. Such changes alter the appropriate mix of assets for meeting an investor’s objectives and constraints. If the changes are perceived as temporary, they may also present opportunities to make tactical changes.

The market and economic environment also require monitoring. Of particular importance can be the yield curve, market risk premia, central bank policy, and unusual deviations from normal relationships between securities or asset classes.

High quality securities markets are those that supply liquidity, transparency and assured completion.

Liquidity can be defined a number of ways:

• Tightness (low bid/ask spread)
• Depth (limited price impact from large trades)
• Resiliency (rapid adjustments for discrepancies between market price and intrinsic value)

Transparency means access to quotes is quick, easy and inexpensive. It also requires that trade details (size and price) are rapidly disseminated to the public.

Assurity of completion simply means that the counterparties of a trade can be trusted to honor the trade.

Accounting systems take the cash and accruals from various transactions and generate financial reports and statements.

The first step is to create journal entries and adjusting entries. The journal is a chronological list of each transaction, the amount, and the accounts affected. Some systems allow entries to include notes or authorizations. Adjustments are typically made at the end of accounting periods to record accruals not yet reflected in the accounting system.

Next, the general ledger and T-accounts can show the transactions sorted by the accounts affected rather than in chronological order. This can be useful for reviewing the activity in an account such as inventory.

Third, a trial balance lists the balance of each account on a given date. Unlike a ledger, only the ending balance is presented. Trial balances represent the first step in producing financial statements.

Finally, financial statements are prepared as a final product of the system, based on the totals from an adjusted trial balance.