Discussed the need of firms to recur to external resources


Learning outcomes

to be able to demonstrate an understanding of the philosophy and traditions of research in finance and to distinguish the ontological assumptions, epistemological approach, methodology and method(s) adopted in finance research

to understand descriptive statistics

to know how to use the finance academic literature, appreciate how academic research is conducted and produced in finance, and understand some of the principles of academic communication

to identify and understand relationships in the data.

Your understanding and application of:

what is financial research

the distinction between qualitative and quantitative research

the ways of analysing and describing financial data.

Question 1

a. Explain the difference between the mean, median, and mode. Describe how the relation between the mean and the median affects the skewness of a distribution.

b. In a paper published in 1998, Rajan and Zingales3 discussed the need of firms to recur to external resources to finance their expenditures in fixed capital. They calculated the so called ‘external financial dependency index'. The index is defined as follows:

Capital dependency = (Capital expenditure - Cash flow)/Capital expenditure = 1 - Cash flow/Capital expenditure

A positive index means that the cash flow generated by the firm is insufficient to cover investment (capital expenditure). In this case, the firm needs external finance to cover its capital expenditure plans (Capital expenditure > Cash flow). The higher the index, the more dependent the firm is on external finance. On the contrary, if the index is negative, the firm generates enough cash flow to cover its investment plans (Capital expenditure < Cash flow).

To estimate the index, the authors collect data for individual firms across many sectors. For each firm in a sector, they calculate the total expenditure of capital and the total cash flow by decade. Then, they apply the above equation in order to obtain the value of the index for the individual firm. Finally, the overall value of the index per sector is obtained by taking the median index value of that sector.

An alternative way of calculating the index could be the following. Instead of taking the median for each sector, the index could be calculated by obtaining the total of capital expenditure and the total of the cash flow by sector during a given period of time.

The worksheet ‘UK' of the Excel file B860_17K_TMA01 offers data on capital expenditure and cash flows for several UK firms of the Mining and Food and Beverage sectors. Data are reported by decade (except for the period 2010-2015; cells with zero values indicate that there are no data during that period of time). Use these data to create the index of external financial dependence for these two sectors in each decade following the two alternative methodologies described above.

Discuss the results: How does the index evolve over time in the two sectors? How much do they rely on external finance? Are there differences in the value of the index calculated between the suggested two methodologies and why? Which methodology would you adopt? Explain your answer.

c. The original index developed by Rajan and Zingales (1998) is estimated at the sectoral level for the

US and is assumed to reflect technical features of each sector. These features are also assumed to be constant through time and across all developed economies. The worksheet ‘Index' of the Excel file reports new estimations of the index for the US, the UK, and Italy. Calculate the mean and standard deviation of the index for all sectors in the UK in the 1980s and 2000s. Is the assumption of Rajan and Zingales plausible?

d. Using the same excel data, plot two scatter charts of the external dependency index.

The first chart should compare values for the US and the UK during the 1980s (US industries should lie on the horizontal axis and UK industries on the vertical axis).

The second chart should compare values for the US and Italy during the 1980s (US industries should lie on the horizontal axis and Italian industries on the vertical axis).

Compare the first and second chart, what are the differences between them? What do these charts imply for the assumption of Rajan and Zingales?

e. Calculate the Z-scores for Fabricated Metals and Printing in the UK during the 2000s. What do your calculations imply for the financial dependency of these two sectors in relation to the average index of all industries?

Question 2

In the worksheet ‘US data' in the Excel file, you will find four time series of US macroeconomic data between 1960 and 2015:

Annual GDP growth (%)

Annual unemployment rate (%)

Annual variation in the unemployment rate

Annual inflation rate (%)

a. In the very last activity of B860 Unit 2 Session 3, you run across the idea of a Phillips curve. The Phillips curve plots the relationship between unemployment and inflation rate. According to the standard interpretation of this curve, if unemployment decreases, an increase in prices must be expected (higher inflation). On the contrary, when unemployment increases, inflation is expected to be lower.

i. For all observations between 1961 and 1970, plot a scatter chart in which unemployment lies on the horizontal axis and values of inflation lie on the vertical axis.

ii. For the observations between 1983 and 2015, plot a similar scatter chart.

Compare the two charts. Are there any differences and if yes, what do they indicate? Explain your answer.

b. The relationship between GDP growth and changes in employment is known as Okun's law. This law states that as the economy grows the unemployment rate decreases.

i. For all observations between 1961 and 1970, plot a scatter chart in which values of GDP growth lie on the horizontal axis and the variation in unemployment rate lies on the vertical axis.

ii. For all observations between 1983 and 2015, plot a similar scatter chart

On the basis of the above evidence, do you think that the relationship described by Okun's Law applies in the US economy? Explain your answer.

c. The spreadsheet ‘Unemployment' in the Excel file B860_17K_TMA01 reports the evolution of the unemployment rate in four different economies (the UK, Germany, Italy, and Spain) between 2000 and 2016. Using proper descriptive statistics, summarize and present the general trend of the unemployment in each country. Is there a difference in the mean unemployment between the pre- crisis period 2000-2007 and the post crisis period 2009-2015? How did the 2008 crisis affect the unemployment rate?

d. Assuming that there is statistical evidence for the above-mentioned Okun's Law, what can you tell for the economic growth of these four countries in the post crisis period?

Reference -

Financial dependence and growth by Rajan, Raghuram G;Zingales, Luigi

The American Economic Review; Jun 1998; 88, 3; ABI/INFORM Collection

Attachment:- data file.xlsx

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