The financial manager of the multinational corporation (MNC) is faced with various tax structures, changing exchange rates, barriers to capital flows, and the possibility of financial market segmentation. The manager must be concerned with determining an optimal capital structure as well as identifying the sources of the relevant funds. Likewise, the manager must be concerned not only with funds flows, but also with the risk that the value of these flows will change owing to changing exchange rates. Finally, the manager must be concerned with operating under widely differing governmental philosophies.

In recent years, increased interest has developed in municipal bonds. This interest seems to be related to higher levels of interest rates, higher marginal tax rates for individuals because of inflation, and large demand for capital funds by municipalities. In spite of this greater awareness of municipal bonds, the academic literature lacks a rigorous analysis comparing municipal bonds with other bonds. The purpose of this paper is to partially fill this gap. Since one major characteristic differentiating municipal bonds from other bonds is the (federal) tax-free status of the coupons on municipals, this paper will trace out the implications of this differential tax treatment by comparing municipal bonds with fully-taxed bonds.

In recent years, there have been a number of studies investigating the yield spread phenomena between new and seasoned bonds ([1], [2], [3], [4], [8], [10], [13]). This literature focuses upon two aspects of the equilibrium pricing of new versus seasoned bonds: (l) analysis of the microeconomic determinants of new issue/seasoned issue yield spreads such as specific differences in coupon rates, call features, maturity features, and the like; and (2) analysis of macroeconomic determinants of yield spreads such as economic growth, interest rate cycles, changing marginal tax rates, and the like.

This paper uses the portfolio theory approach to bank behavior theory in order to examine the effects of two Fed policy variables on bank portfolio riskiness. The policy variables are (1) the level of the reserve requirement against NOW accounts, and (2) the rate of interest paid by the Fed on bank reserves. This second policy variable is currently zero-valued in nominal terms, but in recent years there has been some discussion of raising it, especially now that interest is paid by banks on checkable accounts. (For an early discussion see Tobin [8].)

The theory of portfolio selection and diversification developed by Markowitz [22] and Tobin [33] was based primarily on the criterion of meanvariance (MV) efficiency. The objective was to select an efficient set of portfolios from which every risk averter will choose the optimal portfolio which maximizes his expected utility. The MV criterion is the appropriate rule either for the case in which the utility function is quadratic or if the returns are normally distributed and risk aversion is assumed.

Recently, a debate has developed in both the theoretical and applied statistical literature regarding the appropriateness of various techniques in analytical models with limited (particularly, 0-1) dependent variables. In financial research, limited dependent variable models usually arise in one of two ways:

1. classification (or discrimination)--assigning observations to discrete, a priori determined groups, or

2. regression--relating a qualitative dependent variable to one or more independent variables (which may or may not be qualitative).

It is often desirable to know whether or not a risky asset's beta coefficient has changed and, if so, at what point in time the change occurred. For example, this knowledge is of obvious importance to beta-using security analysts and portfolio managers. As another example, a given theory may imply that a particular firm's beta should have changed at different points in time. Investigators may want to test such a hypothesis. Furthermore, tests are frequently performed on the effects of events on residuals of the market model, tests requiring the assumption of beta stability. For these, and possibly other reasons, it is useful to be able to detect that a change in beta did, in fact, take place as well as, in some instances, identifying the point in time at which the change took place.

Security behavior in bull and bear markets has received some attention in recent years. Fabozzi and Francis [5] first documented evidence that security betas are not influenced by the alternating forces of bull and bear markets. Their subsequent study of mutual fund betas also indicated that mutual funds generally respond indifferently to bull and bear market conditions. Using the concept of bull and bear market variations, Kim and Zumwa1t [9] developed and tested the risk premiums associated with the upside and the downside portions of returns variation. They concluded that investors expect to receive a risk premium for downside risk and pay a premium for upside variation of returns. From their results, Kim and Zumwalt [9] suggested that the down-market beta measuring downside risk (downside variation of returns) may be a more appropriate measure of portfolio risk than the single beta in the market model.

The purpose of this paper is to determine the correct procedure for discounting cash outflows in a capital market context. Beedles has stated flatly that “the risk adjusted discount (RADR) approach should not be applied to investment projects with negative benefits” ([1], p. 176). Lewellen also has recently examined the problem because he felt that there “is something at least vaguely disturbing about the associated write-down of the present value of cash outflows for risk” ([7], p. 1332). Lewellen, however, concluded that “the standard procedure used for inflows can therefore be transferred intact. The logic is symmetric because the sign of the flows is reversed.” In a comment on Lewellen, Celec and Pettway stated that they are “in substantial disagreement with Lewellen's development as well as with any implied generality of employing the standard RADR procedure in valuing cash outflow streams” ([3], P. 1061). This inappropriateness of the standard RADR approach to valuing cash outflows seems to have been accepted in the 1iterature. Kudla [6] recently claimed that it has been proved by the above authors and others that the normative rules in capital budgeting do not hold in evaluating cash outflows.