Book To Price Effect

Discussion of The Book-to-Price Effect in Stock Returns: Accounting for Leverage

-Summary

Our discussion contains the effect of the Book to Price in stock returns and how this is also by the Leverage. But first we need to be clear of the meaning of these two terms to have e better understanding of what we are about to discuss.

We will discuss the benefits or non benefits of these. A comparison between Operating Leverage and Financial Leverage will also be included in this discussion and why the autor amphasyses in separating the liabilities into these two groups.

-Article Synthesis

a. Central Idea

Theorical data indicates that we should deconstruct the book-to-price ratio into two comoponents: (1) Net Operating Asset Component.and (2) Financial Leverage. The author also suggests that this separation is intuitive and has links to theorical asset pricing models and make ideas with respect to the source of the book to price effect to be formal.

b. Content Briefing

Book to Price Definition-A stock's capitalization divided by its book value. The value is the same whether the calculation is done for the whole company or on a per-share basis. This ratio compares the market's valuation of a company to the value of that company as indicated on its financial statements. The higher the ratio, the higher the premium the market is willing to pay for the company above its hard assets. A low ratio may signal a good investment opportunity, but the ratio is less meaningful for some types of companies, such as those in technology sectors. This is because such companies have hidden assets such as intellectual property which are of great value, but not reflected in the book value. In general, price to book ratio is of more interest to value investors than growth investors.

Financial Leverage Definition-portion of a firm's assets financed with debt instead of equity. It involves contractual interest and principal obligations. Financial leverage benefits common stockholders as long as the borrowed funds generate a return in excess of the cost of borrowing, although the increased risk can offset the general cost of capital. For this reason, financial leverage is popularly called trading on equity

The author specifies that the financial leverage should be meassured as the ratio of the market value of the debt to the market value of equity. Then the use of book value of debt as the market value of debt leads us into two forms of measurement error: First-Long term debt values of the debt in balance sheet are assumed to be aproxímate to the market value and this approach could be severely affected by 3 other conditions that could lead us into a calculating or projection errors. (1) Periods of dramatically interests changing, (2) Duration of long term debt, and

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