CFA Institute

Omission PossibleAuthor(s): William SchwartzSource: Financial Analysts Journal, Vol. 28, No. 2 (Mar. - Apr., 1972), p. 107Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4470916 .

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t th Editor

"MONEY PURCHASE" -AN

ADDITIONAL ALTERNATIVE

Bagehot's article "Risk and Reward in Corporate Pension Funds" (Jan.- Feb. 1972) says what has been needed to be said for a long long time. It did not raise sufficient hell, however, with the trustee who accepts either direc- tion on investments from the company or accepts the pressures of the com- pany to perform with the risk going to the beneficiaries. Legally, the trustee is trustee for the beneficiaries and not for the company or the "fund".

"Money purchase" plans restrict company contributions to a f ixed amount; benefits are generally de- cided by a joint committee of manage- ment and union officials based on the value of the funds and the estimates of the actuary. Perhaps "money pur- chase" is one answer that should be added to the alternatives you have suggested. Since the company has no further interest in the dollars except the satisfaction and happiness of its employees, company trustees are gen- erally quite fair in setting investment policies and return goals, and the pen- sion fund no longer becomes a "profit center" to the company. Here the problem is the union representatives who want to pay excessive amounts to retired union members, in order to preserve their power and prestige in the union (e.g., John L. Lewis and the coal workers). This is a different gon- flict of interest, but perhaps it should be mentioned.

CONSTANT READER

New York, N. Y.

OMISSION POSSIBLE

The study by Jerry D. Miller, "Ef- fects of Longevity on Values of Stock Purchase Warrants" (FAJ, Nov.-Dec. 1971) omitted reference to a warrant which could have shed much light on this subject. The old McCrory war- rants expire in 1976, five years sooner than the new M c C r o r y warrants shown in Appendices A&B.

I have observed that at times, both of these warrants trade at the same price. The exercise price in each case

is $20 till 1976, however the new war- rant has an additional life of 5 years at a slightly higher exercise price.

Although the author uses the term "value" in his title and elsewhere in the article, the term "premium" would be more useful.

Miller points to the low volatility of GAC common stock from 1960 through 1966 and that when the common had risen to 64 1/8 by the end of 1968 the warrant had jumped 864%70 to 43 3/8. Without giving the exercise terms, this market action has no special signifi- cance. If the GAC warrant was exer- cisable at 20 and the stock sold at 64, the warrant should have sold at around 44 regardless of the longevity of the warrant or the past volatility of the stock.

WILLIAM SCHWARTZ

Vice President Cantor, Fitzgerald & Co., Inc. New York, N. Y.

RE: THE "MONEY SUPPLY, PORTFOLIO ADJUSTMENTS AND STOCK PRICES" ARTICLE

Readers' Criticism Michael Palmer's article (FAJ, July-

August, 1970) has placed him in the midst of the monetarist movement by attempting to find a simple empiri- cal relationship between percentage changes in narrowly defined money and a broad common stock price index. We do not think that Palmer has iso- lated a usable relationship between the two. In addition, we believe his conclusions concerning such a rela- tionship to be quite misleading for portfolio managers seeking guidelines for predicting stock market price changes.

By comparing plots of annual per- centage rates of change in money sup- ply and stock prices (both smoothed with a six-month moving average) over the period January 1959 through August 1969, and by statistically re- gressing that smoothed stock price change variable on the smoothed money stock variable, Palmer con- cluded that there is "a close relation- ship between changes in the nation's

money supply and common stock prices." In addition, "where a lead relationship exists, the money supply leads [changes in the stock price in- dex], and generally, a one per cent change in the rate of growth of the nation's money supply is associated with a change of approximately 10 per cent in stock prices." We are un- convinced by his analysis.

Although his chart of movements in money and stock prices shows (with different scales for the two series) a significant degree of comovement in the two series, his own regression re- sults cast doubt on the explanatory power of the money supply. For the entire period (January 1959-August 1969), monthly changes in money sup- ply explain only 20 per cent of the variation in stock prices. Is this what we should call "a close relationship be- tween money supply and common stock prices?" Also, the explanatory value of changes in the money supply is quite sensitive to the time period for which the regression was run. In the two-year period 1964-65, changes in money supply explain none (zero per cent) of the variation in stock prices.

Closer inspection of his graphical analysis makes even more doubtful the "closeness" of the relationship between changes in money and stock prices and, in addition, calls into question the lead-lag relationship that Palmer claims exists (see his Chart 1). In 1962, the stock price series turns up before the upturn in the money supply series. In 1964, with the money supply series rising sharply, the stock price series is falling. In 1967, despite a rise in the money supply change series to a level that reflected an extraordinarily rapid rate of growth in money stock, the stock price series begins a sus- tained fall with the downturn coming well before the downturn in the money supply series. There are several other examples. Thus, it would not appear that monthly changes in money supply are a dependable leading indicator of monthly changes in stock prices.

Palmer's apparent claim that a one per cent change in the growth rate of money supply is associated with a

FINANCIAL ANALYSTS JOURNAL / MARCH-APRIL 1972 [ 107

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