FINANCE Corporate financial policy and R and D Management

of preferred equity and long-tem debt are as of the end of the most recent
fiscal year. The market value of equity is computed using the most recent
month’s closing price of the stock.

2.BLEV: Book leverage. This measure is computed as follows:

where CEQtis the book value of common equity, PEtis the book value of
preferred equity, and LDtis the book value of the long-term debt. All val-
ues are as of the end of the most recent fiscal year.

3.DTOA: Debt-to-assets ratio. This ratio is computed as follows:

where LDtis the book value of long-term debt, DCLtis the value of debt in
current liabilities, and TAtis the book value of total assets. All values are as
of the end of the most recent fiscal year.

4.SNRRT: Senior debt rating. This descriptor is constructed as a multilevel
indicator variable of the debt rating of a company.

Currency Sensitivity

1.CURSENS: Exposure to foreign currencies. To construct this descriptor,
the following regression is run:

rit= αI+ βirmt+ εit

where ritis the excess return on the stock and rmtis the excess return on the
S&P 500 index. Let εitdenote the residual returns from this regression.
These residual returns are in turn regressed against the contemporaneous
and lagged returns on a basket of foreign currencies, as follows:

εit= ci+ γi 1 (FX)t+ γi 2 (FX)t–1+ γ 13 (FX)t–2+ μit

where εitis the residual return on stock I, (FX)tis the return on an index of
foreign currencies over month t, (FX)t– 1 is the return on the same index of
foreign currencies over month t – 1, and (FX)t–2is the return on the same
index over month t– 2. The risk index is computed as the sum of the slope
coefficients γi 1 , γi 2 , and γi 3 (i.e., CURSENS = γi 1 + γi 2 + γi 3 ).

DTOA=

LD+DCL

CEQ

tt

t

BLEV=

CEQ++PE LD

CEQ

tt t

t

234 THE USE OF FINANCIAL INFORMATION IN THE RISK AND RETURN OF EQUITY