Finance
PURPOSE OF THIS COURSE
This course covers the foundations of finance with applications in corporate finance and investment management. It discusses many of the major financial decisions made by corporate managers and investors. Essential in many of these decisions is the process of valuation, which will be an important emphasis of the course. Topics include criteria for making investment decisions, valuation of financial assets and liabilities, relationships between risk and return, market efficiency, and the valuation of derivative securities (e.g., options). The course also provides coverage of the major financial instruments issued by corporations including short and long term debt, equity, and convertible securities.
REQUIRED TEXT
Stephen A. Ross, Randolf W. Westerfield, and Jeffrey F. Jaffe, Corporate Finance, 6th edition, Irwin/McGraw-Hill, 2001
All other materials that are required reading are included in the syllabus or distributed in class.
The following books are optional, supplementary readings and can be purchased in many bookstores or from online vendors.
Capital Ideas: The Improbable Origins of Modern Wall Street, by Peter L. Bernstein, Simon & Schuster, 1993.
A Random Walk Down Wall Street, 7th edition, by Burton G. Malkiel, W. W. Norton & Company, 1999.
The Wall Street Journal Guide to Understanding Money and Investing, By Kenneth M. Morris, Virginia B. Morris, and Alan Siegel, Simon & Schuster Trade, 1999 edition.
Valuation: Measuring and Managing the Value of Companies, 3rd edition, by Tom Copeland, Tim Koller and Jack Murrin, John Wiley & Sons, Inc. 2000.
SCHEDULE OF SESSIONS AND READING LIST
Session 1: Introduction
Read: RWJ, Chapter 1
RWJ, Chapter 2
RWJ, Chapter 7 (pages 169-177)
Topic: Overview of the course, some fundamental principles, and the concept of cash flow.
Session 2: Introduction to Discounted Cash Flows and Investment Decision Rules
Read: RWJ, Chapter 4
RWJ, Chapter 6
RWJ, Chapter 7 (pages 177-183)
Optional Reading: RWJ, Chapter 3
Prepare: RWJ Problems 4.2, 4.5, 4.11, 4.23 (pages 96-98)
Illingham Packaging Company (in the reader)
Topics: Valuation under certainty; the market discount function; basic bond concepts; net present value and making corporate investment decisions.
Session 3: Bond Values and Changing Interest Rates
Read: RWJ, Chapter 5 (pages 102-108)
RWJ Chapter 25 (pages 714-720)
Optional Reading: RWJ Chapter 5 (pages 130-139)
Prepare: Argentum Partners (in the reader)
Walt Disney Company's Sleeping Beauty Bonds - Duration Analysis (Questions 1-16)
Topic: More on the NPV rule; bond valuation and duration.
Session 4: The Valuation of Stocks and Market Efficiency
Read: RWJ, Chapter 5 (pages 108-124)
RWJ, Chapter 13
Prepare: RWJ, Problems 5.17, 5.25 (pages 128-129)
RWJ, Problems 13.4, 13.6, 13.7 (pages 366-367)
A Visual Test of the Random Walk Hypothesis (in the reader)
Topics: Dividend discount model; price/earnings ratios; fundamentals and market prices; different forms of market efficiency.
Session 5 Valuing A Company's Stock: the Case of Interco
Prepare: Interco (assignment attached to the case)
Additional assignment might be handed out in class.
Topic: Valuation of a company's stock.
Session 6: Risk and Return
Read: RWJ, Chapter 9
RWJ, Chapter 10 (pages 242-264)
Review Data and Decisions (T265), Lecture 6 Notes
Prepare: RWJ, Problems 9.11 (page 238)
RWJ, Problems 10.3, 10.7, 10.16 (pages 277-278, 280)
Topics: Quantifying risk and return; introduction to modern portfolio theory; mean variance analysis; optimal portfolios and international diversification.
Session 7: Market Pricing of Risky Securities
Read: RWJ, Chapter 10 (pages 264-276)
How the CAPM Establishes Prices? (in the reader)
Prepare: RWJ, 10.20, 10.25, 10.31, 10.36 (pages 280-282)
Topics: Optimal portfolios of risk free and risky securities; capital market equilibrium and Capital Asset Pricing Model (CAPM)
Session 8: Capital Budgeting: Adjusting for Risk
Read: RWJ, Chapter 12 (pages 307-320)
Prepare: Assignment for Session 8 (in the reader)
Liz Claiborne (assignment can be found in the case)
Topics: Testing CAPM; adjust discount rates to risk; division and project required rates of return.
Session 9: More on Market Efficiency and the Determinants of Stock Returns
Read: RWJ, Appendix 10A (pages 283-284)
De Bondt, Werner F. M. and Richard H. Thaler, "Anomalies: A Mean-Reverting Walk Down Wall Street" (in the reader)
Ball, Ray, "The Theory of Stock Market Efficiency: Accomplishments and Limitations" (in the reader)
Optional Reading: Black, Fischer, "Beta and Return." (in the reader)
Topics: Private information and market efficiency; the debate about the risk factors affecting stock returns.
Session 10: Capital Structure and the Cost of Capital I
Read: RWJ, Chapter 14
RWJ, Chapter 15 (pages 390-408)
Topics: The capital structure decision; Modigliani and Miller propositions
Session 11: Capital Structure and the Cost of Capital II
Read: RWJ, Chapter 15 (pages 408-417)
RWJ, Chapter 16
Prepare: RWJ, Problems 15.2, 15.7 (pages 417, 419)
Topics: The effects of taxes and bankruptcy on capital structure and on the cost of capital
Session 12: Valuation and Capital Budgeting with Leverage
Read: RWJ, Chapter 17
Prepare: RJR Nabisco (assignment attached to the case)
Topics: Takeovers and leveraged buyouts (LBOs); adjusted present value.
Session 13: Options and Derivative Securities: An Introduction
Read: RWJ, Chapter 22 (pages 611-625)
Derivative Markets: Structure and Risks (in the reader)
Prepare: RWJ, Problems 22.6, 22.7, 22.8 (page 646)
Topics: Definition of options and derivative securities; arbitrage relations for derivative securities; Put-Call Parity
Session 14: Pricing Derivative Securities I
Read: RWJ, Chapter 22 (pages 625-633).
Exercise Policy of Calls and Puts (in the reader)
Prepare: RWJ, Problems 22.10, 22.12, 22.18 (pages 646-647)
Topics: Pricing derivative securities by arbitrage; dynamic trading strategies; Black-Scholes formula.
Session 15: Pricing Derivative Securities II
Read: RWJ, Chapter 23 (pages 650-655)
CEO Incentives - It's Not How Much You Pay, But How (in the reader)
Prepare: RWJ, Problems 22.22, 22.23 (page 648)
Sally Jameson (assignment, together with Instructions for Options Programs, is attached to the case.)
Topics: Risk and return on options; executive and employee stock options; executive compensation.
Session 16: Applications of Derivatives to Corporate
Read: RWJ, Chapter 22 (pages 633-645)
RWJ, Chapter 23 (pages 655-658, 665-667)
Prepare: RWJ, Problems 22.26, 22.27 (page 649)
Topics: Options in capital budgeting; stocks and bonds as options; conflicts of interest among claimholders.
Session 17: The Use of Convertible Debt
Read: RWJ, Chapter 24 (pages 680-690)
Tri-Tech Computers Inc. (in the reader)
Optional Reading: RWJ, Chapter 24 (pages 674-681)
Topics: Payoffs associated with convertible bonds under various contingencies; reasonable and unreasonable justifications for using convertible bonds.
Session 18: Initial Public Offerings (IPOs)
Read: RWJ, Chapter 19
Netscape's Initial Public Offering (assignment attached to the case)
Topics: The role of investment banks in IPOs; pricing phenomena associated with IPOs.
