ECON 457: Finance

Fall 2005

General information

  • Time and place:  10:50  - 11:50 am,  MWF,  C-304
  • Instructor: Florin Bidian
  • E-mail: bidian@macalester.edu
  • Phone: (651) 696-6764
  • Office: C-306
  • Office hours: Mo 3:20 - 4:30pm; We 3:20-4:30pm; Fr 9:45-10:45am 

Prerequisites: Econ 113, 361 and 381. Knowledge of calculus and statistics is required. Familiarity with Excel is assumed.

Course objectives and synopsis:

Finance is about value. Here, we will focus on  how the manager of a corporation tries to create value by manipulating the two sides of a firm’s balance sheet. On the asset side (left hand side), he selects real projects, which represents the investment decision (or capital budgeting). On the liabilities side  (right hand side), through the financing decision, the manager chooses a financing mix to fund the real projects undertaken. The famous Modigliani-Miller theorem about the irrelevance of the capital structure suggests most value is created by the investment decision (LHS), hence we start by developing a theory of valuation to aid corporate managers in financial decision making. We apply this theory to the valuation of financial assets (bonds and stocks), as well as to the real investment decision (projects) of the firm. In the second part we will analyze the financing and payout policies of the firm. On the way we will present the centerpieces of modern financial economics: the capital asset pricing model, the arbitrage pricing model, the efficient market hypothesis, the option-pricing model.

In a nutshell, we will argue that the manager should pick projects yielding a return greater than the minimum acceptable hurdle rate. He should choose a financing mix that maximizes the value of the project undertaken, and matches the assets being financed. If projects with superior returns (above the hurdle rate) are missing, the managers should return the cash to the owners (stockholders). Whether the cash is returned as dividends or through stock repurchases represents the dividend (payout) decision.

After taking this class you should be able to fully understand the major issues concerning investors, financial managers and other players in the financial markets. Also if you interview for a job related to Finance you should appear as well-read, aware of the important issues and with a good grasp of the pertinent tools. The textbook will be also a good preparation for the Chartered Financial Analyst exam.

 Text:

Brealey, Myers and Allen (2005), Principles of Corporate Finance, 8th Edition, Irwin McGraw Hill.

It is a comprehensive textbook (BMA henceforth) for courses in Finance, with a lot of institutional detail in addition to the cornerstone models of modern finance.  The lecture notes I will provide as we go along will be also a required reading. They will add a lot of detail on some issues and build some new models.

WWW Homepage

The URL for this class is http://www.macalester.edu/~bidian

A copy of this syllabus is available online. Material from lectures will also be posted following (or before)  the lectures. The homeworks will be available for downloading on the class homepage. The homepage also provides links to some web sites related to Economics.

Grades:

Probability and Statistics test       1%
Project (case study)                   9%
Homework Assignments                  20%
Midterm                               25%
Final                                 45%

I will also give up to 3% bonus points to students that enhance the quality of the class discussion.

Grading scale:

A

A-

B+

B

B-

C+

C

C-

D+

D

F

92%-100%

90%-91%

88%-89%

82%-87%

80%-81%

78%-79%

72%-77%

70%-71%

68%-69%

60%-67%

-59%

I reserve the right to lower the cutoffs but not to raise them.

Homeworks/Exams
There will be 4 homeworks. Each assignment is due at the beginning of class at the due date. Solutions will be posted on the due date, thus no late assignments are accepted.  If  a medical certificate is provided, the average on the other homeworks will be applied towards the missed homework. Collaboration is encouraged, however you have to submit the homework individually. Homework will consist of problems and data exercises. Excel will be needed to solve some of the problems and the data problems.

Statistics Background Test (Sept. 9th.): This test will help you refresh some probability and statistics concepts that will be used later in the class. It will  also give you a hint of the statistics and probability  background that will be required in order not to struggle in this class.

Project: this is discussed here.

There is a midterm and a final exam. The midterm is during the regular class hours and the final's time is listed below. Both exams are closed book, but you can bring one (regular size, i.e. 8x11) sheet of notes for the midterm (one-side) and final (two-sides). You need to bring a simple calculator, that handles exponents and logarithms. No devices that can be connected to the net or that can serve as database storage (i.e. palms) are allowed. You must take the midterm and final exams at the scheduled times. If the midterm must be missed for a documented excuse, the final will carry the extra weight. The final must be taken at the scheduled time. The final is cumulative. Homeworks are the best preparation for the exams. Make sure you are able to solve to homework problems with ease.

Tentative Class Schedule

I will attempt to follow the schedule outlined below. For a list of practice problems, click here (Q-questions, P – problems, C – challenge questions):

Week

Class

Readings (BM)  and practice problems

Remarks

1-Sep 7

Sep 9

Introduction -overview of the course; what finance is about, objective of the firm

Probability and Statistics test

Ch 1

Your old statistics notes

 

2-Sep 12,14,16

Present Values -present and future value, compounding, perpetuities, annuities

Ch 2, Ch 3

 

3-Sep 19,21,23

Valuation of bonds and stocks. Term structure of interest rates

Ch 4,  Ch 23

HW 1 handed out

4-Sep 26,28,30

Evaluating projects – internal rate of return, U.S. tax code, general rules for capital budgeting

Ch 5, Ch 6

HW 1 due

5-Oct 3,5,7

Risk and return; Portfolio theory – historical evidence; statistics review; measuring the risk of a portfolio, diversification

Ch 7

 

6-Oct 10,12,14

The Capital Asset Pricing Model (CAPM)  - derivation and uses of CAPM, quantifying the tradeoff between risk and return

Ch 8

HW 2 handed out

7-Oct 17,19,21

Discount rates in practice – estimating betas, market risk premium, multifactor models, WACC

Ch 9

 HW 2 due

8-Oct 24

Oct 26

Oct 28 

MIDTERM

What is happening inside the firm I? – sensitivity analysis, where present value comes from, capital budgeting

FALL BREAK - NO CLASSES

Ch 10, Ch 11

 

9-Oct 31

 Nov 2,4

What is happening inside the firm II? – capital budgeting

Market efficiency -notions of ME, statistical evidence, implications

Ch 12

Ch 13

 

10-Nov 7,9,11

Raising capital – sources of funds, tradeoffs, empirical evidence, stock market reaction

Ch  14, 15

 

11-Nov 14,16,18

Capital structure I – choice between debt-equity, MM theorem, leverage and risk

Ch 17

 HW 3 handed out

12-Nov 21,23

Nov 25

Capital structure II – taxes and after-tax WACC, financial distress

THANKSGIVING – NO CLASSES

Ch 18, Ch  19.1 -19.4

 

 

13-Nov 28,30

Dec 2

Payout policy

Options and financial derivatives I – introduction, put-call parity

Ch 16

Ch 20

HW 3 due

 

14-Dec 5,7,9

Options II - binomial option pricing, introduction to Black-Scholes model

Ch 21

HW 4  handed out

15-Dec 12,14,16

Review

Prepare questions to ask me

 HW 4 due

 Dec 21 (Wed)

Final Exam:   8:00 AM - 10:00 AM

 

 


Return to the class page