introduction to finance and financial markets

15 Pages·2014·0.18 MB·English

by  Akash Deep

API 141
Finance

SYLLABUS
Nov 5, 2014

Akash Deep
API 141 Finance
Syllabus
Akash Deep
November 5, 2014
HARVARD Kennedy School
API-141, Fall 2014
Finance

Faculty Akash Deep
Office Littauer 213
Telephone [phone]
Email [email protected]
Office Hours Monday or Wednesday afternoons (sign-up outside Littauer-213)

Lectures Monday and Wednesday, 11:40 AM to 1:00 PM in Littauer-140
Review Session Friday, 11:40 AM to 1:00 PM in Starr

Faculty assistant Jessica De Simone
Office Rubenstein 110A
Telephone [phone]
Email [email protected]

Teaching Fellow Thomas Etheridge
Email [email protected]

COURSE DESCRIPTION
This introductory (but fast-paced) course provides a general survey of finance and investments. It
emphasizes an intuitive, logically rigorous understanding of the theory and practice of financial
markets, illustrating the concepts through examples and cases drawn from the public, private,
and non-profit sectors. Topics covered include: present value analysis and discounting,
diversification, the tradeoff between risk and return, market efficiency, pricing of stocks and
bonds, the capital asset pricing model, term structure of interest rates, the principle of arbitrage,
pricing of derivative securities (forwards, futures, and options), the use of derivatives for
hedging, risk management, and the regulation of financial markets.
AUDIENCE
The course is intended for students who are interested in learning the basic tools and techniques
of finance and how they are employed for the valuation of complex securities. While an intuitive
appreciation of the principles will be the primary objective, mathematical tools will be employed
to illustrate the implementation of these principles to practical cases. Any advanced mathematics
that is used will be developed in lectures and review sessions.
PREREQUISITE
It is assumed that students will be familiar with introductory concepts in economics (e.g. API
101) and basic (high school level) mathematics. Students with concerns about their backgrounds
are welcome to speak to the instructor. Basic computer spreadsheet skills will be expected, and
required to complete some of the assignments.
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API 141 Finance
Syllabus
Akash Deep
November 5, 2014
REQUIREMENTS
The course must be taken for credit. No auditors please.
Attendance: An alert, inquisitive presence in each and every class is mandatory. Attendance in
review sessions is strongly advised but not required.
Readings: Students will be expected to have completed the assigned readings before class and
review them after class. Note that there are required readings for the first day of class.
Assignments: Weekly problem sets will be assigned throughout the course to illustrate and
reinforce the concepts presented in class as well as in preparation of the case discussions to
follow.
Exam: There will be in-class, closed book and closed notes midterm and final exams. No make-
up exams will be held.
Grading: Class Participation 10%
Written assignments 20%
Midterm Exam 30%
Final Exam 40%
MATERIALS
The textbook for the course, Essentials of Investments, 9th edition by Zvi Bodie, Alex Kane and
Alan Marcus, McGraw-Hill Irwin, 2013 (referred to as “BKM” below). The textbook can be
purchased online.
Readings and cases are available online on the course web page accessible through KNet. Non
HKS students should request HKS Credentials to log into KNet. Instructions for this can be
found at
Regular reading of financial news in publications such as The Wall Street Journal, The Financial
Times or the Business pages of The New York Times is strongly recommended.

OTHER RECOMMENDED (BUT NOT REQUIRED) FINANCE TEXTS
The following are some good introductory finance texts that overlap in parts with the material
covered in the recommended text for this class:
Corporate Finance, 10th edition, Stephen Ross, Jeffrey Jaffe, and Randolph Westerfield, 2012.
Principles of Corporate Finance, 11th edition, Richard Brealey and Stewart Myers, The
McGraw-Hill Companies, 2013.

These are some additional intermediate to advanced texts devoted to asset pricing:
Modern Portfolio Theory and Investment Analysis, 8th edition, Edwin Elton, Martin Gruber,
Stephen Brown and William Goetzmann, John Wiley and Sons, Inc. 2009.
Investment Science, 2nd edition, David Luenberger, Oxford University Press, Inc. 2013.
Options, Futures, and Other Derivatives, 8th edition, John C. Hull, Prentice Hall, 2011.
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TOPICS AT A GLANCE

No Date+ Topic Assignment
. due
1 Sep 5 (F) Introduction to finance and financial markets

2 Sep 8 Present value and the opportunity cost of capital
3 Sep 10 Valuing financial securities: Bonds
4 Sep 15 Valuing financial securities: Equity A

5 Sep 17 Diversification, risk, and return measures
6 Sep 22 Case: The State of South Carolina B
7 Sep 24 Choosing a portfolio
8 Sep 29 The Capital Asset Pricing Model C

9 Oct 1 Efficient markets

10 Oct 6 Case: Communications Satellite Corporation D

11 Oct 8 Arbitrage

12 Oct 15 Midterm Exam

13 Oct 20 Risk management
14 Oct 22 Forward and futures contracts
15 Oct 27 Case: Dozier Industries E

16 Oct 29 Options
17 Nov 3 Case: BASIX F
18 Nov 5 Pricing of options
19 Nov 7 (F) Guest Speaker: Colin MacNaught, Debt Management, State of MA

20 Nov 10 Real options G
Nov 12 (No class)
21 Nov 17 Case: Bidding for Antamina H
22 Nov 19 Case: Federal Deposit Insurance Corporation
23 Nov 24 Case: Subprime Meltdown

24 Dec 1 Financial institutions and policy
25 Dec 3 Review

Dec 11 Final exam (2 to 5 PM)

+ Friday class sessions will be held from 11:40 AM to 1:00 PM
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INTRODUCTION TO FINANCE AND FINANCIAL MARKETS

Required Readings

Introduction to finance and financial markets

“The New Capitalism, How Unfettered finance is fast reshaping the global economy”, Martin Wolf, The
Financial Times, June 19, 2007.

“Introduction: Finance, Stewardship, and Our Goals”, in Finance and the Good Society, Robert J. Shiller,
Princeton University Press, 2012, 1-15.

Chapters 1 and 2, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

Additional Readings

Chapters 3 and 4, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

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VALUATION: PRICING STOCKS AND FIXED INCOME SECURITIES

Required Readings

Present value and the opportunity cost of capital

Chapters 2 and 3, Principles of Corporate Finance, 7th edition, Richard Brealey and Stewart Myers, 2003,
12-50.

Valuing financial securities: Bonds

Chapter 10, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

Valuing financial securities: Equity

Chapter 13 and Section 14.1, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

Additional Readings

“Uses, Abuses, and Alternatives to the Net Present Value Rule”, S. Ross, Financial Management, Vol.
24, 96-102, 1995.

“Market Myths”, G. Bennett Stewart, III, Journal of Applied Corporate Finance, Vol. 2, No. 3, Fall 1989,
6-23.

“Do Stock Prices Reflect Fundamental Values?”, J. Randall Woolridge, Journal of Applied Corporate
Finance, Spring 1995, 64-69.

“Valuation Models for Default-risky Securities: An Overview”, Saikat Nandi, Federal Reserve Bank of
Atlanta Economic Review, Fourth Quarter 1998

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PORTFOLIO SELECTION

Required Readings

Diversification, risk, and return measures

Chapter 5, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

“Risk, Market Sensitivity, and Diversification”, William F. Sharpe, Financial Analysts Journal, Jan-
February, 1995, 84-88.

Choosing a portfolio

Chapter 6, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

“You, too, Can Short Stocks”, Business Week, March 22, 1999

“Long & Short: It’s a Tough Job, So Why Do They Do It? The Backward Business of Short Selling”,
Jesse Eisinger, The Wall Street Journal, March 1, 2006, p C1.

Case: The State of South Carolina

HBS case # 9-201-061
South Carolina, State Treasurer's Office, 1998. Until last year the state pension fund, with over $17
billion in assets, was barred by the state constitution from investing in equities. After the constitution was
amended, the state government has to decide how much to invest in equities, and what assets to choose.

Additional Readings

“Why Not Diversify Internationally rather than Domestically?”, Bruno H. Solnik, Financial Analysts
Journal, Jan-Feb, 1995, 89-94.

"Estimating Expected Return", Fisher Black, Financial Analysts Journal, Jan-Feb 1995, 168-171.

"Why No One Can Tell Who's Winning", J. Michael Murphy, Financial Analysts Journal, May-Jun 1980,
49-57.

"Portfolio Optimization in Practice", Phillipe Jorion, Financial Analysts Journal, January-February, 1992,
68-74.

"Portfolio Theory versus Portfolio Practice", Richard Brealey, Journal of Portfolio Management, Summer
1990, 6-10.

"The Persistence of Risk: Stocks versus Bonds over the Long Term", Martin Leibowitz and William
Krasker, Financial Analysts Journal, November-December 1988, 40-47.

“Global Stock Markets in the Twentieth Century”, Philippe Jorion and William Goetzman, Journal of
Finance, 1999, Vol. 54, no. 3, 953-980.

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THE CAPITAL ASSET PRICING MODEL

Required Readings

The Capital Asset Pricing Model

Sections 7.1-7.3, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

“Risk and Return” The Economist, February 2nd 1991, 72-73.

“Does the Capital Asset Pricing Model Work?” David Mullins, Jr., Harvard Business Review, January-
February, 1982, 105-113

Case: Communications Satellite Corporation

HBS Case No. 276-195
In January 1975, the Federal Communications Commission (FCC) concluded an 11-year
investigation of the appropriate regulation of Comsat. One of the most important of these
was the determination of the fair rate of return on Comsat's capital. Both the qualitative
assessment of risk and the use of analytical techniques had been suggested by eminent
experts.

Additional Readings

"Prediction of Beta from Investment Fundamentals", Barr Rosenberg and James Guy, Financial Analysts
Journal, Jan.-Feb., 1995.

"The Capital Asset Pricing Model and the Market Model", Barr Rosenberg, Journal of Portfolio
Management, Winter 1981.

"Beta and Return", Fisher Black, Journal of Portfolio Management, Fall 1993.

"Efficient? Chaotic? What's the New Finance?" Nancy Nichols, Harvard Business Review, March-April,
1993, 2-7.

"Beta and Return", Fisher Black, Journal of Portfolio Management, Fall 1993, 8-17.

"In Defense of Beta", S.P Kothari and Jay Shanken, Journal of Applied Corporate Finance, Spring 1995,
53-58.

"Tale from the FAR Side", The Economist, November 16th 1996, 86.

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EFFICIENT MARKETS

Required Readings

Efficient markets

Chapter 8, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

“Random Walks in Stock Market Prices”, Eugene F. Fama, Financial Analysts Journal, Jan-February,
1995, 75-80.

“The Efficient Market Hypothesis and its Critics”, Burton G. Malkiel, Journal of Economic Perspectives,
Winter 2003 17 (1) 59-82.

“The Efficient Market Theory Thrives on Criticism”, Dwight Lee and James Verbrugge, Journal of
Applied Corporate Finance, Vol. 9, No. 1, Fall 1996, 35-40.

“Efficiency and beyond” The Economist, July 16th 2009.

Additional Readings

“Behavioral Finance and Technical Analysis”, Chapter 9, Essentials of Investments, 9th edition, Bodie,
Kane & Marcus, 2009.

"Implications of the Random Walk Hypothesis for Portfolio Management", Fisher Black, Financial
Analysts Journal, March-April, 1971, 16-22.

"The Theory of Stock Market Efficiency: Accomplishments and Limitations", Ray Ball, Journal of
Applied Corporate Finance, Spring 1995, 4-17.

"How Rational Investors Deal with Uncertainty (Or Reports of the Death of Efficient Markets are Greatly
Exaggerated)", Keith Brown, W. Harlow, and Seha Tinic, Journal of Applied Corporate Finance, Fall
1989, 45-58.

"I've Got the Horse Right Here: Sports Betting and Market Efficiency", Martin Fridson, Journal of
Applied Corporate Finance, Summer 1993, 88-95.

"The Impact of Macroeconomic News on Financial Markets", Louis Ederington and Jae Lee, Journal of
Applied Corporate Finance, Spring 1996, 41-49.

Manias, Panics & Crashes: A History of Financial Crises, 3rd edition, Charles Kindleberger, John Wiley
& Sons, Inc., 1996.

Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life, 2nd edition, Nassim
Nicholas Taleb, Thomson South-Western, 2004.

“A Survey of Behavioral Finance", Nicholas Barberis and Richard Thaler, Chapter 18 in Handbook of the
Economics of Finance, G. Constantinides, R. Stulz, M. Harris eds., North Holland, Amsterdam, 2003.

"Do fundamentals—or emotions—drive the stock market?", Marc Goedhart, Timothy Koller, and David
Wessels, The McKinsey Quarterly, March 2005.
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ARBITRAGE PRICING

Required Readings

Arbitrage

"Death by the Numbers", David Kestenbaum, Science, February 26, 1999, 1244-1247.

Additional Readings

“Hedge Funds”, Chapter 20, Essentials of Investments, 9th edition, Bodie, Kane & Marcus, 2013.

“What Every CFO Should Know About Scientific Progress in Financial Economics…”, Richard Roll,
Financial Management, 23 (2), Summer, 1994, 69 - 75.

“Arbitrage”, Stephen Ross and Philip Dybvig, The New Palgrave, 1989, 57 - 71.

“The Arbitrage Principle in Financial Economics”, Hal Varian, The Journal of Economic Perspectives,
Autumn, 1987, 55-72.

“How the Eggheads Cracked”, Michael Lewis, The New York Times, January 24, 1999, p 24, Column 5.

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