AF250: Finance

Session: One

Prerequisites: Introductory microeconomics, elementary quantitative methods

Dr Dong Lou
Dr Juanita Gonzalez-Uribe

The course is divided into two parts: one covering asset markets and the other covering corporate finance. The asset-markets part will give a unified perspective of modern valuation methods in the context of three important asset classes – fixed income, stocks, and derivatives. The starting point of valuation is the present-value formula. The course will then proceed to fixed-income securities, focusing mainly on government bonds and emphasizing the relation between valuation and no-arbitrage. The course will then move to stocks, starting with basic notions of risk, return, diversification, and portfolio theory. We will then discuss the capital asset pricing model (CAPM), which shows how risk should be priced in market equilibrium. The course will next examine whether the market values stocks efficiently, or whether there are “abnormal” returns leading to large profits. The last topic will be derivatives, especially futures and options.

The questions addressed in the corporate-finance part can be divided in two broad sets. Decisions regarding how to spend funds on alternative investment projects constitute the first part, usually referred to as capital budgeting. Here the course will describe the alternative techniques commonly employed to assess investment opportunities. The second set of questions regards how to raise funds necessary to finance those investments. There, firms’ decisions over debt/equity ratios will be analyzed. The analysis will then broaden to allow for the possibility that debt/equity choices may affect how firms are run. Incentives to adopt riskier strategies as a function of overall leverage will be considered, as will the debt overhang problem be.

The topics covered will include:

  • Net Present Value technique
  • Introduction to portfolio theory
  • The Capital Asset Pricing Model (CAPM)
  • Stock market efficiency
  • Forward and futures contracts, option pricing
  • Investment decisions and the significance of real options
  • Capital structure and dividend decisions
  • Capital restructuring: Initial Public Offerings 

R.A. Brealey, S.C.Myers, and F. Allen, Principles of Corporate Finance, McGraw-Hill (2007)
Jonathan Berk, Peter De Marzo, Corporate Finance, Pearson International Edition (2007).

Lectures: 36 hours    Classes: 12 hours
Assessment: Two written examinations