1Foundations of Finance (B09.2316)Spring Semester, 1998.InstructorProfessor Anthony Lynch, 9-13 Tisch, phone: (212) 998 0350.Course ContentThis course is about financial markets and how financial assets (securities) are valued and traded. Most of this course is taught from the viewpoint of the user of a financial market: an investor,investment advisor or someone using the market to hedge risk. Although much of what we coveris relevant to corporate finance (that is, financial decisions within the firm), this area is not theprimary focus of the course. Only rarely will we take the viewpoint of a corporate chief financialofficer dealing with internal decisions. This perspective is covered in great detail in CorporateFinance, a separate subsequent course.PrerequisitesThe prerequisites for this course are all core courses in accounting, statistics, operations research andeconomics. Finance is very mathematical and you will need to utilize material developed in theprerequisite courses. If you have not taken these courses, it is highly likely that you will havedifficulty in this one.GradingYour grade will be based on a midterm exam and a final exam. The midterm exam will be worth45% and cover the first half of the course. The final will be worth 55% and cover the entire course. However, if your grade on the final is better than your midterm grade, the final will count for theentire 100%. The date for the midterm exam will be set in the first two weeks of class. Please keepthis date free. No makeup exam for the midterm will be given; makeup exams for the final may begiven only during the first week in June. Both exams will be closed book except as follows: one 8.5"x 11" sheet with anything written on it can be taken into the midterm and two 8.5" x 11" sheets canbe taken into the final. The curve for this course is the one established by the Finance Department for the introductorycourse: A (10%-15%); B (40%-65%); C (15%-25%); D, F (remainder). Problem SetsProblem sets will be assigned throughout the semester, and solutions will be distributed. You arestrongly encouraged to attempt the problem set questions. These questions are designed to reinforceconcepts learnt in class. Finance involves applying theory to solve problems and the only way tolearn how to do this is by solving problems.2TextbooksRequiredBodie, Kane and Marcus, Investments, Third Edition, Irwin (BKM).Solutions Manual, BKM (SM).Ross, Westerfield and Jordon, Fundamentals of Corporate Finance, Second Edition, customversion containing Chapter 5, Irwin (RWJ).OptionalElton and Gruber, Modern Portfolio Theory and Investment Analysis, Fifth Edition, JohnWiley and Sons.Course OrientationBy its very nature, finance is mathematical and theory based. However, most of the theory coveredin this course has immediate practical applications and implications. These will be emphasized asmuch as possible especially before introducing the theory so as to motivate why its being taught. Concepts will wherever possible be illustrated using real data that has been obtained from the WallStreet Journal or some other data service. Every effort will be made to highlight how the theory andconcepts taught in this course would be used by an investor to make real decisions.MiscellaneaSupplementary Material: Other readings and notes will be distributed in class and are anintegral part of the course. Reading of the Wall Street Journal or the financial sections ofthe New York Times is also encouraged.Class Attendance: You are responsible for knowing what occurs in class which may includematerial not covered in the readings, modifications to the syllabus and announcementsconcerning exams.Calculator: To solve financial problems, you will need a financial calculator. In additionto the standard operations (+,-,×,÷), it should be able to compute ex and ln(x) (the exponentialand natural log functions) and should be able to compute present and future values of simplesums and annuities. An ability to compute internal rates of return is sometimes useful butis not required. Suitable calculators include the Hewlett-Packard 10B, 14B and 12C, theTexas Instruments BA II Plus and the Sharp EL 733A. Cheating: If evidence of cheating comes to my attention by any means, I will prosecute tothe extent permitted under faculty guidelines.Use of E-mail: From time to time, I will use E-mail to communicate with you, so you shouldtry and check your E-mail regularly.Where to go for helpThe availability of the TAs for this course will be announced in class. My office hours also will beannounced in class.3Organization of the CourseNumberof Sessions Topic Reading1 Overview BKM Ch 1, skim Ch 23 Time Value of Money RWJ Ch 51 Equities: Characteristics and Markets BKM Ch 3.2-3.71 Stock Positions and Portfolio Return BKM Ch 3.6-3.7 and 4.24 Portfolio Management BKM - Characterizing the return distribution Ch 4.2; A2-A8, A19-A34 - Asset allocation between one risky Ch 5, 6 (partic. 6.3)and one riskless asset - Diversification with two risky assets Ch 7.1-7.3 - Diversification with many risky assets Ch 7.4-7.52 Capital Asset Pricing Model (CAPM) BKM Ch 8.1, 9 (not 9.3)1 More General Asset Pricing Models BKM Ch 8.2, 25.2 and 29.21 Midterm Exam1.5 Asset Pricing Models and Market Efficiency BKM Ch 11 and 12.1-12.21.5 Fixed Income Markets BKM Ch 2.1-2.2 and 13.1-13.43 Bond Pricing and No-arbitrage BKM Ch 141 Bond Portfolio Management BKM Ch 15.1-15.22 Derivatives: Definitions and Payoffs BKM Ch 19.1-19.4, 21.1-21.31.5 Options: Valuation BKM Ch 20 (not 20.3)1.5 Futures and Forward Contracts: Valuation BKM Ch 21.4, 22 (not 22.5)1 Valuation Models BKM Ch 17 (not