© 2007 by Andrew W. Lo All Rights Reserved SLOAN SCHOOL OF MANAGEMENT MASSACHUSETTS INSTITUTE OF TECHNOLOGY Andrew W. Lo Summer 2007E52–454 3–9745 15.414 Financial Management This course provides a rigorous introduction to the fundamentals of modern financial analysis and applications to business challenges in capital budgeting, project evaluation, corporate investment and financing decisions, and basic security analysis and investment management. The four major sections of the course are: (A) an introduction to the financial system, the six unifying principles of modern finance, and fundamental present-value relations; (B) valuation models for stocks, bonds, forwards, futures, and options; (C) methods for incorporating uncertainty into valuation models, including portfolio theory, mean-variance optimization, and the Capital Asset Pricing Model; and (D) applications to corporate financial decisions, including capital budgeting, project financing, and corporate risk management. Course Materials  R. Brealey, S. Myers, and F. Allen, Principles of Corporate Finance, 8th edition, Irwin/McGraw Hill. – ‘Brealey, Myers, and Allen’ is the world’s most popular finance text. It provides a thorough introduction to financial theory and practice.  Class Notes – Class notes will be distributed in class and available on SloanSpace. They contain material not found in Brealey, Myers, and Allen, and provide alternate perspectives on the major themes of the course.  Reading Packet – The reading packet, available from Copy Tech, contains cases and a few additional readings. Course Requirements and Grading Grades will be determined by class participation (15%) and your performance on the assignments (45%) and final exam (40%).15.414 © 2007 by Andrew W. Lo Page 2 of 8 All Rights Reserved As noted in the course outline, there will be 4 written assignments, consisting of both problem sets and cases. The problem sets should be fairly straightforward. Cases are more difficult and will be discussed in class on the day they are due. You should work together on the assignments in groups of four. Please bring the case write-ups and problem solutions to class. Recitations Katy Kaminski ([email protected]), a Sloan PhD student, will hold recitations as indicated in the course outline. During recitations, Katy will review class material and present additional applications and problems. Katy will also be available outside of class for additional help. Students seeking intensive one-on-one help should talk with Professor Lo or Marsha Warren about additional resources that are available. Administrative Assistant Sarah Grosvenor, E52–450, (617) 253–9745, [email protected]. Additional Readings (not required) P. Bernstein, Capital Ideas, Free Press, 1993. – Bernstein is one of the most well-respected and influential practitioners in the financial industry, and the founding editor of the Journal of Portfolio Management. This is a lively and beautifully written account of the most important ideas in academic finance, many of which were developed at MIT in the 1960’s and 1970’s. Z. Bodie, A. Kane, and A. Marcus, Investments, 4th edition, Irwin/McGraw Hill, 1999. – BKM focus exclusively on capital markets. They provide a more rigorous and thorough analysis of investments than Brealey, Myers, and Allen. J. Hull, Introduction to Futures and Options Markets, 3rd edition, Prentice Hall, 1998. – Hull provides a straightforward introduction to options, futures, and swaps (collectively called financial derivatives). The book discusses the valuation of these securities, the mechanics of trading, and the use of financial derivatives in managing risk.15.414 © 2007 by Andrew W. Lo Page 3 of 8 All Rights Reserved Course Schedule This is an approximate schedule for the course; some material may take longer or shorter to cover than the time allotted. Week Session Date – A Date – B Topic Assignment Due 1 1 Jul 24 Jul 24 Introduction 2 Jul 25 Jul 25 Present Value Relations 1 3 Jul 25 Jul 25 Present Value Relations 2 4 Jul 26 Jul 26 Fixed Income Securities 5 Jul 27 Jul 27 Equity Securities 2 6 Jul 30 Jul 30 Trading Lab Session Problem Set 1, Case 7 Jul 31 Jul 31 Futures and Forward Contracts 8 Aug 2 Aug 2 Options 9 Aug 3 Aug 3 Introduction to Risk and Return 3 10 Aug 6 Aug 6 Risk Analytics Problem Set 2 11 Aug 7 Aug 7 Portfolio Theory 12 Aug 9 Aug 9 The CAPM 13 Aug 10 Aug 10 The APT and Other Extensions 4 14 Aug 13 Aug 13 Practical Considerations Problem Set 3, Case 15 Aug 14 Aug 14 Capital Budgeting 1 16 Aug 16 Aug 16 Capital Budgeting 2 17 Aug 17 Aug 17 Corporate Financing 1 5 18 Aug 20 Aug 20 Corporate Financing 2 Problem Set 4, Case 19 Aug 21 Aug 21 Corporate Risk Management 20 Aug 22 Aug 22 Market Efficiency Aug 23 Aug 23 Final Examination Examination Recitations Week Session Date – A Date – B Topic 1 1 Jul 27 Jul 27 Discounting and Present Value2 2 Jul 31 Jul 31 Common Stock 3 Aug 3 Aug 3 Options and Futures 3 4 Aug 7 Aug 7 Risk, Return, and Statistics 5 Aug 10 Aug 10 Portfolio Theory and CAPM 4 6 Aug 16 Aug 16 Capital Budgeting 5 7 Aug 21 Aug 21 Review15.414 © 2007 by Andrew W. Lo Page 4 of 8 All Rights Reserved Course Outline Chapters listed below refer to the main course textbook, Brealey, Myers, and Allen; articles referenced using the authors’ last names are provided in the Readings Packet. PART A. INTRODUCTION July 24 Introduction to Finance and Course Overview Chapter 1–2  Financial decisions of households and corporations  Objectives of corporate financial managers.  Approaches to valuing financial and real assets  The role of financial markets  Unifying principles of finance Read Kahneman and Tversky (1982), Maloney and Mulherin (2003) July 25 Present Value Relations 1 Chapter 3  Net Present Value (NPV)  Opportunity cost of capital  Discount rates and the time value of money PART B. VALUATION July 25 Present Value Relations 2  Mechanics of NPV calculations  Compound interest  Annuity and perpetuity formulas  Real vs. nominal cash flows July 26 Fixed Income Securities Chapters 23–25  Fixed-income markets  Term structure of interest rates  Market conventions,