Institutional and Intellectual Context of the course:

This class serves as an introduction to, and survey of the field of finance. The emphasis is on the use of finance as a tool in corporate management. Finance is a framework to translate strategic decisions into value. The job of a CFO is to develop a comprehensive model of the firm that enables this activity.

Finance starts with financial markets. Any financial analyst or CFO has to understand how the financial markets work, and what financial prices mean. The first part of our course (comprising 510A) is therefore focused on the markets. Financial markets are messy, and in this class we do not use simplified, stylized examples, but actual market outcomes. The reason that corporate decision makers have to understand what financial market prices mean, is that the prices for time, default, and risk that we can meausre from these prices, are needed to assess the valuation impact of corporate decisions. The second part of our course (comprising 510B) is focused on financial decision-making.

The overarching intuition behind finance derives from the principle of arbitrage and the discipline of prices in financial markets. We start with the financial markets to learn how decisions that we make--whether inside a firm or in our personal portfolios--affect value. Of course value is determined in financial markets. We learn from the financial markets about the value of time, measures of risk, and the price of that risk. Then we use that information to consider the effect that our decisions have on value. Arbitrage simply means that if two (potentially very different looking) assets generate the same cash flows in the future, then they must have the same price today.

At the heart of valuation is the present value of future cash flows. Determining present value means that we have to account for the timing of future cash flows, and the time-value of money. Additionally we have to account for the riskiness of future cash flows. Furthermore, strategic decisions often entail the creation and/or destruction of ``real options.'' A key aspect of Finance is reference to financial markets to remove subjectivity from the valuation process. This means that we have to understand the institutional structures of the financial markets.
We also have to understand how economic activities such as capital projects and research and development are financed. There is a link between the nature of an investment and its optimal financing mix. At one extreme an asset that can be pledged as collateral may be financed with relatively cheap debt. At the other extreme, R&D has low collateral value, and has high agency and verification costs so it must be financed with expensive equity.

Accordingly the course proceeds through these steps:

1. Time Value of Money
   1. The mechanics of discounting
   2. The market for US Treasury securities
2. Risk
   1. Expected loss -- example CAT Bonds
   2. Expected loss that is correlated with economic activity -- example AAA Corporate Bonds
3. Debt financing

   Break between FIN 510A and 510B

4. Equity
   1. Basic statistics of stock returns
   2. Basic portfolio mathematics (diversification)
5. Financing mix: Debt and equity and the weighted average cost of capital
6. Identification of future after-tax cash flows
7. Agency problems when positive value projects generate negative accounting earnings.
8. Identification of the dynamic considerations of strategic decisions (i.e., ``Real Option'' valuation)

Conduct of Course and Grading:

I will evaluate you based on the quality of class participation--both in class and in my office, and ad-hoc problem sets. Problem sets must reflect your individual work, and you may be asked to demonstrate your work in my office.

Grading Rubric:

• At the beginning of the semester, I give each student 60 points,
• I will deduct points as follows:
  • Missing a class without a valid excuse provided in advance: -8 points
  • If Jaffe or I see a cell phone in your possession in class: -2 points
  • Coming to class late: Every portion of 5-minute intervals: -2 points (to max -8)
  • If Jaffe or I see non-professional material (non class-related) on laptop: -4 points
  • Talking with a neighbor -- outside of group work times: -3 points
• You will earn points by correctly responding to in-class questions, performing in-class exercises, demonstrating depth of understanding during office hours, and occasional / ad-hoc problem sets. We have a class spinning wheel to randomly call on students.
  • Points awarded will depend on the type of question and the quality, comprehensiveness, and thoughtfulness of your answer.
  • In-class exercises-- in which you are requested to build a spreadsheet in front of the class-- are worth more than in-seat responses. The former may carry as many as 10 possible points and the latter up to 2.
  • Asking an insightful question that reveals a depth of understanding: 1 point (to a maximum of 6 points).
  • Bringing in an article from the business press that relates to class material -- provided you provide the context and some analysis: 1 or 2 points (to a maximum of 10 points).
  • Points may be earned by office visits as well as in class. The visit must demonstrate progression and understanding of the material. Points available: 0 - 4 points per visit.
  • Points are awarded for being the first to identify any errors in my on-line class materials.
• Note that points will only be deducted for unprofessional behavior. And points can only be earned by demonstrating mastery and understanding of the material. The goal is understanding finance as a process for strategic decision making.

Learning Outcomes

• Appropriately discount future cash flows to obtain their present value -- both lump sums and annuities.
• Explain the role of interest rates in our economy and the meaning of the term structure of interest rates.
• Analyze current financial and economic conditions from a finance perspective.
• Comprehend and correctly use financial terminology typically used by financial managers.
• Evaluate and interpret the information available in the capital markets.
• Value securities and break down the risk/return profile of the various sources of capital.
• Explain the role capital markets play in financial management.

Actual financial markets have many confusing institutional features and conventions with which we must be familiar before we can extract the valuable information contained in market prices. Once we crack this code we can glean the information contained in those prices. We need this information to understand how decisions that we make will affect value.

Analytical Tools:

• Extract spot rates from financial press, e.g., Bloomberg.
• Develop an understanding of the law of one price (LOOP) and the absence of arbitrage.
• Apply the LOOP / absence of arbitrage in the US Treasury Market.
• Understand how a hazard function characterizes expected losses.
• Link US Treasury yields and hazard rates to value catastrophe bonds.

We must understand not only the institutions that generate market prices, but also the mathematical representation of how future cash flows relate to observed market prices. Without this we would not be able to model how decisions that we make will affect value.

How to Succeed in My Class

1. Pay attention and ask questions in class. Learning the material starts with my presentation and our working through examples in class. If you do not do this you start the week behind where you have to be. Our class sessions are the most important learning times.
2. Start working on the problem set / old quizzes as soon as possible after the class. The problem sets are not trivial. They require thought and time. I do not want you to memorize very much -- I want you to think, and apply constructs appropriately.
3. Once you start working on a problem set, if something is unclear (even if you get the right answer), send an e-mail to me or Jaffe. This feedback loop highlights the importance of the above 2 points, about time management.
4. If you think you are no good in math, you are wrong. Please read this article. Quantitative and analytical material takes patience and quiet time. Once again, time management! If you are confident in your math and analytical skills, it is because you are patient and not afraid of quiet, solitary study.
5. Review the class notes from Tuesday's class and work on the assigned problem sets and old quizzes before Thursday's class. My recommendation is to spend 3-5 hours as soon as possible after the Tuesday class on the material for the next problem set. Come to Thursday's class aware of what you know and don't understand, and then take full advantage of the Thursday class. Then, spend 3-5 hours after this class filling in the questions you had from Tuesday, and developing a confidence in answering the example problems and conceptual questions. I hate to lay out specific time recommendations because the amount of time needed to learn will vary widely from one student to another. It will also depend critically on the quality of the time you put in. Quiet and focused preparation--with no distractions-- is imperative!
6. If you do not understand something, send me a spreadsheet that shows what you do understand and where your understanding stops. Once again note that the repsonsibility to initiate preparation of your own individualized understanding of the material falls on you.
7. And related to time management and thinking: as the New York Times reminds us: Get enough sleep! As this article points out an all-nighter might help if you have to regurgitate definitions or facts. But my problem sets require you to think, which you can not do if you are not mentally alert.

Excel.

Cognitive Biases:

Be prepared every class!

1. Regular drilling improves and enhances learning. Not surprisingly, research in psychology and education repeatedly finds that repeated testing is the best way to learn. Here's a recent article from The Atlantic on this point.
2. I do not want there to be any confusion about what material you are responsible for. This ensures the cleanest mapping from your understanding to your grade. There are several reasons for this:
   1. Motivation. I can imagine a situation where there is so much material that no one can realistically be expected to learn it, which could discourage preparation.
   2. There's no place to hide. And no one to blame but yourself.
3. Since most of our material is quantitative and analytical your ability to understand the material in Week 6 depends critically on your having learned the material in Weeks 1 - 5. Being prepared for each class makes sure you don't fall behind, and lets me know that everyone is keeping up with the material.
4. Reduce ``test anxiety.'' No one activity (e.g., a test) is critical for your grade.

Spreadsheets

Incomplete Policy

Academic Policies and Institutional Resources

Academic Policies and Procedures:

Academic Integrity:

Statement of copyrighted materials:

MBA Student Support:

• General Course Questions: E-mail Professor Lamoureux: lamoureu@arizona.edu
• Personal Course Questions: E-mail Professor Lamoureux: lamoureu@arizona.edu to discuss grades and/or personal concerns.

Disability Accommodations:

Library Support:

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Map of the first floor of McClelland Hall for Evacuation Purposes.