Institutional and Intellectual Context of the course:

This class serves as an introduction to 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 form 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 projects are financed. There is a link between the nature of an investment and the 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)
   3. Cost of equity capital under the Capital Asset Pricing Model (CAPM)
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 dyanamic considerations of strategic decisions (i.e., ``Real Option'' valuation)

Conduct of Course and Grading:

There are 6 problem sets. You must work on these individually. The problem set is your individual effort. The first five problem sets are worth 15 points each. The final problem set is worth 20 points. Five points are available from class participation.

Learning Outcomes

• Identify and measure the appropriate cost of capital to use for analyzing capital budgeting projects.
• Demonstrate the skills involved in capital budgeting, including cash flow analysis, decision making and risk assessment.
• Demonstrate the impact of financial decisions on a firm’s cash flows and valuation.
• Discuss current financial issues affecting the investment markets and relate them to the core capital decision-making and valuation topics covered in class.
• Calculate the cost of equity capital using the Capital Asset Pricing Model and explain the importance of Beta in assessing risk.

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:

• Statistical modeling of univariate stock returns.
• Multivariate statistical modeling of stock returns -- quantifying diversification.
• Univariate linear regression to estimate a stock's beta.
• Understand that beta is a measure of the stock's systematic risk--and that only systematic risk is ``priced.''
• Measure a firm's weighted average cost of capital.
• Build a timeline of the after-tax cash flows from a ``standard'' capital budgeting project.
• Identify the appropriate cost of capital for a project and measure its Net Present Value.
• Conduct sensitivity analysis on a project to identify key value drivers.
• Apply the concept of dynamic optimization to strategic decision-making. (Real Options).

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. The class sessions are the most important learning times.
2. Start working on the problem set / old quizzes as soon as possible after the class. You may think that waiting until just before the problem set is due will be more efficient, since otherwise you will have to retain the knowledge. Nothing could be more wrong. 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. There will be no review sessions for several reasons:
   • The weekly problem set format means that the material that you will be tested on is well-defined and concise.
   • (As such,) our Thursday classes are effectively ``review sessions.''
   • Because the material is analytical in nature, everyone learns at a separate and unique pace, and has distinct areas of understanding and misunderstanding. In light of this, it is my experience that preparing for the quizzes in a group, or a review session, creates panic and is counterproductive.
   • You have to take the intellectual initiative to learn the material. In my experience review sessions can induce an intellectual laziness, as you wait to be told again what you have to know. This intellectual initiative will also be required in business, so you must develop this work skill.
   • The optimal time to do your own review is as soon as possible after the classes. Questions should be sent to me as soon as you do have made an effort to solve a problem and still cannot see the solution. Such questions should be framed in such as way that I can see what you know and what you don't know.
6. 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 quiz. 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!
7. 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.
8. 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 quizzes require you to think, which you can not do if you are not mentally alert.

Cognitive Biases:

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.

Problem set formats and spreadsheets

Hints for successful Problem Set submissions:

1. Clearly lay out the information that you are given in one section of the worksheet.
2. Every other cell should contain an expression that uses these inputs.
3. Never input to a cell an intermediate result. Refer to the cell that contains the intermediate result.
4. Don't use built-in Excel functions or tools. From our perspective these are a black box, so we can't see what's going on.
5. An ideal problem set is a document to which you can refer in a year, and ascertain exactly what is going on and why. -- Documentation is key.

   Incomplete Policy

   If you experience extraordinary circumstances beyond your control, which prevent you from completing the course within the scheduled 8-week timeframe, you must request an incomplete by e-mailing Professor Lamoureux before the end of the course. Please clearly explain the reasons for the request and provide relevant documentation. Please be aware that you must be receiving a passing grade at the time of the request. If granted an incomplete, you should review the related policy stipulations at http://registrar.arizona.edu/gradepolicy/incomplete.htm

   Academic Policies and Institutional Resources

   Academic Policies and Procedures:

   As a University of Arizona student, you are expected to become familiar with and abide by the university-wide policies and procedures. You can find complete, up-to-date information at https://catalog.arizona.edu/policies. Eller MBA utilizes an additional Ethics and Academic Integrity Policy. Students are required to be familiar with this policy and its procedures.

   Academic Integrity:

   Upon accepting admission to the University of Arizona, you immediately assumed a commitment to uphold the Code of Academic Integrity. You can review these rules at http://deanofstudents.arizona.edu/codeofacademicintegrity. Any instances of academic dishonesty will result in a grade of E for the course and will be reported to the Ethics and Academic Integrity Board for review.

   Statement of copyrighted materials:

   All lecture notes, lectures, study guides and other course materials disseminated by the instructor to the students, whether in class or online, are original materials and reflect intellectual property of the instructor or author of those works. All readings, study guides, lecture notes and handouts are intended for individual use by students. You may not distribute or reproduce these materials for commercial purposes without the express written consent of the instructor. Students who sell or distribute these materials for any use other than their own are in violation of the University's Intellectual Property Policy (available at http://policy.arizona.edu/research/intellectual-property-policy. Violations of the instructors copyright may result in course sanctions and violate the Code of Academic Integrity.

   MBA Student Support:

   The following are guidelines for requesting support:
   • General Course Questions: E-mail Professor Lamoureux: lamoureu@email.arizona.edu
   • Personal Course Questions: E-mail Professor Lamoureux: lamoureu@email.arizona.edu to discuss grades and/or personal concerns.

   Disability Accommodations:

   Students needing special accommodations or special services should contact the Disability Resources Center, 1224 East Lowell Street, Tucson AZ 85721, (520)621-3268, FAX (520)621-9423, e-mail: uadrc@email.arizona.edu, web: http://drc.arizona.edu. You must register and request that the center or DRC send the instructor official notification of your needs as soon as possible. Please contact us to discuss accommodations and how this course's requirements may impact your ability to fully participate. The need for accommodations must be documented by the Disability Resources Center.

   Library Support:

   The University of Arizona Libraries are dedicated to providing the research tools you need at any time. Here is a list of business resources. And here is the MBA Library page. If you need any assistance, please contact Jeremiah Paschke-Wood at jpaschkewood@email.arizona.edu and include your University of Arizona NetID.

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   Evacuation Procedures

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

   

   
   

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   Chris Lamoureux
   Sun Dec 20 10:53:19 MST 2020