SLOAN SCHOOL OF M ANAGEMENT
M ASSACHUSETTS INSTITUTE OF T ECHNOLOGY
Jonathan Lewellen
E52-436
258-8408; lewellen@mit.edu
Financial Management
15.411
Fall 2000
Syllabus
This course provides an introduction to investments and corporate finance, emphasizing the practical
applications of finance theory. The course covers the entire spectrum of finance, including the valuation
of real and financial assets, the empirical properties of stock returns, the trade-off between risk and
expected return in capital markets, corporate financing and dividend policy, and the use of options and
futures. The course draws heavily on empirical research to help guide managerial decisions.
Required reading
R. Brealey and S. Myers, Principles of Corporate Finance, 6th edition, Irwin/McGraw Hill.
The book, known simply as ‘Brealey and Myers’, is the most popular finance textbook, used throughout
the world. It provides a complete introduction to finance theory and practice.
Class notes
The class notes will be available prior to class on the MIT Web page and/or distributed in class. The
notes provide an alternative treatment of the major ideas and cover material not found in Brealey and
Myers. They also include additional readings.
Supplemental reading
Z. Bodie, A. Kane, and A. Marcus, Investments, 4th edition, Irwin/McGraw Hill, 1999.
‘Bodie, Kane, and Marcus’, or BKM, is a good introductory investments textbook. It focuses
exclusively on portfolio theory and the valuation of financial assets, providing a more rigorous, thorough,
and practical analysis than Brealey and Myers.
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.
Office hours
Office hours will be held on Tuesday, 10:00 – 11:30am, and by appointment. The teaching assistant will
also be available to answer questions.
Recitations / teaching assistant
Charlotte Khoo, c_khoo@mit.edu. Recitations: Friday 10:30–11:50am and 1:00–2:20pm, room TBA.
Charlotte will teach the recitations, which will review the material, discuss assigned or recommended
problems, and give you an additional opportunity to ask questions. She will also hold office hours on
Friday, 2:30 – 3:30, room TBA.
Administrative assistant
Alexandra West, E52-430, 253-9747, awest@mit.edu.
Web pages
http://mitsloan.mit.edu/course/15411.html
The web site will be used primarily to distribute course material. It contains information about the
course, lecture notes, homework assignments, and announcements.
http://wrds.wharton.upenn.edu
Wharton Data Research Services (WRDS) provides Web-based access to stock and accounting data
for nearly all publicly-traded companies in the U.S (plus a limited number of international companies).
We will use this data periodically during the course, and you can freely access it whenever desired.
Username: fin411; password: 345m642u.
Course requirements and grading
Grades will be determined by your performance on the assignments (30%), the midterm (35%), and the
final (35%). Class participation is strongly encouraged and will be considered when assigning grades.
As noted on the course outline, there will be approximately 9 homework assignments, consisting of both
problem sets (4) and short cases (5). The problem sets should be relatively straightforward and will give
you an opportunity to apply the material covered in class; the cases will be somewhat more difficult and
longer. You should be prepared to discuss the cases in class on the day they are due.
You may work together on the problem sets, but everyone should hand in a separate assignment. You can
work together and hand in joint cases, in groups of three or four. In addition, the schedule below lists
recommended problems from Brealey and Myers that should help you prepare for the exams. We will
discuss some of these problems in class or in the review sessions.
Course outline
This is an approximate outline for the course; some material may take longer or shorter to cover than the
time allocated. The problems listed after each lecture are recommended, not required, and can be
found at the end of the chapter under the heading ‘Practice Questions.’ The teaching assistant will
typically discuss them in the recitations. You will, of course, get more out of the lectures if you do the
readings and attempt the problems prior to class. Homework problems, class notes, and additional
readings will be distributed in class and/or will be available on the MIT Web page. You are responsible
for obtaining these materials if you miss the lecture.
Part 1. Introduction
Sept. 6
Introduction to finance
Read: Chapter 1, handout (opt.)
What is finance? What types of questions will we
answer?
Ch. 1: 7, 8, 10
Part 2. Valuation: Basics
Sept. 11
Principles of valuation
Read: Chapter 2
The time value of money; the role of financial markets; present value; arbitrage
Ch. 2: 5, 6, 9
Sept. 13
Mechanics of discounting
Read: Chapter 3
Compounding intervals; annuities and perpetuities;
inflation
Ch. 3: 1, 3, 5, 10, 12, 21, 27, 30
Part 3. Valuation: Real assets and capital budgeting
Sept. 18
Capital budgeting I
Read: Chapter 6
Making investment decisions; net present value;
measuring cashflows
Ch. 3: 4, 7, 6, 13; Ch. 6: 5, 6, 10–12, 16
Assignment 1 due
Sept. 20
Capital budgeting II
Internal rate of return; hurdle rate; real options;
pitfalls and warnings
Ch. 5: 3, 4, 7, 8, 13
Read: Chapter 5, 11
Recommended: Chapter 10
Sept. 25
No class (MIT holiday)
Sept. 27
Case discussion
Read: Myers (1984)
‘Acid rain: The Southern Company (A)’
Assignment 2 due
Part 4. Valuation: Financial assets
Oct. 2
Fixed income securities I
Read: Chapter 3.5, 24.1 – 24.6
Types of fixed income securities; bond basics;
bond pricing; interest rate risk (part 1)
Ch. 3: 31, 32
Oct. 4
Fixed income securities II
Read: Handout (BKM, Ch. 16)
Interest rate risk (part 2); duration vs. maturity;
convexity; immunization
BKM Ch. 16: 1, 2, 4, 5, 7, 11
Oct. 9
No class (Columbus Day)
Oct. 11
Fixed income securities III
Read: Chapter 23
Term structure of interest rates; spot rates; forward
rates; expectations hypothesis
Ch. 23: 1, 4–6, 8–10, 12, 15
Oct. 16
Stocks I
Read: Chapter 4, handout (opt.)
Stocks and stock markets; dividends vs. capital gains;
dividend discount model
Ch. 4: 5, 6, 7, 12, 14
Assignment 3 due
Oct. 18
Stocks II
Read: Kim and Ritter (1999),
handouts
Growth opportunities; financial ratios; discount rates
and expected returns
Ch. 4: 8, 10, 17, 18
Oct. 23
Case discussion
‘Cooper Industries, Inc.’
Assignment 4 due
Oct. 25
Midterm exam, covering parts 1 – 4
Read: Case
Part 5. Risk and return
Oct. 30
Introduction to risk and return
Read: Chapter 7 (p. 153–165)
Handouts (opt.)
Historical evidence; measuring the risk of a portfolio;
statistics review (mean, variance, covariance)
Ch. 7: 1, 3, 4, 5
Nov. 1
Portfolio theory
Read: Chapter 7 (165–end), 8.1
Combining stocks into portfolios; diversification;
optimal portfolios
Ch. 7: 6 – 11, 15; Ch. 8: 2, 3, 4
Nov. 6
CAPM and APT
Read: Chapter 8.2 – 8.5
Quantifying the trade-off between risk and return;
measuring the risk of a stock
Ch. 8: 1, 6, 7, 8, 11, 12, 13
Nov. 8
Capital budgeting and risk
Read: Chapter 9, Graham and
Harvey (2000, p. 1–10)
Estimating betas; required return on a project;
market risk premium
Ch. 9: 1, 5, 7, 8, 9, 14
Assignment 5 due
Nov. 13
Case discussion
Read: Case
‘Harris Seafoods, Inc.’
Assignment 6 due
Nov. 15
Market efficiency
Read: Chapter 13, Ball (1995)
Definition of an efficient market; empirical evidence;
efficiency and capital budgeting
Ch. 13: 1, 2, 3, 11, 13
Part 6. Financing and dividend policy
Nov. 20
Raising capital
Read: Chapter 14, 15
Sources of funds; trade-offs; historical evidence;
stock market reaction
Nov. 22
Capital structure I
Debt vs. equity; MM theorem; leverage and risk
Ch. 17: 2 – 6, 10 – 13
Read: Chapter 17
Nov. 27
Capital structure II
Read: Chapter 18.1 – 18.2,
Chapter 19.1 – 19.4
Corporate taxes; the debt tax shield; personal taxes;
after-tax WACC
Ch. 18: 1 – 5
Nov. 29
Capital structure III
Read: Chapter 18.3, Graham
and Harvey (p. 10 - 22)
Financial distress; conflicts between debt- and equityholders; static trade-off theory
Assignment 7 due
Ch. 18: 6, 7, 10 – 12
Dec. 4
Case discussion
Read: Cases
‘UST Inc.’ and ‘Massey-Ferguson, 1980’
Assignment 8 due
Dec. 6
Capital structure IV
Read: Chapter 18.4, Smith
(1986)
Asymmetric information; signalling hypothesis;
pecking-order theory
Ch. 18: 13, 14
Dec. 11
Payout policy
Read: Chapter 16, Black (1976),
Soter, Brigham, Evanson (1996)
Dividends vs. share repurchases; Modigliani-Miller
theorem; taxes; signalling; discussion of FPL
Ch. 16: 3 – 6, 9, 12, 15
Assignment 9 due
Part 7. Summary
Dec. 13
Summing it up
Fundamental lessons of finance; review
Dec. ?
Final exam, covering parts 5 – 7
Read: Chapter 35