SLOAN SCHOOL OF MANAGEMENT
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
Jonathan Lewellen
E52-436
258-8408; lewellen@mit.edu
Financial Management
15.411
Fall 2001
Syllabus
This course provides an introduction to investments and corporate finance, emphasizing the practical
applications of finance theory. The course touches on all aspects of finance, including the valuation of
real and financial assets, risk management and financial derivatives, the trade-off between risk and
expected return, and corporate financing and dividend policy. The course draws heavily on empirical
research to help guide managerial decisions.
Readings
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. I will distribute additional handouts periodically.
Reading packet
The reading packet is available from Copy Tech in the basement of E52. (It should be available
shortly after the semester begins.) It includes cases and additional readings.
Supplements
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.
Teaching assistant
Jorge Rodriguez, jfr@mit.edu. Recitations: Friday, time and place TBA.
Jorge will teach the recitations and will be available outside of class for additional help. The
recitations review the course material, discuss assigned or recommended problems, and give you an
additional opportunity to ask questions.
Administrative assistant
Alexandra West, E52-430, 253-9747, awest@mit.edu.
Web pages
http://sloanspace.mit.edu
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: fin15411; password: ---.
http://web.mit.edu/lewellen/www/
My web page includes links to the syllabus, course web site, and a variety of financial pages with free
data (macroeconomic data, stock indices, bond prices, etc.)
Course requirements and grading
Grades will be determined by your performance on the assignments (1/3), the midterm (1/3), and the final
(1/3). 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
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 (in brief)
This is an approximate outline for the course; some material may take longer or shorter to cover than the
time allocated. Homework problems, class notes, and additional readings will be distributed in class or
will be available on the MIT Web page. You are responsible for obtaining these materials if you miss the
lecture.
#
Date
Topic
Assignment (date due)
1
Sept 5
Introduction
2
Sept 10
Principles of valuation
3
Sept 12
Making investment decisions
Sept 17
Holiday
4
Sept 19
Case
5
Sept 24
Real options
6
Sept 26
Risk management
7
Oct 1
Option pricing
8
Oct 3
Stocks and firms (1)
Oct 8
Holiday
9
Oct 10
Stocks and firms (2)
10
Oct 15
Case
11
Oct 17
Bonds: Interest rate risk
12
Oct 22
Bonds: Term structure
T
Oct 24
Midterm exam
13
Oct 29
Risk and return: Introduction
14
Oct 31
Portfolio theory
15
Nov 5
CAPM
16
Nov 7
Discount rates in practice (1)
Nov 12
Holiday
17
Nov 14
Discount rates in practice (2)
18
Nov 19
Market efficiency
19
Nov 21
Raising capital
20
Nov 26
Capital structure (1)
21
Nov 28
Capital structure (2)
22
Dec 3
Capital structure (3)
Problem set
23
Dec 5
Case
Case
24
Dec 10
Cash / dividend policy
T
Dec 12
Final exam
Problem set
Case
Case / problem set
Case
Exam
Problem set
Case
Exam
Course outline (details)
Chapters refer to Brealey and Myers; articles are referenced using the authors’ last names and can be
found in the reading packet. The study questions listed after each class are recommended, not required,
and can be found at the end of the chapter under ‘Practice Questions.’
Part 1. Introduction
Sept. 5
Introduction to finance
Chapter 1, Handouts (opt.)
What is finance? What types of questions will
answer?
Study questions: Ch. 1: 7, 8, 10
Sept. 10
Principles of valuation
Chapter 2, 3
Opportunity cost of capital; present value; discount
rates; arbitrage; compounding
Study questions: Ch. 2: 5, 6, 9
Ch. 3: 1, 3, 5, 10, 12, 21, 27, 30
Part 2. Capital budgeting
Sept. 12
Making investment decisions
Chapter 6
Net present value; measuring cashflows
Study questions: Ch. 3: 4, 7, 6, 13
Ch. 6: 5, 6, 10 – 12, 16
Sept. 17
MIT holiday
Sept. 19
Acid rain: The Southern Company (A)
Myers (1984)
Sept. 24
Making investment decisions II
Chapter 5, 11
Chapter 10 (opt.)
Real options, internal rate of return
Study questions: Ch. 5: 3, 4, 7, 8, 13
Part 3. Financial assets
Sept. 26
Derivatives (1)
Options and futures; hedging; risk management
Study questions: BKM Ch. 20: 2 – 12
Froot et al. (1995), BKM Ch. 20
Oct. 1
Derivatives (2)
BKM Ch. 21, Siegel et al.
(1985)
Option pricing; put-call parity; binomial model
Black-Scholes model
Study questions: BKM Ch. 21: 1, 2, 7 – 12
Oct. 3
Stocks and firms (1)
Chapter 4, Handouts (opt.)
Stock basics; dividend discount model, free cashflows
and dividends, financial ratios
Study questions: Ch. 4: 5, 6, 7, 12, 14
Oct. 8
MIT holiday
Oct. 10
Stocks and firms (2)
Kim and Ritter (1999),
Handouts
Growth opportunities, reinvestment, and cashflows
Study questions: Ch. 4: 8, 10, 17, 18
Oct. 15
Cooper Industries, Inc.
Oct. 17
Bonds (1)
Chapter 3.5, 24.1 – 24.6
Handout
Bond basics; bond pricing; interest rate risk; duration; convexity
Study questions: Ch. 3: 31, 32
BKM Ch. 16: 1, 2, 4, 5, 7, 11
Oct. 22
Bonds (2)
Chapter 23
Term structure of interest rates; spot rates; forward
rates; expectations hypothesis
Study questions: Ch. 23: 1, 4 – 6, 8 – 10, 12, 15
Oct. 24
Midterm exam, covering parts 1 – 3
Part 4. Risk and return
Oct. 29
Introduction to risk and return
Historical evidence; measuring the risk of a portfolio;
statistics review
Study questions: Ch. 7: 1, 3, 4, 5
Chapter 7 (p. 153–165),
Handouts (opt.)
Oct. 31
Portfolio theory
Chapter 7 (165–end), 8.1
Combining stocks into portfolios; diversification;
optimal portfolios
Study questions: Ch. 7: 6 – 11, 15; Ch. 8: 2, 3, 4
Nov. 5
CAPM
Chapter 8.2 – 8.5
Quantifying the trade-off between risk and return;
measuring the risk of a stock
Study questions: Ch. 8: 1, 6, 7, 8, 11, 12, 13
Nov. 7
Discount rates in practice (1)
Chapter 9, Graham and Harvey
(2000, p. 1–10)
Estimating betas; required return on a project;
market risk premium
Study questions: Ch. 9: 1, 5, 7, 8, 9, 14
Nov. 12
MIT holiday
Nov. 14
Discount rates in practice (2)
Handout
Extensions and warnings; multifactor models;
foreign investment; leverage
Nov. 19
Market efficiency
Chapter 13, Ball (1995)
Definition; empirical evidence; implications for
managers and capital budgeting
Study questions: Ch. 13: 1, 2, 3, 11, 13
Part 5. Financing and dividend policy
Nov. 21
Raising capital
Chapter 14, 15
Sources of funds; trade-offs; historical evidence;
stock market reaction
Nov. 26
Capital structure (1)
The choice between debt and equity; MM theorem;
leverage and risk; fallacies
Study questions: Ch. 17: 2 – 6, 10 – 13
Chapter 17
Nov. 28
Capital structure (2)
Chapter 18.1 – 18.2,
Chapter 19.1 – 19.4
Taxes and the after-tax WACC
Study questions: Ch. 18: 1 – 5
Dec. 3
Capital structure (3)
Chapter 18.3, Graham and
Harvey (p. 10 - 22)
Financial distress; debt overhang; static trade-off
theory
Study questions: Ch. 18: 6, 7, 10 – 12
Dec. 5
UST Inc. and Massey-Ferguson, 1980
Dec. 10
Payout policy
Dividends vs. share repurchases; Modigliani-Miller
theorem; taxes; signalling; FPL
Study questions: Ch. 16: 3 – 6, 9, 12, 15
Dec. 12
Final exam, covering parts 4 – 5
Chapter 16, Black (1976),
Soter et al. (1996)