LESSONS ABOUT THE
STRUCTURE OF FINANCE
An Undergraduate Introductory Textbook
by Thomas W. Downs
April 2006
address: Thomas W. Downs
Department of Economics & Finance
University of Alabama, Box 870224
Tuscaloosa, Al 35487-0224
tel:
fax:
email:
(UA) 205-348-4590; (home office) 205-345-5202
(UA) 205-348-0590
tdowns@cba.ua.edu
1
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
Contents
RECOMMENDATION: Print this document. Then view this PDF document on a computer with a
high speed internet connection. Click on the hyperlinks in the PDF file to view supplementary
information pertinent to the proposal. Peruse this printed document as you read, watch, or listen
to the supplementary information.
Overview
page 2
The Storyline within Lessons about
the Structure of Finance
4
Analysis of the Undergraduate
Textbook Market for Finance
8
Table of Contents
18
List of Tables
21
List of Figures
23
End-of-section problems and
algorithmic software
24
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
2
Overview
Click here for author’s introductory comments
There is an incompleteness in the textbook market for the undergraduate
introductory finance course. The tremendous opportunity that this creates results from
two powerful yet independent movements. The first movement results from institutional
changes. The second movement results from knowledge accumulations in financial
science. Either movement by itself necessitates a change in the content and structure
of the ideal finance textbook. Together, however, they confuse the market and leave
the textbook offerings for finance incomplete.
Most business schools design programs subject to standards imposed by the
American Assembly of Collegiate Schools of Business (AACSB). The AACSB for
decades dictated a curriculum composed of two accounting courses, two economics
courses, and two finance courses. In the mid-1990s the AACSB embraced a policy to
encourage critical thinking by broadening student experiences. Effectively, the AACSB
strategy decentralizes the curriculum by putting more decision-making in student hands.
The new AACSB policy increases the proportion of elective collegiate courses and
reduces the number of required courses.
Today’s typical business school curriculum includes one course each in
accounting, economics, and finance. The leading introductory finance textbooks are
artifacts of the old two-course curriculum. The inadequacy of a two-curriculum book in a
one-curriculum program is especially problematic because few students major in
finance. The majority of students take one finance course in their entire life: the
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
3
undergraduate introductory core course. There does not yet exist a finance textbook
that, in my opinion, adequately addresses the one-course curriculum.
Finance as a scientific discipline is changing rapidly. The rate of change has
accelerated with the advent of telecommunication technologies that globalize financial
markets. Even before the internet age, however, finance was evolving quickly. Major
discoveries in financial science have occurred in the past few decades. Since 1990 the
Nobel Prize has been awarded several times for discoveries in pure finance. This rapid
accumulation of knowledge blurs the view of the discipline. Within the swirl, however, a
unified vision of finance will emerge. There does not yet exist a finance textbook that, in
my opinion, properly presents the unitary field of financial science.
The book that I’ve written resolves these two independent but convergent
movements. My textbook offers fundamental lessons about the unitary structure of
financial science for a one-semester introductory curriculum.
Respectfully submitted,
Thomas W. Downs
Cooper Professor of Teaching Excellence
Tuscaloosa, Alabama
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
4
Highlights of the Storyline within
Lessons about the Structure of Finance
by Thomas W. Downs, 2nd edition, ©2005, Pearson Custom Publishing (450 pp.)
Printing history:
4. ©2003, Pearson Custom Publishing, Lessons about the Structure of Finance. (This was the first typeset
printing; all earlier printings were reproduction & binding of author’s originals, 277 pp.)
rd
3. ©2002, Thomson Custom Publishing, Structure of Finance. 3 edition. (262 pp.)
2. ©2001, Harcourt Custom Publishing, Structure of Finance: An introduction to financial science and applied
nd
finance. 2 edition. (220 pp.)
1. ©2000, Harcourt Custom Publishing, Structure of Finance: An introduction to financial science and applied
finance. (195 pp.; first use in classroom was Fall semester 1999)
0. 1994-1999, preparation of problem sets and chapter handouts to supplement Brigham et al. (the last
undergraduate textbook that I adopted) and Ross et al. (my graduate introductory finance choice).
N.B. Small font chapter descriptions shown below are excerpts from the preface.
● From Chapter 1 onward the curriculum contains novel yet relevant and intuitive
lessons about finance (click here, 7’14”).
Chapter 1 introduces the field of finance. Lessons include a definition for finance, descriptions of
financial functions within the company, and discussion of finance sub-disciplines and certifications.
Attention turns to the Cash flow cycle wherein the company obtains financing from capitalists in
financial markets for purchasing factors of production from stakeholders in real asset markets.
The company adds value when the equilibrium amount that clients pay for the company’s goods
and services exceeds economic production and capital costs. Source of the created wealth is
transformation value. Subsequent discussion details different kinds of capitalists and financial
markets. Between sources and users of wealth there exist important principal-agent relationships.
Novel discussion explains the employee versus management/shareholder agency problem that
arises from pension liabilities. Another important lesson teaches about wealth creation and the
company goal. Lessons presents a novel argument that the objective for company management
is pursuit of policies maximizing capitalized value of wealth creation irrespective of distribution of
economic profit. Stock price maximization is an indicator variable for managerial effectiveness not
a bonafide managerial objective. The chapter concludes with lessons about different definitions
for the “company.” Companies in the corporate sector, noncorporate sector, and even
consideration of households as companies, shows that all make financial decisions that depend on
common underlying concepts.
● Chapters 2 and 3 represent a significant forward step in the way that we can teach
fundamental accounting concepts to finance students (click here, 9’42”).
Chapters 2 and 3 offer in-depth lessons about flows, balances, and financial fundamentals of
accounting. The first lesson explains that a flow is a wealth transfer whereas a balance is a wealth
accumulation. Mention is made of difficulties arising because generally accepted financial
statements mix realized with accrued flows and balances. Balance sheets exist as a snapshot in
time. Mergers provide a wonderful opportunity devoid of time to combine balance sheets for
Raider and Target companies. Presentations infer financial effects of mergers on equity book
value, price-to-book ratio, earnings per share, and shareholder wealth. Problems created for this
setting are unique to Lessons and availability of algorithmic capability is an added bonus.
Discussion turns next to the income statement and ratio analysis. Included within ratio analyses
are problems and explanations about DuPont decomposition and breakeven ratios. Lessons
formula 2.7 is new to the literature and reveals relation between return-on equity, stockholder rate
of return, and price-to-book ratio. Resultant financial problems also are new and of interest to the
literature. Discussions next explain how an income statement encompasses a time window.
Formulas show that the income statement connects with balance sheets at beginning and end of
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
5
the time window through differential processes for Stockholder’s equity and for Plant, property, and
equipment. Chapter 2 closes with lessons determining shareholder rates of return with information
from balance sheets, income statements, and price multiples. Chapter 3 focuses on financial
accounting effects of growth. Initial lessons forecast financing needs given pro forma balance
sheets or income statements. Subsequent lessons examine characteristics of natural growth
rates. Formulas for the internal and sustainable growth rates are unique to Lessons and enable
reconciliation of conflicting presentations apparent across other textbooks. Subsequent lessons
introduce cash flow formulas. Underlying intuition is that cash flow residually reconciles adjacent
balance sheets. Novel problems compute and interpret price-to-cash flow ratios. Chapters 2 and
3 introduce many novel and interesting financial applications for important accounting
fundamentals.
● The two chapters with lessons on time value relationships offer extensive problem
sets, calculator clues, intuitive explanations, and relevance (click here, 5’56”).
Chapters 4 and 5 teach time value relationships. Lessons introduce time value by measuring the
average periodic rate of return. Start at $100, drop a period later to $60, and return a period later
to $100. The arithmetic average of periodic returns is biased whereas the geometric average is
accurate. Rearrange the formula for geometric average and obtain lump-sum time value formula
4.6. Subsequent lessons examine return components such as periodic interest, interest-onprincipal, interest-on-interest, etc. Especially useful are frequent Calculator Clues that teach
keystrokes on the Texas Instruments BA2Plus calculator. Standard lessons on intraperiod
compounding and annual and effective interest rates appear. Lessons subsequently rely on the
additive property of present value to motivate general time value formula 4.11 for mixed cash
flows. Numerical problems may be relatively complex because (a) Calculator Clues raise the level
of acceptable complexity by simplifying computations, and (b) algorithmic capability simplifies
problem creation, study, and learning assessment. The section on inflation and time value is
unique to Lessons. Teachers and financial planners know the importance of inflation and this
section offers simple yet complete lessons integrating its effect. Chapter 5 introduces the constant
annuity formula. Standard lessons appear for using the lump-sum and annuity formulas together
in two-stage problems. Novel is generalization of the Rule of 72 for constant annuities.
Explanations and examples offer extensive lessons on amortization mechanics and loan repricing.
● Three chapters offer fundamental lessons relating time value principles to capital
budgeting, bond valuation, and stock valuation (click here, 10’56”).
Chapter 6 introduces capital budgeting as a time value application. Standard discussions explain
profitability assessment measures and NPV as a measure of economic profit. Explanations,
graphs, and Calculator clues show the relation between NPV and IRR for ranking projects. The
lesson for finding the cross-over rate for two NPV profiles is unique to Lessons. Discussion about
incremental cash flows includes examples on mortgage refinancing. Discussion on importance of
salvage value, recapture taxes, and depreciation tax savings is standard. Extensive problems
take advantage of Calculator clues, paragraph answers at end-of-chapter, and algorithmic
capability of problem creation.
Chapter 7 introduces bond valuation as a time value application. Lessons instruct on the price-to-yield
relation. Strong emphasis is given to partitioning the promised yield into current and capital gains
yield. Problems examine the scientific amortization time path for evolution of bond price given
constant yield-to-maturity. Calculator clues teach “which buttons to push” and consequently
complexity is rigorous relative to the typical introductory textbook. Unique to Lessons is inclusion
of bond horizon analysis and effect of yield changes on ex post rate of return. Also unique is
inclusion of lessons on riding the yield curve.
Chapter 8 pertains to stock valuation. The chapter opens by comparing technical with fundamental
analysis. Lessons examine the moving average trading rule and present novel formulas for
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
6
determining cross-over prices at which signal reversals from buy or sell occur. An excerpt from
Graham and Dodd points us back to fundamental analysis and discussion of intrinsic value.
Examples and problems reaffirm that fundamental analysis is a time value application. A Streetbite describes the distribution of equities among U.S. households and summarizes the different
markets providing trade execution. Attention turns to preferred stocks and a novel problem finding
rate of return when the preferred dividend yield reverts over time to a normal spread. Calculator
clues simplify computations. Subsequent lessons examine common stocks with growing
dividends. Unique to Lessons is estimation from a time series dividend history of the dividend
growth rate using an exponential fit. Calculator clues simplify the procedure. Next appears
discussion about the standard constant growth valuation model. Novel problems ask to find the
shareholder rate of return when at the end of a horizon the stock price converges to intrinsic value.
Reliance on prior financial accounting lessons about sustainable growth allows pretty interesting
and synthesizing questions. The chapter concludes with examination of price multiples. A novel
formula for the intrinsic price-to-earnings ratio provides a lesson that P/E ratios may vary even in
the absence of pricing errors.
● The shift in focus from time value to transformation value represents a change in
objective. Part 2 of Lessons examines security supply and demand and the
rationale for financial market equilibrium (click here, 6’41”).
Chapter 9 is totally descriptive and contains no problems or computations. This chapter commences
Part 2 of Lessons and describes the market backdrop for determining financial equilibrium.
Instead of focusing on time value relations with largely exogenous financing rates, as in Part 1,
lessons now focus on factors driving endogenous market financing rates. Discussion explains that
primary market supply and demand for financial securities is a determinant of equilibrium security
prices. Investigation proceeds with market participants that demand securities: buy-side
institutional investors plus households. Lessons discuss household demand for securities and
interaction between demographics, educational attainment, and life-cycle effects. Next is
discussion of pension funds and dramatic changes in recent decades due to shifts from defined
benefit to defined contribution plans. Mutual funds are the next buy-side participant and
discussions explain major categories and characteristics. Final discussions of buy-side
participants pertain to insurance companies, non-profit institutions, and commercial banks.
Interesting characteristics for each are described as well as discussion on bank sector history and
regulation. Subsequent discussion explains characteristics of security supply on the sell-side such
as open market paper, asset backed securities, government securities, and convertibles,
preferred, and common equities. Finally, find important lessons explaining the rationale for
financial market equilibrium. Lessons clearly distinguish between expected and required rates of
expected
is the internal rate of return that equates the actual security price to the
return. ROR
discounted sum of expected cash flows. RORrequired is the minimum discount rate that an investor
willingly accepts for computing intrinsic value. Discussion explains why required returns equal the
risk-free interest rate plus a risk premium. Further discussion explains why the efficient market
hypothesis implies that expected returns vibrate around required returns. Learning about factors
driving endogenous market financing rates therefore necessitates study of factors driving risk
premia.
● The most important lesson about risk and return is that through diversification some
risk vanishes. Market equilibrium requires that non-vanishing risk, i.e., systematic
risk, receives on-average a fair rate-of-return (click here, 8’51”).
Chapter 10 presents lessons on risk, return, and diversification benefits. The chapter opens with
discussion on dominance and the risk-for-return trade-off. Next appears explanation that at the
limit there exist two primal types of risk: idiosyncratic risk that can be managed or eliminated
through diversification and systematic risk that can’t. Different sources of idiosyncratic risk include
liquidity risk, term risk, default risk (this discussion links back to operating and financial breakeven
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
7
ratios from chapter 3), political risk, and cross-border exchange rate risk. Attention turns toward
investigating how diversification affects portfolio risk and return. Explanations and problems rely
on standard statistical specification of probabilities and outcome rates of return. Problems
examine individual securities and then two-security portfolios. Subsequent lessons assume
outcomes are equally likely in which case Calculator clues teach keystrokes for easily finding risk
and return measurements for a two-security portfolio. Frequent exercises, Calculator clues, and
algorithmic problems simplify teaching and learning these invaluable lessons. Explanations and
examples describe easy methods for graphing the parabola representing a two-security risk-return
profile. This graphic technique vividly illustrates that portfolio risk often diminishes when one sells
a low risk and buys a high risk investment. Definition 10.6 is unique to Lessons and states that
diversification benefit (“DB”) equals the difference between average component risk and actual
portfolio risk. Illustrations show that DB equals the horizontal distance between the risk-return
profile and the line-of-averages. Lessons emphasize that correlation between component
securities determines inflection in the risk-return profile, hence correlation influences diversification
benefits. Final lessons pertain to investment advice that the preceding analyses suggest.
Chapter 11 uses concepts from preceding lessons to explain determination of equilibrium rates of
return. A simple graphical illustration provides intuitive support for the Capital market line and the
equilibrium market price for risk. A general formula specifies that the required rate of return equals
the risk-free rate plus a risk premium. Lessons introduce a simplified loanable funds theory of
interest for a top-down explanation of the short-term risk free rate of return. The role of inflation as
a component of the term risk premium is explicit. Other discussions suggest ad hoc procedures
for determining risk premia for other credit market securities. Explanations then focus on risk
premia for equity securities. When idiosyncratic risk is completely diversifiable and only one
source of systematic risk exists then the risk premium for security A equals the market price for
risk times σA × ρA,market. The lesson reinforces importance of diversification benefits because the
correlation coefficient between security and market measures the proportion of σA that merits the
market price for risk. Figure 11.6 showing rays of correlation overlaid on the Capital market line
and Efficient frontier is new to the literature. Next is introduction of β as a risk measure. The
chapter closes with lessons about the company weighted average cost of capital.
● The no-arbitrage equilibrium is important to the futures, options, and currency
markets. These important financial markets merit study in the introductory finance
curriculum (click here, 4’38”).
Chapter 12 is sole contributor to Part 3 of Lessons on the third source of value: arbitrage. Opening
discussion examines simple futures contracts and explains why market equilibrium requires that
arbitrage profit vibrates within a narrow tolerance range around zero. Simple examples with gold
and stock indexes show how spot and futures prices depend more on today’s prices and interest
rate within a time value relationship and less on expectations about tomorrow’s prices. Futures
contracts allow companies an opportunity to restrict outcome prices and profits within a narrow
range. Problems and examples show how companies use futures contracts to hedge and manage
risk. Lessons next introduce currencies prevalent in global commerce. Examples and formulas
show effects of currency appreciation and depreciation on revenues and profits. Simple examples
illustrate how companies use currency futures contracts to hedge exchange rate risk. Subsequent
lessons examine risk management applications of options. Simple examples of portfolio insurance
with call and put options introduce students to this important derivative security mentioned
frequently in the media. Last section of the chapter explains triangle arbitrage with currencies.
Next is explanation of purchasing power parity (“PPP”) and the relation between inflation and
currency depreciation. The text explains that PPP does not give rise to arbitrage opportunity
because of market incompleteness. For currencies and interest rates, however, interest rate parity
constitutes a powerful force that binds the largest financial market in the world, the foreign
exchange market. Formulas in this chapter are simple and problems are straight-forward and
content is important. The intuition is fundamentally powerful and merits coverage in Lessons
about the Structure of Finance.
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
8
Analysis of the Undergraduate Introductory
Textbook Market for Finance
N.B. I originally wrote this analysis in August 1999. Since then a few new textbooks and many new
editions of old standards have appeared. Probably, the market share for the Stephen Ross lineup
(McGraw-Hill) has overtaken the Eugene Brigham lineup (Dryden). The general nature of the market
and arguments made herein, however, remain largely the same. Citations have not been updated.
This section analyzes historical textbook events that motivate Lessons about the
Structure of Finance. Introductory finance textbooks in the traditional two-course
curriculum belong to either of two stocks: “Corporate Finance” or “Financial Markets &
Institutions.” The markets and institutions books tend to be descriptive with strong
doses of macro-monetary topics. Corporate finance textbooks deal with issues such as
statement analysis, time value, stocks and bonds, and asset pricing. When most
universities recently dropped from a two-course to a one-course finance curriculum,
almost universally the Corporate Finance course remained required. Markets &
Institutions became an elective for most business students and today is largely a
majors-only course. The book-stock used in the traditional Corporate Finance course
generally is adopted in the one-curriculum required finance course.
For about three decades one of the leading corporate finance textbooks has
been from the Dryden lineup by Eugene Brigham, for example
Brigham, Eugene and Joel Houston. Fundamentals of Financial Management, 8th
edition. Dryden Press (1998).
Brigham and the topics he teaches historically define the finance textbook field. One
Brigham hallmark is that each chapter more or less stands alone. This makes it easy to
rearrange chapters, or even entirely cut them.
“Although the chapters in Fundamentals are sequenced logically, they are written in
a flexible, modular format, which will help instructors cover the material in a different
sequence should they choose to do so.”
Brigham, op cit.
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
9
Chapter portability occurs because one chapter depends very little on other
chapters. Instead, commonality occurs because every chapter is consistent with a
singular unifying objective: maximizing shareholder value.
“Structuring the book around markets and valuation enhances continuity and helps
students see how the various topics are related to one another.”
Brigham, op cit.
The connection between Brigham chapters is implicit. Only in a few cases does
one chapter build upon the previous one. Nonetheless, the book offers excellent
presentations on most topics in corporate finance. The book also emphasizes problems
and problem-solving skills. This feature is attractive to professors and students alike.
Professors love to modify problems a little differently than the book presents, and
subsequently to ask students on tests to twist and adapt (some students twist and
shout, too). Students like the direction that problems provide. They like to be able to
practice what is going to be on the test.
Some professors naturally prefer to develop their own explanations for the topics
covered by Brigham. Furthermore, some professors develop clever innovations for
various textbook problems and, sometimes, develop a new textbook. Almost all
developers have used Brigham as a template for launching a textbook. Most
introductory books have chapter titles and topical coverage that mimic Brigham.
Changing financial practices and expanding financial markets motivated bookwriting. Calls by the AACSB in the mid-1980s to internationalize the curriculum caused
a frenzy of textbook activity. Some books had separate chapters on international
finance, while others added appendices, or text boxes, etc.
“[We] incorporate these changes – the increased focus on shareholder wealth
maximization and cash flow management, an emphasis on the international aspects
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
10
of financial management, and a concern for the ethical behavior of managers – into
a text designed primarily for an introductory course in financial management.”
Moyer, R. Charles, James McGuigan, and William Kretlow. Contemporary Financial Management
7th edition. South-Western Publishing (1998).
“We have endeavored to make the text distinctive in several respects: (1) a
concentration on the student user of the text; (2) a real rather than merely a claimed
organization around the theme of valuation; and (3) a substantive and integrated
treatment of the international aspects of financial decision-making.”
Lewellen, Wilbur, John Halloran, and Howard Lanser. Financial Management: An Introduction to
Principles and Practice. South-Western Publishing (2000).
Textbook development also is driven by the need to maintain up-to-date
presentations. Frequent changes in federal corporate tax laws, increased ethics
initiatives, or integration of calculator and spreadsheet techniques sometimes motivated
revised editions or entirely new books. Other authors appeal to the student’s pragmatic
interest about financial topics from the popular press.
“The text emphasizes the most widely used financial innovations – the ones that
occupy most of the CFO’s time. To reinforce this point, I have made extensive use
of quotes and citations from the financial media.”
Levy, Haim. Principles of Corporate Finance. South-Western Publishing (1998).
“[students] wanted to learn about all areas of finance ... they were very interested in
investments and wanted to better understand popular business publications.”
Eakins, Stanley. Finance: Investments, Institutions, and Management. Addison-Wesley Longman
(1999).
Explosive growth in academic and applied finance during the past two decades
includes (1) derivatives in investments, and (2) mergers & acquisitions in corporate
finance. Growing importance of these topics motivates inclusion in textbooks, albeit
often as add-ons at the back of the book.
“Part VI, Special topics in financial management, reviews financial risk management,
corporate restructuring, and bankruptcy … [and] offer the chance to review items of
current interest, including the application of derivatives in financial management.”
Lee, C.F., Joseph Finnerty, and Edgar Norton. Foundations of Financial Management. West
Publishing (1997).
“Options and option-like securities have traditionally been taught in the investments
course. Today, however, corporations such as IBM, Merck, and Intel successfully
employ options and other derivatives to reduce risk. They can be challenged in
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
11
court if they do not use derivatives to reduce risk. … Therefore, chapter 11
emphasizes derivatives as a tool for the financial executive.”
Levy, op cit.
Books were beginning to get pretty thick, however, since all efforts focused on
adding the newest hot topic and, for old topics, showing the most innovative problems.
In the mid-1990s an introductory finance textbook appeared with a radical distinguishing
feature: it was less than one inch thick from inside-cover to inside-cover.
“Teaching an introductory finance class while faced with an ever-expanding
discipline puts additional pressures on the instructor. What to cover, what to omit,
and how to do this while maintaining a cohesive presentation are inescapable
questions.”
Keown, Arthur, J. William Petty, David Scott and John Martin. Foundations of Finance, 2nd edition.
Prentice Hall (1998).
“… we found it helpful to trim the content so that most of the material can be covered
in one semester. The reduced content helps to maintain a focus on the underlying
principles that drive finance rather than attempt to cover concepts and techniques
that are better presented in an intermediate finance course.”
Keown, Arthur, J. William Petty, David Scott and John Martin. Foundations of Finance, Prentice
Hall (1994).
Downsizing was well-received, so other books jumped on the bandwagon, too.
“… we streamlined our text to focus on only essential topics in finance, rather than
special topics that are rarely covered in this first finance course.”
Gallagher, Timothy J. and Joseph D. Andrew. Financial Management, Principles and Practice.
Prentice Hall Publishing (1997).
“Therefore, rather than taking an encyclopedic approach, we develop and reinforce
the essential ideas of finance. By providing a coherent and logical approach to the
subject, we hope to sustain students’ interest in finance, build on their background,
and appeal to their common sense.”
Hickman, Kent and Hugh Hunter. Foundations of Corporate Finance. West Publishing (1996).
“Because Essentials is not a “me-too” book, we have … taken a hard look at what is
really relevant and important for an introductory class. This process led us to take a
fresh, modern approach to many traditional subjects. Along the way, we downplay
purely theoretical issues and associated mathematical formulations, and we avoid
the use of elaborate computations to illustrate points that are either intuitively
obvious or of limited practical use.”
Ross, Stephen, Randolph Westerfield, and Bradford Jordan. Essentials of Corporate Finance, 2nd
edition. Irwin McGraw-Hill (1999).
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
12
“… so we decided three years ago to create the first edition of Fundamentals of
Financial Management: The Concise Edition for those who like Fundamentals but
think a smaller, more concise textbook would better serve their needs. … Concise
is significantly different than Fundamentals primarily because it is shorter.”
Brigham, Eugene and Joel Houston. Fundamentals of Financial Management Concise, 2nd edition.
Dryden Press (1999).
Adaptation to a one-course curriculum eventually exerts influence on textbook
development. Most students no longer study the material from Markets & Institutions,
and its exclusion from the general course of study motivates inclusion in introductory
finance textbooks.
“… we supplement the financial management material with essential background
information on financial markets and institutions. This coverage helps students
better understand the environment in which a firm operates so that they can become
more effective financial decision makers.”
Gallagher, et al., op cit.
“A movement is growing across the United States to offer a more “balanced” first
course in finance. … this book provides a valuable overview of the major concepts
of the discipline. … By exposing students to institutions, markets, and management
as the three major strands of finance, students will finish their course with a greater
understanding of how these three fields interrelate.”
Melicher, Ronald, Merle Welshans, and Edgar Norton. Finance: Introduction to Institutions,
Investments, and Management, 9th edition. South-Western Publishing (1997).
“Instructors usually teach the class from a managerial, or corporate, finance
perspective because that is the focus of the major books. Indeed, the title of many
of these textbooks includes the word managerial or corporate. However, as a
discipline the subject of finance is much broader. Finance encompasses financial
markets and institutions, and investments, in addition to managerial finance.”
Gallinger, George and Jerry Poe. Essentials of Finance: An Integrated Approach. Prentice-Hall
(1995).
“The book represents a survey of key concepts by covering the three general areas
of study in finance: (1) financial markets and institutions, (2) investments, and (3)
managerial finance.”
Besley, Scott and Eugene Brigham. Principles of Finance. Dryden Press (1999).
The search for essential finance fundamentals induces healthy reflection about
the basic structure of the discipline. The ability to downsize by cutting chapters and
infinite possibilities for rearranging chapters exacerbates the difficulty of getting a good
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
13
grip on the ideal course. This inability to define the intrinsic structure of finance is the
single largest dilemma facing the undergraduate introductory textbook market.
“… let’s look at the pattern, or close derivative, that most comprehensive books
follow … [they describe the Brigham model] … In summary, there is an overall lack
of a logical, consistent flow from one topic to another. ”
Gallinger and Poe, op cit.
“Unfortunately, it is all too easy for students to lose sight of the logic that drives
finance and to focus instead on memorizing formulas and procedures. As a result,
students have a difficult time understanding the interrelationships between the topics
covered.”
Scott, David, John Martin, J. William Petty, and Arthur Keown. Basic Financial Management, 8th
edition. Prentice Hall (1999).
“All too often, the beginning student views corporate finance as a collection of
unrelated topics which are unified by virtue of being bound together between the
covers of one book. In many cases, this perception is only natural because the
subject is treated in a way that is both topic oriented and procedural.”
Ross et al., op cit.
Authors attempt to overcome this apparent lack of cohesion by reaffirming that
everything in finance is about value, and that everything in every chapter is about value,
too. Every author emphatically agrees the intrinsic structure of finance revolves around
valuation.
“Most finance textbooks today use a valuation approach, and our text does as well.
We build upon the student’s knowledge of economics and accounting and apply
these concepts to the practice of financial analysis, planning, and project and firm
valuation.”
Lee et al., op cit.
“First, we take a valuation, rather than a balance-sheet approach. That is, market
values are emphasized over book values wherever possible. We stress marginal
analysis, cash flows, and the creation of value. The risk and return coverage
focuses on creating value for the firm’s owners, subject to legal, regulatory, and
ethical constraints.”
Gallagher and Andrew, op cit.
“The financial balance sheet is used throughout the text. A central construct, the
financial balance sheet, is incorporated throughout the text to provide continuity
between the current topic and value creation.”
Hickman and Hunter, op cit.
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
14
“As time passes, the details fade, and what remains, if we are successful, is a sound
grasp of the underlying principles. This is why our overriding concern, from the first
page to the last, is with the basic logic of financial decision making. … Every
subject covered … is firmly rooted in valuation, and care is taken throughout to
explain how particular decisions have valuation effects.”
Ross et al., op cit.
“Structuring the book around markets and valuation enhances continuity and helps
students see how the various topics are related to one another.”
Brigham and Houston, op cit.
No matter how you cut it, most authors develop a story about finance by focusing
on the same old blocks. Perhaps one author improves the restatement, say, of the
capital budgeting block. And another author introduces a fine block on derivatives. Yet
another author deletes the block on corporate capital structure theory. And everyone
rearranges the blocks into his or her peculiar preferred order. Regardless, the chapters
in almost every existing book remain independent modular blocks. The independence
of one chapter from another persists.
“Although the text is sequential, instructors can assign almost any chapter as a selfcontained unit.”
Gitman, Lawrence. Principles of Managerial Finance, 9th edition. Addison Wesley Longman
(2000).
“… we have attempted to present the chapters in a stand-alone fashion so that they
could be easily rearranged to fit almost any desired course structure and course
length.”
Keown et al., op cit.
“… we designed Essentials of Corporate Finance to be as flexible and modular as
possible. There are a total of nine parts, and, in broad terms, the instructor is free to
decide the particular sequence.”
Ross et al., op cit.
“Although the chapters in Concise are sequenced logically, they are written in a
flexible, modular format, which will help instructors cover the material in a different
sequence should they choose to do so.”
Brigham and Houston, op cit.
“Also, we have made every effort to write the chapters in a flexible, modular format,
which helps instructors cover the material in a different sequence should they
choose to do so.”
Besley and Brigham, op cit.
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
15
You can’t tell a good story with independent modular blocks. A good story has a
clear beginning, a clear ending, and rearranging the storyline hardly works in any book.
Ideally, the book carries the reader from cover-to-cover through a story with chapters
that naturally flow from topic to topic.
Existing introductory finance textbooks offer the teacher a set of wonderful selfcontained blocks. A talented teacher makes a good story out of the blocks. A sub-par
teacher relies on ancillary materials and presents good independent blocks. Existing
books, however, leave in the instructor’s hands too much responsibility for establishing
relevance among different topics.
“… the instructor has great control over the topics covered, the sequence in which
they are covered, and the depth of coverage.”
Ross et al., op cit.
“For many years, instructors have been aware of serious problems with most finance
texts in that they are very difficult for students to understand. That isn’t to say the
material is too deep for the students’ abilities. Rather, the presentations are
inconsistent with those abilities. … The result of all this has been that instructors
don’t get much help from textbooks in teaching finance.”
Lasher, William. Practical Financial Management. West Publishing (1997).
The textbook should tell the story of finance. Finance is a story about value. The
undergraduate introductory market is ready for a textbook with cohesive and unifying
lessons showing how the three sources of value define the structure of finance.
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
16
References
Besley, Scott and Eugene Brigham. Principles of Finance. Dryden Press (1999).
Brigham, Eugene and Joel Houston. Fundamentals of Financial Management, 8th
edition. Dryden Press (1998).
Brigham, Eugene and Joel Houston. Fundamentals of Financial Management Concise,
2nd edition. Dryden Press (1999).
Eakins, Stanley. Finance: Investments, Institutions, and Management. Addison-Wesley
Longman (1999).
Gallagher, Timothy J. and Joseph D. Andrew. Financial Management, Principles and
Practice. Prentice Hall Publishing (1997).
Gallinger, George and Jerry Poe. Essentials of Finance: An Integrated Approach.
Prentice-Hall (1995).
Gitman, Lawrence. Principles of Managerial Finance, 9th edition. Addison Wesley
Longman (2000).
Hickman, Kent and Hugh Hunter. Foundations of Corporate Finance. West Publishing
(1996).
Keown, Arthur, David Scott, John Martin, and J. William Petty. Foundations of Finance.
Prentice Hall (1994).
Keown, Arthur, David Scott, John Martin, and J. William Petty. Foundations of Finance,
2nd edition. Prentice Hall (1998).
Lasher, William. Practical Financial Management. West Publishing (1997).
Lee, C.F., Joseph Finnerty, and Edgar Norton. Foundations of Financial Management.
West Publishing (1997).
Levy, Haim. Principles of Corporate Finance. South-Western Publishing (1998).
Lewellen, Wilbur, John Halloran, and Howard Lanser. Financial Management: An
Introduction to Principles and Practice. South-Western Publishing (2000).
Melicher, Ronald, Merle Welshans, and Edgar Norton. Finance: Introduction to
Institutions, Investments, and Management, 9th edition. South-Western Publishing
(1997).
Moyer, R. Charles, James McGuigan, and William Kretlow. Contemporary Financial
Management 7th edition. South-Western Publishing (1998).
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
17
Ross, Stephen, Randolph Westerfield, and Bradford Jordan. Essentials of Corporate
Finance, 2nd edition. Irwin McGraw-Hill (1999).
Scott, David, John Martin, J. William Petty, and Arthur Keown. Basic Financial
Management, 8th edition. Prentice Hall (1999).
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
Table of Contents
Preface
Chapter Organization
Table of Contents
PART 1: FLOWS, BALANCES AND TIME VALUE
CHAPTER 1: INTRODUCTION TO THE STUDY OF FINANCE
1. So Just What Is “Finance” Anyway?
1.A. Finance in the corporate pyramid
1.B. Finance sub-disciplines
1.C. Finance certifications
2. The Company Cash Flow Cycle
2.A. Stakeholders
2.B. Financial markets
2.C. Agency problems
C1. Shareholders versus management
C2. Creditor versus management/shareholder
C3. Employee versus management/shareholder
2.D. Wealth creation and the company goal
3. Clones of the Company Cash Flow Cycle
3.A. Corporate business
3.B. Noncorporate business
3.C. Households as companies
CHAPTER 2: FINANCIAL FUNDAMENTALS OF ACCOUNTING
1. The Relation Between Flows and Balances
1.A. The relativity of time
1.B. Cash flows accumulate to form balances
1.C. Accrued versus realized flows and balances
2. Representing Flows and Balances on Financial Statements
2.A. The Balance Sheet
A1. Liabilities are financing sources
Current Liabilities
Long term Liabilities
STREET-BITE A thrilling financing source: initial public offerings
STREET-BITE Mergers, acquisitions, and contests for corporate control
A2. Assets are financing uses
Current Assets
Long term Assets
Net Working Capital
2.B. The Income Statement
3. Financial ratios
3.A. Ratio categories
3.B. Ratio Relationships
B1. Ratio norms
B2. Return on equity and the DuPont analysis
3.C. Breakeven ratios
4. The income statement links adjacent balance sheets
CHAPTER 3: ACCOUNTING FOR GROWTH
1. Financial forecasting
1.A. Cash budgeting
1.B. Balance sheet forecasts
B1. Fundamentals of forecasting with reliance on balance sheets
STREET-BITE The New York Stock Exchange
B2. Forecasting external financing needs when internal financing is available
18
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
EFN when balances change proportionately with sales
EFN for flexible cases
2. Natural growth rates
2.A. Growth exclusively with internal financing
2.B. The sustainable growth rate
3. Focus on cash flow
3.A. Cash Flow from the corporation to the financial markets
3.B. Other Cash Flow Measures
STREET-BITE An American invention: venture capitalists
CHAPTER 4: TIME VALUE AND RELATIONS BETWEEN RETURNS
1. Framework for properly measuring average rates of return
STREET–BITE Mistaken Measures: Case of the Beardstown Ladies
2. The lump-sum time value formula: one inflow, one outflow
2.A. Ending wealth, FV, as the unknown
2.B. Beginning wealth, PV, as the unknown
STREET–BITE The Fed, the Discount Rate and the Stock Market
2.C. The investment horizon, N, as the unknown
2.D. The rate of return, r, as the unknown
2.E. Approximations with the rule of 72
3 Intraperiod compounding of interest
3.A. The relationship between periodic components
3.B. Annual percentage rate (APR) vs. effective annual rate (EAR)
4. Inflation and time value
5. The general time value formula for cash flow streams
5.A. Ending wealth, FV, as the unknown
5.B. Beginning wealth, PV, as the unknown
5.C. The rate of return, r, as the unknown
CHAPTER 5: FUTURE AND PRESENT VALUES OF ANNUITIES
1. The time value formula for constant annuities
2. Future values of annuities
2.A. Ending wealth, FV, as the unknown variable
2.B. Using the annuity and lump-sum formulas together
3. Present values of annuities
3.A. Beginning wealth, PV, as the unknown variable
3.B. The special case of perpetuities
4. Cash flows connecting beginning and ending wealth
4.A. Cash flow, CF, as the unknown variable
4.B. Other two-stage problems
5. Amortization mechanics
5.A. Partitioning the payment into principal and interest
5.B. Re-pricing loans: book versus market value
CHAPTER 6: TIME VALUE APPLICATION 1, CAPITAL BUDGETING
1. Alternative assessment measures and rules
1.A. Payback period
1.B. Internal rate of return (“IRR”)
1.C. Net present value (“NPV”)
2. Significance of NPV
2.A. NPV represents economic profit
2.B. Relation between NPV and IRR
B1. The NPV profile
B2. Ranking competing investments
Cross-over rates
3. Incremental cash flow streams
3.A. Choosing the proper stream to analyze
3.B. Complications to initial and terminal cash flows
CHAPTER 7: TIME VALUE APPLICATION 2, BOND VALUATION
19
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
20
1. Bond basics: Notation, quotation, and cash flow
2. Relation between price and yield-to-maturity
3. Bond price movements
3.A. Constant interest rates and scientific amortization
3.B. Horizon analysis and changes in interest rate
3.C. Riding the yield curve
CHAPTER 8: TIME VALUE APPLICATION 3, STOCK VALUATION
1. Technical versus fundamental analysis
2. Intrinsic value for stocks
STREET-BITE The NASDAQ Stock Market
2.A. Preferred stocks with constant dividends
2.B. Common stocks with growing dividends
B1. The dividend growth rate
B2. The constant growth dividend valuation model
2.C. Total return partitions into dividend and capital gain yields
3. The fundamental search for true intrinsic value
3.A. Intrinsic value and the sustainable growth rate
3.B. Price multiples and fundamental analysis
PART 2: DIVERSIFICATION BENEFITS AND EQUILIBRIUM RATES OF RETURN
CHAPTER 9: BUY-SIDE DEMAND, SELL-SIDE SUPPLY, AND RATIONALE FOR FINANCIAL MARKET
EQUILIBRIUM
1. SUPPLY AND DEMAND IN THE FINANCIAL MARKETS
2. MAJOR PLAYERS FOR THE BUY-SIDE
2.A. Households
2.B. Pension funds
B1. Defined benefit retirement plans
B2. Defined contribution retirement plans
2.C. Mutual funds
2.D. Insurance companies
2.E. Nonprofit institutions
2.F. Commercial banking, savings institutions, and credit unions
3. CHARACTERISTICS ON THE SELL-SIDE
3.A. Credit market securities
A1. Open market paper
A2. U.S. government securities
Treasury securities
Government sponsored enterprise securities
4. RATIONALE FOR FINANCIAL MARKET EQUILIBRIUM
4.A. Expected returns equilibrate with required returns
4.B. Historical record of financial market rates of return
4.C. The efficient markets hypothesis implies expected returns vibrate around required returns
C1. Nuances of the efficient market hypothesis
CHAPTER 10: MEASURING RISK, RETURN, AND DIVERSIFICATION BENEFITS
1. Overview of risk, return, and the dominance concept
2. Sources of idiosyncratic risk
Liquidity risk
Term risk
Default risk
Operating leverage
Financial leverage
Other common sources of idiosyncratic risk
3. Statistical measurements of risk and return
3.A. Measures for individual securities
3.B. Measures for portfolios of securities
4. Benefits from diversification
4.A. Relation between diversification benefits and correlation
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
21
4.B. The minimum risk portfolio and investment advice
4.C. The risk-return profile for 2-security portfolios
CHAPTER 11: DETERMINATION OF EQUILIBRIUM RETURNS
PART 3: ARBITRAGE VALUE
CHAPTER 12: FINANCIAL ARBITRAGE
1. The arbitrage concept
2. Futures contracts
2.A. Currency transactions
3. Option contracts
3.A. Call options
3.B. Put options
4. Important international financial arbitrage relationships
4.A. Triangle arbitrage and currency prices
4.B. Relative purchasing power parity
4.C. Interest rate parity and covered interest arbitrage
APPENDIX 1: FUTURE AND PRESENT VALUE FACTORS OF ANNUITIES
APPENDEX 2: GLOSSARY
INDEX
List of Tables
TABLE 1.1
TABLE 1.2
TABLE 1.3
TABLE 1.4
TABLE 1.5
TABLE 1.6
TABLE 1.7
TABLE 2.1
TABLE 2.2
TABLE 2.3
TABLE 2.4
TABLE 2.5
TABLE 2.6
TABLE 2.7
TABLE 2.8
TABLE 2.9
TABLE 3.1
TABLE 3.2
TABLE 3.3
TABLE 3.4
TABLE 4.1
Professional Certifications in Finance
Common schemes for categorizing financial markets
American corporate icons.
Quartile breakpoints on key variables for 6,954 public companies.
Aggregate distribution of resources for 6,954 public companies
Relative prevalence of economic entities in U.S.A., circa 1999-2000.
Balance sheets for the nonfarm nonfinancial corporate sector and for
households including nonprofit organizations
International Business Machines Corporation and Subsidiary Companies.
Consolidated Balance Sheet.
Data on initial public offerings.
Recent activity on mergers and acquisitions activity in the USA
International Business Machines Corporation and Subsidiary Companies.
Consolidated Income Statement
Ratio categories, formulas, and company examples
Market-based financial ratios for American corporate icons.
Time series of operating margin for Home Depot, Inc.
Cross-section of operating margins, February 2001, for companies in the
retail home-improvement sector.
Average values for selected financial ratios in different industries.
Growth rates for selected variables of American corporate icons.
Global Stock Market Capitalization ($ trillions)
Natural growth rate dynamics
Venture-backed initial public offerings
Differences between geometric and average rates of return for selected
NYSE and AMEX stocks
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
22
TABLE 4.2 Stock returns after changes to the Fed's discount rate.
TABLE 4.3 Ending wealth of a $1,000 deposit at an 8.4 percent APR for different
compounding frequencies
TABLE 4.4 Payment & discount plans for purchasing inventory
TABLE 4.5 Effective annual rates for different APR and compounding frequencies
TABLE 4.6 Common components in the general time value relationship
TABLE 6.1 Tax depreciation schedules for the Modified Accelerated Cost Recovery
System (MACRS).
TABLE 7.1 Average daily trading volume of selected financial securities
TABLE 7.2 Component characteristics for the total rate of return
TABLE 8.1 Computing moving average stock prices
TABLE 8.2 Number of U.S. households owning equities, 2002.
TABLE 8.3 A typical dividend history
TABLE 8.4 Component characteristics for the total rate of return
TABLE 8.5 Multiples for a peer group of air courier companies
TABLE 9.1 Distribution by employment of 50,000 members of the Association for
Investment Management and Research
TABLE 9.2 Financial assets for the buy-side, by type of investor and asset type.
TABLE 9.3 Average earnings in the U.S.A. by highest degree earned.
TABLE 9.4 Considerations relevant to households for buy-side decision-making.
TABLE 9.5 Assets of Private and Public Pension Funds, 1980 – 2000.
TABLE 9.6 Summary of 401(k) defined contribution plans.
TABLE 9.7 Balance sheet for CREF Growth Mutual fund
TABLE 9.8 Summary of mutual fund categories.
TABLE 9.9 Annual insurance premiums by line
TABLE 9.10 The largest university endowment funds.
TABLE 9.11 Financial assets and selected liabilities for U.S. commercial banks.
TABLE 9.12 Institutions in the bank sector.
TABLE 9.13 Financial liabilities for the sell-side, by type of issuer and instrument.
TABLE 9.14 Government sponsored enterprises
TABLE 9.15 Summary statistics for annual rates of return
TABLE 9.16 Maximum and minimum values of returns for 1-, 5-, 10-, 15-, and 20-year
holding periods
TABLE 10.1 Quintile breakpoints on equity liquidity variables.
TABLE 10.2 Percentage of total trading volume (and median stock price) in each
quintile according to various liquidity measures.
TABLE 12.1 Active futures exchanges in the U.S.A.
TABLE 12.2 Comparison of hedging and speculative motives
TABLE 12.3 World currency prices measured in U.S. dollars
TABLE 12.4 Characteristics of futures and option contracts
TABLE 12.5 Average daily trading volume in the currency foreign exchange market
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
List of Figures
FIGURE 1 (Preface): Chapters pertaining to the three sources of value
FIGURE 1.1 Finance in the corporate hierarchy
FIGURE 1.2 Typical finance group in the company
FIGURE 1.3 The Company Cash Flow Cycle
FIGURE 2.1 Typical managerial steps for mergers and acquisitions
FIGURE 4.1 Interest and inflation rates, 1952-2003.
FIGURE 6.1 NPV profile for a capital budgeting project
FIGURE 6.2 NPV profiles for two projects
FIGURE 6.3 Potential configurations for cross-over points
FIGURE 7.1 Evolution of bond price over time given constant yield-to-maturity
FIGURE 7.2 Normal yield curve
FIGURE 8.1 Moving average trading strategy based on data in table 8.1
FIGURE 8.2: Plot of the dividend history from table 8.3 and the line of best fit for
Example 8
FIGURE 9.1 Supply and demand schedules for primary market financial securities
FIGURE 9.2 Issuers of outstanding open market securities, 12/31/2001.
FIGURE 9.3 Types of marketable Treasury securities.
FIGURE 9.4 Growth of a $1 investment at year-end 1925 in different asset classes
FIGURE 9.5 Price adjustment process to an information event
FIGURE 10.1 Risk, return, and dominance
FIGURE 10.2 Risk and return for Example 5
FIGURE 10.3 Risk, return and the line of averages for two-security portfolios
FIGURE 10.4 X, Y, and the minimum risk portfolio
FIGURE 10.5 Risk-return profile for securities X and Y
FIGURE 10.6 Risk-return profiles depend on correlation
FIGURE 10.7 Risk-return profiles and allocation at the minimum risk portfolio
FIGURE 10.8 Risk-return profile for large (LC) and small cap (SC) stocks
FIGURE 10.9 Two scenarios for investment advice
FIGURE 11.1 Risk-return profiles and the Efficient frontier
FIGURE 11.2 Efficient frontier and the Capital market line
FIGURE 11.3 Supply and demand schedules for risk-free credit market securities
FIGURE 11.4 Inflation and interest rates for corporate bonds and U.S. government
securities.
FIGURE 11.5 Components of U.S. credit market securities
FIGURE 11.6 Capital market line and the rays of correlation
FIGURE 11.7 Expected return and σ for example 3
FIGURE 11.8 The Security market line
FIGURE 11.9 Expected return and β for examples 3 & 4
FIGURE 12.1 Number of option contracts traded per year on U.S. exchanges.
23
Lessons about the Structure of Finance, Thomas W. Downs
April 2006
24
End-of-section problems and algorithmic software
Problem solving repetition reinforces understanding relationships. Therefore,
throughout each chapter examples or questions solve a problem from one direction and
then from another in order to reinforce underlying concepts. At the end of most
subsections find Exercises. Chapter 4, for example, presents five sections with a total
of twelve subsections. Following each is a set of exercises offering a total of 67 unique
questions. While 12 exercise sets appear throughout this one chapter, answers for all
always appear at end-of-chapter.
Exercises ask conceptual as well as numerical questions. End-of-chapter
answers for all are written in paragraph form with varying degree of explanation.
Written answers sometimes expound on chapter lessons with new insights, details, or
shortcuts important for student and teacher alike that may otherwise be overlooked.
Throughout Lessons the answers also provide opportunity for instructors to buttress
class presentations and drive home important intuitive insights.
Numerical problems obviously are important for finance. Numerous and frequent
problems with written paragraph answers assist student learning. Also assisting
students and teachers is algorithmic study software, Algogen©, that accompanies
Lessons. Most textbook problems contain a code that Algogen© uses for repetitively
generating problems with new numbers.
Exercise 4.1, #4, for example, looks like this:
4. Two years ago you purchased a stock for $40. One year ago the price had moved to $19. Today it is
at $60. What are the arithmetic and geometric average annual rates of return? ©ROR3c .
Algogen for Students© allows students to checkmark question ROR3c and make, say,
five different versions, each with different numbers (Algogen© gives answers and clues,
too). Algogen© allows an unprecedented teaching tool for directing student study
efforts. The teacher may announce, for example, “next class starts with a quiz on
Exercise 4.1, #4, so study it!” or “here are codes for one-third of the questions on the
exam.” Students use Algogen© and with a few simple mouse-clicks create documents
containing selected questions, as many versions of as many problems as desired.
Students appreciate direction for studying. It’s great when they study – repetitions build
strength. And algorithmic questions appearing on the quiz or exam have different
numbers than the ones studied.
The Algogen© library that accompanies Lessons contains about 700 questions.
Some questions are very simple, some very complex, some are multi-part, some are
conceptual, most are numerical. And every one looks different with each recalculation.
All questions pertain to Lessons about the Structure of Finance.
To learn more about the Algogen support system, right click here and SAVE the target
pdf presentation to your disk. Then open, read, and watch the Algogen presentation.