API 141
Finance
SYLLABUS
August 31, 2021
Akash Deep
HARVARD Kennedy School
API-141, Fall 2021
Finance
Faculty
Office
Telephone
Email
Office Hours
Akash Deep
Littauer 210
617 495 1340
akash_deep@hks.harvard.edu
TBD
Class Sessions
Tuesday and Thursday, 1:30 to 2:45pm in Wiener Auditorium
Review Sessions
Friday, 12 to 1:15pm in Wexner-436 (starting September 10)
Faculty Assistant
Office
Telephone
Email
Louie Mitchell
Littauer 107A
617 495 8103
louis_mitchell@hks.harvard.edu
Teaching Fellow
Email
Farhana Roslan
farhanaroslan@hks.harvard.edu
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
COURSE DESCRIPTION
This course provides a general survey of finance and investments. It emphasizes an intuitive,
logically rigorous understanding of the theory and practice of financial markets, illustrating the
concepts through examples and cases drawn from diverse settings. Topics covered include:
present value; diversification; the trade-off between risk and return; pricing of stocks and bonds;
the capital asset pricing model; term structure of interest rates; the principle of arbitrage;
derivative securities such as forwards, futures, and options; use of derivatives for hedging; real
options; and risk management. Case discussions illustrate a wide range of applications of the
theory including pension funds, rate of return regulation, investment strategies, currency risk
management, weather micro-insurance, privatization, deposit insurance, and the subprime crisis.
AUDIENCE
The course is intended for students who are interested in learning the basic tools and techniques
of finance and how they are employed for the valuation of complex securities. While an intuitive
appreciation of the principles will be the primary objective, mathematical tools will be employed
to illustrate the implementation of these principles to practical cases. Any advanced mathematics
that is used will be developed in lectures and review sessions.
PREREQUISITE
It is assumed that students will be familiar with basic (high school level) mathematics. Students
with concerns about their backgrounds are welcome to speak to the instructor. Basic computer
spreadsheet skills will be expected and required to complete some of the assignments.
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COURSE STRUCTURE: REQUIRED ENGAGEMENT
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
Each week covers a different topic. Learning is distributed across asynchronous and synchronous
sessions over the course of the week to maximize engagement and interaction.
Preparation
for lecture
Lecture
Preparation
for discussion
Each new topic commences with some preparatory work.
Review required background in a Concepts lecture
Answer the Concept Check questions
Complete assigned readings
The most important principles relating to the topic of the week
are presented in an interactive lecture, which draws upon the
Concepts.
The topic of the week is illustrated, reinforced and extended
through examples and applications.
Complete and submit the weekly Assignment
Read and analyze the Case Study using the Study
Questions. Written answers are not required.
Complete assigned Readings
Discussion
A discussion on the topic of the week is organized using the
Case Study and recent developments. Students are expected to
participate actively and should be prepared to share their
answers and opinions.
before
Thursday
asynchronous
~ 2 hours
Thursday
synchronous
1 ¼ hours
before
Tuesday
asynchronous
~ 4 hours
Tuesday
synchronous
1 ¼ hours
ADDITIONAL ENGAGEMENT OPPORTUNITIES
o Review Sessions: Attendance of the Friday review sessions is strongly advised but not
required. A recording of the review sessions will be made available.
o Practice Questions: Additional, optional practice questions are available for each topic.
o Office hours with Professor Deep: Students have the opportunity to sign up for
individual office hours with Professor Deep.
o Office hours with the Teaching Team: The Teaching Fellow and Course Assistants will
hold weekly office hours that are open to all students enrolled in the course. Prior sign-up
is not required.
o Class-wide communication: A Canvas community board will be available as a forum
for informal communication among the entire class on topics that are relevant to the
course.
2
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
EXAMS
There will be in-class, closed book and closed notes midterm and final exams. No make-up
exams will be held, except in extenuating circumstances. Enrolling in this course requires that
you plan to take the exams on the announced exams dates.
ASSIGNMENTS AND GROUP WORK
Students are encouraged to work together to complete assignments. However, the solutions you
submit to individual assignments must be your own understanding of how to do the assignment
and must be written by you alone. You must state what sources you have consulted, with whom
you have collaborated, and from whom you have received help, in compliance with the Harvard
Kennedy School Academic Code set forth in the Student Handbook.
GRADING
The course must be taken for credit. There is no option to audit the course.
o
o
o
o
Engagement
Assignments
Midterm Exam
Final Exam
10%
30%
20%
40%
CROSS REGISTRATION
Non-HKS students must petition to enroll in the course using my.harvard. Petitions may only be
approved after the end of HKS course enrollment period (September 3) if class enrollment limits
permit. All petitioners are expected to fulfil all class requirements until an enrollment decision
has been made. For non-Harvard students, as soon as they petition to enroll in this course, they
will gain a HarvardKey, which they can use to access the Canvas site for this course.
MATERIALS
The textbook for the course is Essentials of Investments, 12th edition by Zvi Bodie, Alex Kane
and Alan Marcus, McGraw-Hill Irwin, 2022. Recent editions of this textbook may also be used.
It can be purchased or rented in hardcopy or digitally through McGraw-Hill or The Coop.
Upon enrollment in this course, students have access to a Canvas site where all course materials
are available, including all required readings from this textbook, other readings and cases.
Regular reading of financial news in publications such as The Wall Street Journal, The Financial
Times, The Economist, or the Business pages of The New York Times is strongly recommended.
OTHER RECOMMENDED (BUT NOT REQUIRED) FINANCE TEXTS
The following are some good introductory finance texts that overlap in parts with the material
covered in the recommended text for this class:
o Corporate Finance, 13th edition, Stephen Ross, Jeffrey Jaffe, and Randolph Westerfield,
McGraw-Hill Financial, 2022.
o Principles of Corporate Finance, 13th edition, Richard Brealey and Stewart Myers,
McGraw-Hill Financial, 2020.
o Investment Science, 2nd edition, David Luenberger, Oxford University Press, 2013 (uses
calculus).
o Financial Modeling, 4th edition, Simon Benninga, The MIT Press, 2014.
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TOPICS AT A GLANCE
Week
1
2
3
4
5
6
Date
Sep 2 Thu
Sep 7 Tue
Topic
Introduction to finance and financial markets
The tools of finance
Assignment
due
Time
Sep 9 Thu
Bonds
Sep 14 Tue
Predicting the future: Yield curves
A
Sep 16 Thu
Sep 21 Tue
B
Equity
Raising finance: Tombstones
Uncertainty
Sep 23 Thu
Choosing a portfolio
Sep 28 Tue
Investing pension funds: The State of South Carolina
C
Sep 30 Thu
Oct 5 Tue
D
The Capital Asset Pricing Model
Risk-adjusted returns: Communications Satellite Corporation
Information
Oct 7 Thu
Efficient markets
Oct 12 Tue
Financial innovation: Fidelity: Embracing ETFs
Oct 14 Thu
7
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
E
Midterm Exam
Risk Management
Oct 19 Tue
Why manage risk?
8
Oct 21 Thu
Oct 26 Tue
Forward and futures contracts
Managing currency risk: Dozier Industries
F
9
Oct 28 Thu
Nov 2 Tue
Options
Insurance: BASIX
G
10
Nov 4 Thu
Nov 9 Tue
Option pricing, the Binomial approach
Predicting uncertainty: The Black-Scholes Model & implied volatility
H
11
Real Options
Nov 16 Tue
Real options
Nov 18 Thu
Privatization, investment, and uncertainty: Bidding for Antamina
I
12
Financial Institutions
Nov 23 Tue
Banks and financial intermediation: Federal Deposit Insurance Corporation
Nov 30 Tue
Housing finance: Subprime Meltdown
J
Dec 2 Thu
Review
Dec 8 Wed
Final Exam (2 to 5pm)
4
1. INTRODUCTION TO FINANCE AND FINANCIAL MARKETS
Lecture: Introduction to finance and financial markets
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
September 2
Preparation
Chapters 1 and 2, Essentials of Investments, Bodie, Kane & Marcus. (Optional: Chapter 3)
“The slumps that shaped modern finance,” The Economist, April 12, 2014.
“Unfettered finance is fast reshaping the global economy,” Martin Wolf, The Financial Times,
June 19, 2007.
“Introduction: Finance, Stewardship, and Our Goals,” in Finance and the Good Society, Robert J.
Shiller, Princeton University Press, 2012, 1-15.
Lecture: The tools of finance
September 7
Preparation
“Financial Decision Making and the Law of One Price,” Chapter 3 in Corporate Finance, 4th
edition, Jonathan Berk and Peter DeMarzo, Pearson Addison Wesley, 2017.
“The Time Value of Money,” Chapter 4 in Corporate Finance, 4th edition, Jonathan Berk and
Peter DeMarzo, Pearson Addison Wesley, 2017.
Further Reading
o
o
o
The Wall Street Journal Future of Finance, Journal Reports.
Finance and the Good Society, Robert J. Shiller, Princeton University Press, 2013.
The Wall Street Journal Guide to Understanding Money & Investing, Kenneth M. Morris
and Virginia B. Morris, Simon and Schuster, 2004.
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API 141 Finance
Syllabus
Akash Deep
August 31, 2021
2. BONDS
Lecture: Bonds
September 9
Preparation
Chapter 10, Sections 10.1 to 10.5, Essentials of Investments, Bodie, Kane & Marcus.
Discussion: Predicting the future: Yield curves
September 14
Preparation
Chapter 10, Section 10.6, Essentials of Investments, Bodie, Kane & Marcus.
“The Yield Curve as a Leading Indicator”, Federal Reserve Bank of New York, webpage.
“Bond rally pushes global stock of negative-yielding debt above $16tn”, Financial Times, August
5, 2021.
Assignment A
Study Questions
o
o
o
What is the significance of the shape of the yield curve?
Why might anyone invest in a negative yielding financial instrument?
What opportunities do negative yields represent? What challenges might they pose?
Further Reading
o
o
The Handbook of Fixed Income Securities, 8th edition, Frank J. Fabozzi, McGraw-Hill
Professional, 2012.
Fixed Income Securities: Tools for Today's Markets, 3rd edition, Bruce Tuckman, John Wiley &
Sons, 2011.
6
3. EQUITY
Lecture: Equity
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
September 16
Preparation
Concepts: A primer on corporate finance
Concept Check: A primer on corporate finance
Chapter 13, Sections 13.2 – 13.4, and Section 14.1, Essentials of Investments, Bodie, Kane &
Marcus.
“Why yields are the best guide to future stockmarket returns,” Economist, Sep 7 2019.
Discussion: Raising finance
September 21
Preparation
Case: Tombstones
How did six firms – Microsoft, Coca Cola Enterprises, Norfolk Southern, IBM, Ford Motor, and
Cephalon – raise money in US capital markets just after the financial crisis and recession of 200809?
“Alphabet locks in record-low borrowing costs in $10bn deal,” Financial Times, August 3, 2020.
“Rwanda raises $620m in second-ever international bond sale,” Financial Times, August 2, 2021.
Assignment B
Study Questions
o
o
o
o
o
o
Why is Microsoft issuing debt? Would you consider the yield on Microsoft debt to be “high” or
“low”?
Why is Coca Cola issuing debt?
Why is Norfolk Southern issuing debt?
How are the IBM Notes different from the other debt issuances?
Why do you think Ford Motor chose to issue stock rather than debt?
How do the Cephalon Convertible Notes compare to other debt and equity issuances?
Further Reading
o
o
Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, 2nd edition,
Aswath Damodaran, John Wiley & Sons, 2006.
Security Analysis, 6th edition, Benjamin Graham and David Dodd, McGraw-Hill Education, 2008.
7
4. PORTFOLIO SELECTION
Lecture: Choosing a portfolio
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
September 23
Preparation
Concepts: Risk, return and portfolios
Concept check: Risk, return and portfolios
Chapter 5, Section 5.4 to 5.6, and Chapter 6, Sections 6.1 to 6.4, Essentials of Investments, Bodie,
Kane & Marcus.
“You, too, Can Short Stocks,” Business Week, March 22, 1999.
Discussion: Investing pension funds
September 28
Preparation
Case: The State of South Carolina
HBS case # 9-201-061
South Carolina, State Treasurer's Office, 1998. Until last year the state pension fund, with
over $17 billion in assets, was barred by the state constitution from investing in equities.
After the constitution was amended, the state government has to decide how much to
invest in equities, and what assets to choose.
“The Long, Sorry Tale of Pension Promises,” Roger Lowenstein, The Wall Street Journal,
October 1, 2013.
“America’s public-sector pension schemes are trillions of dollars short,” Economist, November
14, 2019.
Assignment C
Study Questions
o
o
o
o
What is the problem that South Carolina faced in 1999 with regard to the management of its
pension funds? How do you know that there is a problem?
What are the potential solutions?
What should the objectives of pension investing be?
How do stocks versus bonds rank on these dimensions?
Further Reading
o
o
Modern Portfolio Theory and Investment Analysis, 9th edition, Edwin Elton, Martin Gruber,
Stephen Brown and William Goetzmann, John Wiley & Sons, 2014.
Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term
Investment Strategies, 5th edition, Jeremy J. Siegel, McGraw-Hill Education, 2014.
8
5. THE CAPITAL ASSET PRICING MODEL
Lecture: The Capital Asset Pricing Model
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
September 30
Preparation
Concepts: Equilibrium
Concept check: Equilibrium
Sections 7.1-7.3, Essentials of Investments, Bodie, Kane & Marcus.
“Risk and Return,” The Economist, February 2nd 1991, 72-73.
“Does the Capital Asset Pricing Model Work?” David Mullins, Jr., Harvard Business Review,
January-February 1982, 105-113.
Discussion: Risk-adjusted returns
October 5
Preparation
Case: Communications Satellite Corporation
HBS Case No. 276-195
In January 1975, the Federal Communications Commission (FCC) concluded an 11-year
investigation of the appropriate regulation of Comsat. One of the most important of these
was the determination of the fair rate of return on Comsat's capital. Both the qualitative
assessment of risk and the use of analytical techniques had been suggested by eminent
experts.
“Regulation and the Cost of Capital,” Tim Jenkinson, in the International Handbook on
Economic Regulation, edited by Michael Crew and David Parker, Edward Elgar, 2006.
Assignment D
Study Questions
o
o
o
o
How risky is the investment in Comsat compared to an investment in AT&T and other
companies? Which of these risks can be classified as systematic and which as unsystematic?
By what methods can the cost of equity and cost of capital be estimated for Comsat (or any other
company)?
How convincing is the argument of the trial staff? What are the implications of its reasoning and
recommendation for all parties concerned and for future government regulated companies such as
Comsat?
What relation, if any, should there be between a firm’s cost of capital and its investment
decisions?
Further Reading
o
o
o
Asset Pricing, revised edition, John H. Cochrane, Princeton University Press, 2005.
The Econometrics of Financial Markets, John Y. Campbell, Andrew W. Lo and A. Craig
MacKinlay, Princeton University Press, 1996.
Dynamic Asset Pricing Theory, 3rd edition, Darrell Duffie, Princeton University Press, 2001.
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6. EFFICIENT MARKETS
Lecture: Efficient markets
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
October 7
Preparation
Concepts: Defining efficiency
Concept check: Defining efficiency
Chapter 8, Essentials of Investments, Bodie, Kane & Marcus.
“Trendspotting in asset markets,” Nobel Prize Committee, 2013.
“Random Walks in Stock Market Prices,” Eugene F. Fama, Financial Analysts Journal, JanuaryFebruary, 1995, 75-80.
“Efficient Markets, Random Walks, and Bubbles,” Chapter 11 in Irrational Exuberance, 3rd
edition, Robert Shiller, Princeton University Press, 2016.
“The Efficient Market Hypothesis and its Critics,” Burton G. Malkiel, Journal of Economic
Perspectives, Winter 2003 17 (1) 59-82.
Discussion: Financial innovation
October 12
Preparation
Case: Fidelity: embracing ETFs
University of Hong Kong Case HK1158
Forced by the investor preference for passive instruments like exchange-traded funds (ETFs)
driven by ETFs' fee and performance advantages, regulatory pressures, and the rise of roboadvisors, the renowned active manager Fidelity embraced ETFs by introducing smart beta ETFs.
As the new chairman, Abigail Johnson had to consider the challenges ahead including
incompatibility with Fidelity's investment philosophy and fierce industry competition.
Assignment E
Study Questions
o How are ETFs different from mutual funds and closed-end funds?
o What are smart beta ETFs? How are they linked to the CAPM and efficient markets theory?
o What is the investment philosophy of Fidelity? Do ETFs conflict with Fidelity’s investment
philosophy? What were the other major challenges for Fidelity to embrace the ETF market in
2016?
o Was the environment in which passive funds did better than active funds just a cyclical
phenomenon?
Further Reading
o Manias, Panics and Crashes: A History of Financial Crises, 7th edition, Charles P. Kindleberger,
John Palgrave MacMillan, 2015.
o Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, 2nd edition,
Nassim Nicholas Taleb, Texere, 2004.
o Extraordinary Popular Delusions and the Madness of Crowds, Charles Mackay, 1841.
o Inefficient Markets: An Introduction to Behavioral Finance, Andrei Shleifer, Oxford University
Press, Clarendon Lectures in Economics, 2000.
o Irrational Exuberance, 3rd edition, Robert Shiller, Princeton University Press, 2016.
o A Random Walk Down Wall Street, 12th edition, Burton G. Malkiel, W. W. Norton & Co., 2019.
o Thinking, Fast and Slow, Daniel Kahneman, Farrar, Straus and Giroux, 2011.
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7. RISK MANAGEMENT
Lecture: Why manage risk?
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
October 19
Preparation
“A Framework for Risk Management,” Kenneth Froot, David Scharfstein, and Jeremy Stein,
Harvard Business Review, November-December 1994, 91-102.
“The Fantastic System of Side Bets,” in Against the Gods: The Remarkable Story of Risk, Peter
Bernstein, 1996, 304-328.
“Financial WMD?” The Economist, January 22, 2004.
Further Reading
o
o
o
Against the Gods: The Remarkable Story of Risk, Peter Bernstein, John Wiley & Sons, 1996.
The Essentials of Risk Management, 2nd edition Michel Crouhy; Dan Galai, Robert Mark,
McGraw-Hill Professional, 2013.
Risk Management and Derivatives, René M. Stulz, Thomson South-Western, 2003.
11
8. FORWARD CONTRACTS
Lecture: Forward and futures contracts
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
October 21
Preparation
Concepts: The structure of forward and futures contracts
Concept check: The structure of forward and futures contracts
Sections 17.1-17.4, Essentials of Investments, Bodie, Kane & Marcus.
“Should We Fear Derivatives?” René Stulz, Journal of Economic Perspectives, Summer 2004 18
(3), 173-192.
Discussion: Managing currency risk
October 26
Preparation
Case: Dozier Industries
"Dozier Industries" in G. Feiger and B. Jacquillat, International Finance, Allyn and Bacon, 1982.
A US company has just secured its first international sales contract in the UK. But the CFO
of the company is concerned that if the value of the pound sterling depreciated, the viability
of the project could be impaired.
Assignment F
Study Questions
o
o
o
What risk/s does Dozier face?
What other financial instruments or derivatives could Dozier have used to hedge its risk
exposure? What would the benefits and costs be?
What changes would you recommend for Dozier with regard to the manner in which it bids for
international contracts?
Further Reading
o
o
Options, Futures, and Other Derivatives, 11th edition, John C. Hull, Prentice Hall, 2022.
Futures, Options, and Swaps, 5th edition, Robert W. Kolb and James A. Overdahl, WileyBlackwell, 2007.
12
9. OPTIONS
Lecture: Options
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
October 28
Preparation
Concepts: The structure of option contracts
Concept check: The structure of option contracts
Chapter 15, Essentials of Investments, Bodie, Kane & Marcus.
“Why everyone is now an options trader”, The Economist, January 16, 2021.
Discussion: Insurance
November 2
Preparation
Case: BASIX
HBS Case # 207-099
BASIX, an Indian microfinance corporation, must decide whether to continue to sell
weather insurance to its clients. A brand-new financial product, weather insurance pays if
measured rainfall during the growing season falls below a pre-specified limit. Mr. Sattaiah,
managing director of the BASIX's bank, considers a revised insurance policy for the
coming season, weighing the costs and potential risks of expanding the product against the
potential benefits.
Assignment G
Study Questions
o
o
o
o
o
What fundamental risks do BASIX customers face? How exposed are they to weather risk?
How well did BASIX’s earlier efforts to offer rainfall insurance fare? Why?
As a BASIX Customer Service Agent, how would you explain and sell the proposed policy to
farmers?
A simulation based on the rainfall distributions shown in Exhibit 6 of the case suggests that a Rs.
125 policy would have an expected payout of Rs. 83. Is the proposed price appropriate?
Is this a product that BASIX should be selling to farmers? If not, how might you modify it to
make it better serve farmers’ needs?
Further Reading
o
o
Options, Futures, and Other Derivatives, 11th edition, John C. Hull, Prentice Hall, 2022.
Futures, Options, and Swaps, 5th edition, Robert W. Kolb and James A. Overdahl, WileyBlackwell, 2007.
13
10. OPTION PRICING
Lecture: Option pricing, the Binomial approach
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
November 4
Preparation
Concepts: Arbitrage pricing
Concept check: Arbitrage pricing
Chapter 16, Sections 16.1 and 16.2, Essentials of Investments, Bodie, Kane & Marcus.
“Of Butterflies and Condors,” The Economist, February 16, 1991, 58-59.
Discussion: Predicting uncertainty: The Black-Scholes Model & implied volatility
November 9
Preparation
Chapter 16, Section 16.3, Essentials of Investments, Bodie, Kane & Marcus.
“A Calculus of Risk,” Gary Stix, Scientific American, May 1998, 92-97.
Jarrow, Robert, A. 1999. "In Honor of the Nobel Laureates Robert C. Merton and Myron S.
Scholes: A Partial Differential Equation That Changed the World." Journal of Economic
Perspectives, 13 (4): 229-248.
Assignment H
Further Reading
o
o
Options, Futures, and Other Derivatives, 11th edition, John C. Hull, Prentice Hall, 2022.
Derivatives: An Introduction, 2nd edition, Robert A. Strong, South-Western, 2005.
14
11. REAL OPTIONS
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
Lecture: Real options
November 16
Preparation“Options Approach to Capital Investment,” Avinash Dixit and Robert Pindyck,
Harvard Business Review, May-June 1995, 105 – 115.
Discussion: Privatization, investment and uncertainty
November 18
Preparation
Case: Bidding for Antamina
HBS Case # 297-054
In June 1996, executives of the multinational mining company RTZ-CRA are
contemplating bidding to acquire the Antamina copper and zinc mine in Peru. The
Antamina project is being offered for sale by auction as part of the privatization of Peru's
state mining company. RTZ-CRA has to determine what the mine is worth, and to
recommend whether and how RTZ-CRA should bid in the upcoming auction. The bidding
rules put in place by the Peruvian government dictate that each company's bid contain two
components: an up-front cash amount and the amount the bidder will invest to develop the
property, if development is warranted after further exploration is completed.
Assignment I
Study Questions
o
o
o
If the winning bidder was legally forced to develop Antamina after completing the exploration
phase, and was required to pay the Peruvian government upfront for this project, how would you
determine the price that they would be willing to pay?
If the winning bidder could choose whether or not to develop Antamina after completing the
exploration phase, but was required to pay the Peruvian government upfront for the right to
develop the project, how would you determine the price that they would be willing to pay?
What are the incentives brought about by the different auction designs described above, and that
chosen by the Peruvian government? Do the rules seem to meet what you perceive to be the goals
of the government?
Further Reading
o
o
o
o
Real Options and Investment under Uncertainty: Classical Readings and Recent Contributions,
edited by Eduardo S. Schwartz and Lenos Trigeorgis, The MIT Press, 2001.
Investment under Uncertainty, Avinash Dixit and Robert Pindyck, Princeton University Press,
1994.
Real Options: Managerial Flexibility and Strategy in Resource Allocation, Lenos Trigeorgis, The
MIT Press, 1996.
Real Options in Capital Investment: Models, Strategies, and Applications, edited by Lenos
Trigeorgis, Greenwood Publishing Group, 1995.
15
12. FINANCIAL INSTITUTIONS
Discussion: Banks and financial intermediation
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
November 23
Preparation
Case: The U.S. Banking Panic of 1933 and Federal Deposit Insurance Corporation
HBS Case # 799-077
‘On March 3 banking operations in the United States ceased ... the government has been
compelled to step in for the protection of depositors and the business of the nation’. As
President Franklin D. Roosevelt spoke these words to Congress on March 9, 1933, the
nation's troubled banking system lay dormant. More than 9,000 banks had ceased
operations between the stock market crash in October 1929 and the banking holiday in
March 1933. The economy was in the midst of the worst economic depression in modern
history. Out of the ruins, birth was given to the FDIC three months later when the President
signed the Banking Act of 1933.
“Banking on the State,” Andrew G Haldane and Piergiorgio Alessandri, based on a
presentation delivered at the Federal Reserve Bank of Chicago twelfth annual International
Banking Conference on The International Financial Crisis: Have the Rules of Finance
Changed? Chicago, 25 September 2009.
“Conclusions,” The Squam Lake Report: Fixing the Financial System, page 135-152 (18 pages),
2010. (Find the full report at https://muse-jhu-edu.ezp-prod1.hul.harvard.edu/book/36288)
Study Questions
o
o
o
o
o
What do commercial banks do? Does this mix of activities make economic sense? How does this
expose commercial banks to risks?
Recall from the BASIX case that any insurance contract can also be viewed as an option. Can this
perspective be utilized to understand deposit insurance?
What regulatory measures can seek to mitigate the risks of banking?
Should Roosevelt agree to deposit insurance? Are there alternatives to reforms of the banking
system that might be preferable from an economic point of view?
What regulatory measures have been used to mitigate the risks of banking?
16
12. FINANCIAL INSTITUTIONS (CONTINUED)
Discussion: Housing finance
API 141 Finance
Syllabus
Akash Deep
August 31, 2021
November 30
Preparation
Case: Subprime Meltdown: American Housing and Global Financial Turmoil
HBS Case # 708-042
“The Federal Reserve and the U.S. Treasury have lately widened the federal safety net
more quickly and more aggressively than at any time since the New Deal era. Indeed, a
recent front-page headline in this newspaper, “Confidence Ebbs for Bank Sector and Stocks
Fall,” had distinctly Depression overtones. (You could almost envision the next line:
“Hoover Urges Calm.”) And not since the Depression (under the Reconstruction Finance
Corporation) has the government bought significant equity in private firms, as the Treasury
has sought the authority to do in the case of Fannie Mae and Freddie Mac. At least during
the 1930s, legislation followed months of deliberation and public hearings. The proffered
fixes to today’s fast-moving crises are worked out hastily and in private.”
- Roger Lowenstein, The New York Times, July 27 2008
“Conclusions of the Financial Crisis Inquiry Commission,” The Financial Crisis Inquiry Report,
page xv to xxviii (14 pages) in the authorized edition, January 2011 (Find the full report at
https://fcic.law.stanford.edu/report)
Assignment J
Study Questions
o Is residential housing a “safe” asset?
o What is securitization? How was securitization used by policymakers in the United States to
channel housing finance to homebuyers?
o What were the major changes in the nature of housing finance markets from the 1990s until the
onset of the financial crisis?
o In what ways did the structure and risks of Government Sponsored Enterprises – Fannie Mae and
Freddie Mac – resemble those of commercial banks? How were they different?
o Overall would you say that the housing finance system has functioned well or poorly through the
last decade?
o What changes would you recommend to the institutions that shape and regulate the housing
finance system?
Further Reading
o “Getting Up to Speed on the Financial Crisis: A One-Weekend-Reader’s Guide,” Gary Gorton
and Andrew Metrick, Journal of Economic Literature, 2012, 50:1, 128–150.
o The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of
the Financial and Economic Crisis in the United States, Financial Crisis Inquiry Commission,
2011.
o Balancing the Banks: Global Lessons from the Financial Crisis, Mathias Dewatripont, JeanCharles Rochet and Jean Tirole, translated by Keith Tribe, Princeton University Press, 2010.
o The Squam Lake Report: Fixing the Financial System, Kenneth R. French, Martin N. Baily, John
Y. Campbell, John H. Cochrane, Douglas W. Diamond, Darrell Duffie, Anil K Kashyap, Frederic
S. Mishkin, Raghuram G. Rajan, David S. Scharfstein, Robert J. Shiller, Hyun Song Shin,
Matthew J. Slaughter, Jeremy C. Stein and René M. Stulz, Princeton University Press, 2010.
o Too Big to Fail, Andrew Ross Sorkin, Viking Press, 2009.
o After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead, Alan S.
Blinder, Penguin Press, 2013.
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