Syllabus E4799 (v. 6/7/2007)
Foundations of Finance (E4799)
Columbia University School of Engineering and Applied Science
Leo M. Tilman
Chief Institutional Strategist and Senior Managing Director, Bear Stearns
Lecturer, Columbia University
Course Description:
This core curriculum course introduces students pursuing a graduate degree in financial
engineering to the key areas and concepts of modern finance. The course’s objective is to
provide a broad perspective on how financial theory and practice interact in real life,
preparing students for successful careers in the financial industry and facilitating in-depth
studies that follow.
Week 1 (7/10/07)
Financial Institutions and Markets
ƒ Course objectives, orientation & logistics
ƒ Flows of funds and capital markets
ƒ Financial institutions and regulation
ƒ Primary and secondary markets; trading mechanisms
ƒ Capital structure and balance sheets of corporations
ƒ Equity markets
ƒ Fixed income markets
ƒ Derivatives, commodities, currencies, mutual funds, and alternative investments
ƒ Careers in modern finance
ƒ Value of a broad perspective on the financial industry and markets
Assignments:
Prior to the class, watch the movie “It’s a Wonderful Life” (1946)
SAB: Chapters 1-3; 13; 16.1-5; 16.9.1-2; 22.5.1-2; 22.8; 25.1-2; 21.2-21.5
Optional:
GT: Chapter 1.3
Miller, “The History of Finance”, Journal of Portfolio Management, Summer 1999
Week 2 (7/17/07)
Financial Analytics
ƒ Cash flows, interest rates, discounting, and compounding
ƒ Term structures of interest rates and related theories
ƒ Bonds and fixed income mathematics
ƒ Sneak preview: valuation of risky assets
ƒ Equity valuation models
ƒ Case study: the U.S. mortgage market (time permitting)
Assignments:
SAB: Chapters 5, 14.1-4; 15.2-15.6; 17.1-3; 17.9
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© Leo M. Tilman
Syllabus E4799 (v. 6/7/2007)
Week 3 (7/24/07)
First Half: Portfolio Theory (I)
ƒ Supply and demand
ƒ Market efficiency
ƒ Portfolio theory (part I)
Second Half: What Moves Financial Markets and Why?*
• Overview of key macroeconomic concepts
• Monetary policy and inflation targeting
• Important economic indicators
• Case Study: Bear Stearns’ outlook for economy, markets, and the Fed
Assignments:
SAB: Chapters 4, 6, 7
“Understanding U.S. Economic Statistics”, Goldman Sachs Economic Research
Optional:
F. and V. Warnock, “International Capital Flows and Interest Rates”, FRB 2005
Mishkin, “Inflation Dynamics”, Annual Macro Conference, FRB of SF, March 2007
Gilles et al, “Long-Term Implications of Economic and Market Trends for ALM
of Insurance Companies,” Journal of Risk Finance, Winter 2003
Week 4 (7/31/07)
CAPM and APT
ƒ Portfolio theory (part II): risk-free borrowing and lending
ƒ Capital asset pricing model (CAPM)
ƒ Arbitrage pricing theory (APT)
ƒ Case Study: Global capital flows and low return environment
Assignments:
SAB: Chapters 8; 9; 11; 16.7; 24.1-5
Optional:
Malkiel, “Irrational Complacency?” WSJ, April 30 2007
Dimson, Marsh & Staunton, “Equity Risk Premium: A Smaller Puzzle”
Week 5 (8/7/07)
Valuation of Risky Assets*
• General problem of valuing risky assets
• Trees, Monte-Carlo simulation, backward induction, Black-Scholes
• Options, futures, interest rate and credit derivatives
• Dynamic replication
• Caveats and deficiencies of financial models
Assignments:
SAB: Chapters 19-20
Optional:
Merton, “Theory of Rational Option Pricing”
*
denotes a guest speaker
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© Leo M. Tilman
Syllabus E4799 (v. 6/7/2007)
Week 6 (8/14/07)
Modern Risk Management
• Defining risk: evolution of risk management ideas
• Parametric fixed income risk measures
• Value-at-Risk, VaR decomposition, and coherent risk measures
• Hedging
• Credit risk measurement and management
• ERM, ALM and balance sheet management
• Case study: Market behavior in times of crisis (time permitting)
• Case study: Pension ALM (time permitting)
Assignments:
GT: Chapters: 1, 2, 4, 5.7; 6.4
CreditMetrics Technical Document (will be distributed)
Optional
SAB: Chapters 15.5
Tilman et al, “Impact of Risk Management on the Recent Market Volatility in
U.S. and Japan“, The Journal of Risk Finance, Fall 2003
Week 7 (8/14/07)
Final Exam (2.5 hours)
Required Texts:
Sharpe, Alexander & Bailey, Investments, 6th Ed., Prentice Hall (SAB)
Golub, Tilman, Risk Management: Approaches for Fixed Income Markets, J. Wiley &
Sons, Inc., 2000 (GT)
Relevant pages may be distributed from: Ho, Lee, Tilman, Financial Institutions: The
Convergence of Strategic Decision Making and Risk Management (Oxford, 2008)
Optional Texts:
Mark Rubinstein, “Great Moments in Financial Economics: Modigliani-Miller Theorem”,
Journal of Investment management, Q2 2003
Robert Merton, “Future Possibilities in Finance Theory and Practice”, Keynote Address
at the World Congress of the Bachelier Finance Society, June 2000
Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital Management.
Peter Bernstein, Against the Gods: The Remarkable Story of Risk
Burton Malkiel, A Random Walk Down Wall Street
Elton, Gruber, Brown and Goetzmann, Modern Portfolio Theory and Investment
Analysis, 6th Edition (EGBG)
Grading: 90% final exam; 10% class participation
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© Leo M. Tilman
Syllabus E4799 (v. 6/7/2007)
Leo M. Tilman is the Chief Institutional Strategist and Senior Managing Director at Bear
Stearns, a leading global investment banking, securities trading and brokerage firm. In
addition to chairing the firm’s Investment Strategy Committee, Mr. Tilman is responsible for
providing the firm’s institutional clients – some of the world’s most sophisticated investors,
financial institutions, and corporations – with comprehensive strategic advice and solutions,
including risk management, investment strategy, debt and capital management, asset/liability
management, corporate finance, and strategic decision making. Prior to joining Bear Stearns,
he served as a Director at BlackRock, an investment management and risk advisory firm.
Mr. Tilman is the editor of the book Asset/Liability Management of Financial
Institutions: Maximizing Shareholder Value Through Risk-Conscious Investing (Euromoney
Institutional Investor, 2003) and co-author of the book Risk Management: Approaches for
Fixed Income Markets (English Edition: 2000; Japanese Edition: 2002, Chinese Edition:
2005). His new book Financial Institutions (with Drs. Ho & Lee, forthcoming from Oxford
University Press, 2007) deals with the evolution of capital markets and the changing nature
of financial intermediation, with a specific focus on far-reaching implications for investment
banking, corporate finance, investments, risk management, and regulation.
Mr. Tilman is a Lecturer at Columbia University and a contributing editor of The
Journal of Risk Finance. He makes regular TV appearances, often quoted in the financial
media (The Wall Street Journal, New York Times, Forbes, Bloomberg, Barron’s), and
frequently speaks at leading business schools and conferences worldwide, including the
World Economic Forum.
Mr. Tilman is the founding chairman of the Young Leaders Committee of Atlantic
Partnership – a non-partisan not-for-profit foreign relations organization whose objective is
to bring into focus and enhance the multifaceted Euro-American relationship. In 2007, was
given the distinction of being named Young Global Leader of the World Economic Forum,
joining 250 executives, public figures and intellectuals – all 40 or younger – recognized for
“their professional accomplishments, commitment to society and potential to contribute to
shaping the future of the world.”
Mr. Tilman holds B.A. and M.A. degrees from Columbia University.
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© Leo M. Tilman