Economics 323: Finance Theory and Applications
Wellesley College
Fall 2008
Eric Hilt
Department of Economics
PNE 411
Email: ehilt@wellesley.edu
Office hours: Mondays, 1:00-2:00 PM; Wednesdays, 2:00-4:00 PM; and by appointment
Class Time and Location
Mondays and Thursdays, 9:50-11:10 AM, in PNE 339. From time to time it may be necessary to start a little early, in order to provide for time for exercises and discussion in
class.
As we will frequently do quantitative exercises together in class, please bring a calculator.
(It does not need to be a fancy one.)
Course Description
This course provides a rigorous treatment of the fundamentals of finance. The prerequisites
for this course are Econ 201 and 203. We will consider: the interpretation of financial
statements; the valuation of distant cash flows; the valuation of financial instruments such
as stocks, bonds and options; and the financing and investment decisions of firms.
Wherever possible, we will study modern academic research that relates to the topics of the
course. But the relevance of the methodologies and research you will study in this class is
not purely academic: unless you understand finance, you cannot understand a company’s
decision-making process thoroughly. This course will thus introduce you to the operations
of the companies you will encounter in your role as employee or consultant or investor.
Readings
The required textbooks are Ross, Westerfield and Jaffe, Corporate Finance (8th ed.), and
Bodie, Kane and Marcus, Investments (8th ed.), available at the Wellesley bookstore. Many
of the readings assigned for this course will be from these textbooks, but various additional
materials will be distributed in class, or made available in the library or the course conference. For those students interested in learning accounting in more detail, some additional
readings (not required) can be found in Kim and Siegel’s Schaum’s Outline Of Theory And
Problems Of Financial Accounting, which is available as an e-book. There is a link within
the Wellesley library catalog, but the URL is:
http://0-site.ebrary.com.luna.wellesley.edu/lib/wellesley/Doc?id=5004742
Other readings, such as articles from finance and economics journals, will be posted to the
conference or distributed in class. These readings will also be a required part of the course.
Finally, I recommend strongly that you follow current events in business and financial
markets by reading the Wall Street Journal (but ignore the editorial page).
Conference
Problem sets, solution sets, and other materials will be posted on the course conference,
ECON323-F08. Please add this conference to your FirstClass desktop.
Assignments
Five problem sets will be assigned. Some will resemble problem sets from other economics
classes (you’ll receive a series of problems to solve), but others will involve hands-on analysis
of data. There will also be a portfolio-picking assignment that lasts throughout the semester.
The assignments will be collected at the beginning of class on the date they are due. Late
assignments will not be accepted.
Exams and Grading
There will be two exams in this course: an in-class midterm, and a final. The midterm will
be Thursday, November 6. Treat the date as you would an important meeting in the
business world—absent some dire emergency, you must be there. No make-up exams will
be given, unless you inform me of a schedule conflict immediately. The self-scheduled final
exam will be comprehensive.
Problem sets and exams will count toward the grade as follows:
1. Assignments, 25%
2. Midterm Exam, 30%
3. Final Exam, 45%
I may (on an individual basis) adjust the weight applied to the final to reward improved
performance.
Some Advice
This is a hard class. Although some of the material is relatively elementary, we will encounter some very challenging topics, and we will proceed through them at a gruelling pace.
As much of the material is cumulative in nature, it is important that you keep yourself from
falling behind. If you have trouble with some of the material, please come to my office hours
for help.
In my experience, the best way to learn finance is by doing it. Therefore, in addition to the
assigned problem sets, I will distribute a number of supplemental exercises, with solutions.
Before the exams, I will also distribute sample problems with solutions, and I recommend
that you do not look at the solutions when you try to solve the problems. Many of the
problems will look easy once you have seen the solution; it is important that you gain the
experience of trying to figure out how to solve the problems.
Students frequently ask for advice when preparing for exams, given the enormous volume of
material covered in the course. It is important to keep in mind that the exams will focus on
the fundamental concepts and the subjects covered in great detail: there will be no surprise
questions based on obscure and unfamiliar material.
Class Schedule
RWJ denotes Ross, Westerfield and Jaffe, Corporate Finance;
BKM denotes Bodie, Kane and Marcus, Investments; and
FA denotes Kim and Siegel, Theory and Problems of Financial Accounting.
Required readings are denoted with an asterisk [*]; readings without an asterisk are not
required.
Part 1: Financial Statements and Accounting Data
September 4
Introduction to financial markets.
*RWJ, ch. 1
*BKM, ch. 1
September 8
Math review. Basic finance concepts.
September 11
Introduction to accounting data and the principal financial statements
*RWJ, ch. 2
FA, ch. 2
September 15
Financial statements: the balance sheet and income statement
*RWJ, Appendix 2A
BKM, ch 19
FA ch. 3
September 18
Problematic areas of accounting rules and financial reporting
*Reading Packet: Accounting
FA ch. 6, 8, 9, 10
Part 2: Valuation
September 22
Present Value (PV) concepts; the Efficient Markets Hypothesis (EMH)
*RWJ, ch. 4
*BKM, sec. 12.1
September 25
Fixed-income securities
*RWJ, sec. 5.1-5.3
RWJ, ch. 20
September 29
Fixed income and interest rate sensitivity: duration and convexity. Review of Excel.
*BKM, ch. 14; sec. 16.1-16.3
October 2
The term structure of interest rates
*BKM, ch. 15
October 6
The term structure of interest rates, continued
*BKM, ch. 15
Part 3: Uncertainty, Risk and Asset Prices
October 9
Expectations, uncertainty, and risk aversion
*BKM, ch. 6
October 16
Risk, return and the allocation of capital: portfolio choice with one risky asset.
*RWJ, sec. 10.1-10.7
*BKM, ch. 7
October 20
Many risky assets: the two-fund theorem and optimal portfolios.
*BKM, ch. 8
October 23
Optimal portfolios, cont’d.
*BKM, ch. 8
October 27
Market equilibrium and the capital asset pricing model (CAPM)
*RWJ, sec. 10.8-10.9
*BKM, ch. 9
October 30
The CAPM, continued. Investor behavior and “behavioral” economics.
*BKM, ch. 12
November 3
Review
November 6
Midterm Exam
Part 4: Investment and Financing Decisions
November 10
The financing decision: capital structure
*RWJ, ch. 14,19
RWJ, ch. 20
November 13
The investment decision: risk, capital structure and capital budgeting
*RWJ, sections 6.1, 6.5, 6.6; ch. 12
November 17
Capital structure and firm value
*RWJ, ch. 15
November 20
Agency costs and capital structure: limits to the use of debt
*RWJ, ch. 16
November 24
Capital structure and investments: Capital budgeting for the levered firm
*RWJ, ch. 17
December 1
Capital structure and investments, continued
*RWJ, ch. 17
December 4
Dividends and firm value
*RWJ, ch. 18
December 8
Review