CALDWELL COLLEGE

Department of Business Administration

 

 

SYLLABUS

BU 455 Financial Economics

 

 

 

Three credits                                                           Instructor: Prof. Anatoly Kandel, Ph.D.

Spring 2006                                                                                      Room 4238. Ext. 3450.

Room 6211, W.7:00-9:30                                                                  akandel@caldwell.edu

 

 

 

       

This course builds on the prerequisite courses. Its purpose is to help students to integrate what they have already learned in the aforementioned courses. This integration equips students with a thorough understanding of the interplay between basic concepts in Economics and Finance. Step by step students will learn how the theory of efficiently functioning competitive markets for goods and services (Economics) laid ground for the theory of informationally efficient capital markets, how concepts of opportunity cost and risk aversion (Economics) laid ground for the concept of risk premium in return on risky asset, and so on. The course explains how the Capital Asset Pricing Model (CAPM) allows to distinguish between systematic risk and nonsystematic risk, and how diversification of assets reduces the systematic risk. Further important connections between Economics and Finance are learned through discussing Option Pricing and Venture (Entrepreneurial) Capital.  Prerequisite: BU337, BU338, BU431, BU440, BU452.

 

 

 

                                          

To assure productive interactions

between students enrolled in this course and the instructor,

 the course uses a blackboard e-learning system.

 

 

 

Students have to send their homework assignments to Dr. Kandel through Bb no later than noon of the day the assignments are due.

No excuses regarding problems with Bb access are accepted.

 

 

 

 

The required literature for the course include

 

Malkiel. 2003 The Efficient Market Hypothesis and Its Critics. Journal of Economic Perspectives, further JEP, 17(1): 59-82.

Shiller. 2003 From Efficient Markets Theory to Behavioral Finance JEP, 17(1): 83-104.

Perold. 2004. The Capital Asset Pricing Model. JEP, 18(3): 3-24.

Fama E.F. & French K.R. 2004. The Capital Asset Pricing Model: Theory and Evidence. JEP, 18(3): 25-46.

Romer & Romer. 2004. Choosing the Federal Reserve Chair. JEP, 18(1):  129-162.

Compers & Lerner. 2001. The Venture Capital Revolution. JEP, 15(2): 145-168.

 

The recommended literature for the course include

 

Varian. The Arbitrage Principle in Financial Economics. JEP, 1(2): 55-72.

Lamont & Thaler. 2003. The Law of One Price. JEP, 17(4): 191-202.

Healy & Palepu. 2003. The Fall of Enron. JEP, 17(2): 3-26.

 

 

The instructor, Dr. Kandel, has permission of the American Economic Association to distribute copies of these articles to students enrolled in the course.

 

 

 

 

REQUIREMENTS AND GRADING Students’ performance will be assessed based on homework assignments, class participation and a final take-home examination. To be accepted and graded, the assignments must be neatly typed.

 

 

 

  Contribution to final grade:

 

Homework                                                                       50%

 

Participation in class discussions                                    25%

                                     

Take-home final examination                                          25%

 

 

 

 

Active class participation and insightful comments – whether right or wrong – are rewarded by extra credits. Five-six such credits increase a final grade by a point.

 

 

 

 

 

TARGET SCHEDULE

 

 

 

Topic 1 (1st, 2nd& 3rd weeks). FINANCIAL ECONOMICS AS APPLICATION OF ECONOMIC THEORY TO PROBLEMS IN FINANCE.  The interplay between basic concepts in Economics and Finance.  Our starting point is the competitive market model in which decision makers have symmetric information about their environments, face market-determined prices, and decide how much to buy and sell of particular goods and services.  In this model, decision makers can specify, agree on, and eventually verify states of the world. They also are assumed to know each other’s preferences and beliefs. Under these assumptions, contracts can be anonymously traded such that their   equilibrium prices are arbitrage free. A transition to traders with asymmetric information. Financial institutions and contracts that have emerged as rational responses to a world in which information is asymmetrically distributed.  In this course, we will repeatedly discuss fundamental economic forces that influence financial decisions.

Assignments:

 

Paper on Information Content of Equity Analyst Reports. Journal of Financial Economics, 75 (2005): 245-282. The problem to solve: Find and interpret statements of general economic interest in this unbelievably dense article. How do equity analysts assign values to business companies? Self-test: If you wrote a good paper, you are ready to perform tasks that require a selection of particular information from a user-non-friendly source.

 

Paper on The Efficient Market Hypothesis. The problem to solve: Develop a sound understanding of the concept. Carefully define and explain key notions. Thoughtfully examine arguments for random walk. Self-test: If you wrote a good paper, you are ready to perform tasks that require capturing an essence of really challenging ideas.

 

Paper on The Critique of Efficient Market Hypothesis. The problem to solve: Develop a sound understanding of the concept of behavioral finance. Carefully define and explain key notions. Thoughtfully examine arguments against random walk. Self-test: If you wrote a good paper, you are ready to perform tasks that require capturing an essence of really challenging ideas.

 

 

Topic 2 (4th, 5th & 6th weeks). PORTFOLIO CHOICE.   From the equilibrium portfolio choice problem to the Capital Asset Pricing Model (CAPM). The equivalence of the problem of choosing assets to hold in portfolio and the problem of choosing state-contingent wealth. The focus of our attention is again the concept that equilibrium prices should be free from arbitrage. If trade in asset markets is not to produce unbounded wealth, then asset payoffs and prices must be such that riskless arbitrage is not possible. A mean-variance utility function as the key instrument in establishing an explicit linear relationship among asset prices in an asset market equilibrium (CAPM).

Assignments:

 

Paper # 1 on CAPM (Perold). The problem to solve: Find and interpret key characteristics of risk, investment portfolio and Sharpe ratio. Self-test: If you wrote a good paper, you are ready to perform tasks that require not just a selection of particular information but its application for solving practical problems.

 

Paper # 2 on CAPM (Perold; Fama). The problem to solve: Develop a sound understanding of logic of CAPM. Self-test: If you wrote a good paper, you are ready to perform tasks that require not just a selection of particular information but its application for solving practical problems.

 

Paper # 3 on CAPM (Perold; Fama). The problem to solve: Develop a sound understanding whether practical applications of CAPM were successful. Self-test: If you wrote a good paper, you are ready to perform tasks that require not just a selection of particular information but its application for solving practical problems.

 

 

 

Topic 3 (7th, 8th & 9th weeks). ARBITRAGE AND OPTION PRICING.    Every asset may have payoffs that can also be obtained by forming an appropriate portfolio of other assets. If markets are complete, then the payoffs to any asset can be synthesized by a portfolio of the existing assets. Since perfect substitutes must command the same price, the price of any asset must equal the price of a portfolio that replicates its payoffs. The possibility of arbitrage imposes constraints on asset prices. In complete (incomplete) markets these constraints uniquely (non-uniquely) determine the discount prices. Call and put option contracts. Option pricing according to the Black-Scholes formula.

Assignments:

 

Paper # 1 on Call and Put Option Contracts.

 

Paper # 2 on Option Pricing.  

 

 

Topic 4 (10th & 11th weeks). VENTURE (ENTREPRENEURIAL) CAPITAL. This capital plays a role of a very important intermediary in financial markets, providing funds to small and young firms that might otherwise have difficulty attracting financing. Our focus is on key phases of the so-called venture capital cycle. This cycle starts with raising a venture fund; proceeds through the investment in, monitoring of, and adding value to small and young firms; continues as the venture capitalists exit successful deals and return capital to investors; and renews itself with the venture capitalists raising new funds. Review of empirical researches that show that venture funding has a strong positive impact on innovation.

 

 

 

 

For a specific Grade the following will be expected:

 

A                     94-100             Consistently highest level of achievement

A-                    90-93               Highest level of achievement

B+                   87-89               Consistently superior work

B                      84-86               Consistently very good

B-                    80-83               Very good

C+                   77-79               Good              

C                     70-76               Satisfactory

D+                   67-69               Unsatisfactory

D                     60-66               Poor performance. Minimum passing grade

F                      Below 60         Failure

 

 

 

 

 

Every student must abide by Caldwell College’s Academic Integrity Policy. The nature and mission of our College demand a high respect for moral values, including intellectual honesty and justice. No student is allowed to submit, as his/her own work, assignments obtained in whole or in part from another student, unless specifically authorized to do so by the instructor.