FinanceProfessor.com

Course Overview 

This is the Advanced Finance Class at most universities.  It is targeted largely at Corporate Finance.

Administrative stuff: 

 Syllabus-- Syllabus

here is the link to the text's main web page for students .  It has quite a few useful pages of notes and online quizzes.  I am sure the quizzes will help also for tests!   I was asked about stats, so if you are looking for help in stats, may I recommend The Statistics Homepage.  It is good. 

Link to mini-corporate summaries, link to the FinanceProfessorblog, link to Financeclassblog 

Notes: 
These notes are constant works in process.  They will likely be updated repeatedly though out the year.  For that reason you should make a practice of printing them just before the class if at all possible.  Also readings should be done prior to the class for maximum effect.--for all non-text readings try to get the top two or three points 
 (Note: each topic also has links that will be mainly background for each class--YOU DO NOT NEED TO PRINT THESE OFF NOR READ EVERY WORD)

Week 1-- Welcome to class!

Please read the Summaries (the introductions and conclusions couldn't hurt either for the real ambitious) for the first 12 chapters of the text.

In past semesters I  had several requests for review material, so here some links from my introductory corporate finance page that should help. We will not spend much time on these, but you are expected to know it.  
Review material that you may find useful:

• Ratios

• projecting cash flow statements

•  Time Value of Money

  • Present value

  • Future Value

• What is a bond?

• Bond pricing and types of bonds

Also if you are looking for help in stats, may I recommend The Statistics Homepage.  It is good.

Actual new stuff begins here

• Why study finance

• What is Finance?

• Human Nature

• Nexus of contracts and conflicts of interest 

• Shareholders as monitors--why are shareholders so important

We will spend quite a bit of time here

Pulling the goalie::
"Galai and Masulis (1976) show that debt in the capital structure may give shareholders the incentive accept risky negative NPV projects and pass on safe positive NPV projects. This happens when the benefits of the project must go to pay off debt holders. The shareholders will want to take on a risky project (even if it has a negative NPV) in order to have a chance at getting paid after the debt holders have been paid."

"Chevalier and Ellison (1996) apply similar logic and show that mutual fund managers who have underperformed their benchmarks increase the risk of their selections in order to “catch-up.” This is partially because of the high correlation between cash inflows into the fund (i.e. “new money”) and recent fund performance. In both settings, the situation is similar: unless something “big” happens, the principals get no, or a dramatically reduced, return. This creates incentives to take risks that in other settings would appear irrational."

Want a football example?  Click here.

Required Readings:  Executive Summaries of chapters 1-12   

Saturday--review of time value of money and valuation

• Time Value of Money--Present Value, Future Value
• Quick Recap of valuation,
• Spreadsheet for bonds
• History of returns

Review of Portfolio Math and Valuation

 Discussion of Normal distribution  

RISK and Return--what is risk? Systematic vs non systematic

Risk aversion (video), notes for thse who want more

Overview: Class notes

• Anomalies from Investorhome.com 

• Discussion of whether markets are efficient or not.  Definitely read this! 
• Summary of behavorial Finance speech by Michael Brennen
  

• Ray Ball's The Theory of Stock Market Efficiency (from Revolution Book) Summary is available: Ray Ball's Article--
• Summary of Fama's 1991 Market Efficiency paper

What's it all means: diversify!,international correlations (home country bias),commodities, real estate, market neutral hedge funds, easier one on hedge funds

• What managers might do: release bad information prior to option grants
• Insider trading and Pete Rose
• About.com (if you do not mind the pop-ups, has a good discussion that includes Barry Switzer
  

• Stock Market Insider Trading: Victims, Violators And Remedies Including An Analogy To Fraud In The Sale Of A
  Used Car With A Generic Defect  by William Wang
  
  
• REQUIRED: The Relationship between Insider Trading and the Bid-Ask Spread: A Critical Evaluation of the 'Adverse
  Selection' Model by Dolgoplov

• OPTIONAL: Envy, Jealousy and Insider Trading: The Case of Martha Stewart  by Jeanne L. Schroeder
  

Chapter 14 notes : essentially definitions/review of what financing alternatives are available

Required Readings:
         Modigliani-Miller proposition after Thirty Years—Merton Miller
         Still Searching for Optimal Capital Structure—Stewart Myers
         Who issues Stock?   Fama and French 2003 working paper

Notes on Capital Structure--center on Modigliani and Miller

Maturity of debt: More risky firms seem to use shorter term maturity (Barclay and Smith 1995)
Bank relationships seem to help small firms (Petersen and Rajan 1994)

          Famous " Smith-Masulis " paper
 
Why capital structure might matter--a quick look at capital budgeting

Readings:
Pecking order--
Text Readings: chapters 14-17, 30

Security Issuance
Timing
Deviations from target ratio and acquisitions

This next section on Short term financial decisions is from chapters 26-29--this will be quite brief.  
Mainly on what is available (from book) and why not to rely on short-term financing.  It is one section that I think you will be able to "get" from reading.  Thus do not expect much class coverage.

My notes

chapter 21--notes from text book

            Project Finance--This will probably not be covered in great detail simply for time reason.  However, here are some links that you should at least be familiar with for test purposes (know basics) and also for your professional careers.  What is Project Finance?  A project finance site run by Harvard.

• Jay Ritter is simply put the man when it comes to IPOs.  Not only do he and Ivo Welch have a classic review article on IPOs, he also has most of the very influential IPO papers as well.  Morevoer, his website is a wealth of IPO data and papers.  For example he  provides evidence of underpricing  on a year by year basis as well as waves, and international IPO underpricing.  He also has a very cool table on the amount of money left on the table by various firms and a list of firms that went up by at least 100% on the first day of trading. He is also the person most responsible for the long run underperformance literature.
  
• Why do companies go public? By Pagano, Panetta, and Zingales
• Why underpricing?  Maybe threat of lawsuits (Lowry and Shu 2002)
  
• A summary of Brav and Gompers on the long run underperformance of IPOs.
• Are waves irrational? Maybe not.  Maybe changes in real options. Very good article by Pastor and Veronesi.
  
• Advertising and IPOs?  They seem to be connected.  As does underpricing and analyst coverage.
  
• SuperBowl and IPOs?  Yep there is a connection!
  
• End of Lock-up periods
• Make some noise!.  The quiet period is over!  Time for analyst coverage to begin.
• Ritter and Loughren on how IPOS have changed
  

1. Forward Contracts

- an agreement between two parties for the delivery of some asset at some time for some price

 - unique to each contract - nonnegotiable, nontransferable, and cannot be traded

- can be customized

 - very illiquid, high transaction costs

- are rarely entered into except by companies that have good credit ratings because of the high risk of default

- payoff of a long position = underlying asset price - price agreed upon

2. Futures Contracts - Standardized

- much more liquid than forward contracts - very active market

- payoff looks the same as forward contracts

           if long: spot-original futures price

•  - if the price of the product goes up then the payoff of the long position goes up
• - every contract is made with a middleman called a clearinghouse
• - marked-to-market daily
• - the contracts used to be settled with delivery but now more people are settling with cash which allows easier speculation

3. Options

- a call gives the purchaser of the option the right but not the obligation to buy the underlying asset at an agreed upon price at either any time before expiration ( American) or at expiration (European)

HINT:  Think of a coupon for a gallon of milk.

            - You can always walk away from a long option position but NOT a short position which creates an  obligation.

- put option gives the purchaser of the option the right but not the obligation to sell the underlying asset at an agreed upon price at any time as an American or an European

- you buy a call when you expect the price to go up and you buy a put when you expect the price to go down

- if you  “long a call” you purchased the call option and if the stock price is above the strike price then you want to exercise the option

- if you “long a put option” you are betting the market price will go down and bought the option to sell - if the stock price is below the strike price then you exercise the option

long a call

            call price = max ( 0, stock price - strike price)

short a call (call writer)

            call price = min ( 0, strike price - stock price)

long a put

            call price = max ( 0, strike price - stock price)

short a put (put writer)

            call price = min ( 0, stock price - strike price)

More Terminology

1. In the money-if exercise would be profitable
2.  at the money
3.  out-of-the money-if exercise would NOT be profitable

 OCC-Options Clearing Corporation: works much like the futures clearing houses

 Naked vs Covered positions

 Zero sum game

 hedge vs speculate

Pricing options-

Black  Scholes...

Bounds on the price of a call.

            upper=price of stock

            lower=stock-PV(x)

Black-Scholes formulas uses differential equations and solves for this price completely.

1. debacles,: Orange County, Barings, LTCM, Bankers Trust             

2. Hedging: why?  Value, taxes, monitoring, lower financial distress costs and better access to capital markets (See Simkins, Carter, and Rogers)

3. Real Options--Football example 

• Discussion from Christian Brothers (CBIS) on Proxy voting, Proxyinformation.com, and maybe the easiest to follow from Pax funds.
  

Transparency and Governance

 Where does auditing fit into this?  Can't improve things unless we know what is going on. 

 Chaney and Phillpich (JAR 2002)  find that stock prices dropped as Andersen's reputation worsened.  Also Callen and Morel as well    who find that with a similar results with a slightly different sampe. 
             Godbey and Mahar (RIF,2004) find that auditor reputation helps mitigate the information asymmetry problem. (yeah this is same paper as above)
(FWIW this is an early edition of the paper, I am not sure how to get around copyright laws, so I just put up working papers)

What is Wrong with Corporate Governance? 

See Enron, Adelphia, Tyco, NYSE, etc., etc.  The list goes on and on.  We will talk about some of the cases in class.  

Lack of transparency is likely the most severe problem. 

What is Right with Corporate Governance?

Overall US system seems to be best there is.  Sure there are problems, but better than alternatives. The problems

A few sites that you may find useful:

• The Corporate Library
• http://www.corpgov.net/

Required Readings:

• Is American Corporate Governance Fatally Flawed? –Merton Miller
• Enron Case Haley and Palepu
• Measuring the Effectiveness of Different Corporate Governance Systems: towards a more Scientific Approach--Macey
• Boot and Macey have a good paper looking the choices of objectivity and control.  VERY good!
  

Week 11

The Market for Corporate Control:  in some ways this is  what happens if internal measures do not work.

Takeovers: 

• Merger: absorption of firm A by firm B...in end all are mergers
• Acqusition of stock: Purchase either in open marget or tender offer
  
• Acquistion of Assets
  
• Proxy contest
  
• Tax implications: if deal is seen as a table event: trigger capital gain, if not then no taxes now.
     also steeped up depreciation
  

Types

Horizontal merger_acquiring competitor
Conglomertae merger--diversifying
Vertical mergers--taking over a supplier or distributor.  Why?  Be careful!  

Fan and Goyal find that there are postivie abnormal returns from vertical acqustions.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=296435

   Takeover waves (and types)

History lesson

• 1898 to early 1900s--Horizontal mergers  
• 1920s--vertical mergers
• 1940s--regulatory driven
• 1960s conglomeration
• 1980s Leveraged bust ups
• late 1990s to now: tech and regulatory as well as vertical

These in  part of can be explained by the Agency Costs and by stock price overvaluation.  

These latter hypotheses won support from Gugler, Mueller, and Yurtoglu (2003)

  Hostile or Friendly?

   LBO--Opler finds improved performance following deal.  Why?  Best guess is better incentives

   Laws

   How a merger can create value

1. Economies of scale
2. Economies of vertical integrtaion (lower Transaction costs) 
3. Combining compliemtary assets (drug company and sales force)
   
4. Synergy
5. Marketing or distribution
6. Market power--Esp with horizontal mergers
7. Elimination of poor management
   
8. Access to a. materials    b. customers, c. capital

Generally overall value is created.  Most of this goes to shareholders of target.

From Jensen and Ruback (1983)

                       Target %      Bidder %
Tender offer     30%                4%
Merger             20                   0 %
Proxy contest    8%                  NA

Unsuccesful bids may have value if they improve management or if they put firm in play.  Bradley, Desai, and Kim (1983) fidn that those firms who do not receive another bid give up their abnormal returns in 2 years.

How a merger can destroy value

    Dissynergy--Comment and Jarrell---can you say deworsifcation

   Megginson, Morgan, and Nail find that focus decreasing (i.e diversifiying deals) destroy value.

   Maybe they destroy value by signalling overvaluation?  That is one interpretation of  Loughran and Vijh (1997)

    Corporate culture
  Chrysler

  Hostile vs friendly

    Hostile deals get the publicty

     Most deals are friendly

how to fight acquistions

• Pre--Maximize Shareholder value!
  

• Post offer (i.e. you are in play!)
  

Other forms of restructring:
    Carve-outs--selling a division (generally part of division) to public in form of IPO
    Spin-offs--giving shares to existing shareholders
    Tracking stock

Key question: Why do we give managers these tools?

• Parachutes: Good or bad?
• Why do we allow managers to fight takeovers?
  

Week 13--
may have to finish up on restructuring and market for corporate control

• Financial Planning is the starting point for much of what we do. 
  
• Short Term Finance Not short term thinking. 
• Cash Management
  

Break time

Multinational finance

3 cases will be done this week.  6 groups, each will have 12 minutes.  You will turn in a 5-7 page paper for each group.  For the other cases (those you are not presenting) each group will be responsible for discussion questions and a one page memo.

Case 1: Adelphia: Group One:  Management  Group Two: Creditors
Case 2:  Springfield Power Case Group three: Shareholders   Group four:  Managment
Case 3: Maharaja Dilemma: Can Pepsi Thrive in Sri Lanka?  Group5 Maharaja Group 6: DLJ

Last hour of class:
Catch-up
Trends in finance
What we know what we do not know
Tying it back together

Using finance

Week 15
Final