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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)
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While it is on the Syllabus, I wanted to have
another
reminder, cheating will not be allowed and will result in a F grade for
the class if I can prove it. 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! Administrative stuff:
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! Link to mini-corporate
summaries Many of the newer articles appear on the
FinanceProfessor
Blog.
Some articles as well as class announcements will also appear on the Finance Class blog.
I highly recommend you "subscribe" to each of the blogs. After a long hiatus since few people were using
it, I will be starting up the podcast
again. If nothing else it will help if you have to miss
class.. BEFORE
PANIC SETS IN: Yes, there is a great deal of reading.
However, I
am sure you can handle it. I really only want you to be able to get the
top one of two things from each article. From many of the links you do
not even need to do that, but rather the links serve as means of
documenting things for class (so you know I am not just making things
up;)). YOU DO NOT HAVE TO READ EVERY WORD! If you
get the
main point (or in some cases a couple of points) from the papers, I am
generally quite happy. :)
I would much rather you learn the material than worry about a
grade. Learn the material and the test should take care of itself.
But really know the material. become an expert it
will help
you and make it more fun at the same time. . Notes:
Week 1
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.
Spreadsheet on the importance of saving and we used to show the importance of assumptions Video section: Want another angle on it? Here are some videos that might help: From SavingandInvesting, PE ratio valuation, Also if you are looking for help in stats, may I recommend The Statistics Homepage. It is good. Week 2 Here is the bond pricing and Duration spreadsheet we used in class. Here is the spreadsheet we used to show the importance of assumptions in long term future value assumptions. Equity Valuation Review Quick Recap of valuation, Be able to show why valuation and capital budgeting are largely the same thing. new stuff begins here We will spend quite a bit of time here Pulling the goalie? These articles are similar in nature to the idea of pullie the goalie when behind in a hockey game. "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." Want a football example? Click here. Week 3
Review
of Portfolio Math and Valuation Discussion of Normal distribution : Taleb's Video--be able to understand why he does not like "Normal finance " RISK and Return--what is risk? Systematic vs non systematic Risk aversion (video), notes for those who want more What's it all means: diversify!,international
correlations (home
country bias),commodities,
real
estate, market
neutral hedge funds, easier
one on hedge funds Notes on CAPM
Why study CAPM if
it doesn't work? Long answer but theory is
important and the idea that systematic risk is important.
Sharpe Ok, so CAPM may or may not work. There is still a soft spot in my heart for CAPM. Why? Because it is such an important and elegant model and I still think it should work. But of course most research over the last decade suggests it does not work very well (example Fama And French!). Now why it does not work is the real fun. Is it the model? The market? The researcher? Or some combination of the above? Research from Ang and Chen finds that the time period studied matters as well. For instance, from 1963 on there appears to be a Value anomaly. However, this disappears when the 1926-2001 period is examined and “the market factor alone is able to explain the spread of average returns of these portfolios.” [note the portfolios were created based on book to market values.] Further they find evidence of a time-varying beta relationship where value stocks (i.e. high book to market or equivalently and more commonly in the popular press low market to book ratios) “were risky in the early part of sample, but not in the latter part. This could be really big. Fama-French Three Factor Model from Wikipedia , from MoneyChimp, Links likely to be useful to you:
Market Efficiency Dean Labaron provides a good introduction, Damodoran has a bit more academic look.Overview: Class notes
Football, Baseball, Weather, and more on behavorial finance Required readings: (read the whole thing of these)
Theory of Stock Market Efficiency-Ray Ball (Summary available) Fama 1991—Efficient Markets II
A paper by Bainbridge that looks at Insider trading (great Bibliography and literature review Will talk about the following in class, but do not worry too much about the specifics until then
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=440380
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=216210 Good description of what is and is not allowed Google search I created. Try it out for insider trading An older paper on Behavorial finance and Market efficiency by Fama
Behavioral
finance Primer by Jay Ritter
Capital
Budgeting: NPV, IRR, etc Capital Structure: Capital structure decisions are basic part of doing business yet often misunderstood. In terms of modern financial theory and EMH it should not matter what we issue as there is a zero NPV. Managers, however, spend much time worrying about what to issue and when. Why? Partially because some of the assumptions we use in developing EMH do not hold, partially because of transaction costs, partially for agency cost reasons, and partially because the Investment banking community is convinced that what firms issue does matter. Chapter 14 notes : essentially definitions/review of what financing alternatives are available Efficient markets and capital structure--Modigliani and Miller Does
it hold
in practice? In
a
Modigliani and Miller world when corporate taxes are introduced,
the optimal debt level increases. Desai, Foley, and Hines have a cool
paper that finds, among other things, that this positive relationship
between tax rates and interest does hold. FWIW one of the
“other
things” that influences debt financing is the interest rate:
the higher
the interest rate, the less debt firms use, which fits nicely with
the story above! (BTW, yes this is predominantly intended as
an
International Finance article, but it is cross-listed here because it
is so relevant.) Philippon
examines firms' capital structure empirically and
theoretically.
He finds that firm value does not exactly fit the static
trade-off model. Specifically he finds that low levels of
debt
are not accompanied by as low of firm values as would be
expected. However, in other areas, what we have been teaching
seems exactly right: more growth options means less debt,
highly
profitable firms do have higher target debt ratios (even though they
may not all be at the targets), and expected future financing deficits
makes financial slack more valuable.
Capital Structure Debt is good, debt is bad ("Debt
makes good times
great, bad times horrible") Pecking order--Myers and Majluf. The "Quess what I am thinking" game!
Why are there so many types of securities? Denis and Mihov find that the largest determinant is the credit rating of the firm. In their
Several papers have shown that capital structure
does
impact
operations. For instance a few papers have looked at grocery
stores and leverage. For instance after LBOs, stores raised
their
prices and another
paper has found that those with high debt had more out of
stocks. Famous "
Smith-Masulis " papers
Introduction to Security Issuance Asquith and Mullins have the classic paper in this area. It is a tad dated (1986) but is still pretty much the gold standard. Rights issuesCapital structure review-- Raising capital continued--IPOs--some blog enries on IPOs
Recent IPO filings: from IPO Monitor The flip side of security issuance--- In
an
upcoming JF, Grullion and Michaely give us an in depth look at stock
repurchases. They find more buybacks and that the buybacks reduce the
free cash flow problem. They also find that buybacks apparently do
not signal improved operating performance in the future. Some of this disagreement is likely from the various biases that result in studies following major restructurings and takeovers. For instance, see Below this is not on test 1 Leasing Why lease? There are many reasons firms lease but in the end they mainly boil down to lower taxes or lower transaction costs. Forbes has a very basic (does not really live up to their usual standards) look at leasing. One highlight: "The primary advantage of leasing business equipment is that it allows you to acquire assets with minimal initial expenditures. Because equipment leases rarely require a down payment, you can obtain the goods you need without significantly affecting your cash flow" Other (admitedly biased) resources are Lease Source, SOKKIA Types of Leases: Operating vs Capital (Financial)
Calculator from Lease vs Buy, Smith and Wakeman's 1985 paper still helps clarify my thinking on leasing more than just about anything else. Derivatives: What
are they?, notes on
how to price them using
the Black
Scholes formula, Put
call parity How to use them: DRAW PAYOFF DIAGRAMS! Why use them? Speculating (leverage gives you much power), stock options can help align incentives (with some problems) Hedging
(operational
hedging
and financial hedging) can lowers risk, can positively impact
cashflows, lowers expected taxes, make it easier to monito management,
and allow management to do what they do best and not worry
about
what is beyond their control. Hedging can also allow firms
better
access to capital markets (SEE Simkins,
Carter, and Rogers and Allayanis and Weston 1998)
Why studying them is important even if you do not personally plan to use them: Derivatives are explosive, zero-sum games. Used correctly they can be powerful tools, used incorrectly they can blow up in your face. Knowing this may allow you to prevent the problems from happening at your firm or firms you do business with. Here are just a few of the debacles,:
Orange
County, Barings,
LTCM,
Bankers
Trust (although this argues for being stupid!)
In
sum, Derivatives are powerful tools. Used correctly they help
greatly, used incorrectly they really can hurt! Long Term Capital Management is a particularly good case dealing at least some with derivatives. If no one selects it as a case to present in week 5, we will spend some time going over it in class.
from
erisk.com LTCM
from The Risk Institute Long Term Capital Management case the view from the Fed's Patrick Parkinson the cry for more regulation was not widely accepted. Corporate Governance Talk about hot
topics!
Corporate Governance has been on the front page of all major papers and
has attracted much attention in academic world as well. It
boils
down to conflicts within the Nexus. Generally this focuses on
manager and shareholder conflicts. A few videos from UCLA professors on governance and differences between the US and Japanese systems. From a practical perspective, governance issues often come down to disagreements about Executive pay, shareholder voting, poison pills and other areas of entrenchment..
Some videos: On differences in US-Japanese governance, Transparency and Governance Where does auditing fit into this? Can't improve things unless we know what is going on. Better earnings quality and transparency lead to lower underpricing in IPOs. 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 sample, Godbey
and Mahar (RIF 2004) find that auditor reputation
helps mitigate the information asymmetry problem. 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. Too high of stock prices? Jensen
talks about what led to the governance crises we saw at Tyco, Enron,
etc. A big part of the answer may be overpriced equity. Why?
A
stock price that is overvalued is caused when investors have overly
optimistic expectations. Thus, if the investors were to learn the
truth, the stock price would fall. This creates an incentive to hide
information from investors. Moreover, to keep the stock price high,
management may be willing to take more chances and further hide the bad
results. Typical control mechanisms fail to work on this problem. For
instance, stock based pay makes the problem worse and the takeover
market fails miserably since no one would want to take over an
overpriced stock. Jensen suggests one solution: the board providing
more information (including to short sellers). Lack of transparency is likely the most severe problem. What is Right with Corporate Governance?
find that valuation and governance are “positively related.” Interestingly, they do not find the same relationship when various “earning based performance measures” were examined. (my guess as to why the latter finding exists: fewer accounting games are played where there is good governance. This game playing would skew any ratio comparison based on accounting numbers.) Link does not work--- US' system good but can be improved.
A few sites that you may find useful: Executive Compensation Much of both the level and form of pay can be quickly summarized in these simple models. LOWER---------------------Level of Pay----------------------------------HIGH Assets in
place
Growth options
---------------------------Form of Pay--------------------------- Straight Salary is a higher
proportion
Market-based pay is more important
Small Firms larger firms Rgulated Firms unregulated firms The
SEC's
information on executive compensatation
Executive
Compensation Resources Papers Erickson,Hanlon,
and Maydew---GREAT!!!! solving this problem? Make the pay package include put options! This might lessen the incentive to “cheat” but would likely open a whole other set of problems by creating an incentive to lower stock prices. http://papers.ssrn.com/paper.taf?abstract_id=488565 For a more “real world” look at options, CFO.com provides a survey that documents that at least some of the problems Gibson and Chesney suggest do in fact happen. READ IT! http://www.cfo.com/Article?article=14397 Required Readings:
Adelphia: Market for corporate Control (mergers, takeovers, etc) The Market for Corporate Control: in some ways this is what happens if internal measures do not work. Off line Readings: Is American Corporate Governance Fatally Flawed? –Merton Miller
Types Horizontal merger_acquiring competitor Fan and Goyal
find
that there are
postivie abnormal returns from vertical acqustions.
Takeover
waves
(and types) History lesson 1898 to early
1900s--Horizontal
mergers 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
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Week
15
Final