Syllabus: Foundations of Finance

Fall Semester 2009-2010

B01.2311.10

August 27, 2009

1 Instructor
Professor Antti Petajisto
Office: KMEC 9-54
Phone: TBA
Fax: (212) 995-4256
Email: antti.petajisto@stern.nyu.edu
Web page: http://www.petajisto.net/
Office Hours: M 12-1pm, M 9-10pm (first in class room, then office), W 3-4pm, or by
appointment.

2 Teaching Assistants
The teaching assistants are TBA. Their office hours will be announced on the class Black-
board site and in class. They will teach two review sections (after classes 2 and 4). Place
and time of the review sections will be announced on the class Blackboard page and in class.

3 Class Time
The class meets once per week on M from 6:00-9:00pm during 12 weeks. Each class time is
divided into two sessions.
Session 1: 6:00-7:25pm
Session 2: 7:40-9:00pm
The first class is on M 10/05.
The last class (final exam) is on M 12/21.
The venue is KMEC, room 4-80.

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Classroom Civility Your behavior should respect your classmates desire to learn. Each
lecture begins exactly at 6:00pm and ends exactly at 9:00pm. I understand your busy
schedules, but try not to come late. Because of the classroom layout, it is disruptive no
matter how quiet you are. If you carry a cell phone or any other type of ‘audible alert
device’, turn it off before entering class. Do not engage in side conversations during the
lecture. Repeated occurrence of such disruptions will be reflected in the final grade. If you
must miss a class or must come late, please let me know by email beforehand.

4 Readings
The textbooks for this class are:
1 “Investments” by Zvi Bodie, Alex Kane, Alan J. Marcus, 8th edition.
2 “Solutions Manual to accompany Investments” by Zvi Bodie, Alex Kane, Alan J. Marcus,
Alan Marcus, 8th edition
3 Selected Materials from “Essentials of Corporate Finance” by Stephen A. Ross, Randolph
W. Westerfield, Bradford D. Jordan, 6th edition
We will mainly use [1], abbreviated BKM below. If you have an earlier edition of BKM
(sixth or seventh), you are fine. There are only minor changes between editions. Page and
chapter numbers may vary slightly, but this is hardly a reason to buy a new copy.1 The
main role of the textbooks is to serve as a source where you can review the material. BKM
is at times very good and tightly linked to the material I cover, but the link to the material
I cover in class is a bit weaker on some other topics. That being said, it is currently the best
book on the market for our purposes, and you will need it to prepare before class and go
over the material after class.
Book [2] will come in handy to solve practice questions. We will only use chapters 4 and
5 from book [3], abbreviated RWJ. These two chapters come as a supplement in the class
material packet if you purchased your class material through the bookstore. The supplement
[3] will only be used in classes 3 and 4. If you did not buy [1] through the bookstore, you
can purchase [2] and [3] separately on the publisher’s web site.2
The main class material is the course pack, which is also available through the bookstore.
It contains all powerpoint slides that I use in class, handouts with important material covered
in class, problem sets, and practice exams. You will want to take notes during class; space
is available next to the slides and on the left page. The handouts at the end of the course
pack are there to alleviate the amount of writing you need to do.
1
If you already own the “Essentials of Investment” textbook by the same authors instead, you will
have more difficulty finding the corresponding chapters, sections, and exercise numbers because they are
all different. You may want to upgrade to the “Investments” book. The same is true for the international
version of the Investments book.
2
Go to https://ebooks.primisonline.com. Click on “Custom eBooks” and follow the links. Item [2]:
ISBN: 0-390-169560, Order: 97155271, price: $19.07. Item [3]: ISBN: 0-390-169501, Order: 97155267, price:
$14.63.

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Staying Up-to-Date The class web site on Blackboard contains links to recent articles
in the financial press that complement the lectures. You are encouraged to follow financial
and macroeconomic news in the Financial Times, Wall Street Journal, or The Economist. If
you encounter an interesting article that you would like to share with the class, send me an
email and I will post it on the class web site. This section of the Blackboard site is regularly
update during the semester.

5 Calculator
You need a calculator for this class. It is a distinct advantage to have a financial calculator,
but not an absolute requirement. If you plan to take other finance classes, you will get good
use out of a financial calculator anyways. Standard financial calculators include the HP 12C
(costs about $70), the HP 10B-II (costs about $30) and the TI BA-II Plus (costs about
$30). You are expected to learn how to operate the calculator on your own. However, you
can get help by attending the teaching assistants’ review sections (after class 2) or his office
hours. Finally, I have included some useful slides in the course pack on how to work with
the calculator.

6 Communication
The class web site is on Blackboard at http://www.sternclasses.nyu.edu/. This is the
central location where all teaching materials are posted. TA office hours and class announce-
ments will be posted here. Problem sets are posted there as well. Solutions to the problem
set will be posted no later than one week after the due date; they will not be distributed in
paper form in class.
The class web site also contains the concept questions (see below), suggested problems,
and some finance links and articles. Finally, there is a discussion board where the TAs and
myself will participate on a regular basis to answer your questions. You are encouraged to
answer each others’ questions. If you have a question, first turn to the discussion board;
chances are the question has been asked and answered there already.

7 Exams and Assignments

Grades will be based on the final exam (40 percent), the midterm exam (30 percent), problem
sets (20 percent), and participation (10 percent). The participation grade consists of class
participation (2/3) and participation in the concept questions on Blackboard (1/3).
The Stern finance department follows a strict grading curve for graduate core courses (see
finance department web site). I am required to strictly adhere to this curve. The finance
curve for core courses is: A (10%), A- (15%), B+ (15%), B (40%), B- (15%), C (5%).

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Honor Code You are responsible for maintaining Stern’s Honor Code which mandates
zero tolerance for cheating and plagiarism. Violations of the honor code will be prosecuted
with a minimum penalty of failure for the course, as required by code of conduct rules. If you
become aware of any violations of the honor code you must take whatever steps are necessary
to stop the violators. Per request of the dean, you must include a signed statement at the top
of each problem set and exam, indicating that you adhere to the honor code. The statement
is: ‘I pledge my honor that I have not violated the Stern Honor Code in the completion of
this exam/problem set.’ It is in your best interest that the market place knows that Stern
takes honesty seriously; it adds to the value of your degree.

Exams The midterm and final exams test your understanding of the key concepts in the
class. They do not test your ability to memorize or to use your calculator. Rather they
probe your deeper understanding of the material. As a result, they may be more challenging
than the exams you are used to. To prepare for these exams, you should review the slides
together with your own class notes, the handouts (at the end of the course pack), the
concept questions, the required readings, the problem sets, the sample exams (located in
your course pack behind the homework), and preferably the suggested problem sets and
suggested readings. The final exam is cumulative.
You will be allowed one double-sided page of notes at the midterm exam and two double-
sided pages of notes at the final exam. The sheets must be no larger than 8.5 inch by 11
inch. There are no restrictions on the content of the formula sheets, except that you are not
allowed to reprint my Powerpoint slides verbatim. You will be asked to turn in these formula
sheets after the midterm and exam, but you will be able to recover the midterm sheet in the
week after the midterm.
You are not allowed to take the exam questions home, and no written answers will be
provided. There will be a post-midterm discussion in class 7. Once graded, you are allowed
to come visit your midterm in my office, during office hours or by appointment. The same
rules apply to the final. If you must miss an exam, you will be required to make it up after
the semester is over. No laptops nor palm pilots are allowed on the exam.

Concept Questions After every other class, concept questions are posted on Blackboard
under Course Documents. The concept questions test your understanding of the main con-
cepts taught in the class of that day and the previous class. Usually, there are between 5
and 10 multiple choice questions per test. After you have reviewed the material from class,
it should take you no more than 10 minutes to complete these concept questions. Every
concept test is available for 10 days, starting from the time the class ends. If you like to keep
the concept questions for your records, you must print them out while the test is online. I do
not distribute these questions by email and do not make the link available after the initial
ten day period.
Participation in the concept questions counts towards your participation grade (it is one-
third of your participation grade). However, I will not keep track of whether you answered
the questions correctly or not. Basically, the concept questions are good preparation for the

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exam and a device that gives you an incentive not to fall behind.

Problem Sets There will be 4 problem sets over the course of the semester. Each problem
set contains 1 excel question, emphasizing a practical implementation of a concept. The
problem sets are graded on a 5 point scale. Late problem sets will not be accepted. You are
encouraged to work in groups on the problems, but you must hand in your own copy and
you are asked to acknowledge any help you received on the front page of your copy. The
homework questions will be in the same spirit of the exam questions, but slightly easier.
After all, they are your first encounter with the implementation of the material.

Suggested Problems Suggested problems are posted on Blackboard under Assignments.

These questions are intended you give you extra practice over and above the homework. You
do not have to turn them in, and there is no credit for them. You can look up solutions in
your solution manual [2]. The solutions to the questions in the RWJ booklet (class 2) are
included in your course pack. Practice makes perfect: You are strongly encouraged to take
the suggested problems seriously.

Study Groups It is highly recommended that you regularly review the class material in
your study group. Don’t wait until exam time to meet with your group. By then it’s too
late. You are encouraged to work on the problem sets with your study group, but you must
hand in your own answers.

8 Course Content and Class Schedule

Content The course is a rigorous, quantitative introduction to financial market structure
and financial asset valuation. The main topics of the course are arbitrage, portfolio selection,
equilibrium asset pricing (CAPM), fixed income securities and derivative pricing. There is
a small section on project valuation.
You are expected to understand valuation formulas and be able to apply them to new
problems. The appropriate tools necessary for solving these problems will be developed at
each stage and practiced in the homework assignments. The models we will cover have
immediate applications and implications for real-world financial decisions. Every effort will
be made to relate the course material to current financial news.

Prerequisites Students must be comfortable with statistics, linear algebra, calculus, and
microeconomics. Students are strongly encouraged to study the review handout on statistics
at the beginning of the semester (Handout H0 located at the end of your course pack).
Alternatively or additionally, the Quantitative Review in appendix A of BKM will help you
through refresh the statistics material.

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Detailed Outline Below is a detailed schedule of the date and topic of each class. Required
readings are indicated as RR, suggested readings as SR. The readings starting with ’H’ are
handouts, situated at the end of your course packet. Homework due dates are also mentioned.

Class 1: Financial Instruments and Markets (M 10/05)

Overview of class RR: Syllabus
Financial Instruments RR: BKM 1.1-4, SR: BKM 1.5-7, 2
Financial Markets RR: BKM 3.1-3, 3.5, 3.7 SR: BKM 3.4, 3.6, 3.8

Class 2: Performance of Securities (M 10/12)

PV, FV, annuities, perpetuities RR: RWJ 4, 5.1-2, H1-2
Compounding and Return measures RR: RWJ 5.3-4, BKM 5.2, 5.4-6, H3-5 SR: BKM 5.1, 5.3

Class 3: Portfolio Theory (M 10/19)

Positions and Portfolio Returns RR: H6-8, BKM 6.2 SR: BKM 5.7-10
Efficient Portfolios with Two Risky Securities RR: BKM 7.1-2, H9
Optimal Portfolios and Investor Preferences RR: BKM 6.1
Homework 1 is due in class.

Class 4: Portfolio Theory (M 10/26)

Efficient and Optimal Portfolios with Riskless Asset RR: BKM 6.2-6, 7.3
Efficient and Optimal Portfolios w/ Multiple Risky Assets RR: BKM 7.3-4, 8.1-4, H10-11 SR: BKM 7.5
Introduction to Capital Asset Pricing Model RR: BKM 9.1

Class 5: Capital Asset Pricing Model (M 11/02)

The Capital Asset Pricing Model RR: BKM 6.6, 8.5, 9.1-2, H12
Applications of the CAPM RR: BKM: 10.1-2, H13-14 SR: BKM 9.3-6, RWJ 8.1, 8.4
Homework 2 is due in class.

Class 6: Midterm and Arbitrage (M 11/09)

Midterm exam in class (90 min)
Arbitrage and the Law of One Price (70 min) RR: H15

Class 7: Equity Valuation (M 11/16)

Dividend Discount Models and Valuation Ratios RR: BKM 18.1 − 4, H16-17 , SR: BKM 18.5-6
Midterm evaluation (20 min)

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Class 8: Fixed Income Securities (M 11/23)
Bond Prices and Yields RR: BKM 14.1 − 4, H18-19, SR: BKM 14.5
Bond returns, Forward Rates, and Yield Curve Theories RR: BKM 15.1-6, H20-22

Class 9: Fixed Income Securities and Options (M 11/30)

Duration and Immunization RR: BKM 16.1-3, H23-24 SR: BKM 16.4-5
Options Basics and Strategies RR: BKM 20.1-3, H25-26
Homework 3 is due in class.

Class 10: Options (M 12/07)

Options Strategies and Minimum Value RR: BKM 20.3-4, 21.1-2, H26-27 SR: BKM 20.4-7
Black-Scholes Option Pricing Formula RR: BKM 21.3-5 SR: BKM 21.6

Class 11: Futures and Market Efficiency (M 12/14)

Futures RR: BKM 22.1, 22.3-5, 23.2, 23.5, H28 SR: BKM 22.2
Market Efficiency RR: BKM 11 SR BKM 12
Homework 4 is due in class.

Class 12: Final (M 12/21)

Final exam in class (180 min)