FFM Outline 2011 12 .pdf

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Name: Farouk Jivrak
E-mail: farouk.jivraj@imperial.ac.uk

This course will provide students with the theoretical tools to analyse modern
financial markets and the decisions of corporate firms. This theory of finance will
enable students to understand why companies and financial markets (investors)
behave the way they do. Throughout the course, the emphasis is both on the
presentation of theory underlying each topic and on the problems and issues that
arise when applying these theories in practice.

 Time value of money
 Valuation of stocks and bonds
 Risk and return in financial markets
 Asset allocation
 The Capital Asset Pricing Model (CAPM)
 Stock market efficiency
 Capital structure (equity vs. debt financing)
 Financial options
 Risk management
 Analytical skills in financial context
 Quantitative skill in financial context
 Critical reasoning

By the end of the course students will be able to:

Think in the terms of a professional financial manager.
Understand the interplay between value and risk for the most common
financial instruments.
Understand financial issues discussed in The Financial Times, The Economist

The main method of teaching is the lecture. These will be focused on theoretical
concepts and be highly interactive. Students will also have tutorials which provide a
forum for discussion and problem solving.

Group assignment – 30%
Written exam – 70%

We encourage students to provide feedback on the course: lectures, tutorials and
content. We would like to continuously improve this course and so participants’
feedback is essential in guiding this effort.

The lecture notes are self-contained but we still encourage students to reference the
following texts below.
Core textbook:
Brealey, Myers, Allen (BMA), Principles of corporate finance, 10th edition, McGrawHill (2011)

There are ten lectures:
1. Time value of money
Present and future value, net present value, opportunity cost of capital, how
capital markets reconcile preferences for current and future consumption,
perpetuity, annuity, compound interest.
Reading: BMA, Chapter 2.
2. Valuation of bonds and the term structure of interest rates
Present value of a bond, sensitivity of bond prices to changes in interest rates,
duration, convexity, bond volatility, yield to maturity, measuring and explaining
the term structure, real and nominal interest rates.
Reading: BMA, Chapter 3.
3. Valuation of common stock
Present value of common stock, discounted cash flow model, constant growth
model, estimating the cost of equity capital, stock prices and earnings per share,
present value of growth opportunities, alternatives to the net present value, the
payback rule, internal rate of return (IRR).
Reading: BMA, Chapter 4.
4. Risk, return and asset allocation
Measuring and estimating returns and risk, historical evidence, calculating
portfolio risk, diversification, efficient frontier, optimal asset allocation, the capital
market line (CML), two-fund separation theorem.
Reading: BMA, Chapter 7.

5. The Capital Asset Pricing Model (CAPM) and market efficiency
An equilibrium relationship between risk and return, the security market line
(SML), market price of risk, alpha & CAPM beta, assumptions behind the CAPM,
testing the CAPM, three forms of capital market efficiency, empirical evidence
about market efficiency.
Reading: BMA, Chapters 8 & 13.
6. Capital structure
Financial leverage in the absence of taxes, the Modigliani-Miller theorems, capital
structure and beta, weighted average cost of capital (WACC), corporate taxes
and capital structure, cost of financial distress.
Reading: BMA, Chapters 14, 17 & 18.
7. Introduction to options
Call options, put options, determinants of option value, the concept of arbitrage,
no-arbitrage bounds on options prices, the put-call parity, replicating option payoffs with stocks and risk-free bonds
Reading: BMA, Chapters 20 & 21.
8. Valuation of options
The binomial model, the Black-Scholes formula, implied volatility.
Reading: BMA, Chapter 21.
9. Credit risk and valuation of corporate bonds
Yields on corporate debt, the option to default, probability of default and bond
ratings, value at risk (VaR)
Reading: BMA, Chapter 23.
10. Risk management
Forward and futures contracts, swaps, hedging, how to set up a hedge, hedging
currency and interest rate risk
Reading: BMA, Chapters 26 & 27.

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