FINANCE 305. Financial Markets, Institutions, and Economic Activity Fall, 2013/2014

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1 FINANCE 305 Financial Markets, Institutions, and Economic Activity Fall, 2013/2014 Course Aims and Objective The objective of this course is to provide students with an understanding of the financial system and economic environment in which financial management and investment decisions are made. Topics covered include: money and the financial system; financial stability; the regulation of the financial system; money creation and the role of the Federal Reserve; Keynesian theories of aggregate demand and interest rates; New Classical theories of the business cycle; Financial aspects of business cycles; Optimal financial contracting; and Cross country comparisons of law and corporate governance. Math is used throughout the course up to and including the level of calculus. The course material is fundamental to an understanding of a number of important economic events that have received high media coverage. For example, it should help the student understand the causes, nature and significance of recent financial crises and how they affect the real economy. It should also help the student to evaluate the effectiveness of monetary policy and financial regulation in combating financial crises, inflation, and unemployment. Current events are an extremely important part of the course and students will be expected to read newspapers such as the Financial Times of London or the Wall Street Journal. This will be useful both for exams and the class assignments. Except where noted all reading assignments are in the packet entitled READINGS FOR FINANCE 305 available for purchase in the Business School Copy Center. Other reading assignments are on reserve for FIN 305 at My UW. Lecture Notes for FIN 305 are also available for purchase in the Copy Center. Course Outline Course Organizer: Mr. Robert E. Krainer Lecturer: Mr. Robert E. Krainer The Financial System Weeks 1-2 I. Financial Institutions A. The Role and Importance of Financial Institutions and Markets in the Economy. 1

2 This section describes the major financial institutions in the U.S. economy in terms of what they invest in and how they finance those investments.. Mishkin and Eakins, Overview of the Financial System, Chapter 2, pp On reserve for FIN 305 at My UW. Hoggarth, Reis, and Saporta Cost of Banking System Instability: Some Empirical Evidence. Journal of Banking and Finance 26, in Readings. B. Banking in the United States Weeks 3-4 Modern Money Mechanics. Federal Reserve Bank of Chicago. On reserve for FIN 305 at My UW. C. Financial Crises and the Regulation of Banking Week 5 7 Banking Crises: A Review Luc Laeven. Annual Review of Financial Economics. pp in the Readings.. What Caused the Current Financial Mess and What Can We Do About It? Boyd,Jagannathan,and Kwak. Unpublished Working Paper. Pp in the Readings. Brief Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act Pp in the Readings. Group of Governors and Heads of Supervision Announce Higher Global Minimum Capital Standards. September Bank for International Settlements. Pp in the Readings. Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance: A Review Robert Krainer. Journal of Financial Stability. Pp in the Readings. 2

3 Towards a Program for Financial Stability Robert Krainer. Journal of Economic Behavior & Organization. Pp in the Readings. Economic Stability under Alternative Banking Systems Robert Krainer. Unpublished Working Paper. Pp in the Readings. II. Macroeconomic This section describes demand-oriented Keynesian models of the economy and New Classical supply-oriented theories. In both models money and monetary policy play a key role in describing aggregates such as GDP, interest rates, and the price level. A. Keynesian Demand Models Weeks 8-10 Macroeconomics Oliver Blanchard. Prentice Hall. Chapters 3-6, pp On reserve for FIN 305 at My UW. B. New Classical Supply Models Weeks Inflation and Unemployment in Rational Expectations. S. Sheffrin. Cambridge. Cambridge University Press, pp On reserve for FIN 305 at My UW. Understanding Business Cycles. Robert Lucas in Stabilization of the Domestic and International Economy edited by K. Brunner and A. Meltzer. Carnegie-Rochester Conference Series on Public Policy. New York, North-Holland pp. 7-29, pp On reserve for FIN 305 at My UW. III. Finance and the Economy This section describes the corporate finance of business cycles in an economy where there is a conflict of interest between bondholders and stockholders of firms. Security prices and financial contracts play an important role in shaping the investment and financing decisions of firms over the business cycle. Weeks

4 A. Theory, Empirical Evidence, and Policy Financial Aspects of Business Cycles for U.S. Nonfinancial Enterprises Robert Krainer Forthcoming in the Journal of Money, Credit, and Banking. Portfolio and Financing Adjustments for U.S. Banks: Some Empirical Evidence. Robert Krainer. Journal of Financial Stability, pp in the Readings. B. Financial Contracting Financial Contracting and Supply Adjustments, Robert Krainer in Finance in a Theory of the Business Cycle. Oxford: Blackwell, pp in the Readings. C. Cross Country Comparisons of Law and Corporate Governance LaPorta, R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny Law and Finance. Journal of Political Economy, 106, pp On reserve for FIN 305 at My UW. IV. Special Topics (if time allows) Weeks 15 Whatever is topical. 4

5 Course Grading Quiz 1 Quiz 2 Term Paper Midterm Exam Final Exam 10 points 10 points 30 points 100 points 100 points Term Paper: Write a no more than 3 page paper on the bankruptcy of Lehman Bros., a large ($600 billion in assets) investment bank. Lehman declared bankruptcy on September15, In your essay: i) describe what caused the bankruptcy, ii) what effect did the bankruptcy have on the world financial system, and iii) should the government have prevented Lehman Bros. from going bankrupt. Dates of Exams First Exam Final Exam Wednesday, October 23, at 5:30-7:00PM. Place to be announced. Wednesday, December18 at 2:45-4:45. Place to be announced. See me immediately if you have a conflict with another final exam. The final exam will not be cumulative for those who take the mid-term exam and will only cover material after the mid-term exam. Students missing the mid-term exam will take a make-up exam that covers material up through the first exam. This make-up exam will be given immediately after the final exam on December 18. All exams are open book and open notes. No computers or other electronic devices can be used in the exams. The exams questions are mostly essay with some problems. School of Business policy states that all electronic devices are to be turned off during classes and exams. That will also be the policy for FIN 305. Re-grading Policy. For the most part essay exam questions are graded on a relative basis; i.e., how well one student does relative to other students. That makes re-grading hard. For that reason re-grading is done on an absolute basis; i.e., whether the answer is right or wrong with nothing in-between. Nevertheless if you think you deserve more points on a question you will be required to describe in writing (and handed in to me) why you think you deserve more credit on a particular question. That in itself is a useful learning exercise. Missed Classes. In the past I have been called away to present research papers at other universities and central banks. This year is no exception. When that occurs I will make up any lost lectures in an evening class on Wednesday either at 5:30-7:00PM or 7:00-8:30PM depending on when I can get a room. This semester I will be giving several talks in Germany and will miss class on Thursday September 26. Office: 3110 Grainger Office hours: Tue. and Thurs. 11:00-11:45 and any time my door is open except before class. 5

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