Class Meetings FIN3560-01: TR 11:30am-1:05pm FIN3560-02: TR 1:15pm-2:50pm FIN3560 Financial Markets & Instruments Spring 2018 Instructor Patrick C. Gregory, CFA Managing Director, Cutler Center for Investments and Finance Faculty Director, Babson College Fund Senior Lecturer, Division of Finance Office: 223 Tomasso Hall Telephone: 781-354-7881 (email preferred) E-mail: pgregory@babson.edu Profile: www.babson.edu/academics/faculty/profiles/pages/gregory-patrick.aspx Office Hours Tuesday, 4pm 6pm; otherwise by appointment Course Description This course provides students with a thorough understanding of the financial markets, the quantitative techniques used to value financial securities, and the risks of investing in those securities. Topics covered include the major global financial markets and their structures, quantitative techniques for valuing financial securities and their cash flow streams, and factors affecting interest rates. The course also provides an introduction to derivatives and risk management. Specific topics include: instruments/markets, issuing securities, organized exchanges vs. over the counter markets, stock valuation, bond valuation, and securities trading. The professor reserves the right to make adjustments to the course material, as necessary, in response to important developments in capital markets which may occur during the semester. Credit hours: 4 Pedagogical Approach This course is discussion and case-based, and accordingly emphasizes classroom participation. Lectures provide a structured introduction to core concepts. Problem sets and case studies are then used to put the course information into a practical, real-world context. The case discussion is facilitated by a list of questions that students consider in advance. Financial market practitioners and policy-makers serve as guest speakers in the course. These individuals provide a unique perspective on the markets and instruments covered in the course based on their first-hand experience. Throughout the course, students use a variety of financial databases to analyze and value financial instruments using real-time data. Course Materials Textbooks: Required: Financial Markets and Institutions: A Modern Perspective (6th Edition) by Anthony Saunders and Marcia Million Cornett, Irwin/McGraw-Hill (2014). Recommended for students who have not taken Security Valuation: Investment Valuation: Tools and Techniques for Determining the Value of Any Asset (3 rd Edition, University Edition) by Aswath Damodaran, Wiley Publishing (2012).
Cases: HBS Coursepack (http://cb.hbsp.harvard.edu/cbmp/access/67620036) that includes: Finance Reading: Introduction to Bonds and Bond Math (2016) UK GILTS Analysis of Bond Investments (May 2014) Tombstones (2014) Matrix Capital - A (2015) Readings: You are expected to read The Financial Times or The Wall Street Journal EVERY DAY. An online subscription is available through the Horn Library. The professor will also be sending you relevant topics each week that should be reviewed. These articles will then be discussed in class. Other: Students should either own or have unrestricted access to a financial calculator. The recommended calculators are the Hewlett-Packard HP 12C Platinum or Texas Instruments BA-II Plus. The calculator should be brought to each class. Note: I use the HP12C Platinum and my solutions are based on that. I can t provide assistance with the BA-II Plus. Grading You will need to complete the required readings, actively participate in the class discussions, and perform well on the assessments (quizzes and final exam) to do well in this course. If you put in the requisite time and effort, you should find the class quite rewarding. The grade a student receives in class will be determined as follows: Bloomberg Market Concepts (individual assignment) 15% Quizzes (individual assignment) 30% Case analysis (group assignment) 30% Final exam (individual assignment) 25% Total 100% While class attendance and participation aren t listed here, both are expected and can only help your grade. DESCRIPTION OF ASSIGNMENTS Bloomberg Market Concepts (15%) Each student in the group is required to register and successfully complete the Bloomberg Market Concepts (BMC) program by April 1. The program can be completed on the Bloomberg terminals available in the Cutler Center or online. The access code needed is CX3WNV6F9G. Each section of the program is graded and then compiled for an overall score for the program. Quizzes (30%) Timed, open book quizzes will be administered through Blackboard or another course management system. Students will be notified when the quiz has been posted and will then have until Sunday at midnight to complete the quiz. These are timed quizzes and students have 60 minutes to submit their responses. Upon submission, you will receive a grade for the quiz. After the submission deadline, you will be provided with detailed solutions for the quiz. The quizzes are based on the readings and material presented and discussed in class. They are designed to reinforce course content and help to ensure that students do not fall behind. There will be no make-up quizzes. 2
Case Analysis (30%) Students will be assigned to groups by the instructor. All groups are required to read the case, prepare solutions to all of the questions, and submit their responses at the beginning of class. The names of each group member must be included along with the section number on the first page. All submitted materials should be properly formatted and legible. The professor may ask any group (or member of a group) to provide a constructive response during the discussion of the case in class. As a guide, your responses should address the questions asked and incorporate a complete analysis of the case. It should not be a reiteration of the facts presented in the case. Final Examination (25%) The exam will focus on the assigned readings, cases, and classroom discussion. Students will be provided with a template for each question on the exam. The template includes financial data and other relevant information needed to answer the question along with a space for the student s response. The exam must be submitted on time. The student s grade on the exam will be reduced by 20% if submitted late. Accommodations/Disabilities Any student who feels he or she may need an accommodation based on the impact of a disability should contact me privately before the first quiz is administered. Students must also contact the Director of Disability Services at 781-239-5509 or in Hollister Hall 122 to coordinate reasonable academic accommodations. Academic Honesty and Integrity The standards and expectation of the Babson Honor Code and its academic honesty and integrity policies apply to this course as well as to any other course you are taking here. The policy is articulated in your Undergraduate Handbook. Failure of any student to take appropriate steps to fully understand the Code will not be an acceptable nor tolerated excuse for any violations. You can find some information related to the Babson Honor Code at: http://www.babson.edu/undergraduate/student-life/community-standards/pages/honor-code.aspx All students have an obligation to act according to the Babson Honor Code. Students may be required to affirm their understanding of and commitment to the Babson Honor Code by writing the following honor code pledge on every exam, paper, project, or other academic exercise: I pledge my honor that I have neither received nor provided unauthorized assistance during the completion of this work. Computer Use Laptops may be used for notetaking purposes only. ipads and other tablets can also be used for electronic note taking (with a stylus or pencil) provided that provided that the wi-fi is disabled. It is expected that all electronic devices are used solely for academic purposes while in the classroom. Mobile devices such as cell phones serve no educational purpose and therefore have no place in a community of learners. Such devices must be silenced (not on vibrate) and STOWED OUT OF SIGHT during class, unless you have informed me in advance that you are expecting an emergency message relating to the health or safety of a family member or a job offer. Do not leave the room during class to check your phone or take a call. Communication Promptly bring to my attention any problems you are having. Two-way communication is vitally important for success in this course. Also, please display your tent card each class. It helps me facilitate a productive discussion during class. 3
Course Schedule Please note that the course schedule is tentative and subject to change. Additional details and course material will be posted on Blackboard. Session Topics Class Preparation & Assignments 1 Jan 23 Overview of Financial Markets Distinguish between primary and secondary markets Describe the basic financial market instruments used by corporations Differentiate between money markets and capital markets Read Saunders Chapter 1 pp. 3-17, Appendix 1A Assignment: Quiz #1 (due Sunday at midnight) 2 Jan 25 Interest Rates and Time Value of Money Identify the determinants of interest rates Understand the relationship between interest rates and time to maturity (terms structure of rates) Describe how interest rates are used to determine the present value and future value of an investment Read Bond Markets and Bond Math (HBS) Read Saunders Chapter 2 pp. 26-27, 35-53 3 Jan 30 4 Feb 1 5 Feb 6 Interest Rates and Security Valuation Appreciate how security prices are affected by interest rate changes Understand how the maturity and coupon rate of a bond affects it price sensitivity to interest rates Introduce the concept of duration Interest Rates and Security Valuation (Cont) Calculate duration Understand how the coupon rate, yield to maturity, and maturity of a bond affect the duration of the security Describe interest rate measures Case: UK Gilts: Analysis of Bond Inv? TVM, YTM, yield curve, relationship between interest rates and bond prices, bond valuation Read Saunders Chapter 3 pp. 57-65, 70-74 Read the case Prepare responses to the UK Gilts case questions Discuss responses to the case questions 4
6 Feb 8 Managing Interest Rate Risk Estimate interest rate risk using Macaulay and modified duration Describe the common characteristics of the various derivative contracts Analyze interest rate forwards and swaps as potential risk management strategies Read Saunders Chapter 3 pp. 75-86, Appendix 3A and B and Chapter 23 pp. 673-682 Assignment: Quiz #2 (due Sunday at midnight) 7 Feb 13 8 Feb 15 9 Feb 22 10 Feb 27 11 Mar 1 5 Managing Interest Rate Risk (Cont) Estimate interest rate risk using Macaulay and modified duration Describe the common characteristics of the various derivative contracts Analyze interest rate forwards and swaps as potential risk management strategies Managing Interest Rate Risk (Cont) Estimate interest rate risk using Macaulay and modified duration Describe the common characteristics of the various derivative contracts Analyze interest rate forwards and swaps as potential risk management strategies Bond Market Securities Describe the characteristics of various bond market securities Explain the bond pricing conventions Explain the methods used to manage credit risk, including credit default swaps (CDS) Bond Market Securities Describe the characteristics of various bond market securities Explain the bond pricing conventions Explain the methods used to manage credit risk, including credit default swaps (CDS) Case: Tombstones Raising capital Senior unsecured notes YTM Term structure of interest rates Bonds with embedded options Read Saunders Chapter 3 pp. 75-86, Appendix 3A and B and Chapter 23 pp. 673-682 Read Saunders Chapter 3 pp. 75-86, Appendix 3A and B and Chapter 23 pp. 673-682 Read Saunders Chapters 6 Read Saunders Chapters 6 Assignment: Read the Tombstones case and prepare responses to the case questions Assignment: Discuss responses to the case questions Quiz #3 (due Sunday at midnight)
12 Mar 6 13 Mar 8 14 Mar 13 15 Mar 15 Equity Market Structure Explore the process by which common stock is issued in the primary market Describe the major secondary markets/exchanges Examine the process by which trades take place in the stock markets, including order type and trade execution cost considerations Define the characteristics of the major stock market indices Guest Speaker (VP, Relationship Manager at NASDAQ) First-hand discussion of market structure, trend in stock exchanges, and the global competitive environment Equity Analysis and Valuation Identify the primary drivers of stock value Describe the various forms of stock valuation (discounted cash flow, relative value analysis, and option-based valuation) Explain the differences between the CAPM, multi-factor models, and proxy models used to estimate the cost of equity capital Estimates the risk free rate used in each of these models and how they differ by country Discounted Cash Flow Analysis Differentiate between historical and forward-looking (i.e., implied) equity risk premiums and illustrate the estimation process Differentiate between regression and bottoms-up beta and estimate the relative risk measure Calculate the cost of capital for a publicly traded company Read Saunders Chapter 8 Read Saunders Chapter 3 pp. 65-69 Read Damodaran Chapters 2 (valuation methods), 7 (estimating the risk free rate) Review the Abbott Labs case Read Damodaran Chapter 8 (estimating risk premiums) Review the Disney case 6
16 Mar 27 17 Mar 29 Discounted Cash Flow Analysis (Cont) Explain the process of forecasting the free cash flow for a global company Explain the assumptions that can be used to estimate the terminal value of a company and illustrate the process Determine the value of a company using a free cash flow model Case: Matrix Capital (A) (Part 1: equity valuation using DCF analysis) Read Damodaran Chapters 10 (from earnings to cash flows), 11 (estimating growth), 12 (estimating terminal value), 15 (firm valuation) Read the Matrix Capital A case and prepare responses to the case questions (Part 1) Review responses to the case 18 Apr 3 19 Apr 5 20 Apr 10 Comparables Analysis Explain the relative value process and common pitfalls investors make when using price multiples Estimate enterprise value/sales, enterprise value/ebitda, and P/E ratios and demonstrate how they can be used to determine the relative value of a company Comprables Analysis (Cont) Illustrate the use of FactSet, Bloomberg, and other Cutler Center resources to value a publicly traded company using discounted cash flow analysis and comparables analysis Case: Matrix Capital (A) (Part 2: equity valuation using multiples analysis) Read Damodaran Chapters 17 (principles of relative valuation), 18 (earnings multiples), 20 (revenue multiples) Assignment: Quiz #4 (due Sunday at midnight) Review the Matrix Capital case and prepare responses to the case questions for Part 2 Read the case Prepare responses to the case questions for Part 2 7
21 Apr 12 22 Apr 17 23 Apr 19 24 Apr 24 Equity Options Describe the major risks faced by investors in the stock market Describe and illustrate how these risks can be hedged with forwards, futures, and options Calculate option prices and explain how an option s value is impacted by various factors ( Greeks ) Equity Options (Cont) Describe the major risks faced by investors in the stock market Describe and illustrate how these risks can be hedged with forwards, futures, and options Calculate option prices and explain how an option s value is impacted by various factors ( Greeks ) Mortgage Markets Describe the characteristics of amortizing and non-amortizing mortgage loans Mortgage Markets and Mortgage-backed Securities Read Saunders Chapter 10 pp;. 306-328, Appendix 10A Assignment: Quiz #5 (Due Sunday by midnight) Read Saunders Chapters 7 Assignment: Quiz #6 (Due Sunday by midnight) Read Saunders Chapters 7 25 Apr 26 Explain the process of mortgage securitization and its role in the financial crisis Financial Jeopardy (conceptual concepts) Review notes and other materials covered during the prior 14 weeks 26 Final Exam Review (problem set) Review the final exam problem set May 1 Finals Week Final Exam 8