Azerbaijan University

School of Business

Fi 8000 Valuation of Financial Assets

Fall, 2010

Instructor: Elchin Huseynov Tel: 050 4466013 Office hours: after class or by appointment E-mail: [email protected], [email protected]

1. PREREQUISITIES Fi 3300 Corporate Finance

2. READINGS Required readings - Bodie, Kane and Marcus. Investments, 5th edition - Lecture notes and case studies

Optional reading - Derivatives and Alternative Investments. CFA Program Curricilium, Volume 6, 2010 - The papers and journal articles provided during the class

3. COURSE OBJECTIVES AND DESCRIPTION

The primary purpose of this course is to explore the concept of valuation. Throughout the semester, we will examine the theory of valuation for many types of risky financial assets. Though the theories have fairly broad applications, we will frequently apply them to pricing financial instruments, such as bonds, stocks, futures, and options. This course will lay a foundation upon which you will build in finance course electives. After this course, you should have a good understanding of arbitrage, currency exchange, portfolios, interest rates, risk and return, and market efficiency.

4. INTENDED LEARNING OUTCOMES Core Learning Area Learning Outcome Methods used for (or Educational Objective) assessing learning Participate in class discussions and Participation in class Interpersonal problem solving exercises. They will discussions and problem Communicatio be able to present their arguments or solving class will be n Skills findings, persuade fellow students of assessed and graded. the usefulness of their own conclusions and objectively critique findings presented by their fellow students

Demonstrate an ability to use MS Class problems and Excel tools in problem solving homework assignments Technology Skills will require the use of Excel spreadsheets.

Work harmoniously with students of Utilise classroom Cultural Sensitivity various nationalities. They will be diversity for projects and Diversity capable of harnessing the diversity and discussion requiring advantage in viewing issues and teamwork problems with a different, if not, international, perspective.

Apply financial models and Class problems and Quantitative formulae to evaluate alternative homework assignments Reasoning investment decisions. will require the use of extensive quantitative reasoning.

Exercise powers of inquiry, logical Lectures and seminars Critical Thinking thinking, and critical analysis of will highlight many real arguments and evidence. Interpret world business issues and evaluate theoretical arguments and examples that and empirical evidence would demand analytical thinking and problem solving skills.

Evaluate and discuss the challenges Lectures and seminars Ethics and Social of issues relating to social will emphasize the Responsibility responsibility, corporate governance importance of ethics and and ethical and professional social responsibility. behavior arising from the recent financial scandals.

Provide a comprehensive Lectures and seminars Management understanding of the principles and will involve real world Knowledge and Skills techniques of finance. Students are data and scenarios, exposed to a number of economic focusing on how and accounting concepts that financial managers make practitioners in the field use and investment and financial apply. decisions in a complex interplay of business dynamics.

5. HOW THE CLASS SESSIONS WILL BE CONDUCTED

This course is combines traditional lecturing and problem solving with discussion of in- depth academic cases and short, real life cases from the current business press. Students are expected and encouraged to participate in the discussions and this participation will be reflected in their grade (see section 7 of syllabus). I expect you to keep up with practice problems (from both the text and those written by me) on a regular/daily basis. To this end, there will be a short (approx. 15 minute) quiz at the beginning of nearly every class meeting

6. POLICY ON THE AVAILABILITY OF LECTURE NOTES

Lecture notes will be handed in advance of the class.

7. CLASS PARTICIPATION

Due to the pragmatic approach of the course it is particularly important that students prepare for the class and participate in the discussions. Good financial analysis incorporates making sensible judgments which is not possible to learn from any textbook. Readings and cases should be read at least two times with an eye to the key points.

Class participation means contributing to the learning of your fellow students and maintaining a respectful learning environment. Asking and answering questions in class, and participating in class discussions and volunteering to solve problems in class are excellent methods of class participation. Almost all participation noted by the instructor will increase the student’s grade, but negative class participation includes disrupting class (e.g. by coming in late), not paying attention during a student presentation, other forms of rudeness toward your fellow students, and a lack of cooperation with methods to ensure that no cheating occurs during minute papers and exams. Grading class participation is necessarily subjective and no subdivision of the grade will be available to students.

Students should come to class ready to challenge others’ views (including the professor’s) but do so in the manner of a mature professional seeking solutions and evaluating alternatives. To emphasize the importance of class participation frequency and quality of students’ contribution will make up 10% of the grade. Sessions should not be missed unless an emergency situation takes place, in which case students should notify the instructor via email before class.

8. MINUTE PAPERS

There are six (6) minute papers in this course and these will be given out on a random basis. These minute papers are all close-book papers and questions are designed to be completed in a few minutes and may comprise of either a few short answer questions, a short essay or a problem. They will be reviewed afterwards in class. They may be given at the start of class, after the break, or at the end of class. The grades for the BEST 3 minute papers will be added to the final grade. Points achieved on minute papers will make up 30 grade points. There is no makeup or resists for minute papers.

9. GRADING

3 minute papers @ 10 points each 30 points

Class participation 10 points

Class attendance 10 points

Mid-term Exam 20 points

Final Exam 30 points Maximum total 100 points

There is ONE closed book final comprehensive exam for this course.

Homework will be divided between respective student groups where you will be expected to discuss and address the questions prior to each class session. Students present their discussions/findings/calculations during the seminar sessions. Each group member should stand ready to present where they will be randomly called upon to do so.

10. COURSE OUTLINE Introduction to Modern Portfolio Theory

Introduction. Empirical Evidence in Security Returns. Session 1 – Lecture  Financial Markets and Market Structure  Financial Securities  Financial Markets and the Corporation  How Securities are Traded

Fundamental Concepts in Financial Analysis Session 2 – Lecture  Cash flows  Working capital and capital expenditures  Return on capital employed and return on equity  Cost of the Different Sources of Capital

Investor Choice: Risk and Reward Session 3 – Lecture  Measuring Risk and Reward  Risk free rates and risk premiums  Portfolios, Diversification, and Investor Preferences Minute Paper #1

The Capital Asset Pricing Model  Estimating the CAPM Inputs Session 4 – Lecture  An Investor’s Risk vs. Reward Tradeoffs

 The Mean-Variance Efficient Frontier and the CAPM Formula

Valuation of Securities Bond Valuation Session 5 – Lecture  Bond Prices and Interest Rates  Yield to Maturity vs. Current Yields  Bond Variations and Risk Minute Paper #2

Equity Analysis  Differentiation Between Growth Company and Growth Session 6 – Lecture Stock  The Stock Markets  Value Stocks vs. Growth Stocks

Managing Bond Portfolios  Bond Duration and Maturity Session 7 – Lecture  Bond Index Funds

Minute Paper #3

Derivative Markets and Instruments Financial Derivatives: Introduction  Types of Derivatives Session 8 – Lecture  Derivative Markets: Past and Present  How Big is the Derivative Markets  Criticism of Derivative Markets

Forward Markets and Contracts I Session 9 – Lecture  Delivery and Settlement of a Forward Contract

 Default Risk and Forward Contracts

Forward Markets and Contracts II  The Structure of Global Forward Markets Session 10 – Lecture  Types of Forward Contracts Minute Paper #4

Futures Markets and Contracts I Session 11 – Lecture  A Brief History of Futures Markets  Futures Trading  Futures Exchanges Futures Markets and Contracts II  Delivery and Cash Settlement Session 12 – Lecture  The Clearinghouse and Regulation

 Types of Futures Contracts Minute Paper #5

Option Markets Session 13 – Lecture  Basic Characteristics of Options  The Concept of Moneyness of an Option  The Structure of Global Option Markets

Options Valuation  Financial Options vs Options on Futures Session 14 – Lecture  Payoff Values

 Put-Call Parity, Lower Bounds and Early Exercise Minute Paper #6

Session 15 – Lecture Risk Management Application of Derivative Trading Review before the exam

Final Exam