MGMT S-2000 Principles of Finance Harvard University Extension School Summer, 2021 Lectures will be available for viewing in accordance with the schedule in the “Course Calendar” below Professor: Bruce Watson bwatson@fas.harvard.edu Teaching Assistants: Sarah Ledoux (Head TA) sarah.mgmte2000@gmail.com Deals with any issues pertaining to Canvas, course logistics, or course policy Rob Munger rob.mgmte2000@gmail.com Sections (On-line and Recorded) Days and times TBA SYLLABUS This course provides an introductory survey of the field of finance It examines the agents, instruments, and institutions that make up the financial system of the modern economy, such as bonds, the stock market, derivatives, and the money market Along the way, standard concepts and tools of financial analysis are introduced: present discounted value, option value, and the efficient markets hypothesis Recent developments in the field in particular, the application of psychology to financial markets (called behavioral finance) also are discussed The course is designed to equip students with the background and tools they need to make their own financial decisions with greater skill and confidence Specifically, we will see how insights from academic finance can inform and improve students’ own investing decisions The course assumes no prior knowledge of finance or investments Prerequisite: High school algebra Please note: This course is part of the Harvard Summer School's Distance Education Program Lectures for this term were recorded when this course was given on the Harvard campus during the Fall Term of 2019 These previously recorded lectures will be posted to the course Canvas site, along with the accompanying Power Point slides, on the afternoon of the dates listed in the course calendar below While the lectures for this course are pre-recorded, other aspects of the course are "live" and are comparable to those of other Summer School courses (where a lecture is presented twice per week in a lecture hall at Harvard.) This means that you are responsible for homework and any exams just as you would be in any other course where you attend weekly lectures in person Sections will be held each week as detailed above Academic Honesty Harvard Summer School takes matters of academic honesty very seriously While you may discuss assignments with your classmates and others, make sure that any material you submit is your own work Use of old course materials, including problem sets or exams from online sources, is strictly prohibited unless made available to all students by the instructor Examples of unacceptable conduct include plagiarism, copying and pasting answers from the internet, downloading answers to problem sets or exams from other students or the internet, collaborating on examinations, etc Collaboration on problem sets is allowed, even encouraged, but there will be absolutely no allowance for any collaboration on exams Any suspected collaboration during an exam, or consultation via text, email, or the web, will result in a full report to the Administrative Board of the Summer School, with subsequent investigation and disciplinary action You are responsible for understanding Harvard Summer School policies on academic integrity (http://www.summer.harvard.edu/policies/student-responsibilities) Not knowing the rules, misunderstanding the rules, running out of time, or being overwhelmed with multiple demands are not acceptable excuses To support your learning about academic integrity rules, please visit the Resources to Support Academic Integrity: (http://www.summer.harvard.edu/resources-policies/resources-support-academicintegrity) where you will find links to the Harvard Guide to Using Sources and two free online 15-minute tutorials to test your knowledge of academic citation policy The tutorials are anonymous openlearning tools Accessibility The Summer School is committed to providing an accessible academic community The Accessibility Office offers a variety of accommodations and services to students with documented disabilities Please visit http://www.summer.harvard.edu/resources-policies/accessibility-services for more information All accommodations need to go through the Accessibility Services Office Separate arrangements for students who approach individual instructors with a disability issue cannot be made Course Evaluation Your constructive assessment of this course plays an indispensable role in shaping education at Harvard Upon completing the course, please take time to fill out the online course evaluation Course Requirements Exams There will be two exams for the course, a midterm and a final Both will be taken on-line on the course Canvas site The midterm will be available on Canvas starting at 6:30 PM (US Eastern Time) on Thursday, July 15 Students will have a 24-hour window, from 6:30 PM (US Eastern Time) on Thursday, July 15 to 6:30 PM (US Eastern Time) on Friday, July 16, in which to complete the exam The exam is one hour long, and, once begun, must be taken in one sitting It cannot be partially finished, saved, and then completed later The midterm will cover all the material presented in lecture from the first lecture, posted on June 21, to the lecture on bonds, posted on July The final will be available on Canvas starting at 6:30 PM (US Eastern Time) on Thursday, Aug Students will have a 24-hour window, from 6:30 PM (US Eastern Time) on Thursday, Aug to 6:30 PM (US Eastern Time) on Friday, Aug 6, in which to complete the exam The exam is two hours long, and, once begun, must be taken in one sitting It cannot be partially finished, saved, and then completed later The final will be cumulative, and cover all the material presented in lectures, from the first lecture posted on June 21 to the last lecture on futures, posted on July 30 However, it will be weighted toward material presented since the midterm Detailed instructions on both exams will be sent to students well in advance of the exam dates Please Note:  It is your responsibility to plan your summer schedule, and especially any travel, around exam dates In particular, the date of the final exam is determined by the Registrar and cannot be changed for any reason Requests to take the final on a different day, including requests for a make-up final, involve a formal appeal process through the Summer School Examination Committee  No makeup midterms will be given  Please see the section below on “Grading” to understand how your semester grade will be determined if you must miss the midterm for any reason Proctorio In order to assure the integrity of the exams, they will be proctored through software called Proctorio The Summer School offers remote proctoring integrated into the course Canvas site, and allows you to take exams wherever you are most comfortable There is no need to take the exams in the lecture hall, and, for distance students, there is no need to hire or pre-schedule an in-person proctor Proctorio requires you to use a computer outfitted with an external or built-in webcam and microphone, Google Chrome browser, and a stable internet connection (LTE hotspots won’t work) More information about setting up your computer and an opportunity to test Proctorio will be provided long before the scheduled exams Problem Sets Problem sets will be completed on Canvas, the same on-line platform on which the midterm and final exams will be taken Full instructions concerning the Canvas platform will be provided well before the first problem set is assigned All students will be assigned to a grader who will grade their problem sets throughout the semester There will be four problem sets assigned during the term All four problem sets will be available on Canvas on the dates indicated in the course calendar below Due dates are also listed in the course calendar below, and as well as in Canvas Problem sets must be completed on Canvas before 11:59 PM, Eastern U.S time, on the date the problem set is due Note: If you live in a different time zone, Canvas will automatically update the due date and time on all assignments to reflect the date and time in your zone We cannot accept late problem sets for any reason However, to compensate for this policy, the lowest of their four problem set scores will be dropped from each student’s semester grade calculation If you cannot get a set done some week, that can be the set that gets dropped Our grading policy is designed with the interests of all students in mind As a teaching staff, we have to be fair to those who submit their problem sets on time, often in spite of difficult situations We drop the lowest problem set score to offer flexibility to those who encounter situations beyond their control, or who just had a bad week With so many students in so many different circumstances, we have found the best way to be fair to everyone is to lay these ground rules out well in advance and follow them without exception Re-grade Requests Students can contact the graders with any questions or concerns about how their problem sets or midterm have been graded However, you must submit requests for problem set or midterm re-grades no later than seven days after your work has been returned In order to allow for a timely and orderly response to your request, we must adhere to this policy without exception We cannot respond to re-grade requests made after these deadlines Graduate Project (Note: This requirement applies only to students registered for graduate credit) Students registered for graduate credit must submit three – page papers, written on Canvas, applying what they have learned in class to a relevant news item that they find in the media— newspapers, magazines, or on-line Due dates for the papers are as follows: July 6, July 26, and Aug Grading Your semester grade will be based on the higher of the two following weightings: 30% problem set scores 30% midterm exam 40% final exam or 30% problem sets 70% final exam So, if you poorly on the midterm, or are unable to take it for any reason, your final exam will automatically be reweighted to be 70% of your semester grade, with the average of your three highest problem set scores constituting the remaining 30% We will make these calculations automatically for each student—you don’t have to “opt in” or “opt out” of one or the other weighting We will make certain you receive the highest grade to which you are entitled Once we compute your semester weighted average, your letter grade will be determined in two ways If there’s any difference in the result, we’ll give you the higher of the two letter grades which result  Curve In the first system, semester letter grades will determined by a curve The nature of a curve is that your grade is based on your performance relative to all other students in the class It does not involve an “absolute standard,” e.g., 90 – 100 = A, 80 – 90 = B, etc., which you may be used to from some other courses With a curve, your grade is based on your percentile rank in the class, i.e., the percentage of students in the class who scored below you If you are in the 60th percentile, for example, that means that 60% of students had scores equal to or below yours, while 40% of students had scores above yours The Curve Used in Assigning Your Letter Grade for the Semester To determine your semester grade, we will employ the (very generous) curve given below: Letter Grade Percentile Rank Range of Letter Grade A 83rd Percentile – 100th Percentile A- 63rd Percentile – 83rd Percentile B+ 44th Percentile – 63rd Percentile B 24th Percentile – 44th Percentile B- 10th Percentile – 24th Percentile C+ 7th Percentile – 10th Percentile C 5th Percentile – 7th Percentile C- 3rd Percentile – 5th Percentile D 2nd Percentile – 3rd Percentile E/F 0th Percentile – 2nd Percentile For example, say that your higher semester weighted average is 82.5%, and that this puts you in the 57th percentile overall Applying the curve, your semester grade would be a B+  Absolute Scale In the second calculation, grades will be determined by the standard curve you may be familiar with from high school In this approach, your letter grade is based on your total points as a percentage of the total possible points for the semester Here is the scale: A 93.0% C+ 77.0% A- 90.0% C 73.0% B+ 87.0% C- 70.0% B 83.0% D 65.0% B- 80.0% E/F 0.0% Extending the example above, if your higher weighted average for the semester were 82.5%, according to the absolute scale, your semester grade would be a B- Since the curve results in a letter grade of B+, but the absolute scale results in a grade of B-, the grade reported to the registrar would be B+, the higher of the two Note for graduate students: Your semester grade, as calculated above, will be lowered by half a letter grade for each of the three graduate papers that you not submit For example, if you fail to submit one of the papers, your grade in the example above would be lowered from a B+ to a B Readings Most of the readings listed in the Course Calendar below are from the textbook: Financial Markets and Institutions, 9th edition, by Frederic Mishkin and Stanley Eakins However—PLEASE NOTE: The book is not required!! You will find that I don’t follow it closely at all Many students have done perfectly well in the class without ever buying the book Others find it useful to reinforce material we have covered, or to extend their knowledge of various subjects Some of the topics we cover not appear in the book Conversely, some of the reading listed below is for background, and will not be covered explicitly in class You should consider the textbook to be most useful as a reference, or as an additional source of review for material we have presented in class You will not be responsible—on problem sets or exams— for material in the book that we have not covered in class If you have purchased the 8th edition, the international edition, or a used copy of an even earlier edition of Mishkin and Eakins, you should still find it useful However, the page numbers given below refer to the latest, 9th, edition Relevant newspaper and magazine articles will also be placed on the “Readings” page of the course web site when relevant Student Profiles Every summer, the course enrolls people from an amazing variety of backgrounds and walks of life And, the reasons for taking the class are almost as diverse as students’ backgrounds In order to share a little of their life stories with their classmates, students are encouraged to submit a few lines about themselves to the “Student Profiles” discussion board on the course website Please note that this is completely voluntary, and also that the only people who will be able to view what you submit will be your classmates and the teaching staff—nobody else Just submit a few lines about your job, background, interests, and/or why you have decided to study finance Even if you decide not to submit a profile, you will enjoy reading about some of your fellow students (NOTE: These lectures were originally recorded in the Fall, 2019 semester While the topics and overall course organization will be the same, please ignore any references to specific dates Go entirely by the lecture posting, problem set, and exam dates given in this course calendar.) COURSE CALENDAR Mon., June 21 The Big Picture! Finance in Our Lives Where companies get the funds they need to grow, finance new projects, buy new equipment or expand into new markets? Introduction and Overview Functions of Financial Markets: What Do Financial Markets Do, and How Do They Do It? Where Do Companies Get Funds? Mishkin and Eakins: Chap Problem Set Available on the Course Web Site Thurs., June 24 The Most Basic Financial Asset—Money What Exactly is Money?? What Is Money, vs What Money Is Why Does It Seem Like Banks Are Getting So Much Bigger—But There Are Fewer Of Them?? Direct vs Indirect Finance Financial Intermediation Primary vs Secondary Markets Introduction to Money and Banking Some Facts About Financial Intermediaries Some Facts About Banks Money and Liquidity Introduction to Bank Accounting Mishkin and Eakins: Chap Mon., June 28 Need a Loan? Have a Checking or Savings Account? How Do Banks Work? How Profitable is Your Bank? You’ve heard the term “leverage”……but exactly what does it mean? Where Does Money Come From?? (Probably Not Where You Think!!) Some Bank Accounting Examples Bank Capital and Measures of Profitability The (Potentially) Fatal Temptation: Leverage The Money Multiplier Process Change in Total Deposits Change in the Money Supply The Reverse Money Multiplier Process Mishkin and Eakins: Chap 17 Problem Set Must be Completed by 11:59 PM (Eastern US Time) Thurs., July The Institution Which Has Enormous Power Over Our Lives: The United States Federal Reserve System What Rate Will You Pay on a Mortgage? An Auto Loan? The Answer Has a LOT to with the Fed! Most Americans don’t have the slightest idea how it works—After this class, you will!! The Federal Reserve: Structure and Functions Monetary Policy Open Market Operations How OMOs Affect Interest Rates Basis Points Real vs Nominal Interest Rates Other Tools of the Fed The Reserve Requirement Discount Lending Economic Consequences of Fed Actions Quantitative Easing Mishkin and Eakins: pp 185 – 196 pp 218 – 229 pp 48 – 51 (Section titled “The Distinction Between Real and Nominal Interest Rates”) Problem Set Available on the Course Web Site Tues., July After This Class…… —You’ll understand when a dollar is not worth a dollar —You’ll Really Understand How to Value a Business Time Value of Money Present Discounted Value (PDV) Net Present Value (NPV) Using NPV in business and investment valuation Internal Rate of Return (IRR) Mishkin and Eakins: pp 38 – 39 (Section titled “Present Value”) Thurs., July Bonds might seem kind of abstract and forbidding…… but you may well have already invested in equivalent instruments! They’re actually quite simple!! Should you think about buying a bond? How much should you pay for it? Time Value of Money (Review) The Bond Market Corporate Bonds Treasury Bonds Municipal Bonds Risks Relating to Bonds Basics of Bond Pricing Components of a Bond Special Kinds of Bonds Zero Coupon Bonds Consols Mishkin and Eakins: Chap 12 pp 43 – 47 (on “Coupon Bond” and “Perpetuity”) Problem Set Must be Completed by 11:59 PM (Eastern US Time) Problem Set Available on the Course Web Site Wed., July 14 Problem Set Must be Completed by 11:59 PM (Eastern US Time) [Note: PS is due on Wednesday instead of Thursday to give you a chance to review the answers before the exam The topics on PS will be covered on the exam.] Thurs., July 15 (6:30 PM) to Fri., July 16 (6:30 PM) Mon., July 19 Midterm Exam (covering material from June 21 to July 8, inclusive) So… finally we get to everybody’s favorite financial market—the stock market It can make you money and make you feel like a genius……or lose you money, and leave you feeling like a sucker It’s endlessly fascinating, treacherous, tempting and terrifying But, in the next three lectures, we cut through all the hype and jargon to see how the stock market really works Introduction to the Stock Market Stocks vs Bonds The Primary Market: How Companies Issue Stocks Stock Market Jargon: Shares Outstanding, Float, Market Cap The Initial Public Offering (IPO) Mishkin and Eakins: pp 534 – 540 pp 297 – 302 Wed., July 21 The way that stocks are traded has completely changed in the last 20 years! After this lecture, you’ll understand the changes and how they affect the market So much jargon!! This lecture explains the important terms After tonight, you’ll never again be intimidated by this stuff!! Do you have an IRA? A 401K? Then a lot of your savings is probably invested in mutual funds But how much you actually know about how they work? How you know if a fund is likely to get you the return you’re looking for? After tonight’s class, you’re going to be in a better position to answer these questions! The Secondary Market Trading Mechanisms and Exchanges The Rise of Electronic Trading ECNs Innovations in Trading High-Frequency Trading Dark Pools Some Market Jargon Explained Mutual Funds The Different Kinds of Funds Structure, Advantages and Disadvantages Net Asset Value (NAV) ETFs—Exchange Traded Funds Mishkin and Eakins: Chap 20 pp 303 – 304 (Section on ETFs) Fri., July 23 Hedge funds are often in the news—both for positive and negative reasons! What are they, and how they work? What stocks should you buy?? In this lecture, we review some of the classic ideas Your brother-in-law has a tip on a great stock—what should you do? (Hint: Run Like Hell!!) This lecture is devoted to helping you avoid the pitfalls that so many investors fall into Constructing your own portfolio The Role of Diversification Risk/Return Trade-off The Capital Asset Pricing Model (CAPM) The Two Main Approaches to Trading: Fundamental and Technical Analysis Arbitrage and the Efficient Markets Hypothesis (EMH) Stock Price as Expected Value Three Forms of EMH Evidence for and Against Market Efficiency Behavioral Finance and Deviations from Rationality Implications for Your Investing Mishkin and Eakins: Chap “Are Markets Efficient? Yes, Even If They Make Errors,” The Wall Street Journal, December 28, 2000 “Are Markets Efficient? No, Arbitrage is Inherently Risky,” The Wall Street Journal, December 28, 2000 “Efficiency and beyond,” The Economist, July 16, 2009 “The grand illusion,” The Economist, March 5, 2009 Jack Naudi, “Faulty Logic,” St Louis Post Dispatch, January 8, 2006 Problem Set Available on the Course Web Site Mon., July 26 Options… ever heard of them? If so, you probably thought that it’s not a market you would ever get involved in—just waaaay too risky and hard to understand But……after the next two lectures, not only will you understand them, you’ll see how you can actually use options to reduce risk! Introduction to Derivatives Options Calls Pricing a Call Intrinsic vs Time Value of a Call Hockey Stick Diagrams for a Call Puts Pricing a Put Intrinsic vs Time Value of a Put Hockey Stick Diagrams for a Put Pricing Calls and Puts The Role of Leverage Mishkin and Eakins: pp 594 – 599 “Future Perfect,” The Economist, Nov 25, 1999 Wed., July 28 Ever heard of a way to make money whether the market goes up or down? You will in tonight’s lecture! Calls and Puts (Review) Hedging Your Stock Portfolio with Options Hockey Stick Diagrams (Review) Option Strategies Spreads Straddles Strangles Fri., July 30 The futures market is another popular derivatives market Risky? Oh Yeah! But, they can also be insanely profitable After this lecture, don’t order the Mercedes, but at least you will have a better idea of what futures contracts are, and whether you should ever consider getting involved Futures Contracts Futures vs Options Futures Trading Mechanics The Mechanics of Stock Index Futures Video: “Trillion Dollar Bet” Mishkin and Eakins: pp 582 – 593 Chicago Mercantile Exchange, “Introduction to Futures and Options,” Chaps – (for background information only—as your time and interest permit) Problem Set Must be Completed by 11:59 PM (Eastern US Time) Problem Set Available on the Course Web Site Mon., Aug Review Session Wed., Aug Problem Set Must be Completed by 11:59 PM (Eastern US Time) Thurs., Aug (6:30 PM) to Fri., Aug (6:30 PM) Final Exam (Cumulative—covers all material from June 21 to July 30, inclusive, but weighted toward material covered since midterm) .. .SYLLABUS This course provides an introductory survey of the field of finance It examines the agents, instruments, and institutions that make up the financial system of the modern... placed on the “Readings” page of the course web site when relevant Student Profiles Every summer, the course enrolls people from an amazing variety of backgrounds and walks of life And, the reasons... it? Time Value of Money (Review) The Bond Market Corporate Bonds Treasury Bonds Municipal Bonds Risks Relating to Bonds Basics of Bond Pricing Components of a Bond Special Kinds of Bonds Zero