MGMT S-2000 Harvard University Summer School

Principles of Finance Summer, 2016

Lectures will be available for viewing every Monday, Wednesday and Friday, in accordance with the
schedule in the “Course Calendar” below

Professor: Bruce Watson

mgmts2000@dce.harvard.edu

Teaching Assistants: Sarah Ledoux (Head TA)

sarah.mgmte2000@gmail.com
Deals with any issues pertaining to Canvas, course logistics, or course policy

Chris Valois
valois.mgmte2000@gmail.com
Sections (On-line and Recorded)
Times To be Announced
 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 2015.
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.

Please see the distance education website for information on the distance education program, technical
support, FAQs, and details on how to view lectures:
http://www.summer.harvard.edu/courses/DistanceEd/

Academic Honesty

Harvard takes matters of academic honesty very seriously. While you may discuss assignments
with your classmates and others, make sure that any written material you submit is your own work.
Use of old course materials, including exams from online sources is prohibited unless made available
to all students by the instructor. You should consult the website
http://www.summer.harvard.edu/policies/student-responsibilities
to familiarize yourself with the possible serious consequences of academic dishonesty.

Examples of unacceptable conduct include plagiarism, cheating on examinations, unauthorized

collaboration, etc.
Disabilities

Students who wish to request accommodation for a disability may do so by registering with the
Accessibility Services office (Accessibility@dcemail.harvard.edu or (617) 998-9640. Students may
only be accommodated upon issuance by Accessibility Services of a signed Accommodation Plan.
Please contact the accessibility office well in advance of any exam to ensure appropriate
accommodations are arranged in a timely fashion.

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 web site.

The midterm will be available on Canvas starting at 6:30 PM (US Eastern Time) on Monday, July 11.
Students will have a 24-hour window, from 6:30 PM (US Eastern Time) on Monday, July 11 to 6:30
PM (US Eastern Time) on Tuesday, July 12, 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, then saved, then
completed later.

The midterm will cover all the material presented in lecture from the first lecture on June 20 to the
lecture posted on July 6.

The final will be available on Canvas starting at 6:30 PM (US Eastern Time) on Thursday, Aug. 4.
Students will have a 24-hour window, from 6:30 PM (US Eastern Time) on Thursday, Aug. 4 to 6:30
PM (US Eastern Time) on Friday, Aug. 5, 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, then saved, then
completed later.

The final will be cumulative, and cover all the material presented in lectures, from the first lecture on
June 20 to the last lecture posted on July 25. However, it will be heavily weighted toward material
presented since the midterm. There will only be a few questions on the material presented before 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 Extension 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.
 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 listed in the course calendar
below, and also 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 problem set scores will be dropped from each student’s semester grade calculation. If
you cannot get a set done some week, that can just 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 whose submit their problem sets on time, often in spite of difficult situations.
However we drop the lowest 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.
Grading

Your semester grade will be the higher of:

30% problem set scores 30% problem sets

30% midterm exam or 70% final exam
40% final exam

So, if you do 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 problem sets 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.

Grading Mechanics: Assigning Letter Grades Based on a Curve

Semester grades are 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. I believe that a
curve is ultimately the fairest way to determine grades, since it does not set some arbitrary absolute
standard, but judges students on their performance relative to their peers.

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.

How We Calculate Total Semester Points

To determine your letter grade for the semester the curve is applied to your total semester points.

Your problem set average (dropping the lowest) will be out of 100 pts. possible; your midterm will be
out of 100 pts. possible; and your final will be out of 133.33 points possible. Alternatively, we will
calculate your total semester points based on 100 pts. possible on the problem set average, and 233.33
pts. possible on the final. These two methods yield the two alternative weightings mentioned in the
first paragraph of this section. For each student, we will use whichever weighting results in a higher
semester point total for that student.

For example, suppose you average 83/100 on your highest problem sets (dropping your lowest) and
93/100 on your midterm. Now, let’s say there are 240 pts. possible on the final, and your score is
200/240 pts. Note that 200/240 = .833 (Meaning, you got 83.3% of the possible points on the exam).
We would then multiply .833 by 133.33, and by 233.33, to calculate your total points using the two
possible weightings on the final.

This would give you .833 × 133.33 = 111.11 pts. weighting the final at 30%, and .833 × 233.33 =
194.44 pts weighting the final at 70%.
So, for the semester, your total points would be 83 + 93 + 111.11 = 287.11 pts using the 30/30/40
weighting. Using the 30/70 weighting, your total points would be 83 + 194.44 = 277.44. So, we
would use the 30/30/40 method, since it gives you higher total points.

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

To return to our example above: recall that your hypothetical semester point total is 287.11/333.33,
and suppose that 43% of students had semester point totals higher than yours (i.e. above 287.11), and
therefore 57% had semester point totals less than or equal to yours (i.e. at or below 287.11). This
means that you are in the 57th percentile overall. Your semester grade, then, would be a B+.

Readings

Most of the reading assignments are drawn from the textbook: Financial Markets and Institutions, 8th
edition, by Frederic Mishkin and Stanley Eakins. The majority of the assigned reading in the text
reinforces material you'll learn in class, but some of the topics we cover may not appear in the books.
Conversely, some of the assigned reading 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 7th 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, 8th, 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 “Say Hello” 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.
 COURSE CALENDAR

Lecture 1 Introduction and Overview

Mon., June 20 Functions of Financial Markets: What Do Financial Markets Do, and How Do They
Do It?
Where Do Companies Get Funds?
Direct vs. Indirect Finance
Financial Intermediation
Primary vs. Secondary Markets

Mishkin and Eakins: Chaps. 1 & 2

“Finance: trick or treat,” The Economist, Oct. 21, 1999

Lecture 2 Introduction to Money and Banking

Wed., June 22 How we got here: Some banking history
The role of the government in banking
Regulation Q, Branching, Glass-Steagal
Money and Liquidity
Basics of Accounting
Bank Accounting
The mortgage industry
Securitization—what is it—what is a CDO, a MBS?

Mishkin and Eakins: Chaps. 17 – 19

Chap. 14

“The business of banking,” The Economist, Oct. 28, 1999

“The trouble with banks,” The Economist, May 1, 2003
“Barbarians at the vault,” The Economist, May 15, 2008

Lecture 3 Bank Accounting (Review)

Fri., June 24 Bank Capital and Measures of Profitability
The Money Multiplier
Change in Total Deposits
Change in the Money Supply
Lecture 4 Money Multiplier (Review)
Mon., June 27 The Federal Reserve: Structure and Functions
Monetary Policy
Open Market Operations
Other Tools of the Fed
Examples and Sample Problems

Mishkin and Eakins: pp. 183 – 199

pp. 217 – 221

Lecture 5 Open Market Operations (Review)

Wed., June 29 How the Fed Controls Interest Rates
Interest Rates
Real vs. Nominal Rates
Basis Points
Economic Consequences of Fed Actions
The Fed’s Response to the Financial Crisis and Recession of 2007 – 2009
New Fed Tools: Quantitative Easing

Mishkin and Eakins: pp. 46 – 50 (Section titled “The Distinction Between Real and
Nominal Interest Rates”)
pp. 228 – 241
pp. 221 – 227

Problem Set 1 Available on the Course Web Site

Lecture 6 Time Value of Money

Fri., July 1 Present Discounted Value (PDV)
Net Present Value (NPV)
Using NPV in business and investment valuation
Internal Rate of Return (IRR)

Mishkin and Eakins: pp. 37 – 38 (Section titled “Present Value”)

 Lecture 7 Time Value of Money (Review)
Wed., July 6 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
Return on a Bond vs. Yield on a Bond

Mishkin and Eakins: Chap. 12

pp. 42 – 46 (on “Coupon Bond” and “Perpetuity”)
pp. 50 – 55 (up to, but not including, “Calculating Duration…”)

Problem Set 1 Due

Problem Set 2 Available on the Course Web Site

Sun., July 10 Problem Set 2 Due

Mon., July 11 -- Midterm Exam available on Canvas

Tues., July 12 (covering material from June 20 – July 6, inclusive)

Lecture 8 Introduction to the Stock Market

Wed. July 13 Stocks vs. Bonds
Types of Markets
Stock Exchanges
The Rise of Electronic Trading
ECNs
The Globalization of Equities Trading
New Trading Strategies and Phenomena
High-Frequency Trading
Dark Pools

Mishkin and Eakins: Chap. 13

“Stocks in trade,” The Economist, Nov. 11, 1999
“Off-exchange share trading,” The Economist, Aug. 18, 2011
Debate on High Frequency Trading at
http://www.economist.com/debate/days/view/816
Aaron Timms, “Ringside at the Michael Lewis High-Frequency-Trading Big Top,”
Institutional Investor, April, 2014
Lecture 9 The Primary Market: How Companies Issue Stocks
Fri., July 15 Stock Market Jargon: Shares Outstanding, Float, Market Cap
The Initial Public Offering (IPO)
The Secondary Market
Trading Mechanisms and Exchanges
Some Market Jargon Explained

“Stocks in trade,” The Economist, Nov. 11, 1999

Lecture 10 Arbitrage
Mon., July 18 The Efficient Markets Hypothesis (EMH)
Stock Price as Expected Value
P/E ratios
Behavioral Finance and Deviations from Rationality
Constructing your own portfolio
The Role of Diversification
Risk/Return Trade-off
The Capital Asset Pricing Model (CAPM)
Approaches to Trading
Fundamental Analysis
Technical Analysis

Mishkin and Eakins: Chap. 6

“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
“Market Savior?” CNBC, July 12, 2012
Mishkin and Eakins: pp. 129 – 130
“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 3 Available on the Course Web Site

Lecture 11 Introduction to Derivatives
Wed., July 20 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. 598 – 603

“Option Basics” on-line tutorials at http://www.cboe.com/LearnCenter/Tutorials.aspx

(There are four on-line tutorials under “Option Basics”)

“Future Perfect,” The Economist, Nov. 25, 1999

Lecture 12 Calls and Puts (Review)

Fri., July 22 Hedging Your Stock Portfolio with Options
Hockey Stick Diagrams (Review)
Option Strategies
Spreads
Straddles
Strangles

Mishkin and Eakins: pp. 606 – 611

“Option Basics” on-line tutorials at http://www.cboe.com/LearnCenter/Tutorials.aspx

(There are 5 on-line tutorials under “Option Basics”)

“Future Perfect,” The Economist, Nov. 25, 1999

Problem Set 3 Due

Problem Set 4 Available on the Course Web Site
Lecture 13 Futures Contracts
Mon., July 25 Futures vs. Options
Futures Trading Mechanics
The Mechanics of Stock Index Futures

Video: “Trillion Dollar Bet”

Mishkin and Eakins: pp. 593 – 605

Chicago Mercantile Exchange, “Introduction to Futures and Options,” Chaps. 1 – 5

Fri., July 29 Review Session for the Final

Problem Set 4 Due

Thurs., Aug. 4 Final Exam available on Canvas (covering all material from the course)
to Fri., Aug. 5