MGMT E-2000

Principles of Finance

Harvard University Extension School

Fall, 2014

Professor: Bruce Watson

mgmte2000@dce.harvard.edu
Tuesdays, 7:40 9:40 PM

Science Center A

Course Web Site: http://isites.harvard.edu/course/ext-13407/2014/fall

Teaching Assistants:

Christopher Valois, CFA

valois.mgmte2000@gmail.com
Sections: (In person and Recorded Video on Course Website):
Mondays 6:30-7:30 pm
Science Center 104
Office Hours:
Tuesdays 5:30-8:00 pm
Sever Hall 107
Teo Nicolais
teo.the.finance.ta@gmail.com
Sections (On-line) at http://chat.dce.harvard.edu:
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.

Course Requirements
Exams
For non-distance students, and distance students living in the six-state New England area:
There will be a midterm exam in our usual classroom (Science Ctr. A) on
Tuesday, Oct. 21, covering the material presented in lectures from Sept. 2 to Oct. 7.
The final exam will be during the regular class period (7:40 9:40 PM) on Tuesday,
Dec. 16, covering all the material presented in the course.
Be sure to arrange your fall schedule to allow for these dates.
For distance students who live outside the six-state New England area:
Students in this category can take exams near where they live or work.
Arrangements for all exams are made in accordance with the procedures
outlined at:
http://www.extension.harvard.edu/distance-education/how-distance-educationworks/academic-policy-exam-proctoring
Please note that most distance students find it quite easy to arrange to take their exams
where it is convenient for them. Hence, you should not let this bit of logistics deter
you in any way from taking this or any other distance class.

Please Note:

It is your responsibility to plan your travel ahead 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
There will be eight problem sets assigned during the term. All problem sets will be available on the
Problem Sets page of the course web site on the dates indicated in the course calendar below.
Due dates are listed in the course calendar below, and also at the top of the problem sets themselves.
Problem sets from distance students must be received by 11:45 PM on the day they are due.
In-class students can simply turn in a paper copy of their problem set at the start of lecture on the day it
is due. Distance students (and in-class students if they wish) can email their work to their grader at the
email address the grader provides.
Do not send your problem sets to the course email account, mgmte2000@dce.harvard.edu.
All students will be assigned a grader to whom they will submit all problem sets. Students will receive
an email as to who their grader is well before the first problem set is due.
We cannot accept late problem sets for any reason. However, to compensate for this policy, the
lowest two of their problem set scores will be dropped from each students semester grade calculation.
If you cannot get a set done some week, that can just be one of the sets that gets dropped.
Submission in Word format is greatly preferred, but students can also scan in their work, and send it to
their grader as a pdf.
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. However
we drop the lowest two scores 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.

Grading
Your semester grade will be the higher of:
30% problem set scores
30% midterm exam
40% final exam

or

30% problem sets

70% 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 studentyou dont 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.
Requests for problem set or midterm exam re-grades must be submitted to your grader no later than
one week 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 accept re-grade requests
made after these deadlines.
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 total semester points will be the higher of:
30% problem set scores
30% midterm exam
40% final exam

or

30% problem sets

70% 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 studentyou dont 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.
Your problem set average (dropping the two 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 two)
and 93/100 on your midterm. Now, lets 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

60th Percentile 100th Percentile

A-

45th Percentile 60th Percentile

B+

40th Percentile 45th Percentile

35th Percentile 40th Percentile

B-

28th Percentile 35th Percentile

C+

25th Percentile 28th Percentile

22nd Percentile 25th Percentile

C-

20th Percentile 22nd Percentile

5th Percentile 20th Percentile

E/F

0th Percentile 5th 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 A-.

Readings
Most of the reading assignments are drawn from the 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 a used copy of an 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 term, 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 course email address: mgmte2000@dce.harvard.edu. These will be formatted and
posted on a Student Profiles page on the course web site.
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 staffnobody else. You do not have to
identify yourself with anything besides your first name if you dont want to. 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
Tues., Sept. 2

Introduction and Overview

Functions of Financial Markets: What Do Financial Markets Do, and How Do They
Do It?
Where Do Companies Get Funds?
Direct vs. Indirect Finance
Primary vs. Secondary Markets
Mishkin and Eakins: Chaps. 1 & 2
Finance: trick or treat, The Economist, Oct. 21, 1999

Tues., Sept. 9

Introduction to Money and Banking

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
Fractional Reserve Banking
The mortgage industry
Securitizationwhat is itwhat 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

Tues., Sept. 16 The Money Multiplier

Change in Total Deposits
Change in the Money Supply
Examples and Sample Problems
Problem Set 1 Available on the Course Web Site

Tues., Sept. 23 The Federal Reserve System

How Does the Fed Work?
Open Market Operations
Other Tools of the Fed
Examples and Sample Problems
Mishkin and Eakins: pp. 183 199
pp. 217 221
Problem Set 1 Due
Tues., Sept. 30 Money Supply and Money Demand
Interest Rates
Real vs. Nominal Interest Rates
Fed Responses to the Financial Crisis and the Great Recession
Quantitative Easing
Economic Consequences of Fed Actions
Mishkin and Eakins: pp. 46 50 (Section titled The Distinction Between Real and
Nominal Interest Rates)
pp. 228 241
pp. 221 227
Problem Set 2 Available on the Course Web Site
Tues., Oct. 7

Present Discounted Value (PDV)

Net Present Value (NPV)
Using NPV in business and investment valuation
Internal Rate of Return (IRR)
Examples and Sample Problems
Mishkin and Eakins: pp. 37 38 (Section titled Present Value)
Problem Set 2 Due
Problem Set 3 Available on the Course Web Site

Tues., Oct. 14

The Bond Market

Who Issues Bonds?
Types of Bonds
Basics of Bond Pricing
Examples and Sample Problems
Capital gain on a bond
Term Structure of Interest Rates: The Yield Curve
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 3 Due

Tues., Oct. 21

Midterm Exam (covering material from Sept. 2 Oct. 7)

Problem Set 4 Available on the Course Web Site

Tues., Oct. 28

Introduction to the Stock Market

Present players in the marketinstitutionsmutual funds, hedge funds
Market mechanics
Short selling
Algo-trading; High Frequency Trading
Stock Price Indexes
Market capitalization
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
Problem Set 4 Due

Tues., Nov. 4

Arbitrage
The Efficient Markets Hypothesis (EMH)
P/E ratios
Constructing your own portfolio
Risk/Return Trade-off
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
Problem Set 5 Available on the Course Web Site

Tues., Nov. 11 Constructing your own portfolio (cont.)

Considerations When Picking Stocks
The Role of Diversification: The Capital Asset Pricing Model (CAPM)
The Art and Science of Picking Stocks
What are some common mistakesbehavioral finance
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

Tues., Nov. 18 Derivatives Markets: Options

Calls
Puts
Hockey Stick Diagrams
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
Problem Set 5 Due
Problem Set 6 Available on the Course Web Site
Tues., Nov. 25 Option Strategies
Spreads
Straddles
Problem Set 6 Due
Problem Set 7 Available on the Course Web Site
Tues., Dec. 2

Derivatives Markets: Futures Contracts

Futures Trading Mechanics
Course Summary
Video: Trillion Dollar Bet
Mishkin and Eakins:

pp. 593 601 (up to, but not including Hedging Foreign
Exchange Risk
Chicago Mercantile Exchange, Introduction to Futures and Options, Chaps. 1 5
(for background information onlyas your time and interest permit)
Problem Set 7 Due
Problem Set 8 Available on the Course Web Site
Tues., Dec. 9

Review Session for the Final Exam

Problem Set 8 Due

Tues., Dec. 16 Final Exam (cumulativecovers all material in the course)