This is a core class that offers the basic concepts and tools necessary to understand how financial markets work, and how financial instruments are used for sound investment decisions.  This knowledge is especially important in the present environment - in the aftermath of the Financial Crisis of 2007-2009 - and during the ongoing debt crisis in Europe.  Topics covered include the following: models of risk and return; time value of money and net present value; asset allocation and modern portfolio theory; equilibrium asset pricing model; securities and trading; forwards and futures, options; fixed income securities; equity valuation and market efficiency; the structure and performance of the money management industry: pension funds, mutual funds, hedge funds.

Effort will be made to relate the course material to current financial issues and problems relevant to practitioners.

Learning outcomes

When you complete this course, you should be able to understand:

  • The basic tradeoff between risk and (expected) return, and how it applies to various types of financial instruments.
  • The time value of money (TVM) and net present value (NPV), and their connection to the discount rate, cost of capital, or the required risk premium of a financial asset.
  • Diversification: how to select a portfolio of securities that maximizes return while minimizing risk. How does diversification work in practice?
  • The main model of asset pricing: the Capital Asset Pricing Model (CAPM). How do we compute the cost of capital/risk premium?
  • Market efficiency and arbitrage. Are markets efficient, or are they dominated by irrational investors? Are prices predictable?
  • Financial instruments: stocks, bonds, and derivatives (futures, options). How are they used for risk hedging or speculation? How are their prices related to interest rates, volatility, etc.?
  • The money management industry and its key players: pension funds, mutual funds, and hedge funds. Do money managers have any superior investment skills?