Financial Economics

Paper Code: 
DECO 611C
Credits: 
6
Contact Hours: 
90.00
Max. Marks: 
100.00
Objective: 

1.      To acquaint the students with the basics of financial economics.

2.      To explain the concept of cash flow and the Capital Asset Pricing Model.

3.      To describe options and derivatives and patterns of corporate finance

18.00
Unit I: 
Deterministic cash-flow streams

·         Basic theory of interest - discounting and present value; internal rate of return; evaluation criteria; fixed-income securities; bond prices and yields; interest rate sensitivity and duration; immunisation

·         The term structure of interest rates; yield curves; spot rates and forward rates

·         Applied interest rate analysis – Capital budgeting, Optimum Portfolios, Dynamic cash flow processes optimal management, harmony theorem, Valuation of a firm

18.00
Unit II: 
Single-period random cash flows

·         Random asset returns; portfolios of assets; portfolio mean and variance; feasible combinations of mean and variance; mean-variance portfolio analysis: the Markowitz model and the two-fund theorem; risk-free assets and the one-fund theorem.

·         Capital Asset Pricing Model (CAPM ) , The capital market line; the capital asset pricing model; the beta of an asset and of a portfolio; security market line; use of the CAPM model in investment analysis and as a pricing formula

18.00
Unit III: 
Options and Derivatives

·         Introduction to derivatives and options

·         Forward and futures contracts; options; other derivatives

·         Forward and future prices; stock index futures

·         Interest rate futures; the use of futures for hedging; duration-based hedging strategies

·         Option markets; call and put options; factors affecting option prices; put-call parity

·         Option trading strategies: spreads; straddles; strips and straps; strangles

·         The principle of arbitrage

·         Discrete processes and the binomial tree model; risk-neutral valuation

 

18.00
Unit IV: 
General Cash Flow Streams

·         Optimal Portfolio Growth – the investment wheel, the log utility approach to growth, properties of the log – optimal strategy, Alternative approaches, Continuous time path, the feasible region, log optimal pricing formula, log optimal pricing and the black – scholes equation  

·         General investment evaluation – multi period securities, risk neutral pricing, optimal pricing, the double lattice, pricing in double lattice, investment with private uncertainity, buying price analysis, continuous time evaluation    

18.00
Unit V: 
Corporate Finance

·         Patterns of corporate financing - common stock; debt; preferences; convertibles;

·         Capital structure and the cost of capital;

·         Corporate debt and dividend policy;

·         The Modigliani-Miller theorem.

Essential Readings: 
  1. David G. Luenberger, Investment Science, Oxford University Press, 2nd Edition, 2013.
  2. Thomas E. Copeland, J. Fred Weston and Kuldeep Shastri, Financial Theory and Corporate Policy, Prentice Hall, 4th Edition, 2003.
  3. Richard A. Brealey and Stewart C. Myers, Principles of Corporate Finance, McGraw Hill, 7th Edition, 2002.
References: 
  1. Chakravarty, Satya R., An Outline of Financial Economics, Anthem Press, 2014.
  2. Roy, Stephen F. Le, Werner, Jan and Ross, Stephen A., Principles of   Financial    Economics, Cambridge University Press, 1st Edition, 2001.
  3. Hull, John C., Options, Futures and Other Derivatives, Pearson Education, 6th Edition, 2005.
  4. Stephen  A.  Ross,  Randolph  W.  Westerfield  and  Bradford  D.  Jordan,
  5. Burton G. Malkiel, A Random Walk Down Wall Street, W.W. Norton & Company, 2003.
  6. William Sharpe, Gordon Alexander and Jeffery Bailey, Investments, Prentice Hall of India, 6th Edition, 2003
Academic Session: 
2023-24
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