Introductory description

This is an elective module for non-WBS students.
Introduce students to the workings of the equity and bond markets.
Equip students with the skills and understanding to use quantitative tools for pricing stocks and bonds.
Develop in students a critical understanding of the trade-off between risk and return, and of techniques for exploiting that trade-off to maximum effect.
Make students aware of key empirical tests of the Efficient Markets Hypothesis, and the implications of those empirical findings.
Provide students with structured opportunities to practise using the key tools and techniques of Financial Markets theory.
Introduce students to the workings of the derivatives markets.
Equip students with the skills and understanding to use quantitative tools for pricing derivatives.
Prepare students for advanced undergraduate and postgraduate studies in Finance.

Module aims

Outline syllabus

This is an indicative module outline only to give an indication of the sort of topics that may be covered. Actual sessions held may differ.

Financial Arithmetic:
Discounted cash flow, annuities, perpetuities, Gordon growth model, net present value, internal rate of return.
Investment under Certainty:
Inter-temporal consumption, Fisher Separation.
Investor Preferences :
Risk aversion, Expected utility
Optimal Portfolio Selection:
Diversification, Risk vs. Return, Capital Market Line.
Capital Asset Pricing Model:
Beta, CAPM, Securities Market Line
Bonds & Interest Rates:
Spot rates, forward rates, bond pricing, term structure of interest rates, Pure Expectations and Liquidity Preference hypotheses.
Market Efficiency :
Efficient Markets Hypothesis, calendar anomalies, speculative bubbles, empirical tests.
Financial Derivatives:
Arbitrage-free futures pricing, binomial and Black-Scholes option pricing.

Learning outcomes

By the end of the module, students should be able to:

• Describe how the equity and bond markets function, and their importance to both individual investors and institutions.
• Explain how these markets price stocks and bonds.
• Explain how risk can be diversified by forming portfolios of assets, and how to construct the optimum portfolio.
• Critically assess theoretical relationships between risk and return.
• Distinguish between spot and forward rates of interest.
• Formulate different hypotheses for the term structure of interest rates.
• List the different forms of market efficiency, and interpret the results of key tests of the Efficient Markets Hypothesis.
• Describe how derivatives markets function.
• Explain how these markets determine the prices of derivative securities.
• Explain key theoretical models, and reflect critically on the limitations of those models and the assumptions that underpin them.
• Interpret empirical evidence.
• Solve structured numerical problems and analyse case-study information.
• Communicate complex ideas effectively, both verbally and in writing.

Indicative reading list

REQUIRED TEXT:
Hillier D, Ross SA, Westerfield RW, Jaffe J and Jordan BD, Corporate Finance (3rd ed. 2016), McGraw-Hill
OTHER TEXTS:
Bodie Z, Kane A & Marcus AJ, Investments (12th ed. 2020), McGraw-Hill
Copeland TE, Weston JF & Shastri K, Financial Theory and Corporate Policy (4th ed. 2013), Pearson Addison-Wesley

Subject specific skills

Use discounted cash-flow techniques to value financial securities and/or estimate the value added by capital projects.
Write informed critiques of key issues in asset valuation.
Analyse short case-studies and construct arguments to support a particular solution.
Calculate spot and forward rates of interest from observed market prices of calibration bonds, and use these rates to price other bonds and identify arbitrage opportunities.
Calculate the forward price of a traded asset using the no-arbitrage principle.
Price option contracts using the one-period binomial model or the Black-Scholes model.

Transferable skills

Construct spreadsheets to value financial instruments and test how robust those values are to changes in key inputs.
Use web-based resources to source and retrieve financial-market data, and spreadsheets to process that data.
Explain and interpret financial-market data.
Use analytical models and/or spreadsheets to value simple derivative securities and to assess how robust those values are to changes in key inputs.