FIN2 Overview—Module 1Feb 1

May 10

Debt & Value: debt issuance, bond valuation, perfect capital markets, taxes, debt and firm value, interest tax shields, APV

Financial Policy: cost of financial distress, agency problems, information asymmetry, optimal capital structure, weighted average cost of capital

Risk, Options & Hedging: option valuation, risk management

Mergers & Acquisitions: value of synergies, forms of consideration, friendly and hostile transactions

Review

FIN2 Policies

Participation (50%)• Be prepared, be on time.• Be relevant, be constructive, be thoughtful.

• Your ideas matter. True for everyone.

• Use absence notification tool.• Cold calls are always benign.

Exercises• Not graded. But count for participation.

Participation feedback• Week after Spring Break.

Final exam (50%)• In class, May 18.

Tutorials• Thursday afternoons• Rimma Yusim, ryusim@hbs.

Office hours• Weekly, almost always Tuesdays, 12:30 – 2:30 pm

• Drop in, no appointment necessary

• Other times by appointment

Anything else• David Frieze, dfrieze@hbs.edu• Adam Scarano, ascarano@hbs.

Home buyer/ owner

Mortgage broker

Synthesizer of

MBOs, e.g.

Morgan Stanley

Mortgage lender, e.g. a bank

$ $ $ $

$

$

Tranche A

Tranche B

Tranche C“toxic”

Fixed Income

investors:

Pension Funds

Sovereign Wealth Funds

Mutual Funds

Hedge funds

Clarence Nathan Mike GarnerGlenn Pizzaluso

Mike Francis

(Rosetree Capital Management)

Pooling and Tranching

Home buyer/ owner

Mortgage

broker

Synthesizer of MBOs,

e.g. Morgan Stanley

Mortgage

lender, e.g. a bank

$ $ $ $

$

$

Tranche A

Tranche B

Tranche C“toxic”

Home buyer/ owner

Mortgage

broker

Synthesizer of MBOs,

e.g. Morgan Stanley

Mortgage

lender, e.g. a bank

$ $ $ $

$

$

Tranche A

Tranche B

Tranche C“toxic”

Home buyer/ owner

Mortgage

broker

Synthesizer of MBOs,

e.g. Morgan Stanley

Mortgage

lender, e.g. a bank

$ $ $ $

$

$

Tranche A

Tranche B

Tranche C“toxic”

$

$$

Asset Pool

Tension between “perfect” and “imperfect” worlds

Finance theory assumes perfect markets with perfect human beings

Human imperfections:– Bounded knowledge (don’t know everything)

– Capacity for deceit (can’t trust everyone)

When perfect theory meets imperfect reality, the result can be profit or disaster

Apply your theory first, then ask, – “What imperfections are allowing me to make a profit?”

– “How big is the gap?”

Best profits are in world that is a little imperfect, but not spinning out of control– It’s called “civilization”

Capital Structure Fallacies

Debt is a “cheaper” source of finance, so debt is better– Must look at “all-in” cost, i.e. weighted average

Debt increases eps, thus firms should borrow– Debt also increases volatility of eps, i.e. “quality of

earnings” goes down

The Real World of Capital Structure