Finance 2 at ESC Toulouse, 2011-12

ATTENTION: Please note that the format of the December 2011 final exam will be different from that of prior years’ exams. This is due to a recent school-level decision taken to accommodate AACSB requirements. The changes are as follows: 1) there will be 25 questions instead of 20; 2) each question will have 4 possible answers instead of 6; 3) there will be a penalty for wrong answers equal to half the points for a correct answer; 4) to compensate for (1) and (3), the questions themselves will be easier on average (the duration of the exam will be 90 minutes, as before). Here is the cover page for the December exam so you can familiarize yourself with it if you’d like. Note that point (3) above implies that it is no longer in your interest to guess at random. Despite the above changes, the best preparation remains practicing with old exams (see links at the bottom of this webpage) – if you do well on old exams, you should expect to do well on the upcoming exam.

The December 2011 final exam questions are here.

The December 2011 final exam solutions are here.

ATTENTION: Please note that although the format of the files and the order of the questions may be different from what you had on the December exam, the actual questions are the same.

In the first part of the Finance module (“Finance 1”) you focused on how financial decisions can be studied under certainty (i.e. when the rate of return is regarded as constant).  In this part (“Finance 2”), we will introduce the concept of investment risk.  This will lead to studying the way risk can be measured and diversified, and then to an equilibrium relationship between risk and return.  The result will be understanding what determines the cost of capital for companies and for individual projects.

Note that the course will be in English.  An effort will be made to translate and clarify English terminology where necessary; in particular, where appropriate, translations of English terms into French will be included in italics (en italique).

You are not required to buy a book for this course.  However, if you feel that you need help, or if want to learn more, consider consulting one of the recommended textbooks:

• Corporate Finance by Jonathan Berk and Peter DeMarzo (BD).  This is a new and highly regarded textbook, already in use at many top business schools.  It is available in both English and French.  New copies of this book include access to MyFinanceLab (www.myfinancelab.com), which is an outstanding study resource.  Our course will cover chapters 10, 11, 12, and 14 of BD.
• Principles of Corporate Finance by Richard Brealey and Stewart Myers (BM).  BM is a classic corporate finance text now in its 10^th U.S. edition (co-authored with Franklin Allen).  Note that in many cases, the 7^th and 8^th French editions substitute U.S. examples with European ones.  However, French editions do not include a student CD-ROM.  If you decide to buy this book, you should get at least the 6^th edition (in English or French).  Several dozen copies of the 6^th U.S. edition are available in the library (http://mediatheque.esc-toulouse.fr).  Our course will cover chapters 7, 8, and 9 of BM (which are renumbered 8, 9, and 10 in the 9^th edition of the book). 
• Corporate Finance: An Introduction by Ivo Welch (IW). This is a very good recent textbook. The material we study in this course is covered in chapters 7, 8, 9, and 16. The disadvantage of using this book is that some of the material is structured differently than it is in the course. The advantage is that the book can be read online, at http://book.ivo-welch.com (although you may have to use Google Chrome as the browser rather than Internet Explorer or Mozilla Firefox). Alternatively, you can find good coverage of Parts 1 and 2 of the course in a portion of Prof.Welch’s book on investments which he has made available online as a PDF file: http://book.ivo-welch.com/bookg.pdf

The course schedule outline and some supplementary materials are below.  Lecture notes for the entire course are here.  Note that to download course materials you will need a login and a password, which you will be given in class.  If you forget the login and the password, ask your instructor.

PART 1 (BD Chapter 10 / BM Chapter 7 / IW Chapters 7-8)

Capital market history and average returns.  Measuring risk. Calculating portfolio risk and return. Diversifiable and non-diversifiable risk. Beta.

You can download a spreadsheet with beta calculations for Air Liquide and Bouygues, and the 2-stock portfolio example with Carrefour and Michelin.

You can also download an additional spreadsheet showing portfolio diversification in the case of a portfolio of two assets (risk_return.xls)

Additional resources:

Study guide for BM Chapter 7 (Chapter 8 in the 9^th edition): http://highered.mcgraw-hill.com/sites/0073286982/student_view0/chapter8/

William Goetzmann’s online course “Introduction to Investment Theory”:

http://viking.som.yale.edu/will/web_pages/will/finman540/classnotes/class1.html and

http://viking.som.yale.edu/will/web_pages/will/finman540/classnotes/class2.html

For a simple explanation of risk and portfolio diversification in French see http://www.bnains.org/risque/risque01.htm and http://www.bnains.org/risque/variance_portefeuille.htm

PART 2 (BD Chapters 11-12 / BM Chapter 8 / IW Chapter 9)

Portfolio optimization theory. Implementing portfolio optimization in practice.  The Capital Asset Pricing Model (CAPM): assumptions, derivation, interpretation, application.

You can download a spreadsheet with the four-stock portfolio optimization example.

You can also download an additional spreadsheet (prepared by Professor Nalpas) which allows you to calculate efficient portfolios for up to 10 stocks (effport.xls)

Note: to make sure the macros in this file work, you first need to open another file (crunch.xla) and to lower the level of security to the minimum (Outil -> macro -> sécurité).

Additional resources:

Study guide for BM Chapter 8 (Chapter 9 in the 9^th edition): http://highered.mcgraw-hill.com/sites/0073286982/student_view0/chapter9/

William Goetzmann’s online course “Introduction to Investment Theory”:

http://viking.som.yale.edu/will/web_pages/will/finman540/classnotes/class2.html and http://viking.som.yale.edu/will/web_pages/will/finman540/classnotes/class3.html

PART 3 (BD Chapter 14 / BM Chapter 9 / IW Chapter 16)

Estimating betas.  Cost of capital (WACC).  Practical issues in calculating cost of capital for companies and projects.  The Holiport (Cani-Veau) mini-case.

Additional resources:

Study guide for BM Chapter 9 (Chapter 10 in the 9^th edition): http://highered.mcgraw-hill.com/sites/0073286982/student_view0/chapter10/

William Goetzmann’s online course “Introduction to Investment Theory”:

http://viking.som.yale.edu/will/web_pages/will/finman540/classnotes/class4.html,

http://viking.som.yale.edu/will/web_pages/will/finman540/classnotes/class5.html,

http://viking.som.yale.edu/will/web_pages/will/finman540/classnotes/class6.html (to get an idea of Arbitrage Pricing Theory) and http://viking.som.yale.edu/will/web_pages/will/finman540/classnotes/class7.html

The CAPM is used at companies around the world.  But how well does it actually work?  Gene Fama and Kenneth French’s discussion of the evidence can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=440920.

John Graham and Campbell Harvey of Duke University asked large U.S. companies how they calculate the cost of capital (and some other questions, too).  The results were published in 2001 in the Journal of Financial Economics (volume 60, issues 2-3, pages 187-243).  An earlier version of this article can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=220251.     

The final exam will consist of approximately 20 multiple choice questions, and will be 90 minutes long.  You will be allowed to bring your lecture notes, BM or BD, an English-French dictionary, and a calculator.  The content will be similar to sample exams which you download (you will need the login and the password again):

            Sample exams are here.

Solutions to the sample exam questions are here.

If at the end of the course you are still interested in finance, and want to learn more about financial careers and how to apply for a job, take a look at http://publication.esc-toulouse.fr/projets/nalpas/job/ (site prepared by Professor Nalpas). Lastly, if you are interested in applying to US/UK investment banks, you should visit http://www.corporatefinancetoulouse.com/ib.htm to watch a presentation by a recent ESCT alumnus now working at JP Morgan (you will need the same login and password as before).