Financial Economics I
This is a course on financial economics that I teach second--year
Ph.D. students at IGIDR,
Bombay.
Books
The course is based on the material covered in Investment
science by David Luenberger. In addition, the following are highly
recommended general reading:
- The Economics of Financial Markets by Houthakker and
Williamson (for market microstructure).
- A random walk down Wall Street by Burton G. Malkiel.
- Capital Ideas by Peter Bernstein.
Course content
- Introduction to the questions in finance
- Defining a financial asset
- Different asset classes by cashflow and maturity characteristics
- Approaches to pricing financial assets
- Who uses finance? Individuals, firms, government
- Types of firms
-
An introduction to debt and equity[Slideshow]
- Placing debt and equity in firm finances
- Debt vs. Equity
- Measurement of debt vs. equity - an example of a firm's balance sheet
Fixed income analytics: an introduction[Slideshow]
- Fixed income instruments
- Pricing fixed income instruments
- Term structure of interest rates -- zero coupon yield curve, ZCYC
- Spot and forward interest rates
- Estimating a yield curve
- Interest rate risk affecting bond prices
- The link between bond returns and interest rate changes
- Duration and Convexity
- Risks in bonds: interest rate risk and credit risk
- Defining credit risk
- Probability of default, Recovery ammounts
- Risk neutrality valuation
- Risk adjusted discount rate -- credit premium
The flowchart in credit risk analytics[Slideshow]
- What is the credit risk problem?
- Credit risk syntax.
- Analytics in creditrisk: estimating probability of default
- Data to estimate prob of default in India
Modelling the probability of default using statistical models[Slideshow]
- Modelling framework: binary choice models -- probit, logit
- The Z-score
- Calculating and using the Odd's Ratio
- Diagnostics
Modelling the probability of default for Indian firms[Slideshow]
- Building the CMIE credit model for Indian firms
- Diagnostics -- the power curve
- Selection of independent variables from accounting ratios
Risky cashflows: equity[Slideshow]
- Expected future cashflows in equity == Dividends
- Sensitivity of price to errors in E(dividends) or equity risk premium
- Accounting data models for equity valuation: free cashflow/dividend discount models
Financial markets and their outcomes[Slideshow]
- Functions of financial markets:
- Price discovery
- Liquidity provision
- Risk management
- Measuring outcomes of financial markets: prices, liquidity, risk
- Market microstructure: Different types of markets
Mechanics
- Susan Thomas can be reached at susant@igidr.ac.in. Office
extension is 557.
- Lectures are held on Wednesdays and Fridays.
- Students are expected to read the following newspapers the Mint,
Financial Express, Economic Times, Business Standard. One student
will be asked to make a 5-minute presentation on both Tuesday and
Thursday on an important issue in Indian finance for the week.
- There will be a final examination (60% of the grade). It will
cover the entire course content covered at the time of the
exam.
- Students will have to take the NCFM Derivatives certification
examination, and the score obtained in this exam will carry a 10%
weightage. Only NCFM scores in the range of 75 to 100 will be
accepted. The scoring will be as follows: 75% will start as 5 and
the maximum score obtained in the class will be taken as 20.
- Two students will work together to write a paper on a topic out
of a list of given topics. This will cover 30% of the grade, and
is due by the end of March. The project paper is expected to be
formatted using LaTeX and submitted as a PDF file. Evaluation
will be based on the final draft of the paper as well as a
presentation before the examination week.
Useful links
Back up to Susan Thomas' teaching page
Susan Thomas,
IGIDR, Bombay
susant@igidr.ac.in