Theory of financial economics, emphasizing capital markets, investment decisions, choice, capital asset pricing model, futures and options markets, efficient markets, and capital structures.
Econ 450 students will be able to
- Understand and derive the fundamental relationship between risk and return that is implied by the Capital Asset Pricing Model (CAPM). Students should also know the assumptions necessary for this model to hold and be capable of identifying when potential investment projects satisfy these assumptions.
- Use linear regression to calculate an asset's historical sensitivity to broad market indices, its implied historical mispricing and an estimate of the asset's idiosyncratic risk. Students should also be capable of performing hypothesis testing on these values.
- Replicate traditional tests of the CAPM using currently available data.
- Be capable of collecting and analyzing asset market data to estimate the efficient frontier of risky assets using either Excel or another software package. Students should also be able to understand the efficient frontier mathematically and the reasons that it is useful.
- Calculate the present value of a stream of payments given an appropriate discount factor. Students should know how to use the CAPM to derive potential discount factors for payment streams.
- Calculate the yield to maturity of a stream of payments given an observed price. Students should also understand the relationship between the coupon rate of traditional bonds, their price and their yield to maturity.
- Calculate forward rates for all future periods given the observed yield curve.
- Understand the liquidity preference theory of bond markets as well as the expectations hypothesis. They should also be able to price complicated payment streams using observations of the yield curve and the expectations hypothesis.
- Calculate the duration and modified duration of a stream of payments and use these to calculate optimal hedges given an arbitrary position in the fixed income market.
- Calculate and understand bond convexity and its role (along with duration) in hedging.
- Price forward contracts by arbitrage given a risk-free rate.
- Price futures contracts whose payoffs are not correlated with the market reinvestment rate.
- Understand currently used hypotheses regarding futures contract pricing.
- Understand the structure of call and put options.
- Price put options given a call option (and vice versa) using the put-call parity relationship.
- Apply the Black-Scholes option pricing formula to price call and put options given beliefs about the volatility of the underlying asset.
- Apply the Black-Scholes option pricing formula to calculate the implied volatility of an asset given its price.