The London School of Economics and Political Science

Department of Finance
FM212: Principles of Finance
Lecturers:
Professor Christopher Polk
Professor Stavros Panageas
Administration:
Student Information Centre, OLD3.06
Course Web-site
FM212: Principles of Finance http://moodle.lse.ac.uk/
Course Objectives:
This course provides a rigorous survey and introduction to finance. The
course is a prerequisite for more advanced finance courses. It also serves as
a stand-alone course for students in other fields, such as economics or
management, who do not intend to take any other finance courses.
The course is divided in two parts. Part One of the course discusses portfolio
choice and asset pricing theory. We introduce time discounting and the
theory of present value. We discuss diversification theory and the impact of
portfolio risk on asset pricing equilibrium. We separately discuss equity and
fixed-income valuation. We discuss the theory of efficient capital markets.
We present derivatives pricing theory in both discrete and continuous time,
and apply it to the pricing of put and call options. We discuss forward and
futures contracts and their use in hedging.
Part Two of the course studies corporate finance theory. This is the theory of
a firms decisions concerning capital budgeting (which investments to make),
payout policy (how to return profits to shareholders), and capital structure
(how to raise capital) as well as related decisions including risk management,
mergers and acquisitions, and the decision to become a publicly-traded firm.
We first examine these decisions in an idealized frictionless world in which
the firm cannot change its value by altering its payout or capital structure
policy. We then explore the effect of frictions (such as taxes, bankruptcy
costs, inefficient or uncompetitive financial markets, and self-interested
managers) on these firm decisions, and consequently on firm value.
Learning and Teaching Delivery
Students receive instruction in two forms:
1. Two weekly one hour lectures covering formal material on the theory and
institutional settings and reviews of the empirical literature, in asset pricing
(Part One, in Michaelmas term) and corporate finance (Part Two in Lent
Term)
2. Weekly one hour tutorial-classes over both terms reviewing assigned
problems and discussing results and applications of results of analyses
reviewed in the lectures.
In addition students are expected to set aside weekly periods (about 5 hours)
of self-study to reflect on the lecture material, undertake the recommended
readings and work on the assigned class exercises.

Classes
Classes for Part One of the course begin in the second week of Michaelmas
term and end in the first week of Lent term (inclusive). Classes for Part Two
begin in the second week of Lent term and end in the first week of Summer
term (inclusive). Two class assignments per term will be graded by the class
teachers, and although these do not count towards the course assessment,
familiarity with the concepts and methods used in the classwork exercises is
necessary to perform adequately on the final exam.
Office Hours
All class tutors are allocated office hours, and if you have any questions or
problems with the course, in the first instance you should discuss these with
your class tutor in the classes or in the class tutors office hours. Students
may also contact the Student Information Centre in room OLD 3.06.
Textbook
The textbook for the course is Corporate Finance by Richard Brealey, Stewart
Myers, and Franklin Allen, 10th edition, McGraw-Hill Inc.
Web Resources:
Lecture notes, class exercises, solutions and past exam papers can be
accessed on the courses Moodle page.
Solutions to class exercises will be made available in the weeks after the
exercises have been scheduled
Assessment
The module is assessed 100% by a three hour written examination at the end
of the course. This examination paper will consist of 6 questions: three in
Section A (based on material covered in Part One) and three in Section B
(based on material in Part Two), and students must answer two questions
from each section. All questions will be given equal weight. Hand calculators
only are allowed in this examination. Copies of past exam papers can be
obtained from the website.

FM212 Lecture Schedule

Lectures take place on Fridays in the Peacock Lecture Theatre from 12-1pm and 23pm
Part 1: Asset Pricing - Michaelmas Term (Professor Stavros Panageas)
Week 1. Present Value
Week 2. How to Calculate Present Values
Week 3. Value of Bonds and Common Stocks
Week 4. Risk, Return and the Cost of Capital
Week 5. Portfolio Theory and Asset Pricing Equilibrium
Week 6. The Six Lessons of Market Efficiency
Week 7. Put and Call Options
Week 8. Options Pricing Theory
Week 9. Valuing Government Bonds
Week 10. Forwards and Futures
Part 2: Corporate Finance - Lent Term (Professor Christopher Polk)
Week 1. Capital Budgeting and the NPV Rule
Week 2. Real Options
Week 3. Payout Policy
Week 4. Does Debt Policy Matter?
Week 5. How Much Should a Firm Borrow I
Week 6. How Much Should a Firm Borrow II
Week 7. The Many Different Types of Debt
Week 8. Mergers, Corporate Governance and Control
Week 9. Initial Public Offerings
Week 10. Risk Management and Hedging

FM212 Part 1, Class and Reading Schedule

Class exercises due in a particular week typically depend on the previous weeks
lecture and reading assignment, detailed below. Class exercises consist of three
questions. Students should bring written answers to these questions to class. In
weeks marked with an asterisk, students will be required to hand in to the class
teacher a problem set for formative assessment.
Reading Assignment

Classwork Due
Michaelmas Term

Week 1.

BMA, ch 2

No class this week

Week 2.

BMA chs 2 and 3.5

Part 1 Classwork #1

Week 3.

BMA chs 3.1 and 4

Part 1 Classwork #2

Week 4.

BMA ch 7

Part 1 Classwork #3

Week 5.

BMA ch 8

Part 1 Classwork #4 *

Week 6.

BMA ch 13

Part 1 Classwork #5

Week 7.

BMA ch 20

Part 1 Classwork #6

Week 8.

BMA ch 21

Part 1 Classwork #7

Week 9.
Week 10.

BMA chs 3.2-3.4

BMA chs 26-27, pp. 680-688, 706-715

Part 1 Classwork #8 *
Part 1 Classwork #9

Lent Term

Week 1.

BMA, chs 5 and 6

Part 1 Classwork #10

Week 2.

BMA chs 10.4 and 22,

Dixit, Avinash and Robert Pindyck,
1995, "The Options Approach to
Capital Investment," Harvard Business
Review May/June 1995, 105-115.

Part 2 Classwork #1

Week 3.

BMA ch 16

Part 2 Classwork #2

Week 4.

BMA chs 14.3, 17, 19.4

Part 2 Classwork #3

Week 5.

BMA ch 18, pp. 468-487

Part 2 Classwork #4*

Week 6.

BMA ch 18, pp. 488-493

Part 2 Classwork #5

Week 7.

BMA ch 24

Part 2 Classwork #6

Week 8.

BMA ch 31
Jensen, Michael, 1986, "Agency
Costs of Free Cash Flow,

Part 2 Classwork #7

Corporate Finance, and

Takeovers," American Economic
Review 76, 323-329.
Week 9.

BMA ch 15

Part 2 Classwork #8*

Week 10.

BMA ch 26
Froot, Kenneth, David Scharfstein,
and Jeremy Stein, 1994, "A
Framework for Risk Management,"
Harvard Business Review
November/December 1994, 91102.

Part 2 Classwork #9

Summer Term

Week 1.

None

Part 2 Classwork #10