Finance Theory - Introduction Lecture (MIT 15.401)
Course Introduction
- Instructor: Professor from Sloan School of Management
- Course: Designed for first-year MBA students, focus on careers in finance and general curiosity in finance
- Objective: To demonstrate the importance and practicality of finance in business management
- Personal Background: 20 years at MIT, taught at Wharton, PhD in Economics from Harvard, undergraduate from Yale
Motivation and Background in Finance
Instructor's Journey in Finance
- Emphasizes real-world application and practical management problems
Importance of Finance
- Finance as the core of business and management
- Finance is universally applicable regardless of career objectives
- Finance involves rigorous research and practical application
Personal Anecdote
- Comparison to the instructor's son's first experience with ice cream — initially skeptical, ended up loving it
- Finance is challenging but rewarding
Course Outline
- Motivation
- Dramatis Personae (Cast of Characters)
- Fundamental Challenges of Financial Analysis
- Framework for Financial Analysis
- Importance of Time and Risk in Financial Analysis
- Six Basic Principles of Finance
- Course Overview and Requirements
- How to Get the Most Out of This Course
Key Concepts
Cast of Characters in Finance
- James Simons
- Founder of Renaissance Technologies, former math professor
- Highly paid hedge fund manager using quantitative investment strategies
- Warren Buffett
- Investment guru, richest man on earth in 2008
- Built wealth through reading and understanding company financials
- Jack Welch
- Former CEO of General Electric
- Increased GE's value through efficiency and good investment decisions
Fundamental Challenges in Finance
- Valuation of Assets
- Management of Assets
- Making decisions based on valuation (which option is more valuable)
Price Discovery Mechanism
- Auction example to understand how markets establish asset value
- Information and constraints affect asset valuation
Financial Analysis Framework
- Accounting: Language of finance
- **Stock and Flow
- Stock: Level of assets
- Flow: Rate of change of assets
- **Balance Sheet and Income Statement
- Balance Sheet: Stock of wealth
- Income Statement: Flow of wealth
Corporate Financial Decisions
- Cash raised from investors
- Cash invested in real assets
- Cash generated by operations
- Cash reinvested
- Cash returned to investors
Personal Financial Decisions Framework
- Applies corporate finance concepts to personal finance
- Managing cash flows in personal life, e.g., student loans, human capital investments, consumption, and savings
Importance of Time and Risk in Financial Analysis
- Time: Decisions at different points in time
- Risk: Uncertainty in outcomes
- Core of Financial Analysis: Combining time and risk leads to modern finance
Six Basic Principles of Finance
- No Free Lunch: No systematic free lunches in financial markets
- Preferences: More money is preferred to less, money now preferred to money later, less risk preferred to more risk
- Self-Interest: Agents act to further their self-interest
- Other Principles (Introduced later in the course)
Course Requirements
- Readings: Braley, Myers chapters 1 and 2
- Participation: Attendance and class participation graded
- Assessments: One case study (10% of grade)
- Exams: Midterm (25%) and final exam (55%)
- Problem Sets: No problem sets, but optional problems will be provided
Tips for Success in the Course
- Engage with the theories and practical aspects of finance
- Participate in the Pro Seminar on the Practice of Finance
- Prepare for and review lectures regularly
- Practice problems both in groups and individually
- Ask questions and stay engaged throughout the course
Next Lecture: Continue discussion on valuation and introduce new readings.