Notes on Lecture: Finance Theory (15401)

Course Overview

• Institution: MIT Sloan School
• Target Audience: First-year MBA students
• Course Duration: 13 weeks
• Course Goals:
  • Introduction to finance for those considering a career in finance or curious about the field.
  • Emphasize the importance of finance in all business and management decisions.

Instructor Background

• Experience:
  • 20 years at MIT, finance group
  • 4 years at the Wharton School
  • PhD in economics from Harvard University
  • Bachelor's in economics from Yale (1980)
• Motivation for Finance:
  • Practical application to management problems
  • Finance is viewed as the "lifeblood" of business.

Importance of Finance

• Finance is central to business management and decision-making.
• Skepticism about the relevance of finance is acknowledged; however, it is presented as essential for all careers.
• Key Quote: "Finance is the most important subject you'll ever encounter."

Initial Activities

• Question to Students:
  • How many have no finance background?
  • Privilege to teach finance for the first time
• Personalization Motivation:
  • The example of the instructor's son discovering ice cream as a parallel to discovering finance.

Course Structure and Content

• Today’s Agenda:
  1. Motivation for finance
  2. Introduction to key concepts and characters in finance
  3. Fundamental challenges of financial analysis
  4. Framework for financial analysis
  5. Discuss time and risk in finance
  6. Six basic principles of finance
  7. Overview of course mechanics

Financial Analysis Challenges

• Two Fundamental Challenges:
  1. Valuation of Assets:
     • Understanding what constitutes value (e.g., diamonds vs water).
  2. Management of Assets:
     • Decision-making based on asset valuation.

Framework for Financial Analysis

• Importance of Time and Risk:
  • Time affects value (cash flows now vs later)
  • Risk complicates financial decisions and analysis.
• Core Structures:
  • Accounting as a Language:
    • Balance Sheet (stock of assets) vs Income Statement (flow of wealth).
  • Cash Flow Analysis:
    • Corporate financial decisions based on cash flow management.

Key Personalities in Finance

1. James Simons:
   • Math professor turned successful hedge fund manager.
   • Founder of Renaissance Technologies.
2. Warren Buffett:
   • Investor known for simple valuation techniques.
3. Jack Welch:
   • Former CEO of GE; known for effective investment decisions.

Six Basic Principles of Finance

1. No Free Lunch:
   • Systematic transfers of wealth are unlikely.
2. Preferences:
   • Individuals prefer more to less, now to later, and less risk to more risk.
3. Self-Interest:
   • All agents act to further their own self-interests.
4. Additional Principles:
   • To be discussed in the final lecture.

Course Requirements

• Readings:
  • Brealey and Myers, chapters 1 and 2 for next class.
• Grading Structure:
  • Case study (10%), participation (10%), midterm (25%), final (55%).
• Learning Approach:
  • Emphasis on problem-solving and active participation.

Getting the Most Out of the Course

• Preparation:
  • Review lecture notes ahead of time.
  • Engage in group studies and discussions.
  • Actively engage in course material to improve understanding.
• Encouragement for Questions:
  • Foster an interactive learning environment.

Conclusion

• Encouragement to take finance concepts personally and apply them to real-life scenarios.
• Next class preparation: Read chapters 1 and 2 of Brealey and Myers.