Corporate Finance Finance II (441) Professor Matsa

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Supplementary Readings and Material

There are tons of articles about finance in the news, on the web, and elsewhere. Here are some that I have come across that are related to the material we cover in class. If you have additional suggestions, please let me know.

Lecture 1

§ Are Markets Efficient? Academics and practioners exchange opinions on the age-old question.

§ Ketchup economics or the Economics of ketchup. Several years ago, an economics professor at Harvard (Lawrence Summers) was explaining to a reporter the difference between an economics professor and a finance professor. Economics professors, he said, study the economics of ketchup - what determines supply and demand, and thus, the price and quantity of ketchup. Finance professors study ketchup economics - they try to explain why two bottles of ketchup cost twice as much as one bottle of ketchup. This was his interpretation of arbitrage arguments behind Black-Scholes and Modigliani-Miller. If you find efficient markets confusing, this paper discusses efficient markets as it applies to grocery shopping as well as international financial markets.

§ Shareholder value in Germany. The idea that managers should maximize shareholder wealth has been less visible and maybe less prevalent in Germany. If we are to believe the financial press, however, this is changing. Enclosed are figures from a Ph.D. student in MORS, Peter Fiss, who examined the increased discussion of shareholder value in Germany. The figures show the increased use of the words "Shareholder Value" in the German financial press and the increased discussion of Shareholder Value in the annual reports of German firms.

Lecture 2

§ Interactive yield curve. You can compare the current yield curve to historic yield curves and see how the level, slope, and shape have changed over time.

§ Current yield curve. This is the current yield on government bonds from several countries.

Lecture 3

§ This spreadsheet shows the calculations underlying the pro-formas and free cash flows for ABP discussed in class. If you want to follow along in class, download the spreadsheet and bring your computer to class.

Lecture 4

§ A violation of put-call parity? This article presents an apparent arbitrage opportunity in Citi's stock and options. Now that you know put-call parity (and can recreate it by combining payoff diagrams), assess this opportunity. Citi's stock price appears too high relative to the creating the same payoffs with options (long call, short put, and long bond), so the arbitrage is to short the stock and take the equivalent options position. Is this arbitrage trade feasible?

§ Dividend spread arbitrage. When investors make inefficient options exercise decisions on dividend-paying stocks, alert investors can take notice and profit.

§ Straddle trade and volatility. A "straddle" position is long call and put options with identical strike prices. This trade is a big bet on volatility in the underlying stock, something you will see well when you draw out the combined payoff diagram.

Lecture 5

§ Getting real. This article from CFO Magazine contains quotes from CFOs and consultants about why real options is better than NPV. Do their arguments make sense? Note that most have the flavor of “if you do NPV correctly [real options], you get a better answer than if you do NPV incorrectly.”

Lecture 7

§ Modigliani-Miller after 40 years. CFO Magazine, July 1998.

§ Debt maturity. In theory, the maturity of debt issued by firms can be of any length. In practice, bank debt tends to be shorter and publicly issued bonds tend to be longer. The enclosed pictures have the distribution of maturities for bonds issued by publicly traded firms in the U.S.

Lecture 8

§ Debt and Taxes. This is Merton Miller’s Presidential Address to the American Finance Association in 1976. He discusses, among other things, how the tax benefit of debt changes when you also consider investors’ personal income taxation.

Lecture 9

§ Financial restructuring at MGM. After undergoing an LBO, MGM studios experienced poor performance in its film library (a fall in DVD revenues) and in its new films. The article discusses disagreements between creditors during the firm’s financial restructuring and various costs of its financial distress.

§ The Federal Express story: a real example of risk shifting. Here is a real life example of manager's increasing the risk of their firms. In expectation, this is good for equity holders. In this specific case, it turned out well for everyone (except the casino).

Lecture 10

§ Buyback binge creates big hangover. Remember the assumptions. For the model we studied in class, the assumption was that managers maximize old (remaining) shareholder value. (In the article, notice that Mr. Buffet understands buy backs are a trade between two groups of shareholders). Managers do this by buying their stock back when it is cheap ("We do our buybacks when the stock is low and not high"). But what happens if managers know less than the market? What happens if managers get caught up in the hype and buy back their stock for more than it is worth? This article discusses some of the implications. If you think this was only true during the last bubble, just wait for the next one.

Lecture 11

§ Managerial overconfidence. Another agency problem can occur when you hire a manager who thinks he’s better than he is.

Lecture 12

§ Risk Management in the Airline Industry. Fuel costs are a significant fraction of airlines' cost structure. In addition, they can be highly variable. Should airlines, therefore, hedge their fuel risk? Here are two newspaper articles that discuss hedging or the lack of hedging in the industry. One is from 1990 and the other is from 2004. Notice how much progress we have made in 15 years.

§ Corporate earnings insurance; a futures contract for movies’ box-office revenue; a derivative product based on your grade in Fin 2 – are these innovative contracts a good idea?

§ A sample swap agreement. This is an example of a generic swap agreement that a customer (a non-financial firm) would sign with its bank.

Lecture 13

§ Convertibles primer. This analyst report is an excellent review of the basics of convertible securities. It describes the pluses and minus of the securities, relative to standard debt or equity. The prior version also had a helpful summary of approximately 40 different securities (and their acronyms) issued by various banks. The summary on page 51 classifies each security into a small number of categories. This way you can see which product issued by one bank (ACES by Goldman) is essentially the same as another product issued by a different bank (PRIDES by Merrill). Remember, if it is a cat name (PRIDES, STRYPES, LYONS, Feline), it’s a Merrill product.

§ Term Sheets. When banks issue securities, they distribute term sheets that contain the basic details for the security. Here are sample term sheets for a convertible bond and a convertible preferred equity offering. Notice the covenants that are included in the documents. These are trying to prevent the shareholders from taking actions that harm the bond’s or preferred’s value. Note that this convertible bond is different from the one we discussed in class, because it is a mandatory convert and the conversion price is variable and depends upon the price of the common stock.

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