FOUNDATIONS OF FINANCIAL THEORY

AREA: FINANCE

MASTER IN ADVANCED

SESSIONS: 18

FINANCE
PROFESSOR: IGNACIO MUOZ-ALONSO
Email:

imunoz-alonso@faculty.ie.edu
imunoz@addaxcapital.com

Corporate Experience
CEO & Partner, Addax Capital LLP (London), 2009 to date
Head of Corporate and Investment Banking EMEA, BBVA (Madrid) 2007-2009
CEO & Global Partner, Rothschild Spain (Madrid), 2000 -2007
Executive Director, Corporate Finance, Lehman Brothers (London, Madrid), 1993 2000
Associate, Debt Capital Markets, HSBC (London)
Academic Background
MSc in International Economics, Kiel Institute of World Economic, Kiel (Germany)
MSc in Economic Theory, Universidad Autonoma, Madrid
BSc Economics, Universidad Autonoma, Madrid
Academic Experience
Associate Professor, IE, 2002 to date
Associate Professor, European Business School, 1988 - 1989.

Published by IE Publishing Department.

Last revised, September, 2013.

OBJECTIVE

A first semester course designed to present an in depth review of the basic financial
concepts, such as arbitrage, market efficiency, risk and preferences, that will set the
foundations required to progress on some core areas of a Master in Finance, such as
Capitals Markets, Portfolio Management and Corporate Finance.
The course is structured in three parts, starting with the microeconomic foundations of
finance and capital markets to follow on the theory of choice. It follows with the analysis of
the objects of choice, capital markets securities and their risk-return patterns covered
under the mean-variance and CAPM methodologies. The course and completes with the
formulation some of the basic capital market functioning principles, such as equilibrium
principles derived from arbitrage and market efficiency theory.
Students are expected to capture the theoretical tools and to develop both intuitively and
analytically the concepts that will be subsequently used to develop much of what will be
taught in the rest of the courses, departing from common methodologies and techniques.

Published by IE Publishing Department.

Last revised, September, 2013.

PROGRAM

I.

Introduction: Consumption, Investment and the Capital Markets (3 Sessions )

1.

The Scope of Finance

2.

Equilibrium, Preferences and Market Prices

3.

Consumption and Investment without Capital Markets

4.

Consumption and Investment with Capital Markets

5.

Separation Theorems

Readings:

Copeland et al.: Chapter 1 Introduction: Capital Markets, Consumption and Investment.

Ross, S. Finance. Chapter 1. Finance, Eatwell, Milgate and Newman, Editors. The
New Palgrave Series, W.W. Norton, 1989

L.A.Tieben: The Concept of Equilibrium in Different Economic Traditions: A Historical

Investigation. Tinbergen Institute Research Series, March 2009

Nordstandt, Microeconomics

Problems:
Copeland et al. Chapter 1: 1, 2, 3 and 6

II.

Rational Choice: How do individuals make financial choices? (6 Sessions)

1. The theory of Choice under Certainty (2 sessions)
1. Individual Utility Preferences and Investments: The Fisher separation Theorem
2. The Agency Problem
3. Shareholders Wealth Maximization
4. Cash Flows and Capital Budgeting Techniques
Readings:

Copeland et al.: Chapter 2 Investment Decisions: The Certainty Case

Evans, M.H. Capital Budgeting Analysis. CFA Excellence in Financial Management

Volkman, D.A. A Consistent Yield-Based Capital Budgeting Method Journal of Finance and Strategic
Decisions, Vol. 10, number 3, Fall 1997

McKinsey & Co. Internal Rate of Return: A cautionary Tale. The McKinsey Quarterly, October 20,
2004

Published by IE Publishing Department.

Last revised, September, 2013.

Mc Leod, B. Should Private Equity Investors Trust IRR? Asian Venture Capital Journal, August 2011
Problems:
Copeland et al. Chapter 2: 5, 6, 7, 8, 10, 11
2. Rational Choice under Uncertainty: Utility Theory (2 sessions)
1. Rationality and Choice
2. Developing Utility Functions
3. Risk Aversion and Risk Premium
4. Portfolio Optimization
3. State Preference Theory (2 sessions)
1. Uncertainty and States of Nature
2. Pure Securities and Market Completion
3. Arbitrage Free Condition
4. Economic Determinants of Security Prices
5. Optimial Portfolio Decisions
Readings:

Copeland et al.: Chapter 3 The Theory of Choice: Utility Theory Given Uncertainty, Sec. C

Copeland et al.: Chapter 4 State Preference Theory Sects. A to G

Byrns, R. The optimizing individual in Modern Microeconomics, 2002

Pulley, L.B. Mean-Variance Approximation to Expected Logarithmic Utility. Operations Research,

Vol. 34 N 4, July-August 1983

John Norstad An Introduction to Utility Theory, paper November 2011

Franz Dietrich and Christian List. Where do preferences come from? London School of Economics.
December 2010

Ser Huang Poon Forecasting Financial Market Volatility, Ch. 1: Volatility: Definition and
Estimation, John Willey & Sons, March 2005

Problems:
Copeland et al.: Chapter 3: 2, 5 and 6

Published by IE Publishing Department.

Last revised, September, 2013.

III. The Objects of Choice: Risk and Return (4 Sessions)

1. Mean - Variance Portfolio Theory
1. Risk and Return
2. Minimum Variance Portfolios
3. Efficient Sets
4. Optimal Portfolios with One Risk Free Assets
5. The Capital Asset Pricing Model

Readings:
Copeland et al.: Chapter 5 Mean Variance Portfolio Theory Sects. A, B, C, D, E.3, E.4, E.5.
Fisher, K., Statman, M. The Mean Variance Optimization Puzzle: Security Portfolios and Food Portfolios.
Fabozzi, F. Gupta, F. Markowitz, H.M. The Legacy of Modern Portfolio Theory. Institutional Investor,
2002
Swisher, P. Post-Modern Portfolio Theory FPA Journal, Sept 2005
Jones, S. The Formula that Felled Wall St., FT. April 24, 2009
McNair, J.A. Using Microsoft Excel to build Efficient Frontiers via the Mean Variance Optimization
Method, April 2003
Problems1:
Copeland et al. Chapter 5: 3, 7, 8, 9, 11, 13
IV. Markets Fundamentals (4 sessions)
1. Arbitrage (2 Sessions)
1. The Basic Arbitrage Theorem
2. Single Period Arbitrage
3. Many Periods: Futures, Options and Market Efficiency
Readings:

Problems for all lessons are taken from Copeland et al. Solutions are provided in the Students Solutions
Manual from Copeland et al. that is available al the IE library
Published by IE Publishing Department.
Last revised, September, 2013.

Damodaran, A Arbitrage

Allingham, M. Arbitrage, Chps. 1, 2 & 3. Macmillan. 1st Edition, 1991

Department of Mathematics, Univ. of Texas Austin Arbitrage Pricing, March 2010

Unay, D. A Note on Interest Rate Parity, Dec. 2005

Problems: Class examples

IV. Markets Fundamentals (Cont.)
2. Efficient Capital Markets: Theory and Evidence (2 Sessions)
1. Defining Capital Market Efficiency
2. A Formal Definition of the Value of Information
3. The Relationship between the Value of Information and Efficient Capital Markets
4. Rational Expectations and Market Efficiency
5. Market Efficiency and Costly Information
6. The Joint Hypothesis of Market Efficiency and the CAPM
Readings:
Stokey, N & Milgrom P. Information, trade and Common Knowledge, Journal of Economic
Theory, Feb. 1982
Braas, A.et al. An Analysis of Trading Profits: How most Trading Rooms Really Make
Money. The New Corporate Finance, Ed. Donald Chew. McGraw Hill, 1993
Brown, K et al. How Investors Deal with Uncertainty. The New Corporate Finance, Ed.
Donald Chew. McGraw Hill, 1993
Malkiel, Burton G. .Efficient Market Hypothesis. The New Palgrave Series, W.W. Norton,
1989

BASIC LITERATURE

Financial Theory and Corporate Policy. Copeland, Weston, Shastri. Addison Wesley. 4rd
Ed.

Portfolio Theory and Capital Markets. William Sharpe. Mc Graw Hill. Several Editions

Arbitrage. Michael Allingham. Macmillan. 1st Edition, 1991

Finance. Eatwell, Milgate and Newman, Editors. The New Palgrave Series, W.W. Norton,
1989

Introduction to Finance. Gitman, Madura. Addison Wesley, 2001

Published by IE Publishing Department.
Last revised, September, 2013.

EVALUATION CRITERIA

Final Exam ....................................60%

Project.................................20%

Class Participation.........................20%

Published by IE Publishing Department.

Last revised, September, 2013.