Dynamic Corporate Finance and Investments / Dynamic Corporate Finance and Investments

Studyboard of Market and Management Anthropology, Economics, Mathematics-Economics, and Environmenta, Odense
Teaching activity id: 9406001.
Teaching language: English.ECTS / weighting: 10 ECTS / 0.167 full-time equivalent.
Examination language: English.
Exam activity id: 9406002.Approved: 07-03-17.
Period: Autumn 2017.
Grading: Internal grading.
Assessment: 7-point scale.
Offered in: Odense.

Subject director:
Christian Riis Flor, Department of Business and Economics.

Prerequisites:
PLEASE NOTE that students who register for this course must meet the following requirements:
The graduate finance courses "Advanced Corporate Finance”, “Derivatives and Risk Management”, and ”Asset Pricing” are required; these courses provide essential building blocks for the present course. It is recommended that each of these three courses have been passed with at least a grade of 4.

More specifically, the course requires that the student has prior and solid knowledge of standard corporate finance issues, such as agency costs, debt capacity, liquidity problems, takeovers, and incentive and information problems. These are all competences acquired in the course Advanced Corporate Finance (course no. 9320821).
The student must also be able to explain and apply Itô calculus on Itô processes; e.g. the student must be able to apply Itô’s Lemma in a multidimensional setting.
Numerical solutions will be used, so some programming experience e.g. in Mathematica, Matlab, or R is expected. These are all competences acquired in the courses Derivatives and Risk Management (course no.  9427401) and Asset Pricing (course no.  8829301).

Purpose:
To give the students a thorough understanding of modern models of corporate finance and corporate investment problems and their solutions. The course addresses corporate investments, e.g., investments in production facilities and capital budgeting. Other corporate finance issues can also be addressed, e.g., when to take over another company as well as agency problems due to debt financing. The course discusses how modern option concepts and theory can be applied to value investment projects with option features, e.g. flexibility about the timing of the investment and the possibility to shut down (temporarily or permanently) the project after its initial implementation. Finally, the course presents modern multi-period and continuous-time models for corporate finance problems, e.g. capital structure decisions in companies, and it discusses implications for e.g. the valuation of stocks, corporate debt, valuation of corporate bonds and credit risk, and agency conflicts. The analysis of the topics will involve analytical as well as numerical solutions of the valuation models.
Another purpose of the course is to prepare the students for their Master’s thesis and to provide the students with practical competences by making them familiar with presentations in front of an audience.


Content - Key areas:
  • Decision-making in multi-period (e.g. continuous-time) models in an uncertain environment
  • Understand how real options are present in a given problem and recognize real options in real life examples
  • Dynamic programming and stochastic control
  • Valuation of stocks and corporate bonds based on firm fundamentals
  • Optimal real investment decisions for firms – possible examples:
     - real options analysis (contingent claims analysis as well as dynamic programming)
     - valuation of investment project
     - capital budgeting
     - entry, exit, lay-up, scrapping
     - sequential investments
     - investment timing and liquidity
     - investment timing and effects of risk or uncertainty
  • Examples of expected topics applying the above framework:
     - Dynamic capital structure problems, e.g. structural valuation of stocks and corporate bonds and links to credit risk  
       when the firm can actively change its capital structure
     - Dynamic corporate investments problems, e.g. corporate investments and stock returns  
     - Corporate decision making in a dynamic setting, e.g. asymmetric information problems and takeovers, or implication
       of macroeconomic risk.          

Goals description (SOLO taxonomy):
To fulfill the purposes of the course the student must be able to:

Demonstrate knowledge about the course’s focus areas enabling the student to:
  • Explain the idea of dynamic programming and the derivation of the Bellman equation in discrete-time models and the Hamilton-Jacobi-Bellman equation in continuous-time models of typical financial optimization problems
  • Describe the principles of real options analysis; including describing the Hamilton-Jacobi-Bellman equation in continuous-time models of typical binary decision problems used in e.g. capital budgeting problems
  • Describe and explain applications of real options analysis, e.g. in a dynamic corporate investment context; discuss and criticize the assumptions made for the applications and interpret the results;
  • Explain the difference between contingent claims analysis and dynamic programming

Demonstrate skills, such that the student is able to:
  • Apply the standard Hamilton-Jacobi-Bellman equation in continuous-time models of typical financial optimization problems
  • Analyze, and criticize the principles of real options analysis; including describing and analyzing the Hamilton-Jacobi-Bellman equation in continuous-time models of typical binary decision problems used in e.g. capital budgeting optimization problems
  • Analyze applications of real options analysis, e.g. adjustment of a firm's assets, and valuation of stock and corporate bonds in a dynamic corporate investment context; discuss and criticize the assumptions made for the applications and interpret the results;
  • Analyze e.g. equity as a contingent claim with a real options analysis view
  • Evaluate and analyze consequences of agency conflicts, e.g. due to conflicting incentives regarding the decision to the investment decision, when to acquire another company etc.
  • Be able to implement corporate finance models numerically.
  • Analyze applications of real options analysis in a dynamic corporate finance context
  • Recognize and identify embedded real options in practical applications as well as in an abstract sense
  • Discuss and criticize the assumptions made for the applications and interpretation of the results;
  • Reflect upon the conclusions obtained by the analysis in the different applications
  • Be able to implement dynamic corporate finance models numerically.

Demonstrate competences, such that the student is able to:
  • Apply the principles of real options analysis -- including modifying the Hamilton-Jacobi-Bellman equation of typical binary decision problems – to independently develop models applicable for analyzing new topics
  • Understand when to use contingent claims analysis and dynamic programming in a given context and use that to independently identify a need for further development
  • Independently apply applications of real options analysis in a dynamic corporate finance context to take on professional responsibility regarding strategic decision making under uncertainty
  • Use the above knowledge and skills to participate in team work and to present the outcome of an analysis; i.e., the student obtains competences in collaboration, communication, and presentation.

Literature:
Examples
  • Chapters from Dixit, A. K. and R. S. Pindyck. “Investment under Uncertainty”, Princeton University Press, 1994, or similar material.
  • Flor, C. R. “Dynamic corporate finance theory”, Lecture notes, University of Southern Denmark, newest edition, or similar material.
  • Articles (papers and working papers) and additional lecture notes.
  • Cases.

Time of classes:
Autumn.

Scheduled classes:
The course is designed as a study group.
Class hours will be announced during the course. It is expected that we meet 2 times (in 2x45 minute sessions) per week for the first four or five weeks. After this the students (in groups) are expected to hand in reports and subsequently make a presentation as opponents based on literature and a report from another group. There will be intervening weeks without class meetings. It is expected that each group hands in two reports and make two presentations as opponents. The form will depend on the number of students. The course ends in December by a presentation of a case (“create-your-own-case”).

Form of instruction:
Course capacity
Maximum number of participants: 16 students.
Priority is given to SDU students. In case more than 16 students seek enrolment, priority is given to those with the highest average grade from the two graduate finance courses: "Advanced Corporate Finance" and "Derivatives and Risk Management".

Students are expected to present a substantial amount of the material for the course.
The study group activities result in an estimated distribution of the work effort of an average student as follows:
Preparation of introduction package: 25 AT
Lectures/class work/case work/discussions/case presentation: 170 AT
Catching up, reflect on material, prepare for take home: 50AT
Exam/take home 1: 25 AT.
Total: 270 AT.

Time of examination:
Ordinary examination throughout the teaching term. Re-exam in February.

Registration for the course is automatically a registration for the ordinary examination in the course. Cancellation is not possible. If the student does not participate in the examination, the student will use an examination attempt.
The university may grant an exemption from the rules in case of exceptional circumstances.
The student is responsible for registering for 2nd and 3rd examination attempt.

Evaluation at the re-exam may be changed.

Examination conditions:
Before taking the exam the student has to pass the constituent compulsory courses for the graduate finance and economics profile:
  • Advanced Corporate Finance (9320821)
  • Derivatives and Risk Management (9262861)
  • Asset Pricing (8829301)
Students having passed the course "Investments" (Course number 9262902) or “Dynamic Investment Strategies” (Course number 9262932) cannot be examined in the course.

An exemption from this rule can be granted on individual basis by the Academic Study Board.  

Form of examination for the certificate:
Portfolio exam consisting of 3 parts; one grade is given:
  1. Take home assignment
  2. Reports, presentations as opponents, and ex auditorio discussions
  3. Case creation and presentation

Supplemental information for the form of examination:
1. Take home assignment done individually.
Duration: Date for submission will be announced via Blackboard. This part of the exam expectedly takes place at the end of September or beginning of October.
Location: Home assignment.
Internet Access: Necessary.
Hand In: Via SDUassignment in the course page in Blackboard.
Extent: Will be announced by the lecturer.
Exam Aids: All exam aids allowed. However, it is not allowed to communicate with anybody regarding any issue related to the assignment.

2. Reports, presentations as opponents, and participation in class discussions
a. Done in groups of two students. The instructor can change the group size. The instructor defines membership of a group.
b. Students are required to present material in class
c. Number, form, and content of presentations will be announced by the instructor
d. Topics and literature is suggested by the students in the respective groups and approved by the instructor
e. The format (layout, size etc.) of the reports are specified by the instructor
f. Presentation as appointed opponent is based on another group’s topic, literature and that group’s report.

3. Case creation and presentation
Done in the same groups as above.
Development of a case.
Presentation of the case in class based on slides.
Before the presentation, the slides (at most 8 slides done in Beamer, PowerPoint, or similar) must be handed in and distributed in class.

All students are expected to participate in discussions of all reports and to provide questions to case presentations ex auditorio.

Participation in all parts is necessary to receive a final grade.


Guidelines for the exam parts:
Additional readings may be required. The material need not be the same for all students (e.g. in case of making a research proposal).

Page limitations may apply and will be stated when applicable (if not stated in the course description).
Please refer to the Formalities for written assignments applying to programmes in economics and business administration available via the Exam webpage.

Any programming code used to answer any part of the exam must be handed in electronically as well. Allowed software: -- preferred -- MS Excel (VBA), Mathematica, Matlab, Visual C++, or -- less preferred -- R.

The evaluation tests the student's understanding of the targets by random check.

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