The role of this module is to apply concepts and techniques learnt in the year 2 Microeconomics Analysis and Money Banking & Finance modules to real world issues affecting financial markets. It provides students with an introduction to financial economics and complements the work they do in the year 3 International Finance module.

The aim of the Financial Economics module is to provide students with a broad background to financial economics with the emphasis on financial asset valuation and risk management..

A    Knowledge and Understanding:

• Understand and learn the microfoundations of and the dynamic general equilibrium approach to financial economics, and in particular, learn the fundamental techniques used in intertemporal financial decision making under uncertainty.
• Understand and implement the concept of risk and risk management, therefore explain how mean, standard deviation, correlation and distributions play an important role in risk management.
• value and understand the characteristics of financial assets such as bonds, equities, perpetuities, discuss the assumptions made for each category of assets, discuss the strength and weakness of the valuation approaches.
• understand utility theory, understand the differences between risk averse, risk neutral and risk loving investors, define and calculate measures of risk
• understand the different notions of market efficiency, discuss the conflicting empirical evidence available, express their own views and link the notions of market efficiency with the theorems in finance.
• Understand and learn the applications of three key models of financial economics, namely, the mean variance model, the capital asset pricing model, and the arbitrage pricing model.
• understand the fundamental nature of derivatives, how they are traded in the market, explain their dramatic growth, develop simple trading strategies, discuss, explain and apply the put-call parity theorem.
• be familiar with derivative valuation techniques such as the Black-Scholes equation and the binomial tree approach, value common stock options using the Black-Scholes equation, value American type options using the lattice.
• be aware of recent derivative disasters, appreciate lessons learnt from such events, understand the notion behind VaR, apply VaR to simple cases.

B    Intellectual Skills: 

• be able to apply  mathematical and financial analysis to finance and risk management.
• be able to evaluate main financial and risk management issues facing modern firms.

C    Discipline Specific Skills: 

• be familiar and competent to research statistical, textual, and internet sources relating to modern financial institutions.
• be able to analyse the economic basis of  financial strategy as it relates to areas such as asset valuation, risk management, financial market strategy.

D    Transferable Skills: 

• be read extensively, and be able to collect, organise and analyse data.
• be familiar with key IT resources for research purposes and to inform classes and assignment work.
• be confident in developing individual ideas, setting personal course goals and schedules

The formal timetabled component of the module is approximately 36 hours of lectures and 8 hours of classes.  The lecture programme is supported by detailed handouts, problem sets and structured reading (recommended reading is detailed in the handout provided at the beginning of the lecture programme).  Class questions attempt to force students to challenge, interpret and understanding the subjects covered.  Students are supported throughout the module through the provision of regular surgeries (approximately 15-20 hours per year), held approximately every week, student lecturer private consultation sessions, revision sessions and email student-lecturer contact.

Indicative study hours:   200

The exam at the end of the Spring semester contains two sections, with 5 questions in each section.  First section contains mainly materials from the Autumn semester and the second section contains materials from the Spring semester.  Students have to attempt 6 questions, at least two from each section.  All questions carry the same number of marks.

Present value calculations; time value of money; annuities; internal rate of return; valuation of bonds; statistics review; general equilibrium approach, intertemporal financial decisions; arbitrage; state-preference approach; contingent claims & arrow securities; risk; optimal portfolio problem; equity premium puzzle; mean variance approach; capital asset pricing model; arbitrage pricing model. 

R.E. Bailey (2005), The Economics of Financial Markets, Cambridge University Press.
Yvan Lengwiler (2004), Microfoundations of Financial Economics, Princeton University Press