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UVA-MOD-0142Y Rev. Oct. 16, 2013 FINANCIAL INSTITUTIONS AND CAPITAL MARKETS GBUS 8490 Syllabus Introduction (Link to Video: Voice of the Instructor) This course highlights the importance of About Darden Course Syllabi institutions and markets. Markets do not exist in a vacuum; rather, participants interact in organized The Darden Graduate School of markets that are set up to promote efficient exchange of Business Administration is regularly funds from buyers to sellers. Institutions such as banks, recognized as having one of the hedge funds, sovereign wealth funds etc., are key world’s premier teaching faculties players in the capital markets looking for arbitrage within business education. Darden opportunities; with their insights and volume of trading, Business Publishing is pleased to provide current Darden course syllabi any arbitrage opportunities are usually eliminated for verified faculty members. These quickly, pushing markets to become more efficient. syllabi provide instructors with context Markets that have existed for some time are generally as to how cases could be used in a efficient but that may not always be true for newer particular sequence to achieve the markets such as some emerging markets. Trading in the learning outcomes of the teaching markets takes place in the form of instruments, the teams at the Darden School. Use the most common of which are stocks and bonds. Constant modules in these course syllabi as a innovation on the part of banks has created a large reference for updating case materials number of alternative securities; to the extent that these within your school’s programs. new instruments facilitate trading (or help in the execution of arbitrage trading strategies), they can have a long life (e.g., stock options) and earn banks fees. Financial engineering (structured products) can provide a solution to clients’ problems often in a cost-effective way. Arbitrage and financial engineering both entail risks; sometimes these risks are not clearly seen and evaluated properly, which can cause (and has caused) problems among banks and even for the entire market-based system (just think of the recent subprime mortgage crisis as one such example). This syllabus was prepared by Yiorgos Allayannis of the Darden Graduate School of Business Administration at the University of Virginia. Copyright 2011 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. -2- UVA-MOD-0142Y Risk management is a key function that firms use to understand their exposures and manage them. Recent moves by banks have elevated its stature, and only time will tell whether these new measures will be sufficient to avert new crises. The government plays a big role in the creation and evolution of the markets, most commonly, via regulation. Regulation can also change the rules of the game altogether and create a new class of winners and losers. Understanding its implications is therefore critical to continued innovation and growth on the part of market participants. This course is important for students pursuing careers in investment banking, private equity, sales and trading, hedge funds, investment management, and financial services. The course is also appropriate for those seeking careers in corporate treasuries or wanting to understand markets, as well as for financial consultants (such as asset management consultants). The course links with several courses in the MBA curriculum, such as Valuation, Investments, M&A, Financial Trading, and Fixed Income. With the exception of Valuation, none of the other courses listed here are requirements for taking or successfully completing this course. Course Outline Session one examines Warren Buffett, his success, his decision to invest in particular securities/industries and start his own reinsurance company while at the same time avoiding any large investment in financial institutions, and how he is now looking for the “new Buffett.” The rest of the course contains the following three modules: 1. The first module, “Financial Institutions” (UVA-MOD-0142), concentrates on financial institutions. Specifically, session 2 analyses a bank, its role, and how it is valued; session 3 examines the way banks use capital strategically to grow; session 4 examines bank risk management (identification, measurement, and management of the various risks that banks face); session 5 discusses the new leaders of financial giants Citi and Merrill and the problems they have faced regarding risk and capital raising, as they were caught in the subprime crisis, and the solutions/plans that they have used to deal with the crisis. 2. The second module, “Innovations in Capital Markets” (UVA-MOD-0143), examines specific markets and innovations in the capital markets. Although some of this survey of markets and instruments may have a historical view, the issues in these cases are ever present. Specifically, sessions 6 and 7 cover the Treasury market, its function, the auction process in the issuance of Treasury securities, and an early case of arbitrage in this market; session 8 discusses CDOs, a more recent innovation linked to the recent financial crisis; session 9 covers the high-yield market and provides an opportunity to discuss the credit rating process and how securities are designed to fit investor appetite in the context of a refinancing deal. Session 10 examines the commercial paper and the CDS markets and the impact that the Lehman Brothers bankruptcy had on them. 3. The third module, “Creation of New Markets” (UVA-MOD-0144), covers the creation of new markets, such as the carbon markets and the emerging equity and bond markets, and key players such as the sovereign wealth funds and infrastructure funds. It concludes with -3- UVA-MOD-0142Y lessons learned from the recent financial crisis—why it happened and how it can be prevented from happening again. Specifically, session 11 discusses carbon markets; session 12 discusses sovereign wealth funds; session 13 discusses infrastructure funds and the Athens Ring Road in southeastern Europe; and session 15 concludes with discussion on the financial crisis, its causes, and its consequences for the markets. Course Requirements Grading is based on class participation (50%), and an exam (50%). For some sessions, preparation involves reading technical notes and applying techniques to specific problems. Other sessions tackle comprehensive cases, while others discuss conceptual issues surrounding capital markets and the role of institutions. Optional readings are from Capital Markets: Institutions, and Instruments, Frank J. Fabozzi and Franco Modigliani, 4th ed., Pearson (FM). These readings provide general background material, and the book is a good reference book to have on capital markets. By the end of the course, students should have mastered the following topics: Structure of markets Institutions Valuation methodologies Financial engineering and innovation Risk and risk management Key players in the markets New markets Darden Course Instructor Darden Teaching Faculty Yiorgos Allayannis Cases by Author Allayannis cases -4- UVA-MOD-0142Y Course Outline Class Materials Introduction 1 “Warren Buffett, 2008” (UVA-F-1550) Optional reading: FM, Ch. 2 “Financial Institutions” (UVA-MOD-0142) 2 “Comerica Incorporated: The Valuation Dilemma” (UVA-F-1581) Supplemental Spreadsheet Available. “Technical Note: Bank Valuation Issues” (UVA-F-1582) Optional reading: FM, Ch. 3 3 “SunTrust Inc. Acquisition of National Commerce” (UVA-F-1554) Supplemental Spreadsheet Available. “Bank Capital Structure: A Primer” (UVA-F-1555) 4 “Risk Exposure and Risk Management at Korea First Bank” (UVAF-1386) Supplemental Spreadsheet Available. 5 “New Leaders of Financial Giants: The Case of Vikram Pandit (Citi) and John Thain (Merrill Lynch)” (UVA-F-1551) “Innovations in Capital Markets” (UVA-MOD-0143) 6 “Salomon and the Treasury Securities Auction” (HBS 9-292-114) Optional reading: FM, Ch. 20, 21 7 “Arbitrage in the Government Bond Market?” (HBS 9-293-093) 8 “Western Asset Arbitrage” (UVA-F-1577) Optional reading: FM, Ch. 26, 28, 32 9 “Metromedia” (HBS 9-286-044) Optional reading: FM, Ch. 22, 23 10 “The Weekend That Changed Wall Street” (UVA-F-1587) “Creation of New Markets” (UVA-MOD-0144) 11 “CO2 Australia—The Case for Carbon Credits” (UVA-F-1585) “Carbon Credit Markets” (UVA-F-1583) 12 “The Case of Sovereign Wealth Funds: A New (Old) Force in the Capital Markets” (UVA-F-1564) 13 “Athens Ring Road (ATTIKI ODOS)” (UVA-F-1576) Supplemental Spreadsheet Available. 14 TBD 15 “The Financial Crisis of 2007–2009: The Road to Systemic Risk” (UVA-F-1590) Topic Intro to institutions and markets Institutions: banks Importance of bank capital; strategic use Bank risk management Subprime crisis and banks Treasury market Arbitrage CDOs High yield Commercial paper; CDS Carbon credit markets Sovereign wealth funds TBD Lessons from the financial crisis