1. FIN2 Overview—Module 1 Feb 1 May 10 Debt & Value: debt issuance, bond valuation, perfect capital markets, taxes, debt and firm value, interest tax shields, APV Financial Policy: cost of financial distress, agency problems, information asymmetry, optimal capital structure, weighted average cost of capital Risk, Options & Hedging: option valuation, risk management Mergers & Acquisitions: value of synergies, forms of consideration, friendly and hostile transactions Review

2. FIN2 Policies Participation (50%) Be prepared, be on time. Be relevant, be constructive, be thoughtful. Your ideas matter. True for everyone. Use absence notification tool. Cold calls are always benign. Exercises Not graded. But count for participation. Participation feedback Week after Spring Break. Final exam (50%) In class, May 18. Tutorials Thursday afternoons Rimma Yusim, ryusim@hbs. Office hours Weekly, almost always Tuesdays, 12:30 – 2:30 pm Drop in, no appointment necessary Other times by appointment Anything else David Frieze, dfrieze@hbs.edu Adam Scarano, ascarano@hbs.

3. Home buyer/ owner Mortgage broker Synthesiz er of MBOs, e.g. Morgan Stanley Mortgage lender, e.g. a bank $$$ $ $ $ Tranche A Tranche B Tranche C “toxic” Fixed Income investors: Pension Funds Sovereign Wealth Funds Mutual Funds Hedge funds Clarence NathanMike Garner Glenn Pizzaluso Mike Francis (Rosetree Capital Management) Pooling and Tranching

4. Home buyer/ owner Mortga ge broker Synthes izer of MBOs, e.g. Morgan Stanley Mortga ge lender, e.g. a bank $$$ $ $ $ Tranche A Tranche B Tranche C “toxic” Home buyer/ owner Mortga ge broker Synthes izer of MBOs, e.g. Morgan Stanley Mortga ge lender, e.g. a bank $$$ $ $ $ Tranche A Tranche B Tranche C “toxic” Home buyer/ owner Mortga ge broker Synthes izer of MBOs, e.g. Morgan Stanley Mortga ge lender, e.g. a bank $$$ $ $ $ Tranche A Tranche B Tranche C “toxic” $ $ $ Asset Pool

5. Tension between “perfect” and “imperfect” worlds  Finance theory assumes perfect markets with perfect human beings  Human imperfections: –Bounded knowledge (don’t know everything) –Capacity for deceit (can’t trust everyone)  When perfect theory meets imperfect reality, the result can be profit or disaster  Apply your theory first, then ask, –“What imperfections are allowing me to make a profit?” –“How big is the gap?”  Best profits are in world that is a little imperfect, but not spinning out of control –It’s called “civilization”

6. Capital Structure Fallacies  Debt is a “cheaper” source of finance, so debt is better –Must look at “all-in” cost, i.e. weighted average  Debt increases eps, thus firms should borrow –Debt also increases volatility of eps, i.e. “quality of earnings” goes down

7. The Real World of Capital Structure