Capital Markets and Financial Institutions

FINE 442
Class schedule
Section 1 Mondays-Wednesdays 11:35-12:55, 045 Bronfman Building
Section 2 Tuesdays-Thursdays 8:35-9:55, 046 Bronfman Building
Section 3 Mondays-Wednesdays 8:35-9:55, 046 Bronfman Building

Professor Laurent Barras

Office 503 Bronfman Building
Telephone (514) 398-8862
Email laurent.barras@mcgill.ca
Office hours Wednesdays 10:00-11:00 or by appointment (email)

Teaching Assistant Pouya Behmaram

Office 467 Bronfman Building
Email pouya.behmaram@mail.mcgill.ca
Office hours Tuesdays-Thursdays 10.00-11.00

Secretary Karen Robertson (for administrative issues only)

Office 305 Bronfman Building
Telephone (514) 398-8144
Email karen.robertson@mcgill.ca

I. Course Description

This course gives an overview of the financial system and its two components, capital
markets and financial institutions. It develops a few simple, but powerful economic
principles to organize students’ thinking about the role, the structure, and the functioning
of the financial system. The course is practically oriented—the concepts learned in class are
applied to articles from the financial press (Financial Times, The Economist), as well as
videos discussed in class. A particular attention is given to the 2008 financial crisis and its
aftermath.

The first part of the course summarizes the key functions of the financial system, and
explains why it has a complex structure (e.g., heavy regulation, complex contracts). Then, it
describes the role played by the central bank in the conduct of monetary policy. Finally, it
examines why financial crises occur and why they are so damaging for the economy.

The second part of the course focuses on capital markets. It begins with a presentation of the
different securities and participants with a focus on debt and equity markets. Then, it covers
the basics of valuation in a unified framework that highlights the determinants of required
returns and the role of information. Finally, it examines the time-variation in valuation and
its implications for the portfolio risk-return trade-off.
 The third part of the course is devoted to financial institutions. First, it examines how the
banking industry is structured and how it has evolved over time. Second, it explains the
regulatory environment faced by banks. Third, it provides a description of the fund
industry and explains how to evaluate its performance.

II. Outline of the Course (Q means contains quantitative material)

Part I: The Financial System

A. Functions of the Financial System

B. Structure of the Financial System
C. The Central Bank
D. Anatomy of Financial Crises

Part II: Capital Markets

A. Securities and Participants

B. The Basics of Valuation (Q)
C. The Dynamics of Valuation (Q)

Part III: Financial Institutions

A. Commercial Banks
B. Banking Trends
C. Banking Regulation
D. Mutual Funds (Q)
E. Performance Evaluation

In the event of extraordinary circumstances beyond the University’s control, the content
and/or evaluation scheme in this course is subject to change.

III. Usefulness for your Career/Future

The objective of this course is to develop a set of key concepts that give students a
general comprehension of how the financial system functions, and can be successfully
applied to real-world situations Topics covered in this course are important for a number
of career paths in finance. Here are a few examples: (i) if you are planning to work in
wealth management, learning about the central bank, the debt and equity markets, or the
mutual and hedge fund industries is extremely useful; (ii) if you are planning to work in
banking, the sections on commercial banks, their regulatory environment, or the structure
of the financial system are particularly relevant; (iii) if you are planning to work in
corporate finance, the second part of the course provides an overview of the different
sources of funding available to corporations.

If you are not planning to work in finance, this course will help you understand the
financial system and form educated opinions about it. It will also help you make better
decisions in your everyday life (such as investing in mutual funds).

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IV. Course Material and Communication

You will find all the course material on “My Courses”:

- The syllabus and schedule
- The lecture material (slides)
- The problem sets and their detailed solutions
- Samples of previous exams (midterm and final exams)
- Additional readings
- Grades

© Instructor generated course materials (slides, problem sets, quizzes, exam

questions, etc.) are protected by law and may not be copied or distributed in any form or
in any medium without explicit permission of the instructor. Note that infringements of
copyright can be subject to follow up by the University under the Code of Student
Conduct and Disciplinary Procedures.

For specific announcements, check your email. You are responsible for making sure that
your mailbox is never full or does not treat my emails as spam.

V. Material Requirement

Course pack
You need to buy the course pack (FINE 442). It contains the two cases on which you will
work during the semester. It is sold at Dave’s store (basement of Bronfman Building).

VI. Optional Readings

I do not impose any reading for this course beyond the material covered in class.
However, I provide for (almost) every topic covered in class a reference to chapters from
the following books available at the library:

- Frederic Mishkin and Stanley Eakins, Financial Markets and Institutions, 9th Edition
2017, Pearson Prentice Hall (referred to as ME)

- Anthony Saunders, Marcia Millon Cornett, and Patricia McGraw, Financial

Institutions Management, 5th Canadian Edition 2014, McGraw-Hill
(referred to as SCM)

- Zvi Bodie, Robert C. Merton, and David Cleeton, Financial Economics, 2nd Edition,
2008, Pearson Prentice Hall (referred to as BMC)

I strongly encourage you to read these books for several reasons: (i) it provides a
complementary tool to learn the topics covered in class; (ii) it forces you to go over the
material again to be sure you understand it; (iii) it provides additional information if you
are not sure about a concept; (iv) it helps you catch up when you have to miss a class.

I will also put some additional readings on My Courses. Most articles are from the
financial press (Financial Times, The Economist).
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VII. Course Requirements

Finance I is a prerequisite for this course—no exceptions.

The course reviews and/or builds on some basic concepts covered in previous courses
and I assume that you understand them well. These include:
1) Time value of money
2) Bond valuation
3) Equity valuation
4) Notions of required expected return and risk premium

VIII. Grading

Group Projects (Two) 20%

Midterm Exam (Oct 18) 25%
Final Exam (Cumulative) 50%
Participation 5%

In accord with McGill University’s charter of students’ rights, students have the right to
submit in English or in French any written work that is to be graded.

Group Projects
Each project represents 10% of the final grade. You will form a team of 3 to 4 students.
For each project, your team will submit a report of 2 pages maximum. The report will be
subject to a set of constraints on the font size, margin space, and number of pages to
guarantee fairness across groups. You cannot exchange information between groups,
only within groups. On the due date, the report has to be given to me at the end of class at
the latest—a late project will not be accepted and will not be graded.

You are free to choose your group members and I urge you to think carefully about your
choice. It will have a significant impact on what you get out of the projects. You have to
give me the composition of your group via email on September 24 (midnight) at the
latest. After the deadline, I will do the rest of the matching myself and you will run the
risks of being matched with students who do not bother to respond. I make no exception
– any email received after the deadline will be ignored.

I expect everyone to participate actively in the group projects. If one member of the
group is free riding then the other members should inform me immediately. If I deem the
evidence of free riding to be sufficiently strong, I reserve the right to reduce the free-
rider's project grade by up to 100%. These decisions will be dealt on a case-by-case basis.

One project covers the recent financial crisis. It describes the actors of the crisis and the
financial innovation that took place during this period. The other project focuses on the
mutual fund industry. It describes the recent development of Exchange Traded Funds
(ETFs). Being successful requires that you understand the cases and material covered in
class very well and that you formulate your answers clearly and concisely.

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Exams
Both the midterm and the final exams are closed-book, closed-notes, and closed-
computer. The exam material covers the slides and the problem sets (including the
articles discussed in class). The final exam is longer than the midterm exam and is
cumulative. Being successful requires: i) memorization skills to learn the key features of
the financial system; (ii) analytical skills to explain the functioning of the financial
system using the economic principles covered in class; (iii) quantitative skills to solve
some of the multiple-choice questions, as well as the numerical questions.

I will post on My Courses sample exams so that you know what to expect. Note that the
level of difficulty of the exams does not affect your grade. I will impose a curve so that
the average grade on each exam will be roughly similar. In short, your grade depends on
your performance relative to that of your peers.

Taking the midterm exam is mandatory. If, for some valid reason, you are not able to
attend the midterm, you must let the Bcom office know as soon as possible and provide
formal written documentation for your absence (e.g., doctor's note) within one week of
the midterm. There will not be any make-up exam, so the final exam will count as 75% of
the final grade. However, if you miss the midterm exam and do not provide any formal
written documentation, your grade will be zero.

If you feel that your performance on the midterm exam is inadequate, you have the
option to drop it and opt for a 75% weight on the final exam. This option is not
automatic and you have to send me a request via email before the final. You cannot
rescind your request – once you send it in, you are committed.

Participation
The participation grade depends on whether you participate to class discussion and give
constructive comments. It also takes into account whether you act with professionalism
and integrity throughout the course (e.g., whether you constantly talk to your neighbors
or go in/out of the classroom).

Given its small weight, the participation grade is unlikely to determine whether you do
extremely well or poorly in this course. However, it can be important if your final grade
is slightly below some threshold (e.g., 68 or 69 instead of 70) as it could be
bumped up (from B- to B in the previous example). The participation adjustment will not
be assigned until after the final exam, so do not contact me about the grade you might
have going into the final exam as I do not know. 

Re-grades
Project/exam re-grades must be requested within one week of the day the copies are made
available to you. You must submit a written and precise explanation of why you think the
project/exam was incorrectly graded. The entire exam will be re-graded and the final
mark may go up or down

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IX. Honour Code
 
McGill University values academic integrity. Therefore, all students must
understand the meaning and consequences of cheating, plagiarism and other
academic offences under the Code of Student Conduct and Disciplinary Procedures
(see www.mcgill.ca/integrity for more information).
 
Since grades are determined competitively, cheating is equivalent to stealing somebody
else's grade. So it is unfair to all the students who work hard in this course. Cheating is
not just copying someone else's exam. It also includes plagiarism on projects, coming up
with a fake excuse to avoid the midterm exam, etc. Since I have zero tolerance for
cheating, I do not hesitate to give zeros and fail cheating students.

X. Things to Consider before Taking this Course

1) This course is dense and we will cover a lot of material. The only way to do well in
this class is to work hard.

2) I am demanding. I do not expect you to just have a basic knowledge of the material. I
expect you to be capable of precisely describing the financial system and applying the
concepts learned in class to interpret real-world situations.

3) I assume that some basic concepts in finance are known (see Section VII Course
Requirements). If you feel you are not comfortable with them, you should either do
additional work to catch up or avoid taking this class.

4) As shown in the course outline (see Section II), some parts of the course are
quantitative. To do well, you have to master both the qualitative and quantitative
aspects of the course.

5) For each part, I will give you a problem set that is part of the exam material. Many
(but not all) questions are discussed in class. For those that are not, I provide a
detailed solution available on My Courses.
6) Not every point raised in class is covered on the slides, so I highly recommend that
you attend class. You are responsible for everything discussed in class so if you miss
a class, get the notes from a friend or come see me.

7) We will not go deep into a limited set of topics. That is not the purpose of the course.
There are a lot of alternative courses that you can take to learn a lot about specific
topics (bonds, derivatives, investment management, etc).

8) As discussed above (see Section III Usefulness for your Career/Future), this course
does not target one specific job in finance. If you look for a training that is job-
specific (wealth management, investment banking, etc), alternative course are more
suited to your needs.

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XI. A Few Basic Tips for a Successful Semester

1) Start to work as early as possible. There are many resources are available to you:
lecture slides, problem sets, books, and office hours. Take advantage of these
resources. If you start early enough then you will have the opportunity to figure out
what you might be doing wrong.  
 
2) Look for the narrative in the lecture slides. I try to link the different parts of the
course in a very structured way. Does the narrative make sense? If not, where does
the chain of logic break?

3) When you take the practice exam, try to make it as real as possible. Have a timer,
hide the solutions and your notes. Only then will you be able to judge whether you
are in good shape for the real exam.
 
4) My experience tells me that most students lose points on exams because they do not
spend enough time reading the questions. Read each of them very carefully and do
not rush as the minutes you initially gains will cost you marks in the end.

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XII. Preliminary Schedule (Subject to Changes)

Section II

1) Sep 3: Part I-Introduction

2) Sep 5: Part I-Functions of the Financial System

Optional reading: BMC, Chapter 2

3) Sep 10: Part I-Structure of the Financial System

Optional reading: ME, Chapter 7

4) Sep 12: Part I-Structure of the Financial System

5) Sep 17: Part I-The Central Bank

Problem Set I

Optional reading: ME, Chapters 9 and 10

6) Sep 19: Part I-The Central Bank

7) Sep 24: Part I- Anatomy of Financial Crises

Optional reading: ME, Chapter 8

8) Sep 26: Open

Preparation for the First Group Project

Distribution of the First Group Project

9) Oct 1: Part II-Securities and Participants

Optional reading: ME, Chapter 11

10) Oct 3: Part II-The Basics of Valuation

Problem Set II

Optional reading: ME, Chapter 12

11) Oct 8: Part II-The Basics of Valuation

12) Oct 10: Part II- The Dynamics of Valuation

Collection of the First Group Project

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13) Oct 15: Part II- The Dynamics of Valuation

Problem Set III

14) Oct 17: Open

Oct 18: Midterm Exam

15) Oct 22: Discussion of the First Group Project

16) Oct 24: Part III-Commercial Banks

Optional reading: ME, Chapter 17; SCM, Chapter 2

17) Oct 29: Part III-Banking Regulation

Problem Set IV

Optional reading: ME, Chapter 18; SMC, Chapter 20

Preparation for the Second Group Project

Distribution of the Second Group Project

18) Oct 31: Part III-Banking Regulation

19) Nov 5: Part III-Banking Trends

Problem Set V

20) Nov 7: Open

21) Nov 12: Part III-Mutual Funds

Collection of the Second Group Project

Optional reading: ME, Chapter 20

22) Nov 14: Part III-Performance Evaluation

23) Nov 19: Part III-Performance Evaluation

Problem Set VI

24) Nov 21: Open

25) Nov 26: Discussion of the Second Group Project

26) Nov 28: Preparation for the Final Exam

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Sections I-III

1) Sep 4: Part I-Introduction

2) Sep 9: Part I-Functions of the Financial System

Optional reading: BMC, Chapter 2

3) Sep 11: Part I-Structure of the Financial System

Optional reading: ME, Chapter 7

4) Sep 16: Part I-Structure of the Financial System

5) Sep 18: Part I-The Central Bank

Problem Set I

Optional reading: ME, Chapters 9 and 10

6) Sep 23: Part I-The Central Bank

7) Sep 25: Part I- Anatomy of Financial Crises

Preparation for the First Group Project

Distribution of the First Group Project

Optional reading: ME, Chapter 8

8) Sep 30: Open

9) Oct 2: Part II-Securities and Participants

Optional reading: ME, Chapter 11

10) Oct 7: Part II-The Basics of Valuation

Problem Set II

Optional reading: ME, Chapter 12

11) Oct 9: Part II-The Basics of Valuation

Oct 10: Collection of the First Group Project

12) Oct 16: Open

Oct 18: Midterm Exam

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13) Oct 21: Part II- The Dynamics of Valuation

14) Oct 23: Discussion of the First Group Project

15) Oct 28: Part II- The Dynamics of Valuation

Preparation for the Second Group Project

Distribution of the Second Group Project

16) Oct 30: Part III-Commercial Banks

Optional reading: ME, Chapter 17; SCM, Chapter 2

Problem Set III

17) Nov 4: Part III-Banking Regulation

Optional reading: ME, Chapter 18; SMC, Chapter 20

18) Nov 6: Part III-Banking Regulation

Problem Set IV

19) Nov 11: Part III-Banking Trends

Nov 12: Collection of the Second Group Project

20) Nov 13: Open

21) Nov 18: Part III-Mutual Funds

Optional reading: ME, Chapter 20

Problem Set V

22) Nov 20: Part III-Performance Evaluation

23) Nov 25: Part III-Performance Evaluation

Problem Set VI

24) Nov 27: Discussion of the Second Group Project

25) Dec 2: Open

26) Dec 3: Preparation for the Final Exam

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