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#### Book Details

### Abstract

“An Outline of Financial Economics” presents a systematic treatment of the theory and methodology of finance and economics. The book follows an analytical and geometric methodology, explaining technical terms and mathematical operations in clear, non-technical language, and providing intuitive explanations of the mathematical results. The text begins with a discussion of financial instruments, which form the basis of finance theory, and goes on to analyze bonds – which are regarded as fixed income securities – in a simple framework, and to discuss the valuation of stocks and cash flows in detail. Highly relevant topics such as attitudes toward risk, uncertainty, the financial structure of a firm, stochastic dominance, portfolio management, option pricing and conditions for non-arbitrage are analyzed explicitly. Because of its wide coverage and analytical, articulate and authoritative presentation, “An Outline of Financial Economics” will be an indispensable book for finance researchers and undergraduate and graduate students in fields such as economics, finance, econometrics, statistics and mathematics.

“‘An Outline of Financial Economics’ provides a nice pedagogical exposition of the basic principles in financial economics, covering firm valuation and capital structure, fixed income securities and options, and portfolio theory and management. The most important concepts and results in the financial economics literature are well presented, including the Modigliani–Miller theorem in capital financing, hedging and dynamic replication in modern asset valuation principles, the Markowitz mean-variance portfolio model and the Sharpe–Lintner capital asset pricing model, and stochastic dominance. This text is well suited for science and engineering students at the undergraduate level, particularly those who would like to acquire some basic knowledge of financial economics at a higher level of quantitative reasoning than offered by standard business school texts in finance and investment.” —Professor Yue Kuen Kwok, Hong Kong University of Science and Technology

“An Outline of Financial Economics” presents a systematic treatment of theory and methodology of finance and economics. It begins by discussing financial instruments, which form the basis of the theory of finance and are defined as legal documents recording monetary transactions. The text then goes on to analyze bonds – which are regarded as fixed income securities – in a simple framework, and to discuss the valuation of stocks and cash flows in detail.

The text follows an analytical and geometric methodology, explaining technical terms and mathematical operations in nontechnical language. It also provides intuitive explanations of the mathematical results of questions concerning important issues such as risk aversion, uncertainty, prospect theory and the theory of stochastic dominance.

The text also covers two alternative approaches to portfolio analysis – namely the mean-variance and mean-Gini approaches – and features an analysis of the Modigliani–Miller theorem, which has played a major role in the development of business finance. It discusses the capital asset pricing model and the intricacies of the methods for determining prices of different types of options, which give the right to buy or sell an asset. Conditions for non-arbitrage that do not allow advantage of price discrimination between markets are also developed.

Because of its wide coverage and analytical, articulate and authoritative presentation, “An Outline of Financial Economics” will be an indispensable book for finance researchers and undergraduate and graduate students in fields such as economics, finance, econometrics, statistics and mathematics.

Satya R. Chakravarty is Professor of Economics at the Indian Statistical Institute in Kolkata, India.

### Table of Contents

Section Title | Page | Action | Price |
---|---|---|---|

Half title | 1 | ||

Title | 3 | ||

Copyright | 4 | ||

Contents | 7 | ||

Preface | 11 | ||

PART I: Introduction and Basic Concepts | 15 | ||

Chapter 1: Basic Concepts | 17 | ||

1.1 Introduction | 17 | ||

1.2 Financial Institutions, Financial Markets and Financial Instruments | 17 | ||

1.3 Portfolio Management | 21 | ||

Bibliographical Notes | 21 | ||

Chapter 2: Intertemporal Decision-Making and Time Value of Money | 22 | ||

2.1 Introduction | 22 | ||

2.2 Consumer’s Time Preferences | 22 | ||

2.3 Discounted Present Value and Fisher’s Proposition | 26 | ||

Bibliographical Notes | 28 | ||

Exercises | 28 | ||

Chapter 3: Risk and Uncertainty | 30 | ||

3.1 Introduction | 30 | ||

3.2 Von Neumann–Morgenstern Utility Function | 30 | ||

3.3 Risk Aversion | 36 | ||

3.4 Certainty Equivalent | 42 | ||

3.5 Mean-Variance Analysis: A Special Case of the Expected Utility Approach | 46 | ||

3.6 Prospect Theory: A Brief Analysis | 50 | ||

Appendix | 52 | ||

Bibliographical Notes | 58 | ||

Exercises | 60 | ||

PART II: Firm Valuation and Capital Structure | 63 | ||

Chapter 4: Valuation of Stocks | 65 | ||

4.1 Introduction | 65 | ||

4.2 Stock Transactions | 67 | ||

4.3 Valuation of Stocks: A Simple Structure | 69 | ||

4.4 Valuation of Stocks: A General Framework | 71 | ||

4.5 Price-to-Earnings Ratio | 73 | ||

Bibliographical Notes | 75 | ||

Exercises | 75 | ||

Chapter 5: Valuation of Cash Flows and Capital Budget Allocation | 76 | ||

5.1 Introduction | 76 | ||

5.2 Net Present Value | 78 | ||

5.3 Internal Rate of Return | 78 | ||

5.4 Benefit–Cost Ratio and Profitability Index | 80 | ||

5.5 Some Additional Issues | 82 | ||

Appendix | 86 | ||

Bibliographical Notes | 86 | ||

Exercises | 86 | ||

Chapter 6: Financial Structure of a Firm | 89 | ||

6.1 Introduction | 89 | ||

6.2 The Modigliani–Miller Theorem | 89 | ||

6.3 Discussion | 95 | ||

Bibliographical Notes | 97 | ||

Exercises | 97 | ||

PART III: Fixed Income Securities and Options | 99 | ||

Chapter 7: Valuation of Bonds and Interest Rates | 101 | ||

7.1 Introduction | 101 | ||

7.2 Discounted Present Values and Constant Earnings Streams | 101 | ||

7.3 Special Case of a Bond | 103 | ||

7.4 Yield to Maturity of Bonds | 103 | ||

7.5 Duration of Bonds | 109 | ||

7.6 Duration and Convexity of a Bond | 111 | ||

7.7 Immunization of Interest Rate Risk | 113 | ||

7.8 Forward Interest Rate | 113 | ||

7.9 Forward Rate Agreement | 115 | ||

Bibliographical Notes | 117 | ||

Exercises | 117 | ||

Chapter 8: Markets for Options | 119 | ||

8.1 Introduction | 119 | ||

8.2 Types of Options | 121 | ||

8.3 Payoff Functions for Options | 123 | ||

8.4 Profit Functions for Options | 129 | ||

8.5 Boundaries for Option Values | 131 | ||

8.6 Forward and Futures Contracts | 141 | ||

Bibliographical Notes | 145 | ||

Exercises | 145 | ||

Chapter 9: Arbitrage and Binomial Model | 148 | ||

9.1 Introduction | 148 | ||

9.2 Conditions for Non-arbitrage: A Simple Model | 148 | ||

9.3 Conditions for Non-arbitrage: A More General Model | 152 | ||

9.4 The Binomial Model | 156 | ||

Appendix | 164 | ||

Bibliographical Notes | 166 | ||

Exercises | 166 | ||

Chapter 10: Brownian Motion and Ito’s Lemma | 168 | ||

10.1 Introduction | 168 | ||

10.2 Random Walk | 168 | ||

10.3 Weiner Process (Brownian Motion) | 170 | ||

10.4 Ito’s Lemma | 172 | ||

10.5 Applications | 172 | ||

Appendix | 176 | ||

Bibliographical Notes | 176 | ||

Exercises | 176 | ||

Chapter 11: The Black–Scholes–Merton Model | 178 | ||

11.1 Introduction | 178 | ||

11.2 The Black–Scholes–Merton Partial Differential Equation | 178 | ||

11.3 The Black–Scholes Pricing Formulae | 184 | ||

11.4 Comparative Statics: The Greek Letters | 184 | ||

11.5 Implied Volatility | 188 | ||

Appendix | 190 | ||

Bibliographical Notes | 192 | ||

Exercises | 192 | ||

Chapter 12: Exotic Options | 195 | ||

12.1 Introduction | 195 | ||

12.2 Digital Options | 197 | ||

12.3 Asian Options | 199 | ||

12.4 Barrier Options | 201 | ||

12.5 Gap Options | 205 | ||

12.6 Discussion | 207 | ||

Appendix | 209 | ||

Bibliographical Notes | 217 | ||

Exercises | 217 | ||

Chapter 13: Risk-Neutral Valuation and Martingales | 218 | ||

13.1 Introduction | 218 | ||

13.2 Martingale: Background and Interpretation | 218 | ||

13.3 Equivalent Martingale Measure: Discrete-Time Models | 224 | ||

13.4 Equivalent Martingale Measure: Continuous-Time Models | 226 | ||

13.5 Equivalent Martingale Measure: Continuous-Time Path and Stochastic Interest Rate | 226 | ||

Bibliographical Notes | 232 | ||

Exercises | 232 | ||

Chapter 14: Portfolio Management: The Mean-Variance Approach | 235 | ||

14.1 Introduction | 235 | ||

14.2 Preliminaries | 237 | ||

14.3 Construction of a Portfolio: The Two-Asset Case and a Diagrammatic Exposition | 239 | ||

14.4 Construction of a Portfolio: The Multi-Asset Case | 245 | ||

14.5 Two-Fund Separation Theorem | 249 | ||

14.6 Capital Asset Pricing Model | 251 | ||

Appendix | 259 | ||

Bibliographical Notes | 265 | ||

Exercises | 267 | ||

Chapter 15: Stochastic Dominance | 267 | ||

15.1 Introduction | 267 | ||

15.2 First Order Stochastic Dominance | 269 | ||

15.3 Second Order Stochastic Dominance | 271 | ||

15.4 Lorenz Ordering, Generalized Lorenz Orderingand Stochastic Dominance | 273 | ||

15.5 Ranking Portfolios | 277 | ||

Appendix | 279 | ||

Bibliographical Notes | 285 | ||

Exercises | 285 | ||

Chapter 16: Portfolio Management: The Mean-Gini Approach | 286 | ||

16.1 Introduction | 286 | ||

16.2 Gini Evaluation Function and Stochastic Dominance | 286 | ||

16.3 Efficient Set | 290 | ||

16.4 Portfolio Analysis | 292 | ||

16.5 Gini Capital Asset Pricing Model | 294 | ||

Appendix | 296 | ||

Bibliographical Notes | 298 | ||

Exercises | 300 | ||

Bibliography | 301 | ||

Index | 307 |