Note: The approach discussed in this blog post has been superseded by a new approach discussed in the more recent blog post “Teaching financial concepts (v1.1).”
With enough explanations, in-class examples and practice on the homework, students eventually learn how to solve numerical finance problems. However, they seem to have a much harder time understanding financial concepts.
I therefore try to have them think much more about financial concepts in class. During each class, I present them with a number of concept questions before discussing the material (see examples below). Students know that they’ll have to write an in-class essay answering at least one of the questions during the same class, but don’t know which one it will be. In addition, students are told that a few of the questions will be on the final exam. They are thus motivated to pay attention to all questions.
Students typically have five minutes for each question. I allow my students to talk to their neighbors while writing the essay, thus stimulating discussion and peer-to-peer teaching. After the time is over, I explain the correct answer and take questions. The essays are graded and students earn up to one percent of the total course grade for each essay.
A sample of essay questions are given below for several areas of study.
Legal form of ownership and corporate governance
- What are the advantages and disadvantages of each form of ownership?
- What is the agency problem in corporations and how can you mitigate it?
- What is the difference between the average and the marginal tax rate?
- What is the purpose of the Du Pont identity?
- What is the difference between the internal and sustainable growth rates?
Time Value of Money and interest rates
- Why do we discount when calculating a present value?
- APR and EAR: Which one is better for making decisions and why?
- What is a bond and what are typical characteristics of corporate bonds in the USA?
- Why do companies issue more bonds than stocks every year?
- What is the yield to maturity?
- Why do investors like convexity?
- How does immunization work?
- What are differences between bonds and stocks?
- Why does the DDM focus only on dividends?
- A higher retention ratio b leads to a higher growth rate g. Since P0=D1/(k-g), does a higher b always lead to a higher P? Why or why not?
- Why is NPV a better decision rule than payback period?
- Why should we consider changes in net working capital for capital budgeting purposes?
- What cash flows should we include for capital budgeting purposes?
Cost of capital
- Why can diversification eliminate some risk, but not all risk?
- What is beta?
- What is the economic/intuitive justification for the expected return-beta relationship from the CAPM?
- What is the cost of capital?
- What does the cost of capital depend on?
- What happens if the WACC is used as the discount rate for all projects?
- Under what conditions is it appropriate to use the WACC as the discount rate for a new project?
- What is leverage?
- How does leverage affect free cash flow and free cash flow per share?
- Why does leverage affect free cash flow and free cash flow per share in that way?
- Justify your answer. What is the optimal capital structure
– without taxes and bankruptcy?
– with taxes, but without bankruptcy?
– in reality?
- Why do airlines have higher D/V ratios than drug companies?
- Do dividends matter?
- Does dividend policy matter?
Raising long-term capital
- Why do firms raise long-term capital?
- What are sources of long-term financing?
- How are new securities sold to the public?
- What are the most common underwriting methods?
Working capital management
- What is working capital?
- Why does working capital management matter?
- What is the cash cycle and why does it matter?
- What are advantages and disadvantages of a flexible financial policy
- What are advantages and disadvantages of a restrictive financial policy?
- What is a cash budget?
- What are sources and uses of cash?
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