1. 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)

2. 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 Jim Finkel, Tonko Gast

3. FIN2 Overview 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

4. FIN2 | Debt & Value | Bonds Bond Promise of specific payments at specific future times, in exchange for money now. Borrow (money) = sell a bond Lend (money) = buy a bond Bond price Bond yield (to maturity) Promised rate (of return) Expected rate (of return) Default risk Replication “Synthetic.” Short Riskless arbitrage Law of One Price (LOOP) Two assets that have the same payoffs in all future states of the world must have the same price today. Mortgage-backed security (MBS) Collateralized debt obligation (CDO) Priority of claims Tranche Credit Default Swap (CDS)

5. Tension between “perfect” and “imperfect” worlds  Finance theory assumes perfect markets with perfect human beings  But we are not ….  When perfect theory meets imperfect reality, the result can be profit or disaster  Apply your theory first, then ask, –“What are the imperfections?” –“How big is the gap?”