# Important Update After Our First Week Online

Dear Finance 4366 students,

Notwithstanding a few hiccups here and there, I think we are off to a good start with the online version of Finance 4366. While it is challenging to pivot from face-to-face to online meetings, we are fortunate to have the tools for making this happen. We just need to learn how to use these tools more effectively.

As your professor, I need and rely upon real-time feedback to teach effectively. In a face-to-face setting, I react to non-verbal and verbal cues that you provide. Besides listening to and responding to your questions and comments, I also adapt my teaching according to non-verbal cues; e.g., puzzled looks signal that further clarification may be an appropriate response. When things go particularly well, sometimes students’ eyes light up, which is a rewarding experience (for student and professor alike)!

As we become more familiar and comfortable with video streaming versus face-to-face class meetings, I expect that the level of student engagement will likely improve. It’s inconvenient to have to audibly unmute oneself to ask questions or offer comments, but this is unfortunately a practical necessity given the limits of this technology. However, there is no compelling reason to remain visually muted during class.

When you log into class on Tuesday, March 31, please unmute your video and keep it that way throughout the scheduled class period. This will enable me to respond more effectively to your ideas, questions, and concerns, and motivate you to be more engaged and less distracted by all the other things one can do while seated in front of a laptop, smartphone, or tablet.

In the meantime, please let me know if you have any questions or concerns about Finance 4366. Let’s do all we can to finish well!

Sincerely,

Dr. Garven

# On the social and cultural history of financial panics

Today’s WSJ article by Jason Zweig on the social and cultural history of financial panics is masterful; see https://on.wsj.com/2yhDyxd! (this link provides subscribers and non-subscribers alike with ungated access to this article)…

# Modifications for Business School Policies for Spring 2020

Y’all may have already received a similar email to this from Krista Howell, who is Assistant Dean for Undergraduate Business Programs at Hankamer. The following information pertains to Spring 2020 grade modifications at Baylor generally and at Hankamer specifically:

Modifications for Business School Policies for Spring 2020

Given the unprecedented circumstances that have arisen during the Spring 2020 semester as a result of the outbreak of COVID-19, the University is giving students the opportunity to elect to convert any of their spring course grades to Pass/Fail at the end of the semester once their final grades have been submitted.

Any course in which a student has earned a C- or above is eligible to be converted to “Pass” based on student election. Courses for which “Pass” or “Fail” is elected by the student will not count toward GPA calculations. Please see the changes to the University Policy: https://www.baylor.edu/provost/news.php?action=story&story=218153. Please see the list of Frequently Asked Questions: https://www.baylor.edu/registrar/index.php?id=967988.

In addition, the Hankamer School of Business is making the following modifications for the Spring 2020 semester only:

First Year Requirements:

For Pre-business students who have not yet met the First Year Requirements, a grade of “Pass” in BUS 1101, BUS 1201, BUS 1305/1350, ENG 1310, MTH 1308 or MTH 1309 will meet the minimum course grade for the First Year Requirements. In addition, those students will receive one extra semester to reach the First Year Requirements (including the 3.0 GPA) if needed. Therefore, if a student started in the BBA degree in Summer/Fall 2019, the First Year Requirements will be extended to the end of Fall 2020. If a student started in the BBA degree in Spring 2020, the First Year Requirements will be extended to the end of Spring 2021.

A 3.0 GPA and course prerequisites for the 2000-level and above business classes remain the same.

For Pre-business students who have met the First Year Requirements but have not yet met the Business School Admission requirements, a grade of “Pass” in BUS 2101, ACC 2303, ACC 2304, ECO 2306, ECO 2307 or QBA 2302 will meet the minimum course grade requirement for admission to the Business School. If at the end of the spring semester, a student goes over 60 hours but has under a 3.0 GPA, the requirement will be extended to the end of Fall 2020.

A 3.0 GPA and course prerequisites for the 2000-level and above business classes remain the same.

Course Retake Policy:

A grade of C or higher or “Pass” will not factor into the course retake policy. If a student does not convert to the Pass/Fail option, a grade of C-, D+, D, D-, F or “Fail” in BUS 1101, BUS 1201, BUS 1305, ENG 1310, MTH 1308, MTH 1309, BUS 2101, ACC 2303, ACC 2304, ECO 2306, ECO 2307 or QBA 2302 will count as a retake in the Business School Course Repetition policy.

Internal Transfer:

Non-BBA students who will reach the 45 Baylor hour limit during the Spring 2020 semester and have less than a 3.0 GPA will be granted an extension until the end of the Fall 2020 semester to reach the minimum GPA requirement to change their major to business.

Prerequisites for BUS 4385:

A grade of “Pass” in BUS 3101, FIN 3309/3310, MGT 3305, MKT 3305, or MGT 3325 will meet the minimum course grade requirement for BUS 4385.

Probation and Suspension:

Probation and suspension requirements will be looked at individually at the end of the semester.

Some course prerequisites and degree progression standards in the Hankamer School of Business require a specific grade requirement. According to the Pass/Fail policy, a grade of “Pass” will satisfy these requirements. However, even though a grade of “Pass” at the end of the Spring 2020 semester will allow a student to progress forward in the Hankamer School of Business, electing a grade of “Pass” does not mean that students should move forward in their major. Students should be encouraged to have robust conversations with the department faculty, academic advisor, and/or dean’s office regarding their preparedness to proceed to subsequent courses.

Students are advised to review the University Pass/Fail Policy and consider its impact on their academic and professional career.

# Extra Credit Opportunity, due March 31st

The Wiener Processes Extra Credit Problem, which follows today’s lecture at http://derivatives.garven.com/2020/03/26/march-26-annotated-lecture-note-plus-class-problems-solutions/ is due at the beginning of class on Tuesday, March 31st. You will find a new assignment page called “Wiener Processes Problem (Extra Credit)” on Canvas, where you may submit a PDF of your work. If you decide to take advantage of this opportunity, I will use the grade you earn on the problem to replace your lowest quiz grade (assuming that your grade on the extra credit is higher than your lowest quiz grade).

# March 26 annotated lecture note, plus class problems/solutions

My annotated teaching note from today’s class meeting is a http://fin4366.garven.com/spring2020/wiener_326_lecture.pdf; the class problem set is at http://fin4366.garven.com/spring2020/wiener_326_classproblem.pdf, and the solutions for the class problem set are at http://fin4366.garven.com/spring2020/wiener_326_classproblemsolutions.pdf.

On Tuesday, we will continue our coverage of the Wiener Processes and Ito’s Lemma topic. I will pick up from where we left off; i.e., we will start back up on the http://fin4366.garven.com/spring2020/lecture10.pdf teaching note, beginning on page 7.

# Erratum: Scheduled Quiz window for 4366 is as indicated on Canvas – 10:30-11 today, NOT 1:30-2:00

In my previous blog posting, I incorrectly listed the scheduled quiz 8 window for today as 1:30-2:00. That is incorrect; the scheduled quiz 8 window for today starts in 5 minutes (at 10:30 am) and ends at 11 am, as is corroborated by Canvas! Sorry about the faux pas!

# Reminders about today’s Quiz 8 and Problem Set 7 in Finance 4366

Don’t forget to complete Quiz 8 prior to the start of today’s meeting of Finance 4366! The quiz (on the “Portfolio and Capital Market Theory” topic) will be available from 10:30 – 11 am CDT at https://baylor.instructure.com/courses/108333/quizzes/107235 (which can also be reached by logging into the Finance 4366 Canvas site, then click on Quizzes, and finally on Quiz 8; once you start the quiz, you will have 10 minutes to complete it.

Also, if you haven’t already done so, be sure to post the PDF of your completed Problem Set 7 prior to the beginning of class at 11 a.m.

See y’all soon!

# Problem Set 7 Q&A between a Finance 4366 student and Professor Garven…

Q (from a Finance 4366 student): “Hi Dr. Garven, I had a question on problem set 7 if you get the chance. Specifically, for problem number, 2 I’m confused how to do the "trial and error approach."

A (from Professor Garven): There are two ways to do trial and error – either manually, or via Solver. Start by using the Pricing of American Options on Non-Dividend Paying Stocks spreadsheet (listed under item 12’s third bullet point) on the course website lecture notes page, and replace the stock price (S), u, d, and interest rate (r) parameters on the “2 timestep put” worksheet tab with the S, u, d, and r parameters indicated in Problem 1 of Problem set 7. By doing this, you’ll obtain the answers for Problem 1A and 1B. Since the value of exercising the American put at the inception of the binomial tree is only K S(t) = \$75 – \$70 = \$5, whereas the value of the American put is more than \$5, the exercise price must be at least a penny higher than the current (date t) value of the American put option in order for it to be optimal to exercise the option immediately.

# Today’s class problem: American Call Option on dividend paying Stock

Today’s class problem (see the last page) of the annotated “Finance 4366 – Early Exercise of American Call and Put options – no dividend” lecture note – there, we modified the two time-step call option pricing problem so that instead of having no dividend, we assumed that the underlying stock pays a 5% dividend of its price at either the or the node.  Without a dividend, it doesn’t pay to exercise an American call option early, so the value of an American call on a non-dividend paying stock is the same as the value of a European call on the said stock.

As we saw in today’s lecture, dividend payments have the effect of slowing down the rate of growth of the underlying asset.  As shown in the “Finance 4366 – Early Exercise of American Call and Put options – no dividend” lecture note, without a dividend, then the beginning share price of \$105 grows to \$110.25 at the u node and declines to \$99.75 at the d node.  Subsequently, the share price at the uu node grows to \$115.76, declines to \$104.74 at the ud node, and declines to \$94.76 at the dd node.  Applying risk neutral valuation, we find that the value of the American call is equal to the value of the European call is equal to \$7.80, because it is not worthwhile to exercise the American call at the beginning of the binomial tree or at nodes u or d.  However, the payment of a 5% dividend after one time-step changes everything, as shown by the following spreadsheet:

Here, when a 5% dividend payment occurs after one time-step, then the ex-dividend price of the stock is \$104.75 at node u and \$94.76 at node d.  Subsequently, the share price at the uu node grows to only \$109.97 at node uu, declines to \$99.50 at the ud node, and declines to \$90.02 at the dd node.  At node u, if the investor exercises the call option at the cum dividend price of \$110.25, then the investor earns \$10.25.  Since the arbitrage-free price of the call option is only  \$5.93 at node u, then the investor exercises the option at this node.  However, it is not profitable to exercise early at node d or at the inception of the option, as shown in the above spreadsheet.  In this case, the arbitrage-free price of a European option on the dividend-paying stock is $c = .99[.6005(5.93) + .3995(0)] = \ 3.53$, whereas the arbitrage-free price of a European option on the dividend-paying stock is $C = .99[.6005(10.25) + .3995(0)] = \ 6.09.$

# Pass/Fail policy adopted for spring semester

Breaking news – Spring 2020 grading policy. The “fine print” on this new policy is available at https://www.baylor.edu/provost/doc.php/352807.pdf. In a nutshell, faculty are instructed to submit course grades based upon the grading scale in their syllabi as they would do at the end of any other semester, and students will have an option to convert ABCDF grades into PF grades. But there are a number of “terms and conditions” associated with a student’s decision whether to exercise this option which requires careful attention and thoughtful consideration.