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ANDREW W. LO: So on behalf of the Sloan School

I want to welcome all of you to 15.401 Finance Theory.

This course is meant for first year MBA students.

And so that's the focus, and I'm going

to assume that that's the background that all of you

will have.

We may have a few other students in the class,

but primarily it will be first year MBAs who

are thinking about a career in finance,

as well as those of you who aren't

sure about a career in finance but are curious about it.

Hopefully over the next 13 weeks we'll

be able to satisfy that curiosity.

I want to start by talking a little bit

about what finance is, and how I got interested in it,

because I think it's often helpful in order

to motivate a subject to get a sense of how

somebody else decided to choose this as a profession.

To do that I have to go back a little bit,

and give you some background about

my own educational experiences.

So let me start by mentioning that I've

been at MIT for the past 20 years,

and been in the finance group all that time.

Before that I taught at the Wharton School for four years.

And before that, I got my PhD in economics

from Harvard University, and then graduated in 1980

from Yale also majoring in economics.

And during that time I've learned an enormous amount

both about finance and the real world,

but one of the things that I keep coming back to

is the fact that the finance field

is almost unique in how it applies to practical management

problems.

And what I want to try to do over the next 13 weeks

is to convince you of the fact that finance

is in fact, the most important subject

that you'll ever encounter.

That in fact, finance is at the core of everything

that you will ever do in business and in management.

Now that's a tall order I recognize,

and I suspect that some of you are

quite skeptical about the role that finance might play

in your own career objectives.

And I know many of you have very different career objectives.

And I'm not even trying to convince all of you

to go into a career in finance, but I

am trying to convince all of you that finance is really

the lifeblood and the basic lingua

franca of all of business.

And that's one of the reasons why finance

is such an important subject.

Now before I begin, let me ask you a question.

How many people have had no finance background whatsoever?

Oh, that's great.

I look forward to a challenge.

But the other reason it's great is

I have to tell you that it's a real privilege for me to be

here in front of you to tell you about finance

for the very first time.

And it reminds me a little bit of my younger

son who is an extraordinarily fussy eater,

he's eight years old now.

But ever since he was born he had some allergies,

and he just refused to eat most of everything.

In fact, my wife often says that my younger son is a vegetarian

except he doesn't eat vegetables.

So he's an incredibly fussy eater,

and somehow when he was one year old

he saw my older son eating an ice cream cone,

and figured that that's something he ought to try.

How he figured that out, I don't know.

But he tasted it for the very first time,

and you could see his face change in about four seconds

from disgust to curiosity to absolute, you know,

enthrallment with the taste and feel of ice cream.

He just loved it thereafter.

That's one of his major food groups now.

It's ice cream.

And so I feel privileged to be able to share that experience

here in the sense that once you get a taste of finance,

I think you're going to be incredibly

excited and enthralled by the subject.

Because it's one of the few subjects,

in fact, that's the only subject that I've encountered

that is both rigorous, it's extraordinarily

challenging from a research and intellectual perspective,

and at the end of the day it's extremely practical.

In fact, I would say it's indispensable

for financial management.

So I'm going to try to convince you of that over the next 13

weeks, and I'm going to do that by going over material

that you will find indispensable.

As many of you know, at the end of the course

we have a ritual where we hand out teaching ratings.

And among the finance faculty, among all the faculty,

we're very concerned about good teaching.

So these teaching ratings actually matter.

And I've always thought that having a teaching rating

survey at the end of the semester,

is somewhat misguided.

What I'd like to do, and what I've proposed

hasn't been adopted yet, I propose

to have teaching ratings submitted five

years after a course is done.

Now this may be a problem for some people who aren't

up to speed in the classroom.

But the reason I say this is, because it will only

be after you get into your jobs, into your careers,

before you realize how useful finance is.

And five years from now, I suspect all of you

will come back and say, gee, this

is one of the most important courses you have ever taken.

Not because of me, but because of the substance of what

we're going to cover over the next 13 weeks.

It's because of you and all of the work

that you will put into this course.

This will be the most challenging course

you will ever love.

So I-- stealing from the military--

I think that you'll really appreciate

how the discipline of financial logic

will help you to think smarter about all of your management

decisions no matter what you decide to do with your careers.

Now that's a very tall order.

I've built up expectations.

So I'm going to have to deliver over the next 13 weeks,

and we'll see whether or not we can do that.

But let me start now by talking about what

we're going to cover today.

I want to start with a little bit of motivation,

and then talk about the dramatis personae.

These are the cast of characters that we're

going to be focusing on over the next 13 weeks.

And then I'm going to lay out the fundamental challenges

of financial analysis.

It turns out there are only two.

There are only two challenges in financial analysis,

and once you figure both of those out, you're done.

So if by chance you can figure that out

before the end of the class, you don't

need to come back for the rest of the lectures.

Then I'm going to turn to providing you

with a framework for thinking about these financial

challenges.

To me it's very important to have a framework to start with,

because I like to organize my thoughts

into things that I know and things that I don't know.

And of the things that I know, how did it relate to the stuff

that I already knew, or thought I knew.

So I want to give you a sense of that kind of framework

to think about financial analysis upfront.

You probably won't fully appreciate it at this point,

but sometime over the next 13 weeks you will get it.

And so I want to give that to you

so that you can start thinking about it subconsciously,

unconsciously, and then eventually you

will understand how all the pieces fit together.

I then want to talk about the importance

of two aspects of financial analysis

that make finance different from every other discipline you

will ever encounter here at MIT and elsewhere.

And that is time and risk.

Without those two factors it turns out

that finance is actually done.

In other words, there's no real research challenges,

no open questions left once you eliminate time and risk.

Put in another way, the only reason

that there exists a finance department, and finance

faculty, and finance journals, and a finance industry,

the only reason is because of time and risk.

So I'm going to come back to that.

Then I'm going to conclude by giving you the six

basic principles of finance.

These are principles that you will encounter

in all of your finance courses for the rest of your stay

at MIT and elsewhere.

These are the ideas, the fundamental ideas,

that have shaped financial markets

and that are at the root cause of all of the financial market

innovations, as well as all of the financial market crises

that we've seen including what's been going on

over the last several months in the subprime mortgage market.

In fact, we're going to talk about the subprime mortgage

problems after we cover fixed income securities.

Right now I suspect most of you know

that there's something going on, know that it's bad stuff,

but you don't know why, how, where, when,

and what to do about it.

Well, in about five lectures, you will.

It's not complicated, but it's different from anything

that you've ever encountered.

And in fact, financial analysis, I suspect,

is different from anything most of you have ever encountered.

I'm hoping that by the end of the course,

it will change the way you think about everything.

And again, I recognize that that's a tall order,

but you tell me 13 weeks from now

whether or not I've delivered.

And then I'll conclude by talking about the course

overview, and then finally I want

to say a few words about how as a student

you can get the most out of this course.

This is a part of the lecture that I've always

felt is critical at the very start of a course

like this, because there are a number of challenges

that you will face over the next 13

weeks regarding this material.

And I've always thought that it would

be helpful for the instructor to let me know where

those challenges might come from,

and what I should do in advance to prepare

for those challenges.

So I'm going to do that at the end of this hour and a half.

For next time I'd like you to read Brealey and Myers,

chapters one and two.

We are going to be covering that today as well as next Monday.

So please keep up with your readings.

And at the end of this lecture, I

will talk a bit about the course requirements

and other aspects of the course mechanics.

Any questions?

All right, let me start with some motivation

about why you might want to study finance

and why finance is so important.

And I've always found that with motivation it's really best

to do it in a personal way.

That is, to try to find an individual or a group

of individuals that personify a particular discipline

or endeavor.

And so there are three people that I'd

like to introduce you to.

I suspect you'll know at least two out of the three,

but my guess is you won't know all of them.

The first person-- oh, before I do