IPO (see Business Snapshot 2.1). The conflicts of interest section gets students thinking
about important issues that they may not have addressed in other courses.
The Further Questions are straightforward and can be used in a number of differ-
ent ways. For example, Problem 2.15 can be discussed in conjunction with Section 2.2.
Problem 2.17 can be discussed when Dutch auctions are covered.
Chapter 3: Insurance Companies and Pension Funds
Apart from updating, this chapter is little different from Chapter 3 of the third edition.
The chapter starts by discussing different types of life insurance contracts and annuity
contracts. It explains the investment component of life insurance contracts and the tax
advantages of these contracts. (The discussion of tax has been improved for the fourth
edition.) Mortality tables enable students to calculate premiums for simple life insurance
contracts. (It can be pointed out that the calculations are similar to those used to determine
the spread for credit default swaps in Appendix K.) The chapter then moves on to discuss
property-casualty insurance, health insurance, moral hazard, adverse selection, the balance
sheets of insurance companies, and pension plans.
Students should understand the types of insurance contracts in the market and the
nature of the risks in life insurance, property-casualty insurance, and health insurance.
They should appreciate the nature of moral hazard and adverse selection. (It is interesting
that individuals who buy life insurance die earlier on average than individuals who buy
annuities.) They should understand why property-casualty companies need more capital.
I consider it important not to cover the pension fund material too quickly. Students
should understand the differences between the two types of pension plans and the risks they
pose for companies. Why are defined benefit pension plans 60% invested in equities when
their liabilities are “bond-like”? The answer appears to be that bonds do not provide a
high enough return for them to be able to meet their obligations. Another way of putting
this is that the only way pension plans have a chance of meeting their obligations is if
equity markets perform well. To emphasize these points, I go through Problem 3.15 in
class (because the calculations are simple) and assign Problem 3.19.
Problems 3.16, 3.17, and 3.19 can be used for assignments. Problem 3.18 is appropriate
for class discussion.
Chapter 4: Mutual Funds and Hedge Funds
Apart from updating, this chapter is little different from Chapter 4 of the third edition.
The chapter explains the differences between open-end mutual funds, closed-end mutual
funds, and ETFs. It reviews the evidence on the performance of mutual funds and discusses
the increasing popularity of index funds. It explains how hedge funds differ from mutual
funds. It considers the incentives of hedge fund managers, describes different hedge fund
strategies, and reviews their performance.
Some students are usually unwilling to accept that a) actively traded mutual funds
do not outperform stock indices and b) that the past performance of a mutual fund is
not a good guide to its future performance. I spend some time explaining Jensen’s classic
results and point out that many other studies conducted since Jensen have reached similar
conclusions. I discuss the growth of index funds. I also explain carefully how ETFs work
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