Chapter 1, The Investment Environment Video Solutions, Investments

Problem 1

Financial engineering has been disparaged as nothing more than paper shuffling. Critics argue that resources used for rearranging wealth (i.e., bundling and unbundling financial assets) might be better spent on creating wealth (i.e., creating real assets). Evaluate this criticism. Are any benefits realized by creating an array of derivative securities from various primary securities?

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Problem 2

Why would you expect securitization to take place only in highly developed capital markets?

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Problem 3

What is the relationship between securitization and the role of financial intermediaries in the economy? What happens to financial intermediaries as securitization progresses?

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Problem 4

Although we stated that real assets constitute the true productive capacity of an economy, it is hard to conceive of a modern economy without well-developed financial markets and security types. How would the productive capacity of the U.S. economy be affected if there were no markets in which to trade financial assets?

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01:03

Problem 5

Firms raise capital from investors by issuing shares in the primary markets. Does this imply that corporate financial managers can ignore trading of previously issued shares in the secondary market?

Jennifer Stoner

Numerade Educator

Problem 6

Suppose housing prices across the world double.
a. Is society any richer for the change?
b. Are homeowners wealthier?
c. Can you reconcile your answers to (a) and (b)? Is anyoae worse off as a result of the change?

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Problem 7

Lanni Products is a start-up computer software development firm. It currently owns computer equipment worth $$\$ 30,000$$ and has cash on hand of $$\$ 20,000$$ contributed by Lanni's owners. For each of the following transactions, identify the real and/or financial assets that trade hands. Are any financial assets created or destroyed in the transaction?
a. Lanni takes out a bank loan. It receives $$\$ 50,000$$ in cash and signs a note promising to pay back the loan over 3 years.
b. Lanni uses the cash from the bank plus $$\$ 20,000$$ of its own funds to finance the development of new financial planning software.
c. Lanni sells the software product to Microsofl, which will market it to the poblic under the Microsoft name. Lanni accepts payment in the form of 500 shares of Microsoft stock.
d. Lanni sells the shares of stock for $$\$ 280$$ per share and uses part of the proceeds to pay off the bank loan.

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Problem 8

Reconsider Lanni Products from the previous problem.
a. Prepare its balance sheet just after it gets the bank loan. What is the ratio of real assets to total assets?
b. Prepare the balance sheet after Lanni spends the $$\$ 70,000$$ to develop its software product. What is the ratio of real assets to total assets?
c. Prepare the balance sheet after Lanni accepts the payment of shares from Microsoft. What is the ratio of real assets to total assets?

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Problem 9

Examine the balance sheet of commercial banks in Table 1.3.
a. What is the ratio of real assets to total assets?
b. What is the ratio of real assets to total assets for nonfinancial firms (Table 1.4)?
c. Why should this difference be expected?

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Problem 10

Consider Figure 1A, which describes an issue of American gold certificates.
a. Is this issue a primary or secondary market transaction?
b. Are the certificates primitive or derivative assets?

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Problem 11

Discuss the advantages and disadvantages of the following forms of managerial compensation in terms of mitigating agency problems, that is, potential conflicts of interest between managers and shareholders.
a. A fixed salary.
b. Stock in the firm that must be held for five years.
c. A salary linked to the firm's profits.

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Problem 12

Oversight by large institutional investors or creditors is one mechanism to reduce agency problems. Why don't individual investors in the firm have the same incentive to keep an eyc on management?

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03:27

Problem 13

Give an example of three financial intermediaries and explain how they act as a bridge between small investors and large capital markets or corporations.

Pragya Ahuja

Numerade Educator

Problem 14

The average rate of return on investments in large stocks has outpaced that on investments in Treasury bills by about $8 \%$ since 1926. Why, then, does anyone invest in Treasury bills?

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Problem 15

What are some advantages and disadvantages of top-down versus bottom-up investing styles?

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01:32

Problem 16

You see an advertisement for a book that claims to show how you can make $$\$ 1$$ million with no risk and with no money down. Will you buy the book?

Harsh Gadhiya

Numerade Educator

01:47

Problem 17

Why do financial assets show up as a component of household wealth but not of national wealth? Why do financial assets still matter for the material well-being of an economy?

Nick Johnson

Numerade Educator

Problem 18

Wall Street firms have traditionally compensated their traders with a share of the trading profits that they generated. How might this practice have affected traders' willingness to assume risk? What agency problem can this practice engender?

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08:24

Problem 19

What reforms to the financial system might reduce its exposure to systemic risk?

Pragya Ahuja

Numerade Educator