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CHAPTER 1: THE INVESTMENT ENVIRONMENT
PROBLEM SETS
1. While it is ultimately true that real assets determine the material well-being of an
economy, financial innovation in the form of bundling and unbundling securities
2. Securitization requires access to a large number of potential investors. To attract
these investors, the capital market needs:
1. a safe system of business laws and low probability of confiscatory
taxation/regulation;
3. Securitization leads to disintermediation; that is, securitization provides a means
for market participants to bypass intermediaries. For example, mortgage-backed
securities channel funds to the housing market without requiring that banks or
4. The existence of efficient capital markets and the liquid trading of financial assets
make it easy for large firms to raise the capital needed to finance their investments
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5. Even if the firm does not need to issue stock in any particular year, the stock market
is still important to the financial manager. The stock price provides important
information about how the market values the firm’s investment projects. For example,
if the stock price rises considerably, managers might conclude that the market
6. a. No. The increase in price did not add to the productive capacity of the
economy.
7. a. The bank loan is a financial liability for Lanni, and a financial asset for the bank.
The cash Lanni receives is a financial asset. The new financial asset created is
Lanni’s promissory note to repay the loan.
b. Lanni transfers financial assets (cash) to the software developers. In return,
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8. a.
Assets
Liabilities &
Shareholders’ Equity
Computers
b.
Assets
Liabilities &
Shareholders’ Equity
Software product*
$ 70,000
Bank loan
$ 50,000
Computers
Total
$100,000
Total
$100,000
c.
Assets
Liabilities &
Shareholders’ Equity
Microsoft shares
$120,000
Bank loan
$ 50,000
Computers
Total
$150,000
Total
$150,000
9. For commercial banks, the ratio is: $166.1/$13,926.0 = 0.0119
For nonfinancial firms, the ratio is: $15,320/$30,649 = 0.4999
10. a. Primary-market transaction in which gold certificates are being offered to
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11. a. A fixed salary means that compensation is (at least in the short run)
independent of the firm’s success. This salary structure does not tie the manager’s
immediate compensation to the success of the firm, so a manager might not feel
too compelled to work hard to maximize firm value. However, the manager
12. Even if an individual shareholder could monitor and improve managers’ performance
and thereby increase the value of the firm, the payoff would be small, since the
ownership share in a large corporation would be very small. For example, if you own
13. Mutual funds accept funds from small investors and invest, on behalf of these
investors, in the domestic and international securities markets.
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14. Treasury bills serve a purpose for investors who prefer a low-risk investment.
15. With a top-down investing style, you focus on asset allocation or the broad
composition of the entire portfolio, which is the major determinant of overall
performance. Moreover, top-down management is the natural way to establish a
portfolio with a level of risk consistent with your risk tolerance. The disadvantage of
16. You should be skeptical. If the author actually knows how to achieve such returns, one
must question why the author would then be so ready to sell the secret to others.
17. Financial assets provide for a means to acquire real assets as well as an expansion
of these real assets. Financial assets provide a measure of liquidity to real assets
and allow for investors to more effectively reduce risk through diversification.
18. Allowing traders to share in the profits increases the traders’ willingness to
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19. Answers may vary, however, students should touch on the following: increased