Investments 13th Edition
. .
by Zvi Bodie, Alex Kane, Alan J. Marcus
. . . . . . .
, CHAPTER 1: THE INVESTMENT ENVIRONMENT
. . . .
PROBLEM. SETS
1. Ultimately,.it.is.true.that.real.assets.determine.the.material. well-
being.of.an.economy..Nevertheless,.individuals.can.benefit.when.financial.engineering.creates
.new.products .t hat .allow.them.to. manage.their. portfolios. of. financial . assets. more.efficiently.. B
ecause.bundling.and.unbundling.creates.financial.products.with.new.properties.and.sensitiviti
es.to.various.sources.of.risk,.it.allows.investors.to.hedge.particular.sources.of.risk.more.efficie
ntly.
2. Securitization.requires.access.to.a.large.number.of.potential.investors.. To.attract.these.inve
stors,.the.capital.market.needs:
(1) a.safe.system.of.business.laws.and.low.probability.of.confiscatory.tax
ation/regulation;
(2) a. well-developed. investment. banking. industry;
(3) a. well-developed. system. of. brokerage. and. financial. transactions,. and;
(4) well-developed. media,. particularly. financial. reporting.
These. characteristics. are. found. in. (indeed. make. for). a. well-developed. financial. market.
3. Securitization.leads.to.disintermediation;.that.is,.securitization.provides.a.means.for.mark
et.participants.to.bypass.intermediaries.. For.example,.mortgage-
backed.securities.channel.funds.to.the.housing.market.without.requiring.that.banks.or.thrif
t.institutions.make.loans.from.their.own.portfolios..As.securitization.progresses,.financial.
intermediaries.must.increase.other.activities.such.as.providing.short-
term.liquidity.to.consumers.and.small.business,.and.financial.services.
4. Financial.assets.make.it.easy.for.large.firms.to.raise.the.capital.needed.to.finance.their.inves
tments.in.real.assets..If.General.Motors,.for.example,.could.not.issue.stocks.or.bonds.to.the.
general.public,.it.would.have.a.far.more.difficult.time.raising.capital..Contraction.of.the.sup
ply.of.financial.assets.would.make.financing.more.difficult,.thereby.increasing.the.cost.of.c
apital.. A.higher.cost.of.capital.results.in.less.investment.and.lower.real.growth.
,5. Even.if.the.firm.does.not.need.to.issue.stock.in.any.particular.year,.the.stock.market.is.still.impor
tant.to.the.financial.manager..The.stock.price.provides.important.information.about.how.the.m
arket.values.the.firm's.investment.projects..For.example,.if.the.stock.price.rises.considerably,.
managers.might.conclude.that.the.market.believes.the.firm's.future.prospects.are.bright..This.mi
ght.be.a.useful.signal.to.the.firm.to.proceed.with.an.investment.such.as.an.expansion.of.the.firm'
s.business.
In.addition,.the.fact.that.shares.can.be.traded.in.the.secondary.market.makes.the.shares.more.attr
active.to.investors.since.investors.know.that,.when.they.wish.to,.they.will.be.able.to.sell.their.shar
es..This.in.turn.makes.investors.more.willing.to.buy.shares.in.a.primary.offering,.and.thus.impro
ves.the.terms.on.which.firms.can.raise.money.in.the.equity.market.
6. a. Cash.is.a.financial.asset.because.it.is.the.liability.of.the.federal.government.
b. No..The.cash.does.not.directly.add.to.the.productive.capacity.of.the.economy.
c. Yes.
d. Society.as.a.whole.is.worse.off,.since.taxpayers,.as.a.group.will.make.up.for.the.liabili
ty.
7. a..The.bank.loan.is.a.financial.liability.for.Lanni..(Lanni's.IOU.is.the.bank's.financial.asset.).T
he.cash.Lanni.receives.is.a.financial.asset..The.new.financial.asset.created.is.Lanni's.pro
missory.note.(that.is,.Lanni’s.IOU.to.the.bank).
b. Lanni.transfers.financial.assets.(cash).to.the.software.developers.. In.return,.Lanni.gets
.a.real.asset,.the. completed. software.. No. financial . assets.are. created. or. destroyed;. cas
h.is.simply.transferred.from.one.party.to.another.
c. Lanni.gives.the.real.asset.(the.software).to.Microsoft.in.exchange.for.a.financial.asset,.1,
500.shares.of.Microsoft.stock.. If.Microsoft.issues.new.shares.in.order.to.pay.Lanni,.then.t
his.would.represent.the.creation.of.new.financial.assets.
d. Lanni.exchanges.one.financial.asset.(1,500.shares.of.stock).for.another.($120,000)..Lan
ni.gives.a.financial.asset.($50,000.cash).to.the.bank.and.gets.back.another.financial.asset.
(its.IOU).. The.loan.is."destroyed".in.the.transaction,.since.it.is.retired.when.paid.off.and.n
o.longer.exists.
, 8. a.
Liabilities.&
Assets
Shareholders’. equity
Cash $.70,000 Bank.loan $.50,000
Computers 30,000 Shareholders’.equity
50,000.Total $100,000 Total
$100,000
Ratio.of.real.assets.to.total.assets.=.$30,000/$100,000 .=.0.30
b.
Liabilities.&
Assets
Shareholders’. equity
Software. product* $.70,000 Bank.loan $.50,000
Computers 30,000 Shareholders’. equity 50,000
Total $100,000 Total $100,000
*Valued.at.cost
Ratio.of.real.assets.to.total.assets.=.$100,000/$100,000.=.1.0
c.
Liabilities.&
Assets
Shareholders’. equity
Microsoft.shares $120,000 Bank.loan $.50,000
Computers 30,000 Shareholders’. equity 100,000
Total $150,000 Total $150,000
Ratio.of.real.assets.to.total.assets.=.$30,000/$150,000 .=.0.20
Conclusion:.when.the.firm.starts.up.and.raises.working.capital,.it.is.characterized.by.a.lo
w.ratio.of.real.assets.to.total.assets..When.it.is.in.full.production,.it.has.a.high.ratio.of.real.a
ssets.to.total.assets.. When.the.project."shuts.down".and.the.firm.sells.it.off.for.cash,.financ
ial.assets.once.again.replace.real.assets.
9. For.commercial.banks,.the.ratio.is:.$107.5/$10,410.9 .=.0.010.Fo
r.non-financial.firms,.the.ratio.is:.$13,295/$25,164.=.0.528
The.difference.should.be.expected.primarily.because.the.bulk.of.the.business.of.financi
al.institutions.is.to.make.loans;.which.are.financial.assets.for.financial.institutions.
10. a. Primary-market. transaction
b. Derivative. assets
c. Investors.who.wish.to.hold.gold.without.the.complication.and.cost.of.physical.stor
age.
. .
by Zvi Bodie, Alex Kane, Alan J. Marcus
. . . . . . .
, CHAPTER 1: THE INVESTMENT ENVIRONMENT
. . . .
PROBLEM. SETS
1. Ultimately,.it.is.true.that.real.assets.determine.the.material. well-
being.of.an.economy..Nevertheless,.individuals.can.benefit.when.financial.engineering.creates
.new.products .t hat .allow.them.to. manage.their. portfolios. of. financial . assets. more.efficiently.. B
ecause.bundling.and.unbundling.creates.financial.products.with.new.properties.and.sensitiviti
es.to.various.sources.of.risk,.it.allows.investors.to.hedge.particular.sources.of.risk.more.efficie
ntly.
2. Securitization.requires.access.to.a.large.number.of.potential.investors.. To.attract.these.inve
stors,.the.capital.market.needs:
(1) a.safe.system.of.business.laws.and.low.probability.of.confiscatory.tax
ation/regulation;
(2) a. well-developed. investment. banking. industry;
(3) a. well-developed. system. of. brokerage. and. financial. transactions,. and;
(4) well-developed. media,. particularly. financial. reporting.
These. characteristics. are. found. in. (indeed. make. for). a. well-developed. financial. market.
3. Securitization.leads.to.disintermediation;.that.is,.securitization.provides.a.means.for.mark
et.participants.to.bypass.intermediaries.. For.example,.mortgage-
backed.securities.channel.funds.to.the.housing.market.without.requiring.that.banks.or.thrif
t.institutions.make.loans.from.their.own.portfolios..As.securitization.progresses,.financial.
intermediaries.must.increase.other.activities.such.as.providing.short-
term.liquidity.to.consumers.and.small.business,.and.financial.services.
4. Financial.assets.make.it.easy.for.large.firms.to.raise.the.capital.needed.to.finance.their.inves
tments.in.real.assets..If.General.Motors,.for.example,.could.not.issue.stocks.or.bonds.to.the.
general.public,.it.would.have.a.far.more.difficult.time.raising.capital..Contraction.of.the.sup
ply.of.financial.assets.would.make.financing.more.difficult,.thereby.increasing.the.cost.of.c
apital.. A.higher.cost.of.capital.results.in.less.investment.and.lower.real.growth.
,5. Even.if.the.firm.does.not.need.to.issue.stock.in.any.particular.year,.the.stock.market.is.still.impor
tant.to.the.financial.manager..The.stock.price.provides.important.information.about.how.the.m
arket.values.the.firm's.investment.projects..For.example,.if.the.stock.price.rises.considerably,.
managers.might.conclude.that.the.market.believes.the.firm's.future.prospects.are.bright..This.mi
ght.be.a.useful.signal.to.the.firm.to.proceed.with.an.investment.such.as.an.expansion.of.the.firm'
s.business.
In.addition,.the.fact.that.shares.can.be.traded.in.the.secondary.market.makes.the.shares.more.attr
active.to.investors.since.investors.know.that,.when.they.wish.to,.they.will.be.able.to.sell.their.shar
es..This.in.turn.makes.investors.more.willing.to.buy.shares.in.a.primary.offering,.and.thus.impro
ves.the.terms.on.which.firms.can.raise.money.in.the.equity.market.
6. a. Cash.is.a.financial.asset.because.it.is.the.liability.of.the.federal.government.
b. No..The.cash.does.not.directly.add.to.the.productive.capacity.of.the.economy.
c. Yes.
d. Society.as.a.whole.is.worse.off,.since.taxpayers,.as.a.group.will.make.up.for.the.liabili
ty.
7. a..The.bank.loan.is.a.financial.liability.for.Lanni..(Lanni's.IOU.is.the.bank's.financial.asset.).T
he.cash.Lanni.receives.is.a.financial.asset..The.new.financial.asset.created.is.Lanni's.pro
missory.note.(that.is,.Lanni’s.IOU.to.the.bank).
b. Lanni.transfers.financial.assets.(cash).to.the.software.developers.. In.return,.Lanni.gets
.a.real.asset,.the. completed. software.. No. financial . assets.are. created. or. destroyed;. cas
h.is.simply.transferred.from.one.party.to.another.
c. Lanni.gives.the.real.asset.(the.software).to.Microsoft.in.exchange.for.a.financial.asset,.1,
500.shares.of.Microsoft.stock.. If.Microsoft.issues.new.shares.in.order.to.pay.Lanni,.then.t
his.would.represent.the.creation.of.new.financial.assets.
d. Lanni.exchanges.one.financial.asset.(1,500.shares.of.stock).for.another.($120,000)..Lan
ni.gives.a.financial.asset.($50,000.cash).to.the.bank.and.gets.back.another.financial.asset.
(its.IOU).. The.loan.is."destroyed".in.the.transaction,.since.it.is.retired.when.paid.off.and.n
o.longer.exists.
, 8. a.
Liabilities.&
Assets
Shareholders’. equity
Cash $.70,000 Bank.loan $.50,000
Computers 30,000 Shareholders’.equity
50,000.Total $100,000 Total
$100,000
Ratio.of.real.assets.to.total.assets.=.$30,000/$100,000 .=.0.30
b.
Liabilities.&
Assets
Shareholders’. equity
Software. product* $.70,000 Bank.loan $.50,000
Computers 30,000 Shareholders’. equity 50,000
Total $100,000 Total $100,000
*Valued.at.cost
Ratio.of.real.assets.to.total.assets.=.$100,000/$100,000.=.1.0
c.
Liabilities.&
Assets
Shareholders’. equity
Microsoft.shares $120,000 Bank.loan $.50,000
Computers 30,000 Shareholders’. equity 100,000
Total $150,000 Total $150,000
Ratio.of.real.assets.to.total.assets.=.$30,000/$150,000 .=.0.20
Conclusion:.when.the.firm.starts.up.and.raises.working.capital,.it.is.characterized.by.a.lo
w.ratio.of.real.assets.to.total.assets..When.it.is.in.full.production,.it.has.a.high.ratio.of.real.a
ssets.to.total.assets.. When.the.project."shuts.down".and.the.firm.sells.it.off.for.cash,.financ
ial.assets.once.again.replace.real.assets.
9. For.commercial.banks,.the.ratio.is:.$107.5/$10,410.9 .=.0.010.Fo
r.non-financial.firms,.the.ratio.is:.$13,295/$25,164.=.0.528
The.difference.should.be.expected.primarily.because.the.bulk.of.the.business.of.financi
al.institutions.is.to.make.loans;.which.are.financial.assets.for.financial.institutions.
10. a. Primary-market. transaction
b. Derivative. assets
c. Investors.who.wish.to.hold.gold.without.the.complication.and.cost.of.physical.stor
age.
