Essay on Solutions Essentials of Investments

18054 Words Oct 24th, 2015 73 Pages
Chapter 01
Investments: Background and Issues

1. Equity is a lower priority claim and represents an ownership share in a corporation, whereas debt has a higher priority claim, but does not have an ownership interest. Debt also pays a specified cash flow over a specific period and the claim will eventually expire. Equity has an indefinite life.

2. A derivative asset provides a payoff that depends on the values of a primary asset. The primary asset has a claim on the real assets of a firm, whereas a derivative asset does not.

3. Asset allocation is the allocation of an investment portfolio across broad asset classes. Security selection is the choice of specific securities within each asset class.

4. Agency
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Real assets still exist, yet the value of the claims on those assets or the cash flows they generate do change. Thus, the difference.

9. a. The bank loan is a financial liability for Lanni. Lanni's IOU is the bank's financial asset. The cash Lanni receives is a financial asset. The new financial asset created is Lanni's promissory note held by the bank.

b. The cash paid by Lanni is the transfer of a financial asset to the software developer. In return, Lanni gets a real asset, the completed software. No financial assets are created or destroyed. Cash is simply transferred from one firm to another.

c. Lanni sells the software, which is a real asset, to Microsoft. In exchange Lanni receives a financial asset, 1,500 shares of Microsoft stock. If Microsoft issues new shares in order to pay Lanni, this would constitute the creation of new financial asset.

d. In selling 1,500 shares of stock for $120,000, Lanni is exchanging one financial asset for another. In paying off the IOU with $50,000 Lanni is exchanging financial assets. The loan is "destroyed" in the transaction, since it is retired when paid.

10. a. [pic] b. [pic]

c. [pic]

11. Ultimately, real assets determine the material well being of an economy. Individuals can benefit when financial engineering creates new

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