Bodie6emidtr08.IMS - CHAPTER 1 THE INVESTMENT ENVIRONMENT 1...

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1-1 CHAPTER 1 THE INVESTMENT ENVIRONMENT 1. a. Cash is a financial asset because it is the liability of the government. b. No. The cash does not directly add to the productive capacity of the economy. c. Yes. You can buy more goods and services than previously. d. If the economy is already operating at full capacity, and you now command the additional purchasing power provided by the $100 billion, then your increased ability to purchase goods must be offset by a decrease in the ability of others to purchase goods. Thus, the other individuals in the economy can be made worse off by your discovery. 2. 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 (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; cash 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 stock in Microsoft. If Microsoft issues new shares in order to pay Lanni, then this would represent the creation of new financial assets. d. Lanni exchanges one financial asset (1,500 shares of stock) for another ($120,000). Lanni 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 no longer exists. 3. a. Assets Liabilities & 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 to total assets = $30,000/$100,000 = 0.30
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1-2 b. Assets Liabilities & Shareholders’ equity Cash $ 5,000 Bank loan $ 50,000 Software product* 65,000 Shareholders’ equity 50,000 Computers 30,000 Total $100,000 Total $100,000 *Valued at cost Ratio of real to total assets = $95,000/$100,000 = .95 c. Assets Liabilities & Shareholders’ equity Cash $ 5,000 Bank loan $ 50,000 Microsoft shares $120,000 Shareholders’ equity 105,000 Computers 30,000 Total $155,000 Total $155,000 Ratio of real to total assets = $30,000/$155,000 = .19 Conclusion: when the firm starts up and raises working capital, it will be characterized by a low ratio of real to total assets. When it is in full production, it will have a high ratio of real assets. When the project "shuts down" and the firm sells it off for cash, financial assets once again replace real assets. 4. Mutual funds accept funds from small investors and invest, on behalf of these investors, in the national and international securities markets. Pension funds accept funds and then invest, on behalf of current and future retirees, thereby channeling funds from one sector of the economy to another. Venture capital firms pool the funds of private investors and invest in start-up firms. Banks accept deposits from customers and loan those funds to businesses, or use the funds to buy securities of large corporations.
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Bodie6emidtr08.IMS - CHAPTER 1 THE INVESTMENT ENVIRONMENT 1...

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