Chap001 - Chapter 01 - Investments: Background and Issues...

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Chapter 01 - Investments: Background and Issues 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 problems are conflicts of interest between managers and stockholders. They are addressed through the corporate governance process via audits, compensation structures and board elections. 5. Real assets are assets used to produce goods and services. Financial assets are claims on real assets or the income generated by them. 6. Investment bankers are firms specializing in the sale of new securities to the public, typically by underwriting the issue. Commercial banking processes the financial transactions of businesses such as checks, wire transfers and savings account management. 7. a. The factory is a real asset that is created. The loan is a financial asset that is created by the transaction. b. When the loan is repaid, the financial asset is destroyed but the real asset continues to exist. c. The cash is a financial asset that is traded in exchange for a real asset, inventory. 8. a. No. The real estate in existence has not changed, merely the perception of its value. b. Yes. The financial asset value of the claims on the real estate has changed, thus the balance sheet of individual investors has been reduced. 1-1
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Chapter 01 - Investments: Background and Issues c. The difference between these two answers reflects the difference between real and financial asset values. 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.
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This note was uploaded on 11/27/2010 for the course ECON ECON132A taught by Professor Ahmadsohrabian during the Spring '10 term at UC Irvine.

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Chap001 - Chapter 01 - Investments: Background and Issues...

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