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.

1. The factory is a real asset that is created. The loan is a financial asset that is

   created by the transaction.

2. When the loan is repaid, the financial asset is destroyed but the real asset continues to exist.

3. The cash is a financial asset that is traded in exchange for a real asset, inventory.

8.

1. No. The real estate in existence has not changed, merely the perception of its

   value.

2. Yes. The financial asset value of the claims on the real estate has changed, thus the balance sheet of individual investors has been reduced.

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.

1. 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.

2. 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.

3. 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.

4. 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.