SOLUTION MANUALFOR INVESTMENTS BY BODIE KANE MARCUS MOHANTY
SOLUTION
MANUAL FOR
INVESTMENT
S BY BODIE
KANE
MARCUS
MOHANTY
1-1
,SOLUTION MANUALFOR INVESTMENTS BY BODIE KANE MARCUS MOHANTY
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 That Allow Them To Manage Their
Portfolios Of Financial Assets More Efficiently. Because Bundling And
Unbundling Creates Financial Products With New Properties And
Sensitivities To Various Sources Of Risk, It Allows Investors To Hedge
Particular Sources Of Risk More Efficiently.
2. Securitization Requires Access To A Large Number Of Potential Investors.
To Attract These Investors, The Capital Market Needs:
(1) A Safe System Of Business Laws And Low Probability Of
Confiscatory Taxation/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 Market Participants To Bypass Intermediaries. For
Example, Mortgage-Backed Securities Channel Funds To The Housing
Market Without Requiring That Banks Or Thrift 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 Investments 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 Supply Of Financial Assets Would Make Financing More Difficult,
Thereby Increasing The Cost Of Capital. A Higher Cost Of Capital Results
In Less Investment And Lower Real Growth.
1-2
,SOLUTION MANUALFOR INVESTMENTS BY BODIE KANE MARCUS MOHANTY
5. Even If The Firm Does Not Need To Issue Stock In Any Particular Year, The
Stock Market Is Still Important To The Financial Manager. The Stock Price
Provides Important Information About How The Market 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 Might 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 Attractive To Investors Since Investors Know That,
When They Wish To, They Will Be Able To Sell Their Shares. This In Turn
Makes Investors More Willing To Buy Shares In A Primary Offering, And Thus
Improves 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 Liability.
7. 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 Microsoft Stock. 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.
1-3
, SOLUTION MANUALFOR INVESTMENTS BY BODIE KANE MARCUS MOHANTY
8. A
. Liabilities &
Assets
Shareholders‟ Equity
Cash $ 70,000 Bank Loan $ 50,000
Computers 30,000 Shareholders‟ 50,000
Equity
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‟ 50,000
Equity
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‟ 100,000
Equity
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 Low Ratio Of Real Assets To Total Assets. When It
Is In Full Production, It Has A High Ratio Of Real Assets To Total
Assets. When The Project "Shuts Down" And The Firm Sells It Off For
Cash, Financial Assets Once Again Replace Real Assets.
9. For Commercial Banks, The Ratio Is:
$107.5/$10,410.9 = 0.010 For 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 Financial Institutions Is To Make Loans; Which Are
Financial Assets For Financial Institutions.
10. A. Primary-Market Transaction
b. Derivative Assets
1-4
SOLUTION
MANUAL FOR
INVESTMENT
S BY BODIE
KANE
MARCUS
MOHANTY
1-1
,SOLUTION MANUALFOR INVESTMENTS BY BODIE KANE MARCUS MOHANTY
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 That Allow Them To Manage Their
Portfolios Of Financial Assets More Efficiently. Because Bundling And
Unbundling Creates Financial Products With New Properties And
Sensitivities To Various Sources Of Risk, It Allows Investors To Hedge
Particular Sources Of Risk More Efficiently.
2. Securitization Requires Access To A Large Number Of Potential Investors.
To Attract These Investors, The Capital Market Needs:
(1) A Safe System Of Business Laws And Low Probability Of
Confiscatory Taxation/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 Market Participants To Bypass Intermediaries. For
Example, Mortgage-Backed Securities Channel Funds To The Housing
Market Without Requiring That Banks Or Thrift 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 Investments 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 Supply Of Financial Assets Would Make Financing More Difficult,
Thereby Increasing The Cost Of Capital. A Higher Cost Of Capital Results
In Less Investment And Lower Real Growth.
1-2
,SOLUTION MANUALFOR INVESTMENTS BY BODIE KANE MARCUS MOHANTY
5. Even If The Firm Does Not Need To Issue Stock In Any Particular Year, The
Stock Market Is Still Important To The Financial Manager. The Stock Price
Provides Important Information About How The Market 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 Might 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 Attractive To Investors Since Investors Know That,
When They Wish To, They Will Be Able To Sell Their Shares. This In Turn
Makes Investors More Willing To Buy Shares In A Primary Offering, And Thus
Improves 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 Liability.
7. 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 Microsoft Stock. 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.
1-3
, SOLUTION MANUALFOR INVESTMENTS BY BODIE KANE MARCUS MOHANTY
8. A
. Liabilities &
Assets
Shareholders‟ Equity
Cash $ 70,000 Bank Loan $ 50,000
Computers 30,000 Shareholders‟ 50,000
Equity
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‟ 50,000
Equity
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‟ 100,000
Equity
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 Low Ratio Of Real Assets To Total Assets. When It
Is In Full Production, It Has A High Ratio Of Real Assets To Total
Assets. When The Project "Shuts Down" And The Firm Sells It Off For
Cash, Financial Assets Once Again Replace Real Assets.
9. For Commercial Banks, The Ratio Is:
$107.5/$10,410.9 = 0.010 For 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 Financial Institutions Is To Make Loans; Which Are
Financial Assets For Financial Institutions.
10. A. Primary-Market Transaction
b. Derivative Assets
1-4
