Chapter 01 - The Investment Environment
SOLUTION MANUAL FOR
Investments
Author: Bodie
13th edition
1-1
,Chapter 01 - The Investment Environment
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 ThatAllow 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 TheseInvestors, The Capital Market Needs:
(1) A Safe System Of Business Laws And Low Probability Of
ConfiscatoryTaxation/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
SecuritiesChannel 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 InvestmentAnd Lower Real Growth.
1-2
,Chapter 01 - The Investment Environment
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 AsAn 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 TheLiability.
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,
LanniGets 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 PayLanni, 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 RetiredWhen Paid Off And No Longer Exists.
1-3
, Chapter 01 - The Investment Environment
8. A
. Liabilities &
Assets
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 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’ Equity 50,000
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’ Equity 100,000
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 ByA 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 ItOff For Cash, Financial Assets Once Again Replace
Real Assets.
9. For Commercial Banks, The Ratio Is: $107.5/$10,410.9 =
0.010For Non-Financial Firms, The Ratio Is:
$13,295/$25,164 = 0.528
The Difference Should Be Expected Primarily Because The Bulk Of The Business
OfFinancial Institutions Is To Make Loans; Which Are Financial Assets For
Financial Institutions.
10. A. Primary-Market Transaction
b. Derivative Assets
c. Investors Who Wish To Hold Gold Without The Complication And Cost Of
1-4
SOLUTION MANUAL FOR
Investments
Author: Bodie
13th edition
1-1
,Chapter 01 - The Investment Environment
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 ThatAllow 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 TheseInvestors, The Capital Market Needs:
(1) A Safe System Of Business Laws And Low Probability Of
ConfiscatoryTaxation/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
SecuritiesChannel 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 InvestmentAnd Lower Real Growth.
1-2
,Chapter 01 - The Investment Environment
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 AsAn 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 TheLiability.
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,
LanniGets 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 PayLanni, 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 RetiredWhen Paid Off And No Longer Exists.
1-3
, Chapter 01 - The Investment Environment
8. A
. Liabilities &
Assets
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 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’ Equity 50,000
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’ Equity 100,000
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 ByA 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 ItOff For Cash, Financial Assets Once Again Replace
Real Assets.
9. For Commercial Banks, The Ratio Is: $107.5/$10,410.9 =
0.010For Non-Financial Firms, The Ratio Is:
$13,295/$25,164 = 0.528
The Difference Should Be Expected Primarily Because The Bulk Of The Business
OfFinancial Institutions Is To Make Loans; Which Are Financial Assets For
Financial Institutions.
10. A. Primary-Market Transaction
b. Derivative Assets
c. Investors Who Wish To Hold Gold Without The Complication And Cost Of
1-4
