CH 1: Background

Question 1

What is investment?

Answer 1

. the sacrifice or expenditure of a resource in an effort to benefit later.
. A vehicle to make money.

Question 2

What are the themes of investments?

Answer 2

1. Risk and Return are positively related
2. Markets are efficient
3. Diversification destroys some risk
4. The value of a financial or economic asset is the value of its future cash flows

Question 3

What is the difference b/w financial and economic (real) assets?

Answer 3

1. Financial Assets: (securities) are claims on real assets or the income generated by them.
   They do not have direct effect on economic activities
   They are represented in economic (GDP) and accounting balance sheets.
   Financial Assets of everybody should add up to $0
2. Real: (physical) used to produce goods and services
   The are only represented in Economic balance sheet

Question 4

What is financial intermediary?

Answer 4

Institution that connect borrowers and lenders by accepting funds from lenders and loaning funds to borrowers.
They provide:
1. access to the market (to the borrowers)
2. allow for diversification of risk (despite the fact that individual investors doesn’t have a lot of money)
3. assessment and monitor of the credit risk for the borrowers

Question 5

What is investment banker?

Answer 5

financial intermediary specializing in the sale of new securities to the public, typically by underwriting the issue.

Question 6

Why are financial markets important?

Answer 6

(a) Information
1. Stock prices are an assessment of a firm’s current performance and future prospects,
2. determine capital allocation in the economy efficiently (directing capital to fields with higher prospect)
(b) Shift of consumption
1. if you have excess, you can store your wealth in financial assets. When needed you can sell them.
(c) Allocation of risk
1. capital markets allow risk to be borne by investors most willing to bear that risk. (each one allowed the amount of risk desired)
(d) Separation of ownership
1. F. M. provide some guidance for shareholders, on the objectives of the firm.

Question 7

define a hedge fund!

Answer 7

a limited partnership of investors that uses high risk methods, such as investing with borrowed money, in hopes of realizing large capital gains.