Solution and Answer Guide: AdairNofsinger, Foundations of Investments, 1e, Chapter 01: Introduction to Investments

Solution and Answer Guide: Adair/Nofsinger, Foundations of Investments, 1e, Chapter 01: Introduction to Investments 1 © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Solution and Answer Guide

Adair/Nofsinger, Foundations of Investments, 1e, Chapter 01: Introduction to

Investments Table of Contents Questions .......................................................................................................................................... 2 Case Study ......................................................................................................................................... 7 All Files Download Link At The End of This File. 1 / 4

Solution and Answer Guide: Adair/Nofsinger, Foundations of Investments, 1e, Chapter 01: Introduction to Investments 2 © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Questions

• Real vs. Financial Assets. Compare and contrast real assets with financial assets.

(LO 1-1)

Answer:

Real assets are assets that either contribute to production or create income or wealth. Most real assets have a physical existence, with the most common examples being real estate and land, machinery, precious metals, and commodities. However, certain intangible assets, such as patents, trademarks, and intellectual property, can also create income, so they are considered real assets, too.Financial assets are nonphysical assets whose values are derived from either a contractual claim on real assets or the cash flows produced by those real assets.Examples of financial assets include stocks, bonds, cash, bank deposits, certificate of deposits (CDs), loans made, corporate receivables, derivative securities, and cryptocurrencies.The difference between real and financial assets is that real assets are used to produce economic output, while financial assets serve to allocate how that output is divided up.

• Capital Flow: Corporate vs. Investor View. Regarding the flow of capital between

investors, corporations, and the government, how does the view of the corporation differ from the view of the investor? (LO 1-2)

Answer:

Investors provide money to companies as capital. The companies use that capital to invest in projects. When the projects return cash flows to the firm, any profits are usually subject to taxation by federal, state, and/or local governments. Some of the remaining after-tax profits are retained in the firm to fund future operations and the rest are paid out to investors.The corporation view of this system focuses on decisions concerning (1) the form and amount of funding received from investors, (2) which projects to put the funds in, (3) how to manage taxes, and (4) how much of the revenues of existing projects to keep versus paying back the firm’s investors.The investors view of this system focus on decisions such as (1) which firms and what types of financial instruments to invest in, (2) what terms and maturities of return cash flows to seek, and (3) how to best manage the timing and amounts of taxes paid.

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Solution and Answer Guide: Adair/Nofsinger, Foundations of Investments, 1e, Chapter 01: Introduction to Investments 3 © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

• Capital Flow Factors. What are the complicating factors that make the flow of

capital among corporations and investors uncertain? (LO 1-2)

Answer:

Some of the complicating factors that make the flow of capital among corporations

and investors uncertain are the following:

The returns from projects in which firms have invested are not always positive, and those investments are not always profitable. The demand for the goods and services produced by those projects are often subject to change over time in a competitive macroeconomic environment. That change could negatively affect a firm’s operations as well as its ability to sell those products and services at their hoped-for prices.Firms’ earnings can fluctuate and are not always as expected. Therefore, a firm cannot guarantee the amount and timing of the returns they can give back to investors. Even if firms could perfectly forecast the before-tax returns from their operations, they have no control over government tax regulations that impact final cash flows.Furthermore, the prices of financial assets change because of those uncertainties, and as more information arrives about a particular company, the valuation of those assets also changes, which causes the price that the investor pays for those assets to change as well. Finally, there is a very large number of financial assets in which investors can invest, which make investing choices more complicated.

• Valuation. What factors are involved in assessing value? (LO 1-3)

Answer:

The valuation of assets is the process of determining what an asset is worth today. It is based on finding today’s value of all the expected future cash flows that the asset will provide over the life of the asset.From this definition, we see that there are three factors involved in valuing the asset: (1) the life of the asset, (2) the expected cash flows the asset will provide over its life, and (3) the risk of those cash flows to determine the discount rate used to find the present value of the cash flows.Those factors vary from one asset to the other and make the valuation process complicated. For example, the expected cash flows on bonds are easier to calculate, while the expected cash flows on stocks are much more difficult to predict. Some assets have finite lives, while others have infinite lives. Also, the riskiness of assets is not the same, which requires different discount rates.

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Solution and Answer Guide: Adair/Nofsinger, Foundations of Investments, 1e, Chapter 01: Introduction to Investments 4 © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

• Risk Aversion. What are the ramifications of an investor being risk averse? (LO 1-3)

Answer:

It is assumed that most rational investors are generally risk averse. This means that they will only take a risk when they feel they will be compensated for it with a higher expected return. But that doesn’t mean they’re all equally risk averse. An investor with a long-time horizon and considerable additional savings can afford to take risks that someone with a shorter horizon and less savings would be uncomfortable with.Because of the differences in risk aversion, people invest in different types of assets with different risk profiles. A more risk-averse investor would invest in less risky assets, such as government bonds, while a less risk averse investor would invest in riskier assets, such as stocks.However, the downside of being risk-averse is in the missed opportunity that comes along with taking on higher-risk, higher-reward investments if it leads you to avoid them altogether.

• Market Efficiency. Why might a market be efficient? (LO 1-4)

Answer:

Financial markets are competitive markets where investors participate freely in the purchase and sale of stocks and bonds. Virtually anyone, from a child to a grandparent, may own an investment, even if it is just a savings account.Competitive financial markets also tend to be extremely efficient at making sure that new information is rapidly taken into account by valuations. If new information suggests that cash flows from different assets will be different than previously thought, the market rapidly adjusts the asset’s price. Thus, an efficient financial market implies that a security’s current price embodies all the known information concerning its potential return and risk.A truly efficient market eliminates the possibility of beating the market, because any information available to any trader is already incorporated into the market price. As the quality and amount of information increases, the market becomes more efficient reducing opportunities for arbitrage and above market returns.

• Asset-Specific Risk. What is an asset-specific risk and how does it relate to portfolio

diversification? (LO 1-5)

Answer:

An asset-specific risk, which is also called unsystematic risk or diversifiable risk, is a type of risk that is only related to one particular asset and doesn’t affect the other assets in the market. For example, if the rating on Walmart’s bonds is downgraded,

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