Solution Manual for Investments , Ninth Canadian Edition

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Bodie et al.Investments9thCanadian EditionSolutions Manual1-1CHAPTER 1:THEINVESTMENTENVIRONMENTPROBLEM SETS:1.While it is ultimatelytrue that real assets determine the material well-being of an economy,financial innovation in the form of bundling and unbundling securities createsopportunitiesfor investors to form more efficient portfolios. Both institutional and individual investorscan benefit when financial engineering creates new products that allow them to managetheir portfolios of financial assets more efficiently. Bundling and unbundling createfinancial products with new properties and sensitivities to various sources of riskthatallowsinvestors toreduce volatility by hedgingparticular sources of risk more efficiently.2.Securitization requires access to a large number of potential investors.To attract theseinvestors, the capital market needs:1.Asafe system of business laws and low probability of confiscatorytaxation/regulation;2.Awell-developed investment banking industry;3.Awell-developed system of brokerage and financial transactions;and4.Awell-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 formarket participants to bypass intermediaries.For example, mortgage-backed securitieschannel funds to the housing market without requiring that banks or thrift institutionsmake loans from their own portfolios.Securitization works well and can benefit many,but only if the market for these securities is highly liquid. As securitization progresses,however, and financial intermediaries lose opportunities, they must increase otherrevenue-generating activities such as providing short-term liquidity to consumers andsmall business and financial services.4.The existence of efficient capital markets and the liquid trading of financial assets makeiteasy for large firms to raise the capital needed to finance their investments in real assets.IfFord, for example, could not issue stocks or bonds to the general public, it would havea far more difficult time raising capital.Contraction of the supply of financial assetswould make financing more difficult, thereby increasing the cost of capital.A higher costof capitalresults inless investment and lower real growth.5.Even if the firm does not need to issue stock in any particular year, the stock market is stillimportant to the financial manager.Thestock price provides important information abouthow the market values the firm's investment projects.For example, if the stock price risesconsiderably, managers might conclude that the market believes the firm's future prospectsare bright.This might be a useful signal to the firm to proceed with an investment such as anexpansion of the firm's business.

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