Fin 327 - Review Questions

Quiz 1 Review Questions

Topic 1. Introduction

1. Explain the difference between financial assets and real assets.

Financial Assets Financial assets are non-real assets (do not produce anything) but we learn them because we need them because make society grow and you can invest without having to be in a certain place. Allows you to invest in your idea without the capital. Also allocates wealth, cross sectional. Time series point of you: (why do I need financial assets?). All procedures leading to retirement and your life come from financial assets or else not possible (time to save and borrow). Financial assets very important to modern life. Examples of Financial Assets: stocks, bonds, mutual funds, loans, options, futures. Real Assets are used to produce goods and services, property and plants, equipment, human capital

1. What’s the investment process? Which decision plays a determinant role?

Don’t chose specific stock first which security selection… is instead first allocate where you want the money invested then go the specifics (what kind of stock you want after). Asset allocation more important than security selection (choosing right stocks). More people talk about selection instead of allocation which is a mistake. Allocation shown is known as is top/bottom allocation you can go bottom/top as well if you know stocks doing well

1. Describe the main players in the financial market

Business Firms

Households

Governments – can be both borrowers and savers

Financial Intermediaries “Connectors of borrowers and lenders”

Commercial Banks

Investment companies

Insurance companies

Pension funds

Hedge funds

Investment Banks- Firms that specialize in the sale of new securities to the public, typically by underwriting the issue. Commercial and investment banks were separated by law from 1933 to 1999. Post 1999 large investment banks operated independently from commercial banks. In September 2008 end era of “wall street

4. What’s securitization? (Understand what happened to home mortgage securitization in

The recent financial crisis) Securitization is the act of pooling mortgages together, repackaging them, and selling as a financial product. They are then sold according to their level of risk from investment banks to investors in the market. It encourages lax mortgage lending because mortgage brokers didn’t have any incentives to check the households to see if they could keep up with the payments, as long as the loans could be sold in an investor.2. What key roles were rating agencies supposed to play in managing the risk associated with securitization? In particular, without a rating agency, why would it have been hard (if not impossible) for securitization to have emerged? Rating agencies were supposed to rate the bonds into different classes of bonds according to their level of risk. “They face pressure from issuers, who could shop around for the most favorable treatment, to provide generous ratings,”(Bodie 19). Without a rating agency, the level of risk would be unavailable to the investor and there would be little incentive to purchase the bonds since the likelihood of the owner defaulting on their mortgage would be unknown. The lack of rating agency disrupts the process of securitization as a whole.