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Lecture 1

FINE 3200 Lecture Notes - Lecture 1: Real Estate Investment Trust, Investment Banking, United States Treasury Security


Department
Finance
Course Code
FINE 3200
Professor
George Klar
Lecture
1

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CHAPTER 1
THE INVESTMENT ENVIRONMENT
1. a. No. The increase in price did not add to the productive capacity of the
economy.
b. Yes, the value of the equity held in these assets has doubled.
c. Future homeowners as a whole are worse off, since mortgage liabilities have
also increased. In addition, this housing price bubble will eventually burst and
society as a whole (and most likely taxpayers) will endure the damage.
2. a. The bank loan is a financial liability for Lanni. (Lannis IOU is the banks
financial asset). The cash Lanni receives is a financial asset. The new financial
asset created is Lannis promissory note (i.e., Lannis IOU to the bank).
b. Lanni transfers financial assets (cash) to the software developers. In return,
Lanni gets 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 stock in Microsoft. If Microsoft issues new
shares in order to pay Lanni, only then would this 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 retired when paid off and no longer exists.
3. a. Lanni’s Balance Sheet
(after bank loan)
Assets
Liabilities & 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 to total assets = $30,000/$100,000 = .30.
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b. Lanni’s Balance Sheet
(after development of product)
Assets
Liabilities & Shareholders Equity
Cash
$ 5,000
Bank loan
$ 50,000
Software product*
65,000
Shareholders equity
50,000
Computers
30,000
Total
$100,000
Total
$100,000
*Valued at cost.
Ratio of real to total assets = $95,000/$100,000 = .95.
c. Lanni’s Balance Sheet
(after accepting payment of shares)
Assets
Liabilities & Shareholders equity
Cash
$ 5,000
Bank loan
$ 50,000
Microsoft shares
$120,000
Shareholders equity
105,000
Computers
30,000
Total
$155,000
Total
$155,000
Ratio of real to total assets = $30,000/$155,000 = .19.
Conclusion: When the firm starts up and raises working capital, it will be
characterized by a low ratio of real to total assets. When it is in full
production, it will have a high ratio of real assets. When the project shuts
down and the firm sells it off for cash, financial assets once again replace real
assets.
4. Mutual funds accept funds from small investors and invest, on behalf of these
investors, in the national and international securities markets. Pension funds
accept funds and then invest, on behalf of current and future retirees, thereby
channelling funds from one sector of the economy to another. Venture capital
firms pool the funds of private investors and invest in start-up firms. Banks accept
deposits from customers and loan those funds to businesses, or use the funds to
buy securities of large corporations.
5. Securitization requires access to a large number of potential investors. To attract
them the capital market needs: (1) a safe system of business laws and low
probability of confiscatory taxation/regulation, (2) a well-developed investment
banking industry, (3) a well-developed system of brokerage and financial
transactions, and (4) well-developed information systems, particularly for
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