Homework

1. Real assets are used to produce the goods and services created by an economy. It shows the productive capacity of the society. Financial assets do not represent a society’s wealth. They contribute indirectly to the productive capacity of the economy. Financial assets are part of an investor’s wealth, but not part of national wealth. They determine how the “national pie” is split up among investor by allocating the wealth of the economy.

Real assets used by a firm ultimately generate income. Financial assets are claims to the income generated by real assets.

Real assets appear only as assets in the balance sheet while financial assets appear on both sides of the balance sheets. So when we aggregate over all balance sheets in an economy, financial assets will cancel out, leaving only the sum of real assets as the net wealth of the aggregate economy.

2. Consumption Timing:

Financial assets help shift the consumption over the course of one’s lifetime, thereby allocating the consumption to periods that provide the greatest satisfaction.

Allocation of Risk:

Financial assets allow investors to invest according to their own risk preferences.

Separation of Ownership and management:

Since there is too much owners in a corporation, it’s impossible for all the owners to be in the management board. So the owners will hire the management board to manage the company. This also facilitates the trading of the financial assets as changes in ownerships won’t have great effect on the management level.

3. a) The discovery makes me richer.

b) The discovery does not make the society richer or poorer as it does not add to the production capacity of the society.

4. C.

Since DJIA is a price-weighted index, and all change by the same dollar amount, the increase brought by each stock is divided by the same divisor. Increase in the highest priced stock will bring the same effect as the lowest priced stock.

5. a) Bank discount rate

= (10000-9900)/10000 *360/120

= 3%

b) Bond equivalent yield

= (10000 – 9900) / 9900 * 365/120

= 3.07%

6. a) Initial value of Price-weighted index

= (40+70+12)/3

= 40.67

b) Initial Divisor:

(40+70+12)/D=100

D=1.22

The initial divisor is 1.22.

c) New divisor:

(40+70/2+12*600/900)/D=100