9. For commercial banks, the ratio is: $140.1/$11,895.1 = 0.0118
For non-financial firms, the ratio is: $12,538/$26,572 = 0.4719
The difference should be expected primarily because the bulk of the business of financial institutions is to make loans; which are financial assets for financial institutions.
10. a. Primary-market transaction
b. Derivative assets
c. Investors who wish to hold gold without the complication and cost of physical storage.
11. a. A fixed salary means that compensation is (at least in the short run) independent of the firm's success. This salary structure does not tie the manager’s immediate compensation to the success of the firm. However, the manager might view this as the safest compensation structure and therefore value it more highly.
b. A salary that is paid in the form of stock in the firm means that the manager earns the most when the shareholders’ wealth is maximized. Five years of vesting helps align the interests of the employee with the long-term performance of the firm. This structure is therefore most likely to align the interests of managers and shareholders. If stock compensation is overdone, however, the manager might view it as overly risky since the manager’s career is already linked to the firm, and this undiversified exposure would be exacerbated with a large stock position in the firm.
c. A profit-linked salary creates great incentives for managers to contribute to the firm’s success. However, a manager whose salary is tied to short-term profits will be risk seeking, especially if these short-term profits determine salary or if the compensation structure does not bear the full cost of the project’s risks. Shareholders, in contrast, bear the losses as well as the gains on the project, and might be less willing to assume that risk.
12. Even if an individual shareholder could monitor and improve managers’ performance, and thereby increase the value of the firm, the payoff would be small, since the ownership share in a large corporation would be very small. For example, if you own $10,000 of Ford stock and can increase the value of the firm by 5%, a very ambitious goal, you benefit by only: 0.05 ´ $10,000 = $500
In contrast, a bank that has a multimillion-dollar loan outstanding to the firm has a big stake in making sure that the firm can repay the loan. It is clearly worthwhile for the bank to spend considerable resources to monitor the firm.
13. 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 channeling 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.
14. Treasury bills serve a purpose for investors who prefer a low-risk investment. The lower average rate of return compared to stocks is the price investors pay for predictability of investment performance and portfolio value.
15. With a “top-down” investing style, you focus on asset allocation or the broad composition of the entire portfolio, which is the major determinant of overall performance. Moreover, top-down management is the natural way to establish a portfolio with a level of risk consistent with your risk tolerance. The disadvantage of an exclusive emphasis on top-down issues is that you may forfeit the potential high returns that could result from identifying and concentrating in undervalued securities or sectors of the market.
With a “bottom-up” investing style, you try to benefit from identifying undervalued securities. The disadvantage is that you tend to overlook the overall composition of your portfolio, which may result in a non-diversified portfolio or a portfolio with a risk level inconsistent with your level of risk tolerance. In addition, this technique tends to require more active management, thus generating more transaction costs. Finally, your analysis may be incorrect, in which case you will have fruitlessly expended effort and money attempting to beat a simple buy-and-hold strategy.