Conclusion: when the firm starts up and raises working capital, it is characterized by a low ratio of real assets to total assets. When it is in full production, it has a high ratio of real assets to total assets. When the project "shuts down" and the firm sells it off for cash, financial assets once again replace real assets.
9. a. For commercial banks, the ratio is: $134.3/$17,532.8 = 0.0077
b. For nonfinancial firms, the ratio is: $23,678/$45,464 = 0.5208
c. The difference should be expected primarily because the bulk of the business of financial institutions is to make loans and the bulk of the business of non-financial corporations is to invest in equipment, manufacturing plants, and property. The loans are financial assets for financial institutions, but the investments of non-financial corporations are real assets.
10. a. Primary-market transaction in which gold certificates are being offered to public investors for the first time by an underwriting syndicate led by JW Korth Capital.
b. The certificates are derivative assets because they represent an investment in physical gold, but each investor receives a certificate and no gold. Note that investors can convert the certificate into gold during the four-year period.
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, so a manager might not feel too compelled to work hard to maximize firm value. 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. The cost, both personal and financial to an individual investor, is likely to be prohibitive and would typically easily exceed any accrued benefits, in this case $500.
In contrast, a creditor, such as 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 domestic and international securities markets.
Pension funds accept funds and then invest in a wide range of financial securities, 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.