Investment Environment Chapter 1 Quiz

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12 Questions

What legislation was passed in 2002 in response to ethics scandals such as Enron and HealthSouth?

Sarbanes-Oxley Act

What is the main focus of the Sarbanes-Oxley Act (SOX)?

Corporate governance

Which investment process approach involves asset allocation followed by selecting specific securities within each asset class?

Top-down approach

What theory suggests that the prices of securities fully reflect all available information?

Efficient market hypothesis

In competitive financial markets, what is the risk-return trade-off principle?

Higher-risk assets are priced to offer higher expected returns

What is the main implication of the efficient market hypothesis for investors?

Expecting to find bargains in security markets is rare

Which type of asset directly contributes to the productive capacity of the economy?

Land

What type of securities promises either a fixed stream of income or a stream of income determined by a specified formula?

Corporate Bond

In financial markets, what is the role of derivative securities?

Payoff depends on the value of other financial variables

What is the primary mechanism used to mitigate potential agency problems in corporations?

Monitoring from the board of directors

Which type of asset represents ownership share in a firm?

Common Stock

What is the main difference between real assets and financial assets?

Real assets directly contribute to the economy's productive capacity, unlike financial assets

Study Notes

Investments Overview

  • The chapter covers the investment environment, including the distinction between "real" and financial assets.

Real Assets vs. Financial Assets

  • Real assets are used to produce goods and services, examples: land, buildings, machines, and intellectual property.
  • Financial assets are claims to the income generated by real assets or claims on income from the government, examples: stocks, bonds.

Types of Financial Assets

  • Fixed-income securities promise a fixed stream of income or a stream determined by a specified formula, example: corporate bond.
  • Equity represents ownership share in a firm, example: common stock.
  • Derivative securities' payoff depends on the value of other financial variables, examples: stock prices, interest rates, exchange rates.

Financial Markets and the Economy

  • Financial markets play an informational role in the economy, helping in consumption timing and allocation of risk.
  • Separation of ownership and management can lead to agency problems, which can be mitigated by compensation plans, monitoring, and the threat of takeover.

Corporate Governance and Corporate Ethics

  • Corporate governance and ethics are crucial, as seen in scandals such as Enron, Rite Aid, and HealthSouth.
  • The Sarbanes-Oxley Act (2002) was passed in response to ethics scandals, focusing on corporate governance.

The Investment Process

  • A portfolio is a collection of investment assets, and asset allocation is the choice among broad asset classes.
  • Security selection is the choice of securities within each asset class, involving security analysis and valuation.

Markets Are Competitive

  • Financial markets are highly competitive, with a risk-return trade-off, where higher-risk assets offer higher expected returns.
  • The efficient market hypothesis states that security prices fully reflect available information, making it difficult to find underpriced or overpriced securities.

Test your knowledge on 'Real' and financial assets, risk-return trade-off, efficient pricing of financial assets, and the financial crisis of 2008 as covered in Chapter One of the INVESTMENTS book by Bodie, Kane, and Marcus.

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