CHAPTER 01 INVESTMENTS: BACKGROUND AND ISSUES 1. Equity is a lower-priority claim on earnings (expressed as dividends) that represents an ownership share in a corporation. Fixed-income (debt) security is a higher-priority claim that legally obligates the issuer to pay the holder of the debt, but does not have an ownership interest. Fixed-income securities typically pay a specified cash flow at precontracted time intervals until the last payment on the maturity date. Shares of equity have an indefinite life. 2. A primary (financial) asset has a claim on the real assets of a firm, whereas a derivative asset provides a payoff that depends on the prices of a primary asset but does not include the claim on the real assets. 3. Asset allocation is the allocation of an investment portfolio across broad asset classes. Security selection is the choice of specific securities within each asset class. 4. Agency problems are conflicts of interest between managers and stockholders. They can be addressed through corporate governance mechanisms, such as the design of executive compensation, oversight by the Board, and monitoring from the institutional investors. 5. Real assets have productive capacity; they are assets used to produce goods and services. Real assets can be tangible (e.g., machinery) or intangible (e.g., a patent). Financial assets are claims on real assets or the income generated by them. 6. Investment bankers are firms specializing in the sale of new securities to the public, typically by underwriting the issue. Commercial banks accept deposits and lend the money to other borrowers. After the Glass-Steagall Act was repealed in 1999, some commercial banks started transforming to “universal banks” which provide the services