CHAPTER 1: THE INVESTMENT ENVIRONMENT
PROBLEM SETS
1. While it is ultimately true that real assets determine the material well-being of an
economy, financial innovation in the form of bundling and unbundling securities
creates opportunities for investors to form more efficient portfolios. Both
institutional and individual investors can benefit when financial engineering creates
new products that allow them to manage their portfolios of financial assets more
efficiently. Bundling and unbundling create financial products with new properties
and sensitivities to various sources of risk that allows investors to reduce (or
increase, depending on the strategy) volatility by hedging sources of risk more
efficiently.
Estimated Time: 1–5 min
2. Securitization requires access to many potential investors. To attract these investors,
the capital market needs:
1. a safe system of business laws and low probability of confiscatory
taxation/regulation;
2. a well-developed investment banking industry;
3. a well-developed system of brokerage and financial transactions; and
4. well-developed media, particularly financial reporting.
These characteristics are found in (and make for) a well-developed capital market.
Estimated Time: 1–5 min
3. Securitization leads to disintermediation; that is, securitization provides a means for
market participants to bypass intermediaries. For example, mortgage-backed
securities channel funds to the housing market without requiring that banks or thrift
institutions make loans from their own portfolios.
Securitization works well and can benefit many, but only if the market for these
securities is highly liquid. As securitization progresses, financial intermediaries
lose opportunities; they must increase other revenue-generating activities such as
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