Week 1 Assignment
Chapters 1 and 2
Chapter 1 Written Assignment – Problems 10, 11, & 13
1 0. Consider Figure 1 .5 , which describes an issue of American gold certificates. a. Is this issue a primary or secondary market transaction? Primary-market transaction
b. Are the certificates primitive or derivative assets? Derivitive assets
c. What market niche is filled by this offering?
Investors who want to hold gold without the complication and cost of physical storage. 11. Discuss the advantages and disadvantages of the following forms of managerial compensation in terms of mitigating agency problems, that is, potential conflicts of interest between managers and shareholders. a. With a fixed salary, compensation is independent of the firm's success in the short run. It does not tie the manager’s immediate compensation to the success of the firm. However, a manager may consider this the safest compensation structure and value it more highly. b. With a salary that is paid in the form of stock in the firm, the manager’s earnings are maximized 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 is 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 generates bi 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. In contrast, the shareholders will...