Self-Check Questions

the overall behavior of the stock market is called an index fund. We can also regard housing and other tangible assets as forms of financial investment, which pay a rate of return in the form of capital gains. Housing can also offer a nonfinancial return—specifically, you can live in it.

17.3 How to Accumulate Personal Wealth

It is extremely difficult, even for financial professionals, to predict changes in future expectations and thus to choose the stocks whose price will rise in the future. Most Americans can accumulate considerable financial wealth if they follow two rules: complete significant additional education and training after graduating from high school and start saving money early in life.

Self-Check Questions

1 . Answer these three questions about early-stage corporate finance: a. Why do very small companies tend to raise money from private investors instead of through an IPO? b. Why do small, young companies often prefer an IPO to borrowing from a bank or issuing bonds? c. Who has better information about whether a small firm is likely to earn profits, a venture capitalist or a potential bondholder, and why? 2 . From a firm’s point of view, how is a bond similar to a bank loan? How are they different? 3 . Calculate the equity each of these people has in their home: a. Eva just bought a house for $200,000 by putting 10% as a down payment and borrowing the rest from the bank. b. Freda bought a house for $150,000 in cash, but if she were to sell it now, it would sell for $250,000. c. Ben bought a house for $100,000. He put 20% down and borrowed the rest from the bank. However, the value of the house has now increased to $160,000 and he has paid off $20,000 of the bank loan. 4 . Which has a higher average return over time: stocks, bonds, or a savings account? Explain your answer. 5 . Investors sometimes fear that a high-risk investment is especially likely to have low returns. Is this fear true? Does a high risk mean the return must be low? 6 . What is the total amount of interest from a $5,000 loan after three years with a simple interest rate of 6%? 7 . If you receive $500 in simple interest on a loan that you made for $10,000 for five years, what was the interest rate you charged? 8 . You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Review Questions

9 . What are the most common ways for start-up firms to raise financial capital? 10 . Why can firms not just use their own profits for financial capital, with no need for outside investors? 11 . Why are banks more willing to lend to well-established firms? 12 . What is a bond? 13 . What does a share of stock represent? 14 . When do firms receive money from a stock sale in their firm and when do they not receive money? 15 . What is a dividend? 16 . What is a capital gain?