Exercise 1: Identify differences that may arise from managing a portfolio of "real" assets as distinct from a portfolio of publicly traded securities (Financial Assets).
Real assets can be defined as assets that are tangible or physical in nature such as plants, equipments whereas financial assets can be defined as assets that are intangible in nature such as bonds, stock, rights, certificates, bank balances etc. Real assets are used in daily business activities to generate output whereas financial assets are used in investing activities to generate return on investment. Most of us cannot own real assets but can get shares in different companies which provide us with income derived from the production.
Real and financial assets are distinguished operationally by the balance sheets of individuals and firms in the economy. Real assets appear only on asset side of balance sheet whereas financial assets appear on both sides of balance sheet. Real assets are destroyed by accident or by wearing out over time whereas financial assets are created and destroyed in ordinary course of doing business. Real assets generate income daily in the economy and financial assets are basically claims to any income generated by real assets.
Exercise 2: Identify some examples of agency costs. Can you identify the types of circumstances where these agency costs of management are more likely to occur?
Agency cost can be defined as the incremental costs of having an agent make decisions for the principal for example bonus, incentives etc. It may arise because the employees raise their own salaries to an unrealistic level, they do not take projects due to fear of failure so that jobs will be lost, insist to buy more expensive furniture and best computer for the offices. It also includes direct benefits such as use of company’s cars etc.
There are different circumstances where these agency costs of management are most likely to occur such as when there is conflict between...