Answer each question in 150 words minimum.

• Relate how percentage rates of return provide a common framework for comparing assets and explain why asset prices and rates of return are inversely related.
• Suppose that the city of New York issues bonds to raise money to pay for a new tunnel linking New Jersey and Manhattan. An investor named Susan buys one of the bonds on the same day that the city of New York pays a contractor for completing the first stage of construction. Is Susan making an economic or a financial investment? What about the city of New York?
• How do stocks and bonds differ in terms of the future payments that they are expected to make? Which type of investment (stocks or bonds) is considered to be more risky? Given what you know, which investment (stocks or bonds) do you think commonly goes by the nickname “fixed income”?
• Discuss why investment decisions are determined primarily by investment returns and nondiversifiable risk and how investment returns compensate for being patient and for bearing nondiversifiable risk. Provide an example of each.
• What determines the vertical intercept of the Security Market Line (SML)? What determines its slope? And what will happen to an asset’s price if it initially plots onto a point above the SML?
• Define and provide an example of the concept of arbitrage. Why is this important?
• What are mutual funds? What different types of mutual funds are there? And why do you think they are so popular with investors?
• Describe how the word risk is used in financial economics and explain the difference between diversifiable and nondiversifiable risk.

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