ACCT 223 | Chapter 2 – Flashcards
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Capital Allocation Process
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The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways: Direct Transfers, Indirect Transfers through Investment Banks, Indirect Transfers through Financial Intermediaries.
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1. Capital Allocation Process
Scenario 1:
Israel launched a 10-year global bond issue of $1.5 billion in early 2009. Leading investment banks like Citigroup, Deutsche Bank, and Goldman Sachs managed the deal. (Source: Reuters.com, Mar, 18, 2009.)
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Indirect Transfer through Investment Banks
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1. Capital Allocation Process
Scenario 2:
Based in Grass Valley, California, L & M Seeds co. is a small company that manufactures organic seeds. To raise capital, the company sells stocks directly to savers in Grass Valley without involving any bank or financial intermediary.
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Direct Transfer
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1. Capital Allocation Process
Scenario 3:
Erin borrows money from her uncle to buy a new laptop.
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Direct Transfer
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1. Capital Allocation Process
Scenario 4:
California Public Employees' Retirement System (CalPERS) manages pension and health benefits of California public employees and retirees. CalPERS collects money from its participants and creates a pool of assets. It manages these assets by making investments across domestic and international markets.
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Indirect Transfers through Financial Intermediaries
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2. Types of Financial Markets
Description of Transaction:
Sonia takes a mortgage loan from a bank to purchase property.
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Financial Asset Markets
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2. Types of Financial Markets
Description of Transaction:
An investor buys $10,000 worth of gold at a certain price today.
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Spot Markets
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2. Types of Financial Markets
Description of Transaction:
Long-term mortgage-backed securities are traded between investors and issuers.
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Capital Market
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2. Types of Financial Markets
Description of Transaction:
Vezio Corp. decides to sell shares worth $15 million directly to a small group of U.S. institutional investors.
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Private Markets
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2. Types of Financial Markets
A hedge fund purchased credit default swaps on securities it did not own because it believed that the securities were likely to default. In this example, the hedge fund is _____.
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Speculating
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3. Financial Institutions
Description:
These financial conglomerates provide a range of services, such as investment banking, commercial banking, and financial advising.
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Financial Services Corporations
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3. Financial Institutions
Description:
They underwrite, distribute, and design investment securities for corporations to help them raise capital.
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Investment Banks
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3. Financial Institutions
Description:
They are owned by members so that members can share funds among themselves. Members who save deposit the funds. These funds are then loaned to members who need the funds.
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Credit Unions
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3. Financial Institutions
Description:
They are established by an employer to facilitate and organize employee retirement funds. They are asset pools that invest in securities that have a potential to give stable returns.
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Pension Funds
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3. Financial Institutions
Description:
They collect a pool of funds from investors for the purpose of diversifying risk, earning interest or dividends, and/or generating profits from the investments; increased value.
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Mutual Funds
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3. Financial Institutions
Description:
They are owned by members so that members can share funds among themselves. Members who save deposit the funds. These funds are then loans to members who need the funds.
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Hedge Funds
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3. Financial Institutions
Description:
They are a pool of assets that trade like stocks on an exchange. They track a group of stocks, such as all stocks in an index or stocks of companies in emerging markets.
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Exchange Traded Funds
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4. The Stock Market
A stock market is a _____ market for trading a company's stocks and derivatives.
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public
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4. The Stock Market
The bid-ask spread in a dealer market represents the profit that a dealer would make on transaction involving a security. Which of the following statements best describes the bid-ask spread?
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The difference between the price at which a dealer is willing to buy a security and the price at which a dealer is willing to sell it.
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4. The Stock Market
Jorge, a trader, wants to buy 1,000 shares of XYZ stock, while a second trader, Adele, is willing to sell 1,500 share of the same stock. Unfortunately, Jorge and Adele don't know one another, and must complete their transactions using the stock exchange's market-making dealer. XYZ's market-maker is willing to sell her shares for $29.20 per share and purchase additional shares for $28.50 per share. Select the most appropriate values int he following table:
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Term | Value
Bid Price | $28.50
Ask Price | $29.20
Bid-Ask Spread | $0.70
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4. The Stock Market
If the market-maker is willing to purchase the entire block of 1,500 shares from Adele and, from the block, resell 1,000 shares to Jorge, then the market-maker's net profit from Jorge's transaction-excluding any inventory effects - will be _____.
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$700.00
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5. The Market for Common Stock
Companies that are owned by a group of investors, who could also be associated with the company's management, make initial public offerings. Such companies are referred to as _____.
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closely held corporations
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5. The Market for Common Stock
When the demand for an initial public offering (IPO) of securities exceeds the number of securities issues, the offering is deemed to be:
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Oversubscribed
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7. Efficient Markets Hypothesis
True or False: The efficient markets hypothesis holds only if all investors are rational.
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False
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7. Efficient Markets Hypothesis
Consider the following statement:
"Current market prices reflect all relevant information, whether it is known publicly or privately."
Identify the form of capital market efficiency based on the preceding statement.
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Strong-form efficiency
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7. Efficient Markets Hypothesis
A pharmaceutical company announces that it has received FDA approval for a new allergy drug that completely prevents hay fever. The consensus analyst forecast for the company's earnings per share (EPS) is $5.00, and insiders agree with analyst expectations. They too expect that, with this new drug, earnings will drive the EPS to $5.00. What will happen when the company releases its next earnings report?
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The stock price will not change, because the market already incorporated that information in the stock price when the announcement about FDA approval was made.
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Chapter 1 & 2 TEST #1
The bankruptcy of Enron Corporation, and the fraud committed by some of its officers, has led to some important changes in business practices.
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True
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Chapter 1 & 2 TEST #2
A publicly owned corporation is a company whose shares are held by the investing public, which may include other corporations as well as institutional investors.
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True
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Chapter 1 & 2 TEST #3
You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction?
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This is an example of a direct transfer of capital.
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Chapter 1 & 2 TEST #4
Money markets are markets for:
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Short-term debt securities such as Treasury bills and commercial paper.
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Chapter 1 & 2 TEST #5
The term IPO stands for "individual purchase order", as when an individual (as opposed to an institution) places an order to buy a stock.
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False
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Chapter 1 & 2 TEST #6
Which of the following statements is CORRECT?
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The New York Stock Exchange is an auction market, and it has a physical location.
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Chapter 1 & 2 TEST #7
The NYSE is defined as a "primary" market because it is one of the largest and most important stock markets in the world.
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False
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Chapter 1 & 2 TEST #8
Which of the following statements would most people in business agree with?
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Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.
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Chapter 1 & 2 TEST #9
A share of common stock is not a derivative, but an option to buy the stock is a derivative because the value of the option is derived from the value of the stock.
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True
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Chapter 1 & 2 TEST #10
The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to
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Maximize the stock price per share over the long run, which is the stock's intrinsic value.
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Chapter 1 & 2 TEST #11
When a corporation's shares are owned by a few individuals who are associated with the firm's management, we say that the stock is closely held.
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True
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Chapter 1 & 2 TEST #12
Which of the following is an example of a capital market instrument?
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Common stock.
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Chapter 1 & 2 TEST #13
Which of the following statements is CORRECT?
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Capital market instruments include both long-term debt and common stocks.
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Chapter 1 & 2 TEST #14
Which of the following is a primary market transaction?
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IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.
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Chapter 1 & 2 TEST #15
The NYSE is defined as a "spot" market purely and simply because it has a physical location. The Nasdaq, on the other hand, is not a spot market because it has no one central location.
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False
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Chapter 1 & 2 TEST #16
The Chairman of the Board may also be the CEO.
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True
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Chapter 1 & 2 TEST #17
Globalization of business has been facilitated by improvements in telecommunications.
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True
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Chapter 1 & 2 TEST #18
Which of the following statements is CORRECT?
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In a "Dutch auction," investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay.
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Chapter 1 & 2 TEST #19
Which of the following statements is CORRECT?
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Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and such investors supposedly can do any necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.
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Chapter 1 & 2 TEST #20
You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of:
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A secondary market transaction.
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Chapter 1 & 2 TEST #21
There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to banks and to stockholders. It is illegal to provide such information to banks, but it is not illegal to provide it to stockholders because they are the owners of the firm, not outsiders.
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False
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Chapter 1 & 2 TEST #22
Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT?
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Relaxant's shareholders (the ex-partners) will now be exposed to less liability.
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Chapter 1 & 2 TEST #23
The "over-the-counter" market received its name years ago because brokerage firms would hold inventories of stocks and then sell them by literally passing them over the counter to the buyer.
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True
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Chapter 1 & 2 TEST #24
Which of the following statements is CORRECT?
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One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.
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Chapter 1 & 2 TEST #25
A stock's market price would equal its intrinsic value if all investors had all the information that is available about the stock. In this case the stock's market price would equal its intrinsic value.
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True
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Chapter 1 & 2 TEST #26
In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price in the long run, or the stock's "intrinsic value".
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True
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Chapter 1 & 2 TEST #27
Which of the following statements is CORRECT?
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Compensating managers with stock options can help reduce conflicts of interest between stockholders and managers, but if the options are all exercisable on a specific date in the near future, this can motivate managers to do something other than try to maximize the stock's intrinsic value.
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Chapter 1 & 2 TEST #28
Which of the following statements is CORRECT?
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Sole proprietorships and partnerships generally have a tax advantage over corporations.
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Chapter 1 & 2 TEST #29
The Sarbanes-Oxley Act requires stockholders to certify that all financial statements are accurate.
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False
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Chapter 1 & 2 TEST #30
A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. A bank that takes in demand deposits and then uses that money to make long-term mortgage loans is one example of a financial intermediary.
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True
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Chapter 1 & 2 TEST #31
Which of the following statements is CORRECT?
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Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.
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Chapter 1 & 2 TEST #32
The dividend yield on any given stock is the stock's dividend for the year divided by the previous closing price.
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True
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Chapter 1 & 2 TEST #33
If you decide to buy 100 shares of Google, you would probably do so by calling your broker and asking him or her to execute the trade for you. This would be defined as a secondary market transaction, not a primary market transaction.
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True
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Chapter 1 & 2 TEST #34
Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders?
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Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.
