Econ Ch 6

The three major types of firms in the USA are
Sole Proprietors, Partnerships and Corporations

Limited Liability means
shareholders in a corp cannot not lose more than their investment in the firm

The govt grants Limited Liability to corp
to limit shareholder risk and thus encourage investment in corps.

Limited Liability becomes more important to firms trying to raise funds from a large num of investors rather than a small num of investors bc
investors that make a small investment in the firm may be unwilling to risk all their personal assets if the firm fails.

Suppose that shortly after grad college you decide to open your own business. Assuming you are starting a small business and want it to be your business alone, which category are you likely to start?
Sole Prop

The establishment for the Limited Liabilities for the owners of corp
causes the business to produce more and over time the countrys production possibilities frontier shifts to the right.

I would like to invest in the stock market but buying stocks of shares in a corp is too risky. Suppose i buy 10,000 ofd G.E. stock and the comp goes bankrupt. Bc im a stockholder i(part owner) might now be responsible for paying their debt. This argument is:
False. Bc shareholders are not liable for the debts of a corp

To help firms raise enough funds to operate railroads and other large scale business, the USA
passed general incorporation laws that limit the liabilities of owners in corp.

Some economists have argued that
spending on research and development by large firms often leads to important improvements in existing products.

What do we mean by separation of ownership from control in large comp?
Shareholders own the corp, but it is controlled by managers.

How is the separation of ownership from control related to the principle-agent problem?
The agents(managers) can pursue their own interests rather than the interest of the principles(firms/shareholders)

It is better to have outside directors on the board of directors, as opposed to only inside directors bc
Independent outsiders would be better suited to monitor and control the management of the corp.

The principle-agent arises all over in the business world- but it also crops up closer to home. Such as the case of the college classroom. In this case, who is the principle and who is the agent?
The principle is the Student and the agent is the Professor.

The principle agent problem in the public corp between ownership and top management results from asymmetric info. All of the following are correct except
The principle-agent problem can be prevented or reduced if the managers are allowed to have the freedom in running the comp.

Sales personnel selling life insurance or subscriptions are typically paid on a commission and not straight on hourly wage. The principle-agent prob between the owner of the bus and the sales force is
reduced when workers are paid commission bc it gives them incentive to work harder.

The separation of ownership from control and large corp and the principle agent problems means that top managers can work short days, take long vacays, in other words slack off. This Statement
may be true if the directors of the corp have not set up approp incentives for their agents.

Some corp have staggered elections for board of directors while others have the full board up for elections each year. Studies show corp that do staggered elections are less profitable than full board elections annually.
The staggered elections for board of directors
raises doubt about the true financial picture of the firm making investors reluctant to invest in the firm.

How does the statement “Given this and that they work for the CEO, it is not surprising that boards cont to support the high levels of CEO compensation related to the princ-agent prob? This situation relates to the principle-agent problem bc
a CEO and board of directors are hired to run the firm for shareholders, but they often pursue their own interest rather than the interest of shareholders.

Direct Finance is borrowing via
Financial Markets

Indirect financing is borrowing from
financial Intermediaries.

If you borrow money to buy a car you are using
indirect finance

A bond represents a
loan to a comp

a share of stock rep
part ownership of a comp

A decrease in the price of a firms stock would tell managers
investors expect the firm to have lower profits in the future.

A decrease in the price of a firms bonds would tell managers
the cost of external funds has increased.

Suppose that at a firm in which you have invested in is making a lot of money, would you rather own the firms stock or the firms bonds?

Suppose you originally invested in a firm that was small and unprofitable. Now the firm has grown to be large and profitable. Would you be better off now if you had bought the firms stock or the firms bonds?

If you deposit 20 thou into a savings account at a bank you might earn 3 % interest in a year. Someone who borrows 20 thou from a bank might pay 8% interest in a year on a loan. Knowing this why don’t you just loan the money to the car buyer and cut out the bank?
Since you would be loaning all your savings to one borrower, it would be risky.

Facebook might have chosen to remain a private comp
to reduce the principle-agent problem. Or to avoid the formal management structure of a public corporation.

Moodys downgraded Japans govt debt from Aa2 to Aa3. What is Moodys top bond rating?
moodys top bond rating is Aaa

Moodys said large budget defecits and the build up in Japans govt debt, were the reasons to downgrade Japans debt rating bc
high defecits and debt are likely to adversely affect Japans ability to achieve a growth rate strong enough to steadily reduce the budget defecit.

What impact would the following have on googles stock? A competitor launches a search engine that is just as good as googles. The price of Googles stock would be expected to

What impact would the following have on googles stock?
The corp income tax is abolished. The price of googles stock would

What impact would the following have on googles stock? Googles board or directors becomes dominated by friends and relatives of its top management. The price of googles stock would

What impact would the following have on googles stock? Google announces a huge proft of 1billion but everyone already anticipated that google would earn 1 billion prfit. The price of googles stock would
stay the same

What impact would the following have on googles stock? The price of wireless internet connections unexpectedly drops, so more and more people use the internet. The price of googles stock would

The French govt isues bonds with 50 year maturities. Would this bond be purchased by only really young investors who expect to still be alive when the bond matures?
NO. bc the bonds can easily be sold to anyone at anytime.

The emerging markets have been about solvency bc
these nations were seen as potential default risks in the past.

The extra penalties the developed economies could face from the increase in perceived risk could be
investors buying govt debt might demand higher interest rates.

The total value of shares of Microsoft stock traded on the NASDAQ last week was 250 million , so the firm actually received MORE rev from stock sales than software sales.
This statement is false bc Microsoft does not receive the money investors paid for the stock.

Loans from banks are most important external funds to businesses bc most businesses are too small to borrow money in financial markets by issuing stocks or bonds. Most investors are reluctant to buy the stocks or bonds of small businesses bc of the difficulty of gathering accurate info of the financical strength and the probability of the business. Nevertheless, news about the stock market is nearly always included in every news program and is often the biggest story in the business section of newspapers.
Is there a contradiction here?
NO bc the news is likely to focus on large companies rather than small businesses.

A firms explicit cost is its
monetary cost where its implicit cost is nonmonetary opportunity cost.

All of the following statements are true except
a firm maxes profits when rev equals cost

Suppose a business earns a positve accounting profit but a negative economic profit
it will be unlikely the business will remain in the long run.

Does Alfredo have a lower cost of producing pizza than Palao does bc Alfredo received his pizza ovens as a gift and Palao had to purchase his?
NO Alfredos cost is equal to Palao bc the opportunity cost of the ovens is the same as what Palao must pay

Asssume they have the same pizza oven and have same revenue.. which is true?
Alfredo has higher accounting profits but their economic profits are the same.

How much is Danes economic profit for the year?
-102 -interest foregone on the extraterrestrial gear. yes he is earning an accounting profit.

economic profit is
a firms rev minus all the implicit and explicit costs.

The Sarbanes-Oxly Act
requires the CEOs to certify the accuracy of Financial Statements. It was passed to promote accountability within corps.

Which of these explain why the Allstate stock rose?
Investors believed the change would improve the quality of the board and therefore improve profits

Corporate Governance is
the way a corp is structured and the effect of that structure on firm behavior

Shareholders would push for stronger corp governance laws so that top mangers of corps
will have less abilty to inflate profits.

What was the source of the problems encountered by financial firms during the Crisis of 2007-2009
the prices of home mortgages plunged.

The board of directors would require top comp execs to own stock so top mangmt would
take actions to increase profits rather than pursue other self interests

The board of directors would include themselves in the stock requirement so that
board members will share with stockholders the desire to see the firm max profits.

Investors would see these stock requirements as
unfavorable bc Board members have incentive not to obj if they wrongly inflate profits and FAVORABLE bc top mngmt and b.m. will have incentive to make the firm profitable.

Is it possible to place a dollar value on the benefits of complying with the S-Ox Act?
NO, trust from corp governance can not be measured explicitly.

The formulas for calculating the price of a stock or bond is similar bc
both rep streams of payments over time

One difference in calculating the price of stock and a bond is
bonds have a fixed maturity date while there may be an infinite stream of dividend paymts

Money that you receive at a future date is worth
LESS than the money you receive today. If the interest rate rises the present value of payments that you receive in the future will fall.

Calculate the present value of a bond
know it.. the 4 parts

On the balance sheet the Operating income is
rev -operating exp. Net Income is Rev- op exps +Invstmt -taxes.

Accounting profit is
REV- OP Exps +Invstmt Inc -taxes

value of bond 894.33 15% 2 85$ 1085$ 2
973.96. 10% 2 yrs. 1085$

Present Value of a BOND formula
PV= C/(1+i)^n