Finance CH 1 & 2 – Flashcards

Which of the following statements is CORRECT? 1.By law in most states, the chairman of the board must also be the CEO. 2.In most corporations, the CFO ranks above the CEO. 3.The CFO generally reports to the firm's chief accounting officer, who is normally the controller. 4.The CFO is responsible for raising capital and for making sure that capital expenditures are desirable, but he or she is not responsible for the validity of the financial statements, as the controller and the auditors have that responsibility. 5.The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.

Question 2. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to... A. Maximize its expected EPS. B. Maximize the stock price per share over the long run, which is the stock's intrinsic value. C. Maximize its expected total corporate income. D. Minimize the chances of losses. E. Maximize the stock price on a specific target date.

Question 3 Which of the following actions would be most likely to reduce potential conflicts between stockholders and bondholders? 1.Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders). 2.The firm begins to use only long-term debt, e.g., debt that matures in 30 years or more, rather than debt that matures in less than one year. 3.A government regulation that banned the use of convertible bonds. 4.The passage of laws that make it harder for hostile takeovers to succeed. 5.Compensating managers with more stock options and less cash income.

Question 4 Managers always attempt to maximize the long-run value of their firms' stocks, or the stocks' intrinsic values. This is exactly what stockholders desire. Thus, conflicts between stockholders and managers are not possible. However, there can be conflicts between stockholders and bondholders. True/False

Question 5 Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders? A. The threat of hostile takeovers. B.The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions. C.Financing risky projects with additional debt. D.Compensating managers with stock options. E.Abolishing the Security and Exchange Commission. B.The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions.

Question 6 Which of the following statements is CORRECT? A.The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders. B.One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm's capital structure. C.The threat of takeovers tends to reduce potential conflicts between stockholders and managers. D.Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers. E.The threat of takeover generally increases potential conflicts between stockholders and managers.

Question 7 The financial manager recognizes revenues and expenses utilizing... A. the accrual method. B. the revenue method C. the standardized, generally accepted, accounting principles.

Question 8 The conflict between the goals of a firm's owners and the goals of its non-owner managers is... incompatibility the agency problem of little importance in most large U.S. firms serious only when profits decline

Question 9 Corporate owners receive realizable return through... increase in share price and cash dividends increase in share price and earnings per share profit and earnings per share earnings per share and cash dividends

Question 10 The primary emphasis of the financial manager is the use of... organization charts profit incentives accrued earnings cash flow

Question 11 Most businesses raise money by selling their securities in... a stock exchange a direct placement a private placement.

Question 12 The major securities traded in the capital markets are Treasury bills and certificates of deposit stocks and bonds commercial paper and Treasury bills bonds and commercial paper

Question 13 The __________ is created by a financial relationship between suppliers and demanders of short-term funds financial market stock market money market capital market

A new public issue of securities is regulated by the SEC Investment Bankers Association FDIC Fed

Question 15 By definition, the money market involves the buying and selling of short-term funds flows of funds funds that mature in more than one year stocks and bonds

Question 16 Which of the following statements is CORRECT? Money markets are markets for long-term debt and common stocks. A liquid security is a security whose value is derived from the price of some other "underlying" asset. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks. While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. The NYSE operates as an auction market, whereas Nasdaq is an example of a dealer market.

Question 17 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. True/False

Question 18 Which of the following statements is CORRECT? Hedge funds have more in common with investment banks than with any other type of financial institution. 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 these investors supposedly can do any necessary "due diligence" on their own rather than have it done by the SEC or some other regulator. Hedge funds have more in common with commercial banks than with any other type of financial institution. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States.

Question 19 Which of the following statements is CORRECT? While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors. The NYSE does not exist as a physical location. Rather it represents a loose collection of dealers who trade stock electronically. Capital market instruments include both long-term debt and common stocks. An example of a primary market transaction would be your uncle transferring 100 shares of Walmart stock to you as a birthday gift. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction.

Question 20 Which of the following statements is CORRECT? Only institutions, and not individuals, can engage in derivative market transactions. If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction. If you purchase 100 shares of Disney stock from your brother-in-law, this is an example of a primary market transaction. The NYSE is an example of an over-the-counter market. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

Question 21 Which of the following statements is CORRECT? Proprietorships are subject to more regulations than corporations. One of the disadvantages of incorporating your business is that you could become subject to the firm's liabilities in the event of bankruptcy. In any partnership, every partner has the same rights, privileges, and liability exposure as every other partner. Corporations of all types are subject to the corporate income tax. Proprietorships and partnerships generally have a tax advantage over corporations.

Question 22 A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership. True/False

Question 23 Which of the following statements is CORRECT? Corporations of all types are subject to the corporate income tax. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability. It is easier to transfer one's ownership interest in a partnership than in a corporation. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote." One of the advantages of the corporate form of organization is that it avoids double taxation.

Question 24 Which of the following statements is CORRECT? Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations. Corporate stockholders are exposed to unlimited liability. Large corporations are taxed more favorably than proprietorships. Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships. Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment.

Question 25 It is generally harder to transfer one's ownership interest in a partnership than in a corporation. True/False

Question 26 Which of the following statements is CORRECT? A hostile takeover is the main method of transferring ownership interest in a corporation. Limited liability is an advantage of the corporate form of organization to its owners (stockholders), but corporations have more trouble raising money in financial markets because of the complexity of this form of organization. Although the stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way, i.e., bondholders can sue the firm's managers if the firm defaults on its debt. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization.

Question 27 Which of the following statements is CORRECT? It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. One disadvantage of operating a business as a proprietor is that the firm is subject to double taxation, because taxes are levied at both the firm level and the owner level. Corporations face fewer regulations than proprietorships. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business. One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership.

Question 28 Which of the following statements is CORRECT? Corporations generally face fewer regulations than proprietorships. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. It is usually easier to transfer ownership in a corporation than in a partnership. There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small. Corporate shareholders are exposed to unlimited liability.

Question 29 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." False/True

Question 30 Which of the following statements is CORRECT? Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects. Because bankruptcy requires that corporate bondholders be paid in full before stockholders receive anything, bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects. Potential conflicts between stockholders and bondholders are increased if a firm's bonds are convertible into its common stock. One advantage of operating a business as a corporation is that stockholders can deduct their pro rata share of the taxes the firm pays, thereby eliminating the double taxation investors would face in a partnership. One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a proprietor.

Which of the following statements is CORRECT? There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small. Corporate shareholders are exposed to unlimited liability. Corporations generally face fewer regulations than proprietorships. It is usually easier to transfer ownership in a corporation than in a partnership. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? Beef up the restrictive covenants in the firm's debt agreements. Pay managers large cash salaries and give them no stock options. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold.

Which of the following statements is CORRECT? Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders' interests. Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders. Corporations have unlimited liability. Corporations are taxed more favorably than proprietorships. Because of their size, large corporations face fewer regulations than smaller corporations and proprietorships.

Which of the following statements is CORRECT? Bondholders should generally be happier than stockholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns. Relative to proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital. There is no good reason to expect a firm's stockholders and bondholders to react differently to the types of assets in which it invests. Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns. One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than are partners.

New Business is just being formed by 10 investors, each of whom will own 10% of the business. The firm is expected to earn $1,000,000 before taxes each year. The corporate tax rate is 34% and the personal tax rate for the firm's investors is 35%. The firm does not need to retain any earnings, so all of its after-tax income will be paid out as dividends to its investors. The investors will have to pay personal taxes on whatever they receive. How much additional spendable income will each investor have if the business is organized as a partnership rather than as a corporation? $21,658 $21,225 $20,800 $20,384 $22,100

In order to maximize its shareholders' value, a firm's management must attempt to maximize the expected EPS. False/True

The Chairman of the Board must also be the CEO. True/False

If management operates in a manner designed to maximize the firm's expected profits for the current year, this will also maximize the stockholders' wealth as of the current year. True/False

As a result of financial scandals occurring during the past decade, there has been a strong push to improve business ethics. False/True

An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships. False/True

Wealth maximization as the goal of the firm implies enhancing the wealth of the Board of Directors the firm's employees the federal government the firm's stockholders

The goal of profit maximization would result in priority for... cash flows available to stockholders timing of the returns earnings per share risk of the investment

Among solutions to the agency problem in publicly held corporations are all of the following EXCEPT? stock options performance shares bonuses based on short-term results cash bonuses tied to goal achievement

All of the following are key strengths of a corporation EXCEPT? Low organizational costs Access to capital Readily transferable ownership limited liability

Which of the following legal forms of organization is characterized by limited liability? C - Corporation General Partnership Professional Partnership Sole Proprietor

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? This is an example of a money market transaction. This is an example of a derivative market transaction. This is an example of a direct transfer of capital. This is an example of a primary market transaction. This is an example of an exchange of physical assets.

Money markets are markets for... Common stocks. Foreign currencies. Consumer automobile loans. Short-term debt securities such as Treasury bills and commercial paper. Long-term bonds.

You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of: A primary market transaction. A money market transaction. An over-the-counter market transaction. A futures market transaction. A secondary market transaction.

Which of the following statements is CORRECT? If an investor sells shares of stock through a broker, then it would be a primary market transaction. Capital markets deal only with common stocks and other equity securities. While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. Home mortgage loans are traded in the money market. The New York Stock Exchange is an auction market, and it has a physical location.

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. True/False

The term IPO stands for "individual purchase order," as when an individual (as opposed to an institution) places an order to buy a stock. False/True

The annual rate of return on any given stock can be found as the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price. False/True

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. True/False

Primary markets are large and important, while secondary markets are smaller and less important. True/False

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. True/False

Trading is carried out on the floor of the New York Stock Exchange by.... a telecommunications network the negotiation process. the auction process investment bankers

The __________ is created by a number of institutions and arrangements that allow the suppliers and demanders of long-term funds to make transactions. credit market capital market financial market money market