Ch. 8 Flashcards
Stocks ARE/ARE NOT the most important source of external financing for businesses?
ARE NOT
Issuing marketable debt and equity securities IS/IS NOT the primary way in which businesses finance their operations.
IS NOT
True or False: Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.
TRUE
TRUE OR FALSE: Financial Intermediaries , particularly banks, are the most important source of external funds used to finance businesses.
TRUE
Only LARGE/SMALL corporations have easy access to securities markets to finance their activities.
LARGE, well established corporations.
TRUE/FALSE: The financial system is does not have many regulations.
FALSE it is among the most heavily regulated sectors of the economy.
TRUE/FALSE: Collateral is a prevalent feature of debt contracts for both households and businesses.
TRUE
Collateral
property that is pledged to a lender to guarantee payment in the event that the borrower is unable to make debt payments.
secured debt vs unsecured debt
secured debt uses collateral; unsecured debt does not have collateral and includes credit card debt. Unsecured debt is the predominant form of borrowing in households and in businesses.
Debt contracts typically are extremely complicated legal documents that place substantial _____________ on the behavior of the borrower.
restrictions
restrictive covenants
restrictions and specify certain activities that the borrower can engage in
How do financial intermediaries reduce transaction costs?
Economies of Scale and Expertise
Economies of scale allow for the __________ reduction in transaction cost per dollar invested. Economies of scale also allow for increased _________ in the portfolio, to reduce risk.
reduction; diversity
the analysis of how asymmetric information problems affect economic behavior is called _____ ______.
agency theory
The presence of _______ problems keeps securities markets from being effective in channeling funds from savers to borrowers.
lemon
One strategy to reduce adverse selection problems is to use private companies that collect and product information on good firms and bad firms such as _________, _______, ________.
S&P, Moody’s, and Value Line
free-rider program
problem occurs when people who do not pay for information take advantage of the information that other people have paid for.
government _____________ help to increase information available; reducing the problem of adverse selection (and assymetric information)
regulations
TRUE/FALSE: Regulations encourage firms to reveal honest information about themselves so that investors can determine how good or bad the firms are.
true
net worth
aka equity capital - the difference between a arms assets and its liabilities
TRUE/FALSE: collateral and high net worth can reduce adverse selection problems
True
Principal-Agent Problem
When managers own only a small fraction of the firm they work for the stockholders who now most of the firm’s equity are the owners. – Managers in control (the agents) may act in their own interest rather that in the interest of the stockholder-owners (principals) because the mangers have less incentive to maximize profits than the stockholder-owners do.
costly state verification
A moral hazard issue where audits by stockholders on firms - can be very expensive in terms of time and money
governments everywhere have laws to force firms to adhere to standard accounting principles that make profit verification easier and pass laws to impost stiff penalties for fraud of hiding and stealing profits. These regulations help protect and reduct moral _______ problems.
hazard
venture capital firm
pool the resources of their partners and use the funds to help budding entrepreneurs stat new businesses. will typically have board of directors that include investors so they can monitor the firms decisions.
debt contracts help to reduce moral hazard how?
the investor doesn’t care about the ongoing supervision of firm, as long as they are getting their payments on time.
restrictive convenants
provisions in debt contract that restrict the firms activities. Helps reduce moral hazard problems.
4 types of restrictive covenants
- to discourage undesirable behavior
- to encourage desirable behavior
- to keep collateral valuable
- to provide information
