Chapter 1 & 5 & 6

Question 1

The goal of a corporation is to

Answer 1

maximize shareholder’s wealth (maximise stock price)

Question 2

Ethics

Answer 2

Firms have an ethical responsibility to provide a safe working environment and to avoid polluting the iar or water.

Question 3

Is stock price maximisation the same as profit maximisation

Answer 3

No. Shareholder wealth maximisation consists of cash flows available, timing and riskiness of cash flows

Question 4

Is profit maximisation an appropriate goal?

Answer 4

No. Does not consider cash flows available to shareholders. Disregards timing and riskiness of cash flows

Question 5

Some important trends

Answer 5

Corporate scandal spur additional regulations, changing information technology, globalization of business

Question 6

Impact of technology

Answer 6

requires implementation of good controls and understanding risks involved

Question 7

Globalization

Answer 7

affects international trade and firms need to keep abreast of changes

Question 8

Agency Relationships

Answer 8

Principal hires agent to act on their behalf;
shareholders-managers
shareholders-creditors

Question 9

Conflict between managers and stockholders

Answer 9

Agency problem (managers are inclined to act in their own interests)

Question 10

Resolve conflict

Answer 10

Managerial compensation plans, direct intervention by shareholders, threat of firing, and threat of hostile takeover

Question 11

Managerial compensation plans

Answer 11

executive stock option for managers to purchase firm’s stock at a fixed price in the future. performance shares given to managers on the basis of time performance

Question 12

Threat of firing

Answer 12

through a proxy by voting out current management

Question 13

Threat of takeover

Answer 13

when shares of the firm might be purchased for control by another firm

Question 14

Shareholders vs Bondholders

Answer 14

Agency problem (risky projects of high return benefit shareholders at the expense of creditors; maximises stock price but are detrimental to creditors)

Question 15

Shareholders vs Bondholders 2

Answer 15

Stockholders are more likely to prefer riskier projects. Bondholder received fixed payments and are more interested in limiting risks. They protect themselves by including covenants that limit use of additional debt

Question 16

Responsibility of financial staff

Answer 16

forecasting and planning, investment and financing decisions, coordination and control, managing risk, transactions in financial market

Question 17

Suppliers of capital

Answer 17

individuals/institutions with “excess funds” who save money and look for a rate of return on their investment

Question 18

Demanders of capital

Answer 18

individuals/institutions who need to raise funds to finance their investment opportunities. Wiling to pay rate of return on the capital they borrow.

Question 19

How is capital transferred between savers and borrowers

Answer 19

Direct transfer, investment banking house (underwrites), financial intermediaries

Question 20

Market

Answer 20

a venue where goods and services are exchanged

Question 21

Financial market

Answer 21

place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds

Question 22

Types of financial markets

Answer 22

physical vs financial, money vs capital, primary vs secondary, spot vs futures, public vs private

Question 23

Well functioning financial markets

Answer 23

facilitate the flow of capital from investors to users of capital. promotes economic growth

Question 24

Deriatives

Answer 24

a derivative security’s value is “derived” from the price of another security. it can be used to reduce risk. can be used to speculate future stock prices, interest rates, exchange rates, commodity prices.. Produce high return if guess write, large losses if guest wrong.

Question 25

Types of financial institutions

Answer 25

commercial banks, investment banks, mutual savings banks, credit unions, pension funds, life insurance companies, mutual funds, hedge funds

Question 26

IPO

Answer 26

company issues stock in public market for the first time.

Question 27

affect level of interest rates

Answer 27

production opportunities, time preferences for consumption, risk, expected inflation

Question 28

r

Answer 28

quoted/required return on a debt security

Question 29

r*

Answer 29

real risk free rate of interest

Question 30

rRF

Answer 30

rate of interest on treasury securities

Question 31

assumptions of peh

Answer 31

mrp = 0, long-term rates are an average of current and future short term rates

Question 32

equity consists of

Answer 32

common stock and retained earnings

Question 33

liabilities consist of

Answer 33

long term debt, a/p, n/p, accruals

Question 34

current assets consist of

Answer 34

a/r, inventories

Question 35

operating cash flow add

Answer 35

net income, depreciation, increase in a/p, increase in accruals

Question 36

operating cash flow less

Answer 36

increase in a/r, inventories

Question 37

financial cash flow

Answer 37

add increase in long term debt, increase in notes payable and less dividends

Question 38

federal reserve policy

Answer 38

increase ms, short term rates decline, long term rates increase due to inflation

Question 39

federal deficit/surpluses

Answer 39

spends more than takes on taxes=deficit ->borrow $->increase demand of funds->push up interest rates

Question 40

international trade

Answer 40

import more than export>foreign trade deficit>borrow $ from nations with surpluse