Chapter 1: The Corporation and Financial Markets

Question 1

Finance

Answer 1

• how firms raise money from investors
• how firms invest money in an attempt to earn a profit
• how firms decide whether to reinvest profits in the business or distribute them back to investors

Question 2

Firm

Answer 2

• exist because investors want access to risky investment opportunities
• main goal is to maximize shareholder wealth

Question 3

Sole Proprietorship

Answer 3

• owned and run by one person
• unlimited personal liability
• few employees
• owner and business income is taxed at the personal level

Question 4

Partnership

Answer 4

• similar to a sole proprietorship but it has more than one owner
• everything is split

Question 5

Limited Partnership

Answer 5

two kinds of owners general partners and limited partners

Question 6

General Partners

Answer 6

have same rights and privileges as partners in a (general) partnership—they are personally liable
for the firm’s debt obligations

Question 7

Limited Partners

Answer 7

• have limited liability (their liability is limited to their investment)
• their private property cannot be seized to pay off the firm’s outstanding debts

Question 8

Limited Liability Partnership (LLP)

Answer 8

• used in the legal and accounting professions
• similar to a general partnership in that the partners can be active in the management of the firm, and they do have a degree of unlimited liability

Question 9

Corporation

Answer 9

• a legally defined separate entity, artificial being (a judicial person or legal entity) separate from its owner
• shareholders have limited liability; they are not liable for any obligations the corporation
  enters into and vice versa
• can exist into perpetuity (forever getting money)

Question 10

Stock

Answer 10

• entire ownership stake of a corporation that is divided into shares
• aka shareholder, stockholder, or equity holder

Question 11

Flow Through Entities

Answer 11

where all income produced by the business flowed to the investors and virtually no earnings were retained within the business

Question 12

Business Income Trust

Answer 12

holds all the debt

Question 13

Unit Holders

Answer 13

equity securities of a corporation (the underlying business) in trust for the trust’s owners

Question 14

Energy Trust

Answer 14

either holds resource properties directly or holds all the debt and equity securities of a resource corporation within the trust

Question 15

Real Estate Investment Trust (REIT)

Answer 15

either holds real estate properties directly or holds all the debt and equity securities of a corporation that owns real estate properties

Question 16

Board of Directors

Answer 16

a group of people that has the ultimate decision-making authority in the corporation

Question 17

Chief Executive Officer (CEO)

Answer 17

in charge of running the corporation by instituting the rules and policies set by the board of directors

Question 18

Chief Financial Officer (CFO)

Answer 18

• reports directly to the CEO
• makes investment and financing decisions and cash management

Question 19

Shareholder Wealth Maximization

Answer 19

one goal that generally unites shareholders because they all benefit from a higher stock price

Question 20

Ethical Dilemma

Answer 20

each person has his or her own set of values, which forms the basis for personal judgments about what is the right thing

Question 21

Principal–agent/Agency Problem

Answer 21

• when managers put their own self-interest ahead of the interests of shareholders
• face the ethical dilemmas to do whats best for the shareholders or themselves

Question 22

Hostile Takeover

Answer 22

a situation in which an individual or organization, sometimes referred to as a corporate raider, purchases a large fraction of a target corporation’s stock and in doing so gets enough votes to replace the target’s board of directors and its CEO

Question 23

Stakeholder

Answer 23

any person with an interest in what a corporation does

ex. employees, customers, suppliers, the community, the government, and investors

Question 24

Stakeholder Satisfaction

Answer 24

a corporate objective that seeks to meet the interests of all stakeholders of a corporation

Question 25

Corporate Social Responsibility

Answer 25

a corporation’s efforts to assess and be responsible for its activities, particularly in relation to their environmental and social impacts, and may also include initiatives to promote positive social and environmental change

Question 26

Liquidation

Answer 26

closing down a business and selling off all its assets; often the result of the business declaring bankruptcy

Question 27

Private Companies

Answer 27

companies whose shares do not trade on a public market

Question 28

Public Companies

Answer 28

corporations whose stock is traded on a stock market or exchange, providing shareholders the ability to quickly and easily convert their investments to cash

Question 29

Liquid

Answer 29

describes an investment that can easily be turned into cash because it can be sold immediately at a competitive market price

Question 30

Primary Market

Answer 30

market used when a corporation itself issues new shares of stock and sells them to investors

Question 31

Secondary Market

Answer 31

market that shares continue to trade on after the initial transaction between the corporation and investors

Question 32

Bid Price

Answer 32

the highest price in a market for which someone is willing to purchase a security

Question 33

Ask/Offer Price

Answer 33

the lowest price in a market for which someone is willing to sell a security

Question 34

Bid-ask Spread

Answer 34

an implicit transaction cost investors have to pay in order to trade quickly

Question 35

Transactions Costs

Answer 35

costs of executing a trade or transaction, normally including broker commissions or other fees

Question 36

Limit Order

Answer 36

an order to buy or sell a security at a specified price

Question 37

Limit Order Book

Answer 37

• the collection of all limit orders at a stock exchange is known as the limit order book
• exchanges make their limit order books public so that investors (or their brokers) can see the best bid and ask prices when deciding where to trade

Question 38

Market Order

Answer 38

order to trade immediately at the best outstanding limit order available

Question 39

Specialists

Answer 39

• individuals on the trading floor of the NYSE who match buyers with sellers
• aka market makers

Question 40

Dark Pools

Answer 40

• investors have the ability to trade at a better price
• for traders who do not want to reveal their demand and who are willing to sacrifice the guarantee of immediacy for a potentially better price