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CFA Level I > Corporate Issuers > Flashcards

Corporate Issuers Flashcards

1
Q

Refers to integrating social or environmental considerations in general into investment decisions:

A

Responsible/sustainable investing

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2
Q

Negative screening refers to :

A

excluding specific companies or industries from portfolio consideration based on ESG factors

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3
Q

Positive screening refers to:

A

including/identifying companies or industries for portfolio consideration based on ESG factors

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4
Q

According to this theory:

The focus of corporate governance is managing conflicts of interest among owners and several groups that have an interest in a company’s activities, including creditors

A

Stakeholder theory

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5
Q

Under this theory:

The primary focus of corporate governance is to manage the the activities of a firm in the best interest of it’s** owners**

A

Shareholder Theory

Foscus: Maximizing shareholder profits/value

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6
Q

Conflicts of interest, under shareholder theory, arise between:

A

shareholders (owners) and managers of a company

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7
Q

Information asymmetry arises between _____ and _____, and decreases their ability to _____ and _____ whether _____ are acting in their best interest

A

shareholders and managers;
monitor and evaluate whether the managers are acting in their best interests

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8
Q

Effective stakeholder management consists of:
1.
2.

A

effective communication with stakeholders
good understanding of all the stakeholder’s interests

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9
Q

An agreement between a company and a labor union, is considered part of the company’s:

A

Organizational infrastructure, of corporate governance

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10
Q

Which type of voting allows minority stockholders greater representation on the BOD?

A

Cumulative voting

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11
Q

The type of resolution most likely to require a supermajority of shareholder votes for passage is a resolution to:

A

mergers/acquisition

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12
Q

Ordinary resolutions include:
& require a ____ vote

A

approval of auditor and election of BOD
simple majority vote

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13
Q

In a two-tier BOD, the ____ are independent of the supervisory board:

A

Executive directors (make up the management board)

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14
Q

This BOD committee

reviews proposals for large acquisitions or projects and also monitors the performance of acquired assets and of projects requiring large capital expenditures

A

investment committee

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15
Q

Corporate governance is the system of ______ and _____ by which individual companies are managed.

A

internal control and procedures

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16
Q

Corporate governance uses checks, balances, and incentives to achieve a goal of:
* minimizing
* managing

A
  • minimizing principal agent conflicts
  • manage conflicting interests between insiders and external shareholders
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17
Q

Which stakeholder group tends to the less concerned with/affected by a company’s financial performance?

A

customers

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18
Q

In the context of of a corporation, who are the players in a principal-agent conflict?

A

principal: shareholders (owners)
agent: management & BOD

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19
Q

The most common principal agent conflict:

  • Shareholders prefer:
  • Managers prefer
A

Risk tolerance
* shareholders prefer more risk
* managers prefer less risk because they have more stake in the game on the firm’s performance, since their employment is dependent on the firm, where shareholder’s hold diversified portfolios

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20
Q

Straight voting means one share, one vote, which leaves minority shareholders with much less representation and can be an example of an:

A

agency conflict

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21
Q

This type of voting:

facilitates shareholder activism

A

Cumulative
by allowing shareholders to accumulate and vote all their shares for a single candidate in an election involving more than one candidate

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22
Q

In recent trends of corporate governance, most firms are expanding the scope to consider the interests of:

A

employees, customers, and suppliers

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23
Q

Ensuring a company has an appropriate enterprise risk management system is a responsibility of:

A

BOD

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24
Q

The two roles that should be separated to prevent too much executive power.

A

CEO & board chair

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25
Q

T/F: The board has the authority to select and terminate senior management

A

True

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26
Q
  • Allows for some shares to be entitled to several votes/share, while others only have one vote/share
  • Aligns economics ownership with control of:
  • Promotes company stability by:
A

Dual-class structure:
* Allows for some shares to be entitled to several votes/share, while others only have one vote/share
* Aligns economic ownership with control of the founding shareholders
* Promotes company stability by being controlled by a consistent group (family)

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27
Q

ESG approach to achieving one goal/factor

A

thematic

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28
Q

Refers to promoting a specific social or environmental goal through investment actions, which may include investing in a particular project:

A

Impact investing

Like investing in green financing

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29
Q

Green financing is an example of ____ investing, by producing ______ growth in a sustainable way

A

impact investing
produces economic growth in a sustainable way

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30
Q

ESG considerations may conflict with fiduciary duty if they result in the manager accepting:

A

Lower returns or higher risk than they otherwise would

Using ESG factors in estimating the risk and returns of a company is not considered a violation of a manager’s fiduciary duty to clients and beneficiaries.

The manager may consider ESG in the anlysis of the company’s risk & return, but there is conflict of a manger’s fiduciary duty if integrating ESG differs from the stated portfolio objectives (Risk & Return)

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31
Q

A value-based appraoch would include:

A

Avoidance of companies that conflict with moral or ethical values

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32
Q

This approach:

  • Refers to considering ESG-related risks and opportunities alongside traditional investment considerations
  • Objective: mitigating risks & identifying opportunities
A

A “value-based” approach to ESG investing

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33
Q

A values based **investment objective: **

  • Investment decisions express an investor’s:
A

Expresses the investor’s ethical beliefs through investment decisions

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34
Q

the framework defining rights, roles, and responsibilities of groups

A

Corporate governance

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35
Q

Covenants protect the interests of:

A

creditors

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36
Q

Proxy voting and restrictions on related party transactions are measures that protect _____ interest

A

shareholder’s

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37
Q

Help to protect management from shareholder pressures and function as a takeover defense

A

cross-shareholding

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38
Q

Equity performance components, like stock options, included in executive remuneration plans are good or bad?

A

Good; helps to better align the interests of executives and investors

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39
Q

Best-in class approach to ESG investing:

  • Selecting firms with the best ESG practices within:
  • Preserves the:
A
  • Selecting firms with the best ESG practices within each sector
  • Preserve the sector weightings of the benchmark portfolio
  • Uses positive screening
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40
Q

The process of planning expenditures on assets where the cash flows to the firm are expected to be greater than 1 year:

A

Capital allocation

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41
Q

Making good capital allocation decisions must be consistent with the manager’s primary goal of:

A

maximizing shareholder value

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42
Q

Are interest costs included in the estimate of the incremental cash flows from an investment?

A

No. Costs to finance the investment are taken into account when the cash flows are discounted at the appropriate cost of capital;
including interest costs in the cash flows would result in double-counting the cost of debt

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43
Q

Should sunk costs be considered in a project/s cash flows?

A

Sunk costs should not be considered when analyzing a project’s cash flows

These costs are not affected by the accept/reject decision because they cannot be avoided

Ex: R & D

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44
Q

The effects on other firm cash flows, when accepting a project:

A

externatilites

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45
Q

A common example of a ____ externality is cannibalization, which occurs when:

A

negative externality because the new project takes sales from an existing one

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46
Q

Cash flows are based on:

A

opportunity costs

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47
Q

Cash flows are analyzed on a basis of:

A

after tax basis
the impacts of taxes must be considered when analyzing all capital allocation projects

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48
Q

Financing costs, like interest payments, are reflected in the project’s:

A

Required rate of return (discount rate) & therefore should not be included in the incremental cash flows

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49
Q

The net present value (NPV) of an investment is equal to the sum of the expected cash flows discounted at the:

A

opportunity cost of capital

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50
Q

When NPV is negative, the IRR

A

IRR < Discount rate

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51
Q

IRR is the discount rate that makes the net present value:

A

IRR is the discount rate that results in: NPV = 0

IRR is the discount rate to make PV inflows = PV outflows

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52
Q

ROIC can be compared to a company’s WACC to indicate:

A

whether the company has increased or decreased the firm value over time

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53
Q

When NPV is postitive, the ROIC is greater than the cost of capital, and these projects are providng returns greater than the:

A

opportunity cost of capital

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54
Q

When comparing ROIC and cost of capital, if all projects have a positive NPV, ROIC is:

A

ROIC > cost of capital

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55
Q

A direct measure of the expected change in firm value from undertaking a project:

A

NPV

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56
Q

____ is related to share value; and should cause a proportionate increase in a company’s stock price, of _____/shares outstanding, but other factors are related

A

NPV
NPV per shares outstanding

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57
Q

IRR shows the return on:

A

Percentage Return on each dollar invested

(advantage of using IRR since it is easier to use/understand)

58
Q

When dealing with mutually exclusive projects, the most reliable decision rule is:

A

NPV

59
Q

The value of a company is the value of its __ plus the __ of all of its future investments

A

existing investments + net present values

60
Q

The net present value (NPV) method assumes that cash flows are reinvested at:

A

cost of capital

61
Q

The internal rate of return method assumes that the cash flows from a project are reinvested at the project’s:

A

IRR

62
Q

Which step is this in the capital allocation process?

The step used to identify systematic errors in the forecasting process and improve operations

A

conducting post audit (last step)

63
Q

For mutually exclusive projects the NPV decision rule is to:

A

accept the project with the highest NPV

64
Q

For independent projects the NPV decision rule is to:

A

accept all projects with a positive NPV

65
Q
  • changing the inputs into a production process:
  • option to sell:
  • option to increase capacity:
A

flexibility option
abandonment
expansion

66
Q

IRR analysis will yield ____ accept/reject decision for a single project compared to NPV

A

the same

67
Q

NPV is the preferred method, but should be used especially when there are ____ IRR

A

multiple project IRRs

68
Q

Unconventional cash flows where the sign of the cash flows change more than once cause:

A

multiple IRRs

Conventional cash flows= 1 IRR

69
Q

NPV will give the sample accept/reject decisions for:

A
  • Independent projects
  • With conventional cash flows
70
Q

Conflict between the NPV and IRR decision rules can arise when evaluating mutually exclusive projects with conventional cash flows because:

A

1) the scale of investments may differ and/or 2) the timing of the cash flows may differ

71
Q

Operating cycle =

A

days of inventory + days of receivables

72
Q

Occurs when disbursements are made too quickly:
* current liabilities are paid instead of being held
* when credit availability is reduced or limited

A

A “pull” on liquidity

Decrease in days of payables

73
Q

Occurs when liquidity is delayed or reduces cash flows;
receipts lag: non-cash current assets do not convert to cash quickly

A

“drag” on liquidity

74
Q

Measures the amount of time it takes the firm to turn the firm’s cash investments in inventory, back into cash:

A

Cash conversion cycle

(Measure of Liquidity)

75
Q

Shorter cycle indicates the company is better able to generate cash, and has a lesser need for outside finance

A

Short cash conversion cycle

(aka Net operating cycle)

76
Q

High cash conversion cycle implies that a company:

A

Has excessive investment in working capital

Liquidity position is undesireable

77
Q

A revolving line of credit is typically ______ than an uncommitted or committed line of credit and thus is considered :

A

for a longer term
a more reliable source of liquidity

78
Q

Debt is generally _____ than preferred or common stock

A

less costly

79
Q

Cost of capital uses _ values:

A

uses market values only, not book values

80
Q

the rate of return required by stockholders

A

cost of equity

81
Q

the market interest rate (YTM)

A

cost of debt

82
Q

What is the formula for calculating cost of preferred stock?

A

dividend/ current price

83
Q

____ risk does not change with a higher debt-to-equity ratio.

A

Asset

84
Q

____risk rises with higher debt

A

Equity

85
Q

NPV w/ floatation costs=

A

PV of cash inflows - cost of project - floatation costs

86
Q

Flotation costs are an additional cost of the project and should be incorporated as an adjustment to the _______ in the valuation computation

A

initial-period cash flows

(aka initial project costs)

87
Q

fees charged by investment bankers when a company raises external equity capital

A

floatation costs

88
Q

For a publicly traded company, the beta of a stock is estimated from the ____ relationship between returns on the stock and the returns on a ______

A

linear relationship
proxy- S&P500 (independent variable)
stock returns (dependent variable)

89
Q

Stock’s systematic risk

A

beta

90
Q

Capital=

A

debt + equity

91
Q

When calculating a company’s cost of equity, the floatation costs of issuing new common stock should included as an:

A

initial cash outflow

92
Q

Stock dividends, like stock splits, have what impact on a company’s equity?

A

No impact on the value of a company’s equity

Therefore, no affect to the capital structure

93
Q

Share appreciation/depreciation has what impact on a company’s equity?

A

increase the market value of equity, thus increasing equity relative to debt

94
Q

Cash flow typically turns positive during the _____ stage, but it may be negative, particularly at the beginning of this stage

A

growth stage

95
Q

Modigliani-Miller Proposition I, with _____ states that in perfect markets the level of debt versus equity in the capital structure has what effect?

A

no taxes;
capital structure has no effect on company value
aka “the capital structure irrelevance theorem”

96
Q

Modigliani-Miller Proposition, with taxes states that a company’s WACC is ______ and its value maximized, with _____

A

WACC minimized
value maximized with 100% debt financing

the value of the levered company is greater than that of the all-equity company by an amount equal to the tax rate multiplied by the value of the debt, also termed the debt tax shield.”

97
Q

The optimal capital structure:

A

maximizes firm value and minimizes its WACC

98
Q

The cost of equity _____ with the _____ debt in the capital structure

A

equity increases with the use of debt

Modigliani- Miller proposition no taxes, proposition II

99
Q

If the company’s WACC increases as a result of taking on additional debt, the company has moved beyond _____

A

the optimal capital range

100
Q

The static trade-off theory indicates that there is a trade-off between:

A

Trade off between:
* tax shield from interest on debt
* costs of financial distress

101
Q

Debt can be a significant portion of the optimal capital structure because of the ______

A

tax-deductibility of interest

102
Q

Because of information asymmetry, Issuing debt may signal to investors:

A

that management is confident in company’s ability to make these payments

103
Q

Because of information asymmetry, Issuing equity may signal to investors:

A

that management believes the stock is overvalued

104
Q

The pecking order state:
1. ____________ are preferable to both:
2. ______
3. _____

A
  1. internally generated funds
  2. new debt
  3. new equity
105
Q

arise because management and shareholders may have conflicting interests

A

agency costs

106
Q

Agency costs can be reduced by:

A

increased debt issuance

107
Q

A company will typically use debt for the largest percentage of its financing during which stage?

A

Mature companies are able to support more debt than start-up companies or growth stage companies because they typically have predictable positive cash flows, lower business risk, and significant liquid assets.

108
Q

Companies have an optimal level of debt & equity, according to which theory?

A

Static trade off

109
Q

____-term debt is more exposed to the risk of a management decision that is not debt-holder friendly, likely resulting in debt-equity conflicts

A

long term debt

110
Q

The additional uncertainty about operating earnigns caused by fixed operating costs:
The higher the proportion of fixed costs to variable costs the:

A

Operating risk increases when a firm has more fixed costs compared to variable costs

111
Q

Business risk is:

  • The uncertainty (risk) associated with a:
  • Results from both:
A
  • The uncertainty (risk) associated with a firm’s operating income (EBIT)
  • Results from both operating risk and sales risk:

Sales risk: the uncertainty about the firm’s sales

112
Q

Risk associated with the refinancing of debt:

A

Rollover risk:

a company financing long-term assets with short-term obligations faces rollover risk, which may threaten profitability if short-term financing costs go up over the financing period

113
Q

A company financing short-term assets by issuing long-term debt most likely increases:

A

Default risk

114
Q

Greater leverage of firm leads to:

A

greater variability of:
* After tax operating earnings
* Net income

115
Q

The amount of fixed costs a firm has, including:
* fixed operating expenses
* fixed financing costs

A

leverage

116
Q

Risk associated with the firm’s operating income (EBIT), due to the variability of sales & production costs

A

business risk

117
Q

measures the percentage of a firm’s costs that are fixed:

A

Degree of operating leverage (DOL)

Business risk

118
Q

Higher DOL = Higher _____ risk = more susceptible to _____ = _____ optimal debt ratio

A

The higher DOL= the higher business risk= the more susceptible to business cycle fluctuations
=lower optimal debt ratio

119
Q

Companies with a high degree of operating risk tend to have highly variable operating cash flows, making them less able to service debt compared to companies with less operating risk, resulting in a capital structure consisting of:

A

High proportion of equity

120
Q

According to pecking order theory, managers prefer to finance a firm with:

A

internally generated capital, than with additional debt

121
Q

Funding an acquisition, especially one that is expected to generate significant cash flows, is often a reason for a company to:

A

issue additional debt

122
Q

Stable cash flows and high proportions of liquid assets typically enable companies to service a:

A

Higher proportion of debt in their capital structures.

Company most likely has a low operating risk

123
Q

the additional uncertainty about earnings caused by fixed operating costs

A

operating risk

124
Q

This risk increases when the firm takes on more fixed expenses, in the form of interest payments

A

financial risk

125
Q

level of sales required to cover fixed operating costs only

A

breakeven quantity of sales; ignoring fixed financing costs (interest)

126
Q

With regard to a corporation’s legal environment, the interests of shareholders and firm creditors are typically best served by:

A

Common Law

Viewed as better protection to shareholders/creditors

Judges/laws; because judges may rule against management actions in situations that are not specifically addressed by statutes

127
Q

A company’s corporate governance procedures and internal systems and practices for managing stakeholder relationships.

A

Organizational Infrastructure

128
Q

Executives & non-executives (independent directors) jointly serve on:

A

One-tier board of directors

joint responsible for determining corporate strategy

129
Q
  1. Idea generation
  2. Analyze project proposals
  3. Create the firm wide capital budget
  4. Monitor decisions and conduct a post-audit
A

Capital Budgeting Process

130
Q

An example of matrix pricing when determing the cost of debt:

A

Debt-rating approach

131
Q

The weights used to calculate WACC should be based on:

A

the firm’s target capital structure

If the company does not provide information about its target capital structure, an analyst can use:
-the company’s current capital structure
-the average capital structure weights for the industry

132
Q

Operating profit/income is also known as:

A

EBIT

133
Q

Measures the sensitivity of EPS to change in sales:

A

Degree of total leverage

Combines DOL & DFL

134
Q

Greater financial leverage decreases:

A

net income, due to interest expense

135
Q

When leverage increases and ROA is greater than debt costs, ROE will:

A

Increases, due to lower equity

136
Q

When deciding between mature companies that are most likely to employ debt, make decisions based on:

A
  • Stable cash flows
  • Fixed asset base/model implies that debt has already been employed
  • Predictable revenues
  • Cyclicality of a business (Less cyclical industries preferred)

Ex: electric utility would employ high portion of debt

137
Q

Which debt-equity situation is most likely to create conflicts?

A

long-term debt

long term debt is more exposed to the possibility of management turnover and differing views on holding debt

138
Q

Common Capital Allocation pitfalls:

A

Basing investment decisions on:
* The change in EPS in the short term
* The effects of not spending the entire capital budget available

Ex: If a division decides against the project, the firm will allocate his division a smaller capital budget next year.. should not be used in consideration

139
Q

The threat of hostile takeovers can acts as a strong:

A

Incentive for managerst to act in the best interests of shareholders

140
Q

Full integration of ESG investing:

A

Including ESG in fundamental analysis

CFA Level I (45 decks)

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