Quiz 1

Question 1

valuation principle

Answer 1

shows how to make costs/benefits comparable to weigh properly
the value of a commodity/asset to the firm/investors is determined by its competitive market price
if benefits > cost, we increase the value of our firm

Question 2

sole proprietorship

Answer 2

one person
72% of firms 3% of revenue
owner has unlimited personal liability for debts
lifetime is owner’s lifetime (difficult to transfer ownership)

Question 3

partnership

Answer 3

business owned and run by 2+ owners
ALL partners are liable for debts
ends with death/withdrawal of any single partner
avoid liquidation if agreement provides alternatives such as buyouts

Question 4

limited partnership

Answer 4

general and limited partners
general have personal liabilities for debts
limited have limited liabilities (death/withdrawal of limited doesn’t end partnership) (limited have no mgmt authority & cannot legally be involved in mgmt decisions)

Question 5

limited liability company

Answer 5

like a limited partnership without a general partner

all limited partners and DO make mgmt decisions

Question 6

corporation

Answer 6

citizen of state in which it was chartered in
separate of owners
85% of US business revenue
can enter contracts/acquire assets/incur obligations
sells stock and all outstanding shares are the equity (shareholders pay 2x taxes, unless it’s an S corps [less than 100 shareholders])

Question 7

financial managers must…

Answer 7

make investment decisions, financial decisions to fund investments, short term cash decisions

Question 8

corporate mgmt team

Answer 8

board of directors: ultimate decision making, decided upon via votes from shareholders
CEO: enforces stuff set by board (can be director on board)
CFO: senior financial manager, reports to CEO, oversees controller (acct/tax) and treasurer (cap budget/risk & credit mgmt)

Question 9

agency problem

Answer 9

managers weigh self interest > shareholder interest

Question 10

hostile takeover

Answer 10

individual/org purchases so many shares that they can oust the board/CEO

Question 11

private corporation

Answer 11

has limited number of owners and no organized market for shares

Question 12

primary market

Answer 12

corporation issuing new shares of stock & selling them to investors

Question 13

secondary market

Answer 13

between investors without involvement of the corporation

Question 14

market makers

Answer 14

match buyers and sellers

known as specialists at NYSE

Question 15

bid price

Answer 15

market maker is willing to buy at this price

CONSUMERS SELL, limit order with highest price

Question 16

ask price

Answer 16

market maker is willing to sell at this price

CONSUMERS BUY, limit order with lowest price

Question 17

NYSE

Answer 17

market makers are called specialists

each stock has 1 specialist

Question 18

NASDAQ

Answer 18

multiple market makers per stock

Question 19

transaction cost

Answer 19

bid-ask spread & broker’s commission

consumers buy at the ASK, sell at the BID

Question 20

limit order

Answer 20

order to buy/sell amount of security at a fixed price

Question 21

limit order book

Answer 21

collection of all current limit orders fora given security
make public so investors/brokers can decide bid/ask
traders who post limit orders PROVIDE liquidity to the market

Question 22

market orders

Answer 22

orders to trade immediately at the best outstanding limit order available
traders who do this TAKE liquidity

Question 23

high frequency traders

Answer 23

take advantage of both liquidity and stale limit orders

Question 24

stale limit orders

Answer 24

news that causes price to move

smart traders take advantage of existing limit orders by executing trades at old prices

Question 25

dark pools

Answer 25

size & price of orders are not disclosed to participants

Question 26

listing standards

Answer 26

requirements a firm must meet to be traded on the exchange

Question 27

financial institutions

Answer 27

entities that provide financial services

Question 28

competitive market

Answer 28

goods can be bought and sold at the same price. PRICE DETERMINES VALUE OF THE GOOD

Question 29

law of one price

Answer 29

in competitive markets, securities and goods with the same cash flows are the same price

Question 30

arbitrage

Answer 30

buying/selling equivalent goods to take advantage of a price difference

Question 31

arbitrage opportunity

Answer 31

no risk profit making

Question 32

time value of money

Answer 32

difference between money today vs tomorrow

Question 33

interest rate

Answer 33

price of money

determined by supply of savings and demand for borrowing

Question 34

price of today in 1 year

Answer 34

1 / (1 + r)

Question 35

compound interest

Answer 35

interest on interest

Question 36

years to double

Answer 36

72/r (in percent)

Question 37

perpetuity

Answer 37

stream of regular cash flows that occur at regular intervals forever

Question 38

consol

Answer 38

perpetual bond

promises owner fixed cash flows annually forever

Question 39

annuity

Answer 39

stream of equal cash flows arriving at regular intervals and ending after a specific time period

Question 40

growing perpetuity

Answer 40

stream of cash flows that occur at regular intervals and grow at a constant rate forever

Question 41

growing annuity

Answer 41

stream of N growing cash flows paid at regular intervals eventually coming to an end