BUS314 Ch2
Type of corporation Triptych Food Corp. recently raised capital through an initial public offering (IPO). Its stock can now be purchased on the NYSE. This company is referred to as: A closely held corporation A publicly owned corporation
A publicly owned corporation At a certain stage in their growth, companies start seeking capital for expansion purposes or to fund their long-term investments. At this stage, privately owned companies, also called closely held corporations, decide to go public—or sell stock to the public at large. This is referred to as an initial public offering (IPO). Because the company is issuing an IPO to raise new capital, the transaction takes place in the primary market. When the company goes public (that is, makes an IPO), the public owns the company, which is called a publicly held corporation.
Several market participants interact in developed markets to organize the exchange of funds from buyers to sellers. Such institutions as investment banks, commercial banks, financial services corporations, credit unions, pension funds, life insurance companies, mutual funds, exchange traded funds, hedge funds, and private equity companies play a key role in facilitating these transfers. Identify the financial institution based on each description given in the following table: They are a pool of assets that trade like stocks on an exchange. They track a group of stocks, such as all stocks in an index or stocks of companies in emerging markets. Hedge funds Exchange traded funds mutual funds
An exchange traded fund (ETF) is a pool of assets similar to a regular mutual fund. ETFs trade in the exchange as stocks. ETFs track (hold) assets, such as stocks and bonds, and they get their values based on the value of the held assets. Most ETFs track a stock market index, such as the S&P 500 (where ETFs are called Spiders, ticker: SPDR) and the Dow Jones Industrial Average Index (where ETFs are called Diamonds Trust, ticker: DIA). ETFs are considered to be attractive investments, because they are convenient, have relatively low costs as compared to mutual funds, and have stock-like features.
The concept of market efficiency underpins almost all financial theory and decision models. When financial markets are efficient, the price of a security—such as a share of a particular corporation's common stock—should be __________ the present value estimate of the firm's expected cash flows discounted by its appropriate rate of return (also called the intrinsic value of the stock).
Equal to The efficient markets hypothesis states that the stock price trades at a value equal to the intrinsic value, which is the true value of a stock. In an efficient market, the stock price remains stable and adjusts quickly to any new information that impacts the stock's intrinsic value. When markets are efficient, participants believe that they can buy and sell stocks at their "fair price"; it is unlikely for a stock's price to be undervalued or overvalued for a sustained period.
Financial markets across economies involve various kinds of participants and trade various types of assets and securities. It is important to understand the kinds of markets in which financial transactions take place. You are preparing to take an exam in your finance class, and you've been making flash cards on different markets and transactions. Indicate the markets in which each of the following transactions will be traded: A bank purchased a credit default swap from another financial institution to protect itself against the default of one of its borrowers. In this example, the bank is: hedging speculating
Hedging Credit default swaps are contracts that offer protection against the default of a particular security. A bank is hedging when it purchases a credit default swap that offers protection against the default of one of its borrowers. The bank will make regular payments to another financial institution. In return, that financial institution agrees to insure the bank against losses that would occur if the borrower defaulted.
The process in which derivatives are used to reduce risk exposure is called
Hedging Hedging is the process in which derivatives are used to reduce risk exposure. Remember, a derivative is a financial instrument whose value is derived from some other asset, called the underlying asset. Derivatives include options, futures, and forward contracts, and these can be combined with each other or traditional securities. Market participants speculate to get higher returns, but speculation also increases risk exposure.
Financial markets across economies involve various kinds of participants and trade various types of assets and securities. It is important to understand the kinds of markets in which financial transactions take place. You are preparing to take an exam in your finance class, and you've been making flash cards on different markets and transactions. Indicate the markets in which each of the following transactions will be traded: A bank purchased a credit default swap from another financial institution to protect itself against the default of one of its borrowers. In this example, the bank is
Hedging (Credit default swaps are contracts that offer protection against the default of a particular security. A bank is hedging when it purchases a credit default swap that offers protection against the default of one of its borrowers. The bank will make regular payments to another financial institution. In return, that financial institution agrees to insure the bank against losses that would occur if the borrower defaulted.)
Almost all financial theory and decision models assume that the financial markets are efficient. The informational efficiency of financial markets determines the ability of investors to "beat" the market and earn excess (or abnormal) returns on their investments. If the markets are efficient, they will react rapidly as new relevant information becomes available. Financial theorists have identified three levels of informational efficiency that reflect what information is incorporated in stock prices. Identify the form of capital market efficiency under the efficient market hypothesis described in the following statement: Current market prices reflect all relevant publicly available information. This statement is consistent with: Weak form efficiency Semistrong form efficiency Strong form efficiency
Semistrong form Efficiency The statement describes semistrong form efficiency. Weak form efficiency implies that current market prices reflect all relevant historical and current information, such as past and current price movements. In this situation, investors will be unable to earn above-average returns simply by examining the company's past and current stock price trends. Semistrong form efficiency implies that the current market prices reflect all relevant publicly available information. If semistrong form efficiency characterizes a market, then investors cannot beat the market by making trades based on information reported in today's Wall Street Journal or in a CNN news report, since the information is immediately incorporated in the company's current share price. Strong form efficiency implies that current market prices reflect all relevant information, whether it is known publicly or privately. This means that investors (even corporate insiders) will not be able to earn above-average returns, because any information that they may trade on has already been incorporated in the current stock price. Different markets do not exhibit the same level of informational efficiency. As a result, different markets offer investors various opportunities to earn abnormal returns and above-average profits.
Almost all financial theory and decision models assume that the financial markets are efficient. The informational efficiency of financial markets deteSmith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (AMEX: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.25% Volume:1,419,317 Prev. Close:46.41 Avg. Vol. (3m):629,072 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):27.02 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%)rmines the ability of investors to "beat" the market and earn excess (or abnormal) returns on their investments. If the markets are efficient, they will react rapidly as new relevant information becomes available. Financial theorists have identified three levels of informational efficiency that reflect what information is incorporated in stock prices. Identify the form of capital market efficiency under the efficient market hypothesis described in the following statement: Current market prices reflect all relevant information, whether it is known publicly or privately. This statement is consistent with: Strong form efficiency Semistrong form efficiency Incorrect Weak form efficiency
The statement describes strong form efficiency. Weak form efficiency implies that current market prices reflect all relevant historical and current information, such as past and current price movements. In this situation, investors will be unable to earn above-average returns simply by examining the company's past and current stock price trends. Semistrong form efficiency implies that the current market prices reflect all relevant publicly available information. If semistrong form efficiency characterizes a market, then investors cannot beat the market by making trades based on information reported in today's Wall Street Journal or in a CNN news report, since the information is immediately incorporated in the company's current share price. Strong form efficiency implies that current market prices reflect all relevant information, whether it is known publicly or privately. This means that investors (even corporate insiders) will not be able to earn above-average returns, because any information that they may trade on has already been incorporated in the current stock price. Different markets do not exhibit the same level of informational efficiency. As a result, different markets offer investors various opportunities to earn abnormal returns and above-average profits.
A financial instrument whose value is derived from the value of an underlying asset is called a derivative speculation hedge
Derivative (A derivative is a financial instrument whose value is derived from some other asset, called the underlying asset. Derivatives include options, futures, and forward contracts. These can be combined with each other or traditional securities, such as stocks, bonds, and loans, to create hybrid instruments. Hedging is the process in which derivatives are used to reduce risk exposure. In contrast, market participants engage in speculation in order to generate higher returns, while also increasing their exposure to risks.)
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification: A small startup firm has each of the partners contribute $50,000 in capital to help the company make payroll for the next three months.
Direct Transfers (Citibank acts like a financial intermediary. Savers deposit money into the bank; the bank then consolidates savings from depositors and uses these funds to issue loans to individuals and businesses that need to raise capital.)
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification: Steve's grandfather loans him $30,000 to start a small coffee shop in the East Village in Manhattan.
Direct Transfers (Steve needs capital to start his coffee shop. He approaches his grandfather (the saver) directly to borrow money for the coffee shop. His grandfather transfers money directly to Steve.)
If the market maker is willing to purchase the entire block of 1,500 shares from Adele and, from that block, resell 1,000 shares to Jorge, then the market maker's net profit from Jorge's transaction—excluding any inventory effects—will be 1000 1500 500 550
1,000 Ignoring any XYZ shares already in the market maker's existing inventory, she will purchase the 1,500 shares from Adele and pay $44,250.00 ($29.50 per share x 1,500 shares) and then resell 1,000 of those shares to Jorge. This would generate $30,500.00 ($30.50 per share x 1,000 shares) in sale proceeds. However, the net profit from the purchase and resale of the 1,000-share transactions, $1,000.00, can be calculated as either the difference between the proceeds from selling 1,000 shares and the cost of the 1,000 shares ($30,500.00 - $29,500.00) or by multiplying the dealer's bid-ask spread ($1.00 per share) by the number of shares traded (1,000 shares). The remaining 500 shares bought from Adele, with their associated cost of $14,750.00, will be added to the market maker's inventory of XYZ shares. Remember, however, in the real world, the market maker will adjust her prices in response to the forces of demand and supply in the market.
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (AMEX: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.25% Volume:1,419,317 Prev. Close:46.41 Avg. Vol. (3m):629,072 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):27.02 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%) What is Smith's earnings per share (EPS) for the trailing 12 months? $1.83 $1.91 $2.24 $2.14 $1.67
$1.91 Earnings per share (EPS) is the firm's net income divided by the number of outstanding shares. This data is not available from the stock quote; however, Smith's current stock price and price-to-earnings (P/E) ratio are available. You can use the stock price and P/E ratio to calculate the EPS as follows: P/E RatioP/E Ratio = = Price per Share/EPSPrice per Share/EPS27.0227.02 = = $51.63/EPS$51.63/EPSEPSEPS = = $51.63/27.02$51.63/27.02EPSEPS = = $1.91$1.91
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (NYSE: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range: 25.48 - 60.71 One-Day Stock Return: 11.58% Volume: 1,419,317 Prev. Close: 46.27 Avg. Vol. (3m): 629,072 Open: 47.25 Market Cap: 1.63B Bid: N/A P/E (ttm): 25.43 Ask: N/A EPS (ttm): 1y Target Est: 55.40 Div. & Yield: 0.20 (0.40%) What is Smith's earnings per share (EPS) for the trailing 12 months? $1.75 $2.14 $2.03 $1.83 $1.97
$2.03 Earnings per share (EPS) is the firm's net income divided by the number of outstanding shares. This data is not available from the stock quote; however, Smith's current stock price and price-to-earnings (P/E) ratio are available. You can use the stock price and P/E ratio to calculate the EPS as follows: P/E Ratio = Price per Share/EPS 25.4325.43 = $51.63/EPS EPS = $51.63/25.43 EPS = $2.03
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (NASDAQ: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.42% Volume:1,419,317 Prev. Close:46.34 Avg. Vol. (3m):1,921,518 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):26.20 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%) How much did the price increase today over yesterday's closing price? $5.29 $5.22 $5.64 $5.15 $5.08
$5.29 At the close of yesterday's trading, Smith's stock price was $46.34 per share, and today it closed at $51.63. So the stock's price increased by $5.29 per share in today's trading, which is a one-day stock return of ($51.63 - $46.34)/$46.34 = 11.42%.
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (NYSE: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range: 25.48 - 60.71 One-Day Stock Return: 11.58% Volume: 1,419,317 Prev. Close: 46.27 Avg. Vol. (3m): 629,072 Open: 47.25 Market Cap: 1.63B Bid: N/A P/E (ttm): 25.43 Ask: N/A EPS (ttm): 1y Target Est: 55.40 Div. & Yield: 0.20 (0.40%) How much did the price increase today over yesterday's closing price? $5.15 $5.36 $5.29 $5.01 $5.22
$5.36 At the close of yesterday's trading, Smith's stock price was $46.27 per share, and today it closed at $51.63. So the stock's price increased by $5.36 per share in today's trading, which is a one-day stock return of ($51.63 - $46.27)/$46.27 = 11.58%.
WAC Inc. is going public and issuing 500,000 shares of common stock. The capital raised in the IPO will fund the company's proposed expansion. A Dutch auction is used to allocate shares in the WAC IPO. The following table shows the number of shares requested by potential investors in each row. Bids Number of Shares Requested Price per Share Bidder # 150,000$56Bidder # 2100,00054Bidder # 3150,00052Bidder # 4200,00050Bidder # 5250,00048Bidder # 6300,00046 What should be the firm's IPO offer price? $50 $55 $48 $52
$50 The market-clearing price in a Dutch auction is the highest price at which all the shares will be sold. The maximum offer price that WAC can set is $50 if it wants to sell all 500,000 shares through the Dutch auction. Remember that investors who are willing to pay more than $50 for a share of WAC stock would be happy if they had to pay only $50 for it.
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (AMEX: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.25% Volume:1,419,317 Prev. Close:46.41 Avg. Vol. (3m):629,072 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):27.02 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%) How much did the price increase today over yesterday's closing price? $5.22 $5.15 $5.57 $5.01 $5.08
5.22 At the close of yesterday's trading, Smith's stock price was $46.41 per share, and today it closed at $51.63. So the stock's price increased by $5.22 per share in today's trading, which is a one-day stock return of ($51.63 - $46.41)/$46.41 = 11.25%.
Financial instruments are assets that have a monetary value or record a monetary transaction. To coordinate the exchange of capital between borrowers and lenders, financial instruments trade in the financial markets. These financial instruments can be categorized on the basis of their issuers, maturity, risk, and other factors. Identify the financial instruments based on the following descriptions. Backed by the U.S. government, these financial instruments are fixed-rate debt securities with a maturity of more than one year. They are considered default free but are subject to interest rate risk. These financial instruments are contractual agreements that give one party a long-term agreement to use an asset by providing regular payments. Corporate bonds Preferred stocks Leases
A lease is a contractual agreement in which the lessee gets a long-term contract for the use of an asset and the lessor receives regular payments for a certain time period. Their risk is similar to that of corporate bonds.
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (AMEX: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.25% Volume:1,419,317 Prev. Close:46.41 Avg. Vol. (3m):629,072 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):27.02 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%) The last trade time is shown to be at 4:00 PM Eastern Time. The abbreviation "ttm" stands for "trailing twelve months," and the number shown reflects data from the previous 12 months. The abbreviation "3m" reflects data from the previous 3 months. What exchange does Smith Enterprises trade on? DAX SME FTSE NASDAQ AMEX
AMEX The top line of the stock quote shows the stock's name, the exchange that it is traded on, and the ticker symbol. Therefore, Smith Enterprises trades on the American Stock Exchange (AMEX). FTSE is the share index of the 100 most highly capitalized UK companies listed on the London Stock Exchange, NASDAQ is the National Association of Securities Dealers Automated Quotation, and DAX is the Deutscher Aktien Index (German stock index). NASDAQ and AMEX are two domestic dealer exchanges that stocks trade on. SME is the ticker symbol for the company.
Financial instruments are assets that have a monetary value or record a monetary transaction. To coordinate the exchange of capital between borrowers and lenders, financial instruments trade in the financial markets. These financial instruments can be categorized on the basis of their issuers, maturity, risk, and other factors. Identify the financial instruments based on the following descriptions. Issued by corporations, these unsecured debt instruments are used to fund corporate short-term financing requirements. If issued by a financially strong company, they have less risk. Commercial paper Certificates of deposit Money market mutual funds
Commercial paper (Corporations often use commercial paper to fund their short-term financing needs. Maturities on commercial paper rarely range any longer than 270 days. Risk associated with commercial paper depends on the credit standing of the issuing firm.)
Which of the following are money market instruments? Check all that apply. Preferred stocks Commercial paper Certificates of deposit Corporate bonds Common stocks
Commercial paper Certificates of deposit Money market instruments are financial instruments that can be traded easily and have a short-term maturity, which means they are highly liquid. Money market instruments, used to meet short-term financing needs, provide short-term investment options. Capital markets trade instruments that have a maturity period of more than one year. They include securities such as preferred stocks, common stocks, corporate bonds, and long-term bank loans.
Financial instruments are assets that have a monetary value or record a monetary transaction. To coordinate the exchange of capital between borrowers and lenders, financial instruments trade in the financial markets. These financial instruments can be categorized on the basis of their issuers, maturity, risk, and other factors. Identify the financial instruments based on the following descriptions. Issued by corporations, these financial instruments give their holders a class ownership in a company. They are considered the most risky but provide higher expected returns. Preferred stocks Corporate bonds Common stocks
Common Stocks (If a company defaults, common stockholders have the last claim on the company's assets and earnings. Common stocks are thus considered to be the riskiest class of ownership. However, common stockholders have voting rights and often get higher returns for the risks that they take.)
Which of the following instruments are traded in the capital markets? Check all that apply. Certificates of deposit Treasury bills Corporate bonds Long-term bank loans Commercial paper
Corporate bonds Long-term bank loans (Capital markets trade instruments that have a maturity period of more than one year. They include securities such as preferred stocks, common stocks, corporate bonds, and long-term bank loans excluding money market instruments. Money market instruments are financial instruments that can be traded easily and have a short-term maturity, which means they are highly liquid. Money market instruments, used to meet short-term financing needs, provide short-term investment options.)
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification: Based in Grass Valley, California, L & M Seeds Co. is a small company that manufactures organic seeds. To raise capital, the company sells stocks directly to savers in Grass Valley without involving any bank or financial intermediary. Direct Transfers Indirect Transfers through investment banks Indirect transfers through financial intermediaries
Direct Transfers Mutual funds operate as financial intermediaries between investors and businesses that seek capital. Elliot invests $25,000 by buying 1,000 shares of the mutual fund. The mutual fund collects money from all its investors (savers) and invests it into stocks, bonds, and other securities issued by companies (demanders of capital).
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification: Erin borrows money from her uncle to buy a new laptop. Direct Transfers Indirect Transfers through investment banks Indirect transfers through financial intermediaries
Direct Transfers xEdu.com wants to raise capital and has decided to go for an IPO. Investors interested in xEdu.com's offering will invest in its stock, but they will do so through the investment bank that is underwriting the issue. Through investment bankers, savers transfer capital indirectly to a demander of capital.
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (NASDAQ: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.42% Volume:1,419,317 Prev. Close:46.34 Avg. Vol. (3m):1,921,518 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):26.20 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%) What is Smith's earnings per share (EPS) for the trailing 12 months? $1.91 $2.24 $2.14 $2.19 $1.97
Earnings per share (EPS) is the firm's net income divided by the number of outstanding shares. This data is not available from the stock quote; however, Smith's current stock price and price-to-earnings (P/E) ratio are available. You can use the stock price and P/E ratio to calculate the EPS as follows: P/E Ratio = Price per Share/EPS 26.20 = $51.63/EPS EPS = $51.63/26.20$51.63/26.20 EPS = $1.97
True or False: The efficient markets hypothesis holds only if all investors are rational.
False This is false. The efficient markets hypothesis does not require all investors to be rational investors. It says that as stock prices deviate from their intrinsic values (because of new information), investors will take advantage of such short-term opportunities. However, some investors will interpret news in a different way and will tend to take reverse actions; that is, if investors are buying a stock that they consider to be undervalued, some investors will sell the stock because they consider it as overvalued, which will drive the stock price to an equilibrium price. The stock price will eventually become equal or close to its intrinsic value.
Financial markets across economies involve various kinds of participants and trade various types of assets and securities. It is important to understand the kinds of markets in which financial transactions take place. You are preparing to take an exam in your finance class, and you've been making flash cards on different markets and transactions. Indicate the markets in which each of the following transactions will be traded: Helen buys 1,000 shares of Microsoft stock through her online brokerage account. Financial Asset Markets Physical asset markets
Financial Asset Markets (Financial assets—in the form of stocks, bonds, mortgages, certificates, bank balances, and so forth—are intangible and distinguished from tangible physical assets. Helen buys 1,000 shares of stock of Microsoft. Stocks are financial assets and trade in the financial asset market. Physical asset markets involve the exchange of tangible (real) physical assets, such as commodities, automobiles, real estate, computers, and machinery; such assets are traded in the physical asset markets.)
Several market participants interact in developed markets to organize the exchange of funds from buyers to sellers. Such institutions as investment banks, commercial banks, financial services corporations, credit unions, pension funds, life insurance companies, mutual funds, exchange traded funds, hedge funds, and private equity companies play a key role in facilitating these transfers. Identify the financial institution based on each description given in the following table: These financial conglomerates provide a range of services, such as investment banking, commercial banking, and financial advising. Financial services corporations Commercial banks Investment banks
Financial conglomerates that combine a range of financial services are called financial services corporations. One such example is Citigroup, which owns Citibank (a commercial bank), Smith Barney (brokerage, investment banking, and asset management services), and other divisions providing various kinds of financial services. In European countries, financial conglomerates are also referred to as universal bankers.
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification: Citibank issues a loan to Jennifer for the expansion of her flower delivery business.
Indirect Transfers through Financial Intermediaries (The startup firm's partners (the savers) each directly transfer $50,000 to the company without the aid of any type of financial institution.)
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification: Israel launched a 10-year global bond issue of $1.5 billion in early 2009. Leading investment banks such as Citigroup, Deutsche Bank, and Goldman Sachs managed the deal. (Source: Reuters.com, Mar. 18, 2009.)
Indirect Transfers through Investment Banks (Israel issued global bonds to raise capital from investors worldwide. Investment banks such as Citigroup, Deutsche Bank, and Goldman Sachs managed the deal. Through the investment banks, the investors transfer capital indirectly to Israel.)
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification: xEdu.com is an early-stage start-up company that plans to issue its first public common stock—called an initial public offering (IPO)—in six months. It hires an investment bank to underwrite the issue. Direct Transfers Indirect Transfers through investment banks Indirect transfers through financial intermediaries
Indirect Transfers through investment banks Erin needs capital to buy her new laptop. She approaches her uncle (the saver) directly to borrow money for the laptop. Her uncle transfers money directly to Erin.
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification: Elliot invests $25,000 by purchasing 1,000 shares of an emerging markets mutual fund. This mutual fund invests in companies in Brazil, India, and China. He bought the mutual fund from the mutual fund company. Direct Transfers Indirect Transfers through investment banks Indirect transfers through financial intermediaries
Indirect transfers through financial intermediaries L & M Seeds Co. needs capital for its expansion plans. It directly sells stock to savers in its local community without involving any bank or financial intermediary. L & M Seeds Co. gives stocks to savers in exchange for the money that it needs for expansion.
Financial instruments are assets that have a monetary value or record a monetary transaction. To coordinate the exchange of capital between borrowers and lenders, financial instruments trade in the financial markets. These financial instruments can be categorized on the basis of their issuers, maturity, risk, and other factors. Identify the financial instruments based on the following descriptions. Backed by the U.S. government, these financial instruments are fixed-rate debt securities with a maturity of more than one year. They are considered default free but are subject to interest rate risk. Issued by money-centered financial firms, these short- or medium-term insured debt instruments pay higher interest than a regular savings account. They are low-risk instruments and have low returns. Certificates of Deposit Money market mutual funds commercial paper
Issued by banks, certificates of deposit (CDs) are short- or medium-term interest-bearing instruments. CDs are also referred to as time deposits because they restrict depositors from withdrawing the money for a certain time period. In return, depositors earn a specified interest rate that is low but more than the earnings from a savings account. CDs are insured by a federal agency (FDIC) and have very low risk.
Financial instruments are assets that have a monetary value or record a monetary transaction. To coordinate the exchange of capital between borrowers and lenders, financial instruments trade in the financial markets. These financial instruments can be categorized on the basis of their issuers, maturity, risk, and other factors. Identify the financial instruments based on the following descriptions. Backed by the U.S. government, these financial instruments are fixed-rate debt securities with a maturity of more than one year. They are considered default free but are subject to interest rate risk. State and local government bonds US Treasury bills US Treasury notes and bonds
Issued by the U.S. government, Treasury notes and bonds (T-bonds) are debt securities with a maturity of more than one year. They are considered default free because they are backed by the government. However, because their maturity is more than a year, T-bonds become subject to interest rate changes and risk. Income received from interest payments made by T-bonds is taxed at the federal level.
Financial instruments are assets that have a monetary value or record a monetary transaction. To coordinate the exchange of capital between borrowers and lenders, financial instruments trade in the financial markets. These financial instruments can be categorized on the basis of their issuers, maturity, risk, and other factors. Identify the financial instruments based on the following descriptions. These financial instruments are investment pools that buy such short-term debt instruments as Treasury bills (T-bills), certificates of deposit (CDs), and commercial paper. They can be easily liquidated. Money market mutual funds Commercial paper Consumer credit
Money Market Mutual Funds (Money market mutual funds invest in financial instruments—such as T-bills, CDs, and commercial paper—that have high liquidity and short maturities. Because the instruments that money market mutual funds invest in are low risk, these funds are considered less risky.)
Financial instruments are assets that have a monetary value or record a monetary transaction. To coordinate the exchange of capital between borrowers and lenders, financial instruments trade in the financial markets. These financial instruments can be categorized on the basis of their issuers, maturity, risk, and other factors. Identify the financial instruments based on the following descriptions. Backed by the U.S. government, these financial instruments are fixed-rate debt securities with a maturity of more than one year. They are considered default free but are subject to interest rate risk. These financial instruments are investment pools that buy such short-term debt instruments as Treasury bills (T-bills), certificates of deposit (CDs), and commercial paper. They can be easily liquidated. Money market mutual funds commercial paper consumer credit
Money market mutual funds invest in financial instruments—such as T-bills, CDs, and commercial paper—that have high liquidity and short maturities. Because the instruments that money market mutual funds invest in are low risk, these funds are considered less risky.
Financial markets across economies involve various kinds of participants and trade various types of assets and securities. It is important to understand the kinds of markets in which financial transactions take place. You are preparing to take an exam in your finance class, and you've been making flash cards on different markets and transactions. Indicate the markets in which each of the following transactions will be traded: Abbey allocates 80% of her portfolio for investments in short-term US Treasury bills. Capital Markets Money Markets
Money markets (All financial transactions that are highly liquid and have a short-term (less than one year) maturity are traded in money markets. Examples include US Treasury bills and short-term securities sold by the US Treasury to finance federal expenditures. All financial transactions with maturities of more than one year are traded in the capital markets. These include stocks, bonds, insurance, leases, and mortgages.)
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (NASDAQ: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.42% Volume:1,419,317 Prev. Close:46.34 Avg. Vol. (3m):1,921,518 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):26.20 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%) The last trade time is shown to be at 4:00 PM Eastern Time. The abbreviation "ttm" stands for "trailing twelve months," and the number shown reflects data from the previous 12 months. The abbreviation "3m" reflects data from the previous 3 months. What exchange does Smith Enterprises trade on? AMEX FTSE NASDAQ DAX SME
NASDAQ The top line of the stock quote shows the stock's name, the exchange that it is traded on, and the ticker symbol. Therefore, Smith Enterprises trades on the National Association of Securities Dealers Automated Quotation (NASDAQ). FTSE is the share index of the 100 most highly capitalized UK companies listed on the London Stock Exchange, DAX is the Deutscher Aktien Index (German stock index), and AMEX is the American Stock Exchange. NASDAQ and AMEX are two domestic dealer exchanges that stocks trade on. SME is the ticker symbol for the company.
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (NYSE: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range: 25.48 - 60.71 One-Day Stock Return: 11.58% Volume: 1,419,317 Prev. Close: 46.27 Avg. Vol. (3m): 629,072 Open: 47.25 Market Cap: 1.63B Bid: N/A P/E (ttm): 25.43 Ask: N/A EPS (ttm): 1y Target Est: 55.40 Div. & Yield: 0.20 (0.40%) The last trade time is shown to be at 4:00 PM Eastern Time. The abbreviation "ttm" stands for "trailing twelve months," and the number shown reflects data from the previous 12 months. The abbreviation "3m" reflects data from the previous 3 months. What exchange does Smith Enterprises trade on? SME AMEX NASDAQ FTSE NYSE
NYSE (The top line of the stock quote shows the stock's name, the exchange that it is traded on, and the ticker symbol. Therefore, Smith Enterprises trades on the New York Stock Exchange (NYSE). NASDAQ is the National Association of Securities Dealers Automated Quotation, AMEX is the American Stock Exchange, and FTSE is the share index of the 100 most highly capitalized UK companies listed on the London Stock Exchange. NASDAQ and AMEX are two domestic dealer exchanges that stocks trade on. SME is the ticker symbol for the company.)
Initial public offering performance When the demand for an initial public offering (IPO) of securities exceeds the number of securities issued, the offering is deemed to be: Undersubscribed Oversubscribed
Oversubscribed The objective of an IPO is to meet the company's funding requirements by selling stocks at a price so that the market has neither a shortage nor a surplus of securities. If there is more demand for an IPO than supply (creating a shortage), a higher price could have been charged, and the issuer could have raised more capital. Such a deal is referred to as an oversubscribed offering.
Several market participants interact in developed markets to organize the exchange of funds from buyers to sellers. Such institutions as investment banks, commercial banks, financial services corporations, credit unions, pension funds, life insurance companies, mutual funds, exchange traded funds, hedge funds, and private equity companies play a key role in facilitating these transfers. Identify the financial institution based on each description given in the following table: They are established by an employer to facilitate and organize employee retirement funds. They are asset pools that invest in securities that have a potential to give stable returns. Credit unions Life insurance companies Pension funds
Pension funds manage and invest funds collected from a corporation's employee retirement savings. A financial intermediary usually manages the funds, but several large corporations handle their funds in-house. The large US pension funds include the California Public Employees' Retirement System, California State Teachers' Retirement System, Federal Retirement Thrift Investment Board, and New York State Teachers' Retirement System.
A stock market is a _____ market for trading a company's stocks and derivatives. Public private
Public All transactions that take place in the form of standardized contracts and are traded in organized exchanges are a part of public market activity. The stock market—a market in which securities are issued and traded through exchanges or over-the-counter markets—is thus a public market. The demand and supply of a company's shares in the stock market drive the prices of its stock. By using fundamental analysis and analyzing risk-and-return data, you can determine the intrinsic value of the stock. Private markets deal with offerings that are not registered with the Securities and Exchange Commission, and the transactions occur privately among the parties involved.
Financial markets across economies involve various kinds of participants and trade various types of assets and securities. It is important to understand the kinds of markets in which financial transactions take place. You are preparing to take an exam in your finance class, and you've been making flash cards on different markets and transactions. Indicate the markets in which each of the following transactions will be traded: The state of California issues new bonds to the public with an investment bank serving as the underwriter to raise capital. Public markets Private markets
Public Markets (All transactions that take place in the form of standardized contracts and are traded in organized exchanges are a part of public market activity. The state of California issues new bonds in the form of bond contracts that investment banks will manage.)
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (NYSE: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range: 25.48 - 60.71 One-Day Stock Return: 11.58% Volume: 1,419,317 Prev. Close: 46.27 Avg. Vol. (3m): 629,072 Open: 47.25 Market Cap: 1.63B Bid: N/A P/E (ttm): 25.43 Ask: N/A EPS (ttm): 1y Target Est: 55.40 Div. & Yield: 0.20 (0.40%) How heavy was the trading of Smith's stock today relative to the normal level of trading? Relatively light trading Relatively heavy trading Average trading
Relatively heavy trading (The average daily trading volume for the previous three months is 629,072 shares. Today's trading volume was 1,419,317, which is much more than the average daily volume. Therefore, today saw relatively heavy trading in Smith's stock.)
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (AMEX: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.25% Volume:1,419,317 Prev. Close:46.41 Avg. Vol. (3m):629,072 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):27.02 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%) How heavy was the trading of Smith's stock today relative to the normal level of trading? Relatively heavy trading Average trading Relatively light trading
Relatively heavy trading The average daily trading volume for the previous three months is 629,072 shares. Today's trading volume was 1,419,317, which is much more than the average daily volume. Therefore, today saw relatively heavy trading in Smith's stock.
Smith Enterprises recently was profiled on a financial information website and touted as a "hot" growth stock. You acquired the stock quote shown here from that website. Smith Enterprises (NASDAQ: SME) Last Trade: 51.63 Day's Range: 47.22 - 51.96 Trade Time: 4:00 PM ET 52wk Range:25.48 - 60.71 One-Day Stock Return:11.42% Volume:1,419,317 Prev. Close:46.34 Avg. Vol. (3m):1,921,518 Open:47.25 Market Cap:1.63B Bid:N/A P/E (ttm):26.20 Ask:N/A EPS (ttm): 1y Target Est:55.40 Div. & Yield:0.20 (0.40%) How heavy was the trading of Smith's stock today relative to the normal level of trading? Relatively light trading Relatively heavy trading Average trading
Relatively light trading The average daily trading volume for the previous three months is 1,921,518 shares. Today's trading volume was 1,419,317, which is much less than the average daily volume. Therefore, today saw relatively light trading in Smith's stock.
Financial markets across economies involve various kinds of participants and trade various types of assets and securities. It is important to understand the kinds of markets in which financial transactions take place. You are preparing to take an exam in your finance class, and you've been making flash cards on different markets and transactions. Indicate the markets in which each of the following transactions will be traded: An investor buys $10,000 worth of gold at a certain price today. Spot markets Futures markets
Sport markets (Spot markets, also called cash markets, handle transactions that come into effect immediately and when contractual fulfillments are executed completely. The investor agrees to buy gold at a certain price today (called the spot price), so this is a spot market transaction. Transactions in the futures markets involve contracts in which the participants agree to buy or sell assets at a certain price at a future date.)
Jorge, a trader, wants to buy 1,000 shares of XYZ stock, while a second trader, Adele, is willing to sell 1,500 shares of the same stock. Unfortunately, Jorge and Adele don't know one another and must complete their transactions using the stock exchange's market-making dealer. XYZ's market maker is willing to sell her shares for $30.50 per share and purchase additional shares for $29.50 per share. Select the most appropriate values in the following table: Bid: 29.50, 30.50, 35.40 Ask: 45.75, 29.50, 30.50 Bid-ask: 99.25, 81.15, 1.00
Term Bid price:$29.50 Ask price:$30.50 Bid-ask spread:$1.00 The bid price of a stock is the price at which the market maker is willing to buy the stock, which in the case of XYZ stock is $29.50. The price at which the market maker is willing to sell the stock, $30.50, is the ask price. The difference between the bid price and the ask price, $1.00 ($30.50 - $29.50), is called the bid-ask spread.
Consider that there is a semistrong form of efficiency in the markets. A pharmaceutical company announces that it has received Federal Drug Administration approval for a new allergy drug that completely prevents hay fever. The consensus analyst forecast for the company's earnings per share (EPS) is $4.50, but insiders know that, with this new drug, earnings will increase and drive the EPS to $5.00. What will happen when the company releases its next earnings report? The stock price will increase and settle at a new equilibrium level. The stock price will not change, because the market already incorporated that information in the stock price when the announcement was made. There will be some volatility in the stock price when the earnings report is released; it is difficult to determine the impact on the stock price.
The stock price will increase and settle at a new equilibrium level. In a semistrong form of market efficiency, the stock price incorporates all current and publicly available information. In this case, when the announcement was made, the stock price would have increased to such that the earnings per share (EPS) reached the consensus level. In a semistrong form of market efficiency, the stock price does not incorporate any private information. So when private insider information is made public—that is, when the earnings report is released—the stock price will increase and adjust to a level where the EPS is equal to $5.00. In a strong form of market efficiency, all information in a market—whether public or private—is incorporated in the stock price. Even insider information is known to market participants, thus minimizing any arbitrage opportunities for a select group of investors. In a weak form of market efficiency, the stock price incorporates only past stock price movements and historical information.
Consider that there is a strong form of efficiency in the markets. A pharmaceutical company announces that it has received Federal Drug Administration approval for a new allergy drug that completely prevents hay fever. The consensus analyst forecast for the company's earnings per share (EPS) is $5.00, and insiders agree with analyst expectations. They too expect that, with this new drug, earnings will drive the EPS to $5.00. What will happen when the company releases its next earnings report? There will be some volatility in the stock price when the earnings report is released; it is difficult to determine the impact on the stock price. The stock price will not change, because the market already incorporated that information in the stock price when the announcement about FDA approval was made. The stock price will increase and settle at a new equilibrium level.
The stock price will not change, because the market already incorporated that information in the stock price when the announcement about FDA approval was made. (The stock price would have increased immediately to a new equilibrium level when the announcement about FDA approval was made. In a strong form of market efficiency, all information in a market—whether public or private—is incorporated in the stock price. Even insider information is known to market participants, which virtually eliminates any arbitrage opportunities for a select group of investors. In a semistrong form of market efficiency, the stock price incorporates all current, publicly available information. In a weak form of market efficiency, the stock price incorporates only past stock price movements and historical information.)
Consider that there is a weak form of efficiency in the markets. A pharmaceutical company announces that it has received Federal Drug Administration approval for a new allergy drug that completely prevents hay fever. The consensus analyst forecast for the company's earnings per share (EPS) is $4.50, but insiders know that, with this new drug, earnings will increase and drive the EPS to $5.00. What will happen when the company releases its next earnings report? The stock price will not change, because the market already incorporated that information in the stock price when the announcement was made. There will be some volatility in the stock price when the earnings report is released, but it is difficult to determine the impact on the stock price. However, the prices will eventually adjust to the news announcement. The stock price will increase and settle at a new equilibrium level.
There will be some volatility in the stock price when the earnings report is released, but it is difficult to determine the impact on the stock price. However, the prices will eventually adjust to the news announcement. In a weak form of market efficiency, the stock price incorporates only past stock price movements and historical information. The release of the earnings report may or may not have an immediate impact on the company's stock price, but the price might eventually adjust to the announcement at some point. In a semistrong form of market efficiency, the stock price incorporates all current, publicly available information. In a strong form of market efficiency, all information in a market—whether public or private—is incorporated in the stock price. Even insider information is known to market participants, thus minimizing any arbitrage opportunities for a select group of investors.
Financial instruments are assets that have a monetary value or record a monetary transaction. To coordinate the exchange of capital between borrowers and lenders, financial instruments trade in the financial markets. These financial instruments can be categorized on the basis of their issuers, maturity, risk, and other factors. Identify the financial instruments based on the following descriptions. Backed by the U.S. government, these financial instruments are short-term debt obligations with a maturity of less than one year. They are considered risk-free investments. US Treasury bills State and local government bonds US Treasury notes and bonds
U.S. Treasury bills (Issued by the U.S. government, Treasury bills (T-bills) finance federal expenditures. Sold in denominations of $1,000 up to a maximum purchase of $5 million, T-bills mature in less than a year. They are simple and considered exceptionally safe because the U.S. government backs them.)
Almost all financial theory and decision models assume that the financial markets are efficient. The informational efficiency of financial markets determines the ability of investors to "beat" the market and earn excess (or abnormal) returns on their investments. If the markets are efficient, they will react rapidly as new relevant information becomes available. Financial theorists have identified three levels of informational efficiency that reflect what information is incorporated in stock prices. Identify the form of capital market efficiency under the efficient market hypothesis described in the following statement: Current market prices reflect all information contained in past price movements. This statement is consistent with: Semistrong form efficiency Weak form efficiency Strong form efficiency
Weak Form efficiency The statement describes weak form efficiency. Weak form efficiency implies that current market prices reflect all relevant historical and current information, such as past and current price movements. In this situation, investors will be unable to earn above-average returns simply by examining the company's past and current stock price trends. Semistrong form efficiency implies that the current market prices reflect all relevant publicly available information. If semistrong form efficiency characterizes a market, then investors cannot beat the market by making trades based on information reported in today's Wall Street Journal or in a CNN news report, since the information is immediately incorporated in the company's current share price. Strong form efficiency implies that current market prices reflect all relevant information, whether it is known publicly or privately. This means that investors (even corporate insiders) will not be able to earn above-average returns, because any information that they may trade on has already been incorporated in the current stock price. Different markets do not exhibit the same level of informational efficiency. As a result, different markets offer investors various opportunities to earn abnormal returns and above-average profits.
The difference between the price at which a dealer will sell a certain security and the price at which a dealer will buy a security is called the ask price bid price bid-ask spread
bid-ask spread The price at which a dealer is willing to buy a security is called the bid price, and the price at which a dealer is willing to sell the security is called the ask price. The difference between the ask price and the bid price is called the bid-ask spread. In general, for most transactions, the bid price is less than the ask price, and dealers make profits from the bid-ask spread.
The concept of market efficiency underpins almost all financial theory and decision models. When financial markets are efficient, the price of a security—such as a share of a particular corporation's common stock—should be ______________ the present value estimate of the firm's expected cash flows discounted by its appropriate rate of return (also called the intrinsic value of the stock).
equal to (The efficient markets hypothesis states that the stock price trades at a value equal to the intrinsic value, which is the true value of a stock. In an efficient market, the stock price remains stable and adjusts quickly to any new information that impacts the stock's intrinsic value. When markets are efficient, participants believe that they can buy and sell stocks at their "fair price"; it is unlikely for a stock's price to be undervalued or overvalued for a sustained period.)
