Chapter 1 & 2

Which of the following factors tend to encourage management to act in their stockholders' best interests?

All of these factors encourage management to act in shareholders' best interests

Which of the following statements reflects the position of most people in business?

Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

Of the following statements, which is CORRECT? a.If you purchase 100 shares of Facebook stock from your friend Sam, this is an example of a primary market transaction. b.If H&R Block issues additional shares of common stock through an investment banker, this would be a secondary market transaction. c.As they are generally defined, money market transactions involve debt securities with maturities of less than one year. d.The NYSE is an example of an over-the-counter market. e.Only institutions, and not individuals, can engage in derivative market transactions.

C. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

Maximizing expected EPS will maximize shareholder value.

FALSE

T/F Maximizing the stock price on a specific target date will maximize shareholder value.

FALSE

T/F The acronym IPO stands for "independent public offering."

FALSE

Which of the following statements describes a primary market transaction?

Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

Which of the following statements about hedge funds is CORRECT?

Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks.

Which of the following is an example of securities traded in money markets?

Short-term debt securities such as Treasury bills and commercial paper

T/ F The board of directors is the highest ranking body in a corporation. The members of the board are elected by the shareholders, and the chairperson of the board is the highest ranking member of the board. The CEO generally reports to the board and its chairperson, and the board generally has the authority to remove the CEO.

TRUE

T/F A corporation is said to be publicly owned if its shares are held by the investing public, which may include individuals, other corporations, and institutional investors.

TRUE

T/F A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. One example is a commercial bank, which takes in demand deposits and then uses that money to make long-term mortgage loans.

TRUE

T/F A stock is considered to be closely held if the corporation's shares are owned by a few individuals who are associated with the firm's management.

TRUE

T/F A stock's return can be broken out into its dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). These returns can be calculated for all of the stocks in the S&P 500. You can find an indicator of the "return on the market" by calculating the weighted average of those returns, using each stock's total market value.

TRUE

T/F Financial institutions are more diversified today than they were in the past, when federal regulations separated investment banks, commercial banks, insurance companies, and other financial companies. Today, large financial services corporations offer services that they could not in the past.

TRUE

T/F Hedge funds are similar to mutual funds except that they are less regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions.

TRUE

T/F There are factors that influence stock price over which managers have virtually no control.

TRUE

T/F To find the annual rate of return on any given stock, add the stock's dividend for the year plus the change in the stock's price during the year, then divide by its beginning-of-year price.

TRUE

Which of the following situations would most likely encourage a firm's managers to make decisions that are in the best interests of shareholders?

The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds, rather than by small individual investors, rises from 10% to 80%.

If you sat on the board of directors of Tyng Corporation, which of the following actions would you recommend to REDUCE potential conflicts of interest between Tyng's stockholders and bondholders?

The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions

Calistoga Combines is a publicly owned firm. In order to best serve shareholders, its primary operating goal should be to _____. a.use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers b.maximize managers' own interests, which are by definition consistent with maximizing shareholders' wealth c.maximize the firm's expected EPS, which must also maximize the firm's price per share d.minimize the firm's risks because most stockholders dislike risk. In turn, this will maximize the firm's stock price e.to attempt to maximize the current stock price than its intrinsic value

a.use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers

Which of the following statements about business organizations is CORRECT? a.It is generally easier to transfer one's ownership interest in a partnership than in a corporation. b.A significant risk in starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business. c.If a corporation elects to be taxed as a P corporation, then both it and its stockholders can avoid all federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. d.It's unlikely for a firm to be organized as a corporation when it requires a lot of capital. e.Tax advantages of incorporation offset the corporate shareholders' exposure to unlimited liability.

b.A significant risk in starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.

Which of the following represents a significant disadvantage to the corporate form of organization? a.Difficulty in transferring ownership. b.Exposure to taxation of corporate earnings and stockholder dividend income. c.Degree of liability to which corporate owners and managers are exposed. d.Level of difficulty corporations' face in obtaining large amounts of capital in financial markets. e.All of these are disadvantages to the corporate form of organization.

b.Exposure to taxation of corporate earnings and stockholder dividend income.

Which of the following statements about financial markets is CORRECT? a.While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. b.The New York Stock Exchange is an auction market, and it has a physical location. c.Home mortgage loans are traded in the money market. d.If an investor sells shares of stock through a broker, then it would be a primary market transaction. e.Capital markets deal only with common stocks and other equity securities.

b.The New York Stock Exchange is an auction market, and it has a physical location.

Three years ago you purchased 500 shares in the Kellogg Company, but yesterday you sold 200 of those shares through your broker. This is _____. a.a primary market transaction b.a secondary market transaction c.a futures market transaction d.an over-the-counter market transaction e.a money market transaction

b.a secondary market transaction

Of the following statements, which is CORRECT?

c.As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

One of the following statements about issuing and owning securities is incorrect. Which statement is NOT correct? a.The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC. b.When a corporation's shares are owned by a few individuals, we say that the firm is closely, or privately, held. c.Going public establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares. d.When stock in a closely held corporation is offered to the public for the first time, the transaction is called going public, or an IPO, and the market for such stock is called the new issue, or IPO, market. e.It is possible for a firm to go public and yet not raise any additional new capital for the firm itself.

c.Going public establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Which of the following statements about IPOs is CORRECT? a.The term "IPO" stands for Individual Purchase Order, and it is the price at which individual shares of a new company are offered for purchase. b.Sometimes, a company is forced to issue more shares than it wants to sell in an IPO because the share price is so low and demand is high. c.In a Dutch auction, investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay. d.It is possible that the price set in an IPO is so high that investors will refuse to buy the number of shares that the company wants to sell. In this situation, the IPO is said to be oversubscribed. e.IPO prices are generally established by the market, and buyers of the new stock must pay the price that prevails at the close of trading on the day that the stock is offered to the public.

c.In a Dutch auction, investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay.

Which of the following statements accurately describes business organizations? a.In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy. b.A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company. c.Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. d.A major disadvantage of a partnership relative to a corporation is the fact that partnership earnings are subject to double taxation while corporate earnings are only taxed once. e.In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business.

c.Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.

Which of the following is an example of a capital market instrument? a.Money market mutual funds b.Commercial paper c.Preferred stock d.U.S. Treasury bills e.Banker's acceptances

c.Preferred stock

Which is TRUE about business organizations? a.Corporate stockholders are exposed to unlimited liability. b.Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of international businesses (in terms of the number of businesses) are organized as corporations, all governed by the same legal statutes. c.Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporate earnings are only subject to taxation once, while earnings from proprietorships and partnerships are taxed twice. d.Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations even though corporate earnings are subject to double taxation. e.Corporate earnings are only subject to taxation once, while proprietorship earnings are subject to double taxation.

d.Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations even though corporate earnings are subject to double taxation.

Which of the following statements describes a primary market transaction? a.One financial institution buys 200,000 shares of BP stock from another institution. An investment banker arranges the transaction. b.You sell 200 shares of Kroger stock on the NYSE through your broker. c.You buy 200 shares of Honda stock from your brother. The trade is not made through a broker; you just give him cash and he gives you the stock. d.Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker. e.Microsoft sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years.

d.Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

Which of the following statements about legal and ethical issues is CORRECT? a.Ethics is not an important consideration in business and in business schools. b.If a lower level person in a firm does something illegal, like "cooking the books," to understate costs and thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted. c.There are many types of unethical business behavior. One example is when executives provide information that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks, but it is not illegal to provide it to stockholders. d.If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted. e.Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are not, and this is what determines ethical behavior in business.

d.If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.

Which of the following is an example of securities traded in money markets?

d.Short-term debt securities such as Treasury bills and commercial paper

Which of the following statements about financial institutions and securities is CORRECT? a.While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. b.Money markets are markets for long-term debt and common stocks. c.Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks. d.The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market. e.A liquid security is a security whose value is derived from the price of some other "underlying" asset.

d.The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market.

If you sat on the board of directors of Tyng Corporation, which of the following actions would you recommend to REDUCE potential conflicts of interest between Tyng's stockholders and bondholders? a.Financing risky projects with additional debt b.Compensating managers with stock options c.The threat of hostile takeovers d.The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions e.Abolishing the Securities and Exchange Commission

d.The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions

You recently sold 100 shares of Facebook stock to your uncle. You had the certificates and gave them to him. In exchange, he wrote you a check. Which of the following best describes this transaction? a.This is an example of a money market transaction. b.This is an example of a primary market transaction. c.This is an example of an exchange of physical assets. d.This is an example of a direct transfer of capital. e.This is an example of a derivative market transaction.

d.This is an example of a direct transfer of capital.

Which of the following statements reflects the position of most people in business? a.It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior. b.Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees. c.Whistleblowers are generally promoted more rapidly than other employees because of the courage it takes to blow the whistle. d.A corporation's short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation. e.Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

e.Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

Thinking about the financial markets, which of the following statements is CORRECT? a.Money market transactions only involve securities denominated in U.S. dollars. b.The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. Spot market transactions involve securities that have maturities of less than one year, whereas futures markets transactions involve securities with maturities greater than one year. c.Capital market transactions involve only preferred stock or common stock. d.If General Electric were to issue new stock this year, this would be considered a secondary market transaction as the company already has stock outstanding. e.Both NASDAQ dealers and specialists on the NYSE hold inventories of stocks.

e.Both NASDAQ dealers and specialists on the NYSE hold inventories of stocks.

Of the following actions, which one is most likely to reduce conflicts of interest between managers and stockholders? a.Pay managers large cash salaries and give them no stock options b.For a firm that compensates managers with stock options, reduce the time before options are vested (i.e., the time before options can be exercised and the shares that are received can be sold). c.Beef up the restrictive covenants in the firm's debt agreements d.Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. e.Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

e.Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

Which of the following statements about hedge funds is CORRECT? a.Hedge funds are extremely popular in Europe and Asia, but they are rarely used or made available in the United States. b.Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. c.Hedge funds have more in common with investment banks than with any other type of financial institution. d.Hedge funds have more in common with commercial banks than with any other type of financial institution. e.Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks.

e.Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks.

The Gabriel Corporation has asked you, a consultant, to recommend an action that is likely to REDUCE potential conflicts between stockholders and bondholders. Which action do you propose? a.Compensating managers with more stock options and less cash income b.The passage of laws that make it harder for hostile takeovers to succeed c.A government regulation that banned the use of convertible bonds d.The firm begins to use only long-term debt (e.g., debt that matures in 30 years or more) rather than debt that matures in less than one year. e.Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders)

e.Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders)

Imagine that you are the chairman of the board of a large corporation. Which of the following mechanisms do you think the board should choose to adopt to motivate top-level managers to act in the best interests of shareholders? a.Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock. b.Decrease the use of restrictive covenants in bond agreements. c.Take actions that reduce the possibility of a hostile takeover. d.Elect a board of directors that allows managers greater freedom of action. e.Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.

e.Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.

Of the following policy changes, which would be the most likely to REDUCE potential conflicts of interest between stockholders and managers? a.A firm's compensation system is changed so that managers receive larger cash salaries and no long-term options to buy stock. b.The company changes the way executive stock options are handled, with all options vesting after one year rather than having 20% of the options awarded vest every two years over a 10-year period. c.The company's outside marketing firm is given a lucrative year-by-year consulting contract with the company. d.Congress passes a law that severely restricts hostile takeovers. e.The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.

e.The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.

T/F Data from the Dow Jones Industrial Average, the S&P 500 Index, and the NASDAQ Composite Index give information about past stock returns.

true

T/F Maximizing the firm's expected profits for the current year does not necessarily maximize the stockholders' wealth for the current year.

true

T/F The equation used to find the annual rate of return on any given stock is the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price. When applied to a large portfolio of stocks, like those in the S&P 500, the average of the returns on each stock can be used to find stock market returns for the year in question.

true