Financial Management: Theory And Practice, 2nd Edition Test Bank

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CHAPTER 1AN OVERVIEW OF FINANCIAL MANAGEMENT AND THE FINANCIALENVIRONMENTPleaseseetheprefaceforinformationontheAACSBletterindicators(F,M,etc.)onthesubjectlines.True/FalseEasy:(1.2)FirmorganizationFMAnswer:bEASY1.Theformoforganizationforabusinessisnotanimportantissue,asthisdecisionhasverylittleeffectontheincomeandwealthofthefirm'sowners.a.Trueb.False(1.2)FirmorganizationFMAnswer:bEASY2.Themajoradvantageofaregularpartnershiporacorporationasaformofbusinessorganizationisthefactthatbothoffertheirownerslimitedliability,whereasproprietorshipsdonot.a.Trueb.False(1.2)PartnershipFMAnswer:aEASY3.Therearethreeprimarydisadvantagesofaregularpartnership:(1)unlimitedliability,(2)limitedlifeoftheorganization,and(3)difficultyoftransferringownership.Thesecombinetomakeitdifficultforpartnershipstoattractlargeamountsofcapitalandthustogrowtoaverylargesize.a.Trueb.False(1.2)ProprietorshipFMAnswer:aEASY4.Twodisadvantagesofaproprietorshipare(1)therelativedifficultyofraisingnewcapitaland(2)theowner'sunlimitedpersonalliabilityforthebusiness'debts.a.Trueb.False

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Page 2True/FalseChapter 1: Overview(1.2)LimitedliabilityFMAnswer:aEASY5.Onekeyvalueoflimitedliabilityisthatitlowersowners'risksandtherebyenhancesafirm'svalue.a.Trueb.False(1.3)ValuemaximizationFMAnswer:bEASY6.Ifafirm'sgoalistomaximizeitsearningspershare,thisisthebestwaytomaximizethepriceofthecommonstockandthusshareholders'wealth.a.Trueb.False(1.4)FinancialintermediariesFMAnswer:aEASY7.IfFirmA'sbusinessistoobtainsavingsfromindividualsandtheninvesttheminfinancialassetsissuedbyotherfirmsorindividuals,FirmAisafinancialintermediary.a.Trueb.False(1.8)FinancialmarketsFHAnswer:bEASY8.Ifanindividualinvestorbuysorsellsacurrentlyoutstandingstockthroughabroker,thisisaprimarymarkettransaction.a.Trueb.False(1.8)FinancialmarketsFHAnswer:aEASY9.Recently,HaleCorporationannouncedthesaleof2.5millionnewlyissuedsharesofitsstockatapriceof$21pershare.Halesoldthestocktoaninvestmentbanker,whointurnsoldittoindividualandinstitutionalinvestors.Thisisaprimarymarkettransaction.a.Trueb.False(1.11)StockmarkettransactionsFHAnswer:aEASY10.OneofthefunctionsofNYSEspecialistsistofacilitatetradingbykeepinganinventoryofsharesofthestocksinwhichtheyspecialize,buyingwheninvestorswanttosellandsellingwhentheywanttobuy.Theychangethebidandaskpricesofthesecuritiessoastokeepsupplyanddemandinbalance.a.Trueb.False

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Chapter 1: OverviewConceptual QuestionsPage 3Medium:(1.2)PartnershipFMAnswer:bMEDIUM11.Thedisadvantagesassociatedwithaproprietorshiparesimilartothoseunderapartnership.Oneexceptionrelatestothemoreformalnatureofthepartnershipagreementandthecommitmentofallpartners'personalassets.Asaresult,partnershipsdonothavedifficultyraisinglargeamountsofcapital.a.Trueb.False(1.2)ProprietorshipFMAnswer:aMEDIUM12.Thefactsthataproprietorship,asabusiness,paysnocorporateincometax,andthatitiseasilyandinexpensivelyformed,aretwokeyadvantagestothatformofbusiness.a.Trueb.FalseMultiple Choice: ConceptualEasy:(1.2)FirmorganizationCMAnswer:dEASY13.WhichofthefollowingstatementsisCORRECT?a.Oneofthedisadvantagesofincorporatingabusinessisthattheownersthenbecomesubjecttoliabilitiesintheeventthefirmgoesbankrupt.b.Soleproprietorshipsaresubjecttomoreregulationsthancorporations.c.Inanytypeofpartnership,everypartnerhasthesamerights,privileges,andliabilityexposureaseveryotherpartner.d.Soleproprietorshipsandpartnershipsgenerallyhaveataxadvantageovermanycorporations,especiallylargeones.e.Corporationsofalltypesaresubjecttothecorporateincometax.

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Page 4Conceptual QuestionsChapter 1: Overview(1.2)FirmorganizationCMAnswer:aEASY14.WhichofthefollowingstatementsisCORRECT?a.Oneofthedisadvantagesofasoleproprietorshipisthattheproprietorisexposedtounlimitedliability.b.Itisgenerallyeasiertotransferone’sownershipinterestinapartnershipthaninacorporation.c.Oneoftheadvantagesofthecorporateformoforganizationisthatitavoidsdoubletaxation.d.Oneoftheadvantagesofacorporationfromasocialstandpointisthateverystockholderhasequalvotingrights,i.e.,“oneperson,onevote.”e.Corporationsofalltypesaresubjecttothecorporateincometax.(1.2)FirmorganizationCMAnswer:dEASY15.WhichofthefollowingstatementsisCORRECT?a.Itisgenerallymoreexpensivetoformaproprietorshipthanacorporationbecause,withaproprietorship,extensivelegaldocumentsarerequired.b.Corporationsfacefewerregulationsthansoleproprietorships.c.Onedisadvantageofoperatingabusinessasasoleproprietorshipisthatthefirmissubjecttodoubletaxation,atboththefirmlevelandtheownerlevel.d.Oneadvantageofformingacorporationisthatequityinvestorsareusuallyexposedtolessliabilitythaninaregularpartnership.e.Ifaregularpartnershipgoesbankrupt,eachpartnerisexposedtoliabilitiesonlyuptotheamountofhisorherinvestmentinthebusiness.(1.2)FirmorganizationCMAnswer:cEASY16.CheersInc.operatesasapartnership.Nowthepartnershavedecidedtoconvertthebusinessintoaregularcorporation.WhichofthefollowingstatementsisCORRECT?a.AssumingCheersisprofitable,lessofitsincomewillbesubjecttofederalincometaxes.b.Cheerswillnowbesubjecttofewerregulations.c.Cheers’shareholders(theex-partners)willnowbeexposedtolessliability.d.Cheers’investorswillbeexposedtolessliability,buttheywillfinditmoredifficulttotransfertheirownership.e.Cheerswillfinditmoredifficulttoraiseadditionalcapital.

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Chapter 1: OverviewConceptual QuestionsPage 5(1.2)FirmorganizationCMAnswer:aEASY17.WhichofthefollowingstatementsisCORRECT?a.Itisusuallyeasiertotransferownershipinacorporationthanitistotransferownershipinasoleproprietorship.b.Corporateshareholdersareexposedtounlimitedliability.c.Corporationsgenerallyfacefewerregulationsthansoleproprietorships.d.Corporateshareholdersareexposedtounlimitedliability,andthisfactormaybecompoundedbythetaxdisadvantagesofincorporation.e.Shareholdersinaregularcorporation(notanScorporation)payhighertaxesthanownersofanotherwiseidenticalproprietorship.(1.2)CorporateformoforganizationCMAnswer:cEASY18.Whichofthefollowingcouldexplainwhyabusinessmightchoosetooperateasacorporationratherthanasasoleproprietorshiporapartnership?a.Corporationsgenerallyfinditrelativelydifficulttoraiselargeamountsofcapital.b.Lessofacorporation’sincomeisgenerallysubjectedtotaxesthanwouldbetrueifthefirmwereapartnership.c.Corporateshareholdersescapeliabilityforthefirm'sdebts,butthisfactormaybeoffsetbythetaxdisadvantagesofthecorporateformoforganization.d.Corporateinvestorsareexposedtounlimitedliability.e.Corporationsgenerallyfacerelativelyfewregulations.(1.4)FinancialtransactionsCHAnswer:cEASY19.Yourecentlysold100sharesofyournewcompany,XYZCorporation,toyourbrotheratafamilyreunion.Atthereunionyourbrothergaveyouacheckforthestockandyougaveyourbrotherthestockcertificates.Whichofthefollowingstatementsbestdescribesthistransaction?a.Thisisanexampleofanexchangeofphysicalassets.b.Thisisanexampleofaprimarymarkettransaction.c.Thisisanexampleofadirecttransferofcapital.d.Thisisanexampleofamoneymarkettransaction.e.Thisisanexampleofaderivativesmarkettransaction.

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Page 6Conceptual QuestionsChapter 1: Overview(1.7)HedgefundsCOAnswer:eEASY21.WhichofthefollowingstatementsisCORRECT?a.HedgefundsarelegalinEuropeandAsia,buttheyarenotpermittedtooperateintheUnitedStates.b.Hedgefundshavemoreincommonwithcommercialbanksthanwithanyothertypeoffinancialinstitution.c.Hedgefundshavemoreincommonwithinvestmentbanksthanwithanyothertypeoffinancialinstitution.d.HedgefundsarelegalintheUnitedStates,buttheyarenotpermittedtooperateinEuropeorAsia.e.Thejustificationforthe"light"regulationofhedgefundsisthatonly“sophisticated”investorswithhighnetworthsandhighincomesarepermittedtoinvestinthesefunds,andsuchinvestorssupposedlycandothenecessary“duediligence”ontheirownratherthanhaveitdonebytheSECorsomeotherregulator.(1.6)InterestratesCHAnswer:aEASY20.WhichofthefollowingstatementsisCORRECT?a.Ifexpectedinflationincreases,interestratesarelikelytoincrease.b.Ifindividualsingeneralincreasethepercentageoftheirincomethattheysave,interestratesarelikelytoincrease.c.Ifcompanieshavefewergoodinvestmentopportunities,interestratesarelikelytoincrease.d.Interestratesonalldebtsecuritiestendtoriseduringrecessionsbecauserecessionsincreasethepossibilityofbankruptcy,hencetheriskinessofalldebtsecurities.e.Interestratesonlong-termbondsaremorevolatilethanratesonshort-termdebtsecuritieslikeT-bills.

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Chapter 1: OverviewConceptual QuestionsPage 7(1.8)MoneymarketsCOAnswer:dEASY22.Moneymarketsaremarketsfora.Foreignstocks.b.Consumerautomobileloans.c.U.S.stocks.d.Short-termdebtsecurities.e.Long-termbonds.(1.8)FinancialmarketsCHAnswer:bEASY23.Whichofthefollowingisaprimarymarkettransaction?a.Yousell200sharesofIBMstockontheNYSEthroughyourbroker.b.IBMissues2,000,000sharesofnewstockandsellsthemtothepublicthroughaninvestmentbanker.c.Youbuy200sharesofIBMstockfromyourbrother.Thetradeisnotmadethroughabroker--youjustgivehimcashandhegivesyouthestock.d.Onefinancialinstitutionbuys200,000sharesofIBMstockfromanotherinstitution.Aninvestmentbankerarrangesthetransaction.e.Youinvest$10,000inamutualfund,whichthenusesthemoneytobuy$10,000ofIBMsharesontheNYSE.(1.8)FinancialmarketsCHAnswer:eEASY24.WhichofthefollowingstatementsisCORRECT?a.IfDisneyissuesadditionalsharesofcommonstockthroughaninvestmentbanker,thiswouldbeasecondarymarkettransaction.b.Ifyoupurchased100sharesofDisneystockfromyourbrother-in-law,thiswouldbeanexampleofaprimarymarkettransaction.c.TheIPOmarketisasubsetofthesecondarymarket.d.Onlyinstitutions,andnotindividuals,canparticipateinderivativesmarkettransactions.e.Astheyaregenerallydefined,moneymarkettransactionsinvolvedebtsecuritieswithmaturitiesoflessthanoneyear.(1.8)FinancialmarketsCHAnswer:cEASY25.Yourecentlysoldtoyourbrother200sharesofDisneystock,andthetransferwasmadethroughabroker,andthetradeoccurredontheNYSE.Thisisanexampleof:a.Afuturesmarkettransaction.b.Aprimarymarkettransaction.c.Asecondarymarkettransaction.d.Amoneymarkettransaction.e.Anover-the-countermarkettransaction.

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Page 8Conceptual QuestionsChapter 1: Overview(Comp:1.7-1.9)FinancialmarketsCHAnswer:aEASY26.WhichofthefollowingstatementsisCORRECT?a.TheNewYorkStockExchangeisanauctionmarketwithaphysicallocation.b.Capitalmarkettransactionsinvolveonlythepurchaseandsaleofequitysecurities,i.e.,commonstocks.c.Ifaninvestorsellssharesofstockthroughabroker,thenthiswouldbeaprimarymarkettransaction.d.Consumerautomobileloansareevidencedbylegaldocumentscalled"promissorynotes,"andtheseindividualnotesaretradedinthemoneymarket.e.Whilethedistinctionsareblurringasinvestmentbanksaretodaybuyingcommercialbanks,andviceversa,investmentbanksgenerallyspecializeinlendingmoney,whereascommercialbanksgenerallyhelpcompaniesraisecapitalfromotherparties.(Comp:1.7-1.9)FinancialmarketsCHAnswer:aEASY27.WhichofthefollowingstatementsisCORRECT?a.Capitalmarketinstrumentsincludebothlong-termdebtandcommonstocks.b.Anexampleofaprimarymarkettransactionwouldbeyouruncletransferring100sharesofWal-Martstocktoyouasabirthdaygift.c.TheNYSEdoesnotexistasaphysicallocation;rather,itrepresentsaloosecollectionofdealerswhotradestockselectronically.d.IfyouruncleinNewYorksold100sharesofMicrosoftthroughhisbrokertoaninvestorinLosAngeles,thiswouldbeaprimarymarkettransaction.e.Whilethetwofrequentlyperformsimilarfunctions,investmentbanksgenerallyspecializeinlendingmoney,whereascommercialbanksgenerallyhelpcompaniesraiselargeblocksofcapitalfrominvestors.

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Chapter 1: OverviewConceptual QuestionsPage 9(Comp:1.7-1.9)FinancialmarketsCHAnswer:eEASY28.WhichofthefollowingstatementsisCORRECT?a.Whilethedistinctionsareblurring,investmentbanksgenerallyspecializeinlendingmoney,whereascommercialbanksgenerallyhelpcompaniesraisecapitalfromotherparties.b.Aliquidsecurityisasecuritywhosevalueisderivedfromthepriceofsomeother“underlying”asset.c.Moneymarketmutualfundsusuallyinvestmostoftheirmoneyinawell-diversifiedportfolioofliquidcommonstocks.d.Moneymarketsaremarketsforlong-termdebtandcommonstocks.e.TheNYSEoperatesasanauctionmarket,whereastheNasdaqisadealermarket.Medium:(1.2)CorporateformoforganizationCMAnswer:aMEDIUM29.Onedrawbackofswitchingfromapartnershiptothecorporateformoforganizationisthefollowing:a.Itsubjectsthefirmtoadditionalregulations.b.Itcannotaffecttheamountofthefirm'soperatingincomethatgoestotaxes.c.Itmakesitmoredifficultforthefirmtoraiseadditionalcapital.d.Itmakesthefirm’sinvestorssubjecttogreaterpotentialpersonalliabilities.e.Itmakesitmoredifficultforthefirm’sinvestorstotransfertheirownershipinterests.(1.2)CorporateformoforganizationCMAnswer:cMEDIUM30.WhichofthefollowingstatementsisCORRECT?a.Ahostiletakeoveristhemainmethodoftransferringownershipinterestinacorporation.b.Unlimitedliabilityandlimitedlifearetwokeyadvantagesofthecorporateformoverotherformsofbusinessorganization.c.Acorporationisalegalentitythatisgenerallycreatedbyastate,andithasalifeandexistencethatisseparatefromthelivesofitsindividualownersandmanagers.d.Limitedliabilityofitsstockholdersisanadvantageofthecorporateformoforganization,butcorporationshavemoretroubleraisingmoneyinfinancialmarketsbecauseofthecomplexityofthisformoforganization.e.Althoughitsstockholdersareinsulatedbylimitedlegalliability,thelegalstatusofthecorporationdoesnotprotectthefirm’smanagersinthesameway,i.e.,bondholderscansueitsmanagersifthefirmdefaultsonitsdebt,evenifthedefaultistheresultofpooreconomicconditions.

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Page 10Conceptual QuestionsChapter 1: Overview(1.2)PartnershipformoforganizationCMAnswer:bMEDIUM31.WhichofthefollowingstatementsisCORRECT?a.Inaregularpartnership,liabilityforotherpartners’misdeedsislimitedtotheamountofaparticularpartner’sinvestmentinthebusiness.b.Partnershipshavemoredifficultyattractinglargeamountsofcapitalthancorporationsbecauseofsuchfactorsasunlimitedliability,theneedtoreorganizewhenapartnerdies,andtheilliquidity(difficultybuyingandselling)ofpartnershipinterests.c.Aslow-growthcompany,withlittleneedfornewcapital,wouldbemorelikelytoorganizeasacorporationthanwouldafastergrowingcompany.d.Inalimitedpartnership,thelimitedpartnershavevotingcontrol,whilethegeneralpartnerhasoperatingcontroloverthebusiness.Also,thelimitedpartnersareindividuallyresponsible,onaproratabasis,forthefirm’sdebtsintheeventofbankruptcy.e.Amajordisadvantageofallpartnershipsrelativetoallcorporationsisthefactthatfederalincometaxesmustbepaidbythepartnersratherthanbythefirmitself.(1.2)PartnershipformoforganizationCMAnswer:dMEDIUM32.WhichofthefollowingstatementsisCORRECT?a.Corporationsareatadisadvantagerelativetopartnershipsbecausetheyhavetofilemorereportstostateandfederalagencies,includingtheSecuritiesandExchangeAdministration,eveniftheyarenotpubliclyowned.b.Inaregularpartnership,liabilityforthefirm'sdebtsislimitedtotheamountaparticularpartnerhasinvestedinthebusiness.c.Afast-growthcompanywouldbemorelikelytosetupasapartnershipforitsbusinessorganizationthanwouldaslow-growthcompany.d.Partnershipshavedifficultyattractingcapitalinpartbecauseoftheirunlimitedliability,thelackofimpermanenceoftheorganization,anddifficultyintransferringownership.e.Amajordisadvantageofapartnershiprelativetoacorporationasaformofbusinessorganizationisthehighcostandpracticaldifficultyofitsformation.

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Chapter 1: OverviewConceptual QuestionsPage 11(1.2)FirmorganizationCMAnswer:cMEDIUM33.WhichofthefollowingstatementsisCORRECT?a.Mostbusinesses(bynumberandtotaldollarsales)areorganizedasproprietorshipsorpartnershipsbecauseitiseasiertosetupandoperateinoneoftheseformsratherthanasacorporation.However,ifthebusinessgetsverylarge,itbecomesadvantageoustoconverttoacorporation,primarilybecausecorporationshaveimportanttaxadvantagesoverproprietorshipsandpartnerships.b.Duetolimitedliability,unlimitedlives,andeaseofownershiptransfer,thevastmajorityofU.S.businesses(intermsofnumberofbusinesses)areorganizedascorporations.c.Duetolegalconsiderationsrelatedtoownershiptransfersandlimitedliability,mostbusiness(measuredbydollarsales)isconductedbycorporationsinspiteoflargecorporations’oftenlessfavorabletaxtreatment.d.Largecorporationsaretaxedmorefavorablythansoleproprietorships.e.Corporatestockholdersareexposedtounlimitedliability.(1.2)FirmorganizationCMAnswer:bMEDIUM34.JaneDoe,whohassubstantialpersonalwealthandincome,isconsideringthepossibilityofstartinganewbusinessinthechemicalwastemanagementfield.Shewillbethesoleowner,andshehasenoughfundstofinancetheoperation.Thebusinesswillhavearelativelyhighdegreeofrisk,anditisexpectedthatthefirmwillincurlossesforthefirstfewyears.However,theprospectsforgrowthandpositivefutureincomelookgood,andJaneplanstohavethefirmpayoutallofitsincomeasdividendstoheronceitiswellestablished.Whichofthelegalformsofbusinessorganizationwouldprobablybestsuitherneeds?a.Proprietorship,becauseofeaseofentry.b.Scorporation,togainsometaxadvantagesandalsotoobtainlimitedliability.c.Partnership,butonlyifsheneedsadditionalcapital.d.Regularcorporation,becauseofthelimitedliability.e.Inthissituation,thevariousformsoforganizationseemequallydesirable.

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Page 12Conceptual QuestionsChapter 1: Overview(1.2)CorporatecharterandbylawsCMAnswer:eMEDIUM35.WhichofthefollowingstatementsisCORRECT?a.Thecorporatebylawsareastandardsetofrulesestablishedbythestateofincorporation.Theserulesareidenticalforallcorporationsinthestate,andtheirpurposeistoensurethatthefirm’smanagersrunthefirminaccordancewithstatelaws.b.Thecorporatecharterisastandarddocumentprescribedbythestateofincorporation,anditspurposeistoensurethatthefirm’smanagersrunthefirminaccordancewithstatelaws.Proceduresforelectingcorporatedirectorsarecontainedinbylaws,whilethedeclarationoftheactivitiesthatthefirmwillpursueandthenumberofdirectorsareincludedinthecorporatecharter.c.Companiesmustestablishahomeoffice,ordomicile,inaparticularstate,andthatstatemustbetheoneinwhichmostoftheirbusiness(sales,manufacturing,andsoforth)isconducted.d.Attorneyfeesaregenerallyinvolvedwhenacompanydevelopsitscharterandbylaws,butsincethesedocumentsarevoluntary,anewcorporationcanavoidthesecostsbydecidingnottohaveeitheracharterorbylaws.e.Thecorporatecharterisconcernedwiththingslikewhatbusinessthecompanywillengagein,whereasthebylawsareconcernedwiththingslikeproceduresforelectingtheboardofdirectors.(1.3)BusinessethicsBMAnswer:cMEDIUM36.Withwhichofthefollowingstatementswouldmostpeopleinbusinessagree?a.Acorporation’sshort-runprofitswillalmostalwaysincreaseifthefirmtakesactionsthatthegovernmenthasdeterminedareinthebestinterestsofthenation.b.Firmsandgovernmentagenciesalmostalwaysagreewithoneanotherregardingtherestrictionsthatshouldbeplacedonhiringandfiringemployees.c.Althoughpeople’smoralcharactersareprobablydevelopedbeforetheygetintoabusinessschool,itisstillusefulforbusinessschoolstocoverethics,includinggivingstudentsanideaabouttheadverseconsequencesofunethicalbehaviortothemselves,theirfirms,andthenation.d.Itisnotusefulforalargecorporationtodevelopaformalsetofrulesdefiningethicalandunethicalbehavior.Suchrulesgenerallycan'tbeappliedinmanyspecificinstances,soitisbettertodealwithethicalissuesonacase-by-casebasis.e.“Whistleblowers,”becauseofthecourageittakestoblowthewhistle,aregenerallypromotedmorerapidlythanotheremployees.

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Chapter 1: OverviewConceptual QuestionsPage 13(1.3)GoaloffirmCMAnswer:aMEDIUM37.Theprimaryoperatinggoalofapublicly-ownedfirminterestedinservingitsstockholdersshouldbetoa.Maximizethestockpricepershareoverthelongrun,whichisthestock’sintrinsicvalue.b.Maximizethefirm'sexpectedEPS.c.Minimizethechancesoflosses.d.Maximizethefirm'sexpectedtotalincome.e.Maximizethestockpriceonaspecifictargetdate.(1.3)CorporategoalsandcontrolCMAnswer:dMEDIUM38.WhichofthefollowingstatementsisCORRECT?a.Thepropergoalofthefinancialmanagershouldbetoattempttomaximizethefirm’sexpectedcashflows,becausethiswilladdthemosttothewealthoftheindividualshareholders.b.Thefinancialmanagershouldseekthatcombinationofassets,liabilities,andcapitalthatwillgeneratethelargestexpectedprojectedafter-taxincomeovertherelevanttimehorizon,generallythecomingyear.c.Theriskinessinherentinafirm’searningspershare(EPS)dependsonthecharacteristicsoftheprojectsthefirmselects,andthusonthefirm’sassets.However,EPSisnotaffectedbythemannerinwhichthoseassetsarefinanced.d.Potentialagencyproblemscanarisebetweenstockholdersandmanagers,becausemanagershiredasagentstoactonbehalfoftheownersmayinsteadmakedecisionsfavorabletothemselvesratherthanthestockholders.e.Large,publicly-ownedfirmslikeAT&TandGMarecontrolledbytheirmanagementteams.Ownershipisgenerallywidelydispersed,hencemanagershavegreatfreedominhowtheymanagethefirm.Managersmayoperateinstockholders’bestinterests,buttheymayalsooperateintheirownpersonalbestinterests.Aslongasmanagersstaywithinthelaw,thereisnowaytoeitherforceormotivatethemtoactinthestockholders’bestinterests.

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Page 14Conceptual QuestionsChapter 1: Overview(1.6)SecuritypricesandinterestratesCHAnswer:eMEDIUM39.SupposetheU.S.Treasuryannouncesplanstoissue$50billionofnewbonds.Assumingtheannouncementwasnotexpected,whateffect,otherthingsheldconstant,wouldthathaveonbondpricesandinterestrates?a.Pricesandinterestrateswouldbothrise.b.Priceswouldriseandinterestrateswoulddecline.c.Pricesandinterestrateswouldbothdecline.d.Therewouldbenochangesineitherpricesorinterestrates.e.Priceswoulddeclineandinterestrateswouldrise.(1.6)InterestratesCHAnswer:dMEDIUM40.Whichofthefollowingwouldbemostlikelytoleadtohigherinterestratesonalldebtsecuritiesintheeconomy?a.Householdsstartsavingalargerpercentageoftheirincome.b.Theeconomymovesfromaboomtoarecession.c.Thelevelofinflationbeginstodecline.d.Corporationsstepuptheirexpansionplansandthusincreasetheirdemandforcapital.e.TheFederalReserveusesmonetarypolicyinanattempttostimulatetheeconomy.(1.6)InterestratesCHAnswer:eMEDIUM41.Whichofthefollowingfactorswouldbemostlikelytoleadtoanincreaseininterestratesintheeconomy?a.Householdsreducetheirconsumptionandincreasetheirsavings.b.TheFederalReservedecidestotrytostimulatetheeconomy.c.Thereisadecreaseinexpectedinflation.d.Theeconomyfallsintoarecession.e.Mostbusinessesdecidetomodernizeandexpandtheirmanufacturingcapacity,andtoinstallnewequipmenttoreducelaborcosts.

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Chapter 1: OverviewConceptual QuestionsPage 15(Comp:1.8,1.9,1.11)FinancialtransactionsCHAnswer:dMEDIUM42.WhichofthefollowingstatementsisCORRECT?a.IfGeneralElectricweretoissuenewstockthisyearitwouldbeconsideredasecondarymarkettransactionsincethecompanyalreadyhasstockoutstanding.b.Capitalmarkettransactionsonlyincludepreferredstockandcommonstocktransactions.c.Thedistinguishingfeaturebetweenspotmarketsversusfuturesmarketstransactionsisthematurityoftheinvestments.Thatis,spotmarkettransactionsinvolvesecuritiesthathavematuritiesoflessthanoneyear,whereasfuturesmarketstransactionsinvolvesecuritieswithmaturitiesgreaterthanoneyear.d.BothNasdaq"dealers"andNYSE“specialists”holdinventoriesofstocks.e.Anelectroniccommunicationsnetwork(ECN)isaphysicallocationexchange.(Comp:1.2,1.3)MiscellaneousconceptsCMAnswer:cMEDIUM43.WhichofthefollowingstatementsisCORRECT?a.Corporationsgenerallyaresubjecttofewerregulationsandmorefavorabletaxtreatmentthansoleproprietorshipsandpartnerships.ThisiswhycorporationsdomostofthebusinessintheUnitedStates.b.Managerswhofacethethreatofhostiletakeoversarelesslikelytopursuepoliciesthatmaximizeshareholdervaluethanaremanagerswhodonotfacethethreatofhostiletakeovers.c.Oneadvantageofthecorporateformoforganizationisthatliabilityoftheownersofthefirmislimitedtotheirinvestmentinthefirm.d.Becauseoftheirsimplifiedorganization,itiseasierforsoleproprietorshipsandpartnershipstoraiselargeamountsofoutsidecapitalthanitisforcorporations.e.Bondcovenantsareaneffectivewaytoresolveconflictsbetweenshareholdersandmanagers.

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