Deck 1: The World of Finance

Question 1

One of the most important disadvantages of the corporate form of business is:

A) unlimited owner liability.
B) ease of transferring ownership.
C) limited owner liability.
D) double taxation.

Answer 1

double taxation.

Question 2

An important advantage a general partner usually has is:

A) only one person in control.
B) unlimited liability.
C) larger share of profit distribution.
D) limited liability.

Answer 2

larger share of profit distribution.

Question 3

Which statement is correct about limited partners?

A) They can lose only one half of their initial investment.
B) They have no tax liability.
C) They take no part in running the business.
D) They have management control limited to their percent of investment.

Answer 3

They take no part in running the business.

Question 4

Profit maximization:

A) maximizes the wealth of the owners.
B) is an economic principle only.
C) is avoided because it is a long- run concept.
D) does not consider cash flow or risk.

Question 5

Wealth maximization:

A) is a long- run perspective used by financial managers for internal use only.
B) is usually discounted by bondholders.
C) takes a long- run perspective that focuses on the owners.
D) is an accounting number.

Question 6

Which of the following is false?

A) Less certain cash flows will result in lower valuation of the firm.
B) In the long run reported profits are always more important than cash flow.
C) Earlier cash inflows are generally preferable to later cash flows of similar size.
D) Risk levels will affect the valuation of the firm.

Question 7

An agent has a fiduciary responsibility to the principals:

A) for ethical obligations only.
B) always.
C) never
D) for legal obligations only.

Question 8

In a very large corporation, the financial planner usually reports directly to the:

A) controller.
B) financial accountant.
C) treasurer.
D) chief financial officer.

Question 9

Which of the following would least affect the value of a firm's stock?

A) risk associated with receiving cash flows
B) cashflows
C) timing on cash flows
D) number of shareholders

Question 10

Cash flow is generally considered more important in finance than profits because:

A) accountants can't agree on profit reporting.
B) profit goals involve timing issues.
C) profit doesn't pay the bills.
D) they are basically the same thing but cash flow is easier to calculate.

Question 11

Larger corporate profit and cash inflows than what had been expected usually:

A) mean a lower stock price.
B) will reduce the fluctuations of the stock price.
C) mean a higher stock price.
D) have no effect on the stock price.

Question 12

Both financial managers and accountants:

A) interpret financial statements for internal use only.
B) examine statements only for the firm they work for.
C) use financial statements.
D) work in the area of applied economics.

Question 13

With respect to cash payments:

A) you would agree to pay a larger amount if the cash payment were due in the future than if it were due right now.
B) cash earns interest in the short term only.
C) because of the time value of money, the later cash is received, the better.
D) less cash would be required if you were asked to wait for money to be received.

Question 14

A principal of the firm is:

A) the owner or owners.
B) the CEO.
C) the chairman of the board.
D) the agent.

Question 15

Which of the following is not a problem with profit maximization as a goal?

A) Profit maximization is an accounting principle.
B) There is not always a single definition of profit.
C) Sometimes profit and cash flow move in opposite directions.
D) Profit cannot be spent.

Question 16

Which of the following would not impose constraints on the firm?

A) worker safety laws
B) environmental laws
C) civil rights laws
D) company pricing decisions

Question 17

The sole proprietor:

A) is liable for all obligations of the business equal to the investment in the firm.
B) has unlimited liability relating to the business.
C) has limited liability relating to injuries on the premises.
D) has unlimited liability but avoids federal taxation.

Question 18

The articles of partnership:

A) are used primarily for limited partners to protect their investment.
B) define the terms of the partnership.
C) are required by all partnerships.
D) are usually just a formality; and rarely needed among consenting individuals.

Question 19

All of the following are true about corporations with the exception of:

A) the owners are not liable for the debts of the corporation.
B) shareholders of all corporations take an active role in the management of the business.
C) it is a form of business that results in double taxation of earnings.
D) corporations are a separate legal entity.

Question 20

In a large corporation, the controller reports to the:

A) CEO.
B) financial planner.
C) chief financial officer.
D) treasurer.

Question 21

An agency problem could occur if:

A) the company sells the executive jet and uses the funds to increase dividends.
B) senior executives set up a bonus system for themselves based on reported earnings per share.
C) the company announces the company will not pay for first class fares for company travel.
D) executive bonuses are tied to share price.

Question 22

What is the primary reason for forming your business as a sole proprietorship?

A) If you buy a corporate jet you will not create an agency problem.
B) It's the simplest way to start out.
C) You don't have to worry about taxes.
D) You will have unlimited liability.

Question 23

Hillary Rotteneggs wishes to form a company that will specialize in toxic waste removal and storage. Which type of business form would be most advantageous?

A) A partnership due to its low cost and diversification of ownership.
B) A corporation due to its limited liability.
C) A sole proprietorship due to its low cost and ease of formation.
D) Any of the above would be acceptable.

Question 24

Which of the following is true

A) As the size of the expected cash flow decreases, the stock price increases.
B) As the riskiness of the cash flow increases, the stock price increases.
C) As the length of time until an expected cash flow increases, the stock price decreases.
D) All of the above are true statements.

Question 25

Which of the following is false?

A) Corporate earnings are subject to the same tax as partnership earnings.
B) Each form of business has its distinct advantages and disadvantages.
C) Agency problems are not pronounced in sole proprietorships.
D) Maximization of owner value and societal benefits are not always consistent.

Question 26

Compare and contrast the roles of the financial manager and accountant.

Question 27

Why is it important for the financial manager to understand the cash flow position of the firm?

Question 28

What is the fiduciary responsibility of an agent?

Question 29

What is meant by double taxation?

Question 30

Explain which type of business organization form affords the most control to the owner?

Question 31

Why would someone choose a limited partnership share over a sole proprietorship?

Question 32

How are partnerships, corporations, and proprietorships taxed?

Question 33

What are the major problems with using profit maximization as a goal of the firm?

Question 34

What are the constraints a firm operates under as it seeks wealth maximization?

Question 35

Explain the difference between an agent and a principal.

Question 36

Why must every firm have a general partner?

Question 37

Why might a company report increasing earnings per share and declining cash flow per share?

Question 38

How do agency problems arise? What are some examples of agency problems? What can corporations do to monitor these costs?

Question 39

What is the main danger, in an agency sense, of setting up an executive bonus system based on profits?

Question 40

Agency problems were not a major factor in business before the 19^th century. Why not?

Question 41

Why are cash flows received today worth more than cash flows received in the future? Would your answer change the interest rate was 0%? Discuss

Question 42

When the degree of risk associated with future cash flows goes down, share prices go up. When the degree of risk associated with future cash flows goes up, share prices go down. Why?

Question 43

Junk bonds are:

A) bonds that have been rated investment grade.
B) bonds that have been rated below investment grade.
C) low interest- rate debt.
D) very liquid.

Question 44

Commercial paper is:

A) secured short term borrowing by corporations.
B) the more formal term for "junk bonds".
C) short term borrowing with a bank guarantee.
D) unsecured borrowing by corporations.

Question 45

Which of the following are traded in money markets?

A) corporate bonds
B) preferred shares
C) banker's acceptances
D) junk bonds

Question 46

A zero- coupon bond:

A) is illegal to sell.
B) usually pays interest semi- annually.
C) makes no periodic interest payments.
D) is usually issued with a maturity of less than five years.

Question 47

A dealer makes his/her money by:

A) charging you a fixed fee per investment transaction.
B) charging you a fee based on the size of the transaction.
C) charging you a fixed percentage to manage your financial assets.
D) buying a financial security at the bid price and selling it to you at the offer price.

Question 48

At auction when Treasury bills are sold:

A) the general public can participate.
B) interest on the treasury bills will be paid semi- annually.
C) the person willing to pay the highest interest will win the auction.
D) the price will be lower than their maturity value.

Question 49

If an investor anticipates that the expected inflation rate for the life of the loan will be 4% and the nominal risk- free rate they demand is 6%; their real rate of interest is:

A) 6%.
B) 10%.
C) 2%.
D) 4%.

Question 50

A primary market is one where:

A) only very high quality products are sold.
B) that is of primary importance for an investment manager who is managing clients stock portfolios.
C) new issues are sold.
D) trades are done through the big stock exchanges.

Question 51

A secondary market is:

A) a market that deals only in junk bonds and the stock of small companies.
B) a market that deals with less important issues.
C) where previously issued shares or bonds are sold.
D) where you go when your investment adviser can't get you a good price.

Question 52

The over the counter (OTC) market is:

A) a place lets you buy and sell stocks and bonds easily without using a broker.
B) how you can buy stocks listed on a major exchange.
C) where you go buy to buy stocks that are sold at retail outlets.
D) a network of dealers around the world who maintain inventories of securities for sale.

Question 53

Commercial paper is:

A) issued for a period greater than one year.
B) sold at a premium over par.
C) a money market instrument.
D) has a slightly lower yield than a Treasury bill of comparable maturity.

Question 54

Bonds that make periodic coupon interest payments:

A) no longer are issued.
B) qualify for the dividend tax credit.
C) are often issued by the Canadian Government.
D) are always issued at a discount to par.

Question 55

Common stock:

A) is riskier than preferred stock of the same corporation.
B) does not pay dividends as does preferred stock.
C) is usually less profitable than preferred stock.
D) is generally issued frequently.

Question 56

Which of the following best describes the nominal risk- free interest rate?

A) equal to the real rate of interest minus the sum of the inflation, maturity, default, and liquidity premiums
B) the inflation premium plus the real rate
C) the real rate of interest minus the inflation premium
D) the sum of the inflation, maturity, default, and liquidity premium

Question 57

A secondary market is one where:

A) you can trade stocks and bonds when the regular markets are closed.
B) the stock of smaller corporations trade.
C) previously issued financial instruments can be bought and sold.
D) special products like junk bonds trade.

Question 58

Liquidity refers to:

A) the price movements of the stocks of overseas shipping companies.
B) the speed at which a financial instrument can be turned into cash.
C) the extent to which the market value of a share changes.
D) the likelihood that the coupon on a bond will change.

Question 59

Money market instruments are considered a good place to "park cash" because:

A) they will always be registered in your name so you'll be sure to get your interest payments.
B) they always pay interest semiannually.
C) you should be able to convert them into cash within one business day.
D) they are all guaranteed to pay both interest and maturity value.

Question 60

All of the following could be considered a financial security with the exception of:

A) Treasury bond.
B) accounts receivable.
C) banker's acceptance.
D) preferred stock.

Question 61

Which of the following is an example of a primary market transaction?

A) The Royal Bank buys a T- bill through the bi- weekly Treasury auction.
B) The Royal Bank pays a dividend on its stock.
C) The investment department of the Royal Bank buys shares on the Toronto Stock Exchange.
D) The Royal Bank sells a T- bill that it owns.

Question 62

Canadian capital markets are considered to be efficient because:

A) Canada's brokerage firms have very good accounting departments.
B) there is almost no government interference.
C) financial securities can be traded easily, quickly and at a low cost.
D) you never have to pay a commission on a trade, only the spread, and this is a fixed amount.

Question 63

Maturity date is:

A) when the first coupon interest payment is due.
B) when a bond is first issued.
C) when the principal is repaid.
D) when the issuer receives the par value.

Question 64

An example of a capital market security would be:

A) a bond.
B) commercial paper.
C) a banker's acceptance.
D) a Treasury bill.

Question 65

If you buy a 90 day, $100,000 treasury bill that yields 3% it will cost you:

A) more than a Government of Canada bond with 3.5% coupon maturing in 2 years.
B) more than $100,000.
C) less than $100,000.
D) $100,000.

Question 66

All of the following are false except:

A) the default risk premium and the inflation risk premium are inversely related.
B) the default risk premium is the same on all types of bonds.
C) the real interest rate consists of the nominal interest rate plus risk premiums.
D) the nominal interest rate consists of the real interest rate plus risk premiums.

Question 67

All of the following are false except:

A) the yield curve will be the same for all securities with the same maturity.
B) the yield curve is based on historical data.
C) the yield curve is a graphical depiction of interest rates for securities that differ only in the time remaining to maturity.
D) the yield curve is only of interest to lenders.

Question 68

Money market securities do NOT include:

A) Treasury bills.
B) negotiable certificates of deposit.
C) commercial paper.
D) corporate bonds.

Question 69

What will be the semi annual interest payment on a $1,000 bond with a 5% coupon?

A) $2.50
B) $50
C) $5
D) $25

Question 70

With respect to Government of Canada bonds, all of the following are true except:

A) the par value of a bond is returned to the bondholder on the maturity date.
B) the coupon rate is expressed as a percentage of par value.
C) face value and par value often differ due to changes in economic conditions.
D) the holder will receive the face value of the bond at maturity.

Question 71

What is the annual interest payment on a bond with a 7% coupon rate and a $1,000.00 par value?

A) $700.00
B) $7.00
C) $70.00
D) More information is needed.

Question 72

Stocks that are not traded on national or regional exchanges but instead are offered for sale in a secondary market that consists of a network of dealers trading over computers are:

A) more expensive than exchange listed stocks.
B) riskier than exchange listed stocks.
C) traded on the "over- the- counter market".
D) not liquid.

Question 73

All else constant, where would a dealer profit more on a given dollar transaction: From the spread on one T- bond transaction or the spread on one transaction of a rarely traded BBB corporate bond? Explain.

Question 74

Would the default premium on an investment grade corporate bond be higher or lower than that on a junk bond? Explain.

Question 75

If expected inflation is 3% and the nominal interest rate is 6%, what is the real rate of interest? If actual inflation turns out to be only 2%, explain who benefits and who loses.

Question 76

Explain how a dealer makes a profit from spread.

Question 77

The more liquid the financial instrument, the wider the spread between the bid and ask price. Explain why you agree or disagree with this statement.

Question 78

The economy is suffering from a recession, explain what will happen to the yield spread between a Treasury bond and a BBB rated corporate bond.

Question 79

Explain how you earn a return on a Treasury bill. How is this different from the manner in which you earn a return on a Government of Canada bond?

Question 80

What is commercial paper? Explain why it would have a higher return than a treasury bill.