Question 1

A financial security that represents a promise to repay a fixed amount of funds is a

Accepted Answer

A bond is a financial security that represents a promise to repay a fixed amount of funds. It typically involves an investor lending money to a corporation or government entity in exchange for periodic interest payments (coupons) and the repayment of the principal at a later date. Shares of stock represent ownership in a company, while dividends are payments made to shareholders out of a company's profits.

Question 2

All of the following represent differences between stocks and bonds except

Accepted Answer

This is the only statement that is incorrect. Bonds do not represent partial ownership in a firm; rather, they are a form of debt that a company issues to raise funds. Stocks represent partial ownership in a company. Choices A, B, and C are true statements that highlight key differences between stocks and bonds.

Question 3

What is the central role of financial intermediaries in a market economy?

Accepted Answer

Financial intermediaries, such as banks, credit unions, and investment companies, bring together savers and borrowers by accepting deposits from savers and then lending those funds to borrowers. This process helps to allocate capital efficiently in the economy by enabling those with surplus funds (savers) to earn a return on their savings and those in need of funds (borrowers) to access the capital necessary to invest in business, real estate, or other ventures. Financial intermediaries play a crucial role in facilitating economic growth and development.

Question 4

Dividends are

Accepted Answer

Dividends are payments made by a corporation to its shareholders, typically as a share of the company's profits. This is a way for shareholders to receive a return on their investment in the company. Option A refers to stocks, not dividends; option B refers specifically to bond payments; and option C is incorrect as stocks do not have an interest rate.

Question 5

Which of the following is a characteristic of a bond?

Accepted Answer

All of these are characteristics of bonds. Bonds represent a promise to repay a fixed amount of funds, the face value or principal plus interest is repaid at a specified period of time, and the length of coupon payments is fixed by the stated maturity period.

Question 6

Which of the following does not take place in the direct finance market?

Accepted Answer

Deposits and loans are characteristic of the indirect finance market, in which financial intermediaries channel funds from savers to borrowers. The direct finance market involves the sale of securities directly by borrowers to savers/investors, such as ownership in corporations in the form of stocks or bonds.

Question 7

You have a bond that pays $60 per year in coupon payments.Which of the following would result in an increase in the price of your bond?

Accepted Answer

A decrease in the coupon payments of newly-issued bonds would make your bond more attractive as it has a higher coupon payment of $60 per year. This increased demand would result in an increase in the price of your bond.

Question 8

Raising funds through financial intermediaries is called

Accepted Answer

Raising funds through financial intermediaries is called indirect finance. This includes obtaining funds from banks, insurance companies, and investment companies who then lend or invest these funds to individuals or businesses. Direct finance refers to obtaining funds directly from investors, while corporate finance deals with how a corporation manages its financial resources. Dividend reinvestment refers to using dividends received from an investment to purchase additional shares in the same company.

Question 9

A proprietorship or partnership can raise funds for expansion in all of the following ways except

Accepted Answer

Proprietorships and partnerships cannot issue stock through financial markets because these business entities are not incorporated and do not have shareholders. Issuing stock is a method of raising funds that is only available to corporations.

Question 10

Dividing the dividend payment by the stock's closing market price determines the

Accepted Answer

Dividing the dividend payment by the stock's closing market price determines the dividend yield.

Question 11

If a corporate bond with a face value of $2,000 pays yearly coupon payments of $50, what is the coupon rate?

Accepted Answer

The coupon rate is calculated by dividing the annual coupon payment by the face value of the bond. Here, $50 / $2,000 = 0.025 or 2.5%.

Question 12

The coupon rate of a bond is equal to

Accepted Answer

The coupon rate of a bond is the interest rate that the bond pays to its investors. This is not to be confused with the coupon payment, which is the actual dollar amount that the bond pays out in interest, or the face value, which is the amount that the bond will be worth at maturity. Therefore, choice C is the correct answer.

Question 13

In 2011, Standard & Poor's (S&P)changed its rating on U.S.Treasury bonds from ________ based on the state of the federal government's budget deficit.

Accepted Answer

S&P changed its rating on U.S. Treasury bonds from "AAA" to "AA+" in 2011 based on the state of the federal government's budget deficit.

Question 14

When an investor buys a corporate bond, the ________ the bond is a loan to the corporation.

Accepted Answer

The face value of a bond is the principal amount that is loaned to the corporation/entity. The interest is the payment made to the bondholder for lending the money, the coupon payment is the periodic payment of interest to the bondholder, and dividends are payments made to shareholders of stock, not bondholders.

Question 15

If Abercrombie & Fitch borrows $8 million from a bank to finance the construction of a new store, this is an example of

Accepted Answer

This is an example of indirect finance, as Abercrombie & Fitch is borrowing from a bank (intermediary) rather than directly from investors in the stock or bond markets.

Question 16

One of the most widely followed stock indexes in the United States is the Dow Jones Industrial Average.This index represents

Accepted Answer

The Dow Jones Industrial Average represents the stock prices of 30 large U.S. corporations.

Question 17

Abercrombie & Fitch wants to raise $8 million to finance the construction of a new store, and the company wishes to raise the funds through direct finance.Which of the following methods could it use?

Accepted Answer

Abercrombie & Fitch could choose either to sell $8 million in bonds or issue $8 million in stocks as both methods involve direct finance. Borrowing $8 million from a bank would involve indirect finance as a financial intermediary (the bank) would be involved. Therefore, option D is the best choice as it allows the company to choose the most suitable method for raising funds.

Question 18

Generally with bond ratings, the higher the rating, the ________ the interest rate an investor will receive and the ________ the risk that the issuer of the bond will default.

Accepted Answer

Higher bond ratings indicate lower risk of default, which typically results in lower interest rates for investors.

Question 19

If a corporate bond with face value of $5,000 has an interest rate of 4 percent paid once a year for a term of 30 years, what is the size of the coupon payment?

Accepted Answer

The coupon payment is calculated by multiplying the face value of the bond by the interest rate: $5,000 * 0.04 = $200.

Question 20

When the coupon rate on newly issued bonds decreases relative to older, outstanding bonds, what happens?

Accepted Answer

When the coupon rate on newly issued bonds decreases, older bonds with higher coupon rates become more attractive, leading to an increase in their market price in the secondary market.

Quiz 8: Firms, the Stock Market, and Corporate Governance