Question 1

The largest source of equity funds comes from&#10;A) Initial public offerings&#10;B) Conversions of convertible bonds&#10;C) Current shareholders through retained earnings&#10;D) Placements by the government

Accepted Answer

Retained earnings, which are the profits that a company chooses to reinvest in itself rather than distribute as dividends to shareholders, represent the largest source of equity funds for most companies. This internal financing method is preferred because it does not dilute existing shareholders' equity and avoids the costs associated with external financing methods.

Question 2

Typically, new equity issuance&#10;A) Roughly matches equity retirements&#10;B) Is exceeded by equity retirements&#10;C) Exceeds equity retirements&#10;D) Takes the form of preferred issues

Accepted Answer

New equity issuance is often exceeded by equity retirements due to stock buybacks and mergers, which reduce the overall number of shares in the market.

Question 3

Preferred shares&#10;A) Are regarded as equity&#10;B) Have a lower claim on cash flow and assets than debt&#10;C) Have a higher claim on cash flow and assets than common shares&#10;D) All of the above

Accepted Answer

Preferred shares are considered a form of equity (A), but they have a lower claim on assets and cash flow compared to debt (B), and a higher claim than common shares (C), making all the provided statements correct.

Question 4

When the government injects funds into a commercial bank or other financial institution&#10;A) This usually takes the form of debt&#10;B) This usually takes the form of common shares&#10;C) This usually takes the form of preferred shares&#10;D) This usually takes the form of a grant

Accepted Answer

Government injections into financial institutions often take the form of preferred shares, as they provide a way to stabilize the institution while giving the government a stake without diluting existing shareholders' equity.

Question 5

When IPOs are priced, the initial price&#10;A) Tends to closely match the price that shares trade at in the secondary market&#10;B) Tends to be below the price that the shares trade at later in the secondary market&#10;C) Tends to be above the price that the shares trade at later in the secondary market&#10;D) Is based on fundamental values

Accepted Answer

IPOs are often priced below the price at which shares trade later in the secondary market to ensure they are attractive to investors, leading to what is known as an "IPO pop."

Question 6

The equity premium&#10;A) Refers to the return that shareholders require over the yield on a risk-free asset&#10;B) Refers to the fee that investors pay brokers when they buy stock&#10;C) Refers to amount paid to buy insurance against downside equity price movements&#10;D) Refers to the fee that registered brokers pay to the SEC

Accepted Answer

The equity premium refers to the excess return that investing in the stock market provides over a risk-free rate. This is the additional return investors require to compensate for the risk of investing in stocks compared to risk-free assets.

Question 7

A higher dividend-payout ratio&#10;A) Unambiguously raises stock prices&#10;B) Unambiguously lowers stock prices&#10;C) Reduces growth in earnings&#10;D) Increases growth in earnings

Accepted Answer

A higher dividend-payout ratio means the company is distributing more of its earnings as dividends rather than reinvesting them into the business, which can reduce the company's growth in earnings over time.

Question 8

Which of the following causes price-earnings ratios to differ between two firms at any time?&#10;A) Differences in idiosyncratic risk&#10;B) Differences in earnings growth prospects&#10;C) Differences in risk-free rates&#10;D) Both a and b

Accepted Answer

Differences in idiosyncratic risk and earnings growth prospects can cause price-earnings ratios to differ between two firms. Idiosyncratic risk affects the discount rate applied to a firm's earnings, and earnings growth prospects influence future earnings expectations, both of which are key components in calculating the P/E ratio. Differences in risk-free rates generally affect all firms in the market similarly, so they are less likely to cause differences in P/E ratios between two specific firms.

Question 9

Share prices provide discipline on managers of underperforming firms by&#10;A) Delivering a wake-up call to managers&#10;B) Prompting shareholders to pressure boards of directors&#10;C) Encouraging activist investors to step in&#10;D) All of the above

Accepted Answer

Share prices act as a signal of a company's performance and health. When share prices fall, it can serve as a wake-up call to managers, prompt shareholders to pressure the board for changes, and attract activist investors who may push for strategic shifts or management changes to improve the firm's value.

Question 10

Share prices rise sharply at the onset of a business cycle expansion because&#10;A) The outlook for profits (earnings growth) improves&#10;B) Risk premiums drift lower&#10;C) Risk-free rates increase&#10;D) Both a and b

Accepted Answer

At the onset of a business cycle expansion, the outlook for profits typically improves as economic conditions become more favorable, leading to higher earnings growth (A). Additionally, risk premiums often drift lower as investors become more willing to take on risk in a growing economy (B). Both factors contribute to the sharp rise in share prices.

Question 11

Which of the following contribute to variations in share prices?&#10;A) Variations in the equity premium&#10;B) Variations in the risk-free rate&#10;C) Variations in the outlook for earnings&#10;D) All of the above

Accepted Answer

The answer of Which of the following contribute to variations...

Deck 11: The Equity Market