Chapter 1Foundations

MULTIPLE CHOICE
1. Which of the following is not one of the three major areas of finance?
a. accounting
b. investments and financial markets
c. financial management of companies
d. the banking system
ANS A !"S 1 NA" f #$% m
"$! $verview of &inance
'. &inancial assets can be distinguished from real assets in that financial assets
a. are pieces of paper rather than tangible( physical objects.
b. are not intended to provide services like transportation or shelter.
c. have value because they provide their owners with claims to future cash flows.
d. all of the above
ANS ) !"S 1 NA" f #$% m
"$! &inancial Assets
*. &inancial assets
a. include cars( houses( and factory e+uipment
b. provide some kind of service
c. have value because of claims to future cash flows
d. are not legal documents
ANS % !"S 1 NA" f #$% m
"$! &inancial Assets
,. &inancial assets like stocks and bonds have value because
a. they represent ownership of companies.
b. people are proud to own them.
c. they provide tangible benefits as do real assets.
d. they give their owners command over future cash flows.
ANS ) !"S 1 NA" f #$% o
"$! &inancial Assets
-. A .... pools the contributions of many investors and employs a professional manager to select
securities that match a particular set of investment goals.
a. mutual fund
b. stock
c. bond
d. real asset
ANS A !"S 1 NA" f #$% o
"$! &inancial Assets
/. Which of the following is not a real asset?
a. 0+uipment
b. #and
c. Stock
d. None of the above
ANS % !"S 1 NA" f #$% m
"$! &inancial Assets
1. "he prices that investors pay for securities are determined by
a. "he collateral of the firm2s liabilities and the profitability of the firm
b. "he profits of the firm and the stability of those profits
c. What financial advisors think of the company.
d. "he cash flows investors e3pect to receive from owning them.
ANS ) !"S 1 NA" f #$% o
"$! &inancial Assets
4. %ommon stock is considered to be a
a. 5eal Asset
b. &inancial Asset
c. )ebt 6nstrument
d. 7oth b 8 c
ANS 7 !"S 1 NA" f #$% o
"$! &inancial Assets
9. Which of the following represents a real asset?
a. #and
b. 7onds
c. Stocks
d. 7oth a 8 c
e. All of the above
ANS A !"S 1 NA" f #$% m
"$! &inancial Assets
1:. &inancial assets
a. are legal documents
b. give their owners claims to past cash flows
c. include stocks and bonds
d. 7oth a 8 c
e. All of the above
ANS ) !"S 1 NA" f #$% m
"$! &inancial Assets
11. Which of the following is not true regarding bonds?
a. 7oth principal and interest are paid to the investor
b. 7ondholders are owners of the borrowing firm
c. 7uying a bond means lending money
d. All of the above
ANS 7 !"S 1 NA" f #$% o
"$! &inancial Assets
1'. A person buying a .... is called an investor.
a. bond
b. stock
c. mutual fund
d. all of the above
ANS ) !"S 1 NA" f #$% o
"$! &inancial Assets
1*. "he principal legal difference between a stockholder and a bondholder is
a. the stockholder receives interest and the bondholder receives dividends
b. only the bondholder can attend annual meetings
c. the bondholder has an ownership interest and the shareholder is a lender
d. the shareholder has an ownership interest and the bondholder is a lender
ANS ) !"S 1 NA" f #$% o
"$! &inancial Assets
1,. Which of the following is considered a security?
a. 67; stock
b. 67; bond
c. <S government bond
d. all of the above
ANS ) !"S 1 NA" f #$% o
"$! &inancial Assets
1-. Which of the following is not a financial market?
a. bond market
b. a market in which small business owners buy and sell their companies
c. stock market
d. All of these are financial markets
ANS 7 !"S 1 NA" f #$% h
"$! &inancial ;arkets
1/. A .... is licensed to trade securities on behalf of investors.
a. stockbroker
b. securities analyst
c. market maker
d. corporation
ANS A !"S 1 NA" f #$% o
"$! &inancial ;arkets
11. A financial market is
a. a place where investors can buy and sell securities
b. the stock market
c. regulated by well=defined rules and regulations
d. All of the above
ANS ) !"S 1 NA" f #$% h
"$! &inancial ;arkets
14. A company can raise money to purchase assets by
a. borrowing money
b. issuing stock
c. using money earned
d. 7oth a 8 b
e. All of the above
ANS 0 !"S 1 NA" f #$% m
"$! &inancial ;arkets
19. "he .... is the largest stock e3change in the world.
a. American Stock 03change
b. %hicago Stock 03change
c. New >ork Stock 03change
d. "okyo Stock 03change
ANS % !"S 1 NA" f #$% h
"$! &inancial ;arkets
':. A collection of securities is called a
a. basket
b. conglomerate
c. portfolio
d. any of the above
ANS % !"S 1 NA" f #$% o
"$! 5aising ;oney
'1. %ompanies finance the purchase of assets through
a. debt financing( the sale of bonds
b. e+uity financing( the sale of stock
c. lease financing
d. only a. and b. above
e. all of the above
ANS 0 !"S 1 NA" f #$% m
"$! 5aising ;oney
''. ?istorically( the field of finance was limited to
a. accounting
b. raising money
c. activities of investors
d. financial management
ANS 7 !"S 1 NA" f #$% m
"$! 5aising ;oney
'*. )ay to day responsibilities of the finance department include
a. maintaining detailed knowledge of activities in major financial markets
b. keeping operating e3penses to an absolute minimum
c. providing financial input to general business decisions
d. all of the above
ANS % !"S 1 NA" f #$% m
"$! &inancial ;anagement
',. "he functions of the finance department include all of the following activities e3cept
a. paying employees and vendors
b. selling products to customers
c. receiving payments from customers
d. selling stock
e. paying dividends
ANS 7 !"S 1 NA" f #$% m
"$! &inancial ;anagement
'-. &inancial management involves
a. financial input for general business decisions
b. providing oversight for the management of money in other departments
c. judging the feasibility of projects
d. 7oth a 8 c
e. All of the above
ANS 0 !"S 1 NA" f #$% m
"$! &inancial ;anagement
'/. 5esponsibilities of the finance department include( but are not limited to
a. managing the company2s money
b. providing financial input to general business decisions
c. looking over everyone else2s shoulder to make sure they2re using money effectively.
d. all of the above
ANS ) !"S 1 NA" f #$% m
"$! &inancial ;anagement
'1. "he e3ecutive in charge of the finance department is the company2s
a. %0$
b. %$$
c. %&$
d. %6$
ANS % !"S 1 NA" f #$% m
"$! &inancial ;anagement
'4. 5aising money and handling financial relationships with outsiders is a function of the
a. controller
b. treasury department
c. accounting department
d. all of the above
ANS 7 !"S 1 NA" f #$% m
"$! &inancial ;anagement
'9. "he price that investors are willing to pay for a firm2s securities can best be described by which of the
following statements?
a. 6f a company is performing poorly( investors will not buy that company2s securities.
b. 6f a company is performing well( investors will buy the company2s stock at almost any
price because the price of the stock should increase.
c. Since the value of a company2s securities depends largely on future cash flows( investors
will consider the company2s performance in estimating the future cash flows that will come
from owning its securities.
d. Since risk is difficult to assess for any particular company( investors don2t usually consider
risk when deciding how much to pay for a company2s securities.
ANS % !"S 1 NA" f #$% o
"$! "he !rice of Securities
*:. "he finance function and the accounting function look at the sale of product to a customer on credit in
different ways. Which of the following best describes that difference?
a. Accounting views the sale as a completed transaction to be recorded as revenue while
finance views it as incomplete until the cash is received.
b. &inance views the sale as a completed transaction to be recorded as revenue while
accounting views it as incomplete until the cash is received.
c. Accounting is more interested in the cash inflows and outflows than finance.
d. &inance is more interested in reporting the appropriate transactions in the proper time
period than accounting.
ANS A !"S 1 NA" f #$% m
"$! &inance and Accounting
*1. Which of the following are true about accounting
a. Accounting is a system of record keeping
b. Accounting focuses on cash flow
c. Accounting emphasi@es financial theory
d. 7oth a 8 b
ANS A !"S 1 NA" f #$% m
"$! &inance and Accounting
*'. Accounting is
a. focused on cash flow
b. the language of finance
c. an outgrowth of economics
d. 7oth a 8 b
ANS 7 !"S 1 NA" f #$% m
"$! &inance and Accounting
**. 6f a company buys a machine for A1:(::: cash and plans to depreciate it at A1(::: per year for 1:
years( the two most important aspects of this transaction to the finance manager Bas opposed to the
accountantC are
a. the purchase of the machine and the ta3 savings from the depreciation e3pense.
b. the purchase of the machine and the depreciation e3pense
c. the depreciation e3pense and the ta3 savings from the depreciation e3pense.
d. the purchase of the machine and its impact on net income.
ANS A !"S 1 NA" f #$% k
"$! "he 6mportance of %ash &lows
*,. &inance has its theoretical roots in ....( but re+uires a practical understanding of .....
a. accounting( economics
b. accounting( the stock market
c. mathematics( accounting
d. economics( accounting
ANS ) !"S 1 NA" f #$% m
"$! &inancial "heory
*-. &inancial theory stems primarily from
a. ;athematics
b. &inance
c. 0conomics
d. Accounting
ANS % !"S 1 NA" f #$% m
"$! &inancial "heory
*/. Which of the following apply to an S=type corporation?
a. )ouble ta3ation of earnings
b. "a3ation similar to a partnership
c. %an be owned by another corporation
d. None of the above
ANS 7 !"S 1 NA" f #$% m
"$! &orms of 7usiness $rgani@ation
*1. A big disadvantage of proprietorships versus corporations is
a. the ine3perience of proprietors
b. the difficulty of raising money BcapitalC to start or e3pand the business
c. ta3es on the proprietor
d. the limited personal liability of the proprietor
ANS 7 !"S 1 NA" f #$% m
"$! "he !roprietorship &orm
*4. "he primary advantage of the proprietor form of business over the corporate form is:
a. ease of raising capital BmoneyC
b. avoidance of double ta3ation
c. unlimited life
d. limited liability
ANS 7 !"S 1 NA" f #$% m
"$! "he !roprietorship &orm
*9. All of the following are characteristics of proprietorships e3cept
a. ease of formation
b. income treated as part of the sole proprietor2s income for ta3 purposes
c. ease of raising additional money for e3pansion
d. limited life
ANS % !"S 1 NA" f #$% m
"$! "he !roprietorship &orm
,:. "he principal financial advantage of the corporate form of organi@ation is
a. ease of transferability of ownership
b. accumulation of earnings for retention in the business
c. limited liability
d. ease of raising money through selling stock
ANS ) !"S 1 NA" f #$% m
"$! "he %orporate &orm
,1. Assume that pre=ta3 profit of A-:(::: has been earned by a business( and the ownerDproprietor wants
to withdraw all of the after=ta3 profit for personal use. Assume the ta3 rate for a % corporation is *,E(
while the rate for a person is '1E. "he after=ta3 earnings available under the corporate and
proprietorship forms are
a. &or a corporation( A**(:::F for a proprietorship( A*/(-::
b. &or a corporation( A'*(1/:F for a proprietorship( A*/(-::
c. &or either a corporation or a proprietorship( A*/(-::
d. &or either a corporation or a proprietorship( A'*(1/:
ANS 7
%orporation A-:(::: B.//CB.1'C G A'*(1/:
!roprietorship A-:(::: B.1'C G A*/(-::
!"S 1 NA" c #$% m "$! "he %orporate &orm
,'. Stockholders own corporations. Which of the following is inconsistent with that role
a. attend annual shareholder meetings as a forum for voicing discontent
b. receive annual reports that detail the past( present( and future direction of the firm
c. share in the firm2s profits
d. receive interest on the amount loaned to the company
ANS ) !"S 1 NA" f #$% g
"$! "he %orporate &orm
,*. All of the following are characteristics of % %orporations e3cept
a. unlimited life
b. limited liability for the stockholders
c. avoidance of double ta3ation
d. ease of raising additional capital for e3pansion
ANS % !"S 1 NA" f #$% m
"$! "he %orporate &orm
,,. A proprietor who operates hisDher own business can incorporate and become the only shareholder. "his
action might be taken to provide the owner with the limited liability of the corporate form. Which of
the following best describes the impact of incorporation in this situation on the limited liability issue?
a. "he owner has achieved the full protection of limited liability.
b. "he owner can protect hisDher personal assets unless fraud is involved in the conduct of the
business.
c. "he owner has achieved the full protection of limited liability e3cept for default on
borrowed funds.
d. "he owner has in reality achieved very little in the way of limited liability protection.
ANS ) !"S 1 NA" f #$% m
"$! "he "ruth About #imited #iability
,-. %ompanies generally create liabilities that e3ceed assets by
a. borrowing money they cannot repay.
b. issuing additional stock.
c. losing a lawsuit.
d. a and c
ANS ) !"S 1 NA" f #$% m
"$! #imited #iability
,/. All of the following are characteristics of S %orporations e3cept
a. unlimited life
b. unlimited liability for the stockholders
c. avoidance of double ta3ation
d. ease of raising additional capital for e3pansion
ANS 7 !"S 1 NA" f #$% m
"$! S="ype %orporations and #imited #iability %ompanies
,1. An S=type corporation is different from a %=type corporation in the following wayBsC
a. the way they are ta3ed
b. liability
c. ability to sell stock
d. all of the above
ANS A !"S 1 NA" f #$% m
"$! S="ype %orporations
,4. "he primary financial goal of a corporation is to ma3imi@e
a. shareholders wealth
b. earnings per share
c. stock price
d. 7oth a 8 c
e. All of the above
ANS ) !"S 1 NA" f #$% m
"$! "he Hoals of ;anagement
,9. "he ma3imi@ation of shareholders wealth is measured by increases in
a. profits
b. earnings
c. stock price
d. sales
ANS % !"S 1 NA" f #$% m
"$! "he Hoals of ;anagement
-:. 6n finance the primary goal of management is to
a. utili@e its economic resources in the most advantageous way
b. minimi@e all possible e3penses
c. ma3imi@e shareholder wealth which is generally achieved by ma3imi@ing stock price
d. make the best use of its assets
ANS % !"S 1 NA" f #$% m
"$! "he Hoals of ;anagement
-1. Which of the following does not represent a stakeholder in a corporation?
a. "elevision media
b. Stockholders
c. ;anagement
d. Suppliers
ANS A !"S 1 NA" f #$% m
"$! Stakeholders
-'. Which of the following groups is not a stakeholder in a corporation?
a. %ustomers
b. Hovernment $fficials
c. %reditors
d. Suppliers
ANS 7 !"S 1 NA" f #$% m
"$! Stakeholders
-*. All of the following constituencies would be considered stakeholders of a business e3cept
a. management and employees
b. suppliers and creditors
c. the local community in which the business operates
d. stockholders
e. all of the groups listed above are stakeholders
ANS 0 !"S 1 NA" f #$% m
"$! Stakeholders and %onflicts of 6nterest
-,. "he most common e3ample of abuse of the agency relationship is
a. management2s compensation and per+uisites.
b. managers working long hours.
c. breach of fiduciary responsibilities.
d. gross disregard of bondholders2 interests
ANS A !"S 1 NA" b #$% m
"$! Agency
--. Which of the following is BareC effective in controlling the agency problem?
a. tie a large part of managements2 compensation to company profit
b. offer numerous per+uisites
c. employ auditors to periodically review company books
d. both a and c
ANS ) !"S 1 NA" b #$% m
"$! Agency
-/. 7ecause of conflicts of interest between shareholders and management( it is in the interest of
shareholders to monitor management2s performance through
a. regular management letters to shareholders
b. visits to the corporate facility
c. attendance at the annual shareholder meetings
d. periodic financial reports reviewed by independent auditors
ANS ) !"S 1 NA" b #$% m
"$! Agency
-1. "he conflict of interest between management and stockholders is known as
a. the stockholderDmanagement problem
b. the management problem
c. the agency problem
d. a problem relating to e3cess compensation
ANS % !"S 1 NA" b #$% m
"$! "he Agency !roblem
-4. "he agency problem e3ists primarily in companies of which
a. ownership is widely dispersed
b. common stock is closely held
c. management has stock ownership
d. both a 8 c
ANS A !"S 1 NA" b #$% m
"$! Agency
-9. Which of the following best describes the agency relationship in a business setting?
a. Stockholders are the agents of the bondholders.
b. ;anagement are the agents of the employees.
c. 7ondholders are the agents of management.
d. ;anagement are the agents of the stockholders.
e. Stockholders are the agents of the employees.
ANS ) !"S 1 NA" b #$% m
"$! "he Agency !roblem
/:. !rincipals can use the all of the following techni+ues to control their agents Bin a business settingC
e3cept
a. compensation tied to performance
b. stock options
c. bond redemption
d. the threat of firing
e. per+uisites
ANS % !"S 1 NA" b #$% m
"$! "he Agency !roblem
/1. .... generally involves the use of power by one group to gain a benefit at the e3pense of others.
a. <nethical behavior
b. Shareholder wealth ma3imi@ation
c. #imited liability
d. A personal guarantee
ANS A !"S 1 NA" b #$% m
"$! 0thics
/'. Which of the following best describes the financial link between stockholders and bondholders?
a. "he action of stockholders cannot affect the financial position of bondholders.
b. "he action of stockholders can increase the risk of a business which will affect the
financial position of bondholders.
c. "he action of bondholders can increase the risk of a business which will affect the financial
position of stockholders.
d. "he actions of stockholders and bondholders are independent.
e. 7oth a. and c. are correct.
ANS 7 !"S 1 NA" f #$% g
"$! %reditors vs. Stockholders
/*. #enders protect themselves from conflicts of interest with shareholders through
a. cooperative agreements signed by shareholders and lenders
b. limiting the amount of funds bondholders lend
c. loan agreements that prohibit borrowing companies from undertaking e3cessive risk
d. offering lenders a share of profits
ANS % !"S 1 NA" b #$% m
"$! Stakeholders and %onflicts of 6nterest
/,. .... is a growing practice in which people concern themselves with the activities of the issuing
business.
a. Agency control
b. ;orality analysis
c. Socially responsible investing
d. Wealth ma3imi@ation
ANS % !"S 1 NA" b #$% o
"$! 0thics
/-. Which is not a financial asset?
a. Stock
b. 7ond
c. Shares in a mutual fund
d. Savings account
ANS ) !"S 1 NA" f #$% m
"$! &inancial Assets
//. 6f a company uses a bond issue to raise capital( the financing is an e3ample of
a. e+uity financing
b. debt financing
c. lease financing
d. debt and e+uity financing
ANS A !"S 1 NA" f #$% m
"$! 5aising ;oney
/1. Which statement is true?
a. "he finance department has an oversight responsibility for the effective management of the
money other departments spend.
b. "he Iice !resident of &inance is usually a position very different from that of a %&$.
c. "he finance department will oversee the selling of stock( but not the paying of dividends.
d. 6ndividual departments determine the feasibility of projects( while the finance department
is only concerned with the funding of the project.
ANS A !"S 1 NA" f #$% m
"$! &inancial ;anagement
/4. Which entity is most directly responsible for the accounting within the firm?
a. "reasurer
b. %ontroller
c. %&$
d. %0$
ANS 7 !"S 1 NA" f #$% m
"$! &inancial ;anagement
/9. Which is not a legitimate form of business organi@ation?
a. !artnership
b. %=type corporation
c. "=type corporation
d. ##%
ANS % !"S 1 NA" f #$% m
"$! &orms of 7usiness $rgani@ation
1:. #arge corporations tend to be
a. !artnerships
b. "=type corporations
c. %=type corporations
d. Sole !roprietorships
ANS % !"S 1 NA" f #$% m
"$! &orms of 7usiness $rgani@ation
11. What does it mean for a new business loan to be collaterali@ed?
a. Should the business fail( the loan is simply not repaid.
b. "he lender may sell a specific asset to recover the loan
c. "he borrower does not pay interest on the loan.
d. "he borrower only pays interest when the entire loan is due.
ANS 7 !"S 1 NA" f #$% m
"$! !roprietorship &orm
1'. What is double ta3ation?
a. 6t is when two separate ta3 authorities ta3 the same corporation.
b. 6t is a situation that only affects sole proprietorships.
c. 6t occurs when the business owner pays himself or herself a salary.
d. 6t occurs when earnings are ta3ed once at the corporate level and then ta3ed a second time
as personal income.
ANS ) !"S 1 NA" f #$% m
"$! %orporate &orm
1*. Suppose pre=ta3 earnings are A1::(:::.:: and the corporate ta3 rate is ,'E. ?ow much additional
money can a business owner receive by declaring the earnings as personal income which is ta3ed at a
rate of *1E?
a. A11(:::.::
b. A,'(:::.::
c. A*1(:::.::
d. A*('::.::
ANS A
%orporate ta3 ,'EBA1::(:::C G A,'(:::
!ersonal ta3 *1EJBA1::(:::C G A*1(:::
Savings A,'(::: = A*1(::: G A11(:::
!"S 1 NA" c #$% m "$! %orporate &orm
1,. Which statement is true?
a. ##%s cannot have earnings pass through as personal income.
b. ##%s are ideal for joint ventures.
c. S=type corporations can be partially owned by other corporations
d. ##%s can only be owned by people and not other corporations.
ANS 7 !"S 1 NA" f #$% m
"$! S="ype %orporations and ##%s
1-. "he term Kbuying a bondK is misleading because
a. 7onds are not available to the general public
b. A bond can only be bought with assets other than money
c. 7onds represent a debt relationship so a bond buyer is actually lending money
d. 7onds are not owned( only held in trust for a buyer2s beneficiaries
ANS % !"S 1 NA" f #$% g
"$! &inancial Assets
1/. "he following is true of financial assets
a. %ompanies issue financial assets in order to raise capital BmoneyC.
b. 6nvestors purchase financial assets in order to earn a return on funds they don2t currently
need.
c. "hey differ from real assets in that they are pieces of paper as opposed to physical objects.
d. All of these are true.
ANS ) !"S 1 NA" f #$% g
"$! &inancial Assets
11. 6n the simplified financial system depicted in &igure 1=1 of the te3t( which direction do interest and
dividends flow?
a. from marketDinvestors to companies.
b. from market to investors.
c. investors to market.
d. from companies to marketDinvestors.
ANS ) !"S 1 NA" f #$% h
"$! &inancial ;arkets
14. "o LfinanceM an asset is
a. to lend money to buyers so they can improve their portfolios.
b. to sell the asset for more than market value.
c. to raise money in order to ac+uire the asset.
d. All of these are correct.
ANS % !"S 1 NA" f #$% o
"$! &inancial Assets
19. "he following positionBsC andDor departmentBsC isDare in the finance department under the %&$
a. "reasurer
b. %ontroller
c. Accounting department
d. All of these are correct.
ANS ) !"S 1 NA" f #$% h
"$! &inance and Accounting
4:. Which of the following in not a legal form of business organi@ation?
a. Sole proprietorship
b. !artnership
c. %orporation
d. Small business owner
ANS ) !"S 1 NA" f #$% h
"$! &orms of 7usiness $rgani@ation
41. &or financial purposes( a partnership is
a. essentially a sole proprietorship with more than one owner.
b. a joining of two corporations.
c. an agreement between two corporations.
d. None of these are correct.
ANS A !"S 1 NA" f #$% h
"$! &orms of 7usiness $rgani@ation
4'. #imited liability may not be an advantage of the corporate form for owner=operated small businesses
because
a. a negligent worker can escape liability for his own acts.
b. lenders usually demand personal guarantees from the owners of small businesses.
c. stockholders participate in the business itself.
d. All of these are correct.
ANS 7 !"S 1 NA" f #$% h
"$! &orms of 7usiness $rgani@ation
4*. Security analysis may be conducted by
a. only investors themselves.
b. only professional analysts
c. investors and professional analysts.
d. None of these are correct.
ANS % !"S 1 NA" f #$% o
"$! Securities Analysis
4,. Assets pledged to guarantee a loan are
a. factored.
b. collateral.
c. hypothecated.
d. assumed.
ANS 7 !"S 1 NA" f #$% g
"$! &inancial Assets
TRUEF!L"E
1. "he world of finance can be divided into three broad areas( the banking system( financial management
and investmentsDfinancial markets.
ANS " !"S 1 NA" f #$% m
"$! An $verview of &inance
'. 5eal assets are always long=lived items such as buildings and heavy vehicles.
ANS & !"S 1 NA" f #$% m
"$! &inancial Assets
*. &inancial assets are valuable because they give owners rights to future cash flows.
ANS " !"S 1 NA" f #$% m
"$! &inancial Assets
,. 7ondholders are rewarded by receiving interest and a share of the company2s profits.
ANS & !"S 1 NA" f #$% g
"$! &inancial Assets
-. &irms typically invest in real assets such as plant and e+uipment because of the services they provide.
ANS " !"S 1 NA" f #$% m
"$! &inancial Assets
/. 6nvesting in stock represents partial ownership of a corporation and gives the investor the potential for
future cash flows from earnings distribution and stock price appreciation if the business prospers.
ANS " !"S 1 NA" f #$% g
"$! &inancial Assets
1. %=corporations issue real assets( such as debt( in order to raise money.
ANS & !"S 1 NA" f #$% m
"$! &inancial Assets
4. 7ecause it historically provides a positive return( common stock is typically classified as a real asset.
ANS & !"S 1 NA" f #$% g
"$! &inancial Assets
9. 6nvestments in financial assets can be made directly by buying shares in a mutual fund.
ANS & !"S 1 NA" f #$% o
"$! &inancial Assets
1:. Another name for a financial asset like a stock or a bond is a security.
ANS " !"S 1 NA" f #$% g
"$! &inancial Assets
11. A stockbroker is licensed to trade securities on behalf of investors.
ANS " !"S 1 NA" f #$% m
"$! &inancial ;arkets
1'. "he stock market is really the entire network of investors( brokers( and e3changes all connected
together.
ANS " !"S 1 NA" f #$% h
"$! &inancial ;arkets
1*. "he essence of finance is the process of raising capital BmoneyC( e3clusively through the sale of bonds.
ANS & !"S 1 NA" f #$% m
"$! 5aising ;oney
1,. A portfolio is a collection of securities.
ANS " !"S 1 NA" f #$% h
"$! 5aising ;oney
1-. 5esponsibilities of the chief financial officer are similar to the responsibilities of the corporate
controller when associated with the financial decision making process.
ANS & !"S 1 NA" f #$% m
"$! &inancial ;anagement
1/. "he "reasurer is usually the e3ecutive in charge of the finance department in a large corporation.
ANS & !"S 1 NA" f #$% m
"$! &inancial ;anagement
11. "he %&$ is the person primarily responsible for judging the financial viability of projects proposed by
other e3ecutives.
ANS " !"S 1 NA" f #$% m
"$! &inancial ;anagement
14. 6n firms of moderate si@e or larger( the finance department is typically relieved of the KwatchdogK
responsibility of monitoring the efficient use of money by other departments.
ANS & !"S 1 NA" f #$% m
"$! &inancial ;anagement
19. %orporate controllers are responsible for the accounting functions in most large corporations.
ANS " !"S 1 NA" f #$% m
"$! &inancial ;anagement
':. "he treasurer is in charge of accounting while the controller supervises most other financial functions.
ANS & !"S 1 NA" f #$% m
"$! &inancial ;anagement
'1. "he sole driving force behind investor e3pectations about returns is always the company2s potential
sales.
ANS & !"S 1 NA" f #$% m
"$! "he !rice of Securities
''. Shareholders focus solely on the firm2s e3pected profit to assign a price to its stock.
ANS & !"S 1 NA" f #$% g
"$! "he !rice of Securities
'*. "he value the market assigns to a firm2s securities is a function of the e3pected cash flows that come
from owning the securities and the risk of actually receiving those cash flows.
ANS " !"S 1 NA" f #$% k
"$! "he !rice of Securities
',. 6nvestors buy securities for the future cash flows that come from owning them.
ANS " !"S 1 NA" f #$% o
"$! "he !rice of Securities
'-. Accounting and finance have consistent orientations about financial results.
ANS & !"S 1 NA" f #$% m
"$! &inance and Accounting
'/. When valuing a firm2s stocks and bonds( finance professionals place e+ual significance on accounting
results and cash flows.
ANS & !"S 1 NA" f #$% g
"$! "he 6mportance of %ash &lows
'1. &inancial theory has grown out of economics.
ANS " !"S 1 NA" f #$% m
"$! &inancial "heory = "he 5elationship with 0conomics
'4. &inancial theory was originally a branch of economics.
ANS " !"S 1 NA" f #$% m
"$! &inancial "heory = "he 5elationship with 0conomics
'9. A major disadvantage of the proprietorship form is the difficulty of raising money.
ANS " !"S 1 NA" f #$% m
"$! "he !roprietorship &orm
*:. "he proprietorship form of organi@ation gives the business owner the protection of limited liability.
ANS & !"S 1 NA" f #$% m
"$! "he !roprietorship &orm
*1. Assets pledged to guarantee a loan are collateral.
ANS " !"S 1 NA" f #$% m
"$! "he !roprietorship &orm
*'. )ouble ta3ation of earnings is the primary financial disadvantage of the corporate form of business
organi@ation.
ANS " !"S 1 NA" f #$% m
"$! "he %orporate &orm
**. "he traditional %=corporation( in which the firm2s income is ta3ed independently of that of its owners(
is overwhelmingly preferred by small companies.
ANS & !"S 1 NA" f #$% m
"$! S="ype %orporations
*,. "he S=corporation was designed to address the concerns of shareholders of large( publicly traded
companies that wanted to avoid the double ta3ation of their income.
ANS & !"S 1 NA" f #$% m
"$! S="ype %orporations
*-. A decision that increases immediate net profit is always consistent with ma3imi@ing shareholder
wealth.
ANS & !"S 1 NA" f #$% m
"$! "he Hoals of ;anagement
*/. "he primary financial goal of the corporation is to ma3imi@e profits.
ANS & !"S 1 NA" f #$% m
"$! "he Hoals of ;anagement
*1. All of the following are stakeholders in a company = Stockholders( %ustomers( %reditors( 0mployees(
;anagement( Suppliers and the #ocal %ommunity.
ANS " !"S 1 NA" f #$% m
"$! Stakeholders and %onflicts of 6nterest
*4. %onflicts of interest arise when managers act for their own personal benefit rather than for the benefit
of shareholders.
ANS " !"S 1 NA" b #$% m
"$! "he Agency !roblem
*9. "he agency problem is generally the most prevalent in companies where ownership is held by only a
few people.
ANS & !"S 1 NA" b #$% m
"$! "he Agency !roblem
,:. 0thical investors buy the securities of firms that behave according to accepted ethical and moral
standards.
ANS " !"S 1 NA" b #$% o
"$! 0thics
M!TCHI#$
Match the following:
a. 6ts income is ta3ed directly by the federal government
b. A proprietorship with several owners
c. 6ts income is ta3ed at the individual level
d. "he owner has unlimited personal liability
1. !roprietorship
'. !artnership
*. % %orporations
,. S %orporations
1. ANS ) !"S 1 "$! &orms of 7usiness $rgani@ation
'. ANS 7 !"S 1 "$! &orms of 7usiness $rgani@ation
*. ANS A !"S 1 "$! &orms of 7usiness $rgani@ation
,. ANS % !"S 1 "$! &orms of 7usiness $rgani@ation
E""!%
1. "he agency problem can seriously restrain the economic success of a company. What avenues are
available to shareholders to bring their goals and those of management into alignment?
ANS
"he best method to align the goals of managers and stockholders is to tie management2s compensation
to profitability andDor stock price. "his incentivi@es managers to take actions that simultaneously
benefit themselves and stockholders.
!"S 1 NA" b #$% m "$! "he Agency !roblem
'. Should investors be concerned about the ethics of the firms in which they invest? Why or why not? 6f
most of investors worry about it( how will that affect corporate behavior?
ANS
Should is a subjective term. Students will be divided on the issue. 6f most investors did concern
themselves with the ethics of the companies in which they invest( it would incentivi@e managers to act
ethically. Acting unethically would drive investors away from the stock pushing its price down.
!"S 1 NA" b #$% o "$! 0thical 6nvesting
*. %an a firm go out of business while making an accounting profit. "hink about a company that buys a
lot of inventory( starts a factory running and then sells most of the product Bat a price far above costC to
a customer who is slow in paying. 03actly why may the company fail?
ANS
>es. Accounting profit is recogni@ed when a sale is made even though the money is uncollected. 6f a
substantial number of customers never pay( the firm will not have the cash to pay for its inventory or to
pay its employees. 6f that happens vendors will sue and employees will leave forcing the firm out of
business. BSee the bo3 KHoing 7roke !rofitablyK at the beginning of %hapter 1- on working capital
management for a detailed description of the phenomenon.C
!"S 1 NA" f #$% k
"$! "he 6mportance of %ash &lows