chapter 1

Question 1

sole proprietorship

Answer 1

a business owned and run by one person. there is no separation between the firm and the owner. the owner has unlimited personal liability for any of the firm’s debts and the life of a sole proprietorship is limited to the life of the owner.

Question 2

partnership

Answer 2

is identical to a sole proprietorship, except it has more than one owner. all partners are liable for the firm’s debt and the partnership ends on the death or withdrawal of a partner.

Question 3

limited partnership

Answer 3

a partnership with two kinds of owners; general partners and limited partner.

Question 4

general partners

Answer 4

have the same rights and privileges as partners in a partnership. they are personally liable for the firm’s debt obligations.

Question 5

limited partners

Answer 5

have limited liability. meaning that their liability is limited to their investment.

Question 6

limited liability company (LLC)

Answer 6

a limited partnership without a general partner. so, all owners have limited liability, but unlike limited partners they can also run the business.

Question 7

corporation

Answer 7

a legally defined, artificial being, separate from its owners. It has many legal powers, eg. entering into contracts, acquiring assets, and incurring obligations. It has protection against seizure of its property. The owners are not liable for any obligations of the corporation. the entire ownership stake of a corporation is divided into shares known as stocks.

Question 8

equity of the corporation

Answer 8

the collection of all the outstanding shares of a corporation.

Question 9

shareholder/stockholder/ equity holder

Answer 9

an owner of a share of stock in the corporation who is entitled to dividend payments. they are called ‘owners’ but do not have full ownership rights, only some economic and voting rights.

Question 10

dividend payments

Answer 10

payments made at the discretion of the corporation to its equity holders. shareholders usually receive a share of the dividend payments that is proportional to the amount of stock they own.

Question 11

double taxation

Answer 11

corporation’s profits are subject to taxation separate from its owners’ tax obligations. first, the corporation pays tax on its profits. then, the remaining profits are distributed to shareholders who pay personal income tax on this income.

Question 12

‘S’ corporations

Answer 12

when the firm’s profits are not subject to corporate taxes but are allocated directly to shareholders based on their ownership share.

Question 13

‘C’ corporations

Answer 13

corporations subject to corporate taxes. double taxation occurs.

Question 14

board of directors

Answer 14

a group of people who have the ultimate decision-making authority in the corporation.

Question 15

chief executive officer (CEO)

Answer 15

charged with running the corporation by instituting the rules and policies set by the board of directors.

Question 16

chief financial officer (CFO)

Answer 16

the most senior financial manager who often reports directly to the CEO.

Question 17

investment decisions

Answer 17

the most important task. Costs and benefits of investments and projects are weighed. These decisions shape what the firm does and how it adds value for its owners. ‘what assets to purchase/investments to make?’

Question 18

financing decisions

Answer 18

means deciding how to pay for the investments. A corporation can raise more money by selling more shares of stock (equity) or borrowing the money (debt). ‘how to fund investments? what is the optimal capital structure?’

Question 19

cash management

Answer 19

ensuring the firm has enough cash to meet its day-to-day obligations, also known as managing working capital. It can mean the difference between success and failure.

Question 20

agency problem

Answer 20

the agency problem arises because a corporation is run by a management team, separate from its owners which gives rise to conflict of interest. it arises when managers put their own self-interest ahead of the interest of shareholders.

Question 21

corporate charter

Answer 21

specifies the initial rules that govern how the corporation is run.

Question 22

hostile takeover

Answer 22

when an individual or organisation acts as a corporate raider and purchases a large fraction of the stock and acquires enough votes to replace the board of directors and the CEO. it creates a “market for corporate control” and disciplines bad managers and motivates boards of directors to make difficult decisions.

Question 23

liquidation

Answer 23

involves the business shutting down and selling off its assets. It is usually best for debt holders to run the firm in the most profitable way possible.

Question 24

corporate bankruptcy

Answer 24

best thought of as a change in ownership of the corporation and not necessarily as a failure of the underlying business.

Question 25

private companies

Answer 25

have a limited set of shareholders and their shares are not regularly traded. the value of their shares can be difficult to determine.

Question 26

public companies

Answer 26

companies whose shares are traded on stock markets.

Question 27

stock markets

Answer 27

organised markets that provide liquidity and determine a market price for a company’s shares.

Question 28

liquid investment

Answer 28

an investment is liquid if it possible to sell it quickly and easily for a price very close to the price at which you could contemporaneously buy it.

Question 29

primary market

Answer 29

used when the corporation issues new shares and sells them to investors.

Question 30

secondary market

Answer 30

used when investors trade shares without involvement of the corporation. This is the majority of trading in the stock market.

Question 31

market makers

Answer 31

match buyers and sellers. they two prices for every stock in which they made a market; the bid price and the ask price. they provide liquidity by ensuring that market participants always have somebody to trade with.

Question 32

bid price

Answer 32

the price at which market makers are willing to buy the stock.

Question 33

ask price

Answer 33

the price at which market makers are willing to sell the stock.

Question 34

bid-ask spread

Answer 34

the difference between the bid price and the ask price. it is a transaction cost investors pay to trade.

Question 35

limit order

Answer 35

an order to buy or sell a set amount at a fixed price, eg. buy 100 shares at a price of $138/share. anyone can make a market in a stock by posting a limit order. this provides liquidity.

Question 36

limit order book

Answer 36

the collection of all limit orders.

Question 37

market orders

Answer 37

orders that trade immediately at the best outstanding limit order. they are said to be ‘takers’ of liquidity.

Question 38

high frequency traders (HFTs)

Answer 38

a class of traders who, with the aid of computers, will place, update, cancel, and execute trades many times per second in respond to new information and other orders, profiting by providing liquidity and taking advantage of stale limit orders.

Question 39

dark pools

Answer 39

alternative trading systems that do not make their limit order books visible. They offer investors the ability to trade at a better price, but the order might not be filled if an excess of buy or sell orders is received.
It is attractive for traders who do not want to reveal their demand price and are willing to sacrifice the guarantee of immediacy for a potentially better price.

Question 40

fintech

Answer 40

the relation between financial innovation and technical innovation.

Question 41

blockchain technology

Answer 41

technology allows a transaction to be recorded in a publicly verifiable way without the need for a trusted third party to certify the authenticity of the transaction.

Question 42

cryptocurrency

Answer 42

a currency whose creation and ownership is determined via a public blockchain.

Question 43

bitcoin

Answer 43

the first cryptocurrency. All transactions are recorded in a public ledger using blockchain technology to allow individuals to create and trade bitcoins and verify those transactions digitally.

Question 44

robo-advisors

Answer 44

computer programs intended to replace the work of financial advisors by providing detailed and customised investment recommendations.

Question 45

stale limit orders

Answer 45

occurs when information causes the price of the stock to move. traders can take advantage of this by quickly executing trades at the old price.

Question 46

separation of ownership and control

Answer 46

firms have managers and shareholders who are often not the same people. this leads to separation of ownership and control. shareholders are ‘owners’ and managers are ‘control’. this introduces an agency problem.