Chapter 1

Question 1

What are the major areas of finance?

Answer 1

Corporate Finance
Investments
Financial Institutions
International (Sub-set of the others)

Question 2

Capital budgeting

Answer 2

The process of planning and managing a firm’s long-term investments

Question 3

What is the essence of capital budgeting?

Answer 3

Evaluating the size, timing, and risk of future cash flows.

Question 4

Capital structure

Answer 4

The mixture of debt and equity maintained by a firm.

Question 5

Working capital

Answer 5

A firm’s short-term assets and liabilities.

Question 6

What is the goal of financial management?

Answer 6

To maximize the current value per share of the existing stock

Question 7

What is the more general financial management goal?

Answer 7

Maximize the market value of the existing owner’s equity.

Question 8

What is the agency problem?

Answer 8

The possibility of conflict of interest between the owners and management of a firm.

Question 9

What is the relationship between stockholders and management called?

Answer 9

An agency relationship

Question 10

When does an agency relationship exist?

Answer 10

Whenever someone (the principal) hires another (the agent) to represent their interest.

Question 11

What mechanisms exist to ensure managers act in the stockholder’s interest?

Answer 11

Managerial compensation tied to financial performance and/or stock value.

Control of the firm ultimately rests with stockholders (proxy fight).

Firm can be taken over ( poorly managed firms are attractive acquisitions)

Question 12

Stakeholder

Answer 12

Someone other than a stockholder or creditor who potentially has a claim on the cash flows of the firm.

Question 13

What is agency cost?

Answer 13

When management acts it their best interest, which is not the best interest of the owners.

Question 14

What does capital budgeting determine on financial statements?

Answer 14

The fixed assets side of the balance sheet.

Question 15

What does capital structure decisions detemine on financial statements?

Answer 15

Long-term liabilities and equity side of balance sheet.

Question 16

What does working capital management manage?

Answer 16

Cash, accounts receivable, inventory, and short term liabilities.

Question 17

What is the relationship of risk to return?

Answer 17

The higher the perceived risk, the higher the required return and vice versa.

Question 18

What is risk in finance?

Answer 18

The possibility of lower return than anticipated.

Question 19

What is the measure of risk called?

Answer 19

The volatility of return.

Question 20

What provides managers with a performance card?

Answer 20

Daily price changes in the common stock of each publicly traded company.

Question 21

What reflects risk and return expectations?

Answer 21

The market price of the common stock.

Question 22

What act governs the issue of new securities?

Answer 22

Securities act of 1933

Question 23

What does the Securities Act of 1933 require?

Answer 23

Corporations to provide full disclosure of all pertinent information (Prospectus)

Question 24

What act was created to regulate securities trading and regulate the securities?

Answer 24

Securities Exchange Act of 1934

Question 25

What act prohibits insider trading?

Answer 25

Securities Exchange Act of 1934

Question 26

What act created the SEC?

Answer 26

The Securities Exchange Act of 1934

Question 27

What is the SEC?

Answer 27

Securities and Exchange Commission is a regulatory organization that regulates the stock market and trading in the stock market.

Question 28

What did the Securities Act Amendment of 1975 do?

Answer 28

Supervise the SEC in the development of national securities markets

Question 29

What act set up a five member Public Company Accounting Oversight Board (PCAOB)?

Answer 29

Sarbanes-Oxley Act of 2002

Question 30

What is the responsibility of the PCAOB?

Answer 30

Auditing standards within a company Controlling the quality of audits Setting rules and standards for the independence of the auditors

Question 31

What is the major focus of Sarbox?

Answer 31

To make sure that publicly-traded corporations accurately present their assets, liabilities, equity, and income on their financial statements.

Question 32

What are the three main questions to be addressed if you want to start your own business?

Answer 32

1. What long-term investments should you take on? That is, what type of business will you be in, and what sorts of buildings, machinery, and equipment will you need? 2. Where will you get the long-term financing to pay for your investments? Will you bring in other owners or borrow the money? 3. How will you manage your everyday financial activities, such as collecting from customers and paying suppliers.

Question 33

What does the Sarbox require of corporate officers?

Answer 33

Review and sign the annual report, attest that the annual report does not contain false statements or material omissions and also that the financial statements fairly represent the company’s financial results

Question 34

What are the disadvantages of the sole proprietorship and partnership for of business organization?

Answer 34

1. Unlimited liability for business debts on the part of owners. 2. Limited life of the business. 3. Difficulty of transferring ownership. 4. Ability to grow can be seriously limited by an inability to raise cash for investment.

Question 35

In a large corporation, what two groups report to the CFO?

Answer 35

Treasury and controller

Question 36

Which group that reports to the CFO is the focus of corporate finance?

Answer 36

Treasury