Chapter 1 – Introduction to Corporate Finance

(Multiple-Choice Flashcards) Flashcards covering all major terms and questions for my Corporate Finance Exam.

What are the three main components of the financial system?
A) Markets, Intermediaries, and Instruments
B) Banks, Loans, and Interest Rates
C) Income, Wealth, and Debt
D) Taxes, Prices, and Goods

A) Markets, Intermediaries, and Instruments — The financial system is built on markets where securities trade, institutions that move funds, and instruments that transfer resources or risk.

Which best describes what each component of the financial system does?
A) Markets store money; institutions issue taxes; instruments print currency
B) Markets trade assets; institutions connect savers and borrowers; instruments represent claims
C) Markets lend funds; instruments regulate policy; institutions trade stocks
D) Markets only manage banks

B) Markets trade assets, institutions connect savers and borrowers, and instruments are financial contracts that represent claims between parties.

What is the main difference between a financial asset and a financial security?
A) Assets are physical, securities are digital
B) Assets are tradable, securities are not
C) Securities are tradable forms of financial assets
D) They are the same thing

C) Securities are standardized, tradable financial assets (like stocks and bonds). All securities are assets, but not all assets are securities.

Financial securities are primarily related to financial markets because:
A) Markets are where securities are created and traded
B) Markets are unrelated to securities
C) Securities regulate markets
D) Markets issue regulations

A) Financial markets exist to trade securities, allowing liquidity, price discovery, and the flow of funds.

Which of the following is not a key financial asset?
A) Stocks
B) Bonds
C) Real Estate
D) Derivatives

C) Real Estate — It’s a physical asset, not a financial one. The five key financial assets are money, stocks, bonds, loans, and derivatives.

What does each type of financial asset represent?
A) Only a physical claim
B) A financial relationship involving money or value
C) Ownership or debt agreement between two parties
D) A and C

D) Stocks represent ownership, bonds and loans represent debt agreements, and all reflect financial relationships of value exchange.

Why is a security an asset to a saver but a liability to a borrower?
A) Because savers gain value and borrowers owe value
B) Because both lose money
C) Because borrowers earn interest
D) Because the government requires it

A) Savers expect payments (asset), while borrowers owe those payments (liability).

How can the financial system match savers and borrowers?
A) Only through government agencies
B) Directly and indirectly
C) Only through banks
D) Only through credit cards

B) Through direct finance (borrowers sell securities to savers) and indirect finance (intermediaries collect savings to lend).

What is a financial intermediary?
A) An investor who trades stocks
B) A middleman connecting savers and borrowers
C) A government regulator
D) A securities exchange

B) Intermediaries like banks and insurance companies connect savers and borrowers indirectly, reducing risk and cost.

What services do financial intermediaries provide?
A) Liquidity, risk sharing, and information
B) Tax collection and regulation
C) Product distribution
D) Stock market oversight

A) They reduce transaction costs, share risk, provide liquidity, and collect financial information to allocate funds efficiently.

What distinguishes direct from indirect finance?
A) Intermediaries are used in both
B) Direct uses markets; indirect uses intermediaries
C) Both skip financial markets
D) Direct involves insurance only

B) Direct finance = borrowers and savers interact via markets. Indirect finance = intermediaries stand between savers and borrowers.

Financial markets are best defined as what?
A) Systems for exchanging goods and services
B) Platforms for buying and selling financial instruments
C) Places to store physical assets
D) Locations for taxes and wages

B) Markets allow trading of financial instruments, setting prices and allocating capital efficiently.

Which of the following best describes an OTC market?
A) A government agency
B) A centralized exchange like NYSE
C) A decentralized network where dealers trade directly
D) A marketplace for physical commodities only

C) OTC markets are dealer-based networks (like NASDAQ) that trade securities electronically rather than through a physical exchange.

Which statement correctly compares primary and secondary markets?
A) Primary = resale of securities; Secondary = issuance of new ones
B) Primary = new issues; Secondary = existing securities trade
C) Both issue new securities
D) Both are government-run

B) Primary markets sell new securities to raise funds (e.g., IPOs), while secondary markets allow investors to trade existing ones.

Why is the financial system heavily regulated?
A) To prevent fraud, protect investors, and maintain economic stability
B) To increase taxes
C) To limit access to capital
D) To control inflation only

A) Regulation ensures safety, fairness, and stability because financial crises can harm the entire economy.

Which of the following is not a major financial regulator in the U.S.?
A) SEC
B) FDIC
C) CFTC
D) IRS

D) IRS — It collects taxes, not regulate markets. Key regulators: Fed, SEC, FDIC, OCC, and CFTC.

What is the Federal Reserve’s main role?
A) Managing the stock market
B) Printing money for private banks
C) Conducting monetary policy and stabilizing the economy
D) Setting tax policy

C) The Fed manages the money supply, sets interest rates, supervises banks, and promotes financial stability.

Who appoints the Federal Reserve’s Board of Governors?
A) Congress
B) The President and Senate
C) The Supreme Court
D) Private banks

B) The President appoints and the Senate confirms seven governors serving staggered 14-year terms for independence.

What was the original purpose of the Federal Reserve in 1913?
A) Regulate international trade
B) Control stock prices
C) Prevent banking panics and serve as lender of last resort
D) Fund wars

C) The Fed was established after banking crises to stabilize banks and provide emergency liquidity.

Which of the following best describes the Fed’s responsibilities today?
A) Managing unemployment only
B) Supervising banks, controlling money supply, and influencing inflation and employment
C) Setting tax rates
D) Issuing corporate loans

B) The modern Fed handles monetary policy, bank regulation, and economic stability.

What is a key function of the financial system?
A) Collect taxes
B) Channel funds from savers to borrowers efficiently
C) Eliminate inflation
D) Create government spending

B) The financial system allocates funds, provides liquidity, and supports transactions and risk management.

What key services does the financial system offer to savers and borrowers?
A) Savings accounts only
B) Access to capital, liquidity, safety, and diversification
C) Free money
D) Tax deductions

B) Savers gain safety and returns; borrowers gain funding opportunities — both benefit from efficient fund transfer and risk reduction.

Why is the financial system one of the most regulated sectors?
A) Because it directly affects national security
B) Because instability can harm the entire economy
C) To prevent globalization
D) To restrict lending

B) Failures in finance can trigger recessions; regulation ensures trust and system stability.

Which market deals with short-term debt securities under one year?
A) Money market
B) Capital market
C) Stock exchange
D) Derivative market

A) The money market trades short-term debt instruments like Treasury bills. The capital market handles long-term securities.

How do financial systems promote economic growth?
A) By collecting taxes
B) By channeling savings into productive investment and managing risk
C) By limiting lending
D) By increasing consumer spending only

B) Financial systems direct funds toward productive businesses, enabling innovation and expansion across the economy.