Business Finance Test 1

Partnerships and proprietorships generally have a tax advantage over corporations.

true

A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership

false

An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships

false

Some partners in a partnership may have different rights, privileges, and responsibilities than other partners

true

One advantage of the corporate form of organization is that it avoids double taxation

false

It is generally harder to transfer one’s ownership interest in a partnership than in a forporation

true

One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided I you formed a corporation to operate the business

true

If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small business.

false

It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required.

false

The more capital a firm is likely to require, the greater the probability that it will be organized as a corporation

true

One disadvantage of forming a corporation rather than a partnership is that this makes it more difficult for the firm’s investors to transfer their ownership interests.

false

Organizing as a corporation makes it easier for the firm to raise capital. This is because corporations’ stockholders are not subject to personal liabilities if the firm goes bankrupt and also because it is easier to transfer shares of stock than partnership interests.

true

In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the stock price in the long run, or the stock’s “intrinsic value.”

true

If management operates in a manner designed to maximize the firm’s expected profits for the current year, this will also maximize the stockholders’ wealth as of the current year

false

In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the expected EPS.

false

In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the stock price on a specific target date

false

As a result of financial scandals occurring during the past decade, there has been a strong push to improve business ethics.

true

There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to banks and to stockholders. It is illegal to provide such information to banks, but it is not illegal to provide it to stockholders because they are the owners of the firm, not outsiders.

false

A stock’s market price would equal its intrinsic value if all investors had all the information that is available about the stock. In this case the stock’s market price would equal its intrinsic value.

true

If a stock’s market price is above its intrinsic value, then the stock can be thought of as being undervalued, and it would be a good buy.

false

If stock’s intrinsic value is greater than its market price, then the stock is overvalued and should be sold.

false

For a stock to be in equilibrium as the book defines it, its market price should exceed its intrinsic value

false

The term “marginal investor” means an investor who is active in the market and would tend to buy a stock if its price fell and sell it if it rose, barring any new information coming out about the stock. It is the “marginal investor” who determines the actual stock price.

true

Managers always attempt to maximize the long-run value of their firms’ stocks, or the stocks’ intrinsic values. This is exactly what stockholders desire. Thus, conflicts between stockholders and managers are not possible.

false

A hostile takeover is said to occur when another corporation or group of investors gain voting control over a firm and replaces the old managers. If the old managers were managing the firm inefficiently, then hostile takeovers can improve the economy. However, hostile takeovers are controversial, and legislative actions have been taken to make them more difficult to undertake.

true

If someone deliberately understates costs and thereby increases profits, this can cause the stock price to rise above its intrinsic value. The stock price will probably fall in the future. Also, those who participated in the fraud can be prosecuted, and the firm itself can be penalized.

true

If a firm’s board of directors wants to maximize value for its stockholders in general (as opposed to some specific stockholders), it should design an executive compensation system whose focus is on the firm’s long-term value.

true

Which of the following statements is CORRECT?

proprietorships and partnerships generally have a tax advantage over corporations.

Which of the following statements is CORRECT?

One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability

Which of the following statements is CORRECT?

One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership.

Relaxant Inc. operates as a partnership. Now the painters have decided to convert the business into a corporation. Which of the following statements is CORRECT?

Relaxant’s shareholders (the ex-partners) will now be exposed to less liability.

Which of the following statements is CORRECT?

It is usually easier to transfer ownership in a corporation than in a partnership.

Which of the following could explain why a business might choose to operate as a corporation rather than as a proprietorship or a partnership?

corporations generally find it easier to raise large amount of capital.

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to

Maximize the stock price per share over the long run, which is the stock’s intrinsic value.

Which of the following statements is CORRECT?

The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.

Which of the following statements is CORRECT?

Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations’ less favorable tax treatment

Which of the following statements is CORRECT?

A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers.

Which of the following statements is CORRECT?

Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interest

The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to

Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers?

change the corporation’s formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers?

The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders?

The use of covenants in bond agreements that limit the firm’s use of additional debt and constrain managers’ actions.

Which of the following actions would be most likely to reducepotential conflicts between stockholders and bondholders?

Including restrictive covenants in the company’s bond indenture (which is the contract between the company and its bondholders)

Which of the following statements is CORRECT?

If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.

With which of the following statements would most people in business agree?

Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

Which of the following statements is CORRECT?

The threat of takeovers tends to reduce potential conflicts between stockholders and mangers.

Which of the following statements is CORRECT?

Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders .

Which of the following statements is CORRECT?

Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers.

Which of the following statements is CORRECT?

The managers of established, stable companies sometimes attempt to get their state legislatures to ​impose rules that make it more difficult for raiders to succeed with hostile takeovers.

Which of the following statements is CORRECT?

One advantage to forming a corporation is that the owners of the firm have limited liability.

The NYSE is defined as a “spot” market purely and simply because it has a physical location. The NASDAQ, on the other hand, is not a spot market because it has no one central location.

false

The NYSE is defined as a “primary” market because it is one of the largest and most important stock markets in the world.

false

Private markets are those like the NYSE, where transactions are handled by members of the organization, while public markets are those like the NASDAQ, where anyone can make transactions.

false

A share of common stock is not a derivative, but an option to buy the stock is a derivative because the value of the option is derived from the value of the stock

true

Financial institutions are more diversified today than they were in the past, when federal laws kept investment banks, commercial banks, insurance companies, and similar organizations quite separate. Today the larger financial services corporations offer a variety of services, ranging from checking accounts, to insurance, to underwriting securities, to stock brokerage.

true

Trades on the NYSE are generally completed by having a brokerage firm acting as a “dealer” buy securities and adding them to its inventory or selling from its inventory, The NASDAQ, on the other hand, operates as an action market, where buyers offer to buy, and sellers to sell, and the price is negotiated on the floor of the exchange.

false

The “over-the-counter” market received its name years ago because brokerage firms would hold inventories of stocks and then sell them by literally passing them over the counter to the buyer.

true

If you decide to buy 100 shares of Google, you should probably do so by calling your broker and asking him or her to execute the trade for you. This would be defined as a secondary market transaction, not a primary market transaction.

true

The term IPO stands for “individual purchase order,” as when an individual (as opposed to an institution places an order to buy a stock.

false

In a "Dutch auction" for new stock, individual investors place bids for shares directly. Each potential bidder indicates the price he or she is willing to pay and how many shares he or she will purchase at that price. The highest price that permits the company to sell all the shares it wants to sell is determined, and this is the "market clearing price." All bidders who specified this price or higher are allowed to purchase their shares at the market clearing price.

true

When a corporation’s shares are owned by a few individuals who are associated with the firm’s management, we say that the stock is closely held.

truea

publicly owned corporation is a company whose shares are held by the investing public, which may include other corporations as well as institutional investors.

true

The annual rate of return on any given stock can be found as the stock’s dividend for the year plus the change in the stock’s price during the year, dividend by its beginning-og-year price.

true

Each stock's rate of return in a given year consists of a dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). Such returns are calculated for all the stocks in the S&P 500. A weighted average of those returns, using each stock's total market value, is then calculated, and that average return is often used as an indicator of the "return on the market."

true

​Each stock's rate of return in a given year consists of a dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). Such returns are calculated for all the stocks in the S&P 500. A simple average of those returns (which gives equal weight to each company in the S&P 500) is then calculated. That average is called "the return on the S&P Index," and it is often used as an indicator of the "return on the market."

false

You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction?

this is an example of a direct transfer of capital

Which of the following statements is CORRECT?

Capital market instruments include both long-term debt and common stocks.

Which of the following is a primary market transaction?

IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

Which of the following is an example of a capital market instrument?

Preferred stock

Money markets are markets for

Short-term debt securities such as Treasury bills and commercial paper.

Which of the following statements is CORRECT?

As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of:

A secondary market transaction

Which of the following statements is CORRECT?

Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and these investors supposedly can do any necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.

Which of the following statements is CORRECT?

The New York Stock Exchange is an auction market, and it has physical location

Which of the following statements is CORRECT?

Both NASDAQ dealers and “specialists” on the NYSE hold inventories of stocks.