Finance Introduction and Corporate Financial Management

Multiple choice

What is a financial intermediary?

An institution that facilitates the flow of funds between savers and borrowers, making financial markets work efficiently.

Why would a financial market without intermediaries fail to function well?

Because small savers and large borrowers would face high search, transaction, and monitoring costs that prevent efficient fund matching.

Name four key functions performed by financial intermediaries.

1) Bundle small savings into larger investments; 2) Transform financial assets into new securities; 3) Spread or diversify risk via portfolios; 4) Facilitate contact between market players, reducing risk and cost of capital while increasing liquidity.

Give five examples of financial intermediaries.

Commercial banks, savings banks (Sparkassen), building societies (Bausparkassen), insurance companies, and investment funds (also pension funds, FinTechs, brokers).

What is the primary responsibility of corporate financial management?

Raising financial funds, advising on their best use, and interacting with financial intermediaries.

List the four main functions within corporate financial management.

1) Interacting with financial markets; 2) Investment advice (capital budgeting/appraisal); 3) Treasury management (cash & liquidity); 4) Risk management (keeping exposure at desired levels at minimum cost).

What is common stock?

Equity that represents ownership in a company, giving voting rights and entitlement to residual cash after taxes and debt obligations.

What two key rights do preferred stockholders usually have?

Priority in receiving dividends and liquidation proceeds, often at a fixed minimum dividend rate.

Why is preferred stock sometimes considered similar to debt?

Because it often pays a fixed dividend and may carry little or no voting rights, resembling fixed-income obligations.

Why do equity investors usually demand a return premium?

They bear the residual business risk and therefore expect compensation above the risk-free rate.

Define mezzanine finance.

A hybrid form of high-risk, high-return debt that often includes equity-linked features such as warrants.

When is mezzanine finance typically used?

When traditional bank borrowing is unavailable and pure equity is too expensive, especially in highly leveraged transactions like management buyouts.

What is an equity warrant?

A right attached to mezzanine or other securities that allows the holder to purchase common stock at a fixed price on or before a set date.

What is a corporate bond?

A fixed-interest security issued by a company with predetermined terms such as maturity, coupon rate, and whether it is secured or unsecured.

What distinguishes a convertible bond from a regular corporate bond?

It can be converted into a predetermined number of equity shares under specified conditions.

Define a bank loan in corporate finance.

A specific amount of money provided by a bank to a company under agreed terms regarding interest, maturity, and repayment.

What is commercial paper?

A short-term, fixed-interest security issued by large, creditworthy companies to meet immediate funding needs.

Explain leasing in one sentence.

A contractual arrangement in which the lessor retains ownership of an asset while the lessee pays fixed fees for the right to use it.

State three reasons a company might choose leasing over buying an asset.

Cancellation options and flexibility, short-term convenience, tax advantages, and off-balance-sheet financing treatment.

What is financial leverage (gearing)?

The proportion of debt in a company’s capital structure that amplifies the effect of profits or losses on shareholders’ returns.

How does high leverage affect shareholder returns in good and bad years?

In profitable years, ROE increases more than proportionally; in low-profit or loss years, ROE decreases (or turns negative) more than proportionally.

Provide the basic formula for Return on Equity (ROE).

ROE = Net income ÷ Equity.

Why do higher debt levels generally raise a firm’s Weighted Average Cost of Capital (WACC)?

Because additional debt increases overall risk, leading both owners and investors to demand higher returns on capital.