Page 1

Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

Chapter 2 The Financial Environment and the Level of Interest Rates Learning Objectives 1.

Discuss the primary role of the financial system in the economy, and describe the two basic ways in which fund transfers take place. The primary role of the financial system is to transfer money from those that have more money than they need to spend (surplus spending units, or SSUs) to businesses and consumers who need to borrow money (deficit spending units, or DSUs). The more efficient the financial system, the more likely it is that consumers will get the highest possible interest rate on their savings, businesses will be able to borrow at the lowest possible cost, and the most desirable investment opportunities with the highest rates of return will be funded. Money is transferred from SSUs to DSUs in two basic ways: (1) directly, through financial markets or (2) indirectly, through intermediation markets. The direct markets are wholesale markets in which large public corporations transact. Smaller business firms, as well as consumers, secure most of their financial services from commercial banks and other financial intermediaries because their transactions are too small for the wholesale markets.

2.

Discuss direct financing and the important role that investment banks play in this process. 1


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin Direct markets are wholesale markets where large public corporations transact. These corporations sell securities, such as stocks and bonds, directly to investors in exchange for money, which they use to invest in their businesses. Investment banks are important in the direct markets because they help firms sell their new security issues. The services provided by investment bankers include origination, underwriting, and distribution.

3.

Describe the primary and secondary markets, and explain why secondary markets are so important to businesses. Primary markets are markets in which new securities are sold for the first time. Secondary markets provide the aftermarket for securities previously issued. Not all securities have secondary markets. Secondary markets are important because they enable investors to convert securities easily to cash. Business firms whose securities are traded in secondary markets are able to issue securities at a lower cost than they otherwise could because investors are willing to pay a premium price for securities that have secondary markets.

4.

Explain why money markets are important financial markets for large corporations. Large corporations use money markets to adjust their liquidity because cash inflows and outflows are rarely perfectly synchronized. Thus, on the one hand, if cash expenditures exceed cash receipts, the firm can borrow short term by issuing commercial paper or, if the firm holds a portfolio of money market instruments, some of the securities can be sold for cash. On the other hand, if cash receipts exceed expenditures, the firm can temporarily invest the funds in short-term money market instruments such as Treasury

2


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin bills, negotiable CDs, or commercial paper issued by other corporations. Businesses are willing to invest large amounts of idle cash in money market instruments because of their high degree of marketability and their low default risk.

5.

Discuss the most important stock market exchanges and indexes. Capital markets are the wholesale markets where capital assets, such as plant and equipment, are financed. The two most important capital market instruments are corporate bonds and common stock. Compared with money market instruments, capital market instruments are less marketable and carry more default risk.

6.

Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets and describe how corporations use the financial system. The problem with direct financing is that it takes place in a wholesale market. Most small businesses and consumers do not have the professional skills or the money to transact in this market. In contrast, a large portion of the intermediation market focuses on providing financial services to consumers and small businesses. For example, commercial banks collect money from consumers in small dollar amounts by selling them checking accounts, savings accounts, and consumer CDs. They then aggregate the funds and make loans in larger amounts to consumers and businesses. The financial services bought or sold by intermediaries are tailor made to fit the needs of the market they serve.

3


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 7.

Explain how the real rate of interest is determined in the economy, differentiate between the real rate and the nominal rate of interest, and be able to compute the nominal or real rate of interest. The real rate of interest is the long-term interest rate in the economy in the absence of inflation. It is determined by the interaction of (1) the rate of return that business can expect to earn on capital goods and (2) individuals’ time preference for consumption. The interest rate we observe in the marketplace is called the nominal rate of interest. The nominal rate of interest is composed of two parts: (1) the real rate of interest and (2) the expected rate of inflation. The inflation premium provides protection to the lender and borrower against changes in purchasing power due to inflation.

I.

True or False Questions

1.

The role of the financial system is to gather money from people and businesses that have funds to invest and to channel money to those that need it.

2.

a.

True

b.

False

The financial system is nothing more than a collection of financial markets.

a.

True

b.

False

4


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 3.

4.

5.

6.

7.

Without a financial market, purchasing a house would require a cash purchase.

a.

True

b.

False

Governments are the principal SSUs in the economy.

a.

True

b.

False

Businesses are the principal DSUs in the economy.

a.

True

b.

False

Direct financial markets could be broadly labeled as wholesale markets for funding.

a.

True

b.

False

A privately held corporation securing a loan from its regional commercial bank is an example of a direct market transaction.

5


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

8.

a.

True

b.

False

A primary market is any financial market in which owners of outstanding securities can resell them to other investors.

9.

a.

True

b.

False

The vast preponderance of securities sales on the New York Stock Exchange are classified as secondary market transactions.

10.

a.

True

b.

False

The existence of an active secondary market for a security will help enhance the price for a security in the primary market.

11.

a.

True

b.

False

The Securities and Exchange Commission was established by the Securities Act of 1933.

6


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

12.

a.

True

b.

False

The Securities Act of 1933 requires full disclosure of all relevant information related to issuing new securities in the primary markets..

13.

a.

True

b.

False

The law that barred commercial banks from investment banking activities is the Financial Services Modernization Act of 1999.

14.

15.

a.

True

b.

False

Today, large money center banks have been allowed back into the investment business.

a.

True

b.

False

The downside to a private placement transaction is that it does not require the fees and expenses associated with an SEC registration.

7


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

16.

17.

a.

True

b.

False

Brokers are market specialists who do not bear risk.

a.

True

b.

False

The term money market reflects the idea that the instruments traded in the money market are highly marketable and easily converted into cash.

18.

19.

a.

True

b.

False

Equities are generally traded in the capital market.

a.

True

b.

False

LIBOR refers to the rate that U.S. banks quote to each other for overnight borrowing. a.

True

b.

False

8


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 20.

21.

The method that most individuals use to fund their needs is through indirect financing.

a.

True

b.

False

The elimination of small financial institutions is primarily a by-product of deregulating the financial markets.

22.

23.

24.

a.

True

b.

False

Business finance companies obtain the majority of their funds by selling equity.

a.

True

b.

False

The nominal rate of interest is indirectly related to real rates.

a.

True

b.

False

Real rates of interest are perfectly observable.

9


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

25.

a.

True

b.

False

It is impossible for the nominal rate of interest to be below the real rate of interest.

a.

True

b.

False

10


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

II.

Multiple-Choice Questions

26.

An economy with a large flow of funds requires

27.

28.

a.

a lot of gold reserves.

b.

a tightly controlled central bank.

c.

an efficient financial system.

d.

all of the above.

Financial markets and financial institutions are both part of

a.

the U.S. Treasury.

b.

the financial system.

c.

the SEC.

d.

none of the above.

Savings by ________ is the origin of much of the money that funds large business loans in the economy.

a.

consumers

b.

the U.S. government

c.

small businesses

d.

none of the above

11


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

29.

The financial system’s primary concern is funneling money from ________ to _________

30.

31.

a.

wealthy individuals, individuals.

b.

SSUs , DSUs

c.

DSUs, SSUs

d.

the government, wealthy individuals

________ are the principal SSUs in the economy.

a.

Households

b.

The federal government

c.

State governments

d.

Businesses

Elf Toy Products increased the amount of cash in its bank account this year. Elf is a

a.

DSU.

b.

SSU.

c.

neither a DSU nor a SSU.

d.

both a DSU and a SSU.

12


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 32.

33.

34.

35.

An important function of the financial system is

a.

to direct money to the best investment opportunities in the economy.

b.

to allow the federal government to view all financial transactions.

c.

to help state governments to coordinate state tax levies.

d.

all of the above.

A surplus budget position means that an entity’s

a.

income and expenditures are equal.

b.

income for the period exceeds expenses.

c.

expenditures for the period exceed revenues.

d.

none of the above.

Direct financing occurs when

a.

an SSU borrows directly from a DSU.

b.

a DSU borrows directly from a SSU.

c.

an SSU borrows from the federal government.

d.

a DSU borrows from the federal government.

Which types of individuals are able to participate in the direct financial market?

13


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

36.

37.

a.

entrepreneurs

b.

wealthy individuals

c.

venture capitalists

d.

all of the above.

The major players in the direct financial markets are

a.

investment banks.

b.

commercial banks.

c.

regional banks.

d.

both a and b.

What is the generally recognized minimum denominated transaction in the direct financial markets?

38.

a.

$10,000

b.

$100,000

c.

$1,000,000

d.

$10,000,000

The financial market where a new security is sold for the first time is

a.

a primary market.

14


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

39.

40.

b.

a secondary market.

c.

an indirect market.

d.

none of the above.

Secondary financial markets are similar to

a.

direct auction markets.

b.

new-car markets.

c.

used-car markets.

d.

all of the above.

If you just purchased a share of IBM through a New York Stock Exchange-based transaction, you participated in

41.

a.

a primary market transaction.

b.

a secondary market transaction.

c.

a futures market transaction.

d.

none of the above.

The ease with which a security can be sold and converted into cash is called

a.

convertibility.

b.

book value.

15


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

42.

43.

44.

c.

marketability.

d.

none of the above.

The presence of a financial market increases the marketability of a financial security by

a.

essentially insuring the price of the security.

b.

reducing the transaction costs for selling the security.

c.

guaranteeing the accuracy of information produced by the issuer of the security.

d.

none of the above.

Which law established the United States Securities Exchange Commission?

a.

the Securities Act of 1933

b.

the Securities Exchange Act of 1934

c.

the Glass-Steagall Act of 1933

d.

the Financial Services Modernization Act of 1933

Which law essentially barred commercial banks from investment banking activities?

a.

the Securities Act of 1933

b.

the Securities Exchange Act of 1934

c.

the Glass-Steagall Act of 1933

d.

the Financial Services Modernization Act of 1933

16


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

45.

Which law is responsible for rolling back many of the rules against commercial banks offering investment banking activities?

46.

47.

a.

the Securities Act of 1933

b.

the Securities Exchange Act of 1934

c.

the Glass-Steagall Act of 1933

d.

the Financial Services Modernization Act of 1999

One of the main services offered by investment banks to companies is

a.

helping companies sell new debt or equity issues in the security markets.

b.

making loans to companies.

c.

taking deposits from companies.

d.

all of the above.

Which of the following would most likely be involved in a public securities underwriting service?

a.

a regional commercial banker

b.

a broker

c.

a dealer

d.

None of the above would ever be involved in underwriting.

17


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

48.

49.

50.

The NYSE is an example of

a.

an over-the-counter market exchange.

b.

an organized exchange.

c.

an electronic market exchange.

d.

all of the above.

The oldest stock exchange in the United States is

a.

the Boston Stock Exchange.

b.

the New York Stock Exchange.

c.

the Philadelphia Stock Exchange.

d.

the Chicago Stock Exchange.

Which of the following stock exchange organizational forms has no physical location?

a.

a futures exchange

b.

an over-the-counter market

c.

an auction market.

d.

none of the above.

18


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 51.

Which index is considered best for measuring the performance of the largest companies in the U.S. economy?

52.

a.

the Dow Jones Industrial Average

b.

the New York Stock Exchange Index

c.

the Standard and Poor’s 500 Index

d.

the NASDAQ Composite Index

Which index is considered best for measuring the performance of the high-tech sector in the United States?

53.

a.

the Dow Jones Industrial Average

b.

the New York Stock Exchange Index

c.

the Standard and Poor’s 500 Index

d.

the NASDAQ Composite Index

A highly liquid financial instrument with a maturity of 90 days would be traded in

a.

the money market.

b.

the bond market.

c.

the stock market.

d.

none of the above.

19


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 54.

55.

56.

57.

Money market instruments are generally issued by

a.

firms in dire need of cash to maintain their credit rating.

b.

firms of the highest credit rating.

c.

firms of the lower credit ratings.

d.

all of the above.

The term money market came about because

a.

firms that issue securities in this market are in dire need of cash.

b.

it is a market where stocks are converted into money.

c.

the securities traded in this market are a close substitute for cash.

d.

none of the above.

If a firm needs to adjust its liquidity position, then it would participate in

a.

the money market.

b.

the bond market.

c.

the stock market.

d.

all of the above.

If a firm needs to finance a new corporate headquarters building, then it would most likely seek the funds in the

20


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

58.

a.

money market.

b.

capital market.

c.

futures market.

d.

all of the above.

If a Japanese bank needs to borrow U.S. dollars for an overnight loan, then it would access the

59.

60.

a.

money market.

b.

Eurodollar market.

c.

bond market.

d.

all of the above.

The most commonly quoted interest rate for Eurodollar overnight lending is known as

a.

FIBOR.

b.

LIBOR.

c.

PIBOR.

d.

none of the above.

The most common reason that corporate firms use the futures and options markets is

21


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

61.

a.

to hedge risk.

b.

to take risk.

c.

to make deposits.

d.

none of the above.

Which of the following grants the owner the right to purchase an asset at a prespecified price for a prespecified period of time?

62.

a.

a call option

b.

a put option

c.

a futures contract

d.

all of the above

If you have an asset that you will be selling during the next two weeks, then you might be able to hedge the proceeds from the asset sale by

63.

a.

purchasing a call option on the asset.

b.

purchasing a put option on the asset.

c.

purchasing more of the asset.

d.

none of the above.

If your firm primarily borrows from commercial banks, then it primarily accesses the capital markets through

22


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

a.

direct financing.

b.

indirect financing.

c.

a legal loophole that allows all commercial banks the ability to underwrite securities.

d.

64.

none of the above.

The process of converting financial securities with one set of characteristics into securities with another set of characteristics is called

65.

66.

a.

financial bundling.

b.

financial intermediation.

c.

financial disintermediation.

d.

none of the above.

One aspect of deregulating the financial markets has been

a.

the elimination of smaller, less efficient institutions.

b.

the reemergence of smaller, less efficient institutions.

c.

the elimination of larger institutions.

d.

none of the above.

A line of credit to a corporation is like _______ to an individual.

23


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

67.

a.

a term loan

b.

a bond

c.

a credit card

d.

none of the above

Which of the following are the primary investment vehicles for the funds in which life insurance companies must invest?

68.

a.

CDs

b.

stocks

c.

long-term corporate bonds

d.

both b and c

Casualty insurance companies sell

a.

protection against loss of income in the event of the death of the insured.

b.

protection against loss of property from fire, theft, accidents, and other predictable causes.

c.

protection against a loss of pension revenue for retirees.

d.

all of the above.

24


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 69.

Which of the following would not make up a major proportion of a pension fund investment portfolio?

70.

71.

a.

commercial paper

b.

long-term corporate bonds

c.

stocks

d.

none of the above

A mutual fund is an example of

a.

a commercial bank.

b.

an insurance company.

c.

an investment fund.

d.

a pension fund.

If a small business opts not to borrow from a commercial bank, then what is probably its next best alternative?

a.

an insurance company

b.

a pension

c.

an investment fund

d.

a finance company

25


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 72.

73.

74.

75.

The price of borrowing money is called

a.

inflation.

b.

return.

c.

interest.

d.

all of the above.

The nominal rate of interest is made up of

a.

the real rate of interest.

b.

compensation for inflation.

c.

a commodity cross-index return.

d.

both a and b above.

The real rate of return can be justified, at a basic level, by

a.

compensation for inflation.

b.

compensation for deferring consumption.

c.

compensation for the level of international borrowing.

d.

all of the above.

If you are a borrower, which would you prefer to occur during the life of your loan?

26


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin a.

a level of inflation that is higher than that anticipated at the outset of the loan

b.

a level of inflation that is lower than that anticipated at the outset of the loan

76.

c.

a level of inflation that is exactly as anticipated at the outset of the loan

d.

no inflation at all

If inflation is anticipated to be 5 percent during the next year, while the real rate of interest for a one-year loan is 5 percent, then what should the nominal rate of interest be for a risk-free one-year loan?

77.

a.

5 percent

b.

10 percent

c.

25 percent

d.

none of the above

The general level of interest rates tends to follow

a.

deflation.

b.

the business cycle.

c.

the default cycle.

d.

all of the above.

27


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 78.

79.

80.

During an economic expansion, we would expect

a.

interest rates to increase.

b.

interest rates to decrease.

c.

interest rates to remain the same.

d.

the price of money to decrease.

In the United States, the real rate of interest is generally about

a.

1 percent.

b.

3 percebt.

c.

5 percent.

d.

7 percent.

If the supply of loanable funds decreases relative to the demand for those funds, then we would expect

a.

interest rates to remain unchanged.

b.

interest rates to increase.

c.

interest rates to decrease.

d.

the price of money to remain unchanged.

28


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

29


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

III. Answers to True or False Questions

1.

True

2.

False

3.

True

4.

False

5.

True

6.

True

7.

True

8.

False

9.

True

10.

True

11.

False

12.

True

13.

False

14.

True

15.

False

16.

True

17.

True

18.

True

19.

False

20.

True

21.

True

30


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 22.

False

23.

False

24.

False

25.

False

31


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin

IV.

Answers to Multiple-Choice Questions

26.

c

27.

b

28.

a

29.

b

30.

a

31.

b

32.

a

33.

b

34.

b

35.

b

36.

d

37.

c

38.

a

39.

c

40.

b

41.

c

42.

b

43.

b

44.

c

45.

d

46.

a

32


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 47.

c

48.

b

49.

b

50.

b

51.

c

52.

d

53.

a

54.

b

55.

c

56.

a

57.

b

58.

b

59.

b

60.

a

61.

a

62.

b

63.

b

64.

b

65.

a

66.

c

67.

d

68.

b

69.

a

33


Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate-finance-1st-edition-parrin 70.

c

71.

d

72.

c

73.

d

74.

b

75.

a

76.

b

77.

b

78.

a

79.

b

80.

b

34

Test bank fundamentals of corporate finance 1st edition parrino  

test bank fundamentals of corporate finance 1st edition parrino. Full file at http://testbank360.eu/test-bank-fundamentals-of-corporate...

Read more
Read more
Similar to
Popular now
Just for you