Chapter 20 3 The commitment fee in revolving credit agreements provides

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

Objective: 20.3

20. To get a line of credit, the borrower must pay a commitment fee.

a. True

b. False

Difficulty: 2 Page-Reference: 637

Question ID: 20-2-147 Skill: Knowledge

Objective: 20.3

21. Commitment fees are usually required for revolving credit agreements, but not for lines of credit.

a. True

b. False

Difficulty: 2 Page-Reference: 637

Question ID: 20-2-148 Skill: Knowledge

Objective: 20.3

22. The commitment fee in revolving credit agreements provides assurance to the lender that the

borrower is committed to actually borrowing the money.

a. True

b. False

Difficulty: 2 Page-Reference: 637

Question ID: 20-2-149 Skill: Knowledge

Objective: 20.3

23. Although the bank may issue a line of credit to a business firm for a certain amount, the bank

does not guarantee that the funds will be available when requested.

a. True

b. False

Difficulty: 2 Page-Reference: 637

Question ID: 20-2-150 Skill: Knowledge

Objective: 20.3

24. Factoring accounts receivable is feasible only for the most creditworthy and largest firms.

a. True

b. False

Difficulty: 2 Page-Reference: 636

Question ID: 20-2-151 Skill: Knowledge

Objective: 20.3

25. Secured loans allow borrowers to get funds when they might not qualify for unsecured credit.

a. True

b. False

Difficulty: 2 Page-Reference: 636

Question ID: 20-2-152 Skill: Knowledge

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

Objective: 20.3

26. A company that pledges accounts receivable is probably in financial difficulty.

a. True

b. False

Difficulty: 2 Page-Reference: 636

Question ID: 20-2-153 Skill: Comprehension

Objective: 20.3

27. Some unsecured loans are one-time-only arrangements, and may take the form of lines of credit,

revolving credit agreements, or commercial paper.

a. True

b. False

Difficulty: 2 Page-Reference: 636

Question ID: 20-2-154 Skill: Knowledge

Objective: 20.3

28. Debt financing refers to the long-term borrowing of funds from outside the company.

a. True

b. False

Difficulty: 1 Page-Reference: 638

Question ID: 20-2-155 Skill: Knowledge

Objective: 20.4

29. The two primary sources for obtaining long-term borrowing from outside the business firm are the

issuance of commercial paper and factoring of accounts receivable.

a. True

b. False

Difficulty: 2 Page-Reference: 636, 638

Question ID: 20-2-156 Skill: Knowledge

Objective: 20.4

30. Of the two basic types of long-term financing (debt and equity), debt is usually the best.

a. True

b. False

Difficulty: 1 Page-Reference: 638

Question ID: 20-2-157 Skill: Comprehension

Objective: 20.4

31. Most corporations get their long-term loans from a chartered bank.

a. True

b. False

Difficulty: 1 Page-Reference: 638

Question ID: 20-2-158 Skill: Knowledge

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

Objective: 20.4

32. Excel Corp. has a long-term loan with a bank at 1 percent above prime. This is an example of a

fixed loan rate.

a. True

b. False

Difficulty: 1 Page-Reference: 638

Question ID: 20-2-159 Skill: Comprehension

Objective: 20.4

33. Usually loans and bonds both carry fixed interest rates and must be paid regardless of how well

the company is performing.

a. True

b. False

Difficulty: 1 Page-Reference: 638

Question ID: 20-2-160 Skill: Knowledge

Objective: 20.4

34. A corporate bond is used to raise a large amount of money for long periods of time.

a. True

b. False

Difficulty: 1 Page-Reference: 638

Question ID: 20-2-161 Skill: Knowledge

Objective: 20.4

35. Debt financing appeals most strongly to companies that have predictable profits and cash-flow

patterns.

a. True

b. False

Difficulty: 1 Page-Reference: 640

Question ID: 20-2-162 Skill: Knowledge

Objective: 20.4

36. Equity financing is obtained by borrowing funds from the corporation’s shareholders.

a. True

b. False

Difficulty: 2 Page-Reference: 640

Question ID: 20-2-163 Skill: Knowledge

Objective: 20.4

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

37. Paying dividends is more expensive than paying bond interest because interest paid to

bondholders is tax deductible, but dividends paid to shareholders are not.

a. True

b. False

Difficulty: 3 Page-Reference: 640

Question ID: 20-2-164 Skill: Comprehension

Objective: 20.4

38. The bond indenture specifies the terms of the bond and any collateral supporting the bond.

a. True

b. False

Difficulty: 3 Page-Reference: 638

Question ID: 20-2-165 Skill: Knowledge

Objective: 20.4

39. Equity financing involves obtaining long-term funding from within the business firm.

a. True

b. False

Difficulty: 2 Page-Reference: 640

Question ID: 20-2-166 Skill: Knowledge

Objective: 20.4

40. The business firm may elect to provide for long-term funding needs by retaining earnings instead

of paying dividends to the shareholders.

a. True

b. False

Difficulty: 1 Page-Reference: 640

Question ID: 20-2-167 Skill: Knowledge

Objective: 20.4

41. Payments to preferred shareholders are fixed in amount, but they can be withheld if the company

wishes.

a. True

b. False

Difficulty: 2 Page-Reference: 641

Question ID: 20-2-168 Skill: Knowledge

Objective: 20.4

42. Corporation A has a capital structure of 40 percent equity and 60 percent debt, while Corporation

B has a capital structure of 70 percent equity and 30 percent debt. Corporation A has the most

conservative capital structure.

a. True

b. False

Difficulty: 2 Page-Reference: 641

Question ID: 20-2-169 Skill: Comprehension

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

Objective: 20.4

43. In liquidation, shareholders must wait until creditors are paid; as well, preferred equity precedes

common equity.

a. True

b. False

Difficulty: 2 Page-Reference: 641-642

Question ID: 20-2-170 Skill: Knowledge

Objective: 20.4

44. Junk bonds are so called because they pay unattractive interest rates to holders.

a. True

b. False

Difficulty: 1 Page-Reference: 642

Question ID: 20-2-171 Skill: Knowledge

Objective: 20.4

45. High-grade corporate bonds rate low in terms of risk and high in terms of expected returns.

a. True

b. False

Difficulty: 2 Page-Reference: 642

Question ID: 20-2-172 Skill: Knowledge

Objective: 20.4

46. If a company fails to make a bond payment, the company is in default.

a. True

b. False

Difficulty: 2 Page-Reference: 638

Question ID: 20-2-173 Skill: Knowledge

Objective: 20.4

47. The two primary sources of debt financing are pledging accounts receivable and selling bonds.

a. True

b. False

Difficulty: 1 Page-Reference: 638

Question ID: 20-2-174 Skill: Knowledge

Objective: 20.4

48. Equity financing puts more constraints on management than debt financing.

a. True

b. False

Difficulty: 2 Page-Reference: 640

Question ID: 20-2-175 Skill: Knowledge

Objective: 20.4

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

49. High quality cyclical common stocks are riskier than medium quality preferred shares.

a. True

b. False

Difficulty: 2 Page-Reference: 643

Question ID: 20-2-176 Skill: Knowledge

Objective: 20.4

50. Small businesses often fail to consider venture capital as a source of funding, and they are

notorious for not planning cash-flow needs properly.

a. True

b. False

Difficulty: 2 Page-Reference: 643

Question ID: 20-2-177 Skill: Knowledge

Objective: 20.5

51. Start-up firms without proven financial success usually must present a business plan to

demonstrate that the firm is a good credit risk.

a. True

b. False

Difficulty: 2 Page-Reference: 643

Question ID: 20-2-178 Skill: Knowledge

Objective: 20.5

52. The two basic types of business risk are speculative risk and pure risk.

a. True

b. False

Difficulty: 1 Page-Reference: 645

Question ID: 20-2-179 Skill: Knowledge

Objective: 20.6

53. At Coast Capital Savings Credit Union, one top manager focuses on protecting the company

against online fraud, holdups, and information system failures. This person is a Chief Risk Officer.

a. True

b. False

Difficulty: 1 Page-Reference: 644-645

Question ID: 20-2-180 Skill: Comprehension

Objective: 20.6

54. Companies have traditionally had CEOs, CFOs, and COOs, but not CROs.

a. True

b. False

Difficulty: 1 Page-Reference: 644

Question ID: 20-2-181 Skill: Knowledge

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

Objective: 20.6

55. A survey of 600 executives conducted by Watson Gardner Brown found that the easiest jobs to

staff are in the area of risk management because companies have begun to realize the importance of risk

management to their survival.

a. True

b. False

Difficulty: 1 Page-Reference: 645

Question ID: 20-2-182 Skill: Comprehension

Objective: 20.6

56. Acres Corp. is involved in the risk management process. They have just completed identifying the

risks the company faces and the potential losses that might be incurred. Their next step should be to

evaluate various alternatives and choose the techniques that will best handle the potential losses.

a. True

b. False

Difficulty: 1 Page-Reference: 646

Question ID: 20-2-183 Skill: Application

Objective: 20.6

57. The possibility of a flood is pure risk, while the possibility of a new product failure is a speculative

risk.

a. True

b. False

Difficulty: 2 Page-Reference: 645

Question ID: 20-2-184 Skill: Knowledge

Objective: 20.6

58. Claremont Corp. wants to buy insurance to protect itself against the possibility of financial loss if

its new product line does not sell well. But Claremont will find that no company will sell it such insurance

because new product development violates the verifiability criterion for insurable risks.

a. True

b. False

Difficulty: 3 Page-Reference: 645, 647-648

Question ID: 20-2-185 Skill: Comprehension

Objective: 20.6

59. Developing a new product is a pure risk because there is the possibility of either a gain or a loss.

a. True

b. False

Difficulty: 2 Page-Reference: 645

Question ID: 20-2-186 Skill: Knowledge

Objective: 20.6

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

60. When a delivery service trains its drivers in defensive–driving techniques and maintains their

trucks in good working order, it is practising risk avoidance.

a. True

b. False

Difficulty: 2 Page-Reference: 646

Question ID: 20-2-187 Skill: Comprehension

Objective: 20.6

61. Firms can practice risk transfer through loss prevention or loss reduction techniques.

a. True

b. False

Difficulty: 1 Page-Reference: 646

Question ID: 20-2-188 Skill: Knowledge

Objective: 20.6

62. A trucking company that decides it is cheaper to pay for vandalism repairs than it is to submit

claims to its insurance company is practicing risk control.

a. True

b. False

Difficulty: 1 Page-Reference: 646

Question ID: 20-2-189 Skill: Comprehension

Objective: 20.6

63. Landsdowne Corp. has decided to insure its buildings and equipment against loss by fire. It is

practising risk control.

a. True

b. False

Difficulty: 2 Page-Reference: 646

Question ID: 20-2-190 Skill: Comprehension

Objective: 20.6

64. The transfer of risk from one organization to another can be accomplished through the use of

burglar alarms and security video services.

a. True

b. False

Difficulty: 2 Page-Reference: 646

Question ID: 20-2-191 Skill: Knowledge

Objective: 20.6

65. An insurance company makes a profit by taking in more in premiums than it pays out to cover

customer losses.

a. True

b. False

Difficulty: 1 Page-Reference: 647

Question ID: 20-2-192 Skill: Knowledge

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

Objective: 20.6

66. The first step in the risk management process is to measure the frequency and severity of losses

and their impact.

a. True

b. False

Difficulty: 2 Page-Reference: 646

Question ID: 20-2-193 Skill: Knowledge

Objective: 20.6

67. Conserving a firm’s financial assets by minimizing the financial effect of accidental losses is risk

management.

a. True

b. False

Difficulty: 2 Page-Reference: 645

Question ID: 20-2-194 Skill: Knowledge

Objective: 20.6

68. To measure the frequency and severity of losses, managers must consider both past history and

current activities.

a. True

b. False

Difficulty: 2 Page-Reference: 646

Question ID: 20-2-195 Skill: Knowledge

Objective: 20.6

69. Liability means responsibility for damages in case of accidental or deliberate harm to individuals

or property.

a. True

b. False

Difficulty: 2 Page-Reference: 648

Question ID: 20-2-196 Skill: Knowledge

Objective: 20.7

1. What is a financial manager?

Difficulty: 2 Page-Reference: 632

Question ID: 20-3-197 Skill: Knowledge

Objective: 20.1

2. What are the four responsibilities of finance (corporate finance)?

Difficulty: 2 Page-Reference: 632

Question ID: 20-3-198 Skill: Knowledge

Objective: 20.1

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

3. What is financial control?

Difficulty: 2 Page-Reference: 633

Question ID: 20-3-199 Skill: Knowledge

Objective: 20.1

4. What do credit terms of 2/10; net 30 refer to?

Difficulty: 2 Page-Reference: 634

Question ID: 20-3-200 Skill: Comprehension

Objective: 20.2

5. List four sources of short-term funds.

Difficulty: 2 Page-Reference: 635

Question ID: 20-3-201 Skill: Knowledge

Objective: 20.3

6. What is open-book credit?.

Difficulty: 2 Page-Reference: 635

Question ID: 20-3-202 Skill: Knowledge

Objective: 20.3

7. What is the difference between a trade draft and a trade acceptance?

Difficulty: 2 Page-Reference: 635

Question ID: 20-3-203 Skill: Comprehension

Objective: 20.3

8. What is a line of credit?

Difficulty: 2 Page-Reference: 637

Question ID: 20-3-204 Skill: Knowledge

Objective: 20.3

9. What is commercial paper?

Difficulty: 2 Page-Reference: 637

Question ID: 20-3-205 Skill: Knowledge

Objective: 20.3

10. What are the two primary sources of debt financing?

Difficulty: 2 Page-Reference: 638

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

Question ID: 20-3-206 Skill: Knowledge

Objective: 20.4

11. What is the risk-return relationship?

Difficulty: 1 Page-Reference: 642

Question ID: 20-3-207 Skill: Knowledge

Objective: 20.4

12. What is venture capital?

Difficulty: 2 Page-Reference: 643

Question ID: 20-3-208 Skill: Knowledge

Objective: 20.5

13. What is the difference between pure and speculative risk?

Difficulty: 2 Page-Reference: 645

Question ID: 20-3-209 Skill: Comprehension

Objective: 20.6

14. List the four choices that a company has to handle risk.

Difficulty: 2 Page-Reference: 646

Question ID: 20-3-210 Skill: Knowledge

Objective: 20.6

15. List the four characteristics of an insurable risk.

Difficulty: 2 Page-Reference: 647-648

Question ID: 20-3-211 Skill: Knowledge

Objective: 20.7

16. What are two forms of insurance that apply to the death or departure of key employees or owners.

Difficulty: 2 Page-Reference: 650

Question ID: 20-3-212 Skill: Knowledge

Objective: 20.7

1. Briefly explain the three general objectives of a financial manager.

Difficulty: 1 Page-Reference: 632-633

Question ID: 20-4-213 Skill: Knowledge

Objective: 20.1

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

2. What are the three financial or operational areas that must be carefully managed by the financial

manager to provide for short-term expenditures?

Difficulty: 2 Page-Reference: 634

Question ID: 20-4-214 Skill: Knowledge

Objective: 20.2

3. What are the primary short-term sources of funds? How can the lender gain some sort of assurance

that the borrower of funds will repay the debt?

Difficulty: 3 Page-Reference: 635-636

Question ID: 20-4-215 Skill: Comprehension

Objective: 20.3

4. Identify and briefly describe the three key sources of unsecured, short-term funds.

Difficulty: 2 Page-Reference: 637

Question ID: 20-4-216 Skill: Knowledge

Objective: 20.3

5. Define and describe the process of factoring.

Difficulty: 1 Page-Reference: 636

Question ID: 20-4-217 Skill: Knowledge

Objective: 20.3

6. What are the customary methods of long-term debt financing? Which methods do most corporations

use as their major source of long-term debt financing?

Difficulty: 1 Page-Reference: 638-640

Question ID: 20-4-218 Skill: Comprehension

Objective: 20.4

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

7. Identify, briefly describe, and give one example for each of the two types of long-term financing.

Difficulty: 1 Page-Reference: 638-341

Question ID: 20-4-219 Skill: Comprehension

Objective: 20.4

8. What are the two methods of equity financing for long-term funding requirements? What issues

must be considered before the choice is made between the two methods? Explain your reason.

Difficulty: 2 Page-Reference: 640-641

Question ID: 20-4-220 Skill: Comprehension

Objective: 20.4

9. Discuss the advantages and disadvantages of financing using preferred stock.

Difficulty: 1 Page-Reference: 641

Question ID: 20-4-221 Skill: Comprehension

Objective: 20.4

10. Why is preferred stock referred to as hybrid financing?

Difficulty: 2 Page-Reference: 641

Question ID: 20-4-222 Skill: Comprehension

Objective: 20.4

11. Compare debt financing to equity financing on the issues of repayment, claims on income, claims

on assets, management control, tax effect, and management flexibility.

Difficulty: 2 Page-Reference: 642

Question ID: 20-4-223 Skill: Comprehension

Objective: 20.4

12. What is risk? What is the difference between speculative risk and pure risk? What is risk

management?

Difficulty: 1 Page-Reference: 645

Question ID: 20-4-224 Skill: Comprehension

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management

Objective: 20.6

13. What are the five steps in the risk management process?

Difficulty: 2 Page-Reference: 645-647

Question ID: 20-4-225 Skill: Knowledge

Objective: 20.6

14. What are the methods used by business firms to cope with risk?

Difficulty: 2 Page-Reference: 646

Question ID: 20-4-226 Skill: Knowledge

Objective: 20.6

15. What are the four criteria that an insurable risk must satisfy? Explain.

Difficulty: 2 Page-Reference: 647-648

Question ID: 20-4-227 Skill: Comprehension

Objective: 20.7

16. What are the differences among liability insurance, property insurance, and life insurance?

Difficulty: 1 Page-Reference: 648-649

Question ID: 20-4-228 Skill: Comprehension

Objective: 20.7

17. Discuss the two forms of insurance that apply to the departure or death of key employees or

owners.

Difficulty: 1 Page-Reference: 650

Question ID: 20-4-229 Skill: Knowledge

Objective: 20.7

Business, Eighth Canadian Edition Griffin, Ebert, Starke, Dracopoulos, Lang

Chapter 20—Financial Decisions and Risk Management