79) Corporate managers and shareholders do not always have the same goals.
80) Tying salaries of top managers to the profits of the firm is a way to reduce the effect of the principal-
agent problem.
81) Javier wants to start a microbrewery business and is thinking of setting it up as a sole
proprietorship. What are the advantages and disadvantages he will face by setting up the business as a
sole proprietorship as opposed to a partnership or a corporation?
82) Shontae wants to start a pet hotel and is thinking of setting it up as a partnership with her sister
Victoria. What are the advantages and disadvantages she will face by setting up the business as a
partnership as opposed to a sole proprietorship or a corporation?
83) Angelica wants to open a restaurant and is thinking of setting it up as a corporation. What are the
advantages and disadvantages she will face by setting up the business as a corporation as opposed to a
sole proprietorship or a partnership?
84) By the percentage of each type of business organization in the United States, rank sole
proprietorships, partnerships, and corporations in terms of the number of firms, revenue, and profits.
85) Explain the difference between a sole proprietorship and a partnership.
86) With respect to business types, what does the term ‘limited liability’ mean?
87) Describe the three main categories of firms.
88) In the eyes of the law, a corporation is a legal “person,” separate from its owners. Explain what this
means.
89) What does it mean to say there is a separation of ownership from control in large corporations?
90) How is the separation of ownership from control related to the principal-agent problem?
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91) In a public corporation, asymmetric information often results in a principal-agent problem between
top management and ownership. What information would help to prevent this principal-agent
problem?
92) Pietro is a manager at a carwash. He has hired 10 workers to wash and detail cars for him and is
considering what type of payment scheme he should set up for his workers. He can pay each of his
workers $9 per hour to wash and detail cars, or he can pay his workers $12 for each car a worker washes
and details. (It takes 75 minutes, on average, for an employee to wash and detail a car.) If Pietro wants
to maximize the number of cars his workers wash and detail in one day, which payment scheme should
he use? Explain.
6.2 How Firms Raise Funds
1) It is the role of ________ to transfer funds from savers to borrowers.
A) the Federal Reserve
B) the federal government
C) an economy’s financial system
D) corporate governance
2) Profits that are reinvested in a firm rather than paid to the firm’s owners are called
A) dividends.
B) stock options.
C) retained earnings.
D) corporate bonds.
3) If a firm raises funds by recruiting additional owners to invest in the firm,
A) the firm’s financial capital would increase.
B) the firm’s financial capital would decrease.
C) the firm’s stock price would decrease.
D) the firm’s net worth would decrease.
4) Which of the following takes place in the direct finance market?
A) Firms borrow funds from their retained earnings.
B) Borrowers take out loans from banks.
C) Loans to corporations are made from the sale of corporate bonds.
D) Savers make funds available to borrowers by making deposits to savings accounts.
5) If Walmart issues $250 million in new stock to finance the renovation of their retail stores, this is an
example of
A) a bond market transaction.
B) indirect finance.
C) a stock market transaction.
D) direct finance.
6) Walmart wants to raise $250 million to finance the renovation of their retail stores, and the company
wishes to raise the funds through indirect finance. Which of the following methods could it use?
A) It could issue $250 million in stock.
B) It could sell $250 million in bonds.
C) It could borrow $250 million from a bank.
D) It could choose either A or B.
7) A bond is a financial security that represents a promise to repay
A) a yearly interest payment only.
B) a yearly principal payment only.
C) a yearly interest payment and a principal payment.
D) Bonds are investments that do not promise any kind of repayment.
8) Bonds ________ and stocks ________.
A) always pay interest payments forever; always pay dividends forever
B) have a fixed number of interest payments; may pay dividends forever
C) may pay interest payments forever; have a fixed number of dividend payments
D) have a fixed number of interest payments; have a fixed number of dividend payments
9) All of the following are characteristics of stock except
A) stock does not represent a promise to repay a fixed amount of funds.
B) dividends paid to owners of stock represent a firm’s profits.
C) stock promises to repay a fixed amount to of funds to stock owners.
D) stock represents ownership in a firm.
10) Dividends are
A) the interest payments on bonds.
B) the principal payments on bonds.
C) fixed payments to bondholders.
D) payments by a corporation to its shareholders.
11) If a corporate bond with face value of $1,000 has an interest rate of seven percent paid once a year
for a term of 10 years, what is the size of the coupon payment?
A) $1,000
B) $700
C) $70
D) $7
12) If a corporate bond with a face value of $20,000 pays yearly coupon payments of $500, what is the
coupon rate?
A) 2.5%
B) 4%
C) 25%
D) 40%
13) When an investor buys a corporate bond, the ________ is a loan to the corporation.
A) interest on the bond
B) principal of the bond
C) bond’s dividend payments
D) coupon payment
14) The interest rate on a bond is calculated as
A) the coupon divided by the face value.
B) the coupon times the face value.
C) the face value divided by the coupon.
D) the face value divided by the coupon plus the face value.
15) Mutual funds sell shares to investors and use the funds to
A) purchase Treasury bonds.
B) invest in a portfolio of financial assets.
C) purchase newly issued shares of a particular company’s stock.
D) pay dividends.
16) The ________ a corporation keeps to finance future expansion are known as retained earnings.
A) profits
B) stock
C) dividends
D) bonds
17) Small savers who only have enough money to buy a few individual financial assets can use
________ to diversify.
A) one company’s stock
B) one company’s bonds
C) Treasury securities
D) mutual funds
18) Which of the following can only be sold back to the firm that issued them?
A) stocks
B) bonds
C) mutual funds
D) exchange-traded funds
19) When Twitter sells newly issued shares of stock this is an example of
A) direct finance in a primary market.
B) direct finance in a secondary market.
C) indirect finance in a primary market.
D) indirect finance in a secondary market.
20) If you borrow $5,000 from your bank to purchase shares of Twitter from your cousin Vinny, this is
an example of obtaining ________ financing and purchasing the stock in a ________ market.
A) direct; primary
B) direct; secondary
C) indirect; primary
D) indirect; secondary
21) Which of the following is the most important of the over-the-counter markets?
A) New York Stock Exchange
B) the S&P 500
C) the NASDAQ
D) the Chicago Mercantile Exchange
22) One of the most widely followed stock indexes in the United States is the S&P 500. This index
represents
A) the stock prices of 500 large U.S. firms.
B) the stock prices of the 500 most valuable firms worldwide.
C) the stock prices of more than 4,000 U.S. firms.
D) the stock prices of 30 large U.S. corporations.
23) When the coupon rate on newly issued bonds ________ relative to older, outstanding bonds, the
market price of the older bond ________
A) decreases; rises in the secondary market
B) decreases; falls in the secondary market
C) increases; falls in the secondary market
D) increases; falls in the primary market
24) You have a bond that pays $125 per year in coupon payments. Which of the following would result
in an increase in the price of your bond?
A) Coupon payments on newly-issued bonds rise to $140 per year.
B) The likelihood that the firm issuing your bond will default on debt increases.
C) The price of a share of stock in the company falls.
D) Coupon payments on newly-issued bonds fall to $75 per year.
25) Dividing the dividend payment by the stock’s ________ determines the dividend yield.
A) coupon payment
B) closing market price
C) highest yearly price
D) price/earnings ratio
26) Generally with bond ratings, the ________ the rating, the lower the interest rate an investor will
receive and the ________ the risk that the issuer of the bond will default.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
27) In August 2011, Standard & Poor’s (S&P) changed its rating on U.S. Treasury bonds from “AAA” to
“AA+” based on the state of the federal government’s budget deficit. This was the ________ a rating
agency had given Treasury bonds less than a rating of “AAA”.
A) first time ever
B) second time since the year 2000
C) first time since the Great Depression
D) fifth time in history
28) A partnership can raise funds for expansion in which of the following ways?
A) issuing stock through financial markets
B) issuing stock through secondary markets
C) taking on more partners
D) all of the above
29) Raising funds through ________ is called indirect finance.
A) issuing stock
B) issuing bonds
C) financial intermediaries
D) retaining earnings
30) All of the following take place in the direct finance market except
A) ownership in corporations is sold in the form of common stock.
B) deposits from savers are accumulated and loans made to borrowers.
C) ownership in corporations is sold in the form of preferred stock.
D) corporate bonds are sold to savers.
31) If Urban Outfitters borrows $25 million from a bank to finance the construction of a new store, this is
an example of
A) a stock market transaction.
B) direct finance.
C) a bond market transaction.
D) indirect finance.
32) Urban Outfitters wants to raise $25 million to finance the construction of a new store, and the
company wishes to raise the funds through direct finance. Which of the following methods could it use?
A) It could sell $25 million in bonds.
B) It could borrow $25 million from a bank.
C) It could issue $25 million in stock.
D) It could choose either A or C.
33) If you purchased a newly issued 30-year bond from Google with a face value of $3,000 and a coupon
payment of 6 percent, Google would pay you
A) $100 per year for 30 years plus $3,000 at the end of the 30th year.
B) $180 per year for 30 years.
C) $180 per year for 30 years plus $3,000 at the end of the 30th year.
D) $100 per year plus 6 percent per year for 30 years.
34) If you purchased a newly issued 30-year bond from American Airlines with a face value of $1,000
and a coupon payment of 3 percent, American Airlines would pay you
A) $33.33 per year for 30 years plus $1,000 at the end of the 30th year.
B) $30 per year for 30 years.
C) $30 per year for 30 years plus $1,000 at the end of the 30th year.
D) $33.33 per year plus 3 percent per year for 30 years.
35) Which of the following statements is true?
A) A stock can possibly pay dividends forever, but bonds have a fixed number of payments.
B) Differences of opinion about a bond’s future may vary considerably but there is less difference about
a stock’s future.
C) The future growth of a stock is more certain than the payments of a bond.
D) Bonds represent partial ownership in a firm but stocks do not.
36) All of the following are characteristics of a bond except
A) a bond represents a promise to repay a fixed amount of funds.
B) the face value is repaid when the bond matures.
C) the coupon payment is the interest payment on the bond.
D) bonds generally pay dividends each year.
37) If a corporate bond with face value of $8,000 has an interest rate of 4 percent paid once a year for a
term of 30 years, what is the size of the coupon payment?
A) $320
B) $2,000
C) $8,000
D) $9,600
38) If a corporate bond with a face value of $1,000 pays yearly coupon payments of $40, what is the
coupon rate?
A) 2.5%
B) 4%
C) 25%
D) 40%
39) When an investor buys a corporate bond, the face value of the bond is
A) a measure of ownership in the corporation.
B) a loan to the corporation.
C) the coupon rate of the bond.
D) a dividend payment on the bond.
40) Owners of a corporation ________ through dividend payments on shares of that firm’s stock.
A) retain earnings of the firm
B) issue bonds for the firm
C) share in the profits of the firm
D) indirectly finance the firm
41) If a corporation’s retained earnings are expected to create future profits, the market price of the
firm’s stock will ________ and create a ________ for stockholders if the stock is sold.
A) increase; capital gain
B) decrease; capital gain
C) increase; loss of wealth
D) decrease; loss of wealth
42) Kendrick wants to start a tax preparation company and is going to his bank to borrow $50,000. This
is an example of
A) direct finance.
B) indirect finance.
C) a primary market transaction.
D) a secondary market transaction.
43) Sylvia wants to expand her taxidermy business and is going to use profits from the business to do
so. This is an example of using ________ for her expansion.
A) direct finance
B) indirect finance
C) retained earnings
D) dividends
44) Giorgio wants to build a new distribution warehouse for his sporting goods business and is going to
issue new shares of stock to do so. This is an example of using ________ for his building project.
A) direct finance
B) indirect finance
C) retained earnings
D) dividends
45) Yolanda wants to expand her microbrewery business by buying out a competitor and is going to sell
newly-issued corporate bonds to do so. This is an example of using ________ for her expansion plans.
A) direct finance
B) indirect finance
C) coupon payments
D) retained earnings
46) Which of the following is one of the most widely followed stock indexes in the United States?
A) the Dow Jones Industrial Average
B) the Chicago Mercantile Exchange
C) the Fortune 500
D) the Securities and Exchange Commission
47) Securities dealers that trade stocks and bonds ________ comprise the over-the-counter market.
A) directly instead of electronically
B) outside exchanges
C) that have previously been sold
D) valued at less than $1 each
48) When the coupon rate on newly issued bonds ________ relative to older, outstanding bonds, the
market price of the older bond ________.
A) increases; falls in the secondary market
B) increases; rises in the secondary market
C) decreases; falls in the secondary market
D) decreases; falls in the primary market
49) You have a bond that pays $18 per year in coupon payments. Which of the following would result in
a decrease in the price of your bond?
A) Coupon payments on newly-issued bonds fall to $15 per year.
B) The likelihood that the firm issuing your bond will default on debt decreases.
C) The price of a share of stock in the company rises.
D) Coupon payments on newly-issued bonds rise to $22 per year.
50) A bond’s coupon payment divided by the bond’s ________ is equal to the bond’s current yield.
A) face value
B) current price
C) principal
D) interest rate
51) When Electronic Arts, the company behind the games Zuma and Plants vs. Zombies, sold stock to the
public for the first time in September 1989, funds were being raised in a ________ market, and when
those newly issued shares are resold to other buyers, the sales take place in a ________ market.
A) primary; primary
B) primary; secondary
C) secondary; primary
D) secondary; secondary
Article Summary
In an effort to raise funds to cut debt, Fiat Chrysler is selling a stake in Ferrari through an initial
public offering (IPO) to be valued at as much as $9.8 billion. 17.2 million shares of stock in the
company are to be sold, and the stock will be traded on the New York Stock Exchange under the
symbol RACE. One analyst speculates that requests for shares in Ferrari may be ten times less than
the number available. Including debt, Ferrari will have a value of about $12 billion, and chairman
Piero Ferrari will keep a 10 percent stake in the new company and receive about €280 million in cash.
Before taxes and interest, Ferrari’s 2014 earnings were €389 million, with revenue of €2.8 billion.
Source: Tommaso Ebhardt, “Ferrari to Be Valued at Up to $9.82 Billion in IPO,” Bloomberg.com,
October 9, 2015.
52) When Ferrari sells stock to the public in its IPO, it will do so through the New York Stock Exchange.
People who buy the shares will
A) be promised to be repaid their investment plus interest.
B) do so in the indirect finance market.
C) own part of the company.
D) All of the above are true.
53) Stock prices start to rise
A) when investors are confident that the economy is more than 6 months into an economic recovery.
B) when investors begin to expect an economic recovery will soon begin.
C) when investors believe an economic recovery has already begun.
D) when the unemployment rate begins to decline following a recession.
54) Generally with bond ratings, the ________ the rating, the higher the interest rate an investor will
receive and the ________ the risk that the issuer of the bond will default.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
55) Indirect finance refers to the flow of funds from savers to borrowers through financial
intermediaries.
56) Direct finance refers to the flow of funds from savers to borrowers through financial markets.
57) The interest payment on a bond is called a face value payment.
58) The higher the default risk on a bond, the higher the interest rate will be.
59) Stocks represent partial ownership of a firm.
60) Dividends are the interest rates paid on stocks.
61) Both stocks and bonds have maturity dates.
62) A higher bond price indicates a lower cost of new external funds.
63) Mutual funds are a good and relatively inexpensive way for individual investors to diversify.
64) If a partnership raised funds by recruiting additional owners to invest in the firm, what would
happen to the firm’s financial capital?
65) How is the interest rate on a bond calculated?
66) If the face value of a bond is $5,000 and the coupon is $200, what is the interest rate?