MINI CASE
Assume that you recently graduated and have just reported to work as an investment
advisor at the brokerage firm of Balik and Kiefer Inc. One of the firm’s clients is Michelle
Dellatorre, a professional tennis player who has just come to the United States from Chile.
Dellatorre is a highly ranked tennis player who would like to start a company to produce
and market apparel that she designs. She also expects to invest substantial amounts of
money through Balik and Kiefer. Dellatorre is also very bright, and, therefore, she would
like to understand, in general terms, what will happen to her money. Your boss has
developed the following set of questions which you must ask and answer to explain the U.S.
financial system to Dellatorre.
a. Why is corporate finance important to all managers?
Answer: Corporate finance provides the skills managers need to: (1) identify and select the
b. Describe the organizational forms a company might have as it evolves from a start-up
to a major corporation. List the advantages and disadvantages of each form.
Answer: The three main forms of business organization are (1) sole proprietorships, (2)
The proprietorship has three important advantages: (1) it is easily and
inexpensively formed, (2) it is subject to few government regulations, and (3) the
The major advantage of a partnership is its low cost and ease of formation. The
disadvantages are similar to those associated with proprietorships: (1) unlimited
The corporate form of business has three major advantages: (1) unlimited life, (2)
easy transferability of ownership interest, and (3) limited liability. While the corporate
In a limited partnership, the limited partners are liable only for the amount of their
investment in the partnership; however, the limited partners typically have no control.
c. How do corporations “go public” and continue to grow? What are agency
problems? What is corporate governance?
Answer: A company goes public when it sells stock to the public in an initial public as the firm
grows, it might issue additional stock or debt. An agency problem occurs when the
d. What should be the primary objective of managers?
d. 1. Do firms have any responsibilities to society at large?
Answer: Firms have an ethical responsibility to provide a safe working environment, to avoid
polluting the air or water, and to produce safe products. However, the most significant
d. 2. Is stock price maximization good or bad for society?
Answer: The same actions that maximize stock prices also benefit society. Stock price
maximization requires efficient, low-cost operations that produce high-quality goods
d. 3. Should firms behave ethically?
Answer: Yes. Results of a recent study indicate that the executives of most major firms in the
United States believe that firms do try to maintain high ethical standards in all of their
e. What three aspects of cash flows affect the value of any investment?
f. What are free cash flows?
Answer: free cash flows are the cash flows available for distribution to all investors
(stockholders and creditors) after paying expenses (including taxes) and making the
necessary investments to support growth.
g. What is the weighted average cost of capital?
Answer: The weighted average cost of capital (WACC) is the average rate of return required
h. How do free cash flows and the weighted average cost of capital interact to
determine a firm’s value?
k. What are some economic conditions that affect the cost of money?
l. What are financial securities? Describe some financial instruments.
Answer: Financial assets are pieces of paper with contractual obligations. Some short-term
(i.e., they mature in less than a year) are instruments with low default risk are u.s.
treasury bills, banker’s acceptances, commercial paper, negotiable CDs, and
Eurodollar deposits. Commercial loans (which have maturities up to seven years)
m. List some financial institutions.
Answer: Commercial banks, savings & loans, mutual savings banks, and credit unions, life
n. What are some different types of markets?
Answer: A market is a method of exchanging one asset (usually cash) for another asset. Some
o. Along what two dimensions can we classify trading procedures??
Answer: They are categorized by “location” (physical location exchanges or
Open outcry auctions have face-to-face trading. Dealers (i.e., market makers) buy
p. What are the differences between market orders and limit orders?
Answer: Market orders are to transact as quickly as possible at the current price. Limit orders
q. Explain the differences among dealer-broker networks, alternative trading systems,
and registered stock exchanges.
Answer: Broker-dealer networks are registered with the SEC but are much less regulated than
alternative trading systems (ATS) and registered stock exchanges. In a typical
broker-dealer network, the broker-dealer purchases the stock being offered for sale by
An alternative trading system is a broker-dealer than registers with the SEC as
an ATS. An ATS usually has an automated trading platform to match orders from
Stocks can only be listed at a registered stock exchange, although they may be
The NYSE is the oldest U.S. registered stock exchange. The NASDAQ Stock
r. Briefly explain mortgage securitization and how it contributed to the global
economic crisis.
Answer: Homeowners wanted better homes than they could afford. Mortgage brokers
encouraged homeowners to take mortgages that would reset to payments that the
borrowers might not be able to pay because the brokers got a commission for closing
When mortgages reset and borrowers defaulted, the values of CDOs plummeted.
Many of the credit default swaps failed to provide insurance because the counterparty