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website, in whole or in part.
d. 2. Is stock price maximization good or bad for society?
maximization necessitates efficient and courteous service, adequate stocks of
merchandise, and well-located business establishments--factors that are all necessary
to make sales, which are necessary for profits.
d. 3. Should firms behave ethically?
failure to handle the situation properly can lead to huge product liability suits and
even to bankruptcy. There is no room for unethical behavior in the business world.
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.
FCF = sales revenues - operating costs - operating taxes
g. What is the weighted average cost of capital?
h. How do free cash flows and the weighted average cost of capital interact to
determine a firm’s value?
)WACC1(
FCF
....
)WACC1(
FCF
)WACC1(
FCF
Value 2
2
1
1
i. Who are the providers (savers) and users (borrowers) of capital? How is capital
transferred between savers and borrowers?
Answer: Households are net savers. Non-financial corporations are net borrowers.
Governments are net borrowers, although the U.S. government is a net saver when it
j. What do we call the cost that a borrower must pay to use debt capital? What two
components make up the cost of using equity capital? What are the four most
fundamental factors that affect the cost of money, or the general level of interest
rates, in the economy?
productive assets: the more productive a producer firm believes its assets will be, the
more it will be willing to pay for the capital necessary to acquire those assets.
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© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Time preference for consumption refers to consumers’ preferences for current
consumption versus savings for future consumption: consumers with low preferences
for current consumption will be willing to lend at a lower rate than consumers with a
high preference for current consumption.
Inflation refers to the tendency of prices to rise, and the higher the expected rate
of inflation, the larger the required rate of return.
k. What are some economic conditions that affect the cost of money?
l. What are financial securities? Describe some financial instruments.
to their best customers) or LIBOR (the London Interbank Offered Rate, which is the
rate that banks in the U.K. charge one another. U.S. treasury notes and bonds have
m. List some financial institutions.
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website, in whole or in part.
n. What are some different types of markets?
o. Along what two dimensions can we classify trading procedures??
automatically matched by computers. Automated trading platforms match orders and
execute trades automatically
p. What are the differences between market orders and limit orders?
website, in whole or in part.
q. Explain the differences among dealer-broker networks, alternative trading systems,
and registered stock exchanges.
dealer must report the transactions, but not any information prior to the trade. Trades
in broker-dealer networks are called “off exchange” or over-the-counter (OTC).
Trades can be with individuals (called retail trades) or with institutions. Large trades
(10,000 shares or more) are called block trades and are sometimes called “upstairs”
trades.
traded elsewhere. A stock exchange must comply with more regulations than an ATS.
In addition to reporting trades, a stock exchange must also report pre-trade
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
Investment banks sold the CDOs to investors and made big profits. Investors bought
the CDOs but either didn’t understand or care about the risk. Some investors bought
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© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
“insurance” via credit default swaps.
When mortgages reset and borrowers defaulted, the values of CDOs plummeted.
Many of the credit default swaps failed to provide insurance because the counterparty
failed. Many originators and securitizers still owned sub-prime securities, which led
to many bankruptcies, government takeovers, and fire sales, including New Century,
Countrywide, IndyMac, Northern Rock, Fannie Mae, Freddie Mac, Bear Stearns,
Lehman Brothers, and Merrill Lynch.
