Deck 1: An Overview of Financial Management

Question 1

Which of the following statements is most correct?

A) Compensating managers with stock can reduce the agency problem between stockholders and managers.
B) Restrictions are included in credit agreements to protect bondholders from the agency problem that exists between bondholders and stockholders.
C) The threat of a takeover can reduce the agency problem between bondholders and stockholders.
D) Statements a and b are correct.
E) All of the statements above are correct.

Answer 1

D

Question 2

Executive stock options are shares of stock awarded to managers on the basis of corporate performance.

Answer 2

False

Question 3

Which of the following work to reduce agency conflicts between stockholders and bondholders?

A) Including restrictive covenants in the company's bond contract.
B) Providing managers with a large number of stock options.
C) The passage of laws which make it easier for companies to resist hostile takeovers.
D) Statements b and c are correct.
E) All of the statements above are correct.

Answer 3

A

Question 4

If a firm's managers want to maximize stock price it is in their best interests to operate efficient, low-cost plants, develop new and safe products that consumers want, and maintain good relationships with customers, suppliers, creditors, and the communities in which they operate.

Question 5

In a competitive marketplace, if managers deviate too far from making decisions that are consistent with stockholder wealth maximization, they risk being disciplined by the market. Part of this discipline involves the threat of being taken over by groups who are more aligned with stockholder interests.

Question 6

Which of the following actions are likely to reduce agency conflicts between stockholders and managers?

A) Paying managers a large fixed salary.
B) Increasing the threat of corporate takeover.
C) Placing restrictive covenants in debt agreements.
D) All of the statements above are correct.
E) Statements b and c are correct.

Question 7

The primary goal of a publicly-owned firm interested in serving its stockholders should be to

A) Maximize expected total corporate profit.
B) Maximize expected EPS.
C) Minimize the chances of losses.
D) Maximize the stock price per share.
E) Maximize expected net income.

Question 8

Which of the following statements is most correct?

A) Free cash flows are called "free" because the cost of capital for these cash flows is zero.
B) Stock is valuable only because it generates cash flows for the investor.
C) Managers can affect firm value by changing the riskiness of its cash flows.
D) (a) and (b) are correct.
E) (b) and (c) are correct.

Question 9

Which of the following actions are likely to reduce the agency problem between stockholders and managers?

A) Congress passes a law that severely restricts hostile takeovers.
B) A manager receives a lower salary but receives additional shares of the company's stock.
C) The board of directors has become more vigilant in its oversight of the company's management.
D) Statements b and c are correct.
E) All of the statements above are correct.

Question 10

The goal of maximizing stock price is a detriment to society in that few of the actions that result in maximization of stock price also benefit society.

Question 11

Which of the following statements is CORRECT?

A) If expected inflation increases, interest rates are likely to increase.
B) If individuals in general increase the percentage of their income that they save, interest rates are likely to increase.
C) If companies have fewer good investment opportunities, interest rates are likely to increase.
D) Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.
E) Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.

Question 12

An agency relationship exists when one or more persons hire another person to perform some service but withhold decision-making authority from that person.

Question 13

Which of the following mechanisms is used to motivate managers to act in the interests of shareholders?

A) Bond covenants.
B) The threat of a takeover.
C) Executive stock options.
D) Statements a and b are correct.
E) Statements b and c are correct.

Question 14

A hostile takeover is a method of seizing control of a company and involves an action taken against the opposition of incumbent management. However, this action is typically motivated by a desire to control the firm's assets and is rarely motivated by a low share price.

Question 15

An agency problem exists between stockholders and managers. A second agency problem arises between stockholders and creditors.

Question 16

If a firm's stock price falls during the year, this indicates that the firm's managers are not acting in shareholders' best interests.

Question 17

If a firm has a single owner, we may say that the proper goal of a financial manager would be to maximize the firm's earnings per share.

Question 18

Which of the following statements is most correct?

A) A firm's fundamental value is its market value.
B) A firm's fundamental value is the present value of its future free cash flows.
C) A firm's market price is usually greater than its fundamental value.
D) A firm's fundamental value is usually greater than its market price.
E) A firm's fundamental value is its book value.

Question 19

Which of the following statements is most correct?

A) Firms that try to maximize their stock values will tend to lay off employees to cut costs.
B) Firms that try to maximize their stock values will raise the prices of their products, gouging customers and driving them away.
C) Anti-pollution laws are unnecessary because firms will choose not to pollute because that is in their best interests.
D) The government should allow monopolies to operate without regulation so that they may maximize their shareholders' wealth.
E) Newly-privatized firms generally hire more employees.

Question 20

The proper goal of the financial manager should be to maximize the firm's expected profit, since this will add the most wealth to each of the individual shareholders (owners) of the firm.

Question 21

Which of the following statements is most correct?

A) One of the ways in which firms can mitigate or reduce agency problems between bondholders and stockholders is by increasing the amount of debt in the capital structure.
B) The threat of takeover is one way in which the agency problem between stockholders and managers can be alleviated.
C) Managerial compensation can be structured to reduce agency problems between stockholders and managers.
D) Statements b and c are correct.
E) All of the statements above are correct.

Question 22

Which of the following statements is most correct?

A) A market is transparent when trading is inexpensive.
B) A market is transparent when accurate information is available to all market participants.
C) A transparent market has few regulations.
D) A transparent market has many opportunities for trading on insider information.
E) A market is transparent when everyone knows who the person is that they are trading with.

Question 23

Which of the following is an example of a moral hazard?

A) A CEO is awarded $100,000 worth of executive stock options, which he exercises two years later for $1,000,000.
B) A company borrows $1,000,000 for investment in equipment, but uses the money instead to repurchase stock.
C) A company declares bankruptcy, but instead of being liquidated, it is reorganized and one set of bondholders who are owed $10 million accept $3 million in payment for the debt.
D) A CEO orders the headquarters moved just so he can have a nicer office.
E) A group of institutional stockholders votes to oust management.

Question 24

Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?

A) Households start saving a larger percentage of their income.
B) The economy moves from a boom to a recession.
C) The level of inflation begins to decline.
D) Corporations step up their expansion plans and thus increase their demand for capital.
E) The Federal Reserve uses monetary policy in an attempt to stimulate the economy.

Question 25

Which of the following statements is most correct?

A) Agency conflicts between stockholders and managers are not really a problem when outsiders (i.e., non-managers) own shares in a corporation.
B) Managers may operate in stockholders' best interests, or managers may operate in their own personal best interests. As long as managers stay within the law, there are no effective controls that stockholders can implement to control managerial decision making.
C) The agency conflicts between bondholders and stockholders can be reduced with the use of bond covenants.
D) An agency relationship exists when one or more persons hire another person to perform some service but withhold decision-making authority from that person.
E) All of the statements above are false.

Question 26

Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds. Assuming the announcement was not expected, what effect, other things held constant, would that have on bond prices and interest rates?

A) Prices and interest rates would both rise.
B) Prices would rise and interest rates would decline.
C) Prices and interest rates would both decline.
D) There would be no changes in either prices or interest rates.
E) Prices would decline and interest rates would rise.

Question 27

Which of the following statements is most correct?

A) Sarbanes-Oxley requires the Securities Exchange Commission to audit public companies' financial statements.
B) Sarbanes-Oxley made it illegal for company executives to trade on insider information.
C) Sarbanes-Oxley requires the Chairman of the Board of Directors to sign and certify the company's financial statements.
D) Sarbanes-Oxley requires the CEO sign and certify the company's financial statements.
E) Sarbanes-Oxley requires company executives to disclose their fraudulent activities "in a timely and accurate manner."

Question 28

Which of the following statements is most correct?

A) Sarbanes-Oxley established a new Federal agency, the Public Company Auditing Board, to audit public companies' financial statements.
B) Sarbanes-Oxley prohibited investment banks from allowing their analysts to make recommendations on stocks the investment banks do business with.
C) Sarbanes-Oxley requires that either the CEO or CFO hand-deliver the annual and quarterly financial statements to the SEC.
D) Sarbanes-Oxley requires that auditors maintain extensive records to document that their consulting and auditing services for a given company are not conflicting.
E) Sarbanes-Oxley prohibits auditors from providing consulting services to the companies they audit.

Question 29

Which of the following factors would be most likely to lead to an increase in interest rates in the economy?

A) Households reduce their consumption and increase their savings.
B) The Federal Reserve decides to try to stimulate the economy.
C) There is a decrease in expected inflation.
D) The economy falls into a recession.
E) Most businesses decide to modernize and expand their manufacturing capacity, and to install new equipment to reduce labor costs.

Question 30

Which of the following statements is most correct?

A) EVA is a measure of the value added to customers.
B) EVA is a measure of the value added to management.
C) EVA is a measure of the firm's true profitability.
D) EVA is a measure of management compensation.
E) EVA is a measure of stock price.

Question 31

A moral hazard problem arises when:

A) An agent takes unobserved actions on his own behalf.
B) A principal hires another individual to perform some service.
C) Firms borrow money from bondholders.
D) Stockholders have to incur costs to make managers act to maximize stock price.
E) Managers are granted performance shares.