Question 1

Which of the following best describes the difference between direct and indirect finance in the financial system?

Accepted Answer

Direct finance involves funds flowing from savers to firms through financial markets, while indirect finance involves funds flowing through financial intermediaries.

Question 2

A firm issues a coupon bond with a face value of $$1000, a yearly coupon payment of 50$$, and a maturity of 10 years. What is the coupon rate?

Accepted Answer

$$\frac{50}{1000} = 0.05 or 5$$%

Question 3

Which of the following is a key advantage of organizing a business as a corporation rather than a sole proprietorship or partnership?

Accepted Answer

Corporations provide limited liability, shielding owners from losing more than their investment.

Question 4

A firm is considering two investment options. Option A pays $$100 one year from now. Option B pays 110 $$one year from now. If the nominal interest rate is 15%, what is the present value of Option B?

Accepted Answer

$$\frac{110}{1+0.15} = 95.65$$

Question 5

Which of the following best explains the principal-agent problem in corporate governance?

Accepted Answer

It is the problem caused by managers pursuing their own interests rather than those of the owners (shareholders).

Question 6

If a stock is expected to pay a constant dividend of $5 per year and the required rate of return is 8%, what is the price of the stock according to the dividend discount model?

Accepted Answer

$$\frac{5}{0.08} = 62.5$$

Question 7

Which of the following is an implicit cost considered by economists but not by accountants when calculating profit?

Accepted Answer

The opportunity cost of the owner's time spent running the business.

Question 8

A firm’s balance sheet shows assets of $$500,000 and liabilities of 350$$,000. What is the firm’s net worth?

Accepted Answer

$$500,000 - 350$$,000 = $$150,000$$

Question 9

Which of the following is NOT a way that firms typically raise external funds?

Accepted Answer

Reinvesting retained earnings.

Question 10

A coupon bond pays $$40 per year for 5 years and repays a face value of 1000 at $$maturity. If the yield to maturity is 6%, what is the present value of the bond?

Accepted Answer

$$\frac{40}{1+0.06} + \frac{40}{(1+0.06)^2$} + \frac{40}{(1+0.06)^3$} + \frac{40}{(1+0.06)^4$} + \frac{40}{(1+0.06)^5$} + \frac{1000}{(1+0.06)^5$}$$

Question 11

Which of the following statements about mutual funds is correct?

Accepted Answer

Mutual funds allow small investors to diversify by pooling their money to buy stocks of many firms.

Question 12

If a firm’s accounting profit is $$200,000 and its implicit costs are 50$$,000, what is its economic profit?

Accepted Answer

$$200,000 - 50$$,000 = $$150,000$$

Question 13

Which of the following is a potential downside of organizing a business as a corporation?

Accepted Answer

Profits may be taxed twice: once as corporate profits and again when distributed as dividends.

Question 14

A firm is evaluating a project that will pay $$200 in one year, 300 in $$two years, and $500 in three years. If the nominal interest rate is 10%, what is the present value of these payments?

Accepted Answer

$$\frac{200}{1+0.10} + \frac{300}{(1+0.10)^2$} + \frac{500}{(1+0.10)^3$}$$

Question 15

Which of the following best describes retained earnings?

Accepted Answer

Profits reinvested in the firm instead of being paid to firm owners.

Question 16

Which of the following is a method used to help resolve the principal-agent problem in corporations?

Accepted Answer

Paying top managers a large part of their salary in stock or stock options.

Question 17

Which financial statement shows a firm's revenues, costs, and profit over a period of time?

Accepted Answer

Income statement

Question 18

A stock is expected to pay a dividend of $2 next year, and dividends are expected to grow at a rate of 4% per year. If the required rate of return is 10%, what is the price of the stock?

Accepted Answer

$$\frac{2}{0.10 - 0.04} = 33.33$$

Question 19

Which of the following is a real-world example of the principal-agent problem?

Accepted Answer

A manager uses company funds to purchase a private jet for personal use, rather than investing in projects that benefit shareholders.

macro chapter 6

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