Chapter 17 Managing Business Finance Part 1

Business Essentials Chapter 17 Managing Business Finances 1) What value of a stock is calculated by dividing total shareholders' equity by the total number of shares of stock issued? A) Par value B) Market value C) Book value D) Dividend value E) Total value Answer: C Explanation: C) Book value for a share of common stock is determined as the firm's owners' equity (from the balance sheet) divided by the number of common shares owned by all shareholders. Difficulty: Easy AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 2) What is a stock's market value? A) The current price of a share of stock in the stock market B) The average price of one share of stock over the past year C) The face value of a share of stock, set by the issuing company's board of directors D) The price of the stock plus the previous year's dividend E) The monthly average of a stock's price over a year Answer: A Explanation: A) A stock's real value is its market value, the current price of a share in the stock market. Market value reflects the amount that buyers are willing to pay for a share of the company's stock. Difficulty: Easy AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 3) Which of the following is the name for a portion of the ownership of a corporation? A) Schedule C B) Stock C) Partnership D) LLC E) Dividend Answer: B Explanation: B) A corporation will sell stocks, portions of ownership, in order to raise capital. Stock represents a portion of ownership in a corporation. Difficulty: Easy AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 4) What is a stock's book value? A) The current price of a share of stock in the stock market B) The average price of one share of stock over the past year C) The face value of a share of stock, set by the issuing company's board of directors D) The value expressed as total stockholders' equity divided by the total number of shares of stock issued E) The value expressed by the number of stock shares issued by the board of directors Answer: D Explanation: D) Book value is used as a comparison indicator because the market value for successful companies is usually greater than its book value. Difficulty: Moderate AACSB: Analytical thinking Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 5) The time it takes to double an investment can be estimated by using which of the following? A) Book value B) The Rule of 72 C) Blue-chips D) Dividends E) Market value Answer: B Explanation: B) By dividing 72 by the interest rate, you can estimate how many years it will take to double your investment. Difficulty: Easy AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 6) While it's invested, money grows by earning interest or yielding some other form of return. What is this known as? A) Compound growth B) Dividend C) Capital gains D) Security E) Diversity Answer: A Explanation: A) The compound growth comes from interest paid over time that is reinvested. Difficulty: Easy AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 7) What is the cumulative growth of money from interest paid over a given period of time known as? A) Compound growth B) Rule of 72 C) Time value of money D) Interest E) Market value Answer: A Explanation: A) Time value stems from the principle of compound growth, the cumulative growth from interest paid to the investor over given time periods. With each additional time period, an investment grows as interest payments accumulate and earn more interest, thus multiplying the earning capacity of the investment. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 8) How is the market value of a stock determined? A) Interest rates B) The firm's owners' equity C) Number of shares available D) Profit-seeking potential E) How much buyers are willing to pay Answer: E Explanation: E) A stock's real value is its market value, the current price of a share in the stock market. Market value reflects the amount that buyers are willing to pay for a share of the company's stock. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 9) Partial ownership of a firm that is considered to be the strongest and financially sound is done through what method? A) Buying of mutual funds B) Buying of blue-chip stocks C) Dividend reinvestment D) Funding of aggressive growth opportunities E) Buying of load funds Answer: B Explanation: B) The so-called blue-chip stocks, those issued by the strongest, well-established, financially sound and respected firms, such as Coca-Cola and ExxonMobil, have historically provided investors steady income through consistent dividend payouts. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 10) Which of the following is considered to be one of the riskiest of all investments? A) Blue-chip stock B) Mutual funds C) No-load funds D) Common stock E) Load funds Answer: D Explanation: D) Common stocks are among the riskiest of all investments. Uncertainties about the stock market itself can quickly change a given stock's value. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 11) Because of the uncertainties involved in stock prices, investment professionals believe dayto-day prices to be a generally poor indicator of any stock's real value. Answer: TRUE Explanation: A stock's investment value is generally rated in terms of its long-term performance. Difficulty: Easy AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 12) Dividend payments are optional and variable. The corporation's CEO decides whether and when a dividend will be paid, as well as the amount that is best for the future of the company's employees. Answer: FALSE Explanation: While it is true that dividend payments are optional and variable, it is the company's board of directors that decides whether and when a dividend will be paid. The decision should be based on what is best for the future of the company and its shareholders, not necessarily its employees. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 13) Explain the principle of compound growth. Answer: Compound growth is the compounding of interest paid to the investor over given time periods. With each additional time period, interest payments accumulate, are capitalized, and earn more interest, thus multiplying the earning capacity of the investment. The principle of compound growth is the basis for the time value of money. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 14) Explain the Rule of 72. Answer: The Rule of 72 is used to figure out how long it takes to double an investment. You can find the number of years needed to double your money by dividing the annual interest rate (in percent) into 72. The Rule of 72 can also calculate how much interest you must get if you want to double your money in a given number of years. The Rule of 72 lesson for the investor is clear: seek higher interest rates because money will double more frequently. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 15) Differentiate between market value and book value. Answer: Market value is the current price of a share in the stock market and reflects the amount that buyers are willing to pay for a share of the company's stock. Book value for a share of common stock is determined as the firm's owners' equity (from the balance sheet) divided by the number of common shares owned by all shareholders. Book value is used as a comparison indicator because the market value for successful companies is usually greater than its book value. When market price falls to near book value, some profit-seeking investors buy the stock on the principle that it is underpriced and will possibly increase in the future. Difficulty: Moderate AACSB: Analytical thinking Objective: 17.1: Explain the concept of the time value of money and the principle of compound growth, and discuss the characteristics of common stock. 16) Which of the following terms refers to a bundling of stocks, bonds, and other securities? A) Blue-chips B) Mutual funds C) Exchanges D) Commodities E) Dividends Answer: B Explanation: B) Mutual funds are created by companies such as T. Rowe Price and Vanguard that pool cash investments from individuals and organizations to purchase bundles of stocks, bonds, and other securities. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 17) To avoid paying a commission on an investment, what type of fund might an investor choose? A) Blue-chip stock B) Mutual funds C) No-load funds D) Common stock E) Load funds Answer: C Explanation: C) Investors in no-load funds are not charged sales commissions when they buy into or sell out of funds. Investors in load funds generally pay commissions of 2 percent to 8 percent. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 18) Investments such as money market mutual funds offer what advantage to investors? A) Conservative capital growth B) Long-term capital growth C) Market appreciation D) Aggressive growth E) Safety and stability Answer: E Explanation: E) Funds stressing safety seek only modest growth with little fluctuation in principal value regardless of economic conditions. They include money market mutual funds and other funds that preserve the fund holders' capital and reliably pay current income. Difficulty: Moderate AACSB: Analytical thinking Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 19) What type of investment would preserve capital investment but seek capital appreciation? A) Blue-chip stock B) Balanced funds C) Aggressive growth funds D) No-load funds E) Mutual funds Answer: B Explanation: B) Mutual funds that stress preservation of capital and current income but also seek some capital appreciation are called balanced funds. Difficulty: Moderate AACSB: Analytical thinking Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 20) Which type of investment will sacrifice current income potential for long-term returns? A) Blue-chip stock B) Balanced funds C) Aggressive growth funds D) No-load funds E) Mutual funds Answer: C Explanation: C) They are designed for investors who can accept the risk of loss inherent in common stock investing with severe price fluctuations but also the potential for superior returns over time. Difficulty: Moderate AACSB: Analytical thinking Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 21) What is the advantage of exchange-traded funds (EFTs) over mutual funds? A) They can be traded throughout the day like a stock. B) The cost of the fund management is passed on to the holder. C) They do not require the services of a broker to complete a transaction. D) They allow for frequent trading with lower overall transaction fees. E) They regularly out-perform mutual funds. Answer: A Explanation: A) ETFs offer three areas of advantage over mutual funds. They can be traded throughout the day like a stock, they have low operating expenses, and they do not require high initial investments. Difficulty: Moderate AACSB: Analytical thinking Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 22) When an investor wants to enter the market with a minimum amount of investment, what type of opportunities would offer them ease of entry and low operating expenses? A) Securities B) Common stock C) Blue-chip stock D) Exchange-traded funds E) Mutual funds Answer: D Explanation: D) By allowing low minimum investments, ETFs offer ease of entry in addition to low annual operating expenses. Difficulty: Moderate AACSB: Analytical thinking Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 23) An exchange-traded fund (ETF) is a bundle of stocks (or bonds) that are in an index that tracks the overall movement of a market. Answer: TRUE Explanation: ETFs will earn a return that is indexed to the overall market movement. Difficulty: Easy AACSB: Application of knowledge Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 24) Explain what exchange-traded funds are and how they are tracked. Answer: As with an index mutual fund, an exchange-traded fund (ETF) is a bundle of stocks (or bonds) that are in an index that tracks the overall movement of a market; unlike a mutual fund, however, an ETF can be traded like a stock. Each share of an ETF rises and falls as market prices change continuously for the market being tracked. Because they are traded on stock exchanges (hence, exchange traded), ETFs can be bought and sold-priced continuously-any time throughout the day. Difficulty: Difficult AACSB: Analytical thinking Objective: 17.2: Identify reasons for investing and the investment opportunities offered by mutual funds and exchange-traded funds. 25) Which is the MOST widely cited U.S. stock market index? A) Standard & Poor's Composite Index of 500 Stocks B) The NYSE index C) Dow Jones Industrial Average D) Moody's Stock List E) The NASDAQ Answer: C Explanation: C) Further, the Dow measures the performance of U.S. financial markets by focusing on 30 blue-chip companies as reflectors of economic health. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.3: Describe the role of securities markets and identify the major stock exchanges and stock markets. 26) New stocks and bonds are sold in what market? A) Private placement market B) Secondary market C) Primary market D) Tertiary market E) Open market Answer: C Explanation: C) Sales may be public or private in the primary market. Difficulty: Easy AACSB: Application of knowledge Objective: 17.3: Describe the role of securities markets and identify the major stock exchanges and stock markets. 27) Which of the following is the federal government agency that regulates U.S. securities markets? A) New York Stock Exchange B) Federal Reserve C) Commerce Department D) Securities and Exchange Commission E) Treasury Department Answer: D Explanation: D) The SEC must approve a new security before it is brought to market. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.3: Describe the role of securities markets and identify the major stock exchanges and stock markets. 28) Which of the following is an organization of individuals coordinated to provide an institutional setting in which stock can be bought and sold? A) Stock exchange B) Brokerage C) Server D) Over-the-counter market E) Mutual fund Answer: A Explanation: A) Each exchange regulates where and when trading may occur. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.3: Describe the role of securities markets and identify the major stock exchanges and stock markets. 29) Which of the following is a basis for a firm to be listed on the New York Stock Exchange? A) Headquarters in New York B) Total value of outstanding stock C) Industry in which the company operates D) Number of shares of stock E) Global operations Answer: B Explanation: B) Only firms meeting certain minimum requirements and earning power, total value of outstanding stock, and number of shareholders-are eligible for listing on the NYSE. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.3: Describe the role of securities markets and identify the major stock exchanges and stock markets. 30) Which of the following receives and executes buy-and-sell orders for other people in return for commissions? A) Stock exchanges B) Stock brokers C) Investment banks D) Stock agents E) Savings banks Answer: B Explanation: B) Stock brokers usually work on commission. Difficulty: Easy AACSB: Application of knowledge Objective: 17.3: Describe the role of securities markets and identify the major stock exchanges and stock markets. 31) Which of the following is a summary of price trends in a specific industry and/or the stock market as a whole? A) Investment index B) Average index C) Market indicator D) Market index E) Prospectus Answer: D Explanation: D) Market indexes do not indicate the status of individual securities. Difficulty: Easy AACSB: Application of knowledge Objective: 17.3: Describe the role of securities markets and identify the major stock exchanges and stock markets. 32) Which of the following is a function performed by an investment bank? A) Handling a client's portfolio in the secondary market B) Establishing relationships for a client with a commercial bank C) Underwriting purchases of stocks and bonds D) Arranging travel abroad for purchasers of foreign currencies E) Providing insurance services for clients Answer: C Explanation: C) Investment banks advise companies on timing and financial terms of new issues, underwrite new securities, and create distribution networks for moving new securities through groups of other banks and brokers into the hands of individual investors. Difficulty: Moderate AACSB: Application of knowledge Objective: 17.3: Describe the role of securities markets and identify the major stock exchanges and stock markets.