Corporate Finance Fundamentals
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Corporate Finance Fundamentals

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Questions and Answers

What is the primary goal of a firm according to corporate governance policies?

  • Maximize shareholder value while minimizing agency problems (correct)
  • Maximize profits by taking on high levels of risk
  • Minimize the risk of bankruptcy by diversifying investments
  • Optimize the use of financial statement analysis for internal decision-making

    • A portfolio consisting of multiple assets with a correlation coefficient of 0.5 is an example of:

  • Hedging
  • Unsystematic risk reduction
  • Diversification (correct)
  • Systematic risk reduction

    • Which of the following factors has the greatest impact on the value of an option?

  • Volatility of the underlying asset (correct)
  • Time to expiration
  • Interest rate
  • Dividend yield

    • A bond with a face value of $1,000 and a market price of $950 is an example of a:

    <p>Discount bond</p> Signup and view all the answers

    The yield curve is a graphical representation of the:

    <p>Relationship between bond yield and time to maturity</p> Signup and view all the answers

    What is the primary purpose of a country's financial system?

    <p>To facilitate the flow of capital between savers and investors</p> Signup and view all the answers

    Which of the following is a consequence of the agency problem?

    <p>Conflict of interests between management and shareholders</p> Signup and view all the answers

    What is the main advantage of diversification in a portfolio?

    <p>Reduced risk</p> Signup and view all the answers

    What is the relationship between bond duration and interest rate changes?

    <p>Bond duration decreases when interest rates rise</p> Signup and view all the answers

    What is the effect of inflation on the purchasing power of money?

    <p>Inflation reduces purchasing power</p> Signup and view all the answers

    What is the purpose of financial statement analysis?

    <p>To forecast a firm's future performance</p> Signup and view all the answers

    What is the primary function of a country's financial system?

    <p>To allocate resources efficiently</p> Signup and view all the answers

    What is the primary determinant of the value of an asset in a firm?

    <p>Expected future cash flows</p> Signup and view all the answers

    Which of the following is a characteristic of a systematic risk?

    <p>Affects the overall market</p> Signup and view all the answers

    What is the primary goal of a firm's monetary policy decisions?

    <p>To maximize shareholder value</p> Signup and view all the answers

    What is the impact of an increase in interest rates on the value of a bond?

    <p>Decreases the value of the bond</p> Signup and view all the answers

    Which of the following is a consequence of a bank run?

    <p>Failure of the banking system</p> Signup and view all the answers

    What is the relationship between the time value of money and the present value of a cash flow?

    <p>The present value of a cash flow is lower when the time value of money is higher</p> Signup and view all the answers

    What is the primary issue arising from the relationship between principals and agents?

    <p>Conflict of interest</p> Signup and view all the answers

    What is the main goal of corporate governance?

    <p>To balance the interests of stakeholders</p> Signup and view all the answers

    What is the primary purpose of financial statement analysis?

    <p>To identify financial strengths and weaknesses</p> Signup and view all the answers

    What arises when the interests of principals and agents conflict?

    <p>Agency problem</p> Signup and view all the answers

    Who are the principals in the agency theory?

    <p>Shareholders</p> Signup and view all the answers

    What is involved in corporate governance?

    <p>Mechanisms, processes, and relations</p> Signup and view all the answers

    What is the primary principle behind the time value of money?

    <p>Money available today is worth more than the same amount in the future</p> Signup and view all the answers

    What type of risk is impossible to avoid through diversification?

    <p>Systematic risk</p> Signup and view all the answers

    What is the main purpose of diversification in a portfolio?

    <p>To yield higher returns and pose a lower risk</p> Signup and view all the answers

    What determines the value of an asset?

    <p>Cash inflows and outflows, growth potential, inherent risk, and economic environment</p> Signup and view all the answers

    What is the primary difference between a long and short position?

    <p>Long position is buying with the expectation of price rise, while short position is selling with the expectation of price decline</p> Signup and view all the answers

    What is the primary advantage of bonds over stocks?

    <p>Bonds offer fixed interest payments</p> Signup and view all the answers

    What is the primary goal of a company's capital structure decisions?

    <p>To minimize the weighted average cost of capital</p> Signup and view all the answers

    What is the primary function of financial systems?

    <p>To create wealth and facilitate the allocation of resources</p> Signup and view all the answers

    What is the primary difference between common stock and preferred stock?

    <p>Preferred stock is senior to common stock</p> Signup and view all the answers

    What is the primary impact of an increase in volatility on the value of an option?

    <p>The value of the option increases</p> Signup and view all the answers

    What is the core principle of finance that states that money available at the present time is worth more than the same amount in the future?

    <p>Time value of money</p> Signup and view all the answers

    What is the main goal of diversification in a portfolio?

    <p>To decrease risk</p> Signup and view all the answers

    What type of risk affects a large number of assets and is impossible to avoid through diversification?

    <p>Systematic risk</p> Signup and view all the answers

    What is the primary determinant of an asset’s value?

    <p>Cash inflows and outflows</p> Signup and view all the answers

    What is the purpose of financial systems?

    <p>To facilitate the allocation of resources</p> Signup and view all the answers

    What is the primary difference between a long and short position?

    <p>Expectation of price increase or decrease</p> Signup and view all the answers

    What is the primary goal of a firm's capital structure decisions?

    <p>To minimize weighted average cost of capital</p> Signup and view all the answers

    What is the primary characteristic of systematic risk?

    <p>Affects a large number of assets</p> Signup and view all the answers

    What is the primary influence on the value of an option?

    <p>Volatility of the underlying asset</p> Signup and view all the answers

    What is the primary advantage of bonds over stocks?

    <p>Fixed interest payments</p> Signup and view all the answers

    What is the primary source of conflict in the agency theory?

    <p>Conflict between principal's needs and agent's self-interest</p> Signup and view all the answers

    What is the main objective of corporate governance?

    <p>To balance stakeholder interests</p> Signup and view all the answers

    What is the primary purpose of financial statement analysis?

    <p>To identify financial strengths and weaknesses</p> Signup and view all the answers

    Who are the principals in the agency theory?

    <p>Shareholders</p> Signup and view all the answers

    What is the primary goal of effective corporate governance?

    <p>To set and achieve objectives</p> Signup and view all the answers

    What is the agency problem a result of?

    <p>Conflict between principals and agents</p> Signup and view all the answers

    Study Notes

    Firm Performance

    • Agency Theory and Problems: Illustrates the dynamics between shareholders (principals) and company executives (agents) with a focus on decision-making conflicts that may arise.
    • Agency Problem Example: Managers may prioritize personal gains at the expense of maximizing shareholder wealth.
    • Corporate Governance: Encompasses the systems and processes that control, direct, and balance stakeholder interests including shareholders, management, and community.
    • Importance of Corporate Governance: Assists firms in establishing objectives, managing risks, and optimizing resource use.
    • Financial Statement Analysis: Analyzes financial strengths and weaknesses by assessing the relationships within financial statements to evaluate past and current performance.

    Time Value of Money

    • Concept: Emphasizes that present money is inherently more valuable than future money due to potential earning capacity.
    • Implications: Money can earn interest, making earlier receipt of funds more valuable.

    Risk, Diversification, and Asset Pricing

    • Long vs. Short Positions:
      • Long Position: Buying stocks or commodities with expectations of price increases.
      • Short Position: Selling borrowed stocks anticipating repurchase at a lower price for profit.
    • Systematic vs. Unsystematic Risk:
      • Systematic Risk: Affects broad market segments and cannot be avoided through diversification (e.g., recessions).
      • Unsystematic Risk: Specific to individual assets and can be mitigated by diversification.
    • Diversification: A strategy that combines various investments in a portfolio, aiming for higher average returns and lower risk compared to individual investments.

    Valuation

    • Determinants of Asset Value: Assessments of expected cash inflows and outflows over an asset's lifespan, often using discounted cash flow analysis.
    • Factors Influencing Asset Value: Includes growth potential, inherent risk, and the economic environment.
    • Option Valuation Factors: Determined by stock price, strike price, time to maturity, and volatility of underlying assets; expiration time influences the likelihood of finishing in-the-money.
    • Bond Valuation Factors: Affected by interest rate changes, coupon rates, time to maturity, and credit quality; longer maturity bonds are more sensitive to interest fluctuations.

    Monetary Policy and Capital Structure Decisions

    • Riskiness of Securities:
      • Common stock is riskier than preferred stock or bonds with uncertainties around dividends and capital returns.
      • Preferred stock has fixed dividends and ranks above common stock but below bonds.
      • Bonds offer fixed interest payments, regarded as less risky relative to stocks.
    • Optimal Capital Structure: Represents the ideal mix of debt, preferred stock, and common equity to minimize capital costs and maximize stock value.
    • Financial Systems Purpose: Facilitate resource allocation, wealth creation, and economic growth by transferring funds between surplus and deficit entities using various instruments and markets.

    Additional Concepts

    • Understand the implications of bank runs, the components of aggregate demand and supply, and inflation consequences.
    • Recognize the importance of the yield curve and its significance in the financial markets.
    • Familiarize with concepts of purchasing power and bond duration in financial analysis.

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    Description

    Test your understanding of corporate finance concepts, including agency theory, financial statement analysis, time value of money, risk, and diversification. Assess your knowledge of corporate governance policies and asset pricing.

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