Essay Examination 1
Corporate Finance

These questions are from the test bank. An "A" answer requires at least three or four intelligent sentences. Some questions may require more sentences if they have multiple parts.

Lecture 1 - Overview of Corporations

1. (a) What are three benefits of a corporation?

(b) What are two problems of a corporation?

2. (a) What is the difference between common stock and preferred stock?

(b) What is the difference between a bond and common stock?

3. (a) What are two goals of a corporation?

(b) What is the difference between a proprietorship and partnership?

4. (a) What is the principal agent problem?  Why do corporations have more problems with the principal agent problem?

(b) What is the difference between adverse selection and moral hazard? 

(c) How can an insurance company minimize problems with adverse selection and moral hazard?

5. (a) What are two goals of a corporation?

(b) What is the difference between a proprietorship and partnership?

Lecture 2 - Financial Markets and Institutions

6. (a) What is a mutual fund?

(b) What is commercial paper?

(c) What is a Certificate of Deposit (CD)?

7. (a) What is the difference between a money market and capital market? 

(b) Why do investors prefer the money market?

(c) What is the difference between a spot market and derivatives market?

8. What are the three types of securities that the U.S. Treasury Department issues?

9. What is the difference between an organized exchange and the Over-the-Counter (OTC) market?

10. (a) What are three functions of the financial system?

(b) What is the difference between the primary and secondary markets?

(c) What is a financial intermediary? 

(d) Please list two financial intermediaries and their functions?

11. (a) What is the yield curve?

(b) In general, what is the shape of this curve?

(c) How can it be used to predict a recession?

Lectures 4 - Time Value of Money

12. You bought a share of stock for $20.  You sold your shares three years later for $80.  What is your annual rate of return?

13. You have an overseas trust account.  You expect the following annual payments and exchange rates.

Time Payments Exchange rate
0 2,000 € 4.00 rm / €
1 3,000 € 4.25 rm / €
2 4,000 € 4.50 rm / €
3 5,000 € 5.00 rm / €

What is the present value of your cash flows, if your discount rate is 4%?

14. (a) You deposit $1,000 into a savings account that earns 6% APR interest and is compounded monthly.  How much will your savings grow in 10 years?

(b) What is the Effective Annual Rate (EFF)?

(c) Using the Rule of 72, how long will it take for your savings to double in amount?

Lectures 5 - Valuation of Bonds

15. Please quickly define the following bonds?

(a) Bearer bonds

(b) Registered bonds

(c) Debentures

(d) Convertible bonds

(e) Consuls

16. You bought a discount bond for $4,500.  The face value is $5,000.   If the bond matures in 3 months, what is your yield-to-maturity (YTM)?

17. What is the market value of your bond, if your bond has the following characteristics?

(i) Face value is $1,000
(ii) Pays 5% coupon interest rate
(iii) Pays interest twice per year
(iv) The bond matures in 1.5 years.
(v) The market interest rate is 2% APR

Lectures 6 - Valuation of Stocks

18. (a) Identify the problems of a stock market crash and its impact on an economy.

b) Evaluate two methods you could use to profit from a stock market crash.

c) Identify the useful information that a stock market index provides.

d) You invested in shares of stock that pays a $1.50 per share dividend. What is the market value of this share, if you expect dividends to increase 2% per annum, and the discount rate is 5%?

19. (a) What is insider trading?

(b) Why are investment bankers prone to insider trading problems?

(c) What are two benefits of a stock market index?

20. (a) Some internet and brand new companies do not pay dividends.  How could we update our valuation formula to include investment and earnings?

(b) What is the difference between net and gross investment?

(c) Could net investment be negative?  Please explain.