Chap016

Chapter 16 - Financial Management and Securities Markets
Chapter 16
Financial Management and Securities Markets
True / False Questions
1. (p. 489) One aspect of financial management involves managing funds for a business.
TRUE
AACSB: Reflective Thinking
Bloom's Taxonomy: Knowledge
Difficulty: Easy
Learning Objective: 1
2. (p. 491) A lockbox is a technique for getting cash into a business's account faster.
TRUE
AACSB: Technology
Difficulty: Medium
3. (p. 491) A marketable security is a temporary investment of cash.
TRUE
Difficulty: Easy
4. (p. 491) Commercial paper is issued by large companies and backed by collateral.
FALSE
Difficulty: Easy
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5. (p. 492) Eurodollar deposits can only be made at banks located in London.
FALSE
AACSB: Technology
Difficulty: Easy
Multiple Choice Questions
6. (p. 489) Overall, financial management primarily involves acquiring and managing
A. equity.
B. funds.
C. liabilities.
D. inventory.
E. employees.
Difficulty: Easy
7. (p. 489) In the area of short-term assets and liabilities, a word that is synonymous with "short
term" is
A. minimal.
B. current.
C. small.
D. least.
E. fiat.
Difficulty: Medium
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8. (p. 489) Cash, investments, accounts receivable, and inventory are also known as
A. current assets.
B. current liabilities.
C. long-term assets.
D. long-term liabilities.
E. fixed assets.
Difficulty: Easy
9. (p. 489) Current assets include all of the following except
A. accounts receivable.
B. accounts payable.
C. investments.
D. inventory.
E. cash.
Difficulty: Medium
10. (p. 489) Short-term debt obligations that must be repaid within a year are
A. long-term assets.
B. long-term liabilities.
C. current liabilities.
D. current assets.
E. fixed liabilities.
Difficulty: Medium
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11. (p. 489) All of the following are current liabilities except
A. accrued taxes.
B. short-term bank loans.
C. accounts payable.
D. marketable securities.
E. accrued salaries.
Difficulty: Medium
12. (p. 489) If a financial manager focuses on monitoring and influencing the company's current
assets and liabilities, he or she is involved with
A. working capital.
B. current accounts.
C. long-term financing.
D. debt resolution.
E. savings enhancement.
Bloom's Taxonomy: Comprehension
Difficulty: Medium
13. (p. 489) A firm may increase its return to the business through improved management of
A. cash.
B. temporary investments.
C. inventory.
D. accounts receivable.
E. all of the above.
Difficulty: Medium
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14. (p. 489) The goal of financial managers who focus on current assets is to
A. maximize returns on short-term assets.
B. minimize returns on short-term liabilities.
C. minimize returns on short-term assets.
D. decrease return on working capital.
E. none of the above.
Difficulty: Medium
Scrambling: Lokced
15. (p. 490) Good financial managers minimize the amount of cash available to pay bills in
A. marketable securities.
B. transaction balances.
C. inventory.
D. the float.
E. banker's acceptances.
Difficulty: Hard
16. (p. 491) Because having idle cash on hand is undesirable, a manager may choose to invest in
A. credit cards.
B. debit cards.
C. working capital.
D. marketable securities.
E. capital outlay.
Difficulty: Easy
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17. (p. 490) Managing working capital by having a bank pick up payments and immediately
record them is known as
A. electronic funds transfer.
B. playing the float.
C. lockbox collections.
D. a transaction balance.
E. economic order quantity.
Difficulty: Medium
18. (p. 491) To raise money for its operating expenses, the U.S. government may issue short-
term debt obligations called
A. commercial paper.
B. certificates of deposit.
C. banker's acceptances.
D. Treasury bills.
E. stock certificates.
Difficulty: Medium
19. (p. 491-492) All of the following are ways to invest idle cash for the short term except
A. certificates of deposit.
B. Eurodollars.
C. Treasury bills.
D. commercial paper.
E. unsecured loans.
Difficulty: Medium
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20. (p. 493) Which of the following can serve as a short-term source of funds during a cash
shortfall?
A. Inventory
B. Certificates of deposit
C. Accounts Receivable
D. Suppliers
E. Cutting workers' salaries
Difficulty: Medium
21. (p. 493) If a firm tries to produce goods just in time to meet sales demand, its level of
inventory will tend to be
A. relatively low.
B. very high.
C. relatively high.
D. excessive.
E. wasteful.
Difficulty: Medium
22. (p. 493) Companies often keep a close watch on the amount of inventory on hand to
minimize costs. If a company produces inventory in a constant, level pattern, when sales go
down, its inventory level will
A. remain constant.
B. increase.
C. decrease.
D. be optimal.
E. be just right.
Difficulty: Hard
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Essay Questions
23. (p. 491-492) Why would a firm want to invest its idle cash?
Cash ties up business funds just as investments in inventory or plants and equipment do.
Unused or idle cash earns no money so financial managers try to minimize the amount of cash
kept on hand to pay bills. Most businesses invest any cash not needed for such transactions in
marketable securities or use it to reduce debt.
Difficulty: Medium
24. (p. 494) Trade credit is the most widely used source of short-term financing.
TRUE
Difficulty: Easy
25. (p. 494) Principal is the amount of money a business pays to use a bank's funds.
FALSE
Difficulty: Easy
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26. (p. 494) Lenders first evaluate a borrower's history of borrowing and repaying loans by
looking at the borrower's past credit history.
TRUE
Difficulty: Easy
27. (p. 494) Unsecured loans are backed by collateral that the lender can claim if the borrower
does not repay the loan.
FALSE
Difficulty: Medium
28. (p. 494) Interest is a percentage of the principal that the bank charges for use of its money.
TRUE
Difficulty: Easy
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29. (p. 494) Dan bought three new trucks with money borrowed from the First National Bank. If
he fails to repay the loan, the bank will repossess the trucks. The trucks are
A. bought with an unsecured loan.
B. bought with a line of credit.
C. collateral.
D. interest.
E. principal.
Difficulty: Medium
30. (p. 493) If a boat manufacturer orders 50 units of fiberglass material and promises to pay the
supplier at a later date, the manufacturer will record the amount to be paid as a(n)
A. account receivable.
B. current asset.
C. long-term liability.
D. account payable.
E. equity account.
Difficulty: Hard
31. (p. 494) The most widely used source of short-term financing is
A. trade credit.
B. bank loans.
C. commercial paper.
D. mothers and fathers.
E. finance companies.
Difficulty: Medium
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32. (p. 494) Sherry arranged for her business to borrow up to $10,000 whenever it was needed by
writing a check on its account with the First National Bank. This is a(n)
A. secured loan.
B. line of credit.
C. collateral loan.
D. commercial paper.
E. unsecured loan.
Difficulty: Medium
33. (p. 494) If a real estate developer borrows $100,000 from a bank and ends up paying back
$120,000, the $100,000 represents the
A. collateral.
B. interest.
C. down payment.
D. principal.
E. security.
Difficulty: Easy
34. (p. 494) If Linda Wilson borrows $20,000 to buy a car and ends up paying the lender a total
of $24,000, the $4,000 difference represents the
A. principal.
B. collateral.
C. security.
D. discount.
E. interest.
Difficulty: Easy
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35. (p. 494) If the interest rate on a loan changes according to the daily average of the prime rate
over the life of the loan, the interest rate is said to be
A. floating.
B. non-variable.
C. fixed.
D. sporadic.
E. flexible.
Difficulty: Hard
36. (p. 495) A finance company to whom businesses sell their accounts receivable, usually for a
percentage of the total face value, is known as a(n)
A. factor.
B. secured lender.
C. trade creditor.
D. line creditor.
E. trade lender.
Difficulty: Easy
Essay Questions
37. (p. 495) Are banks the only sources of short-term funds for businesses?
No. In fact, virtually all financial institutions, including insurance companies, pension funds,
money market funds, and finance companies make short-term loans to organizations. Large
U.S. companies also engage in borrowing from the Eurodollar and commercial paper markets.
Difficulty: Hard
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38. (p. 495) Most business failures are the result of poor long-term financial planning.
FALSE
Difficulty: Hard
39. (p. 495) Short-term financing is often required for long-term assets.
FALSE
Difficulty: Hard
40. (p. 495) Fixed assets, such as production facilities, are expected to last for many years.
TRUE
Difficulty: Easy
41. (p. 495) Businesses must reinvest in new equipment to stay competitive.
TRUE
Difficulty: Medium
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42. (p. 496) Capital budgeting is the process of analyzing business needs and the selection of
assets that will maximize the value of the business.
TRUE
Difficulty: Easy
43. (p. 495) Plants, offices, and equipment are considered
A. long-term assets.
B. short-term assets.
C. relatively inexpensive items.
D. liabilities.
E. factors.
Difficulty: Easy
44. (p. 495) The financial arrangements required for investment in fixed assets can be
A. quite easily arranged.
B. challenging for even the most profitable organization.
C. trivial.
D. short-term.
E. inexpensive.
Difficulty: Medium
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45. (p. 495) Of the following, which would not be a fixed asset for the Tops Manufacturing
Company?
A. A 10,000-square-foot factory
B. Plastic extruding equipment with a 15-year lifespan
C. $10,000 in T-bills
D. Molds for plastic with lifespan of five years
E. Furniture
Difficulty: Hard
46. (p. 495) Long-term assets are also called which type of asset?
A. Current
B. Lengthy
C. Comprehensive
D. Fixed
E. Relevant
Difficulty: Medium
47. (p. 495) Long-term assets are
A. easily made liquid.
B. convertible to cash in less than six months.
C. expected to last for many years.
D. liabilities.
E. dividends.
Difficulty: Medium
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48. (p. 495) Unless fixed assets are improved and modernized,
A. businesses lose their competitive edge.
B. companies must pay back earnings.
C. equity increases.
D. retained earnings grow.
E. labor costs increase.
Difficulty: Hard
49. (p. 495) Purchasing new technologically improved equipment
A. is usually too costly.
B. is necessary to a firm's continued productivity.
C. increases labor costs.
D. creates problems with OSHA.
E. reduces retained earnings.
Difficulty: Medium
50. (p. 496) The amount of money budgeted for the purchase of long-term assets is called the
A. master budget.
B. year's budget.
C. current budget.
D. fixed budget.
E. capital budget.
Difficulty: Medium
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51. (p. 496) When a company invests a lot of money in a particular project, it is concerned about
the amount of risk involved. In general, the longer the expected life of a project or asset, the
potential risk is
A. lesser.
B. constant.
C. greater.
D. unchanged.
E. nonexistent.
Difficulty: Hard
52. (p. 496) Which of the following is the most risky?
A. Adding to a product line
B. Introducing a new product in a foreign market
C. Introducing a new product in a familiar market
D. Buying new equipment for an established market
E. All of the above carry the same risk.
Difficulty: Medium
Essay Questions
16-17

53. (p. 496-497) Explain the risk factors a firm must assess when considering an investment in a
new asset.
When considering the risk associated with a prospective asset or project, financial managers
must consider several things. If the investment is foreign, risk assessments must include the
political climate and economic stability of the region. Time is another factor to assess when
considering a new asset. The longer an asset is expected to last, the greater is its potential risk.
Other factors are the stability and competitive nature of the marketplace.
Difficulty: Hard
54. (p. 499) Liabilities may take many different forms, some of which are not considered debt.
FALSE
Difficulty: Easy
55. (p. 499) A bond can be transferred from one owner to another.
TRUE
Difficulty: Medium
56. (p. 499) A bond contract is also known as an indenture.
TRUE
Difficulty: Hard
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57. (p. 500) The par value is the interest rate on a bond.
FALSE
Difficulty: Hard
58. (p. 499) Bonds can be issued not only by corporations but also by governments and nonprofit
organizations.
TRUE
Difficulty: Hard
59. (p. 499) Which of the following is an example of a long-term liability?
A. Stock
B. Bond
C. Revenue
D. Discount
E. Equity
Difficulty: Medium
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60. (p. 499-500) A method of long-term financing that requires repaying funds with interest is
A. issuing bonds.
B. using retained earnings.
C. issuing stocks.
D. buying insurance.
Difficulty: Hard
61. (p. 499) Long-term liabilities are
A. debts that are due in less than six months.
B. debts that will be repaid over a number of years.
C. assets.
D. equity.
E. retained earnings.
Difficulty: Easy
62. (p. 499) Items such as a bond's value, date, and rate are specified in the
A. indenture.
B. prospectus.
C. equity preface.
D. ledger.
E. T-account.
Difficulty: Medium
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63. (p. 500) A bond
A. must be repaid according to the terms set in its indenture.
B. may be defaulted without penalty.
C. is the same as a stock.
D. is a fixed asset.
E. is a current liability.
Difficulty: Medium
64. (p. 498) What is the sign of a successful capital budgeting program?
A. lower than normal costs and decreasing stock price
B. higher than normal profits and increasing sales
C. higher employee satisfaction
D. decreased production times
E. increased customer satisfaction
Difficulty: Hard
65. (p. 500) Which of the following is a sequence of small bond issues of progressively longer
maturity?
A. Secured bonds
B. Serial bonds
C. Progressive bonds
D. Junk bonds
E. Sequence bonds
Difficulty: Medium
Essay Questions
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66. (p. 499-501) Other than bank loans and short-term loans, discuss how firms raise long-term
capital using liabilities.
Many corporations can raise capital by issuing bonds, which are long-term debt securities that
a company sells to raise long-term funds. A bond represents a loan from the purchaser to the
issuer of the bonds, and it must be repaid with interest by the date specified.
Difficulty: Hard
67. (p. 502) The market value of common stock is the price at which it is currently trading.
TRUE
Difficulty: Easy
68. (p. 502) The par value is the dollar amount printed on a stock certificate.
TRUE
Difficulty: Medium
69. (p. 502) Retained earnings may be used to finance long-term assets.
TRUE
Difficulty: Easy
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70. (p. 502) Common stock is a safer investment than preferred.
FALSE
Difficulty: Medium
71. (p. 503) An investment banker sells securities for corporations.
TRUE
Difficulty: Easy
72. (p. 502) The last in line for the payment of profits are the
A. bondholders.
B. common stockholders.
C. preferred stockholders.
D. government.
E. customers.
Difficulty: Hard
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73. (p. 502) Stockholders who may receive dividends but cannot vote are called
A. common stockholders.
B. uncommon stockholders.
C. standard stockholders.
D. majority stockholders.
E. preferred stockholders.
Difficulty: Hard
74. (p. 502) When a stock quote includes the stock symbol followed by the letters "pf," it
indicates
A. price fixing.
B. pretty farfetched.
C. common stock.
D. preferred stock.
E. poorly financed.
Difficulty: Hard
75. (p. 502) The 52-week high and low are the highest and lowest prices, respectively, paid for a
stock in the last
A. month.
B. year.
C. decade.
D. week.
E. earnings period.
Difficulty: Easy
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76. (p. 502) The only long-term funds that a company can generate internally are
A. dividend yields.
B. unretained earnings.
C. retained earnings.
D. payout earnings.
E. earnings paid out.
Difficulty: Hard
77. (p. 503) If a company retains all of its earnings, then it will not pay
A. dividends.
B. taxes.
C. expenses.
D. bills.
E. suppliers.
Difficulty: Medium
78. (p. 503) Corporations usually employ an investment banking firm to help sell their securities
in
A. the primary market.
B. secondary markets.
C. tertiary markets.
D. singular markets.
E. multiple markets.
Difficulty: Hard
Essay Questions
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79. (p. 502) Explain the difference between common and preferred stock.
Preferred stock is corporate ownership that grants the owner preference in the distribution of
the company's profits but not the voting rights given to common stockholders. Preferred
stockholders receive dividends before common stockholders and are given preference over
common stockholders in the liquidation process. Consequently, preferred stock is a safer
investment than common stock.
Difficulty: Hard
80. (p. 504-505) Securities markets provide liquidity.
TRUE
Difficulty: Hard
81. (p. 505) Secondary markets exist for the trading of publicly owned securities.
TRUE
Difficulty: Hard
82. (p. 505) On organized exchanges, investors buy and sell only for their own accounts.
FALSE
Difficulty: Hard
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83. (p. 505-506) The over-the-counter markets do not have a central location for trading.
TRUE
Difficulty: Medium
84. (p. 504) Securities markets provide
A. a mechanism for buying and selling stocks and bonds.
B. the primary market where firms raise capital.
C. a secondary market.
D. liquidity.
Difficulty: Medium
85. (p. 505) Once a corporation's stock is publicly owned, owners can trade it in
A. the singular market.
B. tertiary markets.
C. multiple markets.
D. secondary markets.
E. the primary market.
Difficulty: Hard
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86. (p. 505) The two biggest stock markets in the United States are
A. American Stock Exchange and New York Stock Exchange.
B. Chicago Stock Exchange and NASDAQ.
C. New York Stock Exchange and NASDAQ.
D. Southeast Regional Stock Exchange and New York Stock Exchange.
E. Tokyo Stock Exchange and NASDAQ.
Difficulty: Medium
87. (p. 507) Which of the following compares current stock prices with those in a specified base
period?
A. Average
B. Index
C. Dow Jones Industrial Average
D. Dividend yield
E. Current yield
Difficulty: Medium
88. (p. 506) The over-the-counter market
A. trades most corporate bonds and all U.S. government securities.
B. is only for small companies just getting started.
C. isn't as current in its quotes as the NYSE.
D. is located in Philadelphia.
E. is located in Chicago.
Difficulty: Medium
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89. (p. 508) Which of the following is a sluggish, retreating market with declining stock prices?
A. Lion market
B. Deer market
C. Bull market
D. Bear market
E. Horse market
Difficulty: Easy
Essay Questions
90. (p. 505-506) Explain how the over-the-counter markets differ from other exchanges.
The over-the-counter market is a network of dealers all over the country linked by computers,
telephones, and teletype machines. Unlike the other exchanges, it does not have a central
location. Also, the dealers own the securities they trade, and they buy and sell their own
inventories of securities. So, the dealers must balance their supply of securities by changing
the prices they charge to buy and sell.
Difficulty: Medium
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91. (p. 513) Normally, rapidly increasing sales is a good thing. What seems to be the problem
here?
A rule of thumb in finance is to always match short- and long-run investments with short- and
long-term financing, respectively. Organizations experiencing a temporary surge in sales may
use short-term loans to finance the increased sales (added costs from overtime, extra raw
materials, and so forth). However, short-term funds come at a premium, which is why they
should be used only for short-run investments (such as a temporary increase in sales). If sales
are expected to increase from year to year (and assuming the firm is already operating at or
near capacity), operation expansion is the best alternative—a long-run investment that is best
financed through long-term loans. The main problem with Glasspray is that each year it
finances the increased sales with short-term financing (excessive current liabilities). Over
time, this method of capitalizing the organization has produced an undesirable capital
structure—excessive current liabilities relative to current assets.
Bloom's Taxonomy: Analysis
Difficulty: Hard
92. (p. 513) List the important components of a firm's working capital. Include both current
assets and current liabilities.
The current assets associated with working capital include cash, investments, accounts
receivable, and inventory. The current liabilities associated with working capital include
accounts payable, accrued salaries, accrued taxes, and short-term bank loans.
Difficulty: Medium
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93. (p. 513) What are some management techniques applied to current liabilities that Glasspray
might use to improve its working capital position?
Students' answers may vary, but each should get at reducing current liabilities. For example,
Glasspray could begin by replacing some of the short-term debt with long-term financing or
equity (the debt used to finance the increased sales), and it could take advantage of any trade
credit its suppliers offer.
Difficulty: Medium
16-31

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