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BA323 BRINCKS EXAM 1 | ALL QUESTIONS AND
CORRECT ANSWERS | GRADED A+ | NEWEST
VERSION | VERIFIED ANSWERS
•What are derivatives? •Which type of derivative is most frequently used? Which? •Hedgers versus speculators ---------CORRECT ANSWER----------------- Derivatives are like contracts. Derivatives are financial securities who's value is based on a benchmark. Hedgers take an offset position in a derivative in order to avoid risk while speculators bet on the direction that an asset moves for profit. •What is an IPO? Why do companies go public? ---------CORRECT ANSWER-----------------An IPO is the initial public offering when a company publicly list shares on the market. Companies go public in order to raise capital from a wider audience of investors. On average, do IPOs make or lose money over time? Why is it so important for private equity funds to invest in a large number of IPOs? ------- --CORRECT ANSWER-----------------IPOs tend to lose money over time since most companies stock value decreases over a 5 year period. Investing in multiple IPOs is used to reduce risk. What are the implications of market efficiency? ---------CORRECT ANSWER-----------------Understanding the intrinsic value of a stock and how new information may affect its value. Market efficiency is determined by the flow of information and how closely companies are followed by investors. •What is behavioral finance? Know the four behavioral biases discussed in class. ---------CORRECT ANSWER-----------------Behavioral finance are
cognitive biases that cause investors to make systematic mistakes that lead to inefficiencies. Over-optimism/overconfidence ---------CORRECT ANSWER----------------- Investors are more optimistic about expected future returns than they should be. What is the main goal of the corporation? ---------CORRECT ANSWER------ -----------Maximize shareholder value. Who ultimately owns the corporation? What is the relationship between shareholders, the board of directors, and management? ---------CORRECT ANSWER-----------------Shareholders ultimately own the corporation. Shareholders vote in the board of directors. What are the 3 most important management positions? ---------CORRECT ANSWER-----------------Chief Executive Officer, Chief Financial Officer, and Chief Operations Officer What is the Sarbanes-Oxley legislation? Why was it passed? --------- CORRECT ANSWER-----------------The Sarbanes-Oxley legislation holds CEOs and CFOs accountable for their financial reports. Can be jailed if fraud occurs. What is the major disadvantages and advantages of corporations compared to other forms of business organizations? ---------CORRECT ANSWER-----------------Advantages: Unlimited Life
CEO compensation is tracked with an overall market index because it correlates with the corporations performance. What is the bondholder-stockholder conflict? Do bondholders prefer safer or risky corporate investments? ---------CORRECT ANSWER----------------- Stockholders are more likely to prefer riskier projects for additional gains whereas bondholders prefer safer options. What is the difference between shareholder theory and stakeholder theory? ---------CORRECT ANSWER-----------------Shareholders theory states that it is the manager's duty to maximize shareholder returns while stakeholders theory states that managers have the ethical duty to ensure that their activities do not harm the community. Shareholders are involved on a short term basis while stakeholders are involved on a longterm basis. •What are the three ways that capital is transferred between savers and borrowers? •What are examples of each? •Which firms/types of firms will use each method? ---------CORRECT ANSWER-----------------The three ways are: Direct transfer Investment banks Financial intermediaries Direct Transfer ---------CORRECT ANSWER-----------------Business sells stock directly to savers w/o going through a financial institution. Typically done by small firms for little capital gains. investment bank ---------CORRECT ANSWER-----------------Companies sell stock or bonds to the underwriter, which is then sold by the investment
bank to savers.(Ex: Goldman Sachs and Morgan Stanley) Underwriters take on risk. Financial intermediaries (banks) ---------CORRECT ANSWER----------------- Loans made through a financial intermediary (banks, insurance company, mutual fund). Intermediaries obtain funds from savers on exchange for securities •Why do most companies use underwriters to raise capital instead of using direct transfers?
- What purpose do investment banks serve in the underwriting process? ---- -----CORRECT ANSWER-----------------Underwriters assess all the risk involved with a company seeking capital and decide if this risk is worth taking. Investment banks are the ones that provide capital. •Describe the capital allocation process and what role the suppliers of capital plays and the role that the users of capital play. •Why is the financial system often described as the circulatory system of the economy? ---------CORRECT ANSWER-----------------An economy consist of suppliers of capital and users of capital. Suppliers have excess funds that they would use to invest in exchange for a return on their investments. Users are those that need funds and seek out suppliers for capital. Who are suppliers of capital? Who are providers of capital? Can an entity be both at the same time? ---------CORRECT ANSWER----------------- Suppliers of capital include retail and institutional investors while users of capital are businesses, governments, and people. •What is a market?
Physical assets vs. Financial assets ---------CORRECT ANSWER------------- ----Physical: for products such as wheat, autos, real estate, computers and machinery. Financial: for stocks, bonds, notes and mortgages. Deal with derivative securities (values are derived from changes in the prices of other assets). A share of Ford stock is a "pure financial asset." An option to buy Ford shares is a derivative security whose value depends on the price of Ford stock. Spot vs. Futures ---------CORRECT ANSWER-----------------Assets are bought/sold on the spot for Spot Markets while Future markets involves selling products at a future date at a price agreed on today. Money Markets vs. Capital Markets ---------CORRECT ANSWER-------------- ---Money: for short-term (less than 1 year) highly liquid debt securities. (New York, London and Tokyo money markets) Capital: for intermediate (1-10 years) or long-term (more than 10 years) debt and corporate stocks (New York stock exchange) Prospect Theory ---------CORRECT ANSWER-----------------Care more about losses than gains Anchoring ---------CORRECT ANSWER-----------------Care about the first piece of information that you see too much Herding ---------CORRECT ANSWER-----------------Investors have a tendency to revise their initial forecasts to be closer to the average forecast
What is the We Company's business model? ---------CORRECT ANSWER-- ---------------WeWork was a real estate business that tried to pitch themselves as a tech firm. Why does We need to raise capital? ---------CORRECT ANSWER------------- ----WeWork needed capital in order to expand and eventually raise a profit How does We illustrate how the IPO process works? ---------CORRECT ANSWER-----------------WeWork had to be underwritten and several risk were detected. Hedge funds and derivatives: Hedge funds often use derivatives to increase risk. ---------CORRECT ANSWER-----------------Hedge funds often use derivatives to increase risk. What are Quarterly Earnings Reports? Why do investors care about them so much? ---------CORRECT ANSWER-----------------Quarterly Earnings Reports is information published by a company to show their performance.By analyzing quarterly earnings reports, investors can begin to gauge the financial health of the company and determine whether it deserves their investment. What are the four parts of an annual report? ---------CORRECT ANSWER--- --------------Balance Sheet, Income statement, Statement of Cash Flow, Statement of stock holders' equity.
§ Accounts receivable § Inventories Current Liabilities ---------CORRECT ANSWER-----------------Accounts payable
- Accruals
- Notes payable
- Short-term lending What are ratios used for and why are they useful? ---------CORRECT ANSWER-----------------§ Ratios are used to highlight weaknesses and strengths of different firms § Using annual reports, we can analyze the firm •What are the five different categories of ratios? What do we learn about a company from each type of ratio? ---------CORRECT ANSWER----------------- •Liquidity Ratios •Asset Management Ratios •Debt Management Ratios •Profitability Ratios •Market Value Ratio Liquidity Ratios ---------CORRECT ANSWER-----------------Learn about the firm's ability to pay off debts that are maturing within a year § A company needs strong liquidity ratios to continue operating and avoid bankruptcy § "Cash is king" § Two main ratios: • Current Ratio • Quick Ratio (aka as the "Acid Test")
Current Ratio ---------CORRECT ANSWER-----------------current assets / current liabilities Quick Ratio (Acid Test) ---------CORRECT ANSWER-----------------(Current Assets - Inventory) / Current Liabilities More cautious measure of liquidity than current ratio asset management ratios ---------CORRECT ANSWER----------------- financial ratios that measure how effectively a firm is using its assets to generate revenues or cash. Too few assets: • Company can't make the products that the market demands, leaving money on the table Too many assets: • Spent too much! The company has excess assets that aren't' needed. Debt Management Ratios ---------CORRECT ANSWER-----------------A set of ratios that measure how effectively a firm manages its debt. Debt to Total Capital Ratio ---------CORRECT ANSWER-----------------Total Debt / (Total Debt + Total Equity) Operating Margin ---------CORRECT ANSWER-----------------EBIT/Sales Net Profit Margin ---------CORRECT ANSWER-----------------Net Income/Sales
•Know how a change in market conditions/corporate policy will impact ratios •If a company's business weakens (revenues decline, what will happen to ROA or ROE?) •If the company decides to increase its dividend, what will happen to debt- to-capital ratio? •Think through the numerator and denominator ---------CORRECT ANSWER-----------------"Average" performance is not necessarily good, perhaps the firm should aim higher. § Seasonal factors can distort ratios. § "Window dressing" techniques can make statements and ratios look better than they actually are. § Inflation has distorted many firms' balance sheets, so analyses must be interpreted with judgment. •What are the four factors that affect the level of interest rates? --------- CORRECT ANSWER-----------------Production opportunities, time preferences for consumption, risk, and expected inflation How do these factors affect interest rates? ---------CORRECT ANSWER----- ------------Production opportunities • The investment opportunities in productive assets § Time preferences for consumption • The preference of consumers for current consumption as opposed to saving for future consumption § Risk • The chance that investment will provide a low or negative rate of return § Inflation • Amount by which prices increase over time •What is the nominal vs real interest rate? •Which is usually larger? ---------CORRECT ANSWER-----------------Real interest rate - A real interest rate is the interest rate that takes inflation into account. This means it adjusts for inflation and gives the real rate of a bond or loan nominal interest rate - interest rate before inflation
nominal interest rate is usually larger when adjusting for inflation •If the risk-free rate increases, what will happen to interest rates? --------- CORRECT ANSWER-----------------Interest rate is not affected by risk-free rates •Why is the inflation rate and interest rates so highly correlated? --------- CORRECT ANSWER-----------------Inverse correlation. When interest rates are low, economy grows and inflation increases. •What are the five determinants of interest rates and four premiums that investors received for holding interest-paying securities ---------CORRECT ANSWER-----------------Required return on a debt security real risk-free rate of interest inflation premium default risk premium liquidity premium maturity risk premium •Know what premiums that different types of bonds have (Treasury, corporate, short versus long-term) •Which bonds have higher interest rates? ---------CORRECT ANSWER------ -----------All bond types have inflation premium, long-term bonds have maturity premiums, only corporate bonds have default-risk premiums and liquidity premiums Long-term bonds tend to have higher interest rates •What are the three types of term structures?
•Is pure expectations theory an accurate reflection of real life? Why not? --- ------CORRECT ANSWER-----------------No. Expectancy theory tends to overestimate future short-term rates.
