TEST BANK For Foundations of Financial Management, 18th
Edition by Stanley Block, Geoffrey Hirt, Bartley Danielsen
Compare junior debt to senior debt - ANSWER:Senior debt is debt paid first in case of
liquidation, whereas junior debt is paid after senior debt is fully paid. Therefore,
junior debt is more risky because value of assets has to be higher for you to get any
payments back.
What is a rights issue? - ANSWER:A method of raising capital by offering existing
shareholders the opportunity to purchase additional shares at a discounted price,
proportional to existing holdings
What is an open issue? - ANSWER:New shares are offered only to existing holders,
but there is no restriction on the number of new shares that they can buy
What is a public issue? - ANSWER:A method of raising capital by offering shares to
the public through an IPO
What is a private placing? - ANSWER:A method of raising capital by offering shares to
a select group of accredited investors, typically institutional investors or high net
worth individuals, outside of a public offering via a broker or an agent
How will the market react if a company announces an increase in dividend per
share? - ANSWER:If it's an agency problem (e.g. lack of +NPV projects) the share
price will decrease. If it's after +earnings the share price will increase
If you believe that the market is semi-strong form efficient, do you necessarily
believe the market is weak-form efficient as well? Is the converse true? - ANSWER:If
you believe the market is semi-strong form efficient, then you must also believe it is
weak-form efficient as past prices are included in public information. The converse is
not true.
If the market is strong-form efficient, is there any point in gathering and analysing
data about companies? - ANSWER:No, because prices will respond immediately and
appropriately to all new items of relevant information, both public and private.
Suppose you detect a pattern of seasonal movements in share prices. Are these
observations consistent with the Efficient Markets Hypothesis? - ANSWER:No,
seasonal movements are not consistent with even the weak-form of the Efficient
Markets Hypothesis, because such trading opportunities would disappear very
quickly in an efficient market
"In an efficient market, there is no systematic relationship between he level of
today's price and the levels of tomorrow's price." True or false? Explain. -
, ANSWER:True- there is no systematic relationship between today's and tomorrow's
price.
Security prices can be assumed to follow a random walk, meaning security price
change are unpredictable and are driven by relevant new information
Is the small firm in January effect consistent with any other forms of the Efficient
Markets Hypothesis? - ANSWER:It is inconsistent with the weak-form.
If effect was observed year after year, investors would buy shares in small-firm
stocks in December in anticipation of making abnormal profits when they sell in
January. This would create excess demand for these stocks, bringing the effect
forward in time, however this is not observed.
Possible explanation for the small firm in January effect - ANSWER:May reflect profit-
taking at the end of the US tax year. Small cap stocks tend to be riskier than large cap
stocks, so portfolio managers who have failed to capture the benefits of high growth
may sell these small stocks ahead of the end of the year as part of a window-dressing
strategy to make their portfolio seem more successful. They will then buy these
small stocks back after presentations, thus pushing their prices up.
M+M Proposition 1 - ANSWER:The value of the levered firm is the same as the value
of the unlevered firm.
Market value of assets should be equal if both firms have same net operating income
and business risk.
How does WACC change when a firm is levered compared to unlevered? -
ANSWER:The WACC does not change as the firms have the same business risk.
Why are internal funds the first source of financing? (2 reasons) - ANSWER:External
funding has transaction costs, whereas internal funding does not.
Internal funding also does not require public disclosure of commercial-sensitive
information
If the firm's management acts in the interest of shareholders, would management
decide to issue debt or equity if their shares are undervalued? -
ANSWER:Management would never issue shares if they are undervalued, since this
leads to dilution of wealth and voting rights. They would prefer to issue debt when
undervalued.
If the firm's management acts in the interest of shareholders, would management
decide to issue debt or equity if their shares are overvalued? -
ANSWER:Management would be glad to issue new shares because this leads to an
increase in wealth for current shareholders. They would prefer to issue equity when
overvalued.
Assume an investor observes a company making an equity offer. What is the
conclusion of an investor regarding the stock price? What is the consequence for the
issuance of securities? - ANSWER:Investors understand that the stock is overvalued,
Edition by Stanley Block, Geoffrey Hirt, Bartley Danielsen
Compare junior debt to senior debt - ANSWER:Senior debt is debt paid first in case of
liquidation, whereas junior debt is paid after senior debt is fully paid. Therefore,
junior debt is more risky because value of assets has to be higher for you to get any
payments back.
What is a rights issue? - ANSWER:A method of raising capital by offering existing
shareholders the opportunity to purchase additional shares at a discounted price,
proportional to existing holdings
What is an open issue? - ANSWER:New shares are offered only to existing holders,
but there is no restriction on the number of new shares that they can buy
What is a public issue? - ANSWER:A method of raising capital by offering shares to
the public through an IPO
What is a private placing? - ANSWER:A method of raising capital by offering shares to
a select group of accredited investors, typically institutional investors or high net
worth individuals, outside of a public offering via a broker or an agent
How will the market react if a company announces an increase in dividend per
share? - ANSWER:If it's an agency problem (e.g. lack of +NPV projects) the share
price will decrease. If it's after +earnings the share price will increase
If you believe that the market is semi-strong form efficient, do you necessarily
believe the market is weak-form efficient as well? Is the converse true? - ANSWER:If
you believe the market is semi-strong form efficient, then you must also believe it is
weak-form efficient as past prices are included in public information. The converse is
not true.
If the market is strong-form efficient, is there any point in gathering and analysing
data about companies? - ANSWER:No, because prices will respond immediately and
appropriately to all new items of relevant information, both public and private.
Suppose you detect a pattern of seasonal movements in share prices. Are these
observations consistent with the Efficient Markets Hypothesis? - ANSWER:No,
seasonal movements are not consistent with even the weak-form of the Efficient
Markets Hypothesis, because such trading opportunities would disappear very
quickly in an efficient market
"In an efficient market, there is no systematic relationship between he level of
today's price and the levels of tomorrow's price." True or false? Explain. -
, ANSWER:True- there is no systematic relationship between today's and tomorrow's
price.
Security prices can be assumed to follow a random walk, meaning security price
change are unpredictable and are driven by relevant new information
Is the small firm in January effect consistent with any other forms of the Efficient
Markets Hypothesis? - ANSWER:It is inconsistent with the weak-form.
If effect was observed year after year, investors would buy shares in small-firm
stocks in December in anticipation of making abnormal profits when they sell in
January. This would create excess demand for these stocks, bringing the effect
forward in time, however this is not observed.
Possible explanation for the small firm in January effect - ANSWER:May reflect profit-
taking at the end of the US tax year. Small cap stocks tend to be riskier than large cap
stocks, so portfolio managers who have failed to capture the benefits of high growth
may sell these small stocks ahead of the end of the year as part of a window-dressing
strategy to make their portfolio seem more successful. They will then buy these
small stocks back after presentations, thus pushing their prices up.
M+M Proposition 1 - ANSWER:The value of the levered firm is the same as the value
of the unlevered firm.
Market value of assets should be equal if both firms have same net operating income
and business risk.
How does WACC change when a firm is levered compared to unlevered? -
ANSWER:The WACC does not change as the firms have the same business risk.
Why are internal funds the first source of financing? (2 reasons) - ANSWER:External
funding has transaction costs, whereas internal funding does not.
Internal funding also does not require public disclosure of commercial-sensitive
information
If the firm's management acts in the interest of shareholders, would management
decide to issue debt or equity if their shares are undervalued? -
ANSWER:Management would never issue shares if they are undervalued, since this
leads to dilution of wealth and voting rights. They would prefer to issue debt when
undervalued.
If the firm's management acts in the interest of shareholders, would management
decide to issue debt or equity if their shares are overvalued? -
ANSWER:Management would be glad to issue new shares because this leads to an
increase in wealth for current shareholders. They would prefer to issue equity when
overvalued.
Assume an investor observes a company making an equity offer. What is the
conclusion of an investor regarding the stock price? What is the consequence for the
issuance of securities? - ANSWER:Investors understand that the stock is overvalued,
