BSAD 180 Midterm Detailed Concept Questions and Answers Exam 2026

BSAD 180 Midterm Detailed Concept Questions and Answers Exam 2026 Agency Problems Who owns a corporation? Describe the process whereby the owners control the firm's management. What is the main reason that an agency relationship exists in the corporate form of organization? In this context, what kinds of problems can arise? - In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect the directors of the corporation, who in turn appoint the firm's management. This separation of ownership from control in the corporate form of organization is what causes agency problems to exist. Management may act in its own or someone else's best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximizing the share price of the equity of the firm. Not-for-Profit Firm Goals Suppose you were the financial manager of a not-for-profit business (a not-for-profit hospital, perhaps). What kinds of goals do you think would be appropriate? - 2. Such organizations frequently pursue social or political missions, so many different goals are conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and services are offered at the lowest possible cost to society. A better approach might be to observe that even a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximize the value of the equity. Goal of the Firm Evaluate the following statement: Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits. - 3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both short-term and long-term. If this is correct, then the statement is false. Ethics and Firm Goals Can the goal of maximizing the value of the stock conflict with other goals, such as avoiding unethical or illegal behavior? In particular, do you think subjects like customer and employee safety, the environment, and the general good of society fit into this framework, or are they essentially ignored? Think of some specific scenarios to illustrate your answer. - 4. An argument can be made either way. At the one extreme, we could argue that in a market economy, all of these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior, and the framework of stock valuation explicitly includes these. At the other extreme, we could argue that these are non-economic phenomena and are best handled through the political process. A classic (and highly relevant) thought question that illustrates this debate goes something like this: "A firm has estimated that the cost of improving the safety of one of its products is $30 million. However, the firm believes that improving the safety of the product will only save $20 million in product liability claims. What should the firm do?" BSAD 180 BSAD 180 International Firm Goal Would the goal of maximizing the value of the stock differ for financial management in a foreign country? Why or why not? - 5. The goal will be the same, but the best course of action toward that goal may be different because of differing social, political, and economic institutions. Agency Problems Suppose you own stock in a company. The current price per share is $25. Another company has just announced that it wants to buy your company and will pay $35 per share to acquire all the outstanding stock. Your company's management immediately begins fighting off this hostile bid. Is management acting in the shareholders' best interests? Why or why not? - 6. The goal of management should be to maximize the share price for the current shareholders. If management believes that it can improve the profitability of the firm so that the share price will exceed $35, then they should fight the offer from the outside company. If management believes that this bidder, or other unidentified bidders, will actually pay more than $35 per share to acquire the company, then they should still fight the offer. However, if the current management cannot increase the value of the firm beyond the bid price, and no other higher bids come in, then management is not acting in the interests of the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers in situations such as this. Agency Problems and Corporate Ownership Corporate ownership varies around the world. Historically, individuals have owned the majority of shares in public corporations in the United States. In Germany and Japan, however, banks, other large financial institutions, and other companies own most of the stock in public corporations. Do you think agency problems are likely to be more or less severe in Germany and Japan than in the United States? - 7. We would expect agency problems to be less severe in other countries, primarily due to the relatively small percentage of individual ownership. Fewer individual owners should reduce the number of diverse opinions concerning corporate goals. The high percentage of institutional ownership might lead to a higher degree of agreement between owners and managers on decisions concerning risky projects. In addition, institutions may be better able to implement effective monitoring mechanisms on managers than can individual owners, based on the institutions' deeper resources and experiences with their own management. Agency Problems and Corporate Ownership In recent years, large financial institutions such as mutual funds and pension funds have become the dominant owners of stock in the United States, and these institutions are becoming more active in corporate affairs. What are the implications of this trend for agency problems and corporate control? - 8. The increase in institutional ownership of stock in the United States and the growing activism of these large shareholder groups may lead to a reduction in agency problems for U.S. corporations and a more efficient market for corporate control. However, this may not always be the case. If the managers of the mutual fund or pension plan are not concerned with the interests of the investors, the agency problem could potentially BSAD 180 BSAD 180 remain the same, or even increase, since there is the possibility of agency problems between the fund and its investors. Executive Compensation Critics have charged that compensation to top managers in the United States is too high and should be cut back. For example, focusing on large corporations, Dara Khosrowshahi (now at Uber, formerly of Expedia) has been one of the best-compensated CEOs in the United States, earning about $95 million in 2016. Are such amounts excessive? In answering, it might be helpful to recognize that superstar athletes such as Cristiano Ronaldo, top earners in the entertainment field such as James Cameron and Oprah Winfrey, and many others at the top of their respective fields earn at least as much, if not a great deal more. - 9. How much is too much? Who is worth more, Larry Ellison or Tiger Woods? The simplest answer is that there is a market for executives just as there is for all types of labor. Executive compensation is the price that clears the market. The same is true for athletes and performers. Having said that, one aspect of executive compensation deserves comment. A primary reason executive compensation has grown so dramatically is that companies have increasingly moved to stock-based compensation. Such movement is obviously consistent with the attempt to better align stockholder and management interests. In recent years, stock prices have soared, so management has cleaned up. It is sometimes argued that much of this reward is due to rising stock prices in general, not managerial performance. Perhaps in the future, executive compensation will be designed to reward only differential performance, i.e., stock price increases in excess of general market increases. Goal of Financial Management Why is the goal of financial management to maximize the current value of the company's stock? In other words, why isn't the goal to maximize the future value? - 10. Maximizing the current share price is the same as maximizing the future share price at any future period. The value of a share of stock depends on all of the future cash flows of company. Another way to look at this is that, barring large cash payments to shareholders, the expected price of the stock must be higher in the future than it is today. Who would buy a stock for $100 today when the share price in one year is expected to be $80? Compounding PeriodsAs you increase the length of time involved, what happens to future values? What happens to present values? - 1. Assuming positive cash flows and interest rates, the future value increases and the present value decreases. Interest RatesWhat happens to the future value of an annuity if you increase the rate r? What happens to the present value? - 2. Assuming positive cash flows and interest rates, the present value will fall and the future value will rise. Present ValueSuppose two athletes each sign a 10-year contract for $80 million. In one case, we're told that the $80 million will be paid in 10 equal installments. In the other case, we're told that the $80 million will be paid in 10 installments, but the installments will increase by 5 percent per year. Who got the better deal? - 3. The better deal is the one with equal installments. BSAD 180 BSAD 180 APR and EARShould lending laws be changed to require lenders to report EARs instead of APRs? Why or why not? - 4. Yes, they should. APRs generally don't provide the relevant rate. The only advantage is that they are easier to compute, but, with modern computing equipment, that advantage is not very important. Time ValueOn subsidized Stafford loans, a common source of financial aid for college students, interest does not begin to accrue until repayment begins. Who receives a bigger subsidy: a freshman or a senior? Explain. - 5. A freshman does. The reason is that the freshman gets to use the money for much longer before interest starts to accrue. Treasury BondsIs it true that a U.S. Treasury security is risk-free? - 6. It's a reflection of the time value of money. TMCC gets to use the $24,099 immediately. If TMCC uses it wisely, it will be worth more than $100,000 in thirty years. Interest Rate RiskWhich has greater interest rate risk, a 30-year Treasury bond or a 30 year BB corporate bond? - 7. This will probably make the security less desirable. TMCC will only repurchase the security prior to maturity if it is to its advantage, i.e. interest rates decline. Given the drop in interest rates needed to make this viable for TMCC, it is unlikely the company will repurchase the security. This is an example of a "call" feature. Such features are discussed at length in a later chapter. Treasury PricingWith regard to bid and ask prices on a Treasury bond, is it possible for the bid price to be higher? Why or why not? - 8. The key considerations would be: (1) Is the rate of return implicit in the offer attractive relative to other, similar risk investments? and (2) How risky is the investment; i.e., how certain are we that we will actually get the $100,000? Thus, our answer does depend on who is making the promise to repay. Yield to MaturityTreasury bid and ask quotes are sometimes given in terms of yields, so there would be a bid yield and an ask yield. Which do you think would be larger? Explain. - 9. The Treasury security would have a somewhat higher price because the Treasury is the strongest of all borrowers. Coupon RateHow does a bond issuer decide on the appropriate coupon rate to set on its bonds? Explain the difference between the coupon rate and the required return on a bond. - 10. The price would be higher because, as time passes, the price of the security will tend to rise toward $100,000. This rise is a reflection of the time value of money. As time passes, the time until receipt of the $100,000 grows shorter, and the present value rises. In 2019, the price will probably be higher for the same reason. We cannot be sure, however, because interest rates could be much higher, or TMCC's financial position could deteriorate. Either event would tend to depress the security's price. Real and Nominal ReturnsAre there any circumstances under which an investor might be more concerned about the nominal return on an investment than the real return? - 1. BSAD 180 BSAD 180 No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury securities have substantial interest rate risk. Bond RatingsCompanies pay rating agencies such as Moody's and S&P to rate their bonds, and the costs can be substantial. However, companies are not required to have their bonds rated in the first place; doing so is strictly voluntary. Why do you think they do it? - 2. All else the same, the Treasury security will have lower coupons because of its lower default risk, so it will have greater interest rate risk. Bond RatingsU.S. Treasury bonds are not rated. Why? Often, junk bonds are not rated. Why? - 3. No. If the bid were higher than the ask, the implication would be that a dealer was willing to sell a bond and immediately buy it back at a higher price. How many such transactions would you like to do? Term StructureWhat is the difference between the term structure of interest rates and the yield curve? - 4. Prices and yields move in opposite directions. Since the bid pri