Introduction to Corporate Finance , Fifth Edition Booth, Cleary , Rakita Solutions Manual 1 Chapter 1 Copyright © 2020 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited. Chapter 1: An Introduction to Finance Multiple Choice Questions 1. Section: 1.1 Finance Defined Learning Objective: 1. 1 Level of difficulty : Basic CPA: Finance Solution: A 2. Section: 1.2 Real versus Financial Assets Learning Objective: 1.2 Level of difficulty : Intermediate CPA: Finance Solution: C Stocks are financial assets. Examples of real assets are residential structures, non -residential structures, machinery and equipment, durables, inventories, and land. 3. Section: 1.2 Real versus Financial Assets Learning Objective: 1. 2 Level of difficulty : Basic CPA: Finance Solution: D 4. Section: 1.2 Real Versus Financial Assets Learning Objective 1.2 Level of difficulty: Basic CPA: Finance Solution: Liquidity is typically characterized as the ability to change an asset into cash quickly. Many financial assets, for example investments such as stocks and bonds, trade on public financial markets, and their monetary value ca n be readily realized. In contrast, the process of converting a real asset, such as real estate, into cash is considered to be much more time consuming. 5. Section: 1.3 The Financial System Learning Objective: 1.3 Level of difficulty: Basic CPA: Finance Solution: B 6. Section: 1.3 The Financial System Learning Objective: 1.3 Level of difficulty : Intermediate CPA: Finance Solution: A NURSEDOCS Introduction to Corporate Finance , Fifth Edition Booth, Cleary , Rakita Solutions Manual 2 Chapter 1 Copyright © 2020 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited. In the financial system, households are the primary fund providers to government and businesses. 7. Section: 1.3 The Financial System Learning Objective: 1.3 Level of difficulty : Intermediate CPA: Finance Solution: C Banks, pension funds, and insurance firms transform the nature of the underlying financial securities. However, mutual funds do not transform the nature of the underlying financial securities. 8. Section: 1.4 Financial Instruments and Markets Learning Objective: 1. 4 Level of difficulty : Intermediate CPA: Finance Solution: C 9. Section: 1.4 Financial Instruments and Markets Learning Objective: 1.4 Level of difficulty: Intermediate CPA: Finance Solution: A marketable asset is one that can be traded between or among investors after issuance, but before expiry. The asset‘s market value will also change over time while the asset is outstanding. In contrast, non -marketable assets cannot be traded between or among investors. 10. Section 1. 5 The Global Financial Community Learning Objective: 1.5 Level of difficulty: Intermediate CPA: Finance Solution: C Practice Problems Intermediate 11. Section: 1.2 Real versus Financial Assets Learning Objective: 1.2 Level of difficulty : Intermediate CPA: Finance Solution: Balance sheet: Residential structures: $1,000 + $3,000 + $1,500 = $5,500 As there are no foreign assets or liabilities, the net worth or equity of the island is $5,500 NURSEDOCS Introduction to Corporate Finance , Fifth Edition Booth, Cleary , Rakita Solutions Manual 3 Chapter 1 Copyright © 2020 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited. This shows all of the assets and liabilities : Assets Liabilities Fred House $1,000 Debt to Friday $ 500 Robinson House 3,000 Debt to Friday 2,000 Friday House 1,500 Loan to Fred 500 Loan to Robinson 2,000 Totals $8,000 $2,500 The net worth of the economy equals total assets minus total liabilities , or $5,500. 12. Section: 1.2 The Financial System Learning Objective: 1. 3 Level of difficulty : Intermediate CPA: Finance Solution: In the financial system, there are four major sectors: households, government, business , and non-
residents. Within the field of finance , there are four major areas: personal finance, government finance, corporate finance, and internati onal finance. They closely interrelate to each other. Because they are all major parts of the whole financial system, what happens in one market will affect all the other markets. 13. Section: 1.3 The Financial System Learning Objective: 1.3 Level of difficulty : Intermediate CPA: Finance Solution: Banks take in deposits and loan them out to fund borrowers. Pension funds take in pension contributions and pay out pensions to plan participants when they retire. Insurance firms take in premiums and pay out when a certain event occurs. Mutual funds pool small funds together and make large investments that small investors cannot make. Mutual funds also offer investment expertise to ordinary investors. 14. Section: 1.3 The Financial System Learning Objective: 1.3 Level of difficulty : Intermediate CPA: Fi nance NURSEDOCS Introduction to Corporate Finance , Fifth Edition Booth, Cleary , Rakita Solutions Manual 4 Chapter 1 Copyright © 2020 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited. Solution: Five main reasons why financial and market intermediaries exist are: i) They provide anonymousness and convenience to all transaction parties. ii) They efficiently match the needs of the participants in the financial market and aggregate a ll the small transactions. iii) They have procedures for documentation of legal contracts to ensure security. iv) The risk of non -payment is alleviated by maintaining credit ratings and by controlling other accounts. v) Financial institutions transform the nature of the underlying financial securities. 15. Section: 1.4 Financial Instruments and Markets Learning Objective: 1.4 Level of difficulty : Intermediate CPA: Finance CPA: Finance Solution: The two major types of secondary markets are exchanges or auction markets , and dealer or over-
the-counter (OTC) markets. Exchanges have been referred to as auction markets because they involve a bidding process that takes place in a specific location (i.e., similar to an auction) . OTC or dealer markets do not have a physical location, but rather consist of a network of dealers who trade directly with one another . Challenging 16. Section: 1.4 Financial Instruments and Markets Learning Objective: 1.4 Level of difficulty : Challenging CPA: Finance Solution: Secondary market transactions are those where ownership of existing shares changes hands, but the corporations or governments who originally issued the securities receive no financing; trading takes place between investors. This is critical to the functio ning of the primary markets, because governments and companies would not be able to raise financing if investors were unable to sell their investments if necessary. NURSEDOCS
residents. Within the field of finance , there are four major areas: personal finance, government finance, corporate finance, and internati onal finance. They closely interrelate to each other. Because they are all major parts of the whole financial system, what happens in one market will affect all the other markets. 13. Section: 1.3 The Financial System Learning Objective: 1.3 Level of difficulty : Intermediate CPA: Finance Solution: Banks take in deposits and loan them out to fund borrowers. Pension funds take in pension contributions and pay out pensions to plan participants when they retire. Insurance firms take in premiums and pay out when a certain event occurs. Mutual funds pool small funds together and make large investments that small investors cannot make. Mutual funds also offer investment expertise to ordinary investors. 14. Section: 1.3 The Financial System Learning Objective: 1.3 Level of difficulty : Intermediate CPA: Fi nance NURSEDOCS Introduction to Corporate Finance , Fifth Edition Booth, Cleary , Rakita Solutions Manual 4 Chapter 1 Copyright © 2020 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited. Solution: Five main reasons why financial and market intermediaries exist are: i) They provide anonymousness and convenience to all transaction parties. ii) They efficiently match the needs of the participants in the financial market and aggregate a ll the small transactions. iii) They have procedures for documentation of legal contracts to ensure security. iv) The risk of non -payment is alleviated by maintaining credit ratings and by controlling other accounts. v) Financial institutions transform the nature of the underlying financial securities. 15. Section: 1.4 Financial Instruments and Markets Learning Objective: 1.4 Level of difficulty : Intermediate CPA: Finance CPA: Finance Solution: The two major types of secondary markets are exchanges or auction markets , and dealer or over-
the-counter (OTC) markets. Exchanges have been referred to as auction markets because they involve a bidding process that takes place in a specific location (i.e., similar to an auction) . OTC or dealer markets do not have a physical location, but rather consist of a network of dealers who trade directly with one another . Challenging 16. Section: 1.4 Financial Instruments and Markets Learning Objective: 1.4 Level of difficulty : Challenging CPA: Finance Solution: Secondary market transactions are those where ownership of existing shares changes hands, but the corporations or governments who originally issued the securities receive no financing; trading takes place between investors. This is critical to the functio ning of the primary markets, because governments and companies would not be able to raise financing if investors were unable to sell their investments if necessary. NURSEDOCS
