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Chapter 14

The Role of Financial Markets in Financial Management

True/False

1. Sales occurring in the secondary markets increase the total stock of financial assets that exist in the economy.

Difficulty: Moderate

Keywords: secondary market

2. The money market is usually thought of as dealing with long-term debt instruments issued by firms with excellent credit ratings.

Difficulty: Moderate

Keywords: money market

3. Over-the-counter markets include all security markets, with the exception of organized exchanges.

Difficulty: Moderate

Keywords: over-the-counter market

4. For a firm to have its securities listed on an exchange, it must meet certain requirements. These usually include measures of profitability, size, market value, and public ownership.

Difficulty: Moderate

Keywords: listing requirements

5. A new issue of common stock is considered a primary market transaction in the money market.

Difficulty: Moderate

Keywords: primary market, capital market

6. Businesses in the aggregate spend less during a specific period than what they earn.

Difficulty: Easy

Keywords: business spending

7. The financial markets represent institutions and procedures for selling primarily real assets.

Difficulty: Moderate

Keywords: financial markets, financial assets

8. It is common practice among the largest corporations to sell their securities directly to investors.

Difficulty: Moderate

Keywords: direct transfer of funds

9. Total flotation costs expressed as a percent of the gross proceeds of a security issue tend to vary inversely with the size of the issue.

Difficulty: Moderate

Keywords: flotation costs

10. The due diligence meeting is the first in a series of pre-underwriting conferences held between the firm and its investment banker concerning a security issue.

Difficulty: Moderate

Keywords: due diligence

11. Investment bankers are concerned with the turnover of security issues and not with the margin associated with any individual issue.

Difficulty: Moderate

Keywords: investment bankers

12. The bid price is the price which a broker dealer will pay for a security; the asked price is the price at which he will sell a security.

Difficulty: Easy

Keywords: bid price, ask price

13. The underwriter’s spread is the difference between the gross and net proceeds from a given security issue expressed as a percent of the gross proceeds.

Difficulty: Moderate

Keywords: underwriter’s spread

14. In the aggregate, households usually spend more on current consumption than they earn.

Difficulty: Moderate

Keywords: household spending

15. As market interest rates increase, financial managers chose equity instruments over debt instruments when raising internal capital.

Difficulty: Moderate

Keywords: financial managers, internal capital

16. The number of shares traded in the over-the-counter markets exceeds the number of shares traded on the NYSE.

Difficulty: Moderate

Keywords: over-the-counter-markets

17. The red herring does not contain the selling price for the security.

Difficulty: Easy

Keywords: red herring

18. Corporate profits play a part in the choice firms make between using internal versus external capital.

Difficulty: Easy

Keywords: corporate profits, internal capital

19. Financial markets exist in order to allocate savings in the economy to the demanders of those savings.

Difficulty: Easy

Keywords: financial markets

20. Financing through common stock is the most popular method for corporations.

Difficulty: Moderate

Keywords: common stock financing

21. If a firm has unused debt capacity and the general level of equity prices is depressed, financial executives will favor the issuance of debt securities over the issuance of new common stock.

Difficulty: Moderate

Keywords: debt usage

22. Financial intermediaries all offer their own financial claims, called direct securities, to economic units with excess savings.

Difficulty: Moderate

Keywords: financial intermediaries, indirect securities

23. In a typical year, when new funds are being raised, corporate debt markets outweigh corporate equity markets in terms of dollar volume.

Difficulty: Easy

Keywords: capital funds, debt versus equity markets

24. It is the function of a financial intermediary to transfer funds from savers to non-savers in the economy.

Difficulty: Easy

Keywords: function of financial intermediary

25. Financial policies are forced to be more unique during times of economic expansion.

Difficulty: Moderate

Keywords: financial policy

26. Based on historical data, the percentage of external funds for non-financial businesses has been higher than the percentage of internal funds.

Difficulty: Moderate

Keywords: external funds versus internal funds

27. The U.S. tax system favors the use of debt as a means of raising capital for businesses.

Difficulty: Moderate

Keywords: debt usage, tax system

28. Consumer lending is a significant line of business for investment bankers.

Difficulty: Easy

Keywords: investment bankers

29. Common stock is the most utilized financing method used by corporations.

Difficulty: Easy

Keywords: common stock financing

30. Corporate debt markets clearly dominate the corporate equity markets when new funds are being raised.

Difficulty: Easy

Keywords: corporate debt markets

31. "Crowding out" means the private borrower is favored over the government in the financial markets.

Difficulty: Moderate

Keywords: crowding out effect

32. The key distinguishing feature between the money and capital markets is the types of securities traded in each market.

Difficulty: Easy

Keywords: money versus capital markets

33. Primary markets focus on the securities that already trade among investors.

Difficulty: Easy

Keywords: primary market

34. There is no difference between real assets and financial assets.

Difficulty: Easy

Keywords: real versus financial assets

35. In a private placement, the securities are offered and sold to a limited number of investors.

Difficulty: Easy

Keywords: private placement

36. The process of shelf registration will reduce the time needed for the firm to take an issue to market.

Difficulty: Easy

Keywords: shelf registration

37. The most popular transfer of funds that involves an investment banker is the direct sale.

Difficulty: Easy

Keywords: direct sale, transfer of funds

38. Changes in market conditions are important to the financial manager because they influence the precise way corporate funds will be raised.

Difficulty: Easy

Keywords: financial manager, market conditions

39. The corporate equity markets clearly dominate the corporate debt markets when new funds are being raised.

Difficulty: Easy

Keywords: equity versus debt, capital markets

40. The economy would not suffer unduly without a developed financial market system.

Difficulty: Easy

Keywords: role of financial markets

41. The money market refers to all institutions and procedures that provide for transactions in debt instruments with maturity periods of no more than one year.

Difficulty: Moderate

Keywords: money market

42. The commercial banker and the investment banker perform the same functions in the market.

Difficulty: Easy

Keywords: investment banker, commercial banker

43. When an investment banking firm underwrites a security issue, it assumes the risk of selling the issue at a satisfactory price.

Difficulty: Moderate

Keywords: underwriting

44. Of the two types of flotation costs, the issuing costs are larger than the underwriter’s spread.

Difficulty: Moderate

Keywords: flotation costs

45. The objective of requiring firms with new security issues to provide potential investors with accurate, truthful disclosure about the firm and the new securities being offered to the public is to prevent firms from issuing highly speculative securities.

Difficulty: Moderate

Keywords: new security requirements

46. The central characteristic of a financial market is that it acts as the vehicle through which the demand for and supply of a financial claim are brought together.

Difficulty: Moderate

Keywords: characteristics of financial markets

47. If financial assets did not exist, then saving for a given economic unit (e.g., a firm) would have to be accumulated in the form of real assets.

Difficulty: Moderate

Keywords: financial assets

48. Historically, households are the largest net supplier of funds to the financial markets.

Difficulty: Moderate

Keywords: household saving

49. Historically, the non-financial business sector of the economy is the largest net user of funds to the financial markets.

Difficulty: Moderate

Keywords: business saving

50. The non-financial business sector is typically dependent on the household sector to finance its investment needs, while the federal government sector is quite reliant on foreign financing.

Difficulty: Moderate

Keywords: business versus government sector

51. Investment banking firms perform no depository or lending functions.

Difficulty: Easy

Keywords: investment banking functions

52. Firms whose securities are traded on the registered exchanges must comply with SEC reporting requirements but do not necessarily have to comply with reporting requirements of the specific exchange.

Difficulty: Moderate

Keywords: SEC requirements

Multiple Choice

53. Money market instruments include:

a. bankers’ acceptances.

b. preferred stock.

c. corporate bonds.

d. common stock.

Difficulty: Easy

Keywords: money market instruments

54. Capital market instruments include:

a. negotiable certificates of deposit.

b. corporate equities.

c. preferred stock.

1. both b and c.
2. all of the above.

Difficulty: Easy

Keywords: capital market instruments

55. Which of the following would increase the need for external equity?

a. Inadequate investment opportunities

b. A slow-down in economic growth

c. A reduction in corporate profits

d. A seasonal reduction in sales revenues

Difficulty: Moderate

Keywords: external equity

56. When public corporations decide to raise cash in the capital markets, what type of financing vehicle is most favored?

a. Retained earnings

b. Preferred stock

c. Common stock

d. Corporate bonds

Difficulty: Easy

Keywords: bond financing

57. Benefits of an organized security exchange include:

a. helping companies raise new capital.

b. establishing and publicizing fair security prices.

c. providing a continuous market.

d. all of the above.

Difficulty: Easy

Keywords: benefits of organized exchanges

58. Activities of the investment banker include:

a. assuming the risk of selling a security issue.

b. selling new securities to the ultimate investors.

c. providing advice to firms issuing securities.

d. all of the above.

Difficulty: Easy

Keywords: activities of investment bankers

59. Which of the following does not involve underwriting by an investment banker?

a. Competitive bid purchases

b. Negotiated purchases

c. Syndicated purchases

d. Commission basis purchases

Difficulty: Moderate

Keywords: underwriting, investment bankers

60. __________ is a method of offering securities to a limited number of investors.

a. Initial public offering

b. Private placement

c. Public offering

d. Syndicated underwriting

Difficulty: Easy

Keywords: private placement

61. Which of the following is not an advantage of a private placement (as compared to a public offering)?

a. Greater financing flexibility

b. Lower flotation costs

c. Lower interest costs

d. Quicker availability of funds

Difficulty: Moderate

Keywords: private placements

62. Which of the following relationships is true, regarding the costs of issuing the below securities?

a. Common stock > bonds > preferred stock

b. Preferred stock > common stock > bonds

c. Bonds > common stock > preferred stock

d. Common stock > preferred stock > bonds

Difficulty: Moderate

Keywords: cost of issuing securities

63. Which of the following involves the issuing of securities where the investment banker assumes the risk of sale to the public?

a. Private placement

b. Privileged subscription

c. Underwriting

d. Best efforts

Difficulty: Easy

Keywords: underwriting

64. What is an example of an organized exchange?

a. OTC

b. CAPM

c. NYSE

d. NASDAQ

Difficulty: Easy

Keywords: organized exchange

65. Financial intermediaries:

a. offer indirect securities.

b. include insurance companies.

c. usually are underwriting syndicates.

1. both a and b.
2. all of the above.

Difficulty: Moderate

Keywords: financial intermediaries

66. Which of the following is the least costly method of issuing securities to the public?

a. Underwriting

b. Negotiated purchase

c. Best efforts

d. Competitive bid

Difficulty: Easy

Keywords: best efforts method

67. Which of the following is the most significant advantage of a private placement?

a. Lower interest costs

b. Less restrictive covenants

c. Reduced flotation costs

d. A bigger market of buyers of the securities

Difficulty: Moderate

Keywords: private placements

68. The __________ the biggest portion of flotation costs.

a. fees to the SEC are

b. amount paid to bond rating agencies is

c. legal and accounting fees are

d. underwriter’s spread is

Difficulty: Moderate

Keywords: underwriter’s spread

69. The _______ is the federal agency primarily responsible for regulating the securities industry.

a. FTC

b. SEC

c. FRB

d. SCC

Difficulty: Moderate

Keywords: SEC

70. __________ refer to all institutions and procedures that facilitate transactions in long-term financial securities.

a. Currency markets

b. Capital markets

c. Commodity markets

d. Money markets

Difficulty: Moderate

Keywords: capital markets

71. The SEC requires registration of a public issue in which of the following circumstances?

a. A railroad bond issue

b. An issue of commercial paper

c. A public utility issue

d. An issue of $5 million

Difficulty: Moderate

Keywords: SEC registration

72. According to the SEC, the correct sequence of events for a security issue is:

a. red herring, final prospectus, SEC registration.

b. SEC registration, red herring, final prospectus.

c. final prospectus, SEC registration, red herring.

d. red herring, SEC registration, final prospectus.

Difficulty: Moderate

Keywords: sequence of events and the SEC

73. Which of the following is not considered a real asset?

a. Preferred stock

b. Equipment

c. Land

d. Both a and b

Difficulty: Easy

Keywords: real assets

74. The trading of negotiable certificates of deposit takes place on the:

a. Chicago Board of Trade.

b. New York Stock Exchange.

c. American Stock Exchange.

d. none of the above.

Difficulty: Moderate

Keywords: negotiable certificates of deposit

75. The telecommunications system that provides a national information linkup among brokers and dealers operating in the over-the-counter market is called:

a. NCIS.

b. NSQA.

c. NASDAQ.

d. NASQ.

Difficulty: Moderate

Keywords: NASDAQ

76. Which of the following is typically a net borrower of funds when it comes to the financial markets?

a. Households

b. Investment bankers

c. Pension funds

d. Non-financial business sector

Difficulty: Moderate

Keywords: non-financial business sector

77. A __________ is a procedure for issuing new securities where the firm obtains a master registration statement approved by the SEC.

a. conditional placement

b. private placement

c. 403 (b) registration

d. shelf registration

Difficulty: Moderate

Keywords: shelf registration

78. Why are many public companies not listed in an organized exchange?

a. They are too big and, if listed, would affect the market too much.

b. Their shares of common stock trade too frequently.

c. They do not meet the listing requirements.

d. They are too profitable.

Difficulty: Moderate

Keywords: listing requirements, public firms

79. Where is the availability of prices most continuous?

a. Organized exchanges

b. OTC

c. FRB

d. NASDAQ

Difficulty: Moderate

Keywords: continuous pricing, organized exchange

80. An example of a primary market transaction is:

a. a new issue of common stock by AT&T.

b. a sale of some outstanding common stock of AT&T.

c. AT&T repurchasing its own stock from a stockholder.

d. one stockholder selling shares of common stock to another individual.

Difficulty: Moderate

Keywords: primary market transaction

81. __________ is a financial specialist who underwrites and distributes new securities of public corporations.

a. The Federal Reserve Board

b. A commercial banker

c. The SEC

d. An investment banker

Difficulty: Easy

Keywords: investment bankers

82. When crowding occurs:

a. the government borrower is pushed out of the financial markets in favor of the private borrower.

b. the private borrower is pushed out of the financial markets in favor of the government borrower.

c. the private borrower is pushed out of the financial markets in favor of the non-financial business borrowers.

d. the government borrower is pushed out of the financial markets in favor of the non-financial business borrowers.

Difficulty: Moderate

Keywords: crowding out effect

83. Savings are transferred to business firms by which of the following methods?

a. Direct transfer of funds

b. Indirect transfer using the investment banker

c. Indirect transfer using the financial intermediary

d. All of the above

Difficulty: Easy

Keywords: transfer of savings

84. The U.S. tax system favors __________ as a means of raising capital.

a. common stock

b. preferred stock

c. debt

d. IOUs

Difficulty: Easy

Keywords: debt, U.S. tax system

85. Insurance companies invest in the "long-end" of the securities market. In which of the following instruments would an insurance company be least likely to invest most of its assets?

a. Government bonds

b. Corporate bonds

c. Mortgages

d. Commercial paper

Difficulty: Moderate

Keywords: long-end investments

86. An advantage of a private placement is:

a. speed.

b. no flotation costs.

c. financial flexibility.

d. a bigger market.

Difficulty: Easy

Keywords: advantages of private placements

87. The demand for funds by the federal government puts upward pressure on interest rates causing private investors to be pushed out of the financial markets. This is called:

a. the big squeeze.

b. the efficient market hypothesis.

c. the crowding out effect.

d. liquidity preference.

e. government intervention.

Difficulty: Moderate

Keywords: crowding out effect

88. Organized security exchanges provide which of the following benefits?

a. A continuous market

b. Established and publicized fair security prices

c. Help businesses raise new capital

d. All of the above

Difficulty: Easy

Keywords: benefits of organized exchanges

89. In a direct sale, the issuing firm sells the security directly to the:

a. investing public.

b. investment banker.

c. underwriting group.

d. syndicate.

Difficulty: Easy

Keywords: direct sale

90. The investment banker performs three basic functions:

a. underwriting, distributing, and raising new capital.

b. underwriting, advising, and price-pegging.

c. underwriting, distributing, and advising.

d. underwriting, distributing, and negotiating.

Difficulty: Easy

Keywords: functions of investment bankers

91. Which of the following refers to the institutions and procedures that provide for transactions in short-term debt instruments?

a. Capital market

b. Commercial banks

c. Money market

d. Stock market

Difficulty: Moderate

Keywords: money market

92. Which of the following is NOT a benefit provided by organized security exchanges?

a. A continuous market

b. Establishing and publicizing fair security prices

c. Standardization of asset pricing models

d. Helping businesses raise new capital

Difficulty: Moderate

Keywords: benefits of organized exchanges

93. Which of the following best describes "the due diligence meeting" in the negotiated purchase sequence?

a. The meeting at the beginning of the process to select the investment banker

b. A last-chance gathering to get everything in order before taking the offering to the public

c. The first of a series of pre-underwriting conferences that will be held between the firm and the investment banker

d. None of the above

Difficulty: Moderate

Keywords: due diligence

94. Which of the following best describes the relationship between indirect securities and direct securities?

a. Indirect securities and direct securities are the same thing.

b. Financial intermediaries sell indirect securities and direct securities.

c. Financial intermediaries sell direct securities and use the proceeds to buy indirect securities.

d. Financial intermediaries sell indirect securities and use the proceeds to buy direct securities.

Difficulty: Moderate

Keywords: indirect versus direct securities

95. The opportunity cost is defined as the:

a. rate of return based on historical costs.

b. rate of return available to an investor for a given level of risk.

c. cost associated with the acquisition of investments.

d. future value of the purchase price.

Difficulty: Moderate

Keywords: opportunity cost

96. Financial managers like our system of capital markets because:

a. they trust them.

b. the markets are inefficient.

c. prices in the markets quickly and accurately reflect all available information about the value of the underlying securities.

d. both a and c.

e. all of the above.

Difficulty: Moderate

Keywords: financial managers, capital markets

97. Life insurance firms would most likely invest in:

a. short-term financial instruments.

b. mortgages and corporate bonds.

c. corporate stocks versus corporate bonds.

d. Treasury bills.

Difficulty: Moderate

Keywords: life insurance companies

98. Savings are ultimately transferred to the corporation in need of cash by:

a. the direct transfer of funds.

b. indirect transfer using the investment banker.

c. indirect transfer using the financial intermediary.

d. all of the above.

Difficulty: Easy

Keywords: transfer of funds

99. Many publicly traded firms trade in the over-the-counter market versus an organized exchange because they:

a. do not meet the requirements.

b. want to avoid reporting and fee requirements.

c. want the higher prestige of the over-the-counter market.

1. both a and b.
2. all of the above.

Difficulty: Moderate

Keywords: over-the-counter market versus organized exchange

100. More stocks are traded on the over-the-counter market than on the:

a. NASDAQ.

b. organized exchanges.

c. secondary market.

d. primary market.

Difficulty: Moderate

Keywords: over-the-counter market

101. Which of the following statements is/are false?

a. The rate of capital formation would not be as high if financial markets did not exist.

b. More financial managers participate in the financial markets and help ensure the basic concept of efficiency because security prices and returns are competitively determined.

c. Financial market participants care more about the sequence of past price changes in a specific security than about expected risks.

d. Both a and c.

Difficulty: Moderate

Keywords: financial markets

102. The investment banker:

a. assumes no risk if the security issue is sold on a best efforts basis.

b. does not assist firms with private placements, but rather only assists with public placements.

c. can analyze the firm’s existing capital structure and make recommendations about what general source of capital should be issued.

d. both a and c.

Difficulty: Moderate

Keywords: investment banker functions

103. The most prevalent method of securities distribution in the private sector is the:

a. negotiated purchase.

b. competitive bid purchase.

c. privileged subscription.

d. direct sale.

Difficulty: Easy

Keywords: negotiated purchase

104. The target market for a privileged subscription includes:

a. customers.

b. suppliers.

1. employees.
2. both a and c.
3. all of the above.

Difficulty: Easy

Keywords: privileged subscription

105. As the federal government becomes a quasi-permanent savings-deficit sector in the economy:

a. foreign financial investment becomes increasingly important to the activity of the U.S. economy.

b. the private borrower is unaffected.

c. the overall cost of capital to corporations decreases.

d. a serious problem is created for the economy but not for financial managers.

Difficulty: Moderate

Keywords: federal government funds

106. The advantage of a private placement is:

a. interest costs are generally lower than on public placement issues.

b. registration of the issue with the SEC is not required.

c. private placements generally have fewer restrictive covenants than public placement issues.

d. there is a bigger market for private placements.

Difficulty: Moderate

Keywords: private placements

107. The prices of securities that are traded on the New York Stock Exchange are established by:

a. the dealers in the listed securities.

b. the Arbitrage Pricing Model.

c. a modified continuous auction process.

d. the Capital Asset Currency Model.

Difficulty: Easy

Keywords: pricing, New York Stock Exchange

108. An example of a money market security would be:

a. a 30-year bond of Walt Disney Enterprises.

b. a U.S. Treasury bill.

c. the common stock of IBM.

d. the preferred stock of Southern California Edison.

Difficulty: Moderate

Keywords: capital market security

109. The Federal Reserve buys and sells U.S. Treasury securities in large quantities at times in order to influence short-term interest rates. The securities markets monitor changes in short-term interest rates very closely. What is the name of the closely-watched indicator that the Federal Reserve is attempting to influence by taking the above action?

a. The Lehman Brothers Corporate Bond Index

b. The Bellwether U.S. Treasury Bond rate

c. The Federal Funds rate

d. The Dow Jones Industrial Average

Difficulty: Moderate

Keywords: market indicator

110. Which of the following should be included as part of flotation costs?

a. Investment banker’s commissions

b. Fees charged by bond rating agencies

c. Legal and accounting fees

d. Both a and c

e. All of the above

Difficulty: Moderate

Keywords: flotation costs

111. Which of the following would be considered a capital market security?

a. 30-year bonds of Walt Disney Enterprises

b. Common stock shares of IBM

c. A money market mutual fund account at a brokerage house

1. Both a and b
2. All of the above

Difficulty: Moderate

Keywords: capital market

112. Which of the following is the LEAST issued security by U.S. corporations?

a. Bonds

b. Preferred stock

1. Common stock

d. Both a and b

Difficulty: Moderate

Keywords: preferred stock

113. The SEC would not require registration of a public issue if the:

a. firm sells less than $1.5 million of new securities per year.

b. issue is sold entirely intrastate.

c. issue are long-term instruments only.

1. both a and b.
2. all of the above.

Difficulty: Moderate

Keywords: SEC requirements

114. If IBM were to sell a new issue of stock to raise capital, it would be referred to as what type of transaction?

a. A primary market transaction

b. A secondary market transaction

c. A money market transaction

d. A futures market transaction

Difficulty: Moderate

Keywords: primary market transaction

115. If an investor were to sell 100 shares of Microsoft stock to another investor in the securities market, this would be referred to as what type of transaction?

a. A primary market transaction

b. A secondary market transaction

c. A money market transaction

d. A futures market transaction

Difficulty: Moderate

Keywords: secondary market transaction

116. Which sector of the U.S. economy is the largest supplier of funds?

a. U.S. government

b. Corporate business

c. State and local governments

d. Households

Difficulty: Moderate

Keywords: households, suppliers of funds

117. Which sector of the U.S. economy is the largest user of funds?

a. U.S. government

b. Corporate business

c. State and local governments

d. Households

Difficulty: Moderate

Keywords: U.S. government, net user of funds

118. The prices of securities that are traded on the over-the-counter market are established by:

a. matching supply and demand for securities by dealers who offer to buy at a bid price and sell at an asked price.

b. the Arbitrage Pricing Model.

c. a modified continuous auction process.

d. the Capital Asset Currency Model.

Difficulty: Moderate

Keywords: over-the-counter market

119. Which of the following is the most expensive method of issuing securities?

a. Best efforts basis

b. Private placement

c. Underwritten issue

d. Negotiated purchase

Difficulty: Easy

Keywords: transfer of funds

120. What is the role of the SEC as it relates to the issuance of new securities by U.S. corporations?

a. To guaranty the sale of securities to the public

b. To ensure accurate and complete disclosure of information about the issuing firm to the public

c. To reduce the cost of issuing securities to the public

d. To provide investment advice to the purchasing public

Difficulty: Moderate

Keywords: SEC functions

121. Issue costs include all of the following except:

a. trustee fees.

b. legal fees.

c. underwriter fees.

d. accounting fees.

Difficulty: Easy

Keywords: issue costs

Short Answer

122. Briefly discuss the three issues addressed in the Securities Acts Amendments of 1975.

Difficulty: Moderate

Keywords: Security Acts Amendments of 1975

123. Discuss functions or benefits provided by investment bankers to firms issuing securities.

Difficulty: Moderate

Keywords: functions of investment bankers