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Chapter 16 Financial and Risk Management MULTIPLE CHOICE QUESTIONS. Choose the one alternative that best completes the statement or answers the question. 1) Which of the following is correct with regard to the opening case entitled “The Source of a Meltdown, the Joy of a Bounce, and the Prospects Ahead"? A) The 2008 financial crisis did not start in the U.S., but that is where it had its greatest effect B) One of the key factors in causing the meltdown was low interest rates C) The financial meltdown was caused by mortgage lenders demanding too much collateral for loans D) A liquidity crisis, which is normally part of a financial meltdown, did not occur in 2008 E) All of these are correct Answer: B 2) Who is responsible for planning and controlling the acquisition and dispersal of the company's financial assets? A) Financial manager B) Accounting manager C) Sales manager D) Management information systems manager E) Purchasing manager Answer: A 3) Which term is used to identify the business activity that is concerned with determining a firm's long-term investments, obtaining the funds to pay for those investments, and conducting the firm's everyday financial activities? A) Bookkeeping B) Corporate finance C) Investment brokers D) Chartered banks E) Money markets Answer: B 4) Which of the following is not a responsibility of financial managers? A) Determining a firm's long-term investments B) Managing risks C) Obtaining loans D) Identifying markets for the company’s products in order to ensure good cash flow E) Conducting the firm's everyday financial activities Answer: D 5) ________ plan and control the acquisition and dispersal of a firm's financial resources. A) Financial managers B) The board of directors C) Production managers D) Operations mangers E) Accounting managers Answer: A 6) Which of the following represents the overall objective of financial managers? A) To ensure that the company has enough funds on hand to purchase materials needed to produce goods and services B) To ensure that the company has enough money to pay for its debts C) To increase the supply of money for the economy D) To increase the value of the firm and thus to increase shareholder wealth E) To manage the firm's cash flow Answer: D 7) What term identifies the management process of checking actual performance against the financial plans to ensure that the desired financial results occur? A) Financial control B) Activity ratios C) Working capital D) Capital structure E) Cash flow management Answer: A 8) When a firm ensures that it always has enough funds on hand to purchase the materials and human resources that it needs to produce goods and services it is exercising A) cash-flow management. B) government tax reporting. C) accounting. D) financial planning. E) financial control. Answer: A 9) ________ is the process of checking actual performance against plans to ensure that desired financial results occur. A) Cash-flow management B) Financial planning C) Accounting D) Financial control E) Government tax reporting Answer: D 10) ________ are often the backbone of financial control. A) Accounting managers B) Budgets C) Approval sign-offs D) Financial managers E) Authorized spending levels Answer: B 11) A(n) ________ describes a firm's strategies for reaching some future financial position. A) operating plan B) cash-flow statement C) balance sheet D) financial plan E) budget Answer: D 12) All of the following are responsibilities of the financial manager except A) determining a firm’s long-term investments. B) obtaining funds to pay for those investments. C) developing the firm’s financial statements. D) conducting the firm’s everyday financial activities. E) managing the risks that the firm takes. Answer: C 13) Tony is responsible for planning and controlling the acquisition and dispersal of the company's financial assets. What is Tony's job title? A) Management information systems manager B) Financial manager C) Purchasing manager D) Accounting manager E) Chief risk manager Answer: B 14) A financial manager's overall objective is to A) manage the firm’s everyday financial activities. B) decrease the risks facing the firm. C) increase the firm's value. D) manage cash. E) manage wealth. Answer: C 15) David is in the process of checking actual performance against plans to ensure that the desired financial outcome occurs. David is involved in A) cash flow management. B) financial control. C) financial planning. D) determining the firm’s long-term investments. E) obtaining funds to pay for investments. Answer: B 16) When constructing a financial plan, which one of the following questions does a financial manager not ask? A) What funds are needed to meet immediate plans? B) When will the company need more funds? C) Where can the company get the funds to meet its short-term needs? D) Where can the company get the funds to meet its long-term needs? E) How well will the stock market do next year? Answer: E 17) The “measuring stick” against which performance is evaluated is provided by A) a budget. B) a cash-flow statement. C) a financial plan. D) a balance sheet. E) debt levels. Answer: A 18) Henry has received notice from a supplier that all invoices must be paid within 30 days rather than 60 days as previously given. Which of the following will be impacted by this change? A) Inventories B) Raw materials inventory C) Accounts receivable D) Capital expenditures E) Cash flow Answer: E 19) Typically the largest single category of a firm's short-term debt is A) buildings. B) inventories. C) accounts receivable. D) accounts payable. E) equipment. Answer: D 20) Which of the following demonstrates good management of short-term debt? A) Delaying bill payments as long as possible B) Selling stock instead of bonds C) Paying bills when they are received D) Prepaying taxes E) Renting or leasing instead of buying Answer: A 21) When managers at Kraft Foods anticipate how much cheddar cheese Safeway supermarkets will buy each month and when they will pay for those purchases, Kraft is managing its A) accounts payable. B) accounts receivable. C) credit policies. D) capital expenditures. E) inventories. Answer: B 22) David is looking at a bill for supplies his company bought. It is dated May 1st and the terms are 2/10; net 30. In order to pay the least amount, when should he pay the bill? A) Any day in May B) May 10 C) May 21 D) May 31 E) May 15 Answer: B 23) Which of the following terms would a firm use to speed up cash flow? A) 1/10; net 60 B) 1/10; net 30 C) 3/10; net 30 D) 2/10; net 60 E) 2/10; net 30 Answer: C 24) Sally is looking at an invoice dated July 1st for $1000 that has terms of 2/10; net 30. If she pays the bill on July 3rd how much should she write the cheque for? A) $900 B) $980 C) $998 D) $1 000 E) $700 Answer: B 25) What represents the largest single category of short-term debt for most companies? A) Number of shares outstanding B) Accounts payable C) Corporate bonds D) Owners' equity E) Contra-assets Answer: B 26) Why is it necessary for a business firm to establish a credit policy? A) A credit policy is necessary to determine how much money the business can borrow to purchase supplies B) A credit policy is necessary to determine how dividends will be distributed to the shareholders C) A credit policy is necessary to determine which suppliers the firm needs to pay D) A credit policy is a means of accounting for the dollar value of inventory-in-process E) A credit policy provides financial managers with expected dates of payment from buyers of the firm's products and services Answer: E 27) Why is it in the firm's interest to withhold payment as long as it can? A) Withholding payment increases the value of the accounts payable that may be subsequently factored B) The longer the firm withholds payment, the longer it will have cash available for investments or other uses C) The longer it withholds interest, the higher the amount that can be factored from accounts receivable D) The longer it withholds payments the more it can raise the selling price of its own goods E) The longer it withholds funds, the lower the interest rate will be Answer: B 28) Which of the following represents a need for additional funds by business firms? A) To increase the level of accounts payable B) To obtain a long-term loan C) To meet short-term operational expenditures D) To increase the number of outstanding bonds issued by the firm E) To increase the level of accounts receivable Answer: C 29) What does a credit policy of “2/10, net 30” mean? A) If a customer pays its bill within 10 days, it will receive a 30 percent discount B) If a customer pays its bill within 30 days, it will receive a 10 percent discount C) If a customer pays its bill within 2 days, it will receive a 10 percent discount D) If a customer pays its bill within 10 days, it will receive a 2 percent discount E) None of these Answer: D 30) Jenex Corp. has a credit policy that reads “2/10, net 30.” This means that A) the company is offering a 10 percent discount if the customer pays within 2 days. B) the company will give a net reduction of 30 percent in the amount owed if the customer pays within 10 days. C) the customer will have to pay at least 10 percent of the bill by the end of 30 days. D) the customer will have to pay at least 30 percent of the bill by the end of 10 days. E) none of these. Answer: E 31) Sally would like to speed up cash flow for her company. As her financial advisor, what terms would you recommend she use on her accounts receivable? A) 1/10; net 30 B) 2/10; net 60 C) 1/10; net 60 D) 2/10; net 30 E) 3/10; net 30 Answer: E 32) ________ are purchases of fixed assets such as land, buildings, and machinery. A) Operating expenditures B) Budgeted expenditures C) Fixed expenditures D) Investments E) Long-term expenditures Answer: E 33) Which of the following is not an accurate statement about long-term expenditures? A) Long-term expenditures represent an ongoing tie-up of the firm's funds B) Normally, long-term fixed assets are not sold or converted into cash C) Long-term expenditures usually require less planning than operating expenditures D) Acquisition of fixed assets requires a very large investment of company funds E) Long-term expenditures are usually more carefully planned than short-term outlays Answer: C 34) John has received notice from a supplier that all invoices must be paid within 60 days rather than 90 days as previously given. Which of the following will be impacted by this change? A) Accounts receivable B) Capital expenditures C) Working capital D) Cash flow E) Accounts payable Answer: D 35) Scott is managing a company and he has been advised by his financial manager that his largest source of short-term debt is too high. What source of funding is Scott's financial manager probably talking about? A) Inventory loans B) Bank notes C) Credit cards D) Commercial paper E) Accounts payable Answer: E 36) The set of rules developed governing the extension of credit to customers is A) credit limit. B) credit policy. C) line of credit. D) credit terms. E) credit exchange. Answer: B 37) Scott has been informed by his financial manager that his accounts receivable are being paid much too late. To fix this problem, Scott should A) develop a credit policy. B) call the companies and request the funds. C) charge higher interest rates. D) demand that the money be paid. E) sell the late accounts to collection agents. Answer: A 38) Long-term expenditures are usually more carefully planed than short-term outlays because A) they represent a binding commitment of company funds that continues long into the future. B) they are usually sold at high-profit margins. C) they can be used to pay off accounts payable. D) the expenditures must finance items that are easily liquidated. E) all of these. Answer: A 39) Algoma Steel brings in graphite, carbon, iron ore, nickel, and sulphur to produce steel. The supplies are A) production inventory. B) merchandise inventory. C) raw materials inventory. D) work-in-process inventory. E) finished goods inventory. Answer: C 40) For Levi Strauss’ jean-making operation, rolls of denim are considered __________, while cut-but-not-yet-sewn jeans are considered ___________. A) work-in-process inventory; raw materials inventory B) short-term capital; long-term capital C) capital stock; supplies D) raw materials inventory; work-in-process inventory E) short-term credit; long-term credit’ Answer: D 41) The Gap has t-shirts boxed and ready to ship to retailers. These goods make up part of the ________ inventory. A) accounts receivable B) sales C) sales-in-process D) credit E) finished goods Answer: E 42) ATC Machine Shops sends its ________ inventory to Warm Inc. to have its manufactured tools heat-treated. A) raw materials B) work-in-process C) capital goods D) finished goods E) supplies Answer: B 43) Which of the following is an accurate statement about long-term expenditures? A) There is no such category as long-term expenditure of funds B) They represent a non-binding commitment of company funds that does not continue long into the future C) Acquisition of fixed assets requires a very large investment of company funds D) They are normally sold or converted to cash E) All of these Answer: C 44) Which of the following statements best captures the difference between long-term expenditures and short-term expenditures? A) They require long term financing, and are never sold B) They are not normally sold, and they require a large investment C) They require a large investment, and create a need to acquire long term financing D) They are not normally sold, they require a large investment, and they represent a binding commitment of funds E) All of these Answer: D 45) Capital expenditures differ from operating expenditures in that A) they are much smaller. B) they are shorter commitments. C) they are part of working capital. D) they are not budgeted. E) they are not normally sold or converted into cash. Answer: E 46) A "gentlemen's agreement" to pay for products purchased is known as A) commercial paper. B) open-book credit. C) a promissory note. D) a trade draft. E) trade credit. Answer: B 47) Which term is used to identify the granting of credit by one firm to another? A) A line of credit B) A commitment fee C) Trade credit D) A secured loan E) An inter-firm understanding of commercial intent Answer: C 48) Sources of short-term funds include all of the following except A) factoring accounts receivable. B) secured loans. C) bonds. D) unsecured loans. E) trade credit. Answer: C 49) When buyers receive merchandise along with invoices stating credit terms they have most likely been given a(n) A) trade acceptance. B) line of credit. C) revolving credit agreement. D) promissory note. E) open-book credit. Answer: E 50) Mega has just shipped one of its products to Compu cell on faith that they will pay the invoice. This is a(n) A) trade acceptance. B) revolving credit agreement. C) line of credit. D) open-book credit. E) promissory note. Answer: D 51) What is a promissory note? A) A "gentleman's agreement" to pay for products which were shipped on faith that the payment would be forthcoming B) A short-term loan which uses accounts receivable as collateral for a loan C) An agreement signed by the buyer stating when and how much money will be paid to the seller in return for immediate credit D) The requirement for a firm to maintain a certain amount of funds on deposit with the lending bank E) The right given to a bank to seize certain assets if payment is not made when due Answer: C 52) If a firm is not a good credit risk and the seller wants more reassurance, the seller may require the signing of a(n) ________ prior to shipping the merchandise. A) promissory note B) trade acceptance C) open-book credit D) line of credit E) revolving credit agreement Answer: A 53) Before shipping a computer, Mega Computer has insisted that its buyer sign a document that states when and how much money will be paid. This is a(n) A) line of credit. B) revolving credit agreement. C) open-book credit. D) trade acceptance. E) promissory note. Answer: E 54) What is a trade draft? A) A type of secured loan with trade products serving as collateral B) A means of pledging accounts receivable C) An agreement to meet certain terms, which are attached to the shipment, and which must be signed before the goods are delivered to the buyer D) A legal agreement promising to pay for the goods, which is signed by the buyer before the seller will ship the goods E) A standing agreement between a bank and a firm Answer: C 55) A form of trade credit that is particularly useful for international transactions is A) trade acceptance. B) line of credit. C) revolving credit agreement. D) open-book credit. E) promissory notes. Answer: A 56) Jack is setting up a global operation. The form of trade credit that is particularly useful for Jack's international transactions would be A) revolving credit agreement. B) promissory notes. C) trade acceptance. D) line of credit. E) open-book credit. Answer: C 57) Along with a computer, Mega Computers has included an invoice stating credit terms and trusting that the buyer will pay the invoice. This is a(n) A) line of credit. B) trade acceptance. C) open-book credit. D) revolving credit agreement. E) promissory notes. Answer: C 58) The most common form of trade credit is A) open-book credit. B) short term loans. C) trade drafts. D) trade acceptances. E) promissory notes. Answer: A 59) Sallyanne is selling merchandise to a retailer using the terms of a trade draft. As a new employee of Sallyanne's, you find out that a trade draft is A) a means of pledging accounts receivable. B) an agreement to meet certain terms, which is attached to the shipment and which must be signed before the goods are delivered to the buyer. C) a legal agreement promising to pay for the goods, which is signed by the buyer before the seller will ship the goods. D) a type of secured loan with trade products serving as collateral. E) the seller ships products on faith that payment will be forthcoming. Answer: B 60) What is a trade draft? A) A standing agreement between a bank and a firm B) A means of pledging accounts receivable C) A type of secured loan with trade products serving as collateral D) A legal agreement promising to pay for the goods, which is signed by the buyer before the seller will ship the goods E) An agreement that is attached to a merchandise shipment by the seller which states the promised date and amount of payment due Answer: E 61) Sallyanne is selling merchandise to Jack's Machine Shop. Sallyanne felt secure in receiving payment because she had Jack sign a promissory note. Sallyanne felt secure because a promissory note is A) an agreement signed by the buyer stating when and how much money will be paid to the seller in return for immediate credit. B) the requirement for a firm to maintain a certain amount of funds on deposit with the lending bank. C) a "gentleman's agreement" to pay for products which were shipped on faith that the payment would be forthcoming. D) the right given to a bank to seize certain assets if payment is not made when due E) basically the same thing as a trade acceptance. Answer: A 62) Jack and Sam have been doing business for years. Since they have built a mutual trust they choose to use a "gentlemen's agreement" to pay for products. This is known as A) commercial paper. B) a promissory note. C) open-book credit. D) a trade draft. E) trade credit. Answer: C 63) All of the following are forms of trade credit except A) open-book credit. B) a secured loan. C) promissory notes. D) trade draft. E) trade acceptance. Answer: C 64) Along with a computer, Mega Computers has sent a document that states the promised payment date and amount. The buyer must sign it before taking the computer. This is a(n) A) open-book credit. B) trade draft. C) revolving credit agreement. D) promissory note. E) line of credit. Answer: B 65) Which term is used to identify a bank's requirement for the borrower to give the bank the right to seize certain assets if payments are not made as promised? A) Pledging accounts payable B) Open-book credit C) Pledging accounts receivable D) Collateral E) Trade acceptance Answer: D 66) Which of the following requires the borrower to put up collateral? A) Commercial paper B) Unsecured loans C) Secured loans D) Trade credit E) Line of credit Answer: C 67) Which of the following would a bank most likely offer? A) Commercial paper B) Trade credit C) Trade drafts D) Short-term bonds E) Secured loans Answer: E 68) Secured, short-term loans are usually secured by A) deposits with the bank. B) fixed assets. C) inventories. D) commercial paper. E) trade credit. Answer: C 69) For a specific firm, which of the following is most likely to carry the lowest interest rate? A) Loan secured by fixed assets B) Commercial paper C) Loan secured by finished goods D) Unsecured loan E) Loan secured by raw materials Answer: C 70) Which type of inventory represents the best type of collateral? A) Inventory which is difficult to transport is better collateral than inventory which can be easily moved B) Inventory which can be easily converted into cash C) Raw materials inventory D) Inventory which is already serving as collateral for another loan E) Work-in-process inventory Answer: B 71) Which of the following is not a means of providing security for short-term loans? A) Pledging marketable securities B) Corporate bonds C) Inventory loans D) Pledging finished goods E) Pledging accounts receivable Answer: B 72) The process of using accounts receivable as collateral for a short-term loan is known as A) collateralizing accounts receivable. B) commercial paper. C) pledging accounts receivable. D) factoring accounts receivable. E) equity financing. Answer: C 73) Which of the following is usually associated with unsecured short-term loans? A) Trade drafts B) Compensating balances C) Collateral D) Trade acceptances E) Factoring Answer: B 74) How may a firm obtain an unsecured short-term bank loan? A) Obtain open-book credit B) Provide a fixed asset as a guarantee of payment C) Pledge accounts receivable D) Obtain a line of credit agreement E) Obtain an inventory loan Answer: D 75) When is a commitment fee required of the borrower by a lending institution? A) When using a revolving credit agreement in which the bank holds an open line of credit for a borrower B) When issuing commercial paper C) A commitment fee is never required because it is illegal for lending institutions to charge a commitment fee D) When using collateral to secure a bank loan E) When using trade credit Answer: A 76) Which of the following requires a commitment fee? A) Line of credit B) Factoring C) Revolving credit agreement D) Trade acceptance E) Commercial paper Answer: C 77) Which of the following guarantees that funds will be available? A) Trade credit B) Pledging assets C) Trade draft D) Line of credit E) Revolving credit agreement Answer: E 78) A(n) ________ is a standing agreement between a bank and a business in which the bank promises to lend the firm a maximum amount of funds on request. A) open-book credit B) line of credit C) trade agreement D) commercial paper E) revolving line of credit Answer: B 79) Which of the following is backed solely by the firm's promise to pay? A) Trade credit B) Factoring accounts receivable C) Promissory note D) Commercial paper E) Pledging accounts receivable Answer: D 80) Commercial paper can extend up to ________ days. A) 90 B) 120 C) 365 D) 180 E) 270 Answer: E 81) What is the difference between factoring accounts receivable and using accounts receivable as collateral for a short-term loan? A) Factoring is the collateral used when issuing commercial paper B) There is no difference C) Factoring involves selling the accounts receivable instead of using them to obtain a loan D) Factoring accounts receivable is accomplished through a finance company whereas using them as collateral is arranged with a bank E) Factoring involves agreeing to repurchase accounts receivable at a future date instead of using them as collateral to obtain a loan Answer: C 82) Which of the following is a short-term source of funds for an organization? A) Issuing corporate bonds B) Factoring accounts receivable C) Issuing common stock D) Issuing preferred stock E) Obtaining financial help from a venture capitalist Answer: B 83) Why is it necessary for a business firm to put up collateral when it takes out a loan? A) So that the bank can keep a portion as advance payment on the loan B) To show the bank that the business is big enough to require the loan C) To assure the bank that loan payments will be made as promised D) So the financial managers know dates of payment E) So that the accounting people can generate accurate financial statements Answer: C 84) The Royal Bank has the right to seize assets if payments are not made as promised because the borrower A) pledged their accounts receivable. B) agreed to a trade acceptance. C) pledged their accounts payable. D) allowed the bank to open-book credit. E) secured the payment with collateral. Answer: E 85) Which of the following is considered a financing method for short-term funds? A) Retained earnings B) Trade credit C) Equity financing D) Common stock E) Bonds Answer: B 86) Collateral is A) any asset that a lender has the right to seize if a borrower does not repay a secured loan. B) when you use your forecasted sales to secure a loan. C) the use of someone's signature in order to secure a loan. D) when you use liquidated assets to pay off a loan. E) any of these can be collateral. Answer: A 87) Collateral would be needed in which of the following? A) Trade credit B) Unsecured loans C) A line of credit D) Commercial paper E) Secured loans Answer: E 88) Jack is borrowing money which requires him to put up collateral. What type of credit is he using? A) Line of credit B) Unsecured loans C) Trade credit D) Commercial paper E) Secured loans Answer: E 89) The process of using accounts receivable as collateral is called ___________; the specific means by which the money is raised is called ___________. A) commercial paper; factoring B) factoring; commercial paper C) pledging accounts receivable; factoring D) equity financing; debt financing E) short-term credit; long-term credit Answer: C 90) You are managing a company that needs a quick injection of cash. Two ways of raising secured funds quickly are A) bank loans and lines of credit. B) inventory loans and factoring accounts receivable. C) inventory loans and accessing accounts receivable. D) accounts receivable and trade credit. E) lines of credit and commercial paper. Answer: B 91) John is a factor who has just bought $40,000 worth of finished goods for $24,000. The profit that he will make on this transaction depends on A) the quality of the receivables, the cost of collecting them, and interest rates. B) the cash he has available, and the trade credit he is able to get. C) the availability of government loans, the quality of the receivables, and the interest rate. D) the interest rate, the cost of collecting the receivables, and the maturity date of bonds of his company. E) the general state of the economy, the number of firms who might be interested in the receivables, and the amount of money those firms have available. Answer: A 92) What is the difference between a line of credit and a revolving credit agreement? A) A line of credit is normally used by charitable and public-sector organizations, while a revolving credit agreement is usually used by private-sector business firms B) More money can be borrowed with a line of credit than with a revolving credit agreement C) There is no guarantee that the money will be available when it is requested in a line of credit, but there is an agreement that it will be available when requested in a revolving credit agreement D) A line of credit is only obtainable from a credit union, while a revolving credit agreement is only obtainable from a bank E) All of these Answer: C 93) Commercial paper is usually issued for a specific period ranging from ________ days to ________ days but it legally can be issued for ________ days. A) 30; 60; 180 B) 60; 90; 120 C) 90; 120; 180 D) 30; 90; 180 E) 30; 90; 270 Answer: E 94) Which of the following does not create an obligation to pay a sum of money in the future? A) Revolving line of credit B) Factoring accounts receivable C) Commercial paper D) Line of credit E) Trade agreement Answer: B 95) When a bank agrees to make some amount of funds available on demand to a firm for continuing short-term loans, and when the bank guarantees that the money will be available when requested, this is a(n) A) unsecured loan. B) revolving credit arrangement. C) secured loan. D) accounts receivable loan. E) bond. Answer: B 96) When is a commitment fee required of the borrower by a lending institution? A) When using a revolving credit agreement in which the bank holds an open line of credit for a borrower B) When using trade credit C) When issuing commercial paper D) When using collateral to secure a bank loan E) It is illegal for lending institutions to charge a commitment fee Answer: A 97) Monolith Corp.’s credit rating is so high that it is able to issue ________, which is backed solely by the firm's promise to pay. A) accounts receivable B) commercial paper C) promissory notes D) trade credit E) debentures Answer: B 98) Which of the following is a primary source of long-term borrowing from outside the corporation? A) A long-term loan from a bank B) Inventory loans C) Insurance D) Factor accounts receivable E) Trade credit Answer: A 99) Why does a business firm require long-term sources of funds? A) To finance long-term expenditures for fixed assets B) A long-term source of funds replaces the need for insurance C) To obtain funds for purchasing inventories D) To eliminate the need for frequently seeking short-term financing E) To finance annual bonus payments for employees Answer: A 100) The two primary sources of long-term debt funds are A) lines of credit and revolving credit agreements. B) common stock and preferred stock. C) trade credit and commercial paper. D) commercial paper and bank loans. E) long-term loans and the sale of bonds. Answer: E 101) Which of the following is a source of long-term borrowing from outside the corporation? A) Corporate bonds B) Sale of equity shares C) Commercial paper D) Line of credit E) Inventory loans Answer: A 102) Which of the following is a restriction that may be placed on a borrowing firm for a long-term loan? A) The borrower must pledge a certain amount of inventory B) The borrower must pledge future sales C) The borrower must factor accounts receivable D) The borrower must pledge long-term assets as collateral E) The borrower must pledge accounts receivable Answer: D 103) What is the major source of long-term debt financing for most corporations? A) Corporate bonds B) Long-term loans C) Trade credit D) Equity financing E) Retained earnings Answer: A 104) Which of the following is a long-term source of funds? A) Open-book credit B) Revolving credit agreement C) Line of credit D) Commercial paper E) Equity financing Answer: E 105) Which of the following is not one of the advantages of loans as a source of large, long-term funds? A) Ease of finding lenders B) No public disclosure C) Terms can be changed D) Flexible time duration E) Can be quickly arranged Answer: A 106) Which of the following is not specified in the bond indenture? A) Interest rate B) Maturity date C) Who gets paid D) Amount to be paid E) Collateral Answer: C 107) Mega Computer needs a large amount of long-term financing for a long period of time. The best choice is most likely A) loans. B) preferred stock. C) common stock. D) commercial paper. E) bonds. Answer: E 108) If a bond issuer fails to make a bond payment, it is said to be A) bankrupt. B) over-due. C) in arrears. D) in default. E) non-conforming. Answer: D 109) Which of the following would require General Motors to publicly disclose the purpose for which funds are being sought? A) Long-term loan B) Sale of preferred stock C) Short-term loan D) Sale of common stock E) Sale of bonds Answer: E 110) A form of hybrid financing is A) preferred stock. B) factoring. C) common stock. D) commercial paper. E) bonds. Answer: A 111) Which of the following is correct with regard to the box entitled “An Online Community for People 50 and Over”? A) 55-Alive is a social networking site B) 55-Alive has so far been financed with Kelly and Jeff Lantz’s own money C) 55-Alive needs outside funding to expand the site’s content D) 55-Alive receives only about 100,000 visits per month E) All of these are correct Answer: A 112) Which of the following is not an advantage of raising financing through the sale of preferred shares? A) Payments need not be made if the company makes no profit B) Payments are tax deductible C) Does not require repayment at maturity D) No loss of control E) Flexibility in cash flow Answer: B 113) Manitoba Hydro has steady, predictable profits and cash-flow patterns. Its best choice for long-term funding is most likely A) factoring accounts receivable. B) common stock. C) either common or preferred stock but not bonds. D) preferred stock. E) bonds. Answer: E 114) In most cases, equity financing takes two forms A) revolving credit agreements and lines of credit. B) bank loans and commercial paper. C) issuing common stock and retaining the firm's earnings. D) issuing common stock and lines of credit. E) commercial paper and retaining the firm's earnings. Answer: C 115) John is a financial planner who wants to appeal to the broadest possible market and gain access to more funds. Which of the following would he use? A) Long-term debt B) A financial risk index C) A variety of debt and equity forms D) Factoring accounts receivable E) Equity Answer: C 116) The mix of debt and equity funding that a firm uses is called its A) long-term funding mix. B) financial mix. C) corporate capital mix. D) capital structure. E) debt-to-equity ratio. Answer: D 117) Which of the following is the most conservative mix of long-term funding? A) 25% debt, 75% equity B) 75% debt, 25% equity C) 100% equity D) 100% debt E) 50% debt, 50% equity Answer: C 118) Which of the following is the riskiest mix of long-term funding? A) 25% debt, 75% equity B) 100% equity C) 50% debt, 50% equity D) 75% debt, 25% equity E) 100% debt Answer: E 119) Laura is analyzing several investment possibilities. She thinks that some options have better chances of good paybacks but those paybacks are smaller. She is exploring the A) cash flow trade-off. B) cash flow decision. C) risk-return relationship. D) safety factor. E) risky principle. Answer: C 120) ________ shows the amount of risk and the likely rate of return on various financial instruments. A) An umbrella relationship B) A riskiness diagram C) A graph D) The risk rate of return E) The risk-return relationship Answer: E 121) Bonds that have the highest default rate and the highest yield rate are ________ bonds. A) high grade B) investment grade C) mixed grade D) income grade E) junk Answer: E 122) In the financial community, the uncertainty about receiving future cash flows and the likely amount of those cash flows is called the A) cash flow decision. B) safety factor. C) risky principle. D) risk-return relationship. E) cash flow trade-off. Answer: D 123) The principle that safer investments tend to offer lower returns while riskier investments tend to offer higher returns is called the A) safety factor. B) risk-return relationship. C) risky principle. D) cash flow trade-off. E) cash flow decision. Answer: B 124) What is the difference between debt and equity financing? A) Debt financing is more expensive than equity financing B) Equity financing is cheaper than debt financing because no money has to be paid back to the people who bought the company’s stock C) Debt financing is riskier than equity financing because with debt financing debts are incurred which must be paid back D) Debt financing is more short-term oriented than equity financing E) Equity financing can be done successfully only when stock markets are rising, whereas debt financing can be done any time Answer: C 125) All of the following are advantages of long-term loans except A) the number of parties is limited. B) loans can be arranged quickly. C) the duration of the loan can be matched to the borrower’s needs. D) they may require the pledging of assets as collateral. E) if the firm’s needs change, the terms of the loan can be changed. Answer: D 126) Which of the following is correct with respect to long-term loans? A) Businesses try to avoid them whenever possible because banks charge high interest rates B) Large borrowers may have trouble finding lenders to supply enough funds C) Once a loan’s terms are set, they cannot be changed until all the money is paid back D) Loans are difficult to arrange quickly E) The time frame of the loan may be difficult to match with the borrower’s needs Answer: B 127) Which of the following most closely resembles commercial paper? A) Line of credit B) Corporate bond C) Inventory loan D) Accounts payable loan E) Bank loan Answer: B 128) Which of the following is specified in the bond indenture? A) Maturity date B) Collateral C) Interest rate D) Amount to be paid E) All of these Answer: E 129) Which of the following would be a likely result of using retained earnings to provide long-term funds? A) Smaller dividends to stockholders B) Increased interest expenses C) Loss of corporate ownership control D) Stock price may drop E) Smaller dividends to stockholders and the company’s stock price may drop Answer: E 130) Stockholders usually purchase common stock for ________ and ________. A) dividends; appreciation of the stock price B) dividends; interest C) control; appreciation of the stock price D) right to vote at meetings; dividends E) retained earnings; profit Answer: A 131) If Sunshine Tanning's founders invested $10,000 by buying the original 500 shares at $20.00 per share in 1994 and then raised $50,000 by selling 500 more shares at $100 per share, the additional paid-in capital would bring shareholder's equity to A) $40,000 B) $50.00 per shareholder C) $60,000 D) $51,000 E) $100.00 per shareholder Answer: C 132) Equity financing includes A) retained earnings, retaining dividends. B) issuing common stock, issuing preferred stock, retained earnings. C) issuing common stock, retained earnings. D) issuing preferred stock, issuing common stock. E) issuing preferred shares, retained earnings. Answer: C 133) Algoma Steel issued 1,000 common shares at a price of $15.00 each. If all shares sold, Algoma could expect to raise A) $14,000. B) $1,500. C) $15,000. D) $1,000. E) it is not possible to tell with the information that is given. Answer: C 134) Equity financing via common stock can be more expensive than issuing bonds because A) common stocks must be insured. B) there is more administration involved. C) common stocks are backed by retained earnings. D) common stock must be sold through a broker. E) interest paid to bondholders is a tax-deductible business expense, but stock dividends are not tax-deductible. Answer: E 135) Using retained earnings as a source of equity financing has one major disadvantage, which is A) the stockholders do not receive dividends. B) the firm will have to pay the interest to common shareholders. C) the price of the company's stock will increase because the company is using sound financial planning. D) the firm will not have to borrow money. E) there are actually no disadvantages in using retained earnings as a source of equity. Answer: A 136) Adrianna decided to purchase preferred shares because A) common stockholders get paid first at a lower rate of return and preferred shareholders get paid next at a much higher rate of return. B) it has some of the features of corporate bonds and some features of common stock. C) preferred shares allow shareholders to choose whether they wish to receive cash dividends or more shares. D) preferred shares mature very quickly. E) she likes the variable interest rate paid by preferred shares. Answer: B 137) Falling somewhere between debt and equity financing, ________ are also referred to as ___________. A) retained earnings; debt financing B) promissory notes; hybrid financing C) common shares; preferred shares D) preferred shares; hybrid financing E) preferred shares; debt Answer: D 138) What is the capital structure of a firm? A) The organizational structure of the firm’s domestic, but not international, operations B) The mix of debt and equity in the firm's financial base C) The balance of short- and long-term debt D) The number of shares outstanding multiplied by the value of a given share E) The total amount of dividends and bond interest payments that must be made in a given year Answer: B 139) What are the two variables that are used to determine where a specific financial instrument will be placed on the risk-return continuum? A) The prime interest rate and the quality of the company in question B) The amount of debt and the amount of equity the company has C) The size of the financial returns that must be offered to induce investment and the uncertainty about financial returns on investments D) The size of the financial returns that must be offered to induce investment and the economic growth prospects over the next year E) The mix of short- and long-term sources of funds the firm is using Answer: C 140) The most conservative investments are government savings bonds and bank GICs. In decreasing order of conservativeness, the next two investments are A) medium-quality preferred stock and high-grade corporate bonds. B) commercial paper and lower-quality common stocks. C) high-grade corporate bonds and commercial paper. D) commercial paper and medium-quality preferred stocks. E) junk bonds and high-grade corporate bonds. Answer: C 141) The least conservative investments are low-quality common stocks. In decreasing order of aggressiveness, the next two investments are A) medium-quality preferred stock and high-grade corporate bonds. B) commercial paper and lower-quality common stocks. C) junk bonds and medium-quality preferred stocks. D) commercial paper and medium-quality preferred stocks. E) junk bonds and high-quality cyclical common stocks. Answer: E 142) After analyzing several investment possibilities, June concludes that options that have a better chance of giving a payback also (unfortunately) have a higher likelihood of giving a smaller payback. June has just discovered the notion of the A) risk-return relationship. B) cash flow trade-off. C) debt-to-equity ratio. D) safety factor. E) cash flow decision. Answer: A 143) All of the following are reasons for new start-up businesses being under-funded except A) entrepreneurs underestimate the value of establishing bank credit. B) entrepreneurs use trade credit ineffectively. C) entrepreneurs fail to consider venture capital as a source of funding. D) entrepreneurs are notorious for not planning cash flow properly. E) entrepreneurs rely too much on equity financing and not enough on debt financing. Answer: E 144) Samantha is planning to start a new business. The bank has requested she complete ________ so that her cash flow projections can be more understandable. A) a statement of cash flows B) a business plan C) a consumer analysis D) a sales forecast E) a risk-return analysis Answer: B 145) Samantha should prepare a cash flow requirements projection because A) she can see how much anticipated taxes she will have to pay. B) by anticipating shortfalls, she can seek funds in advance and minimize their cost, and by anticipating excess cash she can plan to put funds to work in short-term, interest-bearing investments. C) she will be able to plan her vacation. D) she will know when to hire extra staff for peak periods. E) she will need this information when she is planning for an initial public offering of her company’s stock. Answer: B 146) The business plan outlines all of the following except A) who the money will be paid to. B) how the money will be used to improve the company. C) how much money is needed. D) when the money will be paid back. E) why the money is needed. Answer: A 147) The risk associated with designing and distributing a new product is a(n) ________ risk. A) “act of God” B) speculative C) financial D) market E) pure Answer: B 148) The risk associated with the chance of a warehouse fire is a(n) ________ risk. A) ”act of God” B) pure C) speculative D) financial E) market Answer: B 149) What type of risk involves only the possibility of a loss? A) optimal risk B) pure risk C) risk transfer D) insurable risk E) speculative risk Answer: B 150) Which of the following is the first step in managing risk? A) Choose techniques that best handle the loss B) Identify risks and potential losses C) Implement the risk management program D) Measure the frequency of losses E) Transfer the risk Answer: B 151) ________ risks involve the possibility of gain or loss. A) ”Acts of God” B) Financial C) Speculative D) Pure E) Market Answer: C 152) Conserving the firm's earning power and assets by reducing the threat of losses due to uncontrollable events is ________ management. A) disaster B) financial C) risk D) insurance E) contingency Answer: C 153) The second step in a risk management program is to A) measure frequency and severity of potential losses. B) monitor results of the program. C) evaluate alternatives. D) implement the program. E) identify risks and potential losses. Answer: A 154) The final step in a risk management program is to A) measure frequency and severity of potential losses. B) identify risks and potential losses. C) monitor results of the program. D) implement the program. E) evaluate alternatives. Answer: C 155) Which of the following methods of risk management is a business firm practising when it chooses to terminate its delivery system to avoid the risk of physical damage or injury? A) Risk shift B) Risk control C) Risk transfer D) Risk avoidance E) Risk retention Answer: D 156) When a pharmaceutical maker withdraws a new drug for fear of liability suits it is practising A) risk avoidance. B) risk shift. C) risk control. D) risk transfer. E) risk retention. Answer: A 157) A firm that buys an insurance policy to protect itself against automobile wrecks is practising A) risk avoidance. B) risk transfer. C) risk acceptance. D) risk control. E) risk retention. Answer: B 158) Paying employee medical costs out of company funds rather than buying insurance is an example of A) risk avoidance. B) risk transfer. C) risk control. D) risk retention. E) risk shift. Answer: D 159) Installing a new sprinkler system is an example of A) risk retention. B) risk avoidance. C) risk transfer. D) risk shift. E) risk control. Answer: E 160) Which one of the following risk management techniques does a firm practise when it chooses self-insurance instead of submitting claims to an insurance company? A) Risk transfer B) Risk avoidance C) Risk retention D) Risk control E) Risk shift Answer: C 161) If a restaurant buys an insurance policy that covers vandalism losses up to $40,000, this is an example of the risk management strategy of A) risk retention. B) risk avoidance. C) risk control. D) risk transfer. E) risk shift. Answer: D 162) If riot police officers are trained to handle violent soccer fans, this is an example of the ________ strategy for risk management. A) risk avoidance B) risk transfer C) risk control D) risk retention E) risk shift Answer: C 163) Risk avoidance is A) the practice of evaluating all costs associated with a decision. B) the assumption of financial consequences of loss by the firm. C) the shifting of the risk to an insurance company. D) the practice of minimizing the frequency or severity of losses from risky activities. E) the practice of avoiding risk by declining or ceasing to participate in an activity. Answer: E 164) Risk control is A) the practice of minimizing the frequency or severity of losses from risky activities. B) the practice of avoiding risk by declining or ceasing to participate in an activity. C) the assumption of financial consequences of loss by the firm. D) the shifting of the risk to an insurance company. E) the practice of evaluating all costs associated with a decision. Answer: A 165) Risk retention is A) the practice of avoiding risk by declining or ceasing to participate in an activity. B) the practice of evaluating all costs associated with a decision. C) the shifting of the risk to an insurance company. D) the practice of minimizing the frequency or severity of losses from risky activities. E) the assumption of financial consequences of loss by the firm. Answer: E 166) Blake Corp. wants to transfer its risk to another organization. Which of the following methods would it most likely use? A) surety bonds B) fidelity bonds C) premiums D) contracts E) insurance Answer: E 167) A business firm which purchases insurance is attempting to A) eliminate risk. B) transfer the risk. C) avoid the risk. D) reduce the risk to an acceptable level. E) reduce risk to zero. Answer: B 168) Which of the following represents the reason that insurance companies are willing to assume the risk of certain potentially devastating losses for other companies? A) Insurance companies have more experience with the risk B) In return for a sum of money, they are protected against certain losses C) Profit D) The ultimate purpose of insurance is to indemnify policyholders E) Insurance companies know the likelihood of a particular loss Answer: C 169) Risk transfer is A) the assumption of financial consequences of loss by the firm. B) the practice of avoiding risk by declining or ceasing to participate in an activity. C) the shifting of the risk to an insurance company. D) the practice of minimizing the frequency or severity of losses from risky activities. E) the practice of evaluating all costs associated with a decision. Answer: C 170) Insurance companies make money by taking in more from ________ than they pay out to cover policy-holders' losses. A) receivables B) revenues C) dues D) premiums E) dividends Answer: D 171) ________ are fees paid by a policy-holder for insurance coverage. A) Dividends B) Revenues C) Receivables D) Premiums E) Dues Answer: D 172) Jarvis Corp. is expanding its product line; this is an example of ________ risk. A) speculative B) avoidance C) pure D) transferable E) financial Answer: A 173) Magnum Corp. has embarked on a risk-management process. They have just completed identifying risks and potential losses. What should they do next? A) Choose techniques that best handle the loss B) Implement the risk management program C) Measure the frequency and severity of losses D) Transfer the risk E) Evaluate alternatives for handling risk Answer: C 174) Jerold Corp. has recently bought a fire insurance policy. This is an example of which approach to risk? A) Risk control B) Risk transfer C) Risk retention D) Risk avoidance E) Risk severity Answer: B 175) Parker Corp. has decided to pay employee medical costs out of company funds rather than buying insurance. This is an example of A) risk control. B) risk avoidance. C) risk transfer. D) risk shift. E) risk retention. Answer: E 176) Quick-X Corp. has recently sent its delivery drivers to a defensive driving course in order to reduce accidents with company vehicles. This is an example of A) risk shift. B) risk control. C) risk transfer. D) risk retention. E) risk avoidance. Answer: B 177) Approximately how much money is lost to insurance fraud each year in Canada? A) More than $100 million B) More than $300 million C) More than $1 billion D) More than $4 billion E) More than $11 billion Answer: C 178) Generally speaking, what is the best approach to use when coping with potential losses? A) Risk transfer B) Risk avoidance C) Risk control D) Risk retention E) There is no one best option; it depends on the circumstances Answer: E 179) What is the fundamental reason that insurance companies are willing to assume the risk of certain potentially devastating losses for other companies? A) To indemnify policyholders B) To protect companies against specific losses they might incur C) To identify the likelihood of specific losses D) To make a profit E) To help small business owners who cannot afford large losses Answer: D TRUE/FALSE QUESTIONS. Write 'T' if the statement is true and 'F' if the statement is false. 180) The overall objective of the financial manager is to invest the firm's money wisely. Answer: False 181) A financial manager's overall objective is to increase the value of the firm and thus to increase shareholders' wealth. Answer: True 182) A financial plan describes how a business will reach some financial position it seeks for the future. Answer: True 183) The accounting manager is usually responsible for cash-flow management. Answer: False 184) Budgets are often the backbone of financial control. Answer: True 185) The responsibilities of financial managers fall into three general categories: cash flow management, financial control, and financial planning. Answer: True 186) One study showed that businesses that average about $2 million in annual sales hold about $40,000 in non-interest bearing accounts. This is an example of good cash flow management. Answer: False 187) To increase a firm's value, financial managers must ensure that it always has enough funds on hand to purchase the materials and human resources that it needs to produce goods and services. Answer: True 188) Accurate information about current cash status ensures good cash management. Answer: False 189) Accounts payable is the largest single category of short-term debt for most companies. Answer: True 190) It is in the firm's best interest to pay its accounts payables as rapidly as possible. Answer: False 191) Accounts pay able and accounts receivable are both part of the important category called "short-term expenditures." Answer: True 192) There are two basic categories of inventory: raw materials and finished goods. Answer: False 193) A credit policy of "2/10, net 30" means that the selling company offers a 2 percent discount if the customer pays within 10 days. Answer: True 194) A credit policy of "2/10, net 30" means that the selling company offers a 10 percent discount if the customer pays within 2 weeks, but the customer will have to pay the full amount if the customer doesn't pay until 30 days. Answer: False 195) Capital expenditures are essentially the same as operating expenditures except they last longer than one year. Answer: False 196) Long-term expenditures are usually more carefully planned than are short-term expenditures. Answer: True 197) Accounts payable is an example of short-term expenditures. Answer: True 198) Work-in-process inventory consists of goods partway through the production process that are damaged and will be written off. Answer: False 199) Work-in-process inventory includes things like t-shirts, which a store like the Gap has packaged and made ready to be shipped to customers. Answer: False 200) Accounts payables are expenditures as well as a source of funds. Answer: True 201) Open-book credit is a secured short-term loan that requires that the borrower put up collateral. Answer: False 202) A promissory note states when payment will be made and how much money will be paid to the seller in return for immediate credit. Answer: True 203) Once a trade draft is signed it becomes a trade acceptance. Answer: True 204) Collateral gives the lender the right to seize certain assets if payment is not made as promised. Answer: True 205) Inventory can only rarely be used as collateral. Answer: False 206) When accounts receivables are used as collateral, the process is called factoring accounts receivable. Answer: False 207) To get a line of credit the borrower must pay a commitment fee. Answer: False 208) With a line of credit, a business knows the maximum amount of money it will be able to borrow, but only if the bank has the money available to lend. Answer: True 209) Although the bank issues a line of credit to a business firm for a certain amount, the bank does not guarantee that the funds will be available when requested. Answer: True 210) One key difference between a line of credit and a revolving credit agreement is that in the latter case the bank guarantees that the money will be available. Answer: True 211) One option when obtaining a short-term loan, which is available only to the most creditworthy and largest firms, is to factor accounts receivable. Answer: False 212) The maximum maturity for commercial paper is 180 days. Answer: False 213) Commercial paper is generally issued by companies that have trouble getting bank loans. Answer: False 214) Secured loans allow borrowers to get funds when they might not qualify for unsecured credit. Answer: True 215) A company that pledges accounts receivable is probably in financial difficulty. Answer: False 216) Some unsecured loans are one-time-only arrangements, and may take the form of lines of credit, revolving credit agreements, or commercial paper. Answer: True 217) Using accounts receivable as collateral for a loan is known as pledging accounts receivable. Answer: True 218) Debt financing refers to the long-term borrowing of funds from outside the company. Answer: True 219) The two primary sources for obtaining long-term borrowing from outside the business firm are the issuance of commercial paper and factoring of accounts receivable. Answer: False 220) The two basic types of long-term financing are debt and equity. Answer: True 221) Usually loans and bonds both carry fixed interest rates and must be paid regardless of how well the company does. Answer: True 222) A corporate bond issue is an attractive means of raising a large amount of money for long periods of time. Answer: True 223) Loans are the major source of long-term debt financing for most corporations. Answer: False 224) A bond indenture includes the maturity date of the bond. Answer: True 225) The most important element in the bond indenture is the company's cash flow situation. Answer: False 226) The bond indenture spells out the amount to be paid and the interest rate, but it does not identify the assets that are pledged as collateral for the bonds. Answer: False 227) The bond indenture specifies the terms of the bond and any collateral supporting the bond. Answer: True 228) Equity financing involves obtaining long-term funding from within the business firm. Answer: True 229) Equity financing is obtained by borrowing funds from the corporation's shareholders. Answer: False 230) Paying dividends is more expensive than paying bond interest. Answer: True 231) The business firm may elect to provide for long-term funding needs by retaining earnings instead of paying dividends to the shareholders. Answer: True 232) Preferred shares never mature, however, payments to the holder are fixed in amount and can be withheld if the company wishes. Answer: True 233) The mix between debt and equity financing is termed a company's capital structure. Answer: True 234) In liquidation, shareholders must wait until creditors are paid and preferred equity precedes common equity. Answer: True 235) Junk bonds are bonds that pay very low interest rates to holders. Answer: False 236) Junk bonds are not worth anything on the open market. Answer: False 237) High-grade corporate bonds rate low in terms of risk and high in terms of expected returns. Answer: False 238) If a company fails to make a bond payment, the company is in default. Answer: True 239) Debt financing does not affect management control. Answer: True 240) Debt financing does not affect management flexibility. Answer: False 241) The two primary sources of debt financing are pledging accounts receivable and selling bonds. Answer: False 242) Generally speaking, debt financing is wiser from a financial perspective than equity financing. Answer: False 243) Equity financing puts more constraints on management than debt financing. Answer: False 244) Equity financing of long-term debt is obtained by borrowing funds from the corporation's shareholders. Answer: False 245) High-quality, stable common stocks are riskier than commercial paper. Answer: True 246) Government savings bonds are riskier than high-grade corporate bonds. Answer: False 247) Preferred stock is hybrid because it has some of the features of corporate bonds and some features of a short-term loan. Answer: False 248) High quality cyclical common stocks are riskier than medium quality preferred shares. Answer: True 249) One approach to equity financing is to use retained earnings. Answer: True 250) The business plan is a document that tells potential lenders why money is needed, the amount needed, how the money will be used to improve the company, and when it will be paid back. Answer: True 251) Small businesses often fail to consider venture capital as a source of funding, and they are notorious for not planning cash-flow needs properly. Answer: True 252) Start-up firms without proven financial success usually must present a business plan to demonstrate that the firm is a good credit risk. Answer: True 253) The two basic types of business risk are speculative risks and pure risks. Answer: True 254) Financial managers deal only with speculative risks. Answer: False 255) Designing and distributing a new product is a pure risk because there is the possibility of either a gain or a loss. Answer: False 256) When a delivery service trains its drivers in defensive-driving techniques and maintains their trucks in good working order, they are practising risk avoidance. Answer: False 257) Risk avoidance and risk retention are two methods which business firms use to cope with risks. Answer: True 258) Firms can practice risk transfer through loss prevention or loss reduction techniques. Answer: False 259) When a company decides to insure its buildings and equipment against loss by fire, it is practising risk control. Answer: False 260) The transfer of risk from one organization to another can be accomplished through the use of burglar alarms and security video services. Answer: False 261) An insurance company makes a profit by taking in more in premiums than it pays out to cover customer losses. Answer: True 262) The first step in the risk management process is to measure the frequency and severity of losses and their impact. Answer: False 263) The chance of a flood is pure risk. Answer: True 264) Conserving a firm's financial power or assets by minimizing the financial effect of accidental losses is risk management. Answer: True 265) A trucking company that decides it is cheaper to pay for vandalism repairs than it is to submit claims to its insurance company is practicing risk control. Answer: False 266) To measure the frequency and severity of losses, managers must consider both past history and current activities. Answer: True 267) Because risk management is an ongoing activity, follow-up is always essential. Answer: True SHORT ANSWER QUESTIONS. Write the word or phrase that best completes each statement or answers the question. 268) What is a financial manager? Answer: A financial manager is responsible for planning and controlling the acquisition and dispersal of a firm's financial resources. 269) What is the financial manager's overall objective? Answer: To increase a firm's value (and thus stockholders' wealth). 270) What are the four responsibilities of finance (corporate finance)? Answer: • Determining a firms long term investments • Obtaining funds to pay for those investments • Conducting the firm's everyday financial activities • Helping to manage the risks that the firm takes 271) What is involved in cash flow management? Answer: Stated most generally, financial managers must make sure that the company always has enough funds on hand to purchase the materials and human resources it needs to produce the goods and services that are sold to consumers. Financial managers must also make specific decisions about investing funds that are not needed immediately. 272) What is financial control? Answer: Financial control is the process of checking actual performance against lans to ensure that desired financial outcomes actually occur. Control involves monitoring revenues and making appropriate financial adjustments. 273) What is credit policy? Answer: A credit policy states the guidelines that a company uses when extending credit to customers. A credit policy sets a standard to help managers decide which buyers are eligible for what type of credit. Credit policy also sets specific payment terms. 274) What do credit terms of 2/10; net 30 refer to? Answer: The selling company is offering a two percent discount if the bill is paid within 10 days. The customer has 30 days to pay the regular price. 275) List four sources of short-term funds. Answer: Trade credit, secured loans, unsecured loans, and factoring accounts receivable. 276) What is open-book credit?. Answer: A gentlemen's agreement whereby buyers receive merchandise along with invoices stating credit terms. Sellers ship products on faith that payment will be forthcoming 277) Differentiate between a trade draft and a trade acceptance. Answer: A trade draft is a form of trade credit in which buyers must sign statements of payment terms attached to merchandise by sellers. A trade acceptance is a trade draft that has been signed by the buyer. 278) What is a line of credit? Answer: A line of credit is a standing arrangement in which a lender agrees to make available a specified amount of funds upon the borrower's request. 279) What is commercial paper? Answer: Commercial paper is a short-term security, or note, containing a borrower's promise to pay. 280) What are the two primary sources of debt financing? Answer: Long-term loans and bonds. 281) What is the difference between debt financing and equity financing? Answer: Equity financing means selling ownership in the company (common stock) as a means of getting the long-term funds it needs to buy things like land, buildings, and equipment. This money does not have to be paid back (although investors may expect dividends to be paid on a regular basis). By contrast, debt financing (long-term loans and the sale of bonds) means borrowing money to use in the company. This borrowed money must be paid back at some point. 282) Why is paying dividends more expensive than paying bond interest? Answer: Because bond interest is tax deductible, but stock dividends are not. 283) What is the risk-return relationship? Answer: • the higher the risk, the more return the investors will expect to receive; the lower the risk, the smaller the expected return 284) What is venture capital? Answer: Venture capital is outside equity financing provided in return for part ownership of the borrowing firm. 285) Differentiate between pure and speculative risk. Answer: Speculative risk is risk involving the possibility of gain or loss, while pure risk involves only the possibility of loss or no loss. 286) List the four choices that a company has to handle risk. Answer: Risk avoidance, risk control, risk retention, and risk transfer. ESSAY QUESTIONS. Write your answer in the space provided or on a separate sheet of paper. 287) Briefly explain the three responsibilities of a financial manager. Answer: • cash flow management: managing the pattern in which cash flows into the firm in the form of revenues and out of the firm in the form of debt payments • financial control: the process of checking actual performance against plans to ensure that the desired financial status is achieved • financial planning: a description of how a business will reach some financial position it seeks for the future; includes projections for sources and uses of funds 288) What questions must the financial manager ask in order to develop a sound financial plan? Answer: There are three basic questions: (1) What funds are needed to meet immediate plans? (2) When will the company need more funds? (3) Where can the company get the funds it needs so that it can meet its short- and long-term needs? 289) What are the three financial or operational areas that must be carefully managed by the financial manager to provide for short-term expenditures? Answer: • accounts payable: to pay them on time, but not too early to allow for cash for short-term investments • accounts receivable: to be sure to receive them in a timely fashion with discounts and penalties to shorten the wait period before payment occurs • inventories: inventories must be monitored so as to purchase when needed without having too much cash tied up in inventories 290) How do long-term expenditures differ from short-term expenditures? Answer: Compared to short-term expenditures, long-term expenditures are used to buy fixed assets which are not normally sold or converted to cash. Their acquisition requires a relatively large investment, and they represent a binding commitment of company funds that continues long into the future. 291) Describe the primary short-term sources of funds. Answer: There are four sources: (1) trade credit—the granting of credit by a selling firm to a buying firm (open-book credit, promissory notes, trade drafts) ; (2) secured short-term loans—the borrower is required to put up collateral (inventory loans, accounts receivable) and the lender has these items as security that the loan will be repaid or they take possession of inventories and/or accounts receivable; (3) unsecured short-term loans—the borrower is not required to put up collateral (lines of credit, revolving credit agreements, commercial paper) ; and (4) factoring accounts receivable—selling a firm's accounts receivable to another company for some percentage of their face value in order to realize immediate cash 292) How can a lender gain some sort of assurance that the borrower of funds will repay the debt? Answer: The most basic way is to make a secured loan, which requires the borrower to put up collateral (for example, inventories, accounts receivable, and other assets). 293) Identify and briefly describe the three key sources of unsecured, short-term funds. Answer: • three types of unsecured short-term funds: • lines of credit: a standing agreement that specifies the maximum amount that will be made available to a borrower, which the borrow can get when the funds are available • revolving credit agreement: a guaranteed line of credit for which the funds are available on demand • commercial paper: notes that are sold for less than face value which are bought back by the borrower at a later date for face value 294) How is a line of credit different than a revolving credit agreement? Answer: With a line of credit, the company borrowing the money knows the maximum amount it will be allowed to borrow (if the bank has sufficient funds). With a revolving credit agreement, the company knows not only the maximum amount, but it is also guaranteed that the bank will make the money available (the company pays a commitment fee to get this guarantee). 295) Define and describe the process of factoring accounts receivable. Answer: • A firm can raise funds rapidly by factoring, i.e., by selling the firm's accounts receivables. In this process, the purchaser of the receivables, usually a financial institution, is known as the factor. The factor pays some percentage of the full amount of receivables due to the selling firm. The seller gets this money immediately. The factor profits to the extent that the money it eventually collects exceeds the amount it is paid. 296) Give an example of how commercial paper works. Answer: Suppose Corporation X needs $20 million dollars to buy new equipment. It might issue commercial paper with a total face value of $20.4 million to various other organizations that would like to earn interest on their idle funds (say, for example, an insurance company). These other companies would loan Corporation X a total of $20 million, and after say, 90 days, they would receive a total of $20.4 million from Corporation X. 297) What are the customary methods of debt financing? Which methods do most corporations use as their major source of long-term debt financing? Answer: • long-term loans: extend three to ten years, usually from chartered banks but may also be from insurance companies, credit companies and pension funds • corporate bonds: a promise by the issuing company to pay the holder a certain amount of money on a specified date, with stated interest payments in the interim; a form of long-term debt financing • corporate bonds are the major source of debt financing for most corporations because of the large amounts of money that are available for loan 298) Since equity funding is expensive, why don't businesses rely totally on debt capital? Answer: Because that would be too risky. Long-term loans and bonds carry fixed interest rates and represent a fixed promise to pay regardless of the profitability of the company. If the company can't make its fixed payments, it may have to declare bankruptcy, but it doesn't have pay dividends to stockholders if it is short of funds. 299) Why is retained earnings viewed as a form of equity financing? Answer: Because the earnings that are retained in the business (and not paid out to stockholders as dividends) allow the company to avoid borrowing money and therefore having to pay interest on loans or bonds. This saves the company more money. 300) Identify, briefly describe, and give one example for each of the two types of long-term financing. Answer: • long-term financing can be done though debt or equity financing • debt financing can be done through long-term loans or issuing corporate bonds • equity financing can be done through issuing common stock or using retained earnings 301) What are the two methods of equity financing for long-term funding requirements? What issues must be considered before the choice is made between the two methods? Explain your reason. Answer: • common stock: selling shares in ownership to raise money • retained earnings: using the built up stock of cash as a form of financing • the use of retained earnings means that a company will not have to borrow money or pay interest on that money • however, it will result in lower dividends • lower dividends may lead to lower stock prices 302) Discuss the advantages and disadvantages of financing using preferred stock. Answer: • preferred stock is a form of hybrid financing, falling somewhere between debt and equity financing. It is a hybrid because it has some of the features of corporate bonds, and some of the features of common stock • similar to bonds, payments on preferred stock are for fixed amounts. However, unlike bonds, preferred stock never matures. It can be held indefinitely. Dividends need not be paid if the company makes no profit. If dividends are paid, preferred shareholders receive them first in preference to dividends on common stock. A major advantage of preferred shares financing is the flexibility: no loss of control, no repayment of principal amount, no maturity, and no requirement to pay dividends in leaner times. 303) Why is preferred stock referred to as hybrid financing? Answer: • it has features of both debt and equity financing • like bonds, there are fixed payments and no loss of control as there are no voting rights • like equity it never matures and there is no requirement to pay dividends if the company is unprofitable 304) Compare debt financing to equity financing on the issues of repayment, claims on income, claims on assets, management control, tax effect and management flexibility. Answer: See Figure 20.1 Debt financing involves fixed repayment obligations, whereas equity financing does not require repayment but entails sharing income through dividends. Debt holders have priority claims on assets in case of default, contrasting with equity holders who share residual claims. Debt financing limits management control due to creditor interests, while equity financing preserves managerial autonomy. Tax implications favor debt financing due to interest deductions, but equity financing offers greater flexibility in financial management. 305) What is risk? What is the difference between speculative risk and pure risk? What is risk management? Answer: • risk: uncertainty about future events • speculative risk: involve the possibility of gain or loss • pure risk: involve the possibility of loss or no loss only • risk management: conserving a firm's financial power or assets by minimizing the financial effect of accidental losses 306) What are the five steps in the risk management process? Answer: • Step 1: Identify risks and potential losses • Step 2: Measure the frequency and severity of losses and their impact • Step 3: Evaluate alternatives and choose the techniques that will best handle the losses • Step 4: Implement the risk-management program • Step 5: Monitor results 307) What are the methods used by business firms to cope with risk? Answer: • risk avoidance: stopping participation in or refusing to participate in ventures that carry any risk • risk control: techniques to prevent, minimize, or reduce losses or the consequences of losses • risk retention: the covering of a firm's unavoidable losses with its own funds • risk transfer: the transfer of risk to another individual or firm, often by contract Test Bank for Business Essentials Ronald J. Ebert, Ricky W. Griffin, Frederick A. Starke, George Dracopoulos 9780132479769, 9780134384733

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