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FINA 405 International Financial Management Answers

1. Calculation Questions (20 questions)

1. The international monetary system can be defined as the institutional framework within which A. international payments are made. B. movement of capital is accommodated. C. exchange rates among currencies are determined. D. all of the above

2. The international monetary system went through several distinct stages of evolution. These stages are summarized, in alphabetic order, as follows: (i)- Bimetallism (ii)- Bretton Woods system (iii)- Classical gold standard (iv)- Flexible exchange rate regime (v)- Interwar period The chronological order that they actually occurred is: A. (iii), (i), (iv), (ii), and (v) B. (i), (iii), (v), (ii), and (iv) C. (vi), (i), (iii), (ii), and (v) D. (v), (ii), (i), (iii), and (iv)

3. One potential drawback of the gold standard is that A. the world economy can be subject to deflationary pressure due to the limited supply of monetary gold. B. the world economy can be subject to inflationary pressure without changes in the supply of monetary gold. C. gold price is volatile. D. all of the above

4. Under the Bretton Woods system A. there was an explicit set of rules about the conduct of international monetary policies. B. each country was responsible for maintaining its exchange rate within 1 percent of the adopted par value by buying or selling foreign exchanges as necessary. C. the U.S. dollar was the only currency that was fully convertible to gold. D. all of the above

5. Special Drawing Rights (SDR) are A. an artificial international reserve allotted to the members of the International Monetary Fund (IMF), who can then use it for transactions among themselves or with the IMF. B. a "portfolio" of currencies, and its value tends to be more stable than the currencies that it is comprised of. C. used in addition to gold and foreign exchanges, to make international payments. D. all of the above

6. The Bretton Woods system ended in A. 1945. B. 1973. C. 1981. D. 2001.

7. Put the following in correct date order: A. Jamaica Agreement, Bretton Woods Agreement, Smithsonian Agreement. B. Smithsonian Agreement, Bretton Woods Agreement, Jamaica Agreement. C. Bretton Woods Agreement, Smithsonian Agreement, Jamaica Agreement. D. Bretton Woods Agreement, Jamaica Agreement, Smithsonian Agreement.

8. With regard to the current exchange rate arrangement between the U.S. and the U.K., it is best characterized as A. independent floating (market determined). B. managed float. C. currency board. D. pegged exchange rate within a horizontal band.

9. Benefits from adopting a common European currency include A. reduced transaction costs. B. elimination of exchange rate risk. C. increased price transparency that will promote Europe-wide competition. D. all of the above

10. The main cost of European monetary union is A. the loss of national monetary and exchange rate policy independence. B. increased exchange rate uncertainty. C. lessened political integration. D. none of the above

11. According to the "Trilemma" a country can attain only two of the following three conditions: 1) A fixed exchange rate, (2) Free international flows of capital, (3) An independent monetary policy. This difficulty is also known as A. the incompatible trinity. B. the Triffin Dilemma. C. the Tobin tax. D. all three can be had at the same time

12. Generally speaking, liberalization of financial markets when combined with a weak, underdeveloped domestic financial system tends to A. strengthen the domestic financial system in the short run. B. create an environment susceptible to currency and financial crises. C. raise interest rates and lead to domestic recession. D. none of the above

13. A "good" (or ideal) international monetary system should provide A. liquidity, elasticity, and flexibility. B. elasticity, sensitivity, and reliability. C. liquidity, adjustments, and confidence. D. none of the above

14. The current account includes A. the export and import of goods and services. B. all purchases and sales of assets such as stocks, bonds, bank accounts, real estate, and businesses. C. all purchases and sales of international reserve assets such as dollars, foreign exchanges, gold, and special drawing rights (SDRs). D. none of the above

15. The capital account includes A. the export and import of goods and services. B. all purchases and sales of assets such as stocks, bonds, bank accounts, real estate, and businesses. C. all purchases and sales of international reserve assets such as dollars, foreign exchanges, gold, and special drawing rights (SDRs). D. none of the above

16. In 2012 the United States had a current account deficit. The current account deficit implies that the United States A. had a surplus on legal consulting and engineering services. B. produced more output than it consumed. C. consumed more output than it produced. D. none of the above

17. If the interest rate rises in the U.S. while other variables remain constant A. capital inflows into the U.S. will increase. B. capital inflows into the U.S. may not materialize. C. capital will flow out of the U.S. D. none of the above

18. When the balance-of-payments accounts are recorded correctly, the combined balance of the current account, the capital account, and the reserves account must be A. equal in magnitude to the country's national debt. B. zero. C. equal in magnitude to the Trade Deficit or Surplus. D. none of the above

19. If the central banks of the world chose to diversify their foreign-exchange reserves away from the dollar and into the euro, A. this would have the result of a strengthening of the value of the dollar. B. this would have the result of a weakening in the value of the dollar. C. this would not have much impact, as the information would be lost in the day-to-day volatility of exchange rates.

20. Over the last several years the U.S. has run persistent A. balance-of-payments deficits. B. balance-of-payments surpluses. C. current account deficits. D. capital account deficits.

2. Short-answer Question

Here is a list of international transactions. Identify the types of balance of payment (BOP) account that are affected by these transactions, the accounting impact (debit or credit) and the impact on the account balance (increase or decrease) from the United States balance of payment perspective.

Transaction Descriptions

BOP account affected

(current or capital?)

Debit or Credit the account?

Increase or decrease the account balance?

The Boeing Company, a U.S. firm, sold five aircrafts to India.

Current

Credit

Increase

Kraft Foods, a U.S. company, took over Cadbury, a British chocolate maker.

Capital

Debit

Decrease

A U.S. firm issued $5 million short-term commercial papers in London, U.K.

Capital

Credit

Increase

China Life Insurance Company Ltd., a Chinese firm, issued $3 billion common shares on the New York Stock Exchange.

Capital

Debit

Decrease

McKinsey & Company, a U.S. consulting firm, collected consulting fees from the European clients.

Current

Credit

Increase

A U.S. non-profit organization donated $1million to a cancer research center in South Africa.

Current

Debit

Decrease

Fidelity Equity Fund in the U.S. receives $10 million cash dividend from its portfolio investment in the emerging market stocks.

Current

Credit

Increase

. What is the correct label for the vertical axis in the J-curve? A. Time B. Change in the Trade Balance C. Size of Trade Balance D. Size of Merchandise Trade Balance

In the long run, both exports and imports tend to be A. unresponsive to changes in exchange rates. B. responsive to changes in exchange rates. C. both a and b D. none of the above

With regard to the capital account A . the capital account balance measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets. B. U.S. sales (or exports) of assets are recorded as credits, as they result in capital inflow. C. U.S. purchases (imports) of foreign assets are recorded as debits, as they lead to capital outflow. D. all of the above

The difference between Foreign Direct Investment and Portfolio Investment is that A . Portfolio Investment mostly represents the sale and purchase of foreign financial assets such as stocks and bonds that do not involve a transfer of control. B . Foreign Direct Investment mostly represents the sale and purchase of foreign financial assets such as stocks whereas Portfolio Investment mostly involves the sales and purchase of foreign bonds. C . Foreign Direct Investment is about buying land and building factories, whereas portfolio investment is about buying stocks and bonds. D. All of the above

In the latter half of the 1980s, with a strong yen, Japanese firms A. faced difficulty exporting. B. could better afford to acquire U.S. assets that had become less expensive in terms of yen. C. financed a sharp increase in Japanese FDI in the United States. D. all of the above

International portfolio investments have boomed in recent years, as a result of A. a depreciating U.S. dollar. B. increased gasoline and other commodity prices. C. the general relaxation of capital controls and regulation in many countries. D. none of the above

. If the interest rate rises in the U.S. while other variables remain constant A. capital inflows into the U.S. will increase. B. capital inflows into the U.S. may not materialize. C. capital will flow out of the U.S. D. none of the above

. If for a particular county an increase in the interest rate is more or less matched by an expected depreciation in the local currency, A. traders will probably be tempted to find another country to invest in. B. the interest rate increase per se will not be enough to spark capital flow into the country. C. both a and b are true D. capital will glow out of the country as the disgruntled citizens riot and go to war with the neighbors.

The capital account measures A. the sum of U.S. sales of assets to foreigners and U.S. purchases of foreign assets. B. the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets. C. the difference between U.S. sales of manufactured goods to foreigners and U.S. purchases of foreign products. D. none of the above

When Honda, a Japanese auto maker, built a factory in Ohio, A. it was engaged in foreign direct investment. B. it was engaged in portfolio investment. C. it was engaged in a cross-border acquisition. D. none of the above.

Government controlled investment funds, known as sovereign wealth funds, A. are playing a less-important role in international finance following the end of the fixed exchange rate era. B. are mostly domiciled in Asian and Middle Eastern countries. C. are usually are responsible for converting trade surpluses and oil revenues into foreign exchange reserves. D. none of the above

Foreign direct investment (FDI) occurs A. when an investor acquires a measure of control of a foreign business. B.when there is an acquisition, by a foreign entity in the U.S., of 10 percent or more of the voting shares of a business. C. with sales and purchases of foreign stocks and bonds that do not involve a transfer of control. D. both a and b

The capital account may be divided into three categories: A. cross-border mergers and acquisitions, portfolio investment, and other investment. B. direct investment, portfolio investment, and Cross-border mergers and acquisitions. C. direct investment, mergers and acquisitions, and other investment. D. direct investment, portfolio investment, and other investment.

When Nestlé, a Swiss firm, bought the American firm Carnation, it was engaged in foreign direct investment. If Nestlé had only bought a non-controlling number of shares of the firm, A. Nestlé would have been engaged in portfolio investment. B. Nestlé would have been engaged in a cross-border acquisition. C. it would depend if they bought the shares from an American or a Canadian. D. none of the above

Transactions in currency, bank deposits and so forth A. tend to be insensitive to both changes in relative interest rates and the anticipated change in exchange rate. B. tend to be sensitive to both changes in relative interest rates and the anticipated change in exchange rate. C. tend to be sensitive to changes in relative interest rates but insensitive to the anticipated change in exchange rate. D. tend to be insensitive to changes in relative interest rates but sensitive to the anticipated change in exchange rate

Since security returns tend to have low correlations among countries, A.investors can reduce risk more effectively if they diversify their portfolio holdings internationally rather than purely domestically. B . investors who have a domestically diversified portfolio, with exposures across industry types will not gain much from diversifying abroad. C.investors who diversify internationally will likely underperform investors who keep all their investments in one country. D. none of the above

The world's largest debtor nation and creditor nation, respectively, are A. Japan and the U.S. B. The U.S. and Japan. C. The U.S. and Canada. D. Great Britain and Mexico.

Statistical discrepancy, which by definition represents errors and omissions A. cannot be calculated directly. B. is calculated by taking into account the balance-of-payments identity. C. probably has some elements that are honest mistakes, it can't all be money laundering and drugs. D. all of the above

The statistical discrepancy in the balance-of-payments accounts A.arise since recordings of payments and receipts are done at different times, in different places, possibly using different methods. B. arise since some transactions (illegal transactions) occur "off the books". C. represents omitted and misreported transactions. D. all of the above

Which of the following is most indicative of the pressure that a country's currency faces for depreciation or appreciation? A. The current account B. The capital account C. The statistical discrepancies D. The official settlement balance

The United States is considered A. a net creditor nation. B. a net debtor nation.

Regarding the statistical discrepancy in the balance-of-payments accounts A. there is some evidence that financial transactions may be mainly responsible for the discrepancy. B . the sum of the balance on the capital account and the statistical discrepancy is very close to the balance of the current account in magnitude. C. it tends to be positive one year and negative in others, so it's safe to ignore it. D. a and b

The central bank of the United States is A. the New York Fed. B. the Federal Reserve System. C. the EXIM bank. D. none of the above—the U.S. does not have a central bank.

When a country must make a net payment to foreigners because of a balance-of-payments deficit, the central bank of the country A. should do nothing. B. should run down its official reserve assets (e.g. gold, foreign exchanges, and SDRs). C. should borrow anew from foreign central banks. D. either b or c will work.

Continued U.S. trade deficits coupled with foreigners' desire to diversify their currency holdings away from U.S. dollars A. could further diminish the position of the dollar as the dominant reserve currency. B. could affect the value of U.S. dollar (e.g. through the currency diversification decisions of Asian central banks). C. could lend steam to the emergence of the euro as a credible reserve currency. D. all of the above

Currently, international reserve assets are comprised of A. gold, platinum, foreign exchanges, and special drawing rights (SDRs). B.gold, foreign exchanges, special drawing rights (SDRs), and reserve positions in the International Monetary Fund (IMF). C. gold, diamonds, foreign exchanges, and special drawing rights (SDRs). D. reserve positions in the International Monetary Fund (IMF), only

International reserve assets include "foreign exchanges". These are A. Special Drawing Rights (SDRs) at the IMF. B. reserve positions in the International Monetary Fund (IMF). C. foreign currency held by a country's central bank. D. none of the above

The most important international reserve asset, comprising 94 percent of the total reserve assets held by IMF member countries is A. gold. B. foreign exchanges. C. special Drawing Rights (SDRs). D. reserve positions in the International Monetary Fund (IMF)

The "one word that haunts the dollar" is A. (Central bank) diversification. B. Reunification (Korean). C. Euro. D. (Current account) deficit.

The vast majority of the foreign-exchange reserves held by central banks are denominated in A. local currencies. B. U.S. dollars. C. Yen. D. Euro.

Among IMF member countries, the dollar's dominant position in the world's reserve holdings may decline to a certain extent as the euro becomes a "known quantity" and its external value becomes more stable. In fact, the euro's share has increased A. from zero percent in 1999 to 25.8 percent in 2006. B. from 13.5 percent in 1999 to 25.8 percent in 2006. C. from 13.5 percent in 1999 to 52.8 percent in 2006. D. none of the above

Which of the following would not count as a foreign-exchange reserve held by a central bank? A. The local currency B. U.S. dollars C. SDRs D. Euro

The balance of payments identity is given by BCA + BKA + BRA = 0. Rearrange the identity for a country with a pure flexible exchange rate regime A. BCA + BKA + BRA = 0 B. BCA = -BKA C. BCA + BKA = -BRA D. BRA = -BCA

Assume that the balance-of-payments accounts for a country are recorded correctly. Balance on the current account = BCA = $130 billion Balance on the capital account = BKA = -$86 billion Balance on the reserves account = BRA = ? 69. The balance on the reserves account (BRA), under the fixed exchange regime is A. -$44 billion B. $44 billion C. $216 billion D. none of the above

. The balance on the reserves account (BRA), under the pure flexible exchange regime is A. -$44 billion. B. $44 billion. C. $216 billion. D. none of the above

In a pure flexible exchange rate regime, a country's central banks will not need to maintain official reserves. Under this regime A. -BCA = BKA. B. BCA = -BRA = 0. C. BKA = -BRA. D. BSA = BCA

When the balance-of-payments accounts are recorded correctly, the combined balance of the current account, the capital account, and the reserves account must be A. equal in magnitude to the country's national debt. B. zero. C. equal in magnitude to the Trade Deficit or Surplus. D. none of the above

The balance of payments identity is given by BCA + BKA + BRA = 0. Rearrange the identity to solve for the statistical discrepancy. A. The statistical discrepancy = (BCA + BKA) - BRA B. The statistical discrepancy = BCA - BKA + BRA C. The statistical discrepancy = BCA - BKA - BRA D. The statistical discrepancy = BCA + BKA + BRA

BCA stands for A. the balance on the current account. B. the balance on the capital account. C. the balance on the official reserves. D. net imports.

BKA stands for A. the balance on the current account. B. the balance on the capital account. C. the balance on the official reserves. D. net imports

If the central banks of the world chose to diversify their foreign-exchange reserves away from the dollar and into the euro, A. this would have the result of a strengthening of the value of the dollar. B. this have the result of a weakening in the value of the dollar. C. this would not have much impact, as the information would be lost in the day-to-day volatility of exchange rates.

The economic theory of mercantilism holds that A. a continuing trade surplus should be a government's major policy goal. B. the main source of wealth of a country is its productive capacity. C. free trade is the result of countries exploiting their comparative advantage. D. none of the above

The U.S. Trade Deficit A. is a capital account surplus. B. is a current account deficit. C. is both a capital account surplus and a current account deficit. D. none of the above

As of 2011 gold accounted for A. 90 percent of the total reserve assets held by IMF member countries. B. 70 percent of the total reserve assets held by IMF member countries. C. approximately 50 percent of the total reserve assets held by IMF member countries. D. less than one percent of the total reserve assets held by IMF member countries.

The most popular reserve currency is now the A. U.S. dollar. B. Euro. C. Japanese Yen.

Suppose a country is currently experiencing a trade deficit. In the long run, this could be self correcting if A. the deficit exists because of the import demand for capital goods. B. the deficit exists because of the import demand for consumption goods. C. the deficit exists because foreigners want to buy the country's currency as an investment. D. none of the above

The capital account is divided into three subcategories: direct investment, portfolio investment, and other investment. Direct investment involves A. acquisitions of controlling interests in foreign businesses. B. investments in foreign stocks and bonds that do not involve acquisitions of control. C. bank deposits, currency investment, trade credit, and the like. D. all of the above

The capital account is divided into three subcategories: direct investment, portfolio investment, and other investment. Portfolio investment involves A. acquisitions of controlling interests in foreign businesses. B. investments in foreign stocks and bonds that do not involve acquisitions of control. C. bank deposits, currency investment, trade credit, and the like. D. all of the above

The capital account is divided into three subcategories: direct investment, portfolio investment, and other investment. "Other" investment involves A. acquisitions of controlling interests in foreign businesses. B. investments in foreign stocks and bonds that do not involve acquisitions of control. C. bank deposits, currency investment, trade credit, and the like. D. all of the above

Over the last several years the U.S. has run persistent A. balance-of-payments deficits. B. balance-of-payments surpluses. C. current Account deficits. D. capital Account deficits

If a country must make a net payment to foreigners because of a balance-of-payments deficit, the country should A. either increase its official reserve assets or borrow anew from foreigners. B. either run down its official reserve assets or borrow anew from foreigners. C. either run down its official reserve assets or lend more foreigners. D. none of the above

Under the pure flexible exchange rate regime A . the combined balance on the current and capital accounts will be equal in size, but opposite in sign, to the change in the official reserves. B. the balance on the current and capital accounts will be equal in size, but opposite in sign. C. a current account surplus or deficit must be matched by an official reserves deficit or surplus. D. a capital account surplus or deficit must be matched by an official reserves deficit or surplus

. More important than he absolute size of a country's balance-of-payments disequilibrium A. is the nature and cause of the disequilibrium. B. is whether it is a trade surplus or deficit. C. is whether the local government is mercantilist or not. D. Nothing is more important than he absolute size of a country's balance-of-payments disequilibrium

For question in this section, the notation is Y = GNP = national income C = consumption I = private investment G = government spending X = exports M = imports 90. The current account balance is given by A. C + I + G + X + M B. X - M C. I + X + M D. M - X

Exam

Name___________________________________

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

1) Countries with strong shareholder protection tend to have more valuable stock markets

and more companies listed on stock exchanges per capita than countries with weak

protection.

Answer: True False

Topic: Capital Markets and Valuation

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

2) Corporate governance can be defined as 2)

A) the economic, legal, and institutional framework in which corporate control and

cash flow rights are distributed among shareholders, managers and other

stakeholders of the company.

B) the rules and regulations adopted by boards of directors specifying how to manage

companies.

C) the government-imposed rules and regulations affecting corporate management.

D) the general framework in which company management is selected and monitored.

Answer: A

Topic: Corporate Governance

3) When managerial self-dealings are excessive and left unchecked, 3)

A) they can impede the proper functions of capital markets.

B) they can impede such measures as GDP growth.

C) they can have serious negative effects on share values.

D) all of the options

Answer: D

Topic: Corporate Governance

4) Corporate governance structure 4)

A) varies a great deal across countries.

B) has become homogenized due to cross-listing of shares of many public

corporations.

C) has become homogenized following the integration of capital markets.

D) none of the options

Answer: A

Topic: Corporate Governance

5) The genius of public corporations stems from their capacity to allow efficient sharing or

spreading of risk among many investors, who can buy and sell their ownership shares on

liquid stock exchanges and let professional managers run the company on behalf of

shareholders. This risk sharing stems from

A) the limited liability of bondholders. B) the limited liability of shareholders.

C) the liquidity of the shares. D) the limited ability of shareholders.

Answer: B

Topic: Governance of the Public Corporation: Key Issues

6) In a public company with diffused ownership, the board of directors is entrusted with 6)

A) monitoring the management and safeguarding the interests of shareholders.

B) monitoring the auditors and safeguarding the interests of shareholders.

C) monitoring the shareholders and safeguarding the interests of management.

D) none of the options

Answer: A

Topic: Governance of the Public Corporation: Key Issues

7) The key weakness of the public corporation is 7)

A) conflicts of interests between shareholders and bondholders.

B) too many shareholders, which makes it difficult to make corporate decisions.

C) conflicts of interest between managers and shareholders.

D) relatively high corporate income tax rates.

Answer: C

Topic: Governance of the Public Corporation: Key Issues

8) When company ownership is diffuse, 8)

A) the large number of shareholders ensures strong monitoring of managerial behavior

because with a large enough group, there's almost always someone who will to incur

the costs of monitoring management.

B) a "free rider" problem discourages shareholder activism and few shareholders have

a strong enough incentive to incur the costs of monitoring management.

C) most shareholders will have a strong enough incentive to incur the costs of

monitoring management.

D) a "free rider" problem encourages shareholder activism.

Answer: B

Topic: Governance of the Public Corporation: Key Issues

9) In many countries with concentrated ownership 9)

A) corporate forms of business organization with concentrated ownership are rare.

B) the conflicts of interest are greater between managers and shareholders than

between large controlling shareholders and small outside shareholders.

C) the conflicts of interest between shareholders and managers are worse than in

countries with diffuse ownership of firms.

D) the conflicts of interest are greater between large controlling shareholders and small

outside shareholders than between managers and shareholders.

Answer: D

Topic: Governance of the Public Corporation: Key Issues

10) In what country do the three largest shareholders control, on average, about 60 percent of

the shares of a public company?

10)

A) Canada B) Great Britain C) Italy D) United States

Answer: C

Topic: Governance of the Public Corporation: Key Issues

11) The public corporation 11)

A) offers shareholders limited liability.

B) separates the ownership and control of a firm's assets.

C) is jointly owned by a (potentially) large number of shareholders.

D) all of the options

Answer: D

Topic: Governance of the Public Corporation: Key Issues

12) The key strength(s) of the public corporation is/are 12)

A) their capacity to raise large amounts of funds at relatively low cost.

B) their capacity to allow efficient risk sharing among many investors.

C) their capacity to consolidate decision-making.

D) all of the options

Answer: D

Topic: Governance of the Public Corporation: Key Issues

13) The central issue of corporate governance is 13)

A) how to alleviate the conflicts of interest between managers and shareholders.

B) how to protect creditors from managers and controlling shareholders.

C) how to protect outside investors from the controlling insiders.

D) how to alleviate the conflicts of interest between shareholders and bondholders.

Answer: C

Topic: Governance of the Public Corporation: Key Issues

14) In theory, 14)

A) managers are hired by the shareholders at the annual stockholders meeting. If the

managers turn in a bad year, new ones get hired.

B) managers are hired by the board of directors; the board is accountable to the

shareholders.

C) shareholders hire the managers to oversee the board of directors.

D) none of the options

Answer: B

Topic: Governance of the Public Corporation: Key Issues

15) In the reality of corporate governance at the turn of this century, 15)

A) a typical board of directors often has relatively few outside directors who can

independently and objectively monitor the management.

B) managers of one firm often sit on the boards of other firms, whose managers are on

the board of the first firm. Due to the interlocking nature of these boards, there can

exist a culture of "I'll overlook your problems if you overlook mine."

C) boards of directors are often dominated by management-friendly insiders.

D) all of the options have been true to a greater or lesser extent in the recent past.

Answer: D

Topic: Governance of the Public Corporation: Key Issues

16) The strongest protection for investors is provided by 16)

A) a weak board of directors.

B) socialized firms.

C) French civil law countries, such as Belgium, Italy, and Mexico.

D) English common law countries, such as Canada, the United States, and the U.K.

Answer: D

Topic: Governance of the Public Corporation: Key Issues

17) The public corporation has a key weakness which is 17)

A) the conflicts of interest between bondholders and shareholders.

B) the conflicts of interest between managers and bondholders.

C) the conflicts of interest between managers and shareholders.

D) the conflicts of interest between stakeholders and shareholders.

Answer: C

Topic: Governance of the Public Corporation: Key Issues

18) The separation of the company's ownership and control, 18)

A) is especially prevalent in such countries as Italy and Mexico, where corporate

ownership is highly concentrated.

B) is a rational response to the agency problem.

C) is especially prevalent in such countries as the United States and the United

Kingdom, where corporate ownership is highly diffused.

D) none of the options

Answer: C

Topic: Governance of the Public Corporation: Key Issues

19) In the United States, managers are legally bound by the "duty of loyalty" to 19)

A) the shareholders. B) the government.

C) the bondholders. D) the board of directors.

Answer: A

Topic: Governance of the Public Corporation: Key Issues

20) In the United States, managers are bound by the "duty of loyalty" to serve the

shareholders.

20)

A) This is only a moral obligation; there are no penalties.

B) This is an ethical, not legal, obligation.

C) This is a legal obligation.

D) none of the options

Answer: C

Topic: Governance of the Public Corporation: Key Issues

21) Outside the United States and the United Kingdom, 21)

A) partnerships are more important than corporations.

B) concentrated ownership of the company is more the exception than the rule.

C) diffused ownership of the company is more the exception than the rule.

D) none of the options

Answer: C

Topic: Governance of the Public Corporation: Key Issues

22) A complete contract between shareholders and managers 22)

A) would specify exactly what the manager will do under each of all possible future

contingencies.

B) would eliminate any conflicts of interest (and managerial discretion).

C) would be an expensive contract to write and a very expensive contract to monitor.

D) all of the options

Answer: D

Topic: The Agency Problem

23) Why is it rational to make shareholders "weak" by giving control to the managers of the

firm?

23)

A) This may be rational to the extent that managers are answerable to the board of

directors.

B) This may be rational since many shareholders find it easier to sell their shares in an

underperforming firm than to monitor the management.

C) This may be rational when shareholders may be neither qualified nor interested in

making business decisions.

D) All of the options are explanations for the separation of ownership and control.

Answer: D

Topic: The Agency Problem

24) Free cash flow refers to 24)

A) a firm's cash reserve in excess of interest and tax payments.

B) a firm's income tax refund that is due to interest payments on borrowing.

C) a firm's cash reserve in excess of tax obligation.

D) a firm's funds in excess of what's needed for undertaking all profitable projects.

Answer: D

Topic: The Agency Problem

25) The investors supply funds to the company but are not involved in the company's daily

decision making. As a result, many public companies come to have

25)

A) strong managers and weak shareholders.

B) strong shareholders and weak managers.

C) weak managers and weak shareholders.

D) strong managers and strong shareholders.

Answer: A

Topic: The Agency Problem

26) The agency problem refers to the possible conflicts of interest between 26)

A) self-interested managers as principals and shareholders of the firm who are the

agents.

B) dutiful managers as principals and shareholders of the firm who are the agents.

C) altruistic managers as agents and shareholders of the firm who are the principals.

D) self-interested managers as agents and shareholders of the firm who are the

principals.

Answer: D

Topic: The Agency Problem

27) Self-interested managers may be tempted to 27)

A) waste company funds by undertaking unprofitable projects that benefit themselves

but not shareholders.

B) adopt anti-takeover measures for their company to ensure their personal job

security.

C) indulge in expensive perquisites at company expense.

D) All of the options are potential abuses that self-interested managers may be tempted

to visit upon shareholders.

Answer: D

Topic: The Agency Problem

28) Suppose in order to defraud the shareholders, a manager sets up an independent company

that he owns and sells the main company's output to this company. He would be tempted

to set the transfer price

28)

A) above market prices. B) at the market price.

C) in accordance with GAAP. D) below market prices.

Answer: D

Topic: The Agency Problem

29) Suppose in order to defraud the shareholders, a manager sets up an independent company

that he owns and buys one of the main company's inputs of production from this

company. He would be tempted to set the transfer price

29)

A) at the market price. B) in accordance with GAAP.

C) above market prices. D) below market prices.

Answer: C

Topic: The Agency Problem

30) Why do managers tend to retain free cash flow? 30)

A) These funds are needed for undertaking profitable projects and the issue costs are

less than new issues of stocks or bonds.

B) Managers may not be acting in the shareholders best interest, and for a variety of

reasons, want to use the free cash flow.

C) Managers are in the best position to decide the best use of those funds.

D) none of the options

Answer: B

Topic: The Agency Problem

31) Managerial entrenchment efforts are clear signs of the agency problem. They include 31)

A) changes in the voting procedures to make it more difficult for the firm to be taken

over.

B) anti-takeover defenses.

C) poison pills.

D) all of the options

Answer: D

Topic: The Agency Problem

32) In high-growth industries where companies' internally generated funds fall short of

profitable investment opportunities,

32)

A) managers are more likely to waste funds in unprofitable projects.

B) managers are less likely to waste funds in unprofitable projects.

Answer: B

Topic: The Agency Problem

33) The agency problem tends 33)

A) to be more serious in firms with excessive amounts of excess cash.

B) to be less serious in firms with few numbers of shareholders.

C) to be more serious in firms with free cash flows.

D) all of the options

Answer: D

Topic: The Agency Problem

34) In the graph, X, Y, and Z represent 34)

A) misalignment and alignment.

B) alignment, entrenchment, alignment.

C) agency costs of debt and equity.

D) entrenchment, alignment, entrenchment.

Answer: B

Topic: Remedies for the Agency Problem

35) Morck, Shleifer, and Vishny (1988) studied the relationship between managerial

ownership share and firm value for Fortune 500 U.S. companies. The results of their

analysis suggested that the first turning point (the first vertical, dashed line between X

and Y) is reached at ________ percent and the second turning point (the second vertical,

dashed line between Y and Z) at about ________ percent, respectively.

35)

A) 50; 75. B) 15; 50.

C) 5; 25. D) none of the options

Answer: C

Topic: Remedies for the Agency Problem

36) Which of the following is true regarding leveraged buy-outs (LBOs)? 36)

A) Concentrated ownership and high levels of debt associated with LBOs are the

mechanism for solving the agency problem.

B) LBOs improve a company's free cash flow and this is the mechanism by which they

can solve the agency problem.

C) LBOs involve managers or buyout partners acquiring controlling interests in public

companies, usually financed by heavy borrowing.

D) LBOs involve managers or buyout partners acquiring controlling interests in public

companies (usually financed by heavy borrowing), and concentrated ownership and

high levels of debt associated with LBOs are the mechanism for solving the agency

problem.

Answer: D

Topic: Remedies for the Agency Problem

37) Tobin's Q is 37)

A) the same as the price-to-book ratio.

B) a means to find overvalued stocks: If Q is high it means that the cost to replace a

firm's assets is greater than the value of its stock.

C) the ratio of the market value of company assets to the replacement costs of the

assets.

D) the ratio of the market value of company assets to the replacement costs of the

assets, as well as a means to find overvalued stocks: If Q is high it means that the

cost to replace a firm's assets is greater than the value of its stock.

Answer: C

Topic: Remedies for the Agency Problem

38) It is important for society as a whole to solve the agency problem, since the agency

problem

38)

A) leads to waste of scarce resources. B) retards economic growth.

C) hampers capital market functions. D) all of the options

Answer: D

Topic: Remedies for the Agency Problem

39) In the U.S., the chief role of the board of directors is 39)

A) to hire the management team.

B) to design an effective incentive compatible compensation scheme for themselves.

C) to decide on the annual capital budget.

D) none of the options

Answer: A

Topic: Board of Directors

40) In the United Kingdom, the majority of public companies 40)

A) do not abide by the Code of Best Practice on corporate governance.

B) voluntarily abide by the Code of Best Practice on corporate governance.

C) are compelled by law to abide by the Code of Best Practice on corporate

governance.

D) none of the options

Answer: B

Topic: Board of Directors

41) In Germany, the corporate board is 41)

A) legally charged with looking after the interests of stakeholders (e.g., workers,

creditors, etc.) in general, not just shareholders.

B) legally charged as a management board only.

C) legally charged as a supervisory board only.

D) legally charged with representing the interests of shareholders exclusively.

Answer: A

Topic: Board of Directors

42) In the United States, 42)

A) due to the diffused ownership structure of the public company, management often

gets to choose board members who are likely to be friendly to management.

B) boards of directors are legally responsible for representing the interests of the

shareholders.

C) there is a correlation between underperforming firms and boards of directors who

are not fully independent.

D) all of the options

Answer: D

Topic: Board of Di

1 Corporate governance can be defined as a) the economic, legal, and institutional framework in which corporate control and cash flow rights are distributed among shareholders, managers and other stakeholders of the company. b) the general framework in which company management is selected and monitored. c) the rules and regulations adopted by boards of directors specifying how to manage companies. d) the government-imposed rules and regulations affecting corporate management.

2 Corporate governance structure a) varies a great deal across countries. b) has become homogenized following the integration of capital markets. c) has become homogenized due to cross-listing of shares of many public corporations. d) none of the above

3 In a public company with diffused ownership, the board of directors is entrusted with a) monitoring the auditors and safeguarding the interests of shareholders. b) monitoring the shareholders and safeguarding the interests of management. c) monitoring the management and safeguarding the interests of shareholders. d) none of the above