Chapter 1 Introduction to Finance

I. True or False
1. The purpose of the financial system is to bring savers and borrowers together. true

2. Firms are never DSUs. False

3. There must be an equal number of DSUs and SSUs in a period. false

4. A household is an SSU when income for the period exceeds spending. true

5. Financial claims or securities are written for the mutual benefit of both SSU and DSU. true

6. DSUs and SSUs always have some contact with each other in financial markets. false

7. Households are the major source of funds to the financial system. true

true
8. A financial claim is an “IOU” from a deficit spending unit
9. An investment project is acceptable if the total cash received over the life of the project true

exceeds the total cash spent over the life of the project.
10. The root cause of agency problems is conflicts of interest.
11. The risk-return trade-off is seen in many areas of finance.
12. The sole proprietorship has no legal business structure separate from its owner.

II. Multiple choice questions

1) The primary goal of a corporation is to ________.
A) maximize dividends per share
B) maximize shareholder wealth
C) maximize earnings per share after taxes
D) minimize shareholder risk
2) The five basic principles of finance include all of the following EXCEPT
A) Cash flow is what matters.
B) Money has a time value.
C) Risk requires a reward.
D) Incremental profits determine value.
3) Investors want a return that satisfies the following expectation(s):
A) A return for delaying consumption
B) An additional return for taking on risk
C) An additional return for accepting dividends rather than capital gains

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D) Both A and B.
4) The expected return on a riskless asset is greater than zero due to
A) an expected return for delaying consumption.
B) an expected return for taxes.
C) irrational investors who believe risk is always present.
5) Investors generally don't like risk. Therefore, a typical investor
A) will not be induced to take on any risk.
B) will only take on the least risk possible.
C) will only take on additional risk if he expects to be compensated in the form of additional
return.
6) Assume that an investor is offered a choice of a risk-free government bond that is expected to
return 3.5% or a high-risk corporate stock. According to one of the principles of finance, what
would induce the investor to purchase the corporate stock?
A) a return that is substantially lower than 3.5%
B) cash dividends
C) a return that is substantially higher than 3.5%
D) none of the above
7) Which of the following statements best represents the "Agency Problem"?
A) Managers might attempt to benefit themselves in terms of salary and perquisites at the
expense of shareholders.
B) The agency problem results from the separation of management and the ownership of the
firm.
C) The agency problem may interfere with the implementation of maximizing shareholder
wealth.
D) all of the above
8) The three basic types of issues addressed by the study of finance are
A) capital budgeting, capital structure decisions, and working capital management.
B) capital budgeting, working capital management, and investment analysis.
C) capital structure decisions, working capital management, and sustained profitability.
D) capital budgeting, investment analysis, and cash management.
9) Working capital management is concerned with
A) how a firm can best manage its cash flows as they arise in its day-to-day operations.
B) how a firm should raise money to fund its investments.

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C) what long-term investments a firm should undertake.
D) managing a firm's capital stock.
10) Capital budgeting is concerned with
A) whether a company's assets should be financed with debt or equity.
B) managing a firm's cash budgeting procedures.
C) what long-term investments a firm should undertake.
D) planning sales of a corporation's equity capital.
11) The true owners of the corporation are the
A) holders of debt issues of the firm.
B) preferred stockholders.
C) board of directors of the firm.
D) common stockholders.
12) Joe is deciding whether or not to invest $10,000 in a business that has pending lawsuits
against it. If Joe invests and the business loses the lawsuits, the most Joe can lose is
A) $10,000 if Joe is a general partner.
B) $10,000 if Joe is a sole proprietor.
C) $10,000 if Joe is a limited partner.
13) An SSU’s
A) income and expenditures for the period are equal.
B) income for the period exceeds expenditures.
C) expenditures for the period exceed receipts.
D) spending is entirely financed by credit cards
14) Financial institutions facilitate the flow of investment funds
A) from savers to borrowers
B) from SSUs to DSUs
C) from the household sector to the business sector
D) any of the above
15) Which sector has been most consistently in a surplus budget position?
A) Business
B) Government
C) Foreign
D) Household
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16) Which of the following are “economic units”?
A) households
B) businesses
C) governments
D) all of the above
17) Surplus spending units (SSU) are also called
A) lenders.
B) borrowers.
C) sellers of securities.
D) balanced budget units
18) During 2008, Bob and Nancy Gutierrez expect total income of about $225,000 and are
budgeting total expenditures of about $180,000. For this budget period, the Gutierrez family is
most specifically a(n)
A) DSU
B) business
C) SSU
D) household
19) Financial managers are responsible for determining:
I. how suppliers will be paid. II. the appropriate level of debt for a firm.
III. which projects a firm should undertake. IV. how to invest the firm's cash.
A) I and II only
B) II and III only
C) I, II and III only
D) I, II, III and IV
20) Capital structure refers to the:
A) types of equipment a firm employs in its production process.
B) mixture of short-term and long-term debt a firm uses to finance its operations.
C) amount of long-term debt and equity a firm uses.
D) composition of a firm's short-term assets.
E) size, timing, and risk of a firm's future cash flows.