Econ stydy plan for exam 2
The three major types of firms in the United States are called
Sole proprietorships, partnerships, and corporations
Limited liability means that
Shareholders in a corporation cannot lose more than their investment in the firm
The government grants limited liability to the owners of corporations
To limit shareholder risk and thus encourage investment in corporations
Limited liability becomes more important for firms trying to raise funds from a large number
of investors, rather than from a small number of investors, because
Investors that make a small investment in a firm may be unwilling to risk all their personal assets
if the firm fails
What do we mean by the separation of ownership from control in large corporations?
Shareholders own the corporation, but it is controlled by managers
How is the separation of ownership from control related to the principal-agent problem?
The agents (managers) may pursue their own interests rather than the interests of the
principals (shareholders)
Suppose that shortly after graduating from college you decide to start your own business.
Assuming you are starting a small business and want it to be your business a lone which
category of firm are you most likely to start?
Sole proprietorship
An article discussing the reasons that the Connecticut state legislature passed a general
incorporation law in 1873 observes that prior to the passage of the law, investors were afraid that
large businesses "were not a safe bet for their money." The author argues that investors' fear was
because prior to the passage of the law,
Owners of all businesses established in Connecticut had unlimited liability
I would like to invest in the stock market, but I think that buying shares of stock in a corporation is
too risky. Suppose I buy $10,000 of Twitter stock, and the company ends up going bankrupt.
Because as a stockholder, I'm part owner of the company, I might be responsible for paying
hundreds of thousands of dollars of the company's debts. This statement is:
False because shareholders are not liable for the debts of a corporation
"Family-run companies ... could not raise sufficient capital to exploit the large-scale opportunities
tied to the rise of the steam engine, notably railways and (with limited exceptions) global shipping
and automated manufacturing." How did the United States solve the problem of firms raising
enough funds to operate railroads and other large-scale businesses?
To help firms raise enough funds to operate railroads and other large-scale businesses, the
United States
Passed general incorporation laws which limit the liability of owners in corporations
Two economists at the Brookings Institution argue that "new firms rather than existing ones have
accounted for a disproportionate share of disruptive and thus highly productivity enhancing
innovations in the past—the automobile, the airplane, the computer and personal computer,
air conditioning, and Internet search, to name just a few."
New firms might be more likely than older firms to introduce "disruptive" innovations because new
firms
,May find it difficult to compete with the same types of goods and services already being produced
by the larger, established firms
Assuming these economists are correct about the most important source of productivity
enhancing innovations, the declining trend in the formation of new businesses implies that
The U.S. economy will become less dynamic and less able to sustain high rates of economic
growth
An Associated Press article noted that some groups have filed lawsuits over what the groups
describe as "overzealous licensing schemes, in occupations such as hair braiders, yoga teachers
and casket makers."
Government licensing requirements would cause the rate of new businesses being formed to
decrease
Given your answer to part (a), state and local governments pass these type of licensing
requirements because
They are designed to insure the quality of service providers
The principal-agent problem arises almost everywhere in the business world—but it also crops
up even closer to home, such as the case of the college classroom. In this case, who is the
principal and who is the agent?
The principal is the student and the agent is the professor
.
The principal-agent problem in the public corporation between ownership and top management
results from asymmetric information. All of the following are correct, except
This principal-agent problem can be prevented or reduced if the managers are allowed to have
freedom in running the company
Sales personnel, whether selling life insurance, automobiles, or pharmaceuticals, typically get
paid on commission instead of a straight hourly wage. The principal-agent problem between the
owner of the business and its sales force is
Reduced when workers are paid on commission because it gives them an incentive to work
harder
Private equity firms, such as Blackstone and Kohlberg Kravis Roberts & Co., search for firms
where the managers appear not to be maximizing profits. A private equity firm can buy stock in
these firms and have its employees elected to the firms' board of directors and may even acquire
control of the targeted firm and replace the top management. Do private equity firms improve
corporate governance?
Yes, private equity firms replace poorly performing managers with shareholder-friendly managers
For which of the following types of business organizations is there a legal distinction between the
personal assets of the owners of the firm and the assets of the firm?
There is no limit to your liability
In the United States, account for the majority of revenue earned and
account for the majority of business organizations.
Corporations; sole proprietorships
What term do economists use to refer to the conflict between the interests of shareholders and
the interests of top management?
A principal-agent problem
,Direct finance is borrowing via financial markets, while indirect finance is borrowing from
financial intermediaries. If you borrow money from a bank to buy a new car, you are using
indirect finance
A bond represents a loan to the company, while a share of stock represents part ownership of
the company
.
The stock and bond markets provide information to businesses through changes in prices.
A decrease in the price of a firm's stock would tell managers which of the following?
Investors expect the firm to have lower profits in the future
A decrease in the price of a firm's bonds would tell managers which of the following?
The cost of external funds has increased.
Suppose that a firm in which you have invested is making a lot of moneymaking a lot of money.
Would you rather own the firm's stock or the firm's bonds? Stock If losing a lot of money: bonds
Suppose you originally invested in a firm when it was large and profitable. Now the firm has
downsized and is small and unprofitable. Would you be better off now if you had bought the firm's
stock or the firm's bonds? Bonds
If you deposit $20,000 in a savings account at a bank, you might earn 3 percent interest per year.
Someone who borrows $20,000 from a bank to buy a new car might have to pay an interest rate
of 8 percent per year on the loan. Knowing this, why don't you just lend your money directly to the
car buyer, cutting out the bank?
Since you would be loaning all of your savings to one borrower, it would be extremely risky
The shares of stock issued as a result of Twitter's Initial Public Offering (IPO) were sold in a
primary market. The IPO is an example of direct finance.
According to an article in the Wall Street Journal, in May 2015, Moody's Investors Service cuts its
rating on McDonald's bonds from A3 to A2. Source: Chelsey Dulaney, "Moody's Downgrades
McDonald's, Following S&P and Fitch," Wall Street Journal, May 15, 2015. What is Moody's top
bond rating? Aaa
Under what circumstances would Moody's, or the other bond rating agencies, be likely to cut the
rating on a firm's bonds? None of the above
The likely result of this rating's cut will be
McDonald's will have to pay a higher interest rate when it sells bonds
Moody's, S&P and Fitch don't sell their services directly to investors because they argue that
Doing so creates a "free rider" problem
What impact would each of the following events be likely to have on the price of Google's stock?
A competitor launches a search engine that is just as good as Google's.
, State whether the following statement is true or false:
"The total value of the shares of Microsoft stock traded on the NASDAQ last week was $250
million, so the firm actually received more revenue from stock sales than from selling software."
The statement is false because Microsoft does not receive the money investors paid for the stock
A column in the Wall Street Journal titled "Three Mistakes Investors Keep Making Again and
Again" listed "trying to forecast what stocks will do next" as one of the three mistakes.
Trying to forecast stock prices would be a mistake for the average investor because
Stock prices are based on expected future profitability, which is very unpredictable
In a letter to his company's stockholders, Warren Buffett offered the following opinion:
"Most investors, of course, have not made the study of business prospects a priority in their
lives... I have good news for these non-professionals: The typical investor doesn't need this skill."
Warren Buffet is advising non-professional investors to
Concentrate on buying shares of mutual funds that charge relatively low fees
Stocks are financial securities that represent partial ownership of a firm. Three of the most widely
followed stock indexes are the Dow Jones Industrial Average, theS&P 500, and the NASDAQ.
Which of the following does not describe the general movements of these three stock indexes?
Stock prices decreased during the expansion of the late 1990s
Which of the following terms refers to a flow of funds from savers to firms through
financial markets? Direct finance
The payments by a corporation to its shareholders are called , and the interest
payments on a bond are called . Dividends; coupon payments
An increase in a firm's stock price most likely indicates which of the following?
Optimism about the firm's profit prospects
If the price of a firm's bonds decreases, this indicates
A higher cost of new external funds
Which of the following stock indexes experienced a sharp decline in late 2007, reflecting the
severity of the recession, which began late that year? All of the above
The three major types of firms in the United States are called
Sole proprietorships, partnerships, and corporations
Limited liability means that
Shareholders in a corporation cannot lose more than their investment in the firm
The government grants limited liability to the owners of corporations
To limit shareholder risk and thus encourage investment in corporations
Limited liability becomes more important for firms trying to raise funds from a large number
of investors, rather than from a small number of investors, because
Investors that make a small investment in a firm may be unwilling to risk all their personal assets
if the firm fails
What do we mean by the separation of ownership from control in large corporations?
Shareholders own the corporation, but it is controlled by managers
How is the separation of ownership from control related to the principal-agent problem?
The agents (managers) may pursue their own interests rather than the interests of the
principals (shareholders)
Suppose that shortly after graduating from college you decide to start your own business.
Assuming you are starting a small business and want it to be your business a lone which
category of firm are you most likely to start?
Sole proprietorship
An article discussing the reasons that the Connecticut state legislature passed a general
incorporation law in 1873 observes that prior to the passage of the law, investors were afraid that
large businesses "were not a safe bet for their money." The author argues that investors' fear was
because prior to the passage of the law,
Owners of all businesses established in Connecticut had unlimited liability
I would like to invest in the stock market, but I think that buying shares of stock in a corporation is
too risky. Suppose I buy $10,000 of Twitter stock, and the company ends up going bankrupt.
Because as a stockholder, I'm part owner of the company, I might be responsible for paying
hundreds of thousands of dollars of the company's debts. This statement is:
False because shareholders are not liable for the debts of a corporation
"Family-run companies ... could not raise sufficient capital to exploit the large-scale opportunities
tied to the rise of the steam engine, notably railways and (with limited exceptions) global shipping
and automated manufacturing." How did the United States solve the problem of firms raising
enough funds to operate railroads and other large-scale businesses?
To help firms raise enough funds to operate railroads and other large-scale businesses, the
United States
Passed general incorporation laws which limit the liability of owners in corporations
Two economists at the Brookings Institution argue that "new firms rather than existing ones have
accounted for a disproportionate share of disruptive and thus highly productivity enhancing
innovations in the past—the automobile, the airplane, the computer and personal computer,
air conditioning, and Internet search, to name just a few."
New firms might be more likely than older firms to introduce "disruptive" innovations because new
firms
,May find it difficult to compete with the same types of goods and services already being produced
by the larger, established firms
Assuming these economists are correct about the most important source of productivity
enhancing innovations, the declining trend in the formation of new businesses implies that
The U.S. economy will become less dynamic and less able to sustain high rates of economic
growth
An Associated Press article noted that some groups have filed lawsuits over what the groups
describe as "overzealous licensing schemes, in occupations such as hair braiders, yoga teachers
and casket makers."
Government licensing requirements would cause the rate of new businesses being formed to
decrease
Given your answer to part (a), state and local governments pass these type of licensing
requirements because
They are designed to insure the quality of service providers
The principal-agent problem arises almost everywhere in the business world—but it also crops
up even closer to home, such as the case of the college classroom. In this case, who is the
principal and who is the agent?
The principal is the student and the agent is the professor
.
The principal-agent problem in the public corporation between ownership and top management
results from asymmetric information. All of the following are correct, except
This principal-agent problem can be prevented or reduced if the managers are allowed to have
freedom in running the company
Sales personnel, whether selling life insurance, automobiles, or pharmaceuticals, typically get
paid on commission instead of a straight hourly wage. The principal-agent problem between the
owner of the business and its sales force is
Reduced when workers are paid on commission because it gives them an incentive to work
harder
Private equity firms, such as Blackstone and Kohlberg Kravis Roberts & Co., search for firms
where the managers appear not to be maximizing profits. A private equity firm can buy stock in
these firms and have its employees elected to the firms' board of directors and may even acquire
control of the targeted firm and replace the top management. Do private equity firms improve
corporate governance?
Yes, private equity firms replace poorly performing managers with shareholder-friendly managers
For which of the following types of business organizations is there a legal distinction between the
personal assets of the owners of the firm and the assets of the firm?
There is no limit to your liability
In the United States, account for the majority of revenue earned and
account for the majority of business organizations.
Corporations; sole proprietorships
What term do economists use to refer to the conflict between the interests of shareholders and
the interests of top management?
A principal-agent problem
,Direct finance is borrowing via financial markets, while indirect finance is borrowing from
financial intermediaries. If you borrow money from a bank to buy a new car, you are using
indirect finance
A bond represents a loan to the company, while a share of stock represents part ownership of
the company
.
The stock and bond markets provide information to businesses through changes in prices.
A decrease in the price of a firm's stock would tell managers which of the following?
Investors expect the firm to have lower profits in the future
A decrease in the price of a firm's bonds would tell managers which of the following?
The cost of external funds has increased.
Suppose that a firm in which you have invested is making a lot of moneymaking a lot of money.
Would you rather own the firm's stock or the firm's bonds? Stock If losing a lot of money: bonds
Suppose you originally invested in a firm when it was large and profitable. Now the firm has
downsized and is small and unprofitable. Would you be better off now if you had bought the firm's
stock or the firm's bonds? Bonds
If you deposit $20,000 in a savings account at a bank, you might earn 3 percent interest per year.
Someone who borrows $20,000 from a bank to buy a new car might have to pay an interest rate
of 8 percent per year on the loan. Knowing this, why don't you just lend your money directly to the
car buyer, cutting out the bank?
Since you would be loaning all of your savings to one borrower, it would be extremely risky
The shares of stock issued as a result of Twitter's Initial Public Offering (IPO) were sold in a
primary market. The IPO is an example of direct finance.
According to an article in the Wall Street Journal, in May 2015, Moody's Investors Service cuts its
rating on McDonald's bonds from A3 to A2. Source: Chelsey Dulaney, "Moody's Downgrades
McDonald's, Following S&P and Fitch," Wall Street Journal, May 15, 2015. What is Moody's top
bond rating? Aaa
Under what circumstances would Moody's, or the other bond rating agencies, be likely to cut the
rating on a firm's bonds? None of the above
The likely result of this rating's cut will be
McDonald's will have to pay a higher interest rate when it sells bonds
Moody's, S&P and Fitch don't sell their services directly to investors because they argue that
Doing so creates a "free rider" problem
What impact would each of the following events be likely to have on the price of Google's stock?
A competitor launches a search engine that is just as good as Google's.
, State whether the following statement is true or false:
"The total value of the shares of Microsoft stock traded on the NASDAQ last week was $250
million, so the firm actually received more revenue from stock sales than from selling software."
The statement is false because Microsoft does not receive the money investors paid for the stock
A column in the Wall Street Journal titled "Three Mistakes Investors Keep Making Again and
Again" listed "trying to forecast what stocks will do next" as one of the three mistakes.
Trying to forecast stock prices would be a mistake for the average investor because
Stock prices are based on expected future profitability, which is very unpredictable
In a letter to his company's stockholders, Warren Buffett offered the following opinion:
"Most investors, of course, have not made the study of business prospects a priority in their
lives... I have good news for these non-professionals: The typical investor doesn't need this skill."
Warren Buffet is advising non-professional investors to
Concentrate on buying shares of mutual funds that charge relatively low fees
Stocks are financial securities that represent partial ownership of a firm. Three of the most widely
followed stock indexes are the Dow Jones Industrial Average, theS&P 500, and the NASDAQ.
Which of the following does not describe the general movements of these three stock indexes?
Stock prices decreased during the expansion of the late 1990s
Which of the following terms refers to a flow of funds from savers to firms through
financial markets? Direct finance
The payments by a corporation to its shareholders are called , and the interest
payments on a bond are called . Dividends; coupon payments
An increase in a firm's stock price most likely indicates which of the following?
Optimism about the firm's profit prospects
If the price of a firm's bonds decreases, this indicates
A higher cost of new external funds
Which of the following stock indexes experienced a sharp decline in late 2007, reflecting the
severity of the recession, which began late that year? All of the above
