Difficulty: Easy
44. A fixed-income security pays ____________.
A. a fixed level of income for the life of the owner
B. a fixed stream of income or a stream of income that is determined according to a specified formula for the life of the security
C. a variable level of income for owners on a fixed income
D. a fixed or variable income stream at the option of the owner
E. none of the above
Only answer B is correct.
Difficulty: Easy
45. Money market securities ____________.
A. are short term
B. pay a fixed income
C. are highly marketable
D. generally very low risk
E. all of the above
All answers are correct.
Difficulty: Easy
46. Financial assets permit all of the following except ____________.
A. consumption timing
B. allocation of risk
C. separation of ownership and control
D. elimination of risk
E. all of the above
Financial assets do not allow risk to be eliminated. However, they do permit allocation of risk, consumption timing, and separation of ownership and control.
Difficulty: Moderate
47. The Sarbanes-Oxley Act ____________.
A. requires corporations to have more independent directors
B. requires the firm's CFO to personally vouch for the firm's accounting statements
C. prohibits auditing firms from providing other services to clients
D. A and B are correct.
E. A, B, and C are correct.
The Sarbanes-Oxley Act does all of the above.
Difficulty: Moderate
48. Asset allocation refers to ____________.
A. choosing which securities to hold based on their valuation
B. investing only in "safe" securities
C. the allocation of assets into broad asset classes
D. bottom-up analysis
E. all of the above
Asset allocation refers to the allocation of assets into broad asset classes.
Difficulty: Moderate
49. Which of the following portfolio construction methods starts with security analysis?
A. Top-down
B. Bottom-up
C. Middle-out
D. Buy and hold
E. Asset allocation
Bottom-up refers to using security analysis to find securities that are attractively priced. Top-down refers to using asset allocation as a starting point.
Difficulty: Moderate
50. Which of the following portfolio construction methods starts with asset allocation?
A. Top-down
B. Bottom-up
C. Middle-out
D. Buy and hold
E. Asset allocation
Bottom-up refers to using security analysis to find securities that are attractively priced.
Difficulty: Moderate
Short Answer Questions
51. Discuss the agency problem in detail.
Managers are the agents of the shareholders, and should act on their behalf to maximize shareholder wealth (the value of the stock). A conflict (the agency conflict) arises when managers take self-interested actions to the detriment of shareholders. The roles of the board of directors selected by the shareholders are to oversee management and to minimize agency problems. However, often these boards are figureheads, and individual shareholders do not own large enough blocks of the shares to override management actions. One potential resolution of an agency problem occurs when inefficient management actions cause the price of the stock to be depressed. The firm may then become a takeover target. If the acquisition is successful, managers may be replaced and potentially, stockholders benefit.
Feedback: The question is designed to ascertain that the student understands the corporate relationship between shareholders, management, and the board of directors. In addition, this problem has been addressed extensively in recent years, both in the popular financial press during the mergers and acquisitions mania of the 1980s, and in the academic literature as agency theory.
Difficulty: Moderate
52. Discuss the similarities and differences between real and financial assets.
Real assets represent the productive capacity of the firm, and appear as assets on the firm's balance sheet. Financial assets are claims against the firm, and thus appear as liabilities on the firm's balance sheet. On the other hand, financial assets are listed on the asset side of the balance sheet of the individuals who own them. Thus, when financial statements are aggregated across the economy, the financial assets cancel out, leaving only the real assets, which directly contribute to the productive capacity of the economy. Financial assets contribute indirectly only.