Chapter 14: Financing, Stock Markets, Policy Lags, and Fiscal Policy – Guided Study

Q1. Why do firms issue bonds?

Background

Topic: Corporate Finance and Bonds

This question tests your understanding of why firms use bonds as a method of financing and what their primary purpose is in the context of business operations.

Key Terms:

• Bond: A debt instrument issued by firms or governments to raise capital, promising to pay back with interest.

• Return: The profit made on an investment.

• Monetary Policy: Central bank actions that influence the money supply and interest rates.

Step-by-Step Guidance

1. Consider what a bond represents: Is it a way for a firm to borrow money, lend money, or something else?

2. Think about the relationship between the firm and the bondholder. Who is providing funds to whom?

3. Eliminate options that do not fit the typical role of a firm in the bond market (e.g., influencing monetary policy, earning a return, lending money).

Try solving on your own before revealing the answer!

Q2. Which of the following is NOT a way firms can finance capital spending?

Background

Topic: Corporate Financing Methods

This question checks your understanding of the different ways firms can raise funds for investment and which options do not actually provide financing.

Key Terms:

• Capital Spending: Expenditures on physical assets like equipment or buildings.

• Dividends: Payments made to shareholders from profits.

Step-by-Step Guidance

1. Review each option and determine if it provides new funds to the firm or not.

2. Recall that financing means raising money, not distributing it.

3. Identify which option involves paying out money rather than bringing it in.

Try solving on your own before revealing the answer!

Q3. How can a firm finance a capital expenditure?

Background

Topic: Sources of Business Financing

This question asks you to identify which actions actually provide financing for capital expenditures.

Key Terms:

• Capital Expenditure: Spending on long-term assets.

• Stock: Ownership shares in a company.

• Bonds: Debt instruments issued to raise funds.

Step-by-Step Guidance

1. Evaluate each option to see if it results in the firm receiving funds for investment.

2. Consider whether buying bonds or engaging in monetary policy actually provides capital to the firm.

3. Identify the option(s) that directly raise money for the firm's investments.

Try solving on your own before revealing the answer!

Q4. What determines the price of a share of stock in a firm?

Background

Topic: Stock Valuation

This question tests your understanding of the factors that influence stock prices, especially the role of expected future dividends.

Key Terms:

• Dividends: Payments to shareholders from profits.

• Stock Price: The market value of a share.

• Time to Maturity: Relevant for bonds, not stocks.

Step-by-Step Guidance

1. Recall what investors consider when valuing a stock (future cash flows, dividends, etc.).

2. Eliminate options that are more relevant to bonds or unrelated to stock valuation.

3. Focus on the option that directly affects the expected return from owning the stock.

Try solving on your own before revealing the answer!

Q5. What happens to a company's stock price if its risk increases?

Background

Topic: Risk and Stock Prices

This question examines the relationship between perceived risk and the market price of a company's stock.

Key Terms:

• Risk: The uncertainty regarding returns or future performance.

• Stock Price: The current market value of a share.

Step-by-Step Guidance

1. Think about how investors react to increased risk—do they demand higher returns or pay less for the same asset?

2. Consider the effect of risk on demand for the stock.

3. Eliminate options that do not align with basic risk-return principles in finance.

Try solving on your own before revealing the answer!

Q6. When would you expect the price of a share of stock to rise?

Background

Topic: Stock Price Determinants

This question tests your understanding of what factors can cause stock prices to increase, such as changes in expected dividends or macroeconomic conditions.

Key Terms:

• Dividend: A payment made to shareholders from profits.

• Interest Rate: The cost of borrowing money, which can affect stock prices.

Step-by-Step Guidance

1. Review each option and consider how it would affect the expected return from owning the stock.

2. Recall that higher expected dividends generally make stocks more attractive.

3. Consider the impact of macroeconomic events like recessions or changes in interest rates on stock prices.

Try solving on your own before revealing the answer!