Respond To The Following Questions. Write Your Responses In

Respond To The Following Questions Write Your Responses In a Word Doc

Respond to the following questions. Write your responses in a Word document. Use references to support your answers as needed. Be sure to cite all references using correct APA style. Your responses should be free of grammar and spelling errors, demonstrating strong written communication skills.

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1. Define the terms finance and financial management. What are the major sub-areas of finance? Identify and define the three basic forms of business ownership. Describe the advantages and disadvantages of each. Define the terms agency relationship and agency problem. Explain three different approaches to minimizing the agency problem. Explain why ethical behavior is so important in the field of finance. Explain the concept of shareholder wealth maximization. Is there a conflict between the goal of shareholder wealth maximization and the financial manager's need to act in an ethical manner? Why or why not?

Finance refers to the broad field concerned with the study of money management, including activities such as investing, borrowing, lending, budgeting, saving, and forecasting. Financial management specifically focuses on managing a firm's resources to achieve its financial objectives, primarily maximizing shareholder wealth (Brigham & Ehrhardt, 2016). The major sub-areas of finance include corporate finance, investments, financial institutions, and international finance. Corporate finance deals with capital structure, funding, and investment decisions; investments involve asset valuation and portfolio management; financial institutions cover banking and credit systems; international finance addresses cross-border financial activities.

The three basic forms of business ownership are sole proprietorship, partnership, and corporation. A sole proprietorship is owned and operated by one individual, offering advantages such as simplicity, full control, and tax benefits. Disadvantages include unlimited liability and limited access to capital (Ross, Westerfield, & Jaffe, 2019). A partnership involves two or more owners sharing profits and liabilities; it benefits from combined resources and expertise but faces potential conflicts and unlimited liability unless structured as a limited partnership. A corporation is a legal entity separate from its owners, providing limited liability and easy capital raising through stock issuance; however, it is subject to double taxation and higher regulatory costs (Moyer, McGuigan, & Kretlow, 2018).

An agency relationship exists when one party (the principal) hires another (the agent) to perform tasks on their behalf, such as shareholders hiring managers. The agency problem arises when the interests of the agent diverge from those of the principal, potentially leading to actions that are not aligned with the principals' best interests (Jensen & Meckling, 1976). To minimize agency problems, approaches include implementing incentive alignment through compensation schemes, increasing transparency and monitoring, and establishing corporate governance practices. Ethical behavior is crucial in finance because it fosters trust, ensures fair markets, and prevents fraudulent activities, ultimately supporting the efficient functioning of financial systems (Boatright, 2017).

The shareholder wealth maximization goal focuses on increasing the value of shareholders' investments. While this enhances firm value, conflicts can arise if managers pursue personal goals that do not align with shareholder interests. Ethical behavior is vital because it ensures that managers act transparently and responsibly, balancing profitability with societal and stakeholder interests (Baker & Martin, 2018). Ethical lapses can undermine investor confidence, lead to legal penalties, and impair long-term shareholder value, highlighting the importance of maintaining ethical standards in financial decision-making.

2. Categorize each of the following transactions as taking place in either the primary or secondary market

A. Supercorp issues $180 million of new common stock. — Primary market

B. HiTech, Inc. issues $30 million of common stock in an IPO. — Primary market

C. Megaorg sells $10 million of HiTech preferred stock from its marketable securities portfolio. — Secondary market

D. The XYA Fund buys $220 million of previously issued Supercorp bonds. — Secondary market

E. Corporation sells $15 million of XYZ common stock. — Primary market

3. Identify whether the following financial instruments are capital market securities or money market securities

• U.S. Treasury bills — Money market securities
• U.S. Treasury notes — Capital market securities
• U.S. Treasury bonds — Capital market securities
• Mortgages — Capital market securities
• Federal funds — Money market securities
• Negotiable certificates of deposit — Money market securities
• Common stock — Capital market securities
• State and government bonds — Capital market securities
• Corporate bonds — Capital market securities

4. Identify the different types of financial institutions. What are the main services each of these financial institutions offers?

Financial institutions can be categorized into depository institutions (such as commercial banks, savings banks, credit unions), contractual institutions (insurance companies, pension funds), investment institutions (mutual funds, investment banks), and finance companies. Commercial banks provide deposit services, loans, and payment processing. Insurance companies offer risk management products. Pension funds manage retirement assets. Mutual funds pool investor capital to invest in diversified portfolios. Investment banks assist with underwriting securities, mergers, and acquisitions. Finance companies provide loans and credit outside traditional banking systems (Mishkin & Eakins, 2016).

5. Define the six factors that determine the nominal interest rate on a security.

The six factors include: (1) Default risk—chance the issuer may fail to pay interest or principal; (2) Liquidity preference—investors prefer more liquid assets; (3) term to maturity—longer-term securities typically demand higher rates; (4) Tax considerations—taxable vs. tax-exempt instruments; (5) Inflation expectations—anticipated inflation reduces purchasing power; (6) Market conditions—supply and demand for funds influence interest rates (Brigham & Ehrhardt, 2016).

6. Define the concept of term structure of interest rates. What are three theories that explain the future yield curve of interest rates?

The term structure of interest rates describes the relationship between bond yields and their maturities. It shows how interest rates vary across different time horizons, reflecting investor expectations and economic conditions. Theories explaining the yield curve include: (1) Expectations Theory—future interest rates are derived from current long-term rates; (2) Liquidity Premium Theory—long-term bonds have higher yields due to added risk and lower liquidity; (3) Market Segmentation Theory—interest rates are determined by supply and demand within specific maturity segments (Fabozzi & Mann, 2010).

7. Explain the concept of cash flow in corporate finance. Explain how present value and future values are related. Explain how present values are affected by changes in interest rates.

Cash flow in corporate finance refers to the net amount of cash generated or consumed by a business during a specific period, fundamental for investment and financing decisions. Present value (PV) discounts future cash flows to their current worth using a discount rate, while future value (FV) compounds current cash flows to future periods. The relationship between PV and FV is inverse; higher discount rates reduce PV, making future cash flows appear less valuable today. Changes in interest rates directly affect PV: an increase in rates decreases PV, and a decrease in rates increases PV (Ross, Westerfield, & Jaffe, 2019).

8. Explain whether you would rather have a savings account that paid interest compounded on a monthly basis or compounded on an annual basis? Why? Describe what an amortization schedule is and its uses. Explain the purpose of an amortization schedule. Interest on a home mortgage is tax deductible. Explain why interest paid in the early years of a home mortgage is more helpful in reducing taxes than interest paid in later years.

I would prefer a savings account with monthly compounding because it results in a higher effective yield compared to annual compounding due to more frequent application of interest (Mishkin & Eakins, 2016). An amortization schedule is a detailed table outlining each periodic payment on a loan, showing how much goes toward interest and principal over time. Its purpose is to provide clarity on repayment progression, aiding borrowers in understanding loan obligations. Regarding mortgage interest, early payments consist largely of interest, which is tax-deductible; thus, paying more interest upfront allows for greater tax deductions in initial years, providing immediate tax benefits that diminish over time (Brealey, Myers, & Allen, 2017).

9. Describe the rights and advantages belonging to shareholders. Explain the differences between common stock and preferred stock. Explain what a call provision enables bond issuers to do. Why would bond issuers exercise a call provision? Define a discount bond and a premium bond. Provide examples of each. Describe the relationship between interest rates and bond prices. Describe the differences between a coupon bond and a zero coupon bond.

Shareholders have rights including voting on corporate policies, receiving dividends, and residual claim on assets upon liquidation. Advantages include potential capital appreciation and voting rights. Common stock typically offers voting rights and dividends, with higher risk and potential reward; preferred stock generally pays fixed dividends and has priority over common stock but lacks voting rights. A call provision allows bond issuers to redeem bonds before maturity, enabling debt refinancing when interest rates fall; issuers exercise calls to reduce interest costs. A discount bond is sold below its face value, e.g., a bond bought at $950 with a face value of $1,000; a premium bond is sold above face value, e.g., $1,050 for a $1,000 bond. Interest rates and bond prices have an inverse relationship: rising rates cause bond prices to fall, and falling rates cause prices to rise. Coupon bonds pay periodic interest, while zero-coupon bonds are purchased at a discount and pay only face value at maturity (Mishkin & Eakins, 2016).

10. Define risk, and explain how it is measured. Identify a source of firm-specific risk. What is the source of market risk? Explain what the coefficient of variation measures.

Risk in finance refers to the uncertainty concerning the return on an investment. It is measured using statistical tools like standard deviation and variance of returns. A source of firm-specific risk includes management decisions or product recalls, which impact only a single company. Market risk stems from macroeconomic factors such as interest rate changes or geopolitical events affecting the entire market. The coefficient of variation measures the risk per unit of return, calculated as the standard deviation divided by the mean return, allowing comparison of relative risk across investments (Jorion, 2007).

11. Explain why expected return is considered forward-looking. What challenges arise in using expected return? Explain how differences in allocations between the risk-free security and the market portfolio can determine the level of market risk.

Expected return is forward-looking because it estimates the average future return based on forecasts and probabilities, guiding investment decisions (Bodie, Kane, & Marcus, 2014). Challenges include accurately predicting future economic conditions, market volatility, and modeling assumptions. The level of market risk depends on the proportion of assets allocated to risky securities relative to risk-free assets; higher allocations increase exposure to market fluctuations, elevating overall risk (Sharpe, 1964).

12. Explain the net present value (NPV) method for determining a capital budgeting project's desirability. What is the acceptance benchmark when using NPV? Explain the payback period statistic. What is the acceptance benchmark when using the payback period statistic? Describe the internal rate of return (IRR) as a method for deciding the desirability of a capital budgeting project. What is the acceptance benchmark when using IRR? Describe the modified internal rate of return (MIRR) as a method for deciding the desirability of a capital budgeting project. What are MIRR's strengths and weaknesses?

The NPV method evaluates capital projects by calculating the present value of expected cash inflows minus initial investment; a positive NPV indicates project acceptance (Ross, Westerfield, & Jaffe, 2019). The acceptance benchmark is typically when NPV exceeds zero. The payback period measures how long it takes to recover initial investment from cash inflows; projects with shorter payback periods are often preferred. The benchmark is the maximum acceptable payback period set by management. IRR is the discount rate that makes the project's NPV zero; a project is acceptable if IRR exceeds the required rate of return. MIRR improves upon IRR by assuming reinvestment at the project's cost of capital, providing a more accurate reflection of profitability. Its strengths include better reinvestment assumptions, but weaknesses involve increased computational complexity (Brealey, Myers, & Allen, 2017).

References

• Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments (10th ed.). McGraw-Hill Education.
• Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of Corporate Finance (12th ed.). McGraw-Hill Education.
• Boatright, J. R. (2017). Ethics in Finance. Wiley.
• Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs, and ownership structure. Journal of Financial Economics, 3(4), 305-360.
• Jorion, P. (2007). Value at Risk: The Quantitative Approach (3rd ed.). McGraw-Hill.
• Mishkin, F. S., & Eakins, S. G. (2016). Financial Markets and Institutions (8th ed.). Pearson.
• Moyer, R. C., McGuigan, J. R., & Kretlow, W. J. (2018). Contemporary Financial Management (13th ed.). Cengage Learning.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
• Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance, 19(3), 425-442.
• Fabozzi, F. J., & Mann, S. V. (2010). Fixed Income Securities: Tools for Today's Markets. Wiley.