PRINCIPLE OF FINANCE

Questions 1. Classify the following transactions as taking place in the primary or secondary markets: a. IBM issues $200 million of new common stock – primary market b. The New Company issues $50 million of common stock in an IPO – primary market c. IBM sells $5 million of GM preferred stock out of its marketable securities portfolio – secondary market d. The Magellan Fund buys $100 million of previously issued IBM bonds – secondary market e. Prudential Insurance Co. sells $10 million of GM common stock – secondary market 2. Classify the following financial instruments as money market securities or capital market securities: a. Federal Funds – money market security b. Common Stock – capital market security c. Corporate Bonds – capital market security d. Mortgages – capital market security e. Negotiable Certificates of Deposit – money market security f. U.S. Treasur

CHAPTER 7 – Valuing Stocks Questions 1. As owners, what rights and advantages do shareholders obtain? They are able to participate in the economic growth of publicly traded firms without having to manage business entities directly. They have the right to residual cash flows of corporate profits and often receive some of these cash flows through dividends. In addition, shareholders vote on the members for board of directors and other proposals for the company. Shareholder capital losses are capped in that they can only lose their initial investment. Stocks are very liquid and investors can enjoy this liquidity in both their entrance into the stock market and their exit from it. 2. Describe how being a residual claimant can be very valuable. Residual claimant’s are able to delegate the operations of the firm to professional managers, enjoying the possibly vast gains in value that can be created by some firms over time. 3. Obtain a current quot

CHAPTER 6 – Valuing Bonds Questions 1. What does a call provision allow the issuer to do, and why would they do it? A call provision on a bond issue allows the issuer to pay off the bond debt early at a cost of the principal plus any call premium. Most of the time a bond issuer is called, it is because interest rates have substantially declined in the economy. The issuer calls the existing bonds and issues new bonds at the lower interest rate. This reduces the interest payments the issuer must pay each year. 2. List the differences between the new TIPS and traditional Treasury bonds. Traditional Treasury bonds have a fixed principal and constant payments. Because the principal and coupon rate are fixed, interest rate changes in the economy cause the market price of the bonds to have large fluctuations. On the other hand, the principal of a TIPS increases with the rate of inflation. Similar to a T-bond, the TIPS has a constant coupon rate. However, since the principal of the TIP

Questions 5-1 How can you add a cash flow in year two and a cash flow in year four in year seven? To add cash flows, they need to be moved to the same time period. The cash flows in years two and four should be moved forward with interest to year seven, then they can be added together. 5-2 People can become millionaires in their retirement years quite easily if they start saving early in employer 401(k) or 403(b) programs (or even if their employers don’t offer such programs). Demonstrate the growth of a $250 monthly contribution for 40 years earning 9 percent APR. Using equation 5-2, we have: 5-3 When you discount multiple cash flows, how does the future period that a cash flow is paid affect its present value and its contribution to the value of all the cash flows? Discounting reduces a future cash flow to a smaller present value. Cash flows far into the future become very small when discounted to the present. Thus, cash flows