1st slot

MCQs (1 mark each)

1. Capital structure decisions are concerned with

a. how much and what types of debt and equity should be used to finance the firm
b. what types of assets should be purchased
c. how much of earnings to pay out as dividends rather than retaining for reinvestment
d. deciding how much of an economy’s budget to allocate to capital goods production

2. Which of the following are characteristics of an OTC market?

i. A centralized physical location
ii. Operates as an auction market
iii. Dealers make the market through bid and ask prices

a. i only
b. ii and iii
c. iii only
d. none

3. Shares are not part of the money market because

a. They are not a medium of exchange
b. They have no specific maturity
c. They are not very liquid
d. They do not give a fixed return

4. Which of the following explains the role of an investment bank in the capital formation
process?
a. It takes depositors’ funds to create mortgages and business loans
b. It helps an issuer sell securities in return for a commission
c. It enables stock ownership of stock exchanges through demutualization
d. It issues trading licenses to investors who wish to get electronic access to the trading
floor.
Short questions (2 marks each)

1. What is the difference between a dealer and a broker?

Ans: Any TWO of the following points:

i. Dealers operate only in the OTC market while different types of brokers are
present in both OTC and exchange.
ii. Dealers earn through the bid-ask spread while brokers earn through commissions.
iii. Dealers OWN inventories of securities that they buy and sell. Brokers trade
securities on behalf of their clients which the CLIENTS own.
iv. Dealers are buyers and sellers. Brokers are the middlemen between buyers and
sellers.
v. Other relevant points

2. Briefly discuss the following ways of reducing the agency problem:

i. Managerial compensation

Ans: Tying managerial compensation to the achievement of long term performance

targets that increase stock price will ensure that managers work in the shareholders’
interest.

ii. Threat of takeover

Ans: Hostile takeovers when the stock price plunges due to poor management usually
result in management being fired or losing all power post-takeover, motivating managers
to maximize stock price.

3. Briefly discuss whether profit maximization and stock price maximization can be
achieved together. Which is the more important objective?
Ans: Stock price maximization is more important, plus any ONE of the following points:

i. Timings of the earnings: Shareholders want dividends sooner rather than later,
hence a project that results in profits later rather than sooner will not result in
stock price maximization although it will maximize profit.
ii. Risk: a highly risky and uncertain project may end up maximizing profit, but
will reduce demand for the shares due to the probability of failure, reducing
stock price.
2nd slot

MCQs (1 mark each)

1. The act of financial intermediation consists of

a. transforming equity shares into debt instruments such as bonds.

b. converting gold into paper currency.
c. transforming liabilities into assets.
d. safekeeping other people's funds.

2. A primary market is one in which

a. newly printed money is transferred to the banks.

b. money market dealers make their most important trades.
c. the Bank of Canada conducts its monetary policy.
d. financial assets are traded for the first time.

3. Which of the following are benefits of running a proprietorship?

i. It is expensive to form
ii. It faces double taxation
iii. It has unlimited liability

a. i and ii
b. ii and iii
c. i only
d. none

4. The primary goal of a company’s management is to

a. maximize the share price
b. minimize cost per unit
c. maximize market share
d. maximize profitability
Short questions (2 marks each)

1. Briefly explain any two benefits of investing in money markets.

Ans: Any TWO of the following points:

i. Low interest rate risk/price risk: the securities can be sold at a price close to what
was initially paid for them.
ii. Low default risk: Securities such as commercial paper can only be issued by blue
chip companies with strong financials
iii. Enable earning a return on cash surplus available for a short period
iv. Trading liquidity: all else equal, it is easier to sell a security at a ‘good’ price the
closer it is to maturity
v. Other relevant points

2. Give two differences between an OTC market and an exchange.

Ans: Any TWO of the following points:

i. Physical centralized location of an exchange

ii. Exchange operates as an auction market
iii. OTC market has dealers and brokers while exchange has specialists and brokers
iv. OTC has counterparty risk (credit risk/default risk)
v. Other relevant points

3. Briefly discuss the following ways of reducing the agency problem:

i. Managerial compensation (answer given in 1st slot solution)

ii. Shareholder intervention

Ans: Strong institutional investors with a lot of voting power such as pension funds
monitor management, realign managers’ decisions with the interests of shareholders, and
otherwise threaten to overthrow management.
3rd slot

MCQs (1 mark each)

1. A portfolio is

a. a collection of personal liabilities

b. a collection of assets.
c. a collection of various debt instruments.
d. the information collected by banks to evaluate a customer's borrowing capacity.

2. The trade-through rule requires that

a. Investors must trade through a broker
b. Securities must trade through an organized exchange
c. Stock trade should be executed at the best price
d. Issuers must trade through an investment bank

3. The money market is for the trading of ________ instruments while the capital market
is where ________ instruments are traded.

a. bonds, Treasury-bills.
b. long-term, short-term
c. cash, tangible
d. short-term, long-term

4. The primary role of the financial markets is to

a. maximize cash inflows for investors
b. allow people to speculate on market trends
c. control the money supply and prevent deflation
d. enable the transfer of funds from savers to borrowers
Short questions (2 marks each)

1. How is the performance of the primary market linked to that of the secondary
market for a particular security? Which of these two markets is generally more
active?

Ans: Secondary market is generally more active, plus any ONE of the following points:
i. An active secondary market helps issuers determine the appropriate share price for
new issues in the primary market.
ii. Investors buy in the primary market only if the secondary market is active enough
for them to sell the security later on.

2. Are stock options a good way to deal with the agency problem? Why?

Ans: Yes it is a good way. If managers own stock in the company, they are motivated to
make decisions that will increase the share price, which is the goal of the other
shareholders too.

3. Briefly explain any two of the three procedures that can be used for capital
formation.

Ans: Any TWO of the following:

i. Direct transfer: Business sells its stocks or bonds directly to investors in the
OTC or exchange without going through an investment bank or
intermediary
ii. Indirect transfer through an investment banker: the IB is the middleman
which buys the company’s stock and sells it on to investors. The funds
‘pass through’ the IB
iii. Indirect transfer through financial intermediary: The intermediary obtains
funds from savers and then uses the money to lend out or to purchase other
companies’ securities.