Financial Markets and Institutions
Exam Materials
Course Introduction
This course provides an in-depth exploration of the structure, function, and operation of financial markets and institutions within the global economy. Students will examine the roles and responsibilities of various financial intermediaries, such as banks, insurance companies, mutual funds, and investment firms, and analyze the ways they facilitate the flow of funds between savers and borrowers. Key topics include the functioning of money and capital markets, the determination of interest rates, the regulation and supervision of financial institutions, risk management strategies, and the impact of technological and regulatory changes on the financial system. The course emphasizes both theoretical frameworks and real-world case studies to equip students with a comprehensive understanding of contemporary financial systems.
Recommended Textbook
Fundamentals of Corporate Finance 3rd Eition by Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Q1) Why is a stock exchange like NASDAQ considered a secondary market?
A)It trades the second largest volume of shares in the world.
B)Shares sold on it are exchanged between investors without any involvement of the issuing corporation.
C)The exchange has rules that attempt to ensure that bid and ask prices do not get too far apart.
D)NASDAQ is called a secondary market because NYSE is considered a primary market.
Answer: B
Q2) The shares of private corporations are traded on a stock market.
A)True
B)False
Answer: False
Q3) What is the bid-ask spread on the stock shown above?
A)1 cent
B)3 cents
C)6 cents
D)12 cents
Answer: B
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) A printing company prints a brochure for a client and then bills them for this service. At the time the printing company's financial disclosure statements are prepared, the client has not yet paid the bill for this service. How will this transaction be recorded?
A)The sale will be added to Net Income on the income statement and retained in Net Income on the statement of cash flows.
B)The sale will be added to Net Income on the income statement but deducted from Net Income on the statement of cash flows.
C)The sale will not be added to Net Income on the income statement but added to Net Income on the statement of cash flows.
D)The sale will neither be added to Net Income on the income statement nor used to adjust Net Income on the statement of cash flows.
Answer: B
Q2) Refer to the partial balance sheet above. If on December 31, 2005 Luther has 8 million shares outstanding trading at $15 per share, then what is Luther's market-to-book ratio?
Answer: Market-to-book = Market value of equity / Book value of equity
Market-to-book = 8 million × $15 / $63.6 = 1.89
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Chapter 3: Time Value of Money: an Introduction
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Q1) How can we convert the value of money from one point in time to another?
A)using the current exchange rate
B)using a cost-benefit analysis
C)using the valuation principle
D)using the current interest rate
Answer: D
Q2) If an analyst incorrectly adds cash flows occurring at different points in time, what is the implied assumption in the process?
Answer: Cash flows occurring at different points in time cannot be added because a dollar today is worth more than a dollar tomorrow. In other words, these cash flows are not in the same units. The compounding and discounting effect causes these cash flows to be different across time. However, this is only valid for nonzero interest rates. Hence, the implied assumption in adding cash flows across time is that interest rate is zero.
Q3) The one-year discount factor is the discount at which we can purchase money in the future, one year from now.
A)True
B)False
Answer: True
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Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) Define the following terms:
(a)perpetuity
(b)annuity
(c)growing perpetuity
(d)growing annuity
Q2) The present value (PV)of a stream of cash flows is just the sum of the present values of each individual cash flow.
A)True
B)False
Q3) An annuity is set up that will pay $1500 per year for ten years. What is the present value (PV)of this annuity given that the discount rate is 9%?
A)$5776
B)$9626
C)$11,551
D)$13,476
Q4) A growing perpetuity, where the rate of growth is greater than the discount rate, will have an infinitely large present value (PV).
A)True
B)False
6
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Chapter 5: Interest Rates
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Q1) What is the present value (PV)of an investment that pays $100,000 every year for four years if the interest rate is 5% APR, compounded quarterly?
A)$353,818
B)$389,200
C)$424,581
D)$459,963
Q2) What, typically, is used to calculate the opportunity cost of capital on a risk-free investment?
A)the best expected return offered in any investment available in the market
B)the interest rate on U.S. Treasury securities with the same term
C)the interest rate of any investments alternatives that are available
D)the best rate of return offered by U.S. Treasury securities
Q3) A $50,000 new car loan is taken out with the terms 12% APR for 48 months. How much are monthly payments on this loan?
A)$1448.36
B)$1580.03
C)$1316.69
D)$1711.70
Q4) How are interest and return of principal handled in an amortizing loan payment?
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Chapter 6: Bonds
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Q1) Which of the following best describes a bond rated by Standard & Poor's and Moody as B?
A)judged to be high quality by all standards
B)considered to be medium grade obligations
C)neither highly protected nor poorly secured
D)generally lacks the characteristics of a desirable investment
Q2) The current zero-coupon yield curve for risk-free bonds is shown above. What is the risk-free interest rate on a 4-year maturity?
A)3.00%
B)3.15%
C)3.25%
D)6.34%
Q3) Prior to its maturity date, the price of a zero-coupon bond is its face value. A)True
B)False
Q4) Treasury bonds have original maturities from one to ten years, while Treasury notes have original maturities of more than ten years.
A)True
B)False
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Chapter 7: Stock Valuation
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Q1) A stock is expected to pay $1.25 per share every year indefinitely and the equity cost of capital for the company is 8.4%. What price would an investor be expected to pay per share ten years in the future?
A)$14.88
B)$22.32
C)$29.76
D)$37.20
Q2) A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor.
A)True B)False
Q3) Rylan Industries is expected to pay a dividend of $5.70 year for the next four years. If the current price of Rylan stock is $31.27, and Rylan's equity cost of capital is 12%, what price would you expect Rylan's stock to sell for at the end of the four years?
A)$21.96
B)$39.53
C)$17.57
D)$61.49
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Chapter 8: Investment Decision Rules
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Q1) Should personal preferences for cash today versus cash tomorrow play a role in the net present value (NPV)decision-making process?
Q2) Jenkins Security has learned that a rival has offered to supply a parking garage with security for ten years for $45,000 up front and a further $15,000 per year. If Jenkins Security offers to provide security for eight years for an upfront cost of $60,000 and a separate yearly payment, by what maximum amount can this yearly payment be over $20,000, so that Jenkins' offer matches the equivalent annual annuity of their rival's offer? (Assume a cost of capital of 5%.)
A)-$89
B)-$94
C)-$100
D)-$111
Q3) When comparing mutually exclusive projects which have different scales, you must know the dollar impact of each investment rather than percentage returns.
A)True
B)False
Q4) What is the decision criteria using internal rate of return (IRR)rule?
Q5) What is the general shape of the net present value (NPV)profile?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.
A)True
B)False
Q2) If available, should MACRS be preferred to straight-line depreciation?
Q3) Ford Motor Company is considering launching a new line of hybrid diesel-electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $30 million next year. Without the new SUV, Ford expects to earn pre-tax income of $80 million from operations next year. Ford pays a 30% tax rate on its pre-tax income. The amount that Ford Motor Company owes in taxes next year with the launch of the new SUV is closest to ________.
A)$15.0 million
B)$9.0 million
C)$33.0 million
D)$24.0 million
Q4) If available, should MACRS be preferred to straight-line depreciation?
Q5) What is the correct tax rate that should be used for capital budgeting decisions?
Q6) Why does the option to abandon a project have value?
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Chapter 10: Stock Valuation: a Second Look
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Q1) In an efficient market, investors will only find positive-NPV trading opportunities if they have some form of competitive advantage over other investors.
A)True
B)False
Q2) Which of the following statements is FALSE?
A)A firm's weighted average cost of capital, denoted r<sub>wacc</sub>, is the cost of capital that reflects the risk of the overall business, which is the combined risk of the firm's equity and debt.
B)Intuitively, the difference between the discounted free cash flow model and the dividend-discount model is that in the divided-discount model, a firm's cash and debt are included indirectly through the effect of interest income and expenses on earnings in the dividend-discount model.
C)We interpret r<sub>wacc</sub> as the expected return a firm must pay to investors to compensate them for the risk of holding the firm's debt and equity together.
D)When using the discounted free cash flow model, we should use a firm's equity cost of capital.
Q3) Which is the best valuation technique when using comparables?
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Chapter 11: Risk and Return in Capital Markets
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Q1) Suppose you invested $100 in the Ishares High Yield Fund (HYG)a month ago. It paid a dividend of $2 today and then you sold it for $95. What was your dividend yield and capital gains yield on the investment?
A)2%, -5%
B)2%, 5%
C)-2%, 5%
D)5%, 2%
Q2) You purchased Alpha Innovative Inc. stock at a price of $25 per share. Its price was $15 after six months and the company declared bankruptcy at the end of the next six months. The realized return over the last year is ________.
A)-99%
B)-75%
C)-150%
D)-100%
Q3) The risk that inflation rates are likely to increase in the next year is an example of common risk.
A)True
B)False
Q4) Which type of investment has historically had the highest volatility?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) Correlation is the degree to which the returns of two stocks share common risks.
A)True
B)False
Q2) Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return?
A)12.2%
B)12.9%
C)13.6%
D)14.3%
Q3) A portfolio has three stocks - 110 shares of Yahoo (YHOO), 210 Shares of General Motors (GM), and 70 shares of Standard and Poor's Index Fund (SPY). If the price of YHOO is $20, the price of GM is $20, and the price of SPY is $130, calculate the portfolio weight of YHOO and GM.
A)10.6%, 13.5%
B)9.9%, 25.7%
C)13.5%, 24.4%
D)14.2%, 27.1%
Q4) Is it possible for a stock to have high total risk but low systematic risk?
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Chapter 13: The Cost of Capital
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Q1) Assume Bismuth Electronics has a book value of $6 billion of equity and a face value of $19.7 billion of debt. The market values of equity and debt are $2.5 billion and $18.5 billion. A Wall Street financial analyst determines values of equity and debt as $3 billion and $20 billion. Which of the following values should be used for calculating the firm's WACC?
A)$6 billion of equity and $19.7 billion of debt
B)$2.5 billion of equity and $20 billion of debt
C)$3 billion of equity and $19.9 billion of debt
D)$2.5 billion of equity and $18.5 billion of debt
Q2) A firm has $1 million market value and it sells preferred stock with a par value of $100. If the coupon rate on the preferred stock is 5% and the preferred stock trades at $91, what is the cost of preferred stock capital?
A)4.67%
B)4.95%
C)5.22%
D)5.49%
Q3) What type of adjustment to debt is in practice?
Q4) Which of the three costs-debt, preferred stock and common equity-is most difficult to estimate?
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Chapter 14: Raising Equity Capital
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Q1) Newly listed firms tend to perform relatively poorly in the three to five years after their IPOs.
A)True
B)False
Q2) Which of the following statements regarding best efforts IPOs is FALSE?
A)For smaller IPOs, the underwriter commonly accepts the deal on this basis.
B)The underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price.
C)Often these arrangements have an all-or-none clause: either all of the shares are sold in the IPO, or the deal is called off.
D)If the entire issue does not sell out, the underwriter is on the hook.
Q3) Stock issued in an IPO usually trades significantly higher at the end of the first day of trading than the original IPO price.
A)True
B)False
Q4) What are some of the highlights of Google's IPO process?
Q5) The announcement of an SEO usually raises a stock's price.
A)True
B)False
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Chapter 15: Debt Financing
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Q1) Bond covenants tend to increase a bond issuer's borrowing costs.
A)True
B)False
Q2) Convertible bonds have a provision that gives the bondholder an option to convert each bond owned into a fixed number of shares of common stock.
A)True
B)False
Q3) A firm issues $225 million in straight bonds at an original issue discount of 2.0% and a coupon rate of 6%. The firm pays fees of 4% on the face value of the bonds. The net amount of funds that the debt issue will provide for the firm is ________.
A)$200.925 million
B)$211.5 million
C)$222.075 million
D)$232.65 million
Q4) By definition, a preferred stock is a form of debt security.
A)True
B)False
Q5) What is yield to maturity?
Q6) What are callable bonds?
17
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Chapter 16: Capital Structure
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Q1) Equity in a firm with no debt is called unlevered equity.
A)True
B)False
Q2) Which of the following statements is FALSE?
A)The levered equity return equals the unlevered return plus an extra "kick" due to leverage.
B)By holding a portfolio of a firm's equity and its debt, we can replicate the cash flows from holding its levered equity.
C)The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a premium that is proportional to the market value debt-equity ratio.
D)If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid out to its equity holders.
Q3) The presence of a large amount of debt can encourage shareholders to take excessive risk because ________.
A)equity holders are risk seeking by nature
B)the costs of failure are borne largely by debt holders
C)debt holders are risk seeking
D)firm value increases with risk taking
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Chapter 17: Payout Policy
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Q1) Luther Industries has $7 million in excess cash and 1.2 million shares outstanding. Luther is considering investing the cash in one-year Treasury bills that are currently paying 5% interest and then using the cash to pay a dividend next year. Alternatively, Luther can pay the cash out as a dividend immediately and the shareholders can invest in the Treasury bills themselves. Assume that capital markets are perfect. If Luther decides to pay the dividend immediately the dividend per share will be closest to
A)$7.00
B)$4.67
C)$5.83
D)$11.67
Q2) Future investment plans are important determinants of payout policy because of
A)signal to investors
B)costs of raising new capital
C)stock price depreciation
D)debt holder restrictions
Q3) What is the general trend of dividend payments of U.S. corporations over the last few decades?
Q4) What are the ways in which a firm can pay out its free cash flow?
Page 19
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) The market size for Loppins is 80 million units. If SPI Inc. has a market share of 30% and the average sales price is $2 per Loppin, what is the dollar amount of sales of SPI?
A)$40 million
B)$42 million
C)$45 million
D)$48 million
Q2) Forecasting a balance sheet with percent of sales method requires two passes-a first pass to determine financing needs and a second pass that shows the sources and amounts of financing.
A)True
B)False
Q3) Based upon Ideko's Sales and Operating Cost Assumptions, what production capacity will Ideko require in 2009?
A)1,505,000 units
B)1,115,000 units
C)1,323,000 units
D)1,701,700 units
E)1,914,000 units
Q4) How do we compute net new financing?
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Chapter 19: Working Capital Management
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Q1) Luther's cash conversion cycle is closest to ________.
A)51 days
B)66 days
C)71 days
D)129 days
Q2) Luther's Accounts Receivable days is closest to ________.
A)42 days
B)39 days
C)32 days
D)59 days
Q3) If a firm wishes to invest cash that might be needed at short notice in the very near future, they would be most likely to invest in which of the following securities?
A)Treasury bills
B)certificates of deposit
C)repurchase agreements
D)banker's acceptances
Q4) What is a firm's cash cycle?
Q5) What are the five C's of Credit?
Q6) What is a firm's operating cycle?
21
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Chapter 20: Short-Term Financial Planning
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Q1) A loan agreement that requires the firm to pay interest on the loan and pay back the principal in one lump sum at the end of the loan is called ________.
A)a short-term mortgage loan
B)a single, end-of-period-payment loan
C)a bridge loan
D)a line of credit
Q2) An uncommitted line of credit is obtained through a nonbinding, informal agreement.
A)True
B)False
Q3) Which of the following best describes the agreement where all of a firm's inventory is used to secure a loan?
A)pledging of accounts receivable
B)factoring of accounts receivable with recourse
C)factoring of accounts receivable without recourse
D)floating lien
Q4) What is temporary working capital?
Q5) What is permanent working capital?
Q6) What do we understand by seasonality?
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Chapter 21: Option Applications and Corporate Finance
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Q1) How many of the January 2009 put options are in-the-money?
A)1
B)3
C)2
D)4
Q2) Assume you want to buy five call option contracts that with an exercise price closest to being at-the-money and that expires December 2010. The current price that you would have to pay for such a contract is ________.
A)$550
B)$110
C)$475
D)$300
Q3) Equity holders have an incentive to ________ the volatility of a firm's assets because they benefit from such an increase at a cost to ________.
A)decrease, debt holders
B)decrease, suppliers
C)increase, directors
D)increase, debt holders
Q4) When is an option at-the-money?
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Chapter 22: Mergers and Acquisitions
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Q1) For a hostile takeover to succeed, the acquirer must appeal to the target shareholders; this is usually done through ________.
A)a tender offer and a proxy fight
B)a tender offer and a poison pill
C)a white knight and a proxy fight
D)a staggered board and a white knight
Q2) When a hostile takeover appears to be inevitable, a target company will sometimes look for another, friendlier company to acquire it called a ________.
A)poison pill
B)classified board
C)golden parachute
D)white knight
Q3) Most acquirers pay an acquisition premium for a target. Upon announcement of the bid, the target's stock price increases, on average, so that the stock price is the same as the price bid by the acquirer.
A)True
B)False
Q4) What is a white knight?
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Chapter 23: International Corporate Finance
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Q1) Which two currencies account for more than half of all the trading volume in the foreign exchange market?
A)Euro and Chinese yuan
B)U.S. dollar and the British pound
C)Euro and the British pound
D)U.S. dollar and the euro
Q2) You have just landed in Paris with $750 in your wallet. At the foreign exchange booth, you see that euros are being quoted at $1.34/ . How many euros can you exchange for your $750?
A)1,005 euros
B)559.70 euros
C)750.00 euros
D)179.56 euros
Q3) A ________ strategy replicates the forward contract by borrowing in one currency, converting to the other currency and investing in the new currency.
A)cash-and-carry
B)futures
C)forward
D)none of the above
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Chapter 24: Leasing
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Q1) Which of the following statements is FALSE?
A)The decision to lease is often driven by real-world market imperfections related to leasing's accounting, tax, and legal treatment.
B)When publicly traded firms disclose leasing transactions in their financial statements, they must follow the recommendations of the Financial Accounting Standards Board (FASB).
C)In its Statement of Financial Accounting Standards No. 13 (FAS13), the FASB provides specific criteria that distinguish a true tax lease from a nontax lease.
D)The categories used to report leases on the financial statements affect the values of assets on the balance sheet, but they have no direct effect on the cash flows that result from a leasing transaction.
Q2) In the chapter, the lease versus buy decision was called an unfair comparison. Why? What is the correct comparison?
Q3) Calculate the monthly lease payments for a four year fixed price lease that allows the lessee to buy the Bulldozer at the end of the lease for $8,000.
Q4) Calculate the monthly lease payments for a four-year $1.00-out lease of the Bulldozer.
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Chapter 25: Insurance and Risk Management
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Q1) An interest rate that adjusts to current market conditions is called a(n)________.
A)floating rate
B)fixed rate
C)notional rate
D)arbitrage rate
Q2) If your firm is uninsured, the NPV of implementing the new safety policies is closest to
A)$2.25 million
B)-$.25 million
C)$2.5 million
D)$2.15 million
Q3) The duration of a five-year bond with 8% annual coupons trading at par is closest to
A)2.5 years
B)4.3 years
C)5.0 years
D)6.2 years
Q4) What is the actuarially fair cost of full insurance?
Q5) What are some of the disadvantages of long-term supply contracts?
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Chapter 26: Corporate Governance
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Q1) What are some of the negative effects of increasing the sensitivity of managerial pay to firm performance?
Q2) Which of the following statements is FALSE?
A)One study found that firms with fewer restrictions on shareholder power performed worse than firms with more restrictions during the 1990s.
B)Some large public pension funds, such as CalPERS (the California Public Employees Retirement System), take an activist role in corporate governance.
C)In 2004 with the Walt Disney Company, major shareholders were dissatisfied with the recent performance of Disney under long-time CEO and Chairman, Michael Eisner. They began an organized campaign to convince the majority of Disney shareholders to withhold their approval of the reelection of Eisner as director and chairman of the board.
D)Given the importance of shareholder action in corporate governance, researchers and large investors alike have become increasingly interested in measuring the balance of power between shareholders and managers in a firm.
Q3) What is the difference between inside, gray, and outside directors?
Q4) Describe the "stakeholder" model of corporate governance.
Q5) What is corporate governance?
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