1. The applicability of beta depends on a firms A. future p.docx

1. The applicability of beta depends on a firm's
A. future plans.
B. standard deviation.
C. growth rate.
D. historical returns.
2. Suppose a firm has an EBIT of $1,400,000 and finances its
assets with $6,000,000 of debt at 6 percent interest and 300,000
shares of stock selling at $12.50 a share. To lessen the risk
associated with this financial leverage, the firm is thinking
about reducing its debt by $3,000,000 by selling more stock.
The firm is in the 35 percent tax bracket. The change in the
capital structure won't have any effect on the firm's operations,
thus EBIT will remain at $1,400,000. What's the change in the
firm's EPS from this change in capital structure?
A. EPS rises by $0.28 per share
B. EPS falls by $0.36 per share
C. EPS rises by $0.54 per share
D. EPS falls by $0.78 per share
3. Modern portfolio theory demonstrates how
A. stock price movements are correlated.
B. there is an optimal portfolio that minimizes risk.
C. to measure risk-vs-reward.
D. total risk is measured.
4. How long is the useful life of a fixed asset?
A. In excess of two years

B. In excess of one year
C. Not more than 10 years
D. Less than one year
5. What annual rate of return is earned on a $4,000 investment
when it grows to $8,200 in 5 years?
A. 12.22 percent
B. 15.44 percent
C. 13.58 percent
D. 14.34 percent
6. Which one of the following is a feature of an efficient
market?
A. Information restricted to certain well-connected participants
B. Low trading or transaction costs
C. Few buyers and sellers
D. Prohibitively high barriers to entry
7. What characteristic of a bond determines the dollar amount
of interest paid to bondholders?
A. Bid
B. Par value
C. Yield to maturity
D. Coupon rate
8. Which one of these is a common approach to assessing a
stock's relative value?
A. Constant-growth rate
B. Variable-growth rate
C. Price-earnings (P/E) ratio
D. Dividend discount model

9. An 8 percent corporate coupon bond is callable in seven
years for a call premium of one year of coupon payments.
Assuming a par value of $1,000, what's the price paid to the
bondholder if the issuer calls the bond?
A. $1,080
B. $920
C. $1,040
D. $1,160
10. To analyze performance meaningfully, what must ratio
results be interpreted against?
A. The discount rate
B. A standard or benchmark
C. ROE
D. The time value of money (TVM
11. A treasury bond bought at the beginning of the year for
$1,064 pays $48 in interest payments during the year, ending
the year valued at $1,095. What was the percent return?
A. 6.86
B. 4.88
C. 7.42
D. 8.44
12. What happens when a firm issues debt to finance its
assets?
A. The firm's capital structure doesn't change.
B. Debt holders are entitled to receive the same amount of
dividends as stockholders.
C. It gives the debt holders first claim to a fixed amount of its
cash flows.
D. Stockholders surrender their rights to dividends but not

capital gains
13. A three-year Treasury security currently earns 2.11
percent. Over the next three years, the real risk-free rate is
expected to be 1.2 percent per year, and the inflation premium
is expected to be 0.60 percent per year. What's the maturity risk
premium on the three-year Treasury security?
A. 1.44 percent
B. 0.31 percent
C. 0.44 percent
D. 2.71 percent
14. Tasty Snacks, Inc.'s, 2015 income statement shows an
EBIT of $1,440,200, interest expense of $150,000, and taxes of
$345,020. The firm has no preferred stock outstanding and
200,000 shares of common stock outstanding. Calculate the
company's 2015 earnings per share.
A. $3.89
B. $5.84
C. $4.73
D. $3.27
15. Why do bond prices with lower coupons have a greater risk
of declining in price in response to rising interest rates?
A. Reinvestment rate risk
B. Interest rate risk
C. Market risk
D. Default risk
16. You own $12,000 of stock in Company A. The stock has a
beta of 2.8. You also own $7,500 of stock in Company B, which
has a beta of 1.3, and $4,500 of stock in Company C, which has
a beta of 0.3. What's the beta of your portfolio?

A. 1.68
B. 1.86
C. 1.98
D. 0.84
17. A deposit of $1,460 earns the following interest rates: 7
percent in year one, 6.5 percent in year two, 6 percent in year
three, and 5 percent in year four. What would be the future
value for year four?
A. $1,885.55
B. $1,925.37
C. $1,825.48
D. $1,851.75
18. The process of earning interest both on the original deposit
and on the earlier interest payments is called
A. compounding.
B. discounting.
C. APR.
D. future value.
19. Year-to-date, Company A has earned a 5.90 percent return.
During the same period, Company B has earned 8.65 percent,
and Company C has earned 14.30 percent. What's your portfolio
return if you have a portfolio made up of the following?
45 percent Company A
35 percent Company B
20 percent Company C

A. 13.41
B. 8.54
C. 5.42
D. 9.38
20. What's the present value of a $150 payment made every
year forever at an interest rate of 7.3 percent?
A. $2,055
B. $1,984
C. $2,175
D. $2,227
1.
The applicability of beta depends on a firm's
A.
future plans.
B.
standard deviation.

C.
growth rate.
D.
historical returns.
2.
Suppose a firm has an EBIT of $1,400,000 and fi
nances its assets with $6,000,000
of debt at 6 percent interest and 300,000 shares of stock selling
at $12.50 a share. To
lessen the risk associated with this financial leverage, the firm
is thinking about
reducing its debt by $3,000,000 by selling more st
ock. The firm is in the 35 percent tax
bracket. The change in the capital structure won't have any
effect on the firm's
operations, thus EBIT will remain at $1,400,000. What's the
change in the firm's EPS
from this change in capital structure?
A.
EPS rises by $0.28 per share

B.
EPS falls by $0.36 per share
C.
EPS rises by $0.54 per share
D.
EPS falls by $0.78 per share
3.
Modern portfolio
theory demonstrates how
A.
stock price
movements are
correlated.
B.

there is an
optimal portfolio that
minimizes risk.
C.
to measure risk
-
vs
-
reward.
D.
total risk is
measured.
4.
How long is
the useful life of
a fixed asset?
1. The applicability of beta depends on a firm's
A. future plans.
B. standard deviation.
C. growth rate.
D. historical returns.

2. Suppose a firm has an EBIT of $1,400,000 and finances its
assets with $6,000,000
of debt at 6 percent interest and 300,000 shares of stock selling
at $12.50 a share. To
lessen the risk associated with this financial leverage, the firm
is thinking about
reducing its debt by $3,000,000 by selling more stock. The firm
is in the 35 percent tax
bracket. The change in the capital structure won't have any
effect on the firm's
operations, thus EBIT will remain at $1,400,000. What's the
change in the firm's EPS
from this change in capital structure?
A. EPS rises by $0.28 per share
B. EPS falls by $0.36 per share
C. EPS rises by $0.54 per share
D. EPS falls by $0.78 per share
3. Modern portfolio
theory demonstrates how
A. stock price
movements are
correlated.
B. there is an
optimal portfolio that
minimizes risk.
C. to measure risk-
vs-reward.
D. total risk is
measured.

4. How long is
the useful life of
a fixed asset?
Study Guide
Financial
Management
By
Joshua Iversen
About the Author
Joshua Iversen holds a Bachelor’s degree in History from the
University of California, Los Angeles. He has worked in the
financial services industry since 1988 and is currently the
President
and Chief Investment Officer of Syzygy Financial LLC. He uses
the
knowledge gained during his more than 25 years in the industry
to
write about topics pertaining to finance and investing.
All terms mentioned in this text that are known to be trademarks
or service marks
have been appropriately capitalized. Use of a term in this text
should not be regarded
as affecting the validity of any trademark or service mark.
Copyright © 2016 by Penn Foster, Inc.

All rights reserved. No part of the material protected by this
copyright may be
reproduced or utilized in any form or by any means, electronic
or mechanical,
including photocopying, recording, or by any information
storage and retrieval
system, without permission in writing from the copyright owner.
Requests for permission to make copies of any part of the work
should be mailed to
Copyright Permissions, Penn Foster, 925 Oak Street, Scranton,
Pennsylvania 18515.
Printed in the United States of America
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INSTRUCTIONS TO STUDENTS 1
LESSON ASSIGNMENTS 5
LESSON 1: FINANCIAL MANAGEMENT 7
LESSON 2: KEY FINANCIAL CONCEPTS 37
LESSON 3: CAPITAL MANAGEMENT 151
SELF-CHECK ANSWERS 223
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YOUR STUDY GUIDE
Welcome to Financial Management! This study guide is
designed to help you make the most of your textbook,
Finance: Applications & Theory, Third Edition. Here you’ll find
a study plan that includes a useful introduction and a list of
your reading assignments. As you work through your study
guide and textbook, you’ll learn about important
principles of finance. When you finish each lesson in the
study guide, you’ll complete a multiple-choice examination.
This course provides a basic introduction to the study of
finance, including financial institutions, investments, and
corporate finance. First, you’ll learn about the essential
concepts and analytical tools of financial management,
because they’re used in all three areas of study. Then, you’ll
explore the key financial concepts underlying these practices.
Finally, you’ll learn about the theory and practice of capital
management. Note that this study guide isn’t meant to take
the place of your textbook. Rather, it’s designed to complement
the text material by highlighting essential concepts and
clarifying difficult content. In addition, the study guide
provides examples and problems to reinforce the textbook
readings, as well as assignments and self-checks to help you
evaluate your understanding of the material before you
complete the examinations.
KNOW YOUR BOOK
Finance: Applications & Theory, Third Edition, is the heart of

this course. This textbook provides the material you need to
know to successfully complete your Financial Management
course. Read the material in the text and study it until you’re
completely familiar with it. This is the material on which your
examinations are based. Before you actually begin reading
your assignments, however, become thoroughly familiar with
the textbook itself. Refer to it as you read through the
following information.
Start your survey of the textbook by turning to the “A Note
from the Authors,” beginning on page viii, which describes the
key themes of the textbook. Continue your survey on the page
Instructions to Students2
titled “Brief Table of Contents.” Note that the textbook is
organized into nine parts. The Table of Contents lists the
topics included in each of the nine parts of the textbook. Skim
these topics to see what to expect in each chapter. As you use
your textbook, take time to study the examples, figures,
equations, tables, and other graphics included. These
illustrations supplement or amplify the discussion—in fact,
many of them are integral parts of the discussion. You’ll also
notice that the margins include definitions from the text.
Be sure to review the appendices associated with Chapter 6,
12, 14, and 20. Finally, the index refers you to page numbers
and is especially useful for reviewing topics. Each chapter
contains viewpoints for both business and personal applications.
Learning goals at the start of each chapter are highlighted
throughout to emphasize key aspects of the text. Each
numbered example has an accompanying video-guided
example that you can access by scanning the QR code or by
going to the book’s student edition website.

Some of this material is analytical in nature and requires
you to understand some mathematical calculations. Example
problems in your textbook and study guide help you to master
these calculations. Math Coach boxes are included in many
chapters to help you complete particular problems. Some of
the problems can be completed manually or with the help
of tables. However, you’ll find that some calculations are
easier to perform with a financial calculator. Your textbook
references two inexpensive financial calculators: the Hewlett-
Packard 10B II Business Calculator and the Texas Instrument
BA II (Plus or Professional). Refer to the Math Coach “Using
a Financial Calculator” in Section 4.2 of your textbook for
further details and instructions for using common financial
buttons. You can also use an electronic spreadsheet such as
Microsoft Excel to perform financial calculations if you prefer.
The Student Equations Handbook includes all equations from
each chapter of your textbook as a quick equation look-up. As
you go through each chapter, be sure to complete the “Time
Out” questions from each section. The answers to these
questions can be found at the end of each chapter.
http://highered.mheducation.com/sites/007786168x/student_vie
w0/index.html
Instructions to Students 3
COURSE OBJECTIVES
When you complete this course, you’ll be able to
n Categorize financial management functions and
organizational structure
n Analyze a firm’s financial statements, cash flow values,
risks, and returns

n Recommend budgeting policies, planning, structures,
and costs for a firm’s capital
A STUDY PLAN
This study guide leads you through your assignments.
The information, instructions, and advice provide a great
approach for building your knowledge in these lessons. You
must read this study guide and your textbook carefully, and
you should follow the instructions for each assignment.
Complete all work related to each assignment before moving
on to the next.
To complete these lessons,
1. Read the short introduction to each assignment in the
study guide.
2. Read the required sections in the textbook, and
work through the practice problems contained in the
assignment.
3. Complete the self-check in the study guide for each
assignment, and check your answers against those
provided at the back of the study guide.
4. When you’ve finished reading all of the assigned text-
book pages for each lesson and you’re sure that you’re
comfortable with the material, complete the examination
for that lesson.
Each examination contains 20 multiple-choice questions.
Take your time as you complete each examination—there’s no
time limit. You may go back to your textbook to review material
at any time when you’re working on the examination.

Lesson Assignments4
Repeat these steps until all three lessons have been completed.
Remember, you may ask your instructor for help whenever
you need it. Your instructor can answer your questions,
provide additional information, and provide further explanation
of your study materials. Your instructor’s guidance and
suggestions
will be helpful as you progress through your course.
Now, look over the lesson assignments. Then, begin your
study of financial management with Lesson 1.
Remember to regularly check your student portal on your
student
homepage. Your instructor may post additional resources that
you
can access to enhance your learning experience.
Please note that a computer can’t be used to take proctored
exams
for this course.
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Lesson 1: Financial Management
For: Read in the Read in the
study guide: textbook:
Assignment 1 Pages 8–15 Chapter 1
Examination 081773 Material in Lesson 1
Lesson 2: Key Financial Concepts

Assignment 8 Pages 96–111 Chapter 6 and Appendix 6A
Assignment 9 Pages 112–131 Chapters 7 and 8
Lesson 3: Capital Management
Assignment 15 Pages 174–185 Chapter 14 and Appendix 14A

Instructions to Students6
Note: To access and complete any of the examinations for this
study
guide, click on the appropriate Take Exam icon on your student
portal. You should not have to enter the examination numbers.
These
numbers are for reference only if you have reason to contact
Student
CARE.
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Financial Management
INTRODUCTION
One of the most important components of any business
operation is financial decision making. Business decisions
at all levels have some underlying financial implications,
either direct or indirect. Financial concepts also arise in the
everyday management of personal resources. It’s important,
therefore, to understand the basics of finance. For example,
the time value of money and the analysis of financial state-
ments are basic components of finance used throughout this
course and in future finance classes. It’s essential that you
take time to master these concepts. As you work your way
through this course, you’ll learn the importance of finance to
the success of every entity, both personal and professional.
In Lesson 1, you’ll learn some important fundamentals of
finance. The lesson also covers issues related to international
corporate finance, including a look at international
opportunities,
issues associated with managing exchange rates, and political
risks associated with doing business in a foreign country. The
final assignment in the lesson focuses on mergers and
acquisitions
and an examination of how companies enter into and deal
with financial distress.
OBJECTIVES
When you complete Lesson 1, you’ll be able to

n Define financial areas, principles, functions, and
business organizations
n Analyze international opportunities, risk, and the foreign
currency exchange
n Classify various types of mergers, acquisitions, and
financial distresses
Financial Management8
ASSIGNMENT 1
Read this assignment. Then read Chapter 1 in your textbook.
The textbook defines finance as the study of applying specific
value to things we own, services we use, and decisions we
make. Financial management refers to the practice of valuing
things from the standpoint of a company or firm. It’s vitally
important to a firm’s success and, looked at broadly, can also
be applied to other financial decision-making processes such
as personal finance.
Cash flow is the process used to pay and receive money. To
understand the concept of cash flow, it’s helpful to consider
an economy’s participants and their relationship to money.
Figure 1.1 in your textbook lists four types of economic
participants. Two of the four groups are relevant to our study
of financial management:
n Type 2 participants, typically called individual investors,
are those who have money to invest but no ideas of their
own in which to invest.

n Type 3 participants are sometimes people but more
typically corporations with research and development
(R&D) departments focused on the development of
innovative ideas (or investment firms formed for the
purpose of investing in companies of this type). They
have viable business ideas but no money of their own
to fund these ideas.
By studying how these two groups interact, we can more
easily understand how money (capital) flows in the form of
capital investments.
Financial markets and financial institutions in most devel-
oped countries allow Type 2 and Type 3 participants to work
together in a mutually beneficial manner. When investors lend
excess capital to companies, those companies can deploy the
capital to pay for expansion projects, as shown in Figure 1.2
in the textbook. If these projects are successful, the compa-
nies will eventually have enough money to return the original
investment along with a profit to their investors. See Figure
1.3 in the textbook.
Lesson 1 9
The amount of capital sent to investors generally doesn’t
equal all of the capital earned by a project. Sources of friction
include retained earnings—funds a company keeps to pay for
ongoing operations—and taxes. Figure 1.4 in the textbook
demonstrates the various perspectives involved in the
investment of capital. Decisions include
n Determining which investment opportunities fit
investors’ risk tolerance and return potential criteria

n Determining how best to distribute the capital
n Deciding which projects to fund, what type of capital to
use, and how much earnings from the project should be
returned to investors
Subareas of Finance
The different methods used and entities involved in financial
activity in a particular sector of an economy make up what
are called subareas of finance. They include the following
categories:
n Investments. This subarea involves the means used to
decide what type of securities an investor will buy, the
specific firms from which an investor will purchase the
securities, and how an investor will be repaid for their
investment. The investment process is demonstrated in
Figure 1.5 of the textbook.
n Financial management. This subarea focuses on how
a firm makes decisions to acquire and use cash (capital)
sourced from investors or retained earnings. The financial
management process as it applies to investment decisions
is outlined in Figure 1.6.
n Financial institutions and markets. These entities
make it easier for capital to flow between investors and
companies. See Figure 1.7 in your textbook.
n International finance. This subarea of finance
deserves a place of its own in the category. Uncertainty
relating to future exchange rates, political risk, and
changes to business laws globally can add significant
complexity to business decisions.

The Financial Function
Cash flows don’t occur immediately, nor are they guaranteed.
The uncertainty involved in future cash flows, both as to timing
and size, is referred to as risk. For investors, risk involves
uncertainty about the return of invested capital. For companies,
risk involves uncertainty about their ability to fund and operate
business projects. The majority of financial decisions revolve
around a comparison of the potential rewards a decision may
bring against the risks generated by that decision. When
comparing
risk and rewards, it helps to determine the current value of
cash flows expected to be received in the future. The price
of financial assets, like stocks and bonds, depends to a
great extent on the expected future cash flows from those
investments.
Financial assets are typically categorized by their risk and
return characteristics. Commonly recognized asset classes
include stocks, bonds, real estate, money market securities,
and derivatives. The measure of current cash flows is called
present value. Relating expected future cash flows to present
cash flows is called the time value of money (TVM). Analyzing
TVM involves taking into account both the timing and level of
risk associated with any projected cash flows.
The highest ranking financial manager at a company is typically
the chief financial officer (CFO). A company’s treasurer and
controller usually report to the CFO. In addition to the financial
duties of the CFO and the managers that report to the CFO,
finance plays a significant role in other areas of most organi-
zations. It’s used to provide guidance for long- and short-term
decisions as well as provide feedback about financial decisions
made by the firm.

Finance is also used in making personal financial decisions
such as
n Borrowing money to buy a new car
n Refinancing your home mortgage at a lower rate
n Making credit card or student loan payments
n Saving for retirement
Topics such as calculating risk, return, and time value of
money will be further covered in other assignments.
Lesson 1 11
Business Organization
There are a number of ways people can choose to structure a
business in the United States. Typically, the number of owners
is the crucial determinant as to how a business structure is
classified. Structure is based on
n Who controls the firm
n Who owns the firm
n What are the owners’ risks
n What access to capital exists
n What are the tax ramifications
Forms of Business

The form of a business is significant. For example, there are
tax advantages and disadvantages to certain forms of ownership.
The majority of businesses are sole proprietorships, owned by
a single individual. A sole proprietorship is easy to form and
has some tax advantages. However, the primary disadvantage
of the sole proprietorship is that the owner has unlimited
personal
liability. Furthermore, the owner’s liability isn’t limited to his
or her investment in the business. Rather, it extends to all
personal assets.
A partnership has many of the same features as a sole propri-
etorship, although the business has two or more owners. As
with the sole proprietorship, each partner (owner) in a general
partnership is legally liable for the business’s debts. Thus, the
advantages and disadvantages of this form of business are
roughly the same as in the sole proprietorship. A limited
partnership limits the level of liability for some of the partners.
This business arrangement grants one or more partners
limited liability for the operations of the business; debts can
be extended only to their investment. A limited partnership
allows some individuals to invest in the business without
bearing personal liability for the firm’s debts. One or more of
the partners still maintain full legal liability and control over
the business operations.
A corporation is a legal entity established by the state. The
corporation is established as an entity and thus can own
assets, collect debt obligations, and pay taxes. The most that
individual owners can lose or be liable for is the amount that
they’ve invested in the firm. One disadvantage of a corporation
is that taxes are due on the corporation’s earnings and also

on any dividends paid by the corporation to its shareholders
as personal taxes.
A hybrid organization is one that offers both limited personal
liability for the owners and passes through the earnings of the
firm, allowing them to avoid the double taxation corporations
are subject to. This type of structure includes S corporations,
limited liability partnerships (LLPs), and limited liability
corporations (LLCs). Hybrid status is generally restricted by
the U.S. government to firms with a limited number of share-
holders or partners in line with the objective of using these
forms of organization to encourage small business formation.
Firm Goals
While some contend that social responsibility should be
favored over maximizing profitability, most financial industry
participants and academics tend to believe that maximizing
shareholder wealth should be the primary focus of a company’s
managers.
To do this, the textbook identifies the following factors a
manager should evaluate:
n How best to bring additional funds into the firm
n Which projects to invest in
n How best to return the profits from those projects to the
owners over time
Agency Theory
When one party (the principal) employs another party (the
agent) to work for him or her, this is known as an agency
relationship. The agent is expected to act in the best inter-
ests of the principal. The agency problem describes situations
in which the agent works for his or her own best interests

Lesson 1 13
instead of those of the principal. For instance, consider the
case of a corporate executive who purchases a luxury vehicle
with company funds, when a more practical car would have
saved the firm money. To deal with the agency problem, a
company can take a variety of approaches:
n Simply ignore the conflicts if the monetary value or effect
is negligible.
n Monitor the behavior of managers. Excessive monitoring
is likely to be counterproductive but can be done via the
process of accounting auditing.
n Take steps to align the personal interests of managers
with the owners of a company by using methods such
as stock ownership in the company via means such as
employee stock option plans (ESOPs).
Corporate Governance
Corporate governance is taking steps to monitor managers
and align their interests with those of shareholders. Since
shareholders don’t typically focus on the daily operations of
a company and its managers, other methods are used. For a
public corporation, this includes the board of directors, who
are appointed to safeguard the interests of shareholders.
Monitoring the firm from outside are auditors, investment
banks, analysts, and credit rating agencies. These entities
help investors judge whether a corporation’s managers are
acting in such a manner as to warrant investment in the
securities of the firm.

Ethics
Ethics has a major role in finance. Financial professionals
and corporate managers working in agency relationships are
responsible for making decisions on behalf of investors and
shareholders. These are known as fiduciary relationships, and
any conflict of interest must be resolved in the best interests
of the party that the fiduciary agent is working for. Financial
institutions (FIs) help others with transactions involving
financial assets that take place in financial markets. Figure
1.10 in the textbook shows how they generate profits by taking
the role of an intermediary in the markets.
Markets are subject to the risk of financial contagion as well
as risk posed by unethical behavior. The financial crisis that
peaked in 2008 and early 2009 was an example of how fear
can spread globally in investment markets. The crisis—which
arose from problems experienced by defaulting subprime
mortgage borrowers in 2006 and 2007—resulted in damage to
financial institutions, decreased the availability of credit, and
damaged investor confidence. The resulting crisis led to the
federal government taking action to stimulate the economy in
response to the slowdown in economic activity. As a result,
by summer and fall 2009 the domestic economy looked to
be starting to recover. However, with lenders and consumers
appearing to be more cautious in the wake of the crisis, the
process of recovery has been longer and slower than in typical
recoveries.
Lesson 1 15

Self-Check 1
At the end of each section of Financial Management, you’ll be
asked to pause and check
your understanding of what you’ve just read by completing a
“Self-Check” exercise.
Answering these questions will help you review what you’ve
studied so far. Please
complete Self-Check 1 now.
Answer the following questions using this study guide and your
textbook. Answers will vary
in length.
1.What’saccomplishedbythesuccessfulapplicationoffinancialtheo
ries?
2.Howdoinvestorsandcompaniesexperiencerisk?
3.Whataresomeofthemostcommonlyacceptedtypesofassetclasses?
4.Atmostcompanies,whatdoesapersoninafinancepositionusehisto
ricalfiguresandcurrent
informationtodetermine?
5.What’sthebiggestdisadvantageofsoleproprietorshiprelativetoot
herformsofownership?
6. Why did Adam Smith argue that the actions of individuals
pursuing their own interests in an
economytendedalsotopromotethegoodoftheoverallcommunity?

7.Whymustethicsplayamajorroleinthepracticeoffinance?
8.What’smeantbythetermcorporategovernance?
9.Whatapproachescanafirmusetodealwiththeagencyproblemasitre
latestothe
firm’smanagers?
10. Whatfactorsledtothefinancialcrisisthatpeakedinfall2008?
11. Whyisacorporationsaidtobesubjecttodoubletaxation?
12. Howdohybridorganizationsavoiddoubletaxation?
13.
Whataresomesituationsinwhichyoucanusefinancetohelpyoumake
goodpersonal
financialdecisions?
Check your answers with those on page 221.
ASSIGNMENT 2
Read this assignment. Then read Chapter 19 in
your textbook.
Our world today is a globalized one, with many corporations
operating all around the world and consumers able to use
goods supplied from or manufactured in areas far from where
they live. While the United States has the largest economy
in the world, other countries such as China and India are
experiencing faster growth rates as they attempt to catch up

to the major developed world economies. Fast-growing
international
economies offer business opportunities that many companies
are interested in taking advantage of. In doing so, they must
be aware of two major factors affecting trade between countries:
(1) restrictions on the types of goods that can enter a country
and (2) tariffs that consist of fees charged on products
transported
across borders.
To make it easier for trade between countries to occur, several
international trade agreements have been reached over the
past two decades. The purpose of these agreements is to lower
or eliminate trade restrictions such as product prohibitions
and duties, tariffs, and other fees. Recent trade agreements
include the
n North American Free Trade Agreement (NAFTA)
n Central America Free Trade Agreement
n Mercosur free-trade zone
In Europe, the European Union (EU) includes 27 members par-
ticipating in an open marketplace, allowing easy trading of
goods and services across borders. In sum, the economic power
of the EU rivals that of the United States. Many countries in the
EU also use the euro, a common currency unit. International
organizations have been formed to promote free trade globally.
The World Trade Organization is one such entity. Located in
Switzerland, it consists of 159 signatory countries.
Lesson 1 17

Corporate expansion into other countries involves a variety
of activities:
n Simple export and import into a foreign country
n Partnering with a foreign company in one of the
following ways:
o Sales subsidiary
o Licensing/franchising
o Joint venture
n Direct capital involvement by establishing direct ownership
of a company’s operational assets in a foreign country
Multinational corporations, which produce products and
services
in multiple countries, invest capital to gain direct ownership of
assets. In some cases, such activity is driven by companies
discovering that it’s better to manufacture products for sale
in a certain country. Capital deployed to operate foreign
operations is called foreign direct investment. This type of
investment, both by U.S. firms and by firms investing in the
United States, has grown substantially in recent years.
Foreign Currency Exchange
When conducting international business, a major challenge
company managers face is the use of different currencies by
foreign countries. To purchase products internationally, U.S.
companies must purchase foreign currencies with U.S. currency.
The price of one currency as compared with another is called
an exchange rate. The price of a currency can be quoted either
in domestic units or in units of a foreign currency. An indirect
quote details the number of foreign currency units needed to

purchase one unit of domestic currency. A direct quote specifies
an exchange rate in terms of the amount of domestic currency
required to purchase a single unit of foreign currency. A direct
quote is equal to the inverse of an indirect quote:
Direct quote 5 1 4 Indirect quote
Let’s look at a problem that illustrates how currency
exchange works.
Example: Brian wants to travel to Australia for a nature tour
of the Outback. He determines he will need $3,000 Australian
dollars to pay for the trip.
Question: How many U.S. dollars will he need to convert into
the required amount of Australian currency?
Solution
: If we use the exchange rate of $.9707 shown in
Table 19.2 in the textbook, the equation is as follows:
Brian needs $3,091 US$ to convert into $3,000 AU$.
If a U.S. firm wishes to exchange two nondollar currencies,

a cross-currency quote is needed. Table 19.3 in the textbook
shows an example of cross rates used for this purpose.
When direct quotes and cross rates diverge, arbitrage, a
technique focused on buying low and selling high, becomes
possible. Arbitrage is used by people seeking to profit by
finding mispriced exchange rates through the comparison of
direct quote exchange rates between two different currencies,
with cross rates calculated in a third currency.
Exchange Rate Risk
While it’s relatively easy for corporations to exchange different
currencies, the problem they face when dealing with currencies
is that their values change over time. Exchange rate risk refers
to the possibility that exchange rates will change in an
unfavorable
manner over time.
Exchange rates for most major currencies are free to change
in accordance with supply and demand factors for a specific
currency; this is known as a freely floating regime. Some gov-
ernments take steps to influence the exchange rate of their
currency by buying or selling the currency to alter supply
and demand. This type of currency manipulation is referred

to as a managed-floating regime. Another approach is a
fixed peg arrangement, typically to a basket composed of
world currencies.
AU US
AUS
US$ , $
$ .
$ ,3 000 1
0 9707
3 091� =
Lesson 1 19
A method used by financial managers to help them lower
exchange rate risk to a degree is to use forward exchange
rates, which price a currency on some future date rather than
using the current, or spot, price. They do this by negotiating an
exchange rate for currency that they’ll exchange for months in
the future. Table 19.4 in your textbook provides an example

of forward exchange rates. Financial managers use the process
of hedging to lessen exchange rate risk. They do this by
minimizing the foreign currency it’s necessary for their firm to
exchange. An alternative strategy is to lock in exchange rates
by taking steps to negotiate future currency trades via the
use of forward rates. Finally, a financial manager can engage
in the use of financial derivatives such as futures contracts,
options, and currency swaps to help hedge currency risks.
Types of Parity
The concept of interest rate parity is used to explain the
divergence often seen in spot and forward currency rates. The
concept holds that the forward rate will be at a level that,
taking into account the total return gained from the interest
rate and exchange rate changes, the total return between the
two countries will be equal. This is the same as saying that
the differences between spot and forward rates occur because
of the different levels of interest rates in the two countries.
Let’s look at a problem that illustrates how interest rate
parity works.
Example: Solve for interest rate parity, using Equation 19–1,
the exchange rates in Table 19.4 of the textbook, and six-

month interest rates of .25% for the United States and .14%
for Switzerland.
Question: What should the forward rate be for the Swiss
Franc?

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