D775 Introduction to Business Finance - Set 1 - Part 3

Correct Answer: Option

Option a is correct because options are financial contracts that give the holder the right but not the obligation to buy or sell an asset at a specified price before a certain date. Option b is incorrect because futures contracts obligate both parties to complete the transaction at a predetermined date and price, with no optional element in the agreement. Option c is incorrect because forward agreements are similar to futures in obligating both parties to complete the transaction, lacking the optional characteristic described in the question. Option d is incorrect because swaps are contracts to exchange cash flows or other financial instruments between parties, not agreements providing optional rights to buy or sell assets.

Correct Answer: Ability to pay without inventory

Option c is correct because the quick ratio assesses a company's ability to fulfill short-term obligations without relying on inventory sales, which may not convert to cash as quickly as other assets. Option a is incorrect because long-term debt capacity is measured by leverage ratios like debt-to-equity, not liquidity ratios like the quick ratio which focus on short-term obligation coverage. Option b is incorrect because total asset efficiency is measured by activity ratios like total asset turnover, not the quick ratio which specifically assesses short-term liquidity without inventory. Option d is incorrect because profitability is measured by ratios like return on equity and profit margin, not the quick ratio which focuses on the ability to meet short-term obligations.

Correct Answer: Owners' residual claim

Option d is correct because shareholders' equity represents the owners' claim on company assets after all liabilities have been settled, including paid-in capital, retained earnings, and other equity components. Option a is incorrect because total company debt is recorded as liabilities on the balance sheet, representing obligations to third parties rather than owners' claims on remaining assets. Option b is incorrect because annual operating expenses appear on the income statement and affect net income, not directly representing equity which is a balance sheet component showing ownership claims. Option c is incorrect because current cash balance is just one component of current assets on the balance sheet, while shareholders' equity represents the total residual ownership interest in all assets.

Correct Answer: Mutual fund

Option a is correct because mutual funds pool money from multiple investors to buy diversified portfolios managed by professionals, with open-end structures allowing continuous share buying and selling. Option b is incorrect because hedge funds are private investment vehicles that use various strategies with higher risk and less regulation, typically restricted to accredited investors only. Option c is incorrect because private equity funds invest in companies not publicly traded, focusing on direct company investment rather than diversified securities portfolio management for retail investors. Option d is incorrect because pension funds manage retirement savings for employees rather than offering investment vehicles that the general public can buy into and sell out of freely.

Correct Answer: NASDAQ

Option c is correct because NASDAQ operates as a dealer market where market makers buy and sell securities for their own accounts, maintaining inventories and providing liquidity through quoted prices. Option a is incorrect because the New York Stock Exchange operates as an auction market where buy and sell orders are aggregated and prices determined through a centralized matching mechanism. Option b is incorrect because the Chicago Board of Trade primarily handles derivatives trading through different mechanisms rather than operating as a dealer market for securities trading. Option d is incorrect because the Tokyo Stock Exchange operates using an order-matching system similar to auction markets rather than the dealer-based model characteristic of NASDAQ.

Correct Answer: EBIT

Option b is correct because EBIT stands for earnings before interest and taxes, representing operating profit after deducting operating expenses but before subtracting interest payments and tax obligations. Option a is incorrect because net income is the final profit figure after all expenses including interest and taxes have been deducted from revenue, coming after EBIT on the income statement. Option c is incorrect because gross margin represents revenue minus cost of goods sold, which comes before subtracting other operating expenses to arrive at earnings before interest and taxes. Option d is incorrect because revenue is the top-line income generated from business operations before any expenses are deducted, representing the starting point for income statement calculations.

Correct Answer: Price-earnings ratio

Option d is correct because the price-earnings ratio compares stock price to earnings per share, with lower values generally indicating stocks that may be cheaper relative to their earnings generation. Option a is incorrect because return on assets measures how efficiently a company uses assets to generate profit, not how the market prices the stock relative to company earnings. Option b is incorrect because debt-to-equity ratio measures financial leverage and capital structure composition, not the relationship between stock price and company earnings. Option c is incorrect because current ratio measures short-term liquidity by comparing current assets to current liabilities, not the market valuation of stock relative to earnings.

Correct Answer: Inflation

Option a is correct because inflation erodes purchasing power over time, meaning a dollar received in the future will buy fewer goods and services than a dollar received and spent today. Option b is incorrect because while taxation affects the net value of money, it is not one of the three fundamental reasons why money today has greater value than the same amount received later. Option c is incorrect because depreciation refers to the decline in value of physical assets over time due to use and age, not the erosion of money's purchasing power through price increases. Option d is incorrect because amortization involves spreading costs over time or gradually paying off debt, not the reduction in purchasing power that makes future money worth less.

Correct Answer: Debt and equity

Option c is correct because capital structure specifically refers to the mixture of debt financing from borrowing and equity financing from ownership stakes used to fund company operations. Option a is incorrect because revenue and expenses are income statement items that affect profitability rather than balance sheet financing sources that comprise the company's capital structure. Option b is incorrect because assets and liabilities are balance sheet categories representing resources and obligations, while capital structure specifically addresses how those resources are financed. Option d is incorrect because profits and losses result from operations and affect retained earnings but do not describe the fundamental financing sources that comprise capital structure decisions.

Correct Answer: Force the firm into bankruptcy

Option d is correct because bond investors have legal rights to force a firm into bankruptcy for failure to repay loans, which gives bondholders powerful remedies when companies default. Option a is incorrect because bondholders receive interest payments rather than dividends, and they have active legal remedies available rather than simply waiting when companies fail to pay. Option b is incorrect because bondholders have contractual rights that enable them to take action against defaulting companies, including initiating bankruptcy proceedings to protect their investments. Option c is incorrect because while bondholders may sometimes negotiate debt restructuring, they typically have no obligation to forgive debt and often pursue aggressive collection through legal channels.