Q&A Hero

Q: A venture capital firm protects its equity investment from moral hazard through which of the following means? A) It places people on the board of directors to better monitor the borrowing firm's activities. B) It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. C) It prohibits the borrowing firm from replacing its management. D) It does both A and B of the above. E) It does both A and C of the above.

Q: There is no need for the seller to perform due diligence on its own operations to ensure that its representations and warranties in the definitive agreement are accurate. True or False

Q: One financial intermediary in our financial structure that helps to reduce the moral hazard arising from the principal-agent problem is the A) venture capital firm. B) money market mutual fund. C) pawn broker. D) savings and loan association.

Q: The financing plan may be affected by the discovery during due diligence of assets that can be sold to pay off debt accumulated to finance the transaction. True or False

Q: Solutions to the moral hazard problem include A) high net worth. B) monitoring and enforcement of restrictive covenants. C) greater reliance on equity contracts and less on debt contracts. D) all of the above. E) only A and B of the above.

Q: Confidentiality agreements are rarely required when target and acquiring firms exchange information. True or False

Q: The principal-agent problem A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. B) would not arise if the owners of the firm had complete information about the activities of the managers. C) in financial markets helps to explain why equity is a relatively important source of finance for American businesses. D) all of the above. E) only A and B of the above.

Q: There is no substitute for performing a complete due diligence on the target firm. True or False

Q: Because managers (________) have less incentive to maximize profits than the stockholders-owners (________) do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to purchase equities. A) principals; agents B) principals; principals C) agents; agents D) agents; principals

Q: Even though time is critical, it is always critical to build a relationship with the CEO of the target firm before approaching her with an acquisition proposal. True or False

Q: Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer. A) principal-agent B) adverse selection C) free-rider D) debt deflation

Q: Debt-to-equity ratios may be used to measure a firms degree of leverage and are frequently used as a search criterion in looking for potential takeover candidates. True or False

Q: Because of the moral hazard problem, A) lenders will write debt contracts that restrict certain activities of borrowers. B) lenders will more readily lend to borrowers with high net worth. C) debt contracts are used less frequently to raise capital than equity contracts. D) all of the above. E) only A and B of the above.

Q: Fees charged by investment bankers are never negotiable. True or False

Q: Commercial and farm mortgages, in which property is pledged as collateral, account for A) one-quarter of borrowing by nonfinancial businesses. B) one-half of borrowing by nonfinancial businesses. C) one-twentieth of borrowing by nonfinancial businesses. D) two-thirds of borrowing by nonfinancial businesses.

Q: More and more firms are identifying potential target companies on their own without the use of investment bankers. True or False

Q: The majority of household debt in the United States consists of A) credit card debt. B) consumer installment debt. C) collateralized loans. D) unsecured loans, such as student loans.

Q: Brokers or finders should never be used in the search process. True or False.

Q: Collateral is A) property that is pledged to the lender if a borrower cannot make his or her debt payments. B) a prevalent feature of debt contracts for households. C) a prevalent feature of debt contracts for businesses. D) all of the above. E) only A and C of the above.

Q: The purchase price for a target firm may be fixed at the time of closing, subject to future adjustment, or be contingent on future performance. True or False

Q: Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called A) points. B) interest. C) collateral. D) good faith money.

Q: Shrewd sellers often negotiate a break-up clause in an agreement of purchase and sale requiring the buyer to pay the seller an amount at least equal to the sellers cost associated with the transaction. True or False

Q: Financial intermediaries (banks in particular) have the ability to avoid the free-rider problem as long as they primarily A) make private loans. B) acquire a diversified portfolio of stocks. C) buy junk bonds. D) do a balanced combination of A and B of the above.

Q: Closing is a phase of the acquisition process that usually occurs shortly after the target has been fully integrated into the acquiring firm. True or False

Q: The buyers ability to obtain adequate financing is a closing condition common to most agreements of purchase and sale. True or False

Q: The pecking order hypothesis predicts that the ________ a corporation is, the more likely it will be to ________. A) smaller and less well known; issue securities B) larger and more well known; borrow from financial intermediaries C) larger and more well known; issue securities D) smaller and less well known; need external financing

Q: The authors' analysis of adverse selection indicates that financial intermediaries A) overcome free-rider problems by holding nontraded loans. B) must buy securities from corporations to diversify the risk that results from holding nontradable loans. C) have not been very successful in dealing with adverse selection problems in financial markets. D) do all of the above. E) do only A and B of the above.

Q: Elaborate multimedia presentations made to potential lenders in an effort to shop for the best financing are often referred to as the road show. True or False

Q: Seller financing represents a very important source of financing for buyers. True or False

Q: The authors' analysis of adverse selection indicates that financial intermediaries in general, and banks in particular (because they hold a large fraction of nontraded loans), A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance. B) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem. C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations, which rely to a greater extent on the new issues market for funds. D) all of the above. E) only A and B of the above.

Q: Bridge financing refers to the temporary financing obtained by the buyer to pay all or a portion of the purchase price until so-called permanent financing can be arranged. True or False

Q: An audit certifies that A) a firm's loans will be repaid. B) a firm's securities are safe investments. C) a firm abides by standard accounting principles. D) the information reported in a firm's accounting statements is correct.

Q: In the United States, the government agency requiring that firms, which sell securities in public markets, adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the A) Federal Corporate Securities Commission. B) Federal Trade Commission. C) Securities and Exchange Commission. D) U.S. Treasury Department. E) Federal Reserve System.

Q: Buyers should not be concerned about performing an exhaustive due diligence since in doing so they could degrade the value of the target firm because of the disruptive nature of a rigorous due diligence. The buyer can be assured that all significant risks can be handled through the standard representations and warranties commonly found in agreements of purchase and sale. True or False

Q: A key finding of the economic analysis of financial structure is that A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses. B) while free-rider problems limit the extent to which securities markets finance some business activities, the majority of funds going to businesses are channeled through securities markets. C) given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets. D) economists do not have a very good explanation for why securities markets are so heavily regulated.

Q: It is usually in the best interests of the seller to allow the buyer unrestricted access to all seller employees and records doing due diligence in order to create an atmosphere of cooperation and goodwill. True or False

Q: That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) provide information that is valued by consumers of used cars. B) are able to prevent others from free-riding off the information that they provide. C) can profit by becoming experts in determining whether an automobile is a good car or a lemon. D) do all of the above.

Q: Due diligence is the process of validating assumptions underlying the initial valuation of the target firm as well as the uncovering of factors that had not previously been considered that could enhance or detract from the value of the target firm. True or False

Q: That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars. B) are able to prevent potential competitors from free-riding off the information that they provide. C) have failed to solve adverse selection problems in this market because "lemons" continue to be traded. D) do all of the above.

Q: Buyers routinely perform due diligence on sellers, but sellers rarely perform due diligence on buying firms. True or False

Q: The concept of adverse selection helps to explain A) why collateral is not a common feature of many debt contracts. B) why large, well-established corporations find it so difficult to borrow funds in securities markets. C) why financial markets are among the most heavily regulated sectors of the economy. D) all of the above.

Q: The actual purchase price paid for a target firm is determined doing the negotiation process and is often quite different from the initial offer price stipulated in a letter of intent. True or False

Q: The problem of adverse selection helps to explain A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. B) why collateral is an important feature of consumer, but not business, debt contracts. C) why direct finance is more important than indirect finance as a source of business finance. D) only A and B of the above.

Q: Discretionary assets are undervalued or redundant assets not required to run the acquired business and which can be used by the buyer to recover a portion of the purchase price. True or False

Q: The problem of adverse selection helps to explain A) why banks prefer to make loans secured by collateral. B) why banks have a comparative advantage in raising funds for American businesses. C) why borrowers are willing to offer collateral to secure their promises to repay loans. D) all of the above. E) only A and B of the above.

Q: The total purchase price paid by the buyer should also reflect the assumption of liabilities stated on the targets balance sheet, but it should exclude all off balance sheet liabilities. True or False

Q: Because of the adverse selection problem, A) good credit risks are more likely to seek loans, causing lenders to make a disproportionate amount of loans to good credit risks. B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town." C) lenders are reluctant to make loans that are not secured by collateral. D) all of the above.

Q: Total consideration refers to what is to be paid for the target firm and usually only consists of cash or stock, exclusively. True or False

Q: Because of the adverse selection problem, A) lenders may make a disproportionate amount of loans to bad credit risks. B) lenders may refuse loans to individuals with low net worth. C) lenders are reluctant to make loans that are not secured by collateral. D) all of the above.

Q: The actual price paid for a target firm is unaffected by the buyers due diligence. True or False

Q: Moral hazard is a problem associated with debt and equity contracts arising from A) the borrower's incentive to undertake highly risky investments. B) the owners' inability to ensure that managers will act in the owners' interest. C) the difficulty lenders have in sorting out good credit risks from bad credit risks. D) all of the above. E) only A and B of the above.

Q: Letters of intent are usually legally binding on the potential buyer but rarely on the target firm. True or False

Q: A borrower who takes out a loan usually has better information about the potential returns and risks of the investment projects he plans to undertake than the lender does. This inequality of information is called A) moral hazard. B) asymmetric information. C) noncollateralized risk. D) adverse selection.

Q: The letter of intent often specifies the type of information to be exchanged as well as the scope and duration of the potential buyers due diligence. True or False

Q: The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________. A) adverse selection; moral hazard B) moral hazard; adverse selection C) costly state verification; free-riding D) free-riding; costly state verification

Q: No shop provisions are seldom found in letters of intent. True or False

Q: In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will A) reflect the highest quality of used cars in the market. B) reflect the lowest quality of used cars in the market. C) reflect the average quality of used cars in the market. D) none of the above.

Q: The signing of a letter of intent usually precludes the target firm from suing the potential acquiring company if the acquirer eventually withdraws its initial offer. True or False

Q: Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ________, which gives rise to the problem of ________. A) low; moral hazard B) low; adverse selection C) high; moral hazard D) high; adverse selection

Q: A letter of intent formally stipulates the reason for the agreement, major terms and conditions, the responsibilities of both parties while the agreement is in force, a reasonable expiration date, and how all fees associated with the transaction will be paid. True or False

Q: If borrowers take on big risks after obtaining a loan, then lenders face the problem of A) free-riding. B) adverse selection. C) moral hazard. D) costly state verification.

Q: Confidentiality agreements usually also cover publicly available information on the potential acquirer and target firms. True or False

Q: If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of A) moral hazard. B) adverse selection. C) free-riding. D) costly state verification.

Q: Confidentiality agreements often cover both the buyer and the seller, since both are likely to be exchanging confidential information, although for different reasons. True or False

Q: (I) The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction. (II) Financial intermediaries facilitate diversification when an investor has only a small sum to invest. A) (I) is true; (II) false. B) (I) is false; (II) true. C) Both (I) and (II) are true. D) Both (I) and (II) are false.

Q: Which of the following best explains the recent decline in the role of financial intermediaries? A) Private production and sale of information B) Government regulation to increase information C) Improvements in information technology D) None of the above can explain the recent decline

Q: Confidentiality agreements are usually signed before any information is exchanged to protect the buyer and the seller from loss of competitive information. True or False

Q: Because information is scarce, A) equity contracts are used much more frequently to raise capital than are debt contracts. B) monitoring managers gives rise to costly state verification. C) government regulations, such as standard accounting principles, can help reduce moral hazard. D) all of the above are true. E) only B and C of the above are true.

Q: So-called permanent financing for an acquisition usually consists of long-term unsecured debt. True or False

Q: Which of the following is not one of the eight basic facts about financial structure? A) The financial system is among the most heavily regulated sectors of the economy. B) Issuing marketable securities is the primary way businesses finance their operations. C) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance in which businesses raise funds directly from lenders in financial markets. D) Financial intermediaries is the most important source of external funds to finance businesses.

Q: Rumors of impending acquisition can have a substantial deleterious impact on the target firm. True or False

Q: In contacting large, publicly traded firms, it is usually preferable to make initial contact through an intermediary and at the highest level of the company possible. True or False

Q: Which of the following is not one of the eight basic facts about financial structure? A) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. B) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance in which businesses raise funds directly from lenders in financial markets. C) Collateral is a prevalent feature of debt contracts for both households and businesses. D) New security issues is the most important source of external funds to finance businesses.

Q: (I) In the United States, nonbank loans are the most important source of external funds for nonfinancial businesses. (II) In Germany and Japan, issuing stocks and bonds is the most important source of external for nonfinancial businesses. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

Q: The appropriate approach for initiating contact with a target firm is essentially the same for large or small, public or private companies. True or False

Q: An excessively long list of screening criteria used to develop a list of potential acquisition targets can severely limit the number of potential candidates. True or False

Q: With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Direct finance is used in less than 5% of the external financing of American businesses. B) Only large, well-established corporations have access to securities markets to finance their activities. C) Loans from banks and other financial intermediaries in the United States provide five times more financing of corporate activities than do stock markets. D) All of the above. E) Only A and B of the above.

Q: With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Marketable securities account for a larger share of external business financing in the United States than in most other countries. B) Since 1970, less than 5% of newly issued corporate bonds and commercial paper have been sold directly to American households. C) The stock market accounted for the largest share of the financing of American businesses in the 1970-2000 period. D) All of the above. E) Only A and B of the above.

Q: Advertising in the business or trade press is generally a very efficient way to locate attractive acquisition target candidates. True or False

Q: The targeted industry and the maximum size of the potential transaction are often the most important selection criteria used in the search process. True or False