FINA 351 – Managerial Finance
Study Guide for Test 3, Final Exam
Chapters 14-18 & Options/Derivatives
You may bring a 3" by 5" piece of paper (index card size) with as much info crammed on both sides as possible, such as
formulas, definitions, etc. You may also bring a brain with both halves crammed with as much knowledge as possible.
Chapter 14
1. T or F: The dividend policy question is whether owners prefer a dollar in their company’s bank account or their
personal bank accounts.
2. Understand the procedure and chronology for dividend payment (declaration, ex-dividend, record, payment date,
etc.). Know how to determine the ex-dividend date [Answer: 2 business days before the date of record, which
means you skip weekends and holidays when counting]. What would be the approximate difference between the
price of a stock purchased on the ex-dividend date vs. the day before? [Answer: the stock price drops by the
amount of the dividend (net of tax), barring other factors.] How many times per year are dividends usually paid?
[Answer: Corporate boards meet quarterly and declare dividends as part of their meetings.]
3. Of the various dividend policies a company might adopt, which one is the ideal approach? [Answer: stable
approach, which means the dividend amount grows consistently.] Which one results in a constant dividend
payout ratio? [Answer: cyclical approach, which means the dividend goes up and down with profits.] Which
approach do most companies follow in a realistic world? [Answer: the compromise approach, which means keep
dividends as stable as possible, with a sustainable growth pattern that does not raise dividends too much.]
4. What is the homemade dividend theory? Why does it suggest that dividend policy is irrelevant? [Answer:
whether the company pays dividends should not matter because you can always sell your stock when cash is
needed . . . however, selling incurs transaction costs and taxes.]
5. What is the signaling theory (or information content effect)? What result would an unexpected reduction or
elimination of cash dividends have on the stock price? [Answer: paying a dividend is a sign that the company is
doing well and has enough cash to reward owners; lowering or eliminating a dividend is a sign of the opposite.]
6. How is the dividend payout ratio determined? [Answer: the percent of profits paid out in dividends or dividends /
net income].
7. How does the lifecycle stage affect dividend payout? Would a start-up company usually pay dividends right
away? Would you expect a high-growth company to have a high or low dividend payout? (See discussion on
instructor notes for these three questions).
8. Why did Microsoft start paying a dividend in 2003? At that time, was MSFT in the growth or maturity stage?
(See Assign. 14a for these two questions).
9. Why are utility companies known for high dividend payout? Why does preferred stock pay high dividends?
[Answer: in both cases, the stock is not expected to grow very much (a boring stock) . . . so dividends make the
stock attractive.]
10. Approximately what was the average dividend yield for the 30 DJIA stocks? How does this compare with current
bank savings rates? (See Assign. 14a)
11. In times of bear markets, do dividends become more or less important? [Answer: when stock prices are tanking,
investors are comforted to know that at least they are getting dividends, which become more important in bear
markets.]
12. Know the reasons for low dividend payout. (See instructor notes). Why might an investor in a high tax bracket
prefer low dividend payout and high capital gains instead? [Answer: it is assumed that if a corporation does not
distribute dividends, the money can be re-invested in the company so that the stock price goes up, causing capital
gains down the road, rather than immediate and taxable dividends. Not only may the capital gains tax rate be
lower but the compounding effect of capital gains occurs tax-free; plus you can choose when to be taxed by
deciding when to sell your stock.]
13. How did the 2003 Bush tax cut affect dividend payout ratios? [Answer: when Bush cut the maximum tax rate to
15%, many companies increased the payout ratio. See the graph in notes that shows the 2003 spike. Obama has,
in part, reversed the Bush tax cut, which has lowered dividend payouts].
14. Know the reasons for high dividend payout. (See instructor notes). What is the bird-in-hand theory (also called
uncertainly resolution)? [Answer: dividends are current and tangible, while waiting for capital gains is down the
road and uncertain.] Why might corporate, elderly, or tax-exempt investors prefer a higher dividend payout?
[Answer: many elderly need the dividend income to survive; tax-exempt investors, such as WWU, would rather
get the cash now than wait for capital gains, which hold no tax-preferences to tax-exempt investors.]
15. What are the advantages a stock repurchase over a dividend payout to an investor? Why are stock advantageous
from the corporation’s perspective? (See instructor notes.)
16. How does a stock dividend differ from a stock split? [Answer: there is no economic difference; e.g. a 100% stock
dividend and a 2-for-1 stock split have the same effect on the number of shares and price per share]. Are stock
dividends and splits just paper transactions or are they actually worth something to the recipient? [Answer:
Theoretically they are worthless . . . so you have twice as many shares each worth half as much . . . big deal.]
Should an investor be excited when a stock dividend is received in lieu of a regular cash dividend? [Answer: No,
they should be alarmed that their company has run out of cash.]
17. Why do stock splits/dividends occur? (See instructor notes.) Does Warren Buffet believe in stock splits? (See
Assign. 14b). What type of signal (positive or negative) do stock splits usually send? [Answer: Usually a
positive signal because only growing stocks are split.]
18. What is a reverse stock split and why would this happen? (See instructor notes.)
19. Make sure to review the assignments for this chapter, including the calculations. Expect questions/problems
similar to those on the assignments.
Chapter 15
1. Why do banks not typically make loans to start-up companies that have no collateral? [Answer: it’s too risky . . .
banks like to have hard assets to back up a loan.]
2. How do venture capitalists limit their risks? How expensive is venture capital?
3. What is crowdfunding? Why is investing in crowdfunding projects considered somewhat risky?
4. Why do companies go public?
5. What are the basic steps in an IPO?
6. What services are performed by an underwriter? [Answer: the underwriter is the IPO expert; it values the
company and sets the IPO price; usually the underwriter also guarantees the IPO price and quantity of shares to be
sold.]
7. Why would a corporation prefer the firm commitment form of underwriting? [Answer: the corporation will a
guaranteed amount of cash from the IPO.]
8. What should happen to the stock price in a successful IPO? [Answer: it should pop 15-20% making IPO
investors happy.]
9. What is the purpose of lockup agreements? [Answer: forces insides and founders to hang on the stock for while
so that they can’t tell lies pumping up the price, make a quick buck selling their shares, and then watch the stock
price tank for everyone else when the truth is revealed.]
10. What are the consequences from setting the IPO price too high? Too low? (See instructor notes.)
11. Review Table 15.5. Why is the underwriting fee percentage larger for a small IPO that a large IPO? [Answer:
essentially larger IPOs get a volume discount.] Why is the underwriting fee percentage larger for an IPO than a
secondary offerings? [Answer: because SEOs are less risky due to an established track-record.] Why is the
underwriting fee percentage larger for an equity sale than a debt sale? [Answer: because stocks are more risky
than bonds.]
12. Are most bonds sold publicly or privately? (Answer: most bonds are privately places to institutional investors,
such as mutual funds, who have the big dollars needed to purchase bonds; small-time investors usually own bonds
indirectly through mutual funds).
Chapter 16
1. What is working capital? What are current assets? What is the formula for the current ratio? Know how to
determine the effect of various transactions on cash, net working capital and the current ratio. (See Assign. 16).
2. How are the cash and operating cycles determined and interpreted? What does it mean when a company has a
negative cash cycle (e.g. Wal-Mart)? Is a negative cash cycle good or bad for a company?
3. What are examples of costs from carrying too large an amount of current assets, such as too much cash,
receivables or inventory? What are these costs called?
4. What are examples of costs incurred if the amount of current assets is too small, such as too little cash or
inventory? What are these costs called? How is the optimal level of current assets determined?
5. Would a restaurant or a retailer typically have more current assets as a percent of total assets? (See Assign. 16).
Have current assets (as a percent of total assets) nation-wide been increasing or decreasing over the last few
decades? Why? [Answer: the amount of currents assets have been decreasing as companies move to more
restrictive policies; this has happened due to improved shipping/transportation methods and faster communication
and payments systems.]
6. Review the sources of short-term financing, both secured and unsecured. What is the difference between
receivable assignment and factoring? [Answer: under assignment, you still own the receivables but are using
them as collateral for a loan; in factoring, you sell the receivables to a factor, such as bank, who then will collect
from your customers; the most common form of factoring is a credit card, where Walmart “sells” its receivable to
Visa, who then collects from you.] Which one results in receivables being removed from the balance sheet?
[Answer: factoring.] Why would a field warehousing arrangement have been good for the banks that loaned
money to Allied Crude Vegetable Oil Corporation? (This is the company that filled its oil tanks with seawater.)
[Answer: inventory stored in an independent warehouse cannot be tampered with.]
7. Would secured or unsecured loans likely carry a higher interest rate? Why? [Answer: from the lender’s
perspective, unsecured loans are more risk and therefore require higher rates to compensate.]
8.
How do the flexible and restrictive policies differ regarding the amounts of current assets and liabilities? Have
firms been moving more towards a flexible or a restrictive approach over the last few decades? [Answer: due to
better shipping and technology, firms have been able to reduce the amount of current assets, which is a trend
toward the restrictive approach.]
Chapter 17
1. What are the reasons for holding cash? (See Assign. 17).
2. What causes float and why is it dying? Is float beneficial to the payer or receiver of funds? T or F: Businesses
attempt to maximize collection float and minimize disbursement float. [Answer: float is the time it takes for a check
to clear your bank; it is dying because of Check 21 Act and fewer checks being used; business want to maximize
disbursement float and minimize collection float.]
3. What are the different approaches used to reduce collection float? [Answer: lockboxes and cash concentration
systems.] How do electronic payments affect collection float? What is the Check 21 Act and how has it affected
float? [Answer: e-payments immediately hit your bank account; under the Check 21 Act, the bank takes a picture of
the check and shreds the paper check; the picture becomes the legal check, and is digitally transferred, as opposed to
paper checks being snail-mailed.]
4. How do lock-boxes work? [Answer: lock boxes are PO boxes in big cities under the control of your banker who
retrieves and deposits the customer payments frequently during the day; this allows you to get your money sooner,
earn interest on it, and reduces the chance of bad customer checks.] What are the benefits of a cash concentration
account? [Answer: pooling cash accounts into one account reduces the amount of safety stock or buffer needed in
separate accounts.]
5. What are some tactics for increasing disbursement float? What ethical implications are there regarding some of these
tactics? [Answer: mailing checks for a distant or rural post office may be legal but of questionable ethics.]
6. What are the benefits of a ZBA (zero-balance) account? [Answer: a ZBA account, such as WWUs’, allows the
checking account balance to remain zero with just enough transferred from saving to cover the checks so that the
amount earning interest is maximized.]
7. Where can idle cash be invested on a short-term basis? (See instructor notes.)
8. What is the credit period and what factors influence its length? How is the cost of forfeiting cash discounts
calculated in terms of an annual rate? (See Assign. 17).
9. What are the advantages and disadvantages of granting credit to customers? (See instructor notes.)
10. How does a firm determine the credit worthiness of a customer? What information is typically required? How does a
credit scoring system work? What is FICO? Would a FICO score of 600 be considered good? How about a score of
820? Does a credit score affect whether you can rent an apartment or obtain auto insurance at a good price? (See
instructor notes for answers to these questions.]
11. How does a firm monitor receivables? What is an aging schedule? What are the typical procedures for collecting
delinquent accounts? How much do collection agencies typically keep for commissions? (See instructor notes for
answers to these questions.]
Chapter 18
1. What is fiat money? What characteristic of gold make it an ideal standard for exchange? How does the Baker Boyer
story illustrate the gold standard? What does it mean to be on the gold standard? Is the U.S. currently on the gold
standard? Why or why not? What advantages/disadvantages are there for being on the gold standard?
2. When exchange rates for a particular country are allowed to float (as opposed to being fixed by the government),
what broad factors affect the exchange rates? What are five specific factors affecting exchange rates and why do they
influence exchange rates?
3. What are the advantages and disadvantages of a strengthening dollar? Would a strengthening U.S. dollar benefit a
U.S. exporter or importer? A U.S. traveler abroad?
4. What are some reasons to believe that the Euro will replace the U.S. dollar as the most important currency? What are
some reasons to believe that the U.S. dollar will continue to dominate world trade? What is expected to happen to the
population of most European countries in the next few decades, in terms of total population and the old-to-young age
ratio? How will this compare to the U.S.? What is one reason every US citizen should be thankful for Mormons and
Mexican-Americans?
5. Who in the U.S. benefits from a weak U.S. dollar? Who in the U.S. is not happy with a weak dollar?
6. What mathematical relationship is there between the left-column and right-column exchange rates? Which column is
assumed unless stated otherwise? (Note: the exceptions to the general rule of left/right column include the Euro,
British Pound, and Australian and New Zealand dollars.) What is a cross rate? What is triangular arbitrage?
7. What are spot rates? What are forward rates? What does it mean when a currency sells in the forward market at a
premium or discount?
8. What does the Purchasing Power Parity tell us? Does absolute PPP hold true for most items? If it did, what would
this say about the costs of a Big Mac in different countries? What imperfections make relative PPP more realistic?
Be able to use the Relative PPP (approx. formula) to estimate changes in relative inflation rates based on an
anticipated change in currency values.
What does Interest Rate Parity tell us? Does it usually make sense to invest your money in a foreign country because
it has much higher interest rates? Be able to use the approximate formula to calculate interest rate differentials
between two countries.
10. What are the various types of risks faced by international financial managers and how can these risks be hedged?
Does the International Country Risk Guide rank the U.S.at the top of the list?
11. Make sure to review the assignments for this chapter carefully and be able to do similar problems on the test.
9.
Derivatives/Options
1. What are derivative securities? What are some examples of spectacular losses from gambling with derivatives? Even
though speculators sometimes lose big bucks, what positive results come from the actions of speculators? What does
hedging mean? What are some examples of using derivatives to reduce risk rather than increase risk?
2. How did the futures and forward markets develop? What city is the capitol city of derivative securities?
3. Be able to distinguish between the following kinds of derivative contracts: futures, forwards, and options.
4. Why have stock options been important to economic development in the United States?
5. What is the difference between a call and a put option? Which one would be purchased if the stock price were
expected to increase? What does it mean to write an option?
6. What does it mean for an option to be in or out of the money? What is the meaning of the strike or exercise price?
7. How is the intrinsic value of an option determined? Why is the actual value of an option prior to expiration higher
than its intrinsic value? (Answer: time value; the value investors will pay for the chance the stock price will move in
the direction they are betting before expiration.). Why do the values of options usually decrease the closer they get to
expiration?
8. Which type of stock option (call or put) is often held by investors as insurance to counter losses on their stocks? Is
buying or selling call options considered more risky? What is the maximum loss to a call option buyer? What is the
maximum loss to a call option seller (writer)?
9. What is the difference between a stock option and a stock warrant?
10. Who was Robert Merton and why is he famous and infamous?
11. Make sure to review the assignments for this chapter carefully and be able to work similar problems on the test.
Financial Indicators
Know the general meaning and trend in the indicators tracked during the quarter. For example, did any evidence of
increased inflation occur during the quarter? What does a consumer confidence index of 90 mean? When MSFT stock
price increases, should the value of call options increase or decrease? It the national debt bigger or small than the GDP?
If the DJIA increases, should the VIX increase as well? Etc.
Come prepared to celebrate all that you have and have not learned. I wish you good luck. But remember that the harder you
work, the more luck you’ll have.