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2 If most investors expect the same cash flows from Companies A and B but are more confident that A s cash flows will be closer to their expected value, which c ompany should have the higher stock price? Explain. The primary goal of a corporation should be to maximize its owner s value. If a ma nager is to maximize shareholder wealth, he or she must know how that wealth is determined. Essentially, shareholder wealth is the number of shares outstanding at times the market price per share. A stock s price at any given time depends on the cash flows a marginal investor expects to receive after buying the stock. That being said Company A s cash flow would increase the stock price. 1.4 When is a stock said to be in equilibrium? At any given time, would you gues s that most stocks are in equilibrium as you defined it? Explain. The situation in which the actual market price equals the intrinsic value, so in vestors are indifferent between buying or selling a stock. When equilibrium exis ts, there is no pressure for a change in the stock s price. Market prices can and do differ from intrinsic values and thus are at or close to equilibrium. However , at times stock prices and equilibrium values are different, so stocks can be t emporarily undervalued or overvalued.

1.5 Suppose three honest individuals gave you their estimates of Stock X s intrins ic value. One person is your current roommate, the second person is a professional security an alyst with an excellent reputation on Wall Street, and the third person is Company X s CFO. I f the three estimates differed, in which one would you have the most confidence? Why? If the three intrinsic value estimates for Stock X were different, I would have the most confidence in Company X s CFO s estimate. Intrinsic values are strictly est imates, and different analysts with different data and different views of the fu ture will form different estimates of the intrinsic value for any given stock. H owever, a firm s managers have the best information about the company sfuture prospe cts, so managers estimates of intrinsic value are generally better than the estim ates of outside investors 2.2 Describe the different ways in which capital can be transferred from suppliers o f capital to those who are demanding capital. Capital will flow efficiently from those who supply capital to those who demand it. This transfer of capital can take place in three different ways: direct tran sfers, indirect transfers through investment bankers and indirect transfers thro ugh a financial intermediary. 1. Direct transfers of money and securities occur when a business sells its stoc ks or bonds directly to savers, without going through any type of financial inst itution. The business delivers its securities to savers, who in turn give the fi rm the money it needs. Example: Foreign direct investment, purchasing the entir e company. 2. Transfers may also go through an investment bank which underwrites the issue. An underwriter serves as a middleman and facilitates the issuance of securities . The company sells its stocks or bonds to the investment bank, which in turn se lls these same securities to savers. The businesses' securities and the savers' money merely "pass through" the investment bank. Example: depositing company's assets in bank. 3. Transfers can also be made through a financial intermediary such as a bank, a n insurance company, or a mutual fund. Here the intermediary obtains funds from

savers in exchange for its own securities. The intermediary uses this money to b uy and hold businesses' securities, while the savers hold the intermediary s secur ities. The existence of intermediaries greatly increases the efficiency of money and capital markets. Example: Stock market, bond markets or purchasing debt of the company. 2.4 Indicate whether the following instruments are examples of money market or c apital market securities. Money Markets The financial markets in which funds are borrowed or loaned for short periods (l ess than one year). Capital Markets The financial markets for stocks and for intermediate or long-term debt (one yea r or longer). a. U.S. Treasury bills : Money Market Instrument (have maturities less than one year). b. Long-term corporate bonds: Capital Market Instrument (have maturities exceedi ng one year). c. Common stocks: Capital Market Instrument d. Preferred stocks: Capital Market Instrument e. Dealer commercial paper: Money Market Instrument

2.5 What would happen to the U.S. standard of living if people lost faith in the safety of the financial institutions? Explain. The U.S. financial institutions are the major pillar of our American Dreams. The destruction of our market system will probably destroy our way of life. Investm ent bankers and other organizations that need capital will not get funded and in vestors will not have place to invest. It will create high unemployment and lowe r productivity. People will not get money to buy luxury products and manufacture r will suffer loss. 2.9 Describe the three different forms of market efficiency. Market efficiency is a measure of the availability of the information th at provides maximum opportunities to buyers and sellers to effect transactions w ith minimum transaction costs. Weak efficiency: This form of market efficiency contends all past prices of a s tock are reflected in today's stock price. Therefore, this form cannot be used t o predict future stock prices and beat a market. Semi-strong efficiency: This form of market efficiency contends that all public ly available information is immediately incorporated into stock prices (i.e., th at one cannot analyze published reports and then beat the market) Strong efficiency: This is the strongest version, which states that all informat ion in a market, whether public or private, is accounted for in a stock price. N

ot even insider information could give an investor an advantage.