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Finance and the Market

1. What is the difference between the primary market and the secondary market?

2. What is the relationship between financial decision making and risk and return?

3. What is an efficient market and what are the implications of efficient markets for us?

4. There are several limitations to ratio analysis. Name three.

5. Napa Valley Winery (NVW) is a boutique winery that produces a high-quality, nonalcoholic red wine from organically grown cabernet sauvignon grapes. It sells each bottle for $30. NVW's chief financial officer, Jackie Cheng, has estimated variable costs to be 70 percent of sales. If NVW's fixed costs are $360,000, how many bottles of its wine must NVW sell to break even?

6. Define the term operating leverage. What type of effect occurs when the firm uses operating leverage?

7. What is a cash budget? A cash budget consists of what four elements?

8. What is the time value of money?

9. What is an annuity? Distinguish between an annuity and a perpetuity.

10. To what amount will the following investments accumulate?
a. $4,000 invested for 11 years at 9 percent compounded annually
b. $8,000 invested for 10 years at 8 percent compounded annually
c. $800 invested for 12 years at 12 percent compounded annually
d. $21,000 invested for 6 years at 5 percent compounded annually

11. What is the present value of the following future amounts?
a. $800 to be received 10 years from now discounted back to the present at 10 percent
b. $400 to be received 6 years from now discounted back to the present at 6 percent
c. $1,000 to be received 8 years from now discounted back to the present at 5 percent
d. $900 to be received 9 years from now discounted back to the present at 20 percent

Solution Preview

1. What is the difference between the primary market and the secondary market?
Primary markets are markets in which corporations raise capital by issuing new securities. Secondary markets are markets in which securities and other financial assets are traded among investors after they have been issued by corporations.

2. What is the relationship between financial decision making and risk and return?
The relationship between financial decision making and the risk and return is that the final decision making will depend on the risk and return a project can generate. Here is an example where standard deviation or sigma is used to measure risks. High sigma will result in a wider normal distribution curve. This means that rate of return are further away from the mean compared to one with low sigma. Therefore, low sigma will cause the actual rate of return closer to the expected rate of return (the mean). Thus, there is less probability that the actual return will end up far below the expected return. To conclude, the lower the sigma value, the tighter the probability distribution is and consequently has lower risk. Therefore, in a situation where there are stocks with same mean (expected rate of return) but different sigma I will say that lower sigma will stimulate one for a high trading in the stock. However, in a situation where different stocks have different sigma and mean, the one with higher coefficient of variation (CV) will be considered as it represents higher risks per unit of return. In the concept where higher risks have higher returns, this will be contradicted in a two alternatives situation where one with higher risks (higher CV) has lower expected return than one with lower risks (lower CV) but has higher expected return. Therefore, the knowledge of sigma really helps in selecting stocks. Great variability in stock price will not always indicate more risks in all trading situations. Instead, it will depend on how risky an unit of return is, the coefficient of variation. The higher the sigma in proportionate to the expected rate of return, the higher the coefficient of variation.

Therefore, regarding my explanation above, I will make a final decision making and prefer a portfolio with higher expected return and less standard ...

Solution Summary

Various finance terms are defined. Guidelines for calculating future values of investments are also given.

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