Question

1. An increase in the share price may be the result of the information problem when...

	a.	markets become too focused on short term results.
	b.	actual accounting information exceeds the market's expectations.
	d.	there is a large influence of insider trading.

2. The value of the firm is best measured by...

	a.	the present value of expected earnings discounted back at a rate the reflects both the riskiness of the firms projects and the financing mix used to fund those projects.
	b.	the future value of expected earnings discounted back at a rate that reflects both the riskiness of the firms projects and financing mix used to fund those projects.
	c.	the present value of expected cash flows discounted back at a rate the reflects both the riskiness of the firms projects and the financing mix used to fund those projects.
	d.

3. Which of the following is not a potential problem associated with the formation of industrial groups in Japan and Germany?

	a.	Conflicts of interest between firms.
	c.	Increased risk taking.
	d.	Contagion effects within the group.

Answer 1

1] D

Information problem is the problem of asymmetric information - some parties have access to better information than others. One consequence of this is insider trading - when insiders with access to better / prior information about a company buy the stock to make gains after the information becomes public.

Markets focusing on short-term results is not related to the information problem. Accounting information exceeding expectations is not an information problem (assuming that accounting information is transparent and cannot be influenced by insiders)

2] C

The value of a firm is best measured by estimating its future cash flows, and then applying an appropriate discount rate to discount these cash flows back to the present. The discount rate should reflect the risk of the businesses, as well as the risk involved in the capital structure.

Future value is incorrect as it is not discounting. Discounting cash flows results in present value.

Discounting earnings is incorrect because accounting earnings are not equal to actual cash flows, and can vary significantly

3] C

Forming of industrial groups can lead to conflicts of interest and potential contagion effects within the group.

Increased risk-taking is not a problem but a benefit because projects with higher risk can be taken up which were not possible before the formation of groups.