Quote from hm2684:
I'm a finance major at penn state, and have a midterm coming up soon. I was wondering if anyone could help me out with a couple questions that have me boggled.
1) What is the difference between maximizing firm value and maximizing stockholder wealth?
2) Why do financial instruments differ? How is risk taken into account for a financial instrument?
3) Interest rates on bank loans exceed rates on commercial paper. Why don't all firms issue commercial paper rather than borrow from banks?
Sorry if this question doesn't belong, but i'm really confused.
As it happens, I'm a finance major too, though my darn degree is taking forever to finish, I work too much hehe...
Anywho, here are some alternate answers.
1) The two aren't necessarily directly related. For example, shareholders directly benefit from things like dividends and share buybacks, but don't necessarily benefit from a firm's value. For example, a firm with money could, say, choose to pay off some debt, invest in new assets (such as equipment), raise wages, etc., but a shareholder will only really see benefit if the firm chooses to utilize some of that money to pay a dividend. Maximizing shareholder wealth essentially means focusing on increasing the market value of the firm's equity.
2) Financial instruments differ in things like term, whether or not they pay interest, structure, and risk. Riskier instruments will tend to offer higher rates of return than lower risk instruments (this is called risk premium by the way).
3) This one is really, really easy to answer - because not all firms are capable of issuing commercial paper. Small and even medium sized companies are likely incapable of posessing the credit ratings (e.g. S&P, Fitch, Moody) necessary for investors to want to purchase their commercial paper. For additional marks you would probably want to mention that the size of debt needed by smaller firms isn't really appropriate for the commerical paper market, in comparison to, say, GMAC.
