Question 1: Are companies willing to provide information voluntarily, if so, when and why?

Question 2: What would the utility function of a risk-taking investor look like? What sort of portfolio would such an individual likely to invest in? What information would the investor need?

Question 3: You have determined that the current quality of financial reporting is summarized in the following information system:

	Financial Statement Information
State of Nature		Good News (GN)	Bad News (BN)
High	.8	.2
Low	.1	.9

The states of nature refer to future firm performance. GN and BN summarizes the information content of current financial statements.

You are a shareholder of ABC, which has just released its quarterly financial report. You analyze this report, and decide that it shows GN. Your decision problem is to sell your shares now (a₁) or hold them for another quarter (a₂).

Your prior probability of the high state is .7. the current market value of ABC shares is $81. If ABC is in the high state, your payoff will be $100 if you sell at the end of the next quarter. If ABC is in the low state, your payoff will be $36. You are risk-adverse, with utility equal to the square root of your payoff.

What information is included in your prior probabilities? Are they subjective or objective? Why?

Are the information system probabilities subjective or objective? What determines these probabilities?

Should you sell or hold your ABC shares? Show your work.

Question 4: Explain why the market might begin to anticipate the good news or bad news in earnings as much as a year in advance, as Ball and Brown found?

Question 5: Frank, a rational investor, has $2,000 to invest for one year while she completes her professional accounting designation. She is contemplating investing the full amount in shares of Northern Oil & Gas Ltd. (a₁) or in a risk-free government bond yielding an annual return of 3.2% (a₂).

Frank identifies two states of nature:

State H: Northern has high future cash flow.

State L: Northern has low future cash flow.

On the basis of her prior information about Northern, Frank assesses the following subjective prior state probabilities:

State H: 0.4

State L: 0.6

The following is the payoff table for these two investments. Payoffs from Northern shares include dividends and estimated capital gain for the year. Capital gain is based on the average analyst forecast for Northerns share price. Payoffs are net of (i.e., they exclude) the original investment.

	State
		H	L
Act	A1	$484	$25
A2	$64	$64

The investor is risk adverse, with utility equal to the square root of the net dollar payoff.

1. On the basis of her prior probabilities, which act should Frank take? Show calculations.

1. Instead of acting now, Frank decides to obtain more about Northern by reading its annual report. He knows that financial statements are based on a mixed measurement model. Also, he is a student of financial accounting theory, and estimates the quality of financial statements prepared according to these standards by the following information system:

	Current Annual Report Evidence
		Good	Bad
State	H	0.7	0.3
L	0.1	0.9

Good evidence means that a company reports profits that are higher than the average analyst forecast. Bad evidence means that the companys profits are less than forecast.

Upon reading the current annual report, Frank finds it is good. Which act should Frank take now? Show calculations.

1. After buying Northern shares, Frank is disappointed to note that the market price of its shares begins to fall, despite the good news in its earnings report. She now suspects that the good news in Northerns financial statements was not as good as she originally believed. Is this possible? Give reasons why or why not.

Question 6: Rainy Ltd. Operates under ideal conditions of uncertainty. Its cash flows depend crucially on the weather. On January 1, 2010, Rainy acquired equipment to be used in its operations. The equipment will last two years, at which time its salvage value will be zero. Rainy financed the equipment purchase by issuing common shares.

In 2010, net cash flows will be $700 if the weather is rainy and $200 if it is dry. In 2011, cash flows will be $900 if the weather is rainy and $300 if it is dry. Cash flows are received at year-end. In each year, the probability that the weather is rainy is 0.3 and 0.7 that it is dry. The interest rate in the economy is 6% in both years.

Rainy pays a dividend of $50 at the end of 2010.

Required:

1. In 2010, the weather is rainy. Prepare a balance sheet at the end of 2010 and an income statement for 2010.
2. If we attempt to apply the present value model under uncertainty to the more realistic conditions under which accountants operate, the expected present value calculations often become unreliable. Explain why.
3. Explain why well-defined (true) net income does not exist under the realistic conditions under which accountants operate. In place of true net income, what criterion have accountants adopted to guide their financial accounting and reporting decisions?

Question 7: What are at least 5 factors that tend to lead to high ERC? What are 4 ways managers can signal to investors that their firm is high quality?

Question 8: Why does prospect theory predict that security prices will differ from their prices under efficient security markets theory?

Question 9: Two firms, of the same risk, release their annual reports on the same day. It turns out that they each report the same amount of net income. Following the release, the share price of one firm rose strongly while the other rose hardly at all. Is such an event possible? Explain

Question 10: Based are the articles by Stephen Zeff or Lynn Turner, list at least 5 events in history that had impact on where our accounting profession is today and what do you believe is the impact.

Question 11: Based on the Frances and Schipper article Have Financial Statements Lost Their Relevance?, They found that from 1952-1994 that the balance sheet has become more relevant and the income statement has lost some relevancy. Looking from 1995 to the present, do you believe that this still holds? Why or why not? Use examples from that period of time to support your answer (i.e. goodwill standard change).

Question 1: Are companies willing to provide information voluntarily, if so, when and why? Question 2: What would the utility function of a risk-taking investor look like? What sort of portfolio would such an individual likely to invest in? What information would the investor need? Question 3: You have determined that the current quality of financial reporting is summarized in the following information system: Financial Statement Information Good News (GN) Bad News (BN) High .8 .2 State of Nature Low .1 .9 The states of nature refer to future firm performance. GN and BN summarizes the information content of current financial statements. You are a shareholder of ABC, which has just released its quarterly financial report. You analyze this report, and decide that it shows GN. Your decision problem is to sell your shares now (a1) or hold them for another quarter (a2). Your prior probability of the high state is .7. the current market value of ABC shares is $81. If ABC is in the high state, your payoff will be $100 if you sell at the end of the next quarter. If ABC is in the low state, your payoff will be $36. You are risk-adverse, with utility equal to the square root of your payoff. a. What information is included in your prior probabilities? Are they subjective or objective? Why? b. Are the information system probabilities subjective or objective? What determines these probabilities? c. Should you sell or hold your ABC shares? Show your work. Question 4: Explain why the market might begin to anticipate the good news or bad news in earnings as much as a year in advance, as Ball and Brown found? Question 5: Frank, a rational investor, has $2,000 to invest for one year while she completes her professional accounting designation. She is contemplating investing the full amount in shares of Northern Oil & Gas Ltd. (a1) or in a risk-free government bond yielding an annual return of 3.2% (a2). Frank identifies two states of nature: State H: Northern has high future cash flow. State L: Northern has low future cash flow. On the basis of her prior information about Northern, Frank assesses the following subjective prior state probabilities: State H: 0.4 State L: 0.6 The following is the payoff table for these two investments. Payoffs from Northern shares include dividends and estimated capital gain for the year. Capital gain is based on the average analyst forecast for Northern's share price. Payoffs are net of (i.e., they exclude) the original investment. State Act A1 A2 H $484 $64 L $25 $64 The investor is risk adverse, with utility equal to the square root of the net dollar payoff. a. On the basis of her prior probabilities, which act should Frank take? Show calculations. b. Instead of acting now, Frank decides to obtain more about Northern by reading its annual report. He knows that financial statements are based on a mixed measurement model. Also, he is a student of financial accounting theory, and estimates the quality of financial statements prepared according to these standards by the following information system: Current Annual Report Evidence Good Bad H 0.7 0.3 State L 0.1 0.9 Good evidence means that a company reports profits that are higher than the average analyst forecast. Bad evidence means that the company's profits are less than forecast. Upon reading the current annual report, Frank finds it is good. Which act should Frank take now? Show calculations. c. After buying Northern shares, Frank is disappointed to note that the market price of its shares begins to fall, despite the good news in its earnings report. She now suspects that the good news in Northern's financial statements was not as good as she originally believed. Is this possible? Give reasons why or why not. Question 6: Rainy Ltd. Operates under ideal conditions of uncertainty. Its cash flows depend crucially on the weather. On January 1, 2010, Rainy acquired equipment to be used in its operations. The equipment will last two years, at which time its salvage value will be zero. Rainy financed the equipment purchase by issuing common shares. In 2010, net cash flows will be $700 if the weather is rainy and $200 if it is dry. In 2011, cash flows will be $900 if the weather is rainy and $300 if it is dry. Cash flows are received at year-end. In each year, the probability that the weather is rainy is 0.3 and 0.7 that it is dry. The interest rate in the economy is 6% in both years. Rainy pays a dividend of $50 at the end of 2010. Required: a. In 2010, the weather is rainy. Prepare a balance sheet at the end of 2010 and an income statement for 2010. b. If we attempt to apply the present value model under uncertainty to the more realistic conditions under which accountants operate, the expected present value calculations often become unreliable. Explain why. c. Explain why well-defined (true) net income does not exist under the realistic conditions under which accountants operate. In place of true net income, what criterion have accountants adopted to guide their financial accounting and reporting decisions? Question 7: What are at least 5 factors that tend to lead to high ERC? What are 4 ways managers can signal to investors that their firm is high quality? Question 8: Why does prospect theory predict that security prices will differ from their prices under efficient security markets theory? Question 9: Two firms, of the same risk, release their annual reports on the same day. It turns out that they each report the same amount of net income. Following the release, the share price of one firm rose strongly while the other rose hardly at all. Is such an event possible? Explain Question 10: Based are the articles by Stephen Zeff or Lynn Turner, list at least 5 events in history that had impact on where our accounting profession is today and what do you believe is the impact. Question 11: Based on the Frances and Schipper article \"Have Financial Statements Lost Their Relevance?\