Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Use the information for the question(s) below.
An independent film maker is considering producing a new movie. The initial cost for making this movie will be $20
million today. Once the movie is completed, in one year, the movie will be sold to a major studio for $25 million. Rather
than paying for the $20 million investment entirely using its own cash, the film maker is considering raising additional
funds by issuing a security that will pay investors $11 million in one year. Suppose the risk–free rate of interest is 10%.
1)
What is the NPV of this project if the film maker does not issue the new security? What is the NPV
if the film maker issues the new security?
1)
A)
$1.7 million; $1.7 million
B)
$1.7 million; $2.7 million
C)
$2.7 million; $1.7 million
D)
$2.7 million; $2.7 million
2)
Suppose a security with a risk–free cash flow of $1000 in one year trades for $909 today. If there
are no arbitrage opportunities, then the current risk–free interest rate is closest to:
2)
A)
8%
B)
10%
C)
11%
D)
12%
Use the table for the question(s) below.
Project
Cash flow
today
Cash flow
in one year
“eenie” –10 15
“meenie” 10 –8
“minie” –15 20
“moe” 10 –15
3)
If the risk–free interest rate is 10%, then the NPV for “eenie” is closest to:
3)
A)
–3.64
B)
2.73
C)
3.18
D)
3.64
4)
If the risk–free interest rate is 10%, then of the four projects listed, which project would you never
want to invest in?
4)
A)
Eenie
B)
Meenie
C)
Minie
D)
Moe
Use the table for the question(s) below.
Security
Cash flow
today
Cash flow
in one year
A 0 100
B100 0
C100 100
5)
If the value of security “C” is $180, then what must be the value of security “A”?
5)
A)
$80
B)
$90
C)
$100
D)
Unable to determine without the risk–free rate.
6)
Which of the following formulas regarding NPV is incorrect?
6)
A)
NPV =PV(All project cash flows)
B)
NPV =PV(benefits) –PV(costs)
C)
NPV +PV(benefits) =PV(Cost)
D)
NPV +PV(costs) =PV(benefits)
Use the information for the question(s) below.
An independent film maker is considering producing a new movie. The initial cost for making this movie will be $20
million today. Once the movie is completed, in one year, the movie will be sold to a major studio for $25 million. Rather
than paying for the $20 million investment entirely using its own cash, the film maker is considering raising additional
funds by issuing a security that will pay investors $11 million in one year. Suppose the risk–free rate of interest is 10%.
7)
Without issuing the new security, the npv for this project is closest to what amount? Should the
film maker make the investment?
7)
A)
$1.7 million; Yes
B)
$1.7 million; No
C)
$2.7 million; Yes
D)
$2.7 million; No
Use the table for the question(s) below.
Project
Cash flow
today
Cash flow
in one year
“eenie” –10 15
“meenie” 10 –8
“minie” –15 20
“moe” 10 –15
8)
If the risk–free interest rate is 10%, then of the four projects listed, if you could only invest in one
project, which on e would you select?
8)
A)
Eenie
B)
Meenie
C)
Minie
D)
Moe
A
C
Use the table for the question(s) below.
Market Price Cash Flow in One Year
Security Today Poor Economy Good Economy
A200 840 0
B600 0840
C??? 840 4200
9)
Based upon the information provided about securities A, B, and C, the risk–free rate of interest is
closest to:
9)
A)
4%
B)
5%
C)
8%
D)
10%
10)
Which of the following statements regarding the NPV decision rule is false?
10)
A)
Reject those projects with a negative NPV, as not doing them has NPV = 0.
B)
Reject projects with a NPV of zero, as accepting them is equivalent to loosing the present
value of the projects costs.
C)
Accept those projects with a positive NPV, as accepting them is equivalent to receiving their
NPV in cash today.
D)
When faced with a set of alternatives, choose the one with the highest NPV.
11)
If the risk–free rate of interest (rf) is 6%, then you should be indifferent between receiving $250
today or:
11)
A)
$235.85 in one year
B)
$250.00 in one year
C)
$265.00 in one year
D)
None of the above
12)
Which of the following statements regarding arbitrage is the most correct?
12)
A)
Any situation in which it is possible to make a profit without taking any risk is known as an
arbitrage opportunity.
B)
We call a competitive market in which there are no arbitrage opportunities an arbitrage
market.
C)
Any situation in which it is possible to make a profit without making any investment is
known as an arbitrage opportunity.
D)
The practice of buying and selling equivalent goods in different markets to take advantage of
a price difference is known as arbitrage.
Use the table for the question(s) below.
Project
Cash flow
today
Cash flow
in one year
“eenie” –10 15
“meenie” 10 –8
“minie” –15 20
“moe” 10 –15
13)
If the risk–free interest rate is 10%, then of the four projects listed, if could only invest in two of
these projects, which two projects would you select?
13)
A)
Eenie & Meenie
B)
Minie & Eenie
C)
Eenie & Moe
D)
Minie & Meenie
14)
Walgreen Company (NYSE: WAG) is currently trading at $48.75 on the NYSE. Walgreen Company
is also listed on NASDAQ and assume it is currently trading on NASDAQ at $48.50. Does an
arbitrage opportunity exists and if so how would you exploit it and how much would you make
on a block trade of 100 shares?
14)
A)
No, no arbitrage opportunity exists
B)
Yes, buy on NASDAQ and sell on NYSE, make $25
C)
Yes, buy on NYSE and sell on NASDAQ, make $25
D)
Yes, buy on NASDAQ and sell on NYSE, make $250
Use the information for the question(s) below.
An exchange traded fund (ETF) is a security that represents a portfolio of individual stocks. Consider an ETF for which each
share represents a portfolio of two shares of International Business Machines (IBM), three shares of Merck (MRK), and three
shares of Citigroup Inc. (C). Suppose the current market price of each individual stock are shown below:
Stock Current Price
IBM $79.50
MRK $40.00
C$48.50
15)
Suppose that the ETF is trading for $424.50; you should
15)
A)
do nothing, no arbitrage opportunity exists.
B)
buy the EFT and sell 2 shares of IBM, 3 shares of MRK, and 3 shares of C.
C)
sell the EFT and buy 2 shares of IBM, 3 shares of MRK, and 3 shares of C.
D)
sell the EFT and buy 3 shares of IBM, 2 shares of MRK, and 3 shares of C.
16)
Which of the following statements regarding the valuing of costs and benefits is not correct?
16)
A)
The first step in evaluating a project is to identify its costs and benefits.
B)
Because competitive markets exist for most commodities and financial assets, we can use
them to determine cash values and evaluate decisions in most situations.
C)
In the absence of competitive markets, we can use one–sided prices to determine exact cash
values.
D)
Competitive market prices allow us to calculate the value of a decision without worrying
about the tastes or opinions of the decision maker.
17)
Which of the following statements is false?
17)
A)
The price of a security should equal the present value of its cash flows, up to the transaction
costs of trading the security and the cash flows.
B)
Because you will generally pay a slightly lower price when you buy a security (the ask price)
than you receive when you sell (the bid price) you will pay the bid–ask spread.
C)
No arbitrage opportunities will exist until the underlying prices diverge by more than the
amount of the transaction costs.
D)
In most markets, you must pay transactions costs to trade securities.
18)
Suppose you have $500 today and the risk–free interest rate (rf) is 5%. The equivalent value in one
year is closest to:
18)
A)
$475
B)
$476
C)
$500
D)
$525
19)
You have an investment opportunity in Germany that requires an investment of $250,000 today
and will produce a cash flow of €208,650 in one year with no risk. Suppose the risk–free rate of
interest in Germany is 6% and the current competitive exchange rate is €0.78 to $1.00. What is the
NPV of this project? Would you take the project?
19)
A)
NPV = 0; No
B)
NPV = 2,358; No
C)
NPV = 2,358; Yes
D)
NPV = 13,650; Yes
Use the table for the question(s) below.
Security
Cash flow
today
Cash flow
in one year
A 0 100
B100 0
C100 100
20)
If the risk–free rate of interest is 7.5%, then the value of security “A” is closest to:
20)
A)
$91.00
B)
$92.50
C)
$93.00
D)
$100.00
21)
Which of the following statements regarding arbitrage and security prices is incorrect?
21)
A)
In financial markets it is possible to sell a security you do not own by doing a short sale.
B)
The general formula for the no–arbitrage price of a security is Price(security) =PV(All cash
flows paid by the security).
C)
When a bond is underpriced, the arbitrage strategy involves selling the bond and investing
some of the proceeds.
D)
We call the price of a security in a normal market the no–arbitrage price for the security.
Use the table for the question(s) below.
Consider the following prices from a McDonald’s Restaurant:
Big Mac Sandwich $2.99
Large Coke $1.39
Large Fry $1.09
22)
A McDonald’s Big Mac value meal consists of a Big Mac Sandwich, Large Coke, and a Large Fry.
Assuming that there is a competitive market for McDonald‘s food items, at what price must a Big
Mac value meal sell to insure the absence of an arbitrage opportunity and uphold the law of one
price?
22)
A)
$4.08
B)
$4.38
C)
$5.47
D)
$5.77
23)
Which of the following statements is incorrect?
23)
A)
We define the risk–free interest rate, rf for a given period as the interest rate at which money
can be borrowed or lent without risk over that period.
B)
For most financial decisions, costs and benefits occur at different points in time.
C)
In general, money toady is worth more than money in one year.
D)
We refer to (1 –rf) as the interest rate factor for risk–free cash flows.
24)
Which one of the following statements is false?
24)
A)
When we compute the return of a security based on the average payoff we expect to receive,
we call it the expected return.
B)
The more risk averse investors are, the higher the current price of a risky asset will be
compared to a risk–free bond.
C)
The notion that investors prefer to have a safe income rather than a risky one of the same
average amount is call risk aversion.
D)
Because investors are risk averse, the risk–free interest rate is not the right rate to use when
converting risky cash flows across time.
25)
Which of the following statements regarding the Law of One Price is incorrect?
25)
A)
An important property of the Law of One Price is that it holds even in markets where
arbitrage is not possible.
B)
If equivalent goods or securities trade simultaneously in different competitive markets, then
they will trade for the same price in both markets.
C)
At any point in time, the price of two equivalent goods trading in different competitive
markets will be the same.
D)
One useful consequence of the Law of One Price is that when evaluating costs and benefits to
compute a net present value, we can use any competitive price to determine a cash value,
without checking the price in all possible markets.
26)
You are offered an investment opportunity in which you will receive $23,750 today in exchange for
paying $25,000 in one year. Suppose the risk–free interest rate is 6% per year. Should you take this
project? The NPV for this project is closest to:
26)
A)
Yes; NPV = $165
B)
No; NPV = $165
C)
Yes; NPV = – $165
D)
No; NPV = – $165
27)
You have an investment opportunity in Germany that requires an investment of $250,000 today
and will produce a cash flow of €208,650 in one year with no risk. Suppose the risk–free rate of
interest in Germany is 7% and the current competitive exchange rate is €0.78 to $1.00. What is the
NPV of this project? Would you take the project?
27)
A)
NPV = 0; No
B)
NPV = 2,358; No
C)
NPV = 2,358; Yes
D)
NPV = 13,650; Yes
Use the table for the question(s) below.
Market Price Cash Flow in One Year
Security Today Poor Economy Good Economy
A200 840 0
B600 0840
C??? 840 4200
28)
What is the no–arbitrage price for security C?
28)
A)
$800
B)
$1600
C)
$3200
D)
$4000
Use the information for the question(s) below.
An exchange traded fund (ETF) is a security that represents a portfolio of individual stocks. Consider an ETF for which each
share represents a portfolio of two shares of International Business Machines (IBM), three shares of Merck (MRK), and three
shares of Citigroup Inc. (C). Suppose the current market price of each individual stock are shown below:
Stock Current Price
IBM $79.50
MRK $40.00
C$48.50
29)
The price per share of the ETF in a normal market is closest to:
29)
A)
$168.00
B)
$336.00
C)
$424.50
D)
$504.00
Use the table for the question(s) below.
Security Bid Ask
IBM 79.45 79.50
MRK 39.95 40.05
C48.50 48.55
30)
Consider an ETF that is made up of one share each of IBM, MRK, and C. The minimum ask price
for this ETF in a normal market is closest to:
30)
A)
$167.80
B)
$167.90
C)
$168.00
D)
$168.10
31)
Which of the following statements is false?
31)
A)
We cannot separate a firm’s investment decision from the decision of how to finance the
investment.
B)
In normal markets, trading securities neither creates nor destroys value.
C)
The NPV of trading a security in a normal market is zero.
D)
Financial transactions are not sources of value, but merely serve to adjust the timing and risk
of the cash flows to best suit the needs of the firm or its investors.
32)
If the risk–free rate of interest (rf) is 6%, then you should be indifferent between receiving $250 in
one year or:
32)
A)
$235.85 today
B)
$250.00 today
C)
$265.00 today
D)
None of the above
33)
Suppose you will receive $500 in one year and the risk–free interest rate (rf) is 5%. The equivalent
value today is closest to:
33)
A)
$475
B)
$476
C)
$500
D)
$525
Use the information for the question(s) below.
Alaska North Slope Crude Oil (ANS) $71.75/Bbl
West Texas Intermediate Crude Oil (WTI) $73.06/Bbl
As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one barrel of Alaska North Slope (ANS) crude
oil. Because of its lower sulfur content, you can produce $77 worth of unleaded gasoline from one barrel of West Texas
Intermediate (WTI) crude.
34)
Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS) crude oil for
10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you just purchased 10,000 Bbls
of WTI crude at the current market price, the total benefit (cost) to you if you take the trade is
closest to:
34)
A)
$730,600
B)
$770,000
C)
$771,400
D)
$773,908
35)
Assuming you currently have 10,000 Bbls of WTI crude, the added benefit (cost) to you if you were
to sell the 10,000 Bbls of WTI crude and use the proceeds to purchase and refine ANS crude is
closest to:
35)
A)
($1,400)
B)
$1,400
C)
($3,908)
D)
$3,908
Use the table for the question(s) below.
Consider the following prices from a McDonald’s Restaurant:
Big Mac Sandwich $2.99
Large Coke $1.39
Large Fry $1.09
36)
A McDonald’s Big Mac value meal consists of a Big Mac Sandwich, Large Coke, and a Large Fry.
Assume that there is a competitive market for McDonald‘s food items and that McDonalds sells the
Big Mac value meal for $4.79. Does an arbitrage opportunity exists and if so how would you
exploit it and how much would you make on one extra value meal?
36)
A)
No, no arbitrage opportunity exists
B)
Yes, buy Big Mac, Coke, and Fries then sell value meal to make arbitrage profit of $0.68
C)
Yes, buy Big Mac, Coke, and Fries then sell value meal to make arbitrage profit of $1.09
D)
Yes, buy extra value meal and then sell Big Mac, Coke, and Fries to make arbitrage profit of
$0.68
Use the information for the question(s) below.
An independent film maker is considering producing a new movie. The initial cost for making this movie will be $20
million today. Once the movie is completed, in one year, the movie will be sold to a major studio for $25 million. Rather
than paying for the $20 million investment entirely using its own cash, the film maker is considering raising additional
funds by issuing a security that will pay investors $11 million in one year. Suppose the risk–free rate of interest is 10%.
37)
Assuming that the film maker issues the new security, the npv for this project is closest to what
amount? Should the film maker make the investment?
37)
A)
$1.7 million; Yes
B)
$1.7 million; No
C)
$2.7 million; Yes
D)
$2.7 million; No
C
D