13) Venture capitalists invest in promising early-stage companies in exchange for a portion of
the firm’s equity.
14) American Depositary Receipts (ADRs) are claims issued by U.S. banks representing
ownership of shares of a foreign company’s stock held on deposit by the U.S. bank in the foreign
market and issued in dollars to U.S. investors.
15) A prospectus is another term for a firm’s annual report showing the firm’s prospects for the
coming year.
16) A prospectus is a portion of the security registration statement that describes the key aspects
of the issue, the issuer, and its management and financial position.
17) An underwritten issue of common stock is one in which a firm purchases insurance to cover
unexpected losses suffered by shareholders.
18) Regarding the tax treatment of payments to securities holders, it is true that ________.
A) interest and preferred stock dividends are not tax-deductible, while common stock dividends
are tax deductible
B) interest and preferred stock dividends are tax-deductible, while common stock dividends are
not tax-deductible
C) common stock dividends and preferred stock dividends are tax-deductible, while interest is
not tax-deductible
D) common stock dividends and preferred stock dividends are not tax-deductible, while interest
is tax-deductible
19) Which of the following is a marketable security?
A) mutual funds
B) treasury bill
C) provident fund
D) forward contracts
20) Which of the following is true of outstanding shares?
A) A firm cannot sell more shares than the outstanding shares mentioned in the charter.
B) Authorized shares become outstanding shares when they are issued or sold to investors.
C) Outstanding shares are indicated in a firm’s corporate charter.
D) Outstanding shares are the shares repurchased by the firm.
21) Shares of stock currently owned by a firm’s shareholders are called ________.
A) authorized shares
B) issued shares
C) outstanding shares
D) treasury shares
22) If a firm has class A and class B common stock outstanding, it means that ________.
A) each class receives a different dividend
B) the par value of each class is different
C) the dividend paid to one of the classes is tax deductible by the corporation
D) one of the classes is probably nonvoting stock
23) Common stockholders expect to earn a return by receiving ________.
A) semiannual interest
B) fixed periodic payments
C) dividends
D) annual interest
24) The purpose of nonvoting common stock is to ________.
A) limit the voting power of the management
B) allow the minority interest to elect one director
C) raise capital without giving up any voting control
D) give preference on distribution of earnings to those shareholders who own the stock
25) A proxy statement gives shareholders the right ________.
A) of one vote for each share owned
B) to give up their vote to another party
C) to maintain their proportionate ownership in the corporation when new common stock is
issued
D) to sell their share of stock at a premium
26) A proxy battle is the attempt by ________.
A) the creditors of a bankrupt corporation to seize assets of the corporation
B) the management to dismiss the board of directors for their incapability to manage the
operations
C) a nonmanagement group to unseat the existing management and gain control of the firm
D) the employees to form trade unions to influence decisions on behalf of members
27) The attempt by a nonmanagement group to gain control of the management of a firm by
soliciting a sufficient number of proxy votes is called a ________.
A) hostile takeover
B) bankruptcy proceeding
C) proxy battle
D) management buyout
28) Which of the following is true of par value of a common stock?
A) It is determined on the basis of the stock’s market value.
B) It is an arbitrary value established for legal purposes in a firm’s corporate charter.
C) It indicates the market value at which the stock was originally sold.
D) It allows stockholders to purchase additional shares at a price below the market price.
29) A firm issued 5,000 shares of $1 par-value common stock, receiving proceeds of $20 per
share. The amount recorded for the paid-in capital in excess of par account is ________.
A) $5,000
B) $95,000
C) $100,000
D) $0
30) A firm issued 10,000 shares of $2 par-value common stock, receiving proceeds of $40 per
share. The amount recorded for the paid-in capital in excess of par account is ________.
A) $420,000
B) $380,000
C) $400,000
D) $800,000
31) A firm issued 10,000 shares of no par-value common stock, receiving proceeds of $40 per
share. The amount recorded is ________.
A) $0 in the Common Stock account
B) $0 in the Paid-in Capital in Excess of Par account
C) $400,000 in the Common Stock account
D) $400,000 in the Paid-in Capital in Excess of Par account
32) ________ are financial instruments that allow stockholders to purchase additional shares at a
price below the market price, in direct proportion to their number of owned shares.
A) Rights offering
B) Treasury stocks
C) Preemptive rights
D) Proxy statements
33) Which of the following is true of a common stock?
A) It gives voting rights which permit determination of the amount of dividend receivable.
B) It gives claims on income and assets which are superior to the claims of creditors of the firm.
C) Dividends on commonstock are fully tax-deductible.
D) There is no fixed dividend payment obligation for the company.
34) Stock rights provide the stockholder with ________.
A) the right to purchase additional shares in direct proportion to their number of owned shares
B) the right to elect the board of directors
C) cumulative voting privileges over the preference stockholders
D) the opportunity to receive extraordinary earnings
35) The preemptive right gives shareholders the right ________.
A) to caste one vote for each share owned at the annual meeting of the company
B) to give up their vote to another party if they do not attend the annual meeting
C) to maintain their proportionate ownership in the corporation when new common stock is
issued
D) to sell their share of stock at a premium in the event of liquidation
36) A firm has the balance sheet accounts, Common Stock and Paid-in Capital in Excess of Par,
with values of $10,000 and $250,000, respectively. The firm has 10,000 common shares
outstanding. If the firm had a par value of $1, the stock originally sold for ________.
A) $24/share
B) $25/share
C) $26/share
D) $30/share
37) A firm has the balance sheet accounts, Common Stock and Paid-in Capital in Excess of Par,
with values of $40,000 and $500,000, respectively. The firm has 40,000 common shares
outstanding. If the firm had a par value of $1, the stock originally sold for ________.
A) $11.50/share
B) $12.50/share
C) $13.50/share
D) $15.50/share
38) A(n)________ is hired by a firm to find prospective buyers for its new stock or bond issue.
A) securities analyst
B) trust officer
C) commercial loan officer
D) investment banker
39) Which of the following is true of securities analysts?
A) They raise initial external equity finance privately for firms.
B) They are primarily involved in underwriting of securities.
C) They find prospective buyers for new stocks or bonds issue.
D) They use a variety of models and techniques to value stocks.
40) In a ________, new shares are sold to the existing shareholders.
A) private placement
B) public offering
C) rights offering
D) direct placement
41) Treasury stock refers to the ________.
A) sale of stock at a price greater than the par value
B) stock issued by the US government
C) repurchase of outstanding stock
D) authorization of additional shares of stock by the board of directors
42) Which of the following is an attribute of investment bankers?
A) They make long-term investments for banking institutions.
B) They bear the risk of selling a security issue.
C) They act as middlemen between the issuer and the banker.
D) They provide the issuer with advice relating to the amounts of dividend to be paid.
43) Which of the following is true of the issuance of nonvoting common stock?
A) It is issued in the event of a hostile takeover to preserve the interests of existing owners.
B) It helps the corporation to raise capital through the sale of common stock, without giving up
its voting control.
C) It helps the existing stockholders to automatically transfer their voting rights to new
stockholders without any legal proceeding.
D) It tends to result in the dilution of voting rights of current stockholders.
44) A group formed by an investment banker to share the financial risk associated with
underwriting new securities is called a(n) ________.
A) underwriting syndicate
B) selling group
C) investment banking consortium
D) broker pool
32
45) Zheng Sen’s Chinese Take-Out had earnings before interest and taxes of $4,000,000 last
year. The firm has a marginal tax rate of 40 percent and currently has the following capital
structure:
(a) Calculate the firm’s after-tax return on equity (ROE) and earnings per share (EPS).
(b) If the firm retires $4,000,000 of preferred stock using the proceeds from an equal increase in
long-term debt, what would have been the after-tax return on equity (ROE) and earnings per
share (EPS)?
(c) If the firm retires $4,000,000 of preferred stock using the proceeds from the sale of 500,000
shares of common stock, what would have been the after-tax return on equity (ROE) and
earnings per share (EPS)?
7.4 Understand the concept of market efficiency and basic stock valuation using zero-growth,
constant-growth, and variable-growth models.
1) Investors purchase a stock when they believe that it is undervalued and sell when they feel
that it is overvalued.
2) In an efficient market, the expected return and the required return are equal.
3) In an efficient market, stock prices adjust quickly to new public information.
4) In an inefficient market, stock prices adjust quickly to new public information.
5) In an inefficient market, securities are typically in equilibrium, which means that they are
fairly priced and that their expected returns equal their required returns.
6) In an efficient market, securities are typically in equilibrium, which means that they are fairly
priced and that their expected returns equal their required returns.
7) To a buyer, an asset’s value represents the minimum price that he or she would pay to acquire
it.
8) If the expected return is less than the required return, investors will sell the asset, because it is
not expected to earn a return commensurate with its risk.
9) If the expected return were above the required return, investors would buy an asset, driving its
price up and its expected return down.
10) Efficient-market hypothesis is the theory describing the behavior of an assumed “perfect”
market in which securities are typically in equilibrium, security prices fully reflect all public
information available and react swiftly to new information, and, because stocks are fairly priced,
investors need not waste time looking for mispriced securities.
11) If a market is truly efficient, investors should not waste their time trying to find and
capitalize on mispriced securities.
12) Behavioral finance is a growing body of research that focuses on investor behavior and its
impact on investment decisions and stock prices.
13) The constant growth model is an approach to dividend valuation that assumes a constant
future dividend.
14) The constant growth model is an approach to dividend valuation that assumes that dividends
grow at a constant rate indefinitely.
15) Rational buyers and sellers use their assessment of an asset’s risk and return to determine its
value. Relative to this concept, which of the following is true?
A) To a buyer the asset’s value represents the minimum price that he or she would pay to acquire
it.
B) To a seller the asset’s value represents the maximum sale price.
C) To a buyer the asset’s value represents the maximum price that he or she would pay to acquire
it.
D) To a seller the asset’s value represents the price at which he acquired the asset.
16) According to the efficient market hypothesis, prices of actively traded stocks ________.
A) can be under- or over-valued in an efficient market
B) can only be under-valued in an efficient market
C) do not differ from their true values in an efficient market
D) can only be over-valued in an efficient market
17) If expected return is less than required return on an asset, rational investors will ________.
A) buy the asset, which will drive the price up and cause expected return to reach the level of the
required return
B) sell the asset, which will drive the price down and cause the expected return to reach the level
of the required return
C) sell the asset, which will drive the price up and cause the expected return to reach the level of
the required return
D) buy the asset, since price is expected to increase
18) If the expected return is above the required return on an asset, rational investors will
________.
A) buy the asset, which will drive the price up and cause expected return to reach the level of the
required return
B) buy the asset, which will drive the price down and cause the expected return to reach the level
of the required return
C) sell the asset, which will drive the price up and cause the expected return to reach the level of
the required return
D) sell the asset, since price is expected to decrease
19) Which of the following is true of efficient-market hypothesis?
A) Securities are typically in disequilibrium, meaning they are fairly priced and their expected
returns are more than their required returns.
B) Insider trading scandals have proven that stocks are not fully and fairly priced; as a result, it
would be worthwhile for investors should spend time searching for mispriced (over- or under-
valued) stocks.
C) At any point in time, security prices fully reflect all internal information available about the
firm and its securities, and these prices are insensitive to new information.
D) Since stocks are fully and fairly priced, it follows that investors should not waste their time
trying to find and capitalize on miss-priced (undervalued or overvalued) securities.
20) Preferred stock is valued as if it were a ________.
A) fixed-income obligation
B) bond
C) perpetuity
D) common stock
21) A firm has an issue of preferred stock outstanding that has a stated annual dividend of $4.
The required return on the preferred stock has been estimated to be 16 percent. The value of the
preferred stock is ________.
A) $64
B) $16
C) $25
D) $50
22) A firm has to pay a dividend of $1.20 per share till perpetuity, a zero growth rate of
dividends, and a required return of 10 percent. The value of the firm’s preferred stock is
________.
A) $120
B) $10
C) $12
D) $100
23) A firm has an issue of preferred stock outstanding that has a par value of $100 and a 4%
dividend. If the current market price of the preferred stock is $50, the yield on the preferred stock
is ________.
A) 4.00%
B) 6.00%
C) 8.00%
D) 12.00%
24) The ________ is utilized to value preferred stock.
A) capital asset pricing model
B) arbitrage pricing model
C) zero-growth model
D) Black-Scholes model