If you accept the dividend irrelevancy theory, it is possible to maintain a high dividend
clientele and still fund future growth.
The addition of investment grade baseball trading cards is likely to expand the efficient
frontier to a better risk return trade off.
Opportunity costs should not be included as they are missed opportunities.
Equivalent annual cash flow approach can be used to determine the year in which the
existing machine can be profitably replaced with a new machine.
The duration of a zero coupon bond is the same as its maturity.
Defaulted bonds often pay some level of residual?
Enterprise zones, a government program that provides financial incentives to make
negative NPV investments, increases APV.
Firms with cyclical revenues tend to have lower asset betas.
Company cost of capital is the cost of debt of the firm.
The WACC formula works for the “average risk” project.
Treasury bills have provided the highest average return, both in nominal terms and in
real terms, between 1900-2006.
Generally, subsidized loan decreases the APV of a project.
The binomial model is a discrete time model.
Company cost of capital is the cost of equity of the firm.
Modigliani and Miller Proposition II states that the rate of return required by the
shareholders increases, steadily, as the firm’s debt-equity ratio increases.
The present value of the interest tax shield is the same regardless of whether the firm
plans to borrow permanently or temporarily.
Most of the trading on the NYSE is in ordinary common stocks.
Because greenmail involves the repurchase of stock at a price higher than the market
price, all shareholders benefit.
The U.S. Treasury issues inflation-indexed bonds known as TIPs.
A portfolio with a beta of one offers an expected return equal to the market risk
premium.
Total uses of funds is equal to investments in net working capital plus investments in
fixed assets plus dividends paid to shareholders.
The duration of any bond is the same as its maturity.
The percentage of sales method is the simplest of the financial planning models.
In an efficient market, information is costless.
For log-normally distributed returns the annual geometric average return is greater than
the arithmetic average return.
A call options gives its owner the right to buy stock at a fixed strike price during a
specified period of time.
The yield to maturity on a bond is really its internal rate of return.
The right to default is valuable for the stockholders of firms.
Buying an in the money option will almost always produce a profit.
Value of a firm is estimated by calculating the present value of free cash flows using
WACC (weighted average cost of capital) for discount rate.
Sunk costs are bygones, they are unaffected by the decision to accept or reject and
should be ignored.
Delta of a put option is equal to the delta of an equivalent call option minus one.
Abandonment option is a call option, while the option to expand is a put option.
The company cost of capital is the correct discount rate for any project undertaken by
the company.
Leverage ratios show how heavily the company is in debt.
Tests of CAPM have confirmed that Capital Asset Pricing Model holds good under all
circumstances.
According to the trade-off theory, more profitable firms should have more debt and thus
the highest debt ratios.
The beta of the firm is equal to the weighted average of the betas on its debt and equity
under the assumption of no taxes.
All things being equal, the closer an option gets to expiration, the lower the option
price.
If an investor buys “a” proportion of the equity of a levered firm (firm L) then his/her
payoff is:
A. (a) * (profits)
B. (a) * (interest)
C. (a) * (profits – interest)
D. none of the above
Given the following data for a stock: beta = 1.5; risk-free rate = 4%; market rate of
return = 12%; and Expected rate of return on the stock = 15%. Then the stock is:
A. overpriced
B. under priced
C. correctly priced
D. cannot be determined
The main advantage of debt financing for a firm is:
I) no SEC registration is required for bond issue
II) interest expense of a firm is tax deductible
III) unlevered firms have higher value than levered firms
A. I only
B. II only
C. III only
D. I and III only
Given the following data: Long term debt = 100; Value of leases = 20; Book value of
equity = 80; Market value of equity = 100, calculate the debt ratio.
A. 0.56
B. 0.50
C. 0.55
D. 0.60
If the nominal interest rate is 7. 5% and the inflation rate is 4%, what is the real interest
rate?
A. 4%
B. 9.5%
C. 3.4%
D. None of the above
Which of the following is generally considered an example of a perpetuity:
A. Interest payments on a 10-year bond
B. Interest payments on a 30-year bond
C. Consols
D. None of the above
Short-term financial plans are developed using the following methods:
I) Trial and error
II) Simulation programs
III) Optimization models
A. I only
B. I and II only
C. II and III only
D. I, II and III
In which of the following exchanges a computer acts as the auctioneer:
I) New York Stock Exchange, II) London Stock Exchange, III) Tokyo Stock Exchange
IV) Frankfurt Stock Exchange
A. I, II, III, and IV
B. I, III, and IV only
C. I, II, and III only
D. II, III, and IV only
The term [N(d2) * PV(EX)] in the Black-Scholes model represents:
A. call option delta
B. bank loan
C. put option delta
D. none of the above
The managers of a firm can maximize stockholder wealth by:
A. Taking all projects with positive NPVs
B. Taking all projects with NPVs greater than the cost of investment
C. Taking all projects with NPVs greater than present value of cash flow
D. All of the above
A firm’s investment decision is also called the:
A. Financing decision
B. Liquidity decision
C. Capital budgeting decision
D. None of the above
John House has taken a 20-year, $250,000 mortgage on his house at an interest rate of
6% per year. What is the value of the mortgage after the payment of the fifth annual
installment?
A. $128,958.41
B. $211,689.53
C. $141,019.50
D. None of the above
The correlation coefficient between stock A and the market portfolio is +0.6. The
standard deviation of return of the stock is 30% and that of the market portfolio is 20%.
Calculate the beta of the stock.
A. 1.1
B. 1.0
C. 0.9
D. 0.6
A three-year bond has 8.0% coupon rate and face value of $1000. If the yield to
maturity on the bond is 10%, calculate the price of the bond assuming that the bond
makes semi-annual coupon interest payments.
A. $857.96
B. $949.24
C. $1057.54
D. $1000.00
Mr. X invests $1000 at 10% nominal rate for one year. If the inflation rate is 4%, what
is the real value of the investment at the end of one year?
A. $1100
B. $1000
C. $1058
D. None of the above
A project costs $14 million and is expected to produce cash flows of $4 million a year
for 15 years. The opportunity cost of capital is 20%. If the firm has to issue stock to
undertake the project and issue costs are $1 million, what is the project’s APV?
A. $3.7 million
B. $4.5 million
C. $4.7 million
D. $3.0 million
If the 5-year spot rate is 10% and the 4-year spot rate is 9%, what is the one-year
forward rate of interest four years from now?
A. 14.1%
B. 9.5%
C. 1.0%
D. 11.0%
Given the following data: risk-free rate = 4%, average risk premium = 7.7%.
Calculate the required rate of return:
A. 5.6%
B. 7.6%
C. 11.7%
D. None of the given answers
How can one invest today at the 2-year forward rate of interest?
I) By buying a 2-year bond and selling a 1-year bond with the same coupon
II) By buying a 1-year bond and selling a 2-year bond with the same coupon
III) By buying a 1-year bond and then after a year reinvesting in a further 1-year bond
A. I only
B. II only
C. III only
D. II and III only
Which of the following statements about the relationship between interest rates and
bond prices is true?
I) There is an inverse relationship between bond prices and interest rates.
II) There is a direct relationship between bond prices and interest rates.
III) The price of short-term bonds fluctuates more than the price of long-term bonds for
a given change in interest rates. (Assuming that coupon rate is the same for both)
IV) The price of long-term bonds fluctuates more than the price of short-term bonds for
a given change in interest rates. (Assuming that the coupon rate is the same for both)
A. I and IV only
B. I and III only
C. II and III only
D. None of the given statements are true
You are planning to produce a new action figure called “Hillary”. However, you are
very uncertain about the demand for the product. If it is a hit, you will have net cash
flows of $50 million per year for 3 years (starting next year). If it fails, you will only
have net cash flows of $10 million per year for 2 years (starting next year). There is an
equal chance that it will be a hit or failure (probability = 50%). You will not know
whether it is a hit or a failure until the first year’s cash flows are in. You have to spend
$80 million immediately for equipment and the rights to produce the figure. If the
discount rate is 10%, calculate the NPV without the abandonment option.
A. -9.15
B. +13.99
C. +9.15
D. -14.4
Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the
construction of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain
constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity
of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year, which is also
the cost of capital (Ignore taxes). Suppose the oil price is uncertain and can be $70/bbl
or $40/bbl next year and then expected NPV of the project if postponed by one year is:
A. +10,000,000
B. +25,000,000
C. +5,000,000
D. none of the above
A small business is receiving a five-year $1,000,000 loan at a subsidized rate of 3% per
year. The firm will pay 3% annual interest payment each year and the principal at the
end of five years. If market interest rate on similar loans is 6% per year, what is the
NPV of the loan? (Ignore taxes.)
A. +$127,371
B. +$348,369
C. -$501,595
D. None of the above
A forward rate prevailing from period three through to period four can be:
I) readily observed in the market place
II) extracted from spot interest rate with 3 and 4 years to maturity
III) extracted from 1 and 2 year spot interest rates
A. I only
B. II only
C. III only
D. I and III only
In the presence of a risk-free asset, the investor’s job is to:
I) invest in the market portfolio
II) find an interior portfolio using quadratic programming
III) borrow or lend at the risk-free rate
IV) read and understand Markowitz’s portfolio theory
A. I and II only
B. I and III only
C. II and IV only
D. IV only
What is the current value of a six-month call option with an exercise price of $15? The
six-month risk-free interest rate (periodic rate) is 5%. [Use the replicating portfolio
method]
A. $8.73
B. $10.28
C. $16.88
D. $33
What are some of the possible consequences of financial distress?
I) Bondholders, who face the prospect of getting only part of their money back, are
likely to want the company to take additional risks.
II) Equity investors would like the company to cut its dividend payments to conserve
cash.
III) Equity investors would like the firm to shift toward riskier lines of business.
A. I only
B. II only
C. III only
D. I and II only
For a company like Alcoa, what is likely to be the major factor when developing an
arbitrage pricing model?
A. Asset price of stocks
B. Commodity price of aluminum
C. GDP
D. Inflation
Option to expand a project is a:
A. Call option
B. Put option
C. Stock option
D. Swap
Which of the following type of projects has average risk?
A. Speculation ventures
B. New products
C. Expansion of existing business
D. Cost improvement
Briefly explain the term “yield to maturity.”
What is the relationship between interest rates and bond prices?
Briefly discuss the role of the financial managers.
Briefly explain how the use of single company cost of capital to evaluate projects might
lead to erroneous decisions.
Briefly explain the value adding-up property.
Briefly explain the effect of introducing borrowing and lending at the risk-free rate on
the efficient portfolios.
In what way is the modified internal rate of return (MIRR) method better than the IRR
method?
How does Modigliani-Miller’s proposition I is modified when taxes and financial
distress costs are considered?
Briefly explain why, in a competitive securities market, successive price changes are
random.
Discuss the concept of duration.
Define net working capital.
Briefly explain the term “variance” of the returns.
Discuss the general principle in the valuation of a common stock.
Briefly explain how inflation is treated consistently while estimation the project NPV.
“Urban renewal can be accomplished by the provision of government tax and loan
incentives to business, despite the existence of negative NPV projects.” Explain why
this is true.
Briefly explain how “beta” of a stock is estimated.
Define the term, “real interest rate.”
Briefly explain the difference between company and project cost of capital.
Briefly describe the “imputation tax system.”
What is the model that is used to prepare a pro-forma statement?