1) Risk-free strategies that take advantage of misalignments in two prices (e.g., the spot
and forward exchange rates) are called arbitrage strategies.
2) Holders of callable bonds know that the company will wish to buy the issue back if
interest rates fall, and therefore the price of the bond will not rise above the call price.
3) The cost of capital is the interest rate paid on a loan from a bank or some other
financial institution.
4) IPOs are generally overpriced in order to raise large amounts of cash.
5) A capital surplus is obtained when the selling price of new shares is greater than the
par value.
6) If a project has zero NPV when the expected cash flows are discounted at the
weighted-average cost of capital, then the project’s cash flows are just sufficient to give
debtholders and shareholders the return they require.
7) A corporation cannot default on debt that is funded.
8) In many countries it is common for businesses to remain privately owned.
9) A firm can reduce the cash conversion cycle by selling fewer goods on credit.
10) Forward rates are always equal to the actual future exchange rates.
11) Interest rate parity suggests that you may assume that it is cheaper to borrow in a
currency with a low nominal rate of interest.
12) An annuity due must have a present value at least as large as an equivalent ordinary
annuity.
13) For corporate bonds, the higher the credit quality of an issuer, the higher the interest
rate.
14) The more liberal the terms of the collection policy, the less the potential for bad
debts and unprofitable sales.
15) LVMH’s issuance ofa 7-year bond in 2005, raising 600 million euros, is a financing
decision.
16) A rights issue is one in which a public company offers shares only to existing
shareholders in order to raise additional cash.
17) The historical record fails to show that investors have received a risk premium for
holding risky assets.
18) The markets for long-term debt and equity are called capital markets.
19) Biotech firms require large amounts of cash if their drugs succeed in gaining
regulatory approval. Therefore, these firms often have substantial cash holdings to fund
their possible investment needs.
20) The accounting break-even level of sales represents the point where:
A.fixed costs are covered
B.variable costs are covered
C.fixed costs and variable costs are covered
D.fixed costs, variable costs, and depreciation are covered
21) A firm is planning to issue a callable bond with 8% coupon and 10 years to
maturity. A straight bond with similar coupon is priced at $1,000. If the value of the
issuer’s call option is estimated to be $60, what is the value of the callable bond?
A.$940
B.$970
C.$1,000
D.$1,060
22) The principle of “matched maturities” in finance refers to:
A.finding sources of funds with the longest maturity, in order to avoid liquidity crises
B.funding long-term assets with long-term sources, and vice versa
C.using as much short-term financing as possible due to the lower cost of interest
D.buying marketable securities when demand is high and borrowing short-term when
demand is low
23) “Reinvestment” means:
A.new investment in new operations
B.additional investment in existing operations
C.new investment by new shareholders
D.additional investment by existing shareholders
24) Most actively traded forward contracts are written on:
A.U.S. Treasury bills
B.Standard and Poor’s index
C.eurodollar contracts
D.foreign currencies
25) By how much did the price of a $1,000 par-value bond increase if The Wall Street
Journal shows a change of +6 from the previous day?
A.$0.600
B.$1.875
C.$6.000
D.$18.75
26) If an underwriter charges the public $40 per share for a new issue after having
promised the issuer $38 per share, the spread per share is:
A.$1.00
B.$2.00
C.$38.00
D.$40.00
27) The typical sequence of cash flows in a futures contract is:
A.purchase price plus a margin account up-front, differences are settled at expiration
B.margin account up-front, differences are posted daily and settled in cash if margin
drops too low
C.margin account up-front, all differences settled at expiration
D.all funds are paid at expiration of the contract
28) The fundamental difference between IFRS and GAAP is:
A.GAAP rely more on general principles but ignores the spirit of those principles
B.GAAP rely more on specific rules and the spirit of the rules
C.GAAP rely more on specific rules but not the spirit of the rules
D.GAAP rely more on general principles as well as the spirit of those rules
29) From a historical perspective (1900-2007), what would you expect to be the
approximate return on a diversified portfolio of common stocks in a year that Treasury
bills offered 7.5%?
A.8.3%
B.12.3%
C.14.9%
D.19.3%
30) If the 7s of 2005 are offered at 102:23, then the price of a $1,000 bond would be:
A.$1,020.23
B.$1,022.30
C.$1,025.00
D.$1,027.19
31) What is the book value per share of equity for a firm with $1 million in net common
equity, $50,000 in authorized share capital, 25,000 shares issued, and 20,000 shares
outstanding?
A.$38.00
B.$40.00
C.$47.50
D.$50.00
32) “Balanced” mutual funds:
A.offer mixtures of stocks and bonds
B.spread their investments equally over a specified geographic area
C.spread their investments equally over various industries
D.charge a management fee that is proportionate to the investment return
33) With terms of 4/15, net 60, what is the implied interest rate for forgoing a cash
discount and paying at the end of the period?
A.25.63%
B.28.19%
C.39.25%
D.61.15%
34) A rights issue offers the firm’s shareholders one new share of stock at $40 for every
three shares of stock they currently own. What should be the stock price after the rights
issue if the stock sells for $80 per share before the issue?
A.$56.67
B.$60.00
C.$70.00
D.$71.33
35) If the dividend yield for year 1 is expected to be 5% based on the current price of
$25, what will the year 4 dividend be if dividends grow at a constant 6%?
A.$1.33
B.$1.49
C.$1.58
D.$1.67
36) In a financial planning model:
A.inputs are used to create the model
B.financial ratios are used to create the model
C.financial ratios are used to develop forecasts
D.equations are used to develop financial statements
37) A corporation’s board of directors:
A.is selected by and can be removed by management
B.can be voted out of power by the shareholders
C.has a lifetime appointment to the board
D.is selected by a vote of all corporate stakeholders
38) When an investor purchases a $1,000 par value bond that was quoted at 97.16, the
investor:
A.receives 97.5% of the stated coupon payments
B.receives $975 upon the maturity date of the bond
C.pays 97.5% of face value for the bond
D.pays $1,025 for the bond
39) What is the ROE for a firm with times interest earned ratio of 2, a tax liability of $1
million, and interest expense of $1.5 million if equity equals $1.5 million?
A.-33.33%
B.30.00%
C.33.33%
D.50.00%
40) One common reason for issuing two distinct classes of common stock is to:
A.sell different classes to increase profits
B.allow one stock to increase in price while the other class declines
C.restrict voting privileges from some shareholders
D.conserve cash by offering dividends to only one class of stockholders
41) Soft capital rationing is imposed upon a firm from _____ sources, while hard
capital rationing is imposed from _____ sources.
A.internal; external
B.internal; internal
C.external; internal
D.external; external
42) A firm decides to pay for a small investment project through a $1 million increase
in short-term bank loans. This is best described as an example of a(n):
A.financing decision
B.investment decision
C.capital budgeting decision
D.capital market decision
43) A corporation that has an automatic reinvestment plan:
A.forces shareholders to automatically reinvest dividends in the company
B.never physically pays out declared dividends
C.helps investors plan their investment portfolio
D.gives shareholders the option to automatically reinvest dividends in the company
44) Which of the following is the holder of a warrant allowed to do prior to a specified
date?
A.Convert debt into a specified number of shares
B.Sell common shares at a predetermined price
C.Exchange stock for bonds at a specified price
D.Purchase shares at a predetermined price
45) The current exchange rate is $2/£. Cookham Industries is a large British firm that
exports computer games to the United States. If the dollar depreciates relative to the
pound, Cookham will increase the dollar price it charges its U.S. customers. But it
cannot raise its U.S. price enough to fully offset any dollar depreciation because if it
does so, it will lose customers to its U.S. competitors. Its rule of thumb is that for every
$.10/£ increase in the exchange rate (e.g., from $2.00/£ to $2.10/£) it will increase
prices by $5 (e.g., from $200 to $205 per game). The company will not lower the
product price in U.S. dollars if sterling pound depreciates against the U.S. dollar to
below $2/£. Given this rule, it will lose only some of its U.S. sales. Suppose its forecast
of annual sales in the United States as a function of the dollar price is:
Quantity sold = 50,000 – 100 price in dollars
Answer the questions below.
a. Plot the British pound value of Cookham’s revenue from its U.S. sales as a function
of the exchange rate for exchange rates ranging from $1.50/£ to $3.00/£. What is its
exchange rate exposure?
b. Suppose each exchange rate scenario in part (a) is equally likely. What would
Cookham’s expected dollar revenue be? What would be its pound revenue in each
scenario if it sold forward that number of U.S. dollars at a forward exchange rate of
$2/£? Does this seem like an effective hedge?
c. As an alternative, Cookham calculates the hedge ratio (i.e., the number of dollars it
will sell forward) as
[ revenue in £]/[ exchange rate in £/$],
that is, revenue change induced by exchange rate change
Why do you think this hedge ratio performs so much better in offsetting exchange rate
risk than the one you calculated in part (b)?
46) What is the difference between unique risk, which can be diversified away, and
market risk, which cannot?
47) Are there companies that have attempted to increase their market value in unethical
ways recently?
48) Ajax Corporation has received a firm commitment from its underwriter to purchase
1 million shares of stock that will be marketed to the general public at $23 per share.
The underwriter’s spread is $1.90 per share and the issuing firm will pay an additional
$1.65 million in legal and other fees. The issue was fully sold on the first day and the
stock closed at $27.50 on that day. Calculate both the direct expense of issuance and the
indirect (i.e., underpricing) expense. What percentage of the market value of the shares
is represented by these costs?
49) What are some of the practical problems of capital budgeting in large corporations?
50) Consolidated Bakeries needs to acquire 100,000 bushels of wheat each quarter. The
spot price is $3.75 per bushel but is expected to increase. Consolidated can purchase
call options on 5,000 bushels of wheat with a strike price of $3.80 per bushel and a
premium of $0.03 per bushel. Calculate total expected savings from purchasing the
options if wheat is forecasted to sell at $3.90 per bushel in 3 months. Conversely, how
much did it cost to hedge if the wheat price is unchanged in 3 months?
51) How should we compare interest rates quoted over different time intervalsfor
example, monthly versus annual rates?
52) What are index funds and exchange-traded funds? Why are many investors simply
choosing to buy and hold index funds or exchange-traded portfolios (ETFs) that track
the entire stock market?
53) Explain MM proposition II under conditions of corporate taxes and risk-free debt.
How does the analysis change when debt can be risky?