Chapter 6

An aggressive, risk-oriented firm will likely: A. borrow long-term and carry low levels of liquidity. B. borrow short-term and carry low levels of liquidity. C. borrow long-term and carry high levels of liquidity. D. borrow short-term and carry high levels of liquidity.

b

An inverted yield curve would suggest that: A. interest rates are expected to rise. B. interest rates are expected to fall. C. inflation is expected to rise in the future. D. long-term rates are being pushed up by the Bank of Canada's monetary policy.

b

During tight money periods: A. long-term rates are higher than short-term rates. B. short-term rates are higher than long-term rates. C. short-term rates are equal to long-term rates. D. the relationship between short and long-term rates remains unchanged.

b

Pressure for current asset buildup often results from: A. decline in sales growth. B. rapidly expanding sales. C. increased demands of short-term creditors. D. decreased demands of short-term creditors.

b

Publishing companies are characterized by: A. flat production to match sales. B. seasonal sales. C. low inventories due to computer inventory management. D. short term financing choice

b

Some analysts believe that the term structure of interest rates is determined by the behaviour of various types of financial institutions. This theory is called the: A. expectations hypothesis. B. segmentation theory. C. liquidity premium theory. D. theory of industry supply and demand for bonds.

b

The cash flow cycle has a major bearing on the firm's: A. dividend policy. B. liquidity. C. cash management efficiency. D. risk

b

The ratio of long-term financing to short-term financing at any point in time will be greatly influenced by the term structure of interest rates and common stock prices.

f

The successful financial manager is very interested in the term structure of interest rates but is not concerned with the relative volatility or historical level of interest rates.

f

Use of long-term financing and the carrying of highly liquid assets is a high-risk combination.

f

When using level production, inventory will peak in the month where unit sales trend above the production level.

f

Working capital management is relatively unimportant to the small businessperson.

f

. If the liquidity premium theory was correct, yield curves would be upward-sloping.

t

. Inventory remains a significant percentage of current assets for non-financial Canadian corporations.

t

7. Short-term financing is risky because of the possibility of rising short-term rates and the inability of always being able to refund short-term debt.

t

8. Generally speaking, during the past two decades corporations were relying more and more on short-term borrowing to carry less liquid assets.

t

8. If a firm uses a conservative financial plan, it will usually have marketable securities at the bottom of a cyclical sales swing

t

As a general rule, it is desirable to finance the permanent assets, including "permanent current assets," with long-term debt and equity

t

Cash, accounts receivables, and inventory all move monthly in the same direction under level production.

t

During an economic "boom" period, a shortage of low-cost financing alternatives exists.

t

During tight money periods, short-term financing may be difficult to find.

t

Expected value techniques allow consideration of more than one possible outcome.

t

Firms with highly volatile and perishable inventory should assume relatively low levels of risk.

t

Heavy use of long-term debt will allow a firm to carry less liquid, more profitable assets.

t

Humped yield curves have higher intermediate term rates (4-7 year maturities) than either short-term or long-term rates.

t

Immediate access to capital markets allows greater risk-taking capability.

t

Increased use of long-term financing is generally a more conservative approach to current asset financing.

t

One reason for long-term diminishing liquidity is more efficient cash management

t

Only the segmentation theory has any significant impact on interest rates.

t

Short-term interest rates are generally lower than long-term interest rates.

t

Short-term interest rates have historically been more volatile than long-term rates.

t

The "term structure of interest rates" refers to the relationship between yields on debt and their maturities.

t

The behaviour of various kinds of financial institutions determines the shape of the yield curve, according to the segmentation theory.

t

The key to current asset planning is the ability of management to forecast sales accurately and then match production schedules with the sales forecast.

t

The more short-term financing relative to long-term financing, the more risky the financial structure.

t

he use of on-line point-of-sale terminals has made it easier for many retail store managers to manage their inventory.

t

. If a firm uses level production with seasonal sales: A. as sales decline inventory will increase. B. as sales decline inventory will decrease. C. as sales decline accounts receivable will increase. D. as sales decline accounts receivable will remain unchanged.

a

. When the term structure of interest rates is downward sloping and interest rates are expected to decline, the: A. financial manager generally borrows short-term. B. financial manager borrows at the lower long-term rates. C. corporation's ratio of short-term to long-term debt is low. D. financial managers view short-term rates as high risk.

a

If a firm uses long-term financing to cover short-term needs it is: A. assuring itself of having adequate capital at all times. B. is taking a profitable approach to financing. C. is taking a relatively risky approach to financing. D. incurring a lower overall interest cost in comparison with short-term financing

a

Normally, permanent current assets should be financed by: A. long-term funds. B. short-term funds. C. borrowed funds. D. internally generated funds

a

One advantage of level production is that: A. manpower and equipment are used efficiently at lower cost. B. current assets fluctuate more than with seasonal production. C. seasonal bulges and sharp declines in current assets occur. D. the risk of obsolete inventory increase

a

Risk exposure due to heavy short-term borrowing can be compensated for by: A. carrying highly liquid assets. B. carrying illiquid assets. C. carrying longer term, more profitable current assets. D. carrying more receivables to increase cash flow.

a

The term structure of interest rates: A. changes daily to reflect current competitive conditions in the money and capital markets. B. plots returns for securities of different risk. C. shows the relative interest spread between bonds with different risk ratings such as AAA, AA, A, BBB, etc. D. depicts interest rates for T-bills over the last year.

a

The theory of the term structure of interest rates, which suggests that long-term rates are determined by the average of short-term rates expected over the time that a long-term bond is outstanding is the: A. expectations hypothesis. B. segmentation theory. C. liquidity premium theory. D. market average rate theory.

a

Which of the following combinations of asset structures and financing patterns is likely to create the most volatile earnings? A. Illiquid assets and heavy short-term borrowing B. Illiquid assets and heavy long-term borrowing C. Liquid assets and heavy long-term borrowing D. Liquid assets and heavy short-term borrowing

a

A "normal" term structure of interest rates would depict: A. short-term rates higher than long-term rates. B. long-term rates higher than short-term rates. C. no general relationship between short-and long-term rates. D. medium rates (1-5 years) lower than both short-term and long-term rates.

b

A firm will usually increase the ratio of short-term debt to long-term debt when: A. short-term debt has a lower cost than long-term equity. B. the term structure is inverted and expected to shift down. C. the term structure is upward sloping and expected to shift up. D. the firm is undertaking a large capital budgeting project.

b

The "term structure of interest rates" is a schedule that tells when a company's bonds mature and shows how many dollars a firm must pay in interest payments.

f

The concept of a self-liquidating asset implies that: A. the working capital associated with a product will be liquidated within a one year period. B. all the product will be sold, receivables collected, and bills paid over the time period specified. C. assets associated with the production of a product will be liquidated over the amortized life of the assets. D. self-liquidating assets will be financed by long-term sources of capital.

b

The term structure of interest rates: A. is based on historical yields. B. is based on current yields. C. is based on future yields. D. is based on current and future prices.

b

Which of the following is not a condition under which a prudent manager would accept some risk in financing? A. Predictable cash-flow patterns B. Inventory is highly perishable C. Price of inventory is stable D. Easy access to capital markets

b

Which of the following yield curves would be characteristic at peak periods of economic expansions? A. Upward sloping B. Downward sloping C. Horizontal D. Humped

b

Working capital management is primarily concerned with the management and financing of: A. cash and inventory. B. current assets and current liabilities. C. current assets. D. receivables and payables

b

. Ideally, which of the following types of assets should be financed with long-term financing? A. Capital assets only B. Capital assets and temporary current assets C. Capital assets and permanent current assets D. Temporary and permanent current assets

c

. Under normal conditions (70% probability), Financing Plan A will produce $24,000 higher return than Plan B. Under tight money conditions (30% probability), Plan A will produce $40,000 less than Plan B. What is the expected value of return for Plan A over Plan B? A. $28,800 B. $4,000 C. $4,800 D. $35,200

c

An aggressive working capital policy would have which of the following characteristics? A. A high ratio of long-term debt to capital assets B. A low ratio of short-term debt to total debt C. A high ratio of short-term debt to long-term sources of funds D. A short average collection period

c

Ideally, all current assets will be: A. financed by short-term debt. B. long-term in nature. C. self-liquidating. D. internally financed.

c

The belief that investors require a higher return to entice them into holding long-term securities is the viewpoint of the: A. the expectations hypothesis. B. segmentation theory. C. the liquidity premium theory. D. market credit crunch theory

c

The term "permanent current assets" implies: A. the same thing as capital assets. B. nonmarketable assets. C. some minimum level of current assets that is not self-liquidating. D. inventory

c

The term structure of interest rates or the yield curve: A. is normal when short-term rates are higher than long-term rates. B. is inverted when short-term rates are lower than long-term rates. C. shows the yield to maturity for securities of equal risk over time. D. is always flat in the short-term.

c

Which of the following is a true statement concerning interest rates? A. Short-term rates are not influenced by inflation B. Long-term rates are influenced by current demands for money. C. During 1990 the term structure of interest rates formed an inverted yield curve. D. During 2016 the term structure of interest rates formed an inverted yield curve.

c

The finance manager at Ruthless Manufacturing Inc (RMI) was comparing plans for financing inventory. Under normal conditions (60% probability), Financing Plan A will produce $60,000 higher return than Plan B. Under tight money conditions (40% probability), Plan A will produce $50,000 less than Plan B. Which finance plan should RMI choose and why? A. Plan A because it will produce $36,000 higher expected value than Plan B. B. Plan B because it will produce $50,000 higher expected value than Plan A. C. Plan A because it will produce $16,000 higher expected value than Plan B. D. Either, as both expected values are equal.

c 60k*.4 50k*.4=36k-20k=c

. A conservatively financed firm would: A. use long-term financing for all capital assets and short-term financing for all other assets. B. finance a portion of permanent assets and short-term assets with short-term debt. C. use equity to finance capital assets, long-term debt to finance permanent assets, and shortterm debt to finance fluctuating current assets. D. use long-term financing for permanent assets and capital assets and a portion of the shortterm fluctuating assets and use short-term financing for all other short-term assets.

d

. As the economy moves through a business cycle, which of the following term structure of interest rates theories describe the shape of the yield curve? A. Expectations theory, agency theory and segmentation theory. B. Market segmentation theory, agency theory and liquidity premium theory. C. Liquidity preference theory, segmentation theory and agency theory. D. Liquidity premium theory, segmentation theory and expectation hypothesis.

d

. The cash conversion cycle is equal to: A. the cash flow cycle. B. inventory holding period less the average collection period less the accounts payable period. C. inventory holding period less the average collection period plus the accounts payable period. D. inventory holding period plus the average collection period less the accounts payable period.

d

. The term structure of interest rates: A. is not an indication of investors' expectations about inflation and future interest rates. B. will be upward sloping if short-term interest rates are higher than long-term rates. C. will be downward sloping under normal conditions. D. is referred to as the yield curve.

d

7. The use of cash budgeting procedures: A. increases revenue for a given production plan. B. makes managing inventory harder under seasonal production. C. reduces the need for temporary permanent assets. D. illustrates fluctuating levels of current assets for a given production plan.

d

A financial executive devotes the most time to: A. long-range planning. B. capital budgeting. C. short-term financing. D. working capital management.

d

The "term structure of interest rates" depicts the competitive cost of funds for the various types of short-term sources of funds such as Treasury bills, commercial paper, and bankers' acceptances.

f

Generally, more use is made of short-term financing because: A. short-term financing is usually more predictable than long-term financing. B. most firms do have easy access to the capital markets. C. short-term interest rates are generally higher than long-term interest rates. D. short-term interest rates are generally lower than long-term interest rate

d

Hedging is: A. matching assets and liabilities to measure risk. B. a risk measurement system. C. possible to achieve perfectly in practice. D. matching the maturities of assets and liabilities to reduce risk.

d

It is difficult to construct a perfectly hedged financial plan because: A. it is easy to determine which part of assets is temporary and which part is permanent. B. it is difficult to liquidate current assets. C. a financial manager is sure how much short or long-term financing is available at a given time. D. exact timing of asset liquidation is difficult

d

The term structure of interest rates is not influenced by: A. inflation. B. money supply. C. Bank of Canada activities. D. the normal yield curve.

d

The term structure of interest rates is not: A. an indication of investors' expectations about inflation and future interest rates. B. downward sloping if short-term interest rates are higher than long-term rates. C. upward sloping under normal conditions. D. upward sloping if long-term interest rates are lower than short-term rates.

d

The term structure of interest rates: A. is not an indication of investors' expectations about inflation. B. will be upward sloping if short-term interest rates are higher than long-term rates. C. will be downward sloping under normal conditions. D. is an indication of investors' expectations about inflation and future interest rates

d

The term structure of interest rates: A. is not referred to as the yield curve. B. depicts the only long-term interest rates. C. depicts the only short-term interest rates. D. is usually constructed with Government of Canada securities of varying maturities.

d

When actual sales are greater than forecasted sales: A. inventory will increase. B. production schedules might have to be revised downward. C. accounts receivable will decrease. D. inventory will decrease and accounts receivable will increase.

d

When actual sales are greater than forecasted sales: A. inventory will increase. B. production schedules remain constant. C. accounts receivable will decrease. D. production schedules might have to be revised upward.

d

Which of the following combinations of asset structures and financing patterns is likely to create the least volatile earnings? A. Illiquid assets and heavy short-term borrowing B. Illiquid assets and heavy long-term borrowing C. Liquid assets and heavy long-term borrowing D. Liquid assets and no debt

d

Which of the following is a reason for diminishing liquidity in modern corporations? A. Low interest rates. B. Lower utilization of cash via computers. C. Greater utilization of cash via information systems. D. Inflation pushes more cash into inventory.

d

Which of the following techniques allows explicit consideration of more than one possible outcome? A. Operating leverage B. Present value C. Least-squares regression D. Expected value

d

Yield curves change daily to reflect: A. static conditions in the capital markets. B. static conditions in the money markets. C. historical inflation rates. D. changing conditions in the overall economy

d

Under normal conditions (80% probability), Financing Plan A will produce $25,000 higher return than Plan B. Under tight money conditions (20% probability), Plan A will produce $50,000 less than Plan B. What is the expected value of return for Plan A over Plan B? A. $25,000 B. $20,000 C. $15,000 D. $10,000

d=.8*25000 - .2*50000 =20000- 10000 =10000

. The expected value is the sum of the probabilities of all expected events.

f

. The faster a firm's growth in sales, the more likely it is that an increasing percentage of financing will be internally generated.

f

3. Yield curves change very little in the short run (3 months).

f

4. Inflation and interest rates (yields) are inversely related.

f

5. Short-term interest rates are more dependent upon inflation than on current demand for money.

f

8. According to the expectations hypothesis, short-term rates would be expected to rise if they were far below long-term rates.

f

A humped yield curve has lower medium-term rates than both short-term and long-term rates.

f

A risky financial plan will use long-term financing for capital assets, permanent current assets, and a portion of temporary current assets.

f

Firms with predictable cash-flow patterns should assume relatively low levels of risk.

f

Heavy risk exposure due to short-term borrowing can be compensated for by carrying illiquid assets.

f

Heavy use of long-term financing generally leads to lower financing costs.

f

Ideally, permanent current assets should be financed with short-term borrowings.

f

In periods of tight money, long-term rates are often higher than short-term rates

f

Over the last several decades, most business firms have increased their liquidity.

f

Self-liquidating current assets are really capital assets since they have lives greater than one year

f

Short-term interest rates are more dependent upon inflation than on current demand for money

f

The financial manager generally needs to devote little time to management of working capital.

f