Finance Multiple Choice Practice

d

) If the yield to maturity of all of th e following bonds is 6%, which trades at the greatest premium per $100 face value? A) a bond with a $10,000 face value, four years to maturity and 6.2% semiannual coupon payments B) a bond with a $5000 face value, several years to maturity and 5.5% annual coupon payments C) a bond with a $500 face value, ten years to maturity and 5.2% annual coupon payments D) a bond with a $1000 face value, five years to maturity and 6.3% a nnual coupon payments

a

10) Many former employees at Enron, an energy trading and supply company, had a large part of their portfolio invested in Enron stock. These employees were bearing a high degree of ________ risk. A) unsystematic B) non -diversifiable C) market specific D) systematic

a

An investment is acceptable if the IRR exceeds the required return. A) True B) False

b

An investment's return on investment usually has two components, one of which is ___________ which reflects the cash you receive directly while you own the investment. A) the capital gain B) the income component C) your reward for bearing risk D) your total dollar return E) your gross return on that investment

b

Very few large U.S. firms use the payback rule when making capital budgeting decisions. A) True B) False

c

What is a bond's seniority? a)Clauses restricting a company from issuing new debt b) Yield of maturity of a bond as compared to bonds of comarable rating. c) the bondholder's priority in claiming assets in the event of default d) the issue price of the bond as compared to its face value

d

What is a major reason that underwriters tend to offer stocks in an IPO at a price that is below that which the market will pay? a) To increase spread B) To gain from rise in value of any stocks they hold after the IPO c) To benefit greenshoe provisions d) To reduce their exposure to losses from unsold stock

D

What kind of corporate debt can be secured by any specified assets? A) notes B) mortgage bonds C) debentures D) asset-backed bonds

d

The volatility of Home Depot Share prices is 30% and that of General Motors shares is 30%. When I hold both stocks in my portfolio and the stocks returns have zero correlation, the overall volatility of returns of the portfolio is A) less than 30%. B) unchanged at 30% C) more than 30%. D) cannot say for sure

t

There is a minimum level of risk that cannot be eliminated simply by diversifying. A) True B) False

d

1) What is the major advantage corporations have over other business entities? A) A corporation's shares can be freely traded among its shareholders. B) A corporation is treated as a separate legal entity for tax and legal purposes. C) It i s easier for a corporation to raise capital than other forms of businesses. D) All of the above are advantages that a corporation has over other business forms.

d

1) Why is a stock exchange like NASDAQ considered a secondary market? A) NASDAQ is called a secondary market because NYSE is considered a primary market. B) It trades the second largest volume of shares in the world. C) The exchange has rules that attempt to ensure that bid and ask prices do not get too far apart D) Shares sold on it are exchanged between investors without any involvement of the issuing corporation.

D

10. Which of the following statements is FALSE? 10) A) The stronger the covenants in the bond contract, the less likely the issuer will default on the bond, and so the lower the interest rate investors will require to buy the bond. B) Covenants are restrictive clauses in a bond contract that limit the issuer from taking actions that may undercut its ability to repay the bonds. C) Bond agreements often contain covenants that restrict the ability of management to pay dividends. D) If the issuer fails to live up to any covenant, the issuer goes into bankruptcy.

...

11) The expected return is usually ________ the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money. A) higher than B) similar to C) lower than D) none of the above

D

11. What is a call provision? A) the option for the bondholder to convert each bond owned into a fixed number of shares of common stock B) the periodic repurchasing of issued bonds through a sinking fund by the issuer C) a clause in a bond contract that restricts the actions of the issuer that might harm the interests of the bondholders D) an option to the issuer to repurchase the bonds at a predetermined price

d

12) Divisional costs of capital are more appropriate when evaluating a project for a line of business when the types of business in a firm are 12) ______ A) similar B) mature businesses. C) new businesses. D) different.

C

12. Which of the following would be most likely to have the lowest price? 12) A) a convertible senior bond B) a straight subordinated bond C) a callable subordinated bond D) a straight senior bond

c

13) T he offer price of shares in an IPO is generally less than the price those shares sell for at the end of the first trading day. Which of the following parties suffer most from this situation? A) the lead underwriter of the IPO B) the underwriters of the IPO C) the buyers of shares after the initial offering D) the pre -IPO shareholders of the issuing firm

c

14) Which of the following statements is FALSE? A) Once bonds are issued, equity holders have an incentive to increase dividends at the expense of debt holders. B) If the covenants are designed to reduce agency costs b y restricting management's ability to take negative-NPV actions that exploit debt holders, then the reduction in the firm's borrowing cost can more than outweigh the cost of the loss of flexibility associated with covenants. C) By including more covenants, issuers increase their costs of borrowing. D) Covenants may restrict the level of further indebtedness and specify that the issuer must maintain a minimum amount of working capital.

A

15) Market timing means that managers may sell ________ when they believe the stock is over-valued and rely on ________ when the stock is under-valued. A) new shares, debt B) debt, debt C) debt, preferred stock D) debt, shares

C

16) Because ________ are seen as an implicit commitment, they send a ________ signal of financial strength to shareholders. A) dividends, weak B) repurchases, weak C) dividends, strong D) repurchases, strong

C

17) The value of a call option ________ with the risk -free rate, and the value of a put option ________ with the risk-free rate. A) decreases, decreases B) increases, increases C) increases, decreases D) decreases , increases

b

18) Which of the following statements is false? A) For most investors an investment in the stock market is a zero -NPV investment. B) Diversification benefits are by far the most common justification that bidders give for the premium they pay for a target. C) An acquirer might be able to add economic value, as a result of an acquisition, that an individual investor cannot add. D) Chief among the costs associated with size is that larger firms are more difficult to manage.

c

2) Why is it usually necessary to use the time value of money when performing a cost benefit analysis? A) Although costs and benefits generally occur concurrently, the benefits will accrue value over time, due to interest. B) For pr actical purposes, a dollar today may be considered to be equal to a dollar at some future time. C) In most investment projects costs are incurred up front, but benefits are provided in the future. D) For an investment project to be considered, costs must have a higher dollar value from benefits.

b

3) Investment X and Investment Y are both growing perpetuities with initial cash flow of $100. Both investments have the same interest rate (r). The present value of Investment X is $5,000, while the present value of Investment Y is $4,000. Which of the following is true? A) Investment X has a lower growth rate than Investment Y. B) Investment X has a higher growth rate than Investment Y. C) The answer cannot be determined without knowing the interest rate for both investments. D) This makes no sense - with the same initial cash flow and the same interest rate Investment X and Investment Y should have the same present value.

a

4) Why, in general, do investment opportunities offer a rate greater than that offered by U.S. Treasury securities for the same horizon? A) Most investment opportunities offer far greater risk than those offered by U.S. Tre asury securities. B) The opportunity cost of capital for a given horizon is generally based on U.S. Treasury securities with that same horizon. C) The return from U.S. Treasury securities generally attracts less tax than the returns from other investments. D) U.S. Treasury securities are generally considered to b e the best alternative to most investments.

B

4. For each 1% change in the market portfolio's excess return, the investment's excess return is expected to change by percent due to risks that it has in common with the market. A) zero B) beta C) alpha D) cannot say for sure

b

5) Which of the following statements are true? A) Bond prices and interest rates are not connected. B) A rise in interest rates ca uses bond prices to fall. C) A fall in bond prices causes interest rates to fall. D) A fall in interest rates causes a fall in bond pric es.

D

5. Which of the following statements concerning the volume and number of IPOs issued over time is most correct? A) They tend to rise over time. B) They tend to fall over time. C) They remain approximately the same over time. D) They are cyclical.

d

6) Which of the following statements is FALSE? A) Cutting the firm's dividend to increase investment will raise the stock price if, and only if, the new investments have a positive net present value (NPV). B) As firms mature, their earnings exceed their investment needs and they begin to pay dividends. C) Total return equals earnings multiplied by the dividend payout ra te. D) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.

d

6) Which of the following statements is FALSE? A) Treasury bills are U.S. government bonds with a maturity of up to one year. B) The amount of each coupon payment is determined by the coupon rate of the bond. C) The simplest type of bond is a zero -coupon bond. D) Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value.

D

6. How does the total cost of issuing stock for the first time compare to the costs of other securities? A) substantially less than the costs for most other securities B) substantially larger than the costs for most other securities C) substantially less than the cost for a few other securities D) about the same as the cost for most other securities

c

7) Which of the following statements is FALSE regarding profitable and unprofitable growth? A) A firm can increase its growth rate by retaining more of its earnings. B) Cut ting the firm's dividend to increase investment will raise the stock price if, and only if, the new investments have a positive net present value (NPV). C) If a firm wants to increase its share price, it must cut its dividend and invest more. D) If the firm retains more earnings, it will be able to pay out less of those earnings, which means that the firm will have to reduce its dividend.

d

7) You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space? A) payback period B) internal rate of return (IRR) C) net present value (NPV) D) profitability index

D

7. Which of the following terms best describes a loan where a larger line of credit or lower interest rate has been obtained by providing collateral to back that loan? A) a term loan B) a private placement C) a revolving line of credit D) an asset-backed line of credit

b

8) Which of the following statements is FALSE? A) The simplest forecast for the firm's future dividends states that they will grow at a constant rate, i.e., forever. B) We cannot use the general dividend-discount model to value the stock of a firm with rapid or changing growth. C) The dividend -discount model values the stock based on a forecast of the future dividends paid to shareholders. D) As firms mature, their growth slows to rates more typical of established companies.

b

9) Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking? A) option to switch B) option to delay C) option to abandon D) option to expand

A

9. Why do the issuers of bonds not seek to minimize the strength and number of covenants in a bond agreement? A) Covenants lower the interest rate investors will require to buy the bond. B) Covenants force the company to renegotiate the terms of the bond if they are broken. C) Covenants can increase the flexibility of the company issuing the bond. D) Covenants favor the equity holders that managers work for.

t

A firm in South Dakota announces a revolutionary way to make auto airbags in a way that decreases their risk to automobile occupants. This is a type of surprise that would be characterized as unsystematic risk. A) True B) False

e

A firm intends to take on a significant amount of new debt in order to fund the purchase of a close competitor. However the firm cannot complete the transaction unless it first calls one of its outstanding bond issues. It must be true that the called bonds A) are backed by the corporation's fixed assets B) have a higher interest rate than the new bonds will C) have an inferior tax status than the new bonds will D) can be called at a price that is very near par E) have covenants which restrict such increase in debt

d

A maker of kitchenware is planning on selling a new chef-quality kitchen knife. The manufacturer expects to sell 1.6 million knives at a price of $120 each. These knives cost $80 each to produce. Selling, general, and administrative expenses are $500,000. The machinery required to produce the knives cost $1.4 million, depreciated by straight-line depreciation over five years. The maker determines that the EBIT break-even point for units sold and sale price is less than these estimates and that the EBIT break-even point for costs per unit, SG&A, and depreciation are greater than these estimates, so decides to go ahead with manufacturing the knife. Was this the correct decision? 8) _______ A) Yes, since a positive EBIT ensures that the project will have a positive net present value (NPV). B) No, since the cost per unit should be greater than the EBIT -break even point for cost of goods if the project is to have a positive EBIT. C) Yes, since if the estimates for each parameter are correct , the EBIT will be positive. D) It cannot be determined whether the decision was correct, since other factors contributing to the project's net present value (NPV), such as the upfront investment, have not been included in the analysis.

b

According to the historical record, risk premiums grow as the risk of an investment decreases. A) True B) False

horizontal mergers

Combination between firms in the same business activity Rationale is that economies of scale and scope Impact of government regulation due to potential anti competitive effects.

conglomerate mergers

Combination of firms in unrelated types of business activity

vertical mergers

Combinations between firms at different stages Rationale includes information and transaction efficiency

f

If investment funds are limited and the projects under consideration are independent from one another, the IRR should be used to rank projects to determine which ones should be accepted. A) True B) False

f

If you invest in stocks with higher-than-average betas, you are certain to earn higher-than-average returns over the next year. A) True B) False

f

It is NOT possible to construct a portfolio with zero variance of expected returns from assets whose expected returns have positive variance individually. A) True B) False

Merger

Negotiated deals Mutuality of negotiations Most friendly

Tender offer

Offer made directly to shareholders Hostile when offer made without approval of board.

a

Positive net present value projects _____________________. A) tend to be rare in a highly competitive market B) will likely have a source of value that is difficult to determine C) tend to be rare in a highly monopolistic market D) will typically occur in international markets, but not domestic markets E) are common for firms in old, well established industries Feedback: tend to be rare in a highly competitive marke

c

Suppose your grandmother invested some money in 1925. Based on historical returns from 1925 to 1998, what of the following types of securities would have given her the SECOND highest return? A) High quality long-term corporate bonds B) The common stock of small capitalization firms listed on NYSE C) The common stock of the 500 largest firms in the US D) US Treasury bills E) Long-term government bond

a

The essence of _________________ is determining whether a proposed investment or project will generate positive wealth for the owners of the firm once it is in place. A) strategic asset allocation B) capital structure analysis C) cash flow analysis D) payback analysis E) working capital analysis

d

Which of the follow need to be true for an assets to be considered liquid? a) It pays regular dividends b) it is offered for sale on both primary and secondary market c) It can be bought and sold at organized stock market or bourse d) it can be easily bought and sold and the selling price is very close tot he buying price at any given point in time.

b

Which of the following does NOT correctly complete this sentence: Conventional capital budgeting analysis will tend to understate the true NPV of a project unless ________ is considered. A) a contingency plan option B) the option to default C) the option to expand D) the option to abandon E) the option to wait

d

Which of the following is correct? A zero coupon bond _________________. A) typically pays coupons only during the first five years B) sells for a price that is greater than the face value C) has no interest payments and is thus non-taxable until maturity D) is also known as a deep discount bond E) provides no cash flow to the holder at maturity

e

Which of the following is likely to be associated with the highest level of risk? A) Long-term corporate bonds B) US Treasury bills C) Long-term government bonds D) Common stock of the largest companies in the US E) Common stock of the smallest companies listed on NYSE

c

Which of the following is not a diversifiable risk? a) the risk that CEO is killed in a plan crash b) the risk of a key employee being hired away by competitor c) the risk that oil prices rise, increasing productions costs d) the risk of product liability

b

Which of the following risks do debt ratings specifically attempt to assess? I. Interest rate risk II. Default risk III. The risk of a call being made A) I only B) II only C) I and II only D) II and III only E) I, II, and III

A

Which of the following statements regarding best efforts IPOs false? a) If the entire issue does not sell out, the underwriter is on the hook. b) Often these arrangements have an all or none clause either all of the shares are sold in the IPO, or the deal is called off. c) The underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for best possible price d) For smaller IPOs, the underwriter commonly accepts the deal on the basus.

d

Why do long-term government bonds have a risk premium? A) They are not government guaranteed B) They are virtually identical to long-term corporate bonds C) The government cannot easily raise tax money to repay the bonds D) The long time period to maturity E) Long-term government bonds don't have a risk premium

A

You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM) to be 1.9 over the next year. Also, you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year. Which stock has more systematic risk? Which stock has more total risk? A) GM, GM B) XOM, GM C) XOM, XOM D) GM, XOM

a

You want to own equity in a Russian oil firm, but the firm does not have traded stock. If it had ___________ outstanding you could purchase them and then trade them in for shares of stock. A) convertible bonds B) put bonds C) debentures D) zero coupon bonds E) subordinated debentures

c

_________ allows a firm to ask what-if type questions in capital budgeting. I. Scenario analysis II. Sensitivity analysis III. Simulation analysis IV. Break-even analysis A) I and II only B) II and III only C) I, II, and III only D) I, II, and IV only E) I, II, III, and IV

c

__________ included in the bond indenture to protect bondholders from certain actions by the company. A) Indentures are B) Debentures are C) Covenants are D) Articles of incorporation are E) A description of dedicated capital is

d

________________ is an account into which periodic payments are made for the purpose of retiring a bond issue. A) An indenture B) A debenture C) A covenant D) A call option E) A sinking fund

value increased from m&a

efficiency increases -managerial capabilities, growth opportunities, critical mass, utilization of fixed investments. operating synergy -economies of scale, economies of scope, complementary of operations, market power Diversification Financial Synergy -debt capacity relative efficiency of interval vs external financial contracting.