FIN 390 Exam 3 Qualitative Questions

Which of the following statements is CORRECT? Net working capital is defined as current assets minus the difference between current liabilities and notes payable, and any increase in the current ratio automatically indicates that net working capital has increased. A company that matches its use of short-term debt with its use of long-term debt must have a policy of matching maturities. A company that matches its use of common stock with its use of long-term debt as opposed to short-term debt must have a policy of matching maturities. Net working capital is defined as current assets minus the difference between current liabilities and notes payable, and any decrease in the current ratio automatically indicates that net working capital has decreased. Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing.

Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing.

Lawton Pipelines Inc. has developed plans for a new pump that will allow more economical operation of the company's oil pipelines. Management estimates that $2,400,000 will be required to put this new pump into operation. Funds can be obtained from a bank at 12% simple interest, or the company can finance the expansion by delaying payment to its suppliers. Presently, Lawton purchases under terms of 2/10, net 40, but management believes payment could be delayed 30 additional days without penalty; that is, payment could be made in 70 days. Which means of financing should Lawton use? (Use the nominal cost of trade credit.) Trade credit, since the cost is about 0.41 percentage points less than the bank loan. The firm could use either since the costs are identical. Trade credit, since the cost is about 1 percentage point less than the bank loan. Bank loan, since the cost is about 1 percentage point less than trade credit. Bank loan, since the cost is about 0.41 percentage points less than trade credit.

Bank loan, since the cost is about 0.41 percentage points less than trade credit.

_____ is a type of unsecured promissory note issued by large, strong firms and sold primarily to other business firms, to insurance companies, to pension funds, to money market mutual funds, and to banks. Commercial paper A speculative balance A line of credit A revolving credit agreement A promissory note

Commercial paper

As of 2017, which of the following is an accurate assessment of companies and their cash holdings? Companies in general are holding too little cash. The modern economy is too complex to allow for generalizations about the amount of cash that companies "should" hold. No solid conclusions can be formed because companies are not required to be forthcoming about their cash holdings. Companies in general are holding too much cash. Companies in general are holding about the right amount of cash.

Companies in general are holding too much cash.

Company A prefers to have a fixed-rate debt. Company B prefers to have a floating-rate debt. The two companies decide to arrange an interest rate swap. Prior to the swap, _____. both companies should raise the same type of debt, either floating-rate or fixed-rate both companies should raise floating-rate debt both companies should raise fixed-rate debt Company A should raise fixed-rate debt while Company B raises floating-rate debt Company A should raise floating-rate debt while Company B raises fixed-rate debt

Company A should raise floating-rate debt while Company B raises fixed-rate debt

If a firm is in a zero tax bracket, which of the following is NOT directly reflected in the cash budget? Depreciation. Repurchases of common stock. Payment for plant construction. Payments lags. Cumulative cash.

Depreciation

Which of the following statements concerning the cash budget is CORRECT? Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax payments. Changes that affect the DSO do not affect the cash budget. Capital budgeting decisions have no effect on the cash budget until projects go into operation and start producing revenues. Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds. Cash budgets do not include financial items such as interest and dividend payments.

Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax payments.

Which of the following statements regarding the factors that affect put option prices is NOT accurate? The effect of the time to maturity on the put option price is indeterminate. Both put and call option prices are higher when the stock's standard deviation is higher. If the stock's standard deviation is high, then a longer maturity put option will be less valuable. The impact on the put of the underlying stock price, exercise price, and risk-free rate are opposite that of the call option. The same five factors that affect call options affect put options.

If the stock's standard deviation is high, then a longer maturity put option will be less valuable.

Each of the following is a difference between futures contracts and forward contracts EXCEPT: Forward contracts are market-to-market on a daily basis. In a futures contract, the party taking the long position is obligated to buy the underlying asset. Forward contracts do not involve the physical delivery of assets. The risk of default is smaller for forward contracts. Futures contracts are usually standardized instruments traded one exchanges.

In a futures contract, the party taking the long position is obligated to buy the underlying asset.

Which of the following statements is CORRECT? It is generally not appropriate for small firms to develop borrowing relationships with large banks. It is generally not appropriate for large firms to develop borrowing relationships with large banks. Contrary to popular belief, the size of a bank relative to the size of the firms that borrow from it is irrelevant. It is generally not appropriate for large firms to develop borrowing relationships with small banks. It is generally not appropriate for small firms to develop borrowing relationships with small banks.

It is generally not appropriate for large firms to develop borrowing relationships with small banks.

Which of the following is likely to be true regarding the speculative balances of a large company with a high credit rating? Its speculative balances will be relatively high. There is no necessary relationship between a company's speculative balances and its size and credit rating. Its speculative balances will be relatively low. Its speculative balances will fluctuate, running low when the economy is doing well and running high when the economy is in recession. Its speculative balances will fluctuate, running high when the economy is doing well and running low when the economy is in recession.

Its speculative balances will be relatively low.

Which of the following statements concerning bank loans is CORRECT? The various fees and methods of calculating interest mean that the nominal interest rate must reflect the true cost of the loan. Interest is typically calculated on a monthly basis but paid daily. Personal guarantees are not necessary for partnerships or proprietorships. For an interest-only loan, some of the principal is repaid on each payment date. If the interest rate is fixed, then it is generally indexed to LIBOR.

Personal guarantees are not necessary for partnerships or proprietorships.

Which of the following equations correctly expresses put-call parity? Put option = Call option + PV of exercise price Put option = Call option Put option = Stock - Call option Put option + PV of exercise price = Call option + Stock Put option + Stock = Call option + PV of exercise price

Put option + Stock = Call option + PV of exercise price

When considering call options, which of the following statements is accurate? The market value of an option depends in part on the option's length of time until expiration and on the variability of the underlying stock's price. If the company is consistently profitable, its call options will always be in the money. The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin becomes larger. As a stock's price increases, the premium portion of an option on that stock increases because the difference between the stock price and the fixed strike price increases. An option's value is determined by its exercise value, which is the market price of the stock less its strike price. Thus, an option can't sell for more than its exercise value.

The market value of an option depends in part on the option's length of time until expiration and on the variability of the underlying stock's price.

When considering the factors that affect call option prices, which of the following statements is accurate? Two call options on the same stock will have the same value even if they have different strike prices. The price of a call option increases as the risk-free rate increases. If you observe that a put option on a stock increases in value, then a call option on that same stock also increases in value. An option on an extremely volatile stock is worth less than one on a very stable stock. The longer the time until the call option expires the smaller its value and the smaller its premium.

The price of a call option increases as the risk-free rate increases.

There are call options on the common stock of InFlux Corporation. Which of the following best describes the factors that affect call option values? The less volatile a stock's price, the more valuable a call option on the stock is. Assuming the same strike price, a call option that expires in 1 month will sell for a higher price than one that expires in 3 months. If the risk-free rate of interest increases, the value of call options will decrease. The higher the strike price, the higher the call option price. The price of call options will rise if InFlux 's stock price rises.

The price of call options will rise if InFlux 's stock price rises.

Micro System's stock is trading at $20 a share. Three-month call options with an exercise price of $20 have a price of $1.50. Which of the following will occur if the stock price increases 10% to $22 a share? The price of the call option will increase by more than $2. The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%. The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%. The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%. The price of the call option will increase by $2.

The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.

Each of the following is true of forward contracts EXCEPT: They involve a delivery of actual goods. The presence of counterparty risk requires that both parties be morally and financially strong. They are often customized with unique amounts and dates. Historically, they don't involve a central market. They involve little risk of either party defaulting.

They involve little risk of either party defaulting.

In cash management, a lockbox plan is: Used to slow down the collection of checks a firm writes. Used to protect cash, i.e., to keep it from being stolen. Used to identify inventory safety stocks. Used primarily by firms that frequently use currency in transactions, such as fast food restaurants, and less frequently by firms that receive payments as checks. Used to speed up the collection of checks received.

Used to speed up the collection of checks received.

The value of a project if things go badly is known as the _____. VaR NPV CVaR ETL AVaR

VaR

In a Monte Carlo simulation, which of the following is an accurate comparison between VaR and ETL? VaR and ETL both indicate the size of the loss at the threshold percentile, but neither indicates the size of the loss below the threshold percentile. VaR and ETL are the same measure. VaR and ETL both indicate the size of the loss below the threshold percentile, but neither indicates the size of the loss at the threshold percentile. VaR indicates the size of the loss at the threshold percentile, whereas ETL indicates the size of the loss below the threshold percentile. VaR indicates the size of the loss below the threshold percentile, whereas ETL indicates the size of the loss at the threshold percentile.

VaR indicates the size of the loss at the threshold percentile, whereas ETL indicates the size of the loss below the threshold percentile.

Changes to credit policies are generally made on the basis of _____. Monte Carlo simulations quantitative analysis alone what competing firms are doing a mixture of quantitative analysis and subjective judgment subjective judgment alone

a mixture of quantitative analysis and subjective judgment

Risk management is an activity that _____. makes sense only for small companies a significant majority of companies engage in makes sense only for large companies is too complex for most companies to carry out in practice guarantees an increase in stock price

a significant majority of companies engage in

A company receives an order from a customer, ships the order, and sends a bill. If the customer does not pay the bill right away, then the unpaid amount is a(n) _____. piece of net working capital account receivable piece of working capital account payable cost of the supply chain

account receivable

A company places an order and receives a bill. If the company does not pay the bill right away, then the unpaid amount is a(n) _____. piece of net working capital account receivable piece of working capital account payable cost of the supply chain

accounts payable

Companies must _____ consider the impact their decisions have on the safety of their employees and customers. never sometimes rarely usually always

always

Which of the following events is likely to decrease the value of call options on the common stock of NailBit Company? an increase in the risk-free rate an increase in the amount of time until the option expires NailBit's stock price becomes more risky (higher variance) an increase in the exercise price of the option an increase in NailBit's stock price

an increase in the exercise price of the option

An investor creates a replicating portfolio. The payoffs received from the replicating portfolio exactly offset the payoffs owed on the options written on the same investments. This is an example of: arbitrage. the capital asset pricing model. binomial lattice. herding. an efficient portfolio.

arbitrage.

Which type of hedge is ideally suited for managing nonlinear risks? long hedge asymmetric hedge short hedge natural hedge symmetric hedge

asymmetric hedge

Jet Pax, Inc. plans to reduce its annual credit analysis and collection expenditures by 50 percent. The most likely consequence of this change is that _____. bad-debt losses will decrease more customers will obtain payment-related discounts bad-debt losses will increase sales will increase sales will decrease

bad-debt losses will increase

Financial traders discuss changes in _____ points. basis hedge percentage LIBOR EURIBOR

basis

During the supply chain process, companies accrue unpaid taxes _____. because they don't pay the IRS daily only if they are improperly managed if they want to artificially inflate their stock value because they don't pay their employees daily as a "poison pill" to ward against hostile takeovers

because they don't pay the IRS daily

Ignoring safety and health is _____ mistake. an ethical but not a business a business but not an ethical both a business and an ethical neither a business nor an ethical only sometimes a

both a business and an ethical

For highly seasonal companies, _____. aging schedules will yield false positives for customers who have missed payments, but days sales outstanding (DSO) will not days sales outstanding (DSO) will yield false positives for customers who have missed payments, but aging schedules will not both aging schedules and days sales outstanding (DSO) will yield false positives for customers who have missed payments the uncollected balances schedule should not be used neither aging schedules nor days sales outstanding (DSO) will yield false positives for customers who have missed payments

both aging schedules and days sales outstanding (DSO) will yield false positives for customers who have missed payments

Company X sends an email to customers when a bill is 15 days past due; it sends a more strongly worded email, followed by a telephone call, if payment is not received within 45 days; and it turns the account over to a collection agency after 135 days. This describes Company X's _____. collection policy discounts credit standards credit terms credit period

collection policy

Which type of financing is never secured? lines of credit speculative balances commercial paper revolving credit agreements promissory notes

commercial paper

The present value of taxes paid by _____ is higher than that paid by _____ companies. big companies; small successful companies; unsuccessful small companies; big companies with stable earnings; volatile companies with volatile earnings; stable

companies with volatile earnings; stable

If a bank providing services to a customer requires that customer to leave a minimum balance on deposit, then the resulting balance is known as a(n) _____ balance. transactions account payable precautionary compensating target cash

compensating

Which variable of credit policy refers to the required financial strength of acceptable credit customers? collection policy discounts credit standards credit terms credit period

credit standards

All of the following factors affect put option prices EXCEPT the: time to expiration. current market interest rate. stock's standard deviation. underlying stock price. exercise price.

current market interest rate.

Sales terms of 3/15, net 45 mean that _____. customers are required to pay within 45 days, but they are given a 3% discount if they pay by the 15th day customers are required to pay within 45 days, but they are given a 3% discount for every 15 days that they pay early customers receive a 3% discount for every 15 days that they pay early, a maximum of three (45/15) times customers are required to pay within 45 days, and they are assessed a 3% penalty for every 15 days that they are late customers are required to pay within 45 days, but they are given a 15% discount if they pay by the third day

customers are required to pay within 45 days, but they are given a 3% discount if they pay by the 15th day

If a change to credit policy is expected to produce a decrease in sales, then the incremental change in the level of the firm's investment in receivables, ∆I, is calculated as follows: ◬I = (change in days sales outstanding)(Remaining sales per day) + V (??? (incremental sales per day)) In this equation, the question marks represent the _____. variable costs as a percentage of gross sales, including bad-debt losses, financing costs associated with carrying the investment in receivables, and costs of giving discounts cost of financing the investment in receivables variable costs as a percentage of gross sales, excluding bad-debt losses, financing costs associated with carrying the investment in receivables, and costs of giving discounts days sales outstanding prior to the change in credit policy new days sales outstanding after the credit policy change

days sales outstanding prior to the change in credit policy

Major advancements in risk management practices occurred in the 1970s as a result of each of the following factors EXCEPT: decreased volatility in the stock and bond markets the acceleration of international competition the termination of the monetary gold standard significant inflation in the U.S. a reversal in bargaining power between oil companies and OPEC

decreased volatility in the stock and bond markets

Option pricing is used in four major areas of corporate finance, which include all EXCEPT: capital structure decisions. dividend policy. compensation plans. risk management. real options analysis for project evaluation and strategic decisions.

dividend policy.

Project selection risk and liquidity risk pertain primarily to which of the following categories of risk? strategy and reputation technology financial management control and compliance operations

financial management

The average maturity of commercial paper is about _____ month(s). five eighteen one twelve nine

five

A company based in the United States that manufactures clothes out of wool imported from Ireland will be subject to _____ risk. liquidity portfolio project selection foreign exchange customer credit

foreign exchange

Foreign exchange risk is managed primarily by _____. forward contracts natural hedges futures contracts insurance market-to-market contracts

forward contracts

When a change to credit policy is made, the incremental change to pre-tax profits, ∆P, is calculated as follows: ◬P = (SN − S0)(1 − V) - r(◬I) - (BnSn - BoSo) - (DnSnPn - DoSoPo) In this equation, the term (SN − S0)(1 − V) represents the change in _____. gross profit cost of discounts variable costs as a percentage of gross sales cost of carrying receivables bad-debt losses

gross profit

Risk management _____. helps companies increase their debt capacity while maintaining an optimal capital budget has no effect on companies' debt capacity helps companies reduce their debt capacity while maintaining an optimal capital budget helps companies increase their debt capacity at the expense of a suboptimal capital budget helps companies reduce their debt capacity at the expense of a suboptimal capital budget

helps companies increase their debt capacity while maintaining an optimal capital budget

A bank that puts great pressure on a business to liquidate its loans when the firm goes through a bad period is characterized by _____. high loyalty low loyalty high degree of specialization low willingness to assume risk high willingness to assume risk

high loyalty

Although credit default swaps (CDS) are called swaps, they are basically a type of _____. asymmetric hedge insurance symmetric hedge futures contract forward contract

insurance

Most secured short-term business borrowing involves the use of _____ as collateral. inventory equipment marketable securities buildings land

inventory

The key to implementing a multi-period binomial model is to: eliminate the standard deviation from the formula. gradually increase the stock return's annual standard deviation for each additional period. multiply the stock return's annual standard deviation by the number of periods. keep the stock return's annual standard deviation the same no matter how many periods you have during a year. gradually reduce the stock return's annual standard deviation for each additional period.

keep the stock return's annual standard deviation the same no matter how many periods you have during a year.

The value of a call option depends on all of the following factors EXCEPT the: risk-free rate of interest. length of time until option expiration. bond price. variability of the stock price. exercise price.

length of time until option expiration.

Compared to unsecured short-term financing, secured short-term financing has each of the following properties EXCEPT: less risk for the lender lower interest rates less risk for the borrower more onerous monitoring activities more onerous bookkeeping

less risk for the borrower

A company that loses money when commodity prices are low and makes money when commodity prices are high faces _____ risk. linear impure nonlinear operational pure

linear

Factoring is a process whereby a company _____. mitigates its debt and credit risks by purchasing a third party's accounts receivable mitigates its credit risk by selling its accounts receivable to a third party mitigates is debt risk by selling its accounts payable to a third party mitigates its debt risk by selling its accounts receivable to a third party mitigates its credit risk by selling its accounts payable to a third party

mitigates its credit risk by selling its accounts receivable to a third party

A customer with a FICO score of 400 is _____ than a customer with a FICO score of 600. has fewer assets less likely to default has more assets not significantly different more likely to default

more likely to default

An investor who "writes" a call option without the stock in his or her portfolio to back it up is selling a(n): naked option. out-of-the-money option. covered option. put option. call option.

naked option.

If a firm's sales exhibit cyclical or seasonal patterns, the days sales outstanding (DSO) should _____. use whichever data—quarterly, semiannual, or annual—yield the simplest calculations use annual data in its averaging procedure not be used use quarterly data in its averaging procedure use semiannual data in its averaging procedure

not be used

In situations involving safety and health, the trade-off between expected profits and expected losses is _____ for making sound decisions. usually sufficient irrelevant always sufficient not sufficient counterproductive

not sufficient

Which of the following is a call option whose underlying stock value is less than the corresponding exercise price? naked option out-of-the-money option covered option put option straddle option

out-of-the-money option

Risk management was first used _____. over 4,000 years ago in India, in the form of commodity futures contracts by the U.S. government to insure against bank failures after the Great Depression by Genoese maritime insurance companies in the 1300s when Benjamin Franklin invented the concept of fire insurance in 1752 by grain traders selling futures contracts in the 1800s

over 4,000 years ago in India, in the form of commodity futures contracts

Insurance products are most effective at dealing with _____ risks. linear impure nonlinear speculative pure

pure

What is an option that gives the holder the right to sell a stock at a specified price at some time in the future? naked option out-of-the-money option covered option put option call option

put option

A decision regarding a choice between investments in two tangible assets would fall under which area of corporate finance? capital structure decisions dividend policy compensation plans risk management real options analysis for project evaluation and strategic decisions

real options analysis for project evaluation and strategic decisions

In an optimal situation, an interest rate swap will _____. offset a higher cost of debt by reducing the risk offset a higher risk by reducing the cost of debt create a symmetric hedge create an asymmetric hedge reduce both the risk and the effective cost of debt

reduce both the risk and the effective cost of debt

A company that works with hazardous chemicals builds its plants near a biohazard containment facility. According to the COSO framework for ERM, this constitutes what type of risk response? totally avoiding the activity that gives rise to the risk accepting the risk reducing the magnitude of the loss associated with an adverse event transferring the function that produces the risk to a third party reducing the probability of an occurrence of an adverse event

reducing the magnitude of the loss associated with an adverse event

Company X decides to ease its credit policy. As a result, Company X's managers should expect the company's _____. sales and costs to both increase sales to increase while costs go down costs and sales to remain unchanged costs and sales to both go down costs to increase while sales go down

sales and costs to both increase

Which type of hedge would protect a participant from falling prices? long hedge marginal hedge short hedge natural hedge speculative hedge

short hedge

According to the COSO framework for ERM, _____ objectives are based on the company's mission and overall goals. operating strategic reporting financial compliance

strategic

The _____ balance is the amount of cash companies hold in support of ongoing operations. transactions account payable precautionary compensating target cash

target cash

Company X, a company with highly seasonal sales, has an uncollected balances schedule in which the uncollected balances percentage rises from 165% to 205% from Q2 to Q3. This means _____. nothing, because uncollected balances schedules require that a trend persist for at least two quarters before reliable conclusions can be drawn nothing, because uncollected balances schedules yield inaccurate results when studying aggregate customer data for companies with seasonal fluctuations that Company X's customer payment patterns may have changed, but this result must be confirmed by an aging schedule or days sales outstanding (DSO) that Company X's customers are now paying more slowly that Company X's customers are now paying more quickly

that Company X's customers are now paying more slowly

Which of the following was passed to address the corporate fraud scandals involving Arthur Andersen, Tyco, and Enron? the Foreign Corrupt Practices Act Basel III the Sarbanes-Oxley Act the Committee of Sponsoring Organizations Basel I

the Sarbanes-Oxley Act

The binomial option pricing formula in Equation 5-3 does not include the actual probabilities that a stock will go up or down because: the current stock price already incorporates its expected return as a discount rate. it is assumed the stock price will remain constant. only one period is considered. it is assumed the stock will go down. it is assumed the stock will go up.

the current stock price already incorporates its expected return as a discount rate.

The framework for enterprise risk management designed by the Committee of Sponsoring Organizations (COSO) has three dimensions, which are, in order, _____. the risk management process, the category of objectives, and the organizational level the risk management process, the organizational level, and the category of objectives the category of objectives, the organizational level, and the risk management process the organizational level, the risk management process, and the category of objectives the organizational level, the category of objectives, and the risk management process

the organizational level, the category of objectives, and the risk management process

Which of the following is a reason companies hold short-term investments? for liquidation during scheduled transactions to trade debt for equity for liquidation just after scheduled transactions to reduce risk to capitalize on carefully planned opportunities

to reduce risk

Cash balances associated with routine payments and collections are known as _____ balances. transactions account payable precautionary compensating target cash

transactions

If a change to credit policy is expected to produce an increase in sales, then the incremental change in the level of the firm's investment in receivables, ∆I, is calculated as follows: ◬I = (change in days sales outstanding)(Remaining sales per day) + V (DSOn (incremental sales per day)) In this equation, V represents the _____. variable costs as a percentage of gross sales, including bad-debt losses, financing costs associated with carrying the investment in receivables, and costs of giving discounts cost of financing the investment in receivables variable costs as a percentage of gross sales, excluding bad-debt losses, financing costs associated with carrying the investment in receivables, and costs of giving discounts average bad-debt loss at the current sales level as a percentage of current gross sales average bad-debt loss at the new sales level as a percentage of new gross sales

variable costs as a percentage of gross sales, excluding bad-debt losses, financing costs associated with carrying the investment in receivables, and costs of giving discounts

The use of commercial paper is restricted to a comparatively small number of _____ companies that are _____ credit risks. very small; exceptionally good very large; exceptionally good moderately sized; unknown very small; exceptionally bad very large; exceptionally bad

very large; exceptionally good

Trading and risk management groups at financial institutions generally measure CVaR over _____ time horizons. random oscillating very short moderately sized very long

very short

The degree to which a bank's practices are termed "creative" is a reflection of the bank's _____. size specialization ability to provide advice and counsel willingness to assume risk loyalty to customers

willingness to assume risk