FIN 401 Test 3

Two components of the operating cycle are:

I. the receivables period II. the inventory period III. the payables period Iv. the cash flow period I and II

Two of the most important reasons firms have temporary cash surpluses are:

I. timing the market for investments II. financing of planned expenditures III. maintenance of safety stocks IV. seasonal firm activities II and IV

The different types of exchange rate risk include which of the following?

Long-term exposure Translation exposure Short-term exposure

A foreign subsidiary can remit funds to the parent company in which of the following ways?

Management fees Royalties Dividends

If granting credit results in an increase of sales of 20 items per month while the gross profit per unit remains constant at $30, then the present value of this perpetual change at a required return of 0.5% per month forever is:

PV = (20 × $30)/0.005 =$120,000

Which of the five basic factors in evaluating credit policy is impacted by possible price and quantity effects?

Revenue effects

In general, what condition will lead to a lower risk-adjusted discount rate for a firm investing internationally?

The cost of investing abroad are lower for a firm than for its shareholders.

If immediate payment is not required on a draft, then it is a ______ draft.

Time

The market for short-term financial assets is called the:

a. derivatives market b. open market c. money market d. capital market C

Funds from a foreign subsidiary that cannot currently be remitted are sometimes said to be ___.

blocked

The use of local financing from the government of the foreign country where the operation is located ___.

can reduce political risk

Total credit cost is minimized when:

carrying costs equal opportunity costs

The sum of the carrying costs and the opportunity costs of a particular credit policy is called the

credit cost curve

The implicit exchange rate between two currencies when both are quoted in a third currency is called the ____.

cross-rate

Interest rate parity ___.

eliminates covered interest arbitrage opportunities

The purpose of the EOQ inventory management model is to:

establish a minimum total cost point of carrying and shortage costs establish an optimal inventory level

In covered interest arbitrage, investors protect themselves against changes in exchange rates by locking in the ____.

forward exchange rate

A firm that makes an investment internationally could:

lead to lower risk adjusted discount rates lower the risk premium on international projects provide indirect diversification

Immediate payment is required on a _____ draft

sight

The unbiased forward rate condition may not hold if ___.

traders in the forward market are willing to pay a premium to avoid uncertainty

The condition stating that the expected percentage change in the exchange rate is equal to the difference in interest rates between the countries is called ___.

uncovered interest parity

Which of the following are true about commercial paper?

I. It has no especially active secondary market. II. Firms that issue commercial paper do not repurchase it. III. Its marketability can be low. IV. Its default risk depends on the interest rate. I and III

Which of the following are correct when describing purchasing power parity?

I. Purchasing power parity is a major factor in the rate of change in exchange rates. II. Exchange rates adjust to keep purchasing power level between currencies. III. Parity is expressed as both absolute and relative. IV. A unit of currency in any country will buy the same quantity of goods. I, II, III

Assume the current spot rate is Can$1.2803 and the one-year forward rate is Can$1.2745. Also assume the nominal risk-free rate in Canada is 4.8 percent while it is 4.2 percent in the U.S. Using covered interest arbitrage, you can earn a profit of ___ for every $1 invested over the next year.

a. $.0163 b. $.0108 c. −$.0040 d. −$.0088 e. −$.0840 B Arbitrage profit = [($1)(C$1.2803/$1)(1.048)($1/C$1.2745)] − $1(1.042) Arbitrage profit = $.0108

Credit terms of 1/5, net 15 should be interpreted as granting:

a. a 1/5 percent discount for payments within 15 days. b. a five percent discount for next day payments. c. a total credit period of 20 days. d. a credit period of 10 days. e. a one percent discount for payments received within five days. E

Collection float increases:

a. disbursement float. b. the bank balance. c. the book balance. d. the collected balance. e. both book and bank balances. C

The length of the credit period offered by a firm is influenced by all of the following except the:

a. level of consumer demand. b. buyer's operating cycle. c. standardization of the goods being sold. d. FTC guidelines for trade credit. e. customer type. D

The credit period begins on the:

a. shipping date. b. purchase order date. c. shipping arrival date. d. order process date. e. invoice date. E

The international Fisher effect says that _____ rates are equal across countries.

a. spot b. one-year future c. nominal d. inflation e. real E

If you have a $400 float for 6 days, the total float is:

$2400 $400 X 6 days = $2400

Cash balances are often held at commercial banks in order to:

a. compensate for banking services b. earn the highest rate of return c. reduce dependency on foreign exchange rates A

Short-term marketable securities generally have:

a. high maturity risk. b. little, if any, marketability. c. significant default risk. d. a high level of liquidity. e. maturities between one and two years. D

Dollar _______ occurs when the value of a dollar rises and it takes more foreign currency to buy a dollar.

appreciation

The credit period generally increases:

as the size of an account increases

Financial managers often only have input into inventory decisions because

inventory management has become a specialization in its own right.

Firms use lockboxes to accelerate collections. Where are the lockboxes set up?

a. Corporate centers b. Post offices c. Banks d. Airports B

Absolute purchasing power parity tells us that ___.

$1 will buy you the same number of tangerines anywhere in the world

Suppose the euro currently costs $1.37 and the nominal risk-free interest rate in the European Union is 3 percent compared to 2 percent in the U.S. Interest rate parity implies the euro 1-year forward rate will be approximately ___.

$1.37 × [1 + (0.03 - 0.02)] = $1.3837

Bearer deposit notes are quoted for amounts in excess of $_________.

$100,000

The condition stating that the interest rate differential between two countries is approximately equal to the percentage forward premium or discount is called:

a. the unbiased forward rates condition. b. uncovered interest rate parity. c. the international Fisher effect. d. purchasing power parity. e. interest rate parity. E

The average collection period measures the average:

a. time necessary to collect a credit sale. b. number of customers per day who charge their purchases. c. time for a credit customer to return to make a second purchase. d. number of times a credit customer charges a purchase during a year. e. number of items purchased in each credit transaction. A

Currently $1 buys ¥89 on the spot market. The 6-month forward rate is ¥90. According to the unbiased forward rate condition, the expected spot rate for the yen in 6 months is ___.

¥90 According to the unbiased forward rate condition, the expected spot rate for the yen in 6 months is the current 6-month forward rate.

The sum of inventory carrying costs ranges from roughly ______ of inventory value per year.

20-40%

A project in Mexico is expected to return a payment of Ps40,000 three years from now. The risk-free rate is 2 percent in the U.S. and 4 percent in Mexico. Assume the current spot rate is $1 = Ps10. What will that payment be worth in U.S. dollars when it is received?

E(S3) = Ps10 × [1 + (.04 - .02)]3 = Ps10.61208; Ps40,000/Ps10.61208 = $3,769.29

Which of the following are the most popular business credit reporting agencies?

Experian Dun & Bradstreet

On September 1, a firm grants credit with terms of 2/10 net 30. The creditor:

a. must pay a penalty of 2/10 of one percent when payment is made later than October 1. b. must pay a penalty of 10 percent when payment is made later than 2 days after October 1. c. receives a discount of 2 percent when payment is made at least 10 days prior to October 1. d. receives a discount of 2 percent when payment is made on September 1 and pays a penalty of 10 percent if payment is made after October 1. e. receives a discount of 2 percent when payment is made within 10 days. E

All the following are political risks associated with international investing except:

a. nationalization. b. decreasing consumer demand. c. blocking of funds. d. tax law changes. e. contract abrogation. B

The foreign exchange market is where:

a. one country's stocks are exchanged for another's. b. one country's bonds are exchanged for another's. c. one country's currency is traded for another's. d. international banks make loans to one another. e. international businesses finalize import/export relationships with one another. C

The _________ exchange rate quote for the Swiss franc shows that you could buy 0.97 Swiss francs for $1, written SF 0.97/$1.

Indirect The direct exchange rate quote for the Swiss franc would be written as $1.03/SF 1.

If the variable cost is $20 per unit, the price is $40, the probability of default is 30%, and the discount rate on receivables is 3%, then the NPV of granting credit to a one-time customer is:

NPV = -$20 + (1 - 0.3) × $40/(1.03) = $7.18

The number of U.S. dollars required to buy one unit of foreign currency is referred to as ___.

a direct quote

Which method employs uncovered interest parity to project future exchange rates?

The home currency approach

Probably the most sensible cash management policy would be to maintain:

a. sufficient cash on hand to meet all ordinary business needs plus some excess cash to invest in marketable securities as a precautionary measure. b. about 90 percent of the firm's ordinary cash needs in cash and delay payment on the remaining 10 percent. c. enough cash on hand to meet any potential demand for cash. d. a zero-cash balance and transfer funds semi-monthly to pay bills. e. twice the amount of cash on hand that would be typically indicated based on the firm's normal cash flows. A

An agreement to trade currencies based on the exchange rate set today for settlement within two business days is called a(n) _____ trade.

a. swap b. option c. futures d. forward e. spot E

Checks written by a firm generate ______ float.

a. unusual b. collection c. disbursement d. clearance C

If an international firm borrows money in the foreign country where it has operations it can reduce ___.

long-run exchange rate exposure

When a U.S. company calculates its accounting net income, it must report all income, including income from foreign operations, in dollars. This leads to ___ exposure to exchange rate risk.

translation

True or false: It is not a good strategy to carry temporary cash surpluses because cash does not generate any return

False In some instances (such as seasonal activities) it is helpful to have temporary cash surpluses.

True or false: Electronic data interchange is a general term that refers to the network of connections that runs between banks.

False Electronic data interchange refers to the growing practice of direct, electronic information exchange between all types of businesses.

Some examples of real world captive finance companies are:

Ford Motor Credit GMAC (now known as Ally Financial)

Which of the following are true with regard to the sale of US Treasury bills?

I. They are not sold to general public II. They are sold weekly III. They are sold only to foreign governments Iv. They are sold by auction II and IV

Important characteristics of available short-term marketable securities include:

I. default risk II. maturity III. large returns IV. high risk profiles I and II

The management fee for money market mutual funds is compensation for:

I. diversification II. operating expenses III. professional expertise Iv. required rate of return I and III

Which of the following factors are used in evaluating credit policy?

I. the cost of equity II. quantity discounts III. cost effects Iv. revenue effects V. the cost of debt III, IV, V

The size of the float depends on:

I. the dollar amount involved II. the interest rate III. the time delay involved IV. the discount rate I and III

The home currency approach appears to be inferior to the foreign currency approach to capital budgeting. In truth:

The two approaches are the same

When compared to the home currency approach, which of the following are true for the foreign currency approach to capital budgeting?

computes NPV in both foreign and domestic currencies. is computationally easier. requires forecasting the foreign discount rate.

True or false: The only way to satisfy the speculative motive is to hold cash.

False The speculative motive can also be satisfied with reserve borrowing ability or by holding marketable securities.

If the variable cost is $30 per unit, the price is $50, the probability of default is 16%, and the discount rate on receivables is 5%, then the NPV of granting credit to a one-time customer is:

NPV = -$30 + (1 - 0.16) × $50/(1.05) = $10

A project costs Can$700,000 and has expected annual cash inflows of Can$300,000 for Years 1 through 3. The Canadian discount rate is 10 percent. The current spot rate is: $1 = Can$1.07. What is the NPV of this project in U.S. dollars using the foreign currency approach?

NPVUSD = (-Can$700,000 + Can$300,000 × PVIFA10%,3)/Can$1.07 = $43,043

Lemoyne mailed an invoice today in the amount of $1,268 with terms of 2/7 net 30. What is the cost of credit to the customer if they pay on the last day of the credit period? Assume a 365-day year.

a. 41.02 percent b. 39.62 percent c. 37.80 percent d. 37.56 percent e. 39.40 percent C Rate for 23 days = .02($1,268)/[(1 − .02)($1,268)] Rate for 23 days = .020408 EAR = 1.020408^(365/23) − 1 EAR = .3780, or 37.80%

Angie has been offered Can$1.75 for £1. How much profit can she earn on a triangle arbitrage if the official rate is $1 = Can$1.2834 and the USD equivalent of £1 is $1.3699? Assume she currently has $100 in cash.

a. $.46 b. $.73 c. $1.09 d. $1.37 e. $.57 A Profit = [$100(Can$1.2834/$1)(£1/Can$1.75)($1.3699/£1)] − $100Profit = $.46

Assume today you can exchange $100 for either Can$128 or Ps1,892. Also assume that last year, $100 was worth Can$126 or Ps1,847. Which one of the following statements is correct given this information?

a. $100 invested in Canadian dollars last year would now be worth Ps1,824.09. b. $100 invested in Mexican pesos last year would now be worth $98.47. c. $100 invested in Mexican pesos last year would now be worth $101.63. d. $100 invested in Canadian dollars last year would now be worth $99.52. e. $100 invested in Canadian dollars last year would now be worth Ps1,862.44. E Current value in Ps of $100 exchanged to Can$ last year = $100(Can$126/$100)($100/Can$128)(Ps1,892/$100)Current value in Ps of $100 exchanged to Can$ last year = Ps1,862.44 Current value in dollars of $100 exchanged to Ps last year = $100(Ps1,847/$100)($100/Ps1,892)Current value in dollars of $100 exchanged to Ps last year = $97.62 Current value in dollars of $100 exchanged to Can$ last year = $100(Can$126/$100)($100/Can$128)Current value in dollars of $100 exchanged to Can$ last year = $98.44

You are expecting a payment of Can$138,000 two years from now. Assume the risk-free rate of return is 2.7 percent in Canada and 3.1 percent in the U.S. Also assume the current exchange rate is Can$1.2903 = $1. Approximately how much will the payment two years from now be worth in U.S. dollars?

a. $108,319 b. $106,101 c. $107,813 d. $107,381 e. $108,169 C E(S2) = Can$1.2903[1 + (.027 − .031)]^2 E(S2) = Can$1.2800 Payment value = Can$138,000($1/Can$1.2800) Payment value = $107,813

KN Florals receives the same checks each month. Of these monthly checks, 48 are for $82.60 each, 15 are for $71.50 each, and 9 are for $40.70 each. The delay for the $82.60 checks is 1.8 days, for the $71.50 checks 1.1 days, and for the $40.70 checks 1.3 days. Calculate the average daily float. Assume a 30-day month.

a. $293.09 b. $287.46 c. $309.10 d. $299.47 e. $358.02 A Total float = 48($82.60)(1.8) + 15($71.50)(1.1) + 9($40.70)(1.3) Total float = $8,792.58 Average daily float = $8,792.58/30 Average daily float = $293.09

Top Notch Tools has average daily receipts of $3,600. These receipts are available after 1.5 days on average. What is the NPV of eliminating the float if the cost to do so is $1,500?

a. $3,260 b. $3,900 c. $2,100 d. $5,400 e. $3,150 B NPV = 1.5($3,600) − 1,500 NPV = $3,900

During the month Leslie's receives four checks in the amounts of $100, $325, $200, and $500. They are delayed for 1.6 days, 2.1 days, 2.6, and 1 day, respectively. What is the average daily collection float? Assume a 30-day month.

a. $74.93 b. $63.80 c. $62.08 d. $59.47 e. $68.15 C Total float = 1.6($100) + 2.1($325) + 2.6($200) + 1($500) Total float = $1,862.50 Average daily float = $1,862.50/30 Average daily float = $62.08

Sisler's sells 382,000 units a year and orders 10,000 units at a time. The cost of placing an order is $24.90. What is the firm's annual total restocking cost?

a. $909.09 b. $984.23 c. $951.18 d. $1,023.02 e. $811.19 C Total restocking cost = Fixed cost per order (Number of orders) Total restocking cost = $24.90(382,000/10,000) Total restocking cost = $951.18

Sports 'n More receives five checks per month. These checks average $811, $416, $6,420, $22,900, and $8,700. The three larger sized check amounts are available after 1.5 days while the two smaller check amounts are available after one day. What is the weighted average delay?

a. 1.48 days b. 1.39 days c. 1.46 days d. 1.37 days e. 1.00 day A Total receipts = $811 + 416 + 6,420 + 22,900 + 8,700 Total receipts = $39,247 Weighted average delay = [($6,420 + 22,900 + 8,700)/$39,247](1.5) + [($811 + 416)/$39,247](1) Weighted average delay = 1.48 days

If 34 percent of customers pay on Day 10 and the remainder pay in an average of 28 days, what is the average collection period?

a. 19.72 days b. 20.08 days c. 21.88 days d. 18.47 days e. 22.09 days C ACP = .34(10) + .66(28) ACP = 21.88 days

Alexander Moore & Co. is willing to offer credit on a one-time purchase provided the NPV of the transaction is at least $50 at a required monthly return of 2 percent. Assume a potential sale has a sales price of $248 and a variable cost of $164. What is the maximum probability of default that will result in an acceptable offer?

a. 32.55 percent b. 29.62 percent c. 11.98 percent d. 10.02 percent e. 18.50 percent C NPV = −v + (1 − π)P/(1 + R) $50 = −$164 + (1 − π)$248/1.02 π = .1198, or 11.98%

Which one of the following statements is false as it relates to considerations firms use when establishing a credit policy?

a. A firm that supplies a perishable product will tend to offer restrictive credit terms. b. A firm whose customers are in a high-risk business will tend to offer restrictive credit terms. c. Lengthening the credit period effectively reduces the price paid by the customer. d. Small accounts, associated with firms that find it difficult to acquire a line of credit, tend to receive longer credit periods. e. Larger accounts tend to receive more favorable credit terms. D

The camera you want to buy costs $399 in the U.S. If absolute purchasing power parity exists, the identical camera will cost _____ in Australia if the exchange rate is A$1 = $.7752.

a. A$309.30 b. A$393.23 c. A$435.09 d. A$514.71 e. A$506.67 D Cost in Australia = $399(A$1/$.7752) Cost in Australia = A$514.71

A security issued in the United States that represents shares of a foreign stock and allows that stock to be traded in the United States is called a(n):

a. American Depository Receipt b. Yankee bond. c. Yankee stock. d. Eurostock. e. foreign obligation trust certificate. A

Which one of the following related to float management is true?

a. Float management is the practice of speeding up the disbursement of cash. b. An objective of float management is the elimination of disbursement float. c. An objective of float management is to reduce float by reducing sales. d. Firms prefer net disbursement float over net collection float. e. Float management is no longer needed. D

Which one of these statements is true regarding promissory notes?

a. Most trade credit arrangements use promissory notes. b. Promissory notes are used when firms do not anticipate a problem with collections. c. Promissory notes usually involve no cash discount. d. A promissory note must be signed and delivered prior to goods being shipped. e. Promissory notes are used for small orders only. C

Which one of these money market securities generally has the shortest life?

a. Repurchase agreements b. Jumbo certificates of deposit c. Money market preferred stock d. Commercial paper e. U.S. Treasury bills A

According to Keynes, which of the following is not a motive for holding cash?

a. The speculative motive b. The acquisitive motive c. The precautionary motive d. The transaction motive B

Suppose the spot exchange rate is $1 = £.7304 and the 1-month forward rate is $1 = £.7303. Given this, you know the:

a. U.S. inflation rate is higher than the U.K.'s. b. U.S. nominal interest rate is higher than the U.K.'s. c. pound is selling at a discount. d. U.S. real risk-free interest rate is higher than the U.K.'s. e. pound is selling at a premium. E

Money deposited in a financial center outside the country whose currency is involved is called:

a. a foreign depository receipt. b. an international exchange certificate. c. an American Depository Receipt. d. Eurocurrency. e. Eurodollars. D

When credit is granted by one firm to another firm this gives rise to a(n):

a. accounts receivable and is called consumer credit. b. credit due and is called an installment note. c. accounts receivable and is called trade credit. d. trade receivable and is called an installment note. e. trade receivable and is called a secured loan. c

By getting closer to the source of payment, lockboxes can be used to reduce:

a. availability float. b. mailing float. c. in-house processing float. d. disbursement float. e. clearing float. B

A foreign subsidiary can remit funds to the parent firm in the all the following ways except by means of:

a. dividends. b. management fees for central services. c. royalties on the use of trade names. d. royalties on the use of patents. e. nationalization. E

Money market preferred stock offers competitive rates of return similar to traditional money-market instruments but:

a. forfeits the tax benefits normally provided to corporate shareholders. b. still provides the corporate investor with the tax exclusion on dividend income. c. has a fixed rate of dividend income. d. is only an overnight investment. e. has highly volatile stock prices due to the fixed coupon. B

Financial Accounting Standards Board Statement No. 52 requires that most assets and liabilities be translated at the current exchange rate. Translation gains and losses are recorded:

a. in the shareholder's equity section of the balance sheet. b. as a normal income item on the income statement. c. as an extraordinary item on the income statement. d. as a footnote to the financial statements. e. only on income tax returns. A

Assume you graph the costs of granting credit against the amount of credit extended. The optimal credit amount is then determined by the point which:

a. minimizes the total cost curve. b. maximizes the carrying costs associated with granting credit. c. maximizes the opportunity costs associated with granting credit. d. minimizes the carrying costs of granting credit. e. minimizes the opportunity costs of granting credit. A

All the following can create disbursement float except the:

a. payment of wages. b. payment for raw materials. c. disbursement of funds to a supplier. d. distribution of cash dividends. e. sale of an asset. E

Money market securities are best defined as securities:

a. purchased through a bank. b. that are risk-free. c. with maturities of one year or less. d. that are purchased with cash and held until maturity. e. that are held for one week or less. C

The appropriate upper limit to the credit period is the length of the buyer's ______.

a. purchasing cycle b. operating cycle c. business cycle d. inventory cycle B

One primary reason concentration bank accounts are established is to

a. reduce default risk. b. increase disbursement float. c. control disbursements for a specific purpose. d. pool funds. e. replace traditional lockboxes. D

All of these are carrying costs of inventory except:

a. storage costs. b. insurance. c. restocking costs. d. theft. e. the opportunity cost of capital. C

The minimum level of inventory that a firm wants to keep on hand at all times is referred to as:

a. the base level. b. safety stock. c. the opportunity cost. d. the reorder point. e. keiretsu. B