Finance 450

Blake purchases a $100 annual perpetuity for which payments begin in one year. Bob purchases a $100 annual perpetuity for which payments begin immediately. If a 10% rate is appropriate for both cash flow streams, which of the following statements is true? A. Bob's perpetuity is worth $100 more than Blake's B. Blake's perpetuity is worth $100 more than Bob's C. The perpetuities are of equal value today. D. Bob's perpetuity is worth $90.91 more than Blake's E. Blake's perpetuity is worth $90.91 more than Bob's

A. Bob's perpetuity is worth $100 more than Blake's

Which one of these is not true about the Dow Jones Industrial Average? A. it includes Nasdaq, Amex and NYSE stocks B. it is comprised of 30 blue chip stocks C. it changes less frequently than the S&P 500 D. it is the most commonly used measure of market performance by retail investors E. includes less tech stocks than the S&P 500

A. it includes Nasdaq, Amex and NYSE stocks

Which of these is a working capital decision? A. making sure you have enough inventory for the next six months B. issuing new stock C. deciding whether or not to introduce a new product D. deciding whether or not to build a new manufacturing plant E. deciding whether or not to borrow money long term

A. making sure you have enough inventory for the next six months

Assuming positive rates of return, if you have a choice between $500 a quarter for a year or $2000 one year from now you should choose A. the quarterly payments because they have a higher future value B. the lump sum because it has a higher present value C. you would be indifferent between the two D. the quarterly payments because they have a lower present value E. the answer would depend on if the payments are at the beginning or end of the quarter

A. the quarterly payments because they have a higher future value

Capital Budgeting Evaluation Techniques: AVERAGE ACCOUNTING RETURN

AVERAGE ACCOUNTING PROFIT / AVERAGE ACCOUNTING VALUE Rate of Return is comparable to cost strength: -> considers ALL cash flows weaknesses: -> does not use Time Value Money -> accounting profits (net income) not necessarily the same as the cash coming in - does not capture economic profit

All else held the same, an increase in time to maturity will cause an increase in the value of a bond

Always, if the coupon rate is lower than the YTM

Rank these from highest to lowest in terms of management fees: A. Hedge funds, managed mutual funds, ETFs, index funds B. Hedge funds, managed mutual funds, index funds, ETFs C. Hedge funds, ETFs, managed mutual funds, index funds D. ETFs, hedge funds, managed mutual funds, index funds E. Hedge funds, index funds, managed mutual funds, ETFs

B. Hedge funds, managed mutual funds, index funds, ETFs

Which of these is in the correct order in terms of historical risk from highest to lowest? (Morningstar numbers) A. large company stocks, small company stocks, long term corp bonds, long term gov't bonds, T-bills B. small company stocks, long term corp bonds, long term gov't bonds, large company stocks, T-bills C. small company stocks, large company stocks, long term gov't bonds, long term corp bonds, T-bills D. large company stocks, long term gov't bonds, small company stocks, long term corp bonds, T-bills E. small company stocks, large company stocks, long term corp bonds, long term gov't bonds, T-bills

C. small company stocks, large company stocks, long term gov't bonds, long term corp bonds, T-bills

A company regularly paying its bills on time is an example of A. capital budgeting B. capital financing C. working capital management D. risk management E. an agency problem

C. working capital management

You have an opportunity to invest in several annuities. Which of the following 10-year annuities has the lowest present value? Assume all the annuities have the same interest rate. A. An annuity that pays $400 at the beginning of every 6 months B. An annuity that pays $400 at the end of every 6 months C. An annuity that pays $800 at the beginning of each year D. An annuity that pays $800 at the end of each year

D. An annuity that pays $800 at the end of each year

The primary goal of a publicly-owned firm interested in serving its stockholders should be to A. minimize the debt used by the firm B. maximize expected earnings per share C. minimize the chances of losses D. maximize the stock price per share E. maximize expected net income

D. maximize the stock price per share

The primary goal of a publicly-owned firm interested in serving its stockholders should be to A. maximize the company's profit this year B. maximize expected earnings per share C. minimize the chances of losses D. maximize the stock price per share E. maximize expected net income

D. maximize the stock price per share E. maximize expected net income

Which one of these is NOT true? A. the S&P 500 is exactly 500 stocks B. the Dow Jones Industrial Average is exactly 30 stocks C. the Russell 2000 is exactly 2000 stocks D. the Wilshire 5000 is exactly 5000 stocks E. actually all of the above are true

D. the Wilshire 5000 is exactly 5000 stocks

The bond rating of Delta Airlines changed to "junk" this morning (3/25/20). That means

Delta's bond rating is definitely less than BBB and it will be more expensive for them to borrow

Which of these best represents the "buy side" of the investment world? A. investment banks B. corporations C. commercial banks D. US government E. mutual funds

E. mutual funds

401K plans are potentially tax free.

FALSE

A broker market eliminates the need for time-consuming search for a fair deal by buying and selling immediately from their inventory of securities.

FALSE

A decrease in accounts payable would cause cash flows from operations to increase.

FALSE

A primary market is any financial market in which owners of outstanding securities can resell them to other investors

FALSE

All else held constant, an annuity due payment would need to be more than an ordinary annuity to pay off a given present value debt

FALSE

All else held constant, an annuity due payment would need to be more than an ordinary annuity to pay off a given present value debt.

FALSE

All else held the same, there's a direct relationship between bond rating and expected return

FALSE

All else held the same, there's a direct relationship between bond rating and risk.

FALSE

All else the same, an increase in discount rates would cause the present value of an annuity to increase

FALSE

All else the same, as required return increases, stock value increases.

FALSE

All else the same, present values increase as discounting frequency increases

FALSE

All else the same, the market value of a corporate bond is always directly related to its yield to maturity.

FALSE

All else the same, the present values of an annuity decreases as the number of payments increases.

FALSE

An 8K is a time-driven report rather than event-driven report.

FALSE

Anyone with earned income can contribute to a Roth IRA.

FALSE

Companies raise capital in secondary markets by issuing new securities

FALSE

Complete diversification means that the portfolio is no longer subject to market risk

FALSE

Complete diversification means that the portfolio is no longer subject to market risk.

FALSE

ETFs generally have higher management fees than index funds

FALSE

From the panel discussion or video, Aon and Lockton are publicly traded companies.

FALSE

If you have net stocks losses of $7000 this year and use the maximum deduction this year, the amount you would be able to carry over to all future years is $5000

FALSE

Index funds are created to perform higher than the S&P 500

FALSE

Load funds generally have higher returns than no-load funds

FALSE

Low short term inflation is a reason yield curves would invert

FALSE

NYSE is the best-known example of a direct market.

FALSE

Operating leverage refers to the use of debt

FALSE

Preferred stock dividends never increase.

FALSE

Returns on individual stocks tend to be safer than returns on stock indexes over time

FALSE

The Efficient Market Hypothesis refers to the economic efficiency of markets

FALSE

The dependent variable of the Capital Market Line is the expected return of either an individual asset or a portfolio of assets

FALSE

The difference between an ordinary annuity and an annuity due is one payment

FALSE

The independent variable for the Capital Market Line is systematic risk.

FALSE

You buy shares of a closed end fund from the investment company rather than from other investors

FALSE

From our discussion/notes/you working problems, which of these is true? I. the difference between a perpetuity and a perpetuity due is one payment II. the difference between an annuity and an annuity due is one period of interest

I and II --> both true

From our discussion/book, an increase in which of these would cause cash flow from operations to increase? I. net income II. accounts payable III. accounts receivables

I and II only

From our discussion/notes/book concerning business forms, which of these is an advantage of a sole proprietorship? I. no agency costs II. single taxation III. limited liability

I and II only

From our discussion/notes/you working problems, which of these is an inverse relationship (one goes up, the other goes down)? I. interest rates and bond prices II. bond prices and yields III. interest rates and yields

I and II only

The CAPM shows that the expected return for a stock depends on I. the risk-free rate of return II. market risk III. company-specific risk

I and II only

Which of the following are false about the taxability of investments? I. Traditional IRAs are potentially tax free II. Anyone with earned income can contribute to a Roth IRA III. 401K plans can lower your taxable obligation this year

I and II only

From our discussion/notes, which of these is required to be filed by the SEC based on time rather than an event occurring? I. 10K II. 8K III. 10Q

I and III only

From our discussion/notes/you working practice problems, which of these is a direct relationship (one goes up, the other goes up)? I. compounding frequency within a year and EAR II. discount rate and PV of a perpetuity III. number of payments and PV of annuity

I and III only

From our discussion/notes/you working problems, which of these is an inverse relationship (one goes up, the other goes down)? I. discounting frequency within a year and present values II. number of payments and FV of annuity III. discount rate and PV of a perpetuity

I and III only

Which of these are true about the Security Market Line and Capital Market Line models? I. the intercepts are the same II. the independent variable for the Capital Market Line is beta III. the Capital Market Line applies to portfolios only

I and III only

Which of these is true? I. Most managed mutual funds do not outperform the index against which they are being evaluated. II. If you have net stocks losses of $7000 this year and use the maximum deduction this year, the amount you would be able to carry over to all future years is $3000. III. Blend funds blend value and growth.

I and III only

From our discussion/notes/book concerning corporate finance decisions, which of these is a capital budgeting decision? I. building a new plant II. issuing stock III. making sure you have enough inventory to meet this month's production IV. developing a new product

I and IV only

From our discussion of the investment world, which of these is a buy side participant? I. mutual funds II. brokerage firms III. investment banks

I only

From our discussion/notes, which of these is true? I. preferred stock dividends can change II. bond coupons never change III. increases in required rates cause stock values to increase

I only

From our discussion/notes/you working problems, which of these is a direct relationship (one goes up, the other goes up)? I. interest rates and yields II. bond prices and yields III. interest rates and bond prices

I only

From our discussion/notes/you working problems, which of these is true? I. as the number of payments made increases, the interest component of a given payment decreases II. as the number of payments made increases, the repayment component of a given payment decreases

I only

Which of these is an advantage for the bond investor? I. put provision II. convertible provision III. call provision IV. sinking fund

I, II and IV only

From our discussion/notes concerning indices, which of these is true? I. the Dow Jones Industrial Average is exactly 30 stocks II. the S&P 500 is the most common market measure used by retail investors III. the Russell 2000 captures the performance of small cap stocks IV. the Nasdaq Composite captures the performance of tech stocks

I, III and IV only

Which of these is an inverse relationship (one goes up, the other goes down)? I. bond rating of issuer and risk of its bond II. bond rating of an issuer and expected return of its bond

I. Bond Rating of Issuer and Risk of its Bond --> only

Which of these is a direct relationship (one goes up, the other goes up)? I. interest rates and yields II. bond prices and yields

I. Interest Rates and Yields --> only

From our discussion/notes, which of these is required to be filed by the SEC based on a regular time basis? I. 8K II. 10K III. 10Q

II and III only

From our discussion/notes, which of these is required to be filed by the SEC based on a regular time basis? I. 10K II. 8K III. 10Q

II and III only

From our discussion/notes/you working problems, which of these could happen as you switch from an annuity to an annuity due? I. the FV of the payments would go down II. the PV of the payments would go up III. the amount of the payment would go down

II and III only

Which of these is true regarding the historical returns and standard deviations of the broad asset classes? I. corporate bonds are riskier than long term government bonds II. the t-bill rate is less variable than inflation III. intermediate term debt is more variable than short term debt

II and III only

From our discussion/book, an increase in which of these would cause cash flow from operations to decrease? I. net income II. accounts receivables III. accounts payable

II only

From our discussion/notes/you working problems, which of these is true? I. as the number of payments made increases, the interest component of a given payment increases II. as the number of payments made increases, the repayment component of a given payment increases

II only

Which of the following are false about the taxability of investments? I. Roth IRAs are potentially tax free II. Anyone with earned income can contribute to a Roth IRA III. 401K plans can lower your taxable obligation this year.

II only

Which of these are true about the Security Market Line and Capital Market Line models? I. the intercepts are different II. the independent variable for the Capital Market Line is standard deviation III. the dependent variable of each is the expected return of a stock

II only

From our discussion/notes/book, which of these are primarily an advantage for the bond investor? I. call provision II. sinking fund III. put provision IV. protective covenant

II, III, IV only

From our discussion/notes/book, which of these are primarily an advantage for the bond investor? I. call provision II. sinking fund III. put provision IV. protective covenant

II, III, IV only

Which of these is a direct relationship (one goes up, the other goes up)? I. required rate of return and price II. interest rate risk and time to maturity

II. Interest Rate Risk and Time to Maturity --> only

From our discussion/notes, which of these is true? I. preferred stock dividends never change II. bond coupons never change III. increases in required rates cause stock values to decrease

III only

Terms Used With Capital Budgeting: INDEPENDENT vs. MUTUALLY EXCLUSIVE PROJECTS

INDEPENDENT: standalone project, does not correlate or get affected by any other project MUTUALLY EXCLUSIVE: correlates with other projects simultaneously, usually caused by scarce capital. EX. you have $10 mil capital, one project costs $5 mil the other $7 mil. the decisions of one project with affect the other

Moe tells Larry that his company is acquiring a smaller company and that Larry should buy shares in the smaller company now as its price will increase when this information becomes public. Curly, who doesn't know Moe or Larry, overhears this conversation in a public place and decides to buy the smaller company's stock. Larry also buys the smaller company's stock as well. Who all broke the insider trading law as established by the Securities Exchange Act of 1934?

Larry only

Capital Budgeting Evaluation Techniques: NET PRESENT VALUE (NPV)

PV inflows / PV outflows extremely comprehensive, basically brings together everything we have been talking about (goal of corp finance, TVM, risk adj. rates, companies that accept positive NPV, etc.) strengths: -> answer in terms of wealth creation ($ amount) - you get a direct answer of how much shareholder wealth is being created -> uses Time Value Money -> considers all cash flows -> has an absolute standard - accept if NPV > 0, reject if NPV < 0

Capital Budgeting Evaluation Techniques: PROFITABILITY INDEX

PV inflows / PV outflows ratio # if PI > 1 ACCEPT , if PI < 1 REJECT strengths: -> uses Time Value Money -> has an absolute standard -> considers all cash flows weakness: -> can sometimes lead to incorrect decisions with multiple projects

Terms Used With Capital Budgeting: REPLACEMENT vs. EXPANSION DECISIONS

REPLACEMENT: familiar, less risk, EX. replacing machine EXPANSION: higher risk, more likely to be subjected to evaluation, held to a higher standard, EX. moving in some new area

A bond rated BBB would be less likely to require a sinking fund than one rated CC.

TRUE

A fund's 12b-1 charges are its marketing expenses that are usually paid by fund shareholders.

TRUE

A fund's turnover would be an indication of its tax obligation

TRUE

A preemptive right is a benefit to current stockholders.

TRUE

All else held constant, an annuity due would yield a higher present value than an ordinary annuity.

TRUE

All else the same, a decrease in the number of payments would cause the present value of an annuity to decrease.

TRUE

All else the same, an increase in the number of payments would cause the present value of an annuity to increase.

TRUE

All else the same, as time to maturity increases, interest rate risk increases.

TRUE

All else the same, effective annual rates increase as compounding frequency increases.

TRUE

All publicly traded corporations have agency costs.

TRUE

An index fund is a type of open-ended fund but an ETF is not

TRUE

As the number of payments made increases, the interest component of a given payment decreases

TRUE

Beta can be either positive or negative.

TRUE

Blend funds blend value and growth stocks

TRUE

Discounted Payback Period and Payback Period have same advantages and disadvantages, but DPB corrects for not using Time Value Money

TRUE

Discounted Payback Period has a more rigorous standard than regular Payback Period

TRUE

ETFs generally have lower management fees than index funds.

TRUE

Effective annual rates are always greater than or equal to a given APR.

TRUE

From the panel discussion or video, an expanding global supply chain lowers costs to customers but increases volatility.

TRUE

IRR can lead to incorrect decisions when deciding between two different plans because of scale or size, as well as timing of the cash flows

TRUE

If the correlation coefficient of two assets is zero, then the covariance between the returns of two assets must also be zero.

TRUE

If the covariance between the returns of two assets is equal to zero, then the correlation coefficient must also be zero

TRUE

If you have net stocks losses of $8000 this year and use the maximum deduction this year, the amount you would be able to carry over to all future years is $5000.

TRUE

In an auction market, buyers and sellers confront each other directly and bargain over price.

TRUE

In the investment world, pension funds would be classified as "buy side" firms rather than "sell side"

TRUE

Investors should be actively involved in corporate governance.

TRUE

Most managed mutual funds do not outperform the index against which they are being evaluated.

TRUE

Net Present Value, Internal Rate of Return, and Profitability Index will ALWAYS give you the same accept/reject decision with an independent project

TRUE

PI can lead to incorrect decisions when deciding between two different plans because of scale or size

TRUE

PI is NOT affected by timing of cash flows

TRUE

Perfect diversification means that the portfolio has no unsystematic risk

TRUE

Roth IRAs are tax-free rather than tax-deferred.

TRUE

Systematic risk cannot be diversified away

TRUE

Systematic risk cannot be diversified away.

TRUE

The independent variable for the Capital Market Line is total risk

TRUE

The intercepts of the Security Market Line and Capital Market Line are the same

TRUE

The intercepts of the Security Market Line and Capital Market Line are the same.

TRUE

The standard deviation of inflation is higher than the standard deviation of T-bills

TRUE

The turnover of a fund is a measure of the potential tax obligation an investor in that fund may have

TRUE

There is an inverse relationship between the present value of an annuity and discount rate.

TRUE

To compute the coverage ratio, you only need information from the income statement.

TRUE

Traditional IRAs are tax-deferred rather than tax-free

TRUE

Value investors desire stocks with a low PE and high dividend yield.

TRUE

f you have net stocks losses of $7000 this year and use the maximum deduction this year, the amount you would be able to carry over to all future years is $4000.

TRUE

if you have any positive cost of capital, Discounted Payback Period will ALWAYS be higher than regular Payback Period

TRUE

can IRR sometimes lead to incorrect decisions for businesses when compared to NPV and PI?

YES, IRR can sometimes give different results compared to NPV and PI due to the timing of the cash flows ex. if business A has high cash flows near the beginning and business B has high cash flows toward the end, but business B is overall better, NPV and PI will pick up on this and direct you to business B. IRR will direct you to business A due to the early cash flows.

Which of these is true about ETFs and index funds? I. ETFs are more tax-efficient than index funds. II. Generally both ETFs and index funds are trying to replicate the performance of an index.

both

Regarding the statement of cash flows, if a company's interest expense increases

cash flow from operations will decrease and cash flows from financing will be unchanged

Assuming all other variables stay the same, an increase in accounts receivables and a decrease in depreciation would

cause cash flow from operations to decrease

debt vs. equity

differences viewed from the corporate standpoint

Capital Budgeting Evaluation Techniques: INTERNAL RATE OF RETURN

discount rate that balances PV inflows and PV outflows rate that would make NPV = 0 "true" return of project -> "I" IRR > WACC ACCEPT, if IRR < WACC REJECT weakness: -> IRR can sometimes lead to incorrect decisions due to the timing of cash flows ---> early cash flows can cause for IRR to be overstated

cost of capital

expressed as a percentage so it can be applied to a project of any size

Capital Budgeting Evaluation Techniques: DISCOUNTED PAYBACK PERIOD

how long it takes to recoup an investment using discounted cash flows

Capital Budgeting Evaluation Techniques: PAYBACK PERIOD

how long it takes to recoup investment weaknesses: -> referred to as an "arbitrary standard" - no set universal standard -> does not use Time Value Money -> doesn't consider cash flows past payback period

If total assets stay the same, an increase in debt will cause return on equity to

increase

A high amount of demand for long term bonds indicates

lower long term yields and a decrease in the slope of the yield curve

The primary goal of the managers of a publicly traded company should be to

maximize shareholder wealth

Which of these is true about risk? I. Systematic risk can be diversified away. II. A risk-free asset has a beta of zero and an asset with a beta of zero is a risk-free asset.

neither

From our discussion/notes, which of these is true? I. the yield curve depicts the relationship between time to maturity and coupon rates of bonds II. low short term inflation would cause the yield curve to invert

neither is true

From our discussion/notes/book, which of these is a direct relationship (one goes up, the other goes up)? I. bond rating of issuer and risk of its bond II. bond rating of an issuer and expected return of its bond

neither is true

capital structure

the mix of debt and equity used for financing long term projects =target is usually 40% debt, 60% equity

capital budgeting

the process of allocating available investment funds to potential long term projects. cost of capital

capital financing

the process of financing the capital budgeting decisions working capital management: the managing of short time assets and liabilities of company

cost of debt

the yield to maturity we computed earlier is the pre-tax cost of debt corporations use the after-tax cost of debt given by Kd=Y(1-T)

what happens to the Discounted Payback Period if WACC goes up?

there is a direct relationship between WACC and DPB, when WACC goes up so does DPB, if WACC goes down so does DPB ->the higher the discount rate, the lower the present value

Return on equity can never be less than return on assets

true