Business Finance
Exam Answer Key
Course Introduction
Business Finance introduces students to the fundamental principles and practices involved in financial management within a business environment. The course covers essential topics such as financial statement analysis, time value of money, capital budgeting, risk and return, cost of capital, and the planning and control of funds. Students will explore how businesses make investment, financing, and dividend decisions, and gain an understanding of financial markets and instruments. By the end of the course, learners will be equipped with analytical skills to evaluate financial performance, make informed financial decisions, and understand the role of finance in achieving strategic business objectives.
Recommended Textbook
Investments Analysis and Management 13th Edition by Charles P. Jones
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Chapter 1: Understanding Investments
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Q1) In general,the ex ante risk-return tradeoff:
A)slopes upward.
B)slopes downward.
C)is flat.
D)is impossible to determine.
Answer: A
Q2) What are some of the reasons driving so many individual investors to manage their own investments today versus the conventional route of investing through a financial advisor or stockbroker?
Answer: The emergence of the Internet has produced a host of online,discount brokers offering ultra low-cost commissions,sometimes free trades,and real-time quotes on stocks and bonds.There is also now a preponderance of websites offering information on corporate news and SEC filings,which helps investors become more self-sufficient if they so choose.Also,extreme levels of market volatility seen in the last two decades have eroded the wealth of many investors,including whatever portion was being professionally managed by mutual funds or through financial advisors.That begs the question of whether professional management or advice is worth the cost in the face of such tremendous wealth erosion.Many investors have decided to go out on their own,using a discount broker.
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Chapter 2: Investment Alternatives
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Sample Questions
Q1) Who benefits from a futures contract,a call contract,and a put contract,if prices fall?
Answer: The seller of the futures contract,the writer of the call contract,and the buyer of the put contract.
Answer:
Q2) The par value on common stock sets the value that stockholders will receive in case of bankruptcy.
A)True
B)False
Answer: False
Q3) If a bond has a coupon greater than the current market yield,it should be selling at a premium.
A)True
B)False Answer: True
Q4) Does the options market help stabilize or destabilize the stock market?Explain. Answer: Options should be a stabilizing force if options are used to hedge stock positions.Options might be destabilizing if used for speculation.
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Chapter 3: Indirect Investing
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Sample Questions
Q1) You would expect a value fund to buy stock based on a sound earnings record while growth funds might invest in companies with no earnings record at all.
A)True
B)False
Answer: True
Q2) Which of the following ETFs (exchange traded funds)provides exposure to 500 U.S.large-capitalization companies?
A)Spider
B)Clubs
C)Cubes
D)Diamonds
Answer: A
Q3) What are the main differences between a closed-end and an open-end investment company?
Answer: A closed-end investment company has a fixed number of shares,and the price depends on supply and demand.An open-end fund's shares outstanding increase as long as new investors contribute money,and the price is the net asset value of the securities owned.
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Chapter 4: Securities Markets and Market Indexes
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Sample Questions
Q1) A criticism of the Dow Jones Industrial Average (DJIA)is that:
A)it includes too few stocks.
B)it is a value-weighted average.
C)it is an equal-weighted average.
D)it includes too many risky stocks.
Q2) What is the Nasdaq National Market System?
Q3) A computerized trading network that matches buy and sell orders electronically entered by customers is a(n):
A)national market system.
B)electronic communication network.
C)internet investment service.
D)global investment network.
Q4) Automatic shelf registration refers to the practice of allowing seasoned issuers to file registration statements with the SEC that become effective immediately upon:
A)the filing of a "base prospectus," enabling efficient stock issue.
B)the filing of a "base prospectus," enabling efficient debt issue.
C)the filing of a "base prospectus," enabling efficient stock or debt issue.
D)the filing of a "red herring prospectus," enabling efficient stock or debt issue.
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Chapter 5: How Securities Are Traded
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Sample Questions
Q1) The law that requires that all new issues being offered for public sale to be registered with the SEC is the:
A)Securities Act of 1933.
B)Securities Exchange Act of 1934.
C)Maloney Act of 1936.
D)Securities Investor Protection Act of 1970.
Q2) Mr.Whiner bought 1,000 shares of Sure-Fire,Inc.common stock at $85 and sold it three months later at $73.He lost $12,000 plus commissions on this ill-fated stock purchase.He then contacted the SIPC saying that he wanted to file a claim for his investment losses.Is this loss covered by SIPC?What losses are covered?
Q3) Investors who sell short are expecting the price of the security to fall.
A)True
B)False
Q4) What costs and risks are incurred in using a margin account that are not present in a cash account?
Q5) Dollar cost averaging,in which additional shares are purchased over time,is one advantage of dividend reinvestment plans.
A)True
B)False
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Chapter 6: The Risks and Returns From Investing
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Q1) In order to determine the compound growth rate of an investment over some period,an investor would calculate the:
A)arithmetic mean.
B)geometric mean.
C)calculus mean.
D)arithmetic median.
Q2) Total return is equal to:
A)capital gain + price change.
B)yield + income.
C)capital gain - loss.
D)yield + price change.
Q3) If interest rates are expected to rise,you would expect:
A)bond prices to fall more than stock prices.
B)bond prices to rise more than stock prices.
C)stock prices to fall more than bond prices.
D)stock prices to rise and bond prices to fall.
Q4) The less the variability of return,the greater the risk.
A)True
B)False
Q5) What is the best measure of risk for a sole proprietorship?
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Chapter 7: Portfolio Theory
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Sample Questions
Q1) Company specific risk is also known as:
A)market risk.
B)systematic risk.
C)non-diversifiable risk.
D)diversifiable risk.
Q2) A probability distribution shows the likely outcomes that may occur and the probabilities associated with these likely outcomes.
A)True
B)False
Q3) Which of the following statements regarding expected return of a portfolio is true? It can:
A)be higher than the weighted average expected return of the individual assets.
B)be lower than the weighted average return of the individual assets.
C)never differ from the weighted average expected return of the individual assets. D)not be calculated.
Q4) Conventional wisdom has long held that diversification of a stock portfolio should be across industries.Does the correlation coefficient indirectly recommend the same thing?
Q5) An efficiently diversified portfolio still has _____________________ risk.
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Chapter 8: Portfolio Selection
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Sample Questions
Q1) Explain what is efficient about the efficient frontier.
Q2) The efficient set of portfolios represents:
A)investor preferences,whereas indifference curves reflect portfolio possibilities.
B)portfolio possibilities,whereas indifference curves reflect investor preferences.
C)investor risk,whereas indifference curves reflect portfolio return.
D)portfolio return,whereas indifference curves reflect investor preferences.
Q3) Markowitz derived the efficient frontier as an upward-sloping straight line.
A)True
B)False
Q4) A well-diversified portfolio will typically consist of a mix of small,mid,and large cap stocks,both U.S.and foreign,as well as corporate and U.S.Treasury bonds,real estate,and commodities.
A)True
B)False
Q5) The Markowitz model does not depend on the assumption of normally distributed security returns.
A)True
B)False
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Chapter 9: Asset Pricing Models
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Sample Questions
Q1) Under the separation theorem,investors should:
A)hold the same portfolio of risky assets.
B)have different optimal portfolios of risky assets.
C)hold the same percentage of their portfolio in risk-free securities.
D)borrow at the risk-free rate to achieve a lower risk portfolio.
Q2) The expected market return is 16 percent.The risk-free rate of return is 7 percent,and BC Co.has a beta of 1.1.BC's required rate of return is:
A)17.6 percent.
B)16.0 percent.
C)16.9 percent.
D)23.0 percent.
Q3) The expected return on the market for next period is 11 percent.The risk-free rate is 4 percent,and Alpha Company has a beta of 1.1.The market risk premium is:
A)7.7 percent.
B)7 percent.
C)11 percent.
D)12.1 percent.
Q4) Compare the capital market line and the security market line.
Q5) What is the formula for the slope of the CML?What does it represent?
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Chapter 10: Common Stock Valuation
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Sample Questions
Q1) Which of the following is not one of the steps in using discounted cash flow to value a company?
A)Estimate the amount and timing of the future stream of cash flows
B)Estimate an appropriate discount rate
C)Use a present value model to calculate an intrinsic value
D)Compare the intrinsic value to the relative value metric
Q2) Which of the following descriptions of the price/earnings ratio is the most accurate?
A)Investors are generally more pessimistic about the prospects for high P/E stocks.
B)Historically,the average P/E for the market as a whole has been approximately 10.
C)Companies with high growth rates generally have higher P/E ratios.
D)All else the same,investors prefer to purchase stocks with relatively high P/E ratios.
Q3) An increase in interest rates generally reduces P/E ratios and stock prices.
A)True
B)False
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Chapter 11: Common Stocks: Analysis and Strategy
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Q1) A significant advantage of index funds is their:
A)lower market price than other types of funds.
B)superior sector rotation approach.
C)tax efficiency.
D)minimization of risk.
Q2) Sector rotation:
A)is a form of passive investing.
B)is an active strategy similar to stock selection.
C)varies the percentage of equities in the portfolio in order to earn abnormal returns.
D)is not dependent on an accurate assessment of current economic conditions.
Q3) How could one invest indirectly in sectors and practice sector rotation?
Q4) The required return for a common stock is defined as the:
A)expected return based on probabilities assigned to different scenarios.
B)maximum expected return based on estimates of its cash flows.
C)minimum expected return necessary to induce an investor to purchase the stock.
D)mean return for the stock over the past ten years.
Q5) A utility stock is likely to have a beta lower than the overall market.
A)True
B)False
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Chapter 12: Market Efficiency
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Sample Questions
Q1) Which of the following is an investment strategy that relies on the "overreaction hypothesis?"
A)Buy and hold
B)Value investing
C)Momentum
D)Contrarian
Q2) An efficient market requires that:
A)all investors are rational and react quickly to new information.
B)information can be obtained at a considerable cost by investors.
C)new information does not have a significant effect on market prices.
D)investors react quickly and fully to new information.
Q3) The January effect can be largely attributed to the exceptional performance of:
A)low P/E stocks in January.
B)winner stocks in January.
C)loser stocks in January.
D)small stocks in January.
Q4) Financial economists have tested various technical trading rules and found they fail to earn consistent abnormal returns.
A)True
B)False
Page 14
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Chapter 13: Economy Market Analysis
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Sample Questions
Q1) When interest rates fall,bond prices:
A)rise.
B)fall.
C)remain unchanged.
D)rise or fall depending on the expected inflation premium.
Q2) Traditionally,how many months before an economic recovery have stock prices started increasing?
A)3-5,with 4 typical
B)5-7,with 6 typical
C)8-10,with 9 typical
D)10-12,with 11 typical
Q3) Which of the following is considered a leading indicator of a country's economy?
A)Unemployment rate
B)Stock prices
C)Money supply
D)Interest rate spread
Q4) The stock market is a leading indicator of the economy because investors discount future cash flows.
A)True
B)False
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Chapter 14: Industry Analysis
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Sample Questions
Q1) The North American Industry Classification System (NAICS)was developed using a production-oriented approach,resulting in companies being classified into industries based on the activity in which they are primarily engaged.
A)True
B)False
Q2) Portfolio diversification often focuses on cross-industry diversification to pick up correlation coefficients and risk-expected return characteristics that create the portfolio effect.Suggest a realignment of "industry" classifications to reflect fundamental relationships sought through the more casual traditional industries.
Q3) Differentiate between defensive industries and countercyclical industries.
Q4) Based on past evidence,if an industry has the number one ranking on price performance,which of the following statements is most accurate?The investor should:
A)not expect that same industry to be ranked number one again next year.
B)expect that industry to maintain its top ranking for five years or more.
C)expect that industry to do well over the next 10 to 20 years.
D)expect that industry to drop out of the top ten rankings within five years.
Q5) Give several examples of government effects on industries.
Q6) What industries do you think will be the growth industries of the next decade?
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Chapter 15: Company Analysis
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Q1) Regardless of how closely a company adheres to good accounting practices and auditors do their job,investors need to examine "Notes to the Financial Statements" on 10-K and 10-Q Reports to understand the company's financial situation.
A)True
B)False
Q2) In what portion of the statement of cash flows would an investor look to find whether a firm had repurchased common shares?
A)Cash flows from operating activities
B)Cash flows from investing activities
C)Cash flows from financing activities
D)Cash flows from trading activities
Q3) The last step in top-down fundamental analysis is to:
A)analyze individual industries.
B)analyze individual companies.
C)analyze individual securities.
D)perform technical analysis
Q4) How could unexpected inflation affect the P/E ratio?
Q5) What are "earnings surprises?"How do they affect stock prices?
Q6) Should an investor seek companies with low P/Es or high P/Es?
Page 17
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Chapter 16: Technical Analysis
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Sample Questions
Q1) What are support and resistance levels?
Q2) Which of the following statements about the put/call ratio is most accurate?
A)A negative ratio is bullish.
B)Investors interpret a ratio greater than 1 to be a bearish indicator.
C)Investors interpret a relatively low ratio to be a bearish indicator.
D)Investors interpret a relatively high ratio to be a bearish indicator.
Q3) One of the primary tools of a technical analyst is:
A)sell-side research.
B)buy-side research.
C)Value Line earnings estimates.
D)charts of stock price and volume.
Q4) A period of correction is often followed by a period of:
A)channel lines.
B)momentum.
C)reversals.
D)consolidation.
Q5) Explain three specific buy signals using a moving average.
Q6) Institutional investors are often considered to have the "smart money," while small,individual investors are not so well informed about the market.Which two sentiment indicators treat both institutions and individuals alike?
Page 18
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Chapter 17: Bond Yields
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Sample Questions
Q1) The term structure of interest rates denotes the relationship between _____________ and _________________ for a specific category of bonds at a particular point in time.
Q2) What is meant by the real risk-free rate of interest?It is the:
A)opportunity cost of foregoing consumption.
B)rate actually used in the market,not in textbooks.
C)rate quoted on long-term Treasury bonds.
D)the nominal risk-free interest rate,multiplied by 1 minus the marginal tax rate.
Q3) Bond traders use the term "basis point" to mean one percentage point in interest rate.
A)True
B)False
Q4) If interest rates rise,then price risk and reinvestment risk decline.
A)True
B)False
Q5) Reinvestment risk represents the possibility that future payments cannot be reinvested at the assumed rate.
A)True
B)False
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Chapter 18: Bonds: Analysis and Strategy
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Q1) Under a laddering approach,investors mitigate the effects of an interest rate increase by:
A)purchasing bonds in two maturity groups,long or short.
B)purchasing bonds with the same maturity date but with a variety of coupon rates.
C)purchasing bonds with a variety of maturity dates.
D)purchasing bonds with a variety of YTMs.
Q2) A coupon bond has 10-years to maturity and a YTM of 8%.If the YTM instantaneously increases to 9%,what happens to the bond's price and duration?
A)The price decreases and the duration increases.
B)The price increases and the duration decreases.
C)The price decreases and the duration decreases.
D)The price decreases and the duration stays the same.
Q3) Which of the following 10-year,8% bonds will offer the highest YTM?
A)AAA-rated,callable bond
B)AAA-rated,non-callable bond
C)BBB-rated,callable bond
D)BBB-rated,non-callable bond
Q4) What are two passive management strategies?Two active strategies?
Q5) Why is immunization considered to be a hybrid strategy?
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Chapter 19: Options
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Q1) Concerning stock index options,which of the following statements is false?
A)Index options appeal to speculators due to the leverage they offer.
B)Investors can write index options.
C)If exercised,the holder of a stock index call receives the underlying stock.
D)Index options are settled in cash.
Q2) Which of the following is true regarding option pricing?
A)The longer the maturity of the option,the higher the premium
B)The more volatile the underlying stock,the lower the premium
C)Option prices are less volatile than equity prices
D)European options are more valuable than American options
Q3) Which of the following is not a determinant of the value of a call option in the Black-Scholes model?
A)The interest rate
B)The exercise price of the stock
C)The price of the underlying stock
D)The beta of the underlying stock
Q4) ?Options traded on organized exchanges are protected against cash dividends.
A)True
B)False
Q5) What is meant by portfolio insurance?
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Chapter 20: Futures
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Q1) The National Futures Association is the federal agency which regulates the futures markets.
A)True
B)False
Q2) How often are futures contracts marked to market?
A)Daily
B)Weekly
C)Monthly
D)Quarterly
Q3) Futures contracts are handled by specialists on futures exchanges.
A)True
B)False
Q4) An investor who sells a T-bond futures contract is expecting to profit from:
A)an increase in the price of the T-bond.
B)an increase in the level of interest rates.
C)interest rates remaining unchanged.
D)the coupon payments from the T-bond.
Q5) What are the methods of settling a futures contract?
Q6) What is the difference between hedgers and speculators in the futures markets?
Q7) What economic functions are fulfilled by futures?
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Chapter 21: Portfolio Management
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Q1) An investor's marginal tax rate is equal to total taxes paid divided by total income.
A)True
B)False
Q2) Which of the following is not true regarding the life-cycle approach to investment?
A)It is most appropriate for institutions.
B)It automatically becomes more conservative as the investor nears retirement age.
C)It is suited to 401(k)plans.
D)It can be implemented using life-cycle (also known as target-date)funds.
Q3) Living expenses are covered from accumulated assets rather than from earned income in the:
A)accumulation phase of the life cycle.
B)consolidation phase of the life cycle.
C)spending phase of the life cycle.
D)saving phase of the life cycle.
Q4) What are the steps in the portfolio management process?
Q5) How does the prudent investor rule affect asset allocation?
Q6) Explain the life-cycle theory of portfolio policies.
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Chapter 22: Evaluation of Investment Performance
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Q1) Superior portfolio performance can result from:
A)the ability to select undervalued securities,only.
B)the ability to time market turns,only.
C)superior selectivity or timing performance.
D)neither superior selectivity nor timing because the market is too efficient.
Q2) GIPS requirements include: uniformity in certain performance calculations and disclosures;inclusion of all actual fee-paying discretionary portfolios in composites with similar objectives;compliant history for at least 5 years,or since inception if less than 5 years.
A)True
B)False
Q3) What is the major question when evaluating the performance of an individual's portfolio?
A)Does the portfolio align with the investor's characteristics?
B)Does the expected return of the portfolio meet the needs of the investor?
C)Is the return on the portfolio adequate to compensate for its risk?
D)Is the portfolio's risk in line with the personal characteristics of the investor?
Q4) What is the major difference between the Sharpe and Treynor measures?
Q5) How is regression analysis used to measure portfolio diversification?
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