Capital Markets and Institutions
Exam Practice Tests
Course Introduction
This course provides a comprehensive overview of capital markets and the key financial institutions that operate within them. Students will explore the structure, functioning, and importance of capital markets in facilitating the flow of funds between investors and entities in need of capital. The course examines the roles of various financial institutions such as banks, investment firms, insurance companies, and regulatory bodies, while also analyzing the instruments traded in capital markets, including stocks, bonds, and derivatives. Topics include market efficiency, risk management, regulatory frameworks, and the impact of global economic factors on capital markets. Through case studies and practical examples, students will gain insights into the contemporary challenges and opportunities present in capital markets and institutional finance.
Recommended Textbook
Corporate Finance The Core 3rd Edition by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Sample Questions
Q1) The distinguishing feature of a corporation is that:
A) their is no legal difference between the corporation and its owners.
B) it is a legally defined, artificial being, separate from its owners.
C) it spreads liability for its corporate obligations to all shareholders.
D) provides limited liability only to small shareholders.
Answer: B
Q2) How much would you have to pay to purchase 100 shares of XYZ stock on November 18th?
A) $2520
B) $2525
C) $2593
D) $2600
Answer: D
Q3) If you buy shares of Coca-Cola on the secondary market:
A) Coca-Cola receives the money because the company has issued new shares.
B) you buy the shares from another investor who decided to sell the shares.
C) you buy the shares from the New York Stock Exchange.
D) you buy the shares from the Federal Reserve.
Answer: B
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Chapter 2: Introduction to Financial Statement Analysis
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Sample Questions
Q1) If in 2009 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share,then using the market value of equity,the debt to equity ratio for Luther in 2009 is closest to:
A) 1.47
B) 1.78
C) 2.31
D) 4.07
Answer: B
Q2) If Moon Corporation has an increase in sales,which of the following would result in no change in its EBIT margin?
A) A proportional increase in its net income
B) A proportional decrease in its EBIT
C) A proportional increase in its EBIT
D) An increase in its operating expenses
Answer: C
Q3) If on December 31,2008 Luther has 8 million shares outstanding trading at $15 per share,then what is Luther's market-to-book ratio?
Answer: market-to-book = market value of equity/book value of equity market-to-book = 8 million × $15/$63.6 = 1.89
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Page 4
Chapter 3: Financial Decision Making and the Law of One
Price
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Sample Questions
Q1) If the interest rate is 7%,the NPV of alternative #1 is closest to:
A) $350,000
B) $357,000
C) $375,500
D) $400,000
Answer: A
Q2) Suppose a risky security pays an average cash flow of $100 in one year.The risk-free rate is 5%,and the expected return on the market index is 13%.If the returns on this security are high when the economy is strong and low when the economy is weak,but the returns vary by only half as much as the market index,what risk premium is appropriate for this security?
A) 4%
B) 6.5%
C) 9%
D) 11%
Answer: A
Q3) The price per share of the ETF in a normal market is:
Answer:
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Chapter 4: The Time Value of Money
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Q1) If the current rate of interest is 8%,then the present value of an investment that pays $1000 per year and lasts 20 years is closest to:
A) $18,519
B) $45,761
C) $9,818
D) $20,000
Q2) After your grandmother retired,she purchased an annuity contract for $250,000 that will pay her $25,000 at the end of every year until she dies.The appropriate interest rate for this annuity is 8%.The number of years that your grandmother must live in order to get more value out of the annuity than what she paid for it is closest to:
A) 21
B) 16
C) 8
D) 10
Q3) The future value at retirement (age 65)of your savings is:
Q4) In terms of present value,how much will Joe receive for selling the family business?
Q5) Draw a timeline detailing Joe's cash flows from the sale of the family business.
Q6) Draw a timeline detailing the cash flows from investment "A."
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Chapter 5: Interest Rates
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Q1) Should the nominal interest rate ever be negative? Can the real interest rate ever be negative? Explain.
Q2) If an investment providing a nominal return of 12.25% only offers a real rate of return of 5.70%,then the inflation rate is closest to:
A) 5.70%
B) 6.20%
C) 6.55%
D) 12.25%
Q3) Which of the following statements is FALSE?
A) The plot of the relationship between the investment risk and the interest rate is call the yield curve.
B) Each of the last six recessions in the United States was preceded by a period with an inverted yield curve.
C) The nominal interest rate does not represent the increase in purchasing power that will result from investing
D) A risk-free cash flow received in two years should be discounted at the two-year interest rate.
Q4) What is the effective after-tax rate of each instrument,expressed as an EAR?
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Chapter 6: Valuing Bonds
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Sample Questions
Q1) Consider a corporate bond with a $1000 face value,8% coupon with semiannual coupon payments,7 years until maturity,and a YTM of 9%.It has been 57 days since the last coupon payment was made and there are 182 days in the current coupon period.The dirty (cash)price for this bond is closest to:
A) $949.70
B) $961.40
C) $936.40
D) $948.90
Q2) Consider a four-year,default-free bond with an annual coupon rate of 4.5% and a face value of $1000.The YTM on this bond is closest to:
A) 3.85%
B) 4.20%
C) 4.35%
D) 4.40%
Q3) Which of these bonds sells at a discount?
A) #1
B) #2
C) #3
D) #4
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Page 8
Chapter 7: Investment Decision Rules
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Q1) Explain why the NPV decision rule might provide Larry with a different decision outcome than the IRR rule when evaluating Larry's three movie deal offer.
Q2) The IRR of Palin's book deal is closest to:
A) -27.25%
B) -37.50%
C) 27.25%
D) 37.50%
Q3) The NPV of project A is closest to:
A) 12.0
B) 12.6
C) 15.0 D) 42.9
Q4) The internal rate of return (IRR)for project B is closest to:
A) 21.6%
B) 23.3%
C) 42.9%
D) 7.7%
Q5) If the discount rate for project A is 16%,then what is the NPV for project A?
Q6) If the discount rate for project B is 15%,then what is the NPV for project B?
Page 9
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Chapter 8: Fundamentals of Capital Budgeting
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Q1) Which of the following statements is FALSE?
A) Most projects will require the firm to invest in net working capital.
B) The main components of net working capital are cash, inventory, receivables, and property, plant and equipment.
C) NWC<sub>t</sub> = NWC<sub>t</sub> - NWC<sub>t - 1.</sub>
D) In the final year of a project, the firm ultimately recovers the investment in net working capital.
Q2) Which of the following statements is FALSE?
A) Depreciation is not a cash expense paid by the firm.
B) Net Working Capital = Cash + Inventory + Payables - Receivables.
C) Since 1997, companies can "carry back" losses for two years and "carry forward" losses for 20 years.
D) Earnings do not represent real profits.
Q3) Construct a simple income statement showing the incremental EBIT and the incremental unlevered net income for all three years of the Sisyphean Companies project.
Q4) Epiphany would like to know how sensitive the project's NPV is to changes in the discount rate.How much can the discount rate vary before the NPV reaches zero?
Q5) How does scenario analysis differ from sensitivity analysis?
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Chapter 9: Valuing Stocks
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Sample Questions
Q1) Wyatt Oil just reported that a major fire destroyed one of its oil production facilities in Colorado.While the facility was fully insured,the loss of oil production will decrease Wyatt's free cash flow by $120 million at the end of this year and by $80 million at the end of next year.Wyatt has 50 million shares outstanding and has a weighted average cost of capital of 9%.Assuming the value of Wyatt's debt is not affected by this event,the expected decrease in Wyatt's stock price is closest to:
A) $2.00
B) $3.55
C) $3.87
D) $4.00
Q2) Wyatt oil presently pays no dividend.You anticipate Wyatt Oil will pay an annual dividend of $0.56 per share two years from today and you expect dividends to grow by 4% per year thereafter.In Wyatt Oil's equity cost of capital is 12%,then the value of a share of Wyatt oil today is:
A) $4.67
B) $5.00
C) $6.25
D) $7.00
Q3) Calculate the enterprise value for DM Corporation.
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Page 11
Chapter 10: Capital Markets and the Pricing of Risk
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Q1) Which of the following statements is FALSE?
A) Fluctuations of a stock's returns that are due to firm-specific news are common risks.
B) The volatility in a large portfolio will decline until only the systematic risk remains.
C) When we combine many stocks in a large portfolio, the firm-specific risks for each stock will average out and be diversified.
D) The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk.
Q2) Which of the following statements is FALSE?
A) Firm specific news is good or bad news about the company itself.
B) Firms are affected by both systematic and firm-specific risk.
C) When firms carry both types of risk, only the firm-specific risk will be diversified when we combine many firms' stocks into a portfolio.
D) The risk premium for a stock is affected by its idiosyncratic risk.
Q3) Using the data provided in the table,calculate the average annual return,the variance of the annual returns,and the standard deviation of the average returns for the market from 2000 to 2009.
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Chapter 11: Optimal Portfolio Choice and the Capital Asset Pricing Model
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Sample Questions
Q1) The Sharpe Ratio for the market portfolio is closest to:
A) 0.40
B) 0.48
C) 0.56
D) 0.80
Q2) Which of the following statements is FALSE?
A) When stocks are perfectly positively correlated, the set of portfolios is identified graphically by a straight line between them.
B) An investor seeking high returns and low volatility should only invest in an efficient portfolio.
C) When the correlation between securities is less than 1, the volatility of the portfolio is reduced due to diversification.
D) Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected returns.
Q3) Suppose that you want to maximize your expected return without increasing your risk.How can you achieve this goal? Without increasing your risk,what is the maximum expected return you can expect?
Q4) Calculate the correlation between Stock Y's and Stock Z's returns .
Page 13
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Chapter 12: Estimating the Cost of Capital
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Sample Questions
Q1) Wyatt Oil has a bond issue outstanding with seven years to maturity,a yield to maturity of 7.0%,and a BBB rating.The bondholders' expected loss rate in the event of default is 70%.Assuming a normal economy the expected return on Wyatt Oil's debt is closest to:
A) 3.0%
B) 3.5%
C) 4.9%
D) 6.7%
Q2) Which of the following statements is FALSE?
A) Beta is the expected percent change in the excess return of the security for a 1% change in the excess return of the market portfolio.
B) Beta represents the amount by which risks that affect the overall market are amplified for a given stock or investment.
C) It is common practice to estimate beta based on the historical correlation and volatilities.
D) Beta measures the diversifiable risk of a security, as opposed to its market risk, and is the appropriate measure of the risk of a security for an investor holding the market portfolio.
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Chapter 13: Investor Behavior and Capital Market Efficiency
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Sample Questions
Q1) Which of the following statements is FALSE?
A) The size effect is the observation that small stocks have positive alphas.
B) When considering portfolios formed based on the book-to-market ratio, most of the portfolios plot below the security market line.
C) The largest alphas occur in the smallest size deciles.
D) When considering portfolios formed based on size, although the portfolios with the higher betas yield higher returns, most size portfolios plot above the security market line.
Q2) Using the FFC four factor model and the historical average monthly returns,the expected monthly return for GE is closest to:
A) 0.53%
B) 0.73%
C) 0.79%
D) 0.71%
Q3) Explain why the market portfolio proxy may not be efficient.
Q4) What does the existence of a positive alpha investment strategy imply?
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15
Chapter 14: Capital Structure in a Perfect Market
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Sample Questions
Q1) Sisyphean Bolder Movers Incorporated has no debt,a total equity capitalization of $50 billion,and a beta of 2.0.Included in Sisyphean's assets are $12 billion in cash and risk-free securities.Calculate Sisyphean's enterprise value and unlevered cost of equity considering the fact that Sisyphean's cash is risk-free.
Q2) Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as with.You have $5000 of your own money to invest and you plan on buying With stock.Using homemade (un)leverage,how much do you need to invest at the risk-free rate so that the payoff of your account will be the same as a $5000 investment in Without stock?
A) $5000
B) $0
C) $2,500
D) $4,000
Q3) The market value of Luther's non-cash assets is closest to:
A) $20 billion
B) $19 billion
C) $25 billion
D) $24 billion
Q4) What is the conservation of value principle?
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Chapter 15: Debt and Taxes
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Q1) Which of the following statements is FALSE?
A) A biotech firm might be developing drugs with tremendous potential, but it has yet to receive any revenue from these drugs. Such a firm will not have taxable earnings. In that case, a tax-optimal capital structure does not include debt.
B) No corporate tax benefit arises from incurring interest payments that regularly exceed EBIT.
C) The optimal level of leverage from a tax saving perspective is the level such that interest equals EBIT.
D) In general, as a firm's interest expense approaches its expected taxable earnings, the marginal tax advantage of debt increases, limiting the amount of equity the firm should use.
Q2) In 2005,assuming an average dividend payout ratio of 50%,the effective tax advantage for debt ( *)was closest to:
A) 24%
B) 18%
C) 35%
D) 15%
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Chapter 16: Financial Distress, managerial Incentives, and Information
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Q1) What is the expected payoff to debt holders under JR's new riskier business strategy?
A) $20 million
B) $4 million
C) $15 million
D) $11 million
Q2) Assume that capital markets are perfect except for the existence of corporate taxes and that your firm pays 35% of earnings in taxes.If you want to maintain ownership of at least a 50%,then calculate the minimum amount of debt that you must issue to fund the expansion.
Q3) Which of the following firms is likely to maintain low levels of debt?
A) An electric utility
B) A tobacco company
C) An Internet firm
D) A mature restaurant chain
Q4) What is the expected value of Rearden's assets if it were run efficiently?
A) $265 million
B) $280 million
C) $295 million
D) $300 million
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Chapter 17: Payout Policy
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Q1) Absent any other trading frictions or news,Rearden's share price just after the dividend is paid will be closest to:
A) $35
B) $36
C) $37
D) $40
Q2) If Luther invests the excess cash in treasury bills,then the dividend per share next year will be closest to:
A) $5.00
B) $5.25
C) $4.75
D) $1.05
Q3) The value of Iota if they use the $200 million to expand is closest to:
A) $825 million
B) $688 million
C) $840 million
D) $950 million
Q4) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
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Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) The unlevered cost of capital for Anteater Enterprises is closest to:
A) 10.1%
B) 9.5%
C) 9.9%
D) 10.3%
Q2) The value of Galt's equity using the APV method is closest to:
A) $150 million
B) $180 million
C) $230 million
D) $240 million
Q3) The WACC for this project is closest to:
A) 3.0%
B) 5.0%
C) 7.0%
D) 8.2%
Q4) The weighted average cost of capital for "Meenie" is closest to:
A) 10.5%
B) 7.4%
C) 10.0%
D) 8.8%
Page 20
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) The after tax interest expense in 2008 is closest to:
A) 2,380
B) 4,420
C) 6,800
D) 7,820
Q2) If Ideko's loans will have an interest rate of 6.8%,then the interest expense paid in 2009 is closest to:
A) $6,800
B) $7,310
C) $7,820
D) $7,990
Q3) The unlevered beta for Oakley is closest to:
A) 0.70
B) 1.50
C) 1.00
D) 0.60
Q4) What range for the market value of equity for Ideko is implied by the range of EV/Sales multiples for the comparable firms if Ideko holds $6.5 million of cash in excess of its working capital needs?
Q5) What is the purpose of the sensitivity analysis?
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