Corporate Finance
Exam Answer Key
Course Introduction
Corporate Finance is a foundational course that explores the principles and techniques used by firms to make key financial decisions. Topics include the valuation of investments, capital budgeting, risk analysis, cost of capital, capital structure, dividend policy, working capital management, and financial planning. Through case studies and real-world examples, students learn how corporations allocate resources, manage financial risks, and create value for shareholders while considering the regulatory and ethical environment in which they operate.
Recommended Textbook
Investments 7th Canadian Edition by Zvi Bodie
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Chapter 1: Investments: Background and Issues
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Q1) Which of the following are mechanisms that have evolved to mitigate potential agency problems?
I.compensation in the form of the firm's stock options
II.hiring bickering family members as corporate spies
III.underperforming management teams being forced out by boards of directors
IV.security analysts monitoring the firm closely
V.takeover threats
A) II and V
B) I,III,and IV
C) I,III,IV,and V
D) III,IV,and V
E) I,III,and V
Answer: C
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Chapter 2: Asset Classes and Financial Instruments
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Q1) Which of the following is true regarding a firm's securities?
A) Common dividends are paid before preferred dividends.
B) Preferred stockholders have voting rights.
C) Preferred dividends are usually cumulative.
D) Preferred dividends are contractual obligations.
E) Common dividends usually can be paid if preferred dividends have been skipped.
Answer: C
Q2) Bond market indexes can be difficult to construct because
A) they cannot be based on firms' market values.
B) bonds tend to trade infrequently,making price information difficult to obtain.
C) there are so many different kinds of bonds.
D) prices cannot be obtained for companies that operate in emerging markets.
E) corporations are not required to disclose the details of their bond issues.
Answer: B
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4
Chapter 3: Securities Markets
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Q1) The following statements regarding the specialist are true:
A) Specialists maintain a book listing outstanding unexecuted limit orders.
B) Specialists earn income from commissions and spreads in stock prices.
C) Specialists stand ready to trade at quoted bid and ask prices.
D) Specialists cannot trade in their own accounts.
E) a,b,and c are all true.
Answer: E
Q2) List two advantages and two disadvantages or concerns about the use of Electronic Communications Networks (ECNs).
Answer: Some advantages are that the systems allow brokers and dealers to view quotes for all markets.This increases the chance that clients will get the best price.The goal of ECNs is to unify markets.Some disadvantages or concerns are that the systems don't provide for automatic execution in the market with the best price and they may be too slow to integrate NYSE prices.Also,they may lead to market fragmentation rather than integration because users of one ECN may not have information from other ECNs.
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Chapter 4: Mutual Funds and Other Investment Companies
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Q1) Ceteris paribus,a decrease in the demand for loanable funds
A) drives the interest rate down.
B) drives the interest rate up.
C) might not have any effect on interest rate.
D) results from an increase in business prospects and a decrease in the level of savings.
E) none of these.
Q2) An investor purchased a bond 45 days ago for $985.He received $15 in interest and sold the bond for $980.What is the holding period return on his investment?
A) 1.52%
B) 0.50%
C) 1.02%
D) 0.01%
E) 0.10%
Q3) Discuss concepts covariance and correlation.How do these concepts differ in terms of calculation and interpretation?
Q4) Discuss concepts covariance and correlation.How do these concepts differ in terms of calculation and interpretation?
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Chapter 5: Risk and Return: Past and Prologue
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Q1) In the mean-standard deviation graph an indifference curve has a ________ slope.
A) negative
B) zero
C) positive
D) northeast
E) cannot be determined
Q2) According to the mean-variance criterion,which one of the following investments dominates all others?
A) E(r)= 0.15;Variance = 0.20
B) E(r)= 0.10;Variance = 0.20
C) E(r)= 0.10;Variance = 0.25
D) E(r)= 0.15;Variance = 0.25
E) none of these is dominates the other alternatives.
Q3) Describe how an investor may combine a risk-free asset and one risky asset in order to obtain the optimal portfolio for that investor.
Q4) Discuss the differences between the asset allocation decision and the security selection decision.
Q5) Discuss the differences between investors who are risk averse,risk neutral,and risk loving.
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Chapter 6: Efficient Diversification
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Q1) Given an optimal risky portfolio with expected return of 13% and standard deviation of 26% and a risk free rate of 5%,what is the slope of the best feasible CAL?
A) 0.60
B) 0.14
C) 0.08
D) 0.36
E) 0.31
Q2) Security X has expected return of 12% and standard deviation of 20%.Security Y has expected return of 15% and standard deviation of 27%.If the two securities have a correlation coefficient of 0.7,what is their covariance?
A) 0.038
B) 0.070
C) 0.018
D) 0.013
E) 0.054
Q3) Discuss how the investor can use the separation theorem and utility theory to produce an efficient portfolio suitable for the investor's level of risk tolerance.
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Chapter 7: Capital Asset Pricing and Arbitrage Pricing
Theory
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Q1) The CAPM applies to
A) portfolios of securities only.
B) individual securities only.
C) efficient portfolios of securities only.
D) efficient portfolios and efficient individual securities only.
E) all portfolios and individual securities.
Q2) Assume that a security is fairly priced and has an expected rate of return of 0.13.The market expected rate of return is 0.13 and the risk-free rate is 0.04.The beta of the stock is
A) 1.25.
B) 1.7.
C) 1.
D) 0.95.
E) none of these
Q3) The capital asset pricing model assumes
A) all investors are price takers.
B) all investors have the same holding period.
C) investors pay taxes on capital gains.
D) both a and b are true.
E) a,b and c are all true.
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Chapter 8: The Efficient Market Hypothesis
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Q1) If a firm's beta was calculated as 1.6 in a regression equation,a commonly used adjustment technique would provide an adjusted beta of A) less than 0.6 but greater than zero.
B) between 0.6 and 1.0.
C) between 1.0 and 1.6.
D) greater than 1.6.
E) zero or less.
Q2) Assume that stock market returns do not resemble a single-index structure.An investment fund analyzes 100 stocks in order to construct a mean-variance efficient portfolio constrained by 100 investments.They will need to calculate ____________ covariances.
A) 45
B) 100
C) 4,950
D) 10,000
E) none of these
Q3) Discuss the advantages of the multifactor APT over the single factor APT and the CAPM.What is one shortcoming of the multifactor APT and how does this shortcoming compare to CAPM implications?
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Page 10
Chapter 9: Behavioral Finance and Technical Analysis
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Sample Questions
Q1) Banz (1981)found that,on average,the risk-adjusted returns of small firms
A) were higher than the risk-adjusted returns of large firms
B) were the same as the risk-adjusted returns of large firms
C) were lower than the risk-adjusted returns of large firms
D) were unrelated to the risk-adjusted returns of large firms
E) were negative
Q2) Empirical research by DeBondt and Thaler (1985),Jagadeesh (1990)and Lehman (1990)
A) found that poorly stocks that performed poorly in one period experienced sizable reversals in the subsequent period
B) found that stocks that performed poorly in one period experienced poor performance in the subsequent period
C) found that stocks that performed poorly in one period experienced neither better nor worse performance than other stocks in the subsequent period
D) did not try to test the reversal effect
E) reinforces the EMH
Q3) With regard to market efficiency,what is meant by the term "anomaly"? Give three examples of market anomalies and explain why each is considered to be an anomaly.
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Chapter 10: Bond Prices and Yield
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Q1) After taking a position based on an identified trend,technical traders generally ____________________.
A) continue with it until a reversal of the trend is indicated
B) continue with it until price stabilizes.
C) continue until trading volume begins to decline
D) none of these
Q2) According to Dow theory,secondary trends are _________________.
A) daily fluctuations which are of little importance
B) short-term deviations from the underlying price trend line
C) long-term price movements lasting from months to years
D) none of these
Q3) A support level is _________________.
A) a level beyond which the market is unlikely to rise
B) a level below which the market is unlikely to fall
C) an equilibrium price level justified by characteristics such as earnings and cash flows
D) the through of a market wave or cycle
Q4) How do you distinguish between fundamental analysis and technical analysis?
Q5) How do technicians and professionals try to defend the importance of technical analysis?
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Chapter 11: Managing Bond Portfolios
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Sample Questions
Q1) In the empirical study of a multi-factor model by Chen,Roll,and Ross,a factor that appeared to have significant explanatory power in explaining security returns was
A) the change in the expected rate of inflation
B) the risk premium on bonds
C) the unexpected change in the rate of inflation
D) industrial production
E) b,c and d
Q2) Benchmark error
A) refers to the use of an incorrect market proxy in tests of the CAPM.
B) can result in inconclusive tests of the CAPM.
C) can result in incorrect evaluation measures for portfolio managers.
D) a and b.
E) a,b,and c.
Q3) Discuss the Black Jensen Scholes (BJS)study of the zero-beta version of the CAPM.
Q4) Describe some of the ways the CAPM is applied in practice.
Q5) Discuss the results of the studies of John Lintner (1965)and Merton Miller and Myron Scholes (1972)in terms of the validity of the capital asset pricing model (CAPM).
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Page 13
Chapter 12: Macroeconomic and Industry Analysis
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Sample Questions
Q1) You purchased an annual interest coupon bond one year ago with 6 years remaining to maturity at the time of purchase.The coupon interest rate is 10% and par value is $1,000.At the time you purchased the bond,the yield to maturity was 8%.If you sold the bond after receiving the first interest payment and the bond's yield to maturity had changed to 7%,your annual total rate of return on holding the bond for that year would have been _________.
A) 7.00%
B) 8.00%
C) 9.95%
D) 11.95%
E) none of these
Q2) A coupon bond that pays interest semi-annually has a par value of $1,000,matures in 5 years,and has a yield to maturity of 10%.The intrinsic value of the bond today will be __________ if the coupon rate is 12%.
A) $922.77
B) $924.16
C) $1,075.80
D) $1,077.22
E) none of these
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Page 14
Chapter 13: Equity Valuation
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Q1) An upward sloping yield curve
A) is an indication that interest rates are expected to increase.
B) incorporates a liquidity premium.
C) reflects the confounding of the liquidity premium with interest rate expectations.
D) all of these.
E) none of these.
Q2) If forward rates are known with certainty and all bonds are fairly priced
A) all bonds would have the same yield to maturity.
B) all short-maturity bonds would have lower prices than all long-maturity bonds.
C) all bonds would have the same price.
D) all bonds would provide equal 1-year rates of return.
E) none of these.
Q3) An upward sloping yield curve is a(n)_______ yield curve.
A) normal.
B) humped.
C) inverted.
D) flat.
E) none of these.
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Chapter 14: Financial Statement Analysis
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Sample Questions
Q1) The curvature of the price-yield curve for a given bond is referred to as the bond's
A) modified duration.
B) immunization.
C) sensitivity.
D) convexity.
E) tangency.
Q2) Holding other factors constant,which one of the following bonds has the smallest price volatility?
A) 5-year,0% coupon bond
B) 5-year,12% coupon bond
C) 5 year,14% coupon bond
D) 5-year,10% coupon bond
E) Cannot tell from the information given.
Q3) According to experts,most pension funds are underfunded because
A) their liabilities are of shorter duration than their assets.
B) their assets are of shorter duration than their liabilities.
C) they continually adjust the duration of their liabilities.
D) they continually adjust the duration of their assets.
E) they are too heavily invested in stocks.
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Page 16
Chapter 15: Options Markets
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Sample
Questions
Q1) Construction Machinery Company has an expected ROE of 11%.The dividend growth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends.
A) 3.0%
B) 4.8%
C) 8.25%
D) 9.0%
E) none of these
Q2) Fiscal policy generally has a _______ direct impact than monetary policy on the economy,and the formulation and implementation of fiscal policy is ______ than that of monetary policy.
A) more,quicker
B) more,slower
C) less,quicker
D) less,slower
E) Cannot tell from the information given
Q3) Describe the free cash flow approach to firm valuation.How does it compare to the dividend discount model (DDM)?
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Chapter 16: Option Valuation
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Q1) Which of the following are issues when dealing with the financial statements of international firms?
I.Many countries allow firms to set aside larger contingency reserves than the amounts allowed for Canadian firms.
II.Many firms outside Canada use accelerated depreciation methods for reporting purposes,whereas most Canadian firms use straight-line depreciation for reporting purposes.
III.Intangibles such as goodwill may be amortized over different periods or may be expensed rather than capitalized.
IV.There is no way to reconcile the financial statements of non-Canadian firms to GAAP.
A) I and II
B) II and IV
C) I,II,and III
D) I,III,and IV
E) I,II,III,and IV
Q2) Many different debt,or financial leverage,ratios are reported.Explain the relationship between total assets/equity and debt/equity.
Q3) The duPont system decomposes ROE into the following components:
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Chapter 17: Futures Markets and Risk Management
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Q1) Suppose the price of a share of IBM stock is $100.An April call option on IBM stock has a premium of $5 and an exercise price of $100.Ignoring commissions,the holder of the call option will earn a profit if the price of the share
A) increases to $104.
B) decreases to $90.
C) increases to $107.
D) decreases to $96.
E) none of these.
Q2) You purchased one BCE March 50 call and sold one BCE March 55 call.Your strategy is known as
A) a long straddle.
B) a horizontal spread.
C) a vertical spread.
D) a short straddle.
E) none of these.
Q3) Describe the protective put.What are the advantages of such a strategy?
Q4) Discuss the differences in writing covered and naked calls.Are risks involved in the two strategies similar or different? Explain.
Q5) List two types of exotic options and describe their characteristics.
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Chapter 18: Performance Evaluation and Active Portfolio Management
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Q1) Rubinstein (1994)observed that the performance of the Black-Scholes model had deteriorated in recent years,and he attributed this to
A) investor fears of another market crash.
B) higher than normal dividend payouts.
C) early exercise of American call options.
D) decreases in transaction costs.
E) none of these.
Q2) The elasticity of a stock call option is always
A) greater than one.
B) smaller than one.
C) negative.
D) infinite.
E) none of these.
Q3) Options sellers who are delta-hedging would most likely
A) sell when markets are falling
B) buy when markets are rising
C) both a and b.
D) sell whether markets are falling or rising.
E) buy whether markets are falling or rising.
Page 20
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Chapter 19: Globalization and International Investing
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Q1) You took a short position in two S&P 500 futures contracts at a price of 910 and closed the position when the index futures was 892,you incurred:
A) A gain of $9,000.
B) A loss of $9,000.
C) A loss of $18,000.
D) A gain of $18,000.
E) None of these.
Q2) Describe the differences between futures and forward contracts.
Q3) Which of the following is true about profits from futures contracts?
A) The person with the long position gets to decide whether to exercise the futures contract and will only do so if there is a profit to be made.
B) It is possible for both the holder of the long position and the holder of the short position to earn a profit.
C) The clearinghouse makes most of the profit.
D) The amount that the holder of the long position gains must equal the amount that the holder of the short position loses.
E) Holders of short positions can recognize profits by making delivery early.
Q4) Discuss marking to market and margin accounts in the futures market.
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Page 21
Chapter 20: Taxes, Inflation, and Investment Strategy
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Q1) The Treynor-Black model assumes that
A) the objective of security analysis is to form an active portfolio of a limited number of mispriced securities.
B) the cost of less than full diversification comes from the nonsystematic risk of the mispriced stock.
C) the optimal weight of a mispriced security in the active portfolio is a function of the degree of mispricing,the market sensitivity of the security,and its degree of nonsystematic risk.
D) All of these are true.
E) None of these is true.
Q2) The contribution of asset allocation across markets to the Highwater Marx Bros.'s total excess return was _________.
A) -1.80%
B) -1.00%
C) 0.80%
D) 1.00%
E) none of these
Q3) What is the problem with using the Sharpe measure for evaluation of an active portfolio management strategy?
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Chapter 21: Investors and the Investment Process
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Q1) The contribution of selection within markets to Wiseguys total excess return was
A) 1%
B) 3%
C) 4%
D) 5%
E) none of these
Q2) A purely passive strategy is defined as
A) one that uses only index funds.
B) one that allocates assets in fixed proportions that do not vary with market conditions.
C) one that is mean-variance efficient.
D) both a and b.
E) all of these.
Q3) The Treynor-Black model
A) considers both macroeconomic and microeconomic risks.
B) considers security selection only.
C) is relatively easy to implement.
D) a and c.
E) b and c.
Q4) Describe how one might hedge against systematic risk.
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Chapter 22: Mutual Fund: Objectives, Types, NAV, Turnover
Ratio, and More
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Q1) Assume that you manage a $1.3 million portfolio that pays no dividends,has a beta of 1.45 and an alpha of 1.5% per month.Also,assume that the risk-free rate is 0.025% (per month)and the S&P 500 is at 1220.If you expect the market to fall within the next 30 days you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).
A) selling 1
B) selling 6
C) buying 1
D) buying 6
E) selling 4
Q2) Discuss the relationships between investor objectives,constraints,and policies.
Q3) A bet on particular mispricing across two or more securities,with extraneous sources of risk such as general market exposure hedged away is a _____.
A) pure play
B) relative play
C) long shot
D) sure thing
E) B and D
Q4) Explain the five major differences between hedge funds and mutual funds.
Page 24
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Chapter 23: International Finance and Investments: Understanding Foreign Markets and Risks
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Q1) Assume there is a fixed exchange rate between the Canadian and U.S.dollar.The expected return and standard deviation of return on the U.S.stock market are 18% and 15%,respectively.The expected return and standard deviation on the Canadian stock market are 13% and 20%,respectively.The covariance of returns between the U.S.and Canadian stock markets is 1.5%.If you invested 50% of your money in the Canadian stock market and 50% in the U.S.stock market,the expected return on your portfolio would be
_________.
A) 12.0%
B) 12.5%
C) 13.0%
D) 15.5%
E) none of these
Q2) Home bias refers to
A) the tendency to vacation in your home country instead of traveling abroad.
B) the tendency to believe that your home country is better than other countries.
C) the tendency to give preferential treatment to people from your home country.
D) the tendency to overweight investments in your home country.
E) none of these
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