Financial Markets and Institutions
Exam Solutions
Course Introduction
This course offers a comprehensive overview of financial markets and institutions, exploring their essential roles within the global economy. Students will examine the structure and functions of various financial markets, including money, capital, and derivatives markets, as well as the major types of financial institutions such as banks, insurance companies, mutual funds, and investment firms. Topics include the regulation of financial markets, risk management, interest rate determination, and the impact of monetary policy. Through real-world examples and analytical frameworks, the course enables students to understand how financial markets and institutions facilitate the allocation of resources, promote economic growth, and manage financial risk.
Recommended Textbook
Intermediate Financial Management 13th Edition by Eugene F. Brigham
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Chapter 1: An Overview of Financial Management and the Financial Environment
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Q1) The form of organization for a business is not an important issue, as this decision has very little effect on the income and wealth of the firm's owners.
A)True
B)False
Answer: False
Q2) Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership
A) corporations generally find it relatively difficult to raise large amounts of capital.
B) less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership.
C) corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.
D) corporate investors are exposed to unlimited liability.
E) corporations generally face relatively few regulations.
Answer: C
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Chapter 2: Risk and Return-Part I
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Q1) The CAPM is a multi-period model that takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.
A)True
B)False
Answer: False
Q2) Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Which of the following statements is CORRECT (Assume that the stocks are in equilibrium.)
A) stock b has a higher required rate of return than stock a.
B) portfolio p has a standard deviation of 22.5%.
C) more information is needed to determine the portfolio's beta.
D) portfolio p has a beta of 1.0.
E) stock a's returns are less highly correlated with the returns on most other stocks than are b's returns.
Answer: D
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Page 4
Chapter 3: Risk and Return-Part II
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Q1) The slope of the SML is determined by the value of beta.
A)True
B)False
Answer: False
Q2) You hold a portfolio consisting of a $5,000 investment in each of 20 different stocks. The portfolio beta is equal to 1.12. You have decided to sell a coal mining stock (b = 1.00) at $5,000 net and use the proceeds to buy a like amount of a mineral rights company stock (b = 2.00). What is the new beta of the portfolio?
A) 1.1139
B) 1.1700
C) 1.2311
D) 1.2927
E) 1.3573
Answer: B
Q3) The Y-axis intercept of the SML indicates the return on an individual asset when the realized return on an average (b = 1) stock is zero.
A)True
B)False
Answer: False
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Chapter 4: Bond Valuation
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Sample Questions
Q1) A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?
A) the bond has a current yield greater than 8%.
B) the bond sells at a discount.
C) the bond's required rate of return is less than 7.5%.
D) if the yield to maturity remains constant, the price of the bond will decline over time.
E) the bond sells at a price below par.
Q2) A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates.
A)True
B)False
Q3) The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.
A)True
B)False
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Page 6
Chapter 5: Financial Options
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Q1) The current price of a stock is $50, the annual risk-free rate is 6%, and a 1-year call option with a strike price of $55 sells for $7.20. What is the value of a put option, assuming the same strike price and expiration date as for the call option?
A) $7.33
B) $7.71
C) $8.12
D) $8.55
E) $9.00
Q2) An option that gives the holder the right to sell a stock at a specified price at some future time is
A) a put option.
B) an out-of-the-money option.
C) a naked option.
D) a covered option.
E) a call option.
Q3) The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.
A)True
B)False
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Chapter 6: Accounting for Financial Management
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Q1) Which of the following statements is CORRECT?
A) in the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.
B) dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity. C) in the statement of cash flows, a decrease in accounts payable is reported as a use of cash.
D) in the statement of cash flows, depreciation charges are reported as a use of cash. E) in the statement of cash flows, a decrease in inventories is reported as a use of cash.
Q2) The income statement shows the difference between a firm's income and its costs i.e., its profits during a specified period of time. However, not all reported income comes in the form or cash, and reported costs likewise may not correctly reflect cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period.
A)True
B)False
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Chapter 7: Analysis of Financial Statements
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Sample Questions
Q1) A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger?
A) increase inventories while holding sales and cost of goods sold constant.
B) increase accounts receivable while holding sales constant.
C) increase ebit while holding sales constant.
D) increase accounts payable while holding sales constant.
E) increase notes payable while holding sales constant.
Q2) A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?
A) issue new common stock and use the proceeds to acquire additional fixed assets.
B) offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.
C) issue new common stock and use the proceeds to increase inventories.
D) speed up the collection of receivables and use the cash generated to increase inventories.
E) use some of its cash to purchase additional inventories.
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Chapter 8: Basic Stock Valuation
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Sample Questions
Q1) Orwell Building Supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 25% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock price?
A) $41.58
B) $42.64
C) $43.71
D) $44.80
E) $45.92
Q2) Hirshfeld Corporation's stock has a required rate of return of 10.25%, and it sells for $57.50 per share. The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-end dividend, D<sub>1</sub>?
A) $2.20
B) $2.44
C) $2.69
D) $2.96
E) $3.25
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Page 10
Chapter 9: Corporate Valuation and Financial Planning
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Q1) One of the necessary steps in the financial planning process is a forecast of financial statements under each alternative version of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios.
A)True
B)False
Q2) As a firm's sales grow, its current assets also tend to increase. For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneous liabilities that reduce AFN arise from transactions brought on by sales increases.
A)True
B)False
Q3) Operating plans sketch out broad approaches for realization of the firm's strategic vision. These plans usually are developed for a period no longer than a 1-year time horizon because detail is "lost" by extending out the time horizon by more than 1 year.
A)True
B)False
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Chapter 10: Corporate Governance
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Sample Questions
Q1) Which one of the following statements is TRUE?
A) one tool of corporate governance is how the company's charter affects the likelihood of a takeover.
B) one tool of corporate governance is stock repurchases.
C) one tool of corporate governance is a company's tax avoidance strategy.
D) one tool of corporate governance is choosing a good investment banker.
E) creditors have a claim on a firm's earning stream through the dividend payments they receive.
Q2) A company issues bonds saying that it will use the proceeds for a safe investment. Instead, it uses the proceeds for a risky investment. Which of the following statements is true about this situation.
A) this will result in a decrease in the value of the debt because the company is riskier.
B) this will result in a decrease in the value of the equity because the company is riskier.
C) this will result in a lawsuit from the stockholders because it is bait and switch.
D) this will cause bondholders to convert their bonds to stock.
E) dividends will go up to compensate shareholders for their increased risk.
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Chapter 11: Determining the Cost of Capital
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Q1) When estimating the cost of equity by use of the dividend growth method, the single biggest potential problem is to determine the growth rate that investors use when they estimate a stock's expected future rate of return. This problem leaves us unsure of the true value of rs.
A)True
B)False
Q2) You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of common from reinvested earnings?
A) 9.67%
B) 9.97%
C) 10.28%
D) 10.60%
E) 10.93%
Q3) The component costs of capital are market-determined variables in the sense that they are based on investors' required returns.
A)True
B)False
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Page 13
Chapter 12: Capital Budgeting: Decision Criteria
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) the irr method can never be subject to the multiple irr problem, while the mirr method can be.
B) one reason some people prefer the mirr to the regular irr is that the mirr is based on a generally more reasonable reinvestment rate assumption.
C) the higher the cost of capital, the shorter the discounted payback period.
D) the mirr method assumes that cash flows are reinvested at the crossover rate.
E) the mirr and npv decision criteria can never conflict.
Q2) A project's IRR is independent of the firm's cost of capital. In other words, a project's IRR doesn't change with a change in the firm's cost of capital.
A)True
B)False
Q3) No conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital exceeds the rate at which the projects' NPV profiles cross.
A)True
B)False
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Chapter 13: Capital Budgeting-Estimating Cash Flows and Analyzing Risk
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Q1) Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated.
A)True
B)False
Q2) Sensitivity analysis measures a project's stand-alone risk by showing how much the project's NPV (or IRR) is affected by a small change in one of the input variables, say sales. Other things held constant, with the size of the independent variable graphed on the horizontal axis and the NPV on the vertical axis, the steeper the graph of the relationship line, the more risky the project, other things held constant.
A)True
B)False
Q3) Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy. This is especially true for large product development projects.
A)True
B)False
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Chapter 14: Real Options
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Sample Questions
Q1) Refer to the data for Nationwide Pharmaceutical Corporation (NPC). Calculate the effect of waiting on the project's risk, using the same data. By how much will delaying reduce the project's coefficient of variation? (Hint: Use the expected NPV.) A) 2.23
Q2) Real options are most valuable when the underlying source of risk is very low.
A)True B)False
Q3) Real options affect the size, but not the risk, of a project's expected cash flows.
A)True B)False
Q4) The option to abandon a project is a real option, but a call option on a stock is not a real option.
A)True
B)False
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Chapter 15: Distributions to Shareholders-Dividends and Repurchases
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Q1) Harvey's Industrial Plumbing Supply's target capital structure consists of 40% debt and 60% equity. Its capital budget this year is forecast to be $650,000. It also wants to pay a dividend of $225,000. If the company follows the residual dividend policy, how much net income must it earn to meet its capital requirements, pay the dividend, and keep the capital structure in balance?
A) $584,250
B) $615,000
C) $645,750
D) $678,038
E) $711,939
Q2) If the signaling, hypothesis (which is also called the information content hypothesis) is correct, then changes in dividend policy can have an important effect on the firm's value and capital costs.
A)True
B)False
Q3) Stock dividends and stock splits should, at least conceptually, have the same effect on shareholders' wealth.
A)True
B)False
Page 17
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Chapter 16: Capital Structure Decisions
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Q1) Refer to the data for the Anson Jackson Court Company (AJC). The firm is considering moving to a capital structure that is comprised of 40% debt and 60% equity, based on market values. The new funds would be used to replace the old debt and to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on debt to rise to 7%, while the required rate of return on equity would rise to 9.5%. If this plan were carried out, what would be AJC's new WACC and total value?
A) 7.38%; $800,008
B) 7.38%; $813,008
C) 7.50%; $813,008
D) 7.50%; $790,008
E) 7.80%; $790,008
Q2) Refer to the data for Wilson Dover Inc. What is the value (in millions) of Wilson Dover's equity if it is viewed as an option?
A) $228.77
B) $254.19
C) $282.43
D) $313.81
E) $345.19
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Chapter 17: Dynamic Capital Structures and Corporate Valuation
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Q1) Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?
A) the value of a growing tax shield is greater than the value of a constant tax shield.
B) for a given d/s, the levered cost of equity is greater in the compressed apv model than the levered cost of equity under mm's original (with tax) assumptions.
C) for a given d/s, the wacc is greater in the compressed apv model than the wacc under mm's original (with tax) assumptions.
D) the total value of the firm increases with the amount of debt.
E) the tax shields should be discounted at the cost of debt.
Q2) Refer to data for Kitto Electronics. Using the compressed adjusted present value model, what is the value of Kitto's tax shield?
A) $156,385
B) $164,616
C) $173,280
D) $182,400
E) $192,000
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Q1) If its managers make a tender offer and buy all shares that were not held by the management team, this is called a private placement.
A)True
B)False
Q2) Which of the following is generally NOT true and an advantage of going public?
A) increases the liquidity of the firm's stock.
B) makes it easier to obtain new equity capital.
C) establishes a market value for the firm.
D) makes it easier for owner-managers to engage in profitable self-dealings.
E) facilitates stockholder diversification.
Q3) The term "leaving money on the table" refers to the situation where an investment banking house makes a very low bid for the right to underwrite a firm's new stock offering. The banker is, in effect, "buying the job" with the low bid and thus not getting all the money his firm would normally earn on the job.
A)True
B)False
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Chapter 19: Lease Financing
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Q1) Assume that a piece of leased equipment has a relatively high rather than low expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.
A)True
B)False
Q2) Financial Accounting Standards Board (FASB) Statement #13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the
A) residual value as a liability.
B) present value of future lease payments as an asset and also showing this same amount as an offsetting liability.
C) undiscounted sum of future lease payments as an asset and as an offsetting liability.
D) undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability.
E) residual value as a fixed asset.
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Chapter 20: Hybrid Financing Preferred Stock-Warrants and Convertibles
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Q1) The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.
A)True
B)False
Q2) The common stock of Southern Airlines currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2025. What is the conversion value of the bond?
A) $707.33
B) $744.56
C) $783.75
D) $825.00
E) $866.25
Q3) A detachable warrant is a warrant that can be detached and traded separately from the bond with which it was issued. Most traded warrants are originally attached to bonds or preferred stocks.
A)True B)False
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Chapter 21: Supply Chains and Working Capital Management
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Q1) Tierney Enterprises is constructing its cash budget. Its budgeted monthly sales are $5,000, and they are constant from month to month. 40% of its customers pay in the first month and take the 2% discount, while the remaining 60% pay in the month following the sale and do not receive a discount. The firm has no bad debts. Purchases for next month's sales are constant at 50% of projected sales for the next month. "Other payments," which include wages, rent, and taxes, are 25% of sales for the current month.
Construct a cash budget for a typical month and calculate the average net cash flow during the month.
A) $1,092
B) $1,150
C) $1,210
D) $1,271
E) $1,334
Q2) Net working capital, defined as current assets minus the sum of payables and accruals, is equal to the current ratio minus the quick ratio.
A)True
B)False
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Page 23
Chapter 22: Providing and Obtaining Credit
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Q1) The uncollected balances schedule is constructed at the end of a quarter by dividing the dollar amount of remaining receivables from each month in that quarter by that month's sales.
A)True
B)False
Q2) Suppose that you're planning a vacation and borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent, with interest prepaid (a discounted loan). Also, assume that the bank requires you to maintain a compensating balance equal to 20 percent of the initial loan value. What effective annual interest rate are you being charged?
A) 14.00%
B) 8.57%
C) 16.28%
D) 21.21%
E) 28.00%
Q3) Credit standards refer to the financial strength and importance of a potential customer to the firm required in order to qualify for credit.
A)True
B)False
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Chapter 23: Other Topics in Working Capital Management
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Q1) If a company increases its safety stock, then its EOQ will go up.
A)True
B)False
Q2) Gemini Inc.'s optimal cash transfer amount, using the Baumol model, is $60,000. The firm's fixed cost per cash transfer of marketable securities to cash is $180. In addition, the total estimated cash costs (transfers and carrying cost) for the firm, based on 16 transactions per year, are $5,760. On what opportunity cost of holding cash was this analysis based?
A) 19.2%
B) 10.4%
C) 6.3%
D) 12.1%
E) 9.6%
Q3) A just-in-time system is designed to stretch accounts payable as long as possible.
A)True
B)False
Q4) If a company increases its safety stock, then its average inventory will go up.
A)True
B)False
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Chapter 24: Enterprise Risk Management
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Q1) Suppose the September CBOT Treasury bond futures contract has a quoted price of 89'09. What is the implied annual interest rate inherent in this futures contract?
A) 6.32%
B) 6.65%
C) 7.00%
D) 7.35%
E) 7.72%
Q2) Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses.
A)True
B)False
Q3) One objective of risk management can be to reduce the volatility of a firm's cash flows.
A)True
B)False
Q4) In theory, reducing the volatility of its cash flows will always increase a company's value.
A)True B)False
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Chapter 25: Bankruptcy-Reorganization and Liquidation
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Q1) In the event of bankruptcy under the federal bankruptcy laws, debtholders have a prior claim to a firm's income and assets before both common and preferred stockholders. Moreover, in a bankruptcy all debtholders are treated equally as a single class of claimants.
A)True
B)False
Q2) A central question that must be addressed in bankruptcy proceedings is whether the firm's inability to meet scheduled interest payments results from a temporary cash flow problem or from a potentially permanent problem caused by falling asset values.
A)True
B)False
Q3) The primary test of feasibility in a reorganization is whether the firm's fixed charges after reorganization can be covered by its projected cash flows.
A)True
B)False
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Chapter 26: Mergers and Corporate Control
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Q1) Since the primary rationale for any operating merger is synergy, in planning such mergers, the development of accurate pro forma cash flows is the single most important action.
A)True
B)False
Q2) A parent holding company sells shares in its subsidiary such that the parent now owns only 65% of the subsidiary and, thus, the tax returns of the parent and its subsidiary can't be consolidated. The parent receives annual dividends from the subsidiary of $2,500,000. If the parent's marginal tax rate is 34% and if the exclusion on intercompany dividends is 70%, what is the effective tax rate on the intercompany dividends, and how much net dividends are received
A) 10.2%; $2,245,000
B) 10.2%; $2,135,000
C) 23.8%; $1,905,000
D) 10.2%; $1,750,000
E) 34.0%; $1,650,000
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Chapter 27: Multinational Financial Management
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Q1) If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the British pound will
A) depreciate against the u.s. dollar.
B) remain unchanged against the u.s. dollar.
C) appreciate against other major currencies.
D) appreciate against the dollar and other major currencies.
E) appreciate against the u.s. dollar.
Q2) If the spot rate of the Israeli shekel is 5.51 shekels per dollar and the 180-day forward rate is 5.97 shekels per dollar, then the forward rate for the Israeli shekel is selling at a ____ to the spot rate.
A) premium of 8%
B) premium of 18%
C) discount of 18%
D) discount of 8%
E) premium of 16%
Q3) Multinational financial management requires that financial analysts consider the effects of changing currency values.
A)True
B)False
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Page 29
Chapter 28: Time Value of Money
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Sample Questions
Q1) If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.
A)True
B)False
Q2) What is the present value of the following cash flow stream at a rate of 8.0%?
A) $7,917
B) $8,333
C) $8,772
D) $9,233
E) $9,695
Q3) What's the present value of a 4-year ordinary annuity of $2,250 per year plus an additional $3,000 at the end of Year 4 if the interest rate is 5%?
A) $8,509
B) $8,957
C) $9,428
D) $9,924
E) $10,446
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Page 30
Chapter 29: Basic Financial Tools: A review
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249 Verified Questions
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Sample Questions
Q1) The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
A) since the bonds have the same ytm, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
B) bond c sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
C) bond a sells at a discount (its price is less than par), and its price is expected to increase over the next year.
D) over the next year, bond a's price is expected to decrease, bond b's price is expected to stay the same, and bond c's price is expected to increase. E) bond a's current yield will increase each year.
Q2) Diversification will normally reduce the riskiness of a portfolio of stocks. A)True B)False
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Page 31
Chapter 30: Pension Plan Management
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Q1) Which of the following statements about pension plans if any, is incorrect?
A) under a defined benefit plan, the employer agrees to give retirees a specifically defined benefit, such as $500 per month or 50 percent of the employee's final salary.
B) a portable pension plan is one that an employee can carry from one employer to another.
C) an employer's obligation is satisfied under a defined contribution plan when it makes the required contributions to the plan. the risk of inadequate investment returns is borne by the employee.
D) if assets exceed the present value of benefits, the pension plan is fully funded.
E) a defined contribution plan is, in effect, a savings plan that is funded by employers, although many plans also permit additional contributions by employees.
Q2) Under a defined contribution plan, employees agree to contribute some percentage of their salaries, up to 20 percent, to the firm's pension fund.
A)True
B)False
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Chapter 31: Financial Management in Not for Profit
Businesses
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Q1) Which of the following statements about municipal bond financing is most correct?
A) whereas the vast majority of treasury and corporate bonds are held by institutions, no municipal bonds are held by individual investors.
B) the primary attraction of municipal bonds to individual investors is their high before-tax yields.
C) municipal bonds usually pay higher coupon rates than corporate bonds with similar ratings.
D) municipal bonds are risk-free.
E) in contrast to corporate bonds, municipal bond issues are not required to be registered with the securities and exchange commission.
Q2) The primary goal of investor-owned firms is shareholder wealth maximization, while the primary goal of not-for-profit firms is typically stated in terms of some mission; for example, to provide health care services to the communities served.
A)True
B)False
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