Financial Markets and Institutions
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Course Introduction
This course provides an in-depth exploration of the structure, functions, and operations of financial markets and institutions. Students will examine the roles that various financial intermediaries such as banks, insurance companies, and investment firms play in the economic system. The course covers fundamental concepts such as market efficiency, risk management, interest rates, and the regulatory environment governing financial entities. Emphasis will be placed on analyzing the interactions between financial markets and institutions, how they facilitate capital flows, and their impact on economic growth and stability.
Recommended Textbook
Fundamentals of Corporate Finance 4th Edition Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Q1) An S corporation earns $6.00 per share before taxes. The corporate tax rate is 35%, the personal tax rate on dividends is 20%, and the personal tax rate on non-dividend income is 39%. What is the total amount of taxes paid if the company pays a $2.00 dividend?
A) $1.87
B) $2.81
C) $3.28
D) $2.34
Answer: D
Q2) What is the bid-ask spread on the stock shown above?
A) 1 cent
B) 3 cents
C) 6 cents
D) 12 cents
Answer: B
Q3) It is generally not the duty of financial managers to ensure that a firm has the cash it needs for day-to-day transactions.
A)True
B)False
Answer: False
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) How can we cross check the statement of cash flows?
Answer: The last item in the statement of cash flows should equal the difference in cash balances between two adjacent balance sheets.
Q2) Which ratio would you use to measure the financial health of a firm by assessing that firm's leverage?
A) debt-equity or equity multiplier ratio
B) market-to-book ratio
C) market debt-equity ratio
D) current or quick ratio
Answer: A
Q3) If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in the balance sheet between 2007 and 2008?
A) The company is having difficulties selling its product.
B) The company has reduced its debt.
C) The company has added a major new asset in terms of plant and equipment.
D) The company has experienced a significant rise in its market value.
Answer: A
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Chapter 3: Time Value of Money: an Introduction
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Q1) A wholesale food retailer is offered $15.60 per two-layer carton for 5000 cartons of peaches. The wholesaler can buy peaches from their growers at $13.20 per carton. Shipping costs $2.40 per carton, for the first 1000 cartons, and $1.90 per carton for every carton over that. Will taking this opportunity increase the value of the wholesale food retailer?
A) No, the costs are $1500 more than the benefits.
B) No, the costs and the benefits are the same.
C) Yes, the costs are $2500 less than the benefits.
D) Yes, the costs are $2000 less than the benefits.
Answer: D
Q2) The Law of One Price states that if equivalent goods or securities are traded simultaneously in different competitive markets, they will trade for the same price in each market.
A)True
B)False
Answer: True
Q3) How does arbitrage help the Law of One Price?
Answer: Any arbitrage opportunity will exploit any mispricing to restore the Law of One Price.
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Page 5
Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) A lottery winner will receive $6 million at the end of each of the next twelve years. What is the future value (FV) of her winnings at the time of her final payment, given that the interest rate is 8.6% per year?
A) $94.40 million
B) $118.00 million
C) $165.20 million
D) $188.80 million
Q2) The present value (PV) of a stream of cash flows is just the sum of the present values of each individual cash flow.
A)True
B)False
Q3) Dan buys a property for $210,000. He is offered a 30-year loan by the bank, at an interest rate of 8% per year. What is the annual loan payment Dan must make?
A) $18,653.76
B) $22,384.51
C) $26,115.26
D) $29,846.02
Q4) Can we apply the growing perpetuity equation for negative growth as well?
Page 6
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Chapter 5: Interest Rates
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Q1) For a free-risk investment, the opportunity cost of capital will generally be more than the interest rate offered by U.S. Treasury securities with a similar term.
A)True
B)False
Q2) How do we handle a situation when both compounding period and cash flow interval are given to us but both are less than a year and not equal to each other?
Q3) A house costs $148,000. It is to be paid off in exactly ten years, with monthly payments of $1737.54. What is the APR of this loan?
A) 6.25%
B) 5.25%
C) 7.25%
D) 8.25%
Q4) After examining the yield curve, what predictions do you have about interest rates in the future? About future economic growth and the overall state of the economy?
Q5) What is the implied assumption about interest rates when using the built-in functions of a financial calculator to calculate the present value (PV) of an annuity?
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Chapter 6: Bonds
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Q1) A corporate bond makes payments of $9.67 every month for ten years with a final payment of $2009.67. Which of the following best describes this bond?
A) a 10-year bond with a face value of $2,000 and a coupon rate of 4.8% with monthly payments
B) a 10-year bond with a face value of $2,000 and a coupon rate of 5.8% with monthly payments
C) a 10-year bond with a face value of $2,009.67 and a coupon rate of 4.8% with monthly payments
D) a 10-year bond with a face value of $2,009.67 and a coupon rate of 5.8% with monthly payments
Q2) The current zero-coupon yield curve for risk-free bonds is shown above. What is the risk-free interest rate on a 4-year maturity?
A) 3.00%
B) 3.15%
C) 3.25%
D) 6.34%
Q3) How are the cash flows of a zero-coupon bond different from those of a coupon bond?
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Chapter 7: Stock Valuation
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Q1) The above screen shot from Google Finance shows the basic stock information for Logitech International SA (USA). What is Logitech International SA (USA)'s ticker symbol?
A) LIS
B) LOGITECH
C) LOG
D) LOGI
Q2) Von Bora Corporation (VBC) is expected to pay a $3.00 dividend at the end of this year. If you expect VBC's dividend to grow by 6% per year forever and VBC's equity cost of capital to be 13%, then the value of a share of VBC stock is closest to ________.
A) $42.86
B) $15.79
C) $25.72
D) $17.14
Q3) What is a major assumption about growth rate in the dividend-discount model?
Q4) Stocks that do not pay a dividend must have a value of $0.
A)True
B)False
Q5) How can the dividend-discount model handle changing growth rates?
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Page 9
Chapter 8: Investment Decision Rules
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Q1) A delivery service is buying 600 tires for its fleet of vehicles. One supplier offers to supply the tires for $80 per tire, payable in one year. Another supplier will supply the tires for $20,000 down today, then $45 per tire, payable in one year. What is the difference in PV between the first and the second offer, assuming interest rates are 8.1%?
A) -$860
B) -$229
C) -$574
D) $860
Q2) Which of the following situations can lead to IRR giving a different decision than NPV?
A) delayed investment
B) multiple IRRs
C) differences in project scale
D) All of the above can lead to IRR giving a different decision than NPV.
Q3) What is the decision criterion using the Net Present Value rule?
Q4) You can evaluate alternative projects with different lives by calculating and comparing their equivalent annual annuity.
A)True
B)False
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) The Sisyphean Company is considering a new project that will have an annual depreciation expense of $3.6 million. If Sisyphean's marginal corporate tax rate is 35% and its average corporate tax rate is 30%, then what is the value of the depreciation tax shield on the company's new project?
A) $1,080,000
B) $1,260,000
C) $1,890,000
D) $1,134,000
Q2) Which of the following best describes why the predicted incremental earnings arising from a given decision are not sufficient in and of themselves to determine whether that decision is worthwhile?
A) They do not tell how the decision affects the firm's reported profits from an accounting perspective.
B) They are not easily predicted from historical financial statements of a firm and its competitors.
C) These earnings are not actual cash flows.
D) They do not show how the firm's earnings are expected to change as the result of a particular decision.
Q3) Why does the option to abandon a project have value?
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Page 11
Chapter 10: Stock Valuation: a Second Look
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Q1) Disposition effect is the tendency of individual investors to ________.
A) trade too much based on the mistaken belief that they can pick winners and losers better than investment professionals
B) buy stocks that have been in the news, advertised more, have very high trading volume, or recently had extreme (high or low) returns
C) put too much weight on their own experience rather than considering historical evidence
D) hold on to stocks that have lost value and sell stocks that have risen in value since the time of purchase
Q2) Individual investors trade conservatively, given the difficulty of finding over-valued and under-valued stocks.
A)True
B)False
Q3) In an efficient market, investors will only find positive-NPV trading opportunities if they have some form of competitive advantage over other investors.
A)True
B)False
Q4) Which is the best valuation technique when using comparables?
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Chapter 11: Risk and Return in Capital Markets
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Q1) Consider an economy with two types of firms, S and I. S firms always move together, but I firms move independently of each other. For both types of firms there is a 70% probability that the firm will have a 20% return and a 30% probability that the firm will have a -30% return. The standard deviation for the return on an portfolio of 20 type S firms is closest to ________.
A) 13.75%
B) 22.91%
C) 5.00%
D) 4.58%
Q2) The S&P 500 index delivered a return of 20%, -10%, 20%, and 5% over four successive years. What is the arithmetic average annual return for four years?
A) 10.50%
B) 13.13%
C) 8.75%
D) 9.63%
Q3) Is volatility a reasonable measure of risk when evaluating large portfolios?
Q4) When looking at investment portfolios historically, was there a pattern between returns and volatility?
Q5) What are the two components of realized return from a stock investment?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) The price of Microsoft is $25 per share and that of Apple is $50 per share. The price of Microsoft increases to $36 per share after one year and to $41 after two years. Also, shares of Apple increase to $56 after one year and to $66 after two years. If your portfolio comprises 100 shares of each security, what is your portfolio return over year 1 and year 2? Assume no dividends are paid.
A) 21.53%, 14.67%
B) 22.67%, 16.30%
C) 24.93%, 18.75%
D) 22.21%, 18.26%
Q2) A portfolio has three stocks - 110 shares of Yahoo (YHOO), 210 Shares of General Motors (GM), and 70 shares of Standard and Poor's Index Fund (SPY). If the price of YHOO is $20, the price of GM is $20, and the price of SPY is $130, calculate the portfolio weight of YHOO and GM.
A) 10.6%, 13.5%
B) 9.9%, 25.7%
C) 13.5%, 24.4%
D) 14.2%, 27.1%
Q3) What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?
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Page 14
Chapter 13: The Cost of Capital
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Q1) Assume the market value of Fords' equity, preferred stock and debt are $7 billion, $4 billion and $10 billion respectively. Ford has a beta of 1.4, the market risk premium is 6% and the risk-free rate of interest is 4%. Ford's preferred stock pays a dividend of $3 each year and trades at a price of $25 per share. Ford's debt trades with a yield to maturity of 8.5%. What is Ford's weighted average cost of capital if its tax rate is 35%?
A) 7.69%
B) 8.15%
C) 8.60%
D) 9.05%
Q2) A firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's ________.
A) weighted average cost of capital
B) cost of equity infusion
C) cost of debt
D) cost of preferred stock
Q3) Should a firm with high retained earnings have a lower cost of equity?
Q4) Why do we use market values rather than book values in calculation of WACC?
Q5) What is the assumption about leverage when using WACC to evaluate a project?
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Chapter 14: Raising Equity Capital
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Q1) Braynerd Chemicals sells 40 million shares of stock in an SEO-25 million being primary shares issued by the company and 15 million being secondary shares sold by investors in the company. At the time of the sale, Braynerd's stock was selling at $21.00 per share. If the underwriter charges 5% of the gross proceeds as a fee, how much money was raised in the sale?
A) $374.06 million
B) $423.94 million
C) $498.75 million
D) $573.56 million
Q2) Neutrino Industries stock trades at $49 per share and there are 120 million shares outstanding. The management would like to raise $400 million in an SEO. If the underwriter charges 6% of gross proceeds, how many shares must it sell?
A) 7.38 million
B) 7.82 million
C) 8.25 million
D) 8.68 million
Q3) How do the transaction costs of IPO puzzle financial economists?
Q4) What are some of the disadvantages of going public?
Q5) What is the general long-run performance of an IPO?
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Chapter 15: Debt Financing
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Q1) What is a call provision?
A) the periodic repurchasing of issued bonds through a sinking fund by the issuer
B) an option to the issuer to repurchase the bonds at a predetermined price
C) the option for the bondholder to convert each bond owned into a fixed number of shares of common stock
D) a clause in a bond contract that restricts the actions of the issuer that might harm the interests of the bondholders
Q2) A company issues a callable (at par) five-year, 7% coupon bond with annual coupon payments. The bond can be called at par in one year after release or any time after that on a coupon payment date. On release, it has a price of $110 per $100 of face value. What is the yield to call of this bond when it is released?
A) 1.40%
B) 2.73%
C) 4.71%
D) 5.66%
Q3) Private debt cannot be in the form of bonds.
A)True
B)False
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17
Chapter 16: Capital Structure
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Q1) Even if two firms operate in the same industry, they may prefer different choices of debt-equity ratios.
A)True
B)False
Q2) Financial managers prefer to choose the same debt level no matter which industry they operate in.
A)True
B)False
Q3) A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?
A) 80%
B) 64%
C) 96%
D) 112%
Q4) Equity in a firm with no debt is called unlevered equity.
A)True
B)False
Q5) What effect does debt have on a firm's weighted average cost of capital?
Q6) What are indirect costs of financial distress?
Page 18
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Chapter 17: Payout Policy
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Q1) The firm will pay the dividend to all shareholders who are registered owners on a specific date, set by the board, called the ________.
A) declaration date
B) record date
C) distribution date
D) ex-dividend date
Q2) A(n) ________ is the most common way that firms repurchase shares.
A) targeted repurchase
B) Dutch auction share repurchase
C) tender offer
D) open market share repurchase
Q3) The date two business days prior to the date on which all shareholders of record receive a payment is called the ________ date.
A) declaration
B) record
C) ex-dividend
D) distribution
Q4) What are the characteristics of special dividend?
Q5) What choices does a firm have in using its free cash flow?
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) How do we know if expansion is a good idea for the firm?
Q2) Forecasting a balance sheet with percent of sales method requires two passes-a first pass to determine financing needs and a second pass that shows the sources and amounts of financing.
A)True
B)False
Q3) Assuming that Ideko has an EBITDA multiple of 8.5, then the continuation levered price-earnings ratio of Ideko in 2015 is closest to ________.
A) 19.0
B) 17.2
C) 16.4
D) 14.5
Q4) What is common starting point for forecasting?
Q5) What is minimum required cash?
Q6) Long term financial planning helps a financial manager in budgeting but has little to do with understanding how the business operates.
A)True
B)False
Q7) How do we compute net new financing?
20
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Chapter 19: Working Capital Management
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Q1) Ally Manufacturing has an average accounts payable balance of $420,000. Its average annual cost of goods sold is $10,220,000. It receives terms of 2/15 net 30 from its suppliers. Is Ally managing its accounts payables well?
A) Yes, since it, on average, chooses not to take the discount, but pays when payment is due.
B) Yes, since it, on average, takes the discount, and pays at the end of the discount period.
C) Yes, since it, on average, stretches payment beyond the due payment date.
D) No, since it, on average, does not take advantage of the discount period and pays well before payment is due.
Q2) The three steps in establishing a credit policy are establishing credit standards, establishing credit terms, and establishing a collection policy.
A)True
B)False
Q3) What are the five C's of Credit?
Q4) What is discount period?
Q5) What is credit period?
Q6) Can a firm's cash cycle be longer than a firm's operating cycle?
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Chapter 20: Short-Term Financial Planning
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Q1) Which of the following best describes a bank loan arrangement where a bank agrees to lend a firm any amount up to a stated maximum in an informal agreement which does not legally bind the bank to provide the funds?
A) single, end-of-period payment loan
B) bridge loan
C) committed line of credit
D) uncommitted line of credit
Q2) Which of the following is a financing arrangement in which the lender's claim on the borrower's assets in the event of a default is limited to only explicitly pledged collateral?
A) without recourse
B) with recourse
C) without factoring
D) with factoring
Q3) Commercial paper is usually a more expensive source of funds than a short-term bank loan.
A)True
B)False
Q4) What do we understand by seasonality?
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Chapter 21: Option Applications and Corporate Finance
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Q1) What is the short position of an options contract?
Q2) Which of the following statements is FALSE?
A) Options also allow investors to speculate, or place a bet on the direction in which they believe the market is likely to move.
B) Options where the strike price and the stock price are very far apart are referred to as deep in-the-money or deep out-of-the-money.
C) Call options with strike prices above the current stock price are in-the-money, as are put options with strike prices below the current stock price.
D) European options allow their holders to exercise the option only on the expiration date-holders cannot exercise before the expiration date.
Q3) Suppose that a stock sells at a price of $60 on the expiration date. Compute the payoff to the seller of a put option if the option strike price is $80.
A) -$20
B) -$10
C) 0
D) $40
Q4) When is an option at-the-money?
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Chapter 22: Mergers and Acquisitions
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Q1) Which of the following statements regarding efficiency gains is FALSE?
A) Takeovers relying on the improvement of target management are difficult to complete, and post-takeover resistance to change can be great. Thus not all inefficiently run organizations are necessarily more efficient following a takeover.
B) Although identifying poorly performing corporations is relatively easy, fixing them is another matter entirely.
C) A justification that acquirers cite for paying a premium for a target is efficiency gains, which are often achieved through an elimination of duplication.
D) A chief executive of an inefficiently run corporation can be ousted by current shareholders voting to replace the board of directors, and in fact a large number of ineffective managers are replaced in this way.
Q2) Most acquirers pay an acquisition premium for a target. Upon announcement of the bid, the target's stock price increases, on average, so that the stock price is the same as the price bid by the acquirer.
A)True
B)False
Q3) What is a white knight?
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Page 24
Chapter 23: International Corporate Finance
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Q1) Assume IBM enters into a forward contract to purchase 100,000 euros at a rate of $1.60/euro one year from today. If the spot exchange rate is $2/euro one year later, what is the dollar amount that IBM must pay to receive the euros?
A) $100,000
B) $160,000
C) $200,000
D) $300,000
Q2) Firms use forward foreign exchange contracts rather than a cash-and-carry strategy because ________.
A) of lower transaction costs
B) of inability to borrow in different currencies
C) of higher interest costs if credit quality is poor
D) all of the above
Q3) Hedging with currency options involves a commitment by a firm to buy currency at a fixed rate.
A)True
B)False
Q4) What is a currency forward contract?
Q5) What is cash-and-carry strategy?
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Chapter 24: Leasing
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Q1) Suppose the lease is a five-year fair market value lease, and the trucks have a remaining useful life of 8 years. If the monthly lease payments are $25,000 and the appropriate discount rate is 6% APR with monthly compounding, will the lease be classified as an operating lease or a capital lease for the lessee?
A) Capital lease, because the title to the property transfers to the lessee at the end of the lease term.
B) Capital lease, because the present value of the minimum lease payments at the start of the lease is 90% or more of the asset's fair value.
C) Operating lease, because the present value of the minimum lease payments at the start of the lease is less than 90% of the asset's fair value.
D) Operating lease, because the lease term is more than 75% of the estimated economic life of the asset.
Q2) Which of the following is considered an unfair comparison?
A) FMV lease versus $1.00-out lease
B) $1.00-out lease versus true tax lease
C) lease versus buy
D) lease versus borrow
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Page 26
Chapter 25: Insurance and Risk Management
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Q1) Which of the following statements is FALSE?
A) Because insurance reduces the risk of financial distress, it can relax this tradeoff and allow the firm to increase its use of debt financing.
B) By lowering the volatility of the stock, insurance can discourage concentrated ownership by an outside director or investor who will monitor the firm and its management.
C) When a firm is subject to graduated income tax rates, insurance can produce a tax savings if the firm is in a higher tax bracket when it pays the premium than the tax bracket it is in when it receives the insurance payment in the event of a loss.
D) In a perfect market without other frictions, insurance companies should compete until they are just earning a fair return and the NPV from selling insurance is zero. The NPV is zero if the price of insurance equals the present value of the expected payment; in that case, we say the price is actuarially fair.
Q2) What is the actuarially fair cost of full insurance?
Q3) Assuming that your firm will purchase insurance, what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
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Page 27
Chapter 26: Corporate Governance
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Q1) Which of the following statements is FALSE?
A) The incentives come from owning stock in the company and from compensation that is sensitive to performance.
B) The role of the corporate governance system is to mitigate the conflict of interest that results from the combination of ownership and control without unduly burdening managers with the risk of the firm.
C) Punishment comes when a board fires a manager for poor performance or fraud, or when, upon failure of the board to act, shareholders or raiders launch control contests to replace the board and management.
D) The corporate governance system attempts to align interests by providing incentives for taking the right action and punishments for taking the wrong action.
Q2) Directors who are not as directly connected to the firm but who have existing or potential business relationships with the firm are called ________.
A) gray directors
B) independent directors
C) advising directors
D) inside directors
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