Financial Markets and Institutions
Practice Questions
Course Introduction
This course offers a comprehensive introduction to the structure, functions, and dynamics of financial markets and institutions, both domestically and globally. Students will explore the roles of various financial instruments, such as bonds, stocks, and derivatives, and analyze how financial institutions like banks, insurance companies, mutual funds, and investment firms facilitate capital flow, manage risk, and foster economic growth. The course covers key concepts including interest rates, financial regulation, market efficiency, and the impact of monetary policy on financial systems. Through real-world examples and case studies, students will gain an understanding of the challenges and opportunities in contemporary financial environments.
Recommended Textbook Fundamentals of Corporate Finance 11thEdition by Stephen Ross
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Chapter 1: Introduction to Corporate Finance
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Q1) Sam,Alfredo,and Juan want to start a small U.S.business.Juan will fund the venture but wants to limit his liability to his initial investment and has no interest in the daily operations.Sam will contribute his full efforts on a daily basis but has limited funds to invest in the business.Alfredo will be involved as an active consultant and manager and will also contribute funds.Sam and Alfredo are willing to accept liability for the firm's debts as they feel they have nothing to lose by doing so.All three individuals will share in the firm's profits and wish to keep the initial organizational costs of the business to a minimum.Which form of business entity should these individuals adopt?
A)sole proprietorship
B)joint stock company
C)limited partnership
D)general partnership
E)corporation
Answer: C
Q2) Describe the key advantages associated with the corporate form of organization.
Answer: The advantages of the corporate form of organization are the ease of transferring ownership,the owners' limited liability for business debts,the ability to raise large amounts of capital,and the potential for an unlimited life for the organization.
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Page 3
Chapter 2: Financial Statements, Taxes, and Cash Flow
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Sample Questions
Q1) Which one of these is most apt to be a fixed cost?
A)raw materials
B)manufacturing wages
C)management bonuses
D)office salaries
E)shipping and freight
Answer: D
Q2) Assume you are the financial officer of a major firm.The president of the firm has just stated that she wishes to reduce the firm's investment in current assets since those assets provide little,if any,return to the firm.How would you respond to this statement? Answer: While it is true that current assets provide a low rate of return,those assets are essential to the firm's liquidity.Should the liquid assets be reduced too low,the firm could face a much greater problem than a low rate of return.That problem would be the inability to meet the firm's financial obligations which could even result in a bankruptcy due to a lack of cash flow.
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4
Chapter 3: Working With Financial Statements
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Sample Questions
Q1) The sources and uses of cash over a stated period of time are reflected on the:
A)income statement.
B)balance sheet.
C)tax reconciliation statement.
D)statement of cash flows.
E)statement of operating position.
Answer: D
Q2) A firm has total assets of $310,100 and net fixed assets of $168,500.The average daily operating costs are $2,980.What is the value of the interval measure?
A)31.47 days
B)47.52 days
C)56.22 days
D)68.05 days
E)104.62 days
Answer: B
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Chapter 4: Long-Term Financial Planning and Growth
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Q1) The sustainable growth rate of a firm is best described as the:
A)minimum growth rate achievable assuming a 100 percent retention ratio.
B)minimum growth rate achievable if the firm maintains a constant equity multiplier.
C)maximum growth rate achievable excluding external financing of any kind.
D)maximum growth rate achievable excluding any external equity financing while maintaining a constant debt-equity ratio.
E)maximum growth rate achievable with unlimited debt financing.
Q2) The plowback ratio is:
A)equal to net income divided by the change in total equity.
B)the percentage of net income available to the firm to fund future growth.
C)equal to one minus the retention ratio.
D)the change in retained earnings divided by the dividends paid.
E)the dollar increase in net income divided by the dollar increase in sales.
Q3) Which one of the following statements is correct?
A)Pro forma statements must assume that no new equity is issued.
B)Pro forma statements are projections, not guarantees.
C)Pro forma statements are limited to a balance sheet and income statement.
D)Pro forma financial statements must assume that no dividends will be paid.
E)Net working capital needs are excluded from pro forma computations.
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Page 6
Chapter 5: Introduction to Valuation: The Time Value of Money
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Sample Questions
Q1) Steve invested $100 two years ago at 10 percent interest.The first year,he earned $10 interest on his $100 investment.He reinvested the $10.The second year,he earned $11 interest on his $110 investment.The extra $1 he earned in interest the second year is referred to as:
A)free interest.
B)bonus income.
C)simple interest.
D)interest on interest.
E)present value interest.
Q2) You are scheduled to receive $30,000 in two years.When you receive it,you will invest it for 5 more years,at 6 percent per year.How much money will you have 7 years from now?
A)$38,909.19
B)$39,381.16
C)$40,146.77
D)$47,209.19
E)$51,414.73
Q3) What lesson does the future value formula provide for young workers who are looking ahead to retiring some day?
Page 7
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Chapter 6: Discounted Cash Flow Valuation
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Sample Questions
Q1) Theresa adds $1,500 to her savings account on the first day of each year.Marcus adds $1,500 to his savings account on the last day of each year.They both earn 6.5 percent annual interest.What is the difference in their savings account balances at the end of 35 years?
A)$12,093
B)$12,113
C)$12,127
D)$12,211
E)$12,219
Q2) Kristie owns a perpetuity which pays $12,000 at the end of each year.She comes to you and offers to sell you all of the payments to be received after the 10<sup>th</sup> year.Explain how you can determine the value of this offer.
Q3) How is the principal amount of an interest-only loan repaid?
A)The principal is forgiven over the loan period so does not have to be repaid.
B)The principal is repaid in equal increments and included in each loan payment.
C)The principal is repaid in a lump sum at the end of the loan period.
D)The principal is repaid in equal annual payments.
E)The principal is repaid in increasing increments through regular monthly payments.
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Chapter 7: Interest Rates and Bond Valuation
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Sample Questions
Q1) Global Communications has a 7 percent,semiannual coupon bond outstanding with a current market price of $1,023.46.The bond has a par value of $1,000 and a yield to maturity of 6.72 percent.How many years is it until this bond matures?
A)12.26 years
B)12.53 years
C)18.49 years
D)24.37 years
E)25.05 years
Q2) You own a bond that has a 6 percent annual coupon and matures 5 years from now.You purchased this 10-year bond at par value when it was originally issued.Which one of the following statements applies to this bond if the relevant market interest rate is now 5.8 percent?
A)The current yield-to-maturity is greater than 6 percent.
B)The current yield is 6 percent.
C)The next interest payment will be $30.
D)The bond is currently valued at one-half of its issue price.
E)You will realize a capital gain on the bond if you sell it today.
Q3) Explain the conditions that would need to exist for the Treasury yield curve to be downward sloping.
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Page 9
Chapter 8: Stock Valuation
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Sample Questions
Q1) Combined Communications is a new firm in a rapidly growing industry.The company is planning on increasing its annual dividend by 15 percent a year for the next 4 years and then decreasing the growth rate to 3.5 percent per year.The company just paid its annual dividend in the amount of $0.20 per share.What is the current value of one share of this stock if the required rate of return is 15.5 percent?
A)$1.82
B)$2.04
C)$2.49
D)$2.71
E)$3.05
Q2) Kelley wants to purchase shares in Classic Kars,Inc.,but is torn between buying shares of common stock or shares of preferred stock.What should he consider before determining the type of share he should purchase?
Q3) Using the dividend growth model,explain why a firm would be hesitant to reduce the growth rate of its dividends.
Q4) What are the primary differences and similarities between NASDAQ and the NYSE?
Q5) Explain why small shareholders should prefer cumulative voting over straight voting.
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Page 10
Chapter 9: Net Present Value and Other Investment Criteria
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Q1) Tedder Mining has analyzed a proposed expansion project and determined that the internal rate of return is lower than the firm desires.Which one of the following changes to the project would be most expected to increase the project's internal rate of return?
A)decreasing the required discount rate
B)increasing the initial investment in fixed assets
C)condensing the firm's cash inflows into fewer years without lowering the total amount of those inflows
D)eliminating the salvage value
E)decreasing the amount of the final cash inflow
Q2) Scott is considering a project that will produce cash inflows of $2,100 a year for 4 years.The project has a 12 percent required rate of return and an initial cost of $6,000.What is the discounted payback period?
A)3.72 years
B)3.91 years
C)4.26 years
D)4.38 years
E)never
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Chapter 10: Making Capital Investment Decisions
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Sample Questions
Q1) The net book value of equipment will:
A)remain constant over the life of the equipment.
B)vary in response to changes in the market value.
C)decrease at a constant rate when MACRS depreciation is used.
D)increase over the taxable life of an asset.
E)decrease slower under straight-line depreciation than under MACRS.
Q2) The Pancake House has sales of $1,642,000,depreciation of $27,000,and net working capital of $218,000.The firm has a tax rate of 35 percent and a profit margin of 6 percent.The firm has no interest expense.What is the amount of the operating cash flow?
A)$98,520
B)$125,520
C)$147,480
D)$268,480
E)$343,520
Q3) How can two firms arrive at two different bid prices when bidding for the same job and given the same bid specifications?
Q4) In a single sentence,explain how you can determine which cash flows should be included in the analysis of a project.
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Page 12
Chapter 11: Project Analysis and Evaluation
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Q1) Scenario analysis is best suited to accomplishing which one of the following when analyzing a project?
A)determining how fixed costs affect NPV
B)estimating the residual value of fixed assets
C)identifying the potential range of reasonable outcomes
D)determining the minimal level of sales required to break-even on an accounting basis
E)determining the minimal level of sales required to break-even on a financial basis
Q2) Scenario analysis is defined as the:
A)determination of the initial cash outlay required to implement a project.
B)determination of changes in NPV estimates when what-if questions are posed.
C)isolation of the effect that a single variable has on the NPV of a project.
D)separation of a project's sunk costs from its opportunity costs.
E)analysis of the effects that a project's terminal cash flows has on the project's NPV.
Q3) Assume that a country experiences a financial crisis that causes the nation's financial markets to freeze in a manner that prevents a private firm from raising capital from any source.Explain how project analysis conducted by that firm would work in this situation.
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Page 13
Chapter 12: Some Lessons From Capital Market History
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Q1) A stock has a geometric average return of 14.6 percent and an arithmetic average return of 15.5 percent based on the last 33 years.What is the estimated average rate of return for the next 6 years based on Blume's formula?
A)14.79 percent
B)14.96 percent
C)15.28 percent
D)15.36 percent
E)15.42 percent
Q2) You want to invest in an index fund which directly correlates to the overall U.S.stock market.How can you determine if the market risk premium you are expecting to earn is reasonable for the long-term?
Q3) A stock had returns of 16 percent,4 percent,8 percent,14 percent,-9 percent,and -5 percent over the past six years.What is the geometric average return for this time period?
A)4.26 percent
B)4.67 percent
C)5.13 percent
D)5.39 percent
E)5.60 percent
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Page 14
Chapter 13: Return, Risk, and the Security Market Line
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Q1) Systematic risk is measured by:
A)the mean.
B)beta.
C)the geometric average.
D)the standard deviation.
E)the arithmetic average.
Q2) The principle of diversification tells us that:
A)concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk.
B)concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk.
C)spreading an investment across five diverse companies will not lower the total risk.
D)spreading an investment across many diverse assets will eliminate all of the systematic risk.
E)spreading an investment across many diverse assets will eliminate some of the total risk.
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15
Chapter 14: Cost of Capital
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Sample Questions
Q1) Justice,Inc.has a capital structure which is based on 30 percent debt,5 percent preferred stock,and 65 percent common stock.The flotation costs are 11 percent for common stock,10 percent for preferred stock,and 7 percent for debt.The corporate tax rate is 37 percent.What is the weighted average flotation cost?
A)8.97 percent
B)9.48 percent
C)9.62 percent
D)9.75 percent
E)10.00 percent
Q2) Southern Home Cookin' just paid its annual dividend of $0.65 a share.The stock has a market price of $13 and a beta of 1.12.The return on the U.S.Treasury bill is 2.5 percent and the market risk premium is 6.8 percent.What is the cost of equity?
A)9.98 percent
B)10.04 percent
C)10.12 percent
D)10.37 percent
E)10.45 percent
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Page 16
Chapter 15: Raising Capital
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Sample Questions
Q1) Wagner Trucking is considering investing in a new project that will cost $13 million and increase net income by 6.5 percent.This project will be completely funded by issuing new equity shares.Currently,the firm has 1.25 million shares of stock outstanding with a market price of $42 per share.The current earnings per share are $1.82.What will the earnings per share be if the project is implemented?
A)$1.39
B)$1.45
C)$1.55
D)$1.62
E)$1.69
Q2) Precise Machining is considering a rights offer.The company has determined that the ex-rights price would be $46.The current price is $53 per share,and there are 7 million shares outstanding.The rights offer would raise a total of $70 million.What is the subscription price?
A)$26.48
B)$27.06
C)$27.50
D)$28.18
E)$29.10
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Chapter 16: Financial Leverage and Capital Structure Policy
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Q1) The optimal capital structure:
A)will be the same for all firms in the same industry.
B)will remain constant over time unless the firm changes its primary operations.
C)will vary over time as taxes and market conditions change.
D)places more emphasis on operations than on financing.
E)is unaffected by changes in the financial markets.
Q2) The present value of the interest tax shield is expressed as:
A)(T<sub>C</sub> × D)/R<sub>A.</sub>
B)V<sub>U</sub> + (T<sub>C</sub> × D).
C)[EBIT × (T<sub>C</sub> × D)]/R<sub>U</sub>.
D)[EBIT × (T<sub>C</sub> × D)]/R<sub>A.</sub>
E) T<sub>C</sub> × D.
Q3) You have computed the break-even point between a levered and an unlevered capital structure.Assume there are no taxes.At the break-even level,the:
A)firm is just earning enough to pay for the cost of the debt.
B)firm's earnings before interest and taxes are equal to zero.
C)earnings per share for the levered option are exactly double those of the unlevered option.
D)advantages of leverage exceed the disadvantages of leverage.
E)firm has a debt-equity ratio of .50.
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Chapter 17: Dividends and Payout Policy
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Q1) Jenningston Mills has a market value equal to its book value.Currently,the firm has excess cash of $1,200,other assets of $5,800,and equity valued at $3,750.The firm has 250 shares of stock outstanding and net income of $420.What will the new earnings per share be if the firm uses 25 percent of its excess cash to complete a stock repurchase?
A)$1.83
B)$1.89
C)$1.96
D)$2.00
E)$2.08
Q2) A reverse stock split is defined as:
A)an increase in the number of shares outstanding that does not affect owners' equity.
B)a firm buying back existing shares of its stock on the open market.
C)a firm selling new shares of stock on the open market.
D)a decrease in the number of shares outstanding that does not affect owners' equity. E)a decrease in both the number of shares outstanding and the price per share.
Q3) Explain how cash dividends affect individual shareholders differently than an equal amount of funds spent on a repurchase.
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Chapter 18: Short-Term Finance and Planning
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Q1) New Town Bank offers you a $40,000 line of credit with an interest rate of 1.6 percent per quarter.The loan agreement also requires that 3 percent of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance.Short-term investments are currently paying 1.1 percent per quarter.What is the effective annual interest rate on the line of credit if you borrow the entire $40,000 for one year? Assume any funds borrowed or invested use compound interest.
A)4.47 percent
B)4.58 percent
C)6.56 percent
D)7.78 percent
E)12.33 percent
Q2) Details Corp.has a book net worth of $8,150.Long-term debt is $1,800.Net working capital,other than cash,is $2,150.Fixed assets are $2,000.How much cash does the company have?
A)$4,250
B)$4,550
C)$5,150
D)$5,800
E)$6,750
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Page 20
Chapter 19: Cash and Liquidity Management
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Q1) Yesterday,the president of RB Enterprises received a phone call from DLK,a competitor.DLK is a sole proprietorship.An unexpected family situation has caused the owner to suddenly want to retire and relocate closer to his family.Thus,the assets of DLK are being offered to RB Enterprises at a bargain basement price.While RB Enterprises had not anticipated purchasing these assets,it was decided that the opportunity was too good to pass up.This illustrates which of the following needs to hold cash?
A)precautionary
B)transaction
C)speculative
D)compensation
E)float
Q2) Which one of the following statements is correct?
A)Net float decreases every time a firm issues a check to pay one of its suppliers.
B)A positive net float indicates that collection float exceeds disbursements float.
C)Firms prefer a zero net float over a positive net float.
D)Net float is equal to collection float minus disbursement float.
E)Net float is equal to a firm's available balance minus its book balance.
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Chapter 20: Credit and Inventory Management
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Q1) The best-selling pair of roller skates The Teen Store offers sells for $79.99 a pair.The store consistently sells 5,700 pairs of these roller skates every year.The fixed costs to order more skates is $68 and the carrying costs are $1.95 per pair.What is the economic order quantity?
A)446 pairs
B)515 pairs
C)529 pairs
D)631 pairs
E)648 pairs
Q2) Jillian was recently hired by a major retail store.Her job is to determine the probability that individual customers will fail to pay for their charge sales.Jillian's job best relates to which one of the following?
A)terms of sale
B)credit analysis
C)collection policy
D)payables policy
E)customer service
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Chapter 21: International Corporate Finance
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Q1) You want to invest in a project in Canada.The project has an initial cost of C$2.2 million and is expected to produce cash inflows of C$900,000 a year for 3 years.The project will be worthless after the first 3 years.The expected inflation rate in Canada is 4 percent while it is only 3 percent in the U.S.The applicable interest rate for the project in Canada is 13 percent.The current spot rate is C$1 = $0.8158.What is the net present value of this project in Canadian dollars?
A)-C$91,889
B)-C$87,924
C)-C$74,963
D)C$165,139
E)C$167,528
Q2) Which one of the following names matches the country where the bond is issued?
A)Empire: United Kingdom
B)Western: United States
C)Samurai: China
D)Bulldog: France
E)Rembrandt: Netherlands
Q3) Using currencies A,B,and C construct an example in which triangle arbitrage exists and then show how to exploit it.
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Page 23
Chapter 22: Behavioral Finance: Implications for Financial Management
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Q1) In an efficient market,it is believed by some individuals that the actions of traders who constantly buy and sell on any perceived market mispricings will in effect cause market prices to correctly reflect asset values.A person who believes that the actions of these traders will not result in correctly valued prices are most apt to believe in which one of the following?
A)gambler's fallacy
B)limits to arbitrage
C)availability bias
D)false consensus
E)clustering illusion
Q2) Which one of the following statements is true?
A)Market crashes tend to be accompanied by low market volume.
B)The Asian market crash was followed by a quick recovery.
C)The market crash of 1929 and the crash of 1987 are very similar in both the percentage decline in market value and in the ensuing market recovery.
D)Market crashes tend to follow market bubbles.
E)Market bubbles and crashes prove that financial markets are inefficient.
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Page 24
Chapter 23: Enterprise Risk Management
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Q1) What are the primary motives for a hedger and a speculator in the derivatives market?
If a wheat farmer sells wheat futures,is that hedging or speculating? Explain.
Q2) By hedging financial risk,a firm can:
A)ensure a steady rate of return for its shareholders.
B)eliminate price changes over the long-term.
C)ensure its own economic viability.
D)gain time to adapt to changing market conditions.
E)eliminate its exposure to price increases in raw materials.
Q3) Which one of the following is the primary difference between a swap contract and a forward contract?
A)underlying asset
B)number of exchanges
C)daily marking to the market
D)option versus obligation
E)time of payment
Q4) Explain why a swap is effectively a series of forward contracts.
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25
Chapter 24: Options and Corporate Finance
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Q1) Which one of the following describes the maximum value of a call option?
A)strike price minus the initial cost of the option
B)exercise price plus the price of the underlying stock
C)strike price
D)market price of the underlying stock
E)purchase price
Q2) Which of the following will decrease the value of a call option?
I.a decrease in the exercise price
II.a decrease in the value of the underlying security
III.an increase in the risk-free rate
IV.an increase in the time to expiration
A)II only
B)I and II only
C)III and IV only
D)I, II, and IV only
E)I, II, and III only
Q3) Circle Stores stock is priced at $28 a share.A $40 call on this stock has five months until expiration and a call price of $0.15.Why would an investor purchase a call that is so far out of the money?
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Page 26
Chapter 25: Option Valuation
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Q1) A firm has assets of $21.8 million and a 3-year,zero-coupon,risky bonds with a total face value of $8.5 million.The bonds have a total current market value of $8.1 million.How can the shareholders of this firm change these risky bonds into risk-free bonds?
A)purchase a call option with a 1-year life and a $8.1 million face value
B)purchase a call option with a 5-year life and a $8.5 million face value
C)purchase a put option with a 1-year life and a $21.8 million face value
D)purchase a put option with a 3-year life and a $8.1 million face value
E)purchase a put option with a 3-year life and an $8.5 million face value
Q2) Which of the following variables are included in the Black-Scholes call option pricing formula?
I.put premium
II.N(d<sub>1</sub>)
III.exercise price
IV.stock price
A)III and IV only
B)I, II, and IV only
C)II, III, and IV only
D)I, III, and IV only
E)I, II, III, and IV
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Page 27
Chapter 26: Mergers and Acquisitions
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Sample Questions
Q1) An acquisition completed simply to diversify a firm will:
A)create excessive synergy in almost all situations.
B)lower systematic risk and increase the value of the firm.
C)benefit the firm by eliminating unsystematic risk.
D)benefit the shareholders by providing otherwise unobtainable diversification.
E)generally not add any value to the firm.
Q2) Alliance Chemicals recently acquired Swenson Industries in a transaction that produced a NPV of $1.3 million.This NPV is referred to as:
A)the agency effect.
B)the consolidating value.
C)diversification.
D)the consolidation effect.
E)synergy.
Q3) Firms can frequently create synergy by merging and sharing complementary resources with another firm.Give two examples of situations where this would most likely occur.
Q4) Identify the three basic legal procedures that one firm can use to acquire another and briefly discuss the advantages and disadvantages of each.
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Chapter 27: Leasing
Available Study Resources on Quizplus for this Chatper
72 Verified Questions
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Sample Questions
Q1) A financial lease in which the lessor is the owner for tax purposes is called a(n)_____ lease.
A)open
B)straight
C)operating
D)tax-oriented
E)tax-exempt
Q2) The relevant discount rate for evaluating a lease is the firm's:
A)cost of equity financing.
B)pre-tax cost of borrowing.
C)aftertax cost of borrowing.
D)cost of working capital.
E)rate of return on short-term assets.
Q3) Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".
Q4) Explain the differences between purchasing an asset and leasing an asset.
Q5) Why might a firm opt to sell and leaseback an asset which it currently owns?
Q6) What are some "good" reasons for opting to lease rather than purchase an asset?
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