Financial Markets and Institutions
Test Preparation
Course Introduction
Financial Markets and Institutions explores the structure, function, and significance of financial systems in the economy. The course examines the roles of various financial markets including money, bond, stock, and derivatives markets and the key types of financial institutions, such as commercial banks, investment banks, insurance companies, and mutual funds. Students will learn about the mechanisms of financial intermediation, the determination of interest rates, risk management, and the regulatory environment. The course also covers contemporary issues, innovations, and global trends affecting financial systems, equipping students with the analytical tools to understand and evaluate the functioning and stability of the financial sector.
Recommended Textbook
Fundamentals of Corporate Finance 10th Alternate Edition by Stephen A. Ross
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Chapter 1: Introduction to Corporate Finance
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Sample Questions
Q1) Which one of the following correctly defines the upward chain of command in a typical corporate organizational structure?
A) The vice president of finance reports to the chairman of the board.
B) The chief executive officer reports to president.
C) The controller reports to the president.
D) The treasurer reports to the vice president of finance.
E) The chief operations officer reports to the vice president of production.
Answer: D
Q2) Which one of the following best states the primary goal of financial management?
A) maximize current dividends per share
B) maximize the current value per share
C) increase cash flow and avoid financial distress
D) minimize operational costs while maximizing firm efficiency
E) maintain steady growth while increasing current profits
Answer: B
Q3) 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
Two: Financial Statements and Long-Term Financial Planning
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Sample Questions
Q1) The cash flow of a firm which is available for distribution to the firm's creditors and stockholders is called the:
A) operating cash flow.
B) net capital spending.
C) net working capital.
D) cash flow from assets.
E) cash flow to stockholders.
Answer: D
Q2) Which of the following are included in current liabilities?
I.note payable to a supplier in eight months
II.amount due from a customer next month
III.account payable to a supplier that is due next week
IV.loan payable to the bank in fourteen months
A) I and III only
B) II and III only
C) I,II,and III only
D) I,III,and IV only
E) I,II,III,and IV
Answer: A
4
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Chapter 3: Working With Financial Statements
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Sample Questions
Q1) It is easier to evaluate a firm using financial statements when the firm:
A) is a conglomerate.
B) has recently merged with its largest competitor.
C) uses the same accounting procedures as other firms in the industry.
D) has a different fiscal year than other firms in the industry.
E) tends to have many one-time events such as asset sales and property acquisitions.
Answer: C
Q2) Townsend Enterprises has a PEG ratio of 5.3,net income of $49,200,a price-earnings ratio of 17.6,and a profit margin of 7.1 percent.What is the earnings growth rate?
A) 0.33 percent
B) 1.06 percent
C) 3.32 percent
D) 5.30 percent
E) 10.60 percent
Answer: C
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Chapter 4: Long-Term Financial Planning and Growthpart
Three: Valuation of Future Cash Flows
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Sample Questions
Q1) 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.
Q2) Monika's Dinor is operating at 94 percent of its fixed asset capacity and has current sales of $611,000.How much can the firm grow before any new fixed assets are needed?
A) 4.99 percent
B) 5.78 percent
C) 6.02 percent
D) 6.38 percent
E) 6.79 percent
Q3) A firm's external financing need is financed by which of the following?
A) retained earnings
B) net working capital and retained earnings
C) net income and retained earnings
D) debt or equity
E) owners' equity,including retained earnings
Page 6
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Chapter 5: Introduction to Valuation: the Time Value of Money
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Sample Questions
Q1) You are considering two separate investments.Both investments pay 7 percent interest.Investment A pays simple interest and Investment B pays compound interest.Which investment should you choose,and why,if you plan on investing for a period of 5 years?
Q2) This morning,TL Trucking invested $75,000 to help fund a company expansion project planned for 4 years from now.How much additional money will the firm have 4 years from now if it can earn 5 percent rather than 4 percent on its savings?
A) $2,940.09
B) $3,423.58
C) $4,008.17
D) $4,219.68
E) $4,711.08
Q3) According to the Rule of 72,you can do which one of the following?
A) double your money in five years at 7.2 percent interest
B) double your money in 7.2 years at 8 percent interest
C) double your money in 5 years at 14.4 percent interest
D) triple your money in 7.2 years at 5 percent interest
E) triple your money at 10 percent interest in 7.2 years
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Chapter 6: Discounted Cash Flow Valuation
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Sample Questions
Q1) Today,you borrowed $6,200 on your credit card to purchase some furniture.The interest rate is 14.9 percent,compounded monthly.How long will it take you to pay off this debt assuming that you do not charge anything else and make regular monthly payments of $120?
A) 5.87 years
B) 6.40 years
C) 6.93 years
D) 7.23 years
E) 7.31 years
Q2) You would like to establish a trust fund that will provide $120,000 a year forever for your heirs.The trust fund is going to be invested very conservatively so the expected rate of return is only 5.75 percent.How much money must you deposit today to fund this gift for your heirs?
A) $2,086,957
B) $2,121,212
C) $2,300,000
D) $2,458,122
E) $2,500,000
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Chapter 7: Interest Rates and Bond Valuation
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Sample Questions
Q1) The yield to maturity on a bond is currently 8.46 percent.The real rate of return is 3.22 percent.What is the rate of inflation?
A) 5.08 percent
B) 5.64 percent
C) 6.24 percent
D) 6.53 percent
E) 6.71 percent
Q2) A 16-year,4.5 percent coupon bond pays interest annually.The bond has a face value of $1,000.What is the percentage change in the price of this bond if the market yield to maturity rises to 5.7 percent from the current rate of 5.5 percent?
A) 2.14 percent decrease
B) 1.97 percent decrease
C) 0.21 percent increase
D) 1.97 percent increase
E) 2.14 percent increase
Q3) Describe the relationships that exist between the coupon rate,the yield to maturity,and the current yield for both a discount bond and a premium bond.
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Chapter 8: Stock Valuationpart Four: Capital Budgeting
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Sample Questions
Q1) Dexter Metals,paid its first annual dividend yesterday in the amount of $0.18 a share.The company plans to double each annual dividend payment for the next 3 years.After that time,it plans to pay $1.25 a share for 2 years than then pay a constant dividend of $1.60 per share indefinitely.What is one share of this stock worth today if the market rate of return on similar securities is 10.24 percent?
A) $12.32
B) $12.77
C) $13.20
D) $14.26
E) $14.79
Q2) You are the sole shareholder of a small corporation.Presently,you wish to diversify your holdings and thus want to sell a portion of your shares but do not want to incur the costs associated with SEC filings.Which one of the following markets,if any,might be conducive to this sale?
A) NASDAQ
B) OTCBB
C) Pink Sheets
D) NYSE
Q3) What are the primary differences and similarities between NASDAQ and the NYSE?
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Chapter 9: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) Which one of the following is a project acceptance indicator given an independent project with investing type cash flows?
A) profitability index less than 1.0
B) project's internal rate of return less than the required return
C) discounted payback period greater than requirement
D) average accounting return that is less than the internal rate of return
E) modified internal rate of return that exceeds the required return
Q2) A project has an initial cost of $18,400 and produces cash inflows of $7,200,$8,900,and $7,500 over three years,respectively.What is the discounted payback period if the required rate of return is 16 percent?
A) 2.31 years
B) 2.45 years
C) 2.55 years
D) 2.62 years
E) never
Q3) The profitability index (PI)of a project is 1.0.What do you know about the project's net present value (NPV)and its internal rate of return (IRR)?
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Chapter 10: Making Capital Investment Decisions
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Sample Questions
Q1) Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment.The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project.The equipment can be scraped at the end of the project for 5 percent of its original cost.Annual sales from this project are estimated at $420,000.Net working capital equal to 20 percent of sales will be required to support the project.All of the net working capital will be recouped.The required return is 16 percent and the tax rate is 35 percent.What is the amount of the aftertax salvage value of the equipment?
A) $17,150
B) $31,850
C) $118,800
D) $237,600
E) $343,000
Q2) What is the primary purpose of computing the equivalent annual costs when comparing two machines? What is the assumption that is being made about each machine?
Q3) How can two firms arrive at two different bid prices when bidding for the same job and given the same bid specifications?
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Chapter 11: Project Analysis and Evaluationpart Five: Risk and Return
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Sample Questions
Q1) The change in revenue that occurs when one more unit of output is sold is referred to as:
A) marginal revenue.
B) average revenue.
C) total revenue.
D) erosion.
E) scenario revenue.
Q2) Spencer Tools would like to offer a special product to its best customers.However,the firm wants to limit its maximum potential loss on this product to the firm's initial investment in the project.The fixed costs are estimated at $21,000,the depreciation expense is $11,000,and the contribution margin per unit is $12.50.What is the minimum number of units the firm should pre-sell to ensure its potential loss does not exceed the desired level?
A) 1,220 units
B) 1,680 units
C) 2,215 units
D) 2,560 units
E) 2,750 units
Q3) What is operating leverage and why is it important in the analysis of capital expenditure projects?
Page 13
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Chapter 12: Some Lessons From Capital Market History
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Sample Questions
Q1) The U.S.Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits.Given this,you would be most apt to argue that the markets are less than _____ form efficient.
A) weak
B) semiweak
C) semistrong
D) strong
E) perfect
Q2) Inside information has the least value when financial markets are:
A) weak form efficient.
B) semiweak form efficient.
C) semistrong form efficient.
D) strong form efficient.
E) inefficient.
Q3) 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?
Q4) Define and explain the three forms of market efficiency.
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Six: Cost of Capital and Long-Term Financial Policy
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Sample Questions
Q1) You want your portfolio beta to be 0.90.Currently,your portfolio consists of $4,000 invested in stock A with a beta of 1.47 and $3,000 in stock B with a beta of 0.54.You have another $9,000 to invest and want to divide it between an asset with a beta of 1.74 and a risk-free asset.How much should you invest in the risk-free asset?
A) $3,965.52
B) $4,425.29
C) $4,902.29
D) $5,034.48
E) $5,683.92
Q2) Treynor Industries is investing in a new project.The minimum rate of return the firm requires on this project is referred to as the:
A) average arithmetic return.
B) expected return.
C) market rate of return.
D) internal rate of return.
E) cost of capital.
Q3) According to CAPM,the expected return on a risky asset depends on three components.Describe each component and explain its role in determining expected return.
Page 15
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Chapter 14: Cost of Capital
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Sample
Questions
Q1) New York Deli has 7 percent preferred stock outstanding that sells for $34 a share.This stock was originally issued at $45 per share.What is the cost of preferred stock?
A) 13.68 percent
B) 14.00 percent
C) 18.29 percent
D) 20.59 percent
E) 20.80 percent
Q2) Handy Man,Inc.has zero coupon bonds outstanding that mature in 8 years.The bonds have a face value of $1,000 and a current market price of $640.What is the company's pre-tax cost of debt?
A) 2.55 percent
B) 5.09 percent
C) 5.66 percent
D) 7.31 percent
E) 7.48 percent
Q3) What are some advantages of the subjective approach to determining the cost of capital and why do you think that approach is utilized?
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Chapter 15: Raising Capital
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Sample Questions
Q1) With firm commitment underwriting,the issuing firm:
A) is unsure of the total amount of funds it will receive until after the offering is completed.
B) is unsure of the number of shares it will actually issue until after the offering is completed.
C) knows exactly how many shares will be purchased by the general public during the offer period.
D) retains the financial risk associated with unsold shares.
E) knows up-front the amount of money it will receive from the stock offering.
Q2) Mountain Teas wants to raise $11.6 million to open a new production center.The company estimates the issue costs including the legal and accounting fees will be $440,000.The underwriters have set the stock price at $17.50 a share and the underwriting spread at 9 percent.How many shares of stock does Mountain Teas have to sell to meet its cash need?
A) 728,414 shares
B) 756,044 shares
C) 769,315 shares
D) 772,200 shares
E) 781,909 shares
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Chapter 16: Financial Leverage and Capital Structure Policy
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Q1) Which of the following are correct according to pecking-order theory?
I.Firms stockpile internally-generated cash.
II.There is an inverse relationship between a firm's profit level and its debt level.
III.Firms avoid external debt at all costs.
IV.A firm's capital structure is dictated by its need for external financing.
A) I and III only
B) II and IV only
C) I,III,and IV only
D) I,II,and IV only
E) I,II,III,and IV
Q2) L.A.Clothing has expected earnings before interest and taxes of $48,900,an unlevered cost of capital of 14.5 percent,and a tax rate of 34 percent.The company also has $8,000 of debt that carries a 7 percent coupon.The debt is selling at par value.What is the value of this firm?
A) $222,579.31
B) $223,333.33
C) $224,108.16
D) $225,299.31
E) $225,476.91
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Page 18
Chapter 17: Dividends and Payout Policypart Seven:
Short-Term Financial Planning and Management
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Q1) Which one of the following dates is used to determine the names of shareholders who will receive a dividend payment?
A) ex-rights date
B) ex-dividend date
C) date of record
D) date of payment
E) declaration date
Q2) City Center Pharmacy has 11,500 shares of stock outstanding with a par value of $1 per share and a market value of $12 a share.The company just announced a 3-for-7 reverse stock split.What will the market value per share be after the reverse stock split?
A) $5.14
B) $12.00
C) $23.33
D) $28.00
E) $33.14
Q3) Stock repurchase programs appear to becoming more popular with business firms.Explain the appeal of these programs as compared to that of cash dividend programs from the stock issuer's point of view.
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Chapter 18: Short-Term Finance and Planning
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Q1) Your bank offers you a $40,000 line of credit with an interest rate of 1.75 percent per quarter.The loan agreement also requires that 2 percent of the unused portion of the credit line be deposited in a non-interest bearing account as a compensating balance.Your short-term investments are paying 0.20 percent per month.What is your effective annual interest rate on this arrangement if you do not borrow any money on this credit line during the year? Assume any funds borrowed or invested use compound interest.
A) 2.00 percent
B) 2.43 percent
C) 3.18 percent
D) 7.00 percent
E) 7.19 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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Chapter 19: Cash and Liquidity Management
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Q1) The Blue Moon Hotel and Spa spends $359,000 a week to pay bills and maintains a lower cash balance limit of $250,000.The standard deviation of the disbursements is $46,800.The applicable weekly interest rate is 0.045 percent and the fixed cost of transferring funds is $60.What is the hotel's optimal upper cash limit based on the Miller-Orr model?
A) $430,836
B) $447,905
C) $528,700
D) $739,459
E) $861,672
Q2) Float management systems may provide only minimal benefits to a firm.Given that most firms have other projects with higher positive net present values,why should a firm's managers spend time implementing a float management system?
Q3) Municipal bonds:
A) are less liquid than U.S.Treasury bills.
B) produce income that is subject to federal income taxation.
C) generally pay a higher coupon than corporate bonds.
D) are also referred to as commercial paper.
E) are issued by the federal government.
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Page 21
Topics in Corporate Finance
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Q1) You are considering renting a kiosk in the local mall for a period of three months.Any sale you make will be a one-time sale.There is only a 79 percent chance you will collect payment on a credit sale.The product you want to sell has a variable cost of $3.88 and a sales price of $4.99.The monthly interest rate is 1.5 percent.Should you offer people 30 days to pay? Why or why not?
A) yes;because the NPV of a credit sale is $0.09.
B) yes;because the NPV of a credit sale is $0.03.
C) no;because the NPV of a credit sale is -$0.08.
D) no;because the NPV of a credit sale is -$0.02.
E) It doesn't matter because the NPV of a credit sale is approximately zero.
Q2) Which one of the following statements is correct?
A) The credit period begins when the discount period ends.
B) The discount period is the length of time granted to a customer to pay for a purchase.
C) The credit period begins on the invoice date.
D) With terms of 2/10,net 30,the net credit period is 20 days.
E) With EOM dating,all sales are assumed to have occurred on the 15<sup>th</sup> of each month.
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Chapter 21: International Corporate Finance
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Q1) George and Pat just made an agreement to exchange currencies based on today's exchange rate.Settlement will occur tomorrow.Which one of the following is the exchange rate that applies to this agreement?
A) spot exchange rate
B) forward exchange rate
C) triangle rate
D) cross rate
E) current rate
Q2) Which one of the following securities is used as a means of investing in a foreign stock that otherwise could not be traded in the United States?
A) American Depository Receipt
B) Yankee bond
C) Yankee stock
D) LIBOR
E) gilt
Q3) What is the relationship between the value of the dollar and the value of the euro in relation to the rate of inflation in the United States?
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Chapter 22: Behavioral Finance: Implications for Financial Management
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Q1) Amy has been investing in stocks so she can accumulate sufficient money to purchase her own home.These savings are currently valued at $82,500.As recently as last month,her savings were worth in excess of $110,000.Today,Amy found the perfect house.She knows she can withdraw her savings to pay on this house and borrow the remaining balance from her father at zero percent interest.However,Amy is refusing now to buy any house until her savings increase in value back to their $110,000 previous valuation.Amy is displaying which one of the following behaviors?
A) representativeness heuristic
B) loss aversion
C) house money effect
D) underconfidence
E) confirmation bias
Q2) Which one of the following refers to the fact that an individual may reply differently if a question is asked in a different manner?
A) loss aversion
B) gambler's fallacy
C) frame dependence
D) overconfidence
E) format reference
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Chapter 23: Enterprise Risk Management
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Q1) Farmer Jones raises several hundred acres of corn and would suffer a significant loss should the price of corn decline at harvest time.Which one of the following would he be doing if he purchased financial securities to offset this price risk?
A) abating
B) deriving
C) hedging
D) forwarding
E) manipulating
Q2) A hedge between which two of the following firms is most apt to reduce each firm's financial risk exposure?
A) wheat farmer and bakery
B) oil producer and coal miner
C) wheat grower and pharmaceutical firm
D) pastry bakery and cotton farmer
E) shoe manufacturer and coat manufacturer
Q3) 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.
Q4) Explain why a swap is effectively a series of forward contracts.
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Chapter 24: Options and Corporate Finance
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Q1) The investment timing decision is the:
A) determination of when an option should be exercised.
B) decision of when to purchase an option on an underlying asset.
C) analysis of determining when an asset should be sold.
D) determination of when a project should be abandoned.
E) evaluation of the optimal time to begin a project.
Q2) The price of Time Squared Corp.stock will be either $80 or $95 at the end of the year.Call options are available with one year to expiration.T-bills currently yield 6 percent and the current price of Time Squared Corp.stock is $85.What is the value of a call option if the exercise price is $75 per share?
A) $14.25
B) $15.06
C) $18.78
D) $24.25
E) $25.06
Q3) What are the upper and lower bounds for an American call option? Explain what would happen in each case if the bound was violated.
Q4) What are the basic similarities and basic differences between warrants and call options?
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Chapter 25: Option Valuation
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Q1) Cell Tower stock has a current market price of $62 a share.The one-year call on Cell Tower stock with a strike price of $65 is priced at $7.16 while the one-year put with a strike price of $65 is priced at $7.69.What is the risk-free rate of return?
A) 3.95 percent
B) 4.21 percent
C) 4.67 percent
D) 5.38 percent
E) 5.57 percent
Q2) Which one of the following statements is correct?
A) Mergers benefit shareholders but not creditors.
B) Positive NPV projects will automatically benefit both creditors and shareholders.
C) Shareholders might prefer a negative NPV project over a positive NPV project.
D) Creditors prefer negative NPV projects while shareholders prefer positive NPV projects.
E) Mergers rarely affect bondholders.
Q3) Explain why financial mergers tend to benefit bondholders more than shareholders.
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Chapter 26: Mergers and Acquisitions
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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) Which of the following are examples of cost reductions that can result from an acquisition?
I.allocating fixed overhead across a wider range of products
II.lowering office payroll costs by combining job functions
III.benefiting from economies of scale when purchasing raw materials
IV.reducing the number of management personnel required
A) I and III only
B) II and IV only
C) I,II,and IV only
D) II,III,and IV only
E) I,II,III,and IV
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.
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Chapter 27: Leasing
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Sample Questions
Q1) You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a very common practice with expensive,high-tech equipment).The scanner costs $3.5 million and it would be depreciated straight-line to zero over 4 years.Because of radiation contamination,it will actually be completely valueless in 4 years.You can lease it for $875,000 per year for 4 years.Assume the tax rate is 33 percent.You can borrow at 10 percent before taxes.What is the net advantage to leasing from your company's standpoint?
A) $468,216
B) $491,319
C) $516,007
D) $530,468
E) $541,747
Q2) The party who owns a leased asset is called the:
A) lessee.
B) lessor.
C) guarantor.
D) trustee.
E) manager.
Q3) Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".
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