Financial Markets and Institutions
Practice Questions
Course Introduction
This course provides an in-depth exploration of financial markets and institutions, examining their roles in the global economy. Students will learn about the structure and functioning of various financial markets, including money, bond, equity, and derivatives markets, as well as the diverse institutions that operate within them such as banks, investment firms, and insurance companies. The course covers key concepts such as interest rates, risk management, regulatory frameworks, and the impact of monetary policy on financial systems. Emphasis is placed on understanding the interactions between financial markets and institutions and analyzing their influence on economic stability and growth.
Recommended Textbook
Finance Applications and Theory 3rd Edition by Marcia Millon Cornett
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Chapter 1: Introduction to Financial Management
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Sample Questions
Q1) Which of the following is the firm's highest-level financial manager?
A)Chief executive officer
B)Chief financial officer
C)Board of directors
D)Corporate governance
Answer: B
Q2) When determining a form of business organization,all of the following are considered EXCEPT:
A)who owns the firm.
B)the owners' risks.
C)the tax ramifications.
D)the physical location of the business.
Answer: D
Q3) Which of the following personal decisions is NOT impacted by finance?
A)Borrowing money to purchase cars or homes
B)Making credit card payments
C)Making retirement decisions
D)All of these are impacted by finance.
Answer: D
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Chapter 2: Reviewing Financial Statements
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Q1) Reed's Birdie Shot,Inc.'s 2013 income statement lists the following income and expenses: EBIT = $555,000,interest expense = $178,000,and taxes = $148,000.Reed's has no preferred stock outstanding and 100,000 shares of common stock outstanding.Calculate the 2013 earnings per share.
A)$3.49
B)$2.29
C)$3.14
D)$2.79
Answer: B
Q2) LLV Inc.originally forecasted the following financial data for next year: sales = $1,000,cost of goods sold = $710,and interest expense = $95.The firm believes that COGS will always be 71 percent of sales.Due to pressure from shareholders,the firm wants to achieve a net income of $150.Assuming the interest expense will remain the same,how large must sales be to achieve this goal? Assume a 35 percent tax rate.
A)$1,403.82
B)$1,3009.18
C)$1,123.34
D)$1,296.51
Answer: C
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Chapter 3: Analyzing Financial Statements
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Sample Questions
Q1) Differentiate between time series and cross-section ratio analysis.
Answer: When managers,analysts,or investors review a firm's financial position through ratio analysis,they often start by evaluating trends in the firm's financial position over time (time series analysis)and by comparing a firm's performance with that of other firms in the same industry (cross section analysis).
Q2) Sustainable Growth Rate You have located the following information on Greenwich Company: debt ratio = 60 percent,capital intensity ratio = 0.75 times,profit margin = 13.5 percent,and dividend payout ratio = 80 percent.What is the sustainable growth rate for Greenwich?
A)2.70 percent
B)10.80 percent
C)25.00 percent
D)9.89 percent
Answer: D
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Chapter 4: Time Value of Money
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Sample Questions
Q1) What annual rate of return is earned on a $13,000 investment made in year 2 when it grows to $17,000 by the end of year 7?
A)10.64 percent
B)4.28 percent
C)8.04 percent
D)5.51 percent
Q2) If an average home in your town currently costs $250,000,and house prices are expected to grow at an average rate of 3 percent per year,what will a house cost in 8 years?
A)$255,033.41
B)$255,043.97
C)$314,928.01
D)$316,692.52
Q3) Which of the following is the equivalent of $300 received today?
A)$795.99 to be received 20 years in the future assuming a 5 percent annual interest rate.
B)$100 to be received two years from now and $200 three years from now.
C)$300 compounded at 10 percent for one year.
D)All of these are the equivalent of $300 received today.
Q4) Explain how "interest rate" and "rate of return" are similar,yet different.
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Chapter 5: Time Value of Money
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Q1) Investing for Retirement Monica has decided that she wants to build enough retirement wealth that,if invested at 7 percent per year,will provide her with $3,000 monthly income for 30 years.To date,she has saved nothing,but she still has 20 years until she retires.How much money does she need to contribute per month to reach her goal?
A)$671.78
B)$865.62
C)$3,000.00
D)$7,025.77
Q2) When saving for future expenditures,we can add the ________ of contributions over time to see what the total will be worth at some point in time.
A)present value
B)future value
C)time value to money
D)payment
Q3) What is the difference between an annuity due and an ordinary annuity?
Q4) The interest on your home mortgage is tax deductible.Why are the early years of the mortgage more helpful in reducing taxes than the later years?
Q5) How might credit card companies keep their cardholders in debt for a long time?
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Chapter 7: Valuing Bonds
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Q1) Which of the following statements is correct?
A)There is an inverse relationship between bond prices and bond yields.
B)There is a positive relationship between bond prices and bond yields.
C)There is no relationship between bond prices and bond yields.
D)The relationship between bond prices and bond yields is dependent on the market interest rate.
Q2) If Zeus Energy bonds are upgraded from BBB- to BBB+,which of the following statements is true?
A)The current bond price will decrease and interest rates on new bonds issues will increase.
B)Interest rates required on new bond issues will increase.
C)The current bond price will decrease.
D)The current bond price will increase and interest rates on new bonds issues will decrease.
Q3) Explain what the indenture agreement states.
Q4) If a bond is selling at par value,which of the following statements is correct?
A)The current yield must equal the coupon rate.
B)The current yield must equal the yield to maturity.
C)Both of these statements are correct.
D)None of these statements is correct.
Page 8
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Chapter 8: Valuing Stockspart
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Sample Questions
Q1) Which of the following will only be executed if the order's price conditions are met?
A)A trade
B)A limit order
C)An unlimited order
D)A spread
Q2) Expected Return American Eagle Outfitters (AEO)recently paid a $0.38 dividend.The dividend is expected to grow at a 15.5 percent rate.At the current stock price of $24.07,what is the return shareholders are expecting?
A)15.50 percent
B)15.52 percent
C)17.08 percent
D)17.32 percent
Q3) We can estimate a stock's value by:
A)using the book value of the total stockholder equity section.
B)discounting the future dividends and future stock price appreciation.
C)compounding the past dividends and past stock price appreciation.
D)using the book value of the total assets divided by the number of shares outstanding.
Q4) What are the differences between common stock and preferred stock?
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Chapter 9: Characterizing Risk and Return
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Q1) Which of the following statements is correct?
A)Stocks and long-term Treasury bonds are highly positively correlated.
B)Stocks and Treasury bills are highly positively correlated.
C)Stocks, long-term Treasury bonds, and Treasury bills are all highly correlated.
D)None of these statements is correct.
Q2) The efficient frontier portfolios are:
A)portfolios that risk adverse investors will select.
B)portfolios where all the market risk is diversified away.
C)portfolios where the correlation among assets is 0.0.
D)portfolios that dominate all others.
Q3) Rank the following three stocks by their total risk level,highest to lowest.Night Ryder has an average return of 14 percent and standard deviation of 30 percent.The average return and standard deviation of WholeMart are 12 percent and 25 percent; and of Fruit Fly are 25 percent and 40 percent.
A)Fruit Fly, Night Ryder, WholeMart
B)Night Ryder, WholeMart, Fruit Fly
C)WholeMart, Fruit Fly, Night Ryder
D)WholeMart, Night Ryder, Fruit Fly
Q4) Define diversifiable risk and contrast it with market risk.
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Chapter 10: Estimating Risk and Return
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Q1) IBM's stock price is $22,it is expected to pay a $2 dividend,and analysts expect the firm to grow at 10 percent per year for the next five years.TDI's stock price is $10,it is expected to pay a $1 dividend,and analysts expect the firm to grow at 12 percent per year for the next five years.What is the difference in the two firms' required rate of returns?
A)2.91 percent
B)1.82 percent
C)2.03 percent
D)3.23 percent
Q2) How might a small market risk premium impact people's desire to buy stocks?
A)Investors with high risk aversion will be less willing to invest in stocks.
B)Investors with high risk aversion will be more willing to invest in stocks.
C)It will only impact the share prices.
D)None of these statements is correct.
Q3) Which of the following are the stocks of small companies that are priced below $1 per share?
A)Bargain stocks
B)Hedge fund stocks
C)Penny stocks
D)Stock market bubble stocks
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Chapter 11: Calculating the Cost of Capital
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Q1) Suppose that TW,Inc.has a capital structure of 25 percent equity,15 percent preferred stock,and 60 percent debt.If the before-tax component costs of equity,preferred stock and debt are 13.5 percent,9.5 percent and 4 percent,respectively,what is TW's WACC if the firm faces an average tax rate of 30 percent?
A)6.19 percent
B)6.48 percent
C)7.2 percent
D)9.0 percent
Q2) Which of the following makes this a true statement? If the new project does significantly increase the firm's overall risk:
A)the increased risk will be borne equally amongst the bond holders, preferred stockholders, and common stockholders.
B)the increased risk will be borne disproportionately by bond holders.
C)the increased risk will be borne disproportionately by preferred stockholders.
D)the increased risk will be borne disproportionately by common stockholders.
Q3) Explain why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division.
Q4) Define subjective and objective approaches to divisional cost of capital.
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Chapter 12: Estimating Cash Flows on Capital Budgeting Projects
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Q1) Which of these is the process of estimating expected future cash flows of a project using only the relevant parts of the balance sheet and income statements?
A)Incremental cash flows
B)Cash flow analysis
C)Pro forma analysis
D)Substitutionary analysis
Q2) You are considering the purchase of one of two machines used in your manufacturing plant.Machine A has a life of two years,costs $100 initially,and then $150 per year in maintenance costs.Machine B costs $200 initially,has a life of three years,and requires $120 in annual maintenance costs.Either machine must be replaced at the end of its life with an equivalent machine.Which is the better machine for the firm? The discount rate is 12 percent and the tax rate is zero.
A)Machine A
B)Machine B
C)Both machines A and B
D)Neither machine A nor B
Q3) How is the initial investment adjusted for flotation costs?
Q4) In a cost-cutting proposal,what might cause you to sometimes have a negative EBIT?
Page 13
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Chapter 13: Weighing Net Present Value and Other Capital
Budgeting
Criteria
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Q1) Which of these is a capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows?
A)Discounted payback
B)Net present value
C)Internal rate of return
D)Profitability index
Q2) Rate-based statistics represent summary cash flows,and these summaries tend to lose which two important details?
A)The investment size and cash inflows that occur after the rather arbitrary testing period
B)The investment size and the cash inflows that occur before the testing period
C)The investment size and the cash outflows that occur before the testing period
D)The investment size and the cash inflows that occur during the testing period
Q3) Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.
Q4) Explain what a PI of 35.23 percent would signify.
Q5) Define and evaluate the net present value (NPV)method of evaluating capital investment opportunities.
Q6) Why is a project's cost not an appropriate benchmark for its NPV?
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Chapter 14: Working Capital and Policies
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Q1) If a firm has a cash cycle of 39 days and an operating cycle of 88 days,what is its average payment period?
A)39 days
B)49 days
C)88 days
D)127 days
Q2) If a firm has a cash cycle of 20 days and an operating cycle of 60 days,what is its payables turnover?
A)8.06
B)9.13
C)20.00
D)40.00
Q3) Safety stock is referred to as the:
A)excess amounts of fixed assets kept on hand to meet unexpected shocks in demand.
B)excess amounts of accruals used to fund short-term demands for cash.
C)excess amounts of a current asset kept on hand to meet unexpected shocks in demand.
D)none of these.
Q4) Detail the major differences between the three inventory loan types.
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Chapter 15: Financial Planning and Forecasting
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Q1) Which of the following is a set of financial statements depicting an operating division of a firm's expected financial situation in the foreseeable future under the most reasonable set of assumptions concerning relevant factors?
A)Base case projections
B)Deseasonalized financial statements
C)Na ve financial statements
D)Pro forma financial statements
Q2) Which of the following is the practice of one firm selling to another on credit terms?
A)Accounts payable
B)Accounts receivable
C)Barter transactions
D)Trade credit
Q3) Is forecasting more important for small firms or large firms? Why?
Q4) Which of the following are considered "chunky" or "lumpy" assets?
A)Total assets
B)Current assets
C)Fixed assets
D)Additional funds needed (AFN)
Q5) Explain the process of financial planning process of a firm.
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Chapter 16: Assessing Long-Term Debt, equity, and Capital Structure
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Q1) Which of the following statements is correct?
A)Adding corporate taxes to the M&M model reduces both the level and volatility of EPS.
B)Adding corporate taxes to the M&M model has no impact on the level and volatility of EPS.
C)Adding corporate taxes to the M&M model increases both the level and volatility of EPS.
D)None of these statements are correct.
Q2) Which of these is a situation that arises when a firm's equity is close to worthless,and equity holders will prefer to not invest in safe projects?
A)Leverage problem
B)Overinvestment problem
C)Underinvestment problem
D)Long position
Q3) In M&M's perfect world,will the debt holders ever bear any of the risk of the firm?
Q4) Explain why,in a world with both corporate taxes and the chance of bankruptcy,a small firm with volatile EBIT is unlikely to have much debt?
Q5) Explain why utility firms tend to have fairly high debt ratios.
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Chapter 17: Sharing Firm Wealth: Dividends, share
Repurchases and Other Payouts
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Q1) JEN Corp.is expected to pay a dividend of $2.00 per year indefinitely.If the appropriate rate of return on this stock is 12 percent per year,and the stock consistently goes ex-dividend 25 days before dividend payment date,what will be the expected minimum price in light of the dividend payment logistics?
A)$1.14
B)$16.54
C)$16.67
D)$18.52
Q2) The board of directors announces its intention to pay a dividend on the:
A)ex-dividend date.
B)record date.
C)declaration date.
D)dividend announcement date.
Q3) Suppose a firm has a dividend payout ratio of 25 percent and net income of $5 million.What would be the annual addition to retained earnings?
A)$3,750,000
B)$5,250,000
C)$1,750,000
D)$750,000
Page 18
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Chapter 18: Issuing Capital and the Investment Banking Process
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Q1) One Stop has been approved for a $55,000 loan commitment from its local bank.The bank has offered the following terms: term = one year,up-front fee = 85 basis points,back-end fee = 35 basis points,and rate on the loan = 9.75 percent.Casey's expects to immediately take down $45,000 and no more during the year unless there is some unforeseen need.Calculate the total interest and fees Casey's One Stop can expect to pay on this loan commitment.
A)$5,050
B)$5,115
C)$4,890
D)$4,650
Q2) When stock market values are relatively high:
A)you will tend to observe more IPOs and new stock issuances.
B)you will tend to observe more bond issuances.
C)you will tend to observe firms raising more money from venture capitalists.
D)you will tend to observe firms borrowing more money from banks.
Q3) Most business loans today are:
A)pre-negotiated lines of credit.
B)spot loans.
C)collateralized lines of credit.
D)None of these.
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Chapter 19: International Corporate Finance
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Q1) Over the past decade,China has acquired hundreds of billions of U.S.dollars due to the trade imbalance between the two countries.The Chinese government has used many of these dollars to purchase Treasury bonds.What would be the effect if China suddenly decided to sell the majority of these Treasury bonds and exchange the dollars for pesos?
A)The price of Treasury bonds would rise, the yield on the Treasury bonds would fall, the dollar would weaken, and the peso would strengthen.
B)The price of Treasury bonds would rise, the yield on the Treasury bonds would fall, the dollar would strengthen, and the peso would weaken.
C)The price of Treasury bonds would fall, the yield on the Treasury bonds would rise, the dollar would weaken, and the peso would strengthen.
D)The price of Treasury bonds would fall, the yield on the Treasury bonds would fall, the dollar would strengthen, and the peso would weaken.
Q2) What are the advantages of borrowing money in the country you plan to invest in?
Q3) Explain political risks when investing internationally and how it can be managed.
Q4) What is meant by hedging exchange rate risk and what are some ways it is done?
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Chapter 20: Mergers and Acquisitions and Financial
Distress
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Q1) Calculating the Probability of Bankruptcy A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio.Based on past bankruptcy experience,the linear probability model is estimated as: PD<sub>i</sub> = 0.45 (debt/equity)+ 0.01 (sales/total assets)
A firm you are thinking of lending to has a sales-to-assets ratio of 1.9 and its expected probability of default,or bankruptcy,is estimated to be 7 percent.Calculate the firm's debt ratio.
A)11.33 percent
B)10.18 percent
C)89.82 percent
D)7.00 percent
Q2) Which of the following involves a firm and its creditors agreeing to a private reorganization outside the formal bankruptcy process?
A)Consolidation bankruptcy
B)Prepackaged bankruptcy
C)Chapter 13
D)Chapter 7
Q3) What is the difference between a Chapter 11 and a Chapter 7 bankruptcy?
Page 21
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