Financial Markets and Institutions
Final Test Solutions
Course Introduction
Financial Markets and Institutions explores the fundamental structures and operations of financial systems, examining the roles of banks, non-banking institutions, and regulatory agencies in facilitating the flow of capital within the economy. The course delves into the functioning of money and capital markets, the valuation and trading of financial instruments, and the mechanisms of risk management. Discussions cover how interest rates are determined, the effects of central banking policies, and the impact of globalization on financial systems. Through analysis of real-world cases, students gain insights into the various types of financial intermediaries, market participants, and the challenges posed by technological innovation and regulatory change in modern financial landscapes.
Recommended Textbook
Fundamentals of Corporate Finance 9th Canadian Edition by Richard A Brealey
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Page 2
Chapter 1: Goals and Governance of the Firm
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Q1) Which of the following appears to be the most appropriate goal for corporate management?
A) Maximizing market value of the company's shares
B) Maximizing the company's market share
C) Maximizing the current profits of the company
D) Minimizing the company's liabilities
Answer: A
Q2) Which one of the following gives a corporation its permanence?
A) Multiple owners
B) Limited liability
C) Corporation taxation
D) Separation of ownership and control
Answer: D
Q3) Real assets can be intangible assets.
A)True
B)False
Answer: True
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Page 3
Chapter 2: Financial Markets and Institutions
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Q1) Insurance companies can usually cover the claims of policyholders because:
A) the incidence of claims normally averages out across all policyholders.
B) they issue a very limited number of policies.
C) they are fully insured by the U.S. government.
D) their stockholders will cover any cash shortfalls encountered by the company.
Answer: A
Q2) When corporations need to raise funds through stock issues,they rely on the:
A) primary market.
B) secondary market.
C) tertiary market.
D) centralized NASDAQ exchange.
Answer: A
Q3) Which one of these correctly applies to mutual funds?
A) Mutual funds are a costly means of achieving portfolio diversification.
B) Funds are required to limit their annual fees and expenses to less than 1 percent of the portfolio value.
C) You can generally buy additional shares in the fund at any time.
D) Shareholders sell their shares to other shareholders.
Answer: C
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Page 4
Chapter 3: Accounting and Finance
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Sample Questions
Q1) If a firm's net income is positive and its noncash expenses are positive,which of the following could account for a negative amount of cash provided by operations?
A) Current assets decrease more than current liabilities decrease.
B) Current assets increase more than current liabilities increase.
C) Current assets decrease more than current liabilities increase.
D) A large addition is made to plant and equipment.
Answer: B
Q2) An individual's income for the year includes both dividend and interest payments.Which of these statements correctly applies to that individual's tax liability?
A) Dividends are taxed; tax on interest payments is paid at the corporate level.
B) Interest is taxed; tax on dividend payments is paid at the corporate level.
C) Both dividend and interest payments are taxed at the personal level.
D) All taxes on dividend and interest payments are paid at the corporate level.
Answer: C
Q3) The income statement resembles a snapshot of the firm at a specific time.
A)True
B)False
Answer: False
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Chapter 4: Measuring Corporate Performance
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Q1) Return on assets is always a larger number than the return on equity.
A)True
B)False
Q2) A times interest earned ratio of 5 indicates the firm:
A) pays 5 times its earnings in interest expense.
B) earns significantly more than its interest obligations.
C) has interest expense equal to 5% of EBIT.
D) has a low tax liability.
Q3) Last year's asset turnover ratio was 2.0.Sales have increased by 25% and total assets have increased by 10% since that time.What is the current asset turnover ratio?
A) 1.82
B) 2.05
C) 2.15
D) 2.27
Q4) When a firm's long-term debt-equity ratio is .98,the firm:
A) has too much long-term debt in relation to leases.
B) has less long-term debt than equity.
C) is nearing insolvency.
D) has as much in long-term liabilities as in equity.
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Chapter 5: The Time Value of Money
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Q1) A car's price is currently $20,000 and is expected to rise by 4% a year.If the interest rate is 6%,how much do you need to put aside today to buy the car one year from now?
A) $18,182
B) $19,231
C) $19,623
D) $4,080.08
Q2) A loan officer states,"Thousands of dollars can be saved by switching to a 15-year mortgage from a 30-year mortgage." Calculate the difference in payments on a 30-year mortgage at an interest rate of .75% a month versus a 15-year mortgage with an interest rate of .7% a month.Both mortgages are for $100,000 and have monthly payments.What is the difference in total dollars that will be paid to the lender under each loan? (Round the monthly payment amounts to 2 decimal places.)
A) $89,211
B) $98,406
C) $113,465
D) $124,300
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Chapter 6: Valuing Bonds
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Sample Questions
Q1) Which of the following statements is correct for a 10% coupon bond that has a current yield of 7%?
A) The face value of the bond has decreased.
B) The bond's maturity value exceeds the bond's price.
C) The bond's internal rate of return is 7%.
D) The bond's market value is higher than its face value.
Q2) This morning,you purchased a TIPS.Which one of these should you expect to occur if you hold this bond during an inflationary period?
A) The coupon payment will increase in real terms.
B) The maturity value will increase in nominal terms.
C) The market price will remain constant at par.
D) The market price will decrease.
Q3) What is the rate of return for an investor who pays $1,054.47 for a 3-year bond with an annual coupon payment of 6.5% and sells the bond 1 year later for $1,037.19?
A) 4.53%
B) 5.33%
C) 5.16%
D) 4.92%
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Chapter 7: Valuing Stocks
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Q1) The liquidation value of a firm is equal to the book value of the firm.
A)True
B)False
Q2) What can be expected to happen when stocks having the same expected risk do not have the same expected return?
A) At least one of the stocks becomes temporarily mispriced.
B) This is a common occurrence indicating that one stock has more PVGO.
C) This cannot happen if the shares are traded in an auction market.
D) The expected risk levels will change until the expected returns are equal.
Q3) What should be the price for a common stock paying $3.50 annually in dividends if the growth rate is zero and the discount rate is 8%?
A) $22.86
B) $28.00
C) $42.00
D) $43.75
Q4) Market value,unlike book value and liquidation value,treats the firm as a going concern.
A)True
B)False
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Chapter 8: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) When managers select correctly from among mutually exclusive projects,they:
A) may give up rate of return for NPV.
B) may give up NPV for rate of return.
C) have a tendency to select the largest project.
D) focus on the payback method to avoid conflicting signals.
Q2) A project's payback period is determined to be 4 years.If it is later discovered that additional cash flows will be generated in years 5 and 6,then the project's payback period will:
A) be reduced.
B) be increased.
C) be unchanged.
D) change but the discount rate must be known to determine the nature of the change.
Q3) A project's payback period is the length of time necessary to generate an NPV of zero.
A)True
B)False
Q4) The payback rule always makes shareholders better off.
A)True
B)False
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Chapter 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions
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Q1) What is the effect on a firm's net working capital if a new project requires a $30,000 increase in inventory,a $10,000 increase in accounts receivable,a $35,000 expenditure on machinery,and a $20,000 increase in accounts payable?
A) $5,000
B) $10,000
C) $20,000
D) $55,000
Q2) If a firm sells an asset for more than its value in the IRS's books,the resulting net cash flow will be less than the sales price.
A)True
B)False
Q3) Assume your firm has an unused machine that originally cost $75,000,has a book value of $20,000,and a market value of $25,000.Ignoring taxes,what is the opportunity cost of using this machine?
A) $75,000
B) $25,000
C) $20,000
D) $5,000
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Chapter 10: Project Analysis
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Q1) The option to abandon a project becomes more valuable as the possible outcomes become more varied.
A)True
B)False
Q2) A firm with 60% of sales going to variable costs,$1.5 million fixed costs,and $500,000 depreciation and sales of $3 million.How does the current level of sales compare to the accounting break-even sales level?
A) Current sales are $2 million below the break-even level.
B) Current sales are $333,333 below the break-even level.
C) Current sales are $800,000 below the break-even level.
D) Current sales exceed the break-even level by $360,000.
Q3) Which one of the following would not be included as a traditional capital budgeting project?
A) Machine replacement proposals
B) Salary adjustment proposals
C) New product proposals
D) Plant expansion proposals
Q4) Operating leverage increases with fixed cost.
A)True
B)False
Page 12
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Chapter 11: Introduction to Risk, Return, and the Opportunity
Cost of Capital
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Sample Questions
Q1) Historical returns (1900-2015)suggest that in a year when Treasury bills offered 7.5 the approximate return on portfolio of common stocks should be in the region of:
A) 7.5%
B) 9.3%
C) 15%
D) 18.5%
Q2) Since about 1900,the standard deviation of annual returns on a portfolio of U.S.common stocks has been about:
A) 10%.
B) 6%.
C) 20%.
D) 12%.
Q3) What is the return to an investor who purchases a stock for $30,receives a $1.50 dividend at the end of the year,and then sells the share for $28.50?
A) 5%
B) 0%
C) 5%
D) 10%
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Chapter 12: Risk,Return,and Capital Budgeting
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Q1) When the overall market experiences a decline of 8%,investors with portfolios of aggressive stocks will probably experience portfolio:
A) losses of less than 8%.
B) losses greater than 8%.
C) gains of less than 8%.
D) gains greater than 8%.
Q2) What rate of return should an investor expect for a stock that has a beta of 0.8 when the market is expected to yield 14% and Treasury bills offer 6%?
A) 9.2%
B) 11.2%
C) 12.4%
D) 12.8%
Q3) The basic tenet of the CAPM is that a stock's expected risk premium should be:
A) greater than the expected market return.
B) proportionate to the market return.
C) proportionate to the stock's beta.
D) greater than the risk-free rate of return.
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14
Chapter 13: The Weighted-Average Cost of Capital and Company Valuation
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Q1) For purposes of computing the WACC,if the book value of equity exceeds the market value of equity,then:
A) the book value of equity should be used.
B) the book value of equity less retained earnings should be used.
C) the market value of equity should be used.
D) the market value of equity less retained earnings should be used.
Q2) Which one of the following statements is incorrect?
A) The equity component of WACC reflects the return expected by the company's shareholders.
B) Market values should be used in calculating WACC.
C) Preferred equity is a separate component of WACC.
D) There is a tax shield on the equity dividends paid.
Q3) If a firm has twice as much equity as debt in its capital structure,then the firm is financed with:
A) 75.0% debt.
B) 66.7% equity.
C) 40.0% debt.
D) 33.3% equity.
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Chapter 14: Introduction to Corporate Financing and Governance
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Sample Questions
Q1) An investor might prefer floating-rate debt if she thought that:
A) interest rates would rise.
B) interest rates would decline.
C) its bond rating might be lowered.
D) its bonds were going to be converted into equity.
Q2) Warrants:
A) allow their holder to purchase shares at the current market price.
B) have a guaranteed maturity value.
C) grant the option to purchase either stocks or bonds at the holders discretion.
D) have an expiration date.
Q3) What happens in the case of a bond selling for $1,000 that can be converted to 20 shares of stock that are currently selling for $45 per share?
A) The bondholders will choose to convert.
B) The stock will go up to $50 per share.
C) The bond's price will go down to $900.
D) Bondholders will not convert.
Q4) Firms have the right to resell any Treasury stock they own.
A)True
B)False
Page 16
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Chapter 15: Venture Capital, IPOs, and Seasoned Offerings
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Sample Questions
Q1) Issue costs for equity are higher than those for debt for all of the following reasons except:
A) equity issues have higher administrative costs.
B) underwriting stock is riskier than underwriting bonds.
C) equity issues involve significantly more time to sell.
D) equity issues have no economies of scale.
Q2) What is the market value placed on a firm in which an entrepreneur invests $1 million and a venture capitalist invests $3 million in first-stage financing for a 50% interest in the firm?
A) $4 million
B) $6 million
C) $7 million
D) $8 million
Q3) Which one of the following would not be included among the benefits of shelf registration?
A) Reduction of lead time for security issuance
B) No additional registration necessary for 5 years
C) Issuer can take advantage of favorable conditions
D) Issuer can search for best underwriting terms
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Page 17
Chapter 16: Debt Policy
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Q1) Financial slack means having ready access to cash or debt financing.
A)True B)False
Q2) A firm has a WACC of 14%,an expected return on equity of 19%,and a debt-to-asset ratio of 60%.If the firm does not pay tax,what is the interest rate on the debt?
A) 6.50%
B) 9.90%
C) 10.67%
D) 11.14%
Q3) What is the after-tax cost of debt for a firm in the 35% tax bracket that pays 15% on its debt?
A) 5.25%
B) 9.75%
C) 12.17%
D) 20.25%
Q4) Which of the following pair of firms do you think should be more highly levered: A taxpaying company,or a company with large tax loss carry-forwards?
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18
Chapter 17: Payout Policy
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Q1) Which one of the following statements regarding stock dividends and stock splits is true?
A) A two-for-one stock split is equivalent to a 50% stock dividend.
B) A three-for-one stock split is equivalent to a 66% stock dividend.
C) A three-for-two stock split is equivalent to a 100% stock dividend.
D) A three-for-two stock split is equivalent to a 50% stock dividend.
Q2) Which one of these parties is most likely to prefer a stock with a high-dividend payout policy?
A) Financial institutions
B) Retired individuals
C) Growth-seeking investors
D) Endowment funds
Q3) With respect to the dividend-payment process,the price of a share of stock can logically be expected to drop on:
A) the payment date.
B) the date of record.
C) the ex-dividend date.
D) the declaration date.
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Chapter 18: Long-Term Financial Planning
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Q1) A percentage of sales model projects sales to increase by 5% annually over the next 4 years.If costs are forecast at a constant 80% of sales,and this year's income is $1,250,the forecast income in the fourth year will be:
A) $1,447.03.
B) $1,826.15.
C) $1,595.35.
D) $1,519.38.
Q2) Which one of these is least likely to change proportionally with sales?
A) Depreciation
B) Investment in receivables
C) Cost of goods sold
D) EBIT
Q3) What is the sustainable growth rate for a firm with $250,000 in net income,$100,000 in common stock dividends,and equity of $1 million?
A) 8%
B) 10%
C) 15%
D) 17%
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Chapter 19: Short-Term Financial Planning
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Q1) A firm's permanent working capital refers to the:
A) difference between fixed assets and current assets.
B) maximum difference between current assets and current liabilities.
C) portion of net working capital that is financed from long-term sources.
D) amounts that must be held to meet debt covenants.
Q2) In the preparation of cash budgets,capital expenditures are:
A) not included because these items are depreciated.
B) included as sources of operating cash.
C) included as uses of cash and make the budget lumpy.
D) traditionally offset as a use of cash by interest income.
Q3) The term "tax inversion" refers to the negative tax shield that is created when a firm invests in securities.
A)True B)False
Q4) Firms with large holdings of current assets generally enjoy greater liquidity. A)True
B)False
Q5) Companies with unusually high cash reserves often hold the cash in tax havens. A)True
B)False
Page 21
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Chapter 20: Working Capital Management
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Q1) Most money market instruments have a high degree of liquidity.
A)True
B)False
Q2) Money market securities usually have a maturity of:
A) more than 1 year.
B) less than 1 year.
C) 1 to 3 years.
D) less than a week.
Q3) Which statement is true about terms of trade credit of 2/10,net 30?
A) A 10% cash discount is offered for payment before 30 days.
B) A 2% cash discount can be taken for payment before the 10<sup>th</sup> of the following month.
C) A 10% cash discount can be taken if paid by the second day after invoicing.
D) No cash discount is offered after the tenth day.
Q4) Firms are more likely to grant credit the higher the probability that a potential customer will become a repeat customer.
A)True
B)False
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22
Chapter 21: Mergers,Acquisitions,and Corporate Control
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Q1) If Microsoft were to acquire Dell Computer,it would be an example of a:
A) vertical merger.
B) horizontal merger.
C) conglomerate merger.
D) distribution-channel merger.
Q2) Diversification is often a poor motive for mergers because:
A) vertical integration is rarely successful.
B) investors can diversify on their own account.
C) it does not produce economies of scale.
D) the increase in taxes overcomes any gains in earnings.
Q3) Which one of the following statements is correct concerning the cost of two firms merging? The cost:
A) is fixed when the merger is financed with cash.
B) can be affected by postmerger gains if cash is used.
C) decreases as the postmerger share price increases when stock is used to finance the merger.
D) is not determined until after the merger, regardless of the type of financing.
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Chapter 22: International Financial Management
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Q1) The number of pesos that can be purchased with one U.S.dollar is referred to as an indirect quote.
A)True
B)False
Q2) According to interest rate parity,the interest rate differential must be equal to the differential between forward and spot exchange rates.
A)True
B)False
Q3) If the yen is trading at a forward discount relative to the dollar,then you'll receive less yen per dollar in the future.
A)True
B)False
Q4) If purchasing power parity holds,what will happen to the currency of a country with high inflation?
A) The currency will appreciate.
B) The currency will depreciate.
C) There will be no significant change in the currency's value.
D) The currency will sell at a forward premium.
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Chapter 23: Options
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Q1) What is the most an investor can lose if sells a call on the firm's stock with an exercise price of $100?
A) $100
B) $0
C) $50
D) Unlimited losses
Q2) Which combination of positions will protect the owner from downside risk?
A) Buy the stock and buy a call option
B) Sell the stock and buy a call option
C) Buy the stock and buy a put option
D) Buy the stock and sell a put option
Q3) If a $1,000 convertible bond has a conversion ratio of 50 and the firm's equity is currently selling for $22 per share,then the:
A) bond should trade for at least $900.
B) bond should trade for at least $1,000.
C) bond should trade for at least $1,100.
D) firm will have already converted the bond.
Q4) The value of a call option increases as the exercise price increases.
A)True
B)False
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Chapter 24: Risk Management
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Q1) The derivatives market is characterized by:
A) shrinking activity.
B) the introduction of new contracts.
C) low turnover.
D) regular IPOs.
Q2) The typical sequence of cash flows in a futures contract is:
A) purchase price plus a margin account up-front, differences are settled at expiration.
B) margin account up-front, differences are posted daily and settled in cash if margin drops too low.
C) margin account up-front, all differences settled at expiration.
D) all funds are paid at expiration of the contract.
Q3) The seller of a pork bellies futures contract at $1.41 per pound noted that the closing price of pork bellies was $1.44 today.What will happen to this contract,which requires delivery of 40,000 pounds of pork bellies at expiration?
A) A loss of $400 is posted to the account.
B) A gain of $400 is posted to the account.
C) A loss of $1,200 is posted to the account.
D) A gain of $1,200 is posted to the account.
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