Financial Markets and Institutions
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Course Introduction
This course explores the structure, functions, and operations of financial markets and institutions in the global economy. It examines the roles of key financial intermediaries including banks, insurance companies, and investment firms and analyzes how these entities facilitate the flow of funds between savers and borrowers. Key topics include the determination of interest rates, risk management, the regulatory environment, and the impact of central banks on monetary policy. Through real-world examples and case studies, students gain an understanding of market instruments such as stocks, bonds, and derivatives, while also investigating recent trends and innovations shaping the financial sector.
Recommended Textbook
Corporate Finance 10th Edition by Stephen A. Ross
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Chapter 1: Introduction to Corporate Finance
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Q1) The division of profits and losses among the members of a partnership is formalized in the:
A) indemnity clause.
B) indenture contract.
C) statement of purpose.
D) partnership agreement.
E) group charter.
Answer: D
Q2) Which one of the following business types is best suited to raising large amounts of capital?
A) sole proprietorship
B) limited liability company
C) corporation
D) general partnership
E) limited partnership
Answer: C
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Page 3
Chapter 2: Financial Statements and Cash Flow
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Q1) Debt is a contractual obligation that:
A) requires the payout of residual flows to the holders of these instruments.
B) requires a repayment of a stated amount and interest over the period.
C) allows the bondholders to sue the firm if it defaults.
D) Both requires the payout of residual flows to the holders of these instruments; and requires a repayment of a stated amount and interest over the period.
E) Both requires a repayment of a stated amount and interest over the period; and allows the bondholders to sue the firm if it defaults.
Answer: E
Q2) Dividends per share is equal to dividends paid:
A) divided by the par value of common stock.
B) divided by the total number of shares outstanding.
C) divided by total shareholders' equity.
D) multiplied by the par value of the common stock.
E) multiplied by the total number of shares outstanding.
Answer: B
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Chapter 3: Financial Statements Analysis and Financial Models
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Q1) The percentage of sales method:
A) requires that all accounts grow at the same rate.
B) separates accounts that vary with sales and those that do not vary with sales.
C) allows the analyst to calculate how much financing the firm will need to support the predicted sales level.
D) Both requires that all accounts grow at the same rate; and separates accounts that vary with sales and those that do not vary with sales.
E) Both separates accounts that vary with sales and those that do not vary with sales; and allows the analyst to calculate how much financing the firm will need to support the predicted sales level.
Answer: E
Q2) The inventory turnover ratio is measured as:
A) total sales minus inventory.
B) inventory times total sales.
C) cost of goods sold divided by inventory.
D) inventory times cost of goods sold.
E) inventory plus cost of goods sold.
Answer: C
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Chapter 4: Discounted Cash Flow Valuation
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Q1) You buy an annuity which will pay you $12,000 a year for ten years. The payments are paid on the first day of each year. What is the value of this annuity today at a 7% discount rate?
A) $84,282.98
B) $87,138.04
C) $90,182.79
D) $96,191.91
E) $116,916.21
Q2) The time value of money concept can be defined as:
A) the relationship between the supply and demand of money.
B) the relationship between money spent versus money received.
C) the relationship between a dollar to be received in the future and a dollar today.
D) the relationship between interest rate stated and amount paid.
E) None of these.
Q3) There are three factors that affect the present value of an annuity. Explain what these three factors are and discuss how an increase in each will impact the present value of the annuity.
Q4) What is meant by "amortizing a loan"?
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Page 6
Chapter 5: Net Present Value and Other Investment Rules
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Q1) The length of time required for a project's discounted cash flows to equal the initial cost of the project is called the:
A) net present value.
B) internal rate of return.
C) payback period.
D) discounted profitability index.
E) discounted payback period.
Q2) The internal rate of return may be defined as:
A) the discount rate that makes the NPV equal to zero.
B) the difference between the market rate of interest and the NPV.
C) the market rate of interest less the risk-free rate.
D) the project acceptance rate set by management.
E) None of these.
Q3) The profitability index is closely related to:
A) payback.
B) discounted payback.
C) average accounting return.
D) net present value.
E) internal rate of return.
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Page 7
Chapter 6: Making Capital Investment Decisions
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Q1) The annual annuity stream of payments with the same present value as a project's costs is called the project's _____ cost.
A) incremental
B) sunk
C) opportunity
D) erosion
E) equivalent annual
Q2) The cash flows of a project should:
A) be computed on a pre-tax basis.
B) include all sunk costs and opportunity costs.
C) include all incremental costs, including opportunity costs.
D) be applied to the year when the related expense or income is recognized by GAAP.
E) include all financing costs related to new debt acquired to finance the project.
Q3) Should financing costs be included as an incremental cash flow in capital budgeting analysis?
Q4) Explain the half year convention used in MACRS depreciation.
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Page 8
Chapter 7: Risk Analysis, Real Options, and Capital Budgeting
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Q1) Sensitivity analysis evaluates the NPV with respect to:
A) changes in the underlying assumptions.
B) one variable changing while holding the others constant.
C) different economic conditions.
D) All of these.
E) None of these.
Q2) The potential decision to abandon a project has option value because:
A) abandonment can occur at any future point in time.
B) a project may be worth more dead than alive.
C) management is not locked into a negative outcome.
D) All of these.
E) None of these.
Q3) Monte Carlo simulation is:
A) the method of analysis most widely used by executives.
B) a very simple formula.
C) more complex than sensitivity or scenario analysis.
D) the oldest capital budgeting technique.
E) None of these.
Q4) Can different discount rates be used for different stages in a decision tree?
If so,what would be the benefit of such action?
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Chapter 8: Interest Rates and Bond Valuation
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Q1) An asset characterized by cash flows that increase at a constant rate forever is called a:
A) growing perpetuity.
B) growing annuity.
C) common annuity.
D) perpetuity due.
E) preferred stock.
Q2) The outstanding bonds of Boutelle,Inc. provide a real rate of return of 3.6%. The current rate of inflation is 2.5%. What is the nominal rate of return on these bonds?
A) 6.10%
B) 6.13%
C) 6.16%
D) 6.19%
E) 6.22%
Q3) Interest rate risk is often explained by using the concept of a teeter-totter. Explain interest rate risk and how it is related to the movements of a teeter-totter.
Q4) Sometimes it is not clear if a particular security is debt or equity. Explain the basic difference between debt and equity.
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Page 10
Chapter 9: Stock Valuation
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Q1) The Merriweather Co. just announced that it will pay a dividend next year of $1.60 and is establishing a policy whereby the dividend will increase by 2.5% annually thereafter. How much will one share be worth five years from now if the required rate of return is 15%?
A) $14.12
B) $14.48
C) $14.84
D) $15.60
E) $15.78
Q2) The common stock of Energizer's pays an annual dividend that is expected to increase by 10% annually. The stock commands a market rate of return of 12% and sells for $60.50 a share. What is the expected amount of the next dividend to be paid on Energizer's common stock?
A) $.90
B) $1.00
C) $1.10
D) $1.21
E) $1.33
Q3) What are the components of the required rate of return on a share of stock? Briefly explain each component.
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Chapter 10: Risk and Return: Lessons From Market History
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Q1) One year ago,you purchased a stock at a price of $33. The stock pays quarterly dividends of $.60 per share. Today,the stock is worth $35.2 per share. What is the total amount of your dividend income to date from this investment?
A) $0.60
B) $1.80
C) $2.40
D) $3.00
E) $3.20
Q2) A stock had returns of 7%,9%,-3%,and 5% over the past four years. What is the standard deviation of this stock for the past four years?
A) 4.5%
B) 6.4%
C) 6.7%
D) 7.2%
E) 7.5%
Q3) Little John Industries sold for $1.90 on January 1 and ended the year at a price of $2.50. In addition,the stock paid dividends of $0.20 per share. Calculate Little John's dividend yield,capital gains yield,and total rate of return for the year.
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Chapter 11: Return and Risk: the Capital Asset Pricing Model
Capm
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Sample Questions
Q1) A well-diversified portfolio has negligible:
A) expected return.
B) systematic risk.
C) unsystematic risk.
D) variance.
E) Both unsystematic risk; and variance
Q2) The Rotor Co. stock is expected to earn 14% in a recession,6% in a normal economy,and lose 4% in a booming economy. The probability of a boom is 20% while the probability of a normal economy is 55% and the chance of a recession is 25%. What is the expected rate of return on this stock?
A) 6.00%
B) 6.72%
C) 6.80%
D) 7.60%
E) 11.33%
Q3) Explain in words what beta is and why it is important.
Q4) The diagram below represents an opportunity set for a two asset combination. Indicate the correct efficient set with labels; explain why it is so.
Page 13
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Chapter 12: An Alternative View of Risk and Return: The Arbitrage Pricing Theory
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Q1) Suppose the Binder Corporation's common stock has a return of 17%. Assume the risk-free rate is 5%,the expected market return is 8%,and no unsystematic influence affected Binder's return. The beta for Binder is:
A) 0.
B) 2.
C) 3.
D) 4.
E) It is impossible to calculate beta without the inflation ratE. 17 = 5 + (8 - 5); = 4
Q2) For a diversified portfolio including a large number of stocks,the:
A) weighted average expected return goes to zero.
B) weighted average of the betas goes to zero.
C) weighted average of the unsystematic risk goes to zero.
D) return of the portfolio goes to zero.
E) return on the portfolio equals the risk-free ratE.
Q3) You have a 3 factor model to explain returns. Explain what a factor represents in the context of the APT?
Each factor is multiplied by a beta. What do these represent and how do they relate to the actual return?
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Chapter 13: Risk, Cost of Capital, and Valuation
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Q1) Regression analysis can be used to estimate: A) beta.
B) the risk-free rate. C) standard deviation.
D) variance.
E) expected return.
Q2) For the levered firm the equity beta is __________ the asset beta. A) greater than B) less than C) equal to D) sometimes greater than and sometimes less than E) None of these.
Q3) Given the sample of returns of the Top Black Asphalt Company and the S&P 500 index,calculate Top Black's correlation. What can be said about the relationship of Top Black and the market return behavior?
Q4) Explain the factors that determine beta and how an asset beta can differ from equity betas.
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Chapter 14: Efficient Capital Markets and Behavioral Challenges
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Q1) An example of financially irrational behavior is:
A) gambling in Las Vegas.
B) when a firm announces an increase in earnings and the stock price enjoys three days of large abnormal returns.
C) when a firm announces an increase in earnings and the stock price enjoys an immediate surge in value which is captured in one day.
D) Both gambling in Las Vegas; and when a firm announces an increase in earnings and the stock price enjoys three days of large abnormal returns.
E) Both gambling in Las Vegas; and when a firm announces an increase in earnings and the stock price enjoys an immediate surge in value which is captured in one day.
Q2) Financial managers can create value through financing decisions that:
A) reduce costs or increase subsidies.
B) increase the product prices.
C) create a new security.
D) Both reduce costs or increase subsidies; and increase the product prices.
E) Both reduce costs or increase subsidies; and create a new security.
Q3) Define the three forms of market efficiency.
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Page 16
Chapter 15: Long-Term Financing
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Q1) Mike's Mopeds used internal financing as a source of long-term financing for 70% of its total needs in 2011. The company borrowed an additional 20% of its total needs in the long-term debt markets in 2011. What were Calhoun's net new stock issues,in percentage terms,for 2011?
A) -10%
B) -5%
C) 5%
D) 10%
E) 15%
Q2) Debt that may be extinguished before maturity is referred to as:
A) sinking-fund debt.
B) debentures.
C) callable debt.
D) indenture debt.
E) None of these.
Q3) Preferred Stock,as a hybrid security,presents somewhat of a puzzle as to why they are issued. What elements give rise to the puzzle and how is it explained?
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Chapter 16: Capital Structure: Basic Concepts
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Q1) The reason that MM Proposition I does not hold in the presence of corporate taxation is because:
A) levered firms pay less taxes compared with identical unlevered firms.
B) bondholders require higher rates of return compared with stockholders.
C) earnings per share are no longer relevant with taxes.
D) dividends are no longer relevant with taxes.
E) All of
Q2) The proposition that the value of the firm is independent of its capital structure is called:
A) the capital asset pricing model.
B) MM Proposition I.
C) MM Proposition II.
D) the law of one price.
E) the efficient markets hypothesis.
Q3) The cost of capital for a firm,R-WACC,in a zero tax environment is:
A) equal to the expected earnings divided by market value of the unlevered firm.
B) equal to the rate of return for that business risk class.
C) equal to the overall rate of return required on the levered firm.
D) is constant regardless of the amount of leverage.
E) All of
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Chapter 17: Capital Structure: Limits to the Use of Debt
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Q1) Given the following information,leverage will add how much value to the unlevered firm per dollar of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from stocks: 50%
A) $-0.050
B) $-0.188
C) $0.367
D) $0.588
E) None of these.
Q2) An investment is available that pays a tax-free 5%. The corporate tax rate is 25%. Ignoring risk,what is the pre-tax return on taxable bonds?
A) 5%
B) 6.25%
C) 6.67%
D) 7.14%
E) 7.69%.
Q3) What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?
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Page 19
Chapter 18: Valuation and Capital Budgeting for the Levered Firm
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Q1) In order to value a project which is not scale enhancing you need to:
A) typically calculate the equity cost of capital using the risk adjusted beta of another firm in the industry before calculating the WACC.
B) typically increase the beta of another firm in the same line of business and then calculate the discount rate using the SML.
C) typically you can simply apply your current cost of capital.
D) discount at the market rate of return since the project will diversify the firm to the market.
E) typically calculate the equity cost of capital using the risk adjusted beta of another firm in another industry before calculating the WACC.
Q2) A very large firm has a debt beta of zero. If the cost of equity is 10%,and the risk-free rate is 3%,the cost of debt is:
A) 3%.
B) 6%.
C) 11%.
D) 15%.
E) It is impossible to tell without the expected market return.
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Page 20
Chapter 19: Dividends and Other Payouts
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Q1) A reverse stock split is sometimes used as a means of:
A) decreasing the liquidity of a stock.
B) decreasing the market value per share of stock.
C) increasing the number of stockholders.
D) keeping a firm's stock eligible for trading on a stock exchange.
E) raising cash from current stockholders.
Q2) All else equal,the market value of a stock will tend to decrease by roughly the amount of the dividend on the:
A) dividend declaration date.
B) ex-dividend date.
C) date of record.
D) date of payment.
E) day after the date of payment.
Q3) Financial managers:
A) are reluctant to cut dividends.
B) tend to ignore past dividend policies.
C) tend to prefer cutting dividends every time quarterly earnings decline.
D) prefer cutting dividends over incurring flotation costs.
E) place little emphasis on dividend policy consistency.
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Page 21
Chapter 20: Raising Capital
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Q1) Lamar Inc. is attempting to raise $5,000,000 in new equity with a rights offering. The subscription price for the 125,000 new shares will be $40 per share. The stock currently sells for $50 per share and there are 250,000 shares outstanding. What will the price per share be if all rights are exercised?
Q2) Discuss the stages of venture capital financing,defining each in detail.
Q3) For a particular stock the old stock price is $20,the ex-rights price is $15,and the number of rights needed to buy a new share is 2. Assuming everything else constant,the subscription price is ______.
A) $5
B) $13
C) $17
D) $18
E) $20
Q4) The green shoe option is used to:
A) cover oversubscription.
B) cover excess demand.
C) provide additional reward to the investment bankers for a risky issue.
D) provide additional reward to the issuing firm for a risky issue.
E) Both cover oversubscription and cover excess demand.
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Chapter 21: Leasing
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Q1) What are some of the advantages and disadvantages of leasing?
Q2) The price or lease payment that the lessee sets as their bound is known as:
A) the present value of the tax shields.
B) the reservation payment, L<sub>MIN</sub>.
C) the present value of operating savings.
D) the reservation payment, L<sub>MAX</sub>.
E) None of these.
Q3) Your firm is considering leasing a new computer. The lease lasts for 9 years. The lease calls for 10 payments of $1,000 per year with the first payment occurring immediately. The computer would cost $7,650 to buy and would be straight-line depreciated to a zero salvage value over 9 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 8%. The corporate tax rate is 30%. This lease would be classified as a(n):
A) operating lease because the asset will be obsolete.
B) operating lease because there is no amortization.
C) leveraged lease because it is being financed.
D) capital lease because the lease life is greater than 75% of the economic life.
E) sale and leaseback because the company gets full use of the asset.
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Chapter 22: Options and Corporate Finance
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Q1) The lower bound of a call option:
A) can be a negative value regardless of the stock or exercise prices.
B) can be a negative value but only when the exercise price exceeds the stock price. C) can be a negative value but only when the stock price exceeds the exercise price.
D) must be greater than zero.
E) can be equal to zero.
Q2) The delta of a call measures:
A) the change in the ending stock value.
B) the change in the ending option value.
C) the swing in the price of the call relative to the swing in stock price.
D) the ratio of the change in the exercise price to the change in the stock price.
E) None of these.
Q3) Suppose XYZ is priced at $125 a share,has a call with an exercise price of $150,has two months to expiration,and costs $0.125 per contract. Why do you suppose investors would be willing to purchase a call that is so far out of the money?
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Chapter 23: Options and Corporate Finance: Extensions and Applications
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Q1) If real options were not included in calculations of value,would the valuation be under or over-valued and why?
Q2) On the notion of embedded options,which of the following is/are true?
A) If virtually all projects have embedded options, ignoring options is likely to lead to serious undervaluation.
B) There are at least two possible outcomes for virtually every business idea.
C) Virtually every business has both the option to abandon and the option to expand.
D) All of these.
E) Both there are at least two possible outcomes for virtually every business idea; and Virtually every business has both the option to abandon and the option to expand.
Q3) The CFO of NuValue was granted 1,000,000 options. The stock price at the time of the granting of the options was $20 and the options are at the money. The risk free rate was 4% and the options expire in 5 years. The variance on the stock is .05. What is the value of her options contract?
If she had negotiated a larger salary and only 10,000 options,what would be the value of the options contract?
Q4) Why would the company pay the executive in options as opposed to salary?
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Chapter 24: Warrants and Convertibles
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Q1) A convertible bond has an option value which is equal to:
A) the market value of the convertible bond minus the straight bond value.
B) The market value of the convertible bond minus the conversion value.
C) the market value of the convertible bond minus the conversion premium.
D) the market value of the convertible bond minus the maximum of the straight bond value or conversion value.
E) None of these.
Q2) Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder can purchase a new share of stock for five warrants and $5.00 per warrant. The stock is currently selling for $27 per share. A firm has 100 shares of stock and 40 warrants outstanding. The warrants are about to expire,and all of them will be exercised. The market value of the firm's assets is $2,000,and the firm has no debt. Each warrant gives the owner the right to buy 2 shares at $15 per share. What is the price per share of the stock?
A) $11.11
B) $15.00
C) $17.78
D) $20.00
E) None of these.
Q3) Why are warrants and convertibles issued?
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Chapter 25: Derivatives and Hedging Risk
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Q1) If the producer of a product has entered into a fixed price sale agreement for that output,the producer faces:
A) a nice steady profit because the output price is fixed.
B) an uncertain profit if the input prices are volatile. This risk can be reduced by a short hedge.
C) an uncertain profit if the input prices are volatile. This risk can be reduced by a long hedge.
D) a modest profit if the input prices are stable. This risk can be reduced by a long hedge.
E) a modest profit if the input prices are stablE. This risk can be reduced by a short hedgE.
Q2) Derivatives can be used to either hedge or speculate. These actions:
A) increase risk in both cases.
B) decrease risk in both cases.
C) spread or minimize risk in both cases.
D) offset risk by hedging and increase risk by speculating.
E) offset risks by speculating and increase risk by hedging.
Q3) The futures markets are labeled as pure speculation and even gambling. Why is this an inaccurate portrayal of the market's function?
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Chapter 26: Short-Term Finance and Planning
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Q1) Which of the following is not included in current liabilities?
A) Accounts payable
B) Prepaid insurance
C) Accrued expenses payable
D) Taxes payable
E) Notes payable
Q2) Amanda's Interior Design has sales of $462,000,costs of goods sold of $308,000 and average accounts receivable of $48,900. How long does it take its credit customers to pay for their purchases?
A) 36.09 days
B) 38.63 days
C) 41.23 days
D) 44.20 days
E) 57.95 days
Q3) The appropriate amount of short-term borrowing is determined by:
A) cash reserves.
B) maturity hedging.
C) relative interest rates.
D) All of these.
E) None of these.
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Chapter 27: Cash Management
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Q1) Your firm has average daily receipts of $2,500. These receipts are available after 6 days on average. The interest rate that could be earned is .02% (.0002) per day. What is the approximate cost of the float per day?
A) $2.50
B) $3.00
C) $30.00
D) $50.00
E) None of these.
Q2) Efficient funds management attempts to reduce mailing and clearing time. Two methods do this by:
A) moving collections and deposits closer together in concentration banks; and moving surplus funds quickly by wire transfers.
B) moving mailing points to cross country locations and using depository drafts to transfer funds.
C) drawing checks against zero balance accounts and using cross country mailing.
D) wiring funds to zero balance accounts and using lockboxes in many cities.
E) None of these.
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Chapter 28: Credit and Inventory Management
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Q1) Aggie Corporation has been asked by its customers to grant them a 2% discount if they pay their bill within 15 days. The purchase size of the average order is $75,000. Normally,the customer pays within 30 days with no discount. Aggie's cost of debt capital is 12%. Should the request be granted?
Q2) The carrying value of a firm's account receivable is $1,000,000 and the average collection period is 55 days. The firm's credit sales per day are:
A) $33,333.33.
B) $18,181.82.
C) $1,000,000.00.
D) $1,333,333.33.
E) None of these. e
Q3) The credit decision usually includes riskier customers. The credit decision should adjust for this by:
A) determining the probability that customers will pay and reducing the expected cash flow.
B) discounting the net cash flows at a lower discount rate.
C) discounting the cash inflow at a higher discount rate.
D) delaying collections on these customers.
E) speeding up deliveries to riskier customers.
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Page 30
Chapter 29: Mergers, Acquisitions, and Divestitures
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Q1) A merger in which an entirely new firm is created and both the acquired and acquiring firms cease to exist is called a:
A) divestiture.
B) consolidation.
C) tender offer.
D) spinoff.
E) conglomeration.
Q2) Firm A is acquiring Firm B for $40,000 in cash. Firm A has 2,500 shares of stock outstanding at a market value of $18 a share. Firm B has 1,500 shares of stock outstanding at a market price of $25 a share. Neither firm has any debt. The net present value of the acquisition is $2,500. What is the value of Firm A after the acquisition?
A) $40,000
B) $42,500
C) $45,000
D) $47,500
E) $50,000
Q3) Describe 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 30: Financial Distress
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Q1) Insolvency can be defined as:
A) not having cash.
B) being illiquid.
C) an inability to pay one's debts.
D) an inability to increase one's debts.
E) the present value of payments being less than assets.
Q2) Magic Mobile Homes is to be liquidated. All creditors,both secured and unsecured,are owed $2 million. Administrative costs of liquidation and wage payments are expected to be $500,000. A sale of assets is expected to bring $1.8 million after taxes.
Secured creditors have a mortgage lien for $1,200,000 on the factory which will be liquidated for $900,000 out of the sale proceeds. The corporate tax rate is 34%. How much and what percentage of their claim will the secured creditors receive,in total?
A) $900,000; 75%
B) $981,818; 81.82%
C) $1,009,091; 84.1%
D) $1,200,000; 100%
E) Not enough information to answer.
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Page 32
Chapter 31: International Corporate Finance
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Q1) You want to invest in a riskless project in Sweden. The project has an initial cost of SKr2.1 million and is expected to produce cash inflows of SKr810,000 a year for 3 years. The project will be worthless after the first 3 years. The expected inflation rate in Sweden is 2 percent while it is 5 percent in the U.S. A risk-free security is paying 6 percent in the U.S. The current spot rate is $1 = SKr7.55. What is the net present value of this project in Swedish krona using the foreign currency approach? Assume that the international Fisher effect applies.
A) SKr185,607
B) SKr191,175
C) SKr196,910
D) SKr197,867
E) SKr202,818
Q2) When the German mark is quoted as $.52,this quote is a(n):
A) triangular rate.
B) indirect rate.
C) direct rate.
D) cross rate.
E) None of these.
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