Investment Analysis
Exam Questions
Course Introduction
Investment Analysis provides students with a comprehensive understanding of the key concepts, techniques, and tools used to evaluate investment opportunities in financial markets. The course covers topics such as risk and return, portfolio theory, asset pricing models, security valuation, and the analysis of fixed income and equity instruments. Emphasis is placed on the use of quantitative methods and financial data to assess the potential performance of individual assets and portfolios. Students will develop practical skills for making informed investment decisions, taking into account factors such as diversification, market efficiency, and investor behavior.
Recommended Textbook
Corporate Finance 1st European Edition by David Hillier
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Page 2
Chapter 1: Introduction to Corporate Finance
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Q1) The mixture of debt and equity used by a firm to finance its operations is called:
A)working capital management.
B)financial depreciation.
C)cost analysis.
D)capital budgeting.
E)capital structure.
Answer: E
Q2) In a limited partnership:
A)each limited partner's liability is limited to his net worth.
B)each limited partner's liability is limited to the amount he put into the partnership.
C)each limited partner's liability is limited to his annual salary.
D)there is no limitation on liability; only a limitation on what the partner can earn.
E)None of the above.
Answer: B
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Page 3
Chapter 2: Corporate Governance
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Q1) In a limited partnership:
A)each limited partner's liability is limited to his net worth.
B)each limited partner's liability is limited to the amount he put into the partnership.
C)each limited partner's liability is limited to his annual salary.
D)there is no limitation on liability; only a limitation on what the partner can earn.
E)None of the above.
Answer: B
Q2) The articles of incorporation:
A)can be used to remove company management.
B)are amended annually by the company shareholders.
C)set forth the number of shares that can be issued.
D)set forth the rules by which the corporation regulates its existence.
E)can set forth the conditions under which the firm can avoid double taxation.
Answer: C
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4
Chapter 3: Financial Statement Analysis and Long-Term Planning
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Q1) What is the cash flow to creditors for 2010?
A)-£405
B)-£225
C)£225
D)£405
E)£630
Answer: D
Q2) What are the sales for 2010?
A)£4,225
B)£4,385
C)£4,600
D)£4,815
E)£5,000
Answer: C
Q3) Why is interest expense excluded from the operating cash flow calculation?
Answer: Operating cash flow is designed to represent the cash flow a firm generates from its day-to-day operating activities.Interest expense arises from a financing decision and thus should be considered as a cash flow to creditors.
Page 5
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Chapter 4: Discounted Cash Flow Valuation
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Q1) Your employer contributes £25 a week to your retirement plan.Assume that you work for your employer for another twenty years and that the applicable discount rate is 5%.Given these assumptions,what is this employee benefit worth to you today?
A)£13,144.43
B)£15,920.55
C)£16,430.54
D)£16,446.34
E)£16,519.02
Q2) Mr.Miser,who is 35 years old,has just inherited £11,000 and decides to use the windfall towards his retirement.He places the money in a bank which promises a return of 6% per year until his planned retirement in 30 years.If his funds earn 6% interest compounded annually,how much will he have at retirement? Repeat the analysis for both semi-annual and continuous compounding.
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) Using the example of a savings account,explain the difference between the stated rate and the annual percentage rate.
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Chapter 5: How to Value Bonds and Shares
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Q1) Bill Bailey and Sons pays no dividend at the present time.The company plans to start paying an annual dividend in the amount of .30 a share for two years commencing two years from today.After that time,the company plans on paying a constant 1 a share dividend indefinitely.Given a required return of 14%,what is the value of this equity?
Q2) The equity valuation model that determines the current share price by dividing the next annual dividend amount by the excess of the discount rate less the dividend growth rate is called the _____ model.
A)zero growth
B)dividend growth
C)capital pricing
D)earnings capitalization
E)differential growth
Q3) What are the components of the required rate of return on a share of equity? Briefly explain each component.
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Page 7
Chapter 6: Net Present Value and Other Investment Rules
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Q1) No matter how many forms of investment analysis you do:
A)the actual results from a project may vary significantly from the expected results.
B)the internal rate of return will always produce the most reliable results.
C)a project will never be accepted unless the payback period is met.
D)the initial costs will generally vary considerably from the estimated costs.
E)only the first three years of a project ever affect its final outcome.
Q2) Jack is considering adding toys to his general store.He estimates that the cost of inventory will be £4,200.The remodeling expenses and shelving costs are estimated at £1,500.Toy sales are expected to produce net cash inflows of £1,200,£1,500,£1,600,and £1,750 over the next four years,respectively.Should Jack add toys to his store if he assigns a three-year payback period to this project?
A)yes; because the payback period is 2.94 years.
B)yes; because the payback period is 2.02 years.
C)yes; because the payback period is 3.80 years.
D)no; because the payback period is 2.02 years.
E)no; because the payback period is 3.80 years.
Q3) The IRR rule is said to be a special case of the NPV rule.Explain why this is so and why it has some limitations NPV does not?
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Chapter 7: Making Capital Investment Decisions
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Q1) Thornley Machines is considering a 3-year project with an initial cost of 618,000.The project will not directly produce any sales but will reduce operating costs by 265,000 a year.The equipment is depreciated straight-line to a zero book value over the life of the project.At the end of the project the equipment will be sold for an estimated 60,000.The tax rate is 34%.The project will require 23,000 in extra inventory for spare parts and accessories.Should this project be implemented if Thornley's requires a 9% rate of return? Why or why not?
A)No; The NPV is - 2,646.00.
B)Yes; The NPV is 27,354.00.
C)Yes; The NPV is 32,593.78.
D)Yes; The NPV is 43,106.54.
E)Yes; The NPV is 196,884.40.
Q2) 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
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Chapter 8: Risk Analysis, Real Options, and Capital Budgeting
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Q1) The market value of an investment project should be viewed as the sum of the standard NPV and the value of managerial options.Explain three different real or managerial options that management may have,what they are,and how they would influence market value.
Q2) Fixed costs I.are variable over long periods of time. II.must be paid even if production is halted.
III.are generally affected by the amount of fixed assets owned by a firm.
IV.per unit remain constant over a given range of production output.
A)I and III only.
B)II and IV only.
C)I,II,and III only.
D)I,II,and IV only.
E)I,II,III,and IV.
Q3) Which one of the following is most likely a variable cost?
A)Office rent.
B)Property taxes.
C)Property insurance.
D)Direct labour costs.
E)Management salaries.
Page 10
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Chapter 9: Risk and Return: Lessons From Market History
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Q1) The variance of returns is computed by dividing the sum of the:
A)squared deviations by the number of returns minus one.
B)average returns by the number of returns minus one.
C)average returns by the number of returns plus one.
D)squared deviations by the average rate of return.
E)squared deviations by the number of returns plus one.
Q2) You earned a total return of -5% on NoDotCom this year,earned -40% last year,and earned 30% two years ago.Calculate both the three-year holding period return and the average three year return.
Q3) A portfolio of large company shares would contain which one of the following types of securities?
A)equity of the firms which represent the smallest 20% of the companies
B)government treasury bills
C)long-term corporate bonds
D)equities of firms included in the FTSE 100 index
E)long-term government bonds
Q4) What are the lessons learned from capital market history? What evidence is there to suggest these lessons are correct?
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Page 11
Chapter 10: Return and Risk: The Capital Asset Pricing Model
Capm
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Q1) Which one of the following statements is correct concerning the standard deviation of a portfolio?
A)The greater the diversification of a portfolio,the greater the standard deviation of that portfolio.
B)The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio.
C)Standard deviation is used to determine the amount of risk premium that should apply to a portfolio.
D)Standard deviation measures only the systematic risk of a portfolio.
E)The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.
Q2) The slope of an asset's security market line is the:
A)reward-to-risk ratio.
B)portfolio weight.
C)beta coefficient.
D)risk-free interest rate.
E)market risk premium.
Q3) Explain in words what beta is and why it is important.
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Chapter 11: Factor Models and the Arbitrage Pricing Theory
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Q1) Which of the following is true about the impact on market price of a security when a company makes an announcement and the market has discounted the news?
A)The price will change a great deal; even though the impact is primarily in the future,the future value is discounted to the present.
B)The price will change little,if at all,since the impact is primarily in the future.
C)The price will change little,if at all,since the market considers this information unimportant.
D)The price will change little,if at all,since the market considers this information untrue.
E)The price will change little,if at all,since the market has already included this information in the security's price.
Q2) A factor is a variable that:
A)affects the returns of risky assets in a systematic fashion.
B)affects the returns of risky assets in an unsystematic fashion.
C)correlates with risky asset returns in a unsystematic fashion.
D)does not correlate with the returns of risky assets in an systematic fashion.
E)None of the above.
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Chapter 12: Risk, cost of Capital, and Capital Budgeting
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Q1) Beta measures depend highly on the:
A)direction of the market variance.
B)overall cycle of the market.
C)variance of the market and asset,but not their co-movement.
D)covariance of the security with the market and how they are correlated.
E)All of the above.
Q2) The beta of a firm is determined by which of the following firm characteristics?
A)Cycles in revenues.
B)Operating leverage.
C)Financial leverage.
D)All of the above.
E)None of the above.
Q3) Companies that have highly cyclical sales will have a:
A)low beta if sales are highly dependent on the market cycle.
B)high beta if sales are highly dependent on the market cycle.
C)high beta if sales are independent on the market cycle.
D)All of the above.
E)None of the above.
Q4) Explain the factors that determine beta and how an asset beta can differ from equity betas.
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Chapter 13: Corporate Financing Decisions and Efficient
Capital Markets
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Q1) Which form of the efficient market hypothesis implies that security prices reflect only information contained in past prices?
A)Weak form
B)Semistrong form
C)Strong form
D)Hard form
E)Past form
Q2) Which of the following tend to reinforce the argument that the financial markets are efficient?
I.Information spreads rapidly in today's world.
II.There is tremendous competition in the financial markets.
III.Market prices continually fluctuate.
IV.Market prices react suddenly to unexpected news announcements.
A)I and III only.
B)II and IV only.
C)I,II,and III only.
D)II,III,and IV only.
E)I,II,III,and IV.
Q3) Explain why it is that in an efficient market,investments have an expected NPV of zero.
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Chapter 14: Long-Term Financing: An Introduction
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Q1) The written agreement between a corporation and its bondholders might contain a prohibition against paying dividends in excess of current earnings.This prohibition is an example of a(n):
A)maintenance of security provision.
B)collateral restriction.
C)affirmative indenture.
D)restrictive covenant.
E)None of the above.
Q2) Paying off long-term debt by making installment payments is called:
A)foreclosing on the debt.
B)amortizing the debt.
C)funding the debt.
D)calling the debt.
E)None of the above.
Q3) If a debt issue is callable,the call price is ____ par.
A)greater than B)less than
C)equal to
D)unrelated to
E)It varies widely based on the risk of the firm.
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Chapter 15: Capital Structure: Basic Concepts
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Q1) Spartan Ltd has an unlevered cost of capital of 11%,a cost of debt of 8%, and a tax rate of 35%.What is the target debt-equity ratio if the targeted cost Of equity is 12%?
A).44
B).49
C).51
D).56
E).62
Q2) The difference between a market value balance sheet and a book value balance sheet is that a market value balance sheet:
A)places assets on the right hand side.
B)places liabilities on the left hand side.
C)does not equate the right hand with the left hand side. D)lists items in terms of market values,not historical costs. E)uses the market rate of return.
Q3) Based on MM with taxes and without taxes,how much time should a financial manager spend analyzing the capital structure of his firm? What if the analysis is based on the static theory?
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Chapter 16: Capital Structure: Limits to the Use of Debt
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Q1) Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital Structure becomes a 50/50 mix of debt and equity?
A)9.50%
B)10.50%
C)11.00%
D)11.25%
E)12.00%
Q2) Is there an easily identifiable debt-equity ratio that will maximize the value of a firm? Why or why not?
Q3) What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?
Q4) The basic lesson of MM theory is that the value of a firm is dependent upon the:
A)capital structure of the firm.
B)total cash flows of the firm.
C)percentage of a firm to which the bondholders have a claim.
D)tax claim placed on the firm by the government.
E)size of the shareholders claims on the firm.
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Page 18
Chapter 17: Valuation and Capital Budgeting for the Levered Firm
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Q1) The flow-to-equity approach has been used by the firm to value their capital budgeting projects.The total investment cost at time 0 is 640,000.The company uses the flow-to-equity approach because they maintain a target debt to value ratio over project lives.The company has a debt to equity ratio of 0.5.The present value of the project including debt financing is 810,994.What is the relevant initial investment cost to use in determining the value of the project?
A) 170,994
B) 267,628
C) 372,372
D) 543,366
E) 640,000
Q2) A leveraged buyout (LBO)is when a firm is acquired by:
A)a small group of management with equity financing.
B)a small group of equity investors financing the majority of the price by debt.
C)any group of equity investors when the majority is financed with preference shares.
D)any group of investors for the assets of the corporation.
E)None of the above.
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Page 19
Chapter 18: Dividend and Other Payouts
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Q1) Payments made out of a firm's earnings to its owners in the form of cash or equity are called:
A)dividends.
B)distributions.
C)share repurchases.
D)payments-in-kind.
E)stock splits.
Q2) A reverse split is when:
A)the share price gets too high for investors to purchase in round lots.
B)the equity becomes too liquid and highly marketable.
C)the share price moves into the popular trading range.
D)several old shares,such as 4,are replaced by 1 new share.
E)None of the above.
Q3) In a reverse stock split:
A)the number of shares outstanding increases and owners' equity decreases.
B)the firm buys back existing shares on the open market.
C)the firm sells new shares on the open market.
D)the number of shares outstanding decreases but owners' equity is unchanged.
E)shareholders make a cash payment to the firm.
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Page 20
Chapter 19: Equity Financing
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Q1) In a best efforts offering the investment banker makes their money primarily by:
A)earning the spread between the buying and offering price.
B)earning a commission on each share sold.
C)earning the discount between the buying and offering price.
D)charging a flat fee for all services.
E)None of the above.
Q2) Empirical evidence suggests that upon announcement of a new equity issue,current share prices generally:
A)drop,perhaps because the new issue reflects management's view that ordinary equity is currently overvalued.
B)remain about the same since an efficient market anticipates a new equity issue.
C)increase,perhaps because the issues are associated with positive NPV projects.
D)increase,because the market supply is always less than demand.
E)increase,because underwriters exercise their green shoe option.
Q3) 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 equity 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?
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21
Chapter 20: Debt Financing
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Q1) Suppose that a bond is issued at its par value or face value.If market interest rates rise after the issue,the price of the bond will likely:
A)rise significantly above its par value.
B)rise slightly above its par value.
C)remain equal to its par value.
D)fall below its par value.
E)rise or fall,depending on the bond's maturity.
Q2) The written agreement between a corporation and its bondholders contains a limitation on the dividends that the corporation can pay.This limitation is:
A)a nonrecourse covenant.
B)a recourse covenant.
C)a negative covenant.
D)a positive covenant.
E)more than one of the above.
Q3) The choice of whether a private placement or a public bond issue is undertaken depends on many factors.Three elements of primary concern are registration,interest rates and covenants.How do these affect the choice and why might a private placement be chosen?
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Chapter 21: Leasing and Off-Balance-Sheet Financing
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Q1) In valuing the lease versus purchase option,the relevant cash flows are the:
A)tax shield from depreciation.
B)investment outlay for the equipment.
C)reduction in operating costs that are not affected buy leasing.
D)All of the above are irrelevant.
E)None of the above are irrelevant.
Q2) If a lease is for 35 years,it is regarded as a:
A)financial lease.
B)operating lease.
C)capital lease.
D)conditional sale.
E)sale and leaseback.
Q3) A lease is likely to be most beneficial to both parties when:
A)the lessor's tax rate is lower than the lessee's.
B)the lessor's tax rate is higher than the lessee's.
C)the lessor's tax rate is equal to the lessee's.
D)a lease cannot be beneficial to both parties.
E)a lease always has zero NPV,so both parties always break even.
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Chapter 22: Options and Corporate Finance
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Q1) Martha B's has total assets of 1,750.These assets are expected to increase in value to either 1,800 or 2,400 by next year.The company has a pure discount bond outstanding with a face value of 2,000.This bond matures in one year.Currently,Treasury bills are yielding 6%.What is the value of the equity in this firm?
A) 16.98
B) 34.59
Q2) The ordinary shares of Winssonis currently priced at 52.50 a share.One year from now,the share price is expected to be either 54 or 60 a share.The risk-free rate of return is 4%.What is the value of one call option on Winsson share with an exercise price of 55?
A) 0.39
B) 0.41
C) 0.45
D) 0.48
E) 0.51
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Chapter 23: Options and Corporate Finance: Extensions and Applications
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Q1) Which of the following statements is true?
A)The Black Scholes model is the simplest to use and best used for complex situations.
B)The Binomial model does not handle options with dividend payments prior to expiration date.
C)The Black Scholes adequately handles the valuation of an American put.
D)The Binomal model is better for complex situations and is the simplest tool to use.
E)The Black Scholes model is simpler to use,but for complex situations,the binomial model is the necessary tool.
Q2) An example of a special option is:
A)an executive share options.
B)the embedded option in a start-up company.
C)the option in simple business contracts.
D)the option to shut down and reopen a project.
E)All of the above.
Q3) Why would the company pay the executive in options as opposed to salary?
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25
Chapter 24: Warrants and Convertibles
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Q1) Warrants are most often issued in combination with:
A)new publicly placed ordinary equity.
B)new privately placed ordinary equity.
C)new publicly placed debt.
D)new privately placed debt.
E)preference shares.
Q2) A firm has 500 shares of equity and 100 warrants outstanding.The warrants are about to expire,and all of them will be exercised.The market value of the firm's assets is 25,000,and the market value of the debt is 8,000.Each warrant gives the owner the right to buy 5 shares at 25 per share.What is the value of a warrant?
Q3) A convertible bond has a 8% annual coupon and 15 years to maturity.The face value is 1,000 and the conversion ratio is 40.The equity currently sells for 20.875 per share.Similar nonconvertible bonds are priced to yield 9%.The value of the convertible bond is at least:
A) 835.00.
B) 919.39.
C) 1,000.00.
D) 1,570.11.
E)None of the above.
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Page 26
Chapter 25: Financial Risk Management With Derivatives
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Q1) Comparing long-term bonds with short-term bonds,long-term bonds are _____ volatile and therefore experience _____ price change than short-term bonds for the same interest rate shift.
A)less; less B)less; more C)more; more D)more; less E)more; the same
Q2) A financial institution has equity equal to one-tenth of its assets.If its asset duration is currently equal to its liability duration,then to immunize,the firm needs to:
A)decrease the duration of its assets.
B)increase the duration of its assets.
C)decrease the duration of its liabilities.
D)do nothing,i.e.,keep the duration of its liabilities equal to the duration of its assets.
E)None of the above.
Q3) The futures markets are labeled as pure speculation and even gambling.Why is this an inaccurate portrayal of the markets function?
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Chapter 26: Short-Term Finance and Planning
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Q1) Your bank offers you a £70,000 line of credit with an interest rate of 2.75% per quarter.The loan agreement also requires that 5% 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 ½ of 1% 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 that both the funds you borrow and the funds you invest use compound interest.
A)6.00%
B)6.06%
C)6.13%
D)6.17%
E)6.21%
Q2) Which one of the following statements is correct concerning the cash cycle?
A)The longer the cash cycle,the more likely a firm will need external financing.
B)Increasing the trade payabless period increases the cash cycle.
C)A positive cash cycle is preferable to a negative cash cycle.
D)The cash cycle can exceed the operating cycle if the payables period is equal to zero.
E)Adopting a more liberal trade receivables policy will tend to decrease the cash cycle.
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Chapter 27: Cash Management
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Q1) Marketability risk is synonymous with:
A)maturity risk.
B)default risk.
C)liquidity risk.
D)interest rate risk.
E)None of the above.
Q2) The Timberline firm expects a total need of 12,500 over the next 3 months.They have a beginning cash balance of 1,500,and cash is replenished when it hits zero.The fixed cost of selling securities to replenish cash balances is 3.50.The interest rate on marketable securities is 8% per annum.There is a constant rate of cash disbursement and no cash receipts during the month. If interest rates were to rise to 1.00% per month,what would the firm's total savings be if it switches from its current practice to the optimum practice (as given by the Baumol model)?
A) 4.62
B) 7.09
C) 26.42
D) 28.13
E)None of the above.
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Chapter 28: Credit Management
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Q1) Which of the following is not true concerning considerations in setting a credit policy?
A)A firm that supplies a perishable product will tend to offer restrictive credit terms.
B)A firm whose customers are in a high-risk business will tend to offer restrictive credit terms.
C)Lengthening the credit period effectively reduces the price paid by the customer.
D)Small accounts,associated with firms that find it difficult to acquire a line of credit,tend to receive longer credit periods.
E)None of the above.
Q2) Lengthening the credit period _____ the price paid by the customer.Generally,this acts to _____ sales.
A)increases; increase B)increases; decrease
C)decreases; decrease D)decreases; increase E)increases; have no effect on
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Chapter 29: Mergers and Acquisitions
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Q1) If a firm wants to take over another firm but feels the attempt to do so will be viewed as unfriendly it could decide to take a _____ approach to the acquisition.
A)crown jewel
B)shark repellent
C)bear hug
D)countertender offer
E)lockup
Q2) One company wishes to acquire another.Which of the following forms of acquisition does not require a formal vote by the shareholders of the acquired firm?
A)Merger
B)Acquisition of equity
C)Acquisition of assets
D)Consolidation
E)All of the above require a formal vote.
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) What is the absolute priority rule of the following claims once a corporation is determined to be bankrupt?
A)administrative expenses,wages claims,government tax claims,debtholder and then equityholder claims
B)administrative expenses,wages claims,government tax claims,equityholder and then debtholder claims
C)wage claims,administrative expenses,debtholder claims,government tax claims and equityholder claims
D)wage claims,administrative expenses,debtholder claims,equityholder claims and government tax claims
E)None of the above.
Q2) Equityholders may prefer a formal bankruptcy filing because:
A)the firm can issue debtor in possession debt.
B)they can delay pre-bankruptcy interest payments.
C)the lack of information about the length and magnitude of the cash flow problem favors equityholders.
D)All of the above.
E)None of the above.
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Chapter 31: International Corporate Finance
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Q1) The home currency approach:
A)generally produces more reliable results than those found using the foreign currency approach.
B)requires an applicable exchange rate for every time period for which there is a cash flow.
C)uses the current risk-free nominal rate to discount all of the cash flows related to a project.
D)stresses the use of the real rate of return to compute the net present value (NPV)of a project.
E)converts a foreign denominated NPV into a dollar denominated NPV.
Q2) The rate most international banks charge one another for overnight Eurodollar loans is called the:
A)Eurodollar yield to maturity.
B)London Interbank Offer Rate.
C)Paris Opening Interest Rate.
D)United States Treasury bill rate.
E)international prime rate.
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