Principles of Finance Exam Preparation Guide
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools necessary for making sound financial decisions within an organization. The course covers topics such as the time value of money, financial statement analysis, risk and return, valuation of stocks and bonds, capital budgeting, and the functioning of financial markets. Through practical examples and case studies, students learn how managers use financial information to evaluate investment opportunities, finance operations, and maximize shareholder value. This foundational course equips students with critical analytical skills applicable to personal and business finance.
Recommended Textbook
Financial Markets and Institutions 8th Edition by Frederic Mishkin
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27 Chapters
2334 Verified Questions
2334 Flashcards
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Page 2
Chapter 1: Why Study Financial Markets and Institutions?
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67 Verified Questions
67 Flashcards
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Sample Questions
Q1) From the peak of the high-tech bubble in 2000,the stock market ________ by over ________ by late 2002.
A) collapsed; 75%
B) rose; 35%
C) collapsed; 30%
D) rose; 50%
Answer: C
Q2) Although the internet has changed many aspects of our lives,it hasn't proven very useful for collecting and/or analyzing financial and economic data.
A)True
B)False
Answer: False
Q3) A security
A) is a claim or price of property that is subject to ownership.
B) promises that payments will be made periodically for a specified period of time.
C) is the price paid for the usage of funds.
D) is a claim on the issuers future income.
Answer: D
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3
Chapter 2: Overview of the Financial System
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Sample Questions
Q1) Intermediaries who link buyers and sellers by buying and selling securities at stated prices are called
A) investment bankers.
B) traders.
C) brokers.
D) dealers.
E) none of the above.
Answer: D
Q2) The purpose of diversification is to
A) reduce the volatility of a portfolio's return.
B) raise the volatility of a portfolio's return.
C) reduce the average return on a portfolio.
D) raise the average return on a portfolio.
Answer: A
Q3) Distinguish between primary markets and secondary markets.
Answer: 11ec663f_db52_ebd0_bd63_d36f7881685f_TB2777_00
Q4) An example of direct financing is if you were to lend money to your neighbor.
A)True
B)False
Answer: True
Page 4
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Chapter 3: What Do Interest Rates Mean and What Is Their
Role in Valuation?
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106 Flashcards
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Sample Questions
Q1) Dollars received in the future are worth ________ than dollars received today.The process of calculating what dollars received in the future are worth today is called
A) more; discounting
B) less; discounting
C) more; inflating
D) less; inflating
Answer: B
Q2) The duration of a ten-year,10 percent coupon bond when the interest rate is 10 percent is 6.76 years.What happens to the price of the bond if the interest rate falls to 8 percent?
A) It rises 20 percent.
B) It rises 12.3 percent.
C) It falls 20 percent.
D) It falls 12.3 percent.
Answer: B
Q3) All else being equal,the greater the interest rate the greater the duration is.
A)True
B)False
Answer: False
Page 5
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Chapter 4: Why Do Interest Rates Change?
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Sample Questions
Q1) Use the bond demand and supply framework to explain the Fisher effect and why it occurs.
Q2) When the growth rate of the money supply decreases,interest rates end up being permanently lower if
A) the liquidity effect is larger than the other effects.
B) there is fast adjustment of expected inflation.
C) there is slow adjustment of expected inflation.
D) the expected inflation effect is larger than the liquidity effect.
Q3) A ________ prefers stock in a less risky asset than in a riskier asset.
A) risk preferrer
B) risk-averse person
C) risk lover
D) risk-favorable person
Q4) A decrease in the expected rate of inflation causes the demand for bonds to ________ and the supply of bonds to ________.
A) fall; fall
B) fall; rise
C) rise; fall
D) rise; rise
Q5) What is the difference between systematic and nonsystematic risk?
Page 6
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Chapter 5: How Do Risk and Term Structure Affect Interest
Rates?
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Sample Questions
Q1) When the corporate bond market becomes more liquid,other things equal,the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
A) right; right
B) right; left
C) left; left
D) left; right
Q2) According to the expectations theory,the interest rate on a long-term bond is the average of the short-term interest rates expected over the life of the long-term bond.
A)True
B)False
Q3) The spread between interest rates on low-quality corporate bonds and U.S.government bonds ________ during the Great Depression. A) was reversed
B) narrowed significantly
C) widened significantly
D) did not change
Q4) What is meant by the risk structure of interest rates?
Page 7
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Chapter 6: Are Financial Markets Efficient?
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Sample Questions
Q1) An important lesson from the Black Monday Crash of 1987 and the tech crash of 2000 is that
A) factors other than market fundamentals affect stock prices.
B) the strong version of the efficient market hypothesis, that stock prices reflect the true fundamental value of securities, is correct.
C) market psychology has little if any effect on stock prices.
D) there is no such thing as a rational bubble.
Q2) The small-firm effect refers to the observation that small firms' stocks
A) follow a random walk but large firms' stocks do not.
B) have earned abnormally low returns given their greater risk.
C) have earned abnormally high returns even taking into account their greater risk.
D) sell for lower prices than do large firms' stocks.
Q3) An investor gains from short selling by ________ and then later ________.
A) buying a stock; selling it at a higher price
B) selling a stock; buying it back at a lower price
C) buying a stock; selling it at a lower price
D) selling a stock; buying it back at a higher price
Q4) Why are expectations important in understanding how financial instruments are valued?
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Chapter 7: Why Do Financial Institutions Exist?
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Sample Questions
Q1) Because managers (________)have less incentive to maximize profits than the stockholders-owners (________)do,stockholders find it costly to monitor managers; thus,stockholders are reluctant to purchase equities.
A) principals; agents
B) principals; principals
C) agents; agents
D) agents; principals
Q2) What conflicts of interest can arise in accounting firms?
Q3) The concept of adverse selection helps to explain why indirect finance is more important than direct finance as a source of business finance.
A)True
B)False
Q4) A debt contract is said to be incentive compatible if
A) the borrower's net worth reduces the probability of moral hazard.
B) restrictive covenants limit the type of activities that can be undertaken by the borrower.
C) both A and B of the above occur.
D) neither A nor B of the above occur.
Q5) Explain how the "lemons" problem could cause financial markets to fail.
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Chapter 8: Why Do Financial Crises Occur and
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Sample Questions
Q1) The Internet stock market bubble of the late 1990s led to one of the worst financial crises in U.S.history.Banks lost billions of dollars as Internet companies went bankrupt.
A)True
B)False
Q2) What is a collateralized debt obligation?
A) A tranche of an SPV that has been setup based on default risk
B) An agreement to exchange interest payments when one party defaults
C) A type of insurance against defaults
D) A contract between credit rating agencies
Q3) Financial crises
A) are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms.
B) occur when adverse selection and moral hazard problems in financial markets become more significant.
C) frequently lead to sharp contractions in economic activity.
D) are all of the above.
E) are only A and B of the above.
Q4) Explain the relationship between agency theory and a financial crisis.
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Page 10
Chapter 9: Central Banks and the Federal Reserve System
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Sample Questions
Q1) Which of the following functions are not performed by any of the twelve regional Federal Reserve banks?
A) Check clearing
B) Conducting economic research
C) Setting interest rates payable on time deposits
D) Issuing new currency
Q2) All ________ are required to be members of the Fed.
A) state-chartered banks
B) nationally chartered banks
C) banks with more than $100 million in assets
D) banks with more than $500 million in assets
Q3) The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced that
A) the First Bank of the United States had failed to serve as a lender of last resort.
B) the Second Bank of the United States had failed to serve as a lender of last resort.
C) the Federal Reserve System had failed to serve as a lender of last resort.
D) a central bank was needed to prevent future panics.
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11
Chapter 10: Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics
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Sample Questions
Q1) The Fed puts price stability along with maximum employment as its primary goals. This is known as a ________.
A) hierarchical mandate
B) dual mandate
C) singular mandate
D) ubiquitous mandate
Q2) When it comes to choosing an operating target,both the ________ rate and ________ aggregates are easily controllable using the Fed's policy tools.
A) federal funds; monetary
B) federal funds; reserve
C) three-month Treasury bill; monetary
D) ten-year Treasury bond; reserve
Q3) The monetary base consists of
A) currency in circulation and reserves.
B) government securities held by the Fed and discount loans.
C) government securities held by the Fed and currency in circulation.
D) discount loans and reserves.
Q4) What are the arguments for and against central bank intervention during asset-price bubbles?
Page 12
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Chapter 11: The Money Markets
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Sample Questions
Q1) The size of the asset-backed commercial paper market nearly doubled between 2004 and 2007 to about $1 trillion.Discuss how the subprime meltdown and collapse of the ABCP market almost led to the collapse of the money market mutual fund market as well.
Q2) Explain why money market interest rates move so closely together over time.
Q3) Banker's acceptances
A) can be bought and sold until they mature.
B) are issued only by large money center banks.
C) carry low interest rates because of the very low default risk.
D) are all of the above.
E) are only A and B of the above.
Q4) The Fed can lower the federal funds interest rate by ________ securities,thereby ________ reserves.
A) selling; adding B) selling; lowering C) buying; adding D) buying; lowering
Q5) Why would we expect rates on money market securities to move together?
Q6) What are the major types of securities and who are the major participants in the money markets?
Page 13
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Chapter 12: The Bond Market
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Sample Questions
Q1) (I)Because interest rates on Treasury bills are more volatile than rates on long-term securities,the return on short-term Treasury securities is usually above that on longer-term Treasury securities.
(II)A Treasury STRIP separates the periodic interest payments from the final principal repayment.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Q2) (I)The primary issuers of capital market securities are federal and local governments,and corporations.
(II)Governments never issue stock because they cannot sell ownership claims.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
Q3) What is a bond's current yield? How does the current yield differ from the yield to maturity and what determines how close the two values are?
Q4) What is a bond indenture?
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Chapter 13: The Stock Market
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Sample Questions
Q1) According to the Gordon growth model,what is an investor's valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investor's required return is 11 percent?
A) $110
B) $100
C) $11
D) $10
E) $5.24
Q2) A high price earnings ratio (PE)gives what interpretation?
A) The market expects earnings to fall in the future.
B) The market feels the firm's earnings are very high risk and are willing to pay a premium for them.
C) The market expects the earnings to rise in the future.
D) The firm is not paying a dividend.
Q3) The Securities and Exchange Commission requires firms to submit various documents to increase the flow of information to investors but does not verify the accuracy of that information.
A)True
B)False
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Chapter 14: The Mortgage Markets
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Sample Questions
Q1) Which of the following protects the mortgage lender's right to sell property if the underlying loan defaults?
A) A lien
B) A down payment
C) Private mortgage insurance
D) Borrower qualification
E) Amortization
Q2) A FICO score below 660 is considered good while a score above 720 is likely to cause problems in obtaining a loan.
A)True
B)False
Q3) The share of the mortgage market held by savings and loans is
A) over 50 percent.
B) approximately 40 percent.
C) approximately 20 percent.
D) less than 5 percent.
Q4) Why has the online lending market developed in recent years and what are the advantages and disadvantages of this development?
Q5) What are the benefits and side effects of securitized mortgages?
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Chapter 15: The Foreign Exchange Market
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Sample Questions
Q1) Evidence from the United States during the period 1973-2012 indicates the correspondence between nominal interest rates and exchange rate movements is
A) much closer than that between real interest rates and exchange rate movements.
B) not nearly as close as that between government spending and exchange rate movements.
C) not nearly as close as that between government deficits and exchange rate movements.
D) not nearly as close as that between real interest rates and exchange rate movements.
Q2) When the domestic nominal interest rate rises because of an increase in expected inflation,the expected appreciation of the dollar declines,________ shifts out more than ________,and the exchange rate declines.
A) R<sup>F</sup>; R<sup>D</sup>
B) R<sup>F</sup>; R<sup>F</sup>
C) R<sup>D</sup>; R<sup>D</sup>
D) R<sup>D</sup>; R<sup>F</sup>
Q3) Explain the logic underlying the law of one price and the theory of purchasing power parity.
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Page 17
Chapter 16: The International Financial System
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Sample Questions
Q1) The Bretton Woods system was one in which central banks
A) agreed to limit domestic money growth to the average of the seven largest industrial nations.
B) agreed not to intervene in the foreign exchange market to maintain a fixed exchange rate regime that had existed prior to World War I.
C) agreed to limit domestic money growth to the average of the five largest industrial nations.
D) bought and sold their own currencies to keep their exchange rates fixed.
Q2) The official reserve transactions balance
A) equals the current account balance plus the items in the capital account.
B) tells us the net amount of international reserves that must move between central banks in order to finance international transactions.
C) has an important impact on the money supply.
D) is all of the above.
Q3) A managed float regime is when countries intervene in foreign exchange markets in an attempt to influence their exchange rates by buying and selling foreign assets.
A)True
B)False
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Chapter 17: Banking and the Management of Financial Institutions
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Sample Questions
Q1) The value-at-risk method for estimating a bank's risk exposure measures the losses a bank could incur under a worst-case scenario.
A)True
B)False
Q2) Off-balance-sheet activities consist of trading financial instruments and generating income from fees and loan sales,all of which affect bank profits but are not visible on bank balance sheets.
A)True
B)False
Q3) The largest source of bank income is
A) interest on loans.
B) interest on securities.
C) service charges on deposit accounts.
D) noninterest income.
Q4) Which of the following are not reported as assets on a bank's balance sheet?
A) Cash items in the process of collection
B) Borrowings
C) U.S. Treasury securities
D) Reserves
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Chapter 18: Financial Regulation
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Sample Questions
Q1) The increased integration of financial markets across countries and the need to make the playing field equal for banks from different countries led to the Basel Accord agreement to
A) standardize bank capital requirements internationally.
B) reduce, across the board, bank capital requirements in all countries.
C) sever the link between risk and capital requirements.
D) do all of the above.
Q2) The Federal Deposit Insurance Corporation Improvement Act of 1991
A) reduced the scope of deposit insurance in several ways.
B) eliminated restrictions on nationwide banking.
C) allowed well-capitalized banks to do some securities underwriting.
D) did only A and B of the above.
E) did only A and C of the above.
Q3) Of the following assets,the one which has the highest capital requirement under the Basel Accord is
A) municipal bonds.
B) residential mortgages.
C) commercial paper.
D) securities issued by industrialized countries' governments.
Q4) Describe the CAMELS rating system used by bank examiners.
Page 20
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Chapter 19: Banking Industry: Structure and Competition
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Q1) Securitization is the process of transforming illiquid financial assets such as residential mortgages into marketable securities.
A)True
B)False
Q2) The existence of large numbers of banks in the United States indicates the presence of vigorous competition.
A)True
B)False
Q3) In the 1950s,the interest rate on three-month Treasury bills fluctuated between 1.0% and 3.5%.In the 1980s,the three-month Treasury bill rate ranged from 5% to over 15%.From this,one could predict that in the 1980s interest-rate risk was ________ and the demand for financial innovation was ________.
A) greater; lower
B) greater; greater
C) lower; lower
D) lower; greater
Q4) Unlike commercial banks,S&Ls can only be chartered by the federal government.
A)True
B)False
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Chapter 20: The Mutual Fund Industry
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Sample Questions
Q1) Which of the following is an advantage to investors of an open-end mutual fund?
A) Once all the shares have been sold, the investor does not have to put in more money.
B) The investors can sell their shares in the over-the-counter market with low transaction fees.
C) The fund agrees to redeem shares at any time.
D) The market value of the fund's shares may be higher than the value of the assets held by the fund.
Q2) The origins of mutual funds can be traced back to the mid to late 1800s in
A) England and Scotland
B) New York City
C) Boston
D) Germany
Q3) How is an index fund different from the other four primary investment objective classes for mutual funds?
Q4) What are two key differences between a traditional mutual fund and a hedge fund?
Q5) Discuss the proposals that have been made to reduce the conflict of interest abuses in the mutual funds industry.
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Chapter 21: Insurance Companies and Pension Funds
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Sample Questions
Q1) The problem of ________ occurs when those most likely to get large insurance payoffs are the ones who want to purchase insurance the most.
A) asymmetric information
B) moral hazard
C) adverse selection
D) fraudulent behavior
Q2) Which of the following is not a proposal for insuring that sufficient funds will be available to provide Social Security benefits to future retirees?
A) Raise the maximum income cap on which workers and employers are taxed.
B) Provide more generous annual cost of living increases.
C) Raise the minimum age for receiving benefits.
D) Reduce the amount of future benefits.
Q3) Fraudulent practices and other abuses of private pension funds led Congress to enact the ________.
A) Federal Deposit Insurance Corporation Act
B) Employee Retirement Income Security Act
C) Federal Reserve Act
D) Social Security Act
Q4) Distinguish between different types of life insurance.
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Chapter 22: Investment Banks, Security Brokers and Dealers,
and Venture Capital Firms
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Q1) What niche in the financial system do venture capital firms fill?
Q2) The primary function of investment banks is
A) the bundling of deposits into loans.
B) extending long-term credit to other financial institutions.
C) helping corporations raise funds.
D) providing credit to firms engaged in international trade.
Q3) In a ________ agreement,the investment banker makes no guarantee regarding the price the issuing firm will receive,but agrees to sell the securities on a commission basis.
A) best efforts
B) brokered
C) private-placement
D) jump-start
Q4) Private placements
A) do not require the services of investment bankers.
B) need not be registered with the SEC.
C) are more common in the sale of stocks than for bonds.
D) all of the above.
E) are only A and B of the above.
Q5) What is underwriting?
Page 24
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Chapter 23: Risk Management in Financial Institutions
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Q1) If a bank has more rate-sensitive liabilities than rate-sensitive assets,then a(n)________ in interest rates will ________ bank profits. A) increase; increase B) increase; reduce C) decline; reduce D) decline; not affect
Q2) If First National Bank has a gap equal to a negative $30 million,then a 5 percentage point increase in interest rates will cause profits to A) increase by $15 million. B) increase by $1.5 million. C) decline by $15 million. D) decline by $1.5 million.
Q3) What is duration gap analysis and why is it important to a bank?
Q4) What special assumptions do income and duration gap analyses make about interest rate changes and the yield curve?
Q5) Discuss some of the problems in using income gap and duration gap analysis to manage interest rate risk in a financial institution.
Q6) What is gap analysis and why is it important to a bank?
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Chapter 24: Hedging with Financial Derivatives
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Q1) Futures trading is regulated by the Commodity Futures Trading Commission.
A)True
B)False
Q2) When a financial institution is hedging interest-rate risk on its overall portfolio,the hedge is a ________.
A) macro hedge
B) micro hedge
C) cross hedge
D) futures hedge
Q3) Which is not a problem of forward contracts?
A) A lack of liquidity
B) A lack of flexibility
C) The difficulty of finding a counterparty
D) Default risk
Q4) Define and distinguish between call options and put options.
Q5) Discuss the challenges regulators face in controlling the use of derivatives by financial institutions.
Q6) Explain how a long hedge could be used to protect a bank from the risk that interest rates could rise before a loan is funded.
Page 26
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Chapter 25: Financial Crises In Emerging Market Economies
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Q1) Describe the sequence of events in a financial crisis in an emerging market economy and explain why they can cause economic activity to decline.
Q2) The experience with financial crises in emerging market economies suggests a number of government policies that can help make financial crises in emerging market countries less likely,including
A) beefing up prudential regulation and supervision of banks.
B) better bank risk disclosure.
C) limiting the currency mismatch.
D) all of the above.
E) only B and C of the above.
Q3) Stage Two of a financial crisis in an emerging market economy usually involves a ________ crisis.
A) currency
B) stock market
C) banking
D) commodities
Q4) What are some of the steps that emerging market economies can take to avoid a financial crisis?
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Chapter 26: Savings Associations and Credit Unions
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Q1) Since 1980,the number of credit unions has ________. A) declined substantially
B) remained steady C) increased substantially
D) increased slightly
Q2) The capital of financial institutions is often measured by the ________ ratio. A) current B) net worth
C) asset turnover
D) liquidity
Q3) Why did the Competitive Equality in Banking Act of 1987 fail to solve the problems in the thrift industry?
Q4) Since 1993,the number of savings and loan associations has ________. A) held steady
B) risen sharply C) risen slightly
D) declined substantially
Q5) The second major liability of savings and loans is borrowings. A)True
B)False
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Chapter 27: Finance Companies
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Sample Questions
Q1) How do consumer loans differ between those issued by finance companies and those issued by banks?
A) Loans made by finance companies are often riskier than those issued by banks.
B) Consumer finance companies are typically owned by the manufacturer whose products are being financed.
C) Both A and B of the above are correct.
D) None of the above are correct.
Q2) What are the various types of finance companies?
Q3) A balloon loan requires
A) multiple payments at odd, random intervals.
B) periodic payments of principle and interest.
C) a single large payment at the loan's maturity to retire the debt.
D) a steadily increasing payment (floating balloon) to retire the debt.
Q4) In 2013,the largest portion of loans made by finance companies was ________,representing 60% of the loans.
A) consumer loans
B) factoring loans
C) business loans
D) real estate
Q5) Describe the process of factoring? When and why is it used?
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