Principles of Finance Practice Questions
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools of financial management, focusing on how individuals and organizations make investment and financing decisions. The course covers topics such as the time value of money, risk and return analysis, valuation of stocks and bonds, capital budgeting, and the functioning of financial markets. Emphasis is placed on understanding financial statements, the basics of financial planning, and the impact of economic and market factors on financial decision-making. This foundational course equips students with the analytical skills needed to interpret financial information and apply financial principles to real-world scenarios.
Recommended Textbook
Financial Markets and Institutions 9th Edition by Jeff Madura
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Chapter 1: Role of Financial Markets and Institutions
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Q1) Funds are provided to the initial issuer of securities in the
A)secondary market.
B)primary market.
C)deficit market.
D)surplus market.
Answer: B
Q2) The main provider(s) of funds to the U.S.Treasury is (are)
A)households and businesses.
B)foreign financial institutions.
C)the Federal Reserve System.
D)foreign nonfinancial sectors.
Answer: A
Q3) Equity securities
A)have a maturity.
B)pay interest on a periodic basis.
C)represent ownership in the issuer.
D)repay the principal amount at maturity.
Answer: D
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Chapter 2: Determination of Interest Rates
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Q1) To forecast interest rates using the Fisher effect, the real interest rate for an upcoming period can be forecasted by subtracting the expected inflation rate over that period from the nominal interest rate quoted for that period.
A)True
B)False
Answer: True
Q2) The Fisher effect states that the
A)nominal interest rate equals the expected inflation rate plus the real rate of interest.
B)nominal interest rate equals the real rate of interest minus the expected inflation rate.
C)real rate of interest equals the nominal interest rate plus the expected inflation rate.
D)expected inflation rate equals the nominal interest rate plus the real rate of interest.
Answer: A
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Chapter 3: Structure of Interest Rates
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Q1) In some time periods there is evidence that corporations initially financed long-term projects with short-term funds.They planned to borrow long-term funds once interest rates were lower.This specifically supports the ____ for explaining the term structure of interest rates.
A)liquidity premium theory
B)expectations theory
C)segmented markets theory
D)A and C
Answer: B
Q2) Assume that a yield curve is influenced by interest rate expectations and a liquidity premium.Assume the yield curve is initially flat.If liquidity suddenly was no longer important, the yield curve would now have a ____ (assuming no other changes).
A)slight downward slope
B)slight upward slope
C)steep upward slope
D)steep downward slope
Answer: A
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Chapter 4: Functions of the Fed
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Q1) The federal funds rate is the rate at which the Fed lends money directly to member banks.
A)True
B)False
Q2) ____ credit extended by the Fed to financial institutions may be used for any purpose and is available only to depository institutions that satisfy specific criteria reflecting financial soundness.
A)Primary
B)Secondary
C)Tertiary
D)None of the above
Q3) When the Trading Desk sells a sufficient amount of Treasury securities, it creates a surplus of funds in the banking system.Consequently, the federal funds rate decreases along with other interest rates.
A)True
B)False
Q4) The Policy Directive is provided by Board of Governors to the FOMC.
A)True
B)False
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Chapter 5: Monetary Policy
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Q1) The Fed is more likely to use a stimulative policy during a strong-dollar period.
A)True
B)False
Q2) A credit crunch occurs when:
A)interest rates decline.
B)interest rates rise.
C)creditors restrict the amount of loans they are willing to provide.
D)the economy is strong.
Q3) A ____ economic indicator tends to rise or fall a few months after business-cycle expansions and contractions.
A)leading
B)coincident
C)lagging
D)none of the above
Q4) If the Fed implemented a policy of inflation targeting, and if the U.S.inflation rate deviated substantially from the Fed's target inflation rate, the Fed could lose credibility.
A)True
B)False
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Chapter 6: Money Markets
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Q1) The rate at which depository institutions effectively lend or borrow funds from each other is the ____.
A)federal funds rate
B)discount rate
C)prime rate
D)repo rate
Q2) Jarrod King, a private investor, purchases a Treasury bill with a $10,000 par value for $9,645.One hundred days later, Jarrod sells the T-bill for $9,719.What is Jarrod's expected annualized yield from this transaction?
A)13.43 percent
B)2.78 percent
C)10.55 percent
D)2.80 percent
E)none of the above
Q3) A line of credit provided by a commercial bank allows a company the right (but not the obligation) to borrow a specified maximum amount of funds over a specified period of time.
A)True
B)False
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Chapter 7: Bond Markets
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Q1) Zero-coupon bonds do not pay interest.Instead, they are issued at a discount from par value.
A)True
B)False
Q2) Treasury bond auctions are normally conducted only at the beginning of each year.
A)True
B)False
Q3) A variable rate bond allows
A)investors to benefit from declining rates over time.
B)issuers to benefit from rising market interest rates over time.
C)investors to benefit from rising market interest rates over time.
D)none of the above.
Q4) Devin is, a private investor, purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity.Devin will hold the bonds until maturity.Thus, he will earn a return of ____ percent.
A)12
B)9
C)10.5
D)more information is needed to answer this question
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Chapter 8: Bond Valuation and Risk
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Q1) Which of the following bonds is most susceptible to interest rate risk from an investor's perspective?
A)short-term, high-coupon
B)short-term, low-coupon
C)long-term, high-coupon
D)long-term, zero-coupon
Q2) Which of the following will most likely cause bond prices to increase? (Assume no possibility of higher inflation in the future.)
A)reduced Treasury borrowing along with anticipation that money supply growth will decrease
B)reduced Treasury borrowing along with anticipation that money supply growth will increase
C)an anticipated drop in money supply growth along with increasing Treasury borrowing
D)higher levels of Treasury borrowing and corporate borrowing
Q3) In a laddered strategy, investors create a bond portfolio that will generate periodic income that can match their expected periodic expenses.
A)True
B)False
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Page 10
Chapter 9: Mortgage Markets
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Sample Questions
Q1) Rates for adjustable-rate mortgages are commonly tied to the
A)average prime rate over the previous year.
B)Fed's discount rate over the previous year.
C)average Treasury bill rate over the previous year.
D)average Treasury bond rate over the previous year.
Q2) The adjustable-rate mortgage creates uncertainty for the ____ profit margin, but reduces the uncertainty for the ____.
A)originator's; borrower
B)borrower's; originator
C)government's; originator
D)none of the above
Q3) Which of the following is not true with respect to a growing-equity mortgage?
A)It is similar to a graduated-payment mortgage.
B)It allows borrowers to initially make small payments on the mortgage.
C)It involves increased payments, on a graduated basis, over the first five to ten years of the mortgage.
D)It involves payments that level off after the first five to ten years of the mortgage.
E)All of the above are true regarding a growing-equity mortgage.
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Chapter 10: Stock Offerings and Investor Monitoring
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Q1) When a firm buys some of its shares that it had previously issued, this is referred to as a:
A)reverse IPO.
B)leveraged buyout.
C)ladder spin.
D)stock repurchase.
Q2) The prevailing price per share divided by the firm's earnings per share is known as the
A)dividend yield.
B)price-earnings ratio.
C)fully diluted earnings per share.
D)annual dividend.
Q3) IPOs tend to occur more primarily during recessions.
A)True
B)False
Q4) Electronic stock exchanges that execute stock transactions electronically are referred to as electronic communications networks (ECNs).
A)True
B)False
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Chapter 11: Stock Valuation and Risk
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Q1) A firm's stock price is affected not only by macroeconomic and market conditions but also by firm specific conditions.
A)True
B)False
Q2) The limitations of the dividend discount model are most pronounced for a firm that
A)has a high beta.
B)has high expected future earnings.
C)distributes most of its earnings as dividends.
D)retains all of its earnings.
E)none of the above
Q3) While the previous year's earnings are often used as a base for forecasting future earnings, the recent year's earnings do not always provide an accurate forecast of the future.
A)True
B)False
Q4) The credit crisis only affected the stock performance of stocks in the U.S.
A)True
B)False
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Chapter 12: Market Microstructure and Strategies
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Q1) A stop-loss order is a particular type of limit order whereby the investor specifies a selling price that is below the current market price of the stock.
A)True
B)False
Q2) The short interest ratio is commonly measured as the number of shares shorted divided by the number of shares that the firm has repurchased in the last quarter.
A)True
B)False
Q3) The NYSE defines ____as the simultaneous buying and selling of a portfolio of at least 15 different stocks that are contained within the S&P 500 index values at more than $1 million.
A)direct access brokering
B)electronic communication networking
C)program trading
D)regulation of stock trading
Q4) A market order is an order to buy or sell a stock at the best possible price.
A)True
B)False
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Chapter 13: Financial Futures Markets
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Q1) Which of the following statements is incorrect regarding organized exchanges trading financial futures contracts?
A)Organized exchanges establish and enforce rules for the trading of financial futures contracts.
B)Organized exchanges ensure that the seller of the futures contract always delivers the securities covered by the contract, whether the contract was settled prior to the settlement date or not.
C)Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
D)The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
E)All of the above are correct.
Q2) The initial margin of a futures contract is typically between ____ percent of a futures contract's full value.
A)0 and 2
B)5 and 18
C)25 and 40
D)45 and 60
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Page 15
Chapter 14: Options Markets
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Sample Questions
Q1) Options on stock indexes representing non-U.S.stocks are ____; options exchanges have been established ____.
A)available; in numerous non-U.S.countries
B)not available; in numerous non-U.S.countries
C)available; only in the United States
D)not available; only in the United States
Q2) Refer to Exhibit 14-1.Kombs net gain from this strategy is $____.
A)F1F1F1S1 F1F1F102,687.50
B)2,687.50
C)2,375.00
D)7,437.50
E)none of the above
Q3) Put options are more typically used to hedge when portfolio managers are mainly concerned about a temporary decline in a stock's value.
A)True
B)False
Q4) American-style stock options can be exercised only just before expiration.
A)True
B)False
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Chapter 15: Swap Markets
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Sample Questions
Q1) Assume a financial institution that has rate-sensitive liabilities and rate-insensitive assets.If interest rates are expected to decline consistently, this institution would benefit by negotiating a(n)
A)forward swap.
B)callable swap.
C)extendable swap.
D)none of the above
Q2) An arrangement which enables firms to exchange currencies at periodic intervals is called a
A)currency swap.
B)interest rate swap.
C)swap exchange.
D)eurobond swap.
Q3) An equity swap involves the exchange of
A)preferred stock for common stock.
B)interest payments for an equity position in the counterparty's firm.
C)interest payments for payments linked to the degree of change in a stock index.
D)interest payments for newly issued stock by financial institutions.
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Chapter 16: Foreign Exchange Derivative Markets
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Sample Questions
Q1) Bank A asks $.555 for Swiss francs and Banks B and C are willing to pay $.557 for francs.An institution could capitalize on these differences by engaging in
A)covered interest arbitrage.
B)triangular arbitrage.
C)locational arbitrage.
D)witching hour arbitrage.
Q2) Assume that a British pound put option has a premium of $.03 per unit, and an exercise price of $1.60.The present spot rate is $1.61.The expected future spot rate on the expiration date is $1.52.The option will be exercised on this date if at all.What is the expected per unit net gain (or loss) resulting from purchasing the put option?
A)$.01 loss
B)$.09 loss
C)$.09 gain
D)$.05 gain
Q3) A country that pegs its currency is still able to maintain complete control over its local interest rates.
A)True
B)False
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Chapter 17: Commercial Bank Operations
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Q1) Money market deposit accounts differ from conventional time deposits in that they
A)specify a maturity.
B)offer limited check writing privileges.
C)are less liquid.
D)none of the above
Q2) Commercial banks can be a lender or a borrower when using repurchase agreements and loans in the federal funds market.
A)True
B)False
Q3) A bank's sources of funds represent liabilities or equity of the bank.
A)True
B)False
Q4) All other things equal, when banks issue new stock, they
A)increase reported earnings per share.
B)decrease their ability to absorb operating losses.
C)dilute the ownership of the bank.
D)A and B
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Chapter 18: Bank Regulation
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Q1) Which of the following statements is incorrect?
A)The validity of a bank's estimated VAR is assessed with backtests in which the actual daily trading gains or losses are compared to the estimated VAR over a particular period.
B)Some banks supplement the VAR estimate with stress tests.
C)In general, the VAR model does not lend itself to determine capital requirements.
D)All of the statements above are correct.
Q2) There is much emphasis by regulators on the bank's sensitivity to interest rate movements, since many banks have liabilities that are repriced more frequently than their assets and are adversely affected by rising interest rates.
A)True
B)False
Q3) All state banks are required to be members of the Federal Reserve System. A)True
B)False
Q4) Banks commonly use depositor funds to invest in stocks.
A)True
B)False
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Chapter 19: Bank Management
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Sample Questions
Q1) A bank's net interest margin is commonly defined as
A)interest revenues minus interest expenses.
B)(interest revenues minus interest expenses)/total assets.
C)(interest revenues minus interest expenses)/total liabilities.
D)(interest revenues minus interest expenses)/capital.
Q2) For a commercial bank, when the average duration of assets exceeds the average duration of liabilities, the duration gap is
A)zero.
B)positive.
C)negative.
D)B or C
Q3) If a bank obtains a relatively large portion of its funds from conventional demand deposits, interest expenses should be relatively ____, while its noninterest expenses should be relatively ____.
A)high; low
B)low; high
C)high; high
D)low; low
E)none of the above
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Chapter 20: Bank Performance
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Q1) If a bank had long-term fixed-rate assets and short-term liabilities, and interest rates increased over time, its net interest margin should
A)decrease.
B)increase.
C)stay the same.
D)either A or B, depending on whether the asset maturities exceed 10 years
Q2) Which of the following is not a factor that affects cash flows of a commercial bank?
A)changes in economic growth
B)changes in the risk-free interest rate
C)changes in industry conditions
D)changes in management abilities
E)all of the above are factors that affect cash flows of a commercial bank
Q3) Even if other external forces (such as interest rates) are unchanged, a commercial bank's expected cash flows can change in response to a change in its management skills.
A)True
B)False
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Chapter 21: Thrift Operations
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Sample Questions
Q1) For savings institutions in aggregate, ____ are the main asset.
A)investment securities
B)mortgages
C)commercial loans
D)credit card loans
Q2) Savings institutions that reduce their amount of ____ will best reduce their exposure to interest rate risk.
A)fixed-rate mortgages
B)consumer loans
C)commercial loans
D)short-term securities
Q3) The ____ acts as a temporary lender to credit unions.
A)World Bank
B)Central Liquidity Facility
C)Federal Home Loan Bank
D)National Credit Union Administration
Q4) In general, savings institutions are larger than commercial banks.
A)True
B)False
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Chapter 22: Finance Operations
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Q1) If finance companies with a greater rate-sensitivity of liabilities than assets wanted to reduce interest-rate risk, they could
A)shorten their average asset life.
B)lengthen their average asset life.
C)shorten the maturity of debt that they issue.
D)make greater use of fixed-rate loans.
Q2) Finance companies commonly act as ____ for accounts receivable; that is, they purchase a firm's receivables at a discount and are responsible for processing and collecting the balances of these accounts.
A)factors
B)brokers
C)dealers
D)market makers
E)none of the above
Q3) Finance companies primarily invest in
A)consumer loans.
B)real estate loans.
C)business loans.
D)none of the above
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Chapter 23: Mutual Fund Operations
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Q1) The net asset value (NAV) is estimated each day by first determining the market value of all securities comprising the mutual fund.
A)True
B)False
Q2) Hedge funds that exceed a specified size must register with the
A)Securities and Exchange Commission (SEC).
B)Federal Reserve.
C)Office of Thrift Supervision.
D)Federal Mutual Fund Board.
Q3) Hedge funds differ from open-end mutual funds in the sense that
A)they require a much smaller initial investment.
B)they are open to additional investments at any time.
C)they do not accommodate investors who want to sell their shares back to the fund.
D)they invest in very limited set of securities.
Q4) The term "mutual funds" is normally used to represent open-end funds, and does not include closed end funds.
A)True
B)False
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Chapter 24: Securities Operations
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Q1) Requests by customers to purchase or sell securities at a specified price or better are called ____ orders.
A)market
B)limit
C)stop-loss
D)specialist
E)none of the above
Q2) Funds received from a bridge loan are commonly used to
A)purchase junk bonds.
B)purchase high-grade corporate bonds.
C)provide temporary financing for an acquisition.
D)provide financing for individual investors that wish to purchase Treasury bonds.
Q3) Institutional investors that are willing to hold stock for a very short period of time are prime candidates for participating in a private placement.
A)True
B)False
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Page 26
Chapter 25: Insurance and Pension Fund Operations
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Q1) To reduce interest rate risk, pension fund managers can
A)shift from variable-rate to fixed-rate bonds.
B)increase the average maturity on fixed-rate bonds.
C)decrease the average maturity on fixed-rate bonds.
D)reduce the investment in money market securities.
Q2) ____ insurance covers losses due to dishonest employees.
A)Key employee
B)Credit line
C)Malpractice
D)Fidelity bond
Q3) Public pension funds can be classified by the manner in which contributions are received and benefits are paid.
A)True
B)False
Q4) Life insurance companies can attempt to reduce their exposure to interest rate risk by
A)increasing their proportion of long-term assets.
B)diversifying the age distribution of their customer base.
C)increasing their proportion of short-term assets.
D)concentrating on an older age distribution of their customer base.
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