Principles of Finance
Pre-Test Questions
Course Introduction
Principles of Finance introduces students to the fundamental concepts and analytical techniques used in financial management. The course covers key topics such as time value of money, risk and return, valuation of stocks and bonds, capital budgeting, and financial statement analysis. Emphasis is placed on the role of financial markets and institutions, as well as ethical considerations in financial decision-making. By the end of the course, students will develop the skills necessary to understand the financial challenges faced by organizations and make informed decisions to maximize value.
Recommended Textbook
Fundamentals of Investments 3rd Canadian Edition by Bradford Jordan
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Chapter 1: A Brief History of Risk and Return
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Sample Questions
Q1) Which of the following is false?
A) Risky assets have a risk premium on average.
B) In general, the greater the risk, the greater the return.
C) Standard deviation is a commonly used measure of risk.
D) Risk and return have historically exhibited a direct relationship.
E) None of the above.
Answer: E
Q2) The variance measures the:
A) Total difference between the actual returns and the average returns
B) Average difference between the actual squared returns and the risk-free returns
C) Average squared difference between the actual returns and the risk-free returns
D) Total difference between the average returns and the risk-free returns
E) Average squared difference between the actual and the average returns
Answer: E
Q3) What are the two most important lessons from capital market history?
Answer: First, risky assets earn a risk premium on average. This is the reward for bearing risk. Second, the greater the potential reward from a risky investment, the greater is the risk.
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Chapter 2: Diversification and Risky Asset Allocation
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Sample Questions
Q1) If the future return on a security is known with certainty, then the risk premium on that security should be equal to
A) Zero
B) The risk-free rate
C) The market rate
D) The market rate minus the risk-free rate
E) The risk-free rate plus one-half of the market rate
Answer: A
Q2) To lie on the Markowitz efficient frontier, an asset must have a __________ expected return than any other asset with the same standard deviation. The asset must also have a __________ standard deviation than any other asset with the same expected return.
A) higher: higher
B) higher; lower
C) lower; lower
D) lower; higher
E) Insufficient information.
Answer: B
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Page 4
Chapter 3: The Investment Process
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Sample Questions
Q1) You purchase 800 shares of stock at a price of $102 and an initial margin of 50 percent. The call money rate is 5.2 percent and you pay a spread of 1.7 percent. A year later, you close your position at a stock price of $94. With an annual dividend of $1.80 per share, what was your return?
A) - 14.32%
B) - 22.59%
C) - 19.06%
D) - 6.08%
E) - 12.64%
Answer: C
Q2) You purchase 300 shares of stock at a price of $36 per share on 50 percent margin. What is the most you can lose?
A) $10,800
B) $5,000
C) $3,600
D) $5,400
E) There is no limit.
Answer: A
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Chapter 4: Overview of Security Types
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Sample Questions
Q1) Suppose you own 8 of the Willie bonds. If the net change in price is 1.24%, what will be the change in the value of your investment for the next day?
A) $99.20
B) $88.96
C) $73.14
D) $56.00
E) $8.19
Q2) A _____ bond can be exchanged for shares of stock at the bond owner's discretion. A) stock
B) convertible
C) high yield
D) cumulative
E) call option
Q3) What was the closing price on the prior trading day for Distracted's stock?
A) $37.98
B) $38.10
C) $38.16
D) $38.22
E) $38.32
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Page 6
Chapter 5: Mutual Funds
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Sample Questions
Q1) A deferred sales charge is also know as a(n):
A) offering price.
B) special fee.
C) back-end load.
D) front-end load.
E) exchange fee.
Q2) 4 months ago, you purchased 800 shares of a mutual fund at an offering price of $46.50 a share. The find imposes a front-end load of 4% and has a total annual expense of 0.95%. The NPV of the fund today is $48.63. There were no fund distributions or dividends. What was your holding period return on this investment?
A) 4.77%
B) 5.11%
C) 4.95%
D) 3.96%
E) 4.58%
Q3) Why do the performance fees of hedge fund managers often have a "high water mark" constraint?
Q4) How do open-end and closed-end mutual funds differ? How do closed-end funds offer the potential for an 'extra' return?
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Chapter 6: The Stock Market
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Sample Questions
Q1) An index has a market value of $6,450,000 at the beginning of the period and $5,986,000 at the end of the period. If you want the beginning index value to be 600, what is the ending index value?
A) 564.17
B) 556.84
C) 646.51
D) 632.83
E) 570.86
Q2) You place a stop-loss order at $78. The current share price is $82. The stock price drops the next day to $75. What is the best price you could receive for your stock?
A) $75.00
B) $78.00
C) $74.99
D) $82.00
E) $75.01
Q3) What are the major differences between NASDAQ and the NYSE?
Q4) Describe how a stop-limit sell order is executed.
Q5) What is the main advantage of a market order?
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Chapter 7: Common Stock Valuation
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Sample
Questions
Q1) ABC Inc. has announced today that they are going out of business. As of today, no more regular dividends will be paid. The intention of the firm is to pay two liquidating dividends. The first dividend will be paid one year from now in the amount of $20 a share. The second and final dividend will be paid two years from now at an estimated $13 a share. What is the value of this stock to you today if you feel the appropriate discount rate is 16%?
A) $21.14
B) $24.52
C) $26.90
D) $28.45
E) $31.21
Q2) You feel a certain stock will pay dividends of $18, $24, and $30 over the next three years. If you require a return of 11 percent, how much should you pay for the stock?
A) $48.21
B) $57.63
C) $59.88
D) $72.00
E) $61.06
Q3) What is the process of fundamental analysis?
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Chapter 8: Stock Price Behaviour and Market Efficiency
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Sample Questions
Q1) If the financial markets are __________ efficient, then laws prohibiting insider trading are unnecessary.
A) mild-form
B) weak-form
C) historical-form
D) semi-strong form
E) strong-form
Q2) Which one of the following best describes the current understanding of market efficiency?
A) short-term stock price movements are easy to predict B) markets overreact to unanticipated events in a manner which can be used to earn excess returns
C) the market appears to be highly inefficient
D) short-term market movements are difficult, if not impossible, to predict accurately E) markets tend to react slowly to unanticipated announcements
Q3) You invest $10,000 in the market at the beginning of the year, and by the end of the year your account is worth $15,000. During the year the market return was 10%. Does this mean that the market is inefficient?
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Chapter 9: Behavioural Finance and the Psychology of Investing
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Sample Questions
Q1) Which one of the following is considered the best indicator of a bull market according to
A) a breakout of a resistance level
B) a breakout of a support level
C) market prices remaining above the support level
D) prices falling below the support level
E) prices remaining between the resistance and support levels
Q2) Bollinger bands:
A) depict the convergence or divergence of two moving averages.
B) display the relative strength of one market sector versus another.
C) are a graphical representation of an exponential moving average.
D) are based on 2 standard deviations around a moving average.
E) are the current support and resistance levels for the overall market.
Q3) Sentiment-based risk is __________ risk.
A) systematic
B) firm-specific
C) industry-specific
D) emotional-based
E) cost-based
11
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Chapter 10: Interest Rates
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Sample Questions
Q1) Which of the following is generally considered as the bellwether rate for bank loans to business firms?
A) Money market rate
B) Bank rate
C) Call money rate
D) Prime rate
E) Commercial paper rate
Q2) A $1,000,000 face value Treasury bill with 49 days to maturity is currently selling for $991,650. What is the effective annual rate?
A) 6.61%
B) 6.57%
C) 6.39%
D) 6.53%
E) 6.45%
Q3) Identify and describe three of the five components of nominal interest rates as supported by modern term structure theory.
Q4) What is the difference between the term structure of interest rates and the Treasury yield curve?
Q5) What is the yield curve?Why is it important?
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Chapter 11: Bond Prices and Yields
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Sample Questions
Q1) Which one of the following measures a bond's sensitivity to changes in market interest rates?
A) yield to call
B) yield to market
C) duration
D) immunization
E) target date valuation
Q2) For a change in a bond's yield to maturity, the absolute magnitude in the change of the bond's price is ________ related to the bond's coupon rate.
A) Positively
B) Negatively
C) Not
D) Directly
E) Inversely.
Q3) What are the five bond pricing theorems described by Burton Malkiel?
Q4) Why do low coupon bonds change more in price than high coupon bonds?
Q5) Discuss the possible impact of default risk on duration?
Q6) Explain current yield, coupon rate, yield to maturity and yield to call. Can these ever be the same for a given bond?
Page 13
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Chapter 12: Return, Risk and Security Management
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Sample Questions
Q1) You own a portfolio equally invested in the risk-free asset and two stocks. One of the stocks has a beta of 1.30 and the beta of your portfolio is 0.90. What is the beta of the other stock?
A) 1.52
B) 1.63
C) 1.57
D) 1.40 E) 1.46
Q2) A risky security has a variance of 0.034596 and a covariance with the market of 0.0216. The variance of the market is 0.023716. What is the correlation of this risky security to the market?
A) 0.47
B) 0.96
C) 0.75
D) 0.37
E) 0.58
Q3) Explain what beta is and why it is important.
Q4) Explain the primary goal of portfolio diversification as it relates to asset allocation and correlation.
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Chapter 13: Performance Evaluation and Risk Management
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Sample Questions
Q1) Floyd Corp. stock has an annual standard deviation of 37 percent and an expected return of 12 percent. What is the smallest expected loss over the next month with a probability of 2.5 percent? Note: The corresponding "Z" value is 1, 96.
A) -19.93%
B) -21.08%
C) -18.35%
D) -25.43%
E) -23.67%
Q2) What is the Treynor ratio for Portfolio B?
Refer: To: 13-72
A) 0.084
B) 0.076
C) 0.089
D) 0.067
E) 0.073
Q3) What is main difference between passive and active portfolio management strategy?
Q4) Compare and contrast how the Jensen and the Sharpe ratio evaluate management performance. Further discuss the most appropriate application of each.
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Chapter 14: Options
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Sample Questions
Q1) A stock is currently selling for $32 a share. A call option on the stock is available for $3.40 with a strike price of $30 and three months to maturity. The risk-free rate is 4% and the market rate is 11%. What is the price of a 3-month put option with the same strike and expiration? Assume the options are European style.
A) $0.30
B) $0.83
C) $1.11
D) $1.23
E) $1.40
Q2) The maximum price for a call option is:
A) the stock price.
B) the strike price.
C) the intrinsic value.
D) the stock price minus the strike price.
E) There is no upper limit for a call price.
Q3) Explain how a credit default swap is used to manage risk.
Q4) You wrote a put with a strike price of $20 and a premium of $1. Draw a graph depicting your profits or losses for stock prices ranging from $0 to $40. Be sure to completely label your graph.
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Chapter 15: Option Valuation
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Sample Questions
Q1) An increase in the price of the underlying stock will __________ the price of a put option because put option delta is always __________.
A) increase; negative
B) decrease; negative
C) decrease; positive
D) increase; positive
E) not affect; equal to one
Q2) ISD and IVOL are symbols denoting ___________.
A) Rho factors
B) Implied volatility indexes
C) Theta values
D) Variance measures
E) Option maturity dates
Q3) Which of the following will produce the highest call price, all else constant?
A) $24 stock price; $25 exercise price.
B) $36 stock price; $35 exercise price.
C) $15 stock price; $15 exercise price.
D) $29 stock price; $30 exercise price.
E) $19 stock price; $20 exercise price.
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Chapter 16: Futures Contracts
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Sample Questions
Q1) The seller's the ability to have a selection of securities from which to choose one for delivery is called the ________ option.
A) Carrying
B) Cheapest-to-deliver
C) Call
D) Put
E) Bond
Q2) The price established today that will be paid when a commodity is delivered at a later date is called the _________ price.
A) futures
B) long
C) speculative
D) term
E) option
Q3) Compare the pros and cons of a futures hedge with an option hedge.
Q4) Why do futures contracts represent a "zero sum game"
Q5) What is the difference between hedging and speculating? Who are the hedgers? Who are the speculators?
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Chapter 17: Projecting Cash Flow and Earnings
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Q1) Which of the following would not appear on an income statement?
A) Investment income.
B) Prepaid expenses.
C) Interest expense.
D) Income taxes.
E) Operating income.
Q2) Dividend payments are considered as a(n) _________ cash flow.
A) operating
B) investment
C) pro forma
D) financing
E) sales
Q3) Cash flow per share (CFPS)
A) Is used by some analysts who are not willing to accept the accountants' definition of EPS.
B) Is generally below a firm's EPS
C) Is not as closely correlated with stock prices as primary EPS
D) Is calculated using the bottom line on the cash flow statement.
E) Must also be adjusted for a change in a firm's depreciation technique.
Q4) Why is the expected rate of sales growth so critical to pro forma statements?
Page 19
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Chapter 18: Corporate Bonds
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Sample Questions
Q1) Bonds issued with a relatively standard set of features are _________ bonds.
A) put
B) callable
C) plain vanilla
D) convertible
E) exchangeable
Q2) The yield-to-maturity of a bond is equal to the bond's
A) Internal rate of return
B) Net present value
C) Current yield
D) Yield-to-call
E) Realized return
Q3) Which group owns the largest percentage of corporate bonds in the capital market?
A) Individual investors.
B) Pension funds.
C) Foreign investors.
D) Life insurance companies.
E) Banks.
Q4) How is the minimal value for a convertible bond determined?
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Chapter 19: Government Bonds and Mortgaged-Backed Securities
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Sample Questions
Q1) Ownership of Canada Savings Bonds is registered with the:
A) Pension Plans Commission.
B) Bank of Canada.
C) Central Payor and Transfer Agent.
D) Canada Revenue Agency.
E) Broker.
Q2) A Treasury bond with face value of $1,000 matures in 6.5 years has a 5.5% coupon rate and a quoted price of 99.09375. What is the yield-to-maturity?
A) 5.67%
B) 5.56%
C) 5.71%
D) 5.50%
E) 5.75%
Q3) CMHC
A) helps first-time home buyers
B) is a government-owned finance company
C) backs mortgage pools
D) is established in 1946
E) all of the above
Q4) Evaluate this claim: "Treasury bonds have no risk."
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Chapter 20: International Portfolio Investment
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Sample Questions
Q1) Discuss how different accounting practices can distort the analysis for international investing.
Q2) Emerging markets with high risk will likely have the
A) Weakest currency
B) Highest real interest rate
C) Lowest growth
D) Strongest currency
E) Perfect correlations with developed countries
Q3) What will the annual percentage return be on foreign exchange measured with Canadian dollars for this investor?
A) -0.50%
B) -0.20%
C) -0.10%
D) -0.40%
E) -0.30%
Q4) Why has the development of information technology and the impact of globalization affect the correlation between international markets?
Q5) Why do foreign investors often use currency forward or futures contracts to hedge against exchange-rate risk?
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