Principles of Finance
Test Preparation
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools used in financial decision-making within organizations. The course covers topics such as the time value of money, risk and return, asset valuation, capital budgeting, financial statement analysis, and the functioning of financial markets. Emphasis is placed on understanding how financial managers use quantitative techniques to make investment and financing decisions that maximize firm value. By the end of the course, students will have developed the analytical skills needed to approach financial problems critically and apply finance principles in real-world business settings.
Recommended Textbook
Principles of Money Banking and Financial Markets 12th Edition by Ritter
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29 Chapters
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Page 2
Chapter 1: Introducing Money, Banking, and Financial Markets
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Sample Questions
Q1) A __________ will review a commercial bank's books to determine whether loans with delinquent payments impair a bank's capital.
A) loan officer
B) bank examiner
C) broker
D) bank teller
Answer: B
Q2) Paul is a people-oriented person. Paul would probably function best as a A) trader.
B) salesperson.
C) financial economist.
D) researcher.
Answer: B
Q3) Which of the following is not a reference to "banking" in "money, banking, and financial markets?"
A) Commercial banks
B) Savings banks
C) Financial intermediaries
D) Markets in which financial assets can be traded
Answer: D
Page 3
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Chapter 2: The Role of Money in the Macroeconomy
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Sample Questions
Q1) The rate at which money turns over is the definition of A) velocity.
B) liquidity.
C) GDP.
D) aggregate demand.
Answer: A
Q2) A highly liquid asset is one that
A) loses its value.
B) appreciates over time.
C) can be quickly turned into the medium of exchange without loss.
D) cannot be used in financial transactions.
Answer: C
Q3) Which of the following best describes the ideal quantity of money?
A) It equals the amount of spending.
B) It equals the level of GDP.
C) It equals the price level.
D) It stabilizes prices while allowing a high level of employment.
Answer: D
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4
Chapter 3: Financial Instruments, Markets, and Institutions
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Sample Questions
Q1) Which of these financial institutions is the most likely to have a portfolio very similar to those of life insurance companies?
A) Money market mutual funds
B) Mutual savings banks
C) Private noninsured pension funds
D) Property and casualty insurance companies
Answer: C
Q2) Traditionally, the largest asset held by savings-and-loan associations has been
A) NOW deposits.
B) business loans.
C) residential mortgages.
D) consumer loans.
Answer: C
Q3) An example of direct finance would be when
A) a person purchases a certificate of deposit from a bank.
B) a person buys a life insurance policy.
C) a person buys 100 shares of stock from a corporation.
D) a bank makes a loan to a customer.
Answer: C
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Page 5
Chapter 4: Interest Rate Measurement and Behavior
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Sample Questions
Q1) A $10,000, one-month loan pays an annualized interest rate of 10 percent. The dollar amount of interest received from the loan is
A) largest if simple interest is paid.
B) largest if interest is compounded monthly.
C) largest if interest is compounded quarterly.
D) the same whether interest is simple, compounded monthly, or compounded quarterly.
Q2) Which of these will cause the equilibrium interest rate to rise?
A) A decrease in the supply of loanable funds
B) A decrease in the demand for loanable funds
C) An increase in the supply of loanable funds
D) A decrease in the quantity of loanable funds demanded
Q3) Assume that an investor pays $900 for a bond with a face value of $1,000. If the bond pays 10 percent interest annually, the current yield is equal to
A) 9.5 percent.
B) 9.1 percent.
C) 10.0 percent.
D) 11.1 percent.
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Chapter 5: The Term and Risk Structure of Interest Rates
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Q1) Compared with long-term securities, the prices of short-term securities are always A) more volatile.
B) less volatile.
C) higher.
D) lower.
Q2) In the long run, the yield curve tends to be
A) positively sloped.
B) negatively sloped.
C) nearly vertical.
D) nearly horizontal.
Q3) When interest rates are relatively low, investors generally expect interest rates to __________. Thus, investors prefer to hold __________ securities
A) fall; long-term
B) fall; short-term
C) rise; long-term
D) rise; short-term
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Chapter 6: The Structure and Performance of Securities Markets
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Q1) Which of the following is likely to have the narrowest bid-asked spread?
A) A Nasdaq stock
B) A U.S. Treasury bill
C) A corporate bond
D) A Fannie Mae bond
Q2) An important implication of the idea that markets are efficient is that
A) an investor can make money by buying undervalued stocks and selling overvalued ones.
B) the price of a share immediately incorporates new publicly available information that affects its value.
C) dealers can ignore some new information on a share that affects its value.
D) an investor can make above average returns in the stock market by doing careful research of public information about selected stocks.
Q3) When an investment bank guarantees an issuer of new securities a certain price it is acting as a(n)
A) auctioneer.
B) underwriter.
C) broker.
D) dealer.
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Chapter 7: The Pricing of Risky Financial Assets
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Sample Questions
Q1) A mutual fund that purchases a wide variety of stocks will A) eliminate systematic risk.
B) minimize nonsystematic risk.
C) minimize market risk.
D) minimize default risk.
Q2) Assume that a security has two possible outcomes. There is a 50 percent chance that the yield will equal 12 percent and a 50 percent chance that the yield will equal 4 percent. The expected yield for this security is
A) 16 percent.
B) 12 percent.
C) 8 percent.
D) 4 percent.
Q3) The expected yield on an asset with two possible outcomes is equal to the A) difference between the two outcomes.
B) sum of the possible outcomes multiplied by their respective probabilities.
C) standard deviation of the two outcomes.
D) product of the two outcomes.
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Chapter 8: Money and Capital Markets
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Sample Questions
Q1) Because they combine high yield and high risk, junk bonds
A) should never be considered sound investments.
B) may increase the overall yield of a portfolio containing stocks without an undue increase in risk.
C) should be purchased only by risk lovers.
D) None of the above.
Q2) Moody's gives junk bonds a rating below A) Aaa.
B) Aa.
C) A.
D) Baa.
Q3) Suppose a share of stock is expected to pay an annual dividend of $10 forever. At a discount rate of 5 percent, the share's market price should be A) $188.24.
B) $200.00.
C) $29.60.
D) $10.80.
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10
Chapter 9: Demystifying Derivatives
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Sample Questions
Q1) Which of the following futures contracts is available on the various commodity exchanges in the United States?
A) Treasury bond futures
B) Investment-grade bonds
C) Over-the-counter stocks
D) U.S. savings bonds
Q2) The price paid for an option is called the
A) settlement price.
B) mark-to-market price.
C) option premium.
D) call price.
Q3) Futures contracts are marked-to-market
A) every day.
B) every week.
C) every month.
D) every quarter.
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11
Chapter 10: Understanding Foreign Exchange
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Sample Questions
Q1) The more we pay for a euro, the __________ European goods are to us and the __________ European assets are to us.
A) cheaper; cheaper
B) cheaper; more expensive
C) more expensive; cheaper
D) more expensive; more expensive
Q2) If the British sell more Rolls Royce cars to the United States, the United States __________ more pounds and __________ more dollars in the foreign exchange market.
A) supplies; supplies
B) supplies; demands
C) demands; supplies
D) demands; demands
Q3) A self-correcting mechanism tending to bring a country's balance of payments into equilibrium exists under __________ exchange rate systems.
A) fixed and floating
B) floating, but not fixed
C) fixed, but not floating
D) neither fixed nor floating
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Page 12
Chapter 11: The Nature of Financial Intermediation
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Sample Questions
Q1) Nontraded securities are part of
A) direct, but not indirect finance.
B) indirect, but not direct finance.
C) direct and indirect finance.
D) neither direct nor indirect finance.
Q2) After the repeal of Regulation Q, a problem for savings-and-loan associations (S&Ls)was that most of their assets were at __________ interest rates while their deposits were at __________ interest rates.
A) low; low
B) low; high
C) high; low
D) high; high
Q3) Regulation Q was repealed in the __________ by the __________.
A) early 1970s; Garn-St. Germain Act
B) late 1970s; Depository Institutions Deregulation and Monetary Control Act
C) late 1980s; Reigle-Neil Act
D) early 1980s; Depository Institutions Deregulation and Monetary Control Act
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Chapter 12: Depository Financial Institutions
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Sample Questions
Q1) In 2007 ROA for banks in the United States stood at a little under __________ percent.
A) one
B) five
C) eight
D) twenty
Q2) A bank's net interest margin is
A) total interest income minus total interest expense.
B) net interest income as a percent of bank equity.
C) net interest income as a percent of total bank assets.
D) net interest as a percent of total income.
Q3) The largest type of depository institution in the United States is A) savings-and-loans.
B) commercial banks.
C) credit unions.
D) mutual funds.
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Page 14
Chapter 13: Nondepository Financial Institutions
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Sample Questions
Q1) Unlike dealers, brokers
A) deal in the primary market.
B) deal in equity and not in debt.
C) do not buy or sell for their own account.
D) get most of their funds from consumer deposits.
Q2) A fully funded pension liability is one in which
A) the Pension Benefit Guaranty Corporation insures full benefit payments.
B) enough money has been set aside to ensure that the promised pension can be paid out after allowing for interest payments.
C) the yield on the pension fund is equal to the inflation rate.
D) corporation pension contributions are equal to employee contributions.
Q3) Pension plans in which employer contributions are set by the plan and benefits depend on the performance of the assets in the plan is called a
A) defined benefit plan.
B) defined contribution plan.
C) a fully vested plan.
D) an unfunded plan.
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15
Chapter 14: Understanding Financial Contracts
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Sample Questions
Q1) Commercial banks
A) buy private placements for their own portfolio of assets.
B) help firms sell private placements.
C) sell their own private placements.
D) have nothing to do with private placements.
Q2) A clause in a loan contract disallowing the borrower from acquiring other companies during the term of the loan is an example of a
A) guarantee.
B) collateral agreement.
C) restrictive covenant.
D) moral hazard.
Q3) Private placements avoid
A) restrictive agreements.
B) public disclosure of financial information that is required of securities that are registered with the SEC.
C) the need for collateral.
D) the primary market.
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Chapter 15: The Regulation of Markets and Institutions
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Sample Questions
Q1) Combining commercial banking and investment banking in the same organization produces a risk for that organization
A) that must be above that of investment banking.
B) that is the same as investment banking, the riskier of the two activities.
C) somewhere in between the risk of the two activities.
D) that may be below that of commercial banking.
Q2) A bank has total assets of $2,000,000 and capital of $150,000. The bank's leverage ratio is
A) 20%.
B) 15%.
C) 7.5%.
D) None of the above.
Q3) In the 1960s, banks started __________ in order to maneuver around the Glass-Steagall act.
A) opening foreign branches
B) using Section 20 affiliates
C) forming one-bank holding companies
D) dropping Federal Reserve membership
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Chapter 16: Financial System Design
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Sample Questions
Q1) In Germany, banks __________ shares in the large firms they lend to, which __________ lender-stockholder conflict.
A) are not allowed to own; is their way of minimizing B) are not allowed to own; gives rise to C) own a considerable bloc of; is their way of minimizing D) own a considerable bloc of; gives rise to
Q2) The country in which a form of industrial organization in which a group of companies own stock in each other and has a bank that owns stock in each firm is
A) the United Kingdom.
B) the United States.
C) Japan.
D) Germany.
Q3) Conflict resolution of the stockholder-lender conflict in larger banking-oriented firms is most effectively accomplished by A) financial intermediation (monitoring).
B) financial intermediation (ownership consolidation).
C) corporate governance.
D) None of the above.
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18
Chapter 17: Who's in Charge Here?
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Sample Questions
Q1) The Comptroller of the Currency
A) serves as Chairman of the Board of Governors.
B) serves as a member of the Board of Governors.
C) serves as an alternate member of the Board of Governors.
D) does not serve on the Board of Governors.
Q2) In which country is the central bank more independent than the Federal Reserve?
A) Germany
B) Japan
C) Great Britain
D) All of the above.
Q3) If Congress passes legislation reducing Federal Reserve independence, financial market participants are likely to assume that
A) the money supply will decline.
B) inflation will increase.
C) recession will quickly follow.
D) the federal deficit will rise.
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Chapter 18: Bank Reserves and the Money Supply
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Sample Questions
Q1) Assume that the ratio of excess reserves to demand deposits is 0, and the ratio of currency to demand deposits is .2. If the reserve requirement on demand deposits is .3 and there is no reserve requirement on savings accounts, the M1 multiplier is A) 5.5.
B) 4.
C) 2.5.
D) 2.4.
Q2) If the ratio of net worth to vault cash is .2, the prime rate is .05, and the required reserve ratio is .25, the demand deposit expansion multiplier is A) 2.
B) 4.
C) 5.
D) .25.
Q3) When banks make new loans, the effect on reserves is the same as A) holding excess reserves. B) expanding capital. C) purchasing securities.
D) acquiring deposits.
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20
Chapter 19: The Instruments of Central Bankin
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Sample Questions
Q1) Excess reserves immediately increase if
A) reserve requirements increase.
B) reserve requirements decrease.
C) the discount rate increases.
D) the discount rate decreases.
Q2) An outright purchase of government securities by the Fed A) permanently increases bank reserves.
B) temporarily increase bank reserves.
C) permanently reduces bank reserves.
D) temporarily reduces bank reserves.
Q3) Recently, new discount window lending procedures set a penalty rate that is normally __________ short-term market interest rates.
A) just below
B) above
C) approximately equal to
D) None of the above.
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21
Chapter 20: Understanding Movements in Bank Reserves
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Q1) A sound monetary policy response to a sudden temporary increase in currency held by the public would be to
A) reduce the rate of currency printing.
B) carry out defensive open market operations.
C) carry out dynamic open market operations.
D) raise reserve requirements.
Q2) The Federal Reserve float is
A) items in process of collection - deferred credit items.
B) items in process of collection + deferred credit items.
C) deferred credit items - items in process of collection.
D) deferred credit items + items in process of collection.
Q3) If the government collects taxes and makes expenditures of a smaller amount, bank reserves
A) are unaffected.
B) may rise or fall.
C) rise.
D) fall.
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22
Chapter 21: Monetary Policy Strategy
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Sample Questions
Q1) Assume that the actual inflation rate is 3 percent, the target inflation rate is 3 percent, and that the percentage difference between actual and potential real GDP is 2 percent. According to the Taylor rule, the federal funds rate target should be
A) 3.5 percent.
B) 6.5 percent.
C) 5.5 percent.
D) 5.0 percent.
Q2) In general, the fed funds rate
A) moves in the direction suggested by the Taylor rule.
B) moves in the opposite direction as suggested by the Taylor rule.
C) is uncorrelated with the Taylor rule prediction.
D) None of the above.
Q3) The FOMC directive contains a target growth rate for
A) nominal GDP.
B) real GDP.
C) the inflation rate.
D) M2.
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Chapter 22: The Classical Foundations
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Sample Questions
Q1) Modern monetarists view any increases or decreases in total output stemming from expansions or contractions in the money supply as
A) permanent.
B) temporary.
C) irrelevant.
D) extremely important.
Q2) The Cambridge k is all of the following except A) the reciprocal of the income velocity of money.
B) a transactions demand for money.
C) the fraction of GDP that people wish to hold in the form of money balances.
D) the velocity of money.
Q3) The Great Depression is thought to have been prolonged and made deeper by A) contraction of the money supply.
B) the stock market crash.
C) speculative behavior of investors.
D) rapid inflation.
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Chapter 23: The Keynesian Framework
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Sample Questions
Q1) The aggregate demand curve is negatively sloped because a lower price level
A) reduces the real money supply.
B) increases the real money supply.
C) reduces aggregate income.
D) increases aggregate income.
Q2) If the marginal propensity to consume is 0.7 and if output increases by $200, then consumption spending
A) increases by $70.
B) decreases by $70.
C) increases by $140.
D) decreases by $140.
Q3) If autonomous investment spending falls as a result of a decline in the expected rate of return on investment, GDP would not have to fall if the government __________ taxes or __________ government spending.
A) increased; increased
B) increased; decreased
C) decreased; increased
D) decreased; decreased
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25
Chapter 24: The ISLM World
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Q1) A weakness of the simple Keynesian model is that it does not recognize that because the transactions demand for money __________ as income increases, the interest rate __________ as income rises.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases
Q2) The IS curve has a positive slope because a(n)__________ in the interest rate leads to a(n)__________ in desired investment and this leads to a decrease in GDP.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
Q3) Which of the following will cause the LM curve to shift to the right?
A) An increase in investment
B) An increase in money demand
C) A decrease in velocity
D) An increase in the money supply
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26
Chapter 25: Money and Economic Stability in the ISLM
World
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Q1) The quantity of money demanded suddenly increases at every combination of GDP and interest rate. If the Fed holds to an unchanged money supply target, the interest rate __________ and GDP __________.
A) rises; falls
B) rises; remains unchanged
C) remains unchanged; remains unchanged
D) remains unchanged; falls
Q2) Fiscal policy is impotent when the LM curve is
A) vertical.
B) horizontal.
C) downward-sloping.
D) horizontal or downward-sloping.
Q3) "Complete" crowding out of fiscal policy occurs when the A) LM curve is horizontal.
B) LM curve is upward-sloping.
C) LM curve is vertical.
D) IS curve is vertical.
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Chapter 26: An Aggregate Supply and Demand Perspective on Money and Economic Stability
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Q1) Partial crowding out implies that a government deficit financed by selling bonds to the non-bank public will
A) have no effect on aggregate demand.
B) reduce aggregate demand.
C) increase aggregate demand.
D) reduce aggregate demand in the short run but cause demand to increase in the long run.
Q2) To Keynesians, a vertical aggregate supply curve
A) is nonsensical.
B) holds in the short run but not the long run.
C) holds in the long run but not the short run.
D) will only be encountered at the full-capacity output of the economy.
Q3) From a Keynesian perspective, a short-run decrease in investment spending will shift the aggregate
A) supply curve to the left.
B) supply curve to the right.
C) demand curve to the left.
D) demand curve to the right.
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Chapter 27: Rational Expectations: Theory and Policy
Implications
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Q1) Extrapolating past values of a variable to the present is the practice of __________ expectations, which is fairly common among __________ economists.
A) adaptive; New Classical
B) adaptive; Keynesian
C) rational; New Classical
D) rational; Keynesian
Q2) Adaptive inflationary expectations are based on A) monetary growth.
B) all available information.
C) previous inflation rates.
D) price changes in futures markets.
Q3) If wages and prices are flexible, then an anticipated change in the money supply will cause wages and prices to __________ the actual inflation rate. A) increase at the same rate as B) increase at a higher rate than C) increase at a slower rate than D) cannot be exactly predicted
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Page 29
Chapter 28: Empirical Evidence on the Effectiveness of Monetary Policy
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Q1) The Federal Reserve econometric model estimates that a 1 percent increase in government spending, with the money supply increased to hold the interest rate constant, will
A) increase real GDP by 3 percent in 3 years.
B) increase real GDP by 3 percent in 4 years.
C) increase real GDP by 1 percent 2 years.
D) have no effect on real GDP after 3 years.
Q2) The St. Louis Federal Reserve Bank econometric model indicates that crowding out A) is only partial.
B) never occurs.
C) occurs only in highly unusual circumstances. D) is complete.
Q3) The impact lag is the time between
A) a change in the money supply and a change in interest rates.
B) a change in the money supply and a change in GDP.
C) the use of a Federal Reserve tool and its effect on GDP.
D) the use of a Federal Reserve tool and its effect on the money supply.
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Page 30
Chapter 29: Tying It All Together
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Q1) In the stock valuation formula "good news" affects both the numerator and denominator. Conventional wisdom on Wall Street is that the effect on the __________ is __________ the effect on the __________.
A) numerator; less than; denominator
B) numerator; greater than; denominator
C) numerator; the same as; denominator
D) None of the above.
Q2) "Bad news" about an expenditure-related indicator means that A) it is lower than its previous value.
B) it is lower that it was expected to be.
C) it is higher than it was expected to be.
D) it rose more slowly than the rate of inflation.
Q3) Leading economic indicators are economic indicators that __________ changes in economic activity
A) change after
B) change at the same time as C) change before
D) None of the above.
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