Financial Management

Question 1

Forward contract

Answer 1

The buyer of a forward contract gains when prices increases because the buyer has a lower purchase price than the price at which the contracted asset can be sold after the price increase. The seller of a forward contract loses when prices increases because the seller has agreed to sell at a lower price than the price of the asset after the price increase.
Forward contracts are not executed on an exchange but between the two contracting parties and require the holder to purchase or sell a specific quantity of an asset on a specific future date.

Question 2

Payback Period

Answer 2

Initian investment/Annual cash flow

Question 3

Required/expected rate of return

Answer 3

Required/expected rate = risk-free rate + [Beta(expected/market rate - risk-free rate)]

Question 4

Investment’s beta measure

Answer 4

Measure the investment’s systematic risk

Question 5

Profitability index of a project

Answer 5

PV of annual after-tax cash flows divided by th original cash invested in the project

Question 6

Future contracts

Answer 6

Futures contracts are executed on an exchange and require the holder to purchase or sell a specific quantity of an asset on a specific future date.

Question 7

Frequency of compounding

Answer 7

The frequency of compounding explains the difference between the stated rate and the effective rate

Question 8

Graph that plots beta

Answer 8

show the relationship between the return of an individual asset and the return of the entire class of that asset (asset return and benchmark return)

Question 9

Accounting rate of return

Answer 9

Change in annual accounting income / initial investment
Its considers the entire lofe of the project and it assumes that the incremental net income is the same each year

Question 10

Downward sloping curve

Answer 10

short-terms rates are higher than intermediate-term rates which are highe than long-term rates

Question 11

Internal rate of return (IRR)

Answer 11

Annual cash inflow (or savings) x PV Factor = Investment cost
PV Factor = Investment cost / Annual cash inflow (or savings)
The lower the PV the higher the IRR, or the higher the PV factor, the lower the IRR
Is the interest rate that equates the PV of the future cash inflows with the PV of the future cash outflows
The IRR uses the net incremental invetsment and the net annual cash flows. It does not include the incremental average operating income

Question 12

Option

Answer 12

A contract that allows(not required) the holder to purchasea specified quantity of a financial instrument at a specified price.

Question 13

Capital asset pricing model (CAPM)

Answer 13

is an economic model that uses a measure of systematic risk to establish an appropiate rate of return for investment in assets.
It assumes that there is a single risk-free rate and that there are no restrictions on borrowing or lending at the risk-free rate and that all parties can borrow or lend at the risk-free rate.

Question 14

A firm in perfect competition will cease to produce when

Answer 14

When the market price is less than a firm’s average variable cost, the firm should cease to ptoduce and exit the market.

Question 15

Transfer price between affiliated entities

Answer 15

The transfer price would constitute an element of cost in determining total costs incurred by the buying affiliate.
Costs to the buying affiliate would not establish the transfer price paid by the buying affiliate.

Question 16

Most expensive form of additional capital

Answer 16

Common stock is the most expensive form of financing and because of floatation costs new common stock is more expensive than retained earnings.

Question 17

Hedging

Answer 17

Hedging involves sharing the risk with another party
The hedging principle states that the maturity structure of an entity’s financing should be consistent with the cash flow produced by the asset being financed. Assets or projects that provide short-term benefits should be financed with short-term financing and assets or projects of long-term duration or benefit should be financed with long-term or permanent financing.

Question 18

Return paid for the use of borrowed capital is referred to

Answer 18

The retirn paid for the use of borrowed funds is called interest.

Question 19

Operating Cycle

Answer 19

Number of days supply in inventory + Number of days sales in AR
It is the average period of time between the acquisition of inventory until the collection of cash from the sale of that inventory
The fixed asset conversion cycle is not a component used in determining the operating cycle of an entity. The concept of the fixed asset cycle is not commonly used, but when used refers to the period that covers the acquisition, use and disposal of fixed assets. Fixed asset life is not an element included in measuring the operating cycle.

Question 20

Cash Conversion Cycle

Answer 20

Number of days supply in inventory + Number of days sales in AR - Number of days purchases in AP
OR
Number of days in operating cycle - Number of days sales in AP
Is the average period of time between when cash is paid to suppliers of inventory until the collection of cash from the sale of that inventory. It measures from the time cash is paid until realted cash is received.

Question 21

Commercial paper

Answer 21

The maximum period for which commercial paper (short-term, unsecured promissory notes) may be used is 270 days. Notes exceeding 270 days in maturity require SEC registration and would not be considered commercial paper.

Question 22

Floating-rate

Answer 22

Floting-rate bonds are most likely to maintain a constant market value.
The rate of interest paid on floating-rate bonds (also called variable-rate bonds/debt) varies with the changes in some underlying benchmark, usually a market interest rate benchmark (e.g., LIBOR or the Fed Funds Rate). Because the interest rate changes with changes in the market rate of interest, they maintain a relatively stable (constant) market value.

Question 23

Coefficient of variation

Answer 23

The coefficient of variation provides a measure of the relative variability of investments. It is calculated by dividing the standard deviation of the investment by its expected return.

Question 24

Systematic risks (market risk or undiversifiable risk)

Answer 24

Are the risks inherent to an entire economy or major protion thereof.
Changes in inflation, currency exchange rates and interest rates, recessions, and similar macroeconomic factors

Question 25

Unsystematics risk (company risk or diversifiable risk)

Answer 25

Are the risks that are unique to a particular asset/asset class, firm, or industry, and include risk of default by a borrower, labor issues nd strikes, liability associated with a firm’s products, the possibility that a firm may not be able to sell its assets for cash equal to fair value, and similar factors that occur for an asset, firm, or group, of firms.

Question 26

Economic Order Quantity EOQ

Answer 26

Square root of 2 x Annual Demand x Cost per order divided by Carrying cost per unit
The economic order quantity model seeks to determine the order size that will minimize total inventory cost, both order cost and carrying costs.

Question 27

Market price of a bond

Answer 27

The market price of a bond, whether issued at par, at a premium, or at a discount, will be the present value of the principal amount plus the present value of future interest payments, all at the market (effective) rate of interest

Question 28

Serial bonds

Answer 28

Serial bonds are bond issues that mature in installments (on the same date each year over a period of years)

Question 29

Term bonds

Answer 29

Term bonds are bond issues that mature on a single date

Question 30

Common stock

Answer 30

issuing common stock would
(1) not result in fixed charges, since dividends are at the discretion of the Board of Directors,
(2) not result in a fixed maturity date, since common stock does not mature, and
(3) would likely increase the credit-worthiness of the company because the issuance of additional common stock would reduce its debt to equity ratio by increasing equity.
It has voting rights

Question 31

Relative risk

Answer 31

Relative risk is measured as the ratio of the standard deviation of the return to the expected return. This investment’s relative risk is .550 (11%/20%).

Question 32

accounts receivable management

Answer 32

The overall objective of accounts receivable management is to maximize profits. A policy that is too loose will grant credit to those who are not creditworthy and result in unnecessary uncollectible accounts and lower profit. A policy that is too strict will result in not making credit sales that would be paid and, thereby, decrease profit.

Question 33

Geometric average

Answer 33

The geometric average depicts the compound annual return earned by the investor. This method is preferred for evaluating long-term investments.

Question 34

Swap agreement

Answer 34

A swap agreement would be recommended to hedge interest rate risk on long-term floating-rate bonds. In an interest rate swap agreement one stream of future interest payments (e.g., floating-rate payments) is exchanged for another stream of future interest payments (e.g., fixed-rate payments) for a specified principal amount. In this case, an interest rate swap would hedge (mitigate) exposure to fluctuations in interest rates of the floating-rate bonds by exchanging those payments for a fixed-rate payment.

Question 35

Business risk

Answer 35

A firm that utilizes only equity financing would face business risk. Business risk derives from the broad, macro-risk a firm faces largely as a result of the relationship between the firm and the environment in which it operates. The extent of that risk would depend on the susceptible of the firm to changes in the overall economic climate.

Question 36

Risk portfolio reduction

Answer 36

To reduce the risk of a portfolio, the investor should select investments with negatively correlated returns. In that way, when one investment decreases in value others will increase. Therefore, the company should select an investment that correlates negatively to current portfolio holdings.

Question 37

Proportion of equity

Answer 37

Value of equity/Value of debt + Value of equity

Question 38

Preferred stock

Answer 38

Preferred stock, like common stock, conveys an ownership interest in the entity. Preferred stock does not require the payment of dividends nor does it normally convey voting rights.

Question 39

Operating leverage (DOL)

Answer 39

The degree of operating leverage (DOL) is a measure of the change in operating income associated with a given change in sales volume. It is calculated, for a particular level of sales, as
Percent change in operating income divided by percentage change in sales volume

Question 40

U.S Treasury bills

Answer 40

Treasury Bills are debt obligation of the U.S. government, have a maturity of one year or less, and are backed by the full faith and credit of the U.S. government. Treasury Bills are considered the safest securities available to the U.S. investor.

Question 41

Economic rate of return on common stock

Answer 41

(Dividends + change in price) divided by beginning price.
return on stock is measured by the return to the investor both in appreciation and in dividends.

Question 42

credit criteria

Answer 42

The credit criteria are the policies used to decide whether a customer should be extended credit.

Question 43

Field warehouse agreement

Answer 43

In a field warehouse agreement, the inventory that serves as security for a borrowing remains with the borrower, but is place under the control of an independent third party. (Also, in a terminal warehouse agreement, the inventory is moved to a public warehouse and placed under the control of an independent third party.)

Question 44

crowdfunding

Answer 44

Crowdfunding must take place through a SEC-registered broker-dealer or funding portal (Statement I) and an investor is limited in the amount that can be invested through crowdfunding during a 12-month period to $107,000 (Statement III).