Test 3

Question 1

Treasury bonds have original maturities from one to ten years, while Treasury notes have original maturities of
more than ten years.

Answer 1

False

Question 2

Which of the following best describes the valuation principle?

Answer 2

The value of a commodity or an asset to a firm or its investors is determined by its
competitive market price.

Question 3

Which of the following would be best considered to be an agency conflict problem in the
behavior of the following financial managers?

Answer 3

Bill chooses to pursue a risky investment for the company’s funds because his compensation
will substantially rise if it succeeds.

Question 4

The chief advantage of debt financing over financing through raising equity capital is that the former does not
dilute the current owner’s share of the business.

Answer 4

True

Question 5

T/F - Stock markets provide liquidity for a firm’s shares.

Answer 5

True

Question 6

The Law of One Price states that if equivalent goods or securities are traded simultaneously
in different competitive markets, they will trade for the same price in each market.

Answer 6

True

Question 7

If a bond’s coupon rate is less than its yield to maturity, the bond will trade at a

Answer 7

Discount

Question 8

The present value (PV) of a stream of cash flows is just the sum of the present values of each
individual cash flow.

Answer 8

True

Question 9

Capital Gains Yield

Answer 9

(Selling Price – Cost)/Cost

Question 10

Which of the following investments offered the lowest overall return over the past eighty years?

Answer 10

Treasury bills

Question 11

Calculate Growth

Answer 11

Total Cost of Equity Capital - Dividend Yield

Question 12

Which of the following statements regarding perpetuities is FALSE?

Answer 12

PV of a perpetuity = r / C

Question 13

The process of selling stock to the public for the first time is called a seasoned equity offering (SEO).

Answer 13

False

Question 14

T/F - The annual percentage rate indicates the amount of interest, including the effect of any
compounding.

Answer 14

False

Question 15

How do the shareholders of most corporations exercise their control of that corporation?

Answer 15

by electing members of a board of directors

Question 16

Which of the following balance sheet equations is INCORRECT?

Answer 16

Assets - Current liabilities = Long-term liabilities

Question 17

The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its

Answer 17

capital structure

Question 18

Which of the following is/are TRUE?
I. The EAR can never exceed the APR.
II. The APR can never exceed the EAR.
III. The APR and EAR can never be equal.

Answer 18

Only II. is true - The APR can never exceed the EAR

Question 19

An equity issue that raises new funds for a publicly traded company is called

Answer 19

a seasoned equity offering

Question 20

T/F - According to researchers Modigliani and Miller, with perfect capital markets, the total value of a firm
should not depend on its capital structure

Answer 20

True

Question 21

The beta of the market portfolio is

Answer 21

1

Question 22

You are given two choices of investments, Investment A and Investment B. The investments
have identical cash flows. Investment A has a discount rate of 4%, and Investment B has a
discount rate of 5%. Which of the following is true?

Answer 22

The present value of cash flows in Investment A is higher than the present value of cash flows
in Investment B.

Question 23

What type of risk is Volatility?

Answer 23

Total Risk

Question 24

Which of the following is NOT a role of financial institutions?

Answer 24

impaling money for borrowers

Question 25

Equity in a firm with debt is called

Answer 25

levered equity

Question 26

How are investors in zero-coupon bonds compensated for making such an investment?

Answer 26

Such bonds are purchased at a discount to their face value

Question 27

After a list of potential projects is compiled, capital budgeting process is continued by

Answer 27

forecasting the future consequences for the firm of each potential project

Question 28

Dividend Yield

Answer 28

Divident / Purchase Price Per Share

Question 29

Whose interests should a financial manager consider paramount when making a decision?

Answer 29

the stockholders’ interests

Question 30

Total Cost of Equity Capital

Answer 30

Dividend Yield + Growth

Question 31

) You expect General Motors (GM) to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM) to be 0.9 over the next year. Also, you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 50% over the next year. Which stock has more systematic risk? Which stock has more total risk?

Answer 31

GM, XOM

Question 32

The Ontario Teachers' Pension Plan is a pension fund for public school teachers in the province of Ontario. It has a large and diverse portfolio of investments, both in Canada and internationally, and had net assets in December 2007 of C$108.5 billion. Which of the following best describes the Ontario Teachers' Pension Plan?

Answer 32

an institutional investor

Question 33

Which of the following is NOT a limitation of the payback rule?

Answer 33

It is difficult to calculate.

Question 34

A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 6%, what should be the coupon rate offered if the bond is to trade at par?

Answer 34

6%

Question 35

Capital Gain Rate

Answer 35

(Sell Price - Purchase Price) / Purchase Price

Question 36

The credit spread of a bond shrinks if it is perceived that the probability of the issuer defaulting increases.

Answer 36

False

Question 37

What type of risk is beta?

Answer 37

Systematic Risk

Question 38

Bonds with a high risk of default generally offer high yields.

Answer 38

True

Question 39

T/F - Cash flows from an annuity occur every year in the future.

Answer 39

False

Question 40

Which of the following best defines incremental earnings?

Answer 40

the amount by which a firm's earnings are expected to change as a result of an investment decision

Question 41

``` T/F - Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the costs of a project or investment. ```

Answer 41

True

Question 42

Which of the following adjustments should NOT be made when computing free cash flow from incremental earnings?

Answer 42

subtracting depreciation expenses from taxable earnings

Question 43

By definition, preferred stock is a form of debt security.

Answer 43

False

Question 44

The Capital Asset Pricing Model asserts that the expected return

Answer 44

is equal to the risk-free rate plus a risk premium for systematic risk

Question 45

In most corporations, to whom does the chief financial officer typically report?

Answer 45

the chief executive officer

Question 46

According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are

Answer 46

IRR, NPV, Payback period