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FIN 317 Week 5 Mid Term Exam

Chapters 1 Through 6

CHAPTER 1

INTRODUCTION TO FINANCE FOR ENTREPRENEURS

True-False Questions

1. Entrepreneurs provide the financing to individuals who think, reason, and act to convert ideas into commercial opportunities and create opportunities.

2. Entrepreneurship is the process of changing ideas into commercial opportunities and creating value.

3. An entrepreneur is an individual who thinks, reasons, and acts to convert ideas into commercial opportunities and to create value.

4. Mark Twain once said, “I was always able to see an opportunity before it became one.”

5. Small businesses, those with less than 500 employees, represent over 99 percent of all employers, and account for about one-half of the gross domestic product in the United States.

6. Small and growing enterprises are critical to the U.S. economy; small firms provide 20 to 30 percent of net new jobs.

7. Small high-technology firms are responsible for twice as many product innovations per employee and obtain more patents per sales dollar than large high-technology firms.

8. Phillips and Kirchhoff, using Dun & Bradstreet data, found that 24 percent of new firms were still in existence after two years of operation.

9. Nearly half of business failures are due to economic factors such as inadequate sales, insufficient profits, and industry weakness.

10. Although the risks associated with starting a new entrepreneurial venture are large, there is always room for one more success.

11. Studies by Phillips and Kirchhoff, and by Headd, found that about 38%-40% of new firms survived six years of operation.

12. One study of Inc. magazine’s 500 high-growth firms suggests that about 88 percent of founders feel their firms’ successes are due to extraordinary ideas, while the remaining 12 percent feel their firms’ successes are due to exceptional execution of ordinary ideas.

13. “Fads” are large societal, demographic, or technological trends or changes that are slow in forming but once in place continue for many years.

14. “Fads” are not predictable, have short lives, and do not involve macro changes.

15. Three major megatrends discussed in Chapter 1 include: societal trends or changes, demographic trends or changes, and technological trends or changes.

16. In 1982, Harry Dent identified several major or megatrends shaping U.S. society and the world.

17. The so-called “baby boom” generation applies to people born in the United States during the 1946-1964 time period.

18. Perhaps the most important invention shuttling us from an industrial society to an information society is the computer chip.

19. Environmental commerce, or e-commerce, involves the use of electronic means to conduct business online.

20. The Office of Advocacy of the U.S. Small Business Administration documents that “employer firm births” have exceeded 700,000 annually in recent years.

21. Reasonable estimates place nonemployer (e.g., single person or small family) business started each year at less than 100,000.

22. Bill Gates once said: “I was seldom able to see an opportunity, until it ceased to be one.”

23. A study by Phillips and Kirchhoff using Dun & Bradstreet data found that about three-fourths of new firms were still in existence after two years of operation.

24. Studies by Phillips and Kirchhoff, and by Headd, found that one-half of new firms or new employers were still in existence after four years of operation.

25. Nine principles of entrepreneurial finance are identified and explored in this entrepreneurial finance textbook,

26. The “time value of money” is an important component of the rent one pays for using someone else’s financial capital.

27. A venture’s financial objective is to survive.

28. Private financial markets are a place where standardized contracts or securities are traded on organized security exchanges with restrictions on how they can be transferred.

29. Free cash flow is the net income forecast to be available to the venture’s owners over time.

30. Free cash flows are adjusted for risk and the time value of money when used to calculate the value of a venture.

31. Free cash exists when cash exceeds that which is needed to operate, pay creditors, and invest in assets.

32. Free cash is all the cash available to cover operating expenses.

33. Owner-manager (agency) conflicts are differences between manager’s self-interest and that of the owners who hired the manager.

34. The owner-debtholder conflict is the divergence of the owners’ and lenders’ self-interest as the firm gets close to going “public.”

35. The financial objective of increasing value is inconsistent with developing positive character and reputation.

36. Entrepreneurial finance is the application and adaptation of financial tools and techniques to the planning, funding, operations, and valuation of an entrepreneurial venture.

37. Financial distress occurs when cash flow is insufficient to meet current debt obligations.

38. The second stage in a successful venture’s life cycle is the startup stage.

39. The rapid growth stage directly follows the startup stage.

40. Early-stage ventures include firms in their development, startup, or survival live cycle stages.

41. Business angels are wealthy individuals acting as informal or private investors, who provide venture financing for small businesses.

42. Mezzanine financing is temporary financing needed to keep the venture afloat until the next offering.

43. “Crises and bubbles” and “emerging economies and global change” are considered to be sources of entrepreneurial opportunities.

44. In Chapter I five mega-trend categories are identified as sources of entrepreneurial opportunities.

45. Entrepreneurial opportunities can occur only when there are societal changes in the world.

46. One principal of entrepreneurial finance is “risk and expected reward go hand in hand.

47. While cash is the language of business, accounting is the currency.

48. Venture character and reputation can be assets or liabilities.

Section .01 Multiple-Choice Questions

1. Successful entrepreneurs exhibit which of the following traits?
a. recognize and seize commercial opportunities
b. economic pessimism
c. tend to be doggedly optimistic
d. both a and b
e. both a and c

2. While one must be careful to avoid too many generalizations about entrepreneurial traits or characteristics, which one of the following characteristics would not normally be associated with successful entrepreneurs?
a. being able to see and seize a commercial opportunity
b. planning for the venture’s future
c. only being able to see an opportunity after it ceases to be one
d. being optimistic about the venture’s success

3. About one-half of all newly created businesses in the U.S. are dissolved or cease operations within how many years after being started?
a. two years
b. four years
c. six years
d. eight years

4. About 60 percent of all newly created businesses in the U.S. are dissolved or cease operations within how many years after being started?
a. two years
b. four years
c. six years
d. eight years

5. “Fads” are:
a. not predictable
b. have short lives
c. do not involve macro changes
d. all of the above

6. Harry Dent documented major generation waves in the United States during the twentieth century in:
a. 1972
b. 1982
c. 1993
d. 2003

7. “E-commerce” refers to:
a. environmental commerce
b. electronic commerce
c. economic commerce
d. exploratory commerce

8. While entrepreneurial opportunities come from an almost unlimited number of sources, this textbook focuses on:
a. societal changes
b. demographic changes
c. technological changes
d. crises and bubbles
e. emerging economies and global changes
f. all of the above

9. Indicate the number of principles of entrepreneurial finance that are emphasized in this textbook:
a. one
b. three
c. five
d. seven
e. nine

10. Maximizing the value of the venture to its owners is the common financial goal of which of the following?
a. the entrepreneur
b. the debtholders
c. the venture equity investors
d. both a and b
e. both a and c

11. Which of the following is considered to be an “agency” conflict?
a. owner-manager conflict
b. stockholder-manager conflict
c. stockholder-debtholder conflict
d. manager-debtholder conflict

12. Which one of the following possible conflicts of interest is usually minimized through the use of equity incentives?
a. owner-manager conflicts
b. owner-employee conflicts
c. manager-employee conflicts
d. manager-debtholder conflicts

13. Which one of the following possible conflicts of interest increases in divergence at venture gets close to bankruptcy?
a. owner-manager conflict
b. owner-employee conflict
c. manager-employee conflict
d. manager-debtholder conflict

14. Which of the following is not a life cycle stage of a successful venture?
a. development stage
b. startup stage
c. survival stage
d. cash cow stage
e. early-maturity stage

15. Which of the following does not describe activity during the venture’s life cycle startup stage?
a. venture’s organization
b. venture’s development
c. operating cash flows are generated
d. initial revenue model is put in place

16. At which stage of the venture’s life cycle stage is best characterized by the period when revenues start to grow and when cash flows from operations begin covering cash outflows?
a. survival stage
b. startup stage
c. rapid growth stage
d. early-maturity stage

17. Which is not a major source of start-up financing for a venture’s startup stage?
a. entrepreneur’s assets
b. business operations
c. family and friends
d. business angels
e. venture capitalists

18. Obtaining bank loan, issuing bonds, and issuing stock is characteristic of which type of financing during the venture’s life cycle?
a. seed financing
b. second round financing
c. mezzanine financing
d. seasoned financing
e. liquidity stage financing

19. During a venture’s rapid growth stage, funds for plant expansion, marketing expenditures, working capital, and product or service improvements is obtained through?
a. seed financing
b. second round financing
c. mezzanine financing
d. seasoned financing
e. liquidity stage financing

20. Founder and venture investor shares are sold to the public after the initial offering to the public is called?
a. secondary market transaction
b. secondary stock offering
c. venture offering
d. bridge loan

21. Which of the following advise and assist corporations on the type, timing, and costs of issuing new debt and equity securities and facilitate the sale of firms?
a. brokerage firms
b. venture law firms
c. specialist firms
d. investment banking firms

22. Which stage in the venture life cycle is characterized by creating and building value, obtaining additional financing, and examining opportunities?
a. survival stage
b. startup stage
c. rapid growth stage
d. early-maturity stage

23. Which of these statements is correct?
a. The development stage occurs between the startup and survival stages of a venture’s life cycle
b. The early-maturity stage is the final stage of a new venture’s lifecycle
c. Firms typically begin to cover all expenses with internally-generated funds during the survival stage
d. During the startup stage, revenues grow much more rapidly than cash expenditures
e. None of the above

24. The last three stages of a successful venture’s life cycle occur in the following order:
a. startup, development, rapid growth
b. startup, survival, rapid growth
c. survival, rapid growth, early-maturity
d. development, startup, survival

25. The stage that precedes the middle stage in a successful venture’s life cycle is called the:
a. rapid growth stage
b. early-maturity stage
c. development stage
d. survival stage
e. startup stage

26. During the maturity stage of a venture’s life cycle, the primary source of funds is in the form of:
a. mezzanine financing
b. seed financing
c. startup financing
d. first round financing
e. seasoned financing

27. The type of financing that occurs during the development stage of a venture’s life cycle is typically referred to as:
a. seed financing
b. startup financing
c. first round financing
d. second round financing
e. mezzanine financing

28. Mezzanine financing is associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid growth stage
e. early-maturity stage

29. Entrepreneurial finance is the application and adaptation of financial tools and techniques to an entrepreneurial venture. Entrepreneurial finance involves:
a. planning
b. funding
c. operations
d. valuation
e. a and d above
f. all of the above

30. The first three stages of a successful venture’s life cycle occur in the following order:
a. development, rapid growth, survival
b. startup, development, rapid growth
c. startup, survival, rapid growth
d. survival, rapid growth, early-maturity
e. development, startup, survival

31. The last stage in a successful venture’s life cycle is called the:
a. rapid growth stage
b. early-maturity stage
c. development stage
d. survival stage
e. startup stage

32. The type of financing that occurs during the survival stage of a venture’s life cycle is typically referred to as the:
a. seed financing
b. startup financing
c. first round financing
d. second round financing
e. mezzanine financing

33. Which one of the following would not be considered a type of venture financing?
a. seed financing
b. startup financing
c. mezzanine financing
d. liquidity-stage financing
e. seasoned financing

34. One study of successful entrepreneurs indicated that a majority felt that the most important factor in the long-term success of their ventures was:
a. being greedy
b. having high ethical standards
c. working hard
d. taking frequent vacations

35. Financial markets where customized contracts or securities are negotiated, created, and held with restrictions on how they can be transferred are called:
a. private financial markets
b. public financial markets
c. domestic financial markets
d. international financial markets
e. all of the above

36. The time value of money concept is associated with which one of the following principles of entrepreneurial finance:
a. real, human, and financial capital must be rented from owners
b. risk and expected reward go hand in hand
c. while accounting is the language of business, cash is the currency
d. it is dangerous to assume that people act against their own self-interests

37. The goal of the entrepreneurial process is to:
a. develop opportunities
b. gather resources
c. manage and build operations
d. create value

38. Which of the following is not considered to be a mega-trend in this textbook?
a. societal, demographic, and technological changes
b. crises and bubbles
c. fads
d. emerging economies and global changes

Supplementary Questions (may require basic knowledge of probability and/or prior introductory accounting and business concepts)

1. You have the opportunity of making a $5,000 investmen The outcomes one year from now will be either $4,500 or $6,000 with an equal chance of either outcome occurring. What is the expected outcome?
a. $4,500
b. $6,000
c. $5,250
d. $5,750
e. $5,000

2. You have the opportunity of making a $5,000 investmen The outcomes one year from now will be either $5,000 or $6,000 with an equal chance of either outcome occurring. What is the expected rate of return?
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%

3. A project requires an initial investment of $1,000,000. In one year, there is a 40% chance of a $950,000 return; a 50% chance of a $1,200,000 return; and a 10% chance of a $2,000,000 return. What is the project’s expected return one year from now?
a. 12.8%
b. 15.5%
c. 18.0%
d. 38.3%

4. Lindsey and Tobias have the opportunity to invest in a project that requires an investment of $3,000. There is a 35% chance of a $2,900 return; a 40% chance of a $3,400 return; and a 25% chance of a $4,500 return one year from now. Lindsey requires a 15% return on the project after the first year, but Tobias requires a return of only 12%. Using the expected rate of return:
a. Lindsey and Tobias should both invest in the project
b. Only Tobias should invest in the project
c. Only Lindsey should invest in the project
d. Lindsey and Tobias should both reject the project

5. You are considering investing in two independent projects “A” and “B”. Project A requires an initial investment of $12,000. In one year, there is a 30% chance of a $10,500 return; a 50% chance of a $12,500 return; and a 20% chance of a $14,500 return. Project B requires an initial investment of $1,000. In one year, there is a 25% chance of a $950 return; a 25% chance of a $1,000 return; and a 50% chance of a $1,200 return. If you require a 7% return on your investment after one year, you should:
a. Accept A and reject B
b. Accept B and reject A
c. Accept both projects
d. Reject both projects

6. Assume that you can sell a new product at $5.00 per uni Your variable costs are $3.00 per unit and you fixed costs are $20,000. What is your breakeven point in sales units?
a. 5,000
b. 7,500
c. 10,000
d. 12,500
e. 15,000

7. Assume that you can sell a new product at $5.00 per uni Your variable costs are $3.00 per unit and you fixed costs are $20,000. What will be your profit before taxes if you sell 12,000 units next year?
a. $0
b. $1,000
c. $2,000
d. $4,000
e. $8,000

CHAPTER 2

DEVELOPING THE BUSINESS IDEA

True-False Questions

1. For ventures that first get to market or create intellectual property rights, it’s common to price new products or services at high markups or profit margins.

2. Lifestyle firms are growth-driven in terms of revenues, profits, and cash flows and also performance-oriented as reflected in rapid value creation over time.

3. “Salary-replacement” firms provide their owners with income levels comparable to what they could have earned working for much larger firms.

4. An entrepreneur may start a number of different types of businesses, including salary-replacement firms, lifestyle firms, and entrepreneurial firms or ventures.

5. “Entrepreneurial ventures” are firms that allow owners to pursue specific lifestyles while being paid for doing what they like to do.

6. Entrepreneurial ventures emphasize survival and providing an acceptable living for their owners with growth being a secondary goal.

7. A sound business model is a plan to generate investor interest, make profits, and grow asset investments.

8. A sound business model should provide a plan to generate revenues, make profits, and produce free cash flows.

9. Mark Twain said: “Like I tell anybody, if you fail to plan, you’re planning to fail.”

10. Best practices of high-growth, high-performance firms applied in the marketing practices area include “developing new products or services that are considered to be the bes ”

11. Best practices of high-growth, high-performance firms applied in the marketing practices area include “preparing detailed monthly financial plans for the next year and annual financial plans for the next five years.

12. Best practices of high-growth, high-performance firms applied in the financial practices area include “preparing detailed monthly financial plans for the next year and annual financial plans for the next five years.

13. Best practices of high-growth, high-performance firms applied in the management practices area include “assembling a management team that is balanced in both functional area coverage and industry/market knowledge.”

14. Business opportunities, because they exist in real time, have a relatively narrow window of opportunity to become a successful business venture. However being the first to market does not guarantee success.

15. Ideas that are said to be “ahead of their time” are too early to become viable business opportunities for the inventor or innovator.

16. Once conceptualized, a new idea should be examined for its business feasibility.

17. A SWOT analysis is an examination of the strengths, weaknesses, opportunities, and threats to determine the business opportunity viability of an idea.

18. A SWOT analysis focuses on strengths (S), worries (W), opportunities (O), and treats (T).

19. A “venture opportunity screening” is the same thing as preparing a business plan.

20. A SWOT analysis should consider as potential strengths or weaknesses whether there are unfilled customer needs and the extent to which intellectual property rights exis

21. A SWOT analysis should consider the extent of existing competition and the likelihood of substitute products or services as potential strengths or opportunities.

22. Venture opportunity screening involves assessment of an idea’s commercial potential to produce revenue growth, financial performance, and value.

23. A venture with a low score on the VOS Indicator should always be abandoned.

24. The VOS Indicator is useful in assessing the commercial potential of a venture, but should not be used as the sole tool to determine a venture’s fate.

25. The VOS Indicator provides both qualitative and quantitative information about a venture’s commercial potential.

26. A venture opportunity-screening guide, called the VOS Indicator, is used to determine potential attractiveness of venture opportunities as business opportunities.

27. Asset intensity is the net after-tax profit divided by total assets.

28. One way to describe asset intensity is the dollar investment in assets needed to generate a dollar in sales.

29. Business changes resulting in higher net profit always increases ROA.

30. The compound rate of return that equates the present value of the cash inflows with the initial investment outlay is called the internal rate of return (IRR).

31. Bootstrapping refers to the process of minimizing resources such as the need for financial capital and finding unique sources for financing a new venture.

32. Free cash flow to equity is the cash flow from producing and selling a product or providing a service.

33. In a typical business plan, the section covering the management team does not need to disclose the expertise and experience of the managemen

34. The non-financial option available to managers as the venture progresses through its lifecycle is known as real options.

35. The process of moving from entrepreneurial opportunities to new businesses, products, or services begins with ideas, then moves to the preparation of a business plan, and finally ends with a feasibility study.

36. A well-designed entrepreneurial venture bins with an idea that survives an analysis of its feasibility and results in a business model/plan.

37. A successful, sound business model does not have to ultimately produce free cash flows.

38. The first component of a sound business model is the need to generate revenues.

Multiple-Choice Questions

1. Firms that allow owners to pursue specific lifestyles while being paid for doing what they like to do are referred to as:
a. salary-replacement firms
b. lifestyle firms
c. entrepreneurial ventures
d. rapid value creation firms

2. U.S. small businesses are predominately:
a. salary-replacement or entrepreneurial firms
b. lifestyle or entrepreneurial firms
c. entrepreneurial ventures
d. salary-replacement or lifestyle firms

3. The definition of an entrepreneurial firm is:
a. survival, high growth
b. high growth, high performance
c. survival, average performance
d. high, growth, average performance

4. A sound business model provides a plan which includes all of the following except?
a. generates revenues
b. makes profits
c. retains all its earnings
d. produces free cash flows
e. all of the above are included

5. A sound business model includes a plan to:
a. generate revenues, make profits
b. make profits, produce free cash flows
c. produce free cash flows for the owners of the venture
d. generate revenues, make profits, and produce free cash flows

6. Which one of the following components is not a standard component of a sound business model?
a. produce low-cost products
b. generate revenues
c. make profits
d. produce free cash flows

7. Free cash flows, which can be paid back to investors occurs when cash generated from operations exceeds all of the following except?
a. borrowing costs
b. non-cash depreciation
c. taxes
d. investment in assets

8. A venture’s value is determined by
a. the size and timing of its future free cash flows
b. time value of money
c. its net income
d. a and b
e. a and c

9. Developing new and delivering high-quality products or services that command higher prices and margins best describes strong
a. marketing practices
b. financial practices
c. operating practices
d. management practices

10. Effective entrepreneurial management teams should include all of the following except?
a. provide expertise in the areas of marketing, finance, and operations
b. have successful experience in the venture’s industry and markets
c. work collaboratively with each other
d. share the entrepreneurial spirit
e. in-house accounting, auditing, and tax professionals

11. A viable venture opportunity is characterized by all of the following except?
a. creating or meeting a customer need
b. has perceived attraction to prospective investors
c. provides an initial competitive advantage
d. is timely in terms of time-to-market
e. offers the expectation of added value to investors

12. A SWOT analysis does not focus on which of the following components or areas?
a. strengths
b. weaknesses
c. new ideas
d. opportunities
e. threats

13. A SWOT analysis focuses on which of the following components or areas?
a. strengths
b. weaknesses
c. opportunities
d. threats
e. all of the above
a, b, and d

14. When conducting a SWOT analysis, “unfilled customer needs” are examined in terms of:
a. strengths
b. weaknesses
c. opportunities
d. threats
e. a or b
c or d

15. SWOT analysis should at the very least consider which of the following areas:
a. experience/expertise
b. reputation value
c. first mover
d. a and b
e. a, b, and c

16. Which one of the following is not a part of the VOS indicator?
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations
e. location/profitability considerations

17. The evaluation of “entry barriers” occurs under which one of the following parts of the VOS indicator?
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations

18. A VOS indicator stands for:
a. venture opportunity screening indicator
b. viable opportunity statement indicator
c. venture only success indicator
d. viable assessment screening indicator

19. The factor categories in a VOS indicator are:
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations
e. all of the above
a, b, and d

20. A “score” in the range of 2.34-3.00 using the VOS IndicatorTM ¬¬¬¬ ¬would be considered a:
a. a low score
b. an average score
c. a high score
d. a very, very high score

21. An average score on using the VOS Indicator¬TM would fall in the range:
a. 0.00-0.99
b. 1.00-1.66
c. 1.67-2.33
d. 2.34-3.00

22. At the end of a qualitative-based venture opportunity screening exercise, the interviewer prepares a subjective assessment and indicates one of the following except for:
a. natural commercial potential
b. high commercial potential
c. average commercial potential
d. low commercial potential

23. Direct costs of producing a product or providing a service is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin
e. cost of goods sold

24. Revenues minus the cost of goods sold is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin

25. Dollar profit left after all expenses, including financing costs and taxes have been deducted from the firm’s revenues is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin
e. cost of goods sold

26. Return on assets can be stated as which of the following?
a. net after-tax profit divided by total assets
b. net profit margin times asset turnover
c. net cash flow divided by total assets
d. both a and b
e. both a and c

27. All else held constant, a higher asset turnover:
a. increases ROA
b. decreases ROA
c. has no effect on ROA
d. may raise or lower ROA, depending on how it affects revenues.

28. The return on assets (ROA) model measures:
a. revenues divided by net profit times the asset turnover
b. net profit margin times the equity multiplier
c. net profit margin times asset turnover
d. net profit divided by total assets multiplied by the asset turnover

29. Free cash flow to equity is the cash available to the entrepreneur and venture investors after all of the following except?
a. net cash flows
b. operating cash outflows
c. financing and tax cash flows
d. investment in assets needed to sustain the venture’s group
e. net increase in debt capital

30. The free cash flows to equity of an entrepreneurial firm includes cash flows to:
a. venture investors
b. creditors
c. the entrepreneur
d. a and b
e. a and c
f a, b, and c

31. Determine the cost of goods sold for a venture with the following financial information: revenues = $50,000; net profit margin = 20%;
gross profit margin = 70%
a. $40,000
b. $35,000
c. $15,000
d. $10,000

32. Determine gross profit of a venture with the following
financial information: cost of goods sold = $30,000; net profit = $17,000; asset turnover = 1.6; return on assets 32%
a. $85,000
b. $72,000
c. $55,000
d. $38,000
33. Determine the return on assets (ROA) for a venture with the following financial information: revenues = $500,000; net profit = $70,000; and asset turnover = 2.00 times.
a. 10%
b. 14%
c. 20%
d. 28%
e. 34%

34. Determine the dollar amount of total assets for a venture with the following financial information: revenues = $500,000; net profit = $70,000; and asset turnover = 2.00 times.
a. $100,000
b. $250,000
c. $375,000
d. $500,000
e. $650,000

35. Determine the dollar amount of net profit for a venture with the following financial information: revenues = $500,000; return on assets = 20%; and asset turnover = 2.00 times.
a. $10,000
b. $25,000
c. $50,000
d. $60,000
e. $75,000

36. Determine the dollar amount of revenues for a venture with the following financial information: net profit = $60,000; assets turnover = 1.5 times; and return on assets 30%.
a. $300,000
b. $500,000
c. $800,000
d. $1,000,000
e. $1,200,000

37. Determine the asset intensity of a venture with the following financial information: net profit = $22,000; revenues = $132,000; return on assets 30%. a. .05
b. .56
c. 1.8
d. 20

38. In the venture life cycle, moving from the development stage to the startup stage frequently begins with the preparation of a business plan. The business plan is a written document that describes the proposed venture in all of the following terms except:
a. the proposed product or service opportunity
b. the accounting data for the last five years
c. current resources available to the venture
d. financial projections

39. A typical business plan includes all of the following sections except:
a. executive summary
b. business description
c. marketing plan and strategy
d. disclosure of pending litigation
e. operations and support

40. When composing the financial plans and projections section of a business plan, all of the following should be included except:
a. income statements and balance sheets
b. statement of cash flows
c. past and present dividend per share information
d. breakeven analysis
e. funding needs and sources

41. A typical business plan includes all of the following except:
a. management team
b. financial plans and projections
c. risk and opportunities
d. timeline and milestones
e. initial public offering information

42. The first two requirements of a sound business model are:
a. generate revenues, make profits
b. make profits, produce free cash flows
c. produce free cash flows for creditors and owners of the venture
generate revenues and produce free cash flows

43. The process involving minimizing the need for financial capital and finding unique sources for financing a new venture is referred to as:
a. mezzanine financing
b. financial bootstrapping
c. seed financing
d. startup financing

44. A written document that describes the proposed venture in terms of the product or service opportunity, current resources, and financial projections is called a:
a. financial plan
b. business plan
c. entrepreneurial plan
d. survival plan

45. In the Kauffman Center study of best practices of high-growth, high-performance firms, which of the following practices was not included?
a. marketing practices
b. financial practices
c. management practices
d. production/operations practices

46. When moving from entrepreneurial opportunities to new businesses, products, or services, which one of the following is not considered a component?
a. ideas
b. feasibility
c. business plan
d. harvest of venture

47. A firm’s option to abandon a venture is an example of a:
a. bootstrapping option
b. financial option
c. survival option
d. real option

48. A venture’s value to its owners is determined by the:
a. size and timing of its future free cash flows (to equity)
b. level of its past revenues
c. prior losses and expenses
d. all of the above

49. A well-designed entrepreneurial venture typically includes:
a. generating ideas
b. analyzing the feasibility of ideas
c. producing business models/plans
d. only a and c above
e. a, b, and c above

50. Some venture investors like to draw analogies between baseball terms and venture performance. The baseball term used to reflect a total loss of an investment is:
a. home run
b. single
c. strikeout
d. double

CHAPTER 3

ORGANIZING AND FINANCING A NEW VENTURE

True-False Questions

1. The difference between a limited partnership and a general partnership is that the limited partnership has partners who actively manage the day-to-day operations but also has passive investors.

2. A limited partnership limits certain partners’ liabilities to pay the venture’s obligations to the amount each paid for their partnership interests.

3. In a corporate legal entity, the personal assets of the owners are separate from the business’ assets, but the personal liabilities of the owners are no

4. Limited liability in the corporate business structure means creditors can seize only some of the corporation’s assets.

5. The articles of incorporation are the basic legal declarations contained in the corporate charter.

6. Limited liability companies (LLCs) are owned by shareholders with limited liability and its earnings are taxed at the corporate rate.

7. Partnerships are treated with pass-through taxation. This means that profits and losses of the business pass directly through to investors on the basis specified in the partnership agreemen

8. An employment contract is an agreement between an employer and employee about the terms and conditions of employment including the employee’s agreement to keep confidential information secret and to assign ideas and inventions to the employer.

9. Financial bootstrapping maximizes the need for financial capital.

10. The income received by a proprietorship is taxed at personal tax rates.

11. The equity capital sources for a proprietorship are partners, families, and friends.

12. The maximum number of owners in a Subchapter S corporation is 150.

13. An S corporation provides unlimited liability for its shareholders.

14. Professional corporations (PCs) and service corporations (SCs) are corporate structures that “states” provide for professionals such as physicians, dentists, lawyers, and accountants.

15. The marginal tax rate for the first dollar of taxable income is higher for corporations than for individuals.

16. Based on 2012 tax laws, the highest possible marginal tax table rate is higher for corporations than for individuals.

17. The highest marginal income tax rate for taxable personal income is 45 percen

18. There are four types of “marks” that can be used to try to protect intellectual property.

19. Patents, trade secrets, trademarks, and copyrights are intangible assets.

20. “Certification marks” cover memberships in groups (e.g., a sorority or a labor union).

21. “Collective marks” cover memberships in groups (e.g., a sorority or a labor union).

22. Most trademarks take the form of names, words, or graphic designs.

23. A “color mark” is considered to be one four types of “marks” used to try to protect intellectual property.

24. A copyright must be registered with the U.S. Copyright Office in order for a work to be protected.

25. A work does not need to be registered to receive copyright protection; the work’s creation is enough to provide copyright protection.

26. There are four kinds of patents.

27. “Business method” is one kind of paten

28. An idea is enough to be patented.

29. “Design patents” cover most inventions pertaining to new products, services, and processes.

30. “Business method” patents protect a specific way of doing business and the underlying computer codes, programs, and technology.

31. “Patents” are intellectual property rights granted for inventions that are useful, novel, and obvious.

32. Nondisclosure agreements prohibit the creator of an idea or other form of intellectual property from sharing it with others once it has been presented the first time.

33. Confidential disclosure agreements are used to protect intellectual property when disclosure must be made to an outside individual or organization.

34. “Certification marks” are intellectual property rights in the form of inventions and information (e.g., formulas, processes, customer lists, etc.) not generally known to others.

35. “Trademarks” are intellectual property rights that allow firms to differentiate their products and services through the use of unique marks.

36. A trademark must be novel in order to receive protection.

37. Business angels are wealthy individuals who invest in early-stage ventures in exchange for the excitement of launching the business, as well as a share of the firm’s financial gains.

38. “Service marks” refer to services such as those provided by a sorority or a labor union.

39. “Certification marks” provide indications of quality.

40. Copyrights are intellectual property rights to writings in printed and electronically stored forms.

Multiple-Choice Questions

1. In which form of business organization are the owners not offered the protection of limited liability?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. limited liability corporation

2. In which form of business organization is the taxation effects characterized by the income flowing to shareholders taxed at personal tax rates?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. general partnership

3. Which form of business organization is characterized by having the shortest start-up time and lowest legal costs?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. limited liability corporation

4. Which form of business organization typically offers the easiest transfer of ownership?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. general partnership

5. Which form of business organization is characterized as having unlimited life?
a. proprietorship
b. limited partnership
c. limited liability corporation
d. subchapter S corporation
e. general partnership

6. Which of the following is not a right or a duty of general partners?
a. participation in profits and losses
b. some liability for partnership obligations
c. veto right on new partners
d. eventual return of capital
e. access to partnership books

7. The rules and procedures established to govern the corporation are called the
a. corporate charter
b. articles of incorporation
c. corporate bylaws
d. confidentiality disclosure agreements
e. partnership agreements

8. In a general partnership, legal action that treats all partners equally as a group is called:
a. joint and several liability
b. joint liability
c. limited liability
d. accrued liability
e. general liability

9. Which of the following business organizational forms provides the owners with limited investor liability and passes its income before taxes through to the owners?
a. partnership
b. subchapter S (or S) corporation
c. regular or (C ) corporation
d. limited liability company (LLC)
e. both a and b
f. both b and d

10. Which of the following numbers of shareholders is allowed in a Subchapter S (or S) corporation business form?
a. 74
b. 125
c. 130
d. 500

11. Based on 2012 tax schedules, the first dollar of personal taxable income is taxed at which of the following marginal tax rates:
a. 05.0%
b. 10.0%
c. 15.0%
d. 20.0%
e. 25.0%

12. Based on 2012 tax schedules, the first dollar of corporate income is taxed at which of the following marginal tax rates:
a. 05.0%
b. 10.0%
c. 15.0%
d. 20.0%
e. 25.0%

13. Based on 2012 tax schedules, the highest marginal tax rate on personal taxable income is:
a. 25.0%
b. 28.0%
c. 33.0%
d. 35.0%
e. 40.0%

14. Based on 2012 tax schedules, the highest marginal tax rate on corporate taxable income is:
a. 25.0%
b. 28.0%
c. 35.0%
d. 38.0%
e. 39.0%

Note: The following information should be used for multiple choice questions 15-19. Following is a partial 2012 personal income tax schedule for a single filer:
Taxable Income

Beginning Ending Bracket Marginal
Amount Amount Amount Tax Rate
$1 $8,700 $8,700 0.10
$8,700 $35,350 $26,650 0.15
$35,350 $85,650 $50,300 0.25

15. The dollar amount of income taxes paid by a single filer who has taxable income of $8,700 would be:
a. $150
b. $870
c. $3,840
d. $4,675
e. $10,385

16. The cumulative dollar amount of income taxes paid by a single filer who has taxable income of $35,350 would be:
a. $150
b. $835
c. $3,840
d. $4,867.50
e. $10,385

17. The maximum dollar amount of income taxes in the $35,350-$85,650 “bracket” paid by a single filer with taxable income of $85,650 would be:
a. $150
b. $870
c. $3,997.50
d. $4,675
e. $12,575

18. The average tax rate for a single filer with taxable income of $35,350 would be:
e. 10.0%
f. 13.8%
g. 15.0%
h. 16.7%
i. 20.0%

19. The average tax rate for a single filer with taxable income of $85,650 would be:
a. 14.7%
b. 16.7%
b. 20.0%
c. 20.4%
d. 25.0%

Note: The following information should be used for multiple choice questions 20-36. Following is a partial 2012 corporate income tax schedule:

Taxable Income
Beginning Ending Bracket Marginal
Amount Amount Amount Tax Rate
$1 $50,000 $50,000 0.15
$50,000 $75,000 $25,000 0.25
$75,000 $100,000 $25,000 0.34

20. The dollar amount of income taxes paid by a corporation with taxable income of $50,000 would be:
a. $1,500
b. $6,250
c. $7,500
d. $8,500
e. $10,850

21. The cumulative dollar amount of income taxes paid by a corporation with taxable income of $75,000 would be:
a. $6,250
b. $7,500
c. $8,500
d. $13,750
e. $22,250

22. The maximum dollar amount of income taxes in the $75,000-$100,000 bracket paid by a corporation with taxable income of $100,000 would be:
a. $6,250
b. $7,500
c. $8,500
d. $13,750
e. $22,250

23. The average tax rate for a corporation with taxable income of $75,000 would be:
a. 15.0%
b. 18.3%
c. 20.0%
d. 22.7%
e. 25.0%

24. The average tax rate for a corporation with taxable income of $100,000 would be:
a. 15.0%
b. 16.75%
c. 20.0%
d. 22.25%
e. 25.0%

25. Intellectual property can be protected by all of the following except:
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

26. Which of the following are intellectual property rights granted for inventions that are useful, novel, and non-obvious?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

27. Which of the following are intellectual property rights in the form of inventions and information such as formulas, processes, and customer lists that are not generally known to others and which convey economic advantage to the holders?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

28. Which of the following are intellectual property rights that allow firms to differentiate their products and services through the use of unique marks which allow consumers to easily identify the source and quality of the products and services?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

29. Which of the following are intellectual property rights to writings in written and electronically stored forms?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets

30. Which of the following are not sources of seed and start-up financing?
a. family and friends
b. the entrepreneur’s physical and financial assets
c. business angels
d. venture capitalists
e. stock and bond markets

31. Wealthy individuals who invest in early stage ventures in exchange for the excitement of launching a business and a share in any financial rewards are known as:
a. creditors
b. white knights
c. corporate raiders
d. business angels
e. stakeholders

32. Business angels typically initiate their investments during the:
a. early stages of a venture’s lifecycle
b. middle stages of a venture’s lifecycle
c. maturity stage of a venture’s lifecycle
d. all of the above

33. Which of the following forms of protecting intellectual property had its protection limit increased from 17 to 20 years?
a. copyrights
b. trademarks
c. patents
d. trade secrets

34. Patents are intellectual property rights granted for inventions that are:
a. not useful, novel, and non-obvious
b. not useful, not novel, and obvious
c. useful, novel, and non-obvious
d. useful, not novel, and obvious

35. Patents that cover most inventions pertaining to new products, services, and processes, are referred to as:
a. design patents
b. plant patents
c. utility patents
d. electrical patents
e. mechanical patents

36. Intellectual property rights to “writings” in written and electronically-stored forms are protected by:
a. Patents
b. copyrights
c. trade secrets
d. trademarks

37. Which of the following forms of protecting intellectual property currently has a protection limit of 20 years?
a. copyrights
b. patents
c. trade secrets
d. trademarks

38. Certification marks are typically used to:
a. indicate membership in a trade group
b. indicate a certain brand of service
c. indicate quality
d. are symbols used to associate products to a specific brand

39. Which of the following is not a “kind” of patent?
a. Utility
b. Design
c. Mark
d. Plant
e. Business method

40. Which of the following is not a “type” of mark?
a. Trademark
b. Service mark
c. Collective mark
d. Certification mark
e. Design mark

41. During the development stage, seed financing chiefly comprises:
a. funds from business angels and venture capitalists
b. the entrepreneur’s personal assets
c. funds from family and friends
d. a, b, and c
e. only b and c

42. The term that refers only to words, symbols, shapes, and similar items associated with products is:
a. trademarks
b. service marks
c. collective marks
d. certification marks

CHAPTER 4

PREPARING AND USING FINANCIAL STATEMENTS

True-False Questions

1. Assets are financial and physical items controlled or owned by the business.

2. GAAP stands for “General American Accounting Principles.”

3. GAAP stands for “Generally Accepted Accounting Principles.”

4. The practice of recording economic activity when realized is known as accrual accounting.

5. Accrual accounting is the practice of recording economic activity when recognized rather than waiting until realized.

6. The balance sheet equation is: Total Assets = Total Liabilities + Net Income.

7. On the balance sheet, Total Liabilities = Total Assets – Owners Equity.

8. How quickly an asset can be converted into cash is called liability.

9. Cash or other assets that are expected to be converted into cash in less than one year are known as current liabilities.

10. The reduction in value of a fixed asset over its expected life intended to reflect the usage or wearing out of the asset is called accumulated depreciation.

11. Amounts owed to another for purchase made on credit which come due in less than one year are known as receivables.

12. Long-term, non-cancelable leases whereby the owner receives payments that cover the cost of the equipment plus a return on investment in the equipment is known as a capital lease.

13. Operating income, or earnings before interest and taxes, reflects the firm’s profits after all operating expenses, excluding financing costs, have been deducted from net sales.

14. Net income, or profit, is the bottom line measure of what’s left from the firm’s net sales after operating expenses, financing costs, and taxes have been deducted.

15. Net cash burn occurs when the sum of cash flows from operations and investing is positive.

16. Net cash build occurs when the sum of cash flows from operations and investing is negative.

17. During the development stage in a new venture’s life cycle, the balance sheet reflects the acquisition of initial assets and the obtaining of seed financing.

18. During the development stage in a new venture’s life cycle, the income statement typically shows no sales but expenses such as rent, utilities, and a subsistence salary for the entrepreneur.

19. During the startup stage in a new venture’s life cycle, the income statement typically shows no sales but expenses including the production and market of products or services.

20. Production assets (e.g., inventories and equipment to produce products and give credit to customers) usually occurs during the development stage in a new venture’s life cycle.

21. Seed financing (e.g., financing from the entrepreneur’s assets, family, and friends) usually occurs during the development stage in a new venture’s life cycle.

22. Startup financing (e.g., financing from business angels and venture capitalists) usually occurs during the development stage in a new venture’s life cycle.

23. “Cost of goods sold” is the cost of materials, labor, and advertising incurred to produce the products that were sold.

24. “Variable expenses” are costs or expenses that vary directly with revenues.

25. “Variable expenses” are costs that are expected to remain constant over a range of revenues for a specific time period.

26. EBDAT is earnings before interest, taxes, depreciation, and amortization.

27. “Contribution profit margin” is the portion of the sale of a product that contributes to covering the cash fixed costs.

28. EBDAT stands for “Earnings Before Depreciation And Taxes”.

29. Cash fixed costs = survival revenues – variable cost revenue ratio × survival revenues.

True-false questions for Chapter 4, Appendix A:

1. “Economic value added” (EVA) measures a firm’s market value added over a specified time period.

2. Economic value added (EVA) is a measure of a firm’s economic profit over a specified time period.

3. NOPAT equals Net Sales multiplied by on minus the tax rate.

4. When EBIT is zero, a firm’s net operating profit after taxes (NOPAT) also is zero because no taxes are payable.

Multiple-Choice Questions

1. Financial statement that provides a snapshot of a business’ financial position as of a specific date is called the:
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows

2. Financial statement that reports the revenues generated and expenses incurred over an accounting period is called the
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows

3. Financial statement that shows how cash, as reflected in accrual accounting, flows into and out of a company during a specific period of operation is called the:
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows

4. The balance sheet equation states that total assets =
b. total liabilities + depreciation
c. total liabilities + owners’ equity
d. owners’ equity + net income
e. owners’ equity + current liabilities
f. total liabilities + net income

5. Which one of the following is not considered to be a current asset?
a. cash
b. receivables
c. inventories
d. fixed assets

6. “Retained earnings” is:
a. a corporate asset
b. part of owners’ equity
c. neither a or b
d. both a and b

7. Cash includes all of the following except:
a. coins
b. currency
c. checking accounts
d. certificates of deposit

8. Which of the following is not a characteristic of marketable securities?
a. short-term
b. illiquid
c. high-quality
d. interest-bearing

9. Which of the following is not a characteristic of inventories?
a. raw materials
b. finished products
c. goods sold but not yet shipped
d. work-in-process

10. Which of the following is not depreciated?
a. inventory
b. machinery
c. land
d. both a and b
e. both a and c

11. Which of the following is a use of cash?
a. a decrease in inventory
b. an increase in accrued liabilities
c. the sale of an asset for a gain
d. a drop in the amount owed on a bond
e. an increase in stock issued

12. Which of the following is a source of cash?
a. an increase in accounts receivable
b. a decrease in wages payable
c. the acquisition of land
d. an increase in the amount owed on a note payable
e. the repurchase of outstanding shares of stock

13. Which of the following is not a category on the statement of cash flows?
a. cash flow from operating activities
b. cash flow from equity activities
c. cash flow from investing activities
d. cash flow from financing activities

Note: Use the following data for the next three problems (14, 15, & 16).
Acme Pest Control has sales of $13,500, cost of goods sold of $4,000, selling expenses of $3,500, depreciation of $2,000, interest expense of $2,000, and a tax rate of 34%.

14. What is Acme’s operating income?
a. $4,000
b. $2,000
c. $9,500
d. $6,000
e. $1,320

15. What is Acme’s taxable income and tax expense?
a. $6,000; $2,040
b. $2,000; $1,320
c. $4,000; $1,360
d. $2,000; $680
e. $9,500; $3,230

16. What is Acme’s net income?
a. $2,720
b. $897.60
c. $6,460
d. $2,040
e. $1,320

17. Your venture has total assets of $690, net fixed assets of $500, long term debt of $80, and stockholders’ equity of $400. What is the amount of your venture’s current liabilities?
a. -$100
b. $100
c. $210
d. $290
e. $1,090

18. In breakeven analysis, solving for when EBITDA is equal to zero gives breakeven in terms of:
a. economic revenues
b. variable costs
c. survival revenues
d. fixed costs

19. A lease that provides maintenance in addition to financing and is also usually cancelable is called:
a. capital lease
b. liability lease
c. operating lease
d. asset lease
e. equity lease

20. Which one of the following is not considered to be an internal operating schedule?
a. income statement
b. cost of production schedule
c. cost of goods sold schedule
d. inventories schedule

21. “Net cash burn” occurs when the sum of which of the following items is negative?
a. cash flows from operations and financing
b. cash flows from investing and financing
c. cash flows from operations and investing
d. cash flows from net income and depreciation
e. cash flows from operations and net income

22. Expenses or costs that vary directly with revenues are said to be:
a. fixed expenses
b. semi-fixed expenses
c. semi-variable expenses
d. variable expenses

23. EBDAT is equal to:
a. revenues – variable costs – cash fixed costs
b. revenues + variable costs + cash fixed costs
c. revenues – variables costs – total fixed costs
d. revenues + variable costs – cash fixed costs

24. “Gross earnings” is equal to:
a. Revenue – After-Tax cost of financial capital used
b. net income ÷ sales
c. (net sales – the cost of production) × tax rate
d. net sales – the cost of production

25. According to Appendix A of Chapter 4, NOPAT is defined as:
a. revenues times (1 + tax rate)
b. revenues times (1 – tax rate)
c. EBITDA times (1 – tax rate)
d. EBIT times (1 – tax rate)
e. net income times (1 + tax rate)

26. Last year a firm had sales of $200,000. Its cost of goods sold was $75,000, and administrative and marketing expenses were $25,000 each. Depreciation expense was $10,000, while interest expense was $15,000. If the tax rate is 30%, what was the firm’s NOPAT last year?
a. $19,500
b. $35,000
c. $45,500
d. $52,500
e. $80,500

27. What is the survival revenues breakeven based on: cash fixed costs = $400,000 and a variable cost revenue ratio = .65?
a. $460,500
b. $615,385
c. $1,142,857
d. $2,000,334
e. $4,000,667

28. Use the following information to determine the cash fixed costs: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000.
e. $380,000
f. $400,000
g. $480,000
h. $500,000
i. $620,000

29. Find the “contribution profit margin” based on the following information: cash fixed costs = $60,000; variable costs = $70,000; and sales = $100,000.
a. 70%
b. 60%
c. 30%
d. 40%
e. 100%

30. Find the “survival revenues” (SR), also known as the EBDAT breakeven) based on the following information: cash fixed costs = $60,000; variable costs = $70,000; and sales = $100,000.
a. $85,714
b. $100,000
c. $116,667
d. $200,000
e. $300,000

31. What is the survival revenues breakeven based on the following: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000; and a variable cost revenue ratio = .50?
a. $400,000
b. $600,000
c. $800,000
d. $1,000,000
e. $1,200,000

32. A firm with constant variable costs has a survival revenue breakeven of $375,000. This year it had $250,000 in sales, $100,000 of which was a fixed cos What are the firm’s cash fixed costs?
a. $150,000
b. $225,000
c. $625,000
d. $937,500

33. Last year, Beth’s Baked Goods exactly broke even with cash fixed costs of $63,000. If its breakeven survival revenue level was $94,000, what was its variable cost revenue ratio (VCRR)?
a. .27
b. .30
c. .33
d. .67

34. In its first year, Joe’s Start-Up Company had revenues of $125,000 and cost of goods sold of $81,250, which was the only variable cos Depreciation was $20,000, and cash costs were $5,000 in financing costs, admin expenses of $50,000, and $45,000 in marketing expenses – all of which were fixed. What is the survival breakeven revenue?
a. $342,857
b. $285,714
c. $271,429
d. $184,615
e. $153,846

Multiple Choice Questions and Problems for Chapter 4, Appendix A:

1. Economic Value Added (EVA) is calculated as:
a. NOPAT plus after-tax dollar cost of financial capital used
b. ROE minus percentage cost of financial capital
c. NOPAT minus after-tax dollar cost of financial capital used
d. ROE plus the percentage cost of financial capital

2. A firm’s net operating profit after taxes (NOPAT) is calculated as:
a. net profit
b. EBIT times one minus the tax rate
c. EBT minus interest paid
d. EBIT times the tax rate

3. Total operating fixed costs (TOFC) equal:
a. cash operating fixed costs (excluding interest expenses)
b. noncash fixed costs (e.g., depreciation)
c. interest expenses
d. a plus b
e. a plus b plus c

4. Find the NOPAT given the following information: sales = $520,000, earnings before interest = $100,000; interest = $20,000; and the tax rate = 30%.
a. $70,000
b. $56,000
c. $30,000
d. $24,000
e. $10,000

5. Find the NOPAT breakeven revenues (NR) given the following information: total operating fixed costs = $75,000; variable costs = $150,000; and sales = $200,000.
a. $100,000
b. $240,000
c. $300,000
d. $400,000
e. $460,000

6. Determine the total operating fixed costs (TOFC) based on the following: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000.
a. $200,000
b. $380,000
c. $400,000
d. $480,000
e. $500,000

CHAPTER 5

EVALUATING OPERATING AND FINANCIAL PERFORMANCE

True-False Questions

1. Showing the relationships between two or more financial variable and/or time, financial ratios are useful means of summarizing large amounts of financial data for comparative purposes.

2. Second-round, mezzanine, and liquidity-stage financing generally occur during a venture’s survival stage.

3. Commercial banks are important users of financial ratios and measures during the development and startup stages of ventures.

4. Investment bankers are users of financial ratios and measures of ventures primarily during the rapid-growth stage relative to the development and startup stages.

5. Trend analysis is used to examine a venture’s performance over time.

6. Cross-sectional analysis is used to examine a venture’s performance over time.

7. “Cash burn” is the cash a venture expends on its operating, financing, and depreciation expenses.

8. “Net cash burn” occurs when cash burn exceeds cash build in a specified time period.

9. The “cash burn rate” is the cash burn for a fixed period of time, typically a month.

10. The term “cash build” as used in Chapter 5 is equal to net sales minus the change in receivables.

11. Liquidity ratios indicate the venture’s ability to pay short term assets from short-term liabilities.

12. Net working capital reflects current assets deducted from current liabilities.

13. “Net working capital” is calculated as fixed assets minus current liabilities.

14. A venture’s cash, marketable securities, and receivables comprise the venture’s “liquid assets”.

15. The current ratio and the quick ratio differ only because average inventories are subtracted in the numerator of the quick ratio.

16. For a venture with inventories, the quick ratio will always be greater than the current ratio.

17. Net working capital is a dollar amount measure of the cushion between current assets and current liabilities.

18. Leverage ratios indicate the extent to which the venture has used debt and its ability to meet debt obligations.

19. Total debt includes current liabilities, long-term debt, and retained earnings.

20. How efficiently a venture controls its expenses and uses its assets and debt is evaluated with profitability and efficiency ratios.

21. During the development and startup stages of a venture’s life cycle, important financial ratios and measures include cash burn rates and liquidity ratios.

22. During the development and startup stages of a venture’s life cycle, important users of financial ratios and measures include the entrepreneur, business angels, and venture capitalists (VCs).

23. Leverage ratios are generally considered to be more important during the survival and rapid-growth stages compared to the development and startup stages.

24. The equity multiplier is considered an efficiency ratio.

25. The extent to which a venture is in debt and in its ability to repay its debt obligations is indicated by leverage ratios.

26. The equity multiplier shows the extent by which assets are supported by equity and deb

27. Accounting rules require that the current maturities of long-term debt obligations be classified as short-term liabilities.

28. Profitability and efficiency ratios are generally considered to be more important during the development and startup stages compared to the survival and rapid-growth stages.

29. The part of a venture’s interest payment that is subsidized by the government because of the deductibility of interest is called the interest tax shield.

30. How efficiently a venture controls its expenses and uses its assets and debt is evaluated with profitability and efficiency ratios.

31. The Return on Assets model states: ROA = net profit margin × asset turnover × the equity multiplier.

32. If a firm has positive net income, a drop in a venture’s asset intensity ratio will increase its ROE.

Multiple-Choice Questions

1. Investment bankers and commercial banks are important users of financial ratios and measures during which of the following life cycle stages?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. All four stages

2. The entrepreneur, angels, and VCs are important users of financial ratios and measures during which of the following life cycle stages?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. All four stages

3. Which of the following is used to examine a venture’s performance over time?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

4. Which of the following is used to compare a venture’s performance against another firm at the same point in time?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

5. Which of the following is used to compare a venture’s performance against the average performance of other firms in the same industry?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

6. Which one of the following is not a basic ratio techniques used to conduct financial analysis?
a. trend analysis
b. sensitivity analysis
c. cross-sectional analysis
d. industry comparables analysis

7. The term “cash build” is measured as:
a. net income plus depreciation
b. net sales minus expenses minus (plus) an increase (decrease) in inventories
c. net sales minus (plus) an increase (decrease) in receivables
d. net income plus depreciation minus (plus) an increase (decrease) in payables

8. “Net cash burn” is calculated as:
a. cash burn plus cash build
b. cash build minus cash burn
c. cash burn minus cash build
d. cash burn minus cash build squared

9. Using the following information, determine the average monthly net cash burn rate: annual net income = $20,000; annual interest = $10,000; annual cash build = $150,000; and annual cash burn = $186,000.
a. $1,000
b. $3,000
c. $4,000
d. $6,000
e. $7,000

10. Use the following information to determine a firm’s “cash build:” net sales = $150,000; net income = $15,000; beginning-of-period accounts receivable = $60,000; end-of-period accounts receivable = $90,000; and interest = $10,000.
a. $10,000
b. $15,000
c. $30,000
d. $60,000
e. $120,000

11. Average current assets minus average inventories when divided by average current liabilities is called which of the following ratios?
a. current ratio
b. quick ratio
c. net working capital ratio
d. current liabilities to total debt ratio

12. Dividing the average total assets by the average owners’ equity is called which of the following ratios?
a. equity multiplier
b. debt to equity ratio
c. current liabilities to total debt ratio
d. current ratio

13. Net sales minus cost of goods sold when divided by sales is called which of the following ratios?
a. gross profit margin
b. operating profit margin
c. net profit margin
d. net operating profit after taxes margin

14. Net income divided by net sales is called which of the following ratios?
a. net operating profit after taxes margin
b. net profit margin’
c. operating profit margin
d. gross profit margin

15. The difference between a venture’s ability to generate cash to pay interest and the amount of interest it has to pay is determined by which of the following ratios?
a. fixed charges coverage
b. debt to asset
c. equity multiplier
d. debt to equity
e. interest coverage

16. Which of the following is not a profitability and efficiency ratio?
a. sales-to-total-assets
b. return on equity
c. return on assets
d. inventory-to-total assets
e. NOPAT profit margin

17. Which of the following is true?
a. ROA is always greater than or equal to ROE
b. an increase in the asset turnover ratio implies a decrease in the asset
intensity ratio
c. a and b
d. none of the above

18. A firm has the following balance sheet information: total assets = $100,000; current assets = $30,000; inventories = $10,000; cash = $5,000; total liabilities = $30,000; current liabilities = $15,000; notes payable = $2,000. What are the firm’s quick and NWC-to-Total-Assets ratios?
a. 1.00 and .13
b. 1.33 and .13
c. 1.00 and .15
d. 1.33 and .15

19. Last year, Nemo’s Fish ‘n Chips recorded the following financial data: sales = $85,000; cost of goods sold = $45,000; selling and administrative expenses = $25,000; depreciation and amortization = $7,000; interest expense = $12,000. The tax rate was 30%. Find Nemo’s interest coverage for last year.
a. -.29 times
b. .66 times
c. .86 times
d. 1.25 times
e. 3.33 times

20. A venture has net sales of $400,000, cost of goods sold of $200,000, operating expenses (selling, general, and administrative) of $100,000, and interest expenses of $50,000. What is the operating profit margin?
a. 50.0%
b. 75%
c. 25%
d. 40%

21. Last year, Lenny’s Lemonade had $3,500 in sales, and cost of goods sold was $2,000. Depreciation expenses totaled $500 and interest expense was $700. If the tax rate is 25%, what is the net profit margin for Lenny’s Lemonade? What is its NOPAT margin?
a. 6.43% and 21.43%
b. 20.7% and 21.43%
c. 2.14% and 32.14%
d. 22.86% and 32.14%

Note: The following information should be used for the next eleven (22 through 32) problems.
In its closing financial statements for its first year in business, the Runs and Goses Company, had cash of $242, accounts receivable of $850, inventory of $820, net fixed assets of $3,408, accounts payable of $700, short-term notes payable of $740, long-term liabilities of $1,100, common stock of $1,160, retained earnings of $1,620, net sales of $2,768, cost of goods sold of $1,210, depreciation of $360, interest expense of $160, taxes of $312, addition to retained earnings of $508, and dividends paid of $218.

22. What is the return on equity for Runs and Goses?
a. 26.1%
b. 44.7%
c. 62.6%
d. 18.4%
e. 7.9%

23. What is Runs and Goses’ return on total assets?
a. 9.6%
b. 13.6%
c. 19.1%
d. 37.9%
e. 22.5%

24. What is the net profit margin for Runs and Goses?
a. 60.0%
b. 22.7%
c. 7.9%
d. 18.4%
e. 26.2%

25. Runs and Goses operating profit margin is?
a. 26.2%
b. 56.3%
c. 43.3%
d. 30.3%
e. 60.0%

26. The gross profit margin for Runs and Goses is?
a. 26.2%
b. 30.3%
c. 43.3%
d. 56.3%
e. 60.0%

27. What is Runs and Goses’ sales to total asset ratio?
a. 1.91
b. 0.25
c. 0.52
d. 0.23
e. 0.57

28. What is the current ratio for Runs and Goses?
a. 1.46
b. 1.33
c. 1.23
d. 1.21
e. 1.13

29. The total-debt-total-asset ratio for Runs and Goses is?
a. 0.48
b. 0.71
c. 0.27
d. 0.53
e. 0.82

30. What is Runs and Goses’ debt-to-equity ratio?
a. 0.91
b. 2.15
c. 0.48
d. 1.12
e. 2.32

31. What is the equity multiplier for Runs and Goses?
a. 4.59 times
b. 2.35 times
c. 0.48 times
d. 1.12 times
e. 1.91 times

32. The interest coverage ratio for Runs and Goses is:
a. 6.5 times
b. 4.5 times
c. 9.7 times
d. 3.5 times
e. 1.5 times

CHAPTER 6

MANAGING CASH FLOW

True-False Questions

1. The actions of screening business ideas, preparing a business model/plan, and obtaining seed financing occurs during a venture’s development stage.

2. The actions of monitoring financial performance, determining project cash needs, and obtaining first-round financing occurs during a venture’s survival stage.

3. “First-round financing” usually occurs during a venture’s rapid-growth life cycle stage.

4. Short-term financial planning is critical during the survival stage because operations not yet turning a profit and the associated cash burn often lead to a venture’s inability to pay its maturing liabilities.

5. Cash shortages during the rapid growth stage frequently derive from the lack of operating profits to fund working capital and fixed asset investments needed to support sales growth.

6. Due to the difficulty of projecting financial statements for a young firm, short-term financial forecasts are never required of early-stage ventures.

7. Early-stage ventures are defined as firms that are only operating in either their development or startup stages.

8. Even in a young, successful venture, restricted access to bank credit and with little to no access to short-term lending markets can hinder operations until the next round of financing.

9. “First-round financing” usually occurs during a venture’s rapid-growth life cycle stage.

10. Short-term cash planning tools include preparation of a: sales schedule, a purchases schedule, a wages and commissions schedule, and a cash budge

11. Short-term financial planning typically involves preparing monthly financial statements and focuses on identifying and planning for net income demands on the business.

12. A venture’s operating schedules typically include a: sales schedule, purchases schedule, and wages and commissions schedule.

13. A cash budget shows a venture’s projected revenues and expenses over a forecast period.

14. Preparing monthly cash budgets for a full year allows the entrepreneur to determine whether there will be a cash need, the maximum size of the cash need, and whether the need can be repaid during the year.

15. Conversion period ratios show the average time in days it takes to convert certain current assets and current liabilities into cash.

16. A venture’s operating cycle is the same as its cash conversion cycle.

17. The sum of the inventory-to-sale conversion period and the purchase-to-payment conversion period minus the sale-to-cash conversion period is called the cash conversion cycle.

18. The cash conversion cycle refers to the time it takes to convert a sale into net income.

19. The “cash conversion cycle” measures the time it takes to pay off the principal on a loan.

20. The sale-to-cash conversion period is calculated by dividing average revenues by net sales per day.

21. A venture’s cash conversion cycle will decrease if the purchase-to-payment conversion period increases.

Multiple-Choice Questions

1. A firm is said to be an early stage venture when it is in which of the following except?
a. rapid growth stage
b. startup stage
c. development stage
d. survival stage
e. early-maturity stage

2. Seed financing is generally associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage

3. First-round financing is generally associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage

4. Which of the following is not part of the operating cycle?
a. time it takes to purchase products
b. time it takes to produce products
c. time it takes to sell the products
d. time it takes to pay suppliers
e. time it takes to collect receivables

5. Which one of the following “measures” the average days of sales committed to the extension of trade credit?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle period

6. Which of the following is measured by dividing the average daily cost of goods sold into the average inventory?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle

7. Which of the following measures the average time from purchase of materials and labor to actual cash payment?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle

8. Which of the following measures the average time it takes a firm to complete its operating cycle after deducting the days supported by trade credit and delayed payroll financing?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle

9. Which one of the following conversion periods operates to reduce the length of the cash conversion cycle?
a. inventory-to-sale conversion period
b. sale-to-cash conversion period
c. purchase-to-payment conversion period
d. fixed assets-to-usage conversion period

10. Which one of the following conversion periods is not a component in the cash conversion cycle?
a. inventory-to-sale conversion period
b. sale-to-cash conversion period
c. purchase-to-payment conversion period
d. fixed assets-to-usage conversion period

11. Calculate the inventory-to-sale conversion period based on the following information: average inventories = $120,000; average receivables = $90,000; average payables = $40,000; cost of goods sold = $182,500; and net sales = $365,000.
a. 240.0 days
b. 180.0 days
c. 90.0 days
d. 60.0 days
e. 45.0 days

12. Calculate the sale-to-cash conversion period based on the following information: average inventories = $120,000; average receivables = $90,000; average payables = $40,000; cost of goods sold = $182,500; and net sales = $365,000.
a. 240.0 days
b. 180.0 days
c. 90.0 days
d. 60.0 days
e. 45.0 days

13. Based on the following information, determine the venture’s cash conversion cycle: Inventory-to-sale conversion period = 112.9 days; Sale-to-cash conversion period= 57.1 days; and Purchase-to-payment conversion period = 76.8 days.
a. 170.0 days
b. 189.7 days
c. 93.2 days
d. 246.8 days
e. 133.9 days

14. Determine the cash conversion cycle based on the following information: inventory-to-sale conversion period = 112.9 days; sale-to-cash conversion period = 57.1 days; and purchase-to-payment conversion period = 76.8 days.
a. 93.2 days
b. 132.6 days
c. 170.0 days
d. 246.8 days
e. 365.0 days

15. Based on the following information, determine the average receivables (rounded to thousands of dollars) that were outstanding: Net sales = $575,000; Sale-to-cash conversion period = 57.1 days; Purchase-to-payment conversion period = 76.8 days; and Cost of goods sold = $380,000.
a. $90,000
b. $180,000
c. $121,000
d. $31,000
e. $41,000

16. Based on the following information, determine the venture’s inventory-to-sale conversion period: cash conversion cycle = 250 days; sale-to-cash conversion period = 60 days; and purchase-to-payment conversion period = 70 days.
a. 70 days
b. 140 days
c. 240 days
d. 260 days
e. 330 days

FIN 317 Week 11 Final Exam

Chapters 7 Through 15

CHAPTER 7

TYPES AND COSTS OF FINANCIAL CAPITAL

True-False Questions

1. The accounting emphasis on accrued revenue and expenses and depreciation is the same emphasis as that of finance managers.

2. Traditional accounting does not focus on the implicit cost of equity that is the required capital gains to complement dividends. However, evaluation methods exist to determine this value by financial managers.

3. Formal historical accounting procedures include explicit records of debt (interest and principal) and dividend capital costs.

4. Public financial markets are markets for the creation, sale and trade of illiquid securities having less standardized negotiated features.

5. A venture’s “riskiness” in terms of poor performance or failure is usually very high during the maturity stage of its life cycle.

6. A venture’s “riskiness” in terms of poor performance or failure is usually high to moderate during the rapid-growth stage of its life cycle.

7. First-round financing during a venture’s survival stage comes primarily from venture capitalists and investment banks.

8. Startup financing usually comes from entrepreneurs, business angels, and investment bankers.

9. Commercial banks provide liquidity-stage financing for ventures in the rapid-growth stage of their life cycles.

10. A venture’s “riskiness” in terms of the likelihood of poor performance or failure decreases as it moves from its development stage through to its rapid-growth stage.

11. A nominal interest rate is an observed or stated interest rate.

12. The “real interest rate” (RR) is the interest one would face in the absence of inflation, risk, illiquidity, and any other factors determining the appropriate interest rate.

13. The risk-free interest rate is the interest rate on debt that is virtually free of inflation risk.

14. Inflation premium is the rising prices not offset by increasing quality of goods being purchased.

15. “Default-risk” is the risk that a borrower will not pay the interest and/or the principal on a loan.

16. The “prime rate” is the interest rate charged by banks to their highest default risk business customers.

17. Bond ratings reflect the inflation risk of a firm’s bonds.

18. The relationship between real interest rates and time to maturity when default risk is constant is called the term structure of interest rates.

19. The graph of the term structure of interest rates, which plots interest rates to time to maturity is called the yield curve.

20. Liquidity premiums reflect the risk associated with firms that possess few liquid assets.

21. Subordinated debt is secured by a venture’s assets, while senior debt has an inferior claim to a venture’s assets.

22. Early-stage ventures tend to have large amounts of senior debt relative to more mature ventures.

23. Investment risk is the chance or probability of financial loss on one’s venture investment, and can be assumed by debt, equity, and founding investors.

24. A venture with a higher expected return relative to other ventures will necessarily have a higher standard deviation or returns.

25. Historically, large-company stocks have averaged higher long-term returns than small-company stocks.

26. The coefficient of variation measures the standard deviation of a venture’s return relative to its expected return.

27. Closely held corporations are those companies whose stock is traded over-the-counter.

28. Typically, the stocks of closely held corporations aren’t publicly traded.

29. Organized exchanges have physical locations where trading takes place, while the over-the-counter market is comprised of a network of brokers and dealers that interact electronically.

30. Market cap is determined by multiplying a firm’s current stock price by the number of shares outstanding.

31. The excess average return of long-term government bonds over common stock is called the market risk premium.

32. The weighted average cost of capital is simply the blended, or weighted cost of raising equity and debt capital.

33. Venture capital holding period returns (all stages) for the 10-year period ending in 2012 were about the same as the returns on the S&P 500 stocks.

Multiple-Choice Questions

1. Which one of the following markets involve liquid securities with standardized contract features such as stocks and bonds?
a. private financial market
b. derivatives market
c. commodities market
d. real estate market
e. public financial market

2. Which of the following markets involve direct two-party negotiations over illiquid, non-standardized contracts such as bank loans and direct placement of debt?
a. primary market
b. secondary market
c. options market
d. private financial market
e. public financial market

3. Which of the following is an example of rent on financial capital?
a. interest on debt
b. dividends on stock
c. collateral on equity
d. a and b
e. a, b, and c

4. Which of the following describes the observed or stated interest rate?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate

5. Which of the following describes the interest rate in addition to the inflation rate expected on a risk-free loan?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate

6. Which of the following describes the interest rate on debt that is virtually free of default risk?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate

7. Which of the following describes the interest rate charged by banks to their highest quality customers?
a. real rate
b. nominal rate
c. risk-free rate
d. prime rate
e. inflation rate

8. Which of the following is not a component in determining the cost of debt?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. interest rate premium

9. The additional interest rate premium required to compensate the lender for the probability that a borrower will not be able to repay interest and principal on a loan is known as?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. investment risk premium

10. The additional premium added to the real interest rate by lenders to compensate them for a debt instrument which cannot be converted to cash quickly at its existing value is called?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. investment risk premium

11. The added interest rate charged due to the inherent increased risk in long-term debt is called?
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. investment risk premium

12. Suppose the real risk free rate of interest is 4%, maturity risk premium is 2%, inflation premium is 6%, the default risk on similar debt is 3%, and the liquidity premium is 2%. What is the nominal interest rate on this venture’s debt capital?
a. 13%
b. 14%
c. 15%
d. 16%
e. 17%

13. A venture has raised $4,000 of debt and $6,000 of equity to finance its firm. Its cost of borrowing is 6%, its tax rate is 40%, and its cost of equity capital is 8%. What is the venture’s weighted average cost of capital?
a. 8.0%
b. 7.2%
c. 7.0%
d. 6.2%
e. 6.0%

14. Your venture has net income of $600, taxable income of $1,000, operating profit of $1,200, total financial capital including both debt and equity of $9,000, a tax rate of 40%, and a WACC of 10%. What is your venture’s EVA?
a. $400,000
b. $200,000
c. $ 0
d. ($180,000)
e. ($300,000)

15. The “risk-free” interest rate is the sum of:
a. a real rate of interest and an inflation premium
b. a real rate of interest and a default risk premium
c. an inflation premium and a default risk premium
d. a default risk premium and a liquidity premium
e. a liquidity premium and a maturity premium

16. Venture investors generally use which one of the following target rates to discount the projected cash flows of ventures in the “startup” stage of their life cycles:
a. 20%
b. 25%
c. 40%
d. 50%

17. Which one of the following components is not used when estimating the cost of risky debt capital?
a. real interest rate
b. inflation premium
c. default risk premium
d. market risk premium
e. liquidity premium

18. Which of the following components is not typically included in the rate on short-term U.S. treasuries?
a. liquidity premium
b. default risk premium
c. market risk premium
d. b and c
e. a, b, and c

19. The word “risk” developed from the early Italian word “risicare” and means:
a. don’t care
b. take a chance
c. to dare
d. to gamble

20. The difference between average annual returns on common stocks and returns on long-term government bonds is called a:
a. default risk premium
b. maturity premium
c. risk-free premium
d. liquidity premium
e. market risk premium

21. What has been the approximate average annual rate of return on publicly traded small company stocks since the mid-1920s?
a. 10%
b. 16%
c. 25%
d. 30%
e. 40%

22. Venture investors generally use which one of the following target rates to discount the projected cash flows of ventures in the “development” stage of their life cycles:
a. 15%
b. 20%
c. 25%
d. 40%
e. 50%

23. Corporate bonds might involve which of the following types of “premiums.”
a. inflation premium
b. default risk premium
c. liquidity premium
d. maturity premium
e. all of the above
none of the above

24. Which of the following venture life cycle stages would involve seasoned financing rather than venture financing?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. Maturity stage

25. A venture’s “riskiness” in terms of possible poor performance or failure would be considered to be “very high” in which of the following life cycle stages:
a. Startup stage
b. Survival stage
c. Rapid-growth stage
d. Maturity stage

26. Which of the following types of financing would be associated with the highest target compound rate of return?
a. public and seasoned financing
b. second-round and mezzanine financing
c. first-round financing
d. startup financing
e. seed financing

27. The cost of equity for a firm is 20%. If the real interest rate is 5%, the inflation premium is 3%, and the market risk premium is 2%, what is the investment risk premium for the firm?
a. 10%
b. 12%
c. 13%
d. 15%

28. Use the SML model to calculate the cost of equity for a firm based on the following information: the firm’s beta is 1.5; the risk free rate is 5%; the market risk premium is 2%.
a. 4.5%
b. 8.0%
c. 9.5%
d. 10.5%

29. Calculate the weighted average cost of capital (WACC) based on the following information: the capital structure weights are 50% debt and 50% equity; the interest rate on debt is 10%; the required return to equity holders is 20%; and the tax rate is 30%.
a. 7%
b. 10%
c. 13.5%
d. 17.5%
e. 20%

30. Calculate the weighted average cost of capital (WACC) based on the following information: the equity multiplier is 1.66; the interest rate on debt is 13%; the required return to equity holders is 22%; and the tax rate is 35%.
a. 11.5%
b. 13.9%
c. 15.0%
d. 16.6%

31. Calculate the after-tax WACC based on the following information: nominal interest rate on debt = 16%; cost of common equity = 30%; equity to value = 60%; debt to value = 40%; and a tax rate = 25%.
a. 10%
b. 16%
c. 19.8%
d. 22.8%
e. 30%

32. Calculate the after-tax WACC based on the following information: nominal interest rate on debt = 12%; cost of common equity = 25%; common equity = $700,000; interest-bearing debt = $300,000; and a tax rate = 25%.
a. 15%
b. 16.4%
c. 20.2%
d. 22.8%
e. 30%

33. Venture capital holding period returns (all stages) for the 20-year period ending in 2012, had a compound average return of approximately:
a. 35%
b. 28%
c. 21%
d. 14%
e. 7%

Supplemental Problems related to Chapter 7 Appendix A (and Chapter 4 Appendix A)

1. Estimate a firm’s NOPAT based on: Net sales = $2,000,000; EBIT = $600,000; Net income = $20,000; and Effective tax rate = 30%.
a. $600,000
b. $420,000
c. $150,000
d. $70,000
e. $40,000

2. Estimate a firm’s economic value added (EVA) based on: NOPAT = $400,000; amount of financial capital used = $1,600,000; and WACC = 19%.
a. $26,000
b. $36,000
c. $96,000
d. $54,000
e. $64,000

3. Find a venture’s “economic value added” (EVA) based on the following information: EBIT = $200,000; financial capital used = $500,000; WACC = 20%; effective tax rate = 30%.
a. $20,000
b. $25,000
c. $30,000
d. $40,000
e. $50,000

CHAPTER 8

SECURITIES LAW CONSIDERATIONS WHEN OBTAINING VENTURE FINANCING

True-False Questions

1. The securities Exchange act of 1934 provides for the regulation of securities exchanges and over-the-counter markets.

2. The Investment Company Act of 1940 defines investment companies and excludes them from using some of the registration exemptions originating in the 1933 Ac

3. The Investment Advisers Act of 1940 provides a definition of an investment company.

4. According to the Investment Advisers Act of 1940, a bank would not be classified as an “investment advisor”.

5. The Securities Act of 1933 is the main body of federal law governing the creation and sale of securities in the U.S.

6. The Securities Exchange Act was passed in 1933 and the Securities Act was passed in 1934.

7. The trading of securities is regulated under the Securities and Exchange Act of 1954.

8. Regulation of investment companies (including professional venture capital firms) is carried out under the Investment Company Act of 1940.

9. State laws designed to protect high net-worth investors from investing in fraudulent security offerings are known as blue-sky laws.

10. Offerings and sales of securities are regulated under the Securities Act of 1933 and state blue-sky laws.

11. Blue-sky laws are federal laws designed to protect individuals from investing in fraudulent security offerings.

12. The typical business organization for a venture in its rapid-growth stage is a partnership or LLC.

13. Investor liability in a limited liability company (LLC) is limited to the owners’ investments.

14. Investor liability in a proprietorship or corporation is unlimited.

15. The life of a proprietorship is determined by the owner.

16. It is usually easier to transfer ownership in a proprietorship relative to a corporation.

17. The two basic types of exemptions from having to register securities with the SEC are security and transaction exemptions.

18. The Securities Act of 1933 provides a very narrow definition as to what constitutes a security.

19. SEC Rule 147 provides guidance on the issuer’s diligent responsibilities in assuring that offerees are in-state and that securities don’t move across state lines.

20. A private placement, or transactions by an issuer not involving any public offering, is exempt from registering the security.

21. Accredited investors are specifically protected by the Securities Act of 1933 from investing in unregistered securities issues.

22. The typical business organization for a venture in its rapid-growth stage is a partnership or LLC.

23. In SEC v. Ralston Purina (1953), the U.S. Supreme Court took an important step toward defining a public offering for the purposes of Section 4(2) of the Securities Act of 1933.

24. SEC Regulation D requires the registration of securities with the SEC.

25. An early stage venture that is not an investment company and has written compensation agreements can structure compensation-related securities issues so they are exempt from SEC registration requirements.

26. SEC Regulation D took effect in 1932 and provides the basis for “safe harbor” as a private placemen

27. Rule 504 under Regulation D has a $2 million financing limit (i.e., applies to sales of securities not exceeding $2 million).

28. A Rule 504 exemption under Regulation D has no limit in terms of the number and qualifications of investors.

29. A Regulation D Rule 505 offering cannot exceed $5 million in a twelve-month period.

30. A Regulation D Rule 505 offering is limited to 35 accredited investors.

31. A Regulation D Rule 506 offering has no limit in terms of the dollar amount of the offering but is limited to 35 unaccredited investors.

32. Regulation A, while technically considered an exemption from registration, is a public offering rather than a private placemen

33. Regulation A allows for registration exemptions on private security offerings so long as all investors are considered to be financially sophisticated.

34. Regulation A issuers are allowed to “test the waters” before preparing the offering circular (unlike almost all other security offerings).

35. Regulation A offerings are allowed up $10 million and do not have limitations on the number or sophistication of offerees.

36. The objective of the Jumpstart Our Business Startups Act of 2012 is to stimulate the initiation, growth, and development of small business companies.

37. Title II of the JOBS Act of 2012 eliminates the general solicitation and advertising restriction for Regulation D 506 offerings.

Note: Following are true-false questions relating to materials presented in Appendix B of Chapter 8.

1. The definition of an “accredited investor,” initially defined in the Securities Act of 1933, was expanded in Rule 501 of Reg D.

2. One of the monetary requirements for individuals or natural persons as accredited investors as defined in Regulation D Rule 501 is a net worth greater than $1,000,000.

3. One of the monetary requirements for individuals or natural persons as accredited investors as defined in Regulation D Rule 501 is individual annual income greater than $500,000.

4. Regulation D Rule 502 focuses, in part, on resale restrictions imposed on privately-placed securities.

5. Rule 503 of Regulation D states that a Form D should be filed with the SEC within six months after the first sale of securities.

Multiple-Choice Questions

1. Which of the following is not true regarding the Securities Act of 1933?
a. it was passed in response to abuses thought to have contributed to the financial catastrophes of the Great Depression
b. it covers securities fraud
c. it requires securities to be registered formally with the federal government
d. it set of the nature and authority of the Securities and Exchange Commission
e. it focuses on those who provide investment advice

2. The U.S. federal law that impacts the creation and sales of securities is:
a. Securities Exchange Act of 1934
b. Securities Act of 1933
c. Investment Company Act of 1940
d. Investment Advisers Act of 1940

3. The efforts to regulate the trading of securities takes place under which of the following securities laws?
a. Securities Act of 1933
b. state “blue-sky” laws
c. Securities and Exchange Act of 1934
d. Investment Company Act of 1940
e. Investment Advisers Act of 1940

4. Efforts to regulate the offerings and sales of securities take place under which of the following securities laws?
a. Securities Act of 1933
b. state “blue-sky” laws
c. Securities and Exchange Act of 1934
d. Investment Company Act of 1940
e. Investment Advisers Act of 1940
Both a and b
g. Both a and c

5. In securities law, which of the following is (are) true?
a. ignorance is no defense
b. security regulators may alter your investment agreement to the benefit of the investors
c. Securities Act of 1933 gives the SEC broad civil procedures to use in enforcement
d. Securities Act of 1933 gives the SEC some criminal procedures to use in enforcement
e. a, b, and c above
a, b, c, and d above

6. Which of the following is not a security?
a. treasury stock
b. debenture
c. put option
d. real property
e. call option

7. State securities regulations are referred to as:
a. Regulation A legislation
b. “stormy day” laws
c. “blue sky” laws
d. SEC oversight legislation

8. Which of the following is not true about registering securities with the SEC?
a. it is a time consuming process
b. it required the disclosure of accounting information
c. it is usually done with the help of an investment bank
d. it is an inexpensive process
e. it provides information to prospective investors

9. All of the following do not create any securities registration responsibilities except?
a. Treasury securities
b. Municipal bonds
c. securities issued by publicly held companies
d. securities issued by banks
e. securities issued by the government

10. Ventures that reach their survival stage of their life cycles and seek first-round financing are typically organized as:
a. proprietorships or partnerships
b. LLCs or corporations
c. corporations
d. partnerships or LLCs
e. proprietorships or corporations

11. Investor liability is “unlimited” under which of the following types of business organizational forms?
a. proprietorship
b. limited liability company (LLC)
c. corporation
d. S corporation
e. S limited liability company (SLLC)

12. Which one of the following is not a requirement for registration of securities with the SEC?
a. the name under which the issuer is doing business
b. the name of the state where the issuer is organized
c. the names of all products sold by the issuer
d. the names and addresses of the directors
e. the names of the underwriters

13. The returning of all funds to equity investors as a common “remedy” for a “fouled up” securities offering is called:
a. just action
b. fraud
c. second round financing
d. a rescission
e. mezzanine financing

14. “Security” exemptions from registration with the SEC include which of the following:
a. securities issued by banks and thrift institutions
b. government securities
c. intrastate offerings
d. securities issued by large, high quality corporations
e. a, b, and c above
f. a, b, c, and d above

15. The basic types of “transaction” exemptions for registration with the SEC are:
a. private placement exemption
b. “too big to fail” exemption
c. accredited investor exemption
d. intrastate offering exemption
e. a and c above
b and d above

16. In the Ninth Circuit Court of Appeals decision on SEC v. Murphy, all of the following were considerations in determining an offering to be a private placement except:
a. there must be an arm’s length relationship between the issuer of the security and the prospective purchaser
b. the number of offerees must be limited
c. the size and the manner of the offering must not indicate widespread solicitation
d. the offerees must be sophisticated
e. some relationship between the offerees and the issuer must be present

17. Which SEC Regulation took effect in 1982 and provides the basis for “safe harbor” as a private placement?
a. Regulation A
b. Regulation B
c. Regulation C
d. Regulation D
e. Regulation E

18. Unless your security is exempted, what Section of the Securities Act of 1933 requires you to file a registration statement with the SEC?
a. Section 1
b. Section 2
c. Section 3
d. Section 4
e. Section 5

19. Which one of the following is not an exemption method for making an offering exempt from SEC registration?
a. 4(2) private offering
b. accredited investor
c. Regulation D
d. Regulation A
e. Regulation Z

20. Exemptions for private placement offerings and sales of securities in the amount of $2 million are handled under which one of the follow rules under Regulation D?
a. Rule 501
b. Rule 502
c. Rule 503
d. Rule 504
e. Rule 505

21. Which one of the following SEC registration exemptions has a financing limit in a 12-month period and permits a maximum of 35 unaccredited investors?
j. Section 4(2)
k. Reg D: Rule 504
l. Reg D: Rule 505
m. Reg D: Rule 506
n. Regulation A

22. Rule 504 of Regulation D limits the total number of investors to:
a. 35
b. 100
c. 35 unaccredited investors and any number of accredited investors
d. there is no limit on the number of accredited or unaccredited
investors

23. Offerings exempted from registration under rule 505 of Regulation D may raise up to $5 million in a:
a. 6-month period
b. 9-month period
c. 12-month period
d. 18-month period
e. 24-month period

24. Rule 506 of Regulation D is limited in terms of the number of unaccredited investors to:
a. 20
b. 25
c. 30
d. 35
e. 40

25. Which one of the following “rules” under Regulation D has a $5 million financing limit?
a. Rule 504
b. Rule 505
c. Rule 506
d. Rule 507
e. Rule 508

26. While Section 4(2) does not limit the dollar amount of an offering, the interpretation of the law has stipulated that:
a. the investors must be sophisticated
b the number of investors must be limited to 35
c. the funds must be raised within a 12-month period
d. the offering must be extended to the public, and not only investors
who have a relationship with the issuer

27. An offering that raises $2,500,000 over a 12-month period, involving 35 unaccredited investors and 5 accredited investors, might be exempt from registration under:
a. Section 4(6)
b. Regulation D: Rule 504
c. Regulation D: Rule 505
d. none of the above

28. Which one of the following is not a characteristic of Regulation A?
a. An offering is limited to $5 million
b. the number offerees or investors is limited to 35
c. the offering is a public offering
d. the securities issued can generally be freely resold

29. Of the following, which is not true about Regulation A?
a. it is shorter and simpler than the full registration
b. it does not have limitations on the number or sophistication of offerees.
c. it is a public offering rather than a private placement
d. it can generally be freely sold
e. it requires no offering statement be filed with the SEC

30. Which of the following exemptions involves a public, and not a private, offering?
a. Section 4(2)
b. Rule 501
c. Rule 505
d. Rule 506
e. Regulation A

31. Under Regulation A, which one of the following is not true?
a. issuers are allowed to test the waters prior to preparing the offering circular
b. after filing a SEC statement, the issuer can communicate with perspective investors orally, in writing, by advertising in newspapers, radio, television, or via the mail to determine investor interest
c. issuers can take commitments or funds
d. there is a formal delay of 20 calendar days before sales are made
e. if the interest level is insufficient, the issuer can drop Regulation A filing

32. The JOBS Act of 2012 provides for which of the following:
a. establishes a new business classification called “Emerging Growth Company”
b. lifts restrictions on general solicitation and advertising for Reg D 506 accredited investor offerings
c. establishes a small offering registration exemption and calls for SEC rules relating to the sales of securities to an Internet :crowd” (security crowd funding)
d. a and b above
e. a, b, and c

Note: Following are multiple-choice questions relating to materials presented in Appendix B of Chapter 8.

1. Rule 501 of Regulation D expands the categories of accredited investors. Which is not one of the categories?
a. any organization formed for the specific purpose of acquiring securities with assets in excess of $5 million
b. any director or executive officer of the issuer of securities being sold
c. any individual whose net worth exceeds $1 million
d. any partnership
e. any trust with total assets greater the $5 million

2. Which of the following is not a condition of a Regulation D offering under Rule 502?
a. integration
b. offering
c. information
d. solicitation
e. resale

3. Which of the following are requirements of natural persons to be accredited investors under Regulation D Rule 501?
a. net worth greater than $5 million
b. total assets greater than $1 million
c. individual (single) annual income greater than $200,000
d. stock market portfolio greater than $2 million
e. all of the above

4. Rule 502 of Regulation D deals with:
a. integration
f. information
g. solicitation
h. resale
i. a and b above
e. a, b, c, and d above

5. Rule 503 dictates that for all Reg D exemptions, a Form D should be filed within how many days after the first sale of securities?
a. 1 day
b. 15 days
c. 30 days
d. six months
e. one year

6. The primary exemption from the prohibition of resale of unregistered securities (including, but not limited to, securities safely harbored in Rules 505 and 506 offerings) is:
a. Rule 111
b. Rule 122
c. Rule 133
d. Rule 144
e. Rule 147

CHAPTER 9

PROJECTING FINANCIAL STATEMENTS

True-False Questions

1. Long-term financial planning begins with a forecast of annual working capital needs.

2. In a typical venture’s life cycle, the rapid-growth stage involves creating and building value, obtaining additional financing, and examining exit opportunities.

3. Forecasting for firms with operating histories is generally much easier than forecasting for early-stage ventures.

4. Sales forecasts usually are based on either a single specific scenario or weighted averages of several possible realizations.

5. The weighted average of a set of possible outcomes or scenarios is known as expected values.

6. A customer-driven or “bottom-up” approach to forecasting sales is used primarily to forecast industry sales growth rates.

7. Sales forecasting accuracy is usually highest during a venture’s startup stage in its life cycle.

5. “Public or seasoned financing” typically occurs during the survival stage of a venture’s life cycle.

8. The volatility of a firm’s cash balance will steadily decreases as the firm progresses from the survival stage to the rapid-growth stage.

9. “First-round financing” usually occurs during a venture’s rapid-growth life cycle stage.

10. Sales forecasting accuracy is usually lowest during a venture’s development stage in its life cycle.

11. “Internally generated funds” is the cash produced from operating a firm over a specified time period.

12. The rate at which a firm can grow sales based on the retention of business profits is known as sustainable sales growth rate.

13. A firm’s maximum sustainable sales growth rate occurs at a retention ratio of 100%.

14. When using the beginning of period equity base, the sustainable sales growth rate is equal to ROE times the retention ratio.

15. The sustainable sales growth rate is equal to ROA times the retention ratio.

16. “Financial capital needed” (FCN) is the amount of funds needed to acquire assets necessary to support a firm’s sales growth.

17. The cost of obtaining additional funds, such as additional interest expenses from borrowing funds, may be explicit and impact AFN.

18. The added costs associated with obtaining equity capital are based on investor expected rates of return and are explicit costs which affect AFN.

19. “Additional funds needed” (AFN) is the gap remaining between the financial capital needed and that funded by spontaneously generated funds and retained earnings.

20. Increases in accounts receivable and accounts payable that accompany sales increases are called “spontaneously generated funds”.

21. “Spontaneously generated funds” are increases in accounts receivable and accounts payable that accompany sales increases.

22. Increases in accounts payable and notes payable are examples of spontaneously generated funds.

23. A firm with a positive growth rate in sales will require some additional funds, assuming the existing ratios will not be changed.

24. An increase in accounts receivable will require additional financing unless the increase is offset by an equal decrease in another asset accoun

25. The percent of sales forecasting method must project all cost and balance sheet items at the same growth rate as sales.

26. The “constant-ratio forecasting method” is a variant of the “percent-of- sales forecasting method.”

27. The constant ratio forecasting method makes projections based on the assumption that certain costs and some balance sheet items are best expressed as a percentage of sales.

Multiple-Choice Questions

1. Which of the following is not a step in forecasting sales for a seasoned firm?
a. forecast future growth rates based on possible scenarios and the probabilities of those scenarios.
b. attempt to corroborate the projected sales growth rates analyzing both industry growth rates and the firm’s own past market share.
c. refine the sales forecast by using the sales force as a direct contact with both existing and potential customers.
d. take into consideration the likely impact of major operating changes within the firm on the sales forecas
e. consider the effects of changes in the firm’s debt/equity blend on the sales forecasts.

2. Which of the following statements is incorrect?
a. forecasting sales is the first step in creating projected financial
statements
b. financial forecasting tends to be more accurate for mature ventures
than for early-stage ventures
c. forecasting is relatively unimportant for early-stage ventures with
little historical financial data
d. a and b
e. a and c

3. During which round of financing is a venture typically most accurate in forecasting sales?
a. seasoned financing
b. mezzanine financing
c. first round financing
d. startup financing
e. seed financing

4. During which life cycle stage is a venture typically most accurate in forecasting sales?
a. rapid growth stage
b. startup stage
c. development stage
d. early-maturity stage
e. survival stage
5. Public or seasoned financing is generally associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage

6. A “new” venture usually begins its sales forecast by first:
a. forecasting industry sales and expressing the venture’s sales as a percent of industry sales
b. using a “bottom-up” market-driven approach
c. extrapolating past sales
d. working with existing and potential customers

7. An “expected value” is:
a. a simple average of a set of scenarios or possible outcomes
b. a weighted average of a set of scenarios or possible outcomes
c. the highest scenario value or outcome
d. the lowest scenario value or outcome

8. Lola is in the process of forecasting the sales growth rate for an early-stage venture specializing in the production of durable running shoes. Lola predicts a .2 probability of an 80% growth in sales, a .3 probability of a 60% growth in sales, a .4 probability of a 40% growth in sales, and a .1 probability of a 10% decrease in sales. What is the expected sales growth rate of the venture?
a. 47%
b. 49%
c. 51%
d. 53%

9. Which one of the following life cycle stages would generally be associated with the second lowest sales forecasting accuracy?
a. early-maturity
b. rapid-growth
c. survival
d. start-up
e. development

10. Internally generated funds which are available for distribution to owners of for reinvestment back into the business to support future growth can be characterized by which of the following?
a. operating income
b. operating cash flow
c. net income
d. net cash flow
e. pre-tax income

11. Which of the following is not part of the financial forecasting process used to project financial statements?
a. forecast sales
b. forecast tax rates
c. project the income statement
d. project the balance sheet
e project the statement of cash flows

12. A firm projects net income to be $500,000, intends to pay out $125,000 in dividends, and had $2 million of equity at the beginning of the year. The firm’s sustainable growth rate is:
a. 5%
b. 18.75%
c. 6.25%
d. 4.69%
e. none of the above

13. A firm has net income of $320,000 on sales of $3,200,000. Its assets total $2,000,000; the equity at the beginning of the year was $1,600,000 and dividends paid were $80,000. What is the sustainable growth rate?
a. 5%
b. 15%
c. 6.25%
d. 4.69%
e. none of the above

14. A sales growth rate based on the retention of profits is referred to as the:
a. real sales growth rate
b. sustainable sales growth rate
c. spontaneous sales growth rate
d. nominal sales growth rate
e. weighted average sales growth rate

15. Which one of the following ratios is not part of the “standard” return on equity (ROE) model?
a. net profit margin
b. asset turnover
c. equity multiplier
d. retention rate

16. If beginning of period common equity is $200,000 and end of period common equity is $300,000, the sustainable growth rate is:
a. 33%
b. 40%
c. 50%
d. 67%
e. 75%

17. Use the following information to estimate a venture’s sustainable growth rate: Net income = $200,000; Total assets = $1,000,000; equity multiple based on beginning common equity = 2.0 times; and Retention rate = 25%.
a. 50%
b. 25%
c. 20%
d. 10%
e. 5%

18. If a venture has a return on assets (ROA) = 10%, an equity multiplier based on beginning equity = 3.5 times, and a retention rate = 50%, the sustainable growth rate would be:
a. 10%
b. 17.5%
c. 35%
d. 40%
e. 20.5%

19. If a venture has a return on assets (ROA) = 10%, an equity multiplier based on beginning equity = 4.0 times, and a dividend payout ratio of 60%, the sustainable growth rate would be:
a. 10%
b. 16%
c. 20%
d. 24%
e. 40%

20. If a venture has a return on assets (ROA) = 12%, an equity multiplier based on beginning equity = 3.0 times, and a sustainable growth rate of 18%, the retention rate would be:
a. 10%
b. 20%
c. 30%
d. 40%
e. 50%

21. A venture’s common equity was $50,000 at the end of last year. If the venture’s common equity at the end of this year was $60,000, what was its sustainable sales growth rate?
a. 5%
b. 10%
c. 15%
d. 20%
e. 25%

22. A venture’s common equity account increased by $100,000 the past year and ended the year at $500,000. What was its sustainable sales growth rate?
a. 5%
b. 10%
c. 15%
d. 20%
e. 25%

23. Determine a venture’s sustainable growth rate based on the following information: sales = $1,000,000; net income = $100,000; common equity at the beginning of the year = $500,000; and the retention rate = 50%.
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%

24. Determine a venture’s sustainable growth rate based on the following information: sales = $1,000,000; net income = $150,000; common equity at the end of last year = $520,000; and the dividend payout percentage = 20%.
a. 10%
b. 16%
c. 20%
d. 24%
e. 30%

25. Determine a firm’s “financial policy” multiplier based on the following information: sustainable growth rate = 20%; net profit margin = 10%; and asset turnover = 2 times.
a. 1.00
b. 1.25
c. 1.50
d. 1.75
e. 2.00

26. Determine a firm’s “return on assets” percentage based on the following information: sustainable growth rate = 20%; total assets $500,000; beginning of year common equity $200,000; and dividend payout percentage = 60%.
a. 10.0%
b. 12.5%
c. 15.0%
d. 17.5%
e. 20.0%

27. The financial funds needed to acquire assets necessary to support a firm’s sales growth is called: a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

28. The increase in accounts payables and accruals that occur with a sales increase is called:
a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

29. The financial funds still needed to finance asset growth after using spontaneously generated funds and any increase in retained earnings is called:
a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

30. Which one of the following would increase a firm’s need for additional funds?
a. an increasing profit margin
b. a decreasing expected sales growth rate
c. an increase in accruals
d. an increasing dividend payout rate
e. a decrease in assets

31. Your firm recorded sales for the most recent year of $10 million generated from an asset base of $7 million, producing a $500,000 net income. Sales are projected to grow at 20%, causing spontaneous liabilities to increase by $200,000. In the most recent year, $200,000 was paid out as dividends, and the current payout ratio will continue in the upcoming years. What is your firm’s AFN?
a. $200,000
b. $600,000
c. $840,000
d. $960,000
e. $1,400,000

32. Which of the following is a forecasting method used to project financial statements?
a. percent-of-sales method
b. percent-of-expenses method
c. GNP-ratio method
d. a and b
e. a, b, and c

33. When projecting financial statements, one would first , and then proceed to :
a. project of the balance sheet, forecast sales.
b. forecast sales, project the income statement
c. forecast sales, project the balance sheet
d. forecast sales, project the statement of cash flows

CHAPTER 10

VALUING EARLY-STAGE VENTURES

True–False Questions

1. The valuation approach involving discounting present value cash flows for risk and delay is called discounted cash flow (DCF).

2. The stepping stone year is the first year before the explicit forecast period.

3. The terminal or horizon value is the value of a venture at the end of its explicit forecast period.

4. The “stepping stone” year is the second year after the explicit forecast period when valuing a venture.

5. The explicit forecast period is the two to ten year period in which the venture’s financial statements are explicitly forecas

6. The maximum dividend valuation method involves explicitly forecasted dividends to provide surplus cash which is positive.

7. The easiest way to value a venture is to discount the projected maximum dividend/issue stream.

8. The pseudo dividend method treats surplus cash as a free cash flow to equity.

9. The reversion value of a venture is the present value of the venture’s terminal value.

10. A venture’s reversion value is the present value of ongoing expenses.

11. The “reversion value” is the future value of the terminal value.

12. The “terminal” value is the value of the venture at the beginning of the explicit forecast period.

13. As used in this textbook, the “terminal” value is the same as the “horizon” value.

14. Finding the present value of the horizon value produces the venture’s reversion value.

15. Surplus cash is the cash remaining after required cash, all operating expenses, and reinvestments are made.

16. Surplus cash is the cash remaining after required cash, all operating expenses, reinvestments, and dividends payouts are made.

17. Required cash is the amount of cash required to operate a venture through its day-to-day business.

18. Surplus cash is the amount of cash required to pay scheduled dividends for next quarter.

19. The capitalization or “cap” rate is the spread between the discount rate and the growth rate of cash flow in the terminal value period.

20. Pre-money valuation is the present value of a venture prior to a new money investmen

21. Post-money valuation is the pre-money valuation of a venture plus all monies previously contributed by the venture’s founders.

22. “Net operating working capital” is current assets other than surplus cash less non-interest-bearing current liabilities.

23. “Equity valuation cash flow” is defined as: net sales + depreciation and amortization expense – change in net operating working capital (excluding surplus cash) – capital expenditures + net debt issues.

24. The “pseudo dividend method” (PDM) is a valuation method involving zero explicitly forecasted dividends and an adjustment to working capital to strip surplus cash.

25. A “post-money” valuation differs from a “pre-money” valuation by the cost of financial capital.

26. Applying the “maximum dividend method” (MDM) and the “pseudo dividend method” (PDM) result in different valuation estimates.

27. The “maximum dividend method” assumes that all surplus cash will be paid out as dividends.

28. A pseudo dividend involves excess cash that does not need to be invested in a venture’s assets or operations, and may be invested elsewhere for a period of time.

29. The pseudo dividend method treats equity infusions and withdrawals in a “just in time” fashion.

30. The pseudo dividend method treats surplus cash either as stripped out while not in use or as employed outside the venture and stored in a zero NPV investmen

31. The wider the capitalization or “cap” rate (i.e., the discount rate minus the growth rate in the terminal period), the higher the terminal value.

Multiple-Choice Questions

1. The present value of the venture’s expected future cash flows is called?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

2. The value today of all future cash flows discounted to the present at the investor’s required rate of return is called?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

3. The value of the venture at the end of the explicit forecast period is called the horizon value, or what?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

4. The present value of the terminal value is called?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

5. The present value of a set of future flows plus the current undiscounted flow is called?
a. going-concern value
b. present value
c. terminal value
d. reversion value
e. net present value

6. The calculation of equity valuation cash flows nets the cash impact of all other balance sheet and income accounts to focus on the ______ account as the repository of any remaining cash flow.
a. cash
b. debt
c. equity
d. non-interest-bearing liabilities
e. net income

7. Equity valuation cash flow = Net income plus
a. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures plus net debt issues
b. Depreciation and amortization expense plus the change in net operating working capital plus minus capital expenditures plus net debt issues
c. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures minus net debt issues
d. Depreciation and amortization expense minus the change in net operating working capital plus minus capital expenditures plus net debt issues
e. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures plus net debt issues

8. In a wildly successful first year in business that started and ended with no required cash, your firm has operating income of $989,000, net income of $637,000, current assets of $900,000, current liabilities of $659,000, net capital expenditures were $690,000, and depreciation was $460,000. The firm has never financed itself with deb What is your equity valuation cash flow?
a. $648,000
b. $900,000
c. $2,028,000
d. $166,000

9. Your firm has been in business for two years. In its first year, the firm ended with $227,000 of current assets, long-term assets of $143,000, $70,000 in surplus cash, current liabilities of $52,000, and long-term assets of $68,000. At the end of the second year, current assets were $279,000, long-term assets of $195,000, surplus cash of $90,000, current liabilities of $62,000, and long-term assets of $78,000. What is your firm’s change in net operating working capital?
a. $22,000
b. $62,000
c. $42,000
d. $244,000
e. $32,000

10. The equity valuation method involving explicitly forecasted dividends to provide surplus cash of zero is called?
a. maximum dividend method
b. pseudo dividend method
c. sustainable growth method
d. dividend payout method

11. The equity valuation method involving zero explicitly forecasted dividends and an adjustment to working capital to strip surplus cash is called?
a. maximum dividend method
b. pseudo dividend method
c. sustainable growth method
d. dividend payout method

12. “Just in time” capital injections by equity investors is a reference to
a. sustainable growth
b. the present value of the terminal value
c. equity investors’ providing money only when needed
d. dividend payout

13. The maximum dividend method is
a. the cleanest for valuing assets, but creates problems valuing surplus cash
b. the cleanest for valuation purposes but its dividend-laden financial statements can dramatically understate the firm’s cash position
c. the cleanest for cash planning, but creates problems valuing the venture by discounting the dividends
d. calculated by directly discounting the cash flow statement’s projected dividend flow to investors, but ignores risks associated with periodic gluts of surplus cash

14. The pseudo dividend method is
a. the cleanest for valuing assets, but creates problems valuing surplus cash
b. the cleanest for valuation purposes but its dividend-laden financial statements can dramatically understate the firm’s cash position
c. the cleanest for cash planning, but creates problems valuing the venture by discounting the dividends
d. calculated by directly discounting the cash flow statement’s projected dividend flow to investors, but ignores risks associated with periodic gluts of surplus cash

15. “Required cash” is?
a. the cash needed to pay interest expense
b. a valuation method for early stage ventures
c. cash needed to cover a venture’s day-to-day operations
d. cash available to pay as a dividend

16. Most discounted cash flow valuations involve using cash flows from an:
a. historical period, an explicit forecast period, and a terminal value
b. historical period and a terminal value
c. historical period and an explicit forecast period
d. explicit forecast period and a terminal value

17. Which one of the following equity valuation methods records surplus cash on the balance sheet but assumes that the surplus cash is paid out over time for valuation purposes?
a. maximum dividend method
b. pseudo dividend method
c. sustainable growth method
d. return on equity method

18. When estimating the terminal value of a venture using an equity valuation method, a perpetuity growth equation is often applied that uses the capitalization rate for discounting purposes. This “cap” rate is measured as the:
a. equity discount rate minus the perpetuity growth rate
b. equity discount rate plus the perpetuity growth rate
c. risk-free rate plus the perpetuity growth rate
d. risk-free rate minus the perpetuity growth rate

19. A venture’s going-concern value is the:
a. present value of the expected future cash flows
b. net present value of the current and expected future cash flows
c. future value of the expected cash flows
d. net future value of the current and expected cash flows

20. The purpose of the stepping stone year is?
a. to assure that there is sufficient required cash
b. to assure that future dividends are constant
c. to assure that investment flows are consistent with terminal growth rates
d. to allow for a final year of higher-than-sustainable growth

21. When estimating the terminal value of a cash flow perpetuity, which one of the following is not a component?
a. the next period’s cash flow
b. a constant discount rate
c. a constant growth rate
d. the payback period

22. Which one of the following components is not a component of the equity valuation cash flow?
a. NOPAT
b. depreciation and amortization expense
c. change in net operating working capital (without surplus cash)
d. capital expenditures
e. net debt issues

23. What is the difference between pre-money valuation and post-money valuation?
a. size of the capitalization rate
b. amount of money injected by new investors
c. revision value
d. amount of money previously contributed by founders
e. amount of money previously contributed by venture investors

24. To calculate a terminal value, one divides the next period’s cash flow by the:
a. constant discount rate plus a constant growth rate
b. constant discount rate plus a variable growth rate
c. constant discount rate minus a constant growth rate
d. constant growth rate minus constant discount rate
e. constant growth rate plus a variable discount rate

25. The MDM equity valuation method is an abbreviation for:
a. minimum dividend method
b. maximum discount method
c. maximum dividend method
d. minimum discount method
e. Montgomery design method

26. The PDM equity valuation method is an abbreviation for:
a. pseudo dividend method
b. proximate dividend method
c. pseudo discount method
d. proximate discount method
e. pre-money discount method

27. Estimate a venture’s equity valuation cash flow based on the following information: net income = $6,372; depreciation = $4,600; change in net operating working capital = $2,415; capital expenditures = $6,900; and new debt issues = $1,000.
a. $6,487
b. $5,487
c. $4,487
d. $3,787
e. $5,787

28. Estimate a venture’s terminal value based on the following information: current year’s net income = $20,000; next year’s expected cash flow = $26,000; constant future growth rate = 7%; and venture investors’ required rate of return = 20%.
a. $156,846
b. $285,714
c. $200,000
d. $150,000
e. $428,571

29. Estimate a venture’s required rate of return based on the following information: terminal value = $400,000; current year’s net income = $20,000; next year’s expected cash flow = $25,000; and a constant growth rate = 7%.
a. 6%
b. 7%
c. 8%
d. 9%
e. 10%

30. Estimate a venture’s constant growth rate (g) based on the following information: terminal value = $400,000; current year’s net income = $20,000; next year’s expected cash flow = $25,000; and a required rate of return of 20%.
a. 2%
b. 4%
c. 6%
d. 8%
e. 10%

31. Which one of the following components is not a component of the equity valuation cash flow calculation?
a. net income
b. depreciation and amortization expense
c. change in net operating working capital (without surplus cash)
d. capital expenditures
e. net equity repurchases

32. Estimate a venture’s terminal value based on the following information: current year’s net sales = $500,000; next year’s expected cash flow = $16,000; constant future growth rate = 10%; and venture investors’ required rate of return = 20%.
a. $156,846
b. $285,714
c. $200,000
d. $150,000
e. $160,000

33. Estimate a venture’s cash flow expected next year based on the following information: current year’s net sales = $400,000; terminal value = $500,000; constant future growth rate = 10%; and venture investors’ required rate of return = 20%.
a. $20,000
b. $40,000
c. $50,000
d. $60,000
e. $80,000

CHAPTER 11

VENTURE CAPITAL VALUATION METHODS

True–False Questions

1. The venture capital valuation method estimates the venture’s value by projecting both intermediate and terminal/exit flows to investors.

2. Venture investors returns depend on the venture’s ability to generate cash flows or to find an acquirer for the venture.

3. The value of the venture’s equity is equal to the value the financing contributed in the first venture capital round.

4. A direct application of the earnings-per-share ratio to venture earnings is known as the direct comparison valuation method.

5. The venture capital valuation method which capitalizes earnings using a cap rate implied by a comparable ratio is known as direct capitalization.

6. Failure to account for any additional rounds of financing and its accompanying dilution in order to meet projected earnings will result in the investor’s not receiving an adequate number of shares to ensure the required percent ownership at the time of exi

7. Almost without exception, professional venture investors demand that some equity or deferred equity compensation be structured into any valuation.

8. If a venture issues debt prior to the exit period, the initial equity investors will still receive first claims on the venture’s net worth at exit time.

9. The utopia discount process allows the venture investors to value their investment using only the business plan’s explicit forecasts, discounting it at a bank loan interest factor.

10. The internal rate of return is the simple (non-compounded) interest rate that equates the present value of the cash inflows received with the initial investmen

11. The basic venture capital method estimates a venture’s value using only terminal/exit flows to all the venture’s owners.

12. The basic venture capital method estimates a venture’s value using only terminal/exit flows to founders.

13. Post-money valuation of a venture is the pre-money valuation plus money injected by new investors.

14. Staged financing is financing provided in sequences of rounds rather than all at one time.

15. In staged financing, the expected effect of future dilution is borne by both founders and the investors currently seeking to inves

16. The capitalization rate is the sum of the discount rate and the growth rate of the cash flow in the terminal value period.

17. The internal rate of return (IRR) is the compound rate of return that equates the present value of the cash inflows received with the initial investmen

18. The discount rate that one applies in a multiple scenario valuation will usually be lower than the discount rate that would be applied to the business plan cash flows.

19. All of the scenarios in a multiple scenario analysis must have exit cash flows in the same year.

20. The discount rate applied in an Expected PV approach should be the same rate across scenarios.

21. The expected present value method incorporates the present values of different scenarios, as well as their probabilities, into the valuation process.

Note: The following TF questions relate to Learning Supplements 11A and 11B:

1. The return on book equity equals the sustainable growth rate when all earnings are paid out in the form of dividends.

2. A price-earnings ratio is related to the level and growth of earnings.

3. The Venture Capital ShortCut (VCSC) method is a post-money version of the Delayed Dividend Approximation (DDA).

4. The VSCS and DDA methods are “just-in-time” capital methods which do not assess capital charges for idle cash.

5. For the typical business plan having current and early cash outflows and later-stage cash inflows, the VCSC and DDA methods will typically give lower valuations than the MDM and PDM.

6. The VSCS is like a post-money version of the DDA.

7. For the typical business plan having current and early cash outflows and later-stage cash inflows, the VSCS will give a higher valuation than the DDA.

8. The DDA and VCSC methods give the same valuation.

Multiple-Choice Questions

1. The return to venture investors directly depends on which of the following?
a. venture’s ability to generate cash flows
b. ability to convince an acquirer to buy the firm
c. the amount of its short-term liabilities
d. both a and b
e. all of the above

2. To obtain the percent ownership to be sold in order to expect to provide the venture investor’s target return, one must consider the:
a. cash investment today and the cash return at exit multiplied by the venture investor’s target return, then divide today’s cash investment by the venture’s NPV
b. cash investment today and the cash return at exit discounted by the venture investor’s target return, then divide today’s cash investment by the venture’s NPV
c. cash investment today and the cash return at exit multiplied by the venture investor’s target return, then divide today’s cash investment by the venture’s NPV
d. cash investment today and the cash return at exit discounted by the venture investor’s target return, then multiply today’s cash investment by the venture’s NPV

3. The value of the existing venture without the proceeds from the potential new equity issue is known as?
a. pre-money valuation
b. post money valuation
c. staged financing
d. the capitalization rate

4. The value of the existing venture plus the proceeds from the potential new equity issue is known as?
a. pre-money valuation
b. post money valuation
c. staged financing
d . the capitalization rate

5. Financing provided in sequences of rounds rather than all at one time is
known as?
a. pre-money valuation
b. post money valuation
c. staged financing
d. the capitalization rate

[Note: Use the following information for Problems 6 through 11.]

A potential investor is seeking to invest $500,000 in a venture, which currently has 1,000,000 million shares held by its founders, and is targeting a 50% return five years from now. The venture is expected to produce half a million dollars in income per year at year 5. It is known that a similar venture recently produced $1,000,000 in income and sold shares to the public for $10,000,000.

6. What is the percent ownership of our venture that must be sold in order to provide the venture investor’s target return?
a. 33.33%
b. 75.94%
c. 12.76%
d. 15.00%

7. What is the number of shares that must be issued to the new investor in order for the investor to earn his target return?
a. 3,156,276
b. 1,578,138
c. 4,156,276
d. 2,578,138

8. What is the issue price per share?
a. $0.1939
b. $0.1203
c. $0.3168
d. $0.1584

9. What is the pre-money valuation?
a. $120,300
b. $316,800
c. $158,400
d. $193,900

10. What is the post-money valuation?
a. $658,354
b. $499,954
c. $408,377
d. $249,977

11. What is the value of the venture in year five using direct capitalization?
a. $500,000
b. $5,000,000
c. $1,000,000
d. $100,000

12. For early stage ventures, which of the following is a strong reason for having an equity component in employee compensation?
a. the expected deferred and tax-preferred compensation allows the venture to pay a lower current compensation to employees
b. as a way to motivate employees to strive for the same goal of high equity value
c. because any dividends received as part of the equity compensation reduces taxable income
d. both a and b
e. all of the above

13. During the exit period, which of the following will have last crack at the venture’s wealth?
a. banks giving loans to the venture
b. convertible debt holders of the venture
c. initial equity investors of the venture
d. participating preferred equity holders

14. Suppose your venture’s expected mean cash flows are $(85,000) initially, followed by expected mean cash flows at the end of the first, second, and third years of $40,000, $40,000, and $35,000. What is the internal rate of return?
a. 13.9%
b. 14.7%
c. 16.2%
d. 17.2%
e. 19.2%

15. A P/E multiple refers to:
a. price/expectations multiple
b. price/earnings multiple
c. profit/EBIT multiple
d. profit/earnings multiple
e. price/EBITDA multiple

16. Estimate the value of a privately-held firm based on the following information: stock price of a comparable firm = $20.00; net income of a comparable firm = $20,000; number of shares outstanding for the comparable firm = 10,000; and earnings per share for the target firm = $3.00.
a. $10.00
b. $20.00
c. $30.00
d. $40.00
e. $50.00

17. Estimate the value of a privately-held firm based on the following information: total market value (or capitalization value) of a comparable firm = $200,000; net income of a comparable firm = $40,000; number of shares outstanding for the comparable firm = 20,000; net income for the target firm = $15,000; and number of shares outstanding for the target firm = 10,000.
a. $5.00
b. $7.50
c. $10.00
d. $12.50
e. $15.00

18. Determine the market value of a “comparable” firm based on the following information: value of target firm = $4,000,000; net income of target firm = $200,000; and net income of “comparable” firm = $500,000.
a. $4 million
b. $7.5 million
c. $10 million
d. $12.5 million
e. $15 million

19. Determine the net income of a “comparable” firm based on the following information: value of target firm = $4,000,000; net income of target firm = $200,000; stock price of “comparable” firm = $30.00; and 300,000 shares of stock outstanding for the comparable firm.
a. $450,000
b. $500,000
c. $550,000
d. $600,000
e. $700,000

20. Determine the future value of a target venture which has net income expected to be $40,000 at the end of four years from now. A comparable firm currently has a stock price of $20.00 per shares; 100,000 shares outstanding; and net income of $50,000.
a. $1.0 million
b. $1.4 million
c. $1.6 million
d. $2.0 million

21. Which of the following financing rounds dilutes the ownership founders?
a. first-round
b. second-round
c. incentive ownership round
d. a and b
e. a, b, and c

22. The utopian approach to valuation ignores which of the following venture scenarios:
a. black hole scenarios
b. living dead scenarios
c. both a and b
d. neither a or b

23. Which of the following is not a variation of the venture capital valuation method?
a. venture capital method
b. expected present value
c. utopian discount process
d. none of the above

Following are MC questions relating to Learning Supplements 11A and 11B:

1. When a firm has growth that only meets, rather than exceeds, the cost of capital, we would expect its price-earnings multiple to be approximately equal to:
a. the reciprocal of its required return on equity
b. its earnings per share
c. its book-to-market ratio
d. its debt-to-value ratio

2. The two “just-in-time” capital methods are:
a. DDA and VCSC
b. DDA and PDM
c. VSCS and MDM
d. MDM and PDM

3. For the typical venture investing project, the valuation will be highest under:
a. DDA
b. PDM and MDM
c. VCSC
d. initial book value of equity

CHAPTER 12

PROFESSIONAL VENTURE CAPITAL

True–False Questions

1. In addition to having personal financial stakes in their portfolio of investments, professional venture capitalists have raised funds from other investors to invest in the portfolio.

2. The establishment of the Small Business Administration was the first major government foray into venture investing.

3. Created by the Small Business Administration, Small Business Investment Companies possess important tax advantages and were eligible to borrow amounts up to four times their equity base from the governmen

4. Initially, Small business Investment Companies access to borrowed funds appeared attractive. This was because venture investing and debt service commitments are an ideal mixture of financing for start-ups.

5. Professional venture capital, as we know it today, did not exist before World War II.

6. Most venture investing came from wealthy individuals and families prior to World War II.

7. The beginning of professional venture capitalists began with the formation of American Research and Development in 1966.

8. In 1958 the Small Business Administration created Small Business Investment Companies.

9. The first major government foray into venture investing came with the formation of the Small Business Administration (SBA) in 1947.

10. The American Research and Development (ARD) company was formed in 1946.

11. Internet financing led the record level of venture investing in the 1999-2000 time period.

12. The phrase “two and twenty shops” refers to investment management firms having a contract that gives them two percent carried interest and 20 percent of assets annual management fee.

13. When the venture fund calls upon the investors to deliver their investment funds, it reflects the deal flow.

14. The deal flow reflects the flow of business plans and term sheets involved in the venture capital investing process.

15. In the venture investing context, due diligence describes the process of investigating a potentially worthy concept or plan.

16. The summary of the investment terms and conditions accompanying an investment proposed by the venture capitalist is known as the statement of strengths and weaknesses.

17. “Carried interest” is the portion of profits paid to the professional venture capitalist as incentive compensation.

18. The term “capital call” refers to the flow of business plans and term sheets involved in the venture capital investing process.

19. Pension funds are the dominant source of funds for venture investing.

20. Individuals and families are more important suppliers of venture capital relative to finance and insurance firms.

21. Endowments and foundations are more important suppliers of venture capital relative to individuals and families.

22. “Due diligence,” in venture investing context, is the process of ascertaining the viability of a business plan.

23. When a syndicate of VCs invests in a venture, the investor in charge of organizing the due diligence process is known as the “lead investor.”

24. SLOR stands for “standard letter of recognition.”

25. SLOR stands for “standard letter of rejection.”

26. A “term sheet” is a summary of the investment terms and conditions accompanying an investment by venture capitalists.

27. Term sheets consist of the terms and conditions accompanying an investment, as stipulated by the founders of the venture.

28. Two typical issues addressed in a term sheet are valuation and the size and staging of financing.

29. Term sheets may contain demands regarding the voting rights of shares issued to venture investors.

30. Once the venture capital firm has received exit proceeds from a venture in the form of cash or securities, some method of returning the proceeds (less the carried interest) must be determined.

31. Annual VC investments, as indicated in Figure 12.1, reached an all-time high in the year 2000.

32. According to Figure 12.4, individuals and families were the largest supplier of venture capital in 2009.

Multiple-Choice Questions

1. The beginning of professional venture capitalists is considered to have occurred:
a. prior to World War II
b. 1946
c. 1956
d. 1966
e. after the Vietnam War

2. The beginning of professional venture capitalists is considered to have begun with the establishment or formation of:
a. Small Business Administration
b. Small Business Investment Companies
c. American Research and Development organization
d. Professional Venture Capitalists organization

3. Which of the following was the largest source of venture capital funds in 2009 (as reported in Figure 12.4)?
a. pension funds and corporations
b. individuals and families
c. endowments and foundations
d. finance and insurance

4. Venture Capital firms tend to specialize in publicly identified niches because of the potential for value-added investing by venture capitalists. Which is not one of these niches?
a. industry type
b. venture stage
c. size of investment
d. management style
e. geographic area

5. As venture firms attract money from investors, it is placed in a fund. Important issues that must be put in place with the establishment of the fund include all of the following except:
a. determine the general partners
b. establishing a fee structure
c. a profit sharing arrangement
d. establish its governance
e. the management team assigned to each borrower

6. All of the following are typically part of a venture fund’s typical compensation and incentive structure except:
a. some percent annual fee on invested capital
b. a percent share of any profits to the managing general partner
c. carried interest
d. salary for the general partners

7. When evaluating the prospects of a new venture, venture capital firms consider which of the following?
a. characteristics of the proposal
b. characteristics of the entrepreneur/team
c. nature of the proposed industry
d. both b and c
e. all of the above

8. When screening prospective new ventures, venture capital firms consider their own funds’ requirements. Which of the following is not one of the venture firm’s requirements relating to its own funds?
a. investor control
b. rate of return
c. size of investment
d. probable stock listing exchange for the mature venture
e. financial provisions for investors

9. When evaluating the prospects of a new venture, venture capital firms consider the characteristics of the entrepreneur and its team. Which of the following is not part of the review of the entrepreneur/team?
a. its background and experience
b. its managerial capabilities
c. management’s stake in the firm
d. the VC firms’ ability to cash out
e. the capability to sustain an effort

10. When screening prospective new ventures, venture capital firms must consider the nature of the proposed industry. Which of the following is not part of the screening of the proposed industry?
a. market attractiveness
b. managerial references
c. potential size
d. technology
e. threat resistance

11. Professional venture investing usually involves setting up a venture capital firm as a:
a. proprietorship
b. corporation
c. partnership
d. S corporation

12. After a new professional venture capital fund is organized, the fund managers:
a. conduct due diligence and actively invest
b. solicit investments and obtain commitments
c. arrange harvest or liquidation
d. identify prospective venture investments and then solicit investments

13. After determining the next fund’s objectives and policies, the “professional venture investing cycle’s” next step is:
a. solicit investments in new fund
b. organize the new fund
c. obtain commitments for a series of capital calls
d. conduct due diligence and actively invest
e. arrange harvest or liquidation

14. The term “carried interest” refers to:
a. interest not currently paid but which must be paid in the future by a professional venture capitalist
b. interest transported directly to a bank
c. interest owed on a loan in default
d. the portion of profits paid to the professional venture capitalist as incentive compensation

15. If an investment management firm is known to be a “two and twenty shop”, this implies that the firm:
a. receives an annual 2% fee on invested capital, and a 20% carried interest
b. receives an annual 20% fee on invested capital, and a 2% carried interest
c. receives an annual 2% fee on gross operating profits, and a 20% carried interest
d. receives an annual 20% fee on gross operating profits, and a 2% carried interest

16. A venture fund calls upon its investors to deliver their investment funds. This is known as:
a. due diligence
b. deal flow
c. a capital call
d. carried interest
e. a SLOR

17. All of the following are typical issues addressed in a term sheet except?
a. valuation
b. board structure
c. registration rights
d. management fees
e. employment contracts

18. Term sheets are usually drafted by:
a. the mangers of the venture seeking VC funding
b. the VC fund seeking to fund the venture
c. management and founders
d. it is usually done by an third party, in order to
ensure the fair treatment of both parties

19. In a syndicate of venture investors, the investor who is responsible for governing the process of due diligence is:
a. the primary investor
b. the lead investor
c. a small group of secondary investors
d. the investor in charge of issuing SLORs for the syndicate
e. it is a democratic process that is shared by all investors in the group

20. A summary of the investment terms and conditions accompanying an investment is referred to as a:
a. term sheet
b. business plan
c. fund created by professional venture capitalists
d. due diligence in venture investing
e. capital call

21. When screening possible investments, a venture capital firm might issue an SLOR which stands for:
a. standard letter of rejection
b. standing letter of reconciliation
c. standard letter of reassessment
d. senior letter of reference

22. Which of the following is not one of the four likely outcomes of the venture firm’s screening process?
a. seek the lead investor position
b. seek a non-lead investor position
c. close the capital fund
d. refer the venture to more appropriate financial market participants
e. issue a standard letter of rejection

Note: The following MC questions relate to Figure 12.3 Elements of a Venture Capital Fund Placement Memorandum

1. In a Venture Capital Fund Placement Memorandum, which of the following is not a front matter declaration?
a. description of limited manner of the offering
b. targeted fund size
c. imposition of confidentiality
d. notice of lack of SEC registration
e. declaration of the highly risky nature of investment

2. In a Venture Capital Fund Placement Memorandum, which of the following is not part of the offering summary?
a. objective of formation
b. declaration of general partner
c. management fee
d. minimum capital restrictions
e. targeted fund size

3. In a Venture Capital Fund Placement Memorandum, which of the following is not part of the fund overview?
a. fund size
b. investment focus
c. fund management
d. portfolio size
e. general partners’ capital contributions

4. In a Venture Capital Fund Placement Memorandum, all of the following are part of the executive summary except?
a. special limited partners
b. general partners’ capital contributions
c. limitation of liability
d. allocation of gains and losses
e. imposition of confidentiality

5. In a Venture Capital Fund Placement Memorandum, all of the following are included in the summary of terms except?
a. indemnification
b. objective
c. liquidation
d. valuation
e. expenses

CHAPTER 13

OTHER FINANCING ALTERNATIVES

True–False Questions

1. Despite the high risk and costs of using a facilitator or up-front fee solicitor to obtain financing, many start-ups never-the-less seek them as a source of funds due to the length of time it takes to raise new funds.

2. Collateral plays an important role in determining the willingness to lend and the amount and terms of the loan, making it the most important factor in the lending process.

3. Commercial loan officers have the expertise to project new venture’s business successes, and thus are as willing to make funds available to entrepreneurs on the same basis as other businesses.

4. Because investors and commercial lenders both seek returns on the funds given to start-up firms, entrepreneurs can obtain financing as easily from either source.

5. Because of loan restrictions, obtaining funding from commercial lenders is prohibitive for entrepreneurs.

6. Unlike traditional commercial banks, venture banks typically provide debt to start-ups that have already received equity financing from professional venture capital firms.

7. Among start-ups, it is widely understood that bank debt (outside of Small Business Administration loans), is not a very realistic source of financing for ventures with less than two years operating results.

8. Compensation received by commercial loan officers makes them more likely to finance early-stage ventures.

9. Warrants allow lenders to buy equity at a specified price.

10. Warrants are a debt instrument frequently used by commercial banks when financing entrepreneurial ventures.

11. Credit cards issued to start-ups have proven to be an alternative source of start-up financing.

12. The returns to venture bank lenders are generated solely from interest payments made by borrowers plus the return of the loan principal.

13. Commercial banks receive a portion of their returns from warrants in addition to the receipt of interest and the repayment of the principal that was len

14. By an act of Congress, the Small Business Administration (SBA) was created for the purpose of fostering the initiation and growth of small businesses.

15. The Small Business Administration was created by an Act of Congress in 2003.

16. Microloans in the SBA credit program are intended for very small businesses with a maximum amount of $35,000 to be used for general purposes.

17. The SBA’s role in its microloan credit program is to approve the loans and guarantee up to 85% of the loan value.

18. Microloans in the SBA credit program are made by not-for-profit or government-affiliated Community Development Financial Institutions (CDFIs).

19. The SBA’s venture capital credit program works through Community Development Financial Institutions (CDFIs).

20. The 7(a) loan traditionally has been the SBA’s primary loan program

21. SBA 7(a) loans are made usually for 1 to 3 years in amounts up to $5,000,000, require collateral, and can be used for most business purposes.

22. The SBA approves the standard 7(a) loan and guarantees up to 85% of the loan value.

23. For the 504 loan, the SBA approves and guarantees the development company’s portion of the debt but does not guaranteed the debt of the participating commercial bank.

24. Factoring is the sale of payables to a third party at a discount to their face value.

25. In a factoring arrangement, the third party makes its money by purchasing the receivables at a discount from the total amount due on the receivables.

26. With venture leasing, one component of the return to the lessor is the opportunity to take an equity interest in the venture.

27. Receivables lending is the use of receivables as collateral for an equity issue.

28. Factoring is the selling of receivables to a third party at a discount from their face value.

29. Direct public offerings have recently become a serious challenge to traditional venture capital firms.

30. The Immigration and Nationality Act (INA) of 1990 provided an opportunity for foreign nationals to obtain a “green card” through the EB-5 immigrant visas program.

31. A foreign national may seek Lawful Permanent Resident (LPR) status by investing $1 million in the U.S. that will preserve or create at least 100 jobs for U.S. workers.

Multiple-Choice Questions

1. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The ability of the entrepreneur to repay borrowed funds is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

2. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The money the entrepreneur has invested in the business, which is an indication how much is at risk if the business should fail is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

3. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The guarantees, or additional forms of security (such as assets), the entrepreneur can provide the lender is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

4. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The focus on the intended purpose of the loan is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

5. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The general impression the entrepreneur makes on the potential lender or investor is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

6. All of the following are common loan restrictions except?
a. limits on total debt
b. limits on total equity
c. restrictions on dividends or other payments to owners and/or investors
d. restrictions on additional capital expenditures
e. performance standards on financial ratios

7. Unlike traditional commercial banks, venture banks typically provide debt to start-ups that have already received equity financing from professional venture capital firms. In return for providing additional debt financing, these venture banks receive in return all of the following except?
a. interest payments
b. repayment of principal
c. implementation of loan restrictions
d. tax breaks on the interest
e. right to buy equity at a specific price

8. Bank debt is not a realistic source of financing for start-ups due to all of the following reasons except?
a. a large portion of the assets are intangible and provide no collateral
b. payables either don’t yet exist or its history is inadequate
c. the start-up’s dependence on a small number of irreplaceable people is not a good match to demand deposits or other bank liabilities
d. receivables collection track record is incomplete
e. in the event of a default, it is now plausible for the bank to install a management team to help right the operations

9. A provision that allows lenders to acquire equity at a specific price is known as a(n):
a. factor
b. warrant
c. venture lease
d. equity carve-out

10. Personal credit cards have proven to be a source of financing for start-up firms for all of the following reasons except?
a. credit card debt is not based on the firm’s ability to repay, but rather the individual card holder’s ability to repay
b. teaser rates afford initial low cost borrowing
c. balance transfer at below-prime rates
d. credit card debt can create problems if the firm doesn’t generate cash flows to cover credit card payments once low introductory rates expire

11. In the context of new ventures, what does SBA stand for?
a. Standard Business Arrangement
b. Small Business Association
c. Small Business Administration

12. By an act of Congress, the Small Business Administration (SBA) was created in which one of the following years?
a. 1953
b. 1968
c. 1973
d. 1985
e. 1993

13. Which is not a duty of the Small Business Administration?
a. provide capital and credit to entrepreneurial start-ups
b. guaranteeing general business loans
c. provide equity financing for start-ups
d. help create new jobs in small businesses
e. help small firms obtain Federal contracts

14. Which of the following is not a Small Business Administration program?
a. loan guaranty programs
b. certified and preferred lender programs
c. low documentation loan programs
d. energy and conservation loan programs
e. certified financial planner funding programs

15. Which of the following is not a source of debt funding for a start-up firm?
a. accounts payable
b. vendor financing
c. factoring
d. trade notes
e. leasing

16. Venture banks seek loan returns from:
a. interest received
b. principal repayments
c. warrants being exercised
d. all of the above
e. none of the above

17. Which one of the following is not a current Small Business Administration (SBA) credit program?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

18. In which of the following credit programs does the SBA approve and guarantee a not-for-profit Certified Development Company’s portion of the debt?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

19. In which of the following credit programs does the SBA approve a loan and guarantees up to 85% of loan value?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

20. In which of the following credit programs is the SBA role in the loan one of providing a direct loan to a community organization, which reloans the funds in small amounts?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

21. In which of the following credit programs does the SBA borrow money to be lent Small Business Investment Companies (SBICs) and guarantees payment to investors?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

22. Commercial banks, credit unions, and/or financial services firms are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

23. Commercial banks, jointly with not-for-profit Certified Development Companies, are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

24. Not-for-profit or government-affiliated Community Development Financial Institutions (CDFIs) are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

25. Small Business Investment Companies (SBICs) are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

26. Concerning factoring, all of the following are true except:
a. factors prefer business over consumer accounts
b. factoring is done at a discount to the third party purchaser
c. factoring discounts are often a function of the riskiness of the receivables
d. factoring speeds the inflow of cash to the seller of the receivables
e. receivable lending is the process of factoring

27. The use of receivables as collateral for a loan is known as:
a. capital leasing
b. warehouse financing
c. receivables lending
d. a microloan
e. venture leasing

28. Selling receivables to a third party at a discount from their face value is referred to as:
a. factoring
b. receivables lending
c. venture banking
d. vendor financing
e. mortgage lending

29. Which of the following is/are not a type of leasing arrangement?
a. factoring
b. capital lease
c. venture lease
d. mortgage lease
e. both a and d

30. Arranging for partial ownership as a component of the expected return to a lessor is known as:
a. venture leasing
b. capital leasing
c. investment leasing
d. none of the above

CHAPTER 14

SECURITY STRUCTURES AND DETERMINING ENTERPRISE VALUES

True–False Questions

1. Preferred stock is the equity claim senior to common stock providing preference on dividends but not liquidation proceeds.

2. For preferred noncumulative stock, all previously unpaid preferred dividends must be paid before any common stock dividend is paid.

3. Convertible preferred stockholders have the right to convert a preferred share into a specified number of common shares at any time after the expiration date.

4. If a share of preferred stock has a $10 par value, and the stock has a 2:1 conversion ratio, then the conversion price would be $5.

5. By issuing preferred stock, and thus forfeiting bankruptcy rights from the use of debt, the venture and its investors can benefit by committing to an internal reorganization as opposed to bankruptcy reorganization.

6. A call option is the obligation to purchase a specific asset at a pre-determined price.

7. Options generally have no effect on the value of a venture capital investmen

8. For American and Bermudan embedded options, the exercise price can change over time as specified in the security agreemen

9. An American-style option is an option that can be exercised only at the expiration date

10. A European-Style Option may only be exercised on a specific date.

11. A warrant is a call option issued by a company granting the holder the right to buy common stock at a specific price at a specific time.

12. An option granting the right to sell a stock at $10 when that stock currently has a market price $8 is “in the money.”

13. If a call option can be bought for $12 and the stock’s market value is $12, it’s said to be “at the money”.

14. As the underlying stock price increases in value, a put option to sell it becomes more valuable.

15. The value of a warrant can be directly derived from the value of a call option.

16. A preemptive right is a right for existing owners to buy sufficient shares to preserve their ownership share.

17. Convertible debt is debt that converts into preferred stock.

18. An option is a right to buy or sell additional shares of stock.

19. A warrant is a type of call option.

20. An option not currently worth exercising is said to be an out of the money option.

21. Owning a put option on a stock is the same as selling a call option on that same stock.

22. The enterprise method of valuation can be executed with either an after-tax or before-tax weighted cost of capital as long as the rate is applied to the appropriate enterprise cash flows.

23. Entity valuation allows us to answer the question of how much debt a venture needs to issue to achieve a target capital structure (D/V).

24. The concept of an enterprise value is that it is the combined value of all of venture’s financing, typically equity plus all of the deb

25. The enterprise value includes the value of the debt, equity, and warrant pieces of a venture.

Note: The following TF questions relate to Learning Supplements 14A and 14B:

1. An alternative approach to the Enterprise Valuation method adds the tax shield from paying interest back into the flows and discounts at a before-tax weighted average cost of capital.

2. Warrant valuation (as presented in this text) is similar to option valuation except that one applies a dilution factor to the option value to arrive at a warrant value.

3. The unadjusted Black and Scholes model is a model for determining the value of a warrant to buy a new share.

4. The Black and Scholes model requires the stock price as an inpu

5. The Black and Scholes model requires the inflation rate as an inpu

6. The Black and Scholes model requires an exercise price as an inpu

Multiple-Choice Questions

1. Which of the following have the least senior claim on a venture’s asset?
a. common Stock
b. preferred stock
c. convertible preferred stock
d. convertible debt
e. American-style option

2. The right for existing owners to maintain their ownership share by purchasing sufficient shares to keep their percentage share of the firm is called:
a. stock option
b. stock warrant
c. preemptive right
d. participating stock
e. paid-in-kind preferred stock

3. Which of the following stock can be structured to assure the shareholder that they will share in the payment of any dividends to common stockholders?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

4. Which of the following provides the option to transform preferred stock into common stock?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

5. Which of the following offers the option where the dividend obligation can be satisfied in cash or by issuing additional par amounts of the preferred security?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

6. Which of the following requires that all previously unpaid preferred dividends must be paid prior to any common dividend?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

7. Which of the following is never a component of a preferred stock’s security structure?
a. the right to participate in any dividends paid to common stock shareholders
b. payment of dividends in the form of additional shares of preferred stock
c. the option for the holder to convert preferred stock into common stock
d. the option for the venture to call outstanding preferred stock
e. none of the above; all of these may be included in the structure of
preferred stock

8. A round of financing where shares sell for a lower price than previous rounds is known as a:
a. down round
b. recessive round
c. reset round
d. a and c

9. Which of the following are components of common equity?
a. common stock
b. preferred stock
c. a and b
d. none of the above

10. Convertible debt has all of the following except:
a. bankruptcy rights
b. regular dividend payments
c. it can be structured to provide senior interest in specific assets
d. a tax shield due to interest expense
e. a security interest in the firms’ assets

11. Which of the following is not a type of option?
a. call option
b. put option
c. warrant
d. LBO

12. The right to buy a specified asset at a specified price on a specified date is called:
a. a forward contract
b. an American-style put option
c. an American-style call option
d. a European-style call option
e. a European style put option

13. The right to sell a specified asset at a specified price up until a specified date is called:
a. a forward contract
b. an American-style put option
c. an American-style call option
d. a European-style call option
e. a European style put option

14. An option that can be exercised at any time until its expiration is called a:
a. forward contract
b. lookback option
c. American-style option
d. European-style option
e. Bermuda-style option

15. An option that can be exercised only at its expiration date is called a:
a. forward contract
b. lookback option
c. American-Style option
d. European-Style option
e. Bermuda-Style option

16. An option that can be exercised only at a specific set of dates is called a:
a. forward contract
b. lookback option
c. American-Style option
d. European-Style option
e. Bermuda-Style option

17. Which of the following is an example of a call option which is out of the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

18. Which of the following is an example of a call option which is in the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

19. Which of the following is an example of a put option which is out of the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

20. Which of the following is an example of a put option which is in the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

21. Which of the following is an example of a put option which is at the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to sell at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12

22. Generally speaking, warrants are call options that allow the holder to purchase what type of security at a specific price?
a. common stock
b. preferred stock
c. convertible debt
d. none of the above

23. To calculate the enterprise valuation cash flow, one begins with which of the following items from the income statement?
a. net sales
b. operating profit
c. (earnings before interest and taxes) × (1 – enterprise tax rate)
d. net income
e. net income times the enterprise tax rate

24. When consistent assumptions are used, we
a. get the same value for equity under the enterprise and equity methods of valuation
b. we get a higher value of equity under the equity method of valuation
c. we get a lower value of equity under the equity method of valuation
d. we get equity values that cannot be compared across the equity and enterprise methods of valuation

Note: The following MC questions relate to Learning Supplement 14B:

1. The Black and Scholes model is intended to be used to value
a. stocks
b. bonds
c. options
d. futures contracts

2. Which of the following is not an input to the Black and Scholes model?
a. earnings per share
b. stock price
c. risk free rate
d. volatility

3. N(h) in the Black and Scholes model involves the use of
a. the number of shares issued
b. the next time that a venture capitalist will invest money
c. the normal distribution cumulative density function
d. the number of times that the venture will have to raise money

CHAPTER 15

HARVESTING THE BUSINESS VENTURE INVESTMENT

True–False Questions

1. The process of exiting the privately held business venture to unlock the owners’ investment value is known as harvesting.

2. When harvesting a venture, the methodical distribution of assets directly to the owners is known as a systematic liquidation.

3. When harvesting a venture, the outright purchase of the going concern by managers, employees, or external buyers is known as going public.

4. When harvesting a venture, the two-step public equity registration and sale is known as an outright sale.

5. When an initial business plan is prepared, attention should be paid to the investors’ and founders’ desire for eventual liquidity by anticipating a harvest for the venture investors.

6. An advantage of an exit strategy that pays out the venture’s investment value over several years can make it more difficult for entrepreneurs to start a new venture because adequate capital has not been released from the existing venture.

7. When an industry is in decline, systematic liquidation is typically the most attractive harvest strategy.

8. Exit values for many mature ventures are usually determined by (1) discounted cash flow (DCF) methods or (2) relative valuation models based on some form of multiples analysis.

9. In determining a harvest value, non-monetary items such as culture, managerial succession, and employee retention are not factored in.

10. Harvesting is the process of exiting the privately held business venture to unlock the owners’ investment value.

11. Valuation methods that estimate a firm’s worth using value-related multiples of comparable firms are sometimes known as “relative value methods.”

12. The two discounted cash flow (DCF) methods covered in this text are the enterprise method and the debt funds method.

13. One method of harvesting a venture is through systematic distribution of assets directly to the owners.

14. One method of harvesting a successful venture is through systematic distribution of assets directly to lenders.

15. Other than when the venture is operating in a declining industry, it is difficult to think of cases where the disadvantages of liquidation outweigh the advantages.

16. A special type of harvesting process where the firm’s top management continues to run the firm and has a substantial equity position in the reorganized firm is known as a leveraged buyou

17. A leveraged buyout (LBO) takes place when the purchase price of a firm is financed largely with debt financial capital.

18. Ultimately for harvesting purposes, we need to decide on the venture’s value at exit and how that exit value pie will be divided up among investors.

19. An “initial public offering” is the only method used by entrepreneurs when exiting a venture.

20. A management buyout (MBO) is a special type of leveraged buyout (LBO).

21. A leveraged buyout (LBO) is a special type of management buyout (MBO).

22. ESOP stands for “employee stock ownership plan.”

23. An obligatory disclaimer disavowing any intent to act as an offer to sell, or solicit an offer to buy securities is known as a red herring.

24. The sale of new shares of common stock is a secondary offering.

25. The sale of used shares of common stock is a secondary market offering.

26. Most companies choose “best efforts” agreements in order to minimize the inherent risks of going public.

27. IPO underpricing results in a direct loss to the venture’s owners.

28. While not a direct loss to a venture, underpricing can represent a significant opportunity cost to the venture’s owners.

29. A “lockup provision” prohibits insiders from selling their existing shares for a specified period of time.

30. In a typical venture’s life cycle, the rapid-growth stage involves managing ongoing operations, maintaining and adding value, and obtaining seasoned financing.

31. In a typical venture’s life cycle, the examining of exit opportunities often occur during the rapid-growth stage.

Multiple-Choice Questions

1. Which of the following is not a way to harvest a venture?
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

2. When registering equity and selling it via an IPO of new shares followed by a secondary offering of existing shares, this venture harvesting process is known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

3. The acquisition of the venture by family members, managers, or outside buyers is a venture harvesting process known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

4. The distribution of the venture’s cash flows directly to the owners is a venture harvesting process known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

5. Which of the following is not an advantage of a systematic liquidation?
a. maintaining control throughout the harvest period
b. harvesting of the investment value can be spread out over a number of years
c. the taxation treatment of liquidation proceeds as ordinary income
d. the time, effort, and costs of finding a buyer for the venture can be avoided

6. Which of the following is not a disadvantage of a systematic liquidation?
a. the treatment and taxation of liquidation proceeds as ordinary income rather than capital gains
b. the commitment of the entrepreneur’s resources and focus on a dying venture rather than on other more lucrative ventures
c. the harvesting of the investment gets spread out over a number of years
d. the acceleration of the venture’s rate of decline as other industry participants respond to the reduction in investment

7. A venture can be harvested in which of the following ways?
a.. systematic liquidation, outright sale, going public
b. outright sale, going public, acquisition
c. going public, acquisition
d. acquisition, systematic liquidation

8. Which of the following is not a candidate for a leveraged buyout?
a. a venture with stable and adequate operating cash flows
b. a venture with a high amount of equity relative to debt
c. a venture with the ability to protect market share
d. a venture with a high debt ratio

9. Which of the following is the premium that would be applied to venture valuation due to an investor’s majority ownership of a venture?
a. proxy premium
b. control premium
c. influence premium
d. liquidity premium
e. illiquidity premium

10. Shares registered with the Securities and Exchange Commission and state securities regulators and sold to the public are known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

11. In an outright sale of a venture, the venture can be sold to:
a. family members
b. managers
c. employees
d. outside (external) buyers
e. all of the above

12. The sale of new securities is known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

13. The sale of used shares is known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

14. The NYSE participates in:
a. the sale of new securities to private investors
b. primary offerings
c. secondary offerings
d. b and c

15. In the investment banking process, which of the following is a duty of the investment bank?
a. to be the targeted investors for a firm’s securities
b. to provide banking services such as checking accounts to firms
c. to find buyers for a firm’s securities
d. both a and b
e. all of the above

16. Based on the following information, estimate the percentage appreciation on stock bought by the venture investors: founders’ purchase price $.50; venture investors’ purchase price $2.00; current stock price $10.00; founders holding period = 5 years; venture investors holding period = 3 years.
a. 100%
b. 400%
c. 600%
d. 800%

17. Based on the following information, estimate the percentage appreciation on stock bought by the founders: founders’ purchase price $1.00; venture investors’ purchase price $2.00; current stock price $10.00; founders holding period = 5 years; venture investors holding period = 3 years.
a. 100%
b. 400%
c. 600%
d. 900%

18. Assume that a venture is expected to have an EBITDA of $1,500,000 at the end of five years from now. If the venture’s value is expected to be $12,000,000, what “valuation multiple” was being assumed?
a. 1 time
b. 4 times
c. 8 times
d. 10 times
e. 12 times

19. A venture is expected to have an exit value of $10,000,000 two years from now. If venture investors invest $2,000,000 now, and expect a 20% compounded rate of return on their investment, what portion of the exit value would they need?
a. 10%
b. 20.2%
c. 25%
d. 28.8%
e. 32%

20. A venture is expected to have an exit value of $10,000,000 five years from now. If venture investors invest $1,000,000 now, and expect a 20% compounded rate of return on their investment, what portion of the exit value would they need?
a. 10.5%
b. 20.1%
c. 24.9%
d. 28.8%
e. 32.5%

21. If venture investors invest $1,000,000 now, will receive 50% of the exit value, and expect a 20% compounded rate of return on their investment, what will be the amount of the exit value at the end of two years?
a. $1,000,000
b. $1,440,000
c. $2,880,000
d. $5,000,000
e. $5,760,000

22. If venture investors invest $1,000,000 now, will receive 25% of the exit value, and expect a 20% compounded rate of return on their investment, what is the approximate expected exit value at the end of five years?
a. $1,000,000
b. $2,490,000
c. $4,980,000
d. $7,470,000
e. $9,950,000

23. If venture investors invest $6,750,000 now, will receive 32% of the exit value, and expect a 22% compounded rate of return on their investment, what is the exit value at the end of seven years?
a. $27,153,298
b. $39,931,321
c. $69,552,505
d. $84,854,057
e. $103,521,949

24. The difference between what the investment bank gets from selling securities to public investors and what they pay to the issuing firm is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

25. A type of agreement with an investment bank employing only marketing and distribution efforts without the actual transfer of securities ownership to the investment banking syndicate is called:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

26. An agreement with an investment bank that involves the purchase and distribution of new securities is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

27. The investment banks process of ascertaining, to the extent possible, an issuing firm’s financial condition and investment intent is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

28. The arrangement where an underwriter has the option of selling additional shares when the issue is heavily oversubscribed is known as
a. green shoe
b. red herring
c. best efforts
d. lockup

29. Which of the following describes when a syndicate’s offering price is less than the market price immediately following the offering?
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

30. In the aftermarket trading for the venture’s securities, an order that is to be executed as soon as possible at the prevailing market price is known as a:
a. put order
b. market order
c. limit order
d. stop order

31. In the aftermarket trading for the venture’s securities, an order that converts to a market order once a certain price is achieved is known as a:
a. put order
b. market order
c. limit order
d. stop order

32. An order to purchase stock that can be executed only at a specified price or better is called a:
a. market order
b. limit order
c. stop order
d. stock order
e. private order

33. Which of the following is not a type of trading order?
a. market order
b. limit order
c. stop order
d. none of the above

34. The letters IPO stand for:
a. investment pricing organization
b. initial public offering
c. institutional pricing overhead
d. immediate pricing opportunity

35. The negotiated period around an equity securities offering during which insiders are prohibited from selling their existing shares is called:
a. a seasoned offering
b. an unseasoned offering
c. underpricing
d. an underwriting spread
e. a lockup provision

36. An initial public offering (IPO) involves:
a. sale of new securities to private investors
b. sale of used securities to the public
c. a venture’s first offering of SEC-registered securities to the public
d. all of the above
e. none of the above

37. The type of agreement with an investment bank involving the investment bank’s underwritten purchase and resale of securities is called:
a. firm commitment
b. best efforts commitment
c. due diligence
d. making a red herring disclaimer
e. a private placement

FIN 320 Complete Test Bank – Strayer – A+ Graded

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Chapters 1 Through 8
1
Student: ___________________________________________________________________________
1. Financial assets represent _____ of total assets of U.S. households.

A. over 60%

B. over 90%

C. under 10%

D. about 30%

2. Real assets in the economy include all but which one of the following?

A. Land

B. Buildings

C. Consumer durables

D. Common stock

3. Net worth represents _____ of the liabilities and net worth of commercial banks.

A. about 51%

B. about 91%

C. about 11%

D. about 31%

4. According to the Flow of Funds Accounts of the United States, the largest single asset of U.S. households is ___.

A. mutual fund shares

B. real estate

C. pension reserves

D. corporate equity

5. According to the Flow of Funds Accounts of the United States, the largest liability of U.S. households is ________.

A. mortgages

B. consumer credit

C. bank loans

D. gambling debts

6. ____ is not a derivative security.

A. A share of common stock

B. A call option

C. A futures contract

D. None of these options (All of the answers are derivative securities.)

7. According to the Flow of Funds Accounts of the United States, the largest financial asset of U.S. households is ____.

A. mutual fund shares

B. corporate equity

C. pension reserves

D. personal trusts

8. Active trading in markets and competition among securities analysts helps ensure that:

I. Security prices approach informational efficiency
II. Riskier securities are priced to offer higher potential returns
III. Investors are unlikely to be able to consistently find under- or overvalued securities

A. I only

B. I and II only

C. II and III only

D. I, II, and III

9. The material wealth of society is determined by the economy’s _________, which is a function of the economy’s _________.

A. investment bankers; financial assets

B. investment bankers; real assets

C. productive capacity; financial assets

D. productive capacity; real assets

10. Which of the following is not a money market security?

A. U.S. Treasury bill

B. 6-month maturity certificate of deposit

C. Common stock

D. Bankers’ acceptance

11. __________ assets generate net income to the economy, and __________ assets define allocation of income among investors.

A. Financial, financial

B. Financial, real

C. Real, financial

D. Real, real

12. Which of the following are financial assets?

I. Debt securities
II. Equity securities
III. Derivative securities

A. I only

B. I and II only

C. II and III only

D. I, II, and III

13. __________ are examples of financial intermediaries.

A. Commercial banks

B. Insurance companies

C. Investment companies

D. All of these options

14. Asset allocation refers to _________.

A. the allocation of the investment portfolio across broad asset classes

B. the analysis of the value of securities

C. the choice of specific assets within each asset class

D. none of these options

15. Which one of the following best describes the purpose of derivatives markets?

A. Transferring risk from one party to another

B. Investing for a short time period to earn a small rate of return

C. Investing for retirement

D. Earning interest income

16. More than _____________ of currency is traded each day in the market for foreign exchange.

A. $300 million

B. $1 billion

C. $30 billion

D. $1 trillion

17. Security selection refers to the ________.

A. allocation of the investment portfolio across broad asset classes

B. analysis of the value of securities

C. choice of specific securities within each asset class

D. top-down method of investing

18. Which of the following is an example of an agency problem?

A. Managers engage in empire building.

B. Managers protect their jobs by avoiding risky projects.

C. Managers over consume luxuries such as corporate jets.

D. All of these options are examples of agency problems.

19. _____ is a mechanism for mitigating potential agency problems.

A. Tying income of managers to success of the firm

B. Directors defending top management

C. Antitakeover strategies

D. The straight voting method of electing the board of directors

20. __________ is (are) real assets.

A. Bonds

B. Production equipment

C. Stocks

D. Commercial paper

21. __________ portfolio construction starts with selecting attractively priced securities.

A. Bottom-up

B. Top-down

C. Upside-down

D. Side-to-side

22. In a market economy, capital resources are primarily allocated by ____________.

A. governments

B. the SEC

C. financial markets

D. investment bankers

23. __________ represents an ownership share in a corporation.

A. A call option

B. Common stock

C. A fixed-income security

D. Preferred stock

24. The value of a derivative security _________.

A. depends on the value of another related security

B. affects the value of a related security

C. is unrelated to the value of a related security

D. can be integrated only by calculus professors

25. Commodity and derivative markets allow firms to adjust their _________.

A. management styles

B. focus from their main line of business to their investment portfolios

C. ways of doing business so that they’ll always have positive returns

D. exposure to various business risks

26. __________ portfolio management calls for holding diversified portfolios without spending effort or resources attempting to improve investment performance through security analysis.

A. Active

B. Momentum

C. Passive

D. Market-timing

27. Financial markets allow for all but which one of the following?

A. Shift consumption through time from higher-income periods to lower

B. Price securities according to their riskiness

C. Channel funds from lenders of funds to borrowers of funds

D. Allow most participants to routinely earn high returns with low risk

28. Financial intermediaries exist because small investors cannot efficiently _________.

A. diversify their portfolios

B. gather information

C. monitor their portfolios

D. all of these options

29. Methods of encouraging managers to act in shareholders’ best interest include:

I. Threat of takeover
II. Proxy fights for control of the board of directors
III. Tying managers’ compensation to stock price performance

A. I only

B. I and II only

C. II and III only

D. I, II, and III

30. Firms that specialize in helping companies raise capital by selling securities to the public are called _________.

A. pension funds

B. investment banks

C. savings banks

D. REITs

31. In securities markets, there should be a risk-return trade-off with higher-risk assets having _________ expected returns than lower-risk assets.

A. higher

B. lower

C. the same

D. The answer cannot be determined from the information given.

32. When the market is more optimistic about a firm, its share price will ______; as a result, it will need to issue _______ shares to raise funds that are needed.

A. rise; fewer

B. fall; fewer

C. rise; more

D. fall; more

33. Security selection refers to _________.

A. choosing specific securities within each asset class

B. deciding how much to invest in each asset class

C. deciding how much to invest in the market portfolio versus the riskless asset

D. deciding how much to hedge

34. An example of a derivative security is _________.

A. a common share of General Motors

B. a call option on Intel stock

C. a Ford bond

D. a U.S. Treasury bond

35. __________ portfolio construction starts with asset allocation.

A. Bottom-up

B. Top-down

C. Upside-down

D. Side-to-side

36. Which one of the following firms falsely claimed to have a $4.8 billion bank account at Bank of America and vastly understated its debts, eventually resulting in the firm’s bankruptcy?

A. WorldCom

B. Enron

C. Parmalat

D. Global Crossing

37. Debt securities promise:

I. A fixed stream of income
II. A stream of income that is determined according to a specific formula
III. A share in the profits of the issuing entity

A. I only

B. I or II only

C. I and III only

D. II or III only

38. The Sarbanes-Oxley Act tightened corporate governance rules by requiring all but which one of the following?

A. Required that corporations have more independent directors

B. Required that the CFO personally vouch for the corporation’s financial statements

C. Required that firms could no longer employ investment bankers to sell securities to the public

D. Required the creation of a new board to oversee the auditing of public companies

39. The success of common stock investments depends on the success of _________.

A. derivative securities

B. fixed-income securities

C. the firm and its real assets

D. government methods of allocating capital

40. The historical average rate of return on large company stocks since 1926 has been _____.

A. 5%

B. 8%

C. 12%

D. 20%

41. The average rate of return on U.S. Treasury bills since 1926 was _________.

A. less than 1%

B. less than 3%

C. less than 4%

D. less than 7%

42. An example of a real asset is:

I. A college education
II. Customer goodwill
III. A patent

A. I only

B. II only

C. I and III only

D. I, II, and III

43. The 2002 law designed to improve corporate governance is titled the _____.

A. Pension Reform Act

B. ERISA

C. Financial Services Modernization Act

D. Sarbanes-Oxley Act

44. Which of the following is not a financial intermediary?

A. a mutual fund

B. an insurance company

C. a real estate brokerage firm

D. a savings and loan company

45. The combined liabilities of American households represent approximately __________ of combined assets.

A. 11%

B. 19%

C. 25%

D. 33%

46. In 2011 real assets represented approximately __________ of the total asset holdings of American households.

A. 32%

B. 42%

C. 48%

D. 55%

47. In 2011 mortgages represented approximately __________ of total liabilities and net worth of American households.

A. 12%

B. 14%

C. 28%

D. 42%

48. Liabilities equal approximately _____ of total assets for nonfinancial U.S. businesses.

A. 10%

B. 25%

C. 48%

D. 75%

49. Which of the following is not an example of a financial intermediary?

A. Goldman Sachs

B. Allstate Insurance

C. First Interstate Bank

D. IBM

50. Real assets represent about ____ of total assets for commercial banks.

A. 1%

B. 15%

C. 25%

D. 40%

51. Money market securities are characterized by:

I. Maturity less than 1 year
II. Safety of the principal investment
III. Low rates of return

A. I only

B. I and II only

C. I and III only

D. I, II, and III

52. After much investigation, an investor finds that Intel stock is currently underpriced. This is an example of ______.

A. asset allocation

B. security analysis

C. top-down portfolio management

D. passive management

53. After considering current market conditions, an investor decides to place 60% of her funds in equities and the rest in bonds. This is an example of _____.

A. asset allocation

B. security analysis

C. top-down portfolio management

D. passive management

54. Suppose an investor is considering one of two investments that are identical in all respects except for risk. If the investor anticipates a fair return for the risk of the security he invests in, he can expect to _____.

A. earn no more than the Treasury-bill rate on either security.

B. pay less for the security that has higher risk.

C. pay less for the security that has lower risk.

D. earn more if interest rates are lower.

55. The efficient market hypothesis suggests that _______.

A. active portfolio management strategies are the most appropriate investment strategies

B. passive portfolio management strategies are the most appropriate investment strategies

C. either active or passive strategies may be appropriate, depending on the expected direction of the market

D. a bottom-up approach is the most appropriate investment strategy

56. In a perfectly efficient market the best investment strategy is probably _____.

A. an active strategy.

B. a passive strategy.

C. asset allocation.

D. market timing.

57. Market signals will help to allocate capital efficiently only if investors are acting _____.

A. on the basis of their individual hunches.

B. as directed by financial experts.

C. as dominant forces in the economy.

D. on accurate information.

58. Which of the following is (are) true about hedge funds?

I. They are open to institutional investors.
II. They are open to wealthy individuals.
III. They are more likely than mutual funds to pursue simple strategies.

A. I and II only

B. I and III only

C. II and III only

D. I, II, and III

59. Venture capital is _________.

A. frequently used to expand the businesses of well-established companies

B. supplied by venture capital funds and individuals to start-up companies

C. illegal under current U.S. laws

D. most frequently issued with the help of investment bankers

60. Individuals may find it more advantageous to purchase claims from a financial intermediary rather than directly purchasing claims in capital markets because:

I. Intermediaries are better diversified than most individuals
II. Intermediaries can exploit economies of scale in investing that individual investors cannot
III. Intermediated investments usually offer higher rates of return than direct capital market claims

A. I only

B. I and II only

C. II and III only

D. I, II, and III

61. Surf City Software Company develops new surf forecasting software. It sells the software to Microsoft in exchange for 1,000 shares of Microsoft common stock. Surf City Software has exchanged a _____ asset for a _____ asset in this transaction.

A. real; real

B. financial; financial

C. real; financial

D. financial; real

62. Stone Harbor Products takes out a bank loan. It receives $100,000 and signs a promissory note to pay back the loan over 5 years. In this transaction, _____.

A. a new financial asset was created

B. a financial asset was traded for a real asset

C. a financial asset was destroyed

D. a real asset was created

63. Which of the following firms was not engaged in a major accounting scandal between 2000 and 2005?

A. General Electric

B. Parmalat

C. Enron

D. WorldCom

64. Accounting scandals can often be attributed to a particular concept in the study of finance known as the _____.

A. agency problem

B. risk-return trade-off

C. allocation of risk

D. securitization

65. An intermediary that pools and manages funds for many investors is called ______.

A. an investment company

B. a savings and loan

C. an investment banker

D. a commercial bank

66. Financial institutions that specialize in assisting corporations in primary market transactions are called _______.

A. mutual funds

B. investment bankers

C. pension funds

D. globalization specialists

67. When a pass-through mortgage security is issued, what does the issuing agency expect to receive?

A. The amount of the original loan plus a servicing fee

B. The principal and interest that are paid by the homeowner

C. The principal and interest that are paid by the homeowner, minus a servicing fee

D. The interest paid by the homeowner, plus a servicing fee

68. In 2008 the largest corporate bankruptcy in U.S. history involved the investment banking firm of ______.

A. Goldman Sachs

B. Lehman Brothers

C. Morgan Stanley

D. Merrill Lynch

69. The inability of shareholders to influence the decisions of managers, despite overwhelming shareholder support, is a breakdown in what process or mechanism?

A. Auditing

B. Public finance

C. Corporate governance

D. Public reporting

70. Real assets are ______.

A. assets used to produce goods and services

B. always the same as financial assets

C. always equal to liabilities

D. claims on a company’s income

71. A major cause of mortgage market meltdown in 2007 and 2008 was linked to ________.

A. private equity investments

B. securitization

C. negative analyst recommendations

D. online trading

72. In recent years the greatest dollar amount of securitization occurred for which type of loan?

A. Home mortgages

B. Credit card debt

C. Automobile loans

D. Equipment leasing

73. Which of the following is (are) true about nonconforming mortgage loans?

A. They are also known as subprime loans.

B. They have higher default risk than conforming loans.

C. They were able to be offered without due diligence.

D. All of these options are true.

74. The systemic risk that led to the financial crisis of 2008 was increased by _____.

A. collateralized debt obligations

B. subprime mortgages

C. credit default swaps

D. all of the options

75. An investment adviser has decided to purchase gold, real estate, stocks, and bonds in equal amounts. This decision reflects which part of the investment process?

A. Asset allocation

B. Investment analysis

C. Portfolio analysis

D. Security selection

2
Student: ___________________________________________________________________________
1. Which of the following is not a money market instrument?

A. Treasury bill

B. Commercial paper

C. Preferred stock

D. Bankers’ acceptance

2. T-bills are issued with initial maturities of:

I. 4 weeks
II. 16 weeks
III. 26 weeks
IV. 32 weeks

A. I and II only

B. I and III only

C. I, II, and III only

D. I, II, III, and IV

3. When computing the bank discount yield, you would use ____ days in the year.

A. 260

B. 360

C. 365

D. 366

4. A dollar-denominated deposit at a London bank is called _____.

A. eurodollars

B. LIBOR

C. fed funds

D. bankers’ acceptance

5. Money market securities are sometimes referred to as cash equivalents because _____.

A. they are safe and marketable

B. they are not liquid

C. they are high-risk

D. they are low-denomination

6. The most marketable money market security is _____.

A. Treasury bills

B. bankers’ acceptances

C. certificates of deposit

D. common stock

7. The minimum tick size, or spread between prices in the Treasury bond market, is

A. 1/8 of a point.

B. 1/16 of a point.

C. 1/32 of a point.

D. 1/64 of a point.

8. An investor in a T-bill earns interest by _________.

A. receiving interest payments every 90 days

B. receiving dividend payments every 30 days

C. converting the T-bill at maturity into a higher-valued T-note

D. buying the bill at a discount from the face value to be received at maturity

9. ______ would not be included in the EAFE index.

A. Australia

B. Canada

C. France

D. Japan

10. _____ is considered to be an emerging market country.

A. France

B. Norway

C. Brazil

D. Canada

11. Which one of the following is a true statement?

A. Dividends on preferred stocks are tax-deductible to individual investors but not to corporate investors.

B. Common dividends cannot be paid if preferred dividends are in arrears on cumulative preferred stock.

C. Preferred stockholders have voting power.

D. Investors can sue managers for nonpayment of preferred dividends.

12. The bid price of a Treasury bill is _________.

A. the price at which the dealer in Treasury bills is willing to sell the bill

B. the price at which the dealer in Treasury bills is willing to buy the bill

C. greater than the ask price of the Treasury bill expressed in dollar terms

D. the price at which the investor can buy the Treasury bill

13. The German stock market is measured by which market index?

A. FTSE

B. Dow Jones 30

C. DAX

D. Nikkei

14. Deposits of commercial banks at the Federal Reserve are called _____.

A. bankers’ acceptances

B. federal funds

C. repurchase agreements

D. time deposits

15. Which of the following is not a true statement regarding municipal bonds?

A. A municipal bond is a debt obligation issued by state or local governments.

B. A municipal bond is a debt obligation issued by the federal government.

C. The interest income from a municipal bond is exempt from federal income taxation.

D. The interest income from a municipal bond is exempt from state and local taxation in the issuing state.

16. Which of the following is not a characteristic of a money market instrument?

A. Liquidity

B. Marketability

C. Low risk

D. Maturity greater than 1 year

17. An individual who goes short in a futures position _____.

A. commits to delivering the underlying commodity at contract maturity

B. commits to purchasing the underlying commodity at contract maturity

C. has the right to deliver the underlying commodity at contract maturity

D. has the right to purchase the underlying commodity at contract maturity

18. Which of the following is not a nickname for an agency associated with the mortgage markets?

A. Fannie Mae

B. Freddie Mac

C. Sallie Mae

D. Ginnie Mae

19. Commercial paper is a short-term security issued by __________ to raise funds.

A. the Federal Reserve

B. the New York Stock Exchange

C. large well-known companies

D. all of these options

20. The maximum maturity on commercial paper is _____.

A. 270 days

B. 180 days

C. 90 days

D. 30 days

21. Which one of the following is a true statement regarding the Dow Jones Industrial Average?

A. It is a value-weighted average of 30 large industrial stocks.

B. It is a price-weighted average of 30 large industrial stocks.

C. It is a price-weighted average of 100 large stocks traded on the New York Stock Exchange.

D. It is a value-weighted average of all stocks traded on the New York Stock Exchange.

22. Treasury bills are financial instruments issued by __________ to raise funds.

A. commercial banks

B. the federal government

C. large corporations

D. state and city governments

23. Which of the following are true statements about T-bills?

I. T-bills typically sell in denominations of $10,000.
II. Income earned on T-bills is exempt from all federal taxes.
III. Income earned on T-bills is exempt from state and local taxes.

A. I only

B. I and II only

C. I and III only

D. I, II, and III

24. A bond that has no collateral is called a _________.

A. callable bond

B. debenture

C. junk bond

D. mortgage

25. A __________ gives its holder the right to sell an asset for a specified exercise price on or before a specified expiration date.

A. call option

B. futures contract

C. put option

D. interest rate swap

26. A T-bill quote sheet has 90-day T-bill quotes with a 4.92 bid and a 4.86 ask. If the bill has a $10,000 face value, an investor could buy this bill for _____.

A. $10,000

B. $9,878.50

C. $9,877

D. $9,880.16

27. Which one of the following is a true statement regarding corporate bonds?

A. A corporate callable bond gives its holder the right to exchange it for a specified number of the company’s common shares.

B. A corporate debenture is a secured bond.

C. A corporate convertible bond gives its holder the right to exchange it for a specified number of the company’s common shares.

D. Holders of corporate bonds have voting rights in the company.

28. The yield on tax-exempt bonds is ______.

A. usually less than 50% of the yield on taxable bonds

B. normally about 90% of the yield on taxable bonds

C. greater than the yield on taxable bonds

D. less than the yield on taxable bonds

29. __________ is not a money market instrument.

A. A certificate of deposit

B. A Treasury bill

C. A Treasury bond

D. Commercial paper

30. An investor buys a T-bill at a bank discount quote of 4.80 with 150 days to maturity. The investor’s actual annual rate of return on this investment is _____.

A. 4.8%

B. 4.97%

C. 5.47%

D. 5.74%

31. The U.K. stock index is the _________.

A. DAX

B. FTSE

C. GSE

D. TSE

32. A __________ gives its holder the right to buy an asset for a specified exercise price on or before a specified expiration date.

A. call option

B. futures contract

C. put option

D. interest rate swap

33. Which one of the following provides the best example of securitization?

A. Convertible bond

B. Call option

C. Mortgage pass-through security

D. Preferred stock

34. Which of the following indexes are market value-weighted?

I. The NYSE Composite
II. The S&P 500
III. The Wilshire 5000

A. I and II only

B. II and III only

C. I and III only

D. I, II, and III

35. The interest rate charged by large banks in London to lend money among themselves is called _________.

A. the prime rate

B. the discount rate

C. the federal funds rate

D. LIBOR

36. A firm that has large securities holdings and wishes to raise money for a short length of time may be able to find the cheapest financing from which of the following?

A. Reverse repurchase agreement

B. Bankers’ acceptance

C. Commercial paper

D. Repurchase agreement

37. Currently, the Dow Jones Industrial Average is computed by _________.

A. adding the prices of 30 large “blue-chip” stocks and dividing by 30

B. calculating the total market value of the 30 firms in the index and dividing by 30

C. measuring the current total market value of the 30 stocks in the index relative to the total value on the previous day

D. adding the prices of 30 large “blue-chip” stocks and dividing by a divisor adjusted for stock splits and large stock dividends

38. An investor purchases one municipal bond and one corporate bond that pay rates of return of 5% and 6.4%, respectively. If the investor is in the 15% tax bracket, his after-tax rates of return on the municipal and corporate bonds would be, respectively, _____.

A. 5% and 6.4%

B. 5% and 5.44%

C. 4.25% and 6.4%

D. 5.75% and 5.44%

39. If a Treasury note has a bid price of $996.25, the quoted bid price in the Wall Street Journal would be _________.

A. 99:25

B. 99:63

C. 99:20

D. 99:08

40. TIPS are ______.

A. Treasury bonds that pay no interest and are sold at a discount

B. U.K. bonds that protect investors from default risk

C. securities that trade on the Toronto stock index

D. Treasury bonds that protect investors from inflation

41. The price quotations of Treasury bonds in the Wall Street Journal show a bid price of 102:12 and an ask price of 102:14. If you sell a Treasury bond, you expect to receive _________.

A. $1,024.75

B. $1,024.38

C. $1,023.75

D. $1,022.50

42. The Dow Jones Industrial Average is _________.

A. a price-weighted average

B. a value weight and average

C. an equally weighted average

D. an unweighted average

43. Investors will earn higher rates of returns on TIPS than on equivalent default-risk standard bonds if _______________.

A. inflation is lower than anticipated over the investment period

B. inflation is higher than anticipated over the investment period

C. the U.S. dollar increases in value against the euro

D. the spread between commercial paper and Treasury securities remains low

44. Preferred stock is like long-term debt in that ___________.

A. it gives the holder voting power regarding the firm’s management

B. it promises to pay to its holder a fixed stream of income each year

C. the preferred dividend is a tax-deductible expense for the firm

D. in the event of bankruptcy preferred stock has equal status with debt

45. Which of the following does not approximate the performance of a buy-and-hold portfolio strategy?

A. An equally weighted index

B. A price-weighted index

C. A value-weighted index

D. All of these options (Weights are not a factor in this situation.)

46. In calculating the Dow Jones Industrial Average, the adjustment for a stock split occurs _________.

A. automatically

B. by adjusting the divisor

C. by adjusting the numerator

D. by adjusting the market value weights

47. Suppose the market prices of the 30 stocks in the Dow Jones Industrial Average all change by the same dollar amount on a given day. Assuming there are no stock splits, which stock will have the greatest impact on the average?

A. The one with the highest price

B. The one with the lowest price

C. All 30 stocks will have the same impact.

D. The answer cannot be determined from the information given.

48. A bond issued by the state of Alabama is priced to yield 6.25%. If you are in the 28% tax bracket, this bond would provide you with an equivalent taxable yield of _________.

A. 4.5%

B. 7.25%

C. 8.68%

D. none of these options

49. The purchase of a futures contract gives the buyer _________.

A. the right to buy an item at a specified price

B. the right to sell an item at a specified price

C. the obligation to buy an item at a specified price

D. the obligation to sell an item at a specified price

50. Ownership of a put option entitles the owner to the __________ to ___________ a specific stock, on or before a specific date, at a specific price.

A. right; buy

B. right; sell

C. obligation; buy

D. obligation; sell

51. An investor in a 28% tax bracket is trying to decide whether to invest in a municipal bond or a corporate bond. She looks up municipal bond yields (rm) but wishes to calculate the taxable equivalent yield r. The formula she should use is given by ______.

A. r = rm × (1 – 28%)

B. r = rm/(1 – 72%)

C. r = rm × (1 – 72%)

D. r = rm/(1 – 28%)

52. June call and put options on King Books Inc. are available with exercise prices of $30, $35, and $40. Among the different exercise prices, the call option with the _____ exercise price and the put option with the _____ exercise price will have the greatest value.

A. $40; $30

B. $30; $40

C. $35; $35

D. $40; $40

53. Ownership of a call option entitles the owner to the __________ to __________ a specific stock, on or before a specific date, at a specific price.

A. right; buy

B. right; sell

C. obligation; buy

D. obligation; sell

54. The ________ the ratio of municipal bond yields to corporate bond yields, the _________ the cutoff tax bracket at which more individuals will prefer to hold municipal debt.

A. higher; lower

B. lower; lower

C. higher; higher

D. The answer cannot be determined without more information.

55. Which of the following types of bonds are excluded from most bond indexes?

A. Corporate bonds

B. Junk bonds

C. Municipal bonds

D. None of these options

56. The Hang Seng index reflects market performance on which of the following major stock markets?

A. Japan

B. Singapore

C. Taiwan

D. Hong Kong

57. The Standard & Poor’s 500 is __________ weighted index.

A. an equally

B. a price-

C. a value-

D. a share-

58. A firm that fails to pay dividends on its preferred stock is said to be _________.

A. insolvent

B. in arrears

C. insufferable

D. delinquent

59. Large well-known companies often issue their own short-term unsecured debt notes directly to the public, rather than borrowing from banks; their notes are called _________.

A. certificates of deposit

B. repurchase agreements

C. bankers’ acceptances

D. commercial paper

60. Which of the following is most like a short-term collateralized loan?

A. Certificate of deposit

B. Repurchase agreement

C. Bankers’ acceptance

D. Commercial paper

61. Eurodollars are _________.

A. dollar-denominated deposits at any foreign bank or foreign branch of an American bank

B. dollar-denominated bonds issued by firms outside their home market

C. currency issued by Euro Disney and traded in France

D. dollars that wind up in banks as a result of money-laundering activities

62. Which of the following is used to back international sales of goods and services?

A. Certificate of deposit

B. Bankers’ acceptance

C. Eurodollar deposits

D. Commercial paper

63. Treasury notes have initial maturities between ________ years.

A. 2 and 4

B. 5 and 10

C. 10 and 30

D. 1 and 10

64. Which of the following is not a characteristic of common stock ownership?

A. Residual claimant

B. Unlimited liability

C. Voting rights

D. Limited life of the security

65. If you thought prices of stock would be rising over the next few months, you might want to __________________ on the stock.

A. purchase a call option

B. purchase a put option

C. sell a futures contract

D. place a short-sale order

66. A typical bond price quote includes all but which one of the following?

A. Daily high price for the bond

B. Closing bond price

C. Yield to maturity

D. Dividend yield

67. What are business firms most likely to use derivative securities for?

A. Hedging

B. Speculating

C. Doing calculus problems

D. Market making

68. What would you expect to have happened to the spread between yields on commercial paper and Treasury bills immediately after September 11, 2001?

A. No change, as both yields will remain the same

B. Increase, as the spread usually increases in response to a crisis

C. Decrease, as the spread usually decreases in response to a crisis

D. No change, as both yields will move in the same direction

69. A stock quote indicates a stock price of $60 and a dividend yield of 3%. The latest quarterly dividend received by stock investors must have been ______ per share.

A. $0.55

B. $1.80

C. $0.45

D. $1.25

70. Three stocks have share prices of $12, $75, and $30 with total market values of $400 million, $350 million, and $150 million, respectively. If you were to construct a price-weighted index of the three stocks, what would be the index value?

A. 300

B. 39

C. 43

D. 30

71. Which of the following is not considered a money market investment?

A. Bankers’ acceptance

B. Eurodollar

C. Repurchase agreement

D. Treasury note

72. The Federal Reserve Board of Governors directly controls which of the following interest rates?

A. Bankers’ acceptances

B. Brokers’ calls

C. Federal funds

D. LIBOR

73. You decide to purchase an equal number of shares of stocks of firms to create a portfolio. If you wanted to construct an index to track your portfolio performance, your best match for your portfolio would be to construct ______.

A. a value-weighted index

B. an equally weighted index

C. a price-weighted index

D. a bond price index

74. In a ___________ index, changes in the value of the stock with the greatest market value will move the index value the most, everything else equal.

A. value-weighted index

B. equally weighted index

C. price-weighted index

D. bond price index

75. A corporation in a 34% tax bracket invests in the preferred stock of another company and earns a 6% pretax rate of return. An individual investor in a 15% tax bracket invests in the same preferred stock and earns the same pretax return. The after-tax return to the corporation is _______, and the after-tax return to the individual investor is _______.

A. 3.96%; 5.1%

B. 5.39%; 5.1%

C. 6%; 6%

D. 3.96%; 6%

76. All but which one of the following indices is value weighted?

A. NASDAQ Composite

B. S&P 500

C. Wilshire 5000

D. DJIA

77. What is the tax exempt equivalent yield on a 9% bond yield given a marginal tax rate of 28%?

A. 6.48%

B. 7.25%

C. 8.02%

D. 9%

78. A tax free municipal bond provides a yield of 3.2%. What is the equivalent taxable yield on the bond given a 35% tax bracket?

A. 3.2%

B. 3.68%

C. 4.92%

D. 5%

79. An index computed from a simple average of returns is a/an _____.

A. equal weighted index

B. value weighted index

C. price weighted index

D. share weighted index

80. A tax free municipal bond provides a yield of 2.34%. What is the equivalent taxable yield on the bond given a 28% tax bracket?

A. 2.34%

B. 2.68%

C. 3.25%

D. 4.92%

81. The Chompers Index is a price weighted stock index based on the 3 largest fast food chains. The stock prices for the three stocks are $54, $23, and $44. What is the price weighted index value of the Chompers Index?

A. 23.43

B. 35.36

C. 40.33

D. 49.58

82. The Hydro Index is a price weighted stock index based on the 5 largest boat manufacturers in the nation. The stock prices for the five stocks are $10, $20, $80, $50 and $40. The price of the last stock was just split 2 for 1 and the stock price was halved from $40 to $20. What is the new divisor for a price weighted index?

A. 5.00

B. 4.85

C. 4.50

D. 4.75

83. A benchmark index has three stocks priced at $23, $43, and $56. The number of outstanding shares for each is 350,000 shares, 405,000 shares, and 553,000 shares, respectively. If the market value weighted index was 970 yesterday and the prices changed to $23, $41, and $58, what is the new index value?

A. 960

B. 970

C. 975

D. 985

84. A benchmark market value index is comprised of three stocks. Yesterday the three stocks were priced at $12, $20, and $60. The number of outstanding shares for each is 600,000 shares, 500,000 shares, and 200,000 shares, respectively. If the stock prices changed to $16, $18, and $62 today respectively, what is the 1-day rate of return on the index?

A. 5.78%

B. 4.35%

C. 6.16%

D. 7.42%

85. Which of the following mortgage scenarios will benefit the homeowner the most?

A. Adjustable rate mortgage when interest rate increases.

B. Fixed rate mortgage when interest rates falls.

C. Fixed rate mortgage when interest rate rises.

D. None of these options, as the banker’s interest will always be protected.

86. The TED spread refers to

A. the difference between the Treasury bond rate and the Treasury bill rate.

B. the difference between the Treasury note rate and the Treasury bill rate.

C. the difference between the LIBOR rate and the Treasury bill rate.

D. the difference between the LIBOR rate and the Treasury bond rate.

3
Student: ___________________________________________________________________________
1. Underwriting is one of the services provided by _____.

A. the SEC

B. investment bankers

C. publicly traded companies

D. FDIC

2. Under firm-commitment underwriting, the ______ assumes the full risk that the shares cannot be sold to the public at the stipulated offering price.

A. red herring

B. issuing company

C. initial stockholder

D. underwriter

3. Explicit costs of an IPO tend to be around ______ of the funds raised.

A. 1%

B. 7%

C. 15%

D. 25%

4. Barnegat Light sold 200,000 shares in an initial public offering. The underwriter’s explicit fees were $90,000. The offering price for the shares was $35, but immediately upon issue, the share price jumped to $43. What is the best estimate of the total cost to Barnegat Light of the equity issue?

A. $90,000

B. $1,290,000

C. $2,390,000

D. $1,690,000

5. A red herring becomes a prospectus when ____.

A. the preliminary registration statement is approved by the SEC

B. the IPO is complete

C. the offering is seasoned

D. the lockup period expires

6. Private placements can be advantageous, compared to public issue, because:

I. Private placements are cheaper to market than public issues.
II. Private placements may still be sold to the general public under SEC Rule 144A.
III. Privately placed securities trade on secondary markets.

A. I only

B. I and III only

C. II and III only

D. I, II, and III

7. A level _____ subscriber to the NASDAQ system may enter bid and ask prices.

A. 1

B. 2

C. 3

D. 4

8. Which one of the following statements about IPOs is not true?

A. IPOs generally underperform in the short run.

B. IPOs often provide very good initial returns to investors.

C. IPOs generally provide superior long-term performance as compared to other stocks.

D. Shares in IPOs are often primarily allocated to institutional investors.

9. The margin requirement on a stock purchase is 25%. You fully use the margin allowed to purchase 100 shares of MSFT at $25. If the price drops to $22, what is your percentage loss?

A. 9%

B. 15%

C. 48%

D. 57%

10. The NYSE acquired the ECN _______, and NASDAQ recently acquired the ECN ________.

A. Archipelago; Instinet

B. Instinet; Archipelago

C. Island; Instinet

D. LSE; Euronext

11. Rank the following types of markets from least integrated and organized to most integrated and organized:

I. Brokered markets
II. Continuous auction markets
III. Dealer markets
IV. Direct search markets

A. IV, II, I, III

B. I, III, IV, II

C. II, III, IV, I

D. IV, I, III, II

12. As a result of flash crashes, the SEC is trying circuit breakers that will halt trading for 5 minutes if large stocks’ prices change by more than _____ in a 5-minute period.

A. 10%

B. 20%

C. 30%

D. 40%

13. Which one of the following is not an example of a brokered market?

A. Residential real estate market

B. Market for large block security transactions

C. Primary market for securities

D. NASDAQ

14. More than ______ of all trading is believed to be initiated by computer algorithms.

A. 25%

B. 40%

C. 50%

D. 75%

15. Purchases of new issues of stock take place _________.

A. at the desk of the Fed

B. in the primary market

C. in the secondary market

D. in the money markets

16. Initial margin requirements on stocks are set by _________.

A. the Federal Deposit Insurance Corporation

B. the Federal Reserve

C. the New York Stock Exchange

D. the Securities and Exchange Commission

17. Which one of the following types of markets requires the greatest level of trading activity to be cost-effective?

A. Broker market

B. Dealer market

C. Continuous auction market

D. Direct search market

18. Which one of the following is a false statement regarding NYSE specialists?

A. On a stock exchange most buy or sell orders are executed via an electronic system rather than through specialists.

B. Specialists cannot trade for their own accounts.

C. Specialists maintain limit order books, which contain the outstanding unexecuted limit orders.

D. Specialists stand ready to trade at narrower bid-ask spreads in cases where the spread has become too wide.

19. Restrictions on trading involving insider information apply to:

I. Corporate officers and directors
II. Major stockholders
III. Relatives of corporate directors and officers

A. I only

B. I and II only

C. II and III only

D. I, II, and III

20. An order to buy or sell a security at the current price is a ______________.

A. limit order

B. market order

C. stop-loss order

D. stop-buy order

21. The term inside quotes refers to _____.

A. the difference between the lowest bid price and the highest ask price in the limit order book.

B. the difference between the highest bid price and the lowest ask price in the limit order book.

C. the difference between the lowest bid price and the lowest ask price in the limit order book.

D. the difference between the highest bid price and the highest ask price in the limit order book.

22. The term latency refers to _____.

A. the lag between when an order is placed on the NYSE and when it is executed.

B. the amount of time it takes to accept, process, and deliver a trading order.

C. the time it takes to implement new rules and procedures for stock exchanges and computer trading systems.

D. the lag between when an order is executed and when the investor takes possession of the securities.

23. If an investor places a _________ order, the stock will be sold if its price falls to the stipulated level. If an investor places a __________ order, the stock will be bought if its price rises above the stipulated level.

A. stop-buy; stop-loss

B. market; limit

C. stop-loss; stop-buy

D. limit; market

24. On a given day a stock dealer maintains a bid price of $1,000.50 for a bond and an ask price of $1003.25. The dealer made 10 trades that totaled 500 bonds traded that day. What was the dealer’s gross trading profit for this security?

A. $1,375

B. $500

C. $275

D. $1,450

25. Advantages of ECNs over traditional markets include all but which one of the following?

A. Lower transactions costs

B. Anonymity of the participants

C. Small amount of time needed to execute and order

D. Ability to handle very large orders

26. The __________ was established to protect investors from losses if their brokerage firms fail.

A. CFTC

B. SEC

C. SIPC

D. AIMR

27. When matching orders from the public, a specialist is required to use the _______.

A. lowest outstanding bid price and highest outstanding ask price

B. highest outstanding bid price and highest outstanding ask price

C. lowest outstanding bid price and lowest outstanding ask price

D. highest outstanding bid price and lowest outstanding ask price

28. The process of polling potential investors regarding their interest in a forthcoming initial public offering (IPO) is called ________.

A. interest building

B. book building

C. market analysis

D. customer identification

29. The bulk of most initial public offerings (IPOs) of equity securities goes to ___________.

A. institutional investors

B. individual investors

C. the firm’s current shareholders

D. day traders

30. Initial public offerings (IPOs) are usually ___________ relative to the levels at which their prices stabilize after they begin trading in the secondary market.

A. overpriced

B. correctly priced

C. underpriced

D. mispriced, but without any particular bias

31. According to multiple studies by Ritter, initial public offerings tend to exhibit __________ performance initially and __________ performance over the long term.

A. bad; good

B. bad; bad

C. good; good

D. good; bad

32. Specialists try to maintain a narrow bid-ask spread because:

I. If the spread is too large, they will not participate in as many trades, losing commission income.
II. The exchange requires specialists to maintain price continuity.
III. Specialists are nonprofit entities designed to facilitate market transactions rather than make a profit.

A. I only

B. I and II only

C. II and III only

D. I, II, and III

33. In a __________ underwriting arrangement, the underwriter assumes the full risk that shares may not be sold to the public at the stipulated offering price.

A. best-efforts

B. firm-commitment

C. private placement

D. none of these options

34. The ______________ is the most important dealer market in the United States, and the ______________ is the most important auction market.

A. NYSE; NASDAQ

B. NASDAQ; NYSE

C. CME; OTC

D. AMEX; NYSE

35. The inside quotes on a limit order book can be found ______.

A. at the top of the list

B. at the bottom of the list

C. by taking the averages of the bid and ask prices on the list

D. only by direct contact with the specialist who maintains the book

36. The __________ system enables exchange members to send orders directly to a specialist over computer lines.

A. FAX

B. Direct Plus

C. NASDAQ

D. SUPERDOT

37. The fully automated trade-execution system installed on the NYSE is called _____.

A. FAX

B. Direct +

C. NASDAQ

D. SUPERDOT

38. The NYSE Hybrid Market allows _____.

A. individuals to send orders directly to a specialist

B. individuals to send orders directly to an electronic system

C. brokers to send orders directly to a specialist

D. brokers to send orders either to an electronic system or to a specialist

39. Approximately __________ of trades involving shares issued by firms listed on the New York Stock Exchange actually take place on the New York Stock Exchange.

A. 50%

B. 25%

C. 60%

D. 75%

40. The _________ price is the price at which a dealer is willing to purchase a security.

A. bid

B. ask

C. clearing

D. settlement

41. The _________ price is the price at which a dealer is willing to sell a security.

A. bid

B. ask

C. clearing

D. settlement

42. The difference between the price at which a dealer is willing to buy and the price at which a dealer is willing to sell is called the _________.

A. market spread

B. bid-ask spread

C. bid-ask gap

D. market variation

43. The bid-ask spread exists because of _______________.

A. market inefficiencies

B. discontinuities in the markets

C. the need for dealers to cover expenses and make a profit

D. lack of trading in thin markets

44. The NYSE has lost market share to ECNs in recent years. Part of the NYSE’s response to the growth of ECNs has been to:

I. Purchase Archipelago, a major ECN, and rename it NYSE Arca
II. Enable automatic trade execution through its new Market Center
III. Impose a tighter limit on bid-ask spreads

A. I only

B. II and III only

C. I and II only

D. I, II, and III

45. The cost of buying and selling a stock includes:

I. Broker’s commissions
II. Dealer’s bid-asked spread
III. Price concessions that investors may be forced to make

A. I and II only

B. II and III only

C. I and III only

D. I, II, and III

46. Which of the following is (are) true about dark pools?

I. They allow anonymity in trading.
II. They often involve large blocks of stocks.
III. Trades made through them might not be reported.

A. I and II only

B. II and III only

C. I and III only

D. I, II, and III

47. You purchased XYZ stock at $50 per share. The stock is currently selling at $65. Your gains could be protected by placing a _________.

A. limit buy order

B. limit sell order

C. market order

D. stop-loss order

48. Consider the following limit order book of a specialist. The last trade in the stock occurred at a price of $40. If a market buy order for 100 shares comes in, at what price will it be filled?

A. $39.75

B. $40.25

C. $40.375

D. $40.25 or less

49. You find that the bid and ask prices for a stock are $10.25 and $10.30, respectively. If you purchase or sell the stock, you must pay a flat commission of $25. If you buy 100 shares of the stock and immediately sell them, what is your total implied and actual transaction cost in dollars?

A. $50

B. $25

C. $30

D. $55

50. According to SEC Rule 415 regarding shelf registration, firms can gradually sell securities to the public for __________ following initial registration.

A. 1 year

B. 2 years

C. 3 years

D. 4 years

51. What happened to the effective spread on trades when the SEC allowed the minimum tick size to move from one-eighth of a dollar to one-sixteenth of a dollar in 1997 and from one-sixteenth of a dollar to one cent in 2001?

A. The tick size increased in 1997 but decreased in 2001.

B. The tick size increased in both cases.

C. The tick size decreased in 1997 but increased in 2001.

D. The tick size decreased in both cases.

52. Assume you purchased 500 shares of XYZ common stock on margin at $40 per share from your broker. If the initial margin is 60%, the amount you borrowed from the broker is _________.

A. $20,000

B. $12,000

C. $8,000

D. $15,000

53. You sold short 300 shares of common stock at $30 per share. The initial margin is 50%. You must put up _________.

A. $4,500

B. $6,000

C. $9,000

D. $10,000

54. You short-sell 200 shares of Tuckerton Trading Co., now selling for $50 per share. What is your maximum possible loss?

A. $50

B. $150

C. $10,000

D. Unlimited

55. You short-sell 200 shares of Tuckerton Trading Co., now selling for $50 per share. What is your maximum possible gain, ignoring transactions cost?

A. $50

B. $150

C. $10,000

D. Unlimited

56. You short-sell 200 shares of Rock Creek Fly Fishing Co., now selling for $50 per share. If you want to limit your loss to $2,500, you should place a stop-buy order at ____.

A. $37.50

B. $62.50

C. $56.25

D. $59.75

57. You purchased 200 shares of ABC common stock on margin at $50 per share. Assume the initial margin is 50% and the maintenance margin is 30%. You will get a margin call if the stock drops below ________. (Assume the stock pays no dividends, and ignore interest on the margin loan.)

A. $26.55

B. $35.71

C. $28.95

D. $30.77

58. You purchased 250 shares of common stock on margin for $25 per share. The initial margin is 65%, and the stock pays no dividend. Your rate of return would be __________ if you sell the stock at $32 per share. Ignore interest on margin.

A. 35%

B. 39%

C. 43%

D. 28%

59. You sell short 200 shares of Doggie Treats Inc. that are currently selling at $25 per share. You post the 50% margin required on the short sale. If your broker requires a 30% maintenance margin, at what stock price will you get a margin call? (You earn no interest on the funds in your margin account, and the firm does not pay any dividends.)

A. $28.85

B. $35.71

C. $31.50

D. $32.25

60. Transactions that do not involve the original issue of securities take place in _________.

A. primary markets

B. secondary markets

C. over-the-counter markets

D. institutional markets

61. What was the result of high-frequency traders’ leaving the market during the flash crash of 2010?

A. Market liquidity decreased.

B. Market liquidity increased.

C. Market volatility decreased.

D. Trading frequency increased.

62. __________ often accompany short sales and are used to limit potential losses from the short position.

A. Limit orders

B. Restricted orders

C. Limit loss orders

D. Stop-buy orders

63. The market share held by the NYSE Arca system in February 2011 was approximately ____.

A. 65%

B. 45%

C. 25%

D. 10%

64. Regulation NMS:

I. Supports the goal of integrating financial markets
II. Requires the use of specialists to execute trades
III. Requires that exchanges honor quotes of other exchanges when they can be executed automatically

A. I only

B. I and II only

C. I and III only

D. I, II, and III

65. The commission structure on a stock purchase is $50 plus $.03 per share. If you purchase 600 shares of a stock selling for $65, what is your commission?

A. $35

B. $45

C. $53

D. $68

66. All major stock markets today are effectively _______________.

A. specialist trading systems

B. electronic trading systems

C. continuous auction markets

D. direct search markets

67. In 2008, the NASDAQ stock market merged with _____.

A. Euronext

B. OMX, which operates seven Nordic and Baltic stock exchanges

C. the International Securities Exchange (ISE)

D. BATS

68. You hold 5,000 shares of the 1 million outstanding shares of Wealthy Wranglers common stock. You’ve just learned that the company plans to issue more shares, so that 2 million shares will be outstanding. This is called _____.

A. an advanced equity offering

B. a weathered equity offering

C. a seasoned equity offering

D. a veteran equity offering

69. If an investor uses the full amount of margin available, the equity in a margin account used for a stock purchase can be found as ________.

A. market value of the stock – amount owed on the margin loan

B. market value of the stock + amount owed on the margin loan

C. market value of the stock ÷ margin loan

D. margin loan × market value of the stock

70. The average depth of the limit order book is _____.

A. lower for the large stocks in the S&P 500 Index than for the smaller stocks in the Russell 2000 Index

B. higher for the large stocks in the S&P 500 Index than for the smaller stocks in the Russell 2000 Index

C. about the same for both the large stocks in the S&P 500 Index and the smaller stocks in the Russell 2000 Index

D. unrelated to the sizes of the stocks in the indexes

71. The CFA Institute Standards of Professional Conduct require that members _____.

A. place their clients’ interests before their own

B. disclose conflicts of interest to clients

C. inform their employers that they are obligated to comply with the Standards of Professional Conduct

D. all of these options

72. Trading on inside information is:

I. Prohibited by federal law
II. Prohibited by the CFA Institute Standards of Professional Conduct
III. Monitored by the SEC

A. I and II only

B. II and III only

C. I and III only

D. I, II, and III

73. The ____ requires full disclosure of relevant information relating to the issue of new securities.

A. Insider Trading Act of 1931

B. Securities Act of 1933

C. Securities Exchange Act of 1934

D. Investment Company Act of 1940

74. The SIPC was established by the ____.

A. Insider Trading Act of 1931

B. Securities Act of 1933

C. Securities Exchange Act of 1934

D. none of these options

75. Maintenance requirements for margin accounts are set by ____.

A. brokerage firms

B. the SEC

C. the Federal Reserve System’s Board of Governors

D. the Supreme Court

76. Which of the following are true concerning short sales of exchange-listed stocks?

I. Proceeds from the short sale must be kept on deposit with the broker.
II. Short-sellers must post margin with their broker to cover potential losses on the position.
III. The short-seller earns interest on any cash deposited with the broker that is used to meet the margin requirement.

A. I only

B. I and III only

C. I and II only

D. I, II, and III

77. The largest nongovernmental regulator of securities firms in the United States is ________.

A. the CFA Institute

B. the Public Company Accounting Oversight Board

C. the Financial Industry Regulatory Authority

D. the Board of Directors of NYSE Euronext

78. In ________ markets, participants post bid and ask prices at which they are willing to trade, but orders are not automatically executed by computer. ____________ execute trades for people other than themselves, and in _______________ markets a computer matches orders with an existing limit order book and executes the trades automatically.

A. electronic; Dealers; brokers

B. dealer; Brokers; electronic

C. direct search; Brokers; electronic

D. brokered; Dealers; direct search

79. An investor puts up $5,000 but borrows an equal amount of money from his broker to double the amount invested to $10,000. The broker charges 7% on the loan. The stock was originally purchased at $25 per share, and in 1 year the investor sells the stock for $28. The investor’s rate of return was ____.

A. 17%

B. 12%

C. 14%

D. 19%

80. An investor buys $8,000 worth of a stock priced at $40 per share using 50% initial margin. The broker charges 6% on the margin loan and requires a 30% maintenance margin. In 1 year the investor has interest payable and gets a margin call. At the time of the margin call the stock’s price must have been ____.

A. $20

B. $29.77

C. $30.29

D. $32.45

81. The New York Stock Exchange is a good example of _________.

A. an auction market

B. a brokered market

C. a dealer market

D. a direct search market

82. The primary market where new security issues are offered to the public is a good example of _________.

A. an auction market

B. a brokered market

C. a dealer market

D. a direct search market

83. The over-the-counter securities market is a good example of _________.

A. an auction market

B. a brokered market

C. a dealer market

D. a direct search market

84. An investor buys $16,000 worth of a stock priced at $20 per share using 60% initial margin. The broker charges 8% on the margin loan and requires a 35% maintenance margin. The stock pays a $.50-per-share dividend in 1 year, and then the stock is sold at $23 per share. What was the investor’s rate of return?

A. 17.5%

B. 19.67%

C. 23.83%

D. 25.75%

85. Level 3 NASDAQ subscribers _____.

A. are registered market makers.

B. can post bid and ask prices.

C. have the fastest execution of trades.

D. all of these options.

86. You sell short 300 shares of Microsoft that are currently selling at $30 per share. You post the 50% margin required on the short sale. If you earn no interest on the funds in your margin account, what will be your rate of return after 1 year if Microsoft is selling at $27? (Ignore any dividends.)

A. 10%

B. 20%

C. 6.67%

D. 15%

87. The commission structure on a stock purchase is $20 plus $.02 per share. If you purchase four round lots of a stock selling for $56, what is your commission?

A. $20

B. $22

C. $26

D. $28

4
Student: ___________________________________________________________________________
1. Which one of the following invests in a portfolio that is fixed for the life of the fund?

A. Mutual fund

B. Money market fund

C. Managed investment company

D. Unit investment trust

2. ______ are partnerships of investors with portfolios that are larger than most individual investors but are still too small to warrant managing on a separate basis.

A. Commingled funds

B. Closed-end funds

C. REITs

D. Mutual funds

3. A __________ is a private investment pool open only to wealthy or institutional investors that is exempt from SEC regulation and can therefore pursue more speculative policies than mutual funds.

A. commingled pool

B. unit trust

C. hedge fund

D. money market fund

4. Advantages of investment companies to investors include all but which one of the following?

A. Record keeping and administration

B. Low-cost diversification

C. Professional management

D. Guaranteed rates of return

5. Which of the following typically employ significant amounts of leverage?

I. Hedge funds
II. REITs
III. Money market funds
IV. Equity mutual funds

A. I and II only

B. II and III only

C. III and IV only

D. I, II, and III only

6. The NAV of which funds is fixed at $1 per share?

A. Equity funds

B. Money market funds

C. Fixed-income funds

D. Commingled funds

7. The two principal types of REITs are equity trusts, which _______________, and mortgage trusts, which _______________.

A. invest directly in real estate; invest in mortgage and construction loans

B. invest in mortgage and construction loans; invest directly in real estate

C. use extensive leverage; distribute less than 95% of income to shareholders

D. distribute less than 95% of income to shareholders; use extensive leverage

8. A contingent deferred sales charge is commonly called a ____.

A. front-end load

B. back-end load

C. 12b-1 charge

D. top-end sales commission

9. In the United States in 2011, there were approximately _______ mutual funds offered by fewer than _______ fund families.

A. 12,000; 600

B. 7,000; 100

C. 8,000; 700

D. 9,000; 300

10. Part B of a mutual fund prospectus contains information about:

I. Fund holdings by directors and officers
II. Front-end and back-end loads
III. Securities held by the fund at the end of the fiscal year

A. I only

B. I and II only

C. I and III only

D. I, II, and III

11. Mutual funds provide the following for their shareholders:

A. Diversification

B. Professional management

C. Record keeping and administration

D. All of these options

12. The average maturity of fund investments in a money market mutual fund is _______.

A. slightly more than 1 month

B. slightly more than 1 year

C. about 9 months

D. between 2 and 3 years

13. Rank the following fund categories from most risky to least risky:

I. Equity growth fund
II. Balanced fund
III. Sector fund
IV. Money market fund

A. IV, I, III, II

B. III, II, IV, I

C. I, II, III, IV

D. III, I, II, IV

14. Which of the following result in a taxable event for investors?

I. Short-term capital gain distributions from the fund
II. Dividend distributions from the fund
III. Long-term capital gain distributions from the fund

A. I only

B. II only

C. I and II only

D. I, II, and III

15. The type of mutual fund that primarily engages in market timing is called _______.

A. a sector fund

B. an index fund

C. an ETF

D. an asset allocation fund

16. As of 2011, approximately _____ of mutual fund assets were invested in equity funds.

A. 5%

B. 54%

C. 30%

D. 12%

17. As of 2011, approximately _____ of mutual fund assets were invested in bond funds.

A. 14%

B. 19%

C. 37%

D. 47%

18. As of 2011, approximately _____ of mutual fund assets were invested in money market funds.

A. 5%

B. 26%

C. 44%

D. 66%

19. Management fees for open-end and closed-end funds typically range between _____ and _____.

A. .2%; 1.5%

B. .5%; 5%

C. 2%; 5%

D. 3%; 8%

20. The primary measurement unit used for assessing the value of one’s stake in an investment company is ___________________.

A. net asset value

B. average asset value

C. gross asset value

D. total asset value

21. Net asset value is defined as ________________________.

A. book value of assets divided by shares outstanding

B. book value of assets minus liabilities divided by shares outstanding

C. market value of assets divided by shares outstanding

D. market value of assets minus liabilities divided by shares outstanding

22. Assume that you have just purchased some shares in an investment company reporting $500 million in assets, $50 million in liabilities, and 50 million shares outstanding. What is the net asset value (NAV) of these shares?

A. $12

B. $9

C. $10

D. $1

23. Assume that you have recently purchased 100 shares in an investment company. Upon examining the balance sheet, you note that the firm is reporting $225 million in assets, $30 million in liabilities, and 10 million shares outstanding. What is the net asset value (NAV) of these shares?

A. $25.50

B. $22.50

C. $19.50

D. $1.95

24. The Vanguard 500 Index Fund tracks the performance of the S&P 500. To do so, the fund buys shares in each S&P 500 company __________.

A. in proportion to the market value weight of the firm’s equity in the S&P 500

B. in proportion to the price weight of the stock in the S&P 500

C. by purchasing an equal number of shares of each stock in the S&P 500

D. by purchasing an equal dollar amount of shares of each stock in the S&P 500

25. Which of the following is not a type of managed investment company?

A. Unit investment trusts

B. Closed-end funds

C. Open-end funds

D. Hedge funds

26. Which of the following funds invest specifically in stocks of fast-growing companies?

A. Balanced funds

B. Growth equity funds

C. REITs

D. Equity income funds

27. A fund that invests in securities worldwide, including the United States, is called ______.

A. an international fund

B. an emerging market fund

C. a global fund

D. a regional fund

28. The greatest percentage of mutual fund assets are invested in ________.

A. bond funds

B. equity funds

C. hybrid funds

D. money market funds

29. Sponsors of unit investment trusts earn a profit by ___________________.

A. deducting management fees from fund assets

B. deducting a percentage of any gains in asset value

C. selling shares in the trust at a premium to the cost of acquiring the underlying assets

D. charging portfolio turnover fees

30. Investors who want to liquidate their holdings in a unit investment trust may ___________________.

A. sell their shares back to the trustee at a discount

B. sell their shares back to the trustee at net asset value

C. sell their shares on the open market

D. sell their shares at a premium to net asset value

31. Investors who want to liquidate their holdings in a closed-end fund may ___________________.

A. sell their shares back to the fund at a discount if they wish

B. sell their shares back to the fund at net asset value

C. sell their shares on the open market

D. sell their shares at a premium to net asset value if they wish

32. __________ fund is defined as one in which the fund charges a sales commission to either buy into or exit from the fund.

A. A load

B. A no-load

C. An index

D. A specialized-sector

33. Which of the following is a false statement regarding open-end mutual funds?

A. They offer investors a guaranteed rate of return.

B. They offer investors a well-diversified portfolio.

C. They redeem shares at their net asset value.

D. They offer low-cost diversification.

34. __________ funds stand ready to redeem or issue shares at their net asset value.

A. Closed-end

B. Index

C. Open-end

D. Hedge

35. Revenue sharing with respect to mutual funds refers to _________.

A. fund companies paying brokers if the broker recommends the fund to investors

B. allowing certain classes of investors to engage in market timing

C. charging loads to new investors in a mutual fund

D. directly marketing funds over the Internet

36. Higher portfolio turnover:

I. Results in greater tax liability for investors
II. Results in greater trading costs for the fund, which investors have to pay for
III. Is a characteristic of asset allocation funds

A. I only

B. II only

C. I and II only

D. I, II, and III

37. Low-load mutual funds have front-end loads of no more than _____.

A. 2%

B. 3%

C. 4%

D. 5%

38. Most real estate investment trusts (REITs) have a debt ratio of around _________.

A. 10%

B. 30%

C. 50%

D. 70%

39. Measured by assets, about _____ of funds are money market funds.

A. 15%

B. 25%

C. 40%

D. 60%

40. Which of the following is not a type of real estate investment trust?

I. Equity trust
II. Debt trust
III. Mortgage trust
IV. Unit trust

A. I and II only

B. II only

C. II and IV only

D. I, II, and III

41. ______________________ are often called mutual funds.

A. Unit investment trusts

B. Open-end investment companies

C. Closed-end investment companies

D. REITs

42. Mutual funds account for roughly ______ of investment company assets.

A. 30%

B. 50%

C. 70%

D. 90%

43. An official description of a particular mutual fund’s planned investment policy can be found in the fund’s _____________.

A. prospectus

B. indenture

C. investment statement

D. 12b-1 forms

44. Mutual funds that hold both equities and fixed-income securities in relatively stable proportions are called ____________________.

A. income funds

B. balanced funds

C. asset allocation funds

D. index funds

45. ______ are mutual funds that vary the proportions of funds invested in particular market sectors according to the fund manager’s forecast of the performance of that market sector.

A. asset allocation funds

B. balanced funds

C. index funds

D. income funds

46. Specialized-sector funds concentrate their investments in _________________.

A. bonds of a particular maturity

B. geographic segments of the real estate market

C. government securities

D. securities issued by firms in a particular industry

47. If a mutual fund has multiple-class shares, which class typically has a front-end load?

A. Class A

B. Class B

C. Class C

D. Class D

48. The commission, or front-end load, paid when you purchase shares in mutual funds may not exceed __________.

A. 3.5%

B. 6%

C. 8.5%

D. 10%

49. You are considering investing in one of several mutual funds. All the funds under consideration have various combinations of front-end and back-end loads and/or 12b-1 fees. The longer you plan on remaining in the fund you choose, the more likely you will prefer a fund with a __________ rather than a __________, everything else equal.

A. 12b-1 fee; front-end load

B. front-end load; 12b-1 fee

C. back-end load; front-end load

D. 12b-1 fee; back-end load

50. Under SEC rules, the managers of certain funds are allowed to deduct charges for advertising, brokerage commissions, and other sales expenses directly from the fund assets rather than billing investors. These fees are known as ____________.

A. direct operating expenses

B. back-end loads

C. 12b-1 charges

D. front-end loads

51. The SEC requires funds to disclose:

I. After-tax returns for the past year
II. After-tax returns for the last 5-year period
III. The tax impact of portfolio turnover

A. I only

B. I and II only

C. I and III only

D. I, II, and III

52. SEC Rule 12b-1 allows managers of certain funds to deduct __________ expenses from fund assets; however, these expenses may not exceed __________ of the fund’s average net assets per year.

A. marketing; 1%

B. marketing; 5%

C. administrative; .5%

D. administrative; 2%

53. Consider a mutual fund with $300 million in assets at the start of the year and 12 million shares outstanding. If the gross return on assets is 18% and the total expense ratio is 2% of the year-end value, what is the rate of return on the fund?

A. 15.64%

B. 16%

C. 17.25%

D. 17.5%

54. Consider a no-load mutual fund with $200 million in assets and 10 million shares at the start of the year and with $250 million in assets and 11 million shares at the end of the year. During the year investors have received income distributions of $2 per share and capital gain distributions of $.25 per share. Assuming that the fund carries no debt, and that the total expense ratio is 1%, what is the rate of return on the fund?

A. 11.19%

B. 23.75%

C. 24.64%

D. The answer cannot be determined from the information given.

55. Consider a no-load mutual fund with $400 million in assets, 50 million in debt, and 15 million shares at the start of the year and with $500 million in assets, 40 million in debt, and 18 million shares at the end of the year. During the year investors have received income distributions of $.50 per share and capital gain distributions of $.30 per share. If the total expense ratio is .75%, what is the rate of return on the fund?

A. 12.09%

B. 12.99%

C. 8.25%

D. The answer cannot be determined from the information given.

56. Mutual fund returns may be granted pass-through status if _________________.

A. virtually all income is distributed to shareholders

B. the fund qualifies for pass-through status according to the U.S. tax code

C. the fund is sufficiently diversified

D. All of these options (All of the answers must be true for pass-through status to be granted.)

57. _____ is an example of an exchange-traded fund.

A. An SPDR or spider

B. A samurai

C. A Vanguard

D. An open-end fund

58. If you place an order to buy or sell a share of a mutual fund during the trading day, the order will be executed at _____.

A. the NAV calculated at the market close at 4 pm New York time

B. the real time NAV

C. the NAV delayed 15 minutes

D. the NAV calculated at the opening of the next day’s trading

59. According to the 2011 Mutual Fund Fact Book, _______ of total assets were in taxable money market funds and _______ were tax-exempt money market funds.

A. 35%; 14%

B. 12.3%; 75%

C. 22%; 3.9%

D. 5%; 47%

60. In his 1970 study, Malkiel found that mutual funds that do well in one period have an approximately ________ chance of doing well in the subsequent-year period.

A. 33%

B. 52%

C. 65%

D. 85%

61. In a recent study, Malkiel found that evidence of persistence in the performance of mutual funds ________________ in the 1980s.

A. grew stronger

B. remained about the same

C. became slightly weaker

D. virtually disappeared

62. The ratio of trading activity of a portfolio to the assets of the portfolio is called the ____________.

A. reinvestment ratio

B. trading rate

C. portfolio turnover

D. tax yield

63. Which of the following ETFs tracks the S&P 500 Index?

A. Qubes

B. Diamonds

C. Vipers

D. Spiders

64. The Stone Harbor Fund is a closed-end investment company with a portfolio currently worth $300 million. It has liabilities of $5 million and 9 million shares outstanding. If the fund sells for $30 a share, what is its premium or discount as a percent of NAV?

A. 9.26% premium

B. 8.47% premium

C. 9.26% discount

D. 8.47% discount

65. The difference between balanced funds and asset allocation funds is that _____.

A. balanced funds invest in bonds while asset allocation funds do not

B. asset allocation funds invest in bonds while balanced funds do not

C. balanced funds have relatively stable proportions of stocks and bonds while the proportions may vary dramatically for asset allocation funds

D. balanced funds make no capital gain distributions and asset allocation funds make both dividend and capital gain distributions

66. The Wildwood Fund sells Class A shares with a front-end load of 5% and Class B shares with a 12b-1 fee of 1% annually. If you plan to sell the fund after 4 years, are Class A or Class B shares the better choice? Assume a 10% annual return net of expenses before the 12b-1 fee is applied.

A. Class A.

B. Class B.

C. There is no difference.

D. The answer cannot be determined from the information given.

67. A mutual fund has total assets outstanding of $69 million. During the year the fund bought and sold assets equal to $17.25 million. This fund’s turnover rate was _____.

A. 25%

B. 28.5%

C. 18.63%

D. 33.4%

68. Which type of investment fund is commonly known to invest in options and futures in large scale?

A. Commingled funds

B. Hedge funds

C. ETFs

D. REITs

69. Advantages of ETFs over mutual funds include all but which one of the following?

A. ETFs trade continuously, so investors can trade throughout the day.

B. ETFs can be sold short or purchased on margin, unlike fund shares.

C. ETF providers do not have to sell holdings to fund redemptions.

D. ETF values can diverge from NAV.

70. Harold has just taken his company public and owns a large quantity of restricted stock. For purposes of diversification, what fund might he help create in order to diversify his holdings?

A. Commingled funds

B. Hedge funds

C. ETF

D. REITs

71. Which of the following funds is most likely to have a debt ratio of 70% or higher?

A. Bond fund

B. Commingled fund

C. Mortgage-backed securities

D. REIT

72. _______ have become the main way for investors to speculate in precious metals.

A. Strategic income funds

B. Balanced funds

C. Specialized-sector funds

D. Exchange-traded funds

73. From 1971 to 2010 the average return on the Wilshire 5000 Index was _________ the return of the average mutual fund.

A. identical to

B. .8% higher than

C. .8% lower than

D. 1.3% higher than

74. An open-end fund has a NAV of $16.50 per share. The fund charges a 6% load. What is the offering price?

A. $14.57

B. $15.95

C. $17.55

D. $16.49

75. The offer price of an open-end fund is $18 and the fund is sold with a front-end load of 5%. What is the fund’s NAV?

A. $18.74

B. $17.10

C. $15.40

D. $16.57

76. A mutual fund has $50 million in assets at the beginning of the year and 1 million shares outstanding throughout the year. Throughout the year assets grow at 12%. The fund imposes a 12b-1 fee on all shares equal to 1%. The fee is imposed on year-end asset values. If there are no distributions, what is the end-of-year NAV for the fund?

A. $50

B. $55.44

C. $56.12

D. $54.55

77. The assets of a mutual fund are $25 million. The liabilities are $4 million. If the fund has 700,000 shares outstanding and pays a $3 dividend, what is the dividend yield?

A. 5%

B. 10%

C. 15%

D. 20%

78. Which of the following funds are usually most tax-efficient?

A. Equity funds

B. Bond Funds

C. ETFs

D. Specialized-sector funds

79. You invest in a mutual fund that charges a 3% front-end load, 1% total annual fees, and a 2% back-end load, which decreases .5% per year. How much will you pay in fees on a $10,000 investment that does not grow if you cash out after 3 years of no gain?

A. $103

B. $219

C. $553

D. $635

80. You invest in a mutual fund that charges a 3% front-end load, 1% total annual fees, and a 0% back-end load on Class A shares. The same fund charges a 0% front-end load, 1% total annual fees, and a 2% back-end load on Class B shares. What are the total fees in year 1 on a Class A investment of $20,000 with no growth in value?

A. $658

B. $794

C. $885

D. $902

81. You invest in a mutual fund that charges a 3% front-end load, 1% total annual fees, and a 0% back-end load on Class A shares. The same fund charges a 0% front-end load, 1% total annual fees, and a 2% back-end load on Class B shares. What are the total fees in year 1 on a Class B investment of $20,000 if you redeem shares with no growth in value?

A. $596

B. $794

C. $885

D. $902

82. You pay $21,600 to the Laramie Fund, which has a NAV of $18 per share at the beginning of the year. The fund deducted a front-end load of 4%. The securities in the fund increased in value by 10% during the year. The fund’s expense ratio is 1.3% and is deducted from year-end asset values. What is your rate of return on the fund if you sell your shares at the end of the year?

A. 4.35%

B. 4.23%

C. 6.45%

D. 5.63%

83. Which one of the following statements about returns reported by mutual funds is not correct?

A. Reported returns are net of management expenses.

B. Reported returns are net of 12b-1 fees.

C. Reported returns are net of brokerage fees paid on the fund’s trading activity.

D. None of these options. (All of the items are included in reported returns.)

84. The top Morningstar mutual fund performance rating is ________.

A. five stars

B. four stars

C. three stars

D. two stars

85. You are considering investing in a no-load mutual fund with an annual expense ratio of .6% and an annual 12b-1 fee of .75%. You could also invest in a bank CD paying 6.5% per year. What minimum annual rate of return must the fund earn to make you better off in the fund than in the CD?

A. 7.1%

B. 7.45%

C. 7.25%

D. 7.85%

5
Student: ___________________________________________________________________________
1. You put up $50 at the beginning of the year for an investment. The value of the investment grows 4% and you earn a dividend of $3.50. Your HPR was ____.

A. 4%

B. 3.5%

C. 7%

D. 11%

2. The ______ measure of returns ignores compounding.

A. geometric average

B. arithmetic average

C. IRR

D. dollar-weighted

3. If you want to measure the performance of your investment in a fund, including the timing of your purchases and redemptions, you should calculate the __________.

A. geometric average return

B. arithmetic average return

C. dollar-weighted return

D. index return

4. Which one of the following measures time-weighted returns and allows for compounding?

A. Geometric average return

B. Arithmetic average return

C. Dollar-weighted return

D. Historical average return

5. Rank the following from highest average historical return to lowest average historical return from 1926 to 2010.

I. Small stocks
II. Long-term bonds
III. Large stocks
IV. T-bills

A. I, II, III, IV

B. III, IV, II, I

C. I, III, II, IV

D. III, I, II, IV

6. Rank the following from highest average historical standard deviation to lowest average historical standard deviation from 1926 to 2010.

I. Small stocks
II. Long-term bonds
III. Large stocks
IV. T-bills

A. I, II, III, IV

B. III, IV, II, I

C. I, III, II, IV

D. III, I, II, IV

7. You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. If you desire to forecast performance for next year, the best forecast will be given by the ________.

A. dollar-weighted return

B. geometric average return

C. arithmetic average return

D. index return

8. The complete portfolio refers to the investment in _________.

A. the risk-free asset

B. the risky portfolio

C. the risk-free asset and the risky portfolio combined

D. the risky portfolio and the index

9. You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. You always reinvest your dividends and interest earned on the portfolio. Which method provides the best measure of the actual average historical performance of the investments you have chosen?

A. Dollar-weighted return

B. Geometric average return

C. Arithmetic average return

D. Index return

10. The holding period return on a stock is equal to _________.

A. the capital gain yield over the period plus the inflation rate

B. the capital gain yield over the period plus the dividend yield

C. the current yield plus the dividend yield

D. the dividend yield plus the risk premium

11. Your timing was good last year. You invested more in your portfolio right before prices went up, and you sold right before prices went down. In calculating historical performance measures, which one of the following will be the largest?

A. Dollar-weighted return

B. Geometric average return

C. Arithmetic average return

D. Mean holding-period return

12. Published data on past returns earned by mutual funds are required to be ______.

A. dollar-weighted returns

B. geometric returns

C. excess returns

D. index returns

13. The arithmetic average of -11%, 15%, and 20% is ________.

A. 15.67%

B. 8%

C. 11.22%

D. 6.45%

14. The geometric average of -12%, 20%, and 25% is _________.

A. 8.42%

B. 11%

C. 9.7%

D. 18.88%

15. The dollar-weighted return is the _________.

A. difference between cash inflows and cash outflows

B. arithmetic average return

C. geometric average return

D. internal rate of return

16. An investment earns 10% the first year, earns 15% the second year, and loses 12% the third year. The total compound return over the 3 years was ______.

A. 41.68%

B. 11.32%

C. 3.64%

D. 13%

17. Annual percentage rates can be converted to effective annual rates by means of the following formula:

A. [1 + (APR/n)]n – 1

B. (APR)(n)

C. (APR/n)

D. (periodic rate)(n)

18. Suppose you pay $9,700 for a $10,000 par Treasury bill maturing in 3 months. What is the holding-period return for this investment?

A. 3.01%

B. 3.09%

C. 12.42%

D. 16.71%

19. Suppose you pay $9,800 for a $10,000 par Treasury bill maturing in 2 months. What is the annual percentage rate of return for this investment?

A. 2.04%

B. 12 %

C. 12.24%

D. 12.89%

20. Suppose you pay $9,400 for a $10,000 par Treasury bill maturing in 6 months. What is the effective annual rate of return for this investment?

A. 6.38%

B. 12.77%

C. 13.17%

D. 14.25%

21. You have an APR of 7.5% with continuous compounding. The EAR is _____.

A. 7.5%

B. 7.65%

C. 7.79 %

D. 8.25%

22. You have an EAR of 9%. The equivalent APR with continuous compounding is _____.

A. 8.47%

B. 8.62%

C. 8.88%

D. 9.42%

23. The market risk premium is defined as __________.

A. the difference between the return on an index fund and the return on Treasury bills

B. the difference between the return on a small-firm mutual fund and the return on the Standard & Poor’s 500 Index

C. the difference between the return on the risky asset with the lowest returns and the return on Treasury bills

D. the difference between the return on the highest-yielding asset and the return on the lowest-yielding asset

24. The excess return is the _________.

A. rate of return that can be earned with certainty

B. rate of return in excess of the Treasury-bill rate

C. rate of return to risk aversion

D. index return

25. The rate of return on _____ is known at the beginning of the holding period, while the rate of return on ____ is not known until the end of the holding period.

A. risky assets; Treasury bills

B. Treasury bills; risky assets

C. excess returns; risky assets

D. index assets; bonds

26. The reward-to-volatility ratio is given by _________.

A. the slope of the capital allocation line

B. the second derivative of the capital allocation line

C. the point at which the second derivative of the investor’s indifference curve reaches zero

D. the portfolio’s excess return

27. Your investment has a 20% chance of earning a 30% rate of return, a 50% chance of earning a 10% rate of return, and a 30% chance of losing 6%. What is your expected return on this investment?

A. 12.8%

B. 11%

C. 8.9%

D. 9.2%

28. Your investment has a 40% chance of earning a 15% rate of return, a 50% chance of earning a 10% rate of return, and a 10% chance of losing 3%. What is the standard deviation of this investment?

A. 5.14%

B. 7.59%

C. 9.29%

D. 8.43%

29. During the 1926-2010 period the geometric mean return on small-firm stocks was ______.

A. 5.31%

B. 5.56%

C. 9.34%

D. 11.80%

30. During the 1926-2010 period the geometric mean return on Treasury bonds was _________.

A. 5.12%

B. 5.56%

C. 9.34%

D. 11.43%

31. During the 1926-2010 period the Sharpe ratio was greatest for which of the following asset classes?

A. Small U.S. stocks

B. Large U.S. stocks

C. Long-term U.S. Treasury bonds

D. Bond world portfolio return in U.S. dollars

32. During the 1985-2010 period the Sharpe ratio was lowest for which of the following asset classes?

A. Small U.S. stocks

B. Large U.S. stocks

C. Long-term U.S. Treasury bonds

D. Equity world portfolio in U.S. dollars

33. During the 1926-2010 period which one of the following asset classes provided the lowest real return?

A. Small U.S. stocks

B. Large U.S. stocks

C. Long-term U.S. Treasury bonds

D. Equity world portfolio in U.S. dollars

34. Both investors and gamblers take on risk. The difference between an investor and a gambler is that an investor _______.

A. is normally risk neutral

B. requires a risk premium to take on the risk

C. knows he or she will not lose money

D. knows the outcomes at the beginning of the holding period

35. Historical returns have generally been __________ for stocks of small firms as (than) for stocks of large firms.

A. the same

B. lower

C. higher

D. none of these options (There is no evidence of a systematic relationship between returns on small-firm stocks and returns on large-firm stocks.)

36. Historically, small-firm stocks have earned higher returns than large-firm stocks. When viewed in the context of an efficient market, this suggests that ___________.

A. small firms are better run than large firms

B. government subsidies available to small firms produce effects that are discernible in stock market statistics

C. small firms are riskier than large firms

D. small firms are not being accurately represented in the data

37. In calculating the variance of a portfolio’s returns, squaring the deviations from the mean results in:

I. Preventing the sum of the deviations from always equaling zero
II. Exaggerating the effects of large positive and negative deviations
III. A number for which the unit is percentage of returns

A. I only

B. I and II only

C. I and III only

D. I, II, and III

38. If you are promised a nominal return of 12% on a 1-year investment, and you expect the rate of inflation to be 3%, what real rate do you expect to earn?

A. 5.48%

B. 8.74%

C. 9%

D. 12%

39. If you require a real growth in the purchasing power of your investment of 8%, and you expect the rate of inflation over the next year to be 3%, what is the lowest nominal return that you would be satisfied with?

A. 3%

B. 8%

C. 11%

D. 11.24%

40. One method of forecasting the risk premium is to use the _______.

A. coefficient of variation of analysts’ earnings forecasts

B. variations in the risk-free rate over time

C. average historical excess returns for the asset under consideration

D. average abnormal return on the index portfolio

41. Treasury bills are paying a 4% rate of return. A risk-averse investor with a risk aversion of A = 3 should invest entirely in a risky portfolio with a standard deviation of 24% only if the risky portfolio’s expected return is at least ______.

A. 8.67%

B. 9.84%

C. 21.28%

D. 14.68%

42. In the mean standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called the _________.

A. capital allocation line

B. indifference curve

C. investor’s utility line

D. security market line

43. Most studies indicate that investors’ risk aversion is in the range _____.

A. 1-3

B. 1.5-4

C. 3-5.2

D. 4-6

44. Two assets have the following expected returns and standard deviations when the risk-free rate is 5%:

An investor with a risk aversion of A = 3 would find that _________________ on a risk-return basis.

A. only asset A is acceptable

B. only asset B is acceptable

C. neither asset A nor asset B is acceptable

D. both asset A and asset B are acceptable

45. Historically, the best asset for the long-term investor wanting to fend off the threats of inflation and taxes while making his money grow has been ____.

A. Stocks

B. Bonds

C. Money market funds

D. Treasury bills

46. The formula is used to calculate the _____________.

A. Sharpe ratio

B. Treynor measure

C. Coefficient of variation

D. Real rate of return

47. A portfolio with a 25% standard deviation generated a return of 15% last year when T-bills were paying 4.5%. This portfolio had a Sharpe ratio of ____.

A. .22

B. .60

C. .42

D. .25

48. Consider a Treasury bill with a rate of return of 5% and the following risky securities:

Security A: E(r) = .15; variance = .0400
Security B: E(r) = .10; variance = .0225
Security C: E(r) = .12; variance = .1000
Security D: E(r) = .13; variance = .0625

The investor must develop a complete portfolio by combining the risk-free asset with one of the securities mentioned above. The security the investor should choose as part of her complete portfolio to achieve the best CAL would be _________.

A. security A

B. security B

C. security C

D. security D

49. You purchased a share of stock for $29. One year later you received $2.25 as dividend and sold the share for $28. Your holding-period return was _________.

A. -3.57%

B. -3.45%

C. 4.31%

D. 8.03%

50. Security A has a higher standard deviation of returns than security B. We would expect that:

I. Security A would have a higher risk premium than security B.
II. The likely range of returns for security A in any given year would be higher than the likely range of returns for security B.
III. The Sharpe ratio of A will be higher than the Sharpe ratio of B.

A. I only

B. I and II only

C. II and III only

D. I, II, and III

51. The holding-period return on a stock was 25%. Its ending price was $18, and its beginning price was $16. Its cash dividend must have been _________.

A. $.25

B. $1

C. $2

D. $4

52. An investor invests 70% of her wealth in a risky asset with an expected rate of return of 15% and a variance of 5%, and she puts 30% in a Treasury bill that pays 5%. Her portfolio’s expected rate of return and standard deviation are __________ and __________ respectively.

A. 10%; 6.7%

B. 12%; 22.4%

C. 12%; 15.7%

D. 10%; 35%

53. The holding-period return on a stock was 32%. Its beginning price was $25, and its cash dividend was $1.50. Its ending price must have been _________.

A. $28.50

B. $33.20

C. $31.50

D. $29.75

54. Consider the following two investment alternatives: First, a risky portfolio that pays a 15% rate of return with a probability of 40% or a 5% rate of return with a probability of 60%. Second, a Treasury bill that pays 6%. The risk premium on the risky investment is _________.

A. 1%

B. 3%

C. 6%

D. 9%

55. Consider the following two investment alternatives: First, a risky portfolio that pays a 20% rate of return with a probability of 60% or a 5% rate of return with a probability of 40%. Second, a Treasury bill that pays 6%. If you invest $50,000 in the risky portfolio, your expected profit would be _________.

A. $3,000

B. $7,000

C. $7,500

D. $10,000

56. You invest $10,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 15% and a standard deviation of 21% and a Treasury bill with a rate of return of 5%. How much money should be invested in the risky asset to form a portfolio with an expected return of 11%?

A. $6,000

B. $4,000

C. $7,000

D. $3,000

57. You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. __________ of your complete portfolio should be invested in the risky portfolio if you want your complete portfolio to have a standard deviation of 9%.

A. 100%

B. 90%

C. 45%

D. 10%

58. You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. A portfolio that has an expected value in 1 year of $1,100 could be formed if you _________.

A. place 40% of your money in the risky portfolio and the rest in the risk-free asset

B. place 55% of your money in the risky portfolio and the rest in the risk-free asset

C. place 60% of your money in the risky portfolio and the rest in the risk-free asset

D. place 75% of your money in the risky portfolio and the rest in the risk-free asset

59. You invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a Treasury bill with a rate of return of 6%. The slope of the capital allocation line formed with the risky asset and the risk-free asset is approximately _________.

A. 1.040

B. .80

C. .50

D. .25

60. You have $500,000 available to invest. The risk-free rate, as well as your borrowing rate, is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should _________.

A. invest $125,000 in the risk-free asset

B. invest $375,000 in the risk-free asset

C. borrow $125,000

D. borrow $375,000

61. The return on the risky portfolio is 15%. The risk-free rate, as well as the investor’s borrowing rate, is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is _________.

A. 6%

B. 8.75 %

C. 10%

D. 16.25%

62. You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 11%, you should invest __________ of your complete portfolio in Treasury bills.

A. 19%

B. 25%

C. 36%

D. 50%

63. You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 8%, you should invest approximately __________ in the risky portfolio. This will mean you will also invest approximately __________ and __________ of your complete portfolio in security X and Y, respectively.

A. 0%; 60%; 40%

B. 25%; 45%; 30%

C. 40%; 24%; 16%

D. 50%; 30%; 20%

64. You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. If you decide to hold 25% of your complete portfolio in the risky portfolio and 75% in the Treasury bills, then the dollar values of your positions in X and Y, respectively, would be __________ and _________.

A. $300; $450

B. $150; $100

C. $100; $150

D. $450; $300

65. You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. The dollar values of your positions in X, Y, and Treasury bills would be _________, __________, and __________, respectively, if you decide to hold a complete portfolio that has an expected return of 8%.

A. $162; $595; $243

B. $243; $162; $595

C. $595; $162; $243

D. $595; $243; $162

66. You have the following rates of return for a risky portfolio for several recent years:

If you invested $1,000 at the beginning of 2008, your investment at the end of 2011 would be worth ___________.

A. $2,176.60

B. $1,785.56

C. $1,645.53

D. $1,247.87

67. You have the following rates of return for a risky portfolio for several recent years:

The annualized (geometric) average return on this investment is _____.

A. 16.15%

B. 16.87%

C. 21.32%

D. 15.60%

68. A security with normally distributed returns has an annual expected return of 18% and standard deviation of 23%. The probability of getting a return between -28% and 64% in any one year is _____.

A. 68.26%

B. 95.44%

C. 99.74%

D. 100%

69. The Manhawkin Fund has an expected return of 16% and a standard deviation of 20%. The risk-free rate is 4%. What is the reward-to-volatility ratio for the Manhawkin Fund?

A. .8

B. .6

C. 9

D. 1

70. From 1926 to 2010 the world stock portfolio offered _____ return and _____ volatility than the portfolio of large U.S. stocks.

A. lower; higher

B. lower; lower

C. higher; lower

D. higher; higher

71. The price of a stock is $55 at the beginning of the year and $50 at the end of the year. If the stock paid a $3 dividend and inflation was 3%, what is the real holding-period return for the year?

A. -3.64%

B. -6.36%

C. -6.44%

D. -11.74%

72. The price of a stock is $38 at the beginning of the year and $41 at the end of the year. If the stock paid a $2.50 dividend, what is the holding-period return for the year?

A. 6.58%

B. 8.86%

C. 14.47%

D. 18.66%

73. You invest all of your money in 1-year T-bills. Which of the following statements is (are) correct?

I. Your nominal return on the T-bills is riskless.
II. Your real return on the T-bills is riskless.
III. Your nominal Sharpe ratio is zero.

A. I only

B. I and III only

C. II only

D. I, II, and III

74. Which one of the following would be considered a risk-free asset in real terms as opposed to nominal?

A. Money market fund

B. U.S. T-bill

C. Short-term corporate bonds

D. U.S. T-bill whose return was indexed to inflation

75. What is the geometric average return of the following quarterly returns: 3%, 5%, 4%, and 7%?

A. 3.72%

B. 4.23%

C. 4.74%

D. 4.90%

76. What is the geometric average return over 1 year if the quarterly returns are 8%, 9%, 5%, and 12%?

A. 8%

B. 8.33 %

C. 8.47%

D. 8.5 %

77. If the nominal rate of return on investment is 6% and inflation is 2% over a holding period, what is the real rate of return on this investment?

A. 3.92%

B. 4%

C. 4.12%

D. 6%

78. According to historical data, over the long run which of the following assets has the best chance to provide the best after-inflation, after-tax rate of return?

A. Long-term Treasury bonds

B. Corporate bonds

C. Common stocks

D. Preferred stocks

79. The buyer of a new home is quoted a mortgage rate of .5% per month. What is the APR on the loan?

A. .50%

B. 5%

C. 6%

D. 6.5%

80. A loan for a new car costs the borrower .8% per month. What is the EAR?

A. .80%

B. 6.87%

C. 9.6%

D. 10.03%

81. The CAL provided by combinations of 1-month T-bills and a broad index of common stocks is called the ______.

A. SML

B. CAPM

C. CML

D. total return line

82. Which of the following arguments supporting passive investment strategies is (are) correct?

I. Active trading strategies may not guarantee higher returns but guarantee higher costs.
II. Passive investors can free-ride on the activity of knowledge investors whose trades force prices to reflect currently available information.
III. Passive investors are guaranteed to earn higher rates of return than active investors over sufficiently long time horizons.

A. I only

B. I and II only

C. II and III only

D. I, II, and III

83. You have the following rates of return for a risky portfolio for several recent years. Assume that the stock pays no dividends.

What is the geometric average return for the period?

A. 2.87%

B. .74%

C. 2.6%

D. 2.21%

84. You have the following rates of return for a risky portfolio for several recent years. Assume that the stock pays no dividends.

What is the dollar-weighted return over the entire time period?

A. 2.87%

B. .74%

C. 2.6%

D. 2.21%

6
Student: ___________________________________________________________________________
1. Risk that can be eliminated through diversification is called ______ risk.

A. unique

B. firm-specific

C. diversifiable

D. all of these options

2. The _______ decision should take precedence over the _____ decision.

A. asset allocation; stock selection

B. bond selection; mutual fund selection

C. stock selection; asset allocation

D. stock selection; mutual fund selection

3. Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ________.

A. they had to pay huge fines for obstruction of justice

B. their 401k accounts were held outside the company

C. their 401k accounts were not well diversified

D. none of these options

4. Based on the outcomes in the following table, choose which of the statements below is (are) correct?

I. The covariance of security A and security B is zero.
II. The correlation coefficient between securities A and C is negative.
III. The correlation coefficient between securities B and C is positive.

A. I only

B. I and II only

C. II and III only

D. I, II, and III

5. Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______.

A. asset A

B. asset B

C. no risky asset

D. The answer cannot be determined from the data given.

6. Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______.

A. up; right

B. up; left

C. down; right

D. down; left

7. An investor’s degree of risk aversion will determine his or her ______.

A. optimal risky portfolio

B. risk-free rate

C. optimal mix of the risk-free asset and risky asset

D. capital allocation line

8. The ________ is equal to the square root of the systematic variance divided by the total variance.

A. covariance

B. correlation coefficient

C. standard deviation

D. reward-to-variability ratio

9. Which of the following statistics cannot be negative?

A. Covariance

B. Variance

C. E(r)

D. Correlation coefficient

10. Asset A has an expected return of 20% and a standard deviation of 25%. The risk-free rate is 10%. What is the reward-to-variability ratio?

A. .40

B. .50

C. .75

D. .80

11. The correlation coefficient between two assets equals _________.

A. their covariance divided by the product of their variances

B. the product of their variances divided by their covariance

C. the sum of their expected returns divided by their covariance

D. their covariance divided by the product of their standard deviations

12. Diversification is most effective when security returns are _________.

A. high

B. negatively correlated

C. positively correlated

D. uncorrelated

13. The expected rate of return of a portfolio of risky securities is _________.

A. the sum of the securities’ covariances

B. the sum of the securities’ variances

C. the weighted sum of the securities’ expected returns

D. the weighted sum of the securities’ variances

14. Beta is a measure of security responsiveness to _________.

A. firm-specific risk

B. diversifiable risk

C. market risk

D. unique risk

15. The risk that can be diversified away is __________.

A. beta

B. firm-specific risk

C. market risk

D. systematic risk

16. Approximately how many securities does it take to diversify almost all of the unique risk from a portfolio?

A. 2

B. 6

C. 8

D. 20

17. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum-variance portfolio has a standard deviation that is always _________.

A. equal to the sum of the securities’ standard deviations

B. equal to -1

C. equal to 0

D. greater than 0

18. Market risk is also called __________ and _________.

A. systematic risk; diversifiable risk

B. systematic risk; nondiversifiable risk

C. unique risk; nondiversifiable risk

D. unique risk; diversifiable risk

19. Firm-specific risk is also called __________ and __________.

A. systematic risk; diversifiable risk

B. systematic risk; nondiversifiable risk

C. unique risk; nondiversifiable risk

D. unique risk; diversifiable risk

20. Which one of the following stock return statistics fluctuates the most over time?

A. Covariance of returns

B. Variance of returns

C. Average return

D. Correlation coefficient

21. Harry Markowitz is best known for his Nobel Prize-winning work on _____________.

A. strategies for active securities trading

B. techniques used to identify efficient portfolios of risky assets

C. techniques used to measure the systematic risk of securities

D. techniques used in valuing securities options

22. Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______.

A. the returns on the stock and bond portfolios tend to move inversely

B. the returns on the stock and bond portfolios tend to vary independently of each other

C. the returns on the stock and bond portfolios tend to move together

D. the covariance of the stock and bond portfolios will be positive

23. You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation of 24%. You put the rest of your money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolios have a correlation of .55. The standard deviation of the resulting portfolio will be ________________.

A. more than 18% but less than 24%

B. equal to 18%

C. more than 12% but less than 18%

D. equal to 12%

24. On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie to the _____________ of the current investment opportunity set.

A. left and above

B. left and below

C. right and above

D. right and below

25. The term complete portfolio refers to a portfolio consisting of _________________.

A. the risk-free asset combined with at least one risky asset

B. the market portfolio combined with the minimum-variance portfolio

C. securities from domestic markets combined with securities from foreign markets

D. common stocks combined with bonds

26. Rational risk-averse investors will always prefer portfolios _____________.

A. located on the efficient frontier to those located on the capital market line

B. located on the capital market line to those located on the efficient frontier

C. at or near the minimum-variance point on the efficient frontier

D. that are risk-free to all other asset choices

27. The optimal risky portfolio can be identified by finding:

I. The minimum-variance point on the efficient frontier
II. The maximum-return point on the efficient frontier and the minimum-variance point on the efficient frontier
III. The tangency point of the capital market line and the efficient frontier
IV. The line with the steepest slope that connects the risk-free rate to the efficient frontier

A. I and II only

B. II and III only

C. III and IV only

D. I and IV only

28. The _________ reward-to-variability ratio is found on the ________ capital market line.

A. lowest; steepest

B. highest; flattest

C. highest; steepest

D. lowest; flattest

29. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24%, while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio, while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient between the returns on A and B is _________.

A. .583

B. .225

C. .327

D. .128

30. The standard deviation of return on investment A is .10, while the standard deviation of return on investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is _________.

A. .12

B. .36

C. .60

D. .77

31. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35%, while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is .45. Stock A comprises 40% of the portfolio, while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is _________.

A. 23%

B. 19.76%

C. 18.45%

D. 17.67%

32. The standard deviation of return on investment A is .10, while the standard deviation of return on investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is _________.

A. -.0447

B. -.0020

C. .0020

D. .0447

33. Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security B in the minimum-variance portfolio is _________.

A. 10%

B. 20%

C. 40%

D. 60%

34. An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The proportion of the optimal risky portfolio that should be invested in stock A is _________.

A. 0%

B. 40%

C. 60%

D. 100%

35. An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The expected return on the optimal risky portfolio is _________.

A. 14%

B. 15.6%

C. 16.4%

D. 18%

36. An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The standard deviation of return on the optimal risky portfolio is _________.

A. 0%

B. 5%

C. 7%

D. 20%

37. An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The proportion of the optimal risky portfolio that should be invested in stock B is approximately _________.

A. 29%

B. 44%

C. 56%

D. 71%

38. An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The expected return on the optimal risky portfolio is approximately _________. (Hint: Find weights first.)

A. 14%

B. 16%

C. 18%

D. 19%

39. An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The standard deviation of the returns on the optimal risky portfolio is _________.

A. 25.5%

B. 22.3%

C. 21.4%

D. 20.7%

40. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 24%, while the standard deviation on stock B is 14%. The correlation coefficient between the returns on A and B is .35. The expected return on stock A is 25%, while on stock B it is 11%. The proportion of the minimum-variance portfolio that would be invested in stock B is approximately _________.

A. 45%

B. 67%

C. 85%

D. 92%

41. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The expected return on the minimum-variance portfolio is approximately _________.

A. 10%

B. 13.6%

C. 15%

D. 19.41%

42. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The standard deviation of return on the minimum-variance portfolio is _________.

A. 0%

B. 6%

C. 12%

D. 17%

43. A measure of the riskiness of an asset held in isolation is ____________.

A. beta

B. standard deviation

C. covariance

D. alpha

44. Semitool Corp. has an expected excess return of 6% for next year. However, for every unexpected 1% change in the market, Semitool’s return responds by a factor of 1.2. Suppose it turns out that the economy and the stock market do better than expected by 1.5% and Semitool’s products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information, what was Semitool’s actual excess return?

A. 7%

B. 8.5%

C. 8.8%

D. 9.25%

45. The part of a stock’s return that is systematic is a function of which of the following variables?

I. Volatility in excess returns of the stock market
II. The sensitivity of the stock’s returns to changes in the stock market
III. The variance in the stock’s returns that is unrelated to the overall stock market

A. I only

B. I and II only

C. II and III only

D. I, II, and III

46. Stock A has a beta of 1.2, and stock B has a beta of 1. The returns of stock A are ______ sensitive to changes in the market than are the returns of stock B.

A. 20% more

B. slightly more

C. 20% less

D. slightly less

47. Which risk can be partially or fully diversified away as additional securities are added to a portfolio?

I. Total risk
II. Systematic risk
III. Firm-specific risk

A. I only

B. I and II only

C. I, II, and III

D. I and III

48. According to Tobin’s separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________.

A. identifying all investor imposed constraints; identifying the set of securities that conform to the investor’s constraints and offer the best risk-return trade-offs

B. identifying the investor’s degree of risk aversion; choosing securities from industry groups that are consistent with the investor’s risk profile

C. identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor’s degree of risk aversion

D. choosing which risky assets an investor prefers according to the investor’s risk-aversion level; minimizing the CAL by lending at the risk-free rate

49. You are constructing a scatter plot of excess returns for stock A versus the market index. If the correlation coefficient between stock A and the index is -1, you will find that the points of the scatter diagram ___________ and the line of best fit has a ______________.

A. all fall on the line of best fit; positive slope

B. all fall on the line of best fit; negative slope

C. are widely scattered around the line; positive slope

D. are widely scattered around the line; negative slope

50. The term excess return refers to ______________.

A. returns earned illegally by means of insider trading

B. the difference between the rate of return earned and the risk-free rate

C. the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk

D. the portion of the return on a security that represents tax liability and therefore cannot be reinvested

51. You are recalculating the risk of ACE stock in relation to the market index, and you find that the ratio of the systematic variance to the total variance has risen. You must also find that the ____________.

A. covariance between ACE and the market has fallen

B. correlation coefficient between ACE and the market has fallen

C. correlation coefficient between ACE and the market has risen

D. unsystematic risk of ACE has risen

52. A stock has a correlation with the market of .45. The standard deviation of the market is 21%, and the standard deviation of the stock is 35%. What is the stock’s beta?

A. 1

B. .75

C. .60

D. .55

53. The values of beta coefficients of securities are __________.

A. always positive

B. always negative

C. always between positive 1 and negative 1

D. usually positive but are not restricted in any particular way

54. A security’s beta coefficient will be negative if ____________.

A. its returns are negatively correlated with market-index returns

B. its returns are positively correlated with market-index returns

C. its stock price has historically been very stable

D. market demand for the firm’s shares is very low

55. The market value weighted-average beta of firms included in the market index will always be _____________.

A. 0

B. between 0 and 1

C. 1

D. none of these options (There is no particular rule concerning the average beta of firms included in the market index.)

56. Diversification can reduce or eliminate __________ risk.

A. all

B. systematic

C. nonsystematic

D. only an insignificant

57. To construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________.

A. 1

B. .5

C. 0

D. -1

58. Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is _____________.

A. 1

B. less than 1

C. between 0 and 1

D. less than or equal to 0

59. If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the ________.

A. stock’s standard deviation

B. variance of the market

C. stock’s beta

D. covariance with the market index

60. Which of the following provides the best example of a systematic-risk event?

A. A strike by union workers hurts a firm’s quarterly earnings.

B. Mad Cow disease in Montana hurts local ranchers and buyers of beef.

C. The Federal Reserve increases interest rates 50 basis points.

D. A senior executive at a firm embezzles $10 million and escapes to South America.

61. Which of the following statements is (are) true regarding time diversification?

I. The standard deviation of the average annual rate of return over several years will be smaller than the 1-year standard deviation.
II. For a longer time horizon, uncertainty compounds over a greater number of years.
III. Time diversification does not reduce risk.

A. I only

B. II only

C. II and III only

D. I, II, and III

62. You find that the annual Sharpe ratio for stock A returns is equal to 1.8. For a 3-year holding period, the Sharpe ratio would equal _______.

A. 1.8

B. 2.48

C. 3.12

D. 5.49

63.

The beta of this stock is ____.

A. .12

B. .35

C. 1.32

D. 4.05

64.

This stock has greater systematic risk than a stock with a beta of ___.

A. .50

B. 1.5

C. 2

D. 3

65.

The characteristic line for this stock is Rstock = ___ + ___ Rmarket.

A. .35; .12

B. 4.05; 1.32

C. 15.44; .97

D. .26; 1.36

66.

_______________ percent of the variance is explained by this regression.

A. 12

B. 35

C. 4.05

D. 80

67.

The stock is ______ riskier than the typical stock.

A. 32%

B. 15.44%

C. 12%

D. 38%

68. Decreasing the number of stocks in a portfolio from 50 to 10 would likely ________________.

A. increase the systematic risk of the portfolio

B. increase the unsystematic risk of the portfolio

C. increase the return of the portfolio

D. decrease the variation in returns the investor faces in any one year

69. If you want to know the portfolio standard deviation for a three-stock portfolio, you will have to ______.

A. calculate two covariances and one trivariance

B. calculate only two covariances

C. calculate three covariances

D. average the variances of the individual stocks

70. Which of the following correlation coefficients will produce the least diversification benefit?

A. -.6

B. -.3

C. 0

D. .8

71. Which of the following correlation coefficients will produce the most diversification benefits?

A. -.6

B. -.9

C. 0

D. .4

72. What is the most likely correlation coefficient between a stock-index mutual fund and the S&P 500?

A. -1

B. 0

C. 1

D. .5

73. Investing in two assets with a correlation coefficient of -.5 will reduce what kind of risk?

A. Market risk

B. Nondiversifiable risk

C. Systematic risk

D. Unique risk

74. Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk?

A. Market risk

B. Unique risk

C. Unsystematic risk

D. None of these options (With a correlation of 1, no risk will be reduced.)

75. A portfolio of stocks fluctuates when the Treasury yields change. Since this risk cannot be eliminated through diversification, it is called __________.

A. firm-specific risk

B. systematic risk

C. unique risk

D. none of the options

76. As you lengthen the time horizon of your investment period and decide to invest for multiple years, you will find that:

I. The average risk per year may be smaller over longer investment horizons.
II. The overall risk of your investment will compound over time.
III. Your overall risk on the investment will fall.

A. I only

B. I and II only

C. III only

D. I, II, and III

77. You are considering adding a new security to your portfolio. To decide whether you should add the security, you need to know the security’s:

I. Expected return
II. Standard deviation
III. Correlation with your portfolio

A. I only

B. I and II only

C. I and III only

D. I, II, and III

78. Which of the following is a correct expression concerning the formula for the standard deviation of returns of a two-asset portfolio where the correlation coefficient is positive?

A. σ2rp < (W12σ12 + W22σ22) B. σ2rp = (W12σ12 + W22σ22) C. σ2rp = (W12σ12 – W22σ22) D. σ2rp > (W12σ12 + W22σ22)

79. What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of stock A, and the correlation coefficient between the two stocks is -.23.

A. 9.7%

B. 12.2%

C. 14%

D. 15.6%

80. What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A, and the correlation coefficient between the two stocks is -1.

A. 0%

B. 10.8%

C. 18%

D. 24%

81. The expected return of a portfolio is 8.9%, and the risk-free rate is 3.5%. If the portfolio standard deviation is 12%, what is the reward-to-variability ratio of the portfolio?

A. 0

B. .45

C. .74

D. 1.35

82. A project has a 60% chance of doubling your investment in 1 year and a 40% chance of losing half your money. What is the standard deviation of this investment?

A. 25%

B. 50%

C. 62%

D. 73%

83. A project has a 50% chance of doubling your investment in 1 year and a 50% chance of losing half your money. What is the expected return on this investment project?

A. 0%

B. 25%

C. 50%

D. 75%

84. The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index.

Which stock is likely to further reduce risk for an investor currently holding her portfolio in a well-diversified portfolio of common stock?

A. Stock A

B. Stock B

C. There is no difference between A or B.

D. The answer cannot be determined from the information given.

85. The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index.

Which stock is riskier to a nondiversified investor who puts all his money in only one of these stocks?

A. Stock A is riskier.

B. Stock B is riskier.

C. Both stocks are equally risky.

D. The answer cannot be determined from the information given.

7
Student: ___________________________________________________________________________
1. An adjusted beta will be ______ than the unadjusted beta.

A. lower

B. higher

C. closer to 1

D. closer to 0

2. Fama and French claim that after controlling for firm size and the ratio of the firm’s book value to market value, beta is:

I. Highly significant in predicting future stock returns
II. Relatively useless in predicting future stock returns
III. A good predictor of the firm’s specific risk

A. I only

B. II only

C. I and III only

D. I, II, and III

3. Which of the following are assumptions of the simple CAPM model?

I. Individual trades of investors do not affect a stock’s price.
II. All investors plan for one identical holding period.
III. All investors analyze securities in the same way and share the same economic view of the world.
IV. All investors have the same level of risk aversion.

A. I, II, and IV only

B. I, II, and III only

C. II, III, and IV only

D. I, II, III, and IV

4. When all investors analyze securities in the same way and share the same economic view of the world, we say they have ____________________.

A. heterogeneous expectations

B. equal risk aversion

C. asymmetric information

D. homogeneous expectations

5. In a simple CAPM world which of the following statements is (are) correct?

I. All investors will choose to hold the market portfolio, which includes all risky assets in the world.
II. Investors’ complete portfolio will vary depending on their risk aversion.
III. The return per unit of risk will be identical for all individual assets.
IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio.

A. I, II, and III only

B. II, III, and IV only

C. I, III, and IV only

D. I, II, III, and IV

6. Consider the CAPM. The risk-free rate is 6%, and the expected return on the market is 18%. What is the expected return on a stock with a beta of 1.3?

A. 6%

B. 15.6%

C. 18%

D. 21.6%

7. Consider the CAPM. The risk-free rate is 5%, and the expected return on the market is 15%. What is the beta on a stock with an expected return of 17%?

A. .5

B. .7

C. 1

D. 1.2

8. Consider the CAPM. The expected return on the market is 18%. The expected return on a stock with a beta of 1.2 is 20%. What is the risk-free rate?

A. 2%

B. 6%

C. 8%

D. 12%

9. The arbitrage pricing theory was developed by _________.

A. Henry Markowitz

B. Stephen Ross

C. William Sharpe

D. Eugene Fama

10. In the context of the capital asset pricing model, the systematic measure of risk is captured by _________.

A. unique risk

B. beta

C. the standard deviation of returns

D. the variance of returns

11. Empirical results estimated from historical data indicate that betas _________.

A. are always close to zero

B. are constant over time

C. of all securities are always between zero and 1

D. seem to regress toward 1 over time

12. If enough investors decide to purchase stocks, they are likely to drive up stock prices, thereby causing _____________ and ___________.

A. expected returns to fall; risk premiums to fall

B. expected returns to rise; risk premiums to fall

C. expected returns to rise; risk premiums to rise

D. expected returns to fall; risk premiums to rise

13. The market portfolio has a beta of _________.

A. -1

B. 0

C. .5

D. 1

14. In a well-diversified portfolio, __________ risk is negligible.

A. nondiversifiable

B. market

C. systematic

D. unsystematic

15. The capital asset pricing model was developed by _________.

A. Kenneth French

B. Stephen Ross

C. William Sharpe

D. Eugene Fama

16. If all investors become more risk averse, the SML will _______________ and stock prices will _______________.

A. shift upward; rise

B. shift downward; fall

C. have the same intercept with a steeper slope; fall

D. have the same intercept with a flatter slope; rise

17. According to the capital asset pricing model, a security with a _________.

A. negative alpha is considered a good buy

B. positive alpha is considered overpriced

C. positive alpha is considered underpriced

D. zero alpha is considered a good buy

18. Arbitrage is based on the idea that _________.

A. assets with identical risks must have the same expected rate of return

B. securities with similar risk should sell at different prices

C. the expected returns from equally risky assets are different

D. markets are perfectly efficient

19. Investors require a risk premium as compensation for bearing ______________.

A. unsystematic risk

B. alpha risk

C. residual risk

D. systematic risk

20. According to the capital asset pricing model, a fairly priced security will plot _________.

A. above the security market line

B. along the security market line

C. below the security market line

D. at no relation to the security market line

21. According to the capital asset pricing model, fairly priced securities have _________.

A. negative betas

B. positive alphas

C. positive betas

D. zero alphas

22. You have a $50,000 portfolio consisting of Intel, GE, and Con Edison. You put $20,000 in Intel, $12,000 in GE, and the rest in Con Edison. Intel, GE, and Con Edison have betas of 1.3, 1, and .8, respectively. What is your portfolio beta?

A. 1.048

B. 1.033

C. 1

D. 1.037

23. The graph of the relationship between expected return and beta in the CAPM context is called the _________.

A. CML

B. CAL

C. SML

D. SCL

24. Research has revealed that regardless of what the current estimate of a firm’s beta is, beta will tend to move closer to ______ over time.

A. 1

B. 0

C. -1

D. .5

25. The beta of a security is equal to _________.

A. the covariance between the security and market returns divided by the variance of the market’s returns

B. the covariance between the security and market returns divided by the standard deviation of the market’s returns

C. the variance of the security’s returns divided by the covariance between the security and market returns

D. the variance of the security’s returns divided by the variance of the market’s returns

26. According to the capital asset pricing model, in equilibrium _________.

A. all securities’ returns must lie below the capital market line

B. all securities’ returns must lie on the security market line

C. the slope of the security market line must be less than the market risk premium

D. any security with a beta of 1 must have an excess return of zero

27. According to the CAPM, which of the following is not a true statement regarding the market portfolio.

A. All securities in the market portfolio are held in proportion to their market values.

B. It includes all risky assets in the world, including human capital.

C. It is always the minimum-variance portfolio on the efficient frontier.

D. It lies on the efficient frontier.

28. In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line?

A. The capital market line always has a positive slope.

B. The capital market line is also called the security market line.

C. The capital market line is the best-attainable capital allocation line.

D. The capital market line is the line from the risk-free rate through the market portfolio.

29. Consider the single factor APT. Portfolio A has a beta of 1.3 and an expected return of 21%. Portfolio B has a beta of .7 and an expected return of 17%. The risk-free rate of return is 8%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________.

A. A; A

B. A; B

C. B; A

D. B; B

30. Consider the single factor APT. Portfolio A has a beta of .2 and an expected return of 13%. Portfolio B has a beta of .4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________.

A. A; A

B. A; B

C. B; A

D. B; B

31. Consider the multifactor APT with two factors. Portfolio A has a beta of .5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and 2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________ if no arbitrage opportunities exist.

A. 13.5%

B. 15%

C. 16.25%

D. 23%

32. Consider the one-factor APT. The variance of the return on the factor portfolio is .08. The beta of a well-diversified portfolio on the factor is 1.2. The variance of the return on the well-diversified portfolio is approximately _________.

A. .1152

B. .1270

C. .1521

D. .1342

33. Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5%, and the market expected rate of return is 15%. According to the capital asset pricing model, security X is _________.

A. fairly priced

B. overpriced

C. underpriced

D. none of these answers

34. The possibility of arbitrage arises when ____________.

A. there is no consensus among investors regarding the future direction of the market, and thus trades are made arbitrarily

B. mispricing among securities creates opportunities for riskless profits

C. two identically risky securities carry the same expected returns

D. investors do not diversify

35. Building a zero-investment portfolio will always involve _____________.

A. an unknown mixture of short and long positions

B. only short positions

C. only long positions

D. equal investments in a short and a long position

36. An important characteristic of market equilibrium is _______________.

A. the presence of many opportunities for creating zero-investment portfolios

B. all investors exhibit the same degree of risk aversion

C. the absence of arbitrage opportunities

D. the lack of liquidity in the market

37. Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The variance of return on the market portfolio is .0225. If the risk-free rate of return is 4%, the expected return on the market portfolio is _________.

A. 6.75%

B. 9%

C. 10.75%

D. 12%

38. You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of .90. The beta of this portfolio is _________.

A. 1.14

B. 1.2

C. 1.26

D. 1.5

39. In a single-factor market model the beta of a stock ________.

A. measures the stock’s contribution to the standard deviation of the market portfolio

B. measures the stock’s unsystematic risk

C. changes with the variance of the residuals

D. measures the stock’s contribution to the standard deviation of the stock

40. Security A has an expected rate of return of 12% and a beta of 1.1. The market expected rate of return is 8%, and the risk-free rate is 5%. The alpha of the stock is _________.

A. -1.7%

B. 3.7%

C. 5.5%

D. 8.7%

41. The variance of the return on the market portfolio is .04 and the expected return on the market portfolio is 20%. If the risk-free rate of return is 10%, the market degree of risk aversion, A, is _________.

A. .5

B. 2.5

C. 3.5

D. 5

42. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of .8 to offer a rate of return of 12%, then you should _________.

A. buy stock X because it is overpriced

B. buy stock X because it is underpriced

C. sell short stock X because it is overpriced

D. sell short stock X because it is underpriced

43. Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately _________.

A. .60

B. 1

C. 1.67

D. 3.20

44. The risk-free rate and the expected market rate of return are 6% and 16%, respectively. According to the capital asset pricing model, the expected rate of return on security X with a beta of 1.2 is equal to _________.

A. 12%

B. 17%

C. 18%

D. 23%

45. Consider two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.2. Stock B has an expected return of 14% and a beta of 1.8. The expected market rate of return is 9% and the risk-free rate is 5%. Security __________ would be considered the better buy because _________.

A. A; it offers an expected excess return of .2%

B. A; it offers an expected excess return of 2.2%

C. B; it offers an expected excess return of 1.8%

D. B; it offers an expected return of 2.4%

46. According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is _______________.

A. directly related to the risk aversion of the particular investor

B. inversely related to the risk aversion of the particular investor

C. directly related to the beta of the stock

D. inversely related to the alpha of the stock

47. In his famous critique of the CAPM, Roll argued that the CAPM ______________.

A. is not testable because the true market portfolio can never be observed

B. is of limited use because systematic risk can never be entirely eliminated

C. should be replaced by the APT

D. should be replaced by the Fama-French three-factor model

48. Which of the following variables do Fama and French claim do a better job explaining stock returns than beta?

I. Book-to-market ratio
II. Unexpected change in industrial production
III. Firm size

A. I only

B. I and II only

C. I and III only

D. I, II, and III

49. In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by:

I. Including the unsystematic risk of a stock
II. Including human capital in the market portfolio
III. Allowing for changes in beta over time

A. I and II only

B. II and III only

C. I and III only

D. I, II, and III

50. The SML is valid for _______________, and the CML is valid for ______________.

A. only individual assets; well-diversified portfolios only

B. only well-diversified portfolios; only individual assets

C. both well-diversified portfolios and individual assets; both well-diversified portfolios and individual assets

D. both well-diversified portfolios and individual assets; well-diversified portfolios only

51. Liquidity is a risk factor that __________.

A. has yet to be accurately measured and incorporated into portfolio management

B. is unaffected by trading mechanisms on various stock exchanges

C. has no effect on the market value of an asset

D. affects bond prices but not stock prices

52. Beta is a measure of ______________.

A. total risk

B. relative systematic risk

C. relative nonsystematic risk

D. relative business risk

53. According to capital asset pricing theory, the key determinant of portfolio returns is _________.

A. the degree of diversification

B. the systematic risk of the portfolio

C. the firm-specific risk of the portfolio

D. economic factors

54. The expected return of the risky-asset portfolio with minimum variance is _________.

A. the market rate of return

B. zero

C. the risk-free rate

D. The answer cannot be determined from the information given.

55. According to the CAPM, investors are compensated for all but which of the following?

A. Expected inflation

B. Systematic risk

C. Time value of money

D. Residual risk

56. The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM _____________.

A. places less emphasis on market risk

B. recognizes multiple unsystematic risk factors

C. recognizes only one systematic risk factor

D. recognizes multiple systematic risk factors

57. Arbitrage is __________________________.

A. an example of the law of one price

B. the creation of riskless profits made possible by relative mispricing among securities

C. a common opportunity in modern markets

D. an example of a risky trading strategy based on market forecasting

58. A stock’s alpha measures the stock’s ____________________.

A. expected return

B. abnormal return

C. excess return

D. residual return

59. The measure of unsystematic risk can be found from an index model as _________.

A. residual standard deviation

B. R-square

C. degrees of freedom

D. sum of squares of the regression

60. Standard deviation of portfolio returns is a measure of ___________.

A. total risk

B. relative systematic risk

C. relative nonsystematic risk

D. relative business risk

61. One of the main problems with the arbitrage pricing theory is __________.

A. its use of several factors instead of a single market index to explain the risk-return relationship

B. the introduction of nonsystematic risk as a key factor in the risk-return relationship

C. that the APT requires an even larger number of unrealistic assumptions than does the CAPM

D. the model fails to identify the key macroeconomic variables in the risk-return relationship

62. You run a regression of a stock’s returns versus a market index and find the following:

Based on the data, you know that the stock _____.

A. earned a positive alpha that is statistically significantly different from zero

B. has a beta precisely equal to .890

C. has a beta that is likely to be anything between .6541 and 1.465 inclusive

D. has no systematic risk

63. The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, _________.

A. SDA Corp. stock is underpriced

B. SDA Corp. stock is fairly priced

C. SDA Corp. stock’s alpha is -.75%

D. SDA Corp. stock alpha is .75%

64. Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%. Portfolio X has an expected return of 14% and a beta of 1. Portfolio Y has an expected return of 9.5% and a beta of .25. In this situation, you would conclude that portfolios X and Y _________.

A. are in equilibrium

B. offer an arbitrage opportunity

C. are both underpriced

D. are both fairly priced

65.

What is the expected return on the market?

A. 0%

B. 5%

C. 10%

D. 15%

66.

What is the beta for a portfolio with an expected return of 12.5%?

A. 0

B. 1

C. 1.5

D. 2

67.

What is the expected return for a portfolio with a beta of .5?

A. 5%

B. 7.5%

C. 12.5%

D. 15%

68.

What is the alpha of a portfolio with a beta of 2 and actual return of 15%?

A. 0%

B. 13%

C. 15%

D. 17%

69. If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below is possible? Consider each situation independently, and assume the risk-free rate is 5%.

A. Option A

B. Option B

C. Option C

D. Option D

70. Two investment advisers are comparing performance. Adviser A averaged a 20% return with a portfolio beta of 1.5, and adviser B averaged a 15% return with a portfolio beta of 1.2. If the T-bill rate was 5% and the market return during the period was 13%, which adviser was the better stock picker?

A. Advisor A was better because he generated a larger alpha.

B. Advisor B was better because she generated a larger alpha.

C. Advisor A was better because he generated a higher return.

D. Advisor B was better because she achieved a good return with a lower beta.

71. The expected return on the market is the risk-free rate plus the _____________.

A. diversified returns

B. equilibrium risk premium

C. historical market return

D. unsystematic return

72. You consider buying a share of stock at a price of $25. The stock is expected to pay a dividend of $1.50 next year, and your advisory service tells you that you can expect to sell the stock in 1 year for $28. The stock’s beta is 1.1, rf is 6%, and E[rm] = 16%. What is the stock’s abnormal return?

A. 1%

B. 2%

C. -1%

D. -2%

73. If the beta of the market index is 1 and the standard deviation of the market index increases from 12% to 18%, what is the new beta of the market index?

A. .8

B. 1

C. 1.2

D. 1.5

74. According to the CAPM, what is the market risk premium given an expected return on a security of 13.6%, a stock beta of 1.2, and a risk-free interest rate of 4%?

A. 4%

B. 4.8%

C. 6.6%

D. 8%

75. According to the CAPM, what is the expected market return given an expected return on a security of 15.8%, a stock beta of 1.2, and a risk-free interest rate of 5%?

A. 5%

B. 9%

C. 13%

D. 14%

76. What is the expected return on a stock with a beta of .8, given a risk-free rate of 3.5% and an expected market return of 15.5%?

A. 3.8%

B. 13.1%

C. 15.6%

D. 19.1%

77. Research has identified two systematic factors that affect U.S. stock returns. The factors are growth in industrial production and changes in long-term interest rates. Industrial production growth is expected to be 3%, and long-term interest rates are expected to increase by 1%. You are analyzing a stock that has a beta of 1.2 on the industrial production factor and .5 on the interest rate factor. It currently has an expected return of 12%. However, if industrial production actually grows 5% and interest rates drop 2%, what is your best guess of the stock’s return?

A. 15.9%

B. 12.9%

C. 13.2%

D. 12%

78. A stock has a beta of 1.3. The systematic risk of this stock is ____________ the stock market as a whole.

A. higher than

B. lower than

C. equal to

D. indeterminable compared to

79. There are two independent economic factors, M1 and M2. The risk-free rate is 5%, and all stocks have independent firm-specific components with a standard deviation of 25%. Portfolios A and B are well diversified. Given the data below, which equation provides the correct pricing model?

A. E(rP) = 5 + 1.12βP1 + 11.86βP2

B. E(rP) = 5 + 4.96βP1 + 13.26βP2

C. E(rP) = 5 + 3.23βP1 + 8.46βP2

D. E(rP) = 5 + 8.71βP1 + 9.68βP2

80. Using the index model, the alpha of a stock is 3%, the beta is 1.1, and the market return is 10%. What is the residual given an actual return of 15%?

A. .0%

B. 1%

C. 2%

D. 3%

81. The risk premium for exposure to aluminum commodity prices is 4%, and the firm has a beta relative to aluminum commodity prices of .6. The risk premium for exposure to GDP changes is 6%, and the firm has a beta relative to GDP of 1.2. If the risk-free rate is 4%, what is the expected return on this stock?

A. 10%

B. 11.5%

C. 13.6%

D. 14%

82. The two-factor model on a stock provides a risk premium for exposure to market risk of 9%, a risk premium for exposure to interest rate risk of (-1.3%), and a risk-free rate of 3.5%. The beta for exposure to market risk is 1, and the beta for exposure to interest rate risk is also 1. What is the expected return on the stock?

A. 8.7%

B. 11.2%

C. 13.8%

D. 15.2%

83. The risk premium for exposure to exchange rates is 5%, and the firm has a beta relative to exchange rates of .4. The risk premium for exposure to the consumer price index is -6%, and the firm has a beta relative to the CPI of .8. If the risk-free rate is 3%, what is the expected return on this stock?

A. .2%

B. 1.5%

C. 3.6%

D. 4%

84. The two-factor model on a stock provides a risk premium for exposure to market risk of 12%, a risk premium for exposure to silver commodity prices of 3.5%, and a risk-free rate of 4%. The beta for exposure to market risk is 1, and the beta for exposure to commodity prices is also 1. What is the expected return on the stock?

A. 11.6%

B. 13%

C. 15.3%

D. 19.5%

85. The measure of risk used in the capital asset pricing model is ___________.

A. specific risk

B. the standard deviation of returns

C. reinvestment risk

D. beta

8
Student: ___________________________________________________________________________
1. Which of the following beliefs would not preclude charting as a method of portfolio management?

A. The market is strong-form efficient.

B. The market is semistrong-form efficient.

C. The market is weak-form efficient.

D. Stock prices follow recurring patterns.

2. In a 1953 study of stock prices, Maurice Kendall found that ________.

A. there were no predictable patterns in stock prices

B. stock prices exhibited strong serial autocorrelation

C. day-to-day stock prices followed consistent trends

D. fundamental analysis could be used to generate abnormal returns

3. The weak form of the EMH states that ________ must be reflected in the current stock price.

A. all past information, including security price and volume data

B. all publicly available information

C. all information, including inside information

D. all costless information

4. The semistrong form of the EMH states that ________ must be reflected in the current stock price.

A. all security price and volume data

B. all publicly available information

C. all information, including inside information

D. all costless information

5. The strong form of the EMH states that ________ must be reflected in the current stock price.

A. all security price and volume data

B. all publicly available information

C. all information, including inside information

D. all costless information

6. Random price movements indicate ________.

A. irrational markets

B. that prices cannot equal fundamental values

C. that technical analysis to uncover trends can be quite useful

D. that markets are functioning efficiently

7. When the market risk premium rises, stock prices will ________.

A. rise

B. fall

C. recover

D. have excess volatility

8. The small-firm-in-January effect is strongest ________.

A. early in the month

B. in the middle of the month

C. late in the month

D. in even-numbered years

9. Evidence suggests that there may be _______ momentum and ________ reversal patterns in stock price behavior.

A. short-run; short-run

B. long-run; long-run

C. long-run; short-run

D. short-run; long run

10. Proponents of the EMH typically advocate __________.

A. a conservative investment strategy

B. a liberal investment strategy

C. a passive investment strategy

D. an aggressive investment strategy

11. Stock prices that are stable over time _______.

A. indicate that prices are useful indicators of true economic value

B. indicate that the market is not incorporating new information into current stock prices

C. ensure that an economy allocates its resources efficiently

D. indicates that returns follow a random-walk process

12. The tendency when the ______ performing stocks in one period are the best performers in the next and the current ________ performers are lagging the market later is called the reversal effect.

A. worst; best

B. worst; worst

C. best; worst

D. best; best

13. Which of the following is not a method employed by followers of technical analysis?

A. Charting

B. Relative strength analysis

C. Earnings forecasting

D. Trading around support and resistance levels

14. Which of the following is not a method employed by fundamental analysts?

A. Analyzing the Fed’s next interest rate move

B. Relative strength analysis

C. Earnings forecasting

D. Estimating the economic growth rate

15. The primary objective of fundamental analysis is to identify __________.

A. well-run firms

B. poorly run firms

C. mispriced stocks

D. high P/E stocks

16. If you believe in the __________ form of the EMH, you believe that stock prices reflect all publicly available information but not information that is available only to insiders.

A. semistrong

B. strong

C. weak

D. perfect

17. If you believe in the __________ form of the EMH, you believe that stock prices reflect all relevant information, including information that is available only to insiders.

A. semistrong

B. strong

C. weak

D. perfect

18. Most of the stock price response to a corporate earnings or dividend announcement occurs within ________________.

A. about 30 seconds

B. about 10 minutes

C. 6 months

D. 2 years

19. __________ is the return on a stock beyond what would be predicted from market movements alone.

A. A normal return

B. A subliminal return

C. An abnormal return

D. None of these options

20. You believe that stock prices reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume, or short interest, but you do not believe stock prices reflect all publicly available and inside information. You are a proponent of the ____________ form of the EMH.

A. semistrong

B. strong

C. weak

D. perfect

21. You are an investment manager who is currently managing assets worth $6 billion. You believe that active management of your fund could generate an additional one-tenth of 1% return on the portfolio. If you want to make sure your active strategy adds value, how much can you spend on security analysis?

A. $12,000,000

B. $6,000,000

C. $3,000,000

D. $0

22. A mutual fund that attempts to hold quantities of shares in proportion to their representation in the market is called a __________ fund.

A. stock

B. index

C. hedge

D. money market

23. Choosing stocks by searching for predictable patterns in stock prices is called ________.

A. fundamental analysis

B. technical analysis

C. index management

D. random-walk investing

24. Which of the following is not an issue that is central to the debate regarding market efficiency?

A. The magnitude issue

B. The tax-loss selling issue

C. The lucky event issue

D. The selection bias issue

25. Most people would readily agree that the stock market is not _________.

A. weak-form efficient

B. semistrong-form efficient

C. strong-form efficient

D. efficient at all

26. Small firms have tended to earn abnormal returns primarily in __________.

A. the month of January

B. the month July

C. the trough of the business cycle

D. the peak of the business cycle

27. Fama and French have suggested that many market anomalies can be explained as manifestations of ____________.

A. regulatory effects

B. high trading costs

C. information asymmetry

D. varying risk premiums

28. Proponents of the EMH think technical analysts __________.

A. should focus on relative strength

B. should focus on resistance levels

C. should focus on support levels

D. are wasting their time

29. Evidence supporting semistrong-form market efficiency suggests that investors should _________________________.

A. rely on technical analysis to select securities

B. rely on fundamental analysis to select securities

C. use a passive trading strategy such as purchasing an index fund or an ETF

D. select securities by throwing darts at the financial pages of the newspaper

30. “Buy a stock if its price moves up by 2% more than the Dow Average” is an example of a _________________.

A. trading rule

B. market anomaly

C. fundamental approach

D. passive trading strategy

31. Jaffe found that stock prices __________ after insiders intensively bought shares and __________ after insiders intensively sold shares.

A. decreased; decreased

B. decreased; increased

C. increased; decreased

D. increased; increased

32. In a 1988 study, Fama and French found that the return on the aggregate stock market was __________ when the dividend yield was higher.

A. higher

B. lower

C. unaffected

D. more skewed

33. In their 2010 study, Fama and French used a four-factor model to analyze excess returns on equity mutual funds. They found that the funds ______.

A. had negative alphas before fees were considered.

B. had positive alphas after fees were considered.

C. had negative alphas after fees were considered.

D. had negative alphas before fees were considered and had negative alphas after fees were considered.

34. Joe bought a stock at $57 per share. The price promptly fell to $55. Joe held on to the stock until it again reached $57, and then he sold it once he had eliminated his loss. If other investors do the same to establish a trading pattern, this would contradict _______.

A. the strong-form EMH

B. the weak-form EMH

C. technical analysis

D. the semistrong-form EMH

35. According to 1968 research by Ball and Brown, securities markets fully adjust to earnings announcements _______.

A. instantly

B. in 1 day

C. in 1 week

D. gradually over time

36. When stock returns exhibit positive serial correlation, this means that __________ returns tend to follow ___________ returns.

A. positive; positive

B. positive; negative

C. negative; positive

D. positive; zero

37. Basu found that firms with high P/E ratios __________.

A. earned higher average returns than firms with low P/E ratios

B. earned the same average returns as firms with low P/E ratios

C. earned lower average returns than firms with low P/E ratios

D. had higher dividend yields than firms with low P/E ratios

38. Fundamental analysis is likely to yield best results for _______.

A. NYSE stocks

B. neglected stocks

C. stocks that are frequently in the news

D. fast-growing companies

39. You are looking to invest in one of three stocks. All other things being equal, Stock A has high expected earnings growth, stock B has only modest expected earnings growth, and stock C is expected to generate poor earnings growth. According to LaPorta’s 1996 study, which stock is likely to generate the greatest alpha for you?

A. Stock A

B. Stock B

C. Stock C

D. The answer cannot be determined from the information given.

40. You believe that you can earn 2% more on your portfolio if you engage in full-time stock research. However, the additional trading costs and tax liability from active management will cost you about .5%. You have an $800,000 stock portfolio. What is the most you can afford to spend on your research?

A. $4,000

B. $8,000

C. $12,000

D. $16,000

41. Even if the markets are efficient, professional portfolio management is still important because it provides investors with:

I. Low-cost diversification
II. A portfolio with a specified risk level
III. Better risk-adjusted returns than an index

A. I only

B. I and II only

C. II and III only

D. I, II, and III

42. Banz found that, on average, the risk-adjusted returns of small firms __________.

A. were higher than the risk-adjusted returns of large firms

B. were the same as the risk-adjusted returns of large firms

C. were lower than the risk-adjusted returns of large firms

D. were negative

43. If the U.S. capital markets are not informationally efficient, ______.

A. the markets cannot be allocationally efficient

B. systematic risk does not matter

C. no type of analysis can be used to generate abnormal returns

D. returns must follow a random walk

44. “Active investment management may at times generate additional returns of about .1%. However, the standard deviation of the typical well-diversified portfolio is about 20%, so it is very difficult to statistically identify any increase in performance.” Even if true, this statement is an example of the _________ problem in deciding how efficient the markets are.

A. magnitude

B. selection bias

C. lucky event

D. allocation

45. DeBondt and Thaler (1985) found that the poorest-performing stocks in one time period experienced __________ performance in the following period and that the best-performing stocks in one time period experienced __________ performance in the following time period.

A. good; good

B. good; poor

C. poor; good

D. poor; poor

46. J. M. Keyes put all his money in one stock, and the stock doubled in value in a matter of months. He did this three times in a row with three different stocks. J. M. got his picture on the front page of the Wall Street Journal. However, the paper never mentioned the thousands of investors who made similar bets on other stocks and lost most of their money. This is an example of the ________ problem in deciding how efficient the markets are.

A. magnitude

B. selection bias

C. lucky event

D. small firm

47. Most tests of semistrong efficiency are _________.

A. designed to test whether inside information can be used to generate abnormal returns

B. based on technical trading rules

C. unable to generate any evidence of market anomalies

D. joint tests of market efficiency and the risk-adjustment measure

48. The _________ effect may explain much of the small-firm anomaly.

I. January
II. neglected
III. liquidity

A. I only

B. II only

C. II and III only

D. I, II, and III

49. The effect of liquidity on stock returns might be related to:

I. The small-firm effect
II The book-to-market effect
III The neglected-firm effect
IV. The P/E effect

A. I and II only

B. I and III only

C. II and IV only

D. I, II, and III only

50. The broadest information set is included in the _____.

A. weak-form efficiency argument

B. semistrong-form efficiency argument

C. strong-form efficiency argument

D. technical analysis trading method

51. The Fama and French evidence that high book-to-market firms outperform low book-to-market firms even after adjusting for beta means that _________.

A. high book-to-market firms are underpriced or the book-to-market ratio is a proxy for a unique risk factor

B. low book-to-market firms are underpriced or the book-to-market ratio is a proxy for a systematic risk factor

C. either high book-to-market firms are underpriced or the book-to-market ratio is a proxy for a systematic risk factor

D. high book-to-market firms have more post-earnings drift

52. According to results by Seyhun, __________.

A. investors cannot usually earn abnormal returns by following inside trades after knowledge of the trades are made public

B. investors can usually earn abnormal returns by following inside trades after knowledge of the trades are made public

C. investors cannot earn abnormal returns by following inside trades before knowledge of the trades are made public

D. investors cannot earn abnormal returns by trading before insiders

53. If the daily returns on the stock market are normally distributed with a mean of .05% and a standard deviation of 1%, the probability that the stock market would have a return of -23% or worse on one particular day (as it did on Black Monday) is approximately __________.

A. .0%

B. .1%

C. 1%

D. 10%

54. According to the semistrong form of the efficient markets hypothesis, ____________.

A. stock prices do not rapidly adjust to new information

B. future changes in stock prices cannot be predicted from any information that is publicly available

C. corporate insiders should have no better investment performance than other investors even if allowed to trade freely

D. arbitrage between futures and cash markets should not produce extraordinary profits

55. The term random walk is used in investments to refer to ______________.

A. stock price changes that are random but predictable

B. stock prices that respond slowly to both old and new information

C. stock price changes that are random and unpredictable

D. stock prices changes that follow the pattern of past price changes

56. Among the important characteristics of market efficiency is (are) that:

I. There are no arbitrage opportunities.
II. Security prices react quickly to new information.
III. Active trading strategies will not consistently outperform passive strategies.

A. I only

B. II only

C. I and III only

D. I, II, and III

57. Stock market analysts have tended to be ___________ in their recommendations to investors.

A. slightly overly optimistic

B. overwhelmingly optimistic

C. slightly overly pessimistic

D. overwhelmingly pessimistic

58. Assume that a company announces unexpectedly high earnings in a particular quarter. In an efficient market one might expect _____________.

A. an abnormal price change immediately after the announcement

B. an abnormal price increase before the announcement

C. an abnormal price decrease after the announcement

D. no abnormal price change before or after the announcement

59. Market anomaly refers to _______.

A. an exogenous shock to the market that is sharp but not persistent

B. a price or volume event that is inconsistent with historical price or volume trends

C. a trading or pricing structure that interferes with efficient buying and selling of securities

D. price behavior that differs from the behavior predicted by the efficient market hypothesis

60. Which of the following contradicts the proposition that the stock market is weakly efficient?

A. Over 25% of mutual funds outperform the market on average.

B. Insiders earn abnormal trading profits.

C. Every January, the stock market earns above-normal returns.

D. Applications of technical trading rules fail to earn abnormal returns.

61. Which of the following would violate the efficient market hypothesis?

A. Intel has consistently generated large profits for years.

B. Prices for stocks before stock splits show, on average, consistently positive abnormal returns.

C. Investors earn abnormal returns months after a firm announces surprise earnings.

D. High-earnings growth stocks fail to generate higher returns for investors than do low earnings growth stocks.

62. Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis?

A. The average rate of return is significantly greater than zero.

B. The correlation between the market return one week and the return the following week is zero.

C. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.

D. You could have consistently made superior returns by forecasting future earnings performance with your new Crystal Ball forecast methodology.

63. The semistrong form of the efficient market hypothesis implies that ____________ generate abnormal returns and ____________ generate abnormal returns.

A. technical analysis cannot; fundamental analysis can

B. technical analysis can; fundamental analysis can

C. technical analysis can; fundamental analysis cannot

D. technical analysis cannot; fundamental analysis cannot

64. An implication of the efficient market hypothesis is that __________.

A. high-beta stocks are consistently overpriced

B. low-beta stocks are consistently overpriced

C. nonzero alphas will quickly disappear

D. growth stocks are better buys than value stocks

65. One type of passive portfolio management is ________.

A. investing in a well-diversified portfolio without attempting to search out mispriced securities

B. investing in a well-diversified portfolio while only seeking out passively mispriced securities

C. investing an equal dollar amount in index stocks

D. investing in an equal amount of shares in each of the index stocks

66. The four-factor model used to construct performance benchmarks for mutual funds uses the three Fama and French factors and one additional factor related to _________.

A. the tenure of the fund manager

B. momentum

C. fees

D. the age of the fund manager

67. Value stocks may provide investors with better returns than growth stocks if:

I. Value stocks are out of favor with investors.
II. Prices of growth stocks include premiums for overly optimistic growth levels.
III. Value stocks are likely to generate positive-earnings surprises.

A. I only

B. II only

C. I and III only

D. I, II, and III

68. Value stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings ratios.

A. low; low

B. low; high

C. high; low

D. high; high

69. Growth stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings ratios.

A. low; low

B. low; high

C. high; low

D. high; high

70. A day trade with an average stock holding period of under 8 minutes might be most closely associated with which trading philosophy?

A. EMH

B. Fundamental analysis

C. Strong-form market efficiency

D. Technical analysis

71. A technical analyst is most likely to be affiliated with which investment philosophy?

A. Active management

B. Buy and hold

C. Passive investment

D. Index funds

72. Someone who invests in the Vanguard Index 500 mutual fund could most accurately be described as using which approach?

A. Active management

B. Arbitrage

C. Fundamental analysis

D. Passive investment

73. Evidence by Blake, Elton, and Gruber indicates that, on average, actively managed bond funds ______.

A. outperform passive fixed-income indexes

B. underperform passive fixed-income indexes by a wide margin

C. perform as well as passive fixed-income indexes

D. underperform passive fixed-income indexes by an amount equal to fund expenses

74. Insiders are able to profitably trade and earn abnormal returns prior to the announcement of positive news. This is a violation of which form of efficiency?

A. Weak-form efficiency

B. Semistrong-form efficiency

C. Strong-form efficiency

D. Technical analysis

75. In an efficient market and for an investor who believes in a passive approach to investing, what is the primary duty of a portfolio manager?

A. Accounting for results

B. Diversification

C. Identifying undervalued stocks

D. No need for a portfolio manager

76. Which of the following is not a topic related to the debate over market efficiency?

A. IPO results

B. Lucky event issue

C. Magnitude issue

D. Selection bias

77. Which Fidelity Magellan portfolio manager is often referenced as an exception to the general conclusion of efficient markets?

A. Jeff Vinik

B. Peter Lynch

C. Robert Stansky

D. William Hayes

78. The tendency of poorly performing stocks and well-performing stocks in one period to continue their performance into the next period is called the ________________.

A. fad effect

B. martingale effect

C. momentum effect

D. reversal effect

79. Which of the following is not a concept related to explaining abnormal excess stock returns?

A. January effect

B. Neglected-firm effect

C. P/E effect

D. Preferred stock effect

80. The lack of adequate trading volume in stock that may ultimately lead to its ability to produce excess returns is referred to as the ____________________.

A. January effect

B. liquidity effect

C. neglected-firm effect

D. P/E effect

81. Fundamental analysis determines that the price of a firm’s stock is too low, given its intrinsic value. The information used in the analysis is available to all market participants, yet the price does not seem to react. The stock does not trade on a major exchange. What concept might explain the ability to produce excess returns on this stock?

A. January effect

B. Neglected-firm effect

C. P/E effect

D. Reversal effect

82. When testing mutual fund performance over time, one must be careful of ___________, which means that a certain percentage of poorer-performing funds fail over time, making the performance of remaining funds seem more consistent over time.

A. survivorship bias

B. lucky event bias

C. magnitude bias

D. mean reversion bias

83. Most evidence indicates that U.S. stock markets are _______________________.

A. reasonably weak-form and semistrong-form efficient

B. strong-form efficient

C. reasonably weak-form but not semistrong- or strong-form efficient

D. neither weak-, semistrong-, nor strong-form efficient

84. Which of the following statements is (are) correct?

A. If a market is weak-form efficient, it is also semistrong- and strong-form efficient.

B. If a market is semistrong-form efficient, it is also strong-form efficient.

C. If a market is strong-form efficient, it is also semistrong- but not weak-form efficient.

D. If a market is strong-form efficient, it is also semistrong- and weak-form efficient.

85. According to Markowitz and other proponents of modern portfolio theory, which of the following activities would not be expected to produce any benefits?

A. Diversifying

B. Investing in Treasury bills

C. Investing in stocks of utility companies

D. Engaging in active portfolio management to enhance returns

86. According to results by Seyhun, the main reason that investors cannot earn excess returns by following inside trades after they become public is that ______________.

A. the information isn’t available for at least 2 weeks

B. transaction costs offset abnormal returns

C. the SEC late-disclosure rule doesn’t apply to insiders

D. insiders don’t have to disclose their trades

Chapters 9, 10, 12 Through 15 And 17 Through 22

9
Student: ___________________________________________________________________________
1. Testing many different trading rules until you find one that would have worked in the past is called _______.

A. data mining

B. perceived patterning

C. pattern searching

D. behavioral analysis

2. Models of financial markets that emphasize psychological factors affecting investor behavior are called _______.

A. data mining

B. fundamental analysis

C. charting

D. behavioral finance

3. The trin statistic is a ______ indicator.

A. sentiment

B. flow of funds

C. market structure

D. fundamental

4. The put/call ratio is a ______ indicator.

A. sentiment

B. flow of funds

C. market structure

D. fundamental

5. Relative strength is ______ indicator.

A. a fundamental

B. an economic

C. a technical

D. an international

6. Short interest is a ______ indicator.

A. sentiment

B. flow of funds

C. market structure

D. fundamental

7. Moving averages are ______ indicators.

A. sentiment

B. flow of funds

C. trend

D. fundamental

8. Market breadth is a ______ indicator.

A. sentiment

B. flow of funds

C. technical

D. fundamental

9. The cumulative tally of the number of advancing stocks minus declining stocks is called the ______________.

A. market breadth

B. market volume

C. trin ratio

D. relative strength ratio

10. A high amount of short interest is typically considered as a __________ signal, and contrarians may consider it as a _________ signal.

A. bearish; bullish

B. bullish; bearish

C. bearish; false

D. bullish; false

11. Technical analysis focuses on _____________________.

A. finding opportunities for risk-free investing

B. finding repeating trends and patterns in prices

C. changing prospects for earnings growth of particular firms or industries

D. forecasting technical regulatory changes

12. Behavioralists point out that even if market prices are ____________, there may be _______________.

A. distorted; limited arbitrage opportunities

B. distorted; fundamental efficiency

C. allocationally efficient; limitless arbitrage opportunities

D. distorted; allocational efficiency

13. According to market technicians, it is time to sell stock in a head-and-shoulders formation when ___________.

A. the price index pierces the left shoulder

B. the price index pierces the right shoulder

C. the price index pierces the head

D. none of these options takes place

14. When a stock price breaks through the moving average from below, this is considered to be ______.

A. the starting point for a new moving average

B. a bearish signal

C. a bullish signal

D. none of these options

15. When the stock price falls below a moving average, a possible conclusion is that _____.

A. market momentum has become positive

B. market momentum has become negative

C. there is no regular pattern for this stock’s market momentum

D. professional analysts’ opinions are invalid until the stock price rises again

16. Following a period of falling prices, the moving average will _____.

A. be below the current price

B. be above the current price

C. be equal to the current price

D. become more volatile than it had been before prices fell

17. A moving average of stock prices _________________.

A. always lies above the most recent price

B. always lies below the most recent price

C. is less volatile than the actual prices

D. is more volatile than the actual prices

18. When the housing bubble burst in 2007, it set off the worst financial crisis _____.

A. in 25 years.

B. in 40 years.

C. in 50 years.

D. in 75 years.

19. A support level is ___________________.

A. a level beyond which the market is unlikely to rise

B. a level below which the market is unlikely to fall

C. an equilibrium price level justified by characteristics such as earnings and cash flows

D. the peak of a market wave or cycle

20. According to Kondratieff, the macro economy moves in a series of waves that recur at intervals of approximately _________________.

A. 18 months

B. 4 years

C. 8 years

D. 50 years

21. According to Elliot’s wave theory, stock market behavior can be explained as _________________.

A. a series of medium-term wave cycles with no short-term trend

B. a series of long-term wave cycles with no short-term trend

C. a series of superimposed long-term and short-term wave cycles

D. sine and cosine functions

22. Conventional finance theory assumes investors are _______, and behavioral finance assumes investors are _______.

A. rational; irrational

B. irrational; rational

C. greedy; philanthropic

D. philanthropic; greedy

23. The only way for behavioral patterns to persist in prices is if ______________.

A. markets are not weak-form efficient

B. there are limits to arbitrage activity

C. there are no significant trading costs

D. market psychology is inconsistent over time

24. In the context of a point and figure chart, a horizontal band of Xs and Os is a _____________.

A. buy signal

B. sell signal

C. congestion area

D. trend reversal

25. Even though indexing is growing in popularity, only about _____ of equity in the mutual fund industry is held in indexed funds. This may be a sign that investors and managers __________.

A. 5%; are excessively conservative

B. 15%; overestimate their ability

C. 20%; suffer from framing biases

D. 25%; engage in mental accounting

26. If investors are too slow to update their beliefs about a stock’s future performance when new evidence arises, they are exhibiting _______.

A. representativeness bias

B. framing error

C. conservatism

D. memory bias

27. If investors overweight recent performance in forecasting the future, they are exhibiting _______.

A. representativeness bias

B. framing error

C. memory bias

D. overconfidence

28. Trading activity and average returns in brokerage accounts tend to be _________.

A. uncorrelated

B. negatively correlated

C. positively correlated

D. positively correlated for women and negatively correlated for men

29. Your two best friends each tell you about a person they know who successfully started a small business. That’s it, you decide; if they can do it, so can you. This is an example of _____________.

A. mental accounting

B. framing bias

C. conservatism

D. representativeness bias

30. Which of the following is not a sentiment indicator?

A. Confidence index

B. Short interest

C. Odd-lot trading

D. Put/call ratio

31. Which of the following is considered a sentiment indicator?

A. A 200-day moving average

B. Short interest

C. Credit balances in brokerage accounts

D. Relative strength

32. An investor holds a very conservative portfolio invested for retirement, but she takes some extra cash she earned from her year-end bonus and buys gold futures. She appears to be engaging in ___________.

A. overconfidence

B. representativeness

C. forecast errors

D. mental accounting

33. Which of the following analysts focus more on past price movements of a firm’s stock than on the underlying determinants of its future profitability?

A. Credit analysts

B. Fundamental analysts

C. Systems analysts

D. Technical analysts

34. A trin ratio of greater than 1 is considered a __________.

A. bearish signal

B. bullish signal

C. bearish signal by some technical analysts and a bullish signal by other technical analysts

D. trend reversal signal

35. Contrarian investors consider a high put/call ratio a __________.

A. bearish signal

B. bullish signal

C. trend confirmation signal

D. signal to enter the options market

36. The ratio of the average yield on 10 top-rated corporate bonds to the average yield on 10 intermediate-grade bonds is called the __________.

A. bond price index

B. confidence index

C. relative strength index

D. trin ratio

37. An investor needs cash to pay some hospital bills. He is willing to use his dividend income to pay the bills, but he will not sell any stock to do so. He is engaging in ___________.

A. overconfidence

B. representativeness

C. forecast errors

D. mental accounting

38. Bill and Shelly are friends. Bill invests in a portfolio of hot stocks that almost all his friends are invested in. Shelly invests in a portfolio that is totally different from the portfolios of all her friends. Both Bill’s and Shelly’s stocks fall 15%. According to regret theory, _________________________________________.

A. Bill will have more regret over the loss than Shelly

B. Shelly will have more regret over the loss than Bill

C. Bill and Shelly will have equal regret over their losses

D. Bill’s and Shelly’s risk aversion will increase in the future

39. The most common measure of __________ is the spread between the number of stocks that advance in price and the number of stocks that decline in price.

A. market breadth

B. market volume

C. odd-lot trading

D. short interest

40. Jill is offered a choice between receiving $50 with certainty or possibly receiving the proceeds from a gamble. In the gamble a fair coin is tossed, and if it comes up heads, Jill will receive $100; if the coin comes up tails, she will receive nothing. Jill chooses the $50 instead of the gamble. Jill’s behavior indicates __________________.

A. regret avoidance

B. overconfidence

C. that she has a diminishing marginal utility of wealth

D. prospect theory loss aversion

41. When the market breaks through the moving average line from below, a technical analyst would probably suggest that it is a good time to ___________.

A. buy the stock

B. hold the stock

C. sell the stock

D. short the stock

42. If you believed in the reversal effect, you should __________.

A. buy bonds this period if you held stocks last period

B. buy stocks this period that performed poorly last period

C. buy stocks this period that performed well last period

D. do nothing if you held the stock last period

43. According to technical analysts, a shift in market fundamentals will __________.

A. be reflected in stock prices immediately

B. lead to a gradual price change that can be recognized as a trend

C. lead to high volatility in stock market prices

D. leave prices unchanged

44. According to market technicians, a trin statistic of less than 1 is considered a __________.

A. bearish signal

B. bullish signal

C. volume decline

D. signal reversal

45. It is difficult to test the Kondratieff wave theory because _________.

A. it applies to only Russian stocks

B. its main proponent found contrary research results

C. only two independent data points are generated each century

D. the stock market is too volatile to generate smooth waves

46. A _________ is a value above which it is difficult for the market to rise.

A. book value

B. resistance level

C. support level

D. confidence level

47. _____________ is a tool that can help identify the direction of a stock’s price.

A. Prospect theory

B. Framing

C. A moving average

D. Conservatism

48. If the utility you derive from your next dollar of wealth increases by less than a loss of a dollar reduces it, you are exhibiting __________.

A. loss aversion

B. regret avoidance

C. mental accounting

D. framing bias

49. In technical analysis, __________ is a value below which the market is relatively unlikely to fall.

A. book value

B. resistance level

C. support level

D. the Dow line

50. A possible limit on arbitrage activity that may allow behavioral biases to persist is _______.

A. technical trends in prices

B. momentum effects

C. fundamental risk

D. trend reversals

51. If you are not a contrarian, you consider a high put/call ratio to be a __________.

A. bearish signal

B. bullish signal

C. trend confirmation signal

D. signal to enter the options market

52. On day 1, the stock price of Ford was $12 and the automotive stock index was 127. On day 2, the stock price of Ford was $15 and the automotive stock index was 139. Consider the ratio of Ford to the automotive stock index at day 1 and day 2. Ford is __________ the automotive industry, and technical analysts who follow relative strength would advise __________ the stock.

A. outperforming; buying

B. outperforming; selling

C. underperforming; buying

D. underperforming; selling

53. At the end of July, the average yields on 10 top-rated corporate bonds and 10 intermediate-grade bonds were 7.65% and 8.42%, respectively. At the end of August, the average yields on 10 top-rated corporate bonds and 10 intermediate-grade bonds were 6% and 6.71%, respectively. The confidence index _________ during August, and bond technical analysts are likely to be ________.

A. increased; bullish

B. increased; bearish

C. decreased; bullish

D. decreased; bearish

54. On a particular day, there were 890 stocks that advanced on the NYSE and 723 that declined. The volume in advancing issues was 80,846,000, and the volume in declining issues was 70,397,000. The common measure of market breadth is __________.

A. -10,449,000

B. -167

C. 167

D. 10,449,000

55. On a particular day, there were 920 stocks that advanced on the NYSE and 723 that declined. The volume in advancing issues was 80,846,000, and the volume in declining issues was 70,397,000. The trin ratio is __________, and technical analysts are likely to be __________.

A. .90; bullish

B. .90; bearish

C. 1.11; bullish

D. 1.11; bearish

56. An accumulation of cash by mutual funds may be viewed by technical traders as a __________ indicator.

A. bullish

B. neutral

C. bearish

D. trend reversal

57. A point and figure chart:

I. Gives a sell signal when the stock price penetrates previous lows
II. Tracks significant upward or downward movements
III. Has no time dimension
IV. Indicates congestion areas

A. I and II only

B. II and III only

C. I, III, and IV only

D. I, II, III, and IV

58. When technical analysts say a stock has good “relative strength,” they mean that in the recent past __________.

A. it has performed well compared to its closest competitors

B. it has exceeded its own historical high

C. trading volume in the stock has exceeded the normal trading volume

D. it has outperformed the market index

59. Technical traders view mutual fund investors as _________ market timers.

A. excellent

B. frequent

C. neutral

D. poor

60. An important assumption underlying the use of technical analysis techniques is that ___________________.

A. security prices adjust rapidly to new information

B. security prices adjust gradually to new information

C. security dealers will provide enough liquidity to keep price changes relatively small

D. all investors have immediate and costless access to information

61. If the put/call ratio increases, market contrarians may interpret this as what kind of signal?

A. Buy signal

B. Sell signal

C. Hold signal

D. This is not interpreted as a signal

62. The tendency of investors to hold on to losing investments is called the ________.

A. overweighting effect

B. head-in-the-sand effect

C. disposition effect

D. prospector effect

63. Which one of the following best describes fundamental risk?

A. A stock is overpriced, but your fund does not allow you to engage in short sales.

B. Your models indicate a stock is mispriced, but you are not sure if this is a real profit opportunity or a model input error.

C. You buy a stock that you believe is underpriced, and the underpricing persists for a long time, hurting your short-term results.

D. A stock is trading in two different markets at two different prices.

64.

The trin on day 2 is ___.

A. .72

B. 1.04

C. .92

D. .55

65.

The confidence index on day 1 is _____.

A. .82

B. .89

C. .92

D. 1.09

66.

The breadth on day 3 is _______.

A. -70

B. 10

C. 90

D. 170

67.

The cumulative breadth for the first 2 days is ___.

A. -240

B. -50

C. 110

D. 250

68.

Cumulative breadth for the 4 days is ___, which is ___.

A. -140; bullish

B. -140; bearish

C. -300; bullish

D. -300; bearish

69.

From day 1 to day 4, the trin has ___ and is ___.

A. increased; bullish

B. increased; bearish

C. decreased; bullish

D. decreased; bearish

70.

From day 1 to day 4, the confidence index has _____. This is _____.

A. increased; bullish

B. decreased; bullish

C. increased; bearish

D. decreased; bearish

71. Problems with behavioral finance include:

I. The behavioralists tell us nothing about how to exploit any irrationality.
II. The implications of behavioral patterns are inconsistent from case to case, sometimes suggesting overreaction, sometimes underreaction.
III. As with technical trading rules, behavioralists can always find some pattern in past data that supports a behavioralist trait.

A. I only

B. II only

C. I and III only

D. I, II, and III

72. A major problem with technical trading strategies is that ________.

A. it is very difficult to identify a true trend before the fact

B. it is very difficult to identify the correct trend after the fact

C. it is so easy to identify trends that all investors quickly do so

D. Kondratieff showed that you can’t identify trends without 48 to 60 years of data

73. The Elliott wave theory gives a buy signal when you can identify a primary bull trend by identifying _________.

A. when the long-term direction of the market is positive

B. when the long-term direction of the market is negative

C. when the long-term direction of the market is stable

D. good stocks without regard to the long-term direction of the market

74. In 1997 CSX successfully purchased a significant share of Conrail. Immediately after the first offer was announced and the acquisition eventually consummated, the price of CSX fell below preacquisition levels and took many years to recover. This may be an example of ________________.

A. loss aversion

B. mental accounting

C. overreaction

D. managerial overconfidence

75. An investor has her money segregated into checking, savings, and investments. The allocation among the categories is subjective, yet the investor spends freely from the checking account and not the others. This behavior can be explained as _______________.

A. loss aversion

B. mental accounting

C. overreaction

D. winner’s curse

76.

Identify the resistance-level stock price.

A. $40

B. $42

C. $44

D. $46

77.

Identify the support level stock price.

A. $40

B. $42

C. $44

D. $46

78. Investors gravitate toward the latest hot stock even though it has never paid a dividend. Even though net income is projected to fall over the current and next several years, the price of the stock continues to rise. What behavioral concept may explain this price pattern?

A. Overconfidence

B. Loss aversion

C. Mental accounting

D. Calendar bias

79. During a period when prices have been rising, the _________ will be _______ the current price.

A. relative strength index; declining with

B. relative strength index; declining faster than

C. moving average; above

D. moving average; below

80. An investor purchases shares of an index fund. The investor could take on the same level of risk by taking out a loan and purchasing a higher-risk specialty fund. The Sharpe ratio on this complete portfolio is higher than her existing investment. What behavioral concept prevents the investor from taking out the loan and investing in the index fund?

A. Framing bias

B. Excessive volatility

C. Loss aversion

D. Mental accounting

81. The price of a stock fluctuates between $43 and $60. If the time frame referenced encompasses the primary trend, the $43 price may be considered the ___________.

A. intermediate trend level

B. minor trend level

C. resistance level

D. support level

82.

The moving average generates buy signal(s) _____.

A. on days 3, 11, and 15

B. on days 2 and 16

C. on days 5, 9, and 13

D. on no days

83.

The moving average generates sell signals _____.

A. on days 3, 11, and 15

B. on days 7, 15, and 18

C. on days 5, 9, and 13

D. on day 16

84. The price of a stock fluctuates over a period of 10 days. The movement of the stock price below the 10-day minimum price of $25 triggers a rash of selling. The $25 price might now be considered the _______________.

A. congestion area

B. penetration point

C. resistance level

D. support level

85. Trend analysts who follow bonds are most likely to monitor the ____________.

A. confidence index

B. odd-lot trading

C. short interest

D. trin statistic

86. You find that the confidence index is down, the market breadth is up, and the trin ratio is down. In total, how many bullish signs do you have?

A. 0

B. 1

C. 2

D. 3

87. You find that the trin ratio is up, the market breadth is down, and the market has closed below its 50-day moving average. In total, how many bearish signs do you have?

A. 0

B. 1

C. 2

D. 3

10
Student: ___________________________________________________________________________
1. The invoice price of a bond is the ______.

A. stated or flat price in a quote sheet plus accrued interest

B. stated or flat price in a quote sheet minus accrued interest

C. bid price

D. average of the bid and ask price

2. Sinking funds are commonly viewed as protecting the _______ of the bond.

A. issuer

B. underwriter

C. holder

D. dealer

3. A collateral trust bond is _______.

A. secured by other securities held by the firm

B. secured by equipment owned by the firm

C. secured by property owned by the firm

D. unsecured

4. A mortgage bond is _______.

A. secured by other securities held by the firm

B. secured by equipment owned by the firm

C. secured by property owned by the firm

D. unsecured

5. A debenture is _________.

A. secured by other securities held by the firm

B. secured by equipment owned by the firm

C. secured by property owned by the firm

D. unsecured

6. If you are holding a premium bond, you must expect a _______ each year until maturity. If you are holding a discount bond, you must expect a _______ each year until maturity. (In each case assume that the yield to maturity remains stable over time.)

A. capital gain; capital loss

B. capital gain; capital gain

C. capital loss; capital gain

D. capital loss; capital loss

7. Floating-rate bonds have a __________ that is adjusted with current market interest rates.

A. maturity date

B. coupon payment date

C. coupon rate

D. dividend yield

8. Inflation-indexed Treasury securities are commonly called ____.

A. PIKs

B. CARs

C. TIPS

D. STRIPS

9. In regard to bonds, convexity relates to the _______.

A. shape of the bond price curve with respect to interest rates

B. shape of the yield curve with respect to maturity

C. slope of the yield curve with respect to liquidity premiums

D. size of the bid-ask spread

10. A Japanese firm issued and sold a pound-denominated bond in the United Kingdom. A U.S. firm issued bonds denominated in dollars but sold the bonds in Japan. Which one of the following statements is correct?

A. Both bonds are examples of Eurobonds.

B. The Japanese bond is a Eurobond, and the U.S. bond is termed a foreign bond.

C. The U.S. bond is a Eurobond, and the Japanese bond is termed a foreign bond.

D. Neither bond is a Eurobond.

11. The primary difference between Treasury notes and bonds is ________.

A. maturity at issue

B. default risk

C. coupon rate

D. tax status

12. TIPS offer investors inflation protection by ______________ by the inflation rate each year.

A. increasing only the coupon rate

B. increasing only the par value

C. increasing both the par value and the coupon payment

D. increasing the promised yield to maturity

13. You would typically find all but which one of the following in a bond contract?

A. A dividend restriction clause

B. A sinking fund clause

C. A requirement to subordinate any new debt issued

D. A price-earnings ratio

14. To earn a high rating from the bond rating agencies, a company would want to have:

I. A low times-interest-earned ratio
II. A low debt-to-equity ratio
III. A high quick ratio

A. I only

B. II and III only

C. I and III only

D. I, II, and III

15. According to the liquidity preference theory of the term structure of interest rates, an increase in the yield on long-term corporate bonds versus short-term bonds could be due to _______.

A. declining liquidity premiums

B. an expectation of an upcoming recession

C. a decline in future inflation expectations

D. an increase in expected interest rate volatility

16. __________ are examples of synthetically created zero-coupon bonds.

A. COLTS

B. OPOSSMS

C. STRIPS

D. ARMs

17. A __________ bond gives the bondholder the right to cash in the bond before maturity at a specific price after a specific date.

A. callable

B. coupon

C. puttable

D. Treasury

18. TIPS are an example of _______________.

A. Eurobonds

B. convertible bonds

C. indexed bonds

D. catastrophe bonds

19. Bonds issued in the currency of the issuer’s country but sold in other national markets are called _____________.

A. Eurobonds

B. Yankee bonds

C. Samurai bonds

D. foreign bonds

20. You buy a TIPS at issue at par for $1,000. The bond has a 3% coupon. Inflation turns out to be 2%, 3%, and 4% over the next 3 years. The total annual coupon income you will receive in year 3 is _________.

A. $30

B. $33

C. $32.78

D. $30.90

21. The bonds of Elbow Grease Dishwashing Company have received a rating of C by Moody’s. The C rating indicates that the bonds are _________.

A. high grade

B. intermediate grade

C. investment grade

D. junk bonds

22. Bonds rated _____ or better by Standard & Poor’s are considered investment grade.

A. AA

B. BBB

C. BB

D. CCC

23. Consider the liquidity preference theory of the term structure of interest rates. On average, one would expect investors to require _________.

A. a higher yield on short-term bonds than on long-term bonds

B. a higher yield on long-term bonds than on short-term bonds

C. the same yield on both short-term bonds and long-term bonds

D. none of these options (The liquidity preference theory cannot be used to make any of the other statements.)

24. Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays interest of $120 annually. Bond A will mature in 5 years, while bond B will mature in 6 years. If the yields to maturity on the two bonds change from 12% to 14%, _________.

A. both bonds will increase in value but bond A will increase more than bond B

B. both bonds will increase in value but bond B will increase more than bond A

C. both bonds will decrease in value but bond A will decrease more than bond B

D. both bonds will decrease in value but bond B will decrease more than bond A

25. You hold a subordinated debenture in a firm. In the event of bankruptcy you will be paid off before which one of the following?

A. Mortgage bonds

B. Senior debentures

C. Preferred stock

D. Equipment obligation bonds

26. Bonds with coupon rates that fall when the general level of interest rates rise are called _____________.

A. asset-backed bonds

B. convertible bonds

C. inverse floaters

D. index bonds

27. _______ bonds represent a novel way of obtaining insurance from capital markets against specified disasters.

A. Asset-backed bonds

B. TIPS

C. Catastrophe

D. Pay-in-kind

28. The issuer of ________ bond may choose to pay interest either in cash or in additional bonds.

A. an asset-backed

B. a TIPS

C. a catastrophe

D. a pay-in-kind

29. Everything else equal, the __________ the maturity of a bond and the __________ the coupon, the greater the sensitivity of the bond’s price to interest rate changes.

A. longer; higher

B. longer; lower

C. shorter; higher

D. shorter; lower

30. Which one of the following statements is correct?

A. Invoice price = Flat price – Accrued interest

B. Invoice price = Flat price + Accrued interest

C. Flat price = Invoice price + Accrued interest

D. Invoice price = Settlement price – Accrued interest

31. A __________ bond gives the issuer an option to retire the bond before maturity at a specific price after a specific date.

A. callable

B. coupon

C. puttable

D. Treasury

32. Which of the following possible provisions of a bond indenture is designed to ease the burden of principal repayment by spreading it out over several years?

A. Callable feature

B. Convertible feature

C. Subordination clause

D. Sinking fund

33. Serial bonds are associated with _________.

A. staggered maturity dates

B. collateral

C. coupon payment dates

D. conversion features

34. In an era of particularly low interest rates, which of the following bonds is most likely to be called?

A. Zero-coupon bonds

B. Coupon bonds selling at a discount

C. Coupon bonds selling at a premium

D. Floating-rate bonds

35. Consider the expectations theory of the term structure of interest rates. If the yield curve is downward-sloping, this indicates that investors expect short-term interest rates to __________ in the future.

A. increase

B. decrease

C. not change

D. change in an unpredictable manner

36. A convertible bond has a par value of $1,000, but its current market price is $975. The current price of the issuing company’s stock is $26, and the conversion ratio is 34 shares. The bond’s market conversion value is _________.

A. $1,000

B. $884

C. $933

D. $980

37. A convertible bond has a par value of $1,000, but its current market price is $950. The current price of the issuing company’s stock is $19, and the conversion ratio is 40 shares. The bond’s conversion premium is _________.

A. $50

B. $190

C. $200

D. $240

38. A coupon bond that pays interest of 4% annually has a par value of $1,000, matures in 5 years, and is selling today at $785. The actual yield to maturity on this bond is _________.

A. 7.2%

B. 8.8%

C. 9.1%

D. 9.6%

39. A coupon bond that pays interest of $60 annually has a par value of $1,000, matures in 5 years, and is selling today at an $84.52 discount from par value. The yield to maturity on this bond is _________.

A. 6%

B. 7.23%

C. 8.12%

D. 9.45%

40. A coupon bond that pays interest of $60 annually has a par value of $1,000, matures in 5 years, and is selling today at a $75.25 discount from par value. The current yield on this bond is _________.

A. 6%

B. 6.49%

C. 6.73%

D. 7%

41. A callable bond pays annual interest of $60, has a par value of $1,000, matures in 20 years but is callable in 10 years at a price of $1,100, and has a value today of $1055.84. The yield to call on this bond is _________.

A. 6%

B. 6.58%

C. 7.2%

D. 8%

42. A coupon bond that pays interest semiannually has a par value of $1,000, matures in 8 years, and has a yield to maturity of 6%. If the coupon rate is 7%, the intrinsic value of the bond today will be __________.

A. $1,000

B. $1,062.81

C. $1,081.82

D. $1,100.03

43. A coupon bond that pays interest annually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 12%. If the coupon rate is 9%, the intrinsic value of the bond today will be _________.

A. $856.04

B. $891.86

C. $926.47

D. $1,000

44. A coupon bond that pays semiannual interest is reported in the Wall Street Journal as having an ask price of 117% of its $1,000 par value. If the last interest payment was made 2 months ago and the coupon rate is 6%, the invoice price of the bond will be _________.

A. $1,140

B. $1,170

C. $1,180

D. $1,200

45. A Treasury bond due in 1 year has a yield of 6.3%, while a Treasury bond due in 5 years has a yield of 8.8%. A bond due in 5 years issued by High Country Marketing Corp. has a yield of 9.6%, while a bond due in 1 year issued by High Country Marketing Corp. has a yield of 6.8%. The default risk premiums on the 1-year and 5-year bonds issued by High Country Marketing Corp. are, respectively, __________ and _________.

A. .4%; .3%

B. .4%; .5%

C. .5%; .5%

D. .5%; .8%

46. A zero-coupon bond has a yield to maturity of 5% and a par value of $1,000. If the bond matures in 16 years, it should sell for a price of __________ today.

A. $458.11

B. $641.11

C. $789.11

D. $1,100.11

47. Yields on municipal bonds are typically ___________ yields on corporate bonds of similar risk and time to maturity.

A. lower than

B. slightly higher than

C. identical to

D. twice as high as

48. You purchased a 5-year annual-interest coupon bond 1 year ago. Its coupon interest rate was 6%, and its par value was $1,000. At the time you purchased the bond, the yield to maturity was 4%. If you sold the bond after receiving the first interest payment and the bond’s yield to maturity had changed to 3%, your annual total rate of return on holding the bond for that year would have been approximately _________.

A. 5%

B. 5.5%

C. 7.6%

D. 8.9%

49. Analysis of bond returns over a multiyear horizon based on forecasts of the bond’s yield to maturity and reinvestment rate of coupons is called ______.

A. multiyear analysis

B. horizon analysis

C. maturity analysis

D. reinvestment analysis

50. $1,000 par value zero-coupon bonds (ignore liquidity premiums)

The expected 1-year interest rate 1 year from now should be about _________.

A. 6%

B. 7.5 %

C. 9.02%

D. 10.08%

51. $1,000 par value zero-coupon bonds (ignore liquidity premiums)

One year from now bond C should sell for ________ (to the nearest dollar).

A. $857

B. $842

C. $835

D. $821

52. $1,000 par value zero-coupon bonds (ignore liquidity premiums)

The expected 2-year interest rate 3 years from now should be _________.

A. 9.55%

B. 11.74%

C. 14.89%

D. 13.73%

53. The __________ of a bond is computed as the ratio of the annual coupon payment to the market price.

A. nominal yield

B. current yield

C. yield to maturity

D. yield to call

54. A bond has a par value of $1,000, a time to maturity of 10 years, and a coupon rate of 8% with interest paid annually. If the current market price is $750, what is the capital gain yield of this bond over the next year?

A. .72%

B. 1.85%

C. 2.58%

D. 3.42%

55. Consider the following $1,000 par value zero-coupon bonds:

The expected 1-year interest rate 2 years from now should be _________.

A. 7%

B. 8%

C. 9%

D. 10%

56. Which of the following bonds would most likely sell at the lowest yield?

A. A callable debenture

B. A puttable mortgage bond

C. A callable mortgage bond

D. A puttable debenture

57. A 1% decline in yield will have the least effect on the price of a bond with a _________.

A. 10-year maturity, selling at 80

B. 10-year maturity, selling at 100

C. 20-year maturity, selling at 80

D. 20-year maturity, selling at 100

58. Consider the following $1,000 par value zero-coupon bonds:

The expected 1-year interest rate 3 years from now should be _________.

A. 7%

B. 8%

C. 9%

D. 10%

59. Consider the following $1,000 par value zero-coupon bonds:

The expected 1-year interest rate 4 years from now should be _________.

A. 16%

B. 18%

C. 20%

D. 22%

60. You can be sure that a bond will sell at a premium to par when _________.

A. its coupon rate is greater than its yield to maturity

B. its coupon rate is less than its yield to maturity

C. its coupon rate is equal to its yield to maturity

D. its coupon rate is less than its conversion value

61. A corporate bond has a 10-year maturity and pays interest semiannually. The quoted coupon rate is 6%, and the bond is priced at par. The bond is callable in 3 years at 110% of par. What is the bond’s yield to call?

A. 6.72%

B. 9.17%

C. 4.49%

D. 8.98%

62. Consider a 7-year bond with a 9% coupon and a yield to maturity of 12%. If interest rates remain constant, 1 year from now the price of this bond will be _________.

A. higher

B. lower

C. the same

D. indeterminate

63. Under the pure expectations hypothesis and constant real interest rates for different maturities, an upward-sloping yield curve would indicate __________________.

A. expected increases in inflation over time

B. expected decreases in inflation over time

C. the presence of a liquidity premium

D. that the equilibrium interest rate in the short-term part of the market is lower than the equilibrium interest rate in the long-term part of the market

64. The yield to maturity on a bond is:

I. Above the coupon rate when the bond sells at a discount and below the coupon rate when the bond sells at a premium
II. The discount rate that will set the present value of the payments equal to the bond price
III. Equal to the true compound return on investment only if all interest payments received are reinvested at the yield to maturity

A. I only

B. II only

C. I and II only

D. I, II, and III

65. Yields on municipal bonds are generally lower than yields on similar corporate bonds because of differences in _________.

A. marketability

B. risk

C. taxation

D. call protection

66. Assuming semiannual compounding, a 20-year zero coupon bond with a par value of $1,000 and a required return of 12% would be priced at _________.

A. $97.22

B. $104.49

C. $364.08

D. $732.14

67. A discount bond that pays interest semiannually will:

I. Have a lower price than an equivalent annual payment bond
II. Have a higher EAR than an equivalent annual payment bond
III. Sell for less than its conversion value

A. I and II only

B. I and III only

C. II and III only

D. I, II, and III

68. A 6% coupon U.S. Treasury note pays interest on May 31 and November 30 and is traded for settlement on August 10. The accrued interest on the $100,000 face amount of this note is _________.

A. $581.97

B. $1,163.93

C. $2,327.87

D. $3,000

69. The yield to maturity of a 10-year zero-coupon bond with a par value of $1,000 and a market price of $625 is _____.

A. 4.8%

B. 6.1%

C. 7.7%

D. 10.4%

70. Consider a newly issued TIPS bond with a 3-year maturity, par value of $1,000, and coupon rate of 5%. Assume annual coupon payments.

What is the nominal rate of return on the TIPS bond in the first year?

A. 5%

B. 5.15%

C. 8.15%

D. 9%

71. Consider a newly issued TIPS bond with a 3-year maturity, par value of $1,000, and coupon rate of 5%. Assume annual coupon payments.

What is the real rate of return on the TIPS bond in the first year?

A. 5%

B. 8.15%

C. 7.15%

D. 4%

72. On May 1, 2007, Joe Hill is considering one of the following newly issued 10-year AAA corporate bonds.

Suppose market interest rates decline by 100 basis points (i.e., 1%). The effect of this decline would be ______.

A. The price of the Wildwood bond would decline by more than the price of the Asbury bond.

B. The price of the Wildwood bond would decline by less than the price of the Asbury bond.

C. The price of the Wildwood bond would increase by more than the price of the Asbury bond.

D. The price of the Wildwood bond would increase by less than the price of the Asbury bond.

73. On May 1, 2007, Joe Hill is considering one of the following newly issued 10-year AAA corporate bonds.

If interest rates are expected to rise, then Joe Hill should ____.

A. prefer the Wildwood bond to the Asbury bond

B. prefer the Asbury bond to the Wildwood bond

C. be indifferent between the Wildwood bond and the Asbury bond

D. The answer cannot be determined from the information given.

74. On May 1, 2007, Joe Hill is considering one of the following newly issued 10-year AAA corporate bonds.

If the volatility of interest rates is expected to increase, then Joe Hill should __.

A. prefer the Wildwood bond to the Asbury bond

B. prefer the Asbury bond to the Wildwood bond

C. be indifferent between the Wildwood bond and the Asbury bond

D. The answer cannot be determined from the information given.

75. One-, two-, and three-year maturity, default-free, zero-coupon bonds have yields to maturity of 7%, 8%, and 9%, respectively. What is the implied 1-year forward rate 1 year from today?

A. 2.07%

B. 8.03%

C. 9.01%

D. 11.12%

76. If the quote for a Treasury bond is listed in the newspaper as 98:09 bid, 98:13 ask, the actual price at which you can purchase this bond given a $10,000 par value is _____________.

A. $9,828.12

B. $9,809.38

C. $9,840.62

D. $9,813.42

77. If the price of a $10,000 par Treasury bond is $10,237.50, the quote would be listed in the newspaper as ________.

A. 102:10

B. 102:11

C. 102:12

D. 102:13

78. A bond pays a semiannual coupon, and the last coupon was paid 61 days ago. If the annual coupon payment is $75, what is the accrued interest? (Assume 182 days in the 6-month period.)

A. $13.21

B. $12.57

C. $15.44

D. $16.32

79. A bond has a flat price of $985, and it pays an annual coupon. The last coupon payment was made 90 days ago. What is the invoice price if the annual coupon is $69?

A. $999.55

B. $1,002.01

C. $1,007.45

D. $1,012.13

80. If the quote for a Treasury bond is listed in the newspaper as 99:08 bid, 99:11 ask, the actual price at which you can sell this bond given a $10,000 par value is _____________.

A. $9,828.12

B. $9,925

C. $9,934.37

D. $9,955.43

81. A bond has a 5% coupon rate. The coupon is paid semiannually, and the last coupon was paid 35 days ago. If the bond has a par value of $1,000, what is the accrued interest?

A. $4.81

B. $14.24

C. $25

D. $50

82. The price on a Treasury bond is 104:21, with a yield to maturity of 3.45%. The price on a comparable maturity corporate bond is 103:11, with a yield to maturity of 4.59%. What is the approximate percentage value of the credit risk of the corporate bond?

A. 1.14%

B. 3.45%

C. 4.59%

D. 8.04%

83. You buy a bond with a $1,000 par value today for a price of $875. The bond has 6 years to maturity and makes annual coupon payments of $75 per year. You hold the bond to maturity, but you do not reinvest any of your coupons. What was your effective EAR over the holding period?

A. 10.4%

B. 9.57%

C. 7.45%

D. 8.78%

84. You buy an 8-year $1,000 par value bond today that has a 6% yield and a 6% annual payment coupon. In 1 year promised yields have risen to 7%. Your 1-year holding-period return was ___.

A. .61%

B. -5.39%

C. 1.28%

D. -3.25%

85. You buy a 10-year $1,000 par value zero-coupon bond priced to yield 6%. You do not sell the bond. If you are in a 28% tax bracket, you will owe taxes on this investment after the first year equal to _______.

A. $0

B. $4.27

C. $9.38

D. $33.51

86. You buy a 10-year $1,000 par value 4% annual-payment coupon bond priced to yield 6%. You do not sell the bond at year-end. If you are in a 15% tax bracket, at year-end you will owe taxes on this investment equal to _______.

A. $9.10

B. $4.25

C. $7.68

D. $5.20

87. An investor pays $989.40 for a bond. The bond has an annual coupon rate of 4.8%. What is the current yield on this bond?

A. 4.8%

B. 4.85%

C. 9.6%

D. 9.7%

88. If the coupon rate on a bond is 4.5% and the bond is selling at a premium, which of the following is the most likely yield to maturity on the bond?

A. 4.3%

B. 4.5%

C. 5.2%

D. 5.5%

89. The price of a bond (with par value of $1,000) at the beginning of a period is $980 and at the end of the period is $975. What is the holding-period return if the annual coupon rate is 4.5%?

A. 4.08%

B. 4.5%

C. 5.1%

D. 5.6%

90. A bond was purchased at a premium and is now selling at a discount because of a change in market interest rates. If the bond pays a 4% annual coupon, what is the likely impact on the holding-period return if an investor decides to sell now?

A. Increased

B. Decreased

C. Stayed the same

D. The answer cannot be determined from the information given.

91. The ___________ is the document that defines the contract between the bond issuer and the bondholder.

A. indenture

B. covenant agreement

C. trustee agreement

D. collateral statement

12
Student: ___________________________________________________________________________
1. A top-down analysis of a firm’s prospects starts with an analysis of the ____.

A. firm’s position in its industry

B. U.S. economy or even the global economy

C. industry

D. specific firm under consideration

2. In 1980 the dollar-yen exchange rate was about $.0045. In 2012 the yen-dollar exchange rate was about 80 yen per dollar. A Japanese producer would have had to increase the dollar price of a good sold in the United States by approximately _____ to maintain the same yen price in 2012.

A. 178%

B. 79.5%

C. 265.4%

D. 36%

3. An increase in the value of the yen against the U.S. dollar can cause the Japanese automaker Toyota to either _____________ on its U.S. sales.

A. lose market share or reduce its profit margin

B. gain market share or reduce its profit margin

C. lose market share or increase its profit margin

D. gain market share or increase its profit margin

4. You estimate that the present value of a firm’s cash flow is valued at $15 million. The break up value of the firm if you were to sell the major assets and divisions separately would be $20 million. This is an example of what Peter Lynch would call ___________.

A. a stalwart

B. slow growth

C. a star

D. an asset play

5. Between 1999 and 2010, the purchasing power of the U.S. dollar increased relative to the purchasing power of _______.

A. the United Kingdom

B. the Euro

C. Switzerland

D. Canada

6. If you believe the economy is about to go into a recession, you might change your asset allocation by selling _______ and buying ______.

A. growth stocks; long-term bonds

B. long-term bonds; growth stocks

C. defensive stocks; growth stocks

D. defensive stocks; long-term bonds

7. The yield curve spread between the 10-year T-bond yield and the federal funds rate is a _______ economic indicator.

A. leading

B. lagging

C. coincident

D. mixed

8. The Conference Board’s Consumer Confidence Index is released ______.

A. daily

B. weekly

C. monthly

D. quarterly

9. You can earn abnormal returns on your investments via macro forecasting ______.

A. if you can forecast the economy at all

B. if you can forecast the economy as well as the average forecaster

C. if you can forecast the economy better than the average forecaster

D. only if you can forecast the economy with perfect accuracy

10. Which of the following industries would most analysts classify as mature?

A. Internet service providers

B. Biotechnology

C. Wireless communication

D. Auto manufacturing

11. Which one of the following stocks represents industries with below-average sensitivity to the state of the economy?

A. Financials

B. Technology

C. Food and beverage

D. Cyclicals

12. The most widely used monetary policy tool is _________.

A. altering the discount rate

B. altering reserve requirements

C. open market operations

D. increasing the budget deficit

13. Which one of the following is the ratio of actual output from factories to potential output from factories?

A. Capacity utilizationrate

B. Participation rate

C. Durable goods orders rate

D. Industrial production rate

14. According to __________ economists, the growth of the U.S. economy in the 1980s can be attributed to lower marginal tax rates, which improved the incentives for people to work.

A. Keynesian

B. monetarist

C. supply-side

D. demand-side

15. The market value of all goods and services produced during a given time period is called ______.

A. GDP

B. industrial production

C. capacity utilization

D. factory orders

16. A big increase in government spending is an example of a _________.

A. positive demand shock

B. positive supply shock

C. negative demand shock

D. negative supply shock

17. GDP refers to _________.

A. the amount of personal disposable income in the economy

B. the difference between government spending and government revenues

C. the total manufacturing output in the economy

D. the total production of goods and services in the economy

18. Portfolio manager Peter Lynch would classify Coca-Cola as _________.

A. an asset play

B. a slow grower

C. a stalwart

D. a turnaround

19. Attempting to forecast future earnings and dividends is consistent with which of the following approaches to securities analysis?

A. Technical analysis

B. Fundamental analysis

C. Both technical analysis and fundamental analysis

D. Indexing

20. The analysis of the determinants of firm value is called _____________.

A. fundamental analysis

B. technical analysis

C. momentum analysis

D. indexing

21. Which of the following companies is the best example of a turnaround?

A. Coca-Cola

B. Microsoft

C. ExxonMobil

D. Kmart

22. Inflation is caused by ________________.

A. unions

B. rapid growth of the money supply

C. excess supply

D. low rates of capacity utilization

23. Everything else equal, if you expect a larger interest rate increase than other market participants, you should _________.

A. buy long-term bonds

B. buy short-term bonds

C. buy common stocks

D. buy preferred stocks

24. To obtain an approximate estimate of the real interest rate, one must _________ the __________ the nominal risk-free rate.

A. add; default premium to

B. subtract; default premium from

C. add; expected inflation to

D. subtract; expected inflation from

25. Which of the following would not be considered a supply shock?

A. A change in the price of imported oil

B. Frost damage to the orange crop

C. A change in the level of education of the average worker

D. An increase in the level of government spending

26. If economic conditions are such that very slow growth is expected in the foreseeable future, one would want to invest in industries with __________ sensitivity to economic conditions.

A. below-average

B. average

C. above-average

D. Since growth is expected to be slow, sensitivity to economic conditions is not an issue.

27. Which of the following is not an example of fiscal policy?

A. Social Security spending

B. Medicare spending

C. Fed purchases of Treasury securities

D. Changes in the tax rate

28. Supply-side economics tends to focus on _______________.

A. government spending

B. price controls

C. monetary policy

D. increasing productive capacity

29. Which one of the following describes the amount by which government spending exceeds government revenues?

A. Balance of trade

B. Budget deficit

C. Gross domestic product

D. Output gap

30. Which one of the following is probably the most direct and immediate way to stimulate or slow the economy, although it is not very useful for fine-tuning economic performance?

A. Fiscal policy

B. Monetary policy

C. Supply-side policy

D. Rising minimum wages

31. In macroeconomic terms, an increase in the price of imported oil or a decrease in the availability of oil is an example of a _________.

A. demand shock

B. supply shock

C. monetary shock

D. refinery shock

32. ______________ in interest rates are associated with stock market declines.

A. Anticipated increases

B. Unanticipated increases

C. Anticipated decreases

D. Unanticipated decreases

33. The average duration of unemployment is _________.

A. a leading economic indicator

B. a coincidental economic indicator

C. a lagging economic indicator

D. both a coincidental indicator and a lagging indicator

34. The ratio of the purchasing power of two economies is termed the _______.

A. balance of trade

B. real exchange rate

C. real interest rate

D. nominal exchange rate

35. Everything else equal, an increase in the government budget deficit would:

I. Increase the government’s demand for funds
II. Shift the demand curve for funds to the left
III. Increase the interest rate in the economy

A. II only

B. I and II only

C. I and III only

D. I, II, and III

36. Which of the following affects a firm’s sensitivity of its earnings to the business cycle?

I. Financial leverage
II. Operating leverage
III. Type of product

A. II only

B. I and II only

C. I and III only

D. I, II, and III

37. Which of the following describes the rate at which your ability to purchase grows while you hold an interest-earning investment?

A. The nominal exchange rate

B. The nominal interest rate

C. The real exchange rate

D. The real interest rate

38. An example of a highly cyclical industry is the _________.

A. automobile industry

B. tobacco industry

C. pharmaceutical industry

D. utility industry

39. The stock price index and contracts and orders for nondefense capital goods are _________.

A. leading economic indicators

B. coincidental economic indicators

C. lagging economic indicators

D. leading and coincidental indicators, respectively

40. Which one of the following is not a demand shock?

A. Increase in government spending

B. Increases in the money supply

C. Reductions in consumer spending

D. Improvements in education of U.S. workers

41. Which one of the following is not a U.S. supply shock?

A. Unions force an increase in national wage rates.

B. The oil supply from the Middle East drops 30%.

C. Extended droughts reduce U.S. food production 25%.

D. Chinese purchases of U.S. exports increase.

42. Pharmaceuticals, food, and other necessities would be good performers during the ____ stage of the business cycle.

A. peak

B. contraction

C. trough

D. expansion

43. Capital goods industries such as industrial equipment, transportation, and construction would be good investments during the _____ stage of the business cycle.

A. peak

B. contraction

C. trough

D. expansion

44. If you are going to earn abnormal returns based on your macroeconomic analysis, it will most likely have to be because __________.

A. you have more information than others

B. you are a better analyst than others

C. you have the same information as others

D. you are an equally good analyst as others

45. If the economy is going into a recession, a good industry to invest in would be the __________ industry.

A. automobile

B. banking

C. construction

D. medical services

46. Members of the Board of Governors of the Federal Reserve System are appointed by ____________ to serve _____________ terms.

A. the Senate; 10-year

B. the House of Representatives; 8-year

C. the President; 14-year

D. the Secretary of the Treasury; 6-year

47. A firm in the early stages of its industry life cycle will likely have _________.

A. low dividend payout rates

B. low rates of investment

C. low rates of return on investment

D. low R&D spending

48. Which of the following describes the percentage of the total labor force that has yet to find work?

A. The capacity utilization rate

B. The participation rate

C. The unemployment rate

D. The natural rate

49. Which of the following is the rate at which the general level of prices for goods and services is rising?

A. The exchange rate

B. The gross domestic product growth rate

C. The inflation rate

D. The real interest rate

50. An analyst starts by examining the broad economic environment and then considers the implications of the economy on the industry in which the firm operates. Finally, the firm’s position within the industry is examined. This is called __________ analysis.

A. bottom-up

B. outside-inside

C. top-down

D. upside-down

51. Assume that the Federal Reserve increases the money supply. This will cause:

I. Interest rates to decrease
II. Consumption and investment to decrease
III. Inflation to fall

A. I only

B. I and II only

C. II and III only

D. I, II, and III

52. The discount rate is the ________.

A. interest rate banks charge each other for overnight loans of deposits on reserve at the Fed

B. interest rate the Fed charges commercial banks on short-term loans

C. interest rate that the U.S. Treasury pays on its bills

D. interest rate that banks charge their best corporate customers

53. If the currency of your country is depreciating, this should __________ exports and __________ imports.

A. stimulate; stimulate

B. stimulate; discourage

C. discourage; stimulate

D. discourage; discourage

54. If interest rates increase, business investment expenditures are likely to __________ and consumer durable expenditures are likely to _________.

A. increase; increase

B. increase; decrease

C. decrease; increase

D. decrease; decrease

55. Increases in the money supply will cause demand for investment and consumption goods to __________ in the short run and may cause prices to __________ in the long run.

A. increase; increase

B. increase; decrease

C. decrease; increase

D. decrease; decrease

56. The nominal interest rate is 6%. The inflation rate is 3%. The exact real interest rate must be _________.

A. 2.91%

B. 3.85%

C. 1.45%

D. 2.12%

57. The nominal interest rate is 10%. The real interest rate is 4%. The inflation rate must be _________.

A. -6%

B. 4%

C. 5.77%

D. 14.4%

58. Order the following stages in the industry life cycle from the earliest to latest to occur after the start-up phase:

I. Maturity
II. Relative decline
III. Consolidation

A. III, I, II

B. I, III, II

C. III, II, I

D. I, II, III

59. An investment strategy that entails shifting the portfolio into industry sectors that are expected to outperform others based on macroeconomic forecasts is termed ______________.

A. sector rotation

B. contraction/expansion analysis

C. life-cycle analysis

D. business-cycle shifting

60. Firm A produces gadgets. The price of gadgets is $2 each. Firm A has total fixed costs of $1,000,000 and variable costs of $1 per gadget. The corporate tax rate is 40%. If the economy is strong, the firm will sell 2,000,000 gadgets. If the economy enters a recession, the firm will sell only half as many gadgets. If the economy enters a recession, the after-tax profit of firm A will be _________.

A. $0

B. $90,000

C. $180,000

D. $270,000

61. Firm B produce gadgets. The price of gadgets is $2 each. Firm B has total fixed costs of $300,000 and variable costs of $1.40 per gadget. The corporate tax rate is 30%. If the economy is strong, the firm will sell 2,000,000 gadgets. If the economy enters a recession, the firm will sell only half as many gadgets. If the economy is strong, the after-tax profit of firm B will be _________.

A. $90,000

B. $210,000

C. $300,000

D. $630,000

62. The fed funds rate is the __________.

A. interest rate that banks charge their best corporate customers

B. interest rate banks charge each other for overnight loans of deposits on reserve at the Fed

C. interest rate the Fed charges commercial banks on short-term loans

D. interest rate that the U.S. Treasury pays on its bills

63. Firm B produce gadgets. The price of gadgets is $2 each. Firm B has total fixed costs of $300,000 and variable costs of $1.40 per gadget. The corporate tax rate is 40%. What is the breakeven number of gadgets B must sell to make a zero after-tax profit?

A. 300,000

B. 400,000

C. 500,000

D. 600,000

64. The goal of supply-side policies is to _______.

A. increase government involvement in the economy

B. create an environment where workers and owners of capital have the maximum incentive and ability to produce and develop goods

C. maximize tax revenues of the government

D. focus more on wealth redistribution policies

65. An industry analysis for manufacturers of a small personal care gadget observed the following characteristics:

1. Industry sales have grown at 15%-20% per year in recent years and are expected to grow at 10%-15% per year over the next 3 years, still well above the economic growth rate.
2. Some U.S. manufacturers are attempting to enter fast-growing non-U.S. markets, which remain largely unexploited.
3. Some manufacturers have created a new niche in the industry by selling directly to customers through mail order. Sales for this industry segment are growing at 40% per year.
4. The current penetration rate in the United States is 60% of households and will be difficult to increase.
5. Manufacturers compete fiercely on the basis of price, and price wars within the industry are common.
6. Some manufacturers are able to develop new, unexploited niche markets in the United States based on company reputation, quality, and service.
7. Several manufacturers have recently merged, and it is expected that consolidation in the industry will increase.
8. New manufacturers continue to enter the market.

Characteristics 4 and 5 would indicate that the industry is in the _________ stage.

A. start-up

B. consolidation

C. maturity

D. relative decline

66. An industry analysis for manufacturers of a small personal care gadget observed the following characteristics:

1. Industry sales have grown at 15%-20% per year in recent years and are expected to grow at 10%-15% per year over the next 3 years, still well above the economic growth rate.
2. Some U.S. manufacturers are attempting to enter fast-growing non-U.S. markets, which remain largely unexploited.
3. Some manufacturers have created a new niche in the industry by selling directly to customers through mail order. Sales for this industry segment are growing at 40% per year.
4. The current penetration rate in the United States is 60% of households and will be difficult to increase.
5. Manufacturers compete fiercely on the basis of price, and price wars within the industry are common.
6. Some manufacturers are able to develop new, unexploited niche markets in the United States based on company reputation, quality, and service.
7. Several manufacturers have recently merged, and it is expected that consolidation in the industry will increase.
8. New manufacturers continue to enter the market.

Characteristics _______ would be typical of an industry that is in the start-up stage.

A. 4 and 7

B. 1 and 4

C. 2 and 5

D. none of these options

67. An industry analysis for manufacturers of a small personal care gadget observed the following characteristics:

1. Industry sales have grown at 15%-20% per year in recent years and are expected to grow at 10%-15% per year over the next 3 years, still well above the economic growth rate.
2. Some U.S. manufacturers are attempting to enter fast-growing non-U.S. markets, which remain largely unexploited.
3. Some manufacturers have created a new niche in the industry by selling directly to customers through mail order. Sales for this industry segment are growing at 40% per year.
4. The current penetration rate in the United States is 60% of households and will be difficult to increase.
5. Manufacturers compete fiercely on the basis of price, and price wars within the industry are common.
6. Some manufacturers are able to develop new, unexploited niche markets in the United States based on company reputation, quality, and service.
7. Several manufacturers have recently merged, and it is expected that consolidation in the industry will increase.
8. New manufacturers continue to enter the market.

Characteristics ____ would be typical of an industry that is in the consolidation stage.

A. 6 and 7

B. 1 and 4

C. 5 and 6

D. 2 and 8

68. An industry analysis for manufacturers of a small personal care gadget observed the following characteristics:

1. Industry sales have grown at 15%-20% per year in recent years and are expected to grow at 10%-15% per year over the next 3 years, still well above the economic growth rate.
2. Some U.S. manufacturers are attempting to enter fast-growing non-U.S. markets, which remain largely unexploited.
3. Some manufacturers have created a new niche in the industry by selling directly to customers through mail order. Sales for this industry segment are growing at 40% per year.
4. The current penetration rate in the United States is 60% of households and will be difficult to increase.
5. Manufacturers compete fiercely on the basis of price, and price wars within the industry are common.
6. Some manufacturers are able to develop new, unexploited niche markets in the United States based on company reputation, quality, and service.
7. Several manufacturers have recently merged, and it is expected that consolidation in the industry will increase.
8. New manufacturers continue to enter the market.

Which of the characteristics would be typical of an industry that is in the maturity stage?

A. 1, 2, and 3

B. 4 and 5

C. 6, 7, and 8

D. all of these options

69. Countercyclical fiscal policy is best described by which of the following statements?

A. Government surpluses are planned during economic booms, and deficits are planned during economic recessions.

B. The annual budget should always be balanced.

C. Deficits should always equal surpluses.

D. Government deficits are planned during economic booms, and surpluses are planned during economic recessions.

70. A supply-side economist would likely agree with which of the following statements?

A. Real output and aggregate employment are primarily determined by aggregate demand.

B. Real income will rise when government expenditures and tax rates increase.

C. Real output and aggregate employment are primarily determined by tax rates.

D. Increasing the money supply will increase real output without causing higher inflation.

71. Which of the following actions should the central bank take if monetary authorities want to reduce the supply of money to slow the rate of inflation?

A. Sell government bonds, reducing money supply, increasing interest rates, and slowing aggregate demand.

B. Buy government bonds, reducing money supply, increasing interest rates, and slowing aggregate demand.

C. Decrease the discount rate, lowering interest rates and causing both costs and prices to fall.

D. Increase taxes, reducing costs and causing prices to fall.

72. The decline in the value of the dollar relative to the yen will have what impact on the purchase of U.S. goods in Japan?

A. U.S. goods will increase in cost, and Japan will import more.

B. U.S. goods will increase in cost, and Japan will import less.

C. U.S. goods will decrease in cost, and Japan will import more.

D. U.S. goods will increase in cost, and Japan will export less.

73. Which of the following are examples of cyclical industries?

I. Maytag
II. Computer chip manufacturers
III. Kellogg’s Frosted Flakes
IV. Pfizer

A. I and II only

B. I, II, and III only

C. II, III, and IV only

D. I, II, III, and IV

74. You would expect the beta of cyclical industries to be ______ and the beta of defensive industries to be ______.

A. greater than 1; less than 1

B. less than 1; less than 1

C. less than 1; greater than 1

D. greater than 1; greater than 1

75. What economic variable is most closely associated with increasing corporate profits?

A. Exchange rates

B. Inflation

C. Gross domestic product

D. Budget deficits

76. The federal government decides to pay for the transition to private social security accounts with a one-time $1 trillion bond issue. What will be the biggest concern to businesses relative to the “crowding out” effect?

A. Higher interest rates due to the new government borrowing

B. Inflation resulting from more government purchases

C. A negative supply shock

D. Shortage of investment due to new accounts

77. An expanding economy requires more workers. If the supply of workers becomes inadequate to meet the demand, what is the likely impact on the economy?

A. An economic slowdown is likely

B. Employment trends will reverse and unemployment will occur

C. Government deficits will result from capacity utilization

D. Inflation may result from upward wage pressures

78. An expanding economy puts stress on the manufacturing ability of a company. When a firm turns business down during periods of economic expansion, a problem exists in the area of ____________.

A. asset allocation

B. capacity utilization

C. employment management

D. strategic planning

79. The expansion of the money supply at a rate that exceeds the increase in goods and services will likely result in ___________.

A. expanding economy

B. increased inflation

C. interest rate declines

D. lower GDP

80. The supply of funds in the economy is controlled primarily by ____________.

A. the Federal Reserve System

B. Congress

C. money center banks

D. the Treasury department

81. The classification system used to classify firms into industries is now called the _____ code.

A. SIC

B. NAICS

C. ISO 57

D. ISM

82. During 2004 China increased its use of global oil by 40%. This followed a 100% increase during the previous 5 years. How do economists refer to this kind of economic event?

A. Demand shock

B. Equilibrium event

C. Expanding commodity event

D. Supply shock

83. Whenever OPEC attempts to influence the price of oil by significantly altering production, economists refer to this type of event as a ______________.

A. demand shock

B. equilibrium event

C. expanding commodity event

D. supply shock

84. Items that are ____________ and product purchases for which ________ is not important tend to be less cyclical in nature.

A. necessities; income

B. luxuries; leverage

C. discretionary goods; time of purchase

D. produced with high fixed costs; entertainment

85. Cash cows are typically found in the _________ stage of the industry life cycle.

A. start-up

B. consolidation

C. maturity

D. relative decline

86. At what point in the industry life cycle are inefficiencies in competitors most likely to be removed?

A. Start-up stage

B. Consolidation stage

C. Maturity stage

D. Relative decline stage

87. Stalwarts are typically found in the _________ stage of the industry life cycle.

A. start-up

B. consolidation

C. maturity

D. relative decline

88. Large-growth companies generally emerge in the __________ stage.

A. start-up

B. consolidation

C. maturity

D. relative decline

89. Which of the following are barriers to entry?

I. Large economies of scale required to be profitable
II. Established brand loyalty
III. Patent protection for the firm’s product
IV. Rapid industry growth

A. I and II only

B. I, II, and III only

C. II, III, and IV only

D. III and IV only

13
Student: ___________________________________________________________________________
1. The accounting measure of a firm’s equity value generated by applying accounting principles to asset and liability acquisitions is called ________.

A. book value

B. market value

C. liquidation value

D. Tobin’s q

2. The price-to-sales ratio is probably most useful for firms in which phase of the industry life cycle?

A. Start-up phase

B. Consolidation

C. Maturity

D. Relative decline

3. If a firm increases its plowback ratio, this will probably result in _______ P/E ratio.

A. a higher

B. a lower

C. an unchanged

D. The answer cannot be determined from the information given.

4. The value of Internet companies is based primarily on _____.

A. current profits

B. Tobin’s q

C. growth opportunities

D. replacement cost

5. New-economy companies generally have higher _______ than old-economy companies.

A. book value per share

B. P/E multiples

C. profits

D. asset values

6. P/E ratios tend to be _______ when inflation is ______.

A. higher; higher

B. lower; lower

C. higher; lower

D. They are unrelated.

7. Which one of the following statements about market and book value is correct?

A. All firms sell at a market-to-book ratio above 1.

B. All firms sell at a market-to-book ratio greater than or equal to 1.

C. All firms sell at a market-to-book ratio below 1.

D. Most firms have a market-to-book ratio above 1, but not all.

8. Earnings yields tend to _______ when Treasury yields fall.

A. fall

B. rise

C. remain unchanged

D. fluctuate wildly

9. Which one of the following is a common term for the market consensus value of the required return on a stock?

A. Dividend payout ratio

B. Intrinsic value

C. Market capitalization rate

D. Plowback ratio

10. Which one of the following is equal to the ratio of common shareholders’ equity to common shares outstanding?

A. Book value per share

B. Liquidation value per share

C. Market value per share

D. Tobin’s q

11. A firm has current assets that could be sold for their book value of $10 million. The book value of its fixed assets is $60 million, but they could be sold for $95 million today. The firm has total debt at a book value of $40 million, but interest rate changes have increased the value of the debt to a current market value of $50 million. This firm’s market-to-book ratio is ________.

A. 1.83

B. 1.5

C. 1.35

D. 1.46

12. If a stock is correctly priced, then you know that ____________.

A. the dividend payout ratio is optimal

B. the stock’s required return is equal to the growth rate in earnings and dividends

C. the sum of the stock’s expected capital gain and dividend yield is equal to the stock’s required rate of return

D. the present value of growth opportunities is equal to the value of assets in place

13. A stock has an intrinsic value of $15 and an actual stock price of $13.50. You know that this stock ________.

A. has a Tobin’s q value < 1 B. will generate a positive alpha C. has an expected return less than its required return D. has a beta > 1

14. Bill, Jim, and Shelly are all interested in buying the same stock that pays dividends. Bill plans on holding the stock for 1 year. Jim plans on holding the stock for 3 years. Shelly plans on holding the stock until she retires in 10 years. Which one of the following statements is correct?

A. Bill will be willing to pay the most for the stock because he will get his money back in 1 year when he sells.

B. Jim should be willing to pay three times as much for the stock as Bill will pay because his expected holding period is three times as long as Bill’s.

C. Shelly should be willing to pay the most for the stock because she will hold it the longest and hence will get the most dividends.

D. All three should be willing to pay the same amount for the stock regardless of their holding period.

15. A firm that has an ROE of 12% is considering cutting its dividend payout. The stockholders of the firm desire a dividend yield of 4% and a capital gain yield of 9%. Given this information, which of the following statements is (are) correct?

I. All else equal, the firm’s growth rate will accelerate after the payout change.
II. All else equal, the firm’s stock price will go up after the payout change.
III. All else equal, the firm’s P/E ratio will increase after the payout change.

A. I only

B. I and II only

C. II and III only

D. I, II, and III

16. A firm cuts its dividend payout ratio. As a result, you know that the firm’s _______.

A. return on assets will increase

B. earnings retention ratio will increase

C. earnings growth rate will fall

D. stock price will fall

17. __________ is the amount of money per common share that could be realized by breaking up the firm, selling its assets, repaying its debt, and distributing the remainder to shareholders.

A. Book value per share

B. Liquidation value per share

C. Market value per share

D. Tobin’s q

18. An underpriced stock provides an expected return that is ____________ the required return based on the capital asset pricing model (CAPM).

A. less than

B. equal to

C. greater than

D. greater than or equal to

19. Stockholders of Dogs R Us Pet Supply expect a 12% rate of return on their stock. Management has consistently been generating an ROE of 15% over the last 5 years but now believes that ROE will be 12% for the next 5 years. Given this, the firm’s optimal dividend payout ratio is now ______.

A. 0%

B. 100%

C. between 0% and 50%

D. between 50% and 100%

20. The constant-growth dividend discount model (DDM) can be used only when the ___________.

A. growth rate is less than or equal to the required return

B. growth rate is greater than or equal to the required return

C. growth rate is less than the required return

D. growth rate is greater than the required return

21. Suppose that in 2012 the expected dividends of the stocks in a broad market index equaled $240 million when the discount rate was 8% and the expected growth rate of the dividends equaled 6%. Using the constant-growth formula for valuation, if interest rates increase to 9%, the value of the market will change by _____.

A. -10%

B. -20%

C. -25%

D. -33%

22. You want to earn a return of 10% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends is 6% for stock A and 5% for stock B. Using the constant-growth DDM, the intrinsic value of stock A _________.

A. will be higher than the intrinsic value of stock B

B. will be the same as the intrinsic value of stock B

C. will be less than the intrinsic value of stock B

D. The answer cannot be determined from the information given.

23. Each of two stocks, A and B, is expected to pay a dividend of $7 in the upcoming year. The expected growth rate of dividends is 6% for both stocks. You require a return of 10% on stock A and a return of 12% on stock B. Using the constant-growth DDM, the intrinsic value of stock A _________.

A. will be higher than the intrinsic value of stock B

B. will be the same as the intrinsic value of stock B

C. will be less than the intrinsic value of stock B

D. The answer cannot be determined from the information given.

24. You want to earn a return of 11% on each of two stocks, A and B. Stock A is expected to pay a dividend of $3 in the upcoming year, while stock B is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends for both stocks is 4%. Using the constant-growth DDM, the intrinsic value of stock A _________.

A. will be higher than the intrinsic value of stock B

B. will be the same as the intrinsic value of stock B

C. will be less than the intrinsic value of stock B

D. The answer cannot be determined from the information given.

25. You are considering acquiring a common share of Sahali Shopping Center Corporation that you would like to hold for 1 year. You expect to receive both $1.25 in dividends and $35 from the sale of the share at the end of the year. The maximum price you would pay for a share today is __________ if you wanted to earn a 12% return.

A. $31.25

B. $32.37

C. $38.47

D. $41.32

26. The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its expected ROE is 12%, and its expected EPS is $5. If the firm’s plowback ratio is 50%, its P/E ratio will be _________.

A. 8.33

B. 12.5

C. 19.23

D. 24.15

27. The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its expected ROE is 12%, and its expected EPS is $5. If the firm’s plowback ratio is 60%, its P/E ratio will be _________.

A. 7.14

B. 14.29

C. 16.67

D. 22.22

28. Weyerhaeuser Incorporated has a balance sheet that lists $70 million in assets, $45 million in liabilities, and $25 million in common shareholders’ equity. It has 1 million common shares outstanding. The replacement cost of its assets is $85 million. Its share price in the market is $49. Its book value per share is _________.

A. $16.67

B. $25

C. $37.50

D. $40.83

29. Eagle Brand Arrowheads has expected earnings of $1.25 per share and a market capitalization rate of 12%. Earnings are expected to grow at 5% per year indefinitely. The firm has a 40% plowback ratio. By how much does the firm’s ROE exceed the market capitalization rate?

A. .5%

B. 1%

C. 1.5%

D. 2%

30. Gagliardi Way Corporation has an expected ROE of 15%. If it pays out 30% of its earnings as dividends, its dividend growth rate will be _____.

A. 4.5%

B. 10.5%

C. 15%

D. 30%

31. A preferred share of Coquihalla Corporation will pay a dividend of $8 in the upcoming year and every year thereafter; that is, dividends are not expected to grow. You require a return of 7% on this stock. Using the constant-growth DDM to calculate the intrinsic value, a preferred share of Coquihalla Corporation is worth _________.

A. $13.50

B. $45.50

C. $91

D. $114.29

32. Brevik Builders has an expected ROE of 25%. Its dividend growth rate will be __________ if it follows a policy of paying 30% of earnings in the form of dividends.

A. 5%

B. 15%

C. 17.5%

D. 45%

33. A firm is planning on paying its first dividend of $2 three years from today. After that, dividends are expected to grow at 6% per year indefinitely. The stock’s required return is 14%. What is the intrinsic value of a share today?

A. $25

B. $16.87

C. $19.24

D. $20.99

34. Rose Hill Trading Company is expected to have EPS in the upcoming year of $8. The expected ROE is 18%. An appropriate required return on the stock is 14%. If the firm has a plowback ratio of 70%, its dividend in the upcoming year should be _________.

A. $1.12

B. $1.44

C. $2.40

D. $5.60

35. Rose Hill Trading Company is expected to have EPS in the upcoming year of $6. The expected ROE is 18%. An appropriate required return on the stock is 14%. If the firm has a plowback ratio of 70%, its intrinsic value should be _________.

A. $20.93

B. $69.77

C. $128.57

D. $150

36. Cache Creek Manufacturing Company is expected to pay a dividend of $3.36 in the upcoming year. Dividends are expected to grow at 8% per year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalization rate and use the constant-growth DDM to determine the value of the stock. The stock’s current price is $84. Using the constant-growth DDM, the market capitalization rate is _________.

A. 9%

B. 12%

C. 14%

D. 18%

37. Grott and Perrin, Inc., has expected earnings of $3 per share for next year. The firm’s ROE is 20%, and its earnings retention ratio is 70%. If the firm’s market capitalization rate is 15%, what is the present value of its growth opportunities?

A. $20

B. $70

C. $90

D. $115

38. Ace Ventura, Inc., has expected earnings of $5 per share for next year. The firm’s ROE is 15%, and its earnings retention ratio is 40%. If the firm’s market capitalization rate is 10%, what is the present value of its growth opportunities?

A. $25

B. $50

C. $75

D. $100

39. Annie’s Donut Shops, Inc., has expected earnings of $3 per share for next year. The firm’s ROE is 18%, and its earnings retention ratio is 60%. If the firm’s market capitalization rate is 12%, what is the value of the firm excluding any growth opportunities?

A. $25

B. $50

C. $83.33

D. $208

40. Flanders, Inc., has expected earnings of $4 per share for next year. The firm’s ROE is 8%, and its earnings retention ratio is 40%. If the firm’s market capitalization rate is 15%, what is the present value of its growth opportunities?

A. -$6.33

B. $0

C. $20.34

D. $26.67

41. Firm A is high-risk, and Firm B is low-risk. Everything else equal, which firm would you expect to have a higher P/E ratio?

A. Firm A

B. Firm B

C. Both would have the same P/E if they were in the same industry.

D. There is not necessarily any linkage between risk and P/E ratios.

42. Firms with higher expected growth rates tend to have P/E ratios that are ___________ the P/E ratios of firms with lower expected growth rates.

A. higher than

B. equal to

C. lower than

D. There is not necessarily any linkage between risk and P/E ratios.

43. Value stocks are more likely to have a PEG ratio _____.

A. less than 1

B. equal to 1

C. greater than 1

D. less than zero

44. Generally speaking, as a firm progresses through the industry life cycle, you would expect the PVGO to ________ as a percentage of share price.

A. increase

B. decrease

C. stay the same

D. No typical pattern can be expected.

45. Cache Creek Manufacturing Company is expected to pay a dividend of $4.20 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalization rate on the stock and use the constant-growth DDM to determine the intrinsic value of the stock. The stock is trading in the market today at $84. Using the constant-growth DDM and the CAPM, the beta of the stock is _________.

A. 1.4

B. .9

C. .8

D. .5

46. Westsyde Tool Company is expected to pay a dividend of $1.50 in the upcoming year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 14%. Analysts expect the price of Westsyde Tool Company shares to be $29 a year from now. The beta of Westsyde Tool Company’s stock is 1.2. Using the CAPM, an appropriate required return on Westsyde Tool Company’s stock is _________.

A. 8%

B. 10.8%

C. 15.6%

D. 16.8%

47. Westsyde Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 6%, and the expected return on the market portfolio is 12%. Analysts expect the price of Westsyde Tool Company shares to be $29 a year from now. The beta of Westsyde Tool Company’s stock is 1.2. Using a one-period valuation model, the intrinsic value of Westsyde Tool Company stock today is _________.

A. $24.29

B. $27.39

C. $31.13

D. $34.52

48. Todd Mountain Development Corporation is expected to pay a dividend of $2.50 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 12%. The stock of Todd Mountain Development Corporation has a beta of .75. Using the CAPM, the return you should require on the stock is _________.

A. 7.25%

B. 10.25%

C. 14.75%

D. 21%

49. Todd Mountain Development Corporation is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 17%. The stock of Todd Mountain Development Corporation has a beta of .75. Using the constant-growth DDM, the intrinsic value of the stock is _________.

A. 4

B. 17.65

C. 37.50

D. 50

50. Generally speaking, the higher a firm’s ROA, the _________ the dividend payout ratio and the _________ the firm’s growth rate of earnings.

A. higher; lower

B. higher; higher

C. lower; lower

D. lower; higher

51. Interior Airline is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at the rate of 10% per year. The risk-free rate of return is 4%, and the expected return on the market portfolio is 13%. The stock of Interior Airline has a beta of 4. Using the constant-growth DDM, the intrinsic value of the stock is _________.

A. $10

B. $22.73

C. $27.78

D. $41.67

52. Caribou Gold Mining Corporation is expected to pay a dividend of $4 in the upcoming year. Dividends are expected to decline at the rate of 3% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock of Caribou Gold Mining Corporation has a beta of .5. Using the CAPM, the return you should require on the stock is _________.

A. 2%

B. 5%

C. 8%

D. 9%

53. Caribou Gold Mining Corporation is expected to pay a dividend of $6 in the upcoming year. Dividends are expected to decline at the rate of 3% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 13%. The stock of Caribou Gold Mining Corporation has a beta of .5. Using the constant-growth DDM, the intrinsic value of the stock is _________.

A. $50

B. $100

C. $150

D. $200

54. Lifecycle Motorcycle Company is expected to pay a dividend in year 1 of $2, a dividend in year 2 of $3, and a dividend in year 3 of $4. After year 3, dividends are expected to grow at the rate of 7% per year. An appropriate required return for the stock is 12%. Using the multistage DDM, the stock should be worth __________ today.

A. $63.80

B. $65.13

C. $67.95

D. $85.60

55. Ace Frisbee Corporation produces a good that is very mature in the firm’s product life cycles. Ace Frisbee Corporation is expected to pay a dividend in year 1 of $3, a dividend in year 2 of $2, and a dividend in year 3 of $1. After year 3, dividends are expected to decline at the rate of 2% per year. An appropriate required return for the stock is 8%. Using the multistage DDM, the stock should be worth __________ today.

A. $13.07

B. $13.58

C. $18.25

D. $18.78

56. A firm’s earnings per share increased from $10 to $12, its dividends increased from $4 to $4.40, and its share price increased from $80 to $100. Given this information, it follows that _________.

A. the stock experienced a drop in its P/E ratio

B. the company had a decrease in its dividend payout ratio

C. both earnings and share price increased by 20%

D. the required rate of return increased

57. Assuming all other factors remain unchanged, __________ would increase a firm’s price-earnings ratio.

A. an increase in the dividend payout ratio

B. a reduction in investor risk aversion

C. an expected increase in the level of inflation

D. an increase in the yield on Treasury bills

58. A company with an expected earnings growth rate which is greater than that of the typical company in the same industry most likely has _________________.

A. a dividend yield which is greater than that of the typical company

B. a dividend yield which is less than that of the typical company

C. less risk than the typical company

D. less sensitivity to market trends than the typical company

59. Everything else equal, which variable is negatively related to the intrinsic value of a company?

A. D1

B. D0

C. g

D. k

60. Sanders, Inc., paid a $4 dividend per share last year and is expected to continue to pay out 60% of its earnings as dividends for the foreseeable future. If the firm is expected to generate a 13% return on equity in the future, and if you require a 15% return on the stock, the value of the stock is _________.

A. $26.67

B. $35.19

C. $42.94

D. $59.89

61. A firm has PVGO of 0 and a market capitalization rate of 12%. What is the firm’s P/E ratio?

A. 12

B. 8.33

C. 10.25

D. 18.55

62. A firm has an earnings retention ratio of 40%. The stock has a market capitalization rate of 15% and an ROE of 18%. What is the stock’s P/E ratio?

A. 12.82

B. 7.69

C. 8.33

D. 9.46

63. A common stock pays an annual dividend per share of $1.80. The risk-free rate is 5%, and the risk premium for this stock is 4%. If the annual dividend is expected to remain at $1.80 per share, what is the value of the stock?

A. $17.78

B. $20

C. $40

D. None of these options

64. Transportation stocks currently provide an expected rate of return of 15%. TTT, a large transportation company, will pay a year-end dividend of $3 per share. If the stock is selling at $60 per share, what must be the market’s expectation of the constant-growth rate of TTT dividends?

A. 5%

B. 10%

C. 20%

D. None of these options

65. A stock is priced at $45 per share. The stock has earnings per share of $3 and a market capitalization rate of 14%. What is the stock’s PVGO?

A. $23.57

B. $15

C. $19.78

D. $21.34

66. A firm increases its dividend plowback ratio. All else equal, you know that _____________.

A. earnings growth will increase and the stock’s P/E will increase

B. earnings growth will decrease and the stock’s P/E will increase

C. earnings growth will increase and the stock’s P/E will decrease

D. earnings growth will increase and the stock’s P/E may or may not increase

67. A firm has a stock price of $54.75 per share. The firm’s earnings are $75 million, and the firm has 20 million shares outstanding. The firm has an ROE of 15% and a plowback of 65%. What is the firm’s PEG ratio?

A. 1.5

B. 1.25

C. 1.1

D. 1

68. ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of .20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock.

At what price would you expect ART to sell?

A. $25

B. $34.29

C. $42.86

D. $45.67

69. ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of .20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock.

At what P/E ratio would you expect ART to sell?

A. 8.33

B. 11.43

C. 14.29

D. 15.25

70. ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of .20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock.

What is the present value of growth opportunities for ART?

A. $8.57

B. $9.29

C. $14.29

D. $16.29

71. ART has come out with a new and improved product. As a result, the firm projects an ROE of 25%, and it will maintain a plowback ratio of .20. Its earnings this year will be $3 per share. Investors expect a 12% rate of return on the stock.

What price do you expect ART shares to sell for in 4 years?

A. $53.96

B. $44.95

C. $41.68

D. $39.76

72. The EBIT of a firm is $300, the tax rate is 35%, the depreciation is $20, capital expenditures are $60, and the increase in net working capital is $30. What is the free cash flow to the firm?

A. $85

B. $125

C. $185

D. $305

73. A firm reports EBIT of $100 million. The income statement shows depreciation of $20 million. If the tax rate is 35% and total capital expenditures and increases in working capital total $10 million, what is the free cash flow to the firm?

A. $57

B. $65

C. $75

D. $95

74. The free cash flow to the firm is $300 million in perpetuity, the cost of equity equals 14%, and the WACC is 10%. If the market value of the debt is $1 billion, what is the value of the equity using the free cash flow valuation approach?

A. $1 billion

B. $2 billion

C. $3 billion

D. $4 billion

75. If a firm has a free cash flow equal to $50 million and that cash flow is expected to grow at 3% forever, what is the total firm value given a WACC of 9.5%?

A. $679.81 million

B. $715.54 million

C. $769.23 million

D. $803.03 million

76. The free cash flow to the firm is reported as $405 million. The interest expense to the firm is $76 million. If the tax rate is 35% and the net debt of the firm increased by $50 million, what is the free cash flow to the equity holders of the firm?

A. $405.6 million

B. $454.2 million

C. $505.8 million

D. $553.5 million

77. The free cash flow to the firm is reported as $275 million. The interest expense to the firm is $60 million. If the tax rate is 35% and the net debt of the firm increased by $33 million, what is the free cash flow to the equity holders of the firm?

A. $269 million

B. $296 million

C. $305 million

D. $327 million

78. The free cash flow to the firm is reported as $205 million. The interest expense to the firm is $22 million. If the tax rate is 35% and the net debt of the firm increased by $25 million, what is the approximate market value of the firm if the FCFE grows at 2% and the cost of equity is 11%?

A. $2,168 billion

B. $2,445 billion

C. $2,565 billion

D. $2,998 billion

79. The free cash flow to the firm is reported as $198 million. The interest expense to the firm is $15 million. If the tax rate is 35% and the net debt of the firm increased by $20 million, what is the approximate market value of the firm if the FCFE grows at 3% and the cost of equity is 14%?

A. $1,950 billion

B. $2,497 billion

C. $2,585 billion

D. $3,098 billion

80. Firm A has a stock price of $35, and 60% of the value of the stock is in the form of PVGO. Firm B also has a stock price of $35, but only 20% of the value of stock B is in the form of PVGO. We know that:

I. Stock A will give us a higher return than Stock B.
II. An investment in stock A is probably riskier than an investment in stock B.
III. Stock A has higher forecast earnings growth than stock B.

A. I only

B. I and II only

C. II and III only

D. I, II, and III

81. A firm is expected to produce earnings next year of $3 per share. It plans to reinvest 25% of its earnings at 20%. If the cost of equity is 11%, what should be the value of the stock?

A. $27.27

B. $37.50

C. $66.67

D. $70

82. Next year’s earnings are estimated to be $5. The company plans to reinvest 20% of its earnings at 15%. If the cost of equity is 9%, what is the present value of growth opportunities?

A. $9.09

B. $10.10

C. $11.11

D. $12.21

83. Next year’s earnings are estimated to be $6. The company plans to reinvest 33% of its earnings at 12%. If the cost of equity is 8%, what is the present value of growth opportunities?

A. $6

B. $24.50

C. $44.44

D. $75

84. When Google’s share price reached $475 per share, Google had a P/E ratio of about 68 and an estimated market capitalization rate of 11.5%. Google pays no dividends. Approximately what percentage of Google’s stock price was represented by PVGO?

A. 92%

B. 87%

C. 77%

D. 64%

85. A firm has a stock price of $55 per share and a P/E ratio of 75. If you buy the stock at this P/E and earnings fail to grow at all, how long should you expect it to take to just recover the cost of your investment?

A. 27 years

B. 37 years

C. 55 years

D. 75 years

86. In what industry are investors likely to use the dividend discount model and arrive at a price close to the observed market price?

A. Import/export trade

B. Software

C. Telecommunications

D. Utility

87. Estimates of a stock’s intrinsic value calculated with the free cash flow methodology depend most critically on _______.

A. the terminal value used

B. whether one uses FCFF or FCFE

C. the time period used to estimate the cash flows

D. whether the firm is currently paying dividends

88. The greatest value to an analyst from calculating a stock’s intrinsic value is _______.

A. how easy it is to come up with accurate model inputs

B. the precision of the value estimate

C. how the process forces analysts to understand the critical variables that have the greatest impact on value

D. how all the different models typically yield identical value results

89. Which of the following valuation measures is often used to compare firms that have no earnings?

A. Price-to-book ratio

B. P/E ratio

C. Price-to-cash-flow ratio

D. Price-to-sales ratio

14
Student: ___________________________________________________________________________
1. Which of the following assets is most liquid?

A. Cash equivalents

B. Receivables

C. Inventories

D. Plant and equipment

2. Cost of goods sold refers to ___________.

A. direct costs attributable to producing the product sold by the firm

B. salaries, advertising, and selling expenses

C. payments to the firm’s creditors

D. payments to federal and local governments

3. Many observers believe that firms “manage” their income statements to _______.

A. minimize taxes over time

B. maximize expenditures

C. smooth their earnings over time

D. generate level sales

4. Depreciation expense is in what broad category of expenditures?

A. Operating expenses

B. General and administrative expenses

C. Debt interest expense

D. Tax expenditures

5. Firm A acquires firm B when firm B has a book value of assets of $155 million and a book value of liabilities of $35 million. Firm A actually pays $175 million for firm B. This purchase would result in goodwill for firm A equal to _____.

A. $175 million

B. $155 million

C. $120 million

D. $55 million

6. One of the biggest impediments to a global capital market has been _________.

A. volatile exchange rates

B. the lack of common accounting standards

C. lower disclosure standards in the United States than abroad

D. the lack of transparent reporting standards across the EU

7. Benjamin Graham thought that the benefits from detailed analysis of a firm’s financial statements had _________ over his long professional life.

A. increased greatly

B. increased slightly

C. remained constant

D. decreased

8. If the interest rate on debt is higher than the ROA, then a firm’s ROE will _________.

A. decrease

B. increase

C. not change

D. change but in an indeterminable manner

9. Which of the following is not one of the three key financial statements available to investors in publicly traded firms?

A. Income statement

B. Balance sheet

C. Statement of operating earnings

D. Statement of cash flows

10. In 2006 Hewlett-Packard repurchased shares of common stock worth $5,241 million and made dividend payments of $894 million. Other financing activities raised $196 million, and Hewlett-Packard’s total cash flow from financing was -$6,077 million. How much did the long-term debt accounts of Hewlett-Packard change?

A. Increased $138 million

B. Decreased $138 million

C. Increased $836 million

D. Decreased $836 million

11.

What must cash flow from financing have been in 2008 for Interceptors, Inc.?

A. $5

B. $28

C. $30

D. $33

12.
Based on the cash flow data in the table for Interceptors Inc., which of the following statements is (are) correct?

I. This firm appears to be a good investment because of its steady growth in cash.
II. This firm has been able to generate growing cash flows only by borrowing or selling equity to offset declining operating cash flows.
III. Financing activities have been increasingly important for this firm’s operations, at least in the short run.

A. I only

B. II and III only

C. II only

D. I and II only

13. Common-size balance sheets are prepared by dividing all quantities by ____________.

A. total assets

B. total liabilities

C. shareholders’ equity

D. fixed assets

14. Operating ROA is calculated as __________, while ROE is calculated as _________.

A. EBIT/Total assets; Net profit/Total assets

B. Net profit/Total assets; EBIT/Total assets

C. EBIT/Total assets; Net profit/Equity

D. Net profit/EBIT; Sales/Total assets

15. A firm increases its financial leverage when its ROA is greater than the cost of debt. Everything else equal, this change will probably increase the firm’s:

I. Beta
II. Earnings variability over the business cycle
III. ROE
IV. Stock price

A. I and II only

B. III and IV only

C. I, III, and IV only

D. I, II, and III only

16. The highest possible value for the interest-burden ratio is ______, and this occurs when the firm _________.

A. 0; uses as much debt as possible

B. 1; uses debt to the point where ROA = interest cost of debt

C. 1; uses no interest-bearing debt

D. -1; pays down its existing debts

17. Which one of the following ratios is used to calculate the times-interest-earned ratio?

A. Net profit/Interest expense

B. Pretax profit/EBIT

C. EBIT/Sales

D. EBIT/Interest expense

18. The process of decomposing ROE into a series of component ratios is called ______________.

A. DuPont analysis

B. technical analysis

C. comparative analysis

D. liquidity analysis

19. Which of the following is not a ratio used in the DuPont analysis?

A. Interest burden

B. Profit margin

C. Asset turnover

D. Earnings yield ratio

20. By 2008, over 100 countries had adopted financial reporting standards that are in conformance with ________.

A. GAAP

B. IFRS

C. FASB

D. GASB

21. Operating ROA can be found as the product of ______.

A. Return on sales × ATO

B. Tax burden × Interest burden

C. Interest burden × Leverage ratio

D. ROE × Dividend payout ratio

22. A firm has an ROE of 20% and a market-to-book ratio of 2.38. Its P/E ratio is _________.

A. 8.4

B. 11.9

C. 17.62

D. 47.6

23. If a firm has a positive tax rate and a positive operating ROA, and the interest rate on debt is the same as the operating ROA, then operating ROA will be _________.

A. greater than zero, but it is impossible to determine how operating ROA will compare to ROE

B. equal to ROE

C. greater than ROE

D. less than ROE

24. You find that a firm that uses debt has a compound leverage factor less than 1. This tells you that ________.

A. the firm’s use of financial leverage is positively contributing to ROE

B. the firm’s use of financial leverage is negatively contributing to ROE

C. the firm’s use of operating leverage is positively contributing to ROE

D. the firm’s use of operating leverage is negatively contributing to ROE

25. A firm has a P/E ratio of 24 and an ROE of 12%. Its market-to-book-value ratio is _________.

A. 2.88

B. 2

C. 1.75

D. .69

26. A firm has an ROA of 8% and a debt/equity ratio of .5; its ROE is _________.

A. 4%

B. 6%

C. 8%

D. 12%

27. A firm has a tax burden of .7, a leverage ratio of 1.3, an interest burden of .8, and a return-on-sales ratio of 10%. The firm generates $2.28 in sales per dollar of assets. What is the firm’s ROE?

A. 12.4%

B. 14.5%

C. 16.6%

D. 17.8%

28. Economic value added (EVA) is:

A. the difference between the return on assets and the opportunity cost of capital times the capital base

B. ROA × ROE

C. a measure of the firm’s abnormal return

D. largest for high-growth firms

29. Which of the following statements is true concerning economic value added?

A. A growing number of firms tie managers’ compensation to EVA.

B. A profitable firm will always have a positive EVA.

C. EVA recognizes that the cost of capital is not a real cost.

D. If a firm has positive present value of growth opportunities, it will have positive EVA.

30. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The firm’s current ratio for 2012 indicates that Flathead’s liquidity has ________ since 2011.

A. risen

B. fallen

C. stayed the same

D. The answer cannot be determined from the information given.

31. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The firm’s inventory turnover ratio is _________. (Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged.)

A. 11.6

B. 10.2

C. 9.5

D. 7.7

32. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The firm’s debt-to-equity ratio for 2012 is _________.

A. 2.13

B. 2.44

C. 2.56

D. 2.89

33. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The firm’s cash flow from operating activities for 2012 was _______.

A. $810,000

B. $775,000

C. $755,000

D. $735,000

34. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The industry average ACP is 32 days. How is Flathead doing in its collections relative to the industry? (Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged.)

A. Flathead’s receivables are outstanding about 9 fewer days than the industry average.

B. Flathead’s receivables are outstanding about 15 fewer days than the industry average.

C. Flathead’s receivables are outstanding about 12 more days than the industry average.

D. Flathead’s receivables are outstanding about 6 more days than the industry average.

35. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The firm’s total asset turnover for 2012 is _________. (Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged.)

A. 3.56

B. 3.26

C. 3.14

D. 3.02

36. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. In 2012 Flathead generated ______ of EBIT for every dollar of sales.

A. $.075

B. $.086

C. $.092

D. $.099

37. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The firm’s return on equity ratio for 2012 is _________. (Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged.)

A. 6.5%

B. 26.5%

C. 33.4%

D. 38%

38. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The firm’s P/E ratio for 2012 is _________.

A. 3.39

B. 3.6

C. 13.33

D. 10.67

39. The financial statements of Flathead Lake Manufacturing Company are shown below:

Note: The common shares are trading in the stock market for $15 per share

Refer to the financial statements of Flathead Lake Manufacturing Company. The firm’s compound leverage ratio is __________. (Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged.)

A. 1.5

B. 2

C. 2.5

D. 3

40. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s current ratio for 2012 is _________.

A. 1.3

B. 1.5

C. 1.69

D. 2.83

41. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s quick ratio for 2012 is _________.

A. 1.3

B. 1.5

C. 1.69

D. 2.83

42. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s leverage ratio for 2012 is _________.

A. 1.3

B. 1.5

C. 1.69

D. 2.83

43. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s times-interest-earned ratio for 2012 is _________.

A. 2.8

B. 6

C. 9

D. 11.11

44. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s fixed-asset turnover ratio for 2012 is _________. (Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged.)

A. 2.8

B. 6

C. 9

D. 11.11

45. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s asset turnover ratio for 2012 is _________. (Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged.)

A. 1.3

B. 1.5

C. 1.69

D. 2.83

46. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s return-on-sales ratio for 2012 is _________.

A. .0409

B. .0429

C. .0475

D. .0753

47. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s return-on-equity ratio for 2012 is _________. (Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged.)

A. .0409

B. .0429

C. .0462

D. .0923

48. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s P/E ratio for 2012 is _________.

A. 2.8

B. 3.6

C. 6

D. 11.11

49. The financial statements of Burnaby Mountain Trading Company are shown below.

Note: The common shares are trading in the stock market for $27 each.

Refer to the financial statements of Burnaby Mountain Trading Company. The firm’s market-to-book value for 2012 is _________.

A. .1708

B. .1529

C. .1462

D. .1636

50. A firm has a net profit/pretax profit ratio of .6, a leverage ratio of 1.5, a pretax profit/EBIT of .7, an asset turnover ratio of 4, a current ratio of 2, and a return-on-sales ratio of 6%. Its ROE is _________.

A. 7.56%

B. 15.12%

C. 20.16%

D. 30.24%

51. A firm has an ROA of 19%, a debt/equity ratio of 1.8, and a tax rate of 30%, and the interest rate on its debt is 7%. Its ROE is _________.

A. 15.12%

B. 28.42%

C. 37.24%

D. 40.6%

52. The level of real income of a firm can be distorted by the reporting of depreciation and interest expense. During periods of low inflation, the level of reported depreciation tends to __________ income, and the level of interest expense reported tends to __________ income.

A. understate; overstate

B. understate; understate

C. overstate; understate

D. overstate; overstate

53. If a firm’s ratio of stockholders’ equity/total assets is lower than the industry average and its ratio of long-term debt/stockholders’ equity is also lower than the industry average, this would suggest that the firm _________.

A. has more current liabilities than the industry average

B. has more leased assets than the industry average

C. will be less profitable than the industry average

D. has more current assets than the industry average

54. A firm has a lower inventory turnover, a longer ACP, and a lower fixed-asset turnover than the industry averages. You should not be surprised to find that this firm has:

I. Lower ATO than the industry average
II. Lower ROA than the industry average
III. Lower ROE than the industry average

A. I only

B. I and II only

C. II and III only

D. I, II, and III

55. A high price-to-book ratio may indicate which one of the following?

A. The firm expanded its plant and equipment in the past few years.

B. The firm is doing a poorer job controlling its inventory expense than other related firms.

C. Investors may believe that this firm has opportunities for earning a rate of return in excess of the market capitalization rate.

D. All of these options.

56. A firm has an ROE equal to the industry average, but its price-to-book ratio is below the industry average. You know that the firm’s _________.

A. earnings yield is above the industry average

B. P/E ratio is above the industry average

C. dividend payout ratio is too high

D. interest burden must be below the industry average

57. Use the following cash flow data of Haven Hardware for the year ended December 31, 2012.

What is the net cash provided by operating activities of Haven Hardware?

A. -$30,000

B. $220,000

C. $320,000

D. $780,000

58. Use the following cash flow data of Haven Hardware for the year ended December 31, 2012.

What is the net cash provided by or used in investing activities of Haven Hardware?

A. -$12,000

B. -$62,000

C. $12,000

D. $164,000

59. Use the following cash flow data of Haven Hardware for the year ended December 31, 2012.

What is the net cash provided by or used in financing activities of Haven Hardware?

A. -$10,000

B. -$120,000

C. $10,000

D. $120,000

60. Use the following cash flow data of Haven Hardware for the year ended December 31, 2012.

What is the net increase or decrease in cash for Haven Hardware for 2012?

A. -$94,000

B. -$88,000

C. $88,000

D. $188,000

61. Use the following cash flow data of Haven Hardware for the year ended December 31, 2012.

What is the cash at the end of 2012 for Haven Hardware?

A. $6,000

B. $94,000

C. $736,000

D. $188,000

62. All of the following ratios are related to efficiency except _______.

A. total asset turnover

B. fixed-asset turnover

C. average collection period

D. cash ratio

63. Which of the following would result in a cash inflow under the heading “Cash flow from investing” in the statement of cash flows?

A. Purchase of capital equipment

B. Payments to suppliers for inventory

C. Collections on receivables

D. Sale of production machinery

64. When assessing the sustainability of a firm’s cash flows, analysts will prefer to see cash growth generated from which of the following sources?

A. Cash flow from investment activities

B. Cash flow from operating activities

C. Cash flow from financing

D. Cash flow from extraordinary events

65. The ABS company has a capital base of $100 million, an opportunity cost of capital (k) of 15%, a return on assets (ROA) of 9%, and a return on equity (ROE) of 18%. What is the economic value added (EVA) for ABS?

A. $8 million

B. -$6 million

C. $3 million

D. -$4 million

66. Another term for EVA is ______.

A. net income

B. operating income

C. residual income

D. market-based income

67. Which of the following transactions will result in a decrease in cash flow from operations?

A. Increase in accounts receivable

B. Decrease in inventories

C. Decrease in taxes payable

D. Decrease in bonds outstanding

68. Which of the following transactions will result in a decrease in cash flow from investments?

A. Acquisition of another business

B. Capital gain from sale of a subsidiary

C. Decrease in net investments

D. Sale of equipment

69. Which of the following will result in an increase in cash to the firm?

A. Dividends paid

B. A delay in collecting on accounts receivable

C. Net new investments

D. An increase in accounts payable

70. The table below shows some data for Key Biscuit Company:

What must have caused the firm’s ROE to drop?

A. The firm began using more debt as a percentage of financing.

B. The firm began using less debt as a percentage of financing.

C. The compound leverage ratio was less than 1.

D. The operating ROA was declining.

71. A firm purchases goods on credit worth $150. The same firm pays off $100 in old credit purchases. An investment is made via the purchase of a new facility, and equity is issued in the amount of $300 to pay for the purchase. What is the change in net cash provided by operations?

A. $50 increase

B. $100 increase

C. $150 increase

D. $250 increase

72. A firm purchases goods on credit worth $100. The same firm pays off $80 in old credit purchases. An investment is made via the purchase of a new facility, and equity is issued in the amount of $200 to pay for the purchase. What is the change in net cash provided by financing?

A. $20 increase

B. $80 increase

C. $100 increase

D. $200 increase

73. A firm purchases goods on credit worth $90. The same firm pays off $100 in old credit purchases. An investment is made via the purchase of a new facility, and equity is issued in the amount of $180 to pay for the purchase. What is the change in net cash provided by investments?

A. $10 decrease

B. $90 decrease

C. $180 decrease

D. $190 decrease

74. The net income of the company is $120. Accounts payable increase by $20, depreciation is $15, and equipment is purchased for $40. If the firm issued $110 in new bonds, what is the total change in cash for the firm for all activities?

A. Increase of $225

B. Increase of $130

C. Decrease of $195

D. Decrease of $110

75. The term quality of earnings refers to ________.

A. how well reported earnings conform to GAAP

B. the realism and sustainability of reported earnings

C. whether actual earnings matched expected earnings

D. how well reported earnings fit a trend line of earnings growth

76. The practice of “selling” large quantities of goods to customers in order to get quarterly sales up while allowing these customers to return the goods next quarter is termed _____________.

A. channel stuffing

B. clogging the network

C. spamming the johns

D. artificial sales

77. What ratio will definitely increase when a firm increases its annual sales with no corresponding increase in assets?

A. Asset turnover

B. Current ratio

C. Liquidity ratio

D. Quick ratio

78. A firm’s leverage ratio is 1.2, interest-burden ratio is .81, and profit margin is .25, and its asset turnover is 1.1. What is the firm’s compound leverage factor?

A. .243

B. .267

C. .826

D. .972

79. The tax burden of the firm is .4, the interest burden is .65, the return on sales is .05, the asset turnover is .90, and the leverage ratio is 1.35. What is the ROE of the firm?

A. 1.58%

B. 5.68%

C. 12.2%

D. 13.33%

80. The tax burden of the firm is .5, the interest burden is .55, the profit margin is .25, the asset turnover is 1.5, and the leverage ratio is 1.65. What is the ROE of the firm?

A. 1.88%

B. 6.68%

C. 12.15%

D. 17.02%

81. The major difference between IFRS and GAAP is that U.S. standards are ___________ and IFRS standards are _________.

A. strictly enforced; weakly enforced

B. rules-based; principles-based

C. evolutionary; devolutionary

D. based on government standards; based on corporate practice

82. The quick ratio is a measure of a firm’s __________.

A. asset turnover

B. market valuation

C. liquidity

D. interest burden

83. The firm’s leverage ratio is 1.2, interest-burden ratio is .81, and profit margin is .24, and its asset turnover is 1.25. What is the firm’s ROA?

A. .25

B. .3

C. .335

D. .372

84. A firm has a compound leverage factor greater than 1; this indicates that ______.

A. the firm has no interest payments

B. the firm uses less debt as a percentage of financing

C. the firm’s interest payments are equal to the firm’s pretax profits

D. the firm’s debt has a positive contribution to the firm’s ROA

15
Student: ___________________________________________________________________________
1. You purchase one IBM July 120 call contract for a premium of $5. You hold the option until the expiration date, when IBM stock sells for $123 per share. You will realize a ______ on the investment.

A. $200 profit

B. $200 loss

C. $300 profit

D. $300 loss

2. You purchase one IBM July 125 call contract for a premium of $5. You hold the option until the expiration date, when IBM stock sells for $123 per share. You will realize a ______ on the investment.

A. $200 profit

B. $200 loss

C. $500 profit

D. $500 loss

3. You purchase one IBM July 120 put contract for a premium of $3. You hold the option until the expiration date, when IBM stock sells for $123 per share. You will realize a ______ on the investment.

A. $300 profit

B. $300 loss

C. $500 loss

D. $200 profit

4. You write one IBM July 120 call contract for a premium of $4. You hold the option until the expiration date, when IBM stock sells for $121 per share. You will realize a ______ on the investment.

A. $300 profit

B. $200 loss

C. $600 loss

D. $200 profit

5. ______ option can only be exercised on the expiration date.

A. A Mexican

B. An Asian

C. An American

D. A European

6. All else the same, an American style option will be ______ valuable than a ______ style option.

A. more; European-

B. less; European-

C. more; Canadian-

D. less; Canadian-

7. At contract maturity the value of a call option is ___________, where X equals the option’s strike price and ST is the stock price at contract expiration.

A. Max (0, ST – X)

B. Min (0, ST – X)

C. Max (0, X – ST)

D. Min (0, X – ST)

8. At contract maturity the value of a put option is ___________, where X equals the option’s strike price and ST is the stock price at contract expiration.

A. Max (0, ST – X)

B. Min (0, ST – X)

C. Max (0, X – ST)

D. Min (0, X – ST)

9. An American put option gives its holder the right to _________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at the exercise price only at the expiration date

C. sell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at the exercise price only at the expiration date

10. An Asian call option gives its holder the right to ____________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at a price determined by the average stock price during some specified portion of the option’s life

C. sell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at a price determined by the average stock price during some specified portion of the option’s life

11. An Asian put option gives its holder the right to ____________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at a price determined by the average stock price during some specified portion of the option’s life

C. sell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at a price determined by the average stock price during some specified portion of the option’s life

12. A time spread may be executed by _____.

A. selling an option with one exercise price and buying a similar one with a different exercise price

B. buying two options that have the same expiration dates but different strike prices

C. selling two options that have the same expiration dates but different strike prices

D. selling an option with one expiration date and buying a similar option with a different expiration date

13. Which of the following statements about convertible bonds are true?

I. The conversion price does not change over time.
II. The associated stocks may not pay dividends as long as the bonds are outstanding.
III. Most convertibles are also callable at the discretion of the firm.
IV. They may be thought of as straight bonds plus a call option.

A. I and III only

B. I and IV only

C. I, II, and IV only

D. III and IV only

14. A quanto provides its holder with the right to ______________.

A. participate in the payoffs from a portfolio of gambling casino stocks

B. exchange a fixed amount of a foreign currency for dollars at a specified exchange rate

C. participate in the investment performance of a foreign security

D. exchange the payoff from a foreign investment for dollars at a fixed exchange rate

15. You purchase a call option on a stock. The profit at contract maturity of the option position is ___________, where X equals the option’s strike price, ST is the stock price at contract expiration, and C0 is the original purchase price of the option.

A. Max (-C0, ST – X – C0)

B. Min (-C0, ST – X – C0)

C. Max (C0, ST – X + C0)

D. Max (0, ST – X – C0)

16. Strips and straps are variations of __________.

A. straddles

B. collars

C. money spreads

D. time spreads

17. You write a put option on a stock. The profit at contract maturity of the option position is ___________, where X equals the option’s strike price, ST is the stock price at contract expiration, and P0 is the original premium of the put option.

A. Max (P0, X – ST – P0)

B. Min (-P0, X – ST – P0)

C. Min (P0, ST – X + P0)

D. Max (0, ST – X – P0)

18. Longer-term American-style options with maturities of up to 3 years are called __________.

A. warrants

B. LEAPS

C. GICs

D. CATs

19. The initial maturities of most exchange-traded options are generally __________.

A. less than 1 year

B. less than 2 years

C. between 1 and 2 years

D. between 1 and 3 years

20. A futures call option provides its holder with the right to ___________.

A. purchase a particular stock at some time in the future at a specified price

B. purchase a futures contract for the delivery of options on a particular stock

C. purchase a futures contract at a specified price for a specified period of time

D. deliver a futures contract and receive a specified price at a specific date in the future

21. Exchange-traded stock options expire on the _______________ of the expiration month.

A. second Monday

B. third Wednesday

C. second Thursday

D. third Friday

22. The writer of a put option _______________.

A. agrees to sell shares at a set price if the option holder desires

B. agrees to buy shares at a set price if the option holder desires

C. has the right to buy shares at a set price

D. has the right to sell shares at a set price

23. Advantages of exchange-traded options over OTC options include all but which one of the following?

A. Ease and low cost of trading

B. Anonymity of participants

C. Contracts that are tailored to meet the needs of market participants

D. No concerns about counterparty credit risk

24. Each listed stock option contract gives the holder the right to buy or sell __________ shares of stock.

A. 1

B. 10

C. 100

D. 1,000

25. Exercise prices for listed stock options usually occur in increments of ____ and bracket the current stock price.

A. $1

B. $5

C. $20

D. $25

26. You buy a call option and a put option on General Electric. Both the call option and the put option have the same exercise price and expiration date. This strategy is called a _________.

A. time spread

B. long straddle

C. short straddle

D. money spread

27. In 1973, trading of standardized options on a national exchange started on the _________.

A. AMEX

B. CBOE

C. NYSE

D. CFTC

28. An American call option gives the buyer the right to _________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at the exercise price only at the expiration date

C. sell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at the exercise price only at the expiration date

29. A put option on Dr. Pepper Snapple Group, Inc., has an exercise price of $45. The current stock price is $41. The put option is _________.

A. at the money

B. in the money

C. out of the money

D. knocked out

30. You buy a call option on Merritt Corp. with an exercise price of $50 and an expiration date in July, and you write a call option on Merritt Corp. with an exercise price of $55 and an expiration date in July. This is called a ________.

A. time spread

B. long straddle

C. short straddle

D. money spread

31. A call option on Brocklehurst Corp. has an exercise price of $30. The current stock price of Brocklehurst Corp. is $32. The call option is _________.

A. at the money

B. in the money

C. out of the money

D. knocked in

32. You invest in the stock of Rayleigh Corp. and write a call option on Rayleigh Corp. This strategy is called a _________.

A. covered call

B. long straddle

C. naked call

D. money spread

33. You buy a call option on Summit Corp. with an exercise price of $40 and an expiration date in September, and you write a call option on Summit Corp. with an exercise price of $40 and an expiration date in October. This strategy is called a _________.

A. time spread

B. long straddle

C. short straddle

D. money spread

34. A European call option gives the buyer the right to _________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at the exercise price only at the expiration date

C. sell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at the exercise price only at the expiration date

35. You invest in the stock of Valleyview Corp. and purchase a put option on Valleyview Corp. This strategy is called a _________.

A. long straddle

B. naked put

C. protective put

D. short stroll

36. The value of a listed call option on a stock is lower when:

I. The exercise price is higher.
II. The contract approaches maturity.
III. The stock decreases in value.
IV. A stock split occurs.

A. II, III, and IV only

B. I, III, and IV only

C. I, II, and III only

D. I, II, III, and IV

37. The Option Clearing Corporation is owned by _________.

A. the exchanges on which stock options are traded

B. the Federal Deposit Insurance Corporation

C. the Federal Reserve System

D. major U.S. banks

38. The value of a listed put option on a stock is lower when:

I. The exercise price is higher.
II. The contract approaches maturity.
III. The stock decreases in value.
IV. A stock split occurs.

A. II only

B. II and IV only

C. I, II, and III only

D. I, II, III, and IV

39. The maximum loss a buyer of a stock call option can suffer is the _________.

A. call premium

B. stock price

C. stock price minus the value of the call

D. strike price minus the stock price

40. Which one of the statements about margin requirements on option positions is not correct?

A. The margin required will be higher if the option is in the money.

B. If the required margin exceeds the posted margin, the option writer will receive a margin call.

C. A buyer of a put or call option does not have to post margin.

D. Even if the writer of a call option owns the stock, the writer will have to meet the margin requirement in cash.

41. A European put option gives its holder the right to _________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at the exercise price only at the expiration date

C. sell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at the exercise price only at the expiration date

42. The potential loss for a writer of a naked call option on a stock is _________.

A. equal to the call premium

B. larger the lower the stock price

C. limited

D. unlimited

43. A writer of a call option will want the value of the underlying asset to __________, and a buyer of a put option will want the value of the underlying asset to _________.

A. decrease; decrease

B. decrease; increase

C. increase; decrease

D. increase; increase

44. Buyers of listed options __________ required to post margins, and writers of naked listed options __________ required to post margins.

A. are; are not

B. are; are

C. are not; are

D. are not; are not

45. An option with a payoff that depends on the average price of the underlying asset during at least some portion of the life of the option is called ______ option.

A. an American

B. a European

C. an Asian

D. an Australian

46. Which of the following expressions represents the value of a call option to its holder on the expiration date?

A. ST – X if ST > X, 0 if ST ≤ X

B. – (ST – X) if ST > X, 0 if ST ≤ X

C. 0 if ST ≥ X, X – ST if ST < X

D. 0 if ST ≥ X, – (X – ST) if ST < X

47. A “bet” option is also called a ____ option.

A. barrier

B. lookback

C. digital

D. foreign exchange

48. Which one of the following is the ticker symbol for the CBOE option contract on the S&P 100 Index?

A. SPX

B. DJX

C. CME

D. OEX

49. The May 17, 2012, price quotation for a Boeing call option with a strike price of $50 due to expire in November is $20.80, while the stock price of Boeing is $69.80. The premium on one Boeing November 50 call contract is _________.

A. $1,980

B. $4,900

C. $5,000

D. $2,080

50. You purchase one IBM March 120 put contract for a put premium of $10. The maximum profit that you could gain from this strategy is _________.

A. $120

B. $1,000

C. $11,000

D. $12,000

51. You buy one Hewlett Packard August 50 call contract and one Hewlett Packard August 50 put contract. The call premium is $1.25, and the put premium is $4.50. Your highest potential loss from this position is _________.

A. $125

B. $450

C. $575

D. unlimited

52. You sell one Hewlett Packard August 50 call contract and sell one Hewlett Packard August 50 put contract. The call premium is $1.25 and the put premium is $4.50. Your strategy will pay off only if the stock price is __________ in August.

A. either lower than $44.25 or higher than $55.75

B. between $44.25 and $55.75

C. higher than $55.75

D. lower than $44.25

53. Suppose you purchase one Texas Instruments August 75 call contract quoted at $8.50 and write one Texas Instruments August 80 call contract quoted at $6. If, at expiration, the price of a share of Texas Instruments stock is $79, your profit would be _________.

A. $150

B. $400

C. $600

D. $1,850

54. __________ is the most risky transaction to undertake in the stock-index option markets if the stock market is expected to fall substantially after the transaction is completed.

A. Writing an uncovered call option

B. Writing an uncovered put option

C. Buying a call option

D. Buying a put option

55. Which one of the following is a correct statement?

A. Exercise of warrants results in more outstanding shares of stock, while exercise of listed call options does not.

B. A convertible bond consists of a straight bond plus a specified number of detachable warrants.

C. Call options always have an initial maturity greater than 1 year, while warrants have an initial maturity less than 1 year.

D. Call options may be convertible into the stock, while warrants are not convertible into the stock.

56. A put on Sanders stock with a strike price of $35 is priced at $2 per share, while a call with a strike price of $35 is priced at $3.50. The maximum per-share loss to the writer of an uncovered put is __________, and the maximum per-share gain to the writer of an uncovered call is _________.

A. $33; $3.50

B. $33; $31.50

C. $35; $3.50

D. $35; $35

57. You are cautiously bullish on the common stock of the Wildwood Corporation over the next several months. The current price of the stock is $50 per share. You want to establish a bullish money spread to help limit the cost of your option position. You find the following option quotes:

To establish a bull money spread with calls, you would _______________.

A. buy the 55 call and sell the 45 call

B. buy the 45 call and buy the 55 call

C. buy the 45 call and sell the 55 call

D. sell the 45 call and sell the 55 call

58. You are cautiously bullish on the common stock of the Wildwood Corporation over the next several months. The current price of the stock is $50 per share. You want to establish a bullish money spread to help limit the cost of your option position. You find the following option quotes:

Ignoring commissions, the cost to establish the bull money spread with calls would be _______.

A. $1,050

B. $650

C. $400

D. $400 income rather than cost

59. You are cautiously bullish on the common stock of the Wildwood Corporation over the next several months. The current price of the stock is $50 per share. You want to establish a bullish money spread to help limit the cost of your option position. You find the following option quotes:

If in June the stock price is $53, your net profit on the bull money spread (buy the 45 call and sell the 55 call) would be ________.

A. $300

B. -$400

C. $150

D. $50

60. You are cautiously bullish on the common stock of the Wildwood Corporation over the next several months. The current price of the stock is $50 per share. You want to establish a bullish money spread to help limit the cost of your option position. You find the following option quotes:

To establish a bull money spread with puts, you would _______________.

A. sell the 55 put and buy the 45 put

B. buy the 45 put and buy the 55 put

C. buy the 55 put and sell the 45 put

D. sell the 45 put and sell the 55 put

61. You are cautiously bullish on the common stock of the Wildwood Corporation over the next several months. The current price of the stock is $50 per share. You want to establish a bullish money spread to help limit the cost of your option position. You find the following option quotes:

Suppose you establish a bullish money spread with the puts. In June the stock’s price turns out to be $52. Ignoring commissions, the net profit on your position is _______________.

A. $500

B. $700

C. $200

D. $250

62. The common stock of the Avalon Corporation has been trading in a narrow range around $40 per share for months, and you believe it is going to stay in that range for the next 3 months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with the same expiration date and exercise price sells for $4.

What would be a simple options strategy using a put and a call to exploit your conviction about the stock price’s future movement?

A. Sell a call.

B. Purchase a put.

C. Sell a straddle.

D. Buy a straddle.

63. The common stock of the Avalon Corporation has been trading in a narrow range around $40 per share for months, and you believe it is going to stay in that range for the next 3 months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with the same expiration date and exercise price sells for $4.

Selling a straddle would generate total premium income of _____.

A. $300

B. $400

C. $500

D. $700

64. The common stock of the Avalon Corporation has been trading in a narrow range around $40 per share for months, and you believe it is going to stay in that range for the next 3 months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with the same expiration date and exercise price sells for $4.

Suppose you write a strap and the stock price winds up to be $42 at contract expiration. What was your net profit on the strap?

A. $200

B. $300

C. $700

D. $400

65. The common stock of the Avalon Corporation has been trading in a narrow range around $40 per share for months, and you believe it is going to stay in that range for the next 3 months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with the same expiration date and exercise price sells for $4.

How can you create a position involving a put, a call, and riskless lending that would have the same payoff structure as the stock at expiration?

A. Buy the call, sell the put; lend the present value of $40.

B. Sell the call, buy the put; lend the present value of $40.

C. Buy the call, sell the put; borrow the present value of $40.

D. Sell the call, buy the put; borrow the present value of $40.

66. A stock is trading at $50. You believe there is a 60% chance the price of the stock will increase by 10% over the next 3 months. You believe there is a 30% chance the stock will drop by 5%, and you think there is only a 10% chance of a major drop in price of 20%. At-the-money 3-month puts are available at a cost of $650 per contract. What is the expected dollar profit for a writer of a naked put at the end of 3 months?

A. $300

B. $200

C. $475

D. $0

67. A covered call strategy benefits from what environment?

A. Falling interest rates

B. Price stability

C. Price volatility

D. Unexpected events

68. You sell one IBM July 90 call contract for a premium of $4 and two puts for a premium of $3 each. You hold the position until the expiration date, when IBM stock sells for $95 per share. You will realize a ______ on this strip.

A. $300 profit

B. $100 loss

C. $500 profit

D. $200 profit

69. Which strategy benefits from upside price movement and has some protection should the price of the security fall?

A. Bull spread

B. Long put

C. Short call

D. Straddle

70. What combination of puts and calls can simulate a long stock investment?

A. Long call and short put

B. Long call and long put

C. Short call and short put

D. Short call and long put

71. An investor purchases a long call at a price of $2.50. The expiration price is $35. If the current stock price is $35.10, what is the break-even point for the investor?

A. $32.50

B. $35

C. $37.50

D. $37.60

72. An investor is bearish on a particular stock and decided to buy a put with a strike price of $25. Ignoring commissions, if the option was purchased for a price of $.85, what is the break-even point for the investor?

A. $24.15

B. $25

C. $25.87

D. $27.86

73. Which of the following strategies makes a profit if the stock price stays stable?

A. Long call and short put

B. Long call and long put

C. Short call and short put

D. Short call and long put

74. Which of the following strategies makes a profit when the stock price declines and loses money when the stock price increases?

A. Long call and short put

B. Long call and long put

C. Short call and short put

D. Short call and long put

75. If you combine a long stock position with selling an at-the-money call option, the resulting net payoff profile will resemble the payoff profile of a _______.

A. long call

B. short call

C. short put

D. long put

76. What strategy could be considered insurance for an investment in a portfolio of stocks?

A. Covered call

B. Protective put

C. Short put

D. Straddle

77. What strategy is designed to ensure a value within the bounds of two different stock prices?

A. Collar

B. Covered Call

C. Protective put

D. Straddle

78. You are convinced that a stock’s price will move by at least 15% over the next 3 months. You are not sure which way the price will move, but you believe that the results of a patent hearing are definitely going to have a major effect on the stock price. You are somewhat more bullish than bearish however. Which one of the following options strategies best fits this scenario?

A. Buy a strip.

B. Buy a strap.

C. Buy a straddle.

D. Write a straddle.

79. When issued, most convertible bonds are issued _____________.

A. deep in the money

B. deep out of the money

C. slightly out of the money

D. slightly in the money

80. A convertible bond is deep in the money. This means the bond price will closely track the __________.

A. straight debt value of the bond

B. conversion value of the bond

C. straight debt value of the bond minus the conversion value

D. straight debt value of the bond plus the conversion value

81. Warrants differ from listed options in that:

I. Exercise of warrants results in dilution of a firm’s earnings per share.
II. When warrants are exercised, new shares of stock must be created.
III. Warrant exercise results in cash flows to the firm, whereas exercise of listed options does not.

A. I only

B. I and II only

C. II and III only

D. I, II, and III

82. Suppose you find two bonds identical in all respects except that bond A is convertible to common stock and bond B is not. Bond A is priced at $1,245, and bond B is priced at $1,120. Bond A has a promised yield to maturity of 5.6%, and bond B has a promised yield to maturity of 6.7%. The stock of bond A is trading at $49.80 per share. Which of the following statements is (are) correct?

I. The value of the conversion option for bond A is $125.
II. The lower promised yield to maturity of bond A indicates that the bond is priced according to its straight debt value rather than its conversion value.
III. If bond A can be converted into 25 shares of stock, the investor would break even at the current prices.

A. II only

B. I and III only

C. III only

D. I, II, and III

83. You find digital option quotes on jobless claims. You can buy a call option with a strike price of 300,000 jobless claims. This option pays $100 if actual claims exceed the strike price and pays zero otherwise. The option costs $68. A second digital call with a strike price of 305,000 jobless claims is available at a cost of $53. Suppose you buy the option with the 300,000 strike and sell the option with the 305,000 strike and jobless claims actually wind up at 303,000. Your net profit on the position is ______.

A. -$15

B. $200

C. $85

D. $185

84. Bill Jones inherited 5,000 shares of stock priced at $45 per share. He does not want to sell the stock this year due to tax reasons, but he is concerned that the stock will drop in value before year-end. Bill wants to use a collar to ensure that he minimizes his risk and doesn’t incur too much cost in deferring the gain. January call options with a strike of $50 are quoted at a cost of $2, and January puts with a $40 exercise price are quoted at a cost of $3. If Bill establishes the collar and the stock price winds up at $35 in January, Bill’s net position value including the option profit or loss and the stock is _________.

A. $195,000

B. $220,000

C. $175,000

D. $215,000

85. You own a stock portfolio worth $50,000. You are worried that stock prices may take a dip before you are ready to sell, so you are considering purchasing either at-the-money or out-of-the-money puts. If you decide to purchase the out-of-the-money puts, your maximum loss is __________ than if you buy at-the-money puts and your maximum gain is __________.

A. greater; lower

B. greater; greater

C. lower; greater

D. lower; lower

86. You purchase one IBM July 90 call contract for a premium of $4. The stock has a 2-for-1 split prior to the expiration date. You hold the option until the expiration date, when IBM stock sells for $48 per share. You will realize a ______ on the investment.

A. $300 profit

B. $100 loss

C. $400 loss

D. $200 profit

87. You own $75,000 worth of stock, and you are worried the price may fall by year-end in 6 months. You are considering using either puts or calls to hedge this position. Given this, which of the following statements is (are) correct?

I. One way to hedge your position would be to buy puts.
II. One way to hedge your position would be to write calls.
III. If major stock price declines are likely, hedging with puts is probably better than hedging with short calls.

A. I only

B. II only

C. I and III only

D. I, II, and III

17
Student: ___________________________________________________________________________
1. Today’s futures markets are dominated by trading in _______ contracts.

A. metals

B. agriculture

C. financial

D. commodity

2. A person with a long position in a commodity futures contract wants the price of the commodity to ______.

A. decrease substantially

B. increase substantially

C. remain unchanged

D. increase or decrease substantially

3. If an asset price declines, the investor with a _______ is exposed to the largest potential loss.

A. long call option

B. long put option

C. long futures contract

D. short futures contract

4. The clearing corporation has a net position equal to ______.

A. the open interest

B. the open interest times 2

C. the open interest divided by 2

D. zero

5. The S&P 500 Index futures contract is an example of a(n) ______ delivery contract. The pork bellies contract is an example of a(n) ______ delivery contract.

A. cash; cash

B. cash; actual

C. actual; cash

D. actual; actual

6. Which one of the following contracts requires no cash to change hands when initiated?

A. Listed put option

B. Short futures contract

C. Forward contract

D. Listed call option

7. Synthetic stock positions are commonly used by ______ because of their ______.

A. market timers; lower transaction cost

B. banks; lower risk

C. wealthy investors; tax treatment

D. money market funds; limited exposure

8. _____________ are likely to close their positions before the expiration date, while ____________ are likely to make or take delivery.

A. Investors; regulators

B. Hedgers; speculators

C. Speculators; hedgers

D. Regulators; investors

9. Futures contracts have many advantages over forward contracts except that _________.

A. futures positions are easier to trade

B. futures contracts are tailored to the specific needs of the investor

C. futures trading preserves the anonymity of the participants

D. counterparty credit risk is not a concern on futures

10. An investor who is hedging a corporate bond portfolio using a T-bond futures contract is said to have _______.

A. an arbitrage

B. a cross-hedge

C. an over hedge

D. a spread hedge

11. The open interest on silver futures at a particular time is the number of __________.

A. all outstanding silver futures contracts

B. long and short silver futures positions counted separately on a particular trading day

C. silver futures contracts traded during the day

D. silver futures contracts traded the previous day

12. An investor who goes short in a futures contract will _____ any increase in value of the underlying asset and will _____ any decrease in value in the underlying asset.

A. pay; pay

B. pay; receive

C. receive; pay

D. receive; receive

13. An investor who goes long in a futures contract will _____ any increase in value of the underlying asset and will _____ any decrease in value in the underlying asset.

A. pay; pay

B. pay; receive

C. receive; pay

D. receive; receive

14. The advantage that standardization of futures contracts brings is that _____ is improved because ____________________.

A. liquidity; all traders must trade a small set of identical contracts

B. credit risk; all traders understand the risk of the contracts

C. pricing; convergence is more likely to take place with fewer contracts

D. trading cost; trading volume is reduced

15. The fact that the exchange is the counterparty to every futures contract issued is important because it eliminates _________ risk.

A. market

B. credit

C. interest rate

D. basis

16. In the futures market the short position’s loss is ___________ the long position’s gain.

A. greater than

B. less than

C. equal to

D. sometimes less than and sometimes greater than

17. A wheat farmer should __________ in order to reduce his exposure to risk associated with fluctuations in wheat prices.

A. sell wheat futures

B. buy wheat futures

C. buy a contract for delivery of wheat now and sell a contract for delivery of wheat at harvest time

D. sell wheat futures if the basis is currently positive and buy wheat futures if the basis is currently negative

18. Which of the following provides the profit to a long position at contract maturity?

A. Original futures price – Spot price at maturity

B. Spot price at maturity – Original futures price

C. Zero

D. Basis

19. You take a long position in a futures contract of one maturity and a short position in a contract of a different maturity, both on the same commodity. This is called a __________.

A. cross-hedge

B. reversing trade

C. spread position

D. straddle

20. Interest rate futures contracts exist for all of the following except __________.

A. federal funds

B. Eurodollars

C. banker’s acceptances

D. repurchase agreements

21. Initial margin is usually set in the region of ________ of the total value of a futures contract.

A. 5%-15%

B. 10%-20%

C. 15%-25%

D. 20%-30%

22. Margin must be posted by ________.

A. buyers of futures contracts only

B. sellers of futures contracts only

C. both buyers and sellers of futures contracts

D. speculators only

23. The daily settlement of obligations on futures positions is called _____________.

A. a margin call

B. marking to market

C. a variation margin check

D. the initial margin requirement

24. Which of the following provides the profit to a short position at contract maturity?

A. Original futures price – Spot price at maturity

B. Spot price at maturity – Original futures price

C. Zero

D. Basis

25. Margin requirements for futures contracts can be met by ______________.

A. cash only

B. cash or highly marketable securities such as Treasury bills

C. cash or any marketable securities

D. cash or warehouse receipts for an equivalent quantity of the underlying commodity

26. An established value below which a trader’s margin may not fall is called the ________.

A. daily limit

B. daily margin

C. maintenance margin

D. convergence limit

27. Which one of the following is a true statement?

A. A margin deposit can be met only by cash.

B. All futures contracts require the same margin deposit.

C. The maintenance margin is the amount of money you post with your broker when you buy or sell a futures contract.

D. The maintenance margin is the value of the margin account below which the holder of a futures contract receives a margin call.

28. At maturity of a futures contract, the spot price and futures price must be approximately the same because of __________.

A. marking to market

B. the convergence property

C. the open interest

D. the triple witching hour

29. A futures contract __________.

A. is a contract to be signed in the future by the buyer and the seller of a commodity

B. is an agreement to buy or sell a specified amount of an asset at a predetermined price on the expiration date of the contract

C. is an agreement to buy or sell a specified amount of an asset at whatever the spot price happens to be on the expiration date of the contract

D. gives the buyer the right, but not the obligation, to buy an asset some time in the future

30. Which one of the following exploits differences between actual future prices and their theoretically correct parity values?

A. Index arbitrage

B. Marking to market

C. Reversing trades

D. Settlement transactions

31. Which one of the following refers to the daily settlement of obligations on future positions?

A. Marking to market

B. The convergence property

C. The open interest

D. The triple witching hour

32. The most actively traded interest rate futures contract is for ___________.

A. LIBOR

B. Treasury bills

C. Eurodollars

D. Treasury bonds

33. The CME weather futures contract is an example of ______________.

A. a cash-settled contract

B. an agricultural contract

C. a financial future

D. a commodity future

34. Single stock futures, as opposed to stock index futures, are _______________.

A. not yet being offered by any exchanges

B. offered overseas but not in the United States

C. currently trading on One Chicago, a joint venture of several exchanges

D. scheduled to begin trading in 2015 on several exchanges

35. You are currently long in a futures contract. You instruct a broker to enter the short side of a futures contract to close your position. This is called __________.

A. a cross-hedge

B. a reversing trade

C. a speculation

D. marking to market

36. A company that mines bauxite, an aluminum ore, decides to short aluminum futures. This is an example of __________ to limit its risk.

A. cross-hedging

B. long hedging

C. spreading

D. speculating

37. Futures markets are regulated by the __________.

A. CFA Institute

B. CFTC

C. CIA

D. SEC

38. A hog farmer decides to sell hog futures. This is an example of __________ to limit risk.

A. cross-hedging

B. short hedging

C. spreading

D. speculating

39. On May 21, 2012, you could have purchased a futures contract from Intrade for a price of $5.70 that would pay you $10 if Barack Obama won the 2012 presidential election. This tells you _____.

A. that the market believed that Obama had a 57% chance of winning

B. that the market believed that Obama would not win the election

C. nothing about the market’s belief concerning the odds of Obama winning

D. that the market believed Obama’s chances of winning were about 43%

40. An investor would want to __________ to exploit an expected fall in interest rates.

A. sell S&P 500 Index futures

B. sell Treasury-bond futures

C. buy Treasury-bond futures

D. buy wheat futures

41. Forward contracts _________ traded on an organized exchange, and futures contracts __________ traded on an organized exchange.

A. are; are

B. are; are not

C. are not; are

D. are not; are not

42. If the S&P 500 Index futures contract is overpriced relative to the spot S&P 500 Index, you should __________.

A. buy all the stocks in the S&P 500 and write put options on the S&P 500 Index

B. sell all the stocks in the S&P 500 and buy call options on S&P 500 Index

C. sell S&P 500 Index futures and buy all the stocks in the S&P 500

D. sell short all the stocks in the S&P 500 and buy S&P 500 Index futures

43. A long hedge is a simultaneous __________ position in the spot market and a __________ position in the futures market.

A. long; long

B. long; short

C. short; long

D. short; short

44. Investors who take short positions in futures contract agree to ___________ delivery of the commodity on the delivery date, and those who take long positions agree to __________ delivery of the commodity.

A. make; make

B. make; take

C. take; make

D. take; take

45. An investor would want to __________ to hedge a long position in Treasury bonds.

A. buy interest rate futures

B. buy Treasury bonds in the spot market

C. sell interest rate futures

D. sell S&P 500 futures

46. Futures contracts are said to exhibit the property of convergence because _______________.

A. the profits from long positions and short positions must ultimately be equal

B. the profits from long positions and short positions must ultimately net to zero

C. price discrepancies would open arbitrage opportunities for investors who spot them

D. the futures price and spot price of any asset must ultimately net to zero

47. In the context of a futures contract, the basis is defined as ______________.

A. the futures price minus the spot price

B. the spot price minus the futures price

C. the futures price minus the initial margin

D. the profit on the futures contract

48. The __________ is among the world’s largest derivatives exchanges and operates a fully electronic trading and clearing platform.

A. CBOE

B. CBOT

C. CME

D. Eurex

49. Violation of the spot-futures parity relationship results in _______________.

A. fines and other penalties imposed by the SEC

B. arbitrage opportunities for investors who spot them

C. suspension of delivery privileges

D. suspension of trading

50. When dividend-paying assets are involved, the spot-futures parity relationship can be stated as _________________.

A. F1 = S0(1 + rf)

B. F0 = S0(1 + rf – d)T

C. F0 = S0(1 + rf + d)T

D. F0 = S0(1 + rf)T

51. An investor establishes a long position in a futures contract now (time 0) and holds the position until maturity (time T). The sum of all daily settlements will be __________.

A. F0 – FT

B. F0 – S0

C. FT – F0

D. FT – S0

52. A short hedge is a simultaneous __________ position in the spot market and a __________ position in the futures market.

A. long; long

B. long; short

C. short; long

D. short; short

53. Approximately __________ of futures contracts result in actual delivery.

A. 0%

B. less than 1% to 3%

C. less than 5% to 15%

D. less than 60% to 80%

54. A long hedger will __________ from an increase in the basis; a short hedger will __________.

A. be hurt; be hurt

B. be hurt; profit

C. profit; be hurt

D. profit; profit

55. At year-end, taxes on a futures position _______________.

A. must be paid if the position has been closed out

B. must be paid if the position has not been closed out

C. must be paid regardless of whether the position has been closed out or not

D. need not be paid if the position supports a hedge

56. A speculator will often prefer to buy a futures contract rather than the underlying asset because:

I. Gains in futures contracts can be larger due to leverage.
II. Transaction costs in futures are typically lower than those in spot markets.
III. Futures markets are often more liquid than the markets of the underlying commodities.

A. I and II only

B. II and III only

C. I and III only

D. I, II, and III

57. On January 1, you sold one April S&P 500 Index futures contract at a futures price of 1,300. If the April futures price is 1,250 on February 1, your profit would be __________ if you close your position. (The contract multiplier is 250.)

A. -$12,500

B. -$15,000

C. $15,000

D. $12,500

58. The current level of the S&P 500 is 1,250. The dividend yield on the S&P 500 is 3%. The risk-free interest rate is 6%. The futures price quote for a contract on the S&P 500 due to expire 6 months from now should be __________.

A. 1,274.33

B. 1,286.95

C. 1,268.61

D. 1,291.29

59. The spot price for gold is $1,550 per ounce. The dividend yield on the S&P 500 is 2.5%. The risk-free interest rate is 3.5%. The futures price for gold for a 6-month contract on gold should be __________.

A. $1,504.99

B. $1,569.08

C. $1,554.04

D. $1,557.73

60. If you expect a stock market downturn, one potential defensive strategy would be to __________.

A. buy stock-index futures

B. sell stock-index futures

C. buy stock-index options

D. sell foreign exchange futures

61. At contract maturity the basis should equal ___________.

A. 1

B. 0

C. the risk-free interest rate

D. -1

62. You believe that the spread between the September T-bond contract and the June T-bond futures contract is too large and will soon correct. This market exhibits positive cost of carry for all contracts. To take advantage of this, you should ______________.

A. buy the September contract and sell the June contract

B. sell the September contract and buy the June contract

C. sell the September contract and sell the June contract

D. buy the September contract and buy the June contract

63. A 1-year gold futures contract is selling for $1,645. Spot gold prices are $1,592 and the 1-year risk-free rate is 3%.

The arbitrage profit implied by these prices is _____________.

A. $3.27

B. $4.39

C. $5.24

D. $6.72

64. A 1-year gold futures contract is selling for $1,645. Spot gold prices are $1,592 and the 1-year risk-free rate is 3%.

Based on the above data, which of the following set of transactions will yield positive riskless arbitrage profits?

A. Buy gold in the spot with borrowed money, and sell the futures contract.

B. Buy the futures contract, and sell the gold spot and invest the money earned.

C. Buy gold spot with borrowed money, and buy the futures contract.

D. Buy the futures contract, and buy the gold spot using borrowed money.

65. A hypothetical futures contract on a nondividend-paying stock with a current spot price of $100 has a maturity of 1 year. If the T-bill rate is 5%, what should the futures price be?

A. $95.24

B. $100

C. $105

D. $107

66. A hypothetical futures contract on a nondividend-paying stock with a current spot price of $100 has a maturity of 4 years. If the T-bill rate is 7%, what should the futures price be?

A. $76.29

B. $93.46

C. $107

D. $131.08

67. On Monday morning you sell one June T-bond futures contract at 97:27, that is, for $97,843.75. The contract’s face value is $100,000. The initial margin requirement is $2,700, and the maintenance margin requirement is $2,000 per contract. Use the following price data to answer the following questions.

After Monday’s close the balance on your margin account will be ________.

A. $2,700

B. $2,000

C. $3,137.50

D. $2,262.50

68. On Monday morning you sell one June T-bond futures contract at 97:27, that is, for $97,843.75. The contract’s face value is $100,000. The initial margin requirement is $2,700, and the maintenance margin requirement is $2,000 per contract. Use the following price data to answer the following questions.

At the close of day on Tuesday your cumulative rate of return on your investment is _____.

A. 16.2%

B. -5.8%

C. -.16%

D. -2.2%

69. On Monday morning you sell one June T-bond futures contract at 97:27, that is, for $97,843.75. The contract’s face value is $100,000. The initial margin requirement is $2,700, and the maintenance margin requirement is $2,000 per contract. Use the following price data to answer the following questions.

On which of the given days do you get a margin call?

A. Monday

B. Tuesday

C. Wednesday

D. None of these options

70. On Monday morning you sell one June T-bond futures contract at 97:27, that is, for $97,843.75. The contract’s face value is $100,000. The initial margin requirement is $2,700, and the maintenance margin requirement is $2,000 per contract. Use the following price data to answer the following questions.

The cumulative rate of return on your investment after Wednesday is a ____.

A. 79.9% loss

B. 2.6% loss

C. 33% gain

D. 53.9% loss

71. The volume of interest rate swaps increased from almost zero in 1980 to over __________ today.

A. $40 million

B. $400 million

C. $400 billion

D. $400 trillion

72. If the risk-free rate is greater than the dividend yield, then we know that _______________.

A. the futures price will be higher as contract maturity increases

B. F0 < S0 C. FT > ST

D. arbitrage profits are possible

73. Sahali Trading Company has issued $100 million worth of long-term bonds at a fixed rate of 9%. Sahali Trading Company then enters into an interest rate swap where it will pay LIBOR and receive a fixed 8% on a notional principal of $100 million. After all these transactions are considered, Sahali’s cost of funds is __________.

A. 17%

B. LIBOR

C. LIBOR + 1%

D. LIBOR – 1%

74. Interest rate swaps involve the exchange of ________________.

A. actual fixed-rate bonds for actual floating-rate bonds

B. actual floating-rate bonds for actual fixed-rate bonds

C. net interest payments and an actual principal swap

D. net interest payments based on notional principal, but no exchange of principal

75. From the perspective of determining profit and loss, the long futures position most closely resembles a levered investment in a ____________.

A. long call

B. short call

C. short stock position

D. long stock position

76. The _________ contract dominates trading in stock-index futures.

A. S&P 500

B. DJIA

C. Nasdaq 100

D. Russell 2000

77. The ________ and the _______ have the lowest correlations with the large-cap indexes.

A. Nasdaq Composite; Russell 2000

B. NYSE; DJIA

C. S&P 500; DJIA

D. Russell 2000; S&P 500

78. The use of leverage is practiced in the futures markets due to the existence of _________.

A. banks

B. brokers

C. clearinghouses

D. margin

79. You purchase an interest rate futures contract that has an initial margin requirement of 15% and a futures price of $115,098. The contract has a $100,000 underlying par value bond. If the futures price falls to $108,000, you will experience a ______ loss on your money invested.

A. 31%

B. 41%

C. 52%

D. 64%

80. You own a $15 million bond portfolio with a modified duration of 11 years. Interest rates are expected to increase by 5 basis points, or .05%. What is the price value of a basis point?

A. $10,400

B. $14,300

C. $16,500

D. $21,300

81. The price of a corn futures contract is $2.65 per bushel when the contract is issued, and the commodity spot price is $2.55. When the contract expires, the two prices are identical. What principle is represented by this price behavior?

A. Convergence

B. Margin

C. Basis

D. Volatility

82. A corporation will be issuing bonds in 6 months, and the treasurer is concerned about unfavorable interest rate moves in the interim. The best way for her to hedge the risk is to _________________.

A. buy T-bond futures

B. sell T-bond futures

C. buy stock-index futures

D. sell stock-index futures

83. A farmer sells futures contracts at a price of $2.75 per bushel. The spot price of corn is $2.55 at contract expiration. The farmer harvested 12,500 bushels of corn and sold futures contracts on 10,000 bushels of corn.

What are the farmer’s proceeds from the sale of corn?

A. $27,500

B. $31,875

C. $33,875

D. $35,950

84. A farmer sells futures contracts at a price of $2.75 per bushel. The spot price of corn is $2.55 at contract expiration. The farmer harvested 12,500 bushels of corn and sold futures contracts on 10,000 bushels of corn.

Ignoring the transaction costs, how much did the farmer improve his cash flow by hedging sales with the futures contracts?

A. $0

B. $2,000

C. $31,875

D. $33,875

85. A bank has made long-term fixed-rate mortgages and has financed them with short-term deposits. To hedge out its interest rate risk, the bank could ________.

A. sell T-bond futures

B. buy T-bond futures

C. buy stock-index futures

D. sell stock-index futures

86. A market timer now believes that the economy will soften over the rest of the year as the housing market slump continues, and she also believes that foreign investors will stop buying U.S. fixed-income securities in the large quantities that they have in the past. One way the timer could take advantage of this forecast is to ________________.

A. buy T-bond futures and sell stock-index futures

B. sell T-bond futures and buy stock-index futures

C. buy stock-index futures and buy T-bond futures

D. sell stock-index futures and sell T-bond futures

87. The Student Loan Marketing Association (SLMA) has short-term student loans funded by long-term debt. To hedge out this interest rate risk, SLMA could:

I. Engage in a swap to pay fixed and receive variable interest payments
II. Engage in a swap to pay variable and receive fixed interest payments
III. Buy T-bond futures
IV. Sell T-bond futures

A. I and II only

B. I and IV only

C. II and III only

D. II and IV only

18
Student: ___________________________________________________________________________
1. A mutual fund with a beta of 1.1 has outperformed the S&P 500 over the last 20 years. We know that this mutual fund manager _____.

A. must have had superior stock selection ability.

B. must have had superior asset allocation ability.

C. must have had superior timing ability.

D. may or may not have outperformed the S&P 500 on a risk-adjusted basis.

2. The comparison universe is __________.

A. the bogey portfolio

B. a set of mutual funds with similar risk characteristics to your mutual fund

C. the set of all mutual funds in the United States

D. the set of all mutual funds in the world

3. Which one of the following performance measures is the Sharpe ratio?

A. Average excess return to beta ratio

B. Average excess return to standard deviation ratio

C. Alpha to standard deviation of residuals ratio

D. Average return minus required return

4. The M2 measure is a variant of ________________.

A. the Sharpe measure

B. the Treynor measure

C. Jensen’s alpha

D. the appraisal ratio

5. A managed portfolio has a standard deviation equal to 22% and a beta of .9 when the market portfolio’s standard deviation is 26%. The adjusted portfolio P* needed to calculate the M2 measure will have ________ invested in the managed portfolio and the rest in T-bills.

A. 84.6%

B. 118%

C. 18%

D. 15.4%

6. Your return will generally be higher using the __________ if you time your transactions poorly, and your return will generally be higher using the __________ if you time your transactions well.

A. dollar-weighted return method; dollar-weighted return method

B. dollar-weighted return method; time-weighted return method

C. time-weighted return method; dollar-weighted return method

D. time-weighted return method; time-weighted return method

7. Consider the Sharpe and Treynor performance measures. When a pension fund is large and well diversified in total and it has many managers, the __________ measure is better for evaluating individual managers while the __________ measure is better for evaluating the manager of a small fund with only one manager responsible for all investments, which may not be fully diversified.

A. Sharpe; Sharpe

B. Sharpe; Treynor

C. Treynor; Sharpe

D. Treynor; Treynor

8. Consider the theory of active portfolio management. Stocks A and B have the same beta and the same positive alpha. Stock A has higher nonsystematic risk than stock B. You should want __________ in your active portfolio.

A. equal proportions of stocks A and B

B. more of stock A than stock B

C. more of stock B than stock A

D. The answer cannot be determined from the information given.

9. Suppose that over the same time period two portfolios have the same average return and the same standard deviation of return, but portfolio A has a higher beta than portfolio B. According to the Sharpe ratio, the performance of portfolio A __________.

A. is better than the performance of portfolio B

B. is the same as the performance of portfolio B

C. is poorer than the performance of portfolio B

D. cannot be measured since there is no data on the alpha of the portfolio

10. Which model is preferred by academics, and is gaining in popularity with practitioners, when evaluating investment performance?

A. The Treynor-Black model

B. The single-index model

C. The Fama-French three-factor model

D. The Sharpe model

11. The risk-free rate, average returns, standard deviations, and betas for three funds and the S&P 500 are given below.

What is the Treynor measure for portfolio A?

A. 12.38%

B. 2.38%

C. .91%

D. 3.64%

12. The risk-free rate, average returns, standard deviations, and betas for three funds and the S&P 500 are given below.

What is the M2 measure for portfolio B?

A. .43%

B. 1.25%

C. 1.77%

D. 1.43%

13. The risk-free rate, average returns, standard deviations, and betas for three funds and the S&P 500 are given below.

If these portfolios are subcomponents that make up part of a well-diversified portfolio, then portfolio ______ is preferred.

A. A

B. B

C. C

D. S&P 500

14. The risk-free rate, average returns, standard deviations, and betas for three funds and the S&P 500 are given below.

Based on the M2 measure, portfolio C has a superior return of _____ as compared to the S&P 500.

A. -1.33%

B. 1.43%

C. 2%

D. 0%

15. Which one of the following is largely based on forecasts of macroeconomic factors?

A. Security selection

B. Passive investing

C. Market efficiency

D. Market timing

16. Based on the example used in the book, a perfect market timer would have made _______ by 2008 on a $1 investment made in 1926.

A. $100

B. $1,626

C. $1.5 million

D. $36.7 billion

17. The average returns, standard deviations, and betas for three funds are given below along with data for the S&P 500 Index. The risk-free return during the sample period is 6%.

You want to evaluate the three mutual funds using the Sharpe ratio for performance evaluation. The fund with the highest Sharpe ratio of performance is __________.

A. fund A

B. fund B

C. fund C

D. The answer cannot be determined from the information given.

18. The average returns, standard deviations, and betas for three funds are given below along with data for the S&P 500 Index. The risk-free return during the sample period is 6%.

You want to evaluate the three mutual funds using the Treynor measure for performance evaluation. The fund with the highest Treynor measure of performance is __________.

A. fund A

B. fund B

C. fund C

D. The answer cannot be determined from the information given.

19. The average returns, standard deviations, and betas for three funds are given below along with data for the S&P 500 Index. The risk-free return during the sample period is 6%.

You want to evaluate the three mutual funds using the Jensen measure for performance evaluation. The fund with the highest Jensen measure of performance is __________.

A. fund A

B. fund B

C. fund C

D. S&P 500

20. In a particular year, Salmon Arm Mutual Fund earned a return of 16% by making the following investments in asset classes:

The return on a bogey portfolio was 12%, based on the following:

The total excess return on the managed portfolio was __________.

A. 2%

B. 3%

C. 4%

D. 5%

21. In a particular year, Salmon Arm Mutual Fund earned a return of 16% by making the following investments in asset classes:

The return on a bogey portfolio was 12%, based on the following:

The contribution of asset allocation across markets to the total excess return was __________.

A. 1.5%

B. 2%

C. 2.5%

D. 3.5%

22. In a particular year, Salmon Arm Mutual Fund earned a return of 16% by making the following investments in asset classes:

The return on a bogey portfolio was 12%, based on the following:

The contribution of security selection within asset classes to the total excess return was __________.

A. 1.5%

B. 2%

C. 2.5%

D. 3.5%

23. In a particular year, Lost Hope Mutual Fund made the following investments in asset classes:

The return on a bogey portfolio was 12%, based on the following:

The total extra return on the managed portfolio was __________.

A. 1%

B. 2%

C. 3%

D. 4%

24. In a particular year, Lost Hope Mutual Fund made the following investments in asset classes:

The return on a bogey portfolio was 12%, based on the following:

The contribution of asset allocation across markets to the total extra return was __________.

A. -1%

B. 0%

C. 1%

D. 2%

25. In a particular year, Lost Hope Mutual Fund made the following investments in asset classes:

The return on a bogey portfolio was 12%, based on the following:

The contribution of security selection within asset classes to the total extra return was __________.

A. -1%

B. 0%

C. 1%

D. 2%

26. Which one of the following averaging methods is the preferred method of constructing returns series for use in evaluating portfolio performance?

A. Geometric average

B. Arithmetic average

C. Dollar weighted

D. Internal

27. The __________ calculates the reward to risk trade-off by dividing the average portfolio excess return by the portfolio beta.

A. Sharpe ratio

B. Treynor measure

C. Jensen measure

D. appraisal ratio

28. 28. In creating the P* portfolio, one mixes the original portfolio P and T-bills to match the _________ of the market.

A. alpha

B. beta

C. excess return

D. standard deviation

29. The M2 measure of portfolio performance was developed by ______________.

A. Modigliani and Miller

B. Modigliani and Modigliani

C. Merton and Miller

D. Fama and French

30. Probably the biggest problem with evaluating the portfolio performance of actively managed funds is the assumption that __________________________.

A. the markets are efficient

B. portfolio risk is constant over time

C. diversification pays off

D. security selection is more valuable than asset allocation

31. Perfect-timing ability is equivalent to having __________ on the market portfolio.

A. a call option

B. a futures contract

C. a put option

D. a forward contract

32. One hundred fund managers enter a contest to see how many times in 13 years they can earn a higher return than their competitors. The probability distribution of the number of successful years out of 13 for the best-performing money managers is

Out of this sample, chance alone would indicate that there is a ______ probability that someone would beat the market at least 11 times out of 13 years.

A. 51.3%

B. 65.9%

C. 67.1%

D. 10.83%

33. The Treynor-Black model is a model that shows how an investment manager can use security analysis and statistics to construct __________.

A. a market portfolio

B. a passive portfolio

C. an active portfolio

D. an index portfolio

34. If an investor is a successful market timer, his distribution of monthly portfolio returns will __________.

A. be skewed to the left

B. be skewed to the right

C. exhibit kurtosis

D. exhibit neither skewness nor kurtosis

35. Recent analysis indicates that the style of investing is a critical component of fund performance. In fact, on average about _____ of fund performance is attributable to the asset allocation decision.

A. 68%

B. 74%

C. 88%

D. 97%

36. In the Treynor-Black model, the active portfolio will contain stocks with __________.

A. alphas equal to zero

B. negative alphas

C. positive alphas

D. some negative and some positive alphas

37. Portfolio performance is often decomposed into various subcomponents, such as the return due to:

I. Broad asset allocation across security classes
II. Sector weightings within equity markets
III. Security selection with a given sector

The one decision that contributes most to the fund performance is _____.

A. I

B. II

C. III

D. All contribute equally to fund performance.

38. The theory of efficient frontiers has __________.

A. no adherents among practitioners

B. a small number of adherents among practitioners

C. a significant number of adherents among practitioners

D. complete support by practitioners

39. In the Treynor-Black model, security analysts __________.

A. analyze a relatively small number of stocks

B. analyze all stocks that are publicly traded

C. are redundant

D. devote their attention to market timing rather than fundamental analysis

40. In the Treynor-Black model, security analysts __________.

A. analyze the entire universe of stocks

B. assume that markets are inefficient

C. treat market index as a baseline portfolio from which an active portfolio is constructed

D. focus on selecting the best-performing bogey

41. Active portfolio management consists of:

I. Market timing
II. Security selection
III. Sector selection within given markets
IV. Indexing

A. I and II only

B. II and III only

C. I, II, and III only

D. I, II, III, and IV

42. A market-timing strategy is one in which asset allocation in the stock market __________ when one forecasts that the stock market will outperform Treasury bills.

A. decreases

B. increases

C. remains the same

D. may increase or decrease

43. In the Treynor-Black model, the contribution of individual security to the active portfolio should be based primarily on the stock’s _________.

A. alpha

B. beta

C. residual variance

D. information ratio

44. If all ______ are ______ in the Treynor-Black model, there would be no reason to depart from the passive portfolio.

A. alphas; zero

B. alphas; positive

C. betas; positive

D. standard deviations; positive

45. In the Treynor-Black model, the weight of each analyzed security in the portfolio should be proportional to its __________.

A. alpha/beta

B. alpha/residual variance

C. beta/residual variance

D. none of these options

46. The critical variable in the determination of the success of the active portfolio is the stock’s __________.

A. alpha/nonsystematic risk ratio

B. alpha/systematic risk ratio

C. delta/nonsystematic risk ratio

D. delta/systematic risk ratio

47. Consider the theory of active portfolio management. Stocks A and B have the same positive alpha and the same nonsystematic risk. Stock A has a higher beta than stock B. You should want __________ in your active portfolio.

A. equal proportions of stocks A and B

B. more of stock A than stock B

C. more of stock B than stock A

D. The answer cannot be determined from the information given.

48. Consider the theory of active portfolio management. Stocks A and B have the same beta and nonsystematic risk. Stock A has a higher positive alpha than stock B. You should want __________ in your active portfolio.

A. equal proportions of stocks A and B

B. more of stock A than stock B

C. more of stock B than stock A

D. The answer cannot be determined from the information given.

49. The market-timing form of active portfolio management relies on __________ forecasting, and the security selection form of active portfolio management relies on __________ forecasting.

A. macroeconomic; macroeconomic

B. macroeconomic; microeconomic

C. microeconomic; macroeconomic

D. microeconomic; microeconomic

50. Active portfolio managers try to construct a risky portfolio with _______.

A. a higher Sharpe ratio than a passive strategy

B. a lower Sharpe ratio than a passive strategy

C. the same Sharpe ratio as a passive strategy

D. very few securities

51. In performance measurement, the bogey portfolio is designed to _________.

A. measure the returns to a completely passive strategy

B. measure the returns to a similar active strategy

C. measure the returns to a given investment style

D. equal the return on the S&P 500

52. __________ portfolio managers experience streaks of abnormal returns that are hard to label as lucky outcomes, and _________ anomalies in realized returns have been sufficiently persistent that portfolio managers could use them to beat a passive strategy over prolonged periods.

A. No; no

B. No; some

C. Some; no

D. Some; some

53. A passive benchmark portfolio is:

I. A portfolio in which the asset allocation across broad asset classes is neutral and not determined by forecasts of performance of the different asset classes
II. One in which an indexed portfolio is held within each asset class
III. Often called the bogey

A. I only

B. I and III only

C. II and III only

D. I, II, and III

54. The correct measure of timing ability is ____________ for a portfolio manager who correctly forecasts 55% of bull markets and 55% of bear markets.

A. -5%

B. 5%

C. 10%

D. 95%

55. It is very hard to statistically verify abnormal fund performance because of all of the following except which one?

A. Inevitably, some fund managers experience streaks of good performance that may just be due to luck.

B. The noise in realized rates of return is so large as to make it hard to identify abnormal performance in competitive markets.

C. Portfolio composition is rarely stable long enough to identify abnormal performance.

D. Even if successful, there is really not much value to be added by active strategies such as market timing.

56. The term alpha transport refers to _____.

A. establishing alpha and then using index products to hedge market exposure and reduce exposure to particular sectors.

B. establishing alpha and then using sector mutual funds to hedge market exposure and reduce exposure to the general market.

C. establishing alpha and then using sector mutual funds to hedge market exposure and gain exposure to the general market.

D. establishing alpha and then using index products to hedge market exposure and gain exposure to particular sectors.

57. Portfolio managers Martin and Krueger each manage $1 million funds. Martin has perfect foresight, and the call option value of his perfect foresight is $150,000. Krueger is an imperfect forecaster and correctly predicts 50% of all bull markets and 70% of all bear markets. The correct measure of timing ability for Krueger is __________.

A. 20%

B. 60%

C. 75%

D. 120%

58. Portfolio managers Martin and Krueger each manage $1 million funds. Martin has perfect foresight, and the call option value of his perfect foresight is $150,000. Krueger is an imperfect forecaster and correctly predicts 50% of all bull markets and 70% of all bear markets. The value of Krueger’s imperfect forecasting ability is __________.

A. $30,000

B. $67,500

C. $108,750

D. $217,500

59. Douglass, an imperfect forecaster, correctly predicts 57% of all bull markets and 68% of all bear markets. Simmonds is a perfect forecaster. If Douglass is able to charge a fee of $125,000, the fee that Roy Simmonds should charge is __________. Assume that both forecasters manage similar-size funds.

A. $31,250

B. $200,000

C. $500,000

D. $625,000

60. A mutual fund invests in large-capitalization stocks. Its performance should be measured against which one of the following?

A. Russell 2000 Index

B. S&P 500 Index

C. Wilshire 5000 Index

D. Dow Jones Industrial Average

61. Assume you purchased a rental property for $100,000 and sold it 1 year later for $115,000 (there was no mortgage on the property). At the time of the sale, you paid $3,000 in commissions and $1,000 in taxes. If you received $10,000 in rental income (all received at the end of the year), what annual rate of return did you earn?

A. 6%

B. 11%

C. 21%

D. 25%

62. The table presents the actual return of each sector of the manager’s portfolio in column (1), the fraction of the portfolio allocated to each sector in column (2), the benchmark or neutral sector allocations in column (3), and the returns of sector indexes in column 4.

What was the manager’s return in the month?

A. 2.07%

B. 2.21%

C. 2.24%

D. 4.8%

63. The table presents the actual return of each sector of the manager’s portfolio in column (1), the fraction of the portfolio allocated to each sector in column (2), the benchmark or neutral sector allocations in column (3), and the returns of sector indexes in column 4.

What was the bogey’s return in the month?

A. 2.07%

B. 2.21%

C. 2.24%

D. 4.8%

64. The table presents the actual return of each sector of the manager’s portfolio in column (1), the fraction of the portfolio allocated to each sector in column (2), the benchmark or neutral sector allocations in column (3), and the returns of sector indexes in column 4.

What was the manager’s over- or underperformance for the month?

A. Underperformance = .03%

B. Overperformance = .03%

C. Overperformance = .14%

D. Underperformance = 3%

65. The table presents the actual return of each sector of the manager’s portfolio in column (1), the fraction of the portfolio allocated to each sector in column (2), the benchmark or neutral sector allocations in column (3), and the returns of sector indexes in column 4.

What is the contribution of security selection to relative performance?

A. -.15%

B. .15%

C. -.3%

D. .3%

66. The table presents the actual return of each sector of the manager’s portfolio in column (1), the fraction of the portfolio allocated to each sector in column (2), the benchmark or neutral sector allocations in column (3), and the returns of sector indexes in column 4.

What is the contribution of asset allocation to relative performance?

A. -.18%

B. .18%

C. -.15%

D. .15%

67. Morningstar’s RAR produce results that are similar but not identical to ________.

A. Jensen’s alpha

B. M2

C. the Treynor ratio

D. the Sharpe ratio

68. The Treynor-Black model assumes that security markets are _________.

A. completely efficient

B. nearly efficient

C. very inefficient

D. random walks

69. The information ratio is equal to the stock’s ____ divided by its ______.

A. diversifiable risk; beta

B. beta; alpha

C. alpha; beta

D. alpha; diversifiable risk

70. Empirical tests to date show ______________.

A. that many investors have earned large rewards by market timing

B. little evidence of market-timing ability

C. clear-cut evidence of substantial market-timing ability

D. evidence that absolutely no market-timing ability exists

71. A portfolio generates an annual return of 13%, a beta of .7, and a standard deviation of 17%. The market index return is 14% and has a standard deviation of 21%. What is the M2 measure of the portfolio if the risk-free rate is 5%?

A. .58%

B. .68%

C. .78%

D. .88%

72. A portfolio generates an annual return of 17%, a beta of 1.2, and a standard deviation of 19%. The market index return is 12% and has a standard deviation of 16%. What is the M2 measure of the portfolio if the risk-free rate is 4%?

A. 2.15%

B. 2.76%

C. 2.94%

D. 3.14%

73. A portfolio generates an annual return of 13%, a beta of .7, and a standard deviation of 17%. The market index return is 14% and has a standard deviation of 21%. What is the Treynor measure of the portfolio if the risk-free rate is 5%?

A. .1143

B. .1233

C. .1354

D. .1477

74. A portfolio generates an annual return of 16%, a beta of 1.2, and a standard deviation of 19%. The market index return is 12% and has a standard deviation of 16%. What is the Treynor measure of the portfolio if the risk-free rate is 6%?

A. .0833

B. .1083

C. .1114

D. .1163

75. A portfolio generates an annual return of 13%, a beta of .7, and a standard deviation of 17%. The market index return is 14% and has a standard deviation of 21%. What is the Sharpe measure of the portfolio if the risk-free rate is 5%?

A. .3978

B. .4158

C. .4563

D. .4706

76. A portfolio generates an annual return of 16%, a beta of 1.2, and a standard deviation of 19%. The market index return is 12% and has a standard deviation of 16%. What is the Sharpe ratio of the portfolio if the risk-free rate is 6%?

A. .4757

B. .5263

C. .6842

D. .7252

77. A portfolio generates an annual return of 13%, a beta of .7, and a standard deviation of 17%. The market index return is 14% and has a standard deviation of 21%. What is Jensen’s alpha of the portfolio if the risk-free rate is 5%?

A. .017

B. .034

C. .067

D. .078

78. A portfolio generates an annual return of 16%, a beta of 1.2, and a standard deviation of 19%. The market index return is 12% and has a standard deviation of 16%. What is Jensen’s alpha of the portfolio if the risk-free rate is 6%?

A. .017

B. .028

C. .036

D. .078

79. The portfolio that contains the benchmark asset allocation against which a manager will be measured is often called _____________.

A. the bogey portfolio

B. the Vanguard Index

C. Jensen’s alpha

D. the Treynor measure

80. An attribution analysis will not likely contain which of the following components?

A. Asset allocation

B. Index returns

C. Risk-free returns

D. Security selection

81. Which of the following investment strategies would have produced the highest returns in the time period since 1926?

A. T-bills portfolio

B. S&P 500 Index fund

C. Perfect market timing

D. Random stock selection

82. What phrase might be used as a substitute for the Treynor-Black model developed in 1973?

A. Solely active management

B. Enhanced index approach

C. Passive management

D. Random selection

83. What is the term for the process used to assess portfolio manager performance?

A. Active analysis

B. Attribution analysis

C. Passive analysis

D. Treynor-Black Analysis

84. A fund has excess performance of 1.5%. In looking at the fund’s investment breakdown, you see that the fund overweighted equities relative to the benchmark and that the average return on the fund’s equity portfolio was slightly lower than the equity benchmark return. The excess performance for this fund is probably due to _______________.

A. security selection ability

B. better sector weightings in the equity portfolio

C. the asset allocation decision

D. finding securities with positive alphas

85. For a market timer, the _____________ will be higher when RM is higher.

A. portfolio’s alpha and beta

B. portfolio’s unsystematic risk

C. portfolio’s beta and slope of the characteristic line

D. security selection component of the portfolio

86. The Treynor-Black model combines an actively managed portfolio with an efficiently diversified portfolio in order to:

I. Improve the diversification of the overall portfolio
II. Improve the overall portfolio’s Sharpe ratio
III. Reach a higher CAL than would otherwise be possible

A. I only

B. I and II only

C. II and III only

D. I, II, and III

19
Student: ___________________________________________________________________________
1. In 2011, U.S. securities represented ______ of the world market for equities.

A. less than 25%

B. more than two-thirds

C. between 30% and 40%

D. a consistent 50%

2. _____ has the highest market capitalization of listed corporations among developed markets.

A. The United States

B. Japan

C. The United Kingdom

D. Switzerland

3. Total capitalization of corporate equity in the United States in 2011 was about _______ trillion.

A. $13.9

B. $23.4

C. $30.2

D. $45.5

4. If you limit your investment opportunity set to only the largest six countries in the world in terms of equity capitalization as a percentage of total global equity capital, you will include about _______ of the world’s equity.

A. 34%

B. 44%

C. 54%

D. 64%

5. Limiting your investments to the top six countries in the world in terms of market capitalization may make sense for _________ investor but probably does not make sense for ________ investor.

A. an active; a passive

B. a passive; an active

C. a security selection expert; a market timer

D. a fundamental; a technical

6. WEBS are ____________________.

A. investments in country-specific portfolios

B. traded exactly like mutual funds

C. identical to ADRs

D. designed to give investors foreign currency exposure to multiple countries

7. Which one of the following allows you to purchase the stock of a specific foreign company?

A. WEBS

B. MSCI

C. ADR

D. EAFE

8. Generally speaking, countries with ______ capitalization of equities ________.

A. larger; have higher GDP

B. smaller; are wealthier

C. larger; have smaller GDP

D. larger; are higher-growth countries

9. The 32 “developed” countries with the largest equity capitalization made up about _____ of the world GDP in 2011.

A. 22%

B. 44%

C. 68%

D. 85%

10. According to a regression of GDP on market capitalization in 2010, virtually all developed countries had _______ per capita GDP than (as) predicted by the regression.

A. higher

B. lower

C. the same

D. sometimes lower and sometimes higher

11. If the direct quote for the exchange rate for the U.S. dollar versus the Canadian dollar is .98, what is the indirect quote?

A. 1.98

B. 1.02

C. .02

D. 1.05

12. EAFE stands for _______.

A. Equity And Foreign Exchange

B. European, Australian, Far East

C. European, Asian, Foreign Exchange

D. European, American, Far East

13. Which one of the following country risks includes the possibility of expropriation of assets, changes in tax policy, and restrictions on foreign exchange transactions?

A. Default risk

B. Foreign exchange risk

C. Market risk

D. Political risk

14. The __________ index is a widely used index of non-U.S. stocks.

A. CBOE

B. Dow Jones

C. EAFE

D. Lehman Index

15. Suppose that U.S. equity markets represent about 35% of total global equity markets and that the typical U.S. investor has about 95% of her portfolio invested only in U.S. equities. This is an example of _________.

A. home-country bias

B. excessive diversification

C. active management

D. passive management

16. The four largest economies in the world in 2010 were ____________.

A. United States, India, China, and Japan

B. United States, China, Canada, and Japan

C. United States, China, Japan, and Germany

D. China, United Kingdom, Canada, and United States

17. The proper formula for interest rate parity is ___________.

A. [1 + rf(foreign)]/[1 + rf(US)] = F1/E0

B. [1 + rf(US)]/[1 + rf(foreign)] = E0/F1

C. [1 + rf(US)]/[1 + rf(foreign)] = F0/E0

D. [1 + rf(foreign)]/[1 + rf(foreign)] = F0/E1

18. Research indicates that exchange risk of the major currencies has been _________ so far in this century.

A. relatively high

B. relatively low

C. declining slightly

D. declining rapidly

19. It appears from empirical work that exchange rate risk ____________.

A. has been declining for individual investments in recent years

B. is mostly diversifiable

C. is mostly systematic risk

D. is unimportant for an investment in a single foreign country

20. Passive investors with well-diversified international portfolios _________.

A. can safely ignore all political risk in emerging markets

B. can expect very large diversification gains from their international investing

C. do not need to be concerned with hedging exposure to foreign currencies

D. can expect returns to be better than the EAFE on a consistent basis

21. Which stock market has the largest weight in the EAFE index?

A. Japan

B. Germany

C. United Kingdom

D. Australia

22. The correlation coefficient between the U.S. stock market index and stock market indexes of major countries is __________.

A. between -1 and -.5

B. between -.50 and 0

C. between 0 and .5

D. between .5 and 1

23. In 2010, the ___ countries with the largest capitalization of equities made up approximately 60% of the world equity portfolio.

A. 2

B. 4

C. 5

D. 12

24. Investor portfolios are notoriously overweighted in home-country stocks. This is commonly called ________.

A. local fat

B. nativism

C. home-country bias

D. misleading representation

25. Corruption is _________ risk variable.

A. a firm-specific

B. a political

C. a financial

D. an economic

26. A U.S. hedge fund owns Swiss franc bonds. The fund manager believes that if Swiss interest rates rise relative to U.S. interest rates, the value of the franc will rise. To limit the risk to the fund’s dollar return, the fund manager should __________.

A. sell the Swiss franc bonds now

B. sell the Swiss franc forward

C. probably do nothing because the franc move will offset the lower bond price

D. enter into an interest rate swap to pay variable and receive fixed

27. The annual inflation rate is ______ risk variable.

A. a firm-specific

B. a political

C. a financial

D. an economic

28. A U.S. insurance firm must pay €75,000 in 6 months. The spot exchange rate is $1.32 per euro, and in 6 months the exchange rate is expected to be $1.35. The 6-month forward rate is currently $1.36 per euro. If the insurer’s goal is to limit its risk, should the insurer hedge this transaction? If so how?

A. The insurer need not hedge because the expected exchange rate move will be favorable.

B. The insurer should hedge by buying the euro forward even though this will cost more than the expected cost of not hedging.

C. The insurer should hedge by selling the euro forward because this will cost less than the expected cost of not hedging.

D. The insurer should hedge by buying the euro forward even though this will cost less than the expected cost of not hedging.

29. A fund has assets denominated in euros and liabilities in yen due in 6 months. The 6-month forward rate for the euro is $1.36 per euro, and the 6-month forward rate for the yen is 121 yen per dollar. The 6-month forward rate for the euro versus the yen should be ________ per euro.

A. ×88.97

B. ×145.34

C. ×154.67

D. ×164.56

30. You invest in various broadly diversified international mutual funds as well as your U.S. portfolio. The one risk you probably don’t have to worry about affecting your returns is __________.

A. business-cycle risk

B. beta risk

C. inflation risk

D. currency risk

31. According to the International Country Risk Guide in 2011, which of the following countries was the riskiest according to the current composite risk rating?

A. Japan

B. United States

C. China

D. India

32. Suppose the 6-month risk-free rate of return in the United States is 5%. The current exchange rate is 1 pound = US$2.05. The 6-month forward rate is 1 pound = US$2. The minimum yield on a 6-month risk-free security in Britain that would induce a U.S. investor to invest in the British security is ________.

A. 5.06%

B. 6.74%

C. 8.48%

D. 10.13%

33. The quoted interest rate on a 3-month Canadian security is 8%. The current exchange rate is C$1 = US$.68. The 3-month forward rate is C$1 = US$.70. The APR (denominated in US$) that a U.S. investor can earn by investing in the Canadian security is __________.

A. 5%

B. 7.25%

C. 20%

D. 22.43%

34. Suppose the 1-year risk-free rate of return in the United States is 5% and the 1-year risk-free rate of return in Britain is 8%. The current exchange rate is $1 = ₤.50. A 1-year future exchange rate of __________ would make a U.S. investor indifferent between investing in the U.S. security and investing in the British security.

A. ₤.5150

B. ₤.5142

C. ₤.5123

D. ₤.4859

35. The risk-free interest rate in the United States is 4%, while the risk-free interest rate in the United Kingdom is 9%. If the British pound is worth $2 in the spot market, a 1-year futures rate on the British pound should be worth __________.

A. $1.83

B. $1.91

C. $2.08

D. $2.18

36. The risk-free interest rate in the United States is 8%, while the risk-free interest rate in the United Kingdom is 15%. If the 1-year futures price on the British pound is $2.40, the spot market value of the British pound today should be __________.

A. $1.93

B. $2.22

C. $2.56

D. $2.76

37. The present exchange rate is C$1 = US$.77. The 1-year futures rate is C$1 = US$.73. The yield on a 1-year U.S. bill is 4%. A yield of __________ on a 1-year Canadian bill will make investors indifferent between investing in the U.S. bill and the Canadian bill.

A. 9.7%

B. 2.9%

C. 2.8%

D. 2%

38. The yield on a 1-year bill in the United Kingdom is 6%, and the present exchange rate is 1 pound = US$2. If you expect the exchange rate to be 1 pound = US$1.95 a year from now, the return a U.S. investor can expect to earn by investing in U.K. bills is approximately __________.

A. -3%

B. 3%

C. 3.35%

D. 8.72%

39. Assume there is a fixed exchange rate between the Canadian and U.S. dollars. The expected return and standard deviation of return on the U.S. stock market are 13% and 15%, respectively. The expected return and standard deviation of return on the Canadian stock market are 12% and 16%, respectively. The covariance of returns between the U.S. and Canadian stock markets is 1.2%. If you invested 50% of your money in the Canadian stock market and 50% in the U.S. stock market, the expected return on your portfolio would be __________.

A. 12%

B. 12.5%

C. 14%

D. 15.5%

40. Assume there is a fixed exchange rate between the Canadian and U.S. dollars. The expected return and standard deviation of return on the U.S. stock market are 10% and 15%, respectively. The expected return and standard deviation of return on the Canadian stock market are 12% and 16%, respectively. The covariance of returns between the U.S. and Canadian stock markets is .012. If you invested 50% of your money in the Canadian stock market and 50% in the U.S. stock market, the standard deviation of return on your portfolio would be __________.

A. 10.96%

B. 12.25%

C. 13.42%

D. 15.5%

41. Inclusion of international equities in a U.S. investor’s portfolio has historically produced ___________________.

A. a substantially reduced portfolio variance

B. a slightly reduced portfolio variance

C. a substantially poorer portfolio variance

D. a slightly poorer portfolio variance

42. WEBS are _____________.

A. mutual funds marketed internationally on the Internet

B. synthetic domestic stock indexes

C. equity indexes that replicate the price and yield performance of foreign stock portfolios

D. single stock investments in a foreign security

43. You are a U.S. investor who purchased British securities for 3,500 pounds 1 year ago when the British pound cost $1.35. No dividends were paid on the British securities in the past year. Your total return based on U.S. dollars was __________ if the value of the securities is now 4,200 pounds and the pound is worth $1.15.

A. -3.8%

B. 2.2%

C. 5.6%

D. 15%

44. Real U.S. interest rates move above Japanese interest rates. If you believe that Japanese interest rates won’t move and that interest rate parity will hold, then ____________.

A. the yen-per-dollar exchange rate should rise

B. the dollar-per-yen exchange rate should rise

C. the exchange rate should stay the same if parity holds

D. The answer cannot be determined from the information given.

45. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.

How many shares can the investor purchase?

A. 140

B. 100

C. 71.43

D. None of these options

46. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.

After 1 year, the exchange rate is unchanged and the share price is ₤55. What is the dollar-denominated return?

A. 14%

B. 10%

C. 9.3%

D. 7.1%

47. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.

After 1 year, the exchange rate is unchanged and the share price is ₤55. What is the pound-denominated return?

A. 14%

B. 10%

C. 9.3%

D. 7.1%

48. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.

After 1 year, the exchange rate is $1.60/₤ and the share price is ₤55. What is the dollar-denominated return?

A. 25.7%

B. 16%

C. 14.3%

D. 9.3%

49. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.

After 1 year, the exchange rate is $1.50/₤ and the share price is ₤45. How much of your dollar-denominated return is due to the currency change?

A. 10%

B. 6.43%

C. 4.34%

D. 2.12%

50. You find that the exchange rate quote for the yen is 121 yen per dollar. This is an example of ________ quote. You also find that the euro is worth $1.33. This second quote is an example of _______ quote.

A. a direct; an indirect

B. an indirect; a direct

C. a foreign; a U.S.

D. a U.S.; a foreign

51. Among emerging countries the largest equity market in 2011 was located in _____________.

A. China

B. India

C. Brazil

D. Russia

52. In the PRS country composite risk ratings, a score of ______ represents the least risky and a score of _____ represents the most risky.

A. 0; 100

B. 0; 50

C. 50; 0

D. 100; 0

53. Which emerging country had the highest percentage growth in market capitalization during the 2000-2011 period?

A. Brazil

B. China

C. Columbia

D. Turkey

54. The dollar-per-euro spot rate is 1.2 when an importer of French wines places an order. Six months later, when she takes delivery, the spot rate is 1.3 dollars per euro. If her original invoice was for 30,000 euro, what is her gain or loss due to exchange rate risk?

A. $3,000 gain

B. $3,000 loss

C. $6,000 loss

D. No gain or loss

55. An importer of televisions from Japan has a contract to purchase a shipment of televisions for 2 million yen. The spot rate increases from 105 yen per dollar to 108 yen per dollar. What is the importer’s gain or loss?

A. $529 gain

B. $529 loss

C. $619 gain

D. $619 loss

56. A country has a PRS political risk rating of 75, a financial score of 40, and an economic score of 35. The country’s composite rating is _________.

A. 75

B. 50

C. 40

D. 35

57. The risk-free rate in the United States is 2.5%, and the risk-free rate in Europe is 3.2%. If the spot rate of dollars per euro is 1.32, what is the likely forward rate in terms of dollars per euro?

A. 1.30

B. 1.31

C. 1.32

D. 1.33

58. The risk-free rate in the United States is 4%, and the risk-free rate in Japan is 1.2%. If the spot rate of yen to dollars is 105, what is the likely yen-per-dollar forward rate?

A. 101

B. 102

C. 105

D. 108

59. The yen-per-dollar spot rate is 104. The yen-per-dollar forward rate is 107. If the U.S. risk-free rate is 2.4%, what is the likely yen risk-free rate?

A. 1.24%

B. 2.35%

C. 3.98%

D. 5.35%

60. In the PRS financial risk ratings, the United States rates poorly because of the U.S. ________.

I. Large budget deficit
II. Large trade deficit
III. Large amount of total debt

A. I only

B. I and II only

C. I and III only

D. I, II, and III

61. The major participants who directly purchase securities in the capital markets of other countries are predominantly ____________.

A. large institutional investors

B. individual investors

C. government agencies

D. central banks

62. Of the following, which is the most commonly used international index?

A. DJIA

B. EAFE

C. Russell 2000

D. S&P 500

63. WEBS differ from mutual funds in that:

I. WEBS can be shorted.
II. WEBS trade continuously on the AMEX.
III. WEBS are passively managed.

A. II only

B. II and III only

C. I and III only

D. I, II, and III

64. The variation in the betas of emerging markets suggests that ____________.

A. emerging markets are more uniform than developed markets

B. beta does not hold in international markets

C. international diversification may reduce portfolio risk

D. riskier emerging markets have uniformly lower betas

65. One year U.S. interest rates are 5%, and European interest rates are 7%. The spot euro direct exchange rate quote is 1.32, and the 1-year forward rate direct quote is 1.35. If you can borrow either $1 million or €1 million to start with, what would be your dollar profits from interest arbitrage based on these data?

A. $94,322

B. $55,345

C. $44,318

D. $33,595

66. One year U.S. interest rates are 7%, and European interest rates are 5%. The spot euro direct exchange rate quote is 1.30 and the 1-year forward rate direct quote is 1.25. If you can borrow either $1 million or €1 million to start with, what would be your dollar profits from interest arbitrage based on these data?

A. $60,384

B. $42,973

C. $68,422

D. $78,500

67.

All exchange rates are expressed as units of foreign currency that can be purchased with one U.S. dollar. Answer the following about decomposing the manager’s performance.

What is the difference in return of the manager’s portfolio due to currency selection?

A. -5%

B. -3%

C. 2%

D. 1%

68.

All exchange rates are expressed as units of foreign currency that can be purchased with one U.S. dollar. Answer the following about decomposing the manager’s performance.

What is the difference in return of the manager’s portfolio due to country selection?

A. -.60%

B. -.75%

C. .12%

D. .22%

69.

All exchange rates are expressed as units of foreign currency that can be purchased with one U.S. dollar. Answer the following about decomposing the manager’s performance.

What is the difference in return of the manager’s portfolio due to stock selection?

A. 1.15%

B. 3.25%

C. 5.45%

D. 6.13%

20
Student: ___________________________________________________________________________
1. Which of the following are characteristics of a hedge fund?

I. Pooling of assets
II. Strict regulatory oversight by the SEC
III. Investing in equities, debt instruments, and derivative instruments
IV. Professional management of assets

A. I and II only

B. II and III only

C. III and IV only

D. I, III, and IV only

2. A __________ is a private investment pool open only to wealthy or institutional investors that is exempt from SEC regulation and can therefore pursue more speculative policies than mutual funds.

A. commingled pool

B. unit trust

C. hedge fund

D. money market fund

3. Hedge funds are typically set up as _______________.

A. limited liability partnerships

B. corporations

C. REITs

D. mutual funds

4. A(n) _______________ hedge fund attempts to profit from situations such as mergers, acquisitions, restructuring, bankruptcy, or reorganization.

A. multistrategy

B. managed futures

C. dedicated short bias

D. event-driven

5. ______ are private partnerships of a small number of wealthy investors, are often subject to lock-up periods, and are allowed to pursue a wide range of investment activities.

A. Hedge funds

B. Closed-end funds

C. REITs

D. Mutual funds

6. Which of the following typically employ(s) significant amounts of leverage?

I. Hedge funds
II. Equity mutual funds
III. Money market funds
IV. Income mutual funds

A. I only

B. I and II only

C. III and IV only

D. I, II, and III only

7. As of 2012, hedge funds had approximately _____ under management.

A. $.5 trillion

B. $1.6 trillion

C. $2 trillion

D. $3.2 trillion

8. A restriction under which investors cannot withdraw their funds for as long as several months or years is called __________.

A. transparency

B. a lock-up period

C. a back-end load

D. convertible arbitrage

9. Hedge fund managers are compensated by ___________________.

A. deducting management fees from fund assets and receiving incentive bonuses for beating index benchmarks

B. deducting a percentage of any gains in asset value

C. selling shares in the trust at a premium to the cost of acquiring the underlying assets

D. charging portfolio turnover fees

10. Management fees for hedge funds typically range between _____ and _____.

A. .5%; 1.5%

B. 1%; 2%

C. 2%; 5%

D. 5%; 8%

11. Hedge funds can invest in various investment options that are not generally available to mutual funds. These include:

I. Futures and options
II. Merger arbitrage
III. Currency contracts
IV. Companies undergoing Chapter 11 restructuring and reorganization

A. I only

B. I and II only

C. I, II, and III only

D. I, II, III, and IV

12. A typical traditional initial investment in a hedge fund generally is in the range between _____ and _____.

A. $1,000; $5,000

B. $5,000; $25,000

C. $25,000; $250,000

D. $250,000; $1,000,000

13. The difference between market-neutral and long-short hedges is that market-neutral hedge funds _________.

A. establish long and short positions on both sides of the market to eliminate risk and to benefit from security asset mispricing whereas long-short hedges establish positions only on one side of the market

B. allocate money to several other funds while long-short funds do not

C. invest in relatively stable proportions of stocks and bonds while the proportions may vary dramatically for long-short funds

D. invest only in equities and bonds while long-short funds use only derivatives

14. Convertible arbitrage hedge funds _________.

A. attempt to profit from mispriced interest-sensitive securities

B. hold long positions in convertible bonds and offsetting short positions in stocks

C. establish long and short positions in global capital markets

D. use derivative products to hedge their short positions in convertible bonds

15. Assuming positive basis and negligible borrowing cost, which of the following transactions could yield positive arbitrage profits if pursued by a hedge fund?

A. Buy gold in the spot market, and sell the futures contract.

B. Buy the futures contract, and sell the gold spot and invest the money earned.

C. Buy gold spot with borrowed money, and buy the futures contract.

D. Buy the futures contract, and buy the gold spot using borrowed money.

16. An example of a neutral pure play is _______.

A. pairs trading

B. statistical arbitrage

C. convergence arbitrage

D. directional strategy

17. You believe that the spread between the September S&P 500 future and the S&P 500 Index is too large and will soon correct. To take advantage of this mispricing, a hedge fund should ______________.

A. buy all the stocks in the S&P 500 and write put options on the S&P 500 Index

B. sell all the stocks in the S&P 500 and buy call options on the S&P 500 Index

C. sell S&P 500 Index futures and buy all the stocks in the S&P 500

D. sell short all the stocks in the S&P 500 and buy S&P 500 Index futures

18. You believe that the spread between the September S&P 500 future and the S&P 500 Index is too large and will soon correct. This is an example of ______________.

A. pairs trading

B. convergence play

C. statistical arbitrage

D. a long-short equity hedge

19. A 1-year oil futures contract is selling for $74.50. Spot oil prices are $68, and the 1-year risk-free rate is 3.25%.

The 1-year oil futures price should be equal to __________.

A. $68

B. $70.21

C. $71.25

D. $74.88

20. A 1-year oil futures contract is selling for $74.50. Spot oil prices are $68, and the 1-year risk-free rate is 3.25%.

The arbitrage profit implied by these prices is _____________.

A. $6.50

B. $5.44

C. $4.29

D. $3.25

21. A 1-year oil futures contract is selling for $74.50. Spot oil prices are $68, and the 1-year risk-free rate is 3.25%.

Based on the above data, which of the following sets of transactions will yield positive riskless arbitrage profits?

A. Buy oil in the spot market with borrowed money, and sell the futures contract.

B. Buy the futures contract, and sell the oil spot and invest the money earned.

C. Buy the oil spot with borrowed money, and buy the futures contract.

D. Buy the futures contract, and buy the oil spot using borrowed money.

22. Assume that you have invested $500,000 to purchase shares in a hedge fund reporting $800 million in assets, $100 million in liabilities, and 70 million shares outstanding. Your initial lockout period is 3 years.

How many shares did you purchase?

A. 13,333

B. 25,000

C. 50,000

D. 66,000

23. Assume that you have invested $500,000 to purchase shares in a hedge fund reporting $800 million in assets, $100 million in liabilities, and 70 million shares outstanding. Your initial lockout period is 3 years.

If the share price after 3 years increases to $15.28, what is the value of your investment?

A. $553,600

B. $625,000

C. $733,800

D. $764,000

24. Assume that you have invested $500,000 to purchase shares in a hedge fund reporting $800 million in assets, $100 million in liabilities, and 70 million shares outstanding. Your initial lockout period is 3 years.

What is your annualized return over the 3-year holding period?

A. 14.45%

B. 15.18%

C. 16%

D. 17.73%

25. Which of the following are not managed investment companies?

A. Hedge funds

B. Unit investment trusts

C. Closed-end funds

D. Open-end funds

26. You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 3-month S&P 500 future contracts. The S&P contract multiplier is $250.

How many S&P 500 contracts do you need to sell to hedge your portfolio?

A. 25

B. 35

C. 50

D. 60

27. You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 3-month S&P 500 future contracts. The S&P contract multiplier is $250.

When you hedge your stock portfolio with futures contracts, the value of your portfolio beta is __________.

A. 0

B. 1

C. 1.2

D. The answer cannot be determined from the information given.

28. You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 3-month S&P 500 future contracts. The S&P contract multiplier is $250.

What is the expected quarterly return on the hedged portfolio?

A. 0%

B. 2%

C. 3%

D. 4%

29. You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 3-month S&P 500 future contracts. The S&P contract multiplier is $250.

How much is the portfolio expected to be worth 3 months from now?

A. $15,000,000

B. $15,450,000

C. $15,600,000

D. $16,000,000

30. You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 3-month S&P 500 future contracts. The S&P contract multiplier is $250.

Hedging this portfolio by selling S&P 500 futures contracts is an example of ___________.

A. statistical arbitrage

B. pure play

C. a short equity hedge

D. fixed-income arbitrage

31. Hedge funds that change strategies and types of securities invested and also vary the proportions of assets invested in particular market sectors according to the fund manager’s outlook are called ____________________.

A. asset allocation funds

B. multistrategy funds

C. event-driven funds

D. market-neutral funds

32. When a short-selling hedge fund advertises in a prospectus that it is a 120/20 fund, this means that the fund may sell short up to ______ for every $100 in net assets and increase the long position to __________ of net assets.

A. $120; $20

B. $20; $120

C. $20; $20

D. $120; $120

33. The collapse of the Long Term Capital Management hedge fund in 1998 was a case of an extremely unlikely statistical event called ________.

A. statistical arbitrage

B. an unhedged play

C. a tail event

D. a liquidity trap

34. Which of the following investment styles could be the best description of the Long Term Capital Management market-neutral strategies?

A. Convergence arbitrage

B. Statistical arbitrage

C. Pairs trading

D. Convertible arbitrage

35. Consider a hedge fund with $250 million in assets at the start of the year. If the gross return on assets is 18% and the total expense ratio is 2.5% of the year-end value, what is the rate of return on the fund?

A. 15.05%

B. 15.5%

C. 17.25%

D. 18%

36. Consider a hedge fund with $200 million at the start of the year. The benchmark S&P 500 Index was up 16.5% during the same period. The gross return on assets is 21%, and the expense ratio is 2%. For each 1% above the benchmark return, the fund managers receive a .1% incentive bonus.

What was the management cost for the year?

A. $4,877,000

B. $4,900,000

C. $5,929,000

D. $6,446,000

37. Consider a hedge fund with $200 million at the start of the year. The benchmark S&P 500 Index was up 16.5% during the same period. The gross return on assets is 21%, and the expense ratio is 2%. For each 1% above the benchmark return, the fund managers receive a .1% incentive bonus.

What was the annual return on this fund?

A. 16.5%

B. 18.04%

C. 18.55%

D. 21%

38. Consider a hedge fund with $400 million in assets, $60 million in debt, and 16 million shares at the start of the year and with $500 million in assets, $40 million in debt, and 20 million shares at the end of the year. During the year, investors have received an income dividend of $.75 per share. Assuming that the total expense ratio is 2.75%, what is the rate of return on the fund?

A. 6.45%

B. 8.52%

C. 8.95%

D. 9.46%

39. Market-neutral hedge funds may experience considerable volatility. The source of volatile returns is the use of _________.

A. pure play

B. leverage

C. directional bests

D. net short positions

40. A hedge fund has $150 million in assets at the beginning of the year and 10 million shares outstanding throughout the year. Throughout the year assets grow at 12%. The fund charges a 3% management fee on the assets. The fee is imposed on year-end asset values. What is the end-of-year NAV for the fund?

A. $15

B. $15.60

C. $16.30

D. $17.55

41. You pay $216,000 to the Capital Hedge Fund, which has a price of $18 per share at the beginning of the year. The fund deducted a front-end commission of 4%. The securities in the fund increased in value by 15% during the year. The fund’s expense ratio is 2% and is deducted from year-end asset values. What is your rate of return on the fund if you sell your shares at the end of the year?

A. 5.35%

B. 7.23%

C. 8.19%

D. 10%

42. A hedge fund owns a $15 million bond portfolio with a modified duration of 11 years and needs to hedge risk, but T-bond futures are available only with a modified duration of the deliverable instrument of 10 years. The futures are priced at $105,000. The proper hedge ratio to use is ______.

A. 143

B. 157

C. 196

D. 218

43. Unlike market-neutral hedge funds, which have betas near ________, directional long funds exhibit highly _______ betas.

A. zero; positive

B. positive; negative

C. positive; zero

D. negative; positive

44. Portfolio A has a beta of .2 and an expected return of 14%. Portfolio B has a beta of .5 and an expected return of 16%. The risk-free rate of return is 10%. If you manage a long-short equity fund and want to take advantage of an arbitrage opportunity, you should take a short position in portfolio ______ and a long position in portfolio __________.

A. A; A

B. A; B

C. B; A

D. B; B

45. According to a model that was estimated using monthly excess returns from January 2005 through November 2011, average returns of equity hedge funds are __________ the S&P 500 Index.

A. equal to

B. considerably higher than

C. slightly lower than

D. slightly higher than

46. Research by Aragon (2007) indicates that lock-up restrictions tend to hold ____________ portfolios.

A. less liquid

B. more liquid

C. event-driven

D. shorter-maturity

47. Higher returns of equity hedge funds as compared to the S&P 500 Index reflect positive compensation for __________ risk.

A. market

B. liquidity

C. systematic

D. interest rate

48. Portfolio A has a beta of 1.3 and an expected return of 21%. Portfolio B has a beta of .7 and an expected return of 17%. The risk-free rate of return is 9%. If a hedge fund manager wants to take advantage of an arbitrage opportunity, she should take a short position in portfolio __________ and a long position in portfolio __________.

A. A; A

B. A; B

C. B; A

D. B; B

49. In a 2011 study, Agarwal, Daniel, and Naik documented that hedge funds tend to report average returns in ____________ that are __________ than their average returns in other months.

A. September; lower

B. January; higher

C. January; lower

D. December; higher

50. To attract new clients, hedge funds often include past returns of funds only if they were successful. This is called __________.

A. long-short bias

B. survivorship bias

C. backfill bias

D. incentive bias

51. Some argue that abnormally high returns of hedge funds are tainted by __________, which arises when unsuccessful funds cease operations, leaving only successful ones.

A. reporting bias

B. survivorship bias

C. backfill bias

D. incentive bias

52. Malkiel and Saha (2005) estimate that the survivorship bias for hedge funds equals 4.4%, which is __________ the survivorship bias for mutual funds.

A. about the same as

B. much lower than

C. much higher than

D. only slightly lower than

53. Hedge fund managers receive incentive bonuses when they increase portfolio assets beyond a stipulated benchmark but lose nothing when they fail to perform. This is equivalent to __________.

A. writing a call option

B. receiving a free call option

C. writing a put option

D. receiving a free put option

54. A typical hedge fund incentive bonus is usually equal to ________ of investment profits beyond a predetermined benchmark index.

A. 5%

B. 10%

C. 20%

D. 25%

55. The fastest-growing category of hedge funds is feeder funds. These funds invest in ________.

A. other hedge funds

B. convertible securities and preferred stock

C. equities and bonds

D. managed futures and options

56. A high water mark is a limiting factor of hedge fund manager compensation. This means that managers can’t charge incentive fees ________.

A. when a fund stays flat

B. when a fund falls and does not recover to its previous high value

C. when a fund falls by 10% or more

D. none of these options. (Managers can always charge incentive fees.)

57. If the risk-free interest rate is rf and equals the fund’s benchmark, the portfolio’s net asset value is S0, and the hedge fund manager incentive fee is 20% of profit beyond that, the incentive fee is equivalent to receiving ______ call(s) with exercise price ________.

A. .2; S0

B. 1; S0(1 + rf)

C. 1.2; S0

D. .2; S0(1 + rf)

58. Assume the risk-free interest rate is 10% and is equal to the fund’s benchmark, the portfolio’s net asset value is $100, and the fund’s standard deviation is 20%. Also assume a time horizon of 1 year.

What is the exercise price on the incentive fee?

A. $100

B. $105

C. $110

D. $115

59. Assume the risk-free interest rate is 10% and is equal to the fund’s benchmark, the portfolio’s net asset value is $100, and the fund’s standard deviation is 20%. Also assume a time horizon of 1 year.

What is the Black-Scholes value of the call option on the management incentive fee?

A. $6.67

B. $8.18

C. $9.74

D. $10.22

60. Assume the risk-free interest rate is 10% and is equal to the fund’s benchmark, the portfolio’s net asset value is $100, and the fund’s standard deviation is 20%. Also assume a time horizon of 1 year.

Assuming a 2% management fee and a 20% incentive bonus, what is the expected management compensation per share if the fund’s net asset value exceeds the stated benchmark?

A. $4.24

B. $4

C. $3.84

D. $2.20

21
Student: ___________________________________________________________________________
1. Which one of the following is an example of “global” consumption smoothing?

A. Borrowing to buy a car

B. Borrowing to buy a home

C. Saving to send children to college

D. Saving during your working years for retirement

2. Inflation has an adverse effect on your savings because:

I. It erodes the purchasing power of the dollars you have saved.
II. It increases the real rate of return on the dollars you save.
III. Unless sheltered, it increases the taxes owed on investment income.

A. I only

B. II and III only

C. I and III only

D. I, II, and III

3. If you want to tilt your savings toward later years, you might be well advised to purchase which of the following types of readily available insurance?

A. Career failure insurance

B. Disability insurance

C. Unemployment insurance

D. Moral hazard insurance

4. Which one of the following represents local consumption smoothing?

I. Saving during your working years for retirement
II. Borrowing money to buy a car
III. Putting off a vacation for a year until you can afford it

A. I only

B. II and III only

C. I and II only

D. I, II, and III

5. In a private defined benefit pension plan the ___________ bears the investment risk, and in a private defined contribution plan the ____________ bears the investment risk.

A. plan sponsor; employee

B. employee; plan sponsor

C. U.S. government; plan sponsor

D. plan sponsor; U.S. government

6. A decrease of 1% in both your tax exemption and your income tax rate would, on net, _______________.

A. make you better off

B. make you worse off

C. make you neither better off nor worse off

D. make you either better or worse off depending on your age

7. Tax shelters __________________.

A. postpone payment of tax liabilities

B. decrease investment risk

C. increase the pretax rate of return earned

D. benefit the government more than the investor

8. The tax effect of a traditional retirement plan is to _____ taxes.

A. evade

B. postpone

C. erase

D. avoid

9. The U.S. income tax code is generally _____.

A. regressive

B. progressive

C. flat

D. peaked

10. Contributions to a _____________ are not tax deductible.

A. traditional retirement plan

B. Roth retirement plan

C. 401k plan

D. 403b plan

11. No taxes are paid on withdrawals made during retirement from a _________.

A. traditional retirement plan

B. Roth retirement plan

C. 401k

D. 403b plan

12. You earn 6% on your corporate bond portfolio this year, and you are in a 25% federal tax bracket and an 8% state tax bracket. Your after-tax return is _____. (Assume that federal taxes are not deductible against state taxes and vice versa).

A. 4.5%

B. 4.14%

C. 4.02%

D. 3.12%

13. You work for Fun-A-Rama Corporation and receive stock options as an incentive for your performance on the job. You are counting on the stock options to provide the funds you’ll need for your retirement. This is called _____________.

A. adverse selection

B. a 529 plan

C. a moral hazard

D. a Texas hedge

14. You can tax-shelter only one-half of your retirement savings. You want to invest one-half of your savings in bonds and one-half in stocks. How much of the bonds and how much of the stocks should you allocate to the tax-sheltered investment?

A. Stock and bond investments should be equally invested in both tax-sheltered and nonsheltered accounts.

B. You should place all the stocks in tax-sheltered accounts and all the bonds in nonsheltered accounts.

C. You should place all the bonds in tax-sheltered accounts and all the stocks in nonsheltered accounts.

D. It makes no difference how you allocate your stock and bond investments among tax sheltered and nonsheltered accounts.

15. Social Security is ____________.

A. a pension plan only

B. an insurance plan only

C. a combination of a pension and insurance plan

D. an involuntary intergenerational transfer

16. The Social Security system _______________.

A. is financed in a regressive way

B. is regressive in the way it allocates benefits

C. is progressive in the way it is financed

D. is fully funded for the foreseeable future

17. Total annuity income is positively correlated with:

I. Longevity
II. Durability of marriage
III. Expected length of your base (Social Security) annuity

A. I only

B. I and II only

C. II and III only

D. I, II, and III

18. The solvency of Social Security is threatened by ______________.

A. increasing population longevity

B. above-replacement growth of the U.S. population

C. alternative tax shelters

D. the growth of competing defined contribution plans

19. A person in poor health trying to buy supplemental health insurance is an example of ________.

A. moral hazard

B. adverse selection

C. a Texas hedge

D. actuarial error

20. A person in excellent health with a long life expectancy chooses a lifetime annuity. This is an example of _________.

A. moral hazard

B. adverse selection

C. a Texas hedge

D. actuarial error

21. It would be costly to provide wage insurance because of the ___________ problem.

A. moral hazard

B. adverse selection

C. Texas hedge

D. actuarial error

22. You earned 8% on your corporate bond portfolio this year, and you are in a 15% federal tax bracket. If over your holding period inflation was 3%, your real after-tax rate of return was _____.

A. 6.8%

B. 3.69%

C. 4.91%

D. 4.25%

23. As you get older, you decide to reduce the risk level of your retirement portfolio because your portfolio is nearing your minimum acceptable level. As the portfolio does better, you reallocate funds into higher-risk categories. You are practicing a form of ____________.

A. manipulating tax shelters

B. involuntary intergenerational transfers

C. excessive savings

D. dynamic hedging

24. Tilting your retirement savings plan toward your later years should only be done by investors _____________.

A. who are sufficiently risk averse

B. who are more tolerant of risk

C. who are unsure if their income growth will keep up with inflation

D. who want to retire early

25. Employers commonly match at least some portion of employee contributions to:

I. 401k plans
II.403b plans
III. Self-directed retirement plans

A. I only

B. I and II only

C. II only

D. I, II, and III

26. A saver who expects to have a higher tax rate after retirement would prefer a ______.

A. Roth retirement plan

B. traditional retirement plan

C. 401k plan

D. 403b plan

27. A retirement plan that offers a tax shelter will defer ______________ taxes on contributions and investment earnings.

A. income

B. sales

C. property

D. estate

28. A study by Spivack and Kotlikoff (1981) showed that a marriage contract increases the dollar value of lifetime savings by as much as _____.

A. 5%

B. 10%

C. 25%

D. 50%

29. Taxes are applied to the _______________________.

A. real value of sheltered investment income

B. nominal value of unsheltered investment income

C. nominal value of sheltered investment income

D. real value of unsheltered investment income

30. One feasible way to hedge labor income is to ____________________.

A. diversify your investment portfolio away from the industry in which you work

B. save for retirement only from investment income

C. change careers every 7 years

D. invest heavily in the stock options provided by your firm

31. Which one of the following is not likely to be subject to adverse selection?

A. Health insurance providers

B. Lifetime annuity providers

C. Life insurance providers

D. Social Security

32. Average Indexed Monthly Earnings are used to compute ___________.

A. the consumer price index

B. your Social Security retirement benefits

C. your maximum 401k contribution

D. your maximum retirement plan contribution

33. The Social Security Primary Insurance Amount formula favors ______.

A. older workers

B. high-income workers

C. younger workers

D. low-income workers

34. Contributions to a traditional retirement plan are __________, and contributions to a Roth retirement plan are ____________.

A. not tax deductible; not tax deducible

B. tax deductible; tax deductible

C. tax deductible; not tax deductible

D. not tax deductible; tax deductible

35. How many years of Social Security contributions count for determination of benefits?

A. 25

B. 35

C. 45

D. All yearly contributions count.

36. Under current rules most workers will have ________ of their salary deducted to pay for Social Security retirement benefits and _______ toward Medicare.

A. 1.45%; 6.2%

B. 6.2%; 1.45%

C. 7.65%; 1.45%%

D. 15.3%; 4.9%

37. In 2012, the income cap on Social Security taxes was set at _____ with an exemption of _____.

A. $200,000; $10,000

B. $153,600; $7,600

C. $110,100; $0

D. $96,000; $10,000

38. If your marginal tax rate is 15%, your capital gains tax rate on a stock you have held for 10 years would be ___.

A. 5%

B. 15%

C. 20%

D. 27.5%

39. A tax shelter that allows for tax-exempt saving for higher education is called a _____.

A. Roth savings plan

B. 403b

C. 401k

D. 529 plan

40. Withdrawals from a traditional retirement plan prior to age ___ are taxable and must pay a ___ tax penalty.

A. 59½; 10%

B. 62; 5%

C. 65; 7½ %

D. 63½; 5%

41. In planning for retirement, an investor decides she will save $2,000 every year for 25 years. At a 7% return on her investment, how much money will she have at the end of 25 years?

A. $119,015

B. $125,316

C. $126,498

D. $128,420

42. In planning for retirement, an investor decides she will save $11,000 every year for 40 years. At an 11% return on her investment, how much money will she have at the end of 40 years (to the nearest hundred thousand dollars)?

A. $1,400,000

B. $2,800,000

C. $4,900,000

D. $6,400,000

43. An investor plans to retire at age 60 with total savings of $1,000,000. If she is currently 35 years old, has no savings, and expects to earn 8% per year on her investments, how much money must she set aside every year?

A. $15,546

B. $13,679

C. $11,892

D. $10,324

44. An insurance company plans to sell annuities to investors. Based on actuarial calculations, an investor has a 15-year life span, and he wants a $30,000-per-year annuity, payable at the end of each year. If the insurance company uses a 4% assumed investment rate, how much should the annuity cost?

A. $296,928

B. $312,236

C. $333,552

D. $353.982

45. A safe driver who drives faster as a result of purchasing collision car insurance would be an example of the ___________ problem.

A. moral hazard

B. adverse selection

C. Texas hedge

D. actuarial error

46. A worker plans to retire in 20 years. He needs $20,000 per year in retirement income in today’s dollars. If inflation is forecast at 3.5% per year, what annual income should he plan to receive in the first year of retirement in order to maintain the purchasing power on $20,000?

A. $30,353

B. $34,159

C. $37,398

D. $39,796

47. An insurance company plans to sell annuities to investors. Based on actuarial calculations, an investor has a 20-year life span, and she wants a $50,000-per-year annuity, payable at the end of each year. If the insurance company uses a 3% assumed investment rate, how much should the annuity cost?

A. $696,928

B. $743,874

C. $833,552

D. $953.982

48. A worker plans to retire in 30 years. He hopes to receive $65,000 per year in retirement income. If inflation is forecast at 2.5% per year, what annual income should he plan to receive in the first year of retirement in order to maintain the purchasing power on $65,000?

A. $65,000

B. $76,159

C. $98,398

D. $136,342

49. An investor must decide between putting $2,000 into a regular retirement plan or putting $1,440 into a Roth retirement plan. If the investor’s tax rate is 28% now and in retirement, and she expects to earn 12% per year over the next 20 years, which will produce more cash in the end?

A. The investment in the regular retirement plan.

B. The investment in the Roth retirement plan.

C. Both investments will have the same future value after taxes.

D. The answer cannot be determined from the information given.

50. A regular retirement plan requires that taxes be paid at the time the money is removed from the plan. What is the after-tax value of a $5,000 deposit into a retirement plan today that generates an 8% return for 20 years if the investor is taxed at the 28% level?

A. $16,779

B. $20,135

C. $21,685

D. $23,305

51. What is the value of a $2,500 deposit into a retirement plan if the investment earns 12% per year for 15 years?

A. $12,174

B. $13,684

C. $14,652

D. $15,523

52. The employees of a firm complain that they cannot afford to contribute $8,000 per year to a 401k because of the loss of $8,000 of take-home pay. In fact, how much will the take-home pay be reduced if all taxes combined total 33%?

A. $5,360

B. $6,340

C. $7,637

D. $8,000

53. An employee uses her firm’s 401k plan. If she decides to contribute $11,000 per year and pays an effective tax rate for all items of 28%, what is the reduction in her take-home pay each year?

A. $3,080

B. $4,210

C. $7,920

D. $11,000

54. An investor has an effective tax rate on all items of 30%, and he decides to put $8,000 into a 401k. The future value of the investment that results from the deferral of taxes over 30 years at an 8% return equals _____________.

A. $2,400

B. $8,000

C. $10,400

D. $24,150

55. Withdrawals after retirement from a traditional retirement plan are __________, and withdrawals after retirement from a Roth retirement plan are ____________.

A. taxable; not taxable

B. not taxable; taxable

C. tax deductible; not tax deductible

D. not tax deductible; tax deductible

56. If you start saving for retirement only in your later years and your income growth from that point is rapid, then ________________________.

A. a traditional retirement plan is probably a better choice than a Roth retirement plan

B. a Roth retirement plan is probably a better choice than a traditional retirement plan

C. a SEP is probably a better choice than Medicare

D. a 401k is probably a better choice than a 403b

57. Which one of the following statements about 401k plans is not correct?

A. The employer will typically match some portion of an employee’s contributions to a 401k.

B. A 401k plan is a defined contribution plan.

C. Allowable contributions to 401k plans are limited.

D. Withdrawals from 401k plans are not taxed upon retirement.

58. Suppose you have maxed out your allowable contributions to your tax-sheltered retirement plans and you still want to shelter income. The best choice of investment for you to minimize the tax bill is to invest in _________.

A. a bond portfolio

B. stocks with high dividend yields

C. a blended stock and bond portfolio containing zero-coupon bonds

D. stocks with low or zero dividend yields

59. A bond portfolio and a stock portfolio both provided an unrealized pretax return of 8% to a taxable investor. If the stocks paid no dividends, we know that the ________.

A. after-tax return of the stock portfolio was higher than the after-tax return of the bond portfolio

B. after-tax return of the bond portfolio was higher than the after-tax return of the stock portfolio

C. after-tax income of the stock portfolio was equal to the after-tax income of the bond portfolio

D. after-tax income of the stock portfolio could have been higher or lower than the after-tax income of the bond portfolio, depending on the marginal tax rate of the investor

60. Statistics show that life expectancy at age 66 for males is about _____ additional years and for females is about _____ additional years.

A. 15; 20

B. 16; 19

C. 18; 22

D. 19; 24

61. Currently, the maximum combined taxable income of a retired household that avoids having to pay any taxes on a portion of their Social Security benefit is ______.

A. $15,000

B. $32,000

C. $45,000

D. $75,000

62. An investor can earn a 6% nominal rate of return, but inflation is expected to be 3%. If the individual invests $2,000 per year for 20 years, the real future value of this investment is ________. (All investments occur at year-end).

A. $73,571

B. $66,334

C. $53,251

D. $48,732

63. An individual wants to have $95,000 per year to live on when she retires in 30 years. The individual is planning on living for 20 years after retirement. If the investor can earn 6% during her retirement years and 10% during her working years, how much should she be saving during her working life? (Hint: Treat all calculations as annuities.)

A. $9,872

B. $8,234

C. $7,908

D. $6,624

64. If you plan for a bequest for your children, your grandchildren, their children, and so on, your planning horizon becomes _____.

A. equal to the life span of your children

B. 100 years, or your lifetime, whichever ends first

C. infinite

D. double what it would have been without the bequest

65. You want to minimize your current tax bill by maximizing your contributions to your _____________.

A. taxable bond portfolio

B. Roth retirement plan

C. 401k or 403b plan

D. taxable savings account

66. Sharon decides to put $5,000 into her retirement plan at the age of 25. She will continue to invest the same amount for a total of 6 years and then stop contributing. Assume 10% annual return.

How much money will Sharon have in her retirement plan after 6 years?

A. $30,000

B. $35,575

C. $38,578

D. $41,451

67. Sharon decides to put $5,000 into her retirement plan at the age of 25. She will continue to invest the same amount for a total of 6 years and then stop contributing. Assume 10% annual return.

How much money will Sharon have in her retirement plan when she is ready to retire at age 62?

A. $554,856

B. $623,245

C. $740,480

D. $1,311,805

68. A nonprofit organization offers a 5% salary contribution to John’s 403b plan regardless of his own contributions, plus a matching 5% when John contributes 5% of his salary. John makes $56,000 a year.

What is the amount of the total contribution to his 403b if John contributes 5% of his own money?

A. $5,600

B. $8,400

C. $11,200

D. $12,500

69. A nonprofit organization offers a 5% salary contribution to John’s 403b plan regardless of his own contributions, plus a matching 5% when John contributes 5% of his salary. John makes $56,000 a year.

What is John’s effective salary reduction if he is in the 25% tax bracket?

A. $2,100

B. $2,800

C. $5,600

D. $8,400

70. A nonprofit organization offers a 5% salary contribution to John’s 403b plan regardless of his own contributions, plus a matching 5% when John contributes 5% of his salary. John makes $56,000 a year.

What is John’s total cost of his 5% contribution?

A. $2,100 cost

B. $2,800 cost

C. $700 benefit

D. $3.500 benefit

71. The fact that the U.S. government provides deposit insurance to banks creates a form of ___________, which is at least partially offset by requiring banks to hold more capital if they are riskier.

A. moral hazard

B. adverse selection

C. risk aversion

D. interest rate risk

72. An investor in the 34% tax bracket would be indifferent between a corporate bond with a before-tax yield of 8% and a municipal bond with a yield of _________.

A. 3.91%

B. 6.15%

C. 5.28%

D. 10.72%

73. An investor who is in the 35% federal tax bracket and the 5% state bracket buys a 6.5% yield corporate bond. What is his after-tax yield? (Assume that federal taxes are not deductible against state taxes and vice versa).

A. 3.9%

B. 4.75%

C. 6.5%

D. 9.9%

22
Student: ___________________________________________________________________________
1. To _____ means to mitigate a financial risk.

A. invest

B. speculate

C. hedge

D. renege

2. In a defined benefit pension plan, the _____ bears all of the fund’s investment performance risk.

A. employer

B. employee

C. fund manager

D. government

3. In a defined contribution pension plan, the _____ bears all of the fund’s investment performance risk.

A. employer

B. employee

C. fund manager

D. government

4. My pension plan will pay me a yearly retirement amount equal to 2% of my highest annual salary for each year of service. I must have ___________.

A. a defined benefit plan

B. a defined contribution plan

C. an endowment fund

D. a variable annuity

5. A ______ insurance policy provides death benefits, with no buildup of cash value.

A. whole-life

B. universal life

C. variable life

D. term life

6. If the maturity of a bank’s assets is much longer than the maturity of its liabilities and it wants to limit its interest rate risk, the bank may _________.

A. prefer to invest in long-term bonds in its asset portfolio

B. prefer to invest in equities in its asset portfolio

C. prefer to invest in variable-rate assets

D. decide to increase its fixed-rate mortgage holdings

7. You are thinking of investing in one of two assets. Asset A has higher systematic risk than asset B. You can be sure that asset A’s _______ return will be higher than asset B’s, but you can’t be sure if asset A’s _______ return will be higher than asset B’s.

A. realized; expected

B. real; nominal

C. expected; realized

D. nominal; expected

8. A mutual fund may not hold more than ______ of the shares of any publicly traded company.

A. 5%

B. 10%

C. 25%

D. 50%

9. Which one of the following would be considered a “cash equivalent” investment?

A. Treasury bills

B. Common stock

C. Corporate bonds

D. Real estate

10. For a bank, the difference between the interest rate charged to borrowers and the interest rate paid on liabilities is called the __________.

A. insurance premium

B. interest rate spread

C. risk premium

D. term premium

11. Price volatility is greatest on which one of the following investments?

A. Commercial paper

B. 20-year zero-coupon bonds

C. Treasury notes

D. Treasury bills

12. A portfolio manager indexes part of a portfolio and actively manages the rest of the portfolio. This is called a _________ strategy.

A. passive-aggressive

B. passive core

C. passively active

D. balanced fund

13. The major asset most people have during their early working years is their ________.

A. home

B. stock portfolio

C. earning power derived from their skills

D. bond portfolio

14. At the early stage of an individual’s working career, his or her retirement portfolio should probably consist mostly of _______.

A. annuities

B. stocks

C. bonds

D. commodities

15. If an investor wants to invest 100% of her portfolio in safe assets but does not want to manage her portfolio, she should invest in __________.

A. a money market fund

B. a growth stock fund

C. several different money market instruments

D. several different stocks

16. Just 2 months after you put money into an investment, its price falls 25%. Assuming that none of the investment fundamentals have changed, which of the following actions would evidence the greatest risk tolerance?

A. You sell to avoid further worry and buy something else.

B. You do nothing and wait for the investment to come back.

C. You buy more, thinking that if it was a good investment before, now it’s not only good but cheap too.

D. You sue your financial adviser.

17. To become a CFA, you must do all of the following except which one?

A. Pass three exams designed to ensure that you have sufficient knowledge of investments.

B. Obtain 3 years of work experience in money management.

C. Become a member of a local Society of the Financial Analysts Federation.

D. Divest all your own stock holdings to eliminate any potential conflicts of interest with client recommendations.

18. Which of the following is not one of the main areas covered in the examinations that must be taken in order to achieve the designation of Chartered Financial Analyst?

A. Investment management ethics

B. Securities analysis

C. Securities marketing techniques

D. Portfolio management

19. As the typical investor ages, the composition of his wealth usually switches from primarily _______ to primarily _______.

A. human capital; financial capital

B. financial capital; human capital

C. intellectual capital; physical capital

D. investable capital; noninvestable capital

20. The two most important factors in describing an individual’s or organization’s investment objectives are ________________.

A. income level and age

B. income level and risk tolerance

C. age and risk tolerance

D. return requirement and risk tolerance

21. The term hedge refers to an investment that is used ________________.

A. primarily for tax-loss selling purposes

B. to mitigate specific financial risks

C. to conceal one’s true investment strategy from other market participants

D. primarily to defer capital losses

22. The price of your investment increases 20% one month after you buy it. You do not believe that the stock’s prospects have changed. Which one of the following actions would indicate the lowest amount of risk aversion?

A. You hang on to the stock, anticipating that it will go higher.

B. You buy more stock, anticipating that it will go higher.

C. You sell all of your stock holdings immediately.

D. You sell half of your stock holdings and invest the proceeds in other areas of your portfolio.

23. An individual is on the game show Squeal or No Squeal, and she has a choice between receiving a certain gain of $100,000 and receiving a 50% chance of winning $200,000 or zero. If she takes the gamble instead of the certain $100,000, she is acting ____________________.

A. like a person who is risk-neutral

B. like a person who is risk averse

C. like a person who is a risk lover

D. irrationally

24. Which of the following typically strives to earn a return on their investments that exceeds the actuarially determined rate of return?

A. Banks

B. Thrifts

C. Mutual funds

D. Pension funds

25. If an individual confers legal title to property to another person or institution to manage the property on their behalf, the individual has created ___________.

A. a personal trust

B. a charitable trust

C. an endowment fund

D. a mutual fund

26. Personal trusts are typically allowed to engage in which of the following investment activities?

I. Buying and selling futures contracts.
II. Short-selling securities.
III. Purchasing and writing options.
IV. Buying stock on margin.

A. I only

B. II and III only

C. II and IV only

D. None of the given activities are allowed.

27. If a defined benefit pension fund’s actual rate of return is _____ than the actuarial assumed rate, then the ___________.

A. greater; employees will benefit

B. greater; firm’s shareholders will benefit

C. lower; employees will benefit

D. lower; firm’s shareholders will benefit

28. An employee has an average wage of $60,000 and has worked for the firm for 25 years. The defined benefit pension plan pays retirees 2.5% of the average wage times the years of service. The employee can expect to receive _______ per year upon retirement.

A. $18,000

B. $37,500

C. $45,325

D. $55,250

29. Life insurance companies try to hedge the risks inherent in whole-life insurance policies by investing in __________.

A. long-term bonds

B. money market mutual funds

C. savings accounts

D. short-term commercial paper

30. A pension fund will owe $10 million to retirees in 6 years. An actuary assumes an 8% rate of return on the funds invested in the pension plan. If the pension plan receives annual contributions from the company sponsor, how much must the company pay each year to fully fund the pension liability?

A. $1,212,587

B. $1,363,154

C. $1,533,333

D. $1,666,667

31. The risk that a downturn in the market may substantially reduce your investment principal is called _______.

A. purchasing power risk

B. interest rate risk

C. market risk

D. liquidity risk

32. The possibility that you are too conservative and your money doesn’t grow fast enough to keep pace with inflation is called ________.

A. purchasing power risk

B. liquidity risk

C. timing risk

D. market risk

33. A pension fund will owe $15 million to retirees in 20 years. An actuary assumes a 6% rate of return on the funds invested in the pension plan, but the fund actually earns 8%. The pension plan receives annual contributions from the company sponsor. If the 8% rate of return is expected to continue, by how much can the company reduce its pension payments per year?

A. $65,437

B. $79,985

C. $89,462

D. $95,320

34. Many defined benefit pension plans have a target rate of return on investment that is equal to the ____________.

A. firm’s return on equity

B. plan’s assumed actuarial rate of return

C. economic inflation rate because wages often increase with inflation

D. estimated stock market return

35. _______ is a life insurance policy that provides a death benefit and a fixed-rate tax-deferred savings plan.

A. Term life

B. Whole life

C. Variable life

D. Universal life

36. Empirical evidence confirms that investors become __________ as they approach retirement.

A. greedier

B. less interested in investments

C. more risk averse

D. more risk tolerant

37. _______ is a life insurance policy that will provide a death benefit only and has no savings plan.

A. Term life

B. Whole life

C. Variable life

D. Universal life

38. Of the following, the investment time horizon is typically the shortest for __________.

A. banks

B. endowment funds

C. life insurance companies

D. pension funds

39. A passive asset allocation strategy involves _________.

A. investing in the stock of companies that are price takers

B. maintaining approximately the same proportions of a portfolio in each asset class over time

C. varying the proportions of a portfolio in each asset class in response to changing market conditions

D. selecting individual securities in different sectors that are believed to be undervalued

40. An active asset allocation strategy involves _________.

A. investing in the stock of companies that are price takers

B. maintaining approximately the same proportions of a portfolio in each asset class over time

C. varying the proportions of a portfolio in each asset class in response to changing market conditions

D. selecting individual securities in different sectors that are believed to be undervalued

41. Endowment funds are held by __________.

A. financial intermediaries

B. individuals

C. profit-oriented firms

D. nonprofit institutions

42. Which one of the following is a life insurance policy that will provide a fixed death benefit and allows the policyholder to choose where to invest the policy’s cash value?

A. Term life

B. Whole life

C. Variable life

D. Industrial life

43. Under a “passive core” portfolio management strategy, a manager would ___________.

A. index the entire portfolio

B. index part of the portfolio and actively manage the rest

C. delegate the management of core segments of the portfolio to other managers

D. actively manage the entire portfolio

44. Of the following, the most flexible type of life insurance policy from the policyholder’s perspective is probably a ___________ policy.

A. term life

B. whole life

C. variable life

D. universal life

45. The amount of risk an individual should take depends on his or her:

I. Return requirements
II. Risk tolerance
III. Time horizon

A. I only

B. I and II only

C. II and III only

D. I, II, and III

46. Earnings on variable life and universal life insurance policies are ___________.

A. never taxed

B. taxed only at the capital gains tax rate

C. not taxed until the money is withdrawn

D. not taxed at the federal level but are taxed at the state level

47. When a company sets up a defined contribution pension plan, the __________ bears all the risk and the __________ receives all the return from the plan’s assets.

A. employee; employee

B. employee; employer

C. employer; employee

D. employer; employer

48. Suppose that the pretax holding-period returns on two stocks are the same. Stock A has a high dividend payout policy and stock B has a low dividend payout policy. If you are a high-tax rate individual and do not intend to sell the stocks during the holding period, __________.

A. stock A will have a higher after-tax holding-period return than stock B

B. the after-tax holding period returns on stocks A and B will be the same

C. stock B will have a higher after-tax holding-period return than stock A

D. The answer cannot be determined from the information given.

49. The objectives of personal trusts normally are __________ in scope than those of individual investors, and personal trust managers typically are __________ than individual investors.

A. broader; more risk averse

B. broader; less risk averse

C. more limited; more risk averse

D. more limited; less risk averse

50. The prudent investor rule requires __________.

A. executives of companies to avoid investing in options of companies they work for

B. executives of companies to disclose their transactions in stocks of companies they work for

C. professional investors who manage money for others to avoid all risky investments

D. professional investors who manage money for others to constrain their investments to those that would be approved by a prudent investor

51. The prudent investor rule is an example of a regulation designed to ensure appropriate _____________ by money managers.

A. fiduciary responsibility

B. fiscal responsibility

C. monetary responsibility

D. marketing procedures

52. An investor has a long time horizon and desires to earn the market rate of return. However, the investor will need to withdraw funds each year from her investment portfolio. The biggest constraint a planner would face with this client is a ___________ constraint.

A. tax

B. risk-tolerance

C. liquidity

D. social

53. When used in the context of investment decision making, the term liquidity refers to _____________.

A. the ease and speed with which an asset can be sold at any value possible

B. the ease and speed with which an asset can be sold without having to discount the value

C. an aspect of monetary policy

D. the proportion of short-term to long-term investments held in an investor’s portfolio

54. The term investment horizon refers to __________.

A. the proportion of short-term to long-term investments held in an investor’s portfolio

B. the planned liquidation date of an investment

C. the average maturity date of investments held in a portfolio

D. the maturity date of the longest investment in the portfolio

55. The choice of an active portfolio management strategy rather than a passive strategy assumes ___________.

A. the ability to continuously adjust the portfolio to provide superior returns

B. asset allocation involving only domestic securities

C. stable economic conditions over the short term

D. the ability to minimize trading costs

56. Conservative investors are likely to want to invest in __________ mutual funds, while risk-tolerant investors are likely to want to invest in __________.

A. income; high growth

B. income; moderate growth

C. moderate-growth; high growth

D. high-growth; moderate growth

57. The first step any investor should take before beginning to invest is to __________.

A. establish investment objectives

B. develop a list of investment managers with superior records to interview

C. establish asset allocation guidelines

D. decide between active management and passive management

58. Which of the following is the least likely to be included in the portfolio management process?

A. Monitoring market conditions and relative values

B. Monitoring investor circumstances

C. Identifying investor constraints and preferences

D. Organizing the investment management process itself

59. A clearly understood investment policy statement is not critical for which one of the following?

I. Mutual funds
II. Individuals
III. Defined benefit pension funds

A. II only

B. III only

C. I only

D. None of these options (A policy statement is necessary for all three.)

60. An investor refuses to invest in any firm that produces alcohol or tobacco. This is an example of a ___________ constraint.

A. return requirement

B. risk-tolerance

C. liquidity

D. social

61. Under the provisions of a typical defined benefit pension plan, the employer is responsible for _____________.

A. investing in conservative fixed-income assets

B. paying benefits to retired employees

C. counseling employees in the selection of asset classes

D. paying employees the market rate of return on employee contributions

62. A life insurance firm wants to minimize its interest rate risk, and it is planning on paying out $250,000 in 5 years. Which one of the following investments best matches its goal?

A. High-yield utility stocks

B. 5-year zero-coupon bonds

C. 10-year coupon bonds

D. Money market investments rolled over as needed

63. An institutional investor will have to pay off a maturing bond issue in 3 years. The institution has 10,000 bonds outstanding, each with a $1,000 par value. The institutional money manager is reevaluating the fund’s total portfolio of $100 million at this time. She is bullish on stocks and wants to put the most she can into the stock market, but she cannot risk being unable to pay off the bonds. Three-year zero-coupon bonds are available paying 6% interest. What percentage of the total $100 million portfolio can she put in stocks and still ensure meeting the bond payments?

A. 87.4%

B. 88.5%

C. 90%

D. 91.6%

64. An investor with high risk aversion will likely prefer which of the following risk and return combinations?

A. Expected return = 12%, historical standard deviation = 17%

B. Expected return = 14%, historical standard deviation = 19%

C. Expected return = 16%, historical standard deviation = 21%

D. Expected return = 18%, historical standard deviation = 23%

65. An investor with low risk aversion will likely prefer which of the following risk and return combinations?

A. Expected return = 11%, historical standard deviation = 12%

B. Expected return = 12%, historical standard deviation = 14%

C. Expected return = 14%, historical standard deviation = 18%

D. Expected return = 17%, historical standard deviation = 21%

66. Medfield College’s $10 million endowment fund is not allowed to spend any contributed capital or any capital gains. The fund may spend only investment earnings. The fund is expected to need between $500,000 and $1,000,000 to pay for new lab equipment for the science building. Which of the following is (are) true?

I. The fund should have a target rate of return of at least 10%.
II. The limitations on spending require that the fund limit its considerations to growth stocks.
III. The requirement to spend money out of the fund this year provides a liquidity constraint that may reduce the fund’s rate of return.

A. I only

B. II only

C. I and III only

D. I, II, and III

67. An investor is looking at different retirement investment choices, and he is willing to accept one with upside potential even if that means sacrificing certainty. Which of the following will he most likely select?

A. Fixed annuity

B. Defined benefit plan

C. Defined contribution plan

D. Bonds invested in a retirement plan

68. Both a wife and her husband work in the airline industry. They are in their 40s, and they have a high tax bracket and are concerned about their after-tax rate of return. A meeting with their financial planner reveals that they are primarily focused on long-term capital gains and will need at least a 9% to 11% average rate of return to meet their retirement goals. They desire a diversified portfolio, and liquidity is not currently a major concern. Which of the following asset allocations seems to best fit their situation?

A. 10% money market; 40% long-term bonds; 10% commodities; 40% high-dividend-paying stocks

B. 0% money market; 60% long-term bonds; 40% stocks

C. 10% money market; 30% long-term bonds; 10% commodities; 50% high-dividend-paying stocks

D. 5% money market; 30% long-term bonds; 5% commodities; 60% stocks, most with low dividends and high growth prospects

69. A family will retire in a few years. They have a high tax bracket and are concerned about their after-tax rate of return. A meeting with their financial planner reveals that they are primarily focused on safety of principal and will need a 6% to 8% average rate of return on their portfolio. They desire a diversified portfolio, and liquidity is likely to be a concern due to health reasons. Which of the following asset allocations seems to best fit this family’s situation?

A. 10% money market; 50% intermediate-term bonds; 40% blue chip stocks, many with high dividend yields

B. 0% money market; 60% intermediate-term bonds; 40% stocks

C. 10% money market; 30% intermediate-term bonds; 60% high-dividend-paying stocks

D. 5% money market; 35% intermediate-term bonds; 60% stocks, most with low dividends

70. Your sister, an avid outdoors person, works in the airline industry, and she has come to you (the financial guru) for investment advice. She is looking into purchasing stocks she knows something about. She is considering purchasing stock in Boeing, Lockheed Martin, United Technologies (maker of aircraft engines), and Cabela’s Sporting Goods. Based only on the information given, which stock should you recommend for her?

A. Boeing

B. Lockheed Martin

C. United Technologies

D. Cabela’s

71. In 1937 the Eli Lilly family donated millions of dollars in stock to fund a not-for-profit charitable organization. Such organizations are typically called _________________.

A. annuities

B. endowments

C. mutual funds

D. personal trusts

72. Which one of the following institutions typically has the longest investment horizon?

A. Mutual funds

B. Pension funds

C. Property and casualty insurers

D. Banks

73. For which one of the following institutions is liquidity usually the most important?

A. Mutual funds

B. Pension funds

C. Life insurers

D. Banks

74. One of the major functions of the investment committee is to ________________.

A. determine security selection of each portfolio operated by the investment company

B. translate the objectives and constraints of the investment company into an asset universe

C. determine the percentages of each security in the total investment company portfolio

D. calculate and report the overall rate of return to investment company constituents

75. For an investor concerned with maximizing liquidity, which of the following investments should be avoided?

A. Real estate

B. Bonds

C. Domestic stocks

D. International stocks

76. The asset universe is the _____________________.

A. set of investments in which an investment company can legally invest

B. existing set of assets the investment company currently owns in one or more of its portfolios

C. list of assets approved by the investment committee that may be placed into the investment company’s portfolio

D. market portfolio of all available risky assets

77. Go Global Investment Management has an asset allocation strategy of 60% U.S. investments and 40% global investments. Within the United States, Go Global has allocated 70% of its portfolio to equities and 30% to bonds. Go Global now holds 3% of its U.S. equity portfolio in the stock of Wally World. Internationally, Go Global has allocated 55% to equities and 45% to bonds. About what percentage of Go Global’s total portfolio is invested in Wally World?

A. 1%

B. 1.26%

C. 1.5%

D. 1.77%

78. Major functions of the investment committee include all but which one of the following?

A. Engage in security selection for each portfolio managed

B. Broadly determine the overall asset allocation of the investment company

C. Determine the asset-class weights for each portfolio

D. Determine the asset universe

79. A portfolio consists of three index funds: an equity index, a bond index, and an international index. The portfolio manager changes the weights periodically according to forecasts for each sector. This is an example of __________.

A. a passively managed core with an actively managed component

B. a totally passively managed fund

C. passive asset allocation with active security selection

D. active asset allocation with passive security selection

80. A portfolio consists of three index funds: an equity index accounting for 40% of the total portfolio, a bond index accounting for 30% of the total portfolio, and an international index accounting for 30% of the total portfolio. After each quarter the portfolio manager buys and sells some of each sector to preserve the original weights for each sector. This is an example of ____________.

A. a passively managed core with an actively managed component

B. a totally passively managed fund

C. passive asset allocation with active security selection

D. active asset allocation with passive security selection

81. One way that life insurance firms can hedge the risk created by offering whole-life insurance policies is by ________________.

A. holding long-term bonds

B. holding equities

C. holding short-term bonds

D. exercising its right to terminate the policy

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FIN 350 Week 2 Quiz Solution

Chapter 1—Role of Financial Markets and Institutions

1. Financial market participants who provide funds are called
a. deficit units.
b. surplus units.
c. primary units.
d. secondary units.

2. 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.

3. The largest deficit unit is (are)
a. households and businesses.
b. foreign financial institutions.
c. the U.S. Treasury.
d. foreign nonfinancial sectors.

4. Those financial markets that facilitate the flow of short-term funds are known as
a. money markets.
b. capital markets.
c. primary markets.
d. secondary markets.

5. Funds are provided to the initial issuer of securities in the
a. secondary market.
b. primary market.
c. deficit market.
d. surplus market.

6. Which of the following is a capital market instrument?
a. a six-month CD
b. a three-month Treasury bill
c. a ten-year bond
d. an agreement for a bank to loan funds directly to a company for nine months

7. Which of the following is a money market security?
a. Treasury note
b. municipal bond
c. mortgage
d. commercial paper

8. The creditors in the federal funds market are
a. households.
b. depository institutions.
c. firms.
d. government agencies.

9. Equity securities have a ____ expected return than most long-term debt securities, and they exhibit a ____ degree of risk.
a. higher; higher
b. lower; lower
c. lower; higher
d. higher; lower

10. Money market securities generally have ____. Capital market securities are typically expected to have a ____.
a. less liquidity; higher annualized return
b. more liquidity; lower annualized return
c. less liquidity; lower annualized return
d. more liquidity; higher annualized return

11. If security prices fully reflect all available information, the markets for these securities are
a. efficient.
b. primary.
c. overvalued.
d. undervalued.

12. If markets are ____, investors could use available information ignored by the market to earn abnormally high returns.
a. perfect
b. active
c. inefficient
d. in equilibrium

13. If financial markets are efficient, this implies that all securities should earn the same return.
a. True
b. False

14. The Securities Act of 1933
a. required complete disclosure of relevant financial information for publicly offered securities in the primary market.
b. declared trading strategies to manipulate the prices of public secondary securities illegal.
c. declared misleading financial statements for public primary securities illegal.
d. required complete disclosure of relevant financial information for securities traded in the secondary market.
e. all of the above

15. The Securities Exchange Commission (SEC) was established by the
a. Federal Reserve Act.
b. McFadden Act.
c. Securities Exchange Act of 1934.
d. Glass-Steagall Act.
e. none of the above

16. Common stock is an example of a(n)
a. debt security.
b. money market security.
c. equity security.
d. A and B

17. If financial markets were ____, all information about any securities for sale in primary and secondary markets would be continuously and freely available to investors.
a. efficient
b. inefficient
c. perfect
d. imperfect

18. The typical role of a securities firm in a public offering of securities is to
a. purchase the entire issue for its own investment.
b. place the entire issue with a single large investor.
c. spread the issue across several investors until the entire issue is sold.
d. provide all large investors with loans so that they can invest in the offering.

19. Without the participation of financial intermediaries in financial market transactions,
a. information and transaction costs would be lower.
b. transaction costs would be higher but information costs would be unchanged.
c. information costs would be higher but transaction costs would be unchanged.
d. information and transaction costs would be higher.

20. Which of the following is most likely to be described as a depository institution?
a. finance companies
b. securities firms
c. credit unions
d. pension funds
e. insurance companies

21. In aggregate, ____ are the most dominant depository institution, with more total assets than other depository institutions.
a. commercial banks
b. savings banks
c. credit unions
d. S&Ls

22. Which of the following is a nondepository financial institution?
a. savings banks
b. commercial banks
c. savings and loan associations
d. mutual funds

23. Which of the following distinguishes credit unions from commercial banks and savings institutions?
a. Credit unions are non-profit
b. Credit unions accept deposits but do not make loans
c. Credit unions make loans but do not accept deposits
d. Savings institutions restrict their business to members who share a common bond

24. When a securities firm acts as a broker, it
a. guarantees the issuer a specific price for newly issued securities.
b. makes a market in specific securities by adjusting its own inventory.
c. executes transactions between two parties.
d. purchases securities for its own account.

25. When a securities firm acts as a(n) ____, it maintains a position in securities.
a. adviser
b. dealer
c. broker
d. none of the above

26. ____ obtain funds by issuing securities, then lend the funds to individuals and small businesses.
a. Finance companies
b. Securities firms
c. Mutual funds
d. Insurance companies

27. Households with ____ are served by ____.
a. deficient funds; depository institutions and finance companies
b. deficient funds; finance companies only
c. savings; finance companies only
d. savings; pension funds and finance companies

28. ____ concentrate on mortgage loans.
a. Finance companies
b. Commercial banks
c. Savings institutions
d. Credit unions

29. ____ securities have a maturity of one year or less; ____ securities are generally more liquid.
a. Money market; capital market
b. Money market; money market
c. Capital market; money market
d. Capital market; capital market

30. Which of the following is not a major investor in stocks?
a. commercial banks
b. insurance companies
c. mutual funds
d. pension funds

31. Which of the following financial intermediaries commonly invests in stocks and bonds?
a. pension funds
b. insurance companies
c. mutual funds
d. all of the above

32. Securities are certificates that represent a claim on the issuer.
a. True
b. False

33. Debt securities are certificates that represent debt (borrowed funds) by the issuer.
a. True
b. False

34. A five-year security was purchased two years ago by an investor who plans to resell it. The security will be sold by the investor in the so-called
a. secondary market.
b. primary market.
c. deficit market.
d. surplus market.

35. When security prices fully reflect all available information, the markets for these securities are said to be efficient.
a. True
b. False

36. If markets are perfect, securities buyers and sellers to not have full access to information and cannot always break down securities to the precise size they desire.
a. True
b. False

37. A broker executes securities transactions between two parties and charges a fee reflected in the bid-ask spread.
a. True
b. False

38. The euro increased business between European countries and created a more competitive environment in Europe.
a. True
b. False

39. In recent years, financial institutions have consolidated to capitalize on economies of scale and on economies of scope.
a. True
b. False

40. Securities are certificates that represent a claim on the provider of funds.
a. True
b. False

41. Debt securities include commercial paper, Treasury bonds, and corporate bonds.
a. True
b. False

42. Common types of capital market securities include Treasury bills and commercial paper.
a. True
b. False

43. Common types of money market securities include negotiable certificates of deposit and Treasury bills.
a. True
b. False

44. Money market securities are commonly issued in order to finance the purchase of assets such as buildings, equipment, or machinery.
a. True
b. False

45. The total asset value of savings institutions is larger than that of commercial banks.
a. True
b. False

46. Financial markets facilitating the flow of short-term funds with maturities of less than one year are known as
a. secondary markets.
b. capital markets.
c. primary markets.
d. money markets.
e. none of the above

47. Which of the following transactions would not be considered a secondary market transaction?
a. An individual investor purchases some existing shares of stock in IBM through his broker.
b. An institutional investor sells some Disney stock through its broker.
c. A firm that was privately held engages in an offering of stock to the public.
d. All of the above are secondary market transactions.

48. If investors speculate in the underlying asset rather than derivative contracts on the underlying asset, they will probably achieve ____ returns, and they are exposed to relatively ____ risk.
a. lower; lower
b. lower; higher
c. higher; lower
d. higher; higher

49. ____ maintain a larger amount of assets in aggregate than the other types of nondepository institutions.
a. Finance companies
b. Mutual funds
c. Life insurance companies
d. Securities firms

50. A common use of funds for ____ is investment in stocks and businesses, while their main use of funds is providing loans to households and businesses.
a. savings institutions
b. commercial banks
c. mutual funds
d. finance companies

51. Long-term debt securities tend to have a ____ expected return and ____ risk than money market securities.
a. lower; lower
b. lower; higher
c. higher; lower
d. higher; higher

52. Common types of capital market securities include Treasury bills and commercial paper.
a. True
b. False

53. Common types of money market securities include negotiable certificates of deposit and Treasury bills.
a. True
b. False

54. Capital market securities are commonly issued in order to finance the purchase of assets such as buildings, equipment, or machinery.
a. True
b. False

55. Commercial banks in aggregate have more assets than credit unions.
a. True
b. False

56. Those participants who receive more money than they spend are referred to as
a. deficit units.
b. surplus units.
c. borrowing units.
d. government units.

57. 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.

58. The term ____ involves decisions such as how much funding to obtain, and how to invest the proceeds to expand operations.
a. corporate finance
b. investment management
c. financial markets and institutions
d. none of the above

59. There is a ____ relationship between the risk of a security and the expected return from investing in the security.
a. positive
b. negative
c. indeterminable
d. none of the above

60. If a security is undervalued, some investors would capitalize from this by purchasing that security. As a result, the security’s price will ____, resulting in a ____ return for those investors.
a. rise; lower
b. fall; higher
c. fall; lower
d. rise; higher

61. The credit crisis in the 2008-2009 period was caused by weak economies in Asia.
a. True
b. False

62. ____ are classified as a depository institution.
a. Credit unions
b. Pension funds
c. Finance companies
d. Securities firms

63. The main reason that depository institutions experienced financial problems during the credit crisis was their investment in:
a. mortgages.
b. money market securities.
c. stock.
d. Treasury bonds.

64. Those financial markets that facilitate the flow of short-term funds (with maturities of less than one year) are known as capital markets, while those that facilitate the flow of long-term funds are known as money markets.
a. True
b. False

65. Treasury bonds have a maturity of one to three years.
a. True
b. False

66. Since markets are efficient, institutional and individual investors should ignore the various investment instruments available.
a. True
b. False

67. Speculating with derivative contracts on an underlying asset typically results in both higher risk and higher returns than speculating in the underlying asset itself.
a. True
b. False

68. When security prices fully reflect all available information, the markets for these securities are said to be perfect.
a. True
b. False

69. Securities that are not as safe and liquid as other securities are never considered for investment by anyone.
a. True
b. False

70. By requiring full disclosure of information, securities laws prevent investors from making poor investment decisions.
a. True
b. False

71. When a depository institution offers a loan, it is acting as a creditor.
a. True
b. False

72. Savings institutions represent a nondepository institution.
a. True
b. False

73. Most mutual funds obtain funds by issuing securities, then lend the funds to individuals and small businesses.
a. True
b. False

74. Institutional investors not only provide financial support to companies but exercise some degree of corporate control over them.
a. True
b. False

75. Which of the following is not a reason why depository financial institutions are popular?
a. They offer deposit accounts that can accommodate the amount and liquidity characteristics desired by most surplus units.
b. They repackage funds received from deposits to provide loans of the size and maturity desired by deficit units.
c. They accept the risk on loans provided.
d. They use their information resources to act as a broker, executing securities transactions between two parties.
e. They have more expertise than individual surplus units in evaluating the creditworthiness of deficit units.

76. According to your text, which of the following is not considered a money market security?
a. Treasury bills
b. Treasury notes
c. retail CD
d. banker’s acceptance
e. commercial paper

77. ____ are not considered capital market securities.
a. Repurchase agreements
b. Municipal bonds
c. Corporate bonds
d. Equity securities
e. Mortgages

78. ____ are long-term debt obligations issued by corporations and government agencies to support their operations.
a. Common stock
b. Derivative securities
c. Bonds
d. None of the above

79. Equity securities should normally have a ____ expected return and ____ risk than money market securities.
a. lower; lower
b. lower; higher
c. higher; lower
d. higher; higher

80. If investors speculate in derivative contracts rather than the underlying asset, they will probably achieve ____ returns, and they are exposed to relatively ____ risk.
a. lower; lower
b. lower; higher
c. higher; lower
d. higher; higher

81. When particular securities are perceived to be ____ by the market, their prices decrease when they are sold by investors.
a. undervalued
b. overvalued
c. fairly priced
d. efficient
e. none of the above

82. Which of the following are not considered depository financial institutions?
a. finance companies
b. commercial banks
c. savings institutions
d. credit unions
e. All of the above are depository financial institutions.

83. The main source of funds for ____ is proceeds from selling securities to households and businesses, while their main use of funds is providing loans to households and businesses.
a. savings institutions
b. commercial banks
c. mutual funds
d. finance companies
e. pension funds

84. Which of the following statements is incorrect?
a. Financial markets attract funds from investors and channel the funds to corporations.
b. Money markets enable corporations to borrow funds on a short-term basis so that they can support their existing operations.
c. Financial institutions serve solely as intermediaries with the financial markets and never serve as investors.
d. Investors seek to invest their funds in the stock of firms that are presently undervalued and have much potential to improve.

85. Which of the following is not a typical money market security?
a. Treasury bills
b. Treasury bonds
c. Commercial paper
d. Negotiable certificates of deposit

86. Debt securities issued by a small firm may be ________, meaning that _______ investors want to invest in those securities.
a. a. liquid; many
b. a. liquid; not many
c. a. illiquid; not many
d. a. illiquid; many

87. Valuing stocks is easier than valuing debt securities because stocks promise to provide investors with specific payments at regular intervals.
a. True
b. False

88. ____________ applies psychology to financial decisions and offers an explanation for why markets are not always efficient.
a. a. Psychological marketing
b. a. Behavioral finance
c. a. Inefficient markets theory
d. a. Financial psychology

89. International integration of securities markets allows:
a. a. governments and corporations to have easier access to funding from creditors and investors in other countries.
b. a. investors and creditors to benefit from investment opportunities in other countries.
c. a. one’s country’s financial problems to adversely affect other countries.
d. a. All of the above

90. The foreign exchange market facilitates the exchange of:
a. a. information between investors in different countries.
b. a. debt securities.
c. a. equity securities.
d. a. currencies.

91. Which of the following is not an example of the government’s recent increased role in financial markets?
a. a. the Federal Reserve’s purchase of debt securities during the credit crisis
b. a. regulations changing the way that the credit risk of bonds is assessed
c. a. regulations setting maximum rates for Treasury securities
d. a. increased monitoring of stock trading and prosecution of those who trade on inside information

92. Commercial paper represents long-term debt obligations created to finance the purchase of commercial property.
a. True
b. False

93. The risk that financial problems could spread among financial institutions and across financial markets, causing a collapse of the financial system, is known as:
a. a. systemic risk.
b. a. leverage risk.
c. a. financial meltdown risk.
d. a. credit risk.

94. Systemic risk exists because:
a. a. there is no government regulation of financial markets.
b. a. financial institutions invest in similar securities and therefore are similarly exposed to large declines in prices of those securities.
c. a. financial institutions borrow using long-term debt securities but lend their funds for short-term periods.
d. a. financial institutions invest heavily in Treasury securities and therefore are exposed to the possibility that the government will default on its debts.

Chapter 2—Determination of Interest Rates

MULTIPLE CHOICE

1. The level of installment debt as a percentage of disposable income is generally ____ during recessionary periods.
a. higher
b. lower
c. zero
d. negative

2. At any given point in time, households would demand a ____ quantity of loanable funds at ____ rates of interest.
a. greater; higher
b. greater; lower
c. smaller; lower
d. none of the above

3. Businesses demand loanable funds to
a. finance installment debt.
b. subsidize other companies.
c. invest in fixed and short-term assets.
d. none of the above

4. The required return to implement a given business project will be ____ if interest rates are lower. This implies that businesses will demand a ____ quantity of loanable funds when interest rates are lower.
a. greater; lower
b. lower; greater
c. lower; lower
d. greater; greater

5. If interest rates are ____, ____ projects will have positive NPVs.
a. higher; more
b. lower; more
c. lower; no
d. none of the above

6. The demand for funds resulting from business investment in short-term assets is ____ related to the number of projects implemented, and is therefore ____ related to the interest rate.
a. inversely; positively
b. positively; inversely
c. inversely; inversely
d. positively; positively

7. If economic conditions become less favorable, then:
a. expected cash flows on various projects will increase.
b. more proposed projects will have expected returns greater than the hurdle rate.
c. there would be additional acceptable business projects.
d. there would be a decreased demand by business for loanable funds.

8. As a result of more favorable economic conditions, there is a(n) ____ demand for loanable funds, causing an ____ shift in the demand curve.
a. decreased; inward
b. decreased; outward
c. increased; outward
d. increased; inward

9. The federal government demand for loanable funds is ____. If the budget deficit was expected to increase, the federal government demand for loanable funds would ____.
a. interest elastic; decrease
b. interest elastic; increase
c. interest inelastic; increase
d. interest inelastic; decrease

10. Other things being equal, foreign governments and corporations would demand ____ U.S. funds if their local interest rates were lower than U.S. rates. Therefore, for a given set of foreign interest rates, foreign demand for U.S. funds is ____ related to U.S. interest rates.
a. less; inversely
b. more; positively
c. less; positively
d. more; inversely

11. For a given set of foreign interest rates, the quantity of U.S. loanable funds demanded by foreign governments or firms will be ____ U.S. interest rates.
a. positively related to
b. inversely related to
c. unrelated to
d. none of the above

12. The quantity of loanable funds supplied is normally
a. highly interest elastic.
b. more interest elastic than the demand for loanable funds.
c. less interest elastic than the demand for loanable funds.
d. equally interest elastic as the demand for loanable funds.
e. A and B

13. The ____ sector is the largest supplier of loanable funds.
a. household
b. government
c. business
d. none of the above

14. If a strong economy allows for a large ____ in households income, the supply curve will shift ____.
a. decrease; outward
b. increase; inward
c. increase; outward
d. none of the above

15. The equilibrium interest rate
a. equates the aggregate demand for funds with the aggregate supply of loanable funds.
b. equates the elasticity of the aggregate demand and supply for loanable funds.
c. decreases as the aggregate supply of loanable funds decreases.
d. increases as the aggregate demand for loanable funds decreases.

16. The equilibrium interest rate should
a. fall when the aggregate supply funds exceeds aggregate demand for funds.
b. rise when the aggregate supply of funds exceeds aggregate demand for funds.
c. fall when the aggregate demand for funds exceeds aggregate supply of funds.
d. rise when aggregate demand for funds equals aggregate supply of funds.
e. B and C

17. Which of the following is likely to cause a decrease in the equilibrium U.S. interest rate, other things being equal?
a. a decrease in savings by foreign savers
b. an increase in inflation
c. pessimistic economic projections that cause businesses to reduce expansion plans
d. a decrease in savings by U.S. households

18. 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.

19. If the real interest rate was negative for a period of time, then
a. inflation is expected to exceed the nominal interest rate in the future.
b. inflation is expected to be less than the nominal interest rate in the future.
c. actual inflation was less than the nominal interest rate.
d. actual inflation was greater than the nominal interest rate.

20. If inflation is expected to decrease, then
a. savers will provide less funds at the existing equilibrium interest rate.
b. the equilibrium interest rate will increase.
c. the equilibrium interest rate will decrease.
d. borrowers will demand more funds at the existing equilibrium interest rate.

21. If inflation turns out to be lower than expected
a. savers benefit.
b. borrowers benefit while savers are not affected.
c. savers and borrowers are equally affected.
d. savers are adversely affected but borrowers benefit.

22. If the economy weakens, there is ____ pressure on interest rates. If the Federal Reserve increases the money supply there is ____ pressure on interest rates (assume that inflationary expectations are not affected).
a. upward; upward
b. upward; downward
c. downward; upward
d. downward; downward

23. What is the basis of the relationship between the Fisher effect and the loanable funds theory?
a. the saver’s desire to maintain the existing real rate of interest
b. the borrower’s desire to achieve a positive real rate of interest
c. the saver’s desire to achieve a negative real rate of interest
d. B and C

24. Assume that foreign investors who have invested in U.S. securities decide to decrease their holdings of U.S. securities and to instead increase their holdings of securities in their own countries. This should cause the supply of loanable funds in the United States to ____ and should place ____ pressure on U.S. interest rates.
a. decrease; upward
b. decrease; downward
c. increase; downward
d. increase; upward

25. Assume that foreign investors who have invested in U.S. securities decide to increase their holdings of U.S. securities. This should cause the supply of loanable funds in the United States to ____ and should place ____ pressure on U.S. interest rates.
a. decrease; upward
b. decrease; downward
c. increase; downward
d. increase; upward

26. If the federal government needs to borrow additional funds, this borrowing reflects a(n) ____ in the supply of loanable funds, and a(n) ____ in the demand for loanable funds.
a. increase; no change
b. decrease; no change
c. no change; increase
d. no change; decrease

27. If the federal government reduces its budget deficit, this causes a(n) ____ in the supply of loanable funds, and a(n) ____ in the demand for loanable funds.
a. increase; no change
b. decrease; no change
c. no change; increase
d. no change; decrease

28. Due to expectations of higher inflation in the future, we would typically expect the supply of loanable funds to ____ and the demand for loanable funds to ____.
a. increase; decrease
b. increase; increase
c. decrease; increase
d. decrease; decrease

29. Due to expectations of lower inflation in the future, we would typically expect the supply of loanable funds to ____ and the demand for loanable funds to ____.
a. increase; decrease
b. increase; increase
c. decrease; increase
d. decrease; decrease

30. If the real interest rate is expected by a particular person to become negative, then the purchasing power of his or her savings would be ____, as the inflation rate is expected to be ____ the existing nominal interest rate.
a. decreasing; less than
b. decreasing; greater than
c. increasing; greater than
d. increasing; less than

31. If economic expansion is expected to increase, then demand for loanable funds should ____ and interest rates should ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

32. If economic expansion is expected to decrease, the demand for loanable funds should ____ and interest rates should ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

33. If the real interest rate was stable over time, this would suggest that there is ____ relationship between inflation and nominal interest rate movements.
a. a positive
b. an inverse
c. no
d. an uncertain (cannot be determined from information above)

34. If inflation and nominal interest rates move more closely together over time than they did in earlier periods, this would ____ the volatility of the real interest rate movements over time.
a. increase
b. decrease
c. have an effect, which cannot be determined with above information, on
d. have no effect on

35. Canada and the U.S. are major trading partners. If Canada experiences a major increase in economic growth, it could place ____ pressure on Canadian interest rates and ____ pressure on U.S. interest rates.
a. upward; upward
b. upward; downward
c. downward; downward
d. downward; upward

36. If investors shift funds from stocks into bank deposits, this ____ the supply of loanable funds, and places ____ pressure on interest rates.
a. increases; upward
b. increases; downward
c. decreases; downward
d. decreases; upward

37. When Japanese interest rates rise, and if exchange rate expectations remain unchanged, the most likely effect is that the supply of loanable funds provided by Japanese investors to the United States will ____, and the U.S. interest rates will ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

38. Which of the following will probably not result in an increase in the business demand for loanable funds?
a. an increase in positive net present value (NPV) projects
b. a reduction in interest rates on business loans
c. a recession
d. none of the above

39. If the aggregate demand for loanable funds increases without a corresponding ____ in aggregate supply, there will be a ____ of loanable funds.
a. increase; surplus
b. increase; shortage
c. decrease; surplus
d. decrease; shortage

40. A ____ federal government deficit increases the quantity of loanable funds demanded at any prevailing interest rate, causing an ____ shift in the demand schedule.
a. higher; inward
b. higher; outward
c. lower; outward
d. none of the above

41. Which of the following is not true regarding foreign interest rates?
a. The large flow of funds between countries causes interest rates in any given country to become more susceptible to interest rate movements in other countries.
b. The expectations of a strong dollar should cause a flow of funds to the U.S.
c. An increase in a foreign country’s interest rates will encourage investors in that country to invest their funds in other countries.
d. All of the above are true regarding foreign interest rates.

42. Which of the following is least likely to affect household demand for loanable funds?
a. a decrease in tax rates
b. an increase in interest rates
c. a reduction in positive net present value (NPV) projects available
d. All of the above are equally likely to affect household demand for loanable funds.

43. Which of the following statements is incorrect?
a. The Fed’s monetary policy is intended to control the economic conditions in the U.S.
b. The Fed’s monetary policy affects the supply of loanable funds, which affects interest rates.
c. By influencing interest rates, the Fed is able to influence the amount of money that corporations and households are willing to borrow and spend.
d. All of the statements above are true.

44. The ____ suggests that the market interest rate is determined by factors that control the supply of and demand for loanable funds.
a. Fisher effect
b. loanable funds theory
c. real interest rate
d. none of the above

45. Which of the following will probably not result in an increase in the business demand for loanable funds?
a. an increase in positive net present value (NPV) projects
b. a reduction in interest rates on business loans
c. a recession
d. All of the above will result in an increase in the business demand for loanable funds.

46. Other things being equal, a ____ quantity of U.S. funds would be demanded by foreign governments and corporations if their domestic interest rates were ____ relative to U.S. rates.
a. smaller; high
b. larger; high
c. larger; low
d. none of the above

47. The federal government demand for funds is said to be interest inelastic, or ____ to interest rates.
a. sensitive
b. insensitive
c. relatively sensitive as compared to other sectors
d. none of the above

48. If the aggregate demand for loanable funds increases without a corresponding ____ in aggregate supply, there will be a ____ of loanable funds.
a. increase; surplus
b. increase; shortage
c. decrease; surplus
d. decrease; shortage

49. The expected impact of an increased expansion by businesses is an ____ shift in the demand schedule and ____ in the supply schedule.
a. inward; an inward shift
b. inward; an outward shift
c. outward; an inward shift
d. outward; no obvious change

50. Which of the following is a valid representation of the Fisher effect?
a. i = E(INF) + iR
b. iR = E(INF) + i
c. E(INF) = i + iR
d. none of the above

51. The real interest rate can be forecasted by subtracting the ____ from the ____ for that period.
a. nominal interest rate; expected inflation rate
b. prime rate; nominal interest rate
c. expected inflation rate; nominal interest rate
d. prime rate; expected inflation rate

52. According to the Fisher effect, expectations of higher inflation cause savers to require a ____ on savings.
a. higher nominal interest rate
b. higher real interest rate
c. lower nominal interest rate
d. lower real interest rate

53. A ____ federal government deficit increases the quantity of loanable funds demanded at any prevailing interest rate, causing an ____ shift in the demand schedule.
a. higher; inward
b. higher; outward
c. lower; outward
d. none of the above

54. The federal government’s demand for funds is ________, and municipal governments’ demand for funds is somewhat ____________.
a. interest-inelastic; interest-inelastic
b. interest-elastic; interest-elastic
c. interest-inelastic; interest-elastic
d. interest-elastic; interest-inelastic

55. The substantial decline in interest rates during the credit crisis is attributed to which of the following changes in the market for loanable funds?
a. a. an increase in both the supply of and the demand for loanable funds
b. a. a decrease in both the supply of and the demand for loanable funds
c. a. a decrease in the supply of loanable funds and an increase in the demand for loanable funds
d. a. an increase in the supply of loanable funds and a decrease in the demand for loanable funds

56. The crowding-out effect occurs when:
a. a. foreign investors crowd out U.S. investors in the market for loanable funds.
b. a. the federal government’s demand for loanable funds due to a higher budget deficit crowds out the private demand in the market for loanable funds.
c. a. institutional investors crowd out individual investors in the market for loanable funds.
d. a. firms and municipal governments crowd out households in the market for loanable funds.

TRUE/FALSE

57. According to the loanable funds theory, market interest rates are determined by the factors that control the supply of and demand for loanable funds.
a. True
b. False

58. The supply of loanable funds in the U.S. is partly determined by the monetary policy implemented by the Federal Reserve System.
a. True
b. False

59. At any point in time, households and businesses demand a greater quantity of loanable funds at lower rates of interest.
a. True
b. False

60. The business demand for funds resulting from short-term investments is inversely related to the number of projects implemented and inversely related to the interest rate.
a. True
b. False

61. Other things being equal, a smaller quantity of U.S. funds would be demanded by foreign governments and corporations if their domestic interest rates were high relative to U.S. rates.
a. True
b. False

62. If foreign interest rates fall, foreign firms and governments would likely reduce their demand for U.S. funds.
a. True
b. False

63. Since the aggregate demand for loanable funds is the sum of the quantities demanded by the separate sectors, and since most of these sectors are likely to demand a larger quantity of funds at lower interest rates (other things being equal), the aggregate demand for loanable funds is positively related to interest rates at any point in time.
a. True
b. False

64. In general, suppliers of loanable funds are willing to supply more funds if the interest rate is higher.
a. True
b. False

65. If the aggregate demand for loanable funds increases without a corresponding increase in aggregate supply, there will be a surplus of loanable funds.
a. True
b. False

66. The relationship between interest rates and expected inflation is often referred to as the loanable funds theory.
a. True
b. False

67. According to the Fisher effect, if the real interest rate is zero, the nominal interest rate must be equal to the expected inflation rate.
a. True
b. False

68. 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

69. According to the Fisher effect, when the inflation rate is lower than anticipated, the real interest rate is relatively low.
a. True
b. False

70. Forecasters should consider future plans for corporate expansion and the future state of the economy when forecasting business demand for loanable funds.
a. True
b. False

FIN 350 Week 3 Quiz Solution

Chapter 3—Structure of Interest Rates

1. In general, securities with ____ characteristics will offer ____ yields.
a. favorable; higher
b. favorable; lower
c. unfavorable; lower
d. none of the above

2. Default risk is likely to be highest for
a. short-term Treasury securities.
b. AAA corporate securities.
c. long-term Treasury securities.
d. BBB corporate securities.

3. Some financial institutions such as commercial banks are required by law to invest only in
a. junk bonds.
b. corporate stock.
c. Treasury securities.
d. investment-grade bonds.

4. Credit ratings are most commonly used to indicate which financial institutions have available funds that they can lend to borrowers.
a. True
b. False

5. If a security can easily be converted to cash without a loss in value, it
a. is liquid.
b. has a high after-tax yield.
c. has high default risk.
d. is illiquid.

6. Securities that offer ____ liquidity will need to offer a ____ yield.
a. lower; higher
b. lower; lower
c. higher; higher
d. B and C

7. If all other characteristics are similar, ____ would have to offer ____.
a. taxable securities; a higher after-tax yield than tax-exempt securities
b. taxable securities; a higher before-tax yield than tax-exempt securities
c. tax-exempt securities; a higher after-tax yield than taxable securities
d. tax-exempt securities; a higher before-tax yield than taxable securities

8. Assume an investor’s tax rate is 25 percent. The before-tax yield on a security is 12 percent. What is the after-tax yield?
a. 16.00 percent
b. 9.25 percent
c. 9.00 percent
d. 3.00 percent
e. none of the above

9. An investor’s tax rate is 30 percent. What must the before-tax yield on a security be to have an after-tax yield of 11 percent?
a. 7.7 percent
b. 15.71 percent
c. 130 percent
d. 11.00 percent
e. none of the above

10. A firm in the 35 percent tax bracket is aware of a tax-exempt security that is paying a yield of 7 percent. To match this yield, taxable securities must offer a before-tax yield of
a. 7.0 percent.
b. 10.8 percent.
c. 20.0 percent.
d. none of the above

11. Holding other factors such as risk constant, the relationship between the maturity and annualized yield of securities is called the
a. term structure of interest rates.
b. default structure of interest rates.
c. liquidity structure of interest rates.
d. tax structure of interest rates.
e. none of the above

12. The term structure of interest rates defines the relationship
a. between risk and return.
b. between risk and maturity.
c. between maturity and yield.
d. between default risk ratings and maturity.

13. Interest income from municipal bonds is exempt from state taxes but is subject to federal taxes.
a. True
b. False

14. If shorter term securities have higher annualized yields than longer term securities, the yield curve
a. is horizontal.
b. is upward sloping.
c. is downward sloping.
d. cannot be determined unless we know additional information (such as the level of market interest rates).

15. Assume that annualized yields of short-term and long-term securities are equal. If investors suddenly believe interest rates will increase, their actions may cause the yield curve to
a. become inverted.
b. become flat.
c. become upward sloping.
d. be unaffected.

16. If issuers of securities (borrowers) and investors suddenly expect interest rates to decrease, their actions to benefit from their expectations should cause
a. long-term yields to rise.
b. short-term yields to decrease.
c. prices of long-term securities to decrease.
d. A and B
e. none of the above

17. Within the category of capital market securities, municipal bonds have the ____ before-tax yield, and their after-tax yield is typically ____ of Treasury bonds from the perspective of investors in high tax brackets.
a. highest; below that
b. lowest; above that
c. highest; above that
d. lowest; below that

18. The yield offered on a debt security is ____ related to the prevailing risk-free rate and ____ related to the security’s risk premium.
a. negatively; negatively
b. positively; positively
c. negatively; positively
d. positively; negatively

19. The theory for the term structure of interest rates that says the shape of the yield curve is determined solely by expectations of future interest rates is called the
a. segmented markets theory.
b. liquidity premium theory.
c. pure expectations theory.
d. theory of rational expectations.

20. Assume investors are indifferent among security maturities. Today, the annualized 2-year interest rate is 12 percent, and the 1-year interest rate is 9 percent. What is the forward rate according to the pure expectations theory?
a. 15.08 percent
b. 3.00 percent
c. 12.00 percent
d. 12.62 percent
e. 11.41 percent

21. Assume the yield curve is flat. If investors flood the short-term market and avoid the long-term market, they may cause the yield curve to
a. remain flat.
b. become upward sloping.
c. become downward sloping.
d. none of the above

22. According to pure expectations theory, if interest rates are expected to decrease, there will be ____ pressure on the demand for short-term funds by borrowers and ____ pressure on the demand for long-term funds issued by borrowers.
a. upward; upward
b. downward; downward
c. upward; downward
d. downward; upward

23. The degree to which the Treasury’s debt management policy could affect the term structure of interest rates is greatest if
a. most debt is financed by foreign investors.
b. the Treasury’s debt level is small.
c. maturity markets are segmented.
d. A and B

24. According to the pure expectations theory of the term structure of interest rates, the ____ the difference between the implied one-year forward rate and today’s one-year interest rate, the ____ is the expected change in the one-year interest rate.
a. greater; less
b. less; greater
c. greater; greater
d. less; less
e. C and D

25. Assume that today, the annualized two-year interest rate is 12 percent, and the one-year interest rate is 9 percent. A three-year security has an annualized interest rate of 14 percent. What is the one-year forward rate two years from now?
a. 12.67 percent
b. 113 percent
c. 195 percent
d. 15.67 percent
e. none of the above

26. 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

27. According to the liquidity premium theory, the expected yield on a two-year security will ____ the expected yield from consecutive investments in one-year securities.
a. equal
b. be less than
c. be greater than
d. B and C are possible, depending on the size of the liquidity premium

28. Assume that the current yield on one-year securities is 6 percent, and that the yield on a two-year security is 7 percent. If the liquidity premium on a two-year security is 0.4 percent, then the one-year forward rate is
a. 8.0 percent.
b. 7.6 percent.
c. 3.0 percent.
d. 7.0 percent.

29. If liquidity influences the yield curve, but is not considered when deriving the forward interest rate, the forward interest rate ____ the market’s expectation of the future interest rate.
a. overestimates
b. accurately estimates
c. underestimates
d. is an unbiased forecast of (it has an equal chance of overestimating or underestimating)

30. If the liquidity premium exists, a flat yield curve would be interpreted as the market expecting ____ in interest rates.
a. no changes
b. a slight decrease
c. a slight increase
d. a large increase

31. The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the
a. pure expectations theory.
b. liquidity premium theory.
c. segmented markets theory.
d. liquidity habitat theory.

32. According to the segmented markets theory, if most investors suddenly preferred to invest in short-term securities and most borrowers suddenly preferred to issue long-term securities there would be
a. upward pressure on the price of long-term securities.
b. upward pressure on the price of short-term securities.
c. downward pressure on the yield of long-term securities.
d. A and C

33. A theory states that while investors and borrowers may normally concentrate on a particular natural maturity market, conditions may cause them to change maturity markets. This theory is called the
a. liquidity premium theory.
b. efficient markets theory.
c. pure expectations theory.
d. preferred habitat theory.

34. According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term funds, there would be ____ pressure on the supply of short-term funds provided by investors and ____ pressure on the yield of long-term securities.
a. upward; upward
b. downward; downward
c. upward; downward
d. downward; upward

35. If a yield curve is upward sloping, the investment strategy of buying long-term securities, then selling them after a short period (say, one year) is called
a. riding the yield curve.
b. liquidating the yield curve.
c. segmenting the yield curve.
d. a forward roll.
e. none of the above

36. Other things equal, the yield required on A-rated bonds should be ____ the yield required on B-rated bonds whose other characteristics are exactly the same.
a. greater than
b. equal to
c. less than
d. All of the above are possible, depending on the size of the bond offering.

37. Assume that the Treasury bond yield today is 2% higher than it was one year ago. Also assume that the credit (default) risk premium of an A-rated bond declined by 0.4% since one year ago. A newly issued A-rated bond will likely offer a yield today that is ____ the yield that was offered on an A-rated bond issued one year ago.
a. greater than
b. equal to
c. less than
d. A or B are both common

38. 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

39. According to expectations theory, the sudden expectation of lower interest rates in the future will cause a ____ supply of short-term funds provided by investors, and a ____ supply of long-term funds.
a. large; large
b. large; small
c. small; small
d. small; large

40. The yield curve in a foreign country is
a. always downward sloping.
b. non-existent.
c. the same as the United States at any point in time.
d. none of the above

41. If research showed that anticipation about future interest rates was the only important factor for all investors in choosing short-term or long-term securities, this would support the argument made by the
a. liquidity premium theory.
b. expectations theory.
c. segmented markets theory.
d. A and B

42. If research showed that all investors attempt to purchase securities that perfectly match their time in which they will have available funds, this would specifically support the argument made by the
a. liquidity premium theory.
b. real interest rate theory.
c. expectations theory.
d. segmented markets theory.

43. If the Treasury uses a relatively large proportion of ____ debt to finance the deficit, this may place upward pressure on ____ interest rates, and corporations may reduce their investment in fixed assets.
a. long-term; long-term
b. long-term; short-term
c. short-term; long-term
d. B and C

44. You are considering the purchase of a tax-exempt security that is paying a yield of 10.08 percent. You are in the 28 percent tax bracket. To match this after-tax yield, you would consider taxable securities that pay
a. 31.1 percent.
b. 19 percent.
c. 12.5 percent.
d. 14 percent.

45. The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate one-year ahead is ____ percent.
a. 2.8
b. 115
c. 103
d. 15.1

46. The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate two years ahead is ____ percent.
a. 1.8
b. 9.0
c. 15.0
d. none of the above

47. According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place ____ pressure on the demand for long-term funds issued by borrowers and the yield curve will be ____ sloping.
a. upward; downward
b. downward; upward
c. upward; upward
d. downward; downward

48. An upward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.
a. longer; lower
b. longer; higher
c. shorter; lower
d. shorter; higher
e. B and C

49. Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will ____ the supply of T-bills in the market and places ____ pressure on the yield of T-bills.
a. decrease; downward
b. decrease; upward
c. increase; upward
d. increase; downward

50. Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.2 percent default risk premium, a 0.1 percent liquidity premium, and a 0.3 percent tax adjustment are necessary to sell its commercial paper to investors. Furthermore, annualized T-bill rates are 7 percent. Based on this information, Vaughn should offer ____ percent on its commercial paper.
a. 8.0
b. 7.6
c. 7.5
d. 7.9
e. none of the above

51. If liquidity influences the yield curve, the forward rate underestimates the market’s expectation of the future interest rate.
a. True
b. False

52. The yield curve for corporate bonds.
a. would typically lie below the Treasury yield curve.
b. is identical to the Treasury yield curve.
c. typically has the same slope as the Treasury yield curve.
d. is irrelevant to investors.

53. Some types of debt securities always offer a higher yield than others.
a. True
b. False

54. Investors will always prefer the purchase of risk-free Treasury securities, since other securities have a higher level of risk.
a. True
b. False

55. The higher a bond rating, the lower the perceived default risk.
a. True
b. False

56. Treasury securities are exempt from federal and state income taxes.
a. True
b. False

57. The term structure of interest rates defines the relationship between maturity and annualized yield, holding other factors such as risk constant.
a. True
b. False

58. The graphic comparison of maturities and annualized yields is known as the interest rate curve.
a. True
b. False

59. According to the segmented markets theory, the term structure of interest rates is determined solely by expectations of future interest rates.
a. True
b. False

60. The forward rate is commonly used to represent the market’s forecast of the future interest rate.
a. True
b. False

61. Other things being equal, an expected decrease in interest rates will increase the demand for long-term funds by borrowers.
a. True
b. False

62. The preference for more liquid short-term securities places downward pressure on the slope of the yield curve.
a. True
b. False

63. When expectations theory is combined with the liquidity theory, the yield on a security will always be equal to the yield from consecutive investments in shorter-term securities over the same investment horizon.
a. True
b. False

64. The segmented markets theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.
a. True
b. False

65. If the yield curve is upward sloping, some investors may attempt to benefit from the higher yields on longer-term securities, even when they have funds for only a short period of time. This strategy is known as riding the yield curve.
a. True
b. False

66. Yield curves are always upward sloping.
a. True
b. False

67. Which of the following statements is not true with respect to debt securities?
a. Some types of debt securities always offer a higher yield than others.
b. Debt securities offer different yields because they exhibit different characteristics that influence the offered yield.
c. In general, securities with favorable characteristics will offer higher yields to entice investors.
d. All of the above are true with respect to debt securities.

68. Which of the following is not a characteristic affecting the yields on debt securities?
a. default risk
b. liquidity
c. tax status
d. term to maturity
e. All of the above affect yields on debt securities.

69. All other characteristics being equal, securities with ____ liquidity would have to offer a ____ yield to be preferred.
a. lower; higher
b. higher; higher
c. lower; lower
d. none of the above

70. A downward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.
a. longer; lower
b. longer; higher
c. shorter; lower
d. shorter; higher
e. Answers A and D are correct.

71. Assume that the Treasury experiences a large increase in the budget deficit and issues a large number of T-bills. This action will ____ the supply of T-bills in the market and place ____ pressure on the yield of T-bills.
a. decrease; downward
b. decrease; upward
c. increase; upward
d. increase; downward

72. If the liquidity premium theory completely describes the term structure of interest rates, then, on the average, the yield curve should be
a. flat.
b. downward sloping.
c. upward sloping.
d. none of the above.

73. If interest rates are expected to decrease, the yield on new short-term securities may be expected to ____, and the yield curve should be ____ sloping.
a. increase; upward
b. increase; downward
c. decrease; upward
d. decrease; downward

74. According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place ____ pressure on the demand for short-term funds by borrowers and the yield curve will be ____ sloping.
a. upward; downward
b. downward; upward
c. upward; upward
d. downward; downward

75. The ____ theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.
a. pure expectations
b. liquidity premium
c. segmented markets
d. preferred habitat

76. If the Treasury uses a relatively large proportion of ____ debt to finance a budget deficit, this would place ____ pressure on long-term yields.
a. short-term; downward
b. long-term; downward
c. short-term; upward
d. long-term; upward

77. Bonds issued at different times by the same corporation may not receive the same rating from a rating agency.
a. True
b. False

78. Investment-grade bonds are bonds that are rated as Caa or better by Moody’s and as CCC or better by Standard & Poor’s.
a. True
b. False

79. In response to criticism of the ratings they assigned before the credit crisis, credit rating agencies now:
a. a. are paid through fees assessed on the purchasers of bonds.
b. a. are depending more on sensitivity analysis in which they assess how creditworthiness may change in response to abrupt changes in the economy.
c. a. are not allowing the employees who promote an agency to influence the ratings that the agency assigns.
d. a. B and C

80. The Financial Reform Act of 2010 established the __________ within the _________ to regulate credit rating agencies.
a. a. Bureau of Thrift Agency Supervision; Treasury Department
b. a. Office of Credit Ratings; Securities and Exchange Commission
c. a. Federal Ratings Assurance Corporation; Treasury Department
d. a. Ratings Oversight Commission; Federal Reserve

81. The yields of securities commonly move in the same direction over time.
a. True
b. False

82. Because interest rates may vary significantly across countries at a given point in time, investors do not monitor the term structures of interest rates in foreign countries unless they are interested in investing in a particular foreign country.
a. True
b. False

Chapter 4—Functions of the Fed

1. Which of the following is not a major component of the Federal Reserve System?
a. member banks
b. Federal Open Market Committee
c. Securities and Exchange Commission
d. Board of Governors

2. As a result of the Financial Reform Act of 2010, the ____ was assigned the role of regulating financial products and services.
a. Federal Advisory Committee
b. Federal Open Market Committee
c. Consumer Financial Protection Bureau
d. Board of Governors

3. Which of the following is not an activity of Fed district banks?
a. clearing checks
b. replacing old currency
c. providing loans to depository institutions
d. acting as an intermediary to match up lenders and borrowers in the stock market

4. All ____ are required to be members of the Federal Reserve System.
a. state banks
b. national banks
c. savings and loan associations
d. finance companies
e. A and B

5. The ____ is made up of seven individual members, and each member is appointed by the president of the U.S.
a. Board of Governors
b. Federal Reserve district bank
c. Federal Open Market Committee (FOMC)
d. Securities and Exchange Commission

6. Which of the following is currently a main role of the Federal Reserve’s Board of Governors?
a. regulating commercial banks
b. regulating foreign trade
c. controlling monetary policy
d. A and C

7. Members of the Board of Governors serve 14-year nonrenewable terms.
a. True
b. False

8. With regard to monetary policy, which of the following is under direct control of the Federal Reserve’s Board of Governors?
a. revise reserve requirements for depository institutions
b. authorize changes in the amount of borrowing by the Treasury
c. monitor the stock market for insider trading
d. monitor the derivatives market for illegal trading strategies

9. The ____ rate is the interest rate charged on Fed district bank loans to depository institutions.
a. federal funds
b. prime
c. primary credit lending
d. real

10. Which of the following is an action that the Fed uses to increase or decrease the money supply?
a. buying or selling Treasury securities in the secondary market
b. adjusting the tax rate imposed on income earned on Treasury securities
c. adjusting the coupon rate on Treasury bonds
d. selling Treasury securities in the primary market

11. The Policy Directive is provided by Board of Governors to the FOMC.
a. True
b. False

12. Total funds of commercial banks will initially ____ by the dollar amount of securities ____ by the Fed.
a. increase; purchased
b. increase; sold
c. decrease; purchased
d. A and B

13. The purchase of government securities by someone other than the Fed results in
a. an overall increase in funds among commercial banks.
b. an overall decrease in funds among commercial banks.
c. offsetting changes in funds at commercial banks.
d. an increase in securities maintained by the Fed.

14. As the supply of funds in the banking system ____, the federal funds rate ____.
a. increases; declines
b. increases; increases
c. declines, declines
d. none of the above

15. Repurchase agreements are purchased by the Fed to
a. temporarily decrease the aggregate level of bank funds.
b. permanently increase the aggregate level of bank funds.
c. permanently decrease the aggregate level of bank funds.
d. temporarily increase the aggregate level of bank funds.

16. When open market operations are used to ____ bank funds, the yield on debt instruments ____.
a. reduce; decreases
b. reduce; increases
c. increase; increases
d. none of the above

17. ____ open market operations offset the impact of other conditions that affect the level of funds.
a. Active
b. Passive
c. Dynamic
d. Defensive

18. The main monetary policy goal of most central banks is to stabilize the value of the local currency against foreign currencies.
a. True
b. False

19. The primary credit lending rate changes in accordance with changes in the federal funds rate.
a. True
b. False

20. ____ credit may be used for any purpose and is available only to depository institutions that meet specific requirements for financial soundness.
a. Primary
b. Secondary
c. Tertiary
d. None of the above

21. To decrease money supply, the Fed could ____ the reserve requirement ratio.
a. increase
b. stabilize
c. reduce
d. eliminate

22. The ____ the reserve requirement ratio, the ____ the ultimate effect of any initial increase in money supply.
a. lower; less
b. lower; greater
c. greater; less
d. B and C

23. The ____ is directly responsible for controlling money supply growth.
a. Federal Advisory Council
b. FOMC
c. Board of Governors
d. President of the United States

24. Assume that the reserve requirements ratio is 15%. An initial injection of $150 million could result in a maximum change in the money supply of
a. $150 million.
b. $1 billion.
c. $1 million.
d. $22.5 million.

25. The form of money consisting of currency held by the public and checkable deposits at depository institutions is called
a. M1.
b. M2.
c. M3.
d. MMDA.

26. The Monetary Control Act of 1980 subjected
a. only member banks to the reserve requirements set by the Fed.
b. only S&Ls to the reserve requirements set by the Fed.
c. all depository institutions to the reserve requirements set by the Fed.
d. only national banks to reserve requirements set by the Fed.

27. The purpose of the Trading Desk of the Federal Reserve Bank of New York is to buy stocks for member commercial banks.
a. True
b. False

28. The voting members of the Federal Open Market Committee consist of the Board of Governors plus the
a. President of the United States.
b. Presidents of the 12 Fed district banks.
c. Presidents of 5 Fed district banks.
d. Federal Advisory Council.

29. The Board of Governors is composed of
a. seven members appointed by the President of the United States.
b. the 12 presidents of Fed district banks.
c. the Federal Open Market Committee, plus the Federal Advisory Council.
d. the Federal Open Market Committee, plus the President of the United States.

30. The ____ is directly responsible for setting reserve requirements.
a. Federal Advisory Council
b. FOMC
c. Board of Governors
d. President of the United States

31. The ____ is directly responsible for conducting monetary policy.
a. Federal Advisory Council
b. FOMC
c. Senate
d. President of the United States

32. Based on a 2003 policy, the primary credit lending rate is set
a. lower than the federal funds rate.
b. lower than the prevailing Treasury bill rate.
c. lower than the expected inflation rate.
d. above the federal funds rate.

33. A(n) ____ in Federal Reserve float causes a(n) ____ in bank funds.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. A and C

34. The ____ consists of seven members, each of whom is appointed by the President of the United States.
a. Federal Open Market Committee (FOMC)
b. Federal Advisory Council
c. Board of Governors
d. none of the above

35. Assume that the reserve requirement ratio is 12 percent and that the Fed uses open market operations by buying $200 million worth of Treasury securities. Assuming that banks use all funds except required reserves to make loans and that the public does not store any cash, the money supply should ____ by about ____.
a. increase; $200 million
b. increase; $1.67 billion
c. decrease; $200 million
d. decrease; $1.67 billion

36. The federal funds rate is the rate at which the Fed lends money directly to member banks.
a. True
b. False

37. When the Fed purchases securities, the total funds of commercial banks ____ by the market value of securities purchased by the Fed. This activity initiated by the FOMC’s policy directive is referred to as a(n) ____ of money supply growth.
a. increase; loosening
b. decrease; tightening
c. decrease; loosening
d. increase; tightening
e. none of the above

38. The Trading Desk is sometimes directed to ____ a sufficient amount of Treasury securities that will ____ the federal funds rate to a new targeted level set by the FOMC.
a. buy; decrease
b. sell; increase
c. buy; increase
d. sell; decrease
e. A and B

39. Which of the following statements is incorrect with respect to a single European monetary policy?
a. It allows for more consistent economic conditions across the countries.
b. It prevents any participating European country from solving local economic problems with its own unique monetary policy.
c. A policy used in a particular period may not affect the participating countries equally, since they all have the same currency.
d. Each participating country will still be able to apply its own fiscal policy (tax and government expenditure decisions).
e. All of the above are true with respect to a single European monetary policy.

40. Since 2003, the Fed’s rate on short-term loans to depository institutions is referred to as the
a. discount rate.
b. primary credit lending rate.
c. Federal funds rate.
d. prime rate

41. ____ 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

42. Most of the Fed’s income is transferred to the U.S. Department of Justice.
a. True
b. False

43. All commercial banks are required to be members of the Fed.
a. True
b. False

44. Each member of the Board of Governors is appointed by the president of the United States and serves a nonrenewable 14-year term.
a. True
b. False

45. Each Federal Reserve district bank is responsible for reporting its regional conditions, and all of these reports are consolidated to compose the Beige Book.
a. True
b. False

46. 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

47. Adjustment of the primary credit lending rate is the most common means by which the Fed controls the money supply.
a. True
b. False

48. To increase the money supply, the Trading Desk would be instructed to sell government securities.
a. True
b. False

49. To increase the money supply, the Fed may increase the reserve requirement ratio.
a. True
b. False

50. Which of the following is not true with respect to the Federal Reserve Act of 1913?
a. It established reserve requirements for member commercial banks.
b. It specified fourteen districts across the United States as well as a city in each district where a Federal Reserve district bank was to be established.
c. Each district focused on its particular district, without much concern for other districts.
d. All of the above are true.

51. ____ is (are) not a component of the Fed as it exists today.
a. The Federal Advisory Council
b. The Board of Governors
c. National banks
d. The U.S. Department of Commerce
e. All of the above are components of the Fed.

52. The advisory committee making recommendations to the Fed about economic and banking related issues is the
a. Consumer Advisory Council.
b. Thrift Institutions Advisory Council.
c. Federal Advisory Council.
d. none of the above

53. The advisory committee offering views on issues related to credit unions is the
a. Consumer Advisory Council.
b. Thrift Institutions Advisory Council.
c. Federal Advisory Council.
d. none of the above

54. If the Fed desires to ____ the money supply using open market operations, it would instruct the trading desk to ____ government securities.
a. increase; purchase
b. increase; sell
c. decrease; purchase
d. Answers B and C are correct.

55. When the Fed buys Treasury bills as a means of increasing the money supply, it places ____ pressure on their prices and ____ pressure on their yields.
a. upward; upward
b. downward; downward
c. upward; downward
d. downward; upward

56. To increase the money supply growth, the Fed could
a. sell government securities in the secondary market.
b. increase the primary credit lending rate.
c. increase the reserve requirement ratio.
d. all of the above
e. none of the above

57. When the Fed sells securities, the total funds of commercial banks ____ by the market value of securities sold by the Fed. This activity initiated by the FOMC’s policy directive is referred to as a ____ of money supply growth.
a. increase; loosening
b. decrease; loosening
c. increase; tightening
d. decrease; tightening
e. none of the above

58. ____ includes only currency held by the public and checking deposits as well as savings accounts and small time deposits, money market deposit accounts, and some other items.
a. M1
b. M2
c. M3
d. None of the above

59. The ____ consists of seven members, each of whom is appointed by the president of the United States.
a. Federal Open Market Committee (FOMC)
b. Federal Advisory Council
c. Board of Governors
d. none of the above

60. The Fed’s primary goal has historically been to add liquidity to the mortgage market by continuously purchasing mortgage-backed securities.
a. True
b. False

61. When the Fed purchases _______, it is attempting to directly stimulate the housing market.
a. commercial paper
b. short-term Treasury securities
c. mortgage-backed securities
d. consumer loans

62. The Fed’s purchases of long-term Treasury securities in recent years were intended to:
a. reduce long-term interest rates.
b. reduce interest rates on credit cards and consumer loans.
c. increase the federal funds rate.
d. restore confidence in the market for these securities.

63. A criticism of the Fed’s actions during the credit crisis is that it:
a. did not attempt to increase the liquidity of the debt markets.
b. focused too much on financial institutions.
c. allowed Bear Stearns to fail and file for bankruptcy.
d. periodically raised the primary credit rate.

64. Which of the following did the Fed not do during the credit crisis?
a. purchase mortgage-backed securities
b. purchase commercial paper
c. reduce the targeted federal funds rate
d. prevent depository institutions from obtaining funding through the discount window

FIN 350 Week 4 Quiz Solution

Chapter 5—Monetary Policy

1. The Fed can affect the interaction between the demand for money and the supply of money to influence interest rates, the aggregate level of spending, and therefore economic growth.
a. True
b. False

2. The Fed can ____ the level of spending as a means of stimulating the economy by ____ the money supply.
a. increase; decreasing
b. decrease; increasing
c. decrease; decreasing
d. increase; increasing

3. 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.

4. According to the theory of rational expectations, higher inflationary expectations encourage businesses and households to reduce their demand for loanable funds.
a. True
b. False

5. A passive monetary policy adjusts money supply automatically in response to economic conditions.
a. True
b. False

6. 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

7. In general, there is:
a. a positive relationship between unemployment and inflation.
b. an inverse relationship between unemployment and inflation.
c. an inverse relationship between GNP and inflation.
d. a positive relationship between GNP and unemployment.

8. A ____-money policy can reduce unemployment, and a ____-money policy can reduce inflation.
a. tight; loose
b. loose; tight
c. tight; tight
d. loose; loose

9. A loose money policy tends to ____ economic growth and ____ the inflation rate.
a. stimulate; place downward pressure on
b. stimulate; place upward pressure on
c. dampen; place upward pressure on
d. dampen; place downward pressure on

10. When both inflation and unemployment are relatively high, there is more disagreement among FOMC members about the proper monetary policy to implement.
a. True
b. False

11. ____ serves as the most direct indicator of economic growth in the United States.
a. Gross domestic product (GDP)
b. National income
c. The unemployment rate
d. The industrial production index

12. Which of the following is not an indicator of inflation?
a. housing price indexes
b. wage rates
c. oil prices
d. consumer confidence surveys

13. The ____ indicators tend to occur before a business cycle.
a. leading
b. lagging
c. coincident
d. none of the above

14. The ____ indicators tend to occur after a business cycle.
a. leading
b. lagging
c. coincident
d. none of the above

15. The ____ indicators tend to occur before a business cycle.
a. leading
b. lagging
c. coincident
d. none of the above

16. The time lag between when an economic problem arises and when it is reported in economic statistics is the
a. recognition lag.
b. implementation lag.
c. impact lag.
d. open-market lag.

17. The time between when an economic problem is realized and when the Fed tries to correct it with its policies is the
a. recognition lag.
b. implementation lag.
c. impact lag.
d. open-market lag.

18. The time between when the Fed adjusts the money supply and when interest rates change reflects the
a. recognition lag.
b. implementation lag.
c. impact lag.
d. open-market lag.

19. If the Fed attempts to reduce inflation, it would likely increase money supply growth.
a. True
b. False

20. Which of the following best describes the relationship between the Fed and the Administration?
a. The Fed must receive approval by the Administration before conducting monetary policy.
b. The Fed must implement a monetary policy specifically to the support the Administration’s policy.
c. The Administration must receive approval from the Fed before implementing fiscal policy.
d. A and C
e. none of the above

21. A high budget deficit tends to place ____ pressure on interest rates; the Fed’s tightening of the money supply tends to place ____ pressure on interest rates.
a. upward; upward
b. upward; downward
c. downward; downward
d. downward; upward

22. The Fed is usually more willing to monetize the debt when inflation is relatively high.
a. True
b. False

23. International flows of funds can affect the Fed’s monetary policy. For example, if there is downward pressure on U.S. interest rates that can be offset by foreign ____ of funds, the Fed may not feel compelled to use a ____ monetary policy.
a. inflows; loose
b. inflows; tight
c. outflows; loose
d. outflows; tight
e. none of the above

24. Costner National, a commercial bank, obtains short-term deposits and makes long-term fixed-rate loans. It should be adversely affected when the Fed:
a. monetizes the debt.
b. maintains a stable money supply.
c. uses a tight-money policy.
d. uses a loose-money policy.

25. The ____ lag represents the time from when an economic problem exists until it is recognized.
a. recognition
b. adjustment
c. implementation
d. none of the above

26. A ____ dollar tends to exert inflationary pressure in the U.S.
a. stable
b. strong
c. weak
d. both A and B

27. According to the theory of rational expectations, ____ inflationary expectations encourage businesses and households to ____ their demand for loanable funds in order to borrow and make planned expenditures increase.
a. higher; reduce
b. higher; increase
c. lower; reduce
d. lower; increase

28. Historical evidence has shown that, when the Fed significantly increases money supply, U.S. inflation tends to ____ shortly thereafter which in turn places ____ pressure on U.S. interest rates.
a. increase; upward
b. increase; downward
c. decrease; downward
d. decrease; upward

29. If the Fed uses a passive monetary policy during weak economic conditions,
a. it increases money supply substantially.
b. it reduces money supply substantially.
c. it allows the economy to fix itself.
d. it focuses on monetizing the debt.

30. Which of the following is true?
a. Federal deficits require that the Fed purchase government securities.
b. Federal deficits will always result in an increase in money supply.
c. The Federal Reserve monetizes debt by selling securities which ultimately increases money supply.
d. An agreement between the Fed and the Treasury exists whereby the Fed is directly responsible for monetizing the debt whenever the deficit increases.
e. None of the above.

31. Inflation is commonly the result of a
a. large budget deficit.
b. high level of interest rates.
c. high level of unemployment.
d. high level of aggregate demand.

32. According to the theory of rational expectations, if the Fed uses open market operations in order to increase the supply of loanable funds, the ultimate effect on interest rates is definitely
a. a reduction in interest rates.
b. an increase in interest rates.
c. no effect on the interest rates.
d. the impact on interest rates cannot be determined.

33. The Federal Reserve would be most inclined to use a stimulative monetary policy to cure a recession if oil prices are
a. low and steady.
b. low, but rising.
c. very high, but declining slightly.
d. very high and rising.

34. Global crowding out is described in the text to mean the impact of
a. excessive U.S. population growth on interest rates.
b. excessive global population growth on interest rates.
c. an excessive budget deficit in one country on interest rates of another country.
d. an excessive budget deficit in one country on exchange rates.

35. If the federal government is willing to pay whatever is necessary to borrow loanable funds, but the private sector is not, this reflects
a. the crowding-out effect.
b. dynamic open market operations.
c. defensive open market operations.
d. monetizing the debt.

36. When the Fed uses open market operations by purchasing Treasury securities from various financial institutions in the U.S., there will be
a. an outward shift in the supply schedule of loanable funds.
b. an inward shift in the supply schedule of loanable funds.
c. no shift in the supply schedule of loanable funds.
d. an inward shift in the demand schedule for loanable funds.

37. When the Fed uses open market operations by selling some of its Treasury securities to investors in the U.S., there will be
a. an outward shift in the supply schedule of loanable funds.
b. an inward shift in the supply schedule of loanable funds.
c. no shift in the supply schedule of loanable funds.
d. an outward shift in the demand schedule for loanable funds.

38. Which of the following is not a disadvantage of inflation targeting?
a. If the U.S. inflation rate deviates substantially from the Fed’s target inflation rate, the Fed could lose credibility.
b. The Fed’s complete focus on inflation could result in a much higher unemployment level.
c. The Fed’s complete focus on inflation could result in much higher interest rates, which would discourage economic growth.
d. All of the above are disadvantages of inflation targeting.

39. Financial institutions such as commercial banks, bond mutual funds, insurance companies, and pension funds maintain large portfolios of bonds, so their portfolio is ____ affected when the Fed ____ interest rates.
a. unfavorably; decreases
b. unfavorably; increases
c. favorably; increases
d. Answer A and C are correct.

40. According to the theory of rational expectations, higher inflationary expectations encourage businesses and households to reduce their demand for loanable funds.
a. True
b. False

41. A passive monetary policy adjusts money supply automatically in response to economic conditions.
a. True
b. False

42. 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

43. If the Fed attempts to reduce inflation, it would likely increase money supply growth.
a. True
b. False

44. The relationship between the interest rate on loanable funds and the level of business investment is positive.
a. True
b. False

45. The supply schedule of loanable funds indicates the quantity of funds that would be demanded at various possible interest rates.
a. True
b. False

46. To correct excessive inflation, the Fed could use open market operations by buying Treasury securities in the secondary market.
a. True
b. False

47. One of the disadvantages of inflation targeting is that the Fed could lose credibility is the U.S. inflation rate deviates substantially from the Fed’s target inflation rate.
a. True
b. False

48. Economists who work at the Fed recognize that a stimulative monetary policy will not always cure a high unemployment rate and could even ignite inflation.
a. True
b. False

49. An attempt by the Fed to stimulate the economy by reducing short-term interest rates may have a limited effect if long-term interest rates remain unaffected.
a. True
b. False

50. The Fed needs the approval of the presidential administration to make decisions.
a. True
b. False

51. The Fed is more likely to use a stimulative policy during a strong-dollar period.
a. True
b. False

52. A purchase of Treasury securities by the Fed leads to a(n) ____ in interest rates and a(n) ____ in the level of business investment.
a. increase; decrease
b. decrease; decrease
c. increase; increase
d. decrease; increase

53. Which of the following is probably not a goal the Fed is trying to achieve consistently?
a. low inflation
b. high interest rates
c. steady GNP growth
d. low unemployment

54. The ____ is not an indicator of economic growth.
a. producer price index
b. gross domestic product
c. national income
d. unemployment rate
e. All of the above are indicators of economic growth.

55. Which of the following is not true with respect to inflation targeting?
a. The Fed could lose credibility is the inflation rate deviates substantially from the Fed’s target inflation rate.
b. A complete focus on inflation could result in a much higher unemployment rate.
c. Inflation targeting may not only satisfy the inflation goal, but could also achieve the employment stabilization goal in the long run.
d. If unemployment is slightly higher than normal, while inflation is at the peak of the target range, and inflation targeting approach would like advocate a loose monetary policy.

56. 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

57. A weak dollar would stimulate ____, discourage ____, and ____ the U.S. economy.
a. U.S. exports; U.S. imports; weaken
b. U.S. exports; U.S. imports; stimulate
c. U.S. imports; U.S. exports; stimulate
d. none of the above

58. The interest rate that the Fed targets for its monetary policy is the:
a. commercial paper rate.
b. federal funds rate.
c. Treasury bond coupon rate.
d. 1-year certificate of deposit rate.

59. When the Fed purchases Treasury securities, the account balances of the investors who sell their securities to the Fed _________, and there are _________ in the account balances of other financial institutions.
a. increase; offsetting decreases
b. increase; no offsetting decreases
c. decrease; offsetting increases
d. decrease; no offsetting increases

60. The Fed’s monetary policy is commonly intended to alter the supply of funds in the banking system in order to achieve a specific targeted:
a. discount rate.
b. required reserve requirement.
c. federal funds rate.
d. prime rate.

61. If a firm has a credit risk premium of 3 percent and the Treasury security rate is 4 percent, the firm will be able to borrow at ________. If the Fed implements a monetary policy that raises the Treasury security rate to 6 percent, the cost of borrowing for the firm will be ________.
a. 7 percent; 10 percent
b. 4 percent; 6 percent
c. 7 percent; 9 percent
d. 1 percent; 3 percent

62. In the “operation twist” strategy used in 2011 and 2012, the Fed sold _______ Treasury securities and used the proceeds to purchase ________ Treasury securities.
a. long-term; short-term
b. short-term; long-term
c. short-term; long-term
d. long-term; short-term

63. The intent of the Fed’s operation twist strategy in 2011 and 2012 was to:.
a. increase long-term interest rates.
b. require corporations to issue more commercial paper.
c. require bond rating agencies to impose higher standards on their ratings.
d. reduce long-term interest rates.

64. Which of the following is not a reason that a stimulative monetary policy may be ineffective?
a. The effects of a stimulative policy may be disrupted by expectations of inflation.
b. Retirees who rely on interest income may restrict their spending
c. Lending institutions may increase their standards for borrowers, so some potential borrowers may not qualify for loans.
d. Higher interest rates encourage individuals to increase their savings.

65. In 2012, the Fed stated that it would continue to purchase Treasury bonds in the financial markets until GDP growth increased to a target level.
a. True
b. False

66. Which of the following was not true of the eurozone during the Greek crisis?
a. Fear of a financial crisis throughout Europe discouraged investors and firms from moving funds into Europe.
b. By using a more stimulative monetary policy than it desired, the European Central Bank aroused concerns about potential inflation in the eurozone.
c. There was concern that the austerity conditions could weaken the country’s economy further.
d. Greece, Spain, and Portugal focused their efforts on reducing tax rates in order to stimulate their economies.

Chapter 6—Money Markets

1. Securities with maturities of one year or less are classified as
a. capital market instruments.
b. money market instruments.
c. preferred stock.
d. none of the above

2. Which of the following is not a money market security?
a. Treasury bill
b. negotiable certificate of deposit
c. common stock
d. federal funds

3. ____ are sold at an auction at a discount from par value.
a. Treasury bills
b. Repurchase agreements
c. Banker’s acceptances
d. Commercial paper

4. 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

5. If an investor buys a T-bill with a 90-day maturity and $50,000 par value for $48,500 and holds it to maturity, what is the annualized yield?
a. about 13.4 percent
b. about 12.5 percent
c. about 11.3 percent
d. about 11.6 percent
e. about 10.7 percent

6. An investor buys a T-bill with 180 days to maturity and $250,000 par value for $242,000. He plans to sell it after 60 days, and forecasts a selling price of $247,000 at that time. What is the annualized yield based on this expectation?
a. about 10.1 percent
b. about 12.6 percent
c. about 11.4 percent
d. about 13.5 percent
e. about 14.3 percent

7. Assume investors require a 5 percent annualized return on a six-month T-bill with a par value of $10,000. The price investors would be willing to pay is $____.
a. 10,000
b. 9,524
c. 9,756
d. none of the above

8. A newly issued T-bill with a $10,000 par value sells for $9,750, and has a 90-day maturity. What is the discount?
a. 10.26 percent
b. 0.26 percent
c. $2,500
d. 10.00 percent
e. 11.00 percent

9. Large corporations typically make ____ bids for T-bills so they can purchase larger amounts.
a. competitive
b. noncompetitive
c. very small
d. none of the above

10. At any given time, the yield on commercial paper is ____ the yield on a T-bill with the same maturity.
a. slightly less than
b. slightly higher than
c. equal to
d. A and B both occur with about equal frequency

11. T-bills and commercial paper are sold
a. with a stated coupon rate.
b. at a discount from par value.
c. at a premium about par value.
d. A and C
e. none of the above

12. ____ is a short-term debt instrument issued only be well-known, creditworthy firms and is normally issued to provide liquidity or finance a firm’s investment in inventory and accounts receivable.
a. A banker’s acceptance
b. A repurchase agreement
c. Commercial paper
d. A Treasury bill

13. Commercial paper has a maximum maturity of ____ days.
a. 45
b. 270
c. 360
d. none of the above

14. An investor buys commercial paper with a 60-day maturity for $985,000. Par value is $1,000,000, and the investor holds it to maturity. What is the annualized yield?
a. 8.62 percent
b. 8.78 percent
c. 8.90 percent
d. 9.14 percent
e. 9.00 percent

15. A firm plans to issue 30-day commercial paper for $9,900,000. Par value is $10,000,000. What is the firm’s cost of borrowing?
a. 12.12 percent
b. 11.11 percent
c. 13.00 percent
d. 14.08 percent
e. 15.25 percent

16. When firms sell commercial paper at a ____ price than they projected, their cost of raising funds is ____ than projected.
a. higher; higher
b. lower; lower
c. A and B
d. none of the above

17. Which of the following is not a money market instrument?
a. banker’s acceptance
b. commercial paper
c. negotiable CDs
d. repurchase agreements
e. all of the above are money market instruments

18. A repurchase agreement calls for an investor to buy securities for $4,925,000 and sell them back in 60 days for $5,000,000. What is the yield?
a. 9.43 percent
b. 9.28 percent
c. 9.14 percent
d. 9.00 percent

19. The federal funds market allows depository institutions to borrow
a. short-term funds from each other.
b. short-term funds from the Treasury.
c. long-term funds from each other.
d. long-term funds from the Federal Reserve.
e. B and D

20. When a bank guarantees a future payment to a firm, the financial instrument used is called
a. a repurchase agreement.
b. a negotiable CD.
c. a banker’s acceptance.
d. commercial paper.

21. Which of the following instruments has a highly active secondary market?
a. banker’s acceptances
b. commercial paper
c. federal funds
d. repurchase agreements

22. Which of the following is true of money market instruments?
a. Their yields are highly correlated over time.
b. They typically sell for par value when they are initially issued (especially T-bills and commercial paper).
c. Treasury bills have the highest yield.
d. They all make periodic coupon (interest) payments.
e. A and B

23. An investor purchased an NCD a year ago in the secondary market for $980,000. He redeems it today and receives $1,000,000. He also receives interest of $30,000. The investor’s annualized yield on this investment is
a. 2.0 percent.
b. 5.10 percent.
c. 5.00 percent.
d. 2.04 percent.

24. An investor initially purchased securities at a price of $9,923,418, with an agreement to sell them back at a price of $10,000,000 at the end of a 90-day period. The repo rate is ____ percent.
a. 3.10
b. 0.77
c. 1.00
d. none of the above

25. 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

26. ____ are the most active participants in the federal funds market.
a. Savings and loan associations
b. Securities firms
c. Credit unions
d. Commercial banks

27. Eurodollar deposits
a. are U.S. dollars deposited in the U.S. by European investors.
b. are subject to interest rate ceilings.
c. have a relatively large spread between deposit and loan rates (compared to the spread between deposits and loans in the United States).
d. are not subject to reserve requirements.

28. Which money market transaction is most likely to represent a loan from one commercial bank to another?
a. banker’s acceptance
b. negotiable CD
c. federal funds
d. commercial paper

29. The rate on Eurodollar floating rate CDs is based on
a. a weighted average of European prime rates.
b. the London Interbank Offer Rate.
c. the U.S. prime rate.
d. a weighted average of European discount rates.

30. Treasury bills
a. have a maturity of up to five years.
b. have an active secondary market.
c. are commonly sold at par value.
d. commonly offer coupon payments.

31. The yield on commercial paper is ____ the yield of Treasury bills of the same maturity. The difference between their yields would be especially large during a ____ period.
a. greater than; recessionary
b. greater than; boom economy
c. less than; boom economy
d. less than; recessionary

32. The yield on NCDs is ____ the yield of Treasury bills of the same maturity. The difference between their yields would be especially large during a ____ period.
a. greater than; recessionary
b. greater than; boom economy
c. less than; boom economy
d. less than; recessionary

33. Which of the following is sometimes issued in the primary market by nonfinancial firms to borrow funds?
a. NCDs
b. retail CDs
c. commercial paper
d. federal funds

34. The so-called “flight to quality” causes the risk differential between risky and risk-free securities to be
a. eliminated.
b. reduced.
c. increased.
d. unchanged (there is no effect).

35. The effective yield of a foreign money market security is ____ when the foreign currency strengthens against the dollar.
a. increased
b. reduced
c. always negative
d. unaffected

36. The effective yield of a foreign money market security is ____ when the foreign currency weakens against the dollar.
a. increased
b. reduced
c. always negative
d. unaffected

37. Treasury bills are sold through ____ when initially issued.
a. insurance companies
b. commercial paper dealers
c. auction
d. finance companies

38. At a given point in time, the actual price paid for a three-month Treasury bill is
a. usually equal to the par value.
b. more than the price paid for a six-month Treasury bill.
c. equal to the price paid for a six-month Treasury bill.
d. none of the above

39. The minimum denomination of commercial paper is
a. $25,000.
b. $100,000.
c. $150,000.
d. $200,000.

40. Commercial paper is
a. always directly placed with investors.
b. always placed with the help of commercial paper dealers.
c. placed either directly or with the help of commercial paper dealers.
d. always placed by bank holding companies.

41. An investor, purchases a six-month (182-day) T-bill with a $10,000 par value for $9,700. If the Treasury bill is held to maturity, the annualized yield is ____ percent.
a. 6.02
b. 1.54
c. 1.50
d. 6.20
e. none of the above

42. When an investor purchases a six-month (182-day) T-bill with a $10,000 par value for $9,700, the Treasury bill discount is ____ percent.
a. 5.93
b. 6.12
c. 6.20
d. 6.02
e. none of the above

43. Robbins Corp. frequently invests excess funds in the Mexican money market. One year ago, Robbins invested in a one-year Mexican money market security that provided a yield of 25 percent. At the end of the year, when Robbins converted the Mexican pesos to dollars, the peso had depreciated from $.12 to $.11. What is the effective yield earned by Robbins?
a. 25.00 percent
b. 35.41 percent
c. 14.59 percent
d. none of the above

44. An aggregate purchase by investors of low-yield instruments in favor of high-yield instruments places ____ pressure on the yields of low-yield securities and ____ on the yields of high-yield securities.
a. upward; upward
b. downward; downward
c. upward; downward
d. downward; upward

45. Which of the following statements is incorrect with respect to the federal funds rate?
a. It is the rate charged by financial institutions on loans they extend to each other.
b. It is not influenced by the supply and demand for funds in the federal funds market.
c. The federal funds rate is closely monitored by all types of firms.
d. Many market participants view changes in the federal funds rate to be an indicator of potential changes in other money market rates.
e. The Federal Reserve adjusts the amount of funds in depository institutions in order to influence the federal funds rate.

46. Buser Corp. purchases certain securities for $4,921,349, with an agreement to sell them back at a price of $4,950,000 at the end of a 30-day period. The repo rate is ____ percent.
a. 7.08
b. 6.95
c. 6.99
d. 7.04
e. none of the above

47. Commercial paper is subject to:
a. interest rate risk.
b. default risk.
c. A and B.
d. none of the above.

48. If economic conditions cause investors to sell stocks because they want to invest in safer securities with much liquidity, this should cause a ____ demand for money market securities, which placed ____ pressure on the yields of money market securities.
a. weak; downward
b. weak; upward
c. strong; upward
d. none of the above

49. In general the money markets are widely perceived to be efficient in the sense that the prices reflect all available public information.
a. True
b. False

50. Money market securities are must have a maturity of three months or less.
a. True
b. False

51. Money market securities are issued in the primary market through a telecommunications network by the Treasury, corporations, and financial intermediaries that wish to obtain short-term financing.
a. True
b. False

52. An international interbank market facilitates the transfer of funds from banks with excess funds to those with deficient funds.
a. True
b. False

53. The interest rate charged for a short-term loan from a bank to a corporation is referred to as the London interbank offer rate (LIBOR).
a. True
b. False

54. Money markets are used to facilitate the transfer of short-term funds from individuals, corporations, or governments with excess funds to those with deficient funds.
a. True
b. False

55. Because money market securities have a short-term maturity and typically cannot be sold easily, they provide investors with a low degree of liquidity.
a. True
b. False

56. There is no limit to the amount of T-bills that can be purchased by noncompetitive bidders in a T-bill auction.
a. True
b. False

57. T-bills do not offer coupon payments but are sold at a discount from par value.
a. True
b. False

58. Junk commercial paper is commercial paper that is not rated or rated low.
a. True
b. False

59. 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

60. T-bills must offer a premium above the negotiable certificate of deposit (NCD) to compensate for less liquidity and safety.
a. True
b. False

61. Most repo transactions use government securities.
a. True
b. False

62. Exporters can hold a banker’s acceptance until the date at which payment is to be made, yet they frequently sell the acceptance before then at a discount to obtain cash immediately.
a. True
b. False

63. Money market security values are less sensitive to interest rate movements than bonds.
a. True
b. False

64. During periods of uncertainty about the economy, there is a shift from risky money market securities to Treasury securities.
a. True
b. False

65. The price O bidders will pay at a Treasury bill auction is the
a. highest price entered by a competitive bidder.
b. highest price entered by a noncompetitive bidder.
c. weighted average price paid by all competitive bidders whose bids were accepted.
d. equally weighted average price paid by all competitive bidders whose bids were accepted.
e. none of the above

66. Bill Yates, a private investor, purchases a six-month (182-day) T-bill with a $10,000 par value for $9,700. If Bill holds the Treasury bill to maturity, his annualized yield is ____ percent.
a. 6.02
b. 1.54
c. 1.50
d. 6.20
e. none of the above

67. You purchase a six-month (182-day) T-bill with a $10,000 par value for $9,700. The Treasury bill discount is ____ percent.
a. 5.93
b. 6.12
c. 6.20
d. 6.02
e. none of the above

68. A ____ is not a money market security.
a. Treasury bill
b. negotiable certificate of deposit
c. bond
d. banker’s acceptance
e. All of the above are money market securities.

69. Freeman Corp., a large corporation, plans to issue 45-day commercial paper with a par value of $3,000,000. Freeman expects to sell the commercial paper for $2,947,000. Freeman’s annualized cost of borrowing is estimated to be ____ percent.
a. 14.39
b. 14.13
c. 14.59
d. 14.33
e. none of the above

70. When a firm sells its commercial paper at a ____ price than projected, their cost of raising funds will be ____ than what they initially anticipated.
a. higher; higher
b. lower; lower
c. higher; lower
d. lower; higher
e. Answers C and D are correct.

71. Which of the following securities is most likely to be used in a repo transaction?
a. commercial paper
b. certificate of deposit
c. Treasury bill
d. common stock
e. All of the above are equally likely to be used in a repo transaction.

72. A major drawback to investing in Treasury bills is that they cannot easily be liquidated.
a. True
b. False

73. At each T-bill auction, the prices paid for three-month T-bills are significantly lower than the prices paid for six-month bills.
a. True
b. False

74. Ignoring transaction costs, the cost of borrowing with commercial paper is equal to:
a. the yield on T-bills of the same maturity.
b. the yield earned by investors holding the paper until maturity.
c. the federal funds rate.
d. the par value of the paper.

75. LIBOR is:
a. the interest rate charged on international interbank loans.
b. the average rate charged on commercial loans in Europe.
c. the rate charged by the Federal Reserve for loans to banks.
d. the rate charged by the European Central Bank for loans to banks.

76. The LIBOR scandal in 2012 involved:
a. banks reporting inflated earnings from their loans.
b. hackers breaking into the loan documentation files.
c. banks falsely reporting the interest rates they offered in the interbank market.
d. collusion among the banks when setting the commercial paper.

77. Credit guarantees for commercial paper:
a. ensures that the issuer of commercial paper will use the funds obtained to provide credit.
b. are issued by the Federal Reserve Bank of New York.
c. are only as good as the credit of the guarantor.
d. A and C

78. The money market interest rate paid by corporations that borrow short-term funds in a particular country is typically:
a. equal to the rate paid by that country’s government.
b. slightly higher than the rate paid by that country’s government.
c. mostly influenced by the demand for and supply of long-term funds in that country.
d. set by the country’s central bank.

FIN 350 Week 5 Quiz Solution

Chapter 7—Bond Markets

1. ____ require the owner to clip coupons attached to the bonds and send them to the issuer to receive coupon payments.
a. Bearer
b. Registered
c. Treasury
d. Corporate

2. The yield to maturity is the annualized discount rate that equates the future coupon and principal payments to the initial proceeds received from the bond offering.
a. True
b. False

3. Note maturities are usually ____, while bond maturities are ____.
a. less than 10 years; 10 years or more
b. 10 years or more; less than 10 years
c. less than 5 years; 5 years or more
d. 5 years or more; less than 5 years

4. Investors in Treasury notes and bonds receive ____ interest payments from the Treasury.
a. annual
b. semiannual
c. quarterly
d. monthly

5. The Treasury has relied heavily on ____-year bonds to finance the U.S. budget deficit.
a. 50
b. 70
c. 10
d. 5

6. Interest earned from Treasury bonds is
a. exempt from all income tax.
b. exempt from federal income tax.
c. exempt from state and local taxes.
d. subject to all income taxes.

7. Treasury bond auctions are normally conducted only at the beginning of each year.
a. True
b. False

8. ____ bids for Treasury bonds specify a price that the bidder is willing to pay and a dollar amount of securities to be purchased.
a. Competitive
b. Noncompetitive
c. Negotiable
d. Non-negotiable

9. Treasury bond dealers
a. quote an ask price for customers who want to sell existing Treasury bonds to the dealers.
b. profit from a very wide spread between bid and ask prices in the Treasury securities market.
c. may trade Treasury bonds among themselves.
d. make a primary market for Treasury bonds.

10. Under the STRIP program created by the Treasury, stripped securities are created and sold by the Treasury.
a. True
b. False

11. A ten-year, inflation-indexed bond has a par value of $10,000 and a coupon rate of 5 percent. During the first six months since the bond was issued, the inflation rate was 2 percent. Based on this information, the coupon payment after six months will be $____.
a. 250
b. 255
c. 500
d. 510

12. Bonds issued by ____ are backed by the federal government.
a. the Treasury
b. AAA-rated corporations
c. state governments
d. city governments

13. Municipal general obligation bonds are ____. Municipal revenue bonds are ____.
a. supported by the municipal government’s ability to tax; supported by the municipal government’s ability to tax
b. supported by the municipal government’s ability to tax; supported by revenue generated from the project
c. always subject to federal taxes; always exempt from state and local taxes
d. typically zero-coupon bonds; typically zero-coupon bonds

14. In general, variable-rate municipal bonds are desirable to investors who expect that interest rates will ____.
a. remain unchanged
b. fall
c. rise
d. none of the above

15. Which of the following statements is not true regarding zero-coupon bonds?
a. They are issued at a deep discount from par value.
b. Investors are taxed on the total amount of interest earned at maturity.
c. The issuing firm is permitted to deduct the amortized discount as interest expense for federal income tax purposes, even though it does not pay interest until maturity.
d. Zero-coupon bonds are purchased mainly for tax-exempt investment accounts, such as pension funds and individual retirement accounts.
e. All of the above are true.

16. 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.

17. Corporate bonds that receive a ____ rating from credit rating agencies are normally placed at ____ yields.
a. higher; lower
b. lower; lower
c. higher; higher
d. none of the above

18. A private bond placement has to be registered with the SEC.
a. True
b. False

19. Which of the following institutions is most likely to purchase a private bond placement?
a. commercial bank
b. mutual fund
c. insurance company
d. savings institution

20. A protective covenant may
a. specify all the rights and obligations of the issuing firm and the bondholders.
b. require the firm to retire a certain amount of the bond issue each year.
c. restrict the amount of additional debt the firm can issue.
d. none of the above

21. A call provision on bonds normally
a. allows the firm to sell new bonds at par value.
b. gives the firm to sell new bonds above market value.
c. allows the firm to sell bonds to the Treasury.
d. allows the firm to buy back bonds that it previously issued.

22. When would a firm most likely call bonds?
a. after interest rates have declined
b. if interest rates do not change
c. after interest rates increase
d. just before the time at which interest rates are expected to decline

23. Assume U.S. interest rates are significantly higher than German rates. A U.S. firm with a German subsidiary could achieve a lower financing rate, without exchange rate risk by denominating the bonds in
a. dollars.
b. euros and making payments from U.S. headquarters.
c. euros and making payments from its German subsidiary.
d. dollars and making payments from its German subsidiary.

24. Many bonds have different call prices: a higher price for calling the bonds to meet sinking-fund requirements and a lower price if the bonds are called for any other reason.
a. True
b. False

25. Bonds that are not secured by specific property are called
a. a chattel mortgage.
b. open-end mortgage bonds.
c. debentures.
d. blanket mortgage bonds.

26. Bonds that are secured by personal property are called
a. chattel mortgage bonds.
b. first mortgage bonds.
c. second mortgage bonds.
d. debentures.

27. The coupon rate of most variable-rate bonds is tied to
a. the prime rate.
b. the discount rate.
c. LIBOR.
d. the federal funds rate.

28. Assume that you purchased corporate bonds one year ago that have no protective covenants. Today, it is announced that the firm that issued the bonds plans a leveraged buyout. The market value of your bonds will likely ____ as a result.
a. rise
b. decline
c. be zero
d. be unaffected

29. During weak economic periods, newly issued junk bonds require lower risk premiums than in strong economic periods.
a. True
b. False

30. ____ bonds have the most active secondary market.
a. Treasury
b. Zero-coupon corporate
c. Junk
d. Municipal

31. Some bonds are “stripped,” which means that
a. they have defaulted.
b. the call provision has been eliminated.
c. they are transferred into principal-only and interest-only securities.
d. their maturities have been reduced.

32. ____ are not primary purchasers of bonds.
a. Insurance companies
b. Finance companies
c. Mutual funds
d. Pension funds

33. Leveraged buyouts are commonly financed by the issuance of:
a. money market securities.
b. Treasury bonds.
c. corporate bonds.
d. municipal bonds.

34. When firms issue ____, the amount of interest and principal to be paid is based on specified market conditions. The amount of the repayment may be tied to a Treasury bond price index or even to a stock index.
a. auction-rate securities
b. structured notes
c. leveraged notes
d. stripped securities

35. Which of the following statements is true regarding STRIPS?
a. they are issued by the Treasury
b. they are created and sold by various financial institutions
c. they are not backed by the U.S. government
d. they have to be held until maturity
e. all of the above are true regarding STRIPS

36. (Financial calculator required.) Lisa can purchase bonds with 15 years until maturity, a par value of $1,000, and a 9 percent annualized coupon rate for $1,100. Lisa’s yield to maturity is ____ percent.
a. 9.33
b. 7.84
c. 9.00
d. none of the above

37. (Financial calculator required.) Erin is, a private investor, who can purchase $1,000 par value bonds for $980. The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until maturity. Erin’s yield to maturity is ____ percent.
a. 9.96
b. 10.00
c. 10.33
d. 10.24
e. none of the above

38. 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

39. Which of the following is not true regarding zero-coupon bonds?
a. They are issued at a deep discount from par value.
b. Investors are taxed annually on the amount of interest earned, even though the interest will not be received until maturity.
c. The issuing firm is permitted to deduct the amortized discount as interest expense for federal income tax purposes, even though it does not pay interest.
d. Zero-coupon bonds are purchased mainly for tax-exempt investment account, such as pension funds and individual retirement accounts.
e. all of the above are true

40. Which of the following is not true regarding the call provision?
a. It typically requires a firm to pay a price above par value when it calls its bonds.
b. The difference between the market value of the bond and the par value is called the call premium.
c. A principal use of the call provision is to lower future interest payments.
d. A principal use of the call provision is to retire bonds as required by a sinking-fund provision.
e. A call provision is normally viewed as a disadvantage to bondholders.

41. If interest rates suddenly ____, those existing bonds that have a call feature are ____ likely to be called.
a. decline; more
b. decline; less
c. increase; more
d. none of the above

42. Which of the following would not be a likely example of a protective covenant provision?
a. a limit on the amount of dividends a firm can pay
b. a limit on the corporate officers’ salaries a firm can pay
c. the amount of additional debt a firm can issue
d. a call feature

43. Bonds are issued in the primary market through a telecommunications network.
a. True
b. False

44. Corporate bonds can be placed with investors through a public offering or a private placement.
a. True
b. False

45. When a corporation issues bonds, it normally hires a securities firm that targets large institutional investors such as pension funds, bond mutual funds, and insurance companies.
a. True
b. False

46. Rule 144A, which allows small individual investors to trade privately-placed bonds (and some other securities) with each other without requiring that the firms that issued the securities to register them with the SEC.
a. True
b. False

47. Rule 144A creates liquidity for securities that are privately placed.
a. True
b. False

48. Corporate bonds are more standardized than stocks.
a. True
b. False

49. Structured notes are issued by firms to borrow funds, and the repayment of interest and principal is based on specified market conditions.
a. True
b. False

50. Bonds issued by large well-known corporations in large volume are illiquid because most buyers hold these bonds until maturity.
a. True
b. False

51. The bond market is served by bond dealers, who can play a broker role by matching up buyers and sellers.
a. True
b. False

52. Bond dealers do not have an inventory of bonds.
a. True
b. False

53. Bond dealers specialize in small transactions (less than $100,000) in order to enable small investors to trade bonds.
a. True
b. False

54. Many bonds are listed on the New York Stock Exchange (NYSE).
a. True
b. False

55. The primary investors in bond markets are institutional investors such as commercial banks, bond mutual funds, pension funds, and insurance companies.
a. True
b. False

56. The key difference between a note and a bond is that note maturities are usually less than one year, while bond maturities are one year or more.
a. True
b. False

57. Treasury bonds are issued by state and local governments.
a. True
b. False

58. Stripped bonds are bonds whose cash flows have been transformed into a security representing the principal payment only and a security representing interest payments only.
a. True
b. False

59. Inflation-indexed Treasury bonds are intended for investors who wish to ensure that the returns on their investments keep up with the increase in prices over time.
a. True
b. False

60. Savings bonds are bonds issued by the Federal Reserve.
a. True
b. False

61. Corporate bonds usually pay interest on an annual basis.
a. True
b. False

62. The bond debenture is a legal document specifying the rights and obligations of both the issuing firm and the bondholders.
a. True
b. False

63. A sinking-fund provision is a requirement that the issuing firm retire a certain amount of the bond issue each year.
a. True
b. False

64. Subordinated indentures are debentures that have claims against the firm’s assets that are junior to the claims of both mortgage bonds and regular debentures.
a. True
b. False

65. High-risk bonds are called trash bonds.
a. True
b. False

66. Zero-coupon bonds do not pay interest. Instead, they are issued at a discount from par value.
a. True
b. False

67. If interest rates suddenly decline, those existing bonds that have a call feature are less likely to be called.
a. True
b. False

68. Which of the following statements is not true regarding STRIPS?
a. They are not issued by the Treasury.
b. They are created and sold by various financial institutions.
c. They are backed by the U.S. government.
d. They have to be held until maturity.
e. All of the above are true regarding STRIPS.

69. (Financial calculator required.) Paul can purchase bonds with 15 years remaining until maturity, a par value of $1,000, and a 9 percent annual coupon rate for $1,100. Paul’s yield to maturity is ____ percent.
a. 9.33
b. 7.84
c. 9.00
d. none of the above

70. (Financial calculator required.) Steven, a private investor, can purchase $1,000 par value bonds for $980. The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until maturity. Steven’s yield to maturity is ____ percent.
a. 9.96
b. 10.00
c. 10.33
d. 10.24
e. none of the above

71. Jim purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Jim will hold the bonds until maturity. Thus, he will earn a return of ____ percent.
a. 12.00
b. 9.00
c. 10.50
d. More information is needed to answer this question.

72. Which of the following is not an example of a municipal bond?
a. general obligation bond
b. revenue bond
c. Treasury bond
d. All of the above are examples of municipal bonds.

73. Which of the following statements is incorrect?
a. The municipal bond must pay a risk premium to compensate for the possibility of default risk.
b. The Treasury bond must pay a slight premium to compensate for being less liquid than municipal bonds.
c. The income earned from municipal bonds is exempt from federal taxes.
d. All of the above are true.

74. Which of the following is not mentioned in your text as a protective covenant?
a. a limit on the amount of dividends a firm can pay
b. a limit on the corporate officers’ salaries a firm can pay
c. the amount of additional debt a firm can issue
d. the appointment of a trustee in all bond indentures
e. All of the above are mentioned in the text as protective covenants.

75. Everything else being equal, which of the following bond ratings is associated with the highest yield?
a. Baa
b. A
c. Aa
d. Aaa

76. A ____ has first claim on specified assets, while a ____ is a debenture that has claims against a firm’s assets that are junior to the claims of mortgage bonds and regular debentures.
a. first mortgage bond; second mortgage bond
b. first mortgage bond; debenture
c. first mortgage bond; subordinated debenture
d. chattel mortgage bond; subordinated debenture
e. none of the above

77. If a firm believes that it will have sufficient cash flows to cover interest payments, it may consider using ____ debt and ____ equity, which implies a ____ degree of financial leverage.
a. more; less; lower
b. more; less; higher
c. less; more; higher
d. none of the above

78. The yield to investors on Treasury bonds reflects the risk-free rate because these bonds are virtually free from credit (default) risk.
a. True
b. False

79. The issuance of municipal securities is regulated by:
a. the Securities and Exchange Commission.
b. the Consumer Financial Protection Bureau.
c. their respective state governments.
d. the Federal Reserve.

80. For bonds issued under a _______ arrangement, the underwriter guarantees the issuer that the bonds will be sold at a specified price.
a. specific value
b. fixed proceeds
c. best efforts
d. firm commitment

81. For bonds issued under a _______ arrangement, the underwriter attempts to sell the bonds at a specified price but makes no guarantee to the issuer.
a. floating value
b. variable proceeds
c. best efforts
d. firm commitment

82. Which of the following eurozone countries has not recently experienced debt repayment problems?
a. Finland
b. Greece
c. Portugal
d. Spain

83. The Financial Reform Act of 2010 established the __________ to provide oversight for credit rating agencies.
a. Federal Ratings Bureau
b. Office of Credit Ratings
c. Office of Agency Supervision
d. Ratings Oversight Commission

84. A credit rating agency is paid by:
a. the purchasers of the bonds that the agency rates.
b. the issuers of the bonds that the agency rates.
c. the taxpayers, because the rating agencies are government agencies.
d. the New York Stock Exchange or the over-the-counter market where the bonds are listed.

85. All of the bonds issued by a particular company will have the same maturity, price, and credit rating.
a. True
b. False

86. When purchasing bonds, individual investors can use a ________ to specify the maximum price they are willing to pay for a bond.
a. limit order
b. market order
c. stop order
d. price order

87. Online bond brokerage services offer several advantages including:
a. pricing is more transparent because investors can easily compare bid and ask spreads.
b. some services charge commissions, which may be more easily understood than bid and ask spreads.
c. some brokers have narrowed their spreads so that they do not lose business to competitors.
d. all of the above

Chapter 8—Bond Valuation and Risk

1. The appropriate discount rate for valuing any bond is the
a. bond’s coupon rate.
b. bond’s coupon rate adjusted for the expected inflation rate over the life of the bond.
c. Treasury bill rate with an adjustment to include a risk premium if one exists.
d. yield that could be earned on alternative investments with similar risk and maturity.

2. The valuation of bonds is generally perceived to be ____ the valuation of equity securities.
a. more difficult than
b. easier than
c. just as difficult as
d. none of the above

3. A bond with a $1,000 par value has an 8 percent annual coupon rate. It will mature in 4 years, and annual coupon payments are made at the end of each year. Present annual yields on similar bonds are 6 percent. What should be the current price?
a. $1,069.31
b. $1,000.00
c. $9712
d. $927.66
e. none of the above

4. A bond with a ten percent coupon rate bond pays interest semi-annually. Par value is $1,000. The bond has three years to maturity. The investors’ required rate of return is 12 percent. What is the present value of the bond?
a. $1,021
b. $1,000
c. $981
d. $951
e. none of the above

5. A bond with a 12 percent quarterly coupon rate has a yield to maturity of 16 percent. The bond has a par value of $1,000 and matures in 20 years. Based on this information, a fair price of this bond is $____.
a. 1,302
b. 763
c. 761
d. 1,299

6. From the perspective of investing institutions, the most attractive foreign bonds offer a ____ and are denominated in a currency that ____ over the investment horizon.
a. high yield; appreciates
b. high yield; remains stable
c. low yield; appreciates
d. low yield; depreciates

7. The value of ____-risk securities will be relatively ____.
a. high; high
b. high; low
c. low; low
d. none of the above

8. The larger the investor’s ____ relative to the ____, the larger the ____ of a bond with a particular par value.
a. discount rate; required rate of return; discount
b. required rate of return; discount rate; discount
c. required rate of return; discount rate; premium
d. none of the above

9. If the coupon rate equals the required rate of return, the price of the bond
a. should be above its par value.
b. should be below its par value.
c. should be equal to its par value.
d. is negligible.

10. When financial institutions expect interest rates to ____, they may ____.
a. increase; sell bonds and buy short-term securities
b. increase; sell short-term securities and buy bonds
c. decrease; sell bonds and buy short-term securities
d. B and C

11. For a given par value of a bond, the higher the investor’s required rate of return is above the coupon rate, the
a. greater is the premium on the price.
b. greater is the discount on the price.
c. smaller is the premium on the price.
d. smaller is the discount on the price.

12. Zero coupon bonds with a par value of $1,000,000 have a maturity of 10 years, and a required rate of return of 9 percent. What is the current price?
a. $363,212
b. $385,500
c. $422,400
d. $424,100
e. none of the above

13. If the coupon rate ____ the required rate of return, the price of a bond ____ par value.
a. equals; equals
b. exceeds; is less than
c. is less than; is greater than
d. B and C
e. none of the above

14. As interest rates increase, long-term bond prices
a. increase by a greater degree than short-term bond prices.
b. increase by an equal degree as short-term bond prices.
c. decrease by a greater degree than short-term bond prices.
d. decrease by an equal degree as short-term bond prices.
e. decrease by a smaller degree than short-term bond prices.

15. The prices of bonds with ____ are most sensitive to interest rate movements.
a. high coupon payments
b. zero coupon payments
c. small coupon payments
d. none of the above (The size of the coupon payment does not affect sensitivity of bond prices to interest rate movements.)

16. A(n) ____ in the expected level of inflation results in ____ pressure on bond prices.
a. increase; upward
b. increase; downward
c. decrease; downward
d. none of the above

17. Other things held constant, bond prices should increase when inflationary expectations rise.
a. True
b. False

18. An expected ____ in economic growth places ____ pressure on bond prices.
a. increase; downward
b. increase; upward
c. decrease; downward
d. none of the above

19. Assume that the price of a $1,000 zero coupon bond with five years to maturity is $567 when the required rate of return is 12 percent. If the required rate of return suddenly changes to 15 percent, what is the price elasticity of the bond?
a. −.980
b. +.980
c. −.494
d. +.494
e. none of the above

20. If a financial institution’s bond portfolio contains a relatively large portion of ____, it will be ____.
a. high coupon bonds; more favorably affected by declining interest rates
b. zero or low coupon bonds; more favorably affected by declining interest rates
c. zero or low coupon bonds; more favorably affected by rising interest rates
d. high coupon bonds; completely insulated from rising interest rates

21. The prices of ____-coupon and ____ maturities are most sensitive to changes in the required rate of return.
a. low; short
b. low; long
c. high; short
d. high; long

22. An insurance company purchases corporate bonds in the secondary market with six years to maturity. Total par value is $55 million. The coupon rate is 11 percent, with annual interest payments. If the expected required rate of return in 4 years is 9 percent, what will the market value of the bonds be then?
a. $52,115,093
b. $55,341,216
c. $55,000,000
d. $56,935,022

23. A $1,000 par bond with five years to maturity is currently priced at $892. Annual interest payments are $90. What is the yield to maturity?
a. 13 percent
b. 12 percent
c. 11 percent
d. 10 percent

24. A bank buys bonds with a par value of $25 million for $24,040,000. The coupon rate is 10 percent, and the bonds pay annual payments. The bonds mature in four years. The bank wants to sell them in two years, and estimates the required rate of return in two years will be 8 percent. What will the market value of the bonds be in two years?
a. $24,113,418
b. $24,667,230
c. $25,000,000
d. $25,891,632

25. The price of short-term bonds are commonly ____ those of long-term bonds.
a. more volatile than
b. equally volatile as
c. less volatile than
d. A and C occur with about equal frequency

26. Assume that the value of liabilities equals that of earning assets. If asset portfolio durations are ____ than liability portfolio durations, then the market value of assets are ____ interest-rate sensitive than the market value of liabilities.
a. greater; more
b. greater; equally
c. greater; less
d. less; equally
e. B and D

27. As interest rates consistently rise over a specific period, the market price of a bond you own would likely ____ over this period. (Assume no major change in the bond’s default risk.)
a. consistently increase
b. consistently decrease
c. remain unchanged
d. change in a direction that cannot be determined with the above information

28. As interest rates consistently decline over a specific period, the market price of a bond you own would likely ____ over this period. (Assume no major change in the bond’s default risk.)
a. consistently increase
b. consistently decrease
c. remain unchanged
d. change in a direction that cannot be determined with the above information

29. If analysts expect that the demand for loanable funds will increase, and the supply of loanable funds will decrease, they would most likely expect interest rates to ____ and prices of existing bonds to ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

30. If analysts expect that the demand for loanable funds will decrease, and the supply of loanable funds will increase, they would most likely expect interest rates to ____ and prices of existing bonds to ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

31. Consider a coupon bond that sold at par value two years ago. If interest rates are much lower now than when this bond was issued, the coupon rate of that bond will likely be ____ the prevailing interest rates, and the present value of the bonds will be ____ its par value.
a. above; above
b. above; below
c. below; below
d. below; above

32. Consider a coupon bond that sold at par value two years ago. If interest rates are much higher now than when this bond was issued, the coupon rate of that bond will likely be ____ the prevailing interest rates, and the present value of the bonds will be ____ its par value.
a. above; above
b. above; below
c. below; below
d. below; above

33. If bond portfolio managers expect interest rates to increase in the future, they would likely ____ their holdings of bonds now, which could cause the prices of bonds to ____ as a result of their actions.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

34. If bond portfolio managers expect interest rates to decrease in the future, they would likely ____ their holdings of bonds now, which could cause the prices of bonds to ____ as a result of their actions.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

35. 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

36. If the United States announces that it will borrow an additional $10 billion, this announcement will normally cause the bond traders to expect
a. higher interest rates in the future, and will buy bonds now.
b. higher interest rates in the future, and will sell bonds now.
c. stable interest rates in the future, and will buy bonds now.
d. lower interest rates in the future, and will buy bonds now.
e. lower interest rates in the future, and will sell bonds now.

37. The market value of long-term bonds is ____ sensitive to interest rate movements; as interest rates fall, the market value of long-term bonds ____.
a. slightly; rises
b. very; rises
c. very; declines
d. slightly; declines

38. The bonds that are most sensitive to interest rate movements have
a. no coupon and a short-term maturity.
b. high coupons and a short-term maturity.
c. high coupons and a long-term maturity.
d. no coupon and a long-term maturity.

39. When two securities have the same expected cash flows, the value of the ____ security will be higher than the value of the ____ security.
a. high-risk; low-risk
b. low-risk; high-risk
c. high-risk; high-risk
d. low-risk; low-risk
e. none of the above

40. Morgan would like to purchase a bond that has a par value of $1,000, pays $80 at the end of each year in coupon payments, and has 10 years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Morgan pay for the bond?
a. $1,000.00
b. $1,147.20
c. $856.80
d. none of the above

41. Sioux Financial Corp. has forecasted its bond portfolio value for one year ahead to be $105 million. In one year, it expects to receive $10,000,000 in coupon payments. The bond portfolio today is worth $101 million. What is the forecasted return of this bond portfolio?
a. 10 percent
b. 8.82 percent
c. 4.32 percent
d. 13.86 percent
e. none of the above

42. Hurricane Corp. recently purchased corporate bonds in the secondary market with a par value of $11 million, a coupon rate of 12 percent (with annual coupon payments), and four years until maturity. If Bullock intends to sell the bonds in two years and expects investors’ required rate of return at that time on similar investments to be 14 percent at that time, what is the expected market value of the bonds in two years?
a. $9.33 million
b. $11.00 million
c. $10.64 million
d. $9.82 million
e. none of the above

43. Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The duration of this bond is
a. 1.90 years.
b. 1.50 years.
c. 1.92 years.
d. none of the above

44. Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The modified duration of this bond is
a. 1.73 years.
b. 1.71 years.
c. 1.90 years.
d. none of the above

45. The relationship reflecting the actual response of a bond’s price to a change in bond yields is
a. concave.
b. convex.
c. linear.
d. quadratic.

46. If the level of inflation is expected to ____, there will be ____ pressure on interest rates and ____ pressure on the required rate of return on bonds.
a. increase; upward; downward
b. decrease; upward; downward
c. decrease; upward; upward
d. increase; downward; upward
e. increase; upward; upward

47. Using a(n) ____ strategy, investors allocate funds evenly to bonds in each of several different maturity classes.
a. matching
b. laddered
c. barbell
d. interest rate
e. none of the above

48. With a(n) ____ strategy, funds are allocated to bonds with a short term to maturity and bonds with a long term to maturity. Thus, this strategy allocates some funds to achieving a relatively high return and other funds to covering liquidity needs.
a. matching
b. laddered
c. barbell
d. interest rate
e. none of the above

49. 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

50. Which of the following is most likely to cause a decrease in bond prices?
a. a decrease in money supply growth and an increase in the demand for loanable funds
b. a forecast of decreasing oil prices
c. a forecast of a stronger dollar
d. an increase in money supply growth and no change in the demand for loanable funds

51. If the Treasury issues an unusually large amount of bonds in the primary market, it places ____ on bond prices, and ____ on yields to be earned by investors that purchase bonds and plan to hold them to maturity.
a. downward pressure; downward pressure
b. downward pressure; upward pressure
c. upward pressure; upward pressure
d. upward pressure; downward pressure

52. Assume bond portfolio managers actively manage their portfolios. If they expect interest rates to ____, they would shift toward ____.
a. increase; long-maturity bonds with zero-coupon rates
b. decrease; short-maturity bonds with high-coupon rates
c. increase; high-coupon bonds with long maturities
d. decrease; long-maturity bonds with zero-coupon rates

53. The market price of a bond is partly determined by the timing of the payments made to bondholders.
a. True
b. False

54. The appropriate price of a bond is simply the sum of the cash flows to be received.
a. True
b. False

55. The valuation of bonds is generally perceived to be more difficult than the valuation of equity securities.
a. True
b. False

56. Bonds that sell below their par value are called premium bonds.
a. True
b. False

57. A zero-coupon bond makes no coupon payments.
a. True
b. False

58. If the coupon rate of a bond is above the investor’s required rate of return, the price of the bond should be below its par value.
a. True
b. False

59. An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return and therefore causes bond prices to increase.
a. True
b. False

60. The long-term, risk-free interest rate is driven by inflationary expectations, economic growth, the money supply, and the budget deficit.
a. True
b. False

61. If the level of inflation is expected to decrease, there will be upward pressure on interest rates and on the required rate of return on bonds.
a. True
b. False

62. Foreign investors anticipating dollar depreciation are less willing to hold U.S. bonds because the coupon payments will convert to less of their home currency.
a. True
b. False

63. Any announcement that signals stronger than expected economic growth tends to increase bond prices.
a. True
b. False

64. Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return.
a. True
b. False

65. As interest rates increase, prices of short-term bonds will decline by a greater degree than prices on long-term bonds.
a. True
b. False

66. Duration is a measure of bond price sensitivity.
a. True
b. False

67. A bond portfolio containing a large portion of zero-coupon bonds will be more favorably affected by declining interest rates than a bond portfolio containing no zero-coupon bonds.
a. True
b. False

68. International diversification of bonds reduces the sensitivity of a bond portfolio to any single country’s interest rate movements.
a. True
b. False

69. 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

70. Which of the following formulas best describes the value of a bond?
a.
b.
c.
d.
e. none of the above

71. Stephanie would like to purchase a bond that has a par value of $1,000, pays $80 at the end of each year in coupon payments, and has ten years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Stephanie pay for the bond?
a. $1,000.00
b. $1,147.20
c. $856.80
d. none of the above

72. Julia just purchased a $1,000 par value bond with a 10 percent annual coupon rate and a life of twenty years. The bond has four years remaining until maturity, and the yield to maturity is 12 percent. How much did Julia pay for the bond?
a. $1,063.40
b. $1,000
c. $939.25
d. none of the above

73. To determine the present value of a bond that pays semiannual interest, which of the following adjustments should not be made to compute the price of the bond?
a. The annualized coupon should be split in half.
b. The annual discount rate should be divided by 2.
c. The number of annual periods should be doubled.
d. The par value should be split in half.
e. All of the above adjustments have to be made.

74. A $1,000 par value bond, paying $50 semiannually, with an 8 percent yield to maturity and five years remaining to maturity should sell for
a. $1,000.00.
b. $1,081.11.
c. $798.70.
d. $880.22.
e. none of the above.

75. If the level of inflation is expected to ____, there will be ____ pressure on interest rates and ____ pressure on the required rate of return on bonds.
a. increase; upward; downward
b. decrease; upward; downward
c. decrease; upward; upward
d. increase; upward; upward
e. increase; downward; upward

76. An economic announcement signaling ____ economic growth in the future will probably cause bond prices to ____.
a. weak; decrease
b. strong; increase
c. weak; increase
d. strong; decrease
e. Answers C and D are correct.

77. Because of a change in the required rate of return from 11 percent to 13 percent, the bond price of a zero-coupon bond will fall from $1,000 to $860. Thus, the bond price elasticity for this bond is
a. 0.77.
b. −0.77.
c. −0.90.
d. −1.06.
e. none of the above.

78. The required rate of return on a certain bond changes from 12 percent to 8 percent, causing the price of the bond to change from $900 to $1,100. The bond price elasticity of this bond is
a. −0.36.
b. −0.44.
c. −0.55.
d. −0.67.
e. 0.67.

79. Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The duration of this bond is ____ years.
a. 1.92
b. 1.50
c. 1.90
d. none of the above

80. A bond has a $1,000 par value and an 8 percent coupon rate. The bond has four years remaining to maturity and a 10 percent yield to maturity. This bond’s modified duration is ____ years.
a. 1.33
b. 1.27
c. 3.24
d. 1.31
e. none of the above

81. If investors rely strictly on modified duration to estimate the percentage change in the price of a bond, they will tend to ____ the price decline associated with an increase in rates and ____ the price increase associated with a decrease in rates.
a. underestimate; underestimate
b. overestimate; overestimate
c. underestimate; overestimate
d. overestimate; underestimate

82. In the ____ strategy, funds are allocated to bonds with a short term to maturity and bonds with a long term to maturity.
a. matching
b. laddered
c. barbell
d. interest rate
e. none of the above

83. Using a(n) ____ strategy, investors allocate funds evenly to bonds in each of several different maturity classes.
a. matching
b. laddered
c. barbell
d. interest rate
e. none of the above

84. Which of the following is not a factor affecting the market price of a foreign bond held by a U.S. investor?
a. foreign interest rate movements
b. credit risk
c. exchange rate fluctuations
d. All of the above are factors affecting the market price of a foreign bond.

85. When holding other factors constant, increased borrowing by the Treasury can result in a _______ required return and therefore _______ prices on existing bonds.
a. higher; lower
b. higher; higher
c. lower; higher
d. lower; lower

86. Holding other factors constant, a higher budget deficit leads to ______ interest rates, and higher inflationary expectations lead to _______ interest rates.
a. higher; lower
b. higher; higher
c. lower; higher
d. lower; lower

87. The credit risk premium tends to be larger for bonds that have longer terms to maturity.
a. True
b. False

88. The ____________ was recently established to identify risks in the U.S. financial system and make regulatory recommendations that could reduce such risks.
a. Financial Risk Assessment Commission
b. Financial Markets Protection Agency
c. Financial Stability Oversight Council
d. Federal Bureau of Financial Markets

89. When the European Central Bank provides credit to a country that is experiencing debt repayment problems, the ECB commonly:
a. allows the country’s government to conduct its own monetary policy.
b. recommends that the country withdraw from the eurozone.
c. urges the country’s government to increase spending and lower taxes to stimulate the economy.
d. imposes austerity conditions to enable the government to reduce its budget deficit.

90. Although the European debt crisis has had substantial effects on European financial markets, the crisis has been contained and has not affected markets and financial institutions outside Europe.
a. True
b. False

FIN 350 Week 6 Quiz Solution

Chapter 9—Mortgage Markets

1. Mortgage-backed securities are commonly contained within collateralized debt obligations.
a. True
b. False

2. Federally insured mortgages guarantee
a. loan repayment to the lending financial institution.
b. that the interest rate will not increase during the life of the mortgage.
c. the lending financial institution a selling price for the mortgage in the secondary market.
d. all of the above

3. At a given point in time, the interest rate offered on a new fixed-rate mortgage is typically ____ the initial interest rate offered on a new adjustable-rate mortgage.
a. below
b. above
c. equal to
d. all of the above are very common

4. An institution that originates and holds a fixed-rate mortgage is adversely affected by ____ interest rates; the borrower who was provided the mortgage is adversely affected by ____ interest rates.
a. stable; decreasing
b. increasing; stable
c. increasing; decreasing
d. decreasing; increasing

5. 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.

6. Caps on mortgage rate fluctuations with adjustable-rate mortgages (ARMs) are typically
a. 2 percent per year and 5 percent for the mortgage lifetime.
b. 5 percent per year and 15 percent for the mortgage lifetime.
c. 0 percent per year and 10 percent for the mortgage lifetime.
d. 3 percent per year and 8 percent for the mortgage lifetime.

7. From the perspective of the lending financial institution, interest rate risk is
a. lower on a 30-year fixed-rate mortgage than on a 15-year fixed-rate mortgage.
b. lower on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage.
c. higher on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage.
d. higher on a 15-year adjustable-rate mortgage than on a 30-year adjustable-rate mortgage.

8. Mortgage companies specialize in
a. purchasing mortgages originated by other financial institutions.
b. investing and maintaining mortgages that they create.
c. originating mortgages and selling those mortgages.
d. borrowing money through the creation of mortgages that is used to invest in real estate.

9. For any given interest rate, the shorter the life of the mortgage, the ____ the monthly payment and the ____ the total payments over the life of the mortgage.
a. greater; greater
b. greater; lower
c. lower; greater
d. lower; lower

10. A financial institution has a higher degree of interest rate risk on a ____ than a ____.
a. 30-year fixed-rate mortgage; 15-year fixed-rate mortgage
b. 30-year variable-rate mortgage; 30-year fixed-rate mortgage
c. 15-year fixed-rate mortgage; 30-year fixed-rate mortgage
d. 15-year variable-rate mortgage; 15-year fixed-rate mortgage

11. A balloon-payment mortgage requires interest payments for a 10- to 20-year period, at the end of which the borrower must pay the full amount of the principal.
a. True
b. False

12. Use an amortization schedule. A 15-year $100,000 mortgage has a fixed mortgage rate of 9 percent. In the first month, the total mortgage payment is $____, and $____ of this amount represents payment of interest.
a. 1,014; 264
b. 1,241; 750
c. 1,014; 750
d. none of the above

13. A mortgage that requires interest payments for a three- to five-year period, then full payment of principal, is a(n)
a. chattel mortgage.
b. balloon payment mortgage.
c. variable-rate mortgage.
d. open-ended mortgage bond.

14. In an amortization schedule of monthly mortgage payments
a. the amount of interest in each payment is equal to the principal paid.
b. interest payments exceed principal payments early on.
c. principal payments exceed interest payments early on.
d. B and C both occur with about equal frequency

15. A mortgage with low initial payments that increase over time without ever leveling off is a
a. graduated payment mortgage.
b. growing-equity mortgage.
c. second mortgage.
d. shared-appreciation mortgage.

16. The interest rate on a second mortgage is ____ on a first mortgage created at the same time, because the second mortgage is ____ the existing first mortgage in priority claim against the property in the event of default.
a. higher than; behind
b. equal to that; equal to
c. lower than; ahead of
d. higher than; ahead of
e. lower than; behind

17. Which of the following mortgages allows the home purchaser to obtain a mortgage at a below-market interest rate throughout the life of the mortgage?
a. second mortgage
b. growing-equity mortgage
c. graduated payment mortgage
d. shared-appreciation mortgage

18. A ____ mortgage allows the borrower to initially make small payments on the mortgage. The payments then increase over the first 5 to 10 years and then level off.
a. graduated payment mortgage
b. growing-equity mortgage
c. second mortgage
d. shared-appreciation mortgage

19. Mortgage companies, commercial banks and savings institutions are the primary originators of mortgages.
a. True
b. False

20. ____ was created in 1968 as a corporation that is wholly owned by the federal government. It guarantees payment on mortgages that meet specific criteria.
a. Freddie Mac
b. Ginnie Mae
c. Fannie Mae
d. None of the above

21. “Securitization” refers to the private insurance of conventional mortgages.
a. True
b. False

22. A financial institution may service a mortgage even after selling it.
a. True
b. False

23. The difference between the 30-year mortgages rate and the 30-year Treasury bond rate is primarily attributable to
a. interest rate risk.
b. reinvestment rate risk.
c. credit risk.
d. insurance risk.

24. Mortgage prices would normally be expected to ____ when the interest rates ____, holding other factors constant.
a. increase; increase
b. decrease; decrease
c. increase; decrease
d. none of the above

25. Collateralized mortgage obligations (CMOs) are generally perceived to have
a. no prepayment risk but some default risk.
b. no prepayment risk and no default risk.
c. the same interest rate risk as money market securities.
d. a high degree of prepayment risk.

26. Mortgage prices are subject to
a. interest rate risk.
b. credit risk.
c. prepayment risk.
d. all of the above.

27. During a weak economy, the credit risk to a financial institution from investing in mortgage-backed securities representing subprime mortgages is ____ than that of mortgage-backed securities representing prime mortgages.
a. equal to
b. slightly less than
c. more than
d. substantially less than

28. ____ are backed by conventional mortgages.
a. Ginnie Mae mortgage-backed securities
b. Federal Reserve mortgage-backed securities
c. Private-label pass-through securities
d. Shared appreciation pass-through securities

29. Which of the following is not a guarantor of federally insured mortgages?
a. the Federal Housing Administration (FHA)
b. the Veteran’s Administration (VA)
c. the Federal Deposit Insurance Corporation (FDIC)
d. all of the above are guarantors of federally insured mortgages

30. ____ economic growth will probably ____ the risk premium on mortgages and ____ the price of mortgages.
a. Strong; increase; decrease
b. Strong; increase; increase
c. Weak; decrease; increase
d. Weak; increase; increase
e. Weak; decrease; decrease

31. A ____ mortgage allows borrowers to initially make small payments on the mortgage, which are then increased on a graduated basis over the first five to ten years; payments then level off from there on.
a. balloon-payment
b. graduated-payment
c. shared-appreciation
d. growing-equity
e. none of the above

32. 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

33. When financial institutions originate residential mortgages, the mortgage contract should not specify
a. whether the mortgage is federally insured.
b. the amount of the loan.
c. whether the interest rate is fixed or adjustable.
d. the maturity.
e. the mortgage contract should specify all of the above

34. Which of the following is not a common type of mortgage-backed security according to your text?
a. participation certificates (PCs)
b. collateralized mortgage obligations (CMOs)
c. balloon-payment mortgage certificates
d. private-label pass-through securities
e. all of the above are common types of mortgage pass-through securities

35. ____ risk is the risk that a borrower may prepay the mortgage in response to a decline in interest rates.
a. Interest rate
b. Credit
c. Prepayment
d. Reinvestment rate

36. Mortgage-backed securities are assigned ratings by:
a. rating agencies.
b. the Treasury.
c. the Fed.
d. the mortgage originator.

37. In a collateralized mortgage obligation (CMO), mortgages are segmented into ____ (or classes).
a. balloon payments
b. caps
c. tranches
d. strips

38. The credit crisis is mostly attributed to the use of:
a. strict criteria applied by mortgage originators.
b. liberal criteria applied by mortgage originators.
c. very tough credit ratings applied to mortgages.
d. fixed-rate mortgages with long terms to maturity.

39. Fannie Mae and Freddie Mac experienced financial problems during the credit crisis because they:
a. were unwilling to finance new mortgages.
b. invested heavily in balloon mortgages.
c. invested only in prime mortgages that offered very low returns.
d. invested heavily in subprime mortgages.

40. ____ mortgages enabled more people with relatively lower income, or high existing debt, or a small down payment to purchase homes.
a. Prime
b. Balloon
c. Amortized
d. Subprime

41. The secondary mortgage market that accommodates originators of mortgages who desire to sell their mortgages before maturity.
a. True
b. False

42. Regardless of what happens to market interest rates, most adjustable-rate mortgages (ARMs) specify a maximum allowable fluctuation in the mortgage rate per year and over the mortgage life.
a. True
b. False

43. Some adjustable-rate mortgages (ARMs) contain an option clause that allows mortgage holders to switch to a fixed-rate mortgage within a specified period.
a. True
b. False

44. Mortgage lenders normally charge a higher initial interest rate on adjustable-rate mortgages than on fixed-rate mortgages.
a. True
b. False

45. A balloon-payment mortgage requires interest payments for a three- to five-year period. At the end of this period, full payment of the principal (the balloon payment) is required.
a. True
b. False

46. During the early years of a mortgage, most of the monthly payment reflects principal.
a. True
b. False

47. Mortgages are rarely sold in the secondary market.
a. True
b. False

48. An increase in either the risk-free rate or the risk premium on a fixed-rate mortgage results in a higher required rate of return when investing in the mortgage and therefore causes mortgage prices to decrease.
a. True
b. False

49. Strong economic growth tends to reduce the probability that the issuer of a mortgage will default on its debt payments and therefore tends to decrease mortgage prices.
a. True
b. False

50. The higher the level of equity invested by the borrower, the higher the probability that the loan will default.
a. True
b. False

51. Borrowers who have a lower level of income relative to the periodic loan payments are more likely to default on their mortgages.
a. True
b. False

52. Non-U.S. financial institutions never hold mortgages on U.S. property.
a. True
b. False

53. The ____ market accommodates originators of mortgages that desire to sell their mortgages prior to maturity.
a. primary
b. secondary
c. money
d. none of the above

54. Financial institutions that hold fixed-rate mortgages in their asset portfolios are exposed to ____ risk, because they commonly use funds obtained from short-term customer deposits to make long-term mortgage loans.
a. exchange rate
b. prepayment
c. reinvestment rate
d. interest rate
e. exchange rate

55. From the perspective of the lending financial institution, there is a ____ degree of interest rate risk for ____-maturity mortgages.
a. higher; shorter
b. higher; longer
c. lower; shorter
d. lower; higher
e. Answers B and C are correct.

56. During the early years of a mortgage,
a. most of the monthly payment reflects principal reduction.
b. most of the monthly payment reflects interest.
c. about half of the monthly payment reflects interest.
d. Cannot answer without more information.

57. Which of the following will typically require homeowners to ultimately request a new mortgage?
a. graduated-payment mortgage (GPM)
b. growing-equity mortgage
c. balloon-payment mortgage
d. shared-appreciation mortgage

58. 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.

59. ____ economic growth will probably ____ the risk premium on mortgages and ____ the price of mortgages.
a. Strong; decrease; decrease
b. Strong; increase; increase
c. Weak; increase; increase
d. Weak; decrease; increase
e. Weak; decrease; decrease

60. The probability that a borrower will default (credit risk) is influenced by all of the following, except
a. economic conditions.
b. the level of equity invested by the borrower.
c. the borrower’s income level.
d. the borrower’s credit history.
e. Credit risk is affected by all of the above.

61. In a short sale of a home:
a. the lender forecloses and then sells the home for less than what is owed on the mortgage.
b. the lender allows the homeowner to sell the home for less than what is owed on the mortgage.
c. the lender does not recover the full amount of the mortgage.
d. B and C
e. A and C

62. An investor in interest-only collateralized mortgage obligations (CMOs) would not be concerned that homeowners will prepay the underlying mortgages.
a. True
b. False

63. The valuation of mortgage-backed securities is difficult because of limited
transparency.
a. True
b. False

64. A(n) _________ problem occurs when a person or institution does not have to bear the full consequence of its behavior and therefore assumes more risk than it otherwise would.
a. asymmetric information
b. M

oral hazard
c. risk adjustment
d. specific hazard

65. A __________ is a privately negotiated contract that protects investors against the risk of default on particular debt securities such as mortgage-backed securities.
a. default insurance contract
b. default risk swap
c. credit default swap
d. collateralized debt obligation

66. Speculators sell credit default swaps to benefit from the default of specific subprime mortgages.
a. True
b. False

Chapter 10—Stock Offerings and Investor Monitoring

1. Which of the following statements is incorrect?
a. A stock is a certificate representing partial ownership in a corporation.
b. Like debt securities, common stock is issued by firms to obtain funds.
c. Stocks are issued by corporations to raise short-term funds.
d. The secondary stock market enables investors to sell stocks that they had previously purchased.

2. Preferred shareholders
a. typically have the same voting rights as common shareholders.
b. do not share the ownership of the firm with common shareholders.
c. typically participate in the profits of the firm beyond the stated fixed annual dividend.
d. may not receive a dividend every year.

3. From a cost perspective, preferred stock is a less desirable source of capital for a firm than bonds.
a. True
b. False

4. A ____ requires that dividends cannot be paid on common stock until all current and previously omitted dividends are paid on preferred stock.
a. residual claim
b. preferred margin
c. cumulative provision
d. liquidation claim

5. Firms assume ____ risk when they issue preferred stock than when they issue bonds. The payment of dividends on preferred stock ____ be omitted without the firm being forced into bankruptcy.
a. more; can
b. less; can
c. more; cannot
d. less; cannot

6. When a corporation first decides to issue stock to the public, it engages in a(n)
a. secondary offering.
b. initial public offering.
c. seasoned equity offering.
d. none of the above

7. A firm can best avoid the time lag between registering new securities with the SEC and actually selling them by
a. use of proxy.
b. shelf-registration.
c. use of a margin call.
d. use of preemptive rights.

8. The process by which the lead underwriter solicits indications of interest by institutional investors in an IPO at various possible ____ prices is referred to as ____.
a. IPO; margin selling
b. offer; secondary market building
c. offer; bookbuilding
d. IPO; bookbuilding

9. To the extent that shares sold during an IPO are discounted from their appropriate price, the proceeds that the issuing firm receives from the IPO are less than it deserves.
a. True
b. False

10. The transaction costs to the issuing firm in an IPO is usually ____ percent of the funds raised.
a. 1
b. 3
c. 7
d. 25

11. If many investors quickly sell an IPO stock in the secondary market, there will be ____ on the stock’s price.
a. upward pressure
b. downward pressure
c. no additional pressure
d. none of the above

12. The purpose of a lockup provision is to
a. keep individual investors from buying and selling stock.
b. prevent downward pressure on the stock’s price.
c. increase the number of outstanding shares.
d. allocate a larger proportion of stock to institutional investors.

13. When the lockup period expires, the share price commonly
a. remains unchanged.
b. increases significantly.
c. decreases significantly.
d. none of the above

14. IPOs tend to occur more primarily during recessions.
a. True
b. False

15. The initial (one-day) return of IPOs in the United States has averaged about ____ percent over the last 30 years.
a. 10
b. 20
c. 30
d. 50

16. The practice of purchasing IPO stock at the offer price and selling the stock shortly afterward is called
a. flipping.
b. skiing.
c. flopping.
d. none of the above

17. ____ occurs when a securities firm allocates share from an IPO to corporate executives who may be considering an IPO or other business that will require the help of an investment bank.
a. Flipping
b. Spinning
c. Laddering
d. None of the above

18. When brokers encourage investors to place bids for IPO shares on the first day that are above the offer price this is referred to as
a. flipping.
b. spinning.
c. laddering.
d. none of the above

19. On average, IPOs of firms tend to perform ____ over a period of a year or longer.
a. well
b. poorly
c. about the same as the S&P 500 index
d. none of the above

20. A firm that wants to engage in a secondary stock offering does not need to file the offering with the SEC.
a. True
b. False

21. A firm will typically attempt to sell shares from a secondary offering
a. far below the prevailing market price.
b. far above the prevailing market price.
c. at the prevailing market price.
d. at the offer price of the IPO.

22. Buy and sell orders on the OTC market are completed by
a. auction on the trading floor.
b. sealed competitive bids.
c. noncompetitive bids.
d. a telecommunications network.

23. A(n) ____ is a certificate which represents ownership of a foreign stock.
a. ADR
b. SEAQ
c. Nasdaq
d. AMEX

24. The first-time issuance of shares by a specific firm to the public is referred to as a(n)
a. stock repurchase.
b. secondary stock offering.
c. initial rights issue.
d. initial public offering (IPO).

25. A new stock issuance by a specific firm that already has stock outstanding is referred to as a(n)
a. stock repurchase.
b. secondary stock offering.
c. initial rights issue.
d. initial public offering (IPO).

26. Managers of firms may consider a stock repurchase or even a leveraged buyout when they believe their stock is ____ by the market, or a secondary stock offering when they believe their stock is ____ by the market.
a. undervalued; undervalued
b. overvalued; overvalued
c. undervalued; overvalued
d. overvalued; undervalued
e. none of the above

27. The largest organized exchange, listing the largest firms, is the
a. New York Stock Exchange.
b. American Stock Exchange.
c. Midwest Stock Exchange.
d. Pacific Stock Exchange.

28. ____ are employed by brokerage firms and execute orders for clients on the floor of the NYSE.
a. Specialists
b. Commission brokers
c. Independent brokers
d. Dealers

29. The OTC market does not have a trading floor.
a. True
b. False

30. Firms listed as “pink sheets” on the OTC market
a. are typically very large.
b. satisfy Nasdaq’s listing requirements.
c. are typically owned by various institutional and individual investors.
d. none of the above

31. 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.

32. The ____ is a value-weighted average of stock prices of 30 large U.S. firms.
a. Dow Jones Industrial Average
b. Standard and Poor’s 500
c. New York Stock Exchange Index
d. Nasdaq

33. The ____ is a value-weighted index of stock prices of 500 large U.S. firms.
a. Dow Jones Industrial Average
b. Standard and Poor’s 500
c. New York Stock Exchange Index
d. Nasdaq

34. Sudden favorable news about the performance of a firm will make investors believe that the firm’s stock is ____ at its prevailing price.
a. overvalued
b. fixed
c. appropriate
d. undervalued

35. Analysts periodically communicate with high-level managers of the firms whose stock they rate.
a. True
b. False

36. Shareholders can most easily measure a firm’s performance by monitoring changes in its ____ over time.
a. share price
b. employee job descriptions
c. board of directors
d. asset size

37. Which of the following is not true regarding the Sarbanes-Oxley Act?
a. It attempts to force accountants to conform to regular accounting standards in preparing a firm’s financial statements.
b. It requires that only outside board members of a firm be on the firm’s audit committee.
c. It allows public accounting firms to offer nonaudit consulting services to an audit client whether the client’s audit committee pre-approves the nonaudit services or not.
d. It prevents members of a firm’s audit committee from receiving consulting of advising fees or other compensation from the firm beyond that earned from serving on the board.

38. An example of shareholder activism is
a. communication with the firm.
b. engaging in a proxy contest.
c. filing a lawsuit against the board.
d. all of the above

39. ____ are acquisitions that require substantial amounts of borrowed funds.
a. Stock repurchases
b. Corporate controls
c. Leveraged buyouts
d. Stock splits

40. ____ are not barriers to corporate control to eliminate agency problems.
a. Leveraged buyouts
b. Antitakeover amendments
c. Poison pills
d. Golden parachutes

41. Listing stock on a foreign stock exchange
a. enhances the stock’s liquidity.
b. may increase the firm’s perceived financial standing.
c. may protect a firm against hostile takeovers.
d. all of the above

42. American Depository Receipts (ADRs) are similar to
a. stock options.
b. bank deposits.
c. stocks.
d. bonds.

43. ____ are portfolios of international stocks created and managed by various financial institutions.
a. International mutual funds
b. American Depository Receipts
c. Exchange rate options
d. Initial Public Offerings

44. ____ sell shares to investors and use the proceeds to invest in portfolios of international stocks created and managed by portfolio managers.
a. International mutual funds
b. American Depository Receipts
c. World Equity Depository Receipts
d. Initial Public Depository Receipts

45. 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.

46. Whenever _____, the stock price will be driven up.
a. supply exceeds demand
b. demand exceeds supply
c. demand is reduced
d. none of the above

47. Which of the following is not a form of shareholder activism?
a. investors communicating their concerns to other investors in an effort to place more pressure on the firm’s managers or its board members
b. poison pills
c. shareholder lawsuits
d. all of the above

48. Initial public offerings (IPOs) tend to occur more frequently during bearish (weak) stock markets.
a. True
b. False

49. Initial public offerings (IPOs) perform ____ on the day following the IPO and ____ for periods of a year or longer after the IPO.
a. well; poorly
b. poorly; well
c. well; well
d. poorly; poorly

50. Which of the following is not a part of the over-the-counter market?
a. the Nasdaq National Market
b. the Nasdaq Small Cap Market
c. the OTC Bulletin Board
d. the New York Stock Exchange

51. A firm has a current stock price of $15.32. The firm’s annual dividend is $1.14 per share. The firm’s dividend yield is
a. .74 percent.
b. 1.34 percent.
c. 7.44 percent.
d. 1.14 percent.

52. If the secondary market is inactive, then the shares would be illiquid.
a. True
b. False

53. Private firms that need a large equity investment but are not yet in a position to go public may attempt to obtain funding from a venture capital (VC) fund.
a. True
b. False

54. Venture capital (VC) funds receive money from wealth investors and from pension funds that need to receive their money back in one year or less.
a. True
b. False

55. Venture capital (VC) funds commonly serve as advisors to the businesses in which they invest.
a. True
b. False

56. Venture capital (VC) funds usually invest in publicly-traded businesses.
a. True
b. False

57. Venture capital (VC) funds typically plan to exit from their original investment within a period of about one year.
a. True
b. False

58. The phrase “leaving money on the table” refers to investors who pay more for a stock in the secondary market than was paid by those investors who were able to buy shares at the initial (offer) price on the IPO date.
a. True
b. False

59. Underwriters sell most or all of the shares of an IPO to institutional investors.
a. True
b. False

60. The total cost of engaging in an IPO is usually about 1 percent of the total proceeds.
a. True
b. False

61. Since the Sarbanes-Oxley Act of 2002, the initial returns resulting from an IPO have generally been smaller.
a. True
b. False

62. In general, secondary offerings cause an immediate increase in the market price of the stock.
a. True
b. False

63. Electronic stock exchanges that execute stock transactions electronically are referred to as electronic communications networks (ECNs).
a. True
b. False

64. As a result of the Sarbanes-Oxley Act, firms were able to reduce their costs of compiling and reporting financial information.
a. True
b. False

65. As a result of the Sarbanes-Oxley Act, there was a reduced likelihood of fraudulent financial reporting by firms.
a. True
b. False

66. The legal protection of shareholders varies substantially among countries.
a. True
b. False

67. Common law countries such as the U.S., Canada, and the United Kingdom allow for more legal protection than civil law countries such as France or Italy.
a. True
b. False

68. The government enforcement of securities laws varies among countries.
a. True
b. False

69. The laws of the financial information that must be provided by public companies is similar among all developed countries.
a. True
b. False

70. Electronic communications networks (ECNs) are passive funds that track a specific index.
a. True
b. False

71. A venture capital fund typically plans to exit from its original investment within about four to seven years.
a. True
b. False

72. Venture capital funds typically take over businesses and manage them.
a. True
b. False

73. Normally, only the owners of preferred stock are permitted to vote on certain key matters concerning the firm, such as the election of the board of directors.
a. True
b. False

74. If investors become dissatisfied with a firm’s performance, they can compete with management in soliciting proxy votes in what is known as a proxy fight.
a. True
b. False

75. Initial public offerings (IPOs) tend to occur more frequently during bullish stock markets.
a. True
b. False

76. According to financial research, there is evidence that the stock price associated with an IPO typically rises on the first day but then declines over time.
a. True
b. False

77. Shelf-registration allows firms quick access to funds without repeatedly being slowed by the registration process.
a. True
b. False

78. In addition to the Nasdaq market, the OTC market has another segment known as “pink sheets,” where smaller stocks are traded.
a. True
b. False

79. The Dow Jones Industrial Average (DJIA) is a value-weighted average of stock prices of 30 large U.S. firms.
a. True
b. False

80. Research studies have found that the share prices of target firms and of acquiring firms react very positively to announcements of an acquisition.
a. True
b. False

81. If managers believe that their firm’s stock price is weak because it is undervalued by the market, they may consider repurchasing a portion of the shares that are outstanding.
a. True
b. False

82. International exchange-traded funds (ETFs) represent international indexes that reflect composites of stocks for particular countries; shares of the index can be purchased or sold, thereby allowing investors to invest directly in a stock index representing any one of several countries.
a. True
b. False

83. Which of the following is not true with respect to venture capital (VC) funds?
a. When a VC fund decides to invest in a business, it will negotiate the terms of its investment, including the amount of funds it is willing to invest.
b. One common exit strategy for VC funds is to sell its equity stake to the public before the business engages in a public stock offering.
c. VC funds receive money from wealthy investors and from pension funds that are willing to maintain the investment for a long-term period.
d. All of the above are true with respect to VC funds.

84. Assume a firm that is valued at $800 million with 6 million shares of stock outstanding. This firm’s stock should have a price of $____ per share.
a. 6.00
b. 80.00
c. 133.33
d. none of the above

85. The owners of common stock are permitted to vote on the
a. election of the board of directors.
b. authorization to issue new shares of common stock.
c. approval of amendments to the corporate charter.
d. adoption of bylaws.
e. all of the above

86. Which of the following is not true with respect to preferred stock?
a. Preferred stock usually does not allow for significant voting rights.
b. If the firm does not have sufficient earnings from which to pay the preferred stock dividends, the preferred shareholders may force the firm into bankruptcy.
c. Normally, the owners of preferred stock do not participate in the profits of the firm beyond the stated fixed annual dividend.
d. Payment of preferred dividends is not a tax-deductible expense.
e. All of the above are true.

87. Which of the following is false with respect to initial public offerings (IPOs)?
a. IPOs are first-time offerings of shares by a specific firm to the public.
b. Normally, a firm planning an IPO will hire a securities firm to recommend the amount of stock to issue and the asking price for the stock.
c. Owners of firms that engage in IPOs are normally required to retain their shares for at least 3 years before selling them in the secondary market.
d. IPOs are typically intended to raise funds so the corporation can expand.

88. To discourage flipping, some securities firms make ____ shares of future IPOs available to institutional investors that retain shares for a ____ period of time.
a. fewer; long
b. more; short
c. more; long
d. Answers A and B are correct.

89. There is strong evidence that IPOs of firms perform ____ on average over a period of a year or longer.
a. well
b. poorly
c. very well relative to other firms in their industry
d. none of the above

90. Firms are more willing to issue new stock in a secondary stock offering when the market price of their outstanding shares is relatively
a. high.
b. low.
c. either high or low, depending on the overall market.
d. none of the above

91. “Pink sheets” are traded on the
a. New York Stock Exchange.
b. American Stock Exchange.
c. over-the-counter market.
d. Nasdaq market.

92. The annual dividend on Grozky, Inc. stock is $5 per share and the stock’s prevailing price is $93.13 per share. Thus, the stock’s dividend yield is ____ percent.
a. 18.63
b. 5.37
c. 8.81
d. none of the above

93. Which of the following is not a provision specified in the Sarbanes-Oxley Act?
a. It requires that only inside board members of a firm be on the firm’s audit committee.
b. It prevents the members of a firm’s audit committee from receiving consulting or advising fees or other compensation from the firm beyond that earned from serving on the board.
c. It requires that the CEO and CFO of firms that are of at least a specified size certify the audited financial statements are accurate.
d. It allows public accounting firms to offer nonaudit consulting services to an audit client only if the client’s audit committee pre-approves the nonaudit services to be rendered before the audit begins.

94. Which of the following is not a form of shareholder activism?
a. proxy contests
b. antitakeover amendments
c. shareholder lawsuits
d. all of the above are forms of shareholder activism

95. Which of the following is not a barrier to corporate control?
a. antitakeover amendments
b. proxy contests
c. poison pills
d. golden parachutes
e. all of the above are barriers to corporate control

96. Possible disadvantages of private stock exchanges to investors include:
a. only large institutional investors may purchase shares in privately listed stocks
b. required disclosures may be less than those required when a firm goes public.
c. trading volume is limited.
d. B and C

97. After an IPO, firms commonly list their shares on a private stock exchange.
a. True
b. False

98. Managers protected by golden parachutes may be more willing to make decisions that increase the company’s earnings in the long run, even though the decisions adversely affect the stock price in the short run.
a. True
b. False

99. A firm whose stock price has risen:
a. will not have to pay a premium if it acquires another firm.
b. has an incentive to use its stock as currency to acquire the shares of a target firm.
c. is likely to be a candidate for a leveraged buyout.
d. is likely to repurchase some of its shares.

100. Most individual investors attend road shows of firms that are about to go public before they purchase shares at the time of an IPO.
a. True
b. False

101. When a corporation makes a secondary offering, it may direct sales of the stock to its existing shareholders by giving them:
a. preemptive rights.
b. limit orders.
c. subscription rights.
d. presumptive rights.

102. When a firm goes public and issues stock in the primary market:
a. the equity investment in the firm declines.
b. the firm’s debt level increases.
c. the number of the firm’s owners increases.
d. A and C

FIN 350 Week 7 Quiz Solution

Chapter 11—Stock Valuation and Risk

1. The price-earnings valuation method applies the ____ price-earnings ratio to ____ earnings per share in order to value the firm’s stock.
a. firm’s; industry
b. firm’s; firm’s
c. average industry; industry
d. average industry; firm’s

2. A firm is expected to generate earnings of $2.22 per share next year. The mean ratio of share price to expected earnings of competitors in the same industry is 15. Based on this information, the valuation of the firm’s shares based on the price-earnings (PE) method is
a. $2.22.
b. $6.76.
c. $33.30.
d. none of the above

3. The PE method to stock valuation may result in an inaccurate valuation for a firm if errors are made in forecasting the firm’s future earnings or in choosing the industry composite used to derive the PE ratio.
a. True
b. False

4. Bolwork Inc. is expected to pay a dividend of $5 per share next year. Bolwork’s dividends are expected to grow by 3 percent annually. The required rate of return for Bolwork stock is 15 percent. Based on the dividend discount model, a fair value for Bolwork stock is $____ per share.
a. 33.33
b. 166.67
c. 41.67
d. 60.00

5. Protsky Inc. just paid a dividend of $2.20 per share. The dividend growth rate for Protsky’s dividends is 3 percent per year. If the required rate of return on Protsky stock is 12 percent, the stock should be valued at $____ per share according to the dividend discount model.
a. 24.44
b. 25.18
c. 18.88
d. 75.53

6. The limitations of the dividend discount model are more pronounced when valuing stocks
a. that pay most of their earnings as dividends.
b. that retain most of their earnings.
c. that have a long history of dividends.
d. that have constant earnings growth.

7. Vansel Inc. retains most of its earnings. The company currently has earnings per share of $11. Vansel expects its earnings to grow at a constant rate of 2 percent per year. Furthermore, the average PE ratio of all other firms in Vansel’s industry is 12. Vansel is expected to pay dividends per share of $3.50 during each of the next three years. If investors require a 10 percent rate of return on Vansel stock, a fair price for Vansel stock today is $____.
a. 113.95
b. 111.32
c. 105.25
d. none of the above

8. When evaluating stock performance, ____ measures variability that is systematically related to market returns; ____ measures total variability of a stock’s returns.
a. beta; standard deviation
b. standard deviation; beta
c. intercept; beta
d. beta; error term

9. The ____ is commonly used as a proxy for the risk-free rate in the Capital Asset Pricing Model.
a. Treasury bond rate
b. prime rate
c. discount rate
d. federal funds rate

10. A beta of 1.8 implies that the stock has a risk premium of 1.8%.
a. True
b. False

11. Stock prices of U.S. firms primarily involved in exporting are likely to be ____ affected by a weak dollar and ____ affected by a strong dollar.
a. favorably; adversely
b. adversely; adversely
c. favorably; favorably
d. adversely; favorably

12. A weak dollar may enhance the value of a U.S. firm whose sales are dependent on the U.S. economy.
a. True
b. False

13. The January effect refers to the ____ pressure on ____ stocks in January of every year.
a. downward; large
b. upward; large
c. downward; small
d. upward; small

14. The expected acquisition of a firm typically results in ____ in the target’s stock price.
a. an increase
b. a decrease
c. no change
d. none of the above

15. The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock’s volatility.
a. Sharpe
b. Treynor
c. arbitrage
d. margin

16. The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock’s beta.
a. Sharpe
b. Treynor
c. arbitrage
d. margin

17. Stock price volatility increased during the credit crisis.
a. True
b. False

18. The Sharpe Index measures the
a. average return on a stock.
b. variability of stock returns per unit of return
c. stock’s beta adjusted for risk.
d. excess return above the risk-free rate per unit of risk.

19. A stock’s average return is 11 percent. The average risk-free rate is 9 percent. The stock’s beta is 1 and its standard deviation of returns is 10 percent. What is the Sharpe Index?
a. .05
b. .5
c. .1
d. .02
e. .2

20. A stock’s average return is 10 percent. The average risk-free rate is 7 percent. The standard deviation of the stock’s return is 4 percent, and the stock’s beta is 1.5. What is the Treynor Index for the stock?
a. .03
b. .75
c. 1.33
d. .02
e. 50

21. If security prices fully reflect all market-related information (such as historical price patterns) but do not fully reflect all other public information, security markets are
a. weak-form efficient.
b. semi-strong form efficient.
c. strong form efficient.
d. B and C
e. none of the above

22. If security markets are semi-strong form efficient, investors cannot solely use ____ to earn excess returns.
a. previous price movements
b. insider information
c. publicly available information
d. A and C

23. The ____ is commonly used to determine what a stock’s price should have been.
a. Capital Asset Pricing Model
b. Treynor Index
c. Sharpe Index
d. B and C

24. A stock’s beta is estimated to be 1.3. The risk-free rate is 5 percent, and the market return is expected to be 9 percent. What is the expected return on the stock based on the CAPM?
a. 5.2 percent
b. 11.7 percent
c. 16.7 percent
d. 4 percent
e. 10.2 percent

25. According to the text, other things being equal, stock prices of U.S. firms primarily involved in exporting could be ____ affected by a weak dollar. Stock prices of U.S. importing firms could be ____ affected by a weak dollar.
a. adversely; favorably
b. favorably; adversely
c. favorably; favorably
d. adversely; adversely

26. The demand by foreign investors for the stock of a U.S. firm sold on a U.S. exchange may be higher when the dollar is expected to ____, other things being equal. (Assume the firm’s operations are unaffected by the value of the dollar.)
a. strengthen
b. weaken
c. stabilize
d. B and C

27. A higher beta of an asset reflects
a. lower risk.
b. lower covariance between the asset’s returns and market returns.
c. higher covariance between the asset’s returns and the market returns.
d. none of the above

28. The “January effect” refers to a large
a. rise in the price of small stocks in January.
b. decline in the price of small stocks in January.
c. decline in the price of large stocks in January.
d. rise in the price of large stocks in January.

29. Technical analysis relies on the use of ____ to make investment decisions.
a. interest rates
b. inflationary expectations
c. industry conditions
d. recent stock price trends

30. The capital asset pricing model (CAPM) suggests that the required rate of return on a stock is directly influenced by the stock’s :
a. prevailing level of the industry competition.
b. beta.
c. liquidity.
d. size (market capitalization).

31. According to the capital asset pricing model, the required return by investors on a security is
a. inversely related to the risk-free rate.
b. inversely related to the firm’s beta.
c. inversely related to the market return.
d. none of the above

32. Boris stock has an average return of 15 percent. Its beta is 1.5. Its standard deviation of returns is 25 percent. The average risk-free rate is 6 percent. The Sharpe index for Boris stock is
a. 0.35.
b. 0.36.
c. 0.45.
d. 0.28.
e. none of the above

33. Morgan stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Treynor index of Morgan stock is
a. 0.04.
b. 0.05.
c. 0.35.
d. 0.03.
e. none of the above

34. Zilo stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Sharpe index of Zilo stock is
a. 0.36.
b. 0.35.
c. 0.28.
d. 0.45.
e. none of the above

35. Sorvino Co. is expected to offer a dividend of $3.2 per share per year forever. The required rate of return on Sorvino stock is 13 percent. Thus, the price of a share of Sorvino stock, according to the dividend discount model, is $____.
a. 4.06
b. 4.16
c. 40.63
d. 24.62
e. none of the above

36. Kandle stock just paid a dividend of $4.76 per share and plans to pay a dividend of $5 per share next year, which is expected to increase by 3 percent per year subsequently. The required rate of return is 15 percent. The value of Kandle stock, according to the dividend discount model, is $____.
a. 39.67
b. 41.67
c. 33.33
d. 31.73
e. none of the above

37. LeBlanc Inc. currently has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as LeBlanc Inc. is 15. LeBlanc is expected to pay a dividend of $3 per share over the next four years, and an investor in LeBlanc requires a return of 12 percent. What is the forecasted stock price of LeBlanc in four years, using the adjusted dividend discount model?
a. $150.00
b. $163.91
c. $45.00
d. $168.83
e. none of the above

38. Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as Tarzak is 15. Tarzak is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzak requires a return of 12 percent. The estimated stock price of Tarzak today should be ____ using the adjusted dividend discount model.
a. $116.41
b. $104.91
c. $161.15
d. none of the above

39. The standard deviation of a stock’s returns is used to measure a stock’s
a. volatility.
b. beta.
c. Treynor Index.
d. risk-free rate.

40. The formula for a stock portfolio’s volatility does not contain the
a. weight (proportional investment) assigned to each stock.
b. variance (standard deviation squared) of returns of each stock.
c. correlation coefficients between returns of each stock.
d. risk-free rate.

41. If the returns of two stocks are perfectly correlated, then
a. their betas should each equal 1.0.
b. the sum of their betas should equal 1.0.
c. their correlation coefficient should equal 1.0.
d. their portfolio standard deviation should equal 1.0.

42. A stock’s beta can be measured from the estimate of the using regression analysis.
a. intercept
b. market return
c. risk-free rate
d. slope coefficient

43. A beta of 1.1 means that for a given 1 percent change in the value of the market, the is expected to change by 1.1 percent in the same direction.
a. risk-free rate
b. stock’s value
c. stock’s standard deviation
d. correlation coefficient

44. Stock X has a lower beta than Stock Y. The market return for next month is expected to be either −1 percent, +1 percent, or +2 percent with an equal probability of each scenario. The probability distribution of Stock X returns for next month is
a. the same as that of Stock Y.
b. more dispersed than that of Stock Y.
c. less dispersed than that of Stock Y.
d. zero.

45. The beta of a stock portfolio is equal to a weighted average of the
a. betas of stocks in the portfolio.
b. betas of stocks in the portfolio, plus their correlation coefficients.
c. standard deviations of stocks in the portfolio.
d. correlation coefficients between stocks in the portfolio.

46. Value at risk estimates the ____ a particular investment for a specified confidence level.
a. beta of
b. risk-free rate of
c. largest expected loss to
d. standard deviation of

47. A stock has a standard deviation of daily returns of 1 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock’s expected daily return is .2 percent. The lower boundary is
a. −1.45 percent.
b. −1.85 percent.
c. 0 percent.
d. −1.65 percent.

48. A stock has a standard deviation of daily returns of 3 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock’s expected daily return is .1 percent. The lower boundary is
a. −1.65 percent.
b. −3.00 percent.
c. −4.85 percent.
d. −5.05 percent.

49. Which of the following is not commonly used as the estimate of a stock’s volatility?
a. the estimate of its standard deviation of returns over a recent period
b. the trend of historical standard deviations of returns over recent periods
c. the implied volatility derived from an option pricing model
d. the estimate of its option premium derived from an option pricing model

50. The credit crisis caused major problems in the mortgage market but had no impact on the stock market.
a. True
b. False

51. When new information suggests that a firm will experience lower cash flows than previously anticipated or lower risk, investors will revalue the corresponding stock downward.
a. True
b. False

52. A relatively simple method of valuing a stock is to apply the mean price-earnings (PE) ratio of all publicly traded competitors in the respective industry to the firm’s expected earnings for the year.
a. True
b. False

53. 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

54. If investors agree on a firm’s forecasted earnings, they will derive the same value for that firm using the PE method to value the firm’s stock.
a. True
b. False

55. The dividend discount model states that the price of a stock should reflect the present value of the stock’s future dividends.
a. True
b. False

56. The dividend discount model can be adapted to assess the value of any firm, even those that retain most or all of their earnings.
a. True
b. False

57. For firms that do not pay dividends, the free cash flow model may be more suitable than the dividend discount model.
a. True
b. False

58. The capital asset pricing model (CAPM) is based on the premise that the only important risk of a firm is unsystematic risk.
a. True
b. False

59. The prime rate is commonly used as a proxy for the risk-free rate in the capital asset pricing model (CAPM).
a. True
b. False

60. A stock with a beta of 2.3 means that for every 1 percent change in the market overall, the stock tends to change by 2.3 percent in the same direction.
a. True
b. False

61. Stocks that have relatively little trading are normally subject to less price volatility.
a. True
b. False

62. A firm’s stock price is affected not only by macroeconomic and market conditions but also by firm specific conditions.
a. True
b. False

63. Stock repurchases are commonly viewed as an unfavorable signal about the firm.
a. True
b. False

64. The main source of uncertainty in computing the return of a stock is the dividend to be received next year.
a. True
b. False

65. A stock portfolio has more volatility when its individual stock returns are uncorrelated.
a. True
b. False

66. Beta serves as a measure of risk because it can be used to derive a probability distribution of returns based on a set of market returns.
a. True
b. False

67. The value-at-risk method is intended to warn investors about the potential maximum loss that could occur.
a. True
b. False

68. Regarding the value-at-risk method, the same methods used to derive the maximum expected loss of one stock can be applied to derive the maximum expected loss of a stock portfolio for a given confidence level.
a. True
b. False

69. Portfolio managers who monitor systematic risk rather than total risk are more concerned about stock volatility than about beta.
a. True
b. False

70. Regarding the implied standard deviation, by plugging in the actual option premium paid by investors for a specific stock in the option-pricing model, it is possible to derive the anticipated volatility level.
a. True
b. False

71. A portfolio’s beta is the sum of the individual forecasted betas, weighted by the market value of each stock.
a. True
b. False

72. If beta is thought to be the appropriate measure of risk, a stock’s risk-adjusted returns should be determined by the Sharpe index.
a. True
b. False

73. The Treynor index is similar to the Sharpe index, except that is uses beta rather than standard deviation to measure the stock’s risk.
a. True
b. False

74. Fabrizio, Inc. is expected to generate earnings of $1.50 per share this year. If the mean ratio of share price to expected earnings of competitors in the same industry is 20, then the stock price per share is $____.
a. 13.33
b. 3.00
c. 20.00
d. 30.00
e. none of the above

75. Which of the following is not a reason the PE ratio method may result in an inaccurate valuation for a firm?
a. potential errors in the forecast of the firm’s beta
b. potential errors in the forecast of the firm’s future earnings
c. potential errors in the choice of the industry composite used to derive the PE ratio
d. All of the above are reasons the PE ratio method may result in an inaccurate valuation for a firm.

76. The ____ is not a measure of a stock’s risk.
a. stock’s price volatility
b. stock’s return
c. stock’s beta
d. value-at-risk method
e. All of the above are measures of a stock’s risk.

77. If the standard deviation of a stock’s returns over the last 12 quarters is 4 percent, and if there is no perceived change in volatility, there is a ____ percent probability that the stock’s returns will be within ____ percentage points of the expected outcome.
a. 68; 4
b. 68; 8
c. 95; 8
d. 95; 6
e. none of the above

78. 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

79. Which of the following is incorrect regarding the capital asset pricing model (CAPM)?
a. It is sometimes used to estimate the required rate of return for any firm with publicly traded stock.
b. It is based on the premise that the only important risk of a firm is systematic risk.
c. It is concerned with unsystematic risk.
d. All of the above are true.

80. The ____ is not a factor used in the capital asset pricing model (CAPM) to derive the return of an asset.
a. prevailing risk-free rate
b. dividend growth rate
c. market return
d. covariance between the asset’s returns and market returns
e. All of the above are factors used in the CAPM.

81. Steam Corp. has a beta of 1.5. The prevailing risk-free rate is 5 percent and the annual market return in recent years has been 11 percent. Based on this information, the required rate of return on Steam Corp. stock is ____ percent.
a. 21.5
b. 6.5
c. 16.5
d. 14.0
e. none of the above

82. Which of the following is not a type of factor that drives stock prices, according to your text?
a. economic factors
b. market-related factors
c. firm-specific factors
d. All of the above are factors that affect stock prices.

83. The general mood of investors represents:
a. investor sentiment.
b. beta.
c. systematic risk.
d. unsystematic risk.

84. ____ is (are) not a firm-specific factor(s) that affect(s) stock prices.
a. Exchange rates
b. Dividend policy changes
c. Stock offerings and repurchases
d. Earnings surprises
e. All of the above are firm-specific factors that affect stock prices.

85. The U.S. government’s budget deficit has a significant impact on the bond market but does not affect the stock market.
a. True
b. False

86. Investors can avoid unsystematic risk by:
a. using the capital asset pricing model.
b. investing in stocks with low PE ratios.
c. holding diversified portfolios.
d. using the free cash flow model.

87. The market risk premium is:
a. the yield on newly issued Treasury bonds.
b. the return of the market in excess of the risk-free rate.
c. the covariance between the risk-free rate and the return of the market.
d. the return of the market in excess of expected cash flows.

88. The market risk premium is stable over time and is not affected by stock market conditions.
a. True
b. False

89. Holding other factors constant, an increase in the capital gains tax rate will:
a. have more effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
b. have less effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
c. have no effect on the valuations of stocks.
d. have the same effect on the valuation of dividend-paying stocks and stocks with high growth prospects.

90. The VIX (volatility index) indicates the volatility of the bond market in general.
a. True
b. False

91. Holding other factors constant, a stock portfolio has more volatility when its individual stock volatilities are ________ and its individual stock returns have _______ correlations.
a. high; low
b. low; high
c. low; low
d. high; high

92. Emerging market stocks tend to exhibit all of the following except:
a. high political risk.
b. high exchange risk.
c. high correlation with stocks of more developed countries.
d. high volatility.

93. Even though a foreign stock that appears to be overvalued in its own country, the stock may not generate a reasonable return for a U.S. investor if the currency of that country appreciates against the U.S. dollar.
a. True
b. False

94. As a result of market integration, stock markets in emerging markets are likely to be as efficient as U.S. stock markets.
a. True
b. False

Chapter 13—Financial Futures Markets

1. A(n) ____ is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date.
a. option contract
b. brokerage contract
c. financial futures contract
d. margin call

2. Interest rate futures are not available on
a. Treasury bonds.
b. Treasury notes.
c. Eurodollar CDs.
d. the S&P 500 index.

3. ____ take positions in futures to reduce their exposure to future movements in interest rates or stock prices.
a. Hedgers
b. Day traders
c. Position traders
d. None of the above

4. ____ trade futures contracts for their own account.
a. Commission brokers
b. Floor brokers
c. Commission traders
d. Floor traders

5. 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

6. Futures exchanges take buy or sell positions on futures contracts.
a. True
b. False

STA: DISC.FMAI.MADU.15.03

7. If the prices of Treasury bonds ____, the value of an existing Treasury bond futures contract should ____.
a. increase; be unaffected
b. decrease; be unaffected
c. A and B
d. decrease; decrease
e. decrease; increase

8. Assume that a T-bill futures contract with a face value of $1 million is purchased at a price of $95.00 per $100 face value. At settlement, the price of T-bills is $95.50. What is the difference between the selling and purchase price of the futures contract?
a. $.50
b. $50
c. $500
d. $5,000
e. none of the above

9. If speculators believe interest rates will ____, they would consider ____ a T-bill futures contract today.
a. increase; selling
b. increase; buying
c. decrease, selling
d. decrease; purchasing a call option on

10. Financial futures contracts on U.S. securities are ____ by non-U.S. financial institutions.
a. not allowed to be traded
b. are rarely desired
c. are commonly traded
d. A and B

11. Assume that speculators had purchased a futures contract at the beginning of the year. If the price of a security represented by a futures contract ____ over the year, then these speculators would likely have purchased the futures contract for ____ than they can sell it for.
a. increased; more
b. decreased; less
c. remains the same; more
d. increased; less

12. Assume that a futures contract on Treasury bonds with a face value of $100,000 is purchased at 93-00. If the same contract is later sold at 94-18, what is the gain, ignoring transactions costs?
a. $1,180,000
b. $118
c. $11,800
d. $15,625
e. $1,562.50

13. The use of financial leverage
a. magnifies the positive returns of futures contracts.
b. magnifies losses of futures contracts.
c. both A and B
d. none of the above

14. According to the text, when a financial institution sells futures contracts on securities in order to hedge against a change in interest rates, this is referred to as
a. a long hedge.
b. a short hedge.
c. a closed out position.
d. basis trading.

15. A financial institution that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will ____ and the position in futures contracts will result in a ____.
a. increase; gain
b. increase; loss
c. decrease; gain
d. decrease; loss

16. The basis is the
a. difference between the price of a security and the price of a futures contract on the security.
b. gain or loss from hedging with futures contracts.
c. difference between a futures contract price and the initial deposit required.
d. price paid for a futures contract after accounting for transactions costs.
e. price paid for an option contract.

17. The profits of a financial institution with interest-rate sensitive liabilities and interest rate-insensitive assets are ____ with hedging than without hedging if interest rates decrease.
a. higher
b. the same
c. lower
d. higher or the same

18. Assume that a bank obtains most of its funds from large CDs with a one-year maturity. Its assets are in the form of loans with rates that adjust every six months. The bank would be ____ affected if interest rates increase. To partially hedge its position, it could ____ futures contracts.
a. adversely; purchase
b. favorably; sell
c. favorably; purchase
d. adversely; sell

19. According to the text, a futures contract on one financial instrument to protect a position in a different financial instrument is known as
a. cross-hedging.
b. ratio hedging.
c. basis hedging.
d. liquid hedging.

20. The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.
a. True
b. False

21. If a futures contract is more volatile than the portfolio value, the amount of principal represented by the futures contracts to hedge the portfolio is ____ the market value of the securities to be hedged.
a. smaller than
b. greater than
c. equal to
d. B and C are both possible

22. In cross-hedging, if the futures contract value is ____ volatile than the portfolio value, hedging will require a ____ amount of principal represented by the futures contracts.
a. less; greater
b. more; greater
c. more; smaller
d. none of the above

23. Municipal Bond Index (MBI) futures
a. involve a physical exchange of bonds.
b. are based on a Treasury bond index.
c. are based on actively traded corporate bonds.
d. are settled in cash.

24. Systemic risk reflects the risk that a particular event could
a. cause losses at a firm due to inadequate management control.
b. spread adverse effects among several firms or among financial markets.
c. cause a loss in value due to market conditions.
d. have a larger effect on the futures position than on the position being hedged.

25. A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid
a. the gain on the futures contracts offsets the loss on the mortgages.
b. the gain on the mortgages offsets the loss on the futures contracts.
c. the gain on the futures contracts more than offsets any unfavorable effects on mortgages.
d. a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio.

26. If a financial institution expects that the market value of its municipal bonds will decline because of economic conditions, it could hedge its position by ____ futures contracts on ____.
a. purchasing; Treasury bonds
b. purchasing; the S&P 500 Index
c. purchasing; a Municipal Bond Index
d. selling; a Municipal Bond Index

27. The net gain or loss on a futures contract for a stock index that is not closed out is based on the difference between the futures price when the initial position was created and the futures price at
a. the settlement date.
b. the date at which the futures price reaches its maximum.
c. the date at which the futures price reaches its minimum.
d. the date three months beyond the date when the initial position was taken.

28. The value of an S&P 500 futures contract is $500 times the index. Assume the futures price on the S&P 500 index is 1612 at the time of purchase. If the index price is $1619 when the position is closed out, the gain is
a. $700.
b. $7,000.
c. $3,190.
d. $3,120.
e. $3,500.

29. Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This means that the mutual fund
a. liquidates its stocks whenever it expects a market downturn.
b. maintains a constant buy position in stock index futures.
c. maintains a constant sell position in stock index futures.
d. none of the above

30. Companies with international trade can hedge ____ by ____ currency futures.
a. payables; selling
b. receivables; buying
c. payables; buying
d. A and B
e. B and C

31. Assume that corporate bond portfolio managers are concerned about the possibility of many bond defaults resulting from a future recession. A short position in Treasury bond futures ____ an effective hedge against the default risk. A short position in Treasury bill futures ____ an effective hedge against the default risk.
a. would be; would be
b. would be; would not be
c. would not be; would not be
d. would not be; would be

32. Which of the following statements is incorrect with respect to cross-hedging?
a. Even when the futures contract is highly correlated with the portfolio being hedged, the value of the futures contract may change by a higher or lower percentage than the portfolio’s market value.
b. If the futures contract value is more volatile than the portfolio value, hedging will require a greater amount of principal represented by the futures contracts.
c. The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.
d. If the price of the underlying security of the futures contract moves closely in tandem with the security hedged, the futures contract can provide an effective hedge.
e. All of the above are correct with respect to cross-hedging.

33. ____ risk is the risk that the position being hedged by a futures contract is not affected in the same manner as the instrument underlying the futures contract.
a. Market
b. Liquidity
c. Credit
d. Basis
e. None of the above

34. Trading restrictions imposed on specific stocks or stock indices are referred to as
a. index busters.
b. index options.
c. circuit breakers.
d. protective covenants.

35. Financial leverage, when used in association with a futures contract, ____ the positive returns and ____ losses.
a. magnifies; reduces
b. reduces; magnifies
c. magnifies; magnifies
d. reduces; reduces

36. Currency futures may be purchased to hedge ____ or to capitalize on the expected ____ of that currency against the dollar.
a. receivables; appreciation
b. receivables; depreciation
c. payables; depreciation
d. payables; appreciation

37. The risk that the position being hedged by a futures position is not affected in the same manner as the instrument underlying the financial futures contract, is referred to as
a. market risk.
b. liquidity risk.
c. default risk.
d. basis risk.

38. Dynamic asset allocation involves the switching between risky and low-risk investments by institutional investors over time in response to changing expectations.
a. True
b. False

39. The prices of stock index futures
a. are always the same as the prices of the stocks representing the index.
b. are always a little above the prices of the stocks representing the index.
c. are always a little below the prices of the stocks representing the index.
d. none of the above

40. The actions of numerous institutional investors to sell stock index futures instead of selling stocks to prepare for a market decline would likely cause the index futures price to be
a. equal to the prevailing stock prices.
b. below the prevailing stock prices.
c. above the prevailing stock prices.
d. negative.

41. Speculators in futures contracts that normally close out their futures positions on the same day that the positions were initiated are referred to as
a. day traders.
b. hedgers.
c. closed-end traders.
d. position traders.

42. Speculators in futures contracts that normally maintain the futures position that they initiate for extended periods of time (such as weeks or months) are referred to as
a. day traders.
b. hedgers.
c. closed-end traders.
d. position traders.

43. Which of the following 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.

44. Marcia buys an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Marcia’s position in the S&P 500 futures contract is ____ percent.
a. −20
b. −10
c. 25
d. 20
e. 0

45. Laura sells an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Laura’s position in the S&P 500 futures contract is ____ percent.
a. −20
b. −10
c. 25
d. 20
e. 0

46. Assume a corporation is receiving a large amount of funds in the near future. The company plans to use the funds to purchase municipal bonds. Also assume that the company is concerned that interest rates decrease before the purchase date, which would make the municipal bonds more expensive. In order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates decrease, the futures contract will generate a ____.
a. sell; loss
b. purchase; gain
c. purchase; loss
d. sell; gain
e. none of the above

47. If there are ____ traders with buy offers than sell offers for a particular contract, the futures price will ____ until this imbalance is removed.
a. more; decrease
b. more; rise
c. fewer; rise
d. none of the above

48. Which of the following statements is incorrect?
a. Circuit breakers are trading restrictions imposed on specific stocks or stock indexes.
b. Circuit breakers guarantee that prices will turn upward.
c. Circuit breakers may be able to prevent large declines in prices that would be attributed to panic selling rather than to fundamental forces.
d. Circuit breakers may allow investors to determine whether circulating rumors are true.

49. ____ risk is the risk of losses as a result of inadequate management or controls.
a. Basis
b. Systemic
c. Operational
d. Prepayment

50. Financial futures contracts on stock indexes are referred to as interest rate futures.
a. True
b. False

51. Financial futures contracts are rarely sold over the counter.
a. True
b. False

52. Brokers commonly require margin deposits from their customers above those required by the exchanges.
a. True
b. False

53. Purchasers of financial futures contracts usually know who the sellers are, and vice versa.
a. True
b. False

54. The futures price is mainly a function of the prevailing price of the underlying security plus an expected adjustment in that price by the settlement date.
a. True
b. False

55. A financial institution that hedges with interest rate futures is less sensitive to economic events than an institution that does not hedge.
a. True
b. False

56. A bond index futures contract allows for the buying, but not the selling, of a bond index for a specified price at a specified date.
a. True
b. False

57. Market participants who expect the stock market to perform poorly before the settlement date may consider selling S&P 500 index futures.
a. True
b. False

58. Stock index futures cannot be closed out before the settlement date.
a. True
b. False

59. The value of a stock index futures contract has little correlation with the value of the underlying stock index.
a. True
b. False

60. Since stock index futures prices are primarily driven by movements in the corresponding stock indexes, participants in stock index futures monitor indicators that may signal changes in the stock indexes.
a. True
b. False

61. The price of stock index futures may reflect investor expectations about the market more rapidly than stock prices.
a. True
b. False

62. Financial futures contracts on U.S. securities are commonly traded by non-U.S. financial institutions that maintain holdings of U.S. securities.
a. True
b. False

63. Purchasers of currency futures contracts are required to hold the contract until the settlement date and accept delivery of the foreign currency at that time.
a. True
b. False

64. Which of the following statements is incorrect regarding organized futures exchanges?
a. Organized exchanges establish and enforce rules for the trading of financial futures contracts.
b. Organized exchanges serve as market makers for futures contracts by taking positions in futures.
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.

65. Stock index futures are priced ____ than the stock index itself.
a. higher
b. lower
c. either higher or lower
d. none of the above

66. An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and places ____ pressure on Treasury bond futures prices.
a. increase; higher; downward
b. increase; lower; downward
c. increase; higher; upward
d. decrease; higher; downward
e. none of the above

67. Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Baher sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Baher’s nominal profit? The par value of the futures contract is $100,000.
a. $1,030.00; profit
b. $1,030.00; loss
c. $1,093.75; profit
d. $1,093.75; loss
e. none of the above

68. Clarke plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million. However, Clarke is concerned that interest rates might increase over the next three months. To hedge against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells ____ futures contract for a price of 99-12. Assuming that the actual price of the futures contract declined to 97-20, Clarke would make a ____ of $____ from closing out the futures position.
a. 40; profit; $76,800
b. 40; loss; $76,800
c. 50; profit; $70,000
d. 40; profit; $70,000
e. none of the above

69. _________ take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties on many transactions.
a. Speculators; hedgers
b. Hedgers; speculators
c. Arbitrageurs; speculators
d. Hedgers; arbitrageurs

70. Some specialized futures contracts are sold over the counter, whereas standardized financial futures contracts are traded on exchanges.
a. True
b. False

71. A financial institution that wishes to reduce its exposure to the possibility of declining interest rates might use:
a. a long hedge.
b. a short hedge.
c. a day hedge.
d. index arbitrage.

72. Settlement of stock index futures contracts occurs through delivery of the underlying securities.
a. True
b. False

73. ___________ involves the buying or selling of stock index futures with a simultaneous opposite position in the stocks that the index comprises.
a. Dynamic asset allocation
b. Cross-hedging
c. Index arbitrage
d. Net hedging

74. Which of the following is not a type of risk associated with futures contracts?
a. basis risk
b. liquidity risk
c. market risk
d. postpayment risk

75. Credit risk exists for futures contracts traded on exchanges, but it is normally not a concern for over-the-counter futures transactions.
a. True
b. False

76. __________ occurs when a firm does not have adequate controls to monitor the employees responsible for its futures positions and those employees take more speculative positions than the firm desires.
a. Credit risk
b. Control risk
c. Operational risk
d. Management risk

FIN 350 Week 8 Quiz Solution

Chapter 16—Foreign Exchange Derivative Markets

1. At any given point in time, the price at which banks will buy a currency is ____ the price at which they sell it.
a. higher than
b. lower than
c. the same as
d. none of the above

2. Which of the following is most likely to provide currency forward contracts to their customers?
a. commercial banks
b. international mutual funds
c. brokerage firms
d. insurance companies

3. The ____ allowed for the devaluation of the dollar in 1971.
a. Bretton Woods Agreement
b. Louvre Accord
c. Smithsonian Agreement
d. none of the above

4. The Bretton Woods Era was the era
a. of free-floating exchange rates.
b. of floating rates without boundaries, but subject to government intervention.
c. in which governments maintained exchange rates within 1 percent of a specified rate.
d. in which exchange rates were maintained within 10 percent of a specified rate.

5. A system whereby exchange rates are market determined without boundaries but subject to government intervention is called
a. a dirty float.
b. a free float.
c. the gold standard.
d. the Bretton Woods era.

6. A system whereby one currency is maintained within specified boundaries of another currency or unit of account is a
a. pegged system.
b. free float.
c. dirty float.
d. managed float.

7. A country that pegs its currency is still able to maintain complete control over its local interest rates.
a. True
b. False

8. If the demand for British pounds ____, the pound will ____, other things being equal.
a. increases; appreciate
b. decreases; appreciate
c. increases; depreciate
d. B and C

9. A(n) ____ in the supply of euros for sale will cause the euro to ____.
a. increase; appreciate
b. increase; depreciate
c. decrease; depreciate
d. none of the above

10. Beginning with an equilibrium situation, if European inflation suddenly ____ than U.S. inflation, this forced ____ pressure on the value of the euro.
a. becomes much higher; upward
b. becomes much higher; downward
c. becomes much less; upward
d. becomes much less; downward
e. B and C

11. Purchasing Power Parity suggests that the exchange rate will on average change by a percentage that reflects the ____ differential between two countries.
a. income
b. interest rate
c. inflation
d. tax

12. In reality, exchange rates do not always change as suggested by purchasing power parity.
a. True
b. False

13. If U.S. interest rates suddenly become much higher than European interest rates (and if it does not cause concern about higher inflation there), the U.S. demand for euros would ____, and the supply of euros to be exchanged for dollars would ____, other factors held constant.
a. increase; increase
b. increase; decrease
c. decrease; increase
d. decrease; decrease

14. Assume interest rate parity exists. If the spot rate on the British pound is $2 and the 1-year British interest rate is 7 percent, and the 1-year U.S. interest rate is 11 percent, what is the pound’s forward discount or premium?
a. 3.74 percent premium
b. 3.74 percent discount
c. 3.60 percent premium
d. 3.60 percent discount

15. When a government influences factors, such as inflation, interest rates, or income, in order to affect currency’s value, this is an example of
a. direct intervention.
b. indirect intervention.
c. a freely floating system.
d. a pegged system.

16. Which of the following statements is incorrect?
a. Central banks often consider adjusting a currency’s value to influence economic conditions.
b. If the U.S. central bank wishes to stimulate the economy, it could weaken the dollar.
c. A weaker dollar could cause U.S. inflation by reducing foreign competition.
d. Direct intervention occurs when the central bank influences the factors that determine the dollar’s value.

17. Direct intervention is always extremely effective.
a. True
b. False

18. If the U.S. government imposed trade restrictions on U.S. imports, this would ____ the U.S. demand for foreign currencies, and would place ____ pressure on the values of foreign currencies (with respect to the dollar).
a. increase; upward
b. increase, downward
c. limit; upward
d. limit; downward

19. If a commercial bank expects the euro to appreciate against the dollar, it may take a ____ position in euros and a ____ position in dollars.
a. short; short
b. long; short
c. short; long
d. long; long

20. Generally, a ____ home currency can ____ domestic economic growth.
a. weak; dampen
b. strong; stimulate
c. strong; dampen
d. A and B

21. A ____ home currency can ____ domestic inflation.
a. strong; increase
b. weak; decrease
c. strong; decrease
d. A and B

22. If the forward rate of a foreign currency ____ the existing spot rate, the forward rate will exhibit a ____.
a. exceeds; discount
b. is below; premium
c. is below; discount
d. A and B

23. ____ forecasting involves the use of historical exchange rate data to predict future values.
a. Technical
b. Fundamental
c. Market-based
d. Mixed

24. ____ forecasting is usually based on either the spot rate or the forward rate.
a. Technical
b. Fundamental
c. Market-based
d. Mixed

25. Fundamental forecasting has been found to be consistently superior to the other forecasting techniques.
a. True
b. False

26. Which of the following is not a method of forecasting exchange rate volatility?
a. using the volatility of historical exchange rate movements
b. using a time series of volatility patterns in previous periods
c. using the volatility of future exchange rate movements
d. using the exchange rate’s implied standard deviation

27. Assume the following information.

• Interest rate on borrowed euros is 5 percent annualized
• Interest rate on dollars loaned out is 6 percent annualized
• Spot rate for €0.83 per dollar (one € = $1.20)
• Expected spot rate in five days is €0.85 per dollar
• Alonso Bank can borrow €10 million

What is the euro profit to Alonso Bank over the five-day period from shorting euros and going long on dollars?
a. €200,311.11
b. €207,111.11
c. €201,555.56
d. none of the above

28. Which of the following statements is incorrect?
a. Forward contracts are contracts typically negotiated with a commercial bank that allow the purchase or sale of a specified amount of a particular foreign currency at a specified exchange rate on a specified future date.
b. The forward market is located in New York City.
c. Many of the commercial banks that offer foreign exchange on a spot basis also offer forward transactions for the widely traded currencies.
d. Forward contracts can hedge a corporation’s risk that a currency’s value may appreciate over time.

29. If the spot rate of the British pound is $2, and the 180-day forward rate is $2.05, what is the annualized premium or discount?
a. 2.5 percent discount
b. 2.5 percent premium
c. 10 percent premium
d. 5 percent discount
e. 5 percent premium

30. Currency futures contracts differ from forward contracts in that they
a. are an obligation.
b. are not an obligation.
c. are standardized.
d. can specify any amount and maturity date.

31. If the spot rate ____ the exercise price, a currency ____ option would not be exercised.
a. remains below; call
b. remains below; put
c. remains below; put
d. A and B

32. The pegged exchange rate system is no longer used by any countries.
a. True
b. False

33. If a firm planning to hedge receivables is certain of the future direction a spot rate will move, and requires a tailor-made hedge in terms of amount and maturity date, it should use a
a. call options contract traded on an exchange.
b. futures contract traded on an exchange.
c. forward contract.
d. put options contract traded on an exchange.

34. 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

35. The speculative risk of purchasing a ____ is that the foreign currency value ____ over time.
a. put option; increases
b. put option; decreases
c. call option; increases
d. futures contract; increases

36. 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.

37. According to interest rate parity, if the interest rate in a foreign country is ____ than in the home country, the forward rate of the foreign country will have a ____.
a. higher; discount
b. lower; premium
c. higher; premium
d. A and B

38. ____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers.
a. Pension funds
b. International mutual funds
c. Insurance companies
d. Commercial banks
e. None of the above

39. In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.65. The Australian dollar (A$) is quoted for $0.60. What is the value of the Australian dollar in British pounds?
a. A$2.75
b. A$0.36
c. £2.75
d. £0.36
e. none of the above

40. If European inflation suddenly becomes much higher than U.S. inflation, the U.S. demand for European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces will place ____ pressure on the value of the euro.
a. increase; decline; upward
b. increase; decline; downward
c. decrease; increase; upward
d. decrease; increase; downward
e. none of the above

41. If British interest rates suddenly increase substantially relative to U.S. interest rates, the demand by U.S. investors for British pounds ____, the supply of British pounds to be sold in exchange for dollars ____, and the British pound will ____.
a. increases; decreases; appreciate
b. increases; decreases; depreciate
c. decreases; increases; appreciate
d. decreases; increases; depreciate
e. none of the above

42. Assume the following information.

• Interest rate on borrowed euros is 5 percent annualized.
• Interest rate on dollars loaned out is 6 percent annualized.
• Spot rate is 1.10 euros per dollar (one euro = $0.909).
• Expected spot rate in five days is 1.15 euros per dollar.
• Fabrizio Bank can borrow 10 million euros.

If Fabrizio Bank attempts to capitalize on the above information, its profit over the five-day period is
a. 2,653,597.22 euros.
b. 455,266.81 euros.
c. 452,426.04 euros.
d. none of the above

43. A country that pegs its exchange rate to another exchange rate does not have complete control over its interest rates.
a. True
b. False

44. The euro is presently pegged to the British pound in order to stabilize international payments between European countries.
a. True
b. False

45. Financial institutions rarely use the forward market.
a. True
b. False

46. If the quoted cross rate between two foreign currencies is not aligned with the two corresponding exchange rates, investors can profit from triangular arbitrage.
a. True
b. False

47. The indirect exchange rate specifies the value of the currency in U.S. dollars.
a. True
b. False

48. The forward rate premium is dictated by the national income differential of the two currencies.
a. True
b. False

49. The potential benefits from using foreign exchange derivatives are independent of the expected exchange rate movements.
a. True
b. False

50. The forward rate is the exchange rate for immediate delivery.
a. True
b. False

51. The Smithsonian Agreement allowed for a devaluation of the dollar and for a widening of the boundaries within which currencies were allowed to fluctuate.
a. True
b. False

52. A country that pegs its currency does not have complete control over its local interest rates, as its interest rates must be aligned with the interest rates of the currency to which it is tied.
a. True
b. False

53. Exchange rates usually change precisely as suggested by the purchasing power parity (PPP) theory.
a. True
b. False

54. Central bank intervention can be overwhelmed by market forces and may not always succeed in reversing exchange rate movements.
a. True
b. False

55. When countries experience substantial net outflows of funds, they commonly use indirect intervention by raising interest rates to discourage excessive outflows of funds and therefore limit any downward pressure on the value of their currency.
a. True
b. False

56. The forward rate premium reflects the percentage by which the spot rate exceeds the forward rate on an annualized basis.
a. True
b. False

57. The primary advantage of currency options over forward and futures contracts is that they provide a right rather than an obligation to purchase or sell a particular currency at a specified price within a given period.
a. True
b. False

58. A speculator who expects a foreign currency to appreciate could purchase the currency forward and, when received, sell it in the spot market.
a. True
b. False

59. The following information refers to Fresno Bank and Champaign Bank.

Bid Rate on Euros Ask Rate on Euros
Fresno Bank $1.002 $1.009
Champaign Bank $0.997 $1.000

Based on this information, locational arbitrage would be profitable.
a. True
b. False

60. Purchasing power parity suggests that the forward rate premium (or discount) should be about equal to the differential in interest rates between the countries of concern.
a. True
b. False

61. ____ are not foreign exchange derivatives.
a. Forward contracts
b. Currency futures contracts
c. Currency swaps
d. Currency options
e. All of the above are foreign exchange derivatives.

62. ____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers.
a. Commercial banks
b. International mutual funds
c. Insurance companies
d. Pension funds
e. All of the above

63. In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.67. The Australian dollar (A$) is quoted for $0.62. What is the value of the Australian dollar in British pounds?
a. A$2.69
b. £0.37
c. £2.69
d. A$0.37
e. none of the above

64. In a(n) ____ exchange rate system, the foreign exchange market is totally free from government intervention.
a. pegged
b. dirty floating
c. freely floating
d. Bretton Woods
e. none of the above

65. The supply and demand for a currency are influenced by all of the following, except
a. differential interest rates.
b. differential inflation rates.
c. direct government intervention.
d. indirect government intervention.
e. The supply and demand for a currency are affected by all of the above.

66. If U.S. inflation suddenly becomes much higher than European inflation, the U.S. demand for European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces will place ____ pressure on the value of the euro.
a. increase; decline; upward
b. increase; decline; downward
c. decrease; increase; upward
d. decrease; increase; downward
e. none of the above

67. Assume an equilibrium state in which European inflation and U.S. inflation are both 4 percent. If U.S. inflation suddenly decreased to 2 percent, the euro will ____ against the dollar by approximately ____ percent, according to purchasing power parity.
a. appreciate; 2
b. depreciate; 2
c. appreciate; 4
d. depreciate; 4
e. none of the above

68. Which of the following is the least feasible strategy for a speculator who expects the Australian dollar to depreciate?
a. sell Australian dollars forward and then purchase them in the spot market just before fulfilling the forward obligation
b. sell futures contracts on Australian dollar; purchase Australian dollars in the spot market just before fulfilling the futures obligation
c. purchase put options on Australian dollars, at some point before the expiration date, when the spot rate is less than the exercise price, purchase Australian dollars in the spot market and then exercise the put option
d. purchase call options on Australian dollars; at some point before the expiration date, exercise the call option and then sell the Australian dollars received in the spot market
e. All of the above are possible strategies for a speculator who expects the Australian dollar to depreciate.

69. The act of capitalizing on the discrepancy between the forward rate premium and the interest rate differential is called
a. triangular arbitrage.
b. locational arbitrage.
c. covered interest arbitrage.
d. interest rate parity.

70. The indirect exchange rate is always the reciprocal of the direct exchange rate.
a. True
b. False

71. The exchange rate between two foreign (nondollar) currencies is known as a(n):
a. indirect dollar rate.
b. forward rate.
c. cross-exchange rate.
d. derived exchange rate.

72. The devaluation of a country’s currency:
a. makes foreign products more expensive for consumers in that country.
b. increases foreign demand for that country’s exports.
c. can lead to deflation in that country.
d. A and B

73. Currency futures contracts are standardized, whereas forward contracts are more flexible and can specify whatever amount and maturity date are desired.
a. True
b. False

74. When the Federal Reserve attempt to lower interest rates by increasing the U.S. money supply, it puts upward pressure on the value of the dollar.
a. True
b. False

75. A speculator who expects the euro to depreciate might:
a. sell euros forward and then purchase them in the spot market just before fulfilling the forward obligation.
b. purchase euros forward and, when they are received, sell them in the spot market.
c. purchase futures contracts on euros and, when the euros are received, sell them in the spot market.
d. all of the above

Chapter 17—Commercial Bank Operations

1. Which of the following statements is incorrect?
a. Banks have expanded their business across services over time.
b. Acquisitions have been a convenient method for banks to grow quickly and capitalize on economies of scale.
c. The banking industry has become less concentrated in recent years.
d. All of the statements above are correct.

2. Commercial banks have expanded in recent years not only by acquiring other banks but also by acquiring other types of financial service firms.
a. True
b. False

3. Commercial banks can be a lender or a borrower when using repurchase agreements and loans in the federal funds market.
a. True
b. False

4. The operations, management, and regulation of a financial conglomerate are the same irrespective of the types of services offered.
a. True
b. False

5. ____ are offered to bank customers who desire to write checks against their account.
a. Time deposit accounts
b. CDs
c. Demand deposit accounts
d. Money market deposit accounts

6. Which type of savings account transfers funds to a checking account when checks are written?
a. ATS
b. passbook savings
c. CDs
d. MMDAs

7. A(n) ____ account provides checking services as well as interest.
a. demand deposit
b. negotiable order of withdrawal (NOW)
c. passbook savings
d. time deposit

8. Protective covenants impose conditions in which the bank must provide additional loans to a borrower to protect the borrower from going bankrupt.
a. True
b. False

9. A ____ is a time deposit offered by some large banks to corporations, with a specific maturity date, minimum deposit of $100,000 or more, and a secondary market.
a. retail CD
b. negotiable CD
c. market CD
d. protective CD

10. A bank’s sources of funds represent liabilities or equity of the bank.
a. True
b. False

11. 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

12. The intent of federal funds transactions is to
a. correct short-term fund imbalances experienced by banks.
b. correct long-term fund imbalances experienced by banks.
c. serve as a permanent source of bank capital.
d. serve as the primary depository source of funds.

13. For any given bank, federal funds ____ represent a(n) ____.
a. purchased; asset
b. sold; liability
c. purchased; liability
d. A and B

14. The federal funds rate is ____ the yield on a Treasury security with a similar term remaining until maturity.
a. substantially above
b. substantially below
c. close to
d. none of the above; the rate is much higher than the Treasury yield in some periods, and much lower than the Treasury yield in other periods

15. Obtaining funds through ____ is not a common source of funds for banks to satisfy a temporary deficiency of funds?
a. issuing bonds
b. the federal funds market
c. repurchase agreements
d. borrowing from the Federal Reserve

16. Which of the following is true?
a. The primary credit lending rate is set by the president of the United States.
b. The federal funds rate is set by the president of the United States.
c. The primary credit lending rate is set by commercial banks.
d. The primary credit lending rate is now set at a level above the federal funds rate.
e. A and B

17. The Federal Reserve provides loans to banks in order to
a. resolve permanent shortages of funds experienced by banks.
b. resolve temporary shortages of funds experienced by banks.
c. finance the shortages of funds of finance companies.
d. none of the above

18. When a bank in need of funds for a few days sells some of its government securities to a corporation with a temporary excess of funds, then buys them back shortly thereafter, this is a
a. federal funds loan.
b. discount window loan.
c. repurchase agreement.
d. commercial paper transaction.

19. When banks need funding for just a few days, they would most likely
a. issue bonds and then call them.
b. issue stock and then repurchase it.
c. borrow in the federal funds market.
d. issue NCDs.

20. Because U.S. dollars are widely used as an international medium of exchange, the Eurodollar market is very active.
a. True
b. False

21. Subordinated notes and debentures are examples of
a. primary capital.
b. secondary capital.
c. depository sources of funds.
d. repurchase agreements.

22. 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

23. As a source of funds, small banks rely more heavily on ____, and larger banks rely more heavily on ____.
a. time deposits and foreign deposits; savings deposits and short-term borrowings
b. savings deposits and short-term borrowings; foreign deposits and time deposits
c. savings and time deposits; foreign deposits and short-term borrowings
d. foreign deposits and short-term borrowings; savings and time deposits

24. Cash held ____ represents the major portion of a bank’s required reserves.
a. at other commercial banks
b. in a bank’s vault
c. on deposit at the federal funds window
d. on deposit with the Board of Governors

25. The main use of bank funds is for
a. loans.
b. investment securities.
c. fixed assets.
d. repurchase agreements.

26. Bank loans designed to support a firm’s ongoing business operations are called
a. term loans.
b. working capital loans.
c. direct lease loans.
d. revolving credit loans.

27. ____ loans are primarily used to finance the purchase of fixed assets.
a. Term
b. Working capital
c. Informal line of credit
d. Revolving credit

28. Which of the following is most appropriate for a business that may experience a sudden need for funds but does not know precisely when?
a. working capital loan
b. direct lease loan
c. term loan
d. informal line of credit

29. A ____ loan may be especially appropriate when the bank wishes to avoid adding more debt to its balance sheet.
a. term
b. bullet
c. direct lease
d. revolving credit

30. The interest rate banks charge their most creditworthy customers is known as the
a. federal funds rate.
b. primary credit lending rate.
c. prime rate.
d. call money rate.

31. Transaction deposits do not include
a. demand deposits.
b. NCDs.
c. NOW accounts.
d. all of the above are transactions deposits

32. Commercial banks are not allowed to invest in
a. Treasury securities.
b. Freddie Mac securities.
c. Fannie Mae securities.
d. Banks can invest in all securities mentioned above.

33. Money market deposit accounts (MMDAs)
a. require a maturity of 6 months or longer.
b. allow a limited number of checks to be written against the account.
c. pay a higher interest rate than CDs.
d. none of the above

34. Which of the following accounts does not allow checks (at least a limited amount) to be written?
a. NOW accounts
b. money market deposit accounts (MMDAs)
c. retail CDs
d. all of the above allow checks to be written

35. Banks sometimes need funds and sometimes have excess funds available. Which of the following is commonly a source of bank funds and a use of bank funds?
a. MMDAs
b. federal funds
c. the discount window
d. retail CDs

36. The bank holding company structure allows more flexibility to borrow funds, issue stock, repurchase the company’s own stock, and acquire other firms.
a. True
b. False

37. Like other market interest rates, the primary credit lending rate moves in reaction to changes in demand or supply of funds or both.
a. True
b. False

38. The yield on repurchase agreements is slightly higher than the federal funds rate at any given point in time.
a. True
b. False

39. Bank regulators are concerned that banks may maintain a higher level of capital than they should and have therefore imposed capital requirements on them.
a. True
b. False

40. In a revolving credit loan, the bank typically charges businesses a commitment fee on any unused funds.
a. True
b. False

41. Bank rates on credit card balances are usually not very different from the rate charged on business loans.
a. True
b. False

42. While U.S. banks have expanded into non-U.S. markets, few non-U.S. banks have entered U.S. markets.
a. True
b. False

43. ____ is (are) not a major source of funds for commercial banks.
a. Deposit accounts
b. Borrowed funds
c. Commercial loans
d. Bank capital
e. All of the above are commercial banks sources of funds.

44. Which of the following statements is incorrect with respect to the federal funds market?
a. It allows depository institutions to accommodate the short-term liquidity needs of other financial institutions.
b. Federal funds purchased represent an asset to the borrowing bank and a liability to the lending bank that sells them.
c. The federal funds market is typically most active on Wednesday, because that is the final day of each particular settlement period for which each bank must maintain a specified volume of reserves required by the Fed.
d. All of the above are true with respect to the federal funds market.

45. The federal funds rate is typically ____ the primary credit lending rate.
a. greater than
b. less than
c. equal to
d. none of the above

46. ____ are the largest bank source of funds as a percentage of total liabilities.
a. Small-denomination time deposits
b. Money market deposit accounts (MMDAs)
c. Transaction deposits
d. Borrowed funds
e. Savings deposits (including MMDAs)

47. ____ do not specify a maturity and provide limited check-writing ability (they allow only a limited number of transactions per month).
a. Money market deposit accounts (MMDAs)
b. Negotiable CDs (NCDs)
c. Retail CDs
d. Callable CDs
e. Negotiable order of withdrawal (NOW) accounts

48. ____ loans are extended primarily to finance the purchase of fixed assets such as machinery.
a. Term
b. Working capital
c. Federal fund
d. Direct lease

49. Which of the following is not an off-balance sheet activity for commercial banks?
a. consumer loans
b. loan commitments
c. standby letters of credit
d. swap contracts
e. All of the above are off-balance sheet activities.

50. A ____ is a type of loan commitment.
a. standby letter of credit (SLC)
b. note issuance facility (NIF)
c. forward contract
d. swap contract
e. none of the above

51. When a bank obtains funds through a ____, the provider of the funds receives collateral.
a. retail CD
b. NOW account
c. repurchase agreement
d. money market deposit account

52. When banks obtain funds in the federal funds market, the providers of the funds are
a. other depository institutions.
b. nonfinancial corporations.
c. consumers.
d. the Federal Reserve.

53. A single loan in the federal funds market is usually for ____; when a bank sells a single repurchase agreement, the maturity is usually ____.
a. just a few days; one year or more
b. several weeks; one year or more
c. several weeks; just a few days
d. just a few days; just a few days

54. The interest rate charged on loans between depository institutions is commonly referred to as the
a. federal funds rate.
b. discount rate.
c. primary credit lending rate.
d. none of the above

55. The interest rate charged on loans from the Federal Reserve to banks is commonly referred to as the
a. federal funds rate.
b. primary credit lending rate.
c. repo rate.
d. none of the above

56. The primary credit lending rate is determined by
a. the Federal Reserve.
b. Congress.
c. the Treasury.
d. the President of the United States.

57. Bank capital represents funds obtained through ____ and through ____.
a. issuing stock; offering long-term CDs
b. issuing repurchase agreements; issuing bonds
c. issuing stock; retaining earnings
d. offering long-term CDs; issuing bonds

58. Banks sometimes prefer to minimize their amount of capital since
a. interest payments must be paid by the bank on all capital that is held.
b. they try to avoid diluting ownership of the bank.
c. A and B
d. none of the above

59. When a bank obtains funds through ____, households are not a common provider of the funds.
a. NOW accounts
b. retail CDs
c. passbook savings accounts
d. NCDs

60. Which of the following is not an off-balance sheet activity?
a. highly leveraged transactions (HLTs)
b. standby letters of credit
c. forward contracts
d. swap contracts

61. A bank’s uses of funds represent liabilities of a bank.
a. True
b. False

62. ____ are the largest bank source of funds (as a percentage of total liabilities).
a. Small-denomination time deposits
b. Large-denomination time deposits
c. Transaction deposits
d. Savings deposits (including MMDAs)

63. The five largest banks in the United States account for about one-tenth of all assets in U.S. banks.
a. True
b. False

STA: DISC.FMAI.MADU.15.03

64. From a bank manager’s perspective, the differential in interest between a bank’s loans and its deposits;
a. must not exceed the federal funds rate.
b. is called the primary credit lending rate.
c. must be sufficient to cover the bank’s other expenses and generate a reasonable profit for the bank’s owners.
d. must be sufficient to cover the bank’s deposit insurance premiums and its reserve requirements at the Federal Reserve.

65. In a loan participation arrangement, normally all of the participating banks are exposed to credit (default) risk.
a. True
b. False

66. Banks will not accept intangible assets, such as patents and brand names, as collateral for commercial loans.
a. True
b. False

67. Proprietary trading is generally less risky than a bank’s lending operations.
a. True
b. False

68. When a bank engages in proprietary trading, it:
a. uses its own funds to make investments.
b. is not subject to regulations.
c. lends the funds in the federal funds market.
d. normally uses the funds to build its capital.

69. In a standby letter of credit, a bank agrees to:
a. charge a fixed interest rate for a line of credit for a specified period.
b. back a customer’s obligation to a third party.
c. provide a customer with funds up to a specified maximum amount over a specified period.
d. service credit card loans originated by another bank.

70. A forward contract on currency:
a. is a way to hedge credit (default) risk.
b. is used to to swap fixed interest payments in euros for variable interest payments in dollars.
c. is an agreement between a customer and a bank to exchange one currency for another on a specified date at a specified exchange rate.
d. is an agreement between a customer and a bank to exchange one currency for another on a specified date at whatever the exchange rate is on that day.

71. Before the credit crisis, _________ were heavily used to protect against the credit (default) risk from investing in mortgage-backed securities.
a. standby letters of credit
b. interest rate swap contracts
c. credit default swap contracts
d. forward contracts on mortgages

72. Before establishing foreign branches, a U.S. bank must obtain the approval of the:
a. U.S. Treasury.
b. U.S. Commerce Department.
c. Federal Deposit Insurance Corporation.
d. Federal Reserve.

FIN 350 Week 9 Quiz Solution

Chapter 18—Bank Regulation

1. Deposit insurance has a limit of:
a. $10,000.
b. $25,000.
c. $100,000.
d. $250,000.

2. The opening of a commercial bank in the United States
a. does not require a charter.
b. always requires a charter from a state government.
c. always requires a charter from the federal government.
d. requires a charter from a state or the federal government.
e. requires a charter from both the state and federal government.

3. Commercial banks that are not members of the Federal Reserve System ____ borrow from the Fed, and ____ subject to the Fed’s reserve requirements.
a. may; are
b. may; are not
c. may not; are not
d. may not; are

4. National banks are regulated by ____, and state banks are regulated by ____.
a. the Comptroller of the Currency; their state agency
b. the Comptroller of the Currency; the Comptroller of the Currency
c. their state agency; their state agency
d. their state agency; the Comptroller of the Currency

5. All Fed member banks must hold
a. private insurance on deposits.
b. FDIC insurance on deposits.
c. both FDIC and private insurance on deposits.
d. none of the above

6. Commercial banks ____ restricted to a maximum percentage of their capital to loan to a single customer, and ____ allowed to use borrowed or deposited funds to purchase common stock.
a. are; are
b. are; are not
c. are not; are
d. are not; are not

7. Banks commonly use depositor funds to invest in stocks.
a. True
b. False

8. An “off-balance-sheet commitment” that provides the bank’s guarantee on the financial obligations of a borrower to a specific party is a
a. standby letter of credit.
b. federal funds agreement.
c. repurchase agreement.
d. discount window agreement.

9. The Depository Institutions Deregulation and Monetary Control Act of 1980 allowed banks to set their own
a. reserve requirements.
b. capital ratios.
c. interest rates on savings deposits.
d. corporate loan interest rates.

10. The Glass-Steagall Act of 1933 prevented
a. any firm that accepts deposits from underwriting stocks and bonds of corporations.
b. any firm that accepts deposits from underwriting general obligation bonds of states and municipalities.
c. any firm that accepts deposits from holding any corporate bonds in its asset portfolio.
d. state-chartered banks from offering commercial loans.

11. Which of the following is not a main deregulatory provision of Depository Institutions Deregulation and Monetary Control Act of 1980?
a. phase-out of deposit rate ceilings
b. allowance of checkable deposits for all depository institutions
c. new lending flexibility of depository institutions
d. allowance of interstate banking for depository institutions in most states

12. The Financial Reform Act was intended to:
a. prevent another credit crisis.
b. reduce capital ratios.
c. impose interest rate ceilings on deposits.
d. prevent banks from offering securities services.

13. The Garn-St. Germain Act of 1982
a. permitted depository institutions to offer money market deposit accounts.
b. prevented depository institutions from acquiring problem institutions across geographical boundaries.
c. required the Fed to explicitly charge depository institutions for its services.
d. allowed the Fed to provide check clearing to depository institutions at no charge.

14. Which of the following is not a specific criterion the FDIC uses to monitor banks?
a. capital adequacy
b. dollar value of fixed assets
c. asset quality
d. earnings
e. sensitivity to financial market conditions

15. The potential risk that financial problems can spread through financial institutions and the financial system is referred to as:
a. systemic
b. systematic
c. unsystematic
d. market

16. The Basel framework recommends capital requirements in proportion to:
a. mortgages
b. commercial paper
c. liabilities
d. risk-weighted assets

17. The Basel Accord
a. forces banks with greater risk to maintain more deposits.
b. forces banks with greater risk to maintain more capital.
c. forces banks with greater risk to maintain less capital.
d. none of the above

18. In general, a bank defines its value-at-risk as the estimated potential loss from its traditional businesses that could result from adverse movements in market prices.
a. True
b. False

19. 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.

20. Which of the following is an “off-balance-sheet commitment?”
a. long-term debt
b. additional paid-in capital
c. notes payable
d. guarantees backing commercial paper issued by firms

21. The liquidity component of the CAMELS rating refers to
a. regulators’ concern about how a bank’s earnings would change if economic conditions change.
b. how well the bank’s management would detect its own financial problems.
c. a bank’s sensitivity to financial market conditions.
d. monitoring the type of loans that are given, the bank’s process for deciding whether to provide loans, and the credit rating of debt securities that it purchases.
e. excessive borrowing by banks from outside sources, such as the discount window.

22. Which of the following is not a corrective action taken by regulators when a bank is identified as a problem bank?
a. Regulators may examine such banks frequently and thoroughly.
b. Regulators may request that a bank boost its capital level or delay its plans to expand.
c. Regulators can require that additional financial information be periodically updated to allow continued monitoring.
d. Regulators have the authority to take legal action against a problem bank if the bank does not comply with their suggested remedies.
e. All of the above are possible corrective actions taken by bank regulators.

23. The fee banks pay to the FDIC for deposit insurance is now
a. a fixed dollar amount for all banks.
b. a fixed percentage of the bank’s deposit level for all banks.
c. a fixed percentage of the bank’s loan volume for all banks.
d. based on the risk of the bank.

24. Generally, the failure of small banks
a. causes more widespread concern about the safety of the banking system than the failure of large banks.
b. causes equal concern about the safety of the banking system as the failure of large banks.
c. causes less concern about the safety of the banking system than the failure of large banks.
d. Either A or B can be true, depending on the type of business cycle that exists while the failures occur.

25. The Sarbanes-Oxley Act was enacted to make corporate managers, board members, and auditors more accountable for the accuracy of the financial statements that their respective firms provide.
a. True
b. False

26. Bank A has a 10 percent capital ratio and uses a significant proportion of its assets to invest in very highly-rated bonds. Bank B has an 12 percent capital ratio and uses a significant proportion of its assets to invest in highly leveraged transactions. How would Bank A rate versus Bank B using the capital and asset quality criteria?
a. Bank A is perceived as safer by both criteria.
b. Bank B is perceived as safer by both criteria.
c. Bank A is perceived as safer according to capital, but more risky according to asset quality.
d. Bank B is perceived as safer according to capital, but more risky according to asset quality.

27. The key reason for regulatory examinations (such as CAMELS ratings) is to
a. rate past performance.
b. detect problems of a bank in time to correct them.
c. check for embezzlement.
d. monitor reserve requirements.

28. Deposit insurance now covers all bank deposits without imposing any limit.
a. True
b. False

29. Which banking act allowed banks to cross state lines in order to acquire a failing institution?
a. McFadden Act
b. Glass-Steagall Act
c. DIDMCA
d. Garn-St. Germain Act

30. Which banking act allowed for the creation of NOW accounts?
a. McFadden Act
b. Glass-Steagall Act
c. DIDMCA
d. Garn-St. Germain Act

31. Which banking act allowed interstate banking?
a. Reigle-Neal Interstate Banking and Branching Efficiency Act
b. Glass-Steagall Act
c. DIDMCA
d. Sarbanes-Oxley Act

32. Which banking act permanently increased FDIC insurance up to $250,000?
a. DIDMCA
b. Sarbanes-Oxley Act
c. Financial Reform Act
d. Garn-St. Germain Act

33. Which banking act removed deposit rate ceilings?
a. McFadden Act
b. Glass-Steagall Act
c. DIDMCA
d. Garn-St. Germain Act

34. The argument that interstate banking would allow banks to grow and more fully achieve a reduction in operating costs per unit of output as output increases is based on
a. economies of scale.
b. financial leverage.
c. diseconomies of scale.
d. capital adequacy theory.

35. Federal deposit insurance
a. existed since the 1800s.
b. was created in 1933.
c. was created after World War II.
d. was created in 1960.

36. ____ is not a characteristics used by the Federal Deposit Insurance Corporation (FDIC) to rate banks.
a. Capital adequacy
b. Current stock price
c. Asset quality
d. Management
e. All of the above are used by the FDIC to rate banks.

37. The moral hazard problem is minimized when deposit insurance premiums are
a. zero (not imposed by the FDIC).
b. the same percentage of assets for all banks.
c. set at a fixed percentage of assets for large banks, and is zero for small banks.
d. set at a percentage of assets that is based on the bank’s risk level.

38. Which of the following statements is incorrect with respect to the Financial Services Modernization Act of 1999?
a. It complemented the Glass-Steagall Act.
b. It enabled commercial banks to more easily pursue securities and insurance activities.
c. It gave securities firms and insurance companies the right to acquire banks.
d. The Act requires that commercial banks must have a strong rating in community lending in order to pursue additional expansion in securities and other nonbank activities.
e. All of the above are true.

39. The ____ is the fund used to cover insured depositors.
a. Bank Insurance Fund
b. Federal Deposit Insurance Corporation (FDIC)
c. money market mutual fund
d. growth fund
e. none of the above

40. ____ is not a rating criterion used by the FDIC.
a. Capital adequacy
b. Off-balance sheet financing
c. Asset quality
d. Management
e. Liquidity

41. The uniform global capital requirements mandated a minimum level of Tier 1 capital, which primarily consists of funds obtained from
a. issuing commercial paper and bonds.
b. retaining earnings and issuing commercial paper.
c. retaining earnings and issuing common stock.
d. issuing bonds and common stock.

42. During the 2008-2010 period, the ____ was implemented to alleviate the financial problems experienced by banks and other financial institutions with excessive exposure to mortgages or mortgage-backed securities.
a. Riegle Program
b. Sarbanes-Oxley Program
c. FDIC Program
d. Troubled Asset Relief Program (TARP)

43. The act of taking a risk because of protection from adverse consequences due to the risk is referred to as a moral hazard problem.
a. True
b. False

44. The Sarbanes-Oxley Act (SOX) was enacted in 2002 in order to ensure a more transparent process for reporting on productivity and the financial condition of the firm.
a. True
b. False

45. The Sarbanes-Oxley Act (2002) was enacted in response to some banks taking too much risk.
a. True
b. False

46. Publicly-traded banks have incurred larger reporting expenses to comply with the Sarbanes-Oxley Act.
a. True
b. False

47. The Financial Services Modernization Act of 1999
a. gave banks and other financial service firms less freedom to merge.
b. allowed financial institutions to offer a diversified set of financial services without being subjected to stringent constraints.
c. offers very few benefits to a financial institution’s clients.
d. increased the reliance of financial institutions on the demand for the single service they offer.

48. Which of the following is not true regarding the Financial Services Modernization Act of 1999?
a. It provided more momentum for the consolidation of financial services.
b. Financial institutions were finally able to offer a diversified set of financial services without being subjected to stringent constraints on the form or amount of financial services that they could offer.
c. Banks and other financial service firms were given more freedom to merge, but were forced to divest some of the financial services that they acquired.
d. Financial institutions no longer had to search for loopholes or monitor their business to ensure that the degree of financial services offered remained within the regulatory constraints that were previously imposed.
e. all of the above are true

49. All state banks are required to be members of the Federal Reserve System.
a. True
b. False

50. State banks are regulated by the Comptroller of the Currency.
a. True
b. False

51. Banks that are insured by the Federal Deposit Insurance Corporation (FDIC) are also regulated by the FDIC.
a. True
b. False

52. Commercial banks are allowed to invest in junk bonds.
a. True
b. False

53. In general, banks would prefer to maintain a high amount of capital to boost their return on equity ratio, yet regulators have argued that banks need only a sufficient amount of capital to absorb potential operating losses.
a. True
b. False

54. The provision of a letter of credit by a bank to issue commercial paper issued by a corporation is an example of an off-balance sheet commitment.
a. True
b. False

55. As a result of the Reigle-Neal Act, bank customers have benefited because of lower costs to banks and because of convenience.
a. True
b. False

56. 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

57. If regulators reduce bank failures by imposing regulations that reduce competition, bank efficiency will be increased.
a. True
b. False

58. An ideal solution to react to a large failing bank would prevent a run on deposits of other large banks, yet not reward a poorly performing bank with a bailout.
a. True
b. False

59. ____ is not a rating criterion used by the Federal Deposit Insurance Corporation (FDIC).
a. Capital adequacy
b. Off-balance sheet financing
c. Asset quality
d. Management
e. Liquidity

60. A federal bank charter is issued by the
a. Comptroller of the Currency.
b. Securities and Exchange Commission.
c. U.S. Treasury.
d. Federal Reserve.
e. none of the above

61. Bank regulations typically:
a. involve a tradeoff between the safety of the banking system and the efficiency of bank operations.
b. impose restrictions on the types of assets in which banks can invest.
c. set requirements for the minimum amount of capital that banks must hold.
d. all of the above

62. When a bank holds a lower level of capital, a given dollar level of profits represents a lower return on equity.
a. True
b. False

63. Shareholders and managers of banks may prefer that banks be required to hold higher levels of capital because this would allow for higher share prices for the banks and larger bonuses for bank managers.
a. True
b. False

64. A bank can increase its capital ratio by:
a. buying back shares of its stock from shareholders.
b. selling assets.
c. increasing its dividend to encourage more investors to purchase its stock.
d. increasing its off-balance sheet activities.

65. The Basel III framework proposes:
a. lower capital requirements for banks to enable them to generate higher earnings to make up for their losses during the credit crisis.
b. relying on the rating agencies to assess the risk of bank assets.
c. increased capital requirements and liquidity requirements for banks.
d. using the gap ratio to set the capital ratio.

66. During the credit crisis, all of the following occurred except:
a. some securities firms were allowed to become bank holding companies.
b. the Federal Reserve rescued American International Group, an insurance company.
c. the Treasury injected funds into financial institutions.
d. the Supreme Court ruled that the Federal Reserve had exceeded its authority by assisting Bear Stearns because Bear was a securities firm and not a commercial bank.

67. The Volcker rule, named for a former Fed chair:
a. is intended to increase the powers of the Fed.
b. states that the U.S. government will rescue certain large banks if necessary to reduce systemic risk in the financial system.
c. sets limits on banks’ proprietary trading.
d. requires all banks to undergo annual stress tests.

68. The Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) of 2010:
a. ended the system of risk-based insurance premiums.
b. set requirements for the Deposit Insurance Fund’s reserves.
c. raised the limit for insured deposits to $750,000 per depositor.
d. allowed large insurance companies such as American International Group to compete with the FDIC to insure bank deposits.

Chapter 19—Bank Management

1. Which of the following statements is incorrect?
a. Managers may be tempted to make decisions that are in their own best interests rather than shareholder interests.
b. Directors are responsible for making most of the bank’s decisions regarding loans to customers, which encourages a loan department to extend loans with a very high concern for risk.
c. To prevent agency problems, some banks provide stock as compensation to managers.
d. The underlying goal behind the managerial policies of a bank is to maximize the wealth of the bank’s shareholders.

2. When cash outflows temporarily exceed cash inflows, banks are most likely to experience
a. higher dividend payments.
b. illiquidity.
c. a negative duration on its assets.
d. an excess of capital.

3. Banks can resolve cash deficiencies by
a. creating additional liabilities.
b. selling assets.
c. buying back common stock.
d. increasing dividend payouts.
e. A or B

4. As the secondary market for loans has become active, banks are more able to satisfy their liquidity needs with a ____ proportion of loans while achieving ____ profitability.
a. higher; higher
b. lower; lower
c. higher; lower
d. lower; higher

5. Banks are more liquid as a result of securitization because it allows them to request repayment of the loan principal from the borrower upon demand.
a. True
b. False

6. If a bank that relies heavily on short-term deposits expects interest rates to consistently decrease over time, it would allocate most of its loans with ____ rates if it desires to maximize its expected returns. It could reduce its exposure to interest rate risk by setting ____ rates on its loans.
a. fixed; fixed
b. variable; fixed
c. variable; variable
d. fixed; variable

7. During a period of rising interest rates, a bank’s net interest margin will likely ____ if its liabilities are ____ its assets.
a. increase; more rate-sensitive than
b. decrease; more rate-sensitive than
c. increase; equally rate-sensitive as
d. decrease; equally rate-sensitive as

8. If a bank expected interest rates to consistently ____ over time, it will consider allocating most funds to rate-____ assets.
a. decrease; sensitive
b. decrease; insensitive
c. increase; insensitive
d. none of the above

9. Petri Bank had interest revenues of $70 million last year and $30 million in interest expenses. About $300 million of Petri’s $800 million in assets are rate-sensitive, while $600 million of its liabilities are rate-sensitive. Petri Bank’s net interest margin is ____ percent.
a. 4.0
b. 3.6
c. 6.7
d. 5.0

10. Petri Bank had interest revenues of $70 million last year and $30 million in interest expenses. About $300 million of Petri’s $800 million in assets are rate-sensitive, while $600 million of its liabilities are rate-sensitive. Petri Bank’s gap is $____.
a. −300 million
b. 300 million
c. −500 million
d. 500 million

11. Petri Bank had interest revenues of $70 million last year and $30 million in interest expenses. About $300 million of Petri’s $800 million in assets are rate-sensitive, while $600 million of its liabilities are rate-sensitive. Petri Bank’s gap ratio is ____ percent.
a. 37.5
b. 50.0
c. 100.0
d. 40.0

12. The measure of interest rate risk that uses the difference between rate-sensitive assets and rate-sensitive liabilities is called
a. gap measurement.
b. duration measurement.
c. duration ratio.
d. gap ratio.

13. A gap ratio of less than one suggests that
a. rate-sensitive assets exceed rate-sensitive liabilities.
b. an increase in interest rates would increase