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FIN 350 Week 11 Quiz – Strayer University New

FIN/350 Week 11 Quiz – Strayer

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Quiz 10 Chapter 22 and 23

Finance Company Operations

1. ____ finance companies concentrate on purchasing credit contracts from retailers and dealers.
a. Consumer
b. Sales
c. Commercial
d. None of the above

2. Which of the following is not a source of finance company funds to support operations?
a. loans from banks
b. commercial paper
c. federal funds
d. bonds

3. When a finance company’s assets are ____ interest rate sensitive than its liabilities and when interest rates are expected to ____, bonds can provide long-term financing at a rate that is completely insulated from rising market rates.
a. less; increase
b. less; decrease
c. more; increase
d. more; decrease

4. Finance companies differ from commercial banks, savings institutions, and credit unions in that they
a. normally do not obtain funds from deposits.
b. focus on financing acquisitions by companies.
c. focus on providing residential mortgages.
d. use most of their funds to purchase stocks.

5. Which of the following is not a main source of funds for finance companies?
a. bank loans
b. commercial paper issues
c. bonds
d. capital

6. Finance companies are more likely to issue bonds when their assets are presently ____ interest-rate sensitive than their liabilities, and when interest rates are expected to ____.
a. more; decrease
b. less; increase
c. more; increase
d. less; decrease

7. If finance companies were confident about projections of ____ interest rates, they may consider using the funds obtained from issuing bonds to offer loans with ____ rates.
a. declining; variable
b. rising; fixed
c. rising; variable
d. A and B

8. Finance companies would prefer to increase their long-term debt most once interest rates
a. have declined.
b. have increased.
c. were stable for several years.
d. were projected to decline.

9. The main competition for finance companies in the consumer loan market comes from
a. pension funds.
b. life insurance companies and property and casualty insurance companies.
c. commercial banks and savings and institutions.
d. mutual funds.

10. When finance companies purchase a firm’s receivables at a discount, and are responsible for processing and collecting the balances of these accounts, they act as a
a. leasing agent.
b. lessor.
c. lessee.
d. factor.

11. When a finance company purchases equipment for use by another business, the finance company provides financing in the form of
a. factoring.
b. leasing.
c. a banker’s acceptance.
d. a letter of credit.

12. Finance companies are exempt from state regulations.
a. True
b. False

13. Finance companies are not subject to state regulations on intrastate business.
a. True
b. False

14. Finance companies are subject to
a. a maximum limit on loan size.
b. ceiling interest rates on loans provided.
c. a maximum length on loan maturity.
d. regulations on intra-state banking.
e. all of the above

15. If finance companies with a greater rate-sensitivity of liabilities than assets wanted to reduce interest-rate risk, they could
a. shorten their average asset life.
b. lengthen their average asset life.
c. shorten the maturity of debt that they issue.
d. make greater use of fixed-rate loans.

16. Overall, the liquidity risk of finance companies is higher than that of other financial institutions.
a. True
b. False

17. Compared to other lending financial institutions, finance companies have a ____ loan delinquency rate, and the average rate charged on loans is ____ on average.
a. lower; lower
b. lower; higher
c. higher; higher
d. higher; lower

18. A wholly owned subsidiary whose primary purpose is to finance sales of the parent company’s products and services, provide wholesale financing to distributors of the parent company’s products, and purchase receivables of the parent company is a
a. captive finance subsidiary.
b. factor.
c. leasing agent.
d. captive factoring agent.

19. Which of the following statements is incorrect?
a. A captive finance subsidiary’s purpose is to finance sales of the parent company’s products and services.
b. An operating agreement between the parent and the captive specifies the type of receivables that qualify for same and specific services provided by the parent.
c. A captive can be used to finance distributor or dealer inventories until a sale occurs.
d. A captive is rarely used to finance products leased to others.

20. ____ provide loans to firms that cannot obtain financing from commercial banks.
a. Consumer finance companies
b. Sales finance companies
c. Commercial finance companies
d. None of the above

21. Which of the following is not a use of finance company funds?
a. consumer loans
b. business loans
c. commercial paper
d. real estate loans
e. All of the above are uses of finance company funds.

22. Finance companies commonly act as ____ for accounts receivable; that is, they purchase a firm’s receivables at a discount and are responsible for processing and collecting the balances of these accounts.
a. brokers
b. dealers
c. market makers
d. factors
e. none of the above

23. Most finance companies are commonly exposed to all forms of risk below except ____ risk.
a. exchange rate
b. interest rate
c. liquidity
d. credit

24. Changes in economic growth are ____ related to a finance company’s cash flows, and changes in the risk-free rate are ____ related to a finance company’s cash flows.
a. positively; negatively
b. negatively; positively
c. negatively; negatively
d. positively; positively

25. Finance companies participate in the ____ market to reduce interest rate risk.
a. money
b. bond
c. options
d. swap

26. Many consumer finance companies also provide personal loans, directly to individuals to finance purchases of large household items.
a. True
b. False

27. Business finance companies focus on loans to very large businesses.
a. True
b. False

28. Consumer finance companies sometimes provide Business finance companies to individuals.
a. True
b. False

29. Although commercial paper is available only for short-term financing, finance companies can continually roll over their issues to create a permanent source of funds.
a. True
b. False

30. After interest rates increase, finance companies tend to use more long-term debt to lock in the cost of funds over an extended period of time.
a. True
b. False

31. Some finance companies offer credit card loans through a particular retailer.
a. True
b. False

32. The main competition for finance companies in the consumer loan market comes from pension funds and insurance companies.
a. True
b. False

33. The value of a finance company can be modeled as the present value of its future cash flows.
a. True
b. False

34. The most important risk for finance companies is ____ risk.
a. settlement
b. accounting
c. credit
d. exchange rate

35. Finance companies can accumulate capital by doing all of the following except
a. retaining earnings.
b. issuing stock.
c. issuing commercial paper.
d. Finance companies can build their capital base by doing all of the above.

36. Consumer finance companies primarily focus on for
a. consumer loans.
b. consumer advising.
c. consumer regulation.
d. none of the above

37. Finance companies are regulated by the states but are not subject to regulation by an agency of the federal government.
a. True
b. False

38. Historically, captive finance subsidiaries were associated with:
a. the automobile industry.
b. the oil and gas industry.
c. the textile industry.
d. department stores.

Chapter 23—Mutual Fund Operations

1. Which of the following statements is incorrect?
a. Mutual funds serve as a key financial intermediary.
b. Managers of mutual funds do not analyze economic and industry trends.
c. Because of their diversification, management expertise, and liquidity, mutual funds have grown at a rapid pace.
d. Some mutual funds offer check-writing privileges.

2. No-load mutual funds are normally promoted by ____. Load funds are promoted by ____.
a. registered representatives of a brokerage firm; registered representatives of a brokerage firm
b. registered representatives of a brokerage firm; the mutual fund of concern
c. the mutual fund of concern; registered representatives of a brokerage firm
d. the mutual fund of concern; the mutual fund of concern

3. To cover managerial expenses, mutual funds typically charge
a. management fees of less than 2 percent of total assets per year.
b. commissions of typically 8 to 10 percent of transaction market value per year.
c. management fees of typically more than 10 percent of total assets per year.
d. commissions of typically 3 to 5 percent of the transaction market value per year.

4. Mutual funds that are willing to repurchase their shares from investors at any time are referred to as
a. closed-end funds.
b. load mutual funds.
c. no-load mutual funds.
d. open-end mutual funds.

5. ____ funds do not normally repurchase their shares from investors.
a. Closed-end
b. Load mutual
c. No-load mutual
d. Open-end mutual

6. Most closed-end funds invest in
a. stock and bonds.
b. money market securities.
c. gold.
d. derivatives.

7. Exchange-traded funds are like open-end funds in the sense that
a. their shares are traded on an exchange, and their share price changes throughout the day.
b. they have a fixed number of shares.
c. they are not actively managed.
d. none of the above

8. Hedge funds differ from open-end mutual funds in the sense that
a. they require a much smaller initial investment.
b. they are open to additional investments at any time.
c. their investors cannot sell shares back to the fund at any time they desire.
d. they invest in very limited set of securities.

9. Shares of open-end mutual funds are purchased and sold on exchanges.
a. True
b. False

10. Mutual funds
a. are unregulated.
b. are required to disclose the names of their portfolio managers in the prospectus.
c. are not required to disclose any information about their past performance.
d. are exempt from all taxes.

11. Which of the following is not disclosed in the prospectus?
a. the minimum amount of investment required
b. the investment objective of the funds
c. the fees incurred by the mutual fund
d. all of the above are disclosed

12. The net asset value of a mutual fund is estimated once every week.
a. True
b. False

13. Mutual funds with ____ expense ratios tend to ____ others that have a similar investment objective.
a. lower; underperform
b. higher; outperform
c. lower; outperform
d. A and B

14. A front-end load is a withdrawal fee assessed when you withdraw money from the mutual fund.
a. True
b. False

15. Money market funds invest mostly in
a. stocks.
b. long-term bonds.
c. real estate.
d. short-term securities.

16. If investors sell their mutual fund shares after the net asset value of the fund increases, the return is called
a. share price appreciation.
b. capital gains distribution.
c. dividends.
d. split net asset value.

17. Mutual funds composed of stocks that have potential for very high growth, but may also be unproven, are called
a. income funds.
b. capital appreciation funds.
c. specialty funds.
d. dividend funds.

18. Mutual funds composed of bonds that offer periodic coupon payments are
a. income funds.
b. specialty funds.
c. dividend funds.
d. growth funds.

19. Mutual funds whose bonds have a ____ average time to maturity are ____ sensitive to interest rate fluctuations.
a. longer; less
b. shorter; less
c. shorter; more
d. A and C

20. The net asset value of international stock mutual funds ____ as the dollar strengthens against foreign currencies. (Assume no change in the prices of foreign stocks.)
a. increases
b. decreases
c. is unaffected
d. can increase or decrease depending on the dollar’s degree of strength

21. Mutual funds that include some non-U.S. stocks and U.S. stocks are called ____ funds.
a. global
b. foreign
c. combined
d. mixed

22. A mutual fund consisting only of stocks of firms that are in a specific industry is an example of a ____ fund.
a. specialty
b. growth
c. capital appreciation
d. growth and income

23. The majority of mutual fund assets are in the form of
a. common stocks.
b. preferred stocks.
c. U.S. government bonds.
d. municipal bonds.

24. If a mutual fund distributes at least ____ percent of its taxable income to shareholders, the fund is exempt from taxes on dividends, interest, and capital gains distributed to shareholders.
a. 25
b. 50
c. 75
d. 90

25. When the redemptions of money market mutual fund shares exceeds sales of shares, the fund accommodates the amount of excessive redemptions by
a. selling some of the assets contained in the portfolio.
b. issuing stock.
c. issuing bonds.
d. borrowing from banks.

26. Money market fund assets include all of the following, except
a. stocks.
b. repurchase agreements.
c. Treasury bills.
d. CDs.

27. If money market funds definitely expect interest rates to increase, they will ____ their average asset maturity.
a. not adjust
b. shorten
c. lengthen
d. shorten (if the expected change is small) or lengthen (if the expected change is large)

28. Money market funds are normally perceived to have ____ interest rate risk, and ____ default risk.
a. low; high
b. high; high
c. high; low
d. low; low

29. Equity real estate investment trusts invest
a. in mortgage and construction loans.
b. directly in properties.
c. in common stocks issued by construction companies.
d. in common stocks issued by real estate brokerage firms.

30. Because ____ real estate investment trusts essentially represent a fixed income portfolio, their market value will ____ as interest rates increase.
a. equity; increase
b. equity; decrease
c. mortgage; increase
d. mortgage; decrease

31. When interest rates decline, investors who want to earn a high return may tend to ____ in stock mutual funds, and ____ deposits in depository institutions.
a. reduce; reduce
b. reduce; increase
c. increase; reduce
d. increase; increase

32. The composition of asset allocation funds
a. is focused completely on one type of security as specified by the particular mutual fund.
b. is fixed and not altered by the mutual fund managers.
c. A and B
d. none of the above

33. A mutual fund prospectus does not contain
a. minimum amount of investment required.
b. return on the fund since its inception.
c. investment objective of the mutual fund.
d. exposure of the mutual fund to various types of risk.
e. fees incurred by the mutual fund.

34. The ____ of a mutual fund indicates the value per share.
a. net asset value
b. gross asset value
c. net stock value
d. net bond value
e. none of the above

35. Mutual funds whose funds are promoted strictly by the mutual fund of concern are called
a. closed-end funds.
b. load mutual funds.
c. no-load mutual funds.
d. open-end mutual funds.

36. Mutual funds that are composed of bonds that offer periodic coupon payments are called ____ mutual funds.
a. tax-free
b. income
c. high-yield
d. growth
e. none of the above

37. ____ are most likely to invest in mortgages.
a. Stock mutual funds
b. Bond mutual funds
c. Load funds
d. Closed-end funds

38. Hedge funds that exceed a specified size must register with the
a. Securities and Exchange Commission (SEC).
b. Federal Reserve.
c. Office of Thrift Supervision.
d. Federal Mutual Fund Board.

39. According to SEC regulations, the majority of the members on a mutual fund’s board of directors must be
a. employed by the fund.
b. outsiders (not employed by the fund).
c. certified public accountants.
d. certified financial analysts.

40. An expense ratio represents ____ divided by the fund’s ____.
a. annual fees charged to investors; 12b-1 fees
b. annual fees charged to investors; net asset value
c. initial sales charge (load); 12b-1 fees
d. initial sales charge (load); net asset value

41. The most common investment by closed-end funds is in
a. derivatives.
b. bonds.
c. money market securities.
d. international equity securities.

42. ____ are beneficial for investors who want to invest in tax-exempt securities.
a. Municipal bond funds
b. Growth and income funds
c. International and global funds
d. Money market funds

43. When the demand for a particular closed-end fund is ____, the fund is likely priced at a ____.
a. high; discount
b. low; discount
c. high; premium
d. B and C are correct

44. Which of the following statements is incorrect?
a. Commercial paper is commonly purchased by money market funds.
b. From an investor’s perspective, money market funds usually have a low level of credit risk.
c. Money market funds tend to have low interest rate risk compared to bond funds.
d. If mutual fund managers expect interest rates to decrease in the future, they should use funds generated from maturing securities today to purchase new securities with shorter maturities.

45. The number of exchange-traded funds has declined over the last several years because the cost of managing them was excessive.
a. True
b. False

46. Exchange-traded funds can be purchased on margin.
a. True
b. False

47. Investors can sell exchange-traded funds short.
a. True
b. False

48. Mutual fund managers seek securities that have much liquidity so that they could easily sell them in the secondary market at any time.
a. True
b. False

49. Closed-end funds are closed to new investment but allow redemptions by shareholders.
a. True
b. False

50. Closed-end fund managers must hold more cash than mutual fund managers.
a. True
b. False

51. Index mutual funds are not traded throughout the day, while exchange-traded funds are.
a. True
b. False

52. Venture capital funds typically invest in stocks of publicly-traded companies.
a. True
b. False

53. Many businesses that go public are partially backed by venture capital before the IPO.
a. True
b. False

54. Private equity funds use most of their money to invest in stocks of publicly-traded companies.
a. True
b. False

55. Vulture funds are a type of private equity fund that purchase distressed assets of a firm that is in or near bankruptcy.
a. True
b. False

56. Hedge funds commonly engage in short selling.
a. True
b. False

57. ____ are not exchange-traded funds.
a. Spiders
b. Growth mutual funds
c. Diamonds
d. Sector Spiders

58. Which of the following statements is incorrect?
a. ETFs are like index mutual funds because the share price adjusts over time in response to the change in the index level.
b. Both ETFs and index mutual funds pay dividends in the form of additional shares to investors.
c. The portfolio management of both ETFs and index mutual funds is very complex.
d. ETFs can be traded throughout the day.

59. Funds that are designed to mimic particular stock indexes and are traded on a stock exchange are known as
a. index mutual funds.
b. exchange-traded funds.
c. money market funds.
d. none of the above

60. Exchange traded funds can be
a. traded throughout the day.
b. purchased on margin.
c. sold short.
d. all of the above

61. ____ trade at one-tenth of the S&P 500 value.
a. Spiders
b. Cubes
c. Diamonds
d. World Equity Benchmark Shares

62. Mutual funds must register with the U.S. Treasury and provide to interested investors a prospectus that discloses details about the components of the funds and risks involved.
a. True
b. False

63. The net asset value (NAV) is estimated each day by first determining the market value of all securities comprising the mutual fund.
a. True
b. False

64. Portfolio managers are hired by the mutual fund to invest in a portfolio of securities that satisfies the desires of investors.
a. True
b. False

65. The expenses incurred by a mutual fund are billed separately to investors, and are not included in the fund’s net asset value (NAV).
a. True
b. False

66. A front-end load is a withdrawal fee assessed when you withdraw money from the mutual fund.
a. True
b. False

67. Large mutual funds can exert some control over the management of firms because they commonly represent the largest shareholders.
a. True
b. False

68. Investors who feel capable of making their own investment decisions often prefer to invest in load funds.
a. True
b. False

69. The term “mutual funds” is normally used to represent closed-end funds, and does not include open-end funds.
a. True
b. False

70. Exchange-traded funds differ from open-end funds in that their share price is adjusted only at the end of every day.
a. True
b. False

71. Capital appreciation funds are suited for investors who are more willing to risk a possible loss in value.
a. True
b. False

72. The returns on international stock mutual funds are affected only by foreign companies’ stock prices, and are independent of currency movements.
a. True
b. False

73. Index funds are becoming increasingly unpopular because most mutual fund managers consistently outperform indexes.
a. True
b. False

74. A mutual fund’s performance is usually unrelated to market conditions.
a. True
b. False

75. The SEC requires that a majority of the directors of a mutual fund board be independent (not employed by the fund).
a. True
b. False

76. Diversification among types of mutual funds usually does little to reduce the volatility of returns on the overall investment.
a. True
b. False

77. Closed-end funds may sometimes engage in a stock repurchase, in which they purchase shares on the exchange where the shares are listed.
a. True
b. False

78. Because money market funds contain instruments with short-term maturities, their market values are not very sensitive to movements in market interest rates.
a. True
b. False

79. Equity REITs are sometimes purchased to hedge against inflation, as rents and property values tend to rise with inflation.
a. True
b. False

80. Equity REITs essentially represent fixed-income portfolios. Thus, their market values will be influenced by interest rate movements.
a. True
b. False

81. Hedge funds are more heavily regulated than mutual funds.
a. True
b. False

82. Which of the following is not true regarding mutual funds?
a. They are a key financial intermediary.
b. They provide an important service to individual investors seeking to invest funds.
c. Most mutual funds use experienced portfolio managers, so investors do not have to manage the portfolio themselves.
d. They provide a way for individual investors to diversify, but most individual investors are unable to afford the purchase of mutual fund shares.

83. Which of the following statements is incorrect?
a. Exchange-traded funds (ETFs) are designed to mimic particular stock indexes and are traded on a stock exchange.
b. Unlike a closed-end fund, an ETF has a fixed number of shares.
c. ETFs differ from most open-end and closed-end funds in that they are not actively managed.
d. One disadvantage of ETFs is that each purchase of additional shares must be done through the exchange where they are traded.

84. A mutual fund prospectus does not contain the
a. minimum amount of investment required.
b. investment objective of the mutual fund.
c. exposure of the mutual fund to various types of risk.
d. return on the fund since its inception.
e. fees incurred by the mutual fund.

85. The ____ of a mutual fund represents the price at which shares can be purchased from a mutual fund.
a. gross asset value
b. net asset value
c. net stock value
d. net bond value

86. Which of the following is incorrect about money market funds (MMFs)?
a. The credit risk of MMFs is normally perceived to be lower than that of corporate bonds.
b. MMFs have higher interest rate risk than bond funds.
c. MMFs normally generate positive returns over time
d. All of the above are correct.

87. ____ are most likely to invest in mortgages.
a. Stock mutual funds
b. Real estate investment trusts (REITs)
c. Load funds
d. Closed-end funds
e. None of the above

88. Mutual funds are not required to disclose which of the following in the prospectus?
a. the names of the portfolio managers
b. the length of time that the portfolio managers have been employed by the fund in that position
c. the performance record in recent years
d. the number of investors currently investing in the mutual fund
e. Mutual funds are required to disclose all of the above in a prospectus

89. Which of the following is not a way in which mutual funds generate returns for their shareholders?
a. They can pass on any earned income as dividend payments to shareholders.
b. They distribute the capital gains resulting from the sale of securities within the fund.
c. The mutual fund price appreciates.
d. All of the above are ways in which a mutual fund generates returns to its shareholders.

90. A(n) ____ fund contains a sales charge.
a. load
b. no-load
c. closed-end
d. open-end
e. none of the above

91. ____ funds are open to investment from investors at any time.
a. Load
b. No-load
c. Open-end
d. Closed-end
e. None of the above

92. Which of the following statements is incorrect?
a. Investors can purchase shares directly from an open-end fund at any time.
b. The number of shares of an open-end fund is always changing.
c. Open-end funds typically maintain some cash on hand in case investments exceed redemptions.
d. There are many different categories of open-end mutual funds.

93. ____ funds focus on a group of companies sharing a particular characteristic.
a. Specialty
b. Growth and income
c. Closed-end
d. Capital appreciation
e. None of the above

94. Bond portfolios with some bonds rated below Baa by Moody’s or BBB by Standard and Poor’s, available for investors desiring high return and willing to incur high risk, are called ____ funds.
a. growth
b. capital appreciation
c. junk bond
d. bond
e. none of the above

95. Which of the following statements is incorrect?
a. A mutual fund is usually run by an investment company.
b. Although many mutual funds have grown substantially over time, their expense ratios have generally increased over time.
c. For each mutual fund, all expenses charged and reflected in the expense ratio are always valid.
d. The SEC requires that a majority of the directors of a mutual fund board be independent.

96. Money market funds commonly invest in
a. stocks.
b. real estate.
c. commercial paper.
d. U.S. Treasury bonds.
e. none of the above

97. Which of the following is not true with respect to venture capital funds?
a. They typically invest in young, growing firms that need equity funding but are not ready or willing to go public.
b. More than half of all VC investing is in businesses that are being created.
c. Venture capital funds tend to focus on technology firms, which have the potential for high returns but also exhibit a high level of risk.
d. Because VC funds invest in fairly safe ventures, a low percentage of their ventures fail.
e. All of the above are correct with respect to venture capital funds.

98. ____ funds sell shares to wealthy individuals and financial institutions and use the proceeds to invest in securities.
a. Growth
b. Open-end
c. Capital appreciation
d. Hedge
e. Specialty

99. Exchange-traded funds distribute their capital gains to their shareholders, who must pay tax on the gains.
a. True
b. False

100. Shares of exchange-traded funds can be sold _________, and shares of open-end mutual funds can be sold _________.
a. at any time during trading hours; at any time via private trading networks
b. only at the end of the day; at any time during trading hours
c. at any time via private trading networks; at any time during trading hours
d. at any time during trading hours; only at the end of the day

101. The average annual fee on actively managed exchange-traded funds is ________, which is _________.
a. zero.
b. lower than the typical annual fee on open-end mutual funds.
c. higher than the typical annual fee on open-end mutual funds.
d. the same as the typical annual fee on open-end mutual funds.

102. An investor who believes that technology stocks will perform well but does not want to select individual technology stocks might invest in:
a. Spiders.
b. WEBs.
c. Cubes.
d. Diamonds.

103. If interest rates are expected to ________, mortgage real investment trusts (REITs) ___________.
a. decline; become less attractive
b. rise; become less attractive
c. rise; are not affected
d. decline; are not affected

104. Investors who invest in a hedge fund of funds essentially pay two layers of management fees.
a. True
b. False

105. Hedge funds commonly use financial leverage, which can:
a. magnify their returns and magnify their losses.
b. magnify their returns and limit their losses.
c. reduce their risk and limit their losses.
d. magnify their returns and not affect their risk.

FIN 320 Week 11 Final Exam – Strayer University New

FIN/320 Week 11 Final Exam – Strayer

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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

ECO 410 Week 11 Quiz – Strayer University New

ECO/410 Week 11 Quiz – Strayer

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Quiz 10 Chapter 19 and 20

Working Capital Management

19.1 Trident Brazil’s Operating Cycle

Multiple Choice

1) Working capital management involves the management of:
A) current and long-term assets.
B) current assets and current liabilities.
C) current liabilities and long-term assets.
D) current liabilities and long-term debt and equity.

2) The cash conversion cycle:
A) is a subset of the operating cycle.
B) occurs in the latter stages of the operating cycle.
C) is a subset of the accounts receivable period.
D) all of the above.

3) The proper order of events for the operating cycle is:
A) input serving period, accounts receivable period, inventory period, quotation period.
B) quotation period, accounts receivable period, inventory period, input servicing period.
C) quotation period, input servicing period, inventory period, accounts receivable period.
D) accounts receivable period, input servicing period, quotation period, inventory period.

4) TrinityApps Corporation (US) has bid a price on a project for a Korean firm, but the Korean firm has not yet placed an order. This portion of the operating cycle is best described as the:
A) quotation period.
B) input sourcing period.
C) cash conversion cycle.
D) accounts payable cycle.

5) The period in the cash cycle where the customer places the order, and the firm determines what materials for manufacture are NOT in inventory is called the ________ period.
A) quotation
B) input sourcing
C) accounts payable
D) accounts receivable

6) The accounts payable period of the operating cycle:
A) is equal to the inventory period.
B) may run concurrently but shorter than the inventory period.
C) may run concurrently but longer than the inventory period.
D) Any one of the above may be true.

True/False

1) Typically, the inventory period and the accounts payable period at least partially overlap in the firms operating cycle.

2) Typically, the inventory period and the accounts receivable period at least partially overlap in the firms operating cycle.

3) The operating cycle begins with the quotation period and ends with the accounts payable period.

19.2 Trident’s Repositioning Decisions

Multiple Choice

1) Of the following, which would NOT be a significant decision-making factor in a multinational firm’s repositioning decision-making?
A) the subsidiary’s tax environment (high or low)
B) the stability of the local currency
C) the ability to move capital in and out of the subsidiary’s country
D) All of the above are significant factors.

True/False

1) In a country with a relatively high tax rate, it make sense the the MNE to reposition cash flows TO that country.

2) The MNE would prefer to leave capital with a firm in a country with high growth prospects over the alternative of leaving capital with a firm in a country with low growth prospects (other factors equal).

19.3 Constraints on Repositioning Funds

Multiple Choice

1) Each of the following is listed by your authors as a constraint on repositioning funds by an MNE EXCEPT:
A) political constraints.
B) tax constraints.
C) transaction costs.
D) All of the above are listed by your authors.

True/False

1) Local liquidity needs sometimes impact a firm’s worldwide optimal cash position.

2) The constraints on repositioning of funds that occur when exchanging one currency for another are considered to be primarily political constraints.

3) Political constraints can block the transfer of funds either overtly or covertly. OVERT blockage occurs when dividends or other forms of fund remittances are severely limited, heavily taxed, or excessively delayed by the need for bureaucratic approval.

19.4 Conduits for Moving Funds by Unbundling Them

Multiple Choice

1) ________ allows a multinational firm to recover funds from subsidiaries without piquing host country sensitivities over large dividend drains.
A) Unbundling funds
B) Bundling funds
C) Coordinating funds
D) none of the above

2) Unbundling of funds by an MNE may be a useful practice for which of the following reasons?
A) An increase in the funds flow (charges) in any of the before-tax categories reduces the taxable profits of the foreign subsidiary if the host-country tax authorities acknowledge the charge as a legitimate expense.
B) An item-by-item matching of remittance to input, such as royalties for intellectual property, and fees for patents and advice, is equitable to the host country and foreign investor alike.
C) Unbundling facilitates allocation of overhead from a parent”s international division, so-called shared services, to each operating subsidiary in accordance with a predetermined formula.
D) All of the reasons listed above

True/False

1) If all investment inputs are unbundled, part of what might have been classified as residual profits may turn out to be tax-deductible expenses related to a specific purchased benefit.

2) The before-tax/after-tax distinction is quite significant to a parent company attempting to repatriate funds in the most tax-efficient method if it is attempting to manage its own foreign tax credit/deficits between foreign units.

19.5 International Dividend Remittances

Multiple Choice

1) In anticipation of a foreign exchange loss, an MNE may speed up the transfer of funds out of the company via dividends. When undertaking such an activity the MNE must be concerned with all of the following EXCEPT:
A) interest rate differences between the two countries.
B) the negative impact on host country relations.
C) defection on the part of executives in the home headquarters.
D) MNEs must be concerned with all of the above.

True/False

1) Political risk may motivate parent firms to require foreign subsidiaries to remit all locally generated funds above that required to internally finance growth in sales and planned capital expansions.

19.6 Net Working Capital

Multiple Choice

1) One possible definition of net working capital (NWC) provided by your authors is:
A) NWC = A/R + inventory – A/P.
B) NWC = cash + A/P – inventory.
C) NWC = A/P + A/R – short-term loans.
D) NWC = A/R + inventory – long-term debt.

2) Which of the following actions will result in an increase in NWC?
A) an increase in A/P that exceeds an increase in A/R
B) a reduction in inventory
C) a reduction in A/P plus a smaller reduction in A/R
D) an increase in A/P and a smaller reduction in inventory

3) Which of the following statements is true?
A) A/R provide part of the funding for inventory.
B) A/P provide part of the funding for A/R and inventory.
C) Inventory pays for A/R and A/P.
D) None of the above is true.

TABLE 19.1
Use the information to answer following question(s).

TrinityApps Corporation Balance Sheet December 31, 20xx

4) Refer to Table 19.1. The NWC for TrinityApps is:
A) $80,000
B) $680,000
C) $35,000
D) $45,000

5) Refer to Table 19.1. If TrinityApps increases inventory by $10,000 and A/P also by $10,000, the net change in NWC is:
A) $20,000
B) $10,000
C) $0
D) none of the above

6) Refer to Table 19.1. NWC currently makes up what percentage of total firm value for TrinityApps?
A) 6.6%
B) 5.1%
C) 11.8%
D) 9.2%

Instruction 19.1:
Use the information to answer the following question(s).

Sunny Manufacturing Systems Inc. is supplied with plastic chips for their plastic injection molding manufacturing process. Their supplier, Sun Chemical, Inc. offers financing terms of a 2% discount if the accounts payable are paid in 10 days or less with the full balance due in 45 days. Short-term financing available to Sunny Manufacturing is available at an annual rate of 9.6%. Sunny Manufacturing has just purchased $400,000 of plastic chips from Sun Chemical.

7) Refer to Instruction 19.1. What is the amount of money Sunny Manufacturing will save on accounts payable if they accept the discount?
A) $400,000
B) $8,000
C) $33,333
D) $20,000

8) Refer to Instruction 19.1. What is the effective annual interest cost of supplier financing offered by Sun Chemical?
A) 7.3%
B) 9.5%
C) 10.4%
D) 22.9%

9) Refer to Instruction 19.1. Should Sunny Manufacturing take the discount offered by Sun Chemical?
A) Yes, Sunny Manufacturing will get to use their raw materials 35 days earlier than if they waited to pay at the end of the 45 days.
B) No, Sunny Manufacturing will not have to pay any interest if they just pay in 45 days.
C) Yes, Sunny Manufacturing’s short term borrowing rate of 9.6% is less than Sun’s offered cost of carry of 22.9%.
D) No, it costs Sunny Manufacturing 22.9% to accept the discount and they are better off paying the full amount in 45 days.

10) Days working capital is equal to:
A) days payables + days receivables – days inventory.
B) days inventory + days receivables – days payables.
C) days payables + days inventory + days receivables.
D) none of the above

11) Amundsen of Norway receives raw materials from their corporate parent in the U.S. with payment terms of net 60 days. Most of their sales are to firms in Norway where normal payment terms are net 30 days. This causes a problem for the subsidiary with working capital management because:
A) accounts receivable are so much longer than accounts payable.
B) accounts payable are so much longer than accounts receivable.
C) accounts receivable and accounts payable are equal.
D) This doesn’t really cause a problem; in fact it is to the benefit of the Norwegian subsidiary.

True/False

1) In principle, the firm tries to minimize its NWC balance.

2) Other things equal, managers prefer a lower “days working capital” to a higher one.

3) The authors present empirical evidence that shows the days sales basis for working capital to be 30 days GREATER in the U.S. compared to a similar industry in Europe.

Essay

1) What is a free-trade zone? Identify three techniques and provide examples of how firms and countries can benefit from having free trade zones.

19.7 International Cash Management

Multiple Choice

1) Other things equal, a firm would rather have ________ in a depreciating currency, and ________ in an appreciating currency.
A) accounts receivable; accounts payable
B) accounts receivable; accounts receivable
C) accounts payable; accounts receivable
D) none of the above

2) Which of the following is NOT a precautionary motive for holding cash?
A) Anticipated funds to be remitted from several Middle East countries are in question due to unrest in the region.
B) The firm has several short-term obligations in unhedged foreign currency-denominated contracts.
C) The firm must pay ordinary wages in two days.
D) All are precautionary motives.

3) Increases to cash flows can be anticipated if which of the following occurs?
A) A receivables contract is denominated in an appreciating foreign currency.
B) Sales are less than anticipated.
C) Days in accounts receivable increase by 15 days.
D) none of the above

4) A centralized depository benefits the firm primarily by:
A) reducing the cost of repatriating funds.
B) positioning profits where taxes are lowest.
C) reducing the total amount of capital employed within the total firm.
D) earning a higher rate of return than in domestic banking deposits.

5) The Clearing House Interbank Payment System (CHIPS) is:
A) the largest publicly operated payments system in the world.
B) owned and operated by the world’s seven largest central banks.
C) a computerized network that connects banks globally.
D) none of the above

6) An organizational structure employed by an MNE to reduce its use of bank lending for the support of operations is:
A) a centralized depository.
B) a reinvoicing center.
C) a cost center.
D) a syndicated bank.

7) ________ is the process that cancels via offset all, or part, of the debt owed by one entity to another related entity.
A) Syndicated banking
B) Centralized depositing
C) Multilateral netting
D) Debt cancellation

True/False

1) In an inflationary economy, demand for credit usually exceeds supply.

2) For disbursement purposes, it is to the benefit of the firm to minimize float.

3) Regarding wire transfers, CHIPS actually clears transactions whereas SWIFT does not.

4) A significant problem with centralized cash depositories is that they are isolated from the rest of the firm and tend to be at an information disadvantage.

5) A reason for holding all precautionary balances in a central pool is that the total pool, if centralized, can be reduced in size without any loss in the level of protection.

6) A disadvantage of a centralized cash management system is that managers will not be able to get the lowest average rate available for the firm. Instead, it misses out on the really low borrowing rates.

Essay

1) Central depositories are used for international cash management. What is a central depository? Identify and provide examples of at least three advantages to MNEs of having a central depository.

19.8 Financing Working Capital

Multiple Choice

1) A precautionary cash balance:
A) is used to replace spoiled or damaged inventory.
B) is held to facilitate cash disbursements when receipts slow down.
C) is used for normal day-to-day operations.
D) is held for the benefit of a sister affiliate.

2) An in-house bank:
A) is a separate bank chartered to operate within a business firm.
B) is in fact a set of functions performed by the firm’s existing treasury department.
C) assesses the credit standing of the bank’s customers.
D) provides banking services for employees.

3) A foreign banking office that is separately incorporated in the host country is:
A) a correspondent bank.
B) a representative office.
C) a bank subsidiary.
D) an Edge Act corporation.

True/False

1) An Edge Act corporation is a subsidiary of a U.S. bank located outside of the U.S. and incorporated to engage in international banking and financing operations.

2) Because they are direct payments, dividends are among the most efficient way for foreign subsidiaries to remit funds back to the parent.

3) Even though dividends are cash payments, firms typically must consider both cash flow and net income when making dividend distribution decisions.

Chapter 20 International Trade Finance

20.1 The Trade Relationship

Multiple Choice

1) The exporter-importer relationship to a corporation of a foreign importer that has not previously conducted business with the firm would be an:
A) unaffiliated known.
B) affiliated party.
C) unaffiliated unknown.
D) any of the above

2) Which of the following relationships between importing and exporting parties would require the least detailed contract to conduct business?
A) affiliated party
B) unaffiliated unknown party
C) known unaffiliated party
D) domestic supplier

3) Polaris Corporation has made an agreement to ship goods to a foreign firm with whom they have not entered into a contract for three years. However, the firms have communicated regularly since the last sale three years ago. This is an example of an:
A) unaffiliated known party transaction.
B) unaffiliated unknown party transaction.
C) affiliated party transaction.
D) none of the above

True/False

1) Today, international trade is dominated by transactions between unaffiliated parties (known or unknown).

2) Because most international transactions are between affiliated parties, international transaction contracts are less complex, but the management of the total value of the MNE is more complex.

3) An advantage of trading with an affiliated party for an MNE, compared to an unaffiliated party, could be reduced contracting costs and less to even no need to protect against nonpayment.

20.2 The Trade Dilemma

Multiple Choice

1) Which of the following is NOT a financial instrument that may be included in an international trade transaction?
A) Letter of Credit
B) Sight Draft
C) Order bill of lading
D) Federal funds transaction

True/False

1) The fundamental dilemma of foreign trade is being unwilling to trust a stranger in a foreign land.

20.3 Benefits of the System

Multiple Choice

1) The combination of a letter of credit, a sight draft, and an order bill of lading protect both parties in international transactions from which of the following?
A) the risk of noncompletion
B) the risk of foreign exchange risk (when combined with a various hedging techniques)
C) the risk that financing will not be available due to foreign exchange risk
D) All of these risks are reduced when using these trade implements.

True/False

1) If a foreign exchange transaction calls for payment in the importer’s currency, the exporter has the foreign exchange risk.

2) If a foreign exchange transaction calls for payment in the exporter’s currency, the importer has the foreign exchange risk.

3) In the case of international trade, the risk of nonpayment is essentially eliminated with the use of a letter of credit issued through a trustworthy bank.

20.4 Key Documents

Multiple Choice

1) Which of the following is NOT true regarding a letter of credit?
A) The importer and exporter agree on a transaction.
B) The importer applies to its local bank for the issuance of a letter of credit.
C) The exporter applies to its local bank for the issuance of a letter of credit.
D) The importer’s bank cuts a sales contract based on its assessment of the creditworthiness of the importer.

2) A/An ________ letter of credit is intended to serve as a means of arranging payment, but not as a guarantee of payment.
A) irrevocable
B) revocable
C) confirmed
D) unconfirmed

3) A/An ________ letter of credit is an obligation only of the issuing bank whereas other banks honor a/an ________ letter of credit.
A) irrevocable; unconfirmed
B) revocable; confirmed
C) confirmed; irrevocable
D) unconfirmed; confirmed

4) A letter of credit that is confirmed in the ________ country has the additional advantage of eliminating the problem of ________.
A) exporter’s; portfolio risk
B) importer’s; blocked foreign exchange
C) exporter’s; blocked foreign exchange
D) none of the above

5) The draft is the instrument normally used in international commerce to:
A) transfer product.
B) prove ownership.
C) transfer title.
D) initiate the sale.

6) The ________ is the instrument normally used to actually effect payment in international commerce.
A) banker’s acceptance
B) bill of exchange
C) bill of lading
D) letter of credit

7) The person or company initiating the draft or bill of exchange is known as the:
A) maker.
B) drawer.
C) originator.
D) any of the above

8) The person or company to whom the draft or bill of exchange is addressed is the:
A) drawee.
B) drawer.
C) maker.
D) originator.

9) Drafts that have been accepted by banks become:
A) clean drafts.
B) nonmarketable.
C) banker’s acceptances.
D) none of the above

10) Which of the following purposes is NOT served by the bill of lading?
A) It acts as a receipt.
B) It acts as a contract.
C) It acts as a document of title.
D) It acts as all of the above.

11) The ________ is issued to the exporter by a common carrier transporting the merchandise.
A) bill of lading
B) draft
C) banker’s acceptance
D) line of credit

12) A straight bill of lading is most likely to be used under which of the following circumstances?
A) when the merchandise has not been paid for in advance
B) when the transaction is being financed by a bank
C) when the shipment is to an affiliate
D) none of the above

13) To become a negotiable instrument, a draft must conform to the following requirements EXCEPT:
A) it must be in writing and signed by the maker or drawer.
B) it must be payable to order or to bearer.
C) it must be written in English.
D) it must be payable on demand or at a fixed or determinable future date.

True/False

1) A letter of credit is an agreement by the bank to pay against documents rather than the actual merchandise.

2) The primary advantage of a letter of credit is that it reduces risk.

3) The major advantage of a letter of credit to the exporter is that the exporter does not receive any funds until the documents have arrived at a local port or airfield.

4) To constitute a true letter of credit transaction, the issuing bank must receive a fee or other valid business consideration for issuing the L/C.

5) To constitute a true letter of credit transaction, the bank’s L/C must contain a specified expiration date or a definite maturity.

6) To constitute a true letter of credit transaction, the bank’s commitment must be open-ended and cannot have a stated maximum amount of money.

7) A revocable L/C is intended to serve as a means of arranging payment but not as a guarantee of payment.

8) A sight draft is payable on presentation to the drawee; a time draft allows a delay in payment.

9) A draft is sometimes called a revocable letter of credit.

10) A time draft is payable on presentation to the drawee; the drawee must pay at once or dishonor the draft. A sight draft, allows a delay in payment.

11) The bill of lading is issued to the exporter by a common carrier transporting the merchandise. It serves three purposes: a receipt, a contract, and a document of title.

Essay

1) Explain what a letter of credit (L/C) is, who the principle parties are, what the principle advantage is, and how the L/C facilitates international trade.

20.5 Example: Documentation in a Typical Trade Transaction

Multiple Choice

1) In a typical international trade transaction, the order of activity would be which of the following?
A) The foreign buyer places an order; The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The buyer’s bank submits payment to the manufacturer’s bank.
B) The domestic manufacturer ships to the buyer; The buyer’s bank submits payment to the manufacturer’s bank; The foreign buyer places an order; The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance.
C) The foreign buyer places an order; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The domestic manufacturer ships to the buyer; The buyer’s bank submits payment to the manufacturer’s bank.
D) The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The foreign buyer places an order; The buyer’s bank submits payment to the manufacturer’s bank.

True/False

1) Because of the risks involved in international trade, most transactions follow conventional methods and rarely require flexibility or creativity on the part of management.

Comment: Few international transactions are typical and often require flexibility or creativity on the part of management.

20.6 Government Programs to Help Finance Exports

Multiple Choice

1) The Export-Import Bank is an independent agency of the U.S. government established in 1934 to:
A) ship money abroad.
B) import agricultural products during the recession.
C) facilitate and stimulate foreign trade of the United States.
D) none of the above

2) In the United States, the Foreign Credit Insurance Corporation:
A) is a subsidiary of the Export-Import Bank.
B) provides letters of credit for U.S. importers.
C) provides letters of credit for U.S. exporters.
D) provides policies that protect U.S. exporters against default by foreign importers.

Instruction 20.1:
Use the information to answer the following question(s).

Cypress Systems Inc., of Florida, agrees to sell specialized hydroponic growing equipment to Landcaster’s of Australia. Because the two companies have never done business with each other, Cypress requires a banker’s acceptance as payment for the $1,000,000 order. The banker’s acceptance carries a 1.4% commission per annum and payment is to be received in 6 months. If Cypress Inc. chooses to discount or sell the bankers acceptance to its bank, the discount rate is 1.00% per annum.

3) Refer to Instruction 20.1. What is the size of the discount (not including the commission fee) Cypress must take for receiving the proceeds of the sale today rather than waiting for six months?
A) $7,000
B) $5,000
C) $12,000
D) $14.000

4) Refer to Instruction 20.1. What is the size of the commission Cypress will pay the bank for the banker’s acceptance?
A) $7,000
B) $5,000
C) $12,000
D) $14,000

5) Refer to Instruction 20.1. What is the total Cypress can expect to receive if the firm takes payment today?
A) $993,000
B) $995,000
C) $988,000
D) $996,000

6) Refer to Instruction 20.1. ________ is an unsecured promissory note.
A) A banker’s acceptance
B) An overdraft
C) A securitized loan
D) Commercial paper

7) Rogue Spices Inc. has a Canadian receivables contract for $200,000 due in 270 days. The firm has been approached by a factoring firm that offers to purchase the receivables at a 12% per annum discount plus a 1% charge for a nonrecourse clause. What is the annualized percentage all-in-cost of this factoring alternative?
A) 14.82%
B) 13.00%
C) 12.00%
D) 9.09%

True/False

1) The Foreign Credit Insurance Association is a branch of the U.S. federal government.

2) The Export-Import Bank (also called Eximbank) is an independent agency of the U.S. government, established in 1934 to stimulate and facilitate the foreign trade of the United States.

3) Essentially, the Eximbank lends dollars to borrowers inside the United States for the purchase of U.S. goods and services.

4) Banker’s acceptances can be used to finance only international trade receivables but not domestic trade receivables.

Essay

1) What is a banker’s acceptance? How are they initiated? Why are they desirable for the exporter?

20.7 Forfaiting: Medium- and Long-Term Financing

Multiple Choice

1) ________ is a specialized technique to eliminate the risk of nonpayment by importers in instances where the importing firm and/or its government is perceived by the exporter to be too risky for open account credit.
A) Forfeiting
B) Marketable Bank Shares
C) Forfaiting
D) Banker’s Acceptances

True/False

1) In effect, the forfaiter functions both as a money market firm and a specialist in packaging financial deals involving country risk.

FIN 350 Week 9 Quiz – Strayer University New

FIN 350 Week 9 Quiz – Strayer

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Quiz 8 Chapter 18 and 19

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 the bank’s net interest margin.
c. rate-sensitive liabilities exceed rate-sensitive assets.
d. a decrease in interest rates would decrease the bank’s net interest margin.
e. B and D

14. Each bank may have its own classification system of interest rate sensitivity, because there is no perfect measurement of the gap.
a. True
b. False

15. The duration of zero-coupon bonds will be ____ the duration of coupon bonds with the same maturity.
a. lower than
b. higher than
c. the same as
d. A or B, depending on the size of the coupon payment

16. In general, the duration of zero-coupon securities with short maturities is ____ than the duration of zero-coupon securities with long maturities.
a. higher than
b. lower than
c. equal to
d. A or B, depending on the issuer of the securities

17. Other things equal, assets with shorter maturities have ____ durations. Assets that generate more frequent coupon payments have ____ durations.
a. shorter; longer
b. shorter; shorter
c. longer; shorter
d. longer; longer

18. For most banks, the average duration of assets ____ the average duration of liabilities, so the duration gap is ____.
a. exceeds; zero
b. exceeds; negative
c. exceeds; positive
d. is less than; negative

19. Other things being equal assets with ____ maturities and ____ frequent coupon payments have shorter durations.
a. shorter; more
b. shorter; less
c. longer; more
d. longer; less

20. If a bank attempts to reduce exposure to interest rate risk by replacing long-term marketable securities with more floating-rate commercial loans, it is likely that the bank’s
a. default risk would decrease.
b. default risk would increase.
c. liquidity risk would increase.
d. liquidity risk would decrease.
e. B and C

21. Which of the following is not a likely method used by a bank to reduce interest rate risk?
a. maturity matching
b. using fixed-rate loans
c. using interest rate futures contracts
d. using interest rate caps

22. Floating-rate loans cannot completely eliminate interest rate risk; if the cost of funds is changing more frequently than the rate on assets, the bank’s net interest margin is still affected by interest rate fluctuations.
a. True
b. False

23. The ____ of interest rate futures ____ the potential adverse effect of rising interest rates on a bank’s interest expenses.
a. sale; increases
b. sale; reduces
c. purchase; reduces
d. both A and C are correct

24. Which of the following financial institutions would be most willing to swap variable-rate payments for fixed-rate payments in order to reduce exposure to interest rate risk?
a. one whose assets and liabilities are equally interest-rate sensitive
b. one whose assets are more interest-rate sensitive than its liabilities
c. one whose liabilities are more interest-rate sensitive than its assets
d. one whose gap ratio is equal to 1.0

25. Banks increase their risk by increasing their capital as a percentage of assets.
a. True
b. False

26. Banks generally ____ loans and ____ their purchases of low-risk securities when the economy is weak.
a. increase; increase
b. reduce; reduce
c. increase; reduce
d. reduce; increase

27. Banks tend to focus their loans in one industry so that they can specialize on one industry and reduce the credit risk of their loan portfolio.
a. True
b. False

28. Most loan sales enable the bank originating the loan to continue servicing the loan.
a. True
b. False

29. ROE is defined as
a. .
b. .
c. .
d. .

30. The greater the ____, the greater the amount of assets per dollar’s worth of equity.
a. leverage measure
b. ratio of equity to debt
c. capital ratio
d. proportion of loans to securities in the asset portfolio

31. A bank has a return on assets of 2 percent, $40 million in assets, and $4 million in equity. What is the return on equity?
a. 10 percent
b. .2 percent
c. 2 percent
d. 20 percent
e. none of the above

32. A bank has the following asset and liability portfolios. What is the gap?

Rate-sensitive Amount Rate-sensitive Amount
assets (in millions) liabilities (in millions)
Floating-rate
loans $4,000 NOW accounts $1,750

Floating-rate
mortgages 1,000 MMDAs 4,500

Short-term
Treasury securities 1,500 Short-term CDs 1,000

$6,500 $7,250

a. $750 million
b. −$750 million
c. 1.12
d. .896
e. none of the above

33. A bank has the following asset and liability portfolios. What is the gap ratio?

Rate-sensitive Amount Rate-sensitive Amount
assets (in millions) liabilities (in millions)
Floating-rate
loans $4,000 NOW accounts $1,750

Floating-rate
mortgages 1,000 MMDAs 4,500

Short-term
Treasury securities 1,500 Short-term CDs 1,000

$6,500 $7,250

a. $750 million
b. −$750 million
c. 1.12
d. .896
e. none of the above

34. If Bank A has a negative gap and Bank B has a positive gap. Which of the following is true?
a. Bank A is more favorably affected by rising interest rates.
b. Bank B is more favorably affected by falling interest rates.
c. Bank A is adversely affected by falling interest rates.
d. none of the above

35. Which of the following is a measure for banks to assess their exposure to interest rate risk?
a. capital ratio
b. leverage measure
c. duration measurement
d. gap ratio
e. C and D

36. If a bank sells interest rate futures, it ____ of rising interest rates and ____ of declining interest rates on its interest expenses.
a. reduces the potential adverse effect; reduces the potential favorable effect
b. increases the potential adverse effect; increases the potential favorable effect
c. decreases the potential adverse effect; increases the potential favorable effect
d. increases the potential adverse effect; decreases the potential favorable effect

37. Which of the following loan portfolios are best diversified against default risk?
a. consumer loans to farmers and commercial loans to farm equipment dealers in a local area
b. commercial loans to the same industry
c. commercial loans to various retail stores in the same city
d. consumer and commercial loans to different industries in different cities

38. Banks can increase their liquidity position by restructuring their asset portfolio to contain less ____ and more ____.
a. excess reserves; Treasury bills
b. Treasury bonds; corporate bonds
c. loans; Treasury bills
d. none of the above

39. Banks would reduce their liquidity position by restructuring their asset portfolio to contain less ____ and more ____.
a. Treasury securities; excess reserves
b. loans; Treasury securities
c. corporate bonds; Treasury securities
d. none of the above

40. Banks can reduce their default risk by restructuring their asset portfolio to contain less ____ and more ____.
a. Treasury bonds; corporate bonds
b. Treasury bonds; municipal bonds
c. Treasury bonds; commercial loans
d. none of the above

41. Banks can increase their potential interest revenues by restructuring their asset portfolio to contain less ____ and more ____.
a. Treasury bonds; commercial loans
b. Treasury bonds; excess reserves
c. consumer loans; Treasury bills
d. none of the above

42. If a bank desired to maximize its net interest margin, it would best achieve its goal by attempting to obtain most of its funds through ____ and use most of its funds for ____ (assuming that all loans will be repaid).
a. traditional demand deposits; commercial loans
b. traditional demand deposits; consumer loans
c. NOW accounts; consumer loans
d. NOW accounts; commercial loans

43. A bank that holds a greater percentage of traditional demand deposits and loans will likely incur ____ non-interest expenses and have a ____ net interest margin than other banks of the same size (assuming that its loan losses are no higher than those at other banks).
a. greater; higher
b. greater; lower
c. less; higher
d. less; lower

44. A bank’s net interest margin is commonly defined as
a. interest revenues minus interest expenses.
b. (interest revenues minus interest expenses)/total assets.
c. (interest revenues minus interest expenses)/total liabilities.
d. (interest revenues minus interest expenses)/capital.

45. A common method for banks to reduce their default risk is to
a. specialize in loans to just one or a few particular industries in which they have expertise in assessing creditworthiness.
b. specialize in loans of companies whose earnings patterns are quite similar over time.
c. A and B
d. none of the above

46. International diversification of loans can best reduce the bank’s overall default risk if
a. the countries where loans are given are clustered together in a single continent.
b. the countries where loans are given have economic cycles that do not move together over time.
c. A and B
d. none of the above

47. A bank’s net interest margin will likely decline if it has a large amount of
a. rate-sensitive assets and no rate-sensitive liabilities.
b. rate-sensitive liabilities and no rate-sensitive assets.
c. loans to technology firms.
d. real estate loans.

48. Banks can reduce their required capital levels by
a. increasing their loans.
b. reducing their loans.
c. increasing their dividends.
d. obtaining more deposits.

49. Terp Bank obtains a relatively large portion of its funds from conventional demand deposits as it creates many branches with many employees to attract demand deposits. Its interest expenses should be relatively ____, while its noninterest expenses should be relatively ____.
a. high; low
b. low; high
c. high; high
d. low; low
e. none of the above

50. Bank A has interest revenues of $4 million, interest expenses of $5 million, and assets totaling $20 million. Bank A’s net interest margin is
a. $1 million.
b. −$1 million.
c. −5 percent.
d. 5 percent.

51. ____ is not a method used to assess interest rate risk.
a. Efficiency analysis
b. Gap analysis
c. Duration analysis
d. Regression analysis

52. Durango Bank has $2 million in rate-sensitive liabilities and $3 million in rate sensitive assets. Durango’s gap is ____, and Durango is probably more concerned about a(n) ____ in interest rates.
a. −$1 million; increase
b. −$1 million; decrease
c. $1 million; increase
d. $1 million; decrease
e. none of the above

53. Leskar Bank has $2 million in rate-sensitive liabilities and $3 million in rate sensitive assets. Leskar’s gap ratio is ____.
a. 1.5
b. 0.67
c. $1 million
d. none of the above

54. ____ is (are) least likely to be used as a method of reducing interest rate risk.
a. Maturity matching
b. Using floating-rate loans
c. Stock options
d. Using interest rate swaps
e. Using interest rate caps

55. Ringo Bank has a profit after taxes of $3.0 million, total assets of $300 million, and shareholder’s equity of $30 million. Ringo’s return on equity (ROE) is ____ percent.
a. 1.0
b. 10.0
c. 3.0
d. none of the above

56. For a commercial bank, when the average duration of assets exceeds the average duration of liabilities, the duration gap is
a. zero.
b. positive.
c. negative.
d. B or C

57. Assume a bank accepts deposits on Australian dollars (A$) and makes some fixed-rate loans in British pounds. Which of the following would reduce the bank’s profit margin?
a. the A$ appreciates against the pound
b. the A$ is stable against the pound
c. the A$ depreciates against the pound
d. the British interest rates increase
e. C and D

58. The performance of a bank that continually concentrates in short-term deposits in euros and adjustable-rate dollar loans with equal rate-sensitivity is
a. unaffected if European interest rates increase and U.S. rates decrease.
b. unaffected if U.S. interest rates increase and European interest rates decrease.
c. adversely affected if European interest rates increase and U.S. rates decrease.
d. adversely affected if U.S. interest rates increase and European rates decrease.
e. A and B

59. If a bank has assets and liabilities in dollars and euros, its exposure to interest rate risk can best be minimized if the
a. currency mix of assets is similar to that of liabilities.
b. overall rate-sensitivity of assets and liabilities are similar.
c. rate sensitivity of assets and liabilities is matched for each currency.
d. A and B

60. The risk of a loss due to closing out a transaction is referred to as ____ risk.
a. credit
b. settlement
c. interest rate
d. exchange rate
e. none of the above

61. The Sarbanes-Oxley Act has had little impact on the monitoring conducted by the board members of commercial banks.
a. True
b. False

62. Whether a bank has a temporary or a permanent need for funds, the decision should be to borrow in the federal funds market.
a. True
b. False

63. A positive gap (or gap ratio of more than 1.00) suggests that rate-sensitive liabilities exceed rate-sensitive assets.
a. True
b. False

64. For most banks, the average duration of liabilities exceeds the average duration of assets, so the duration gap is positive.
a. True
b. False

65. Floating-rate loans completely eliminate interest rate risk.
a. True
b. False

66. A bank can usually simultaneously maximize its return on assets and minimize credit risk.
a. True
b. False

67. If the currency mix of a bank’s assets is similar to that of its liabilities and the overall rate sensitivity of its assets and liabilities is similar, interest rate risk is completely nonexistent.
a. True
b. False

68. Macon Bank has interest revenues of $4 million, interest expenses of $5 million, and assets totaling $20 million. Macon Bank’s net interest margin is
a. $1 million.
b. −1 million.
c. 5 percent.
d. −5 percent.

69. ____ is not a method used to assess interest rate risk.
a. Gap analysis
b. Ratio analysis
c. Duration analysis
d. Regression analysis
e. All of the above are methods to assess interest rate risk.

70. ____ is (are) least likely to be used as a method of reducing interest rate risk.
a. Maturity matching
b. Floating-rate loans
c. Stock options
d. Interest rate swaps
e. Interest rate caps

71. Crazer Bank has a profit after taxes of $2 million, total assets of $100 million, and shareholder’s equity of $10 million. Crazer’s return on equity (ROE) is ____ percent.
a. 18
b. 210
c. 15
d. 20
e. none of the above

72. Parsons Bank reported $3 million in interest revenues and $1 million in interest expenses. Parsons has $20 million in assets and $8 million in liabilities. Parsons net interest margin is ____ percent.
a. 10
b. −10
c. 35
d. 25
e. none of the above

73. If a bank expects interest rates to consistently ____ over time, it will consider allocating most of its funds to rate-____ assets.
a. decrease; sensitive
b. increase; insensitive
c. increase; sensitive
d. answers A and B are correct
e. none of the above

74. During a period of ____ interest rates, a bank’s net interest margin will likely ____ if its liabilities are more rate sensitive than its assets.
a. decreasing; decrease
b. increasing; increase
c. decreasing; increase
d. increasing; decrease
e. answers C and D are correct

75. If interest rates ____, banks with ____ duration gaps will be ____ affected.
a. rise; positive; positively
b. rise; positive; adversely
c. decrease; positive; adversely
d. decrease; negative; positively
e. none of the above

76. In a regression of a bank’s stock return on an interest rate proxy and market returns, a ____ coefficient for the interest rate variable suggests that bank performance is ____ affected by ____ interest rates.
a. positive; adversely; rising
b. positive; favorably; declining
c. negative; adversely; rising
d. negative; favorably; rising
e. none of the above

77. If a bank has a ____ duration gap, its average asset duration is probably ____ than its liability duration.
a. negative; smaller
b. positive; larger
c. negative; larger
d. none of the above

78. In an interest rate swap, a bank whose liabilities are ____ rate sensitive than its assets can swap payments with a ____ interest rate in exchange for payments with a ____ interest rate.
a. more; fixed; variable
b. more; variable; fixed
c. less; fixed; variable
d. less; fixed; fixed
e. none of the above

79. Because riskier assets offer ____ returns, a bank’s strategy to increase its return will typically entail a(n) ____ in the overall credit risk of its asset portfolio.
a. lower; increase
b. lower; decrease
c. higher; increase
d. higher; decrease
e. none of the above

80. The risk of a loss due to closing out a transaction is referred to as ____ risk.
a. settlement
b. credit
c. interest rate
d. exchange rate
e. none of the above

81. An effective way to align bank managers’ interests with shareholders’ goal of higher returns is to compensate the managers with fixed salaries without a bonus.
a. True
b. False

82. Which of the following is not a function of a bank’s board of directors?
a. overseeing acquisitions
b. determining a compensation system for the bank’s executives
c. overseeing policies for changing the bank’s capital structure
d. pursuing a proxy contest to change the bank’s dividend policy

83. As part of its liquidity management, a bank might:
a. purchase interest rate swaps.
b. issue commercial paper.
c. purchase long-term Treasury securities.
d. A and C

84. A(n) ____________ is an agreement for a fee to receive payments when the interest rate of a particular security rises above a specified level by a specified date.
a. interest rate cap
b. interest rate futures contract
c. interest rate swap
d. maximum rate contract

85. Which of the following is a method that a bank can use to reduce its credit risk?
a. diversifying its loans across industries
b. focusing on credit card loans
c. focusing on consumer loans
d. selling its holdings of Treasury securities

FIN 320 Week 9 Quiz – Strayer University New

FIN/320 Week 9 Quiz – Strayer

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Quiz 7 Chapter 17 and 18
Chapter 17: ___________________________________________________________________________
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

Chapter 18: ___________________________________________________________________________
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

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Quiz 8 Chapter 15 and 16

Multinational Tax Management

15.1 Tax Principles

Multiple Choice

1) The issue of ethics in the reporting of income and the payment of taxes is a considerable one. The authors state that most MNEs operating in foreign countries tend to follow the general principle of:
A) “when in Rome, do as the Romans do.”
B) full disclosure to the tax authorities.
C) maintain a competitive playing field by cheating as much as the local competition, no more, no less.
D) none of the above

2) Which of the following is an unlikely objective of U.S. government policy for the taxation of foreign MNEs?
A) to raise revenues
B) to provide an incentive for U.S. private investment in developing countries
C) to improve the U.S. balance of payments
D) All of the above are objectives.

3) A ________ tax policy is one that has no impact on private decision-making, while a ________ policy is designed to encourage specific behavior.
A) flat; tax incentive
B) neutral; flat
C) neutral; tax incentive
D) none of the above

4) Which of the following is NOT an example of a tax incentive policy?
A) The federal government gives a tax credit to MNEs that make domestic capital improvements but not foreign capital improvements.
B) Corporations are allowed to take a direct tax credit for each dollar of matching donations they make to institutions of higher education.
C) A tax law is passed that makes interest on property non tax-deductible, but interest payments on durable goods are.
D) All are examples of a tax incentive policy.

5) Toyota Motor Company operates in many different countries and pays taxes at many different rates. However, they always pay the same rate as their local competitors. Toyota Motor Company is operating in an environment of ________ tax policy.
A) domestic neutrality
B) foreign neutrality
C) territorial approach
D) none of the above

6) The United States taxes the domestic and remitted foreign earnings of U.S. based MNEs no matter where the earnings occurred. This is an example of a/an ________ approach to levying taxes.
A) worldwide
B) territorial
C) neutral
D) equitable

7) The United States taxes all earnings on U.S. soil by both domestic and foreign firms. This is an example of a ________ approach to levying taxes.
A) worldwide
B) neutral
C) territorial
D) none of the above

8) Bacon Signs Inc. is based in a country with a territorial approach to taxation but generates 100% of its income in a country with a worldwide approach to taxation. The tax rate in the country of incorporation is 25%, and the tax rate in the country where they earn their income is 50%. In theory, and barring any special provisions in the tax codes of either country, Bacon should pay taxes at a rate of:
A) 75%.
B) 62.5%.
C) 0%.
D) 50%.

9) The territorial approach to taxation policy is also termed the ________ approach.
A) source
B) ethical
C) greedy
D) location

10) A tax that is effectively a sales tax at each stage of production is defined as a/an ________ tax.
A) flat
B) equitable
C) value-added tax
D) none of the above

11) What is the total value of taxes paid in the following example if the value added tax is 10%? A farmer raises wheat that he sells for $1.50 to the grain company. The grain company sells to the processor for $2.00 per bushel. The processor turns the wheat into a breakfast cereal and wholesales it for $3.00 per bushel. The retailer sells the cereal for $4.00 per bushel.
A) $0.15
B) $0.20
C) $0.30
D) $0.40

TABLE 15.1
Use the information to answer following question(s).

BayArea Designs Inc., located in Northern California, has two international subsidiaries, one located in the Ukraine, the other in Korea. Consider the information below to answer the next several questions.

12) Refer to Table 15.1. If BayArea pays out 50% of its earnings from each subsidiary, what are the additional U.S. taxes due on the foreign sourced income from the Ukraine and Korea respectively.
A) Ukraine = $0; Korea = ($30,000)
B) Ukraine = $100,000; Korea = $0
C) Ukraine = $0; Korea = $66,250
D) none of the above

13) Refer to Table 15.1. The additional U.S. taxes due on the repatriation of income from the Ukraine to the United States, alone, assuming a 50% payout rate, is:
A) excess foreign tax credits of $110,000.
B) additional U.S. taxes due of $97,000.
C) additional U.S. taxes due of $36,500.
D) excess foreign tax credits of $18,500.

14) Refer to Table 15.1. How much in additional U.S. taxes would be due if BayArea averaged the tax credits and liabilities of the two foreign units, assuming a 50% payout rate from each?
A) $3,750
B) $13,750
C) $2,500
D) $0

15) Refer to Table 15.1. If BayArea set the payout rate from the Ukraine subsidiary at 25%, how should BayArea set the payout rate of the Korean subsidiary (approximately) to more efficiently manage its total foreign tax bill?
A) 28.5%
B) 24.5%
C) 42.6%
D) 82.3%

16) Refer to Table 15.1. What is the minimum effective tax rate that BayArea can achieve on its foreign-sourced income?
A) 26%
B) 35%
C) 40%
D) 0%

17) Tax-haven subsidiaries are typically established in a country that can meet the following requirements:
A) a low tax on foreign investment or sales income earned by resident corporations and a low dividend withholding tax on dividends paid to the parent firm.
B) the facilities to support financial services, for example, good communications, professional qualified office workers, and reputable banking services.
C) a stable government that encourages the establishment of foreign-owned financial and service facilities within its borders.
D) all of the above

18) A tax that is a form of social redistribution of income is defined as a/an ________ tax.
A) un-American
B) transfer
C) flat
D) none of the above

19) A ________ is a direct reduction of taxes whereas a ________ reduces the taxable income before taxes.
A) foreign tax credit; domestic tax credit
B) tax deduction; tax credit
C) tax credit; tax deduction
D) none of the above

Instruction 15.1:
Use the information to answer the following question(s).

Green Valley Exporters USA has $100,000 of before tax foreign income. The host country has a corporate income tax rate of 25% and the U.S. has a corporate income tax rate of 35%.

20) Refer to Instruction 15.1. If the U.S. has no bilateral trade agreement with the host country, what is the total amount of income taxes Green Valley Exporters will pay?
A) $25,000
B) $35,000
C) $51,250
D) $60,000

21) Refer to Instruction 15.1. If the U.S. has a bilateral trade agreement with the host country that calls for the total tax paid to be equal to the maximum amount that could be paid in the highest taxing country, what is the total amount of income taxes Green Valley Exporters will pay to the host country, and how much will they pay in U.S income taxes on the foreign earned income?
A) $25,000; $10,000
B) $25,000; $26,250
C) $35,000; $0
D) none of the above

22) Refer to Instruction 15.1. If the U.S. treated the taxes paid on income earned in the host country as a tax-deductible expense, then Green Valley’s total U.S. corporate tax on the foreign earnings would be:
A) $10,000.
B) $26,250.
C) $35,000.
D) $51,250.

23) Refer to Instruction 15.1. If the U.S. treated the taxes paid on income earned in the host country as a tax-credit, then Green Valley’s total U.S. corporate tax on the foreign earnings would be:
A) $51,250.
B) $35,000.
C) $26,250.
D) $10,000.

24) Tax treaties typically result in ________ between the two countries in question.
A) lower property taxes for U.S. citizens overseas
B) elimination of differential tax rates
C) increased double taxation
D) reduced withholding tax rates

25) Transfer pricing is a strategy that may be used by MNEs to:
A) reduce consolidated corporate income taxes.
B) partially finance a subsidiary in another country.
C) transfer funds from a subsidiary to the parent corporation.
D) all of the above

26) ________ is the pricing of goods, services, and technology between related companies.
A) Among pricing
B) Retail pricing
C) Transfer pricing
D) Wholesale pricing

True/False

1) The primary objective of multinational tax planning is to minimize the firm’s worldwide tax burden.

2) A country CANNOT have both a territorial and a worldwide approach as a national tax policy.

3) Tax treaties generally have the effect of increasing the withholding taxes between the countries that are negotiating the treaties.

4) A value-added tax has gained widespread usage in Western Europe, Canada, and parts of Latin America.

5) All indications are that the value-added tax will soon be the dominant form of taxation in the U.S.

6) Among the G7 nations, the U.S. has a below average corporate income tax rate that makes it attractive for other countries to invest in the U.S.

7) In the mid 1980s the U.S. led the way to higher corporate income tax rates worldwide. Today, most of the G7 nations have surpassed the U.S. and have higher corporate income tax rates than the U.S.

8) The ideal tax should not only raise revenue efficiently but also have as few negative effects on economic behavior as possible.

9) The worldwide approach, also referred to as the residential or national approach to tax policy, levies taxes on the income earned by firms that are incorporated in the host country, regardless of where the income was earned (domestically or abroad).

10) The territorial approach, also referred to as the source approach to tax policy, levies taxes on the income earned by firms that are incorporated in the host country, regardless of where the income was earned (domestically or abroad).

11) Of the OECD 30 countries, most employ a worldwide approach to tax policy, but a few, including the United States, use the worldwide approach.

12) FEW governments rely on income taxes, both personal and corporate, for their primary revenue source.

13) Between 2006 – 2012, global corporate tax rates have trended upward.

14) Tax credits are LESS valuable on a dollar-for-dollar basis than are deductible expenses.

15) Tax treaties typically result in reduced withholding tax rates between the two signatory countries.

16) Tax credits are less valuable on a dollar-for-dollar basis than are tax-deductible expenses.

17) The U.S. Internal Revenue Service can reallocate revenues and expenses between parent corporations and their subsidiaries to more clearly reflect a proper allocation of income. In such instances it is the responsibility of the corporation to prove that the IRS has been arbitrary in its decision-making, thus establishing a “guilty until proved innocent” tax approach.

18) Tax haven subsidiaries of MNEs are categorically referred to as international offshore financial centers.

Essay

1) Explain the worldwide and territorial approaches of national taxation. The authors state that the United States uses both approaches. How can this be? Give an example of each taxation approach.

2) What is a value-added tax? Where is this type of tax in wide usage? Why do you suppose this form of taxation has NOT been widely accepted in the United States?

Chapter 16 International Portfolio Theory and Diversification

16.1 International Diversification and Risk

Multiple Choice

1) Beta may be defined as:
A) the measure of systematic risk.
B) a risk measure of a portfolio.
C) the ratio of the variance of the portfolio to the variance of the market.
D) all of the above

2) ________ risk is measured with beta.
A) Systematic
B) Unsystematic
C) International
D) Domestic

3) A fully diversified domestic portfolio has a beta of:
A) 0.0
B) 1.0
C) -1.0
D) There is not enough information to answer this question.

4) Unsystematic risk:
A) is the remaining risk in a well-diversified portfolio.
B) is measured with beta.
C) can be diversified away.
D) all of the above

5) A well-diversified portfolio has about ________ of the risk of the typical individual stock.
A) 8%
B) 19%
C) 27%
D) 52%

6) An internationally diversified portfolio:
A) should result in a portfolio with a lower beta than a purely domestic portfolio.
B) has the same overall risk shape as a purely domestic portfolio.
C) is only about 12% as risky as the typical individual stock.
D) all of the above

7) In some respects, internationally diversified portfolios are the same in principle as a domestic portfolio because:
A) the investor is attempting to combine assets that are perfectly correlated.
B) investors are trying to reduce systematic risk.
C) investors are trying to reduce the total risk of the portfolio.
D) all of the above

8) In some respects, internationally diversified portfolios are different from a domestic portfolio because:
A) investors may also acquire foreign exchange risk.
B) international portfolio diversification increases expected return but does not decrease risk.
C) investors must leave the country to acquire foreign securities.
D) all of the above

Instruction 16.1:
Use the information to answer the following question(s).

In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.

9) Refer to Instruction 16.1. How many euros will the U.S. investor acquire with his initial $500,000 investment?
A) €650,000
B) €370,370
C) €500,000
D) €384,615

10) Refer to Instruction 16.1. At an average price of €60/share, how many shares of stock will the investor be able to purchase?
A) 8333 shares
B) 6410 shares
C) 6173 shares
D) 10,833 shares

11) Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor’s average rate of return before converting the stock back into dollars?
A) 5.0%
B) -3.0%
C) -5.0%
D) 3.0%

12) Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor’s average rate of return after converting the stock back into dollars?
A) -1.35%
B) 5.0%
C) -5.0%
D) -7.24%

13) A U.S. investor makes an investment in Britain and earns 14% on the investment while the British pound appreciates against the U.S. dollar by 8%. What is the investor’s total return?
A) 22.00%
B) 23.12%
C) 6.00%
D) 4.88%

14) Which of the following statements is NOT true?
A) International diversification benefits induce investors to demand foreign securities.
B) An international security adds value to a portfolio if it reduces risk without reducing return.
C) Investors will demand a security that adds value.
D) All of the above are true.

True/False

1) Portfolio diversification can eliminate 100% of risk.

2) Increasing the number of securities in a portfolio reduces the unsystematic risk but not the systematic risk.

3) International diversification benefits may induce investors to demand foreign securities.

4) If the addition of a foreign security to the portfolio of the investor aids in the reduction of risk for a given level of return, then the security adds value to the portfolio.

5) If the addition of a foreign security to the portfolio of the investor decreases the expected return for a given level of risk, then the security adds value to the portfolio.

16.2 Internationalizing the Domestic Portfolio

Multiple Choice

1) Portfolio theory assumes that investors are risk-averse. This means that investors:
A) cannot be induced to make risky investments.
B) prefer more risk to less for a given return.
C) will accept some risk, but not unnecessary risk.
D) All of the above are true.

2) The efficient frontier of the domestic portfolio opportunity set:
A) runs along the extreme left edge of the opportunity set.
B) represents optimal portfolios of securities that represent minimum risk for a given level of expected portfolio return.
C) contains the portfolio of risky securities that the logical investor would choose to hold.
D) all of the above

3) The addition of foreign securities to the domestic portfolio opportunity set shifts the efficient frontier:
A) down and to the left.
B) up and to the right.
C) up and to the left.
D) down and to the right.

4) Relative to the efficient frontier of risky portfolios, it is impossible to hold a portfolio that is located ________ the efficient frontier.
A) to the left of
B) to the right of
C) on
D) to the right or left of

5) The ________ connects the risk-free security with the optimal domestic portfolio.
A) security market line
B) capital asset pricing model
C) capital market line
D) none of the above

Instruction 16.2:
Use the information to answer the following question(s).

A U.S. investor is considering a portfolio consisting of 60% invested in the U.S. equity index fund and 40% invested in the British equity index fund. The expected returns for the funds are 10% for the U.S. and 8% for the British, standard deviations of 20% for the U.S. and 18% for the British, and a correlation coefficient of 0.15 between the U.S. and British equity funds.

6) Refer to Instruction 16.2. What is the expected return of the proposed portfolio?
A) 9.2%
B) 9.0%
C) 19.2%
D) 19%

7) Refer to Instruction 16.2. What is the standard deviation of the proposed portfolio?
A) 38.00
B) 19.20
C) 19.00
D) 14.45

True/False

1) The graph for the efficient frontier has beta on the vertical axis and standard deviation of the horizontal axis.

2) The portfolio with the least risk among all those possible in the domestic portfolio opportunity set is called the minimum risk domestic portfolio.

3) The optimal domestic portfolio of risky securities is always the portfolio of minimum risk.

4) The standard deviation of a portfolio is the sum of the weighted average standard deviations of the individual assets.

5) The optimal domestic portfolio combines the risk-free asset and a portfolio of domestic securities found on the efficient frontier.

6) The internationally diversified portfolio opportunity set shifts TO THE RIGHT of the purely domestic opportunity set.

Essay

1) Draw the curve representing the Optimal Domestic Efficient Frontier. Be sure to draw and label the following: The vertical axis and the horizontal axis, the risk-free security, the minimum risk portfolio, the domestic portfolio opportunity set, the optimal domestic portfolio, and the capital market line. Choose a point along the domestic portfolio opportunity set between the optimal domestic portfolio and the minimum risk domestic portfolio and explain why that point is not the optimal risky domestic portfolio for investors to hold.

16.3 National Markets and Asset Performance

Multiple Choice

1) The authors present a comparison of correlation coefficients between major global equity markets over a variety of different periods. The comparison yields a number of conclusions listed here EXCEPT:
A) the correlation between equity markets for the full twentieth century shows quite low levels of correlation between some of the largest markets (close to 0.50 in some cases).
B) that same century of data, however, yields a high correlation between the U.S. and Canada (0.80).
C) the correlation coefficients between those same equity markets for selected sub periods over the last quarter of the twentieth century, however, show significantly different correlation coefficients.
D) None of the answers listed are inaccurate conclusions.

True/False

1) Capital markets around the world are on average less integrated today than they were 20 years ago.

2) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) determined that the equity returns in the United States out-performed the other 15 countries in the study.

3) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) found that just under one-half of the 16 countries in the study had negative average returns in their equity markets.

4) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) determined that due to high levels of correlation or returns between countries, there is almost NO BENEFIT to international portfolio diversification.

5) Of the major trading partners with the United States, Canada has among the LOWEST correlation of returns with the U.S.

Essay

1) If an investor is able to determine a global beta for his portfolio and holds a portfolio that is well-diversified with international investments, which performance measure is more appropriate, the Sharpe Measure or the Treynor Measure? Why? Explain each performance measure.

16.4 Market Performance Adjusted for Risk: The Sharpe and Treynor Performance Measures

Multiple Choice

1) The Sharpe measure uses ________ as the measure of risk and the Treynor measure uses ________ as the measure of risk.
A) standard deviation; variance
B) beta; variance
C) standard deviation; beta
D) beta; standard deviation

TABLE 16.1
Use the information to answer following question(s).

2) Refer to Table 16.1. What is the value of the Sharpe Measure for France?
A) 0.113
B) 0.0071
C) either A or B
D) neither A nor B

3) Refer to Table 16.1. What is the value of the Treynor Measure for the Netherlands?
A) 0.197
B) 0.0109
C) either A or B
D) neither A nor B

4) Refer to Table 16.1. ________ appears to have the greatest amount of risk as measured by monthly standard deviation, but ________ has the best return per unit of risk according to the Sharpe Measure.
A) United States; Austria
B) France; Austria
C) United States; Netherlands
D) France; Netherlands

5) The Sharpe and Treynor Measures tend to be consistent in their ranking of portfolios when the portfolios:
A) are poorly diversified.
B) are properly diversified.
C) contain only U.S. equity investments.
D) none of the above

True/False

1) The Sharpe and Treynor measures are each measures of return per unit of risk.

2) Good financial advice would suggest that investors should examine returns by the amount of return per unit of risk accepted, rather than in isolation.

3) The denominator of the Treynor measure is portfolio risk as measured by the standard deviation of the portfolio.

4) The denominator of the Sharpe measure is portfolio risk as measured by the standard deviation of the portfolio.

5) The denominator of the Sharpe measure is the portfolio’s beta, the systematic risk of the portfolio, as measured against the world market portfolio.

6) The denominator of the Treynor measure is the portfolio’s beta, the systematic risk of the portfolio, as measured against the world market portfolio.

FIN 350 Week 8 Quiz – Strayer University New

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Quiz 7 Chapter 16 and 17

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 320 Week 8 Quiz – Strayer University New

FIN/320 Week 8 Quiz – Strayer

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Quiz 6 Chapter 14 and 15
Chapter 14: ___________________________________________________________________________
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

Chapter 15: ___________________________________________________________________________
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

ECO 410 Week 8 Quiz – Strayer University New

ECO/410 Week 8 Quiz – Strayer

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Quiz 7 Chapter 13 and 14

Chapter 13

The Global Cost and Availability of Capital

13.1 Financial Globalization and Strategy

Multiple Choice

1) If a firm lies within a country with ________ or ________ domestic capital markets, it can achieve lower global cost and greater availability of capital with a properly designed and implemented strategy to participate in international capital markets.
A) liquid; segmented
B) liquid; large
C) illiquid; segmented
D) large; illiquid

2) Other things equal, a firm that must obtain its long-term debt and equity in a highly illiquid domestic securities market will probably have a:
A) relatively low cost of capital.
B) relatively high cost of capital.
C) relatively average cost of capital.
D) cost of capital that we cannot estimate from this question.

3) Relatively high costs of capital are more likely to occur in:
A) highly illiquid domestic securities markets.
B) highly liquid domestic securities markets.
C) unsegmented domestic securities markets.
D) none of the above

4) Reasons that firms may find themselves with relatively high costs of capital include:
A) The firms reside in emerging countries with undeveloped capital markets.
B) The firms are too small to easily gain access to their own national securities market.
C) The firms are family owned and they choose not to access public markets and lose control of the firm.
D) all of the above

5) Which of the following is NOT a contributing factor to the segmentation of capital markets?
A) excessive regulatory control
B) perceived political risk
C) anticipated foreign exchange risk
D) All of the above are contributing factors.

6) Which of the following is NOT a contributing factor to the segmentation of capital markets?
A) lack of transparency
B) asymmetric availability of information
C) insider trading
D) All of the above are contributing factors.

7) The weighted average cost of capital (WACC) is:
A) the required rate of return for all of a firm’s capital investment projects.
B) the required rate of return for a firm’s average risk projects.
C) not applicable for use by MNE.
D) equal to 13%.

8) The capital asset pricing model (CAPM) is an approach:
A) to determine the price of equity capital.
B) used by marketers to determine the price of saleable product.
C) that can be applied only to domestic markets.
D) none of the above

9) Which of the following is NOT a key variable in the equation for the capital asset pricing model?
A) the risk-free rate of interest
B) the expected rate of return on the market portfolio
C) the marginal tax rate
D) All are important components of the CAPM.

10) ________ risk is a function of the variability of expected returns of the firm’s stock relative to the market index and the measure of correlation between the expected returns of the firm and the market.
A) Systematic
B) Unsystematic
C) Total
D) Diversifiable

11) Systematic risk:
A) is the standard deviation of a security’s return.
B) is measured with beta.
C) is measured with standard deviation.
D) none of the above

12) Which of the following is generally unnecessary in measuring the cost of debt?
A) a forecast of future interest rates
B) the proportions of the various classes of debt a firm proposes to use
C) the corporate income tax rate
D) All of the above are necessary for measuring the cost of debt.

13) The after-tax cost of debt is found by:
A) dividing the before-tax cost of debt by (1 – the corporate tax rate).
B) subtracting (1 – the corporate tax rate) from the before-tax cost of debt.
C) multiplying the before-tax cost of debt by (1 – the corporate tax rate).
D) subtracting the corporate tax rate from the before-tax cost of debt.

14) A firm whose equity has a beta of 1.0:
A) has greater systematic risk than the market portfolio.
B) stands little chance of surviving in the international financial market place.
C) has less systematic risk than the market portfolio.
D) None of the above is true.

15) The difference between the expected (or required) return for the market portfolio and the risk-free rate of return is referred to as:
A) beta.
B) the geometric mean.
C) the market risk premium.
D) the arithmetic mean.

16) In general the geometric mean will be ________ the arithmetic mean for a series of returns.
A) less than
B) greater than
C) equal to
D) greater than or equal to

17) The beginning share price for a security over a three-year period was $50. Subsequent year-end prices were $62, $58 and $64. The arithmetic average annual rate of return and the geometric average annual rate of return for this stock was:
A) 9.30% and 8.58% respectively.
B) 9.30% and 7.89% respectively.
C) 9.30% and 7.03% respectively.
D) 9.30% and 6.37% respectively.

18) If a company fails to accurately predict it’s cost of equity, then:
A) the firm’s wacc will also be inaccurate.
B) the firm may not be using the proper interest rate to estimate NPV.
C) the firm may incorrectly accept or reject projects based on decisions made using the cost of capital computed with an incorrect cost of equity.
D) All of the above are true.

19) Which of the following statements is NOT true regarding beta?
A) Beta will have a value of less than 1.0 if the firm’s returns are less volatile than the market.
B) Beta will have a value of greater than 1.0 if the firm’s returns are more volatile than the market.
C) Beta will have a value of equal to 1.0 if the firm’s returns are of equal volatility to the market.
D) All of the statements above are true.

20) Which of the following will NOT affect a firm’s beta?
A) the choice of the market portfolio against which to compare the variability of a firm’s returns
B) the choice of the risk-free security
C) the choice of the time period used to calculate the firm’s beta
D) None of the above, because each of them affects the calculation of a firm’s beta.

True/False

1) A national securities market is segmented if the required rate of return on securities in that market differs from comparable securities traded in other, unsegmented markets.

2) Other things equal, an increase in the firm’s tax rate will increase the WACC for a firm that has both debt and equity financing.

3) If a firm’s expected returns are more volatile than the expected return for the market portfolio, it will have a beta less than 1.0.

4) The WACC is usually used as the risk-adjusted required rate of return for new projects that are of the same average risk as the firm’s existing projects.

5) One of the elegant beauties of international equity markets is that over the last 100 or so years, the average market risk premium is almost identical across major industrial countries.

6) Firms acquire debt in either the form of loans from commercial banks, or by selling new common stock.

7) When estimating an average corporate after-tax cost of capital, the component cost of equity is multiplied by (1-t) to allow for the tax-deductibility of dividend payments.

8) International CAPM (ICAPM) assumes that there is a global market in which the firm’s equity trades, and estimates of the firm’s beta, and the market risk premium, must then reflect this global portfolio.

9) Use of the International CAPM (ICAPM) assures that the WACC will be lower than if a purely domestic market portfolio had been used in the estimation of the cost of equity.

10) A global portfolio is an index of all the securities in the world, whereas a world portfolio represents those securities actually available to an investor.

11) The CAPM has now become very widely accepted in global business as the preferred method of calculating the cost of equity for a firm. As a result of this, there is now little debate over what numerical values should be used in its application.

12) The geometric mean will, in all but a few extreme circumstances, yield a larger return than the arithmetic mean return.

Essay

1) What are the components of the weighted average cost of capital (WACC) and how do they differ for an MNE compared to a purely domestic firm?

13.2 The Demand for Foreign Securities: The Role of International Portfolio Investors

Multiple Choice

1) The primary goal of both domestic and international portfolio managers is:
A) to maximize return for a given level of risk, or to minimize risk for a given level of return.
B) to minimize the number of unique securities held in their portfolio.
C) to maximize their WACC.
D) all of the above

2) Which of the following is NOT a portfolio diversification technique used by portfolio managers?
A) diversify by type of security
B) diversify by the size of capitalization of the securities held
C) diversify by country
D) All of the above are diversification techniques.

3) If all capital markets are fully integrated, securities of comparable expected return and risk should have the same required rate of return in each national market after adjusting for:
A) time of day and language requirements.
B) political risk and time lags.
C) foreign exchange risk and political risk.
D) foreign exchange risk and the spot rate.

4) Capital market segmentation is a financial market imperfection caused mainly by:
A) government constraints.
B) institutional practices.
C) investor perceptions.
D) all of the above

5) Capital market imperfections leading to financial market segmentation include:
A) asymmetric information between domestic and foreign-based investors.
B) high securities transaction costs.
C) foreign exchange risks.
D) all of the above

6) Capital market imperfections leading to financial market segmentation include:
A) political risks.
B) corporate governance differences.
C) regulatory barriers.
D) all of the above

7) The authors refer to companies that have access to a ________ as MNEs, and firms without such access are identified as ________.
A) global cost and availability of capital; domestic firms.
B) large domestic capital market; geographically challenged.
C) world financial markets; antiquated.
D) none of the above

8) The MNE can ________ its ________ by gaining access to markets that are more liquid and/or less segmented than its own.
A) increase; MCC.
B) decrease; MCC.
C) maintain; MRR.
D) none of the above

True/False

1) Internationally diversified portfolios often have a lower rate of return and almost always have a higher level of portfolio risk than their domestic counterparts.

2) Empirical tests of market efficiency fail to show that most major national markets are reasonably efficient.

3) A MNEs marginal cost of capital is constant for considerable ranges in its capital budget, but this statement cannot be made for most domestic firms.

4) Capital market segmentation is a financial market imperfection caused mainly by government constraints, institutional practices, and investor perceptions.

5) Since the 1980s and 1990s, segmentation in global financial markets has been reduced. As a result of this, the correlation among securities markets has increased, thereby reducing, but not eliminating, the benefits of international portfolio diversification.

13.3 The Cost of Capital for MNEs Compared to Domestic Firms

Multiple Choice

1) Theoretically, most MNEs should be in a position to support higher ________ than their domestic counterparts because their cash flows are diversified internationally.
A) equity ratios
B) debt ratios
C) temperatures
D) none of the above

2) According to your authors, diversifying cash flows internationally may help MNEs reduce the variability of cash flows because:
A) of a lack of competition among international firms.
B) of an offset to cash flow variability caused by exchange rate variability.
C) returns are not perfectly correlated between countries.
D) none of the above

3) Which of the following statements is NOT true regarding MNEs when compared to purely domestic firms?
A) MNEs tend to rely more on short and intermediate term debt.
B) MNEs have greater foreign exchange risk.
C) MNEs have greater costs of asymmetric information.
D) MNEs have higher agency costs.

4) Empirical research has found that systematic risk for MNEs is greater than that for their domestic counterparts. This could be due to:
A) the fact that the increase in the correlation of returns between the market and the firm is less than the increase in the standard deviation of returns of the firm.
B) the fact that the decrease in the correlation of returns between the market and the firm is greater than the increase in the standard deviation of returns of the firm.
C) the reduction in the correlation of returns between the firm and the market is less than the increase in the variability of returns caused by factors such as asymmetric information, foreign exchange risk, and the like.
D) None of the above; systematic risk is less for MNEs than for their domestic counterparts.

5) The optimal capital budget:
A) occurs where the marginal cost of capital equals the marginal rate of return of the opportunity set of projects.
B) is typically larger for purely domestic firms than for MNEs.
C) is an illusion found only in international finance textbooks.
D) none of the above

6) Empirical studies indicate that MNEs have higher costs of capital than purely domestic firms. This could be due to higher levels of:
A) political risk.
B) exchange rate risk.
C) agency costs.
D) all of the above

7) Despite the theoretical elegance of this hypothesis, empirical studies have come to the opposite conclusion.Despite the favorable effect of international diversification of cash flows, bankruptcy risk was only about the same for MNEs as for domestic firms. However, MNEs faced higher costs for each of the following EXCEPT:
A) agency costs.
B) political risk.
C) asymmetric information.
D) In fact, each of these costs were higher for the MNE than for the domestic firm.

True/False

1) Because of the international diversification of cash flows, the risk of bankruptcy for MNEs is significantly lower than that for purely domestic firms.

2) The opportunity set of projects is typically smaller for MNEs than for purely domestic firms because international markets are typically specialized niches.

3) Surprisingly, empirical studies find that MNEs have a higher level of systematic risk than their domestic counterparts.

Essay

1) What do theory and empirical evidence say about capital structure and the cost of capital for MNEs versus their domestic counterparts?

13.4 The Riddle: Is the Cost of Capital Higher for MNEs?

Multiple Choice

1) Empirical studies indicate that WACC for an MNE is higher than for their domestic competitors. Reasons cited for this increased cost include all of the following EXCEPT:
A) agency costs.
B) foreign exchange risk.
C) political risk.
D) All of the above are cited as reasons for an MNE’s increased WACC.

True/False

1) Empirical studies indicate that MNEs have a lower debt/capital ratio than domestic counterparts, indicating that MNEs have a lower cost of capital.

Chapter 14 Raising Equity and Debt Globally

14.1 Designing a Strategy to Source Capital Globally

Multiple Choice

1) The choice of when and how to source capital globally is usually aided early on by the advice of:
A) an investment banker.
B) your stock broker.
C) a commercial banker.
D) an underwriter.

2) Investment banking services include which of the following?
A) advising when a security should be cross-listed
B) preparation of stock prospectuses
C) help to determine the price of the issue
D) all of the above

3) Which of the following is the typical order of sourcing capital abroad?
A) an international bond issue, then cross listing the outstanding issues on other exchanges, then an international bond issue in the target market
B) an international bond issue in the target market, then cross listing the outstanding issues on other exchanges, then an international bond issue
C) an international bond issue in less prestigious markets, then an international bond issue in the target market, and ultimately a eurobond issue
D) cross listing the outstanding issues on other exchanges, then an international bond issue, then an international bond issue in the target market

4) By cross listing and selling its shares on a foreign stock exchange, a firm typically tries to accomplish which of the following?
A) improve the liquidity of its existing shares
B) increase its share price
C) increase the firm’s visibility
D) all of the above

True/False

1) Most firms raise their initial capital in foreign markets.

14.2 Optimal Financial Structure

Multiple Choice

1) Which financial economists are most closely associated with the financial theory of optimal capital structure?
A) Modigliani and Miller
B) Fama, Fisher, Jensen, and Roll
C) Black and Scholes
D) Markowitz and Sharpe

2) For most firms, the cost of capital decreases to a low point as the firm ________ debt financing. At some point beyond this optimal level, the cost of capital increases as the amount of debt ________.
A) decreases; increases
B) decreases; decreases
C) increases; increases
D) increases; decreases

3) One of the most important factors in making debt less expensive than equity is:
A) the tax deductibility of depreciation.
B) the tax deductibility of equity.
C) the tax deductibility of dividends.
D) the tax deductibility of interest.

4) One of the most important factors in making debt less expensive than equity is:
A) the seniority of equity obligations to debt claims.
B) the tax deductibility of dividends.
C) the tax deductibility of equity.
D) the seniority of debt obligations to equity claims.

5) Which of the following is NOT a factor offsetting the tax advantage of debt as a source of financing?
A) increased agency costs
B) increased probability of financial distress (bankruptcy) due to fixed interest payments
C) alternative tax shields to those supplied by interest payments
D) All of the above offset the tax advantage of debt as a source of financing.

6) Most financial theorists believe that the optimal capital structure is a ________ with a debt to total value ratio somewhere around ________.
A) point; 50%
B) point; 25%
C) range; 30%-60%
D) range; 10%-40%

7) Not all firms have the same optimal capital structure. Factors that might influence a firm’s capital structure include:
A) the industry in which it operates.
B) the volatility of its sales and operating income.
C) the collateral value of its assets.
D) all of the above

8) MNEs situated in countries with small illiquid and segmented markets are most like:
A) small domestic U.S. firms in that they must rely on internally generated funds and bank borrowing.
B) large U.S. MNEs in that they are all MNEs and have worldwide markets and sources of financing.
C) small domestic U.S. firms in that they have a strong niche market in the U.S.
D) None of the above is true.

9) In theory, the MNE should support ________ debt ratios than a purely domestic firm because their cash flows are ________.
A) lower; more stable due to international diversification
B) lower; less stable due to international diversification
C) higher; more stable due to international diversification
D) higher; less stable due to international diversification

10) TropiKana Inc., a U.S firm, has just borrowed $1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 6.00% per year, how much interest will they pay in the first year?
A) $6,000
B) $60,000
C) $600,000
D) €60,000

11) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro depreciates against the dollar from $1.40/€ at the time the loan was made to $1.35/€ at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?
A) $55,000
B) €74,250
C) $74,250
D) $77,000

12) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?
A) $55,000
B) $79,750
C) $77,000
D) $37,931

13) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)?
A) $1,529,750
B) €1,529,750
C) $1,055,000
D) $1,477,000

14) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro depreciates against the dollar from $1.40/€ at the time the loan was made to $1.35/€ at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)?
A) $1,477,000
B) $1,055,000
C) €1,424,250
D) $1,424,250

15) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, what is the before tax cost of capital if the firm repays the entire loan plus interest (rounded)?
A) 1.73%
B) 5.50%
C) 10.50%
D) 9.27%

True/False

1) Financial theory has at last provided us with a single optimal capital structure for domestic firms.

2) Financial practice suggests that there is a range for an optimal capital structure for a firm within an industry rather than a specific optimal ratio of debt to equity.

3) In part because of access to global markets, MNEs are better able than their domestic counterparts to maintain their desired debt ratio even when raising new capital.

4) When a firm borrows in a foreign currency, the effective cost is the foreign interest rate plus an adjustment for changes in the exchange rate.

5) The domestic theory of optimal capital structure does not need to be modified for MNEs.

6) Portfolio diversification of domestic firms reduces risk because cash flows are not perfectly correlated. The same reasoning is often argued for MNEs diversifying into international markets.

7) A significant advantage of borrowing foreign currency-denominated bonds is that the borrower need not worry about relative changes in the value of the home currency.

8) For firms to raise capital in international markets, it is more important to adhere to capital structure ratios similar to those found in the United States and United Kingdom than to those in the firm’s home country.

14.3 Raising Equity Globally

Multiple Choice

1) The stock exchange with the greatest value of shares traded is:
A) NYSE.
B) Tokyo.
C) Nasdaq.
D) London.

2) The number of foreign firms traded on the London exchange is ________ than the number traded on the NYSE, and the costs of listing and disclosure in London are ________ those for the NYSE.
A) less than; less than
B) less than; greater than
C) greater than; less than
D) greater than; greater than

True/False

1) The Tokyo exchange is the number one choice of firms looking to gain liquidity by cross-listing their equity securities.

2) The least liquid stock markets as identified by the authors offer little liquidity for their own domestic firms, and are of little value to foreign firms.

14.4 Depositary Receipts

Multiple Choice

1) ________ are negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank.
A) Negotiable CDs
B) International mutual funds
C) Depositary receipts
D) Eurodeposits

2) Depositary receipts traded outside the United States are called ________ depositary receipts.
A) Euro
B) Global
C) American
D) none of the above

3) Each ADR represents ________ of the shares of the underlying foreign stock.
A) a multiple
B) 100
C) 1
D) ADRs have nothing to do with foreign stocks.

4) Which of the following is NOT an advantage of ADRs to U.S. shareholders?
A) Transfer of ownership is done in the U.S. in accordance with U.S. laws.
B) In the event of the death of the shareholder, the estate does not go through a foreign court.
C) Settlement for trading is generally faster in the United States.
D) All of the above are advantages of ADRs.

5) ADRs that are created at the request of a foreign firm wanting its shares traded in the United States are:
A) facilitated.
B) unfacilitated.
C) sponsored.
D) unsponsored.

6) Who pays the costs of creating a sponsored ADR?
A) the foreign firm whose stocks underlie the ADR
B) the U.S. bank creating the ADR
C) both the U.S. bank and the foreign firm
D) the SEC since they require the regulation

7) Level I ADRs trade primarily:
A) on the New York Stock Exchange.
B) on the American Stock Exchange.
C) over the counter or pink sheets.
D) Level I ADRs typically do not trade at all, but instead are privately issued and held until maturity.

8) Level II ADRs must meet:
A) U.S. GAAP standards.
B) home country accounting standards.
C) both U.S. GAAP and home country standards.
D) none of the above

9) Level ________ is the easiest standard to satisfy for issuing ADRs.
A) 144a
B) III
C) II
D) I

10) Level III ADR commitment applies to:
A) firms that want to list existing shares on the NYSE.
B) banks issuing foreign mutual funds.
C) ADR issues of under $25,000.
D) the sale of a new equity issued in the United States.

True/False

1) ADRs cannot be exchanged for the underlying shares of the foreign stock, therefore, arbitrage cannot keep the prices in line with the foreign price of the stock.

2) An unsponsored ADR may be initiated without the approval of the foreign firm with the underlying stock.

3) ADRs are considered an effective way for firms to improve the liquidity of their stock, especially if the home market is small and illiquid.

Essay

1) ADRs are a popular investment tool for many U.S. investors. In recent years several alternatives for investing in foreign equity securities have become available for U.S. investors, yet ADRs remain popular. Define what an ADR is and provide at least three examples of the advantages they may hold over alternative foreign investment vehicles for U.S. investors.

14.5 Private Placement

Multiple Choice

1) Which of the following were NOT identified by the authors as an alternative instrument to source equity in global markets?
A) sale of a directed public share issue to investors in a target market
B) private placements under SEC rule 144a
C) sale of shares to private equity funds
D) All of the above are alternatives to source equity instruments.

2) A/An ________ is defined as one that is targeted at investors in a single country and underwritten in whole or part by investment institutions from that country.
A) SEC rule 144a placement
B) directed public share issue
C) Euroequity public issue
D) strategic alliance

3) The term “euro” as used in the euro equity market implies:
A) the issuers are located in Europe.
B) the investors are located in Europe.
C) both A and B
D) none of the above

4) Private equity funds (PEF) differ from traditional venture capital (VC) funds in that:
A) VC operates mainly in lesser-developed countries while PEF do not.
B) VC typically invests in family business whereas PEF do not.
C) VC is almost unavailable to emerging markets while PEF capital is available.
D) All of the above are true.

5) Strategic alliances are normally formed by firms that expect to gain synergies from which of the following?
A) economies of scale
B) economies of scope
C) complementary marketing
D) all of the above

True/False

1) SEC rule 144A permits institutional buyers to trade privately placed securities without the previous holding periods restrictions and without requiring SEC registration.

14.6 Foreign Equity Listing and Issuance

Multiple Choice

1) Your authors note several empirical studies that have found:
A) no share price effect for foreign firms that cross-list on major U.S. exchanges.
B) a positive share price effect for foreign firms that cross-list on major U.S. exchanges.
C) a negative share price effect for foreign firms that cross-list on major U.S. exchanges.
D) none of the above

2) Empirical evidence shows that new issues of equity by domestic firms in the U.S. market typically has a ________ stock price reaction and new equity issues in the U.S. markets by foreign firms with segmented domestic markets have a ________ stock price reaction.
A) negative; negative
B) positive; negative
C) negative; positive
D) positive; positive

3) In addition to gaining liquidity, which of the following could also be considered a legitimate reason for cross-listing equity?
A) enhance a firm’s local image
B) become more familiar with the local financial community
C) get better local press coverage
D) all of the above

4) Another school of thought about the worldwide trend toward fuller and more standardized disclosure rules is that the cost of U.S. level equity capital disclosure:
A) chases away potential listers of equity.
B) is an onerous costly burden.
C) leads to fewer foreign firms cross listing in U.S. equity markets.
D) all of the above

5) According to the U.S. school of thought, the worldwide trend toward fuller and more standardized disclosure rules should ________ the cost of equity capital.
A) increase
B) decrease
C) have no impact on
D) none of the above

6) For the most part, U.S. SEC disclosure requirements are ________ other, non-U.S. equity market rules.
A) more stringent than
B) less stringent than
C) equally stringent to
D) none of the above

True/False

1) The combined impact of a new equity issue undertaken simultaneously with a cross-listing has a more favorable impact on stock price than cross-listing alone.

2) Because of stringent SEC rules, American companies typically do not find foreign disclosure rules to be overly onerous.

Essay

1) What are the two schools of thought regarding the worldwide trend toward increased financial disclosure by publicly traded firms. Explain which school of thought you hold to and why.

14.7 Raising Debt Globally

Multiple Choice

1) ________ are domestic currencies of one country on deposit in a second country.
A) LIBORs
B) Eurocurrencies
C) Federal funds
D) Discount window deposits

2) Of the following, which was NOT cited by the authors as a valuable function provided by the Eurocurrency market?
A) Eurocurrency deposits are an efficient and convenient money market device for holding excess corporate liquidity.
B) Eurocurrency deposits are a tool used by the Federal Reserve to regulate the money supply of countries that peg their currency against the U.S. dollar.
C) The Eurocurrency market is a major source of short-term bank loans to finance corporate working capital needs.
D) All of the above were cited by the authors.

3) Eurobanks are:
A) banks where Eurocurrencies are deposited.
B) major world banks that conduct a Eurocurrency business in addition to normal banking activities.
C) financial intermediaries that simultaneously bid for time deposits in and make loans in a currency other than that of the currency of where it is located.
D) All of the above are descriptions of a Eurobank.

4) Eurocredits are:
A) bank loans to MNEs and others denominated in a currency other than that of the country where the bank is located.
B) typically variable rate and tied to the LIBOR.
C) usually for maturities of six months or less.
D) All of the above are true.

5) In general, which has the shorter maturity and is more appropriate for funding short-term inventory needs?
A) commercial paper
B) Euro-Medium-Term notes (EMTNs)
C) the international bond market
D) all of the above

6) Foreign bonds sold in the United States are nicknamed “Yankee bonds,” foreign bonds sold in Japan are called “Samurai bonds.” What are foreign bonds sold in the United Kingdom nicknamed?
A) “Union Jacks”
B) “Royalty”
C) “Bulldogs”
D) “Churchill’s”

7) A ________ is a bond underwritten by a syndicate from a single country, sold within in that country, denominated in that country’s currency, but the issuer is from outside that country.
A) foreign bond
B) Eurobond
C) domestic bond
D) none of the above

True/False

1) Eurocurrencies are NOT the same as the euro developed for the common European currency.

2) The Eurocurrency market continues to thrive because it is a large international money market relatively free of governmental regulation and interference.

3) Moody’s rates international bonds at the request of the issuer with the stipulation that Moody’s will publish the ratings even if the ratings are unfavorable.

Essay

1) The Euro-medium-term-note (EMTN) has filled a substantial niche market in global financing. What are the distinguishing characteristics of the EMTN and why is it such a popular form of financing for MNEs?

Multinational Business Finance by Eiteman – Exam And Quizzes

Multinational Business Finance by Eiteman – Exam And Quizzes

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Chapter 1 Current Multinational Challenges and the Global Economy

True/False

1) BRICs is a term used in international finance to represent assets that are considered to be inexpensive and sturdy, but fundamentally unsound and and incapable of coping with the upheavals now apparent in international financial markets.

2) Multinational enterprises (MNEs) are firms, both for profit companies and not-for-profit organizations, that have operations in more than one country, and conduct their business through foreign subsidiaries,
branches, or joint ventures with host country firms.

3) Ownership, control, and governance changes radically across the world. The publicly traded company is not the dominant global business organization—the privately held or family-owned business is the prevalent structure—and their goals and measures of performance differ dramatically.

Multiple Choice

1) A well-established, large U.S.-based MNE will probably NOT be able to overcome which of the following obstacles to maximizing firm value?
A) an open market place
B) high quality strategic management
C) access to capital
D) none of the above

2) A well-established, large China-based MNE will probably be most adversely affected by which of the following elements of firm value?
A) an open marketplace
B) high-quality strategic management
C) access to capital
D) access to qualified labor pool

3) A well-established, large, Brazil-based MNE will probably be most adversely affected by which of the following elements of firm value?
A) an open marketplace
B) high-quality strategic management
C) access to capital
D) access to qualified labor pool

True/False

1) Comparative advantage is one of the underlying principles driving the growth of global business.

2) Your authors suggest that one way to characterize the global financial marketplace is through its assets, institutions, and linkages.

3) Eurocurrencies are domestic currencies of one country on deposit in a second country.

4) A eurodollar deposit is a demand deposit.

5) Eurocurrency markets serve two valuable purposes: 1) Eurocurrency deposits are an efficient and convenient money market device for holding excess corporate liquidity; and 2) the Eurocurrency market is a major source of short-term bank loans to finance corporate working capital needs, including the financing of imports and exports.

6) The key factor attracting both depositors and borrowers to the Eurocurrency loan market is the narrow interest rate spread within that market.

7) The Eurocurrency market continues to thrive because it is a large international money market relatively free from governmental regulation and interference. Recent events may lead to greater regulation.

Essay

1) List and explain three strategic motives why firms become multinationals and give an example of each.

Multiple Choice

1) The theory that suggests specialization by country can increase worldwide production is:
A) the theory of comparative advantage.
B) the theory of foreign direct investment.
C) the international Fisher effect.
D) the theory of working capital management.

2) Which of the following is NOT a reason governments interfere with comparative advantage?
A) Governments attempt to achieve full employment.
B) Governments promote economic development.
C) national self-sufficiency in defense-related industries
D) All are reasons governments interfere with comparative advantage.

3) Which of the following factors of production DO NOT flow freely between countries?
A) raw materials
B) financial capital
C) (non-military) technology
D) All of the above factors of production flow freely among countries.

4) Which of the following would NOT be a way to implement comparative advantage?
A) IBM exports computers to Egypt.
B) Computer hardware is designed in the United States but manufactured and assembled in Korea.
C) Water of the greatest purity is obtained from wells in Oregon, bottled, and exported worldwide.
D) All of the above are examples of ways to implement comparative advantage.

5) Of the following, which would NOT be considered a way that government interferes with comparative advantage?
A) tariffs
B) managerial skills
C) quotas
D) other non-tariff restrictions

True/False

1) The theory of comparative advantage owes it origins to Ben Bernanke as described in his book The Wealth of Bankers.

2) International trade might have approached the comparative advantage model in the 19th century, and it does so even more today.

3) Comparative advantage shifts over time as less developed countries become more developed and realize their latent opportunities.

4) Comparative advantage in the 21st century is based more on services and their cross border facilitation by telecommunications and the Internet.

5) Comparative advantage was once the cornerstone of international trade theory, but today it is archaic, simplistic, and irrelevant for explaining investment choices made by MNEs.

6) When discussing comparative advantage, it is apparent that today at least two of the factors of production, capital and technology, now flow directly and easily between countries, rather than only indirectly through traded goods and services.

7) It would be safe to make the statement that modern telecommunications now take business activities to labor rather than moving labor to the places of business.

Multiple Choice

1) Which of the following domestic financial instruments have NOT been modified for use in international financial management?
A) currency options and futures
B) interest rate and currency swaps
C) letters of credit
D) All of the above are domestic financial instruments that have also been modified for use in international financial markets.

True/False

1) MNEs must modify finance theories like cost of capital and capital budgeting because of foreign complexities.

2) Relative to MNEs, purely domestic firms tend to have GREATER political risk.

3) Domestic firms tend to make GREATER use of financial derivatives than MNEs because they can bear the greater risk presented by these financial instruments.

4) Because countries have different financial regulations and customs, it is common for MNEs to apply their domestic rules and regulations when doing financial business in a foreign country.

5) A number of financial instruments that are used in domestic financial management have been modified for use in international financial management. Examples are foreign currency options and futures, interest rate and currency swaps, and letters of credit.

Multiple Choice

1) In determining why a firm becomes multinational there are many reasons. One reason is that the firm is a market seeker. Which of the following is NOT a reason why market-seeking firms produce in foreign countries?
A) satisfaction of local demand in the foreign country
B) satisfaction of local demand in the domestic markets
C) political safety and small likelihood of government expropriation of assets
D) All of the above are market-seeking activities.

2) ________ investments are designed to promote and enhance the growth and profitability of the firm. ________ investments are designed to deny those same opportunities to the firm’s competitors.
A) Conservative; Aggressive
B) Defensive; Proactive
C) Proactive; Defensive
D) Aggressive; Proactive

True/False

1) For firms competing in a world characterized by oligopolistic competition, strategic motives can be subdivided into proactive and defensive investments.

2) Defensive measures are designed to enhance growth and profitability of the firm itself.

Multiple Choice

1) The phase of the globalization process characterized by imports from foreign suppliers and exports to foreign buyers is called the:
A) domestic phase.
B) multinational phase.
C) international trade phase.
D) import-export banking phase.

2) The authors describe the multinational phase of globalization for a firm as one characterized by the:
A) ownership of assets and enterprises in foreign countries.
B) potential for international competitors or suppliers even though all accounts are with domestic firms and are denominated in dollars.
C) imports from foreign suppliers and exports to foreign buyers.
D) requirement that all employees be multilingual.

3) A firm in the International Trade Phase of Globalization:
A) makes all foreign payments in foreign currency units and all foreign receipts in domestic currency units.
B) receives all foreign receipts in foreign currency units and makes all foreign payments in domestic currency units.
C) bears direct foreign exchange risk.
D) none of the above

4) Of the following, which was NOT mentioned by the authors as an increase in the demands of financial management services due to increased globalization by the firm?
A) evaluation of the credit quality of foreign buyers and sellers
B) foreign consumer method of payment preferences
C) credit risk management
D) evaluation of foreign exchange risk

5) Of the following, which was NOT mentioned by the authors as an increase in the demands of financial management services due to increased globalization by the firm?
A) evaluation of the credit quality of foreign buyers and sellers
B) foreign consumer method of payment preferences
C) credit risk management
D) evaluation of foreign exchange risk

6) The authors describe the multinational phase of globalization for a firm as one characterized by the:
A) ownership of assets and enterprises in foreign countries.
B) potential for international competitors or suppliers even though all accounts are with domestic firms and are denominated in dollars.
C) imports from foreign suppliers and exports to foreign buyers.
D) requirement that all employees be multilingual.

7) The twin agency problems limiting financial globalization are caused by these two groups acting in their own self-interests rather than the interests of the firm.
A) rulers of sovereign states and unsavory customs officials
B) corporate insiders and attorneys
C) corporate insiders and rulers of sovereign states
D) attorneys and unsavory customs officials

True/False

1) Typically, a firm in its domestic stage of globalization has all financial transactions in its domestic currency.

2) Typically, a “greenfield” investment abroad is considered a greater foreign investment having a greater foreign presence than a joint venture with a foreign firm.

3) The authors argue that financial inefficiency caused by influential insiders may prove to be an increasingly troublesome barrier to international finance.

4) The authors describe a process for development of a MNE that begins with a purely domestic phase, followed by the multinational phase, and topping out with the international trade phase.

5) Today it is widely assumed that there are NO LIMITS to financial globalization.

6) The growth in the influence and self-enrichment of organizational insiders is seen as an impediment to the growth of financial globalization in general.

7) The actions of corporate insiders and the actions of rulers of sovereign states are both agency costs that act as an impediment to the growth of globalization.

Chapter 2 Corporate Ownership, Goals, and Governance

Multiple Choice

1) Foreign stock markets are frequently characterized by controlling shareholders for the individual publicly traded firms. Which of the following is NOT identified by the authors as typical controlling shareholders?
A) the government (for example, privatized utilities)
B) institutions (such as banks in Germany)
C) family (such as in France)
D) All of the above were identified by the authors as controlling shareholders.

2) Which of the following is NOT typically associated with the public ownership of business organizations?
A) the state
B) the government
C) families
D) civil society

3) Which of the following is NOT typically associated with the private ownership of business organizations?
A) the government
B) families
C) individuals
D) publicly traded, widely-held organizations

4) State Owned Enterprises (SOEs):
A) are a form of public ownership.
B) are created for commercial activities rather than civil or social activities.
C) are the dominant form of business organization in some countries.
D) are all of the above.

5) The problems that may arise due to the separation of ownership and management in large business organizations is know as:
A) separation anxiety.
B) the agency problem.
C) corporate disconnect theory.
D) none of the above

6) Privatization is a term used to describe:
A) firms that are purchased by the government.
B) government operations that are purchased by corporations and other investors.
C) firms that do not use publicly available debt.
D) non-public meetings held by members of interlocking directorates.

True/False

1) In the U.S. and U.K. stock markets are characterized by ownership of firms concentrated in the hands of a few controlling shareholders. In contrast, the rest of the world tends to have more widespread ownership of shares.

2) State Owned Enterprises (SOEs) by their very name cannot be traded on stock exchanges because they are government owned.

3) In recent years the trend has been for markets to increasing focus on the shareholder wealth form of wealth maximization.

4) Non-Anglo-American markets are dominated by the “one-vote-one-share” rule.

5) According to recent research, family-owned firms in some highly-developed economies typically outperform publicly-owned firms.

Essay/Short Answer

1) What are the most important distinctions that make state owned enterprises (SOEs) different from other forms of government organizations?

Multiple Choice

1) “Maximize corporate wealth”:
A) is the primary objective of the non-Anglo-American model of management.
B) as a management objective treats shareholders on a par with other corporate stakeholders such as creditors, labor, and local community.
C) has a broader definition than just financial wealth.
D) all of the above

2) The Shareholder Wealth Maximization Model (SWM):
A) combines the interests and inputs of shareholders, creditors, management, employees, and society.
B) is being usurped by the Stakeholder Capitalism Model as those types of MNEs dominate their global industry segments.
C) clearly places shareholders as the primary stakeholder.
D) is the dominant form of corporate management in the European-Japanese governance system.

3) The Stakeholder Capitalism Model (SCM):
A) clearly places shareholders as the primary stakeholder.
B) combines the interests and inputs of shareholders, creditors, management, employees, and society.
C) has financial profit as its goal and is often termed impatient capital.
D) is the Anglo-American model of corporate governance.

4) In the Anglo-American model of corporate governance, the primary goal of management is to:
A) maximize the wealth of all stakeholders.
B) maximize shareholder wealth.
C) minimize costs.
D) minimize risk.

5) In finance, an efficient market is one in which:
A) prices are assumed to be correct.
B) prices adjust quickly and accurately to new information.
C) prices are the best allocators of capital in the macro economy.
D) all of the above

6) Systematic risk can be defined as:
A) the total risk to the firm.
B) the risk of the individual security.
C) the risk of the market in general.
D) the risk that can be systematically diversified away.

7) Unsystematic risk can be defined as:
A) the total risk to the firm.
B) the risk of the individual security.
C) the added risk that a firm’s shares bring to a diversified portfolio.
D) the risk of the market in general.

8) The study of how shareholders can motivate management to accept the prescriptions of the shareholder wealth maximization model is called:
A) market efficiency.
B) the SWM model.
C) agency theory.
D) the SCM model.

9) Under the Shareholder Wealth Maximization Model (SWM) of corporate governance, poor firm performance is likely to be faced with all but which of the following?
A) sale of shares by disgruntled current shareholders
B) shareholder activism to attempt a change in current management
C) as a maximum threat, initiation of a corporate takeover
D) prison time for executive management

10) Which of the following is a reason why managers act to maximize shareholder wealth in Anglo-American markets?
A) the use of stock options to align the goals of shareholders and managers
B) the market for corporate control that allows for outside takeover of the firm
C) performance based compensation for executive management
D) all of the above

11) Which of the following is NOT true regarding the stakeholder capitalism model?
A) Banks and other financial institutions are less important creditors than securities markets.
B) Labor unions are more powerful than in the Anglo-American markets.
C) Governments interfere more in the marketplace to protect important stakeholder groups.
D) All of the above are TRUE.

12) The stakeholder capitalism model:
A) typically avoids the flaw of impatient capital.
B) tries to meet the desires of multiple stakeholders.
C) may leave management without a clear signal about tradeoffs among the several stakeholders.
D) all of the above

13) Which of the following is generally NOT considered to be a viable operational goal for a firm?
A) maintaining a strong local currency
B) maximization of after-tax income
C) minimization of the firm’s effective global tax burden
D) correct positioning of the firm’s income, cash flows and available funds as to country and currency

14) Which of the following operational goals for the international firm may be incompatible with the others?
A) maintaining a strong local currency
B) maximization of after-tax income
C) minimization of the firm’s effective global tax burden
D) Each of these goals may be incompatible with one or more of the others.

15) The primary operational goal for the firm is to:
A) maximize after-tax profits in each country where the firm is operating.
B) minimize the total financial risk to the firm.
C) maximize the consolidated after-tax profits of the firm.
D) maximize the total risk to the firm.

16) Which of the following broad topics is NOT identified as an area to be established as good corporate governance practice by the Organization for Economic Cooperation and Development (OECD)?
A) protect the rights of shareholders
B) disclosure and transparency
C) the proper role of stakeholders in the governance of the firm
D) All of the above should be a concern of good corporate governance.

17) The relationship among stakeholders used to determine and control the strategic direction and performance of an organization is termed:
A) corporate governance.
B) Anglo-American activism.
C) capital structure.
D) working capital management.

18) When discussing the structure of corporate governance, the authors distinguish between internal and external factors. ________ is an example of an internal factor, and ________ is an example of an external factor.
A) Equity markets; executive management
B) Debt markets; board of directors
C) Executive management; auditors
D) Auditors; regulators

19) Which of the following is NOT commonly associated with a government affiliated form of corporate governance regime?
A) no minority influence
B) lack of transparency
C) state ownership of enterprise
D) All are associated with this type of corporate governance regime.

20) Generally speaking, which of the following is NOT considered an important factor in the composition and control of corporate boards of directors?
A) the number of insider vs outside directors
B) the total number of directors on the board
C) the composition of the compensation committee
D) All of the above are important factors of board composition.

21) Signed into law on July 30, 2002, the ________ Act requires CEOs of publicly traded companies to vouch for the veracity of the firm’s published financial statements.
A) Smoot-Hawley
B) Humphrey-Hawkins
C) McCain-Merrill
D) Sarbanes-Oxley

22) The Sarbanes-Oxley Act, passed by the U.S. Congress in July 2002, was designed to:
A) reinstitute heavy tariffs on international trade.
B) reform corporate governance.
C) limit the Federal Reserve Board’s ability to engage in the buying and selling of gold.
D) limit trade with countries deemed lenient on terrorism.

23) Anglo-American markets is a term used to describe business markets in:
A) North, Central, and South America.
B) the United States, Canada, and Western Europe.
C) the United States, United Kingdom, Canada, Australia and New Zealand.
D) the United States, France, Britain, and Germany.

24) The deliberation of the of the process demonstrated in the European-Japanese system of corporate governance has sometimes been termed:
A) socialism.
B) impatient capital.
C) patient capital.
D) communism.

25) With shareholder wealth maximization as the manager’s goal, capital may be termed:
A) impatient.
B) patient.
C) borrowed.
D) bought.

26) Which of the following is NOT an important concept when distinguishing between international and domestic financial management?
A) corporate governance
B) culture, history, and institutions
C) political risk
D) All of the above are important distinguishing concepts.

27) The Board of Directors:
A) consists exclusively of the officers of the corporation.
B) is the legal body which is accountable for the governance of the corporation.
C) are not subject to the external forces of the marketplace.
D) is appointed by the Securities and Exchange Commission (SEC).

28) If share price rises from $12 to $15 per share, and pays a dividend of $1 per share, what was the rate of return to shareholders?
A) 26.67%
B) -13.33%
C) 33.33%
D) 16.67%

29) PolyProduction Inc. has two classes of common stock. Class A has 5 million shares with 10 votes per share. Class B has 5 million shares with 1 vote per share. If the dividends per share are equal for both class A and B stock, then Class A shareholders have ________ of the votes and ________ of the dividends.
A) 90.91%; 90.91%
B) 90.91%; 50.00%
C) 50.00%; 50.00%
D) 83.33%; 33.33%

30) The number of publicly traded firms:
A) peaked in the U.S. in 1996.
B) peaked worldwide in 1996.
C) increased significantly in 2009 as a result of the international financial crisis.
D) all of the above

31) Which of the following is NOT a possible and appropriate response by shareholders dissatisfied with existing firm management of a publicly traded firm?
A) Shareholders could sell their shares of stock.
B) Shareholders could remain quietly disgruntled.
C) Shareholders, perhaps with the help of others, could attempt to initiate a takeover.
D) All of these responses may be possible and appropriate.

True/False

1) The stakeholder capitalism model (SCM) holds that total risk (operational and financial) is more important than just systematic risk.

2) In recent years the trend has been for markets to increasing focus on the shareholder wealth form of wealth maximization.

3) Patient Capitalism is characterized by short-term focus by both management and investors.

4) Agency theory states that unsystematic risk can be eliminated through diversification.

5) The stakeholder capitalism model does not assume that equity markets are either efficient or inefficient.

6) The stakeholder capitalism model assumes that only systematic risk “counts” or is a prime concern for management.

7) Dividend yield is the change in the share price of stock as traded in the public equity markets.

8) Regarding comparative corporate governance regimes: Bank-based regimes characterized by government influence in bank lending and a lack of transparency is often found in countries such as Korea and Germany.

9) Investor protection is typically better in countries with codified civil law (the Code Napoleon) than in countries with a legal system based in English common law.

10) The relatively low cost of compliance with the Sarbanes-Oxley Act (SOX) has been a surprising benefit of the act.

11) According to recent research, family-owned firms in some highly-developed economies typically outperform publicly-owned firms.

12) The goal of all international corporations is to maximize shareholder wealth.

13) Systematic risk can be eliminated through portfolio diversification.

14) According to the authors, dual classes of voting stock are the norm in non-Anglo-American markets.

15) A recent study shows that privately held firms use less financial leverage and enjoy lower costs of debt than publicly traded firms.

16) U.S. listings of publicly traded firms as a percentage of worldwide listings of such firms INCREASED from 11% in 1996 to approximately 33% in 2010.

17) Having Anglo-Americans as members of the board of directors of a non-Anglo-American firm signals poor corporate governance in the firm.

18) In the stakeholder capitalism model (SCM) the assumption of market efficiency is absolutely critical.

Short Answer/ Essay

1) Describe the management objectives of a firm governed by the shareholder wealth maximization model and one governed by the stakeholder wealth maximization model. Give an example of how these two models may lead to different decision-making by executive management.

2) Define patient and impatient capitalism and discuss how each may lead to different decision-making in the shareholder wealth maximization model.

Chapter 3 The International Monetary System

Multiple Choice

1) Under the gold standard of currency exchange that existed from 1879 to 1914, an ounce of gold cost $20.67 in U.S. dollars and £4.2474 in British pounds. Therefore, the exchange rate of pounds per dollar under this fixed exchange regime was:
A) £4.8665/$.
B) £0.2055/$.
C) always changing because the price of gold was always changing.
D) unknown because there is not enough information to answer this question.

2) World War I caused the suspension of the gold standard for fixed international exchange rates because the war:
A) cost too much money.
B) interrupted the free movement of gold.
C) lasted too long.
D) used gold as the main ingredient in armament plating.

3) The post WWII international monetary agreement that was developed in 1944 is known as the:
A) United Nations.
B) League of Nations.
C) Yalta Agreement.
D) Bretton Woods Agreement.

4) Another name for the International Bank for Reconstruction and Development is:
A) the Recon Bank.
B) the European Monetary System.
C) the Marshall Plan.
D) the World Bank.

5) The International Monetary Fund (IMF):
A) in recent years has provided large loans to Russia, South Korea, and Brazil.
B) was created as a result of the Bretton Woods Agreement.
C) aids countries with balance of payment and exchange rate problems.
D) is all of the above.

6) Which of the following led to the eventual demise of the fixed currency exchange rate regime worked out at Bretton Woods?
A) widely divergent national monetary and fiscal policies among member nations
B) differential rates of inflation across member nations
C) several unexpected economic shocks to member nations
D) all of the above

7) Which of the following statements is NOT true?
A) The Gold Standard Era was characterized by growing openness in trade, but limited capital mobility.
B) The time period between world wars 1 and 2 (the inter war Years) witnessed significant reductions in trade barriers and a rapid acceleration in international trade.
C) The Bretton Woods Era (post WWII) realized the increasing benefits of open economies. Furthermore, trade was increasingly dominated by capital.
D) In fact, all of the above statements are true.

True/False

1) Under the terms of Bretton Woods, countries tried to maintain the value of their currencies to within 1% of a hybrid security made up of the U.S. dollar, British pound, and Japanese yen.

2) Members of the International Monetary Fund may settle transactions among themselves by transferring Special Drawing Rights (SDRs).

3) Today, the United States has been ejected from the International Monetary Fund for refusal to pay annual dues.

4) From the time of its creation through July 2012, the euro peaked versus the USD in April 2008 at around $1.60/€

Essay

1) Most Western nations were on the gold standard for currency exchange rates from 1876 until 1914. Today we have several different exchange rate regimes in use, but most larger economy nations have freely floating exchange rates today and are not obligated to convert their currency into a predetermined amount of gold on demand. Currently several parties still call for the “good old days” and a return to the gold standard. Develop an argument as to why this is a good idea.

Multiple Choice

1) Since 2009 the IMF’s exchange rate regime classification system uses a “de facto classification” methodology. Under this system, a country that has given up their own sovereignty over monetary
policy is considered to have:
A) a residual agreement.
B) hard pegs.
C) soft pegs.
D) floating arrangements.

2) Since 2009 the IMF’s exchange rate regime classification system uses a “de facto classification” methodology. Under this system, countries with “fixed exchange rates” are considered to have:
A) a residual agreement.
B) soft pegs.
C) hard pegs.
D) floating arrangements.

3) A small economy country whose GDP is heavily dependent on trade with the United States could use a(n) ________ exchange rate regime to minimize the risk to their economy that could arise due to unfavorable changes in the exchange rate.
A) pegged exchange rate with the United States
B) pegged exchange rate with the Euro
C) independent floating
D) managed float

4) Since 2009 the IMF’s exchange rate regime classification system uses a “de facto classification” methodology. Under this system, currencies that are predominantly market-driven are considered to be:
A) soft pegs.
B) hard pegs.
C) floating arrangements.
D) a residual agreement.

True/False

1) The euro is an example of a rigidly fixed system, acting as a single currency for its member countries. However, the euro itself is an independently floating currency against all other currencies.

2) Although the contemporary international monetary system is typically referred to as a “floating regime,” it is clearly not the case for the majority of the world’s nations.

Essay

1) The mobility of international capital flows is causing emerging market nations to choose between a free-floating currency exchange regime and a currency board (or taken to the limit, dollarization). Describe how each of the regimes would work and identify at least two likely economic results for each regime.

Multiple Choice

1) Based on the premise that, other things equal, countries would prefer a fixed exchange rate, which of the following statements is NOT true?
A) Fixed rates provide stability in international prices for the conduct of trade.
B) Fixed exchange rate regimes necessitate that central banks maintain large quantities of international reserves for use in the occasional defense of the fixed rate.
C) Fixed rates are inherently inflationary in that they require the country to follow loose monetary and fiscal policies.
D) Stable prices aid in the growth of international trade and lessen exchange rate risks for businesses.

2) Which of the following is NOT an attribute of the “ideal” currency?
A) monetary independence
B) full financial integration
C) exchange rate stability
D) All are attributes of an ideal currency.

3) The authors discuss the concept of the “Impossible Trinity” or the inability to achieve simultaneously the goals of exchange rate stability, full financial integration, and monetary independence. If a country chooses to have a pure float exchange rate regime, which two of the three goals is a country most able to achieve?
A) monetary independence and exchange rate stability
B) exchange rate stability and full financial integration
C) full financial integration and monetary independence
D) A country cannot attain any of the exchange rate goals with a pure float exchange rate regime.

True/False

1) Based on the premise that, other things equal, countries would prefer a fixed exchange rate: Variable rates provide stability in international prices for the conduct of trade.

2) If exchange rates were fixed, investors and traders would be relatively certain about the current and near future exchange value of each currency.

Multiple Choice

1) Which of the following is NOT a required convergence criteria to become a full member of the European Economic and Monetary Union (EMU)?
A) National birthrates must be at 2.0 or lower per person.
B) The fiscal deficit should be no more than 3% of GDP.
C) Nominal inflation should be no more than 1.5% above the average inflation rate for the three members with the lowest inflation rates in the previous year.
D) Government debt should be no more than 60% of GDP.

2) According to the authors, what is the single most important mandate of the European Central Bank?
A) Promote international trade for countries within the European Union.
B) Price, in euros, all products for sale in the European Union.
C) Promote price stability within the European Union.
D) Establish an EMU trade surplus with the United States.

3) Which of the following is a way in which the euro affects markets?
A) Countries within the Euro zone enjoy cheaper transaction costs.
B) Currency risks and costs related to exchange rate uncertainty are reduced.
C) Consumers and business enjoy price transparency and increased price-based competition.
D) all of the above

4) For the three years from early 2002 to early 2005, the euro maintained a strong and steady rise in value against the U.S. dollar (USD). After a brief respite in 2005, the euro continued its climb against the USD into 2008. Which of the following were NOT a contributing factor in the assent of the euro and the decline in the dollar?
A) severe U.S. balance of payments deficits
B) a general weakening of the dollar after the attacks of September 11, 2001
C) large U.S. balance of payment surpluses
D) All of the above were contributing factors.

5) The countries that use the euro as their currency have:
A) agreed to use a single currency (exchange rate stability), allow the free movement of capital in and out of their economies (financial integration), but give up individual control of their own money supply (monetary independence).
B) gained control over their own money supply (monetary independence), allowed the free movement of capital in and out of their economies (financial integration), but give up exchange rate stability.
C) agreed to use a single currency (exchange rate stability), allow individual control of their own money supply (monetary independence), but give up the free movement of capital in and out of their economies (financial integration).
D) none of the above

True/False

1) The Euro currency is fixed against other currencies on the international currency exchange markets, but allows member country currencies to float against each other.

2) The European Central Bank is a strong and independent central bank that has completely replaced the individual central banks of the countries that use the euro as their currency.

3) The members of the EU do have relative freedom to set their own fiscal policies— government spending, taxation, and the creation of government surpluses or deficits. They are expected to keep deficit spending within limits.

Multiple Choice

1) Beginning in 1991 Argentina conducted its monetary policy through a currency board. In January 2002, Argentina abandoned the currency board and allowed its currency to float against other currencies. The country took this step because:
A) the Argentine Peso had grown too strong against major trading powers thus the currency board policies were hurting the domestic economy.
B) the United States required the action as a prerequisite to finalizing a free trade zone with all of North, South, and Central America.
C) the Argentine government lost the ability to maintain the pegged relationship as in fact investors and traders perceived a lack of equality between the Argentine Peso and the U.S. dollar.
D) all of the above

2) In January 2002, the Argentine Peso changed in value from Peso1.00/$ to Peso1.40/$, thus, the Argentine Peso ________ against the U.S. dollar.
A) strengthened
B) weakened
C) remained neutral
D) all of the above

3) In January 2000 Ecuador officially replaced its national currency, the Ecuadorian sucre, with the U.S. dollar. This practice is known as:
A) bi-currencyism.
B) sucrerization.
C) a Yankee bailout.
D) dollarization.

4) You have been hired as a consultant to the central bank for a country that has for many years suffered from repeated currency crises and depends heavily on the U.S. financial and product markets. Which of the following policies would have the greatest effectiveness for reducing currency volatility of the client country with the United States?
A) dollarization
B) an exchange rate pegged to the U.S. dollar
C) an exchange rate with a fixed price per ounce of gold
D) an internationally floating exchange rate

5) Which of the following is NOT an argument against dollarization?
A) Dollarization causes a loss of sovereignty over domestic monetary policy.
B) Dollarization removes currency volatility against the dollar.
C) Dollarization causes the country to lose the power of seignorage.
D) The central bank of the dollarized country loses the role of lender of last resort.

6) The ability of a country to profit from its ability to print money is known as:
A) profiteering.
B) dollarization.
C) seignorage.
D) inflation.

7) Which of the following factors make it difficult for emerging market economies to choose a specific currency regime?
A) weak fiscal, financial, and monetary institutions
B) the tendency for commerce to allow currency substitution and the denomination of liabilities in dollars
C) the emerging market’s vulnerability to sudden stoppages of outside capital flows
D) all of the above

True/False

1) A currency board exists when a country’s central bank commits to back its money supply entirely with foreign reserves at all times.

2) Dollarization is a common solution for countries suffering from currency revaluation.

3) By and large, high capital mobility is forcing emerging market nations to choose between the two extremes of a free floating regime or an exchange rate regime of dollarization of a currency board.

Multiple Choice

1) Of the following, which is NOT a trade-off that must be dealt with in any exchange rate regime?
A) cooperation vs independence
B) rules vs discretionary action
C) dollars vs pounds
D) All of the above are rate regime trade-offs.

True/False

1) All exchange rate regimes must deal with the trade-off between rules and discretion as well as between cooperation and independence.

2) Regime structures like the gold standard required no cooperative policies among countries, only the assurance that all would abide by the “rules of the game.”

3) Bretton Woods required less in the way of cooperation among countries than did the gold standard.

Chapter 4 The Balance of Payments

Multiple Choice

1) Which of the following is NOT a major subaccount of the Balance of Payments?
A) the financial account
B) the accounts payable
C) the capital account
D) the current account

2) Which of the following international transactions would NOT be counted as a balance of payments (BOP) transaction?
A) An American tourist purchases cheese in Milwaukee, Wisconsin.
B) The U.S. subsidiary of a British firm pays profits (dividends) back to its parent firm in London.
C) A Canadian lumber baron purchases a U.S. corporate bond through an investment broker in
Seattle.
D) All of the above are considered BOP transactions.

3) The balance of payments as applied to a course in international finance may be defined as:
A) the amount still owed by an exporting firm after making an initial down payment.
B) the amount still owed by governments to the International Monetary Fund.
C) the measurement of all international economic transactions between the residents of a country and foreign residents.
D) the amount of a country’s merchandise trade deficit or surplus.

4) Balance of payment (BOP) data may be important for any of the following reasons:
A) BOP data helps to forecast a country’s market potential, especially in the short run.
B) The BOP is an important indicator of a country’s foreign exchange rate.
C) Changes in a country’s BOP may signal a change in controls over payment of dividends and interest.
D) all of the choices provided above

5) A country experiencing a serious BOP ________ is more likely to ________ exports than otherwise.
A) surplus; contract
B) surplus; expand
C) deficit; expand
D) none of the above

6) Which of the following would NOT be considered a typical BOP transaction?
A) Toyota U.S.A. is a U.S. distributor of automobiles manufactured in Japan by its parent company.
B) The U.S. subsidiary of European financial giant, Credit Suisse, pays dividends to its parent in Zurich.
C) A U.S. tourist purchases gifts at a museum in London.
D) All are example of BOP transactions.

True/False

1) When the world went to a system of floating exchange rates, the Balance of Payments became a relic of a system of fixed exchange rates and is no longer watched by serious economic groups.

2) Changes in the BOP may predict the imposition or removal of foreign exchange controls.

3) A country experiencing a serious trade deficit is not as likely to expand imports as it would
be if running a surplus.

Multiple Choice

1) Which of the following is NOT a part of the Current Account of BOP?
A) net export/import of goods
B) balance of trade
C) net portfolio investment
D) net export/import of services

2) Which of the following is NOT part of the Financial Account of the BOP?
A) net foreign direct investment
B) net import/export of services
C) net portfolio investment
D) other Financial items

3) Which of the following is NOT an item to be considered in BOP calculations?
A) A foreign resident purchases a U.S. Treasury Bill.
B) A U.S.-based firm manages the development of an oil field in Kazakhstan.
C) A consumer buys a VCR made in Korea from a Florida Wal-Mart store.
D) A U.S. citizen living in Minnesota travels to Winnipeg, Canada, and buys a case of LaBatt’s Canadian beer.

4) The balance of payments:
A) determines the eligibility of countries for IMF aid.
B) adds up the value of all assets and liabilities of a country on a specific date.
C) records all international transactions for a country over a period of time.
D) all of the above

5) An American tourist purchases a leather jacket while in Italy. Which of the following statements is true?
A) The leather purchase would be considered an import for the U.S. BOP.
B) This transaction would be properly accounted for in the Current Account of the U.S. BOP.
C) The leather purchase is considered an import of a good, and thus, considered part of the balance of trade as well.
D) All of these statements are true.

True/False

1) The authors identify a tip for understanding BOP accounting. They recommend that you “follow the cash flow.”

2) The BOP must be in balance, but the current account need not be.

3) Expenditures by U.S. tourists in foreign countries for foreign goods or services are factored into BOP calculations.

4) Like a balance sheet, the Balance of Payments adds up the value of all assets and liabilities
of a country on a specific date.

Essay

1) What is a country’s balance of (merchandise) trade, and why is it so widely reported in the financial and popular press?

2) What is the Official Reserves Account (ORA), and why is it more important for countries under a fixed exchange rate regime than for ones under a floating exchange rate regime?

Multiple Choice

1) Which of the following is NOT part of the balance of payments account?
A) the current account
B) the financial/capital account
C) the official reserves account
D) All of the above are BOP accounts.

2) The ________ includes all international economic transactions with income or payment flows occurring within the year.
A) capital account
B) current account
C) financial account
D) IMF account

3) If your company were to import and export textiles, the transactions would be recorded in the current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.

4) The travel services provided to international travelers by United Airlines would be recorded in the current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.

5) Anaconda Copper Inc. created a subsidiary in Chile last year to mine copper ore. The proportion of net income paid back to the parent company as a dividend would be recorded in the current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.

6) The subcategory that typically dominates the current account is:
A) goods (merchandise) trade.
B) services trade.
C) income trade.
D) transfer accounts.

7) In 2010 the United States posted a current account deficit of -$471 billion. The bulk of the negative value came from:
A) a net transfer deficit.
B) an income balance deficit.
C) a goods trade deficit.
D) an income trade deficit.

8) Over the last two decades the surplus on U.S. services trade has typically been ________ the deficit on U.S. goods trade.
A) greater than
B) equal to
C) less than
D) The relationship is constantly shifting from greater than to less than.

True/False

1) Because current and financial/capital account balances use double-entry bookkeeping it is unusual to find serious discrepancies in the debits and credits.

2) In general, as a country’s income increases, so does the demand for imports.

3) For at least the last decade, the United States has consistently run a surplus in services trade income.

4) Expenditures by U.S. students abroad and foreign students pursuing studies in the United States would be considered a services trade and part of the U.S. current account.

Multiple Choice

1) The ________ of the balance of payments measures all international economic transactions of financial assets.
A) current account
B) merchandise trade account
C) services account
D) capital and financial accounts

2) The financial account consists COMPLETELY of which four components?
A) stock investment, bond investment, derivative investment, and mutual fund investment
B) direct investment, stock investment, net financial derivatives, and bond investment
C) direct investment, portfolio investment, net financial derivatives, and other asset investment
D) mutual fund investment, portfolio investment, derivative investment, and stock investment

3) When categorizing investments for the financial account component of the balance of payments the ________ is an investment where the investor has no control whereas the ________ is an investment where the investor has control over the asset.
A) direct investment; portfolio investment
B) direct investment; indirect investment
C) portfolio investment; indirect investment
D) portfolio investment; direct investment

4) In general there is consensus that ________ should be free, but there is no such consensus that ________ should be free.
A) international investment; international goods trade
B) international investment; international trade
C) international trade; international goods trade
D) international trade; international investment

5) The two major concerns about foreign direct investment are:
A) national defense and taxes.
B) who controls the assets and who receives the profits.
C) who receives the profits and taxes.
D) who pays the taxes and who receives the taxes.

6) Portfolio investment is capital invested in activities that are ________ rather than made for ________.
A) short term; the long term
B) long term; profit
C) profit motivated; control
D) control motivated; profit

7) Under an international regime of fixed exchange rates, countries with a BOP ________ should consider ________ their currency while countries with a BOP ________ should consider ________ their currency.
A) deficit, revaluing; surplus, revaluing
B) deficit, devaluing; surplus, devaluing
C) surplus, devaluing; deficit, revaluing
D) surplus, revaluing; deficit, devaluing

8) Consider the following: A foreign automobile company builds a manufacturing plant in Tennessee and European investors buy U.S. Treasury Bonds.
A) Both activities would be considered direct investment.
B) Both activities would be considered portfolio investment.
C) The auto manufacturer in engaging in portfolio investment, and the European investors are engaged in direct investing.
D) The auto manufacturer in engaging in direct investment, and the European investors are engaged in portfolio investing.

True/False

1) International debt security purchases and sales are defined as portfolio investments for financial account purposes because by definition debt securities do not provide the buyer with ownership or control.

2) Significant amounts of United States Treasury issues are purchased by foreign investors, therefore the U.S. must earn foreign currency to repay this debt.

3) In the United States and most developed countries, the current account and the combined financial/capital accounts tend to be inversely related in that when one is positive, the other tends to be negative.

Multiple Choice

1) China is currently experiencing a surplus in its current account and its capital/financial accounts. Which of the following is NOT a contributing factor for this unusual situation?
A) The exceptional growth in the Chinese economy contributes to the current account surplus.
B) The positive prospects for China’s continued growth contribute to the capital/financial account surplus.
C) China’s inevitable acquisition of Taiwan is driving the market for Chinese investment.
D) All of the above are contributing factors for China’s twins surpluses.

2) If China wished to reduce their accumulation of foreign exchange reserves they could:
A) allow their currency, the yuan, to float freely in the market place.
B) reduce their current account surplus by importing more goods than they export.
C) undertake both of the activities identified in choices A and B.
D) dig a big hole and bury the reserves.

True/False

1) The biggest problem that China faces in maintaining a stable value for their currency, the yuan, is their lack of foreign exchange reserves.

2) As of year-end 2010, the United States still held the world’s largest foreign exchange reserve, but the total was rapidly being approached by China.

3) China’s current political plan includes reducing their foreign exchange reserve balance by allowing the yuan to float freely and by switching their goods balance from one of a net surplus to a net deficit.

4.6 The Balance of Payments in Total

Multiple Choice

1) The largest single component of the United States current account is:
A) current transfers.
B) income payments and receipts.
C) goods (merchandise) imports and exports.
D) services imports and exports.

2) Which of the following statements about the balance of payments is NOT true?
A) The BOP is the summary statement of all international transactions between one country and all other countries.
B) The BOP is a flow statement, summarizing all international transactions that occur across the geographic borders over a period of time, typically a year.
C) Although the BOP must always balance in theory, in practice there are substantial imbalances as a result of statistical errors and misreporting of current account and financial account flows.
D) All of the above are true.

True/False

1) An excess of merchandise exports over merchandise imports results in a balance of trade deficit.

2) The BOP should always balance.

3) The transition to floating exchange rate regimes in the 1970s (described in Chapter 3) changed the focus from the total BOP to its various subaccount like the current and financial account balances.

4.7 The Balance of Payments Interaction with Key Macroeconomic Variables

Multiple Choice

1) Use the following terms for this question:
C = consumption
I = capital investment spending
G = government spending
X = exports of goods and services
M = imports of goods and services
BOP = balance of payments
GDP = gross domestic product
NPV = net present value
INF = inflation
R = real rate of return

The static equation for the nations GDP is:
A) GDP = C + I + G + (X + M ) × INF
B) GDP = C + I + G + X + M
C) GDP = C + I + G + X – M
D) GDP = C + I + X – M + R

2) Imports have the potential to lower a country’s inflation rate because of each of the following EXCEPT:
A) the import of lower priced goods limits what domestic competitors can charge for goods.
B) the import of lower priced services limits what domestic competitors can charge for services.
C) the higher prices of foreign goods spurs domestic competitors to cut prices.
D) all of the above

3) Under a fixed exchange rate system, the government bears the responsibility to ensure that the BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves. If the sum of the first two accounts is GREATER THAN ZERO, a ________ demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervene in the foreign exchange market and ________ domestic currency for foreign currencies or gold so as to bring the BOP back near zero.
A) surplus; sell
B) surplus; buy
C) deficit; sell
D) deficit; buy

4) Under a fixed exchange rate system, the government bears the responsibility to ensure that the BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves. If the sum of the first two accounts is LESS THAN ZERO, a ________ demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervene in the foreign exchange market and ________ domestic currency for foreign currencies or gold so as to bring the BOP back near zero.
A) surplus; sell
B) surplus; buy
C) deficit; sell
D) deficit; buy

True/False

1) An increase in GDP should lead to a decrease in imports.

2) The effect of an imbalance in the BOP is the same for countries on a fixed exchange rate regime as for those on a floating exchange rate regime.

3) Under a floating exchange rate system, the government bears the responsibility to ensure that the BOP is near zero.

4) A country with a managed float that wishes to WEAKEN its currency may choose to raise domestic interest rates to attract additional capital from abroad.

5) A country’s overall level of interest rates should have an impact on the financial account of the BOP. Relatively low real interest rates should normally stimulate an outflow of capital seeking higher interest rates in other country currencies.

6) Imports have the potential to lower a country’s inflation rate. In particular, imports of HIGHER-priced goods and services place a limit on what domestic competitors charge for comparable goods and services.

4.8 Trade Balances and Exchange Rates

Multiple Choice

1) Of the following, which is NOT a part of J-Curve adjustment path?
A) the currency contract period
B) the exchange rate pass-through period
C) the quantity adjustment period
D) Each of the above is part of the J-Curve adjustment path.

2) Which of the following is NOT likely to occur in the quantity adjustment phase of the J-Curve adjustment path?
A) Imports become relatively more expensive.
B) Exports become relatively less expensive.
C) The balance of trade gets worse.
D) All of the above are true.

True/False

1) When a currency is devalued the immediate impact may be an increase in a country’s trade deficit. However, this situation tends to correct itself in 2 to 5 weeks.

Comment: This situation tends to correct itself in 3 to 12 MONTHS or more.

4.9 Capital Mobility

Multiple Choice

1) The authors identify four distinct periods of capital mobility since 1860. Which do they term as a “period of global economic destruction”?
A) 1860 – 1914
B) 1914 – 1945
C) 1945 – 1971
D) 1971 – 2007

2) ________ is the cross-border purchase of assets that are then managed in a way that hides the movement of money and its ownership.
A) Capital flight
B) Capital mobility
C) Irrational exuberance
D) Money laundering

3) This was an era dominated by industrialized nation economies that were dependent on gold convertibility to maintain confidence in the system.
A) The Gold Standard, 1860-1914
B) The Interwar Years , 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997

4) This dollar-based fixed exchange rate system gave rise to a long period of economic recovery and growing openness of both international trade and capital flows in and out of more and more countries.
A) The Gold Standard, 1860-1914
B) The Interwar Years , 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997

5) An era of retrenchment, in which major economic powers returned to policies of isolationism and protectionism, restricting trade and nearly eliminating capital mobility.
A) The Gold Standard, 1860-1914
B) The Interwar Years , 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997

6) A ________ is any restriction that limits or alters the rate or direction of capital movement into or out of a country.
A) capital budget
B) capital control
C) balance of trade deficit
D) balance of trade surplus

True/False

1) The Bretton Woods era realized a great expansion of international trade in goods and services.

Essay/Short Answer

1) Dutch Disease is a term applied to a problem in the 1970 whereby the Netherlands were experiencing massive and sudden inflows of capital from abroad. What was the cause of this sudden influx of capital, and what types of potential problems did it have for the Dutch or could it have for any small single resource country?

Chapter 5 The Continuing Global Financial Crisis

5.1 The Credit Crisis of 2008-2009

Multiple Choice

1) Investment banks and stock brokerages have traditionally been regulated by the:
A) Federal Reserve System (FED).
B) Federal Deposit Insurance Corporation (FDIC).
C) Securities and Exchange Commission (SEC).
D) Internal Revenue Service (IRS).

2) The Glass-Steagall Act of 1933:
A) separated commercial banking activities from investment banking activities.
B) created the Federal Reserve System.
C) developed the system of commercial bank deposit insurance.
D) all of the above

3) Which of the following is NOT another term for a prime mortgage loan?
A) conventional loan
B) top-qual loan
C) conforming loan
D) All of the above are suitable terms for a prime mortgage loan.

4) The process of turning an illiquid asset into a liquid saleable asset is called:
A) swapping.
B) wrapping.
C) securitization.
D) creationism.

5) Asset-backed securities (ABSs) may be securitized based on:
A) auto loans.
B) home-equity loans.
C) credit card receivables.
D) all of the above

6) A ________ is a financial intermediation device that allowed the participant to borrow short and lend long.
A) sub-prime loan
B) structured investment vehicle
C) non-conforming loan
D) all of the above

7) A ________ is a securitized financial instrument that is sold to the market in tranches representing different levels of default risk.
A) guaranteed security asset (GSA)
B) mortgaged backed security (MBS)
C) credit default swap (CDS)
D) collateralized debt obligation (CDO)

8) Which of the following statements concerning credit default swaps is FALSE?
A) As of year-end 2008, CDSs are completely outside of regulatory boundaries.
B) A CDS is a derivative security that may be used for hedging risk or for speculative purposes.
C) In order be a party to a CDO, at least one of either the buyer or seller must own the underlying asset.
D) CDSs allow banks to severe their links to their borrowers, thereby reducing their incentive to screen and monitor the ability of borrowers to repay.

9) ________ is the method of making investments more attractive to prospective buyers by reducing their perceived risk.
A) Subordination
B) Credit enhancement
C) Derivation
D) Deregulation

True/False

1) Mortgage loans in the U.S. are classified by risk into one of three types: prime, alt-A, and sub-prime.

2) Alt-A mortgage loans are NOT eligible for sale to GSEs such as Fannie Mae or Freddie Mac.

3) The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 explicitly allowed corporate combinations of commercial banks with other types of financial institutions such as insurance companies and investment banking firms.

4) Subprime mortgages did not exceed 8% of all outstanding mortgage obligations by 2007, but by the end of 2008 they were the source of 65% of bankruptcy filings by homeowners in the United States.

5) Even though household debt as a percentage of disposable income rose rapidly in the United States in early 2000s, the rate was even greater in Britain, topping out at over 170% in 2008.

6) From 1990 through 2007, the amount of securitized loans outstanding dropped from over $25 trillion to less than $5 trillion and was a key element in the loss of market liquidity.

7) It is pretty clear after reading this chapter that securitization in and of itself is a poor financial idea.

8) Securitization may degrade credit quality because the process severs the link of lending and repayment (risk and reward) between the originator of the loan and the borrower.

9) The authors make it clear that the main source of market failure with collateralized debt obligations lay almost exclusively with the rating agencies.

10) Credit Default Swaps are highly regulated financial instruments as a result of the Commodity Futures Modernization Act of 2000.

Essay/Short Answer

1) What is a Collateralized Debt Obligation (CDO)? In your answer explain how CDOs are generally separated into one of three tranches. What types of mistakes were made by security rating agencies that contributed to the collapse of the CDO market?

5.2 Global Contagion

Multiple Choice

1) Which of the following is NOT identified by the authors as a “safe-haven” currency?
A) the euro
B) the British pound
C) the U.S. dollar
D) the Japanese yen

2) The accounting procedure whereby assets are revalued to market value basis on a daily basis is known as:
A) FASB rule 62.
B) market value accounting.
C) marked-to-market.
D) none of the above

3) The typical TED spread, the difference between the LIBOR and the interest rate swap index, is typically about ________ basis points.
A) 350
B) 180
C) 120
D) 80

4) The three stages of the global credit crisis of 2009-2009 were:
A) 1. The failure of commercial and investment financial institutions, 2. the failure of specific mortgage-backed securities, 3. a credit-induced global recession.
B) 1. The failure of specific mortgage-backed securities, 2. the failure of commercial and investment financial institutions, and 3. a credit-induced global recession.
C) 1. The failure of commercial and investment financial institutions, 2. a credit-induced global recession, 3. the failure of specific mortgage-backed securities credit-induced global recession.
D) 1. The failure of specific mortgage-backed securities, 2. a credit-induced global recession, 3. failure of commercial and investment financial institutions.

5) The British Bankers Association (BBA) estimates that LIBOR was used in the pricing of more than ________ in assets globally.
A) $100 billion
B) $360 billion
C) $360 trillion
D) $100 trillion

6) Which of the following pieces of U.S. legislation was developed and passed in response to the 2008-2009 international credit crisis?
A) Gramm-Leach-Bliley Financial Services Modernization Act
B) Dodd-Frank Wall Street Reform and Consumer Protection Act
C) Depository Institutions Deregulation and Monetary Control Act
D) The Glass-Steagall Act

True/False

1) Bear-Stearns is the largest single bankruptcy in U.S. history.

2) The international credit crisis began in full force in September 2008.

3) Near the end of the U.S. housing boom, many of the mortgages classified as Alt-A were in fact sub-prime.

4) LIBOR stand for the London Interbank Offered Rate.

5) The credit crisis was worsened by the destabilizing effects of speculators, in a variety of different institutions, betting that particular instruments or markets or securities would fail.

Essay/Short Answer

1) What is TARP? Provide an argument for why TARP was necessary and successful.

5.3 The European Debt Crisis of 2009-2012

Multiple Choice

1) Portfolio theory relies on combining assets with ________ return correlation exclusively to reduce risk.
A) highly positive
B) low
C) zero
D) none of the above

2) Future financial market regulation must include all of the following EXCEPT:
A) renewed regulatory requirements.
B) increased reporting.
C) greater transparency in pricing and valuation.
D) Regulation must include all of the above.

3) In finance, a liquid asset:
A) sells quickly.
B) sells at or near its market value.
C) both A and B
D) none of the above

4) Debt issued by the national government is called:
A) debenture debt.
B) municipal debt.
C) sovereign debt.
D) none of the above

5) The member nations of the European Union have relative freedom to set their own fiscal policies EXCEPT for which of the following?
A) government spending
B) government taxation
C) government surpluses or deficits
D) government printing of the euro currency

6) When the EU moved to a single currency with the adoption of the euro, its member states agreed to each of the following EXCEPT:
A) a single currency.
B) control of their own money supply.
C) free movement of capital in and out of their economies.
D) In fact, the member states agreed to ALL of the above.

7) As of 2011, the European countries with the highest debt/GDP ratio were, in order:
A) Greece, Italy, Portugal, and Slovenia.
B) Greece, Italy, France, and Germany.
C) Greece, Italy, Ireland, and Portugal.
D) Greece, Italy, Great Britain, and Portugal.

8) In October 2009, the new government of Greece estimated the size of the 2009 government budget deficit as 12.7% of GDP rather than the previously published:
A) 3.4%.
B) 6.7%.
C) 8.6%.
D) 10.2%.

True/False

1) The authors conclude the chapter with a specific road map for future financial regulation.

2) Baring the (hopefully temporary setback of 2008) capital is more mobile today than ever before.

3) Securitization is likely to be declared illegal in the U.S. though it may still exist elsewhere in the world.

4) Every EU member nation has the right to simply print more euros.

5) The members of the EU’s eurozone (euro participants) do NOT have the ability to conduct independent monetary policy.

6) The European Financial Stability Facility (EFSF) has a mandate to safeguard financial stability in Europe by providing financial assistance to euro area Member States.

7) Ireland and Greece had the same issues lead to their financial crises in 2009. In each case, the previous government had dramatically understated the size of their federal budget deficit as a percentage of GDP.

Chapter 6 The Foreign Exchange Theory and Markets

6.1 Geographical Extent of the Foreign Exchange Market

Multiple Choice

1) Which of the following is NOT true regarding the market for foreign exchange?
A) The market provides the physical and institutional structure through which the money of one country is exchanged for another.
B) The rate of exchange is determined in the market.
C) Foreign exchange transactions are physically completed in the foreign exchange market.
D) All of the above are true.

2) A/An ________ is an agreement between a buyer and seller that a fixed amount of one currency will be delivered at a specified rate for some other currency.
A) Eurodollar transaction
B) import/export exchange
C) foreign exchange transaction
D) interbank market transaction

3) While trading in foreign exchange takes place worldwide, the major currency trading centers are located in:
A) London, New York, and Tokyo.
B) New York, Zurich, and Bahrain.
C) Paris, Frankfurt, and London.
D) Los Angeles, New York, and London.

True/False

1) Because the market for foreign exchange is worldwide, the volume of foreign exchange currency transactions is level throughout the 24-hour day.

2) Business firms in countries with exchange controls, for example, China (mainland), often must surrender foreign exchange earned from exports to the central bank at the daily fixing price.

Essay

1) Define spot, forward, and swap transactions in the foreign exchange market and give an example of how each could be used.

6.2 Functions of the Foreign Exchange Market

Multiple Choice

1) The ________ is the mechanism by which participants transfer purchasing power between countries, obtain or provide credit for international trade transactions, and minimize exposure to the risks of exchange rate changes.
A) futures market
B) federal open market
C) foreign exchange market
D) LIBOR

2) Which of the following is NOT a motivation identified by the authors as a function of the foreign exchange market?
A) the transfer of purchasing power between countries
B) obtaining or providing credit for international trade transactions
C) minimizing the risks of exchange rate changes
D) All of the above were identified as functions of the foreign exchange market.

True/False

1) Foreign exchange markets are a relatively recent phenomenon, beginning with the agreement at Bretton Woods.

6.3 Market Participants

Multiple Choice

1) The authors identify two tiers of foreign exchange markets:
A) bank and nonbank foreign exchange.
B) commercial and investment transactions.
C) interbank and client markets.
D) client and retail market.

2) It is characteristic of foreign exchange dealers to:
A) bring buyers and sellers of currencies together but never to buy and hold an inventory of currency for resale.
B) act as market makers, willing to buy and sell the currencies in which they specialize.
C) trade only with clients in the retail market and never operate in the wholesale market for foreign exchange.
D) All of the above are characteristics of foreign exchange dealers.

3) Which of the following may be participants in the foreign exchange markets?
A) bank and nonbank foreign exchange dealers
B) central banks and treasuries
C) speculators and arbitrageurs
D) all of the above

4) ________ seek to profit from trading in the market itself rather than having the foreign exchange transaction being incidental to the execution of a commercial or investment transaction.
A) Speculators and arbitrageurs
B) Foreign exchange brokers
C) Central banks
D) Treasuries

5) In the foreign exchange market, ________ seek all of their profit from exchange rate changes while ________ seek to profit from simultaneous exchange rate differences in different markets.
A) wholesalers; retailers
B) central banks; treasuries
C) speculators; arbitrageurs
D) dealers; brokers

6) Foreign exchange ________ earn a profit by a bid-ask spread on currencies they purchase and sell. Foreign exchange ________, on the other hand, earn a profit by bringing together buyers and sellers of foreign currencies and earning a commission on each sale and purchase.
A) central banks; treasuries
B) dealers; brokers
C) brokers; dealers
D) speculators; arbitrageurs

7) ________ are agents who facilitate trading between dealers without themselves becoming principals in the transaction.
A) Central banks
B) Foreign exchange brokers
C) Arbitrageurs
D) Foreign exchange dealers

True/False

1) Dealers in foreign exchange departments at large international banks act as market makers and maintain inventories of the securities in which they specialize.

2) Currency trading lacks profitability for large commercial and investment banks but is maintained as a service for corporate and institutional customers.

3) The primary motive of foreign exchange activities by most central banks is profit.

4) Banks, and a few nonbank foreign exchange dealers, operate ONLY in the interbank markets.

5) Dealers in the foreign exchange departments of large international banks often function as “market makers.” Such dealers stand willing at all times to buy and sell those currencies in which they specialize and thus maintain an “inventory” position in those currencies.

6) Currency trading is a service center rather than a profit center for commercial and investment banks.

7) For individuals and firms involved in the import and export of goods and services ,using the foreign exchange market is necessary, but incidental, to their underlying commercial or investment purpose.

Essay/Short Answer

1) What are some of the reasons central banks and treasuries enter the foreign exchange markets, and in what important ways are they different from other foreign exchange participants?

6.4 Transactions in the Foreign Exchange Market

Multiple Choice

1) ________ are NOT one of the three categories reported for foreign exchange.
A) Spot transactions
B) Swap transactions
C) Strip transactions
D) Futures transactions

2) The greatest amount of foreign exchange trading takes place in the following three cities:
A) New York, London, and Tokyo.
B) New York, Singapore, and Zurich.
C) London, Frankfurt, and Paris.
D) London, Tokyo, and Zurich.

3) The four currencies that constitute about 80% of all foreign exchange trading are:
A) U.K pound, Chinese yuan, euro, and Japanese yen.
B) U.S. dollar, euro, Chinese yuan, and U.K. pound.
C) U.S. dollar, Japanese yen, euro, and U.K. pound.
D) U.S. dollar, U.K. pound, yen, and Chinese yuan.

4) A ________ transaction in the foreign exchange market requires an almost immediate delivery (typically within two days) of foreign exchange.
A) spot
B) forward
C) futures
D) none of the above

5) A ________ transaction in the foreign exchange market requires delivery of foreign exchange at some future date.
A) spot
B) forward
C) swap
D) currency

6) A forward contract to deliver British pounds for U.S. dollars could be described either as ________ or ________.
A) buying dollars forward; buying pounds forward
B) selling pounds forward; selling dollars forward
C) selling pounds forward; buying dollars forward
D) selling dollars forward; buying pounds forward

7) A common type of swap transaction in the foreign exchange market is the ________ where the dealer buys the currency in the spot market and sells the same amount back to the same bank in the forward market.
A) “forward against spot”
B) “forspot”
C) “repurchase agreement”
D) “spot against forward”

8) The ________ is a derivative forward contract that was created in the 1990s. It has the same characteristics and documentation requirements as traditional forward contracts except that they are only settled in U.S. dollars and the foreign currency involved in the transaction is not delivered.
A) nondeliverable forward
B) dollar only forward
C) virtual forward
D) internet forward

9) Which of the following is NOT true regarding nondeliverable forward (NDF) contracts?
A) NDFs are used primarily for emerging market currencies.
B) Pricing of NDFs reflects basic interest rate differentials plus an additional premium charged for dollar settlement.
C) NDFs can only be traded by central banks.
D) All of the above are true.

10) A ________ transaction in the interbank market is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.
A) spot
B) forward-forward
C) swap
D) futures

True/False

1) A spot transaction in the interbank market for foreign exchange would typically involve a two-day delay in the actual delivery of the currencies, while such a transaction between a bank and its commercial customer would not necessarily involve a two-day wait.

2) Swap and forward transactions account for an insignificant portion of the foreign exchange market.

3) Nondeliverable Forwards were originally envisioned as a method of currency speculation, but it is now estimated that 70% of NDFs are trading for hedging purposes.

4) In general, NDF markets normally develop for country currencies having large cross-border capital movements, but still subject to convertibility restrictions.

5) NDFs are traded and settled inside the country of the subject currency, and therefore are within the control of the country’s government.

6) A contract to deliver dollars for euros in six months is both “buying euros forward for dollars” and “selling dollars forward for euros.”

6.5 Size of the Foreign Exchange Market

Multiple Choice

1) Daily trading volume in the foreign exchange market was about ________ per ________ in 2010.
A) $3,200 billion; month
B) $1,000 billion; month
C) $3,200 billion; day
D) $1,000 billion; day

2) The greatest volume of daily foreign exchange transactions are:
A) spot transactions.
B) forward transactions.
C) swap transactions.
D) This question is inappropriate because the volume of transactions are approximately equal across the three categories above.

3) The United Kingdom and United States together make up nearly ________ of daily currency trading.
A) 25%
B) 35%
C) 45%
D) 55%

4) The top three currency pairs traded with the U.S. dollar are:
A) U.K. pound, Chinese Yuan, Japanese yen.
B) Swiss franc, euro, Japanese yen.
C) U.K. pound, euro, Japanese yen.
D) euro, Chinese Yuan, Japanese yen.

True/False

1) As you might expect, the foreign exchange daily trading volume in in New York City is roughly twice as large as the daily trading volume in London.

2) The low level of interest rates around the globe in recent years, combined with slowing economic growth and new debt issuances, has had a dampening impact on the swap market.

3) Since the global financial crisis of 2008-2009, the Chinese renminbi (yuan) has become the most widely traded currency with the U.S. dollar surpassing the euro, yen, and pound as dollar trading pairs.

6.6 Foreign Exchange Rates and Quotations

Multiple Choice

1) A foreign exchange ________ is the price of one currency expressed in terms of another currency. A foreign exchange ________ is a willingness to buy or sell at the announced rate.
A) quote; rate
B) quote; quote
C) rate; quote
D) rate; rate

2) Most foreign exchange transactions are through the U.S. dollar. If the transaction is expressed as the foreign currency per dollar this known as ________ whereas ________ are expressed as dollars per foreign unit.
A) European terms; indirect
B) American terms; direct
C) American terms; European terms
D) European terms; American terms

3) The following is an example of an American term foreign exchange quote:
A) $20/£
B) €0.85/$
C) ¥100/€
D) none of the above

4) American and British meanings differ for the word billion. Therefore, when traders refer to an American billion, they call it a/an:
A) Kiwi.
B) Loony.
C) Uncle Sam.
D) Yard.

5) From the viewpoint of a British investor, which of the following would be a direct quote in the foreign exchange market?
A) SF2.40/£
B) $1.50/£
C) £0.55/€
D) $0.90/€

6) A/an ________ quote in the United States would be foreign units per dollar, while a/an ________ quote would be in dollars per foreign currency unit.
A) direct; direct
B) direct; indirect
C) indirect; indirect
D) indirect; direct

7) If the direct quote for a U.S. investor for British pounds is $1.43/£, then the indirect quote for the U.S. investor would be ________ and the direct quote for the British investor would be ________.
A) £0.699/$; £0.699/$
B) $0.699/£; £0.699/$
C) £1.43/£; £0.699/$
D) £0.699/$; $1.43/£

8) ________ make money on currency exchanges by the difference between the ________ price, or the price they offer to pay, and the ________ price, or the price at which they offer to sell the currency.
A) Dealers; ask; bid
B) Dealers; bid; ask
C) Brokers; ask; bid
D) Brokers; bid; ask

TABLE 6.1
Use the table to answer following question(s).

9) Refer to Table 6.1. The current spot rate of dollars per pound as quoted in a newspaper is ________ or ________.
A) £1.4484/$; $0.6904/£
B) $1.4481/£; £0.6906/$
C) $1.4484/£; £0.6904/$
D) £1.4487/$; $0.6903/£

10) Refer to Table 6.1. The one-month forward bid price for dollars as denominated in Japanese yen is:
A) -¥20.
B) -¥18.
C) ¥129.74/$.
D) ¥129.62/$.

11) Refer to Table 6.1. The ask price for the two-year swap for a British pound is:
A) $1.4250/£.
B) $1.4257/£.
C) -$230.
D) -$238.

12) Refer to Table 6.1. According to the information provided in the table, the 6-month yen is selling at a forward ________ of approximately ________ per annum. (Use the mid rates to make your calculations.)
A) discount; 2.09%
B) discount; 2.06%
C) premium; 2.09%
D) premium; 2.06%

13) Given the following exchange rates, which of the multiple-choice choices represents a potentially profitable intermarket arbitrage opportunity?
¥129.87/$
€1.1226/$
€0.00864/¥
A) ¥115.69/€
B) ¥114.96/€
C) $0.8908/€
D) $0.0077/¥

14) The U.S. dollar suddenly changes in value against the euro moving from an exchange rate of $0.8909/euro to $0.08709/€. Thus, the dollar has ________ by ________.
A) appreciated; 2.30%
B) depreciated; 2.30%
C) appreciated; 2.24%
D) depreciated; 2.24%

15) A German firm is attempting to determine the euro/pound exchange rate and has the following exchange rate information: USD/pound = $1.5509/£ and the USD/euro rate = $1.2194/€. Therefore, the euro/pound rate must be:
A) £1.2719/€.
B) €1.2719/£.
C) €0.7316/£.
D) €0.7863/£.

True/False

1) The European and American terms for foreign currency exchange are square roots of one another.

2) When the cross rate for currencies offered by two banks differs from the exchange rate offered by a third bank, a triangular arbitrage opportunity exists.

3) Most transactions in the interbank foreign exchange trading are primarily conducted via telecommunication techniques and little is conducted face-to-face.

4) A confusing “quirk” of international exchange rates occurs when calculating the percentage change in spot rates from one period to another. The percent change in the spot rate from one period to another when quoted using foreign currency terms is always greater than the percent changes quoted when using home currency terms.

Chapter 7 International Parity Conditions

7.1 Prices and Exchange Rates

Multiple Choice

1) If an identical product can be sold in two different markets, and no restrictions exist on the sale or transportation costs, the product’s price should be the same in both markets. This is known as:
A) relative purchasing power parity.
B) interest rate parity.
C) the law of one price.
D) equilibrium.

2) The Economist publishes annually the “Big Mac Index” by which they compare the prices of the McDonald’s Corporation’s Big Mac hamburger around the world. The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and therefore, the price should be the same. If a Big Mac costs $2.54 in the United States and 294 yen in Japan, what is the estimated exchange rate of yen per dollar as hypothesized by the Hamburger index?
A) $0.0086/¥
B) ¥124/$
C) $0.0081/¥
D) ¥115.75/$

3) If the current exchange rate is 113 Japanese yen per U.S. dollar, the price of a Big Mac hamburger in the United States is $3.41, and the price of a Big Mac hamburger in Japan is 280 yen, then other things equal, the Big Mac hamburger in Japan is:
A) correctly priced.
B) under priced.
C) over priced.
D) There is not enough information to determine if the price is appropriate or not.

4) The price of a Big Mac in the U.S. is $3.41 and the price in Mexico is Peso 29.0. What is the implied PPP of the Peso per dollar?
A) Peso 8.50/$1
B) Peso 10.8/$1
C) Peso 11.76/$1
D) None of the above

5) Assume the implied PPP rate of exchange of Mexican Pesos per U.S. dollar is 8.50 according to the Big Mac Index. Further, assume the current exchange rate is Peso 10.80/$1. Thus, according to PPP and the Law of One Price, at the current exchange rate the peso is:
A) overvalued.
B) undervalued.
C) correctly valued.
D) There is not enough information to answer this question.

6) According to the Big Mac Index, the implied PPP exchange rate is Mexican peso 8.50/$1 but the actual exchange rate is peso10.80/$1. Thus, at current exchange rates the peso appears to be ________ by ________.
A) overvalued; approximately 21%
B) overvalued; approximately 27%
C) undervalued; approximately 21%
D) undervalued; approximately 27%

7) Other things equal, and assuming efficient markets, if a Honda Accord costs $24,682 in the U.S., then at an exchange rate of $1.57/£, the Honda Accord should cost ________ in Great Britain.
A) £24,682
B) £38,751
C) £10,795
D) £15,721

8) One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be approximately:
A) $0.96/C$
B) $1/C$
C) $1.04/C$
D) Relative PPP provides no guide for this type of question.

9) ________ states that differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate.
A) The Fisher Effect
B) The International Fisher Effect
C) Absolute Purchasing Power Parity
D) Relative Purchasing Power Parity

10) Two general conclusions can be made from the empirical tests of purchasing power parity (PPP):
A) PPP holds up well over the short run but poorly for the long run, and the theory holds better for countries with relatively low rates of inflation.
B) PPP holds up well over the short run but poorly for the long run, and the theory holds better for countries with relatively high rates of inflation.
C) PPP holds up well over the long run but poorly for the short run, and the theory holds better for countries with relatively low rates of inflation.
D) PPP holds up well over the long run but poorly for the short run, and the theory holds better for countries with relatively high rates of inflation.

11) A country’s currency that strengthened relative to another country’s currency by more than that justified by the differential in inflation is said to be ________ in terms of PPP.
A) overvalued
B) over compensating
C) undervalued
D) under compensating

12) If we set the real effective exchange rate index between Canada and the United States equal to 100 in 1998, and find that the U.S. dollar has risen to a value of 112.6, then from a competitive perspective the U.S. dollar is:
A) overvalued.
B) undervalued.
C) very competitive.
D) There is not enough information to answer this question.

13) If we set the real effective exchange rate index between the United Kingdom and the United States equal to 100 in 2005, and find that the U.S. dollar has changed to a value of 91.4, then from a competitive perspective the U.S. dollar is:
A) overvalued.
B) undervalued.
C) equally valued.
D) There is not enough information to answer this question.

14) The government just released international exchange rate statistics and reported that the real effective exchange rate index for the U.S. dollar vs the Japanese yen decreased from 105 last year to 95 currently and is expected to fall still further in the coming year. Other things equal U.S. ________ to/from Japan think this is good news and U.S. ________ to/from Japan think this is bad news.
A) importers; exporters
B) importers; importers
C) exporters; exporters
D) exporters; importers

True/False

1) If a market basket of goods cost $100 is the US and €70 in France, then the PPP exchange rate would be $.70/€.

2) The assumptions for relative PPP are more rigid than the assumptions for absolute PPP.

3) Empirical tests prove that PPP is an accurate predictor of future exchange rates.

4) Consider the price elasticity of demand. If a product has price elasticity less than one it is considered to have relatively elastic demand.

Essay

1) The authors state that empirical tests of purchasing power parity “have, for the most part, not proved PPP to be accurate in predicting future exchange rates.” The authors then state that PPP does hold up reasonably well in two situations. What are some reasons why PPP does not accurately predict future exchange rates, and under what conditions might we reasonably expect PPP to hold?

7.2 Exchange Rate Pass-Through

Multiple Choice

1) ________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.
A) Absolute PPP
B) Relative PPP
C) The Law of One Price
D) The Fisher Effect

2) In its approximate form the Fisher effect may be written as ________. Where: i = the nominal rate of interest, r = the real rate of return and π = the expected rate of inflation.
A) i = (r)(π)
B) i = r + π + (r)(π)
C) i = r + π
D) i = r + 2π

3) Assume a nominal interest rate on one-year U.S. Treasury Bills of 2.60% and a real rate of interest of 1.00%. Using the Fisher Effect Equation, what is the approximate expected rate of inflation in the U.S. over the next year?
A) 2.10%
B) 2.05%
C) 1.60%
D) 1.00%

4) Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation in the U.S. over the next year?
A) 1.84%
B) 1.80%
C) 1.76%
D) 1.72%

5) The relationship between the percentage change in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets is known as:
A) absolute PPP.
B) the law of one price.
C) relative PPP.
D) the international Fisher Effect.

6) According to the international Fisher Effect, if an investor purchases a five-year U.S. bond that has an annual interest rate of 5% rather than a comparable British bond that has an annual interest rate of 6%, then the investor must be expecting the ________ to ________ at a rate of at least 1% per year over the next 5 years.
A) British pound; appreciate
B) British pound; revalue
C) U.S. dollar; appreciate
D) U.S. dollar; depreciate

7) ________ states that the spot exchange rate should change in an equal amount but in the opposite direction to the difference in interest rates between two countries.
A) Fisher-open
B) Fisher-closed
C) The Fisher Effect
D) none of the above

8) Exchange rate pass-through may be defined as:
A) the bid/ask spread on currency exchange rate transactions.
B) the degree to which the prices of imported and exported goods change as a result of exchange rate changes.
C) the PPP of lesser-developed countries.
D) the practice by Great Britain of maintaining the relative strength of the currencies of the Commonwealth countries under the current floating exchange rate regime.

9) Phillips NV produces DVD players and exports them to the United States. Last year the exchange rate was $1.25/euro and Plillips charged 120 euro per player in Euroland and $150 per DVD player in the United States. Currently the spot exchange rate is $1.45/euro and Phillips is charging $160 per DVD player. What is the degree of pass through by Phillips NV on their DVD players?
A) 92%
B) 33.3%
C) 41.7%
D) 4.1%

10) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the amount the company will receive in pounds at the new exchange rate?
A) £22,803
B) £25,581
C) £27,363
D) £55,000

11) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the percentage margin the company will realize given the new exchange rate?
A) 20.0%
B) 15.3%
C) 12.4%
D) 7.2%

12) The price elasticity of demand for DVD players manufactured by Sony of Japan is greater than one. If the Japanese yen appreciates against the U.S. dollar by 10% and the price of the Sony DVD players in the U.S also rises by 10%, then other things equal, the total dollar sales revenues of Sony DVDs would:
A) decline.
B) increase.
C) stay the same.
D) insufficient information

True/False

1) The final component of the equation for the Fisher Effect, (r)(π), where r = the real rate of return and π = the expected rate of inflation, is often dropped from the equation because the number is simply too large for most Western economies.

2) Empirical studies show that the Fisher Effect works best for short-term securities.

3) The current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange rate is ¥127/$ then the yen is at a forward premium.

4) The premium or discount on forward currency exchange rates between any two countries is visually obvious when you plot the interest rates of each country on the same yield curve. The currency of the country with the higher yield curve should be selling at a forward discount.

5) Use interest rate parity to answer this question. A U.S. investor has a choice between a risk-free one-year U.S. security with an annual return of 4%, and a comparable British security with a return of 5%. If the spot rate is $1.43/£, the forward rate is $1.44/£, and there are no transaction costs, the investor should invest in the U.S. security.

6) Both covered and uncovered interest arbitrage are risky operations in the sense that even without default in the securities, the returns are unknown until all transactions are complete.

7) All that is required for a covered interest arbitrage profit is for interest rate parity to not hold.

Essay/Short Answer

1) The authors describe an application of uncovered interest arbitrage (UIA) known as “yen carry trade.” Define UIA and describe the example of yen carry trade. Why would an investor engage in the practice of yen carry trade and is there any risk of loss or lesser profit from this investment strategy?

2) The Fisher Effect is a familiar economic theory in the domestic market. In words, define the Fisher Effect and explain why you think it is also appropriately applied to international markets.

7.3 The Forward Rate

Multiple Choice

1) If the forward rate is an unbiased predictor of the expected spot rate, which of the following is NOT true?
A) The expected value of the future spot rate at time 2 equals the present forward rate for time 2 delivery, available now.
B) The distribution of possible actual spot rates in the future is centered on the forward rate.
C) The future spot rate will actually be equal to what the forward rate predicts.
D) All of the above are true.

2) Which of the following is NOT an assumption of market efficiency?
A) Instruments denominated in other currencies are perfect substitutes for one another.
B) Transaction costs are low or nonexistent.
C) All relevant information is quickly reflected in both spot and forward exchange markets.
D) All of the above are true.

3) Empirical tests have yielded ________ evidence about market efficiency with a general consensus that developing foreign markets are ________.
A) conflicting; not efficient
B) conflicting; efficient
C) consistent; inefficient
D) none of the above

4) A ________ is an exchange rate quoted today for settlement at some time in the future.
A) spot rate
B) forward rate
C) currency rate
D) yield curve

5) Assume the current U.S. dollar-British spot rate is 0.6993£/$. If the current nominal one-year interest rate in the U.S. is 5% and the comparable rate in Britain is 6%, what is the approximate forward exchange rate for 360 days?
A) £1.42/$
B) £1.43/$
C) £0.6993/$
D) £0.7060/$

6) Assume the current U.S. dollar-yen spot rate is 90 ¥/$. Further, the current nominal 180-day rate of return in Japan is 1% and 2% in the United States. What is the approximate forward exchange rate for 180 days?
A) ¥89.12/$
B) ¥89.55/$
C) ¥90.89/$
D) ¥90.45/$

7) The current U.S. dollar-yen spot rate is 125¥/$. If the 90-day forward exchange rate is 127 ¥/$ then the yen is selling at a per annum ________ of ________.
A) premium; 1.57%
B) premium; 6.30%
C) discount; 1.57%
D) discount; 6.30%

8) The theory of ________ states that the difference in the national interest rates for securities of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or premium for the foreign currency, except for transaction costs.
A) international Fisher Effect
B) absolute PPP
C) interest rate parity
D) the law of one price

9) With covered interest arbitrage:
A) the market must be out of equilibrium.
B) a “riskless” arbitrage opportunity exists.
C) the arbitrageur trades in both the spot and future currency exchange markets.
D) all of the above

10) Covered interest arbitrage moves the market ________ equilibrium because ________.
A) toward; purchasing a currency on the spot market and selling in the forward market narrows the differential between the two
B) toward; investors are now more willing to invest in risky securities
C) away from; purchasing a currency on the spot market and selling in the forward market increases the differential between the two
D) away from; demand for the stronger currency forces up interest rates on the weaker security

True/False

1) If exchange markets were not efficient, it would pay for a firm to spend resources on forecasting exchange rates.

2) If the forward exchange rate is an unbiased predictor of future spot rates, then future spot rates will always be equal to current forward rates.

3) COVERED interest arbitrage (CIA), is where investors borrow in countries and currencies exhibiting relatively low interest rates and convert the proceeds into currencies that offer much higher interest rates. The transaction is “covered,” because the investor does not sell the higher yielding currency proceeds forward.

7.4 Prices, Interest Rates, and Exchange Rates in Equilibrium

Multiple Choice

1) According to the International Fisher Effect, the forecast change in the spot rate between two countries is equal to:
A) the current spot rate multiplied by the ratio of the inflation rates in the respective countries.
B) but the opposite sign to the difference between nominal interest rates.
C) but the opposite sign to the difference between inflation rates.
D) but the opposite sign to the difference between real interest rates.

True/False

1) In their approximate form, PPP, IRP, and forward rates as an unbiased predictor of the future spot rate lead to similar forecasts of the future spot rate.

Chapter 8 Foreign Currency Derivatives and Swaps

8.1 Foreign Currency Futures

Multiple Choice

1) Financial derivatives are powerful tools that can be used by management for purposes of:
A) speculation.
B) hedging.
C) human resource management.
D) A and B above

2) A foreign currency ________ contract calls for the future delivery of a standard amount of foreign exchange at a fixed time, place, and price.
A) futures
B) forward
C) option
D) swap

3) Which of the following is NOT a contract specification for currency futures trading on an organized exchange?
A) size of the contract
B) maturity date
C) last trading day
D) All of the above are specified.

4) About ________ of all futures contracts are settled by physical delivery of foreign exchange between buyer and seller.
A) 0%
B) 5%
C) 50%
D) 95%

5) Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is called a:
A) collateralized deposit.
B) marked market sum.
C) margin.
D) settlement.

6) A speculator in the futures market wishing to lock in a price at which they could ________ a foreign currency will ________ a futures contract.
A) buy; sell
B) sell; buy
C) buy; buy
D) none of the above

7) A speculator that has ________ a futures contract has taken a ________ position.
A) sold; long
B) purchased; short
C) sold; short
D) purchased; sold

8) Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month currency futures contract is available today at a rate of $1.44/£. If Peter was to speculate in the currency futures market, and his expectations are correct, which of the following strategies would earn him a profit?
A) Sell a pound currency futures contract.
B) Buy a pound currency futures contract.
C) Sell pounds today.
D) Sell pounds in six months.

9) Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the dollar appreciate to a value of $1.4250 at which time he sold the pound futures. If each pound futures contract is for an amount of £62,500, how much money did Jack gain or lose from his speculation with pound futures?
A) $937.50 loss
B) $937.50 gain
C) £937.50 loss
D) £937.50 gain

10) Which of the following statements regarding currency futures contracts and forward contracts is NOT true?
A) A futures contract is a standardized amount per currency whereas the forward contact is for any size desired.
B) A futures contract is for a fixed maturity whereas the forward contract is for any maturity you like up to one year.
C) Futures contracts trade on organized exchanges whereas forwards take place between individuals and banks with other banks via telecom linkages.
D) All of the above are true.

11) Which of the following is NOT a difference between a currency futures contract and a forward contract?
A) The futures contract is marked to market daily, whereas the forward contract is only due to be settled at maturity.
B) The counterparty to the futures participant is unknown with the clearinghouse stepping into each transaction, whereas the forward contract participants are in direct contact setting the forward specifications.
C) A single sales commission covers both the purchase and sale of a futures contract, whereas there is no specific sales commission with a forward contract because banks earn a profit through the bid-ask spread.
D) All of the above are true.

12) A foreign currency ________ gives the purchaser the right, not the obligation, to buy a given amount of foreign exchange at a fixed price per unit for a specified period.
A) future
B) forward
C) option
D) swap

13) A foreign currency ________ option gives the holder the right to ________ a foreign currency, whereas a foreign currency ________ option gives the holder the right to ________ an option.
A) call, buy, put, sell
B) call, sell, put, buy
C) put, hold, call, release
D) none of the above

14) The price at which an option can be exercised is called the:
A) premium.
B) spot rate.
C) strike price.
D) commission.

15) An ________ option can be exercised only on its expiration date, whereas a/an ________ option can be exercised anytime between the date of writing up to and including the exercise date.
A) American; European
B) American; British
C) Asian; American
D) European; American

16) An ________ option can be exercised only on its expiration date, whereas a/an ________ option can be exercised anytime between the date of writing up to and including the exercise date.
A) American; European
B) American; British
C) Asian; American
D) European; American

17) A call option whose exercise price exceeds the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) over-the-spot.

18) A call option whose exercise price is less than the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) under-the-spot.

19) An option whose exercise price is equal to the spot rate is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) on-the-spot.

20) The main advantage(s) of over-the-counter foreign currency options over exchange traded options is (are):
A) expiration dates tailored to the needs of the client.
B) amounts that are tailor made.
C) client desired expiration dates.
D) all of the above

21) As a general statement, it is safe to say that businesses generally use the ________ for foreign currency option contracts, and individuals and financial institutions typically use the ________.
A) exchange markets; over-the-counter
B) over-the-counter; exchange markets
C) private; government sponsored
D) government sponsored; private

TABLE 8.1
Use the table to answer following question(s).

April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).

22) Refer to Table 8.1. What was the closing price of the British pound on April 18, 2009?
A) $1.448/£
B) £1.448/$
C) $14.48/£
D) none of the above

23) Refer to Table 8.1. The exercise price of ________ giving the purchaser the right to sell pounds in June has a cost per pound of ________ for a total price of ________.
A) 1460; 0.68 cents; $425.00
B) 1440; 1.06 cents; $662.50
C) 1450; 1.02 cents; $637.50
D) 1440; 1.42 cents; $887.50

24) Refer to Table 8.1. The May call option on pounds with a strike price of 1440 mean:
A) $88/£ per contract.
B) $0.88/£.
C) $0.0088/£.
D) none of the above

25) Dash Brevenshure works for the currency trading unit of ING Bank in London. He speculates that in the coming months the dollar will rise sharply vs. the pound. What should Dash do to act on his speculation?
A) Buy a call on the pound.
B) Sell a call on the pound.
C) Buy a put on the pound.
D) Sell a put on the pound.

26) A put option on yen is written with a strike price of ¥105.00/$. Which spot price maximizes your profit if you choose to exercise the option before maturity?
A) ¥100/$
B) ¥105/$
C) ¥110/$
D) ¥115/$

27) A call option on euros is written with a strike price of $1.30/euro. Which spot price maximizes your profit if you choose to exercise the option before maturity?
A) $1.20/euro
B) $1.25/euro
C) $1.30/euro
D) $1.35/euro

28) A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the break-even price for the option?
A) $2.03/£
B) $2.07/£
C) $2.05/£
D) The answer depends upon if this is a long or a short call option.

29) Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To protect yourself against unexpected changes in the dollar/pound exchange rate you should:
A) buy a pound put option.
B) sell a pound put option.
C) buy a pound call option.
D) sell a pound call option.

30) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. Jasper should ________ at ________ to profit from changing currency values.
A) buy yen; the forward rate
B) buy dollars; the forward rate
C) sell yen; the forward rate
D) There is not enough information to answer this question.

31) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper buys $100,000 worth of yen at today’s spot price and sells within the next six months at ¥128/$, he will earn a profit of:
A) $146.09
B) $101,460.94
C) $1460.94
D) nothing; he will lose money

32) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper buys $100,000 worth of yen at today’s spot price her potential gain is ________ and her potential loss is ________.
A) $100,000; unlimited
B) unlimited; unlimited
C) $100,000; $100,000
D) unlimited; $100,000

33) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper’s expectations are correct, then he could profit in the forward market by ________ and then ________.
A) buying yen for ¥128.00/$; selling yen at ¥128.53/$
B) buying yen for ¥128.53/$; selling yen at ¥128.00/$
C) There is not enough information to answer this question
D) He could not profit in the forward market.

34) The maximum gain for the purchaser of a call option contract is ________ while the maximum loss is ________.
A) unlimited; the premium paid.
B) the premium paid; unlimited.
C) unlimited; unlimited.
D) unlimited; the value of the underlying asset.

35) The buyer of a long call option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has an unlimited maximum gain potential.
D) all of the above

36) Which of the following is NOT true for the writer of a call option?
A) The maximum loss is unlimited.
B) The maximum gain is unlimited.
C) The gain or loss is equal to but of the opposite sign of the buyer of a call option.
D) All of the above are true.

37) Which of the following is NOT true for the writer of a put option?
A) The maximum loss is limited to the strike price of the underlying asset less the premium.
B) The gain or loss is equal to but of the opposite sign of the buyer of a put option.
C) The maximum gain is the amount of the premium.
D) All of the above are true.

38) The buyer of a long put option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has maximum gain potential limited to the difference between the strike price and the premium paid.
D) all of the above

39) The value of a European style call option is the sum of two components:
A) the present value plus the intrinsic value.
B) the time value plus the present value.
C) the intrinsic value plus the time value.
D) the intrinsic value plus the standard deviation.

True/False

1) Currency futures contracts have become standard fare and trade readily in the world money centers.

2) The major difference between currency futures and forward contracts is that futures contracts are standardized for ease of trading on an exchange market whereas forward contracts are specialized and tailored to meet the needs of clients.

3) The writer of the option is referred to as the seller, and the buyer of the option is referred to as the holder.

4) Foreign currency options are available both over-the-counter and on organized exchanges.

5) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper would earn a higher rate of return by buying yen and a forward contract than if he had invested her money in 6-month US Treasury securities at an annual rate of 2.50%.

6) Most option profits and losses are realized through taking actual delivery of the currency rather than offsetting contracts.

Essay

1) Why are foreign currency futures contracts more popular with individuals and banks while foreign currency forwards are more popular with businesses?

2) Compare and contrast foreign currency options and futures. Identify situations when you may prefer one vs. the other when speculating on foreign exchange.

8.2 Option Pricing and Valuation

Multiple Choice

1) Which of the following is NOT a factor in determining the premium price of a currency option?
A) the present spot rate
B) the time to maturity
C) the standard deviation of the daily spot price movement
D) All of the above are factors in determining the premium price.

2) The ________ of an option is the value if the option were to be exercised immediately. It is the option’s ________ value.
A) intrinsic value; maximum
B) intrinsic value; minimum
C) time value; maximum
D) time value; minimum

3) Assume that a call option has an exercise price of $1.50/£. At a spot price of $1.45/£, the call option has:
A) a time value of $0.04.
B) a time value of $0.00.
C) an intrinsic value of $0.00.
D) an intrinsic value of -$0.04.

4) The single largest interest rate risk of a firm is:
A) interest sensitive securities.
B) debt service.
C) dividend payments.
D) accounts payable.

5) ________ is the possibility that the borrower’s creditworthiness is reclassified by the lender at the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
D) Credit risk; Repricing risk

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.

• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.

6) Refer to Instruction 8.1. Choosing strategy #1 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

7) Refer to Instruction 8.1. Choosing strategy #2 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

8) Refer to Instruction 8.1. Choosing strategy #3 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

9) Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?
A) Strategy #1
B) Strategy #2
C) Strategy #3
D) Strategies #1 and #2

10) Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at worst, remain at current levels, and were very confident about the firm’s credit rating for the next 10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)
A) Strategy #3
B) Strategy #2
C) Strategy #1
D) Strategy #1, #2, or #3; you are indifferent among the choices.

11) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #2 is: (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above

12) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above

13) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

14) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

15) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

True/False

1) The time value is asymmetric in value as you move away from the strike price (i.e., the time value at two cents above the strike price is not necessarily the same as the time value two cents below the strike price).

8.3 Interest Rate Derivatives

Multiple Choice

1) An interbank-traded contract to buy or sell interest rate payments on a notional principal is called a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above

2) A/an ________ is a contract to lock in today interest rates over a given period of time.
A) forward rate agreement
B) interest rate future
C) interest rate swap
D) none of the above

3) An agreement to exchange interest payments based on a fixed payment for those based on a variable rate (or vice versa) is known as a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above

4) The financial manager of a firm has a variable rate loan outstanding. If she wishes to protect the firm against an unfavorable increase in interest rates she could:
A) sell an interest rate futures contract of a similar maturity to the loan.
B) buy an interest rate futures contract of a similar maturity to the loan.
C) swap the adjustable rate loan for another of a different maturity.
D) none of the above

5) An agreement to swap a fixed interest payment for a floating interest payment would be considered a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above

6) An agreement to swap the currencies of a debt service obligation would be termed a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above

7) Which of the following would be considered an example of a currency swap?
A) exchanging a dollar interest obligation for a British pound obligation
B) exchanging a eurodollar interest obligation for a dollar obligation
C) exchanging a eurodollar interest obligation for a British pound obligation
D) All of the above are examples of a currency swap.

8) A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.

9) A firm with variable-rate debt that expects interest rates to rise may engage in a swap agreement to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.

10) The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is to:
A) do nothing.
B) pay floating and receive fixed.
C) receive floating and pay fixed.
D) none of the above

11) The potential exposure that any individual firm bears that the second party to any financial contract will be unable to fulfill its obligations under the contract is called:
A) interest rate risk.
B) credit risk.
C) counterparty risk.
D) clearinghouse risk.

12) Which of the following is an unlikely reason for firms to participate in the swap market?
A) To replace cash flows scheduled in an undesired currency with cash flows in a desired currency.
B) Firms may raise capital in one currency but desire to repay it in another currency.
C) Firms desire to swap fixed and variable payment or receipt of funds.
D) All of the above are likely reasons for a firm to enter the swap market.

True/False

1) Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

2) Unlike the situation with exchange rate risk, there is no uncertainty on the part of management for shareholder preferences regarding interest rate risk. Shareholders prefer that managers hedge interest rate risk rather than having shareholders diversify away such risk through portfolio diversification.

3) Interest rate futures are relatively unpopular among financial managers because of their relative illiquidity and their difficulty of use.

4) A basis point is one-tenth of one percent.

5) A swap agreement may involve currencies or interest rates, but never both.

6) Some of the world’s largest and most financially sound firms may borrow at variable rates less than LIBOR.

7) Counterparty risk is greater for exchange-traded derivatives than for over-the-counter derivatives.

8) Swap rates are derived from the yield curves in each major currency.

Essay

1) Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

2) How does counterparty risk influence a firm’s decision to trade exchange-traded derivatives rather than over-the-counter derivatives?
Answer: With exchange-traded derivatives, the exchange is the clearinghouse. Thus, firms do not need to worry about the other party making good on its obligations and it is easier to trade the derivative products.

Chapter 9 Foreign Exchange Rate Determination and Forecasting

9.1 Exchange Rate Determination: The Theoretical Thread

Multiple Choice

1) An important thing to remember about foreign exchange rate determination is that parity conditions, asset approach, and balance of payments approaches are ________ theories rather than ________ theories.
A) competing; complementary
B) competing; contemporary
C) complementary; contiguous
D) complementary; competing

2) Which of the following did NOT contribute to the exchange rate collapse in emerging markets in the 1990s?
A) infrastructure weaknesses
B) speculation on the part of market participants
C) the sharp reduction of cross-border foreign direct investment
D) All of the above contributed to the emerging markets exchange rate collapse of the 1990s.

3) The ________ provides a means to account for international cash flows in a standardized and systematic manner.
A) parity conditions
B) asset approach
C) balance of payments
D) International Fisher Effect

4) The ________ approach argues that equilibrium exchange rates are achieved when the net inflow of foreign exchange arising from current account activities is equal to the net outflow of foreign exchange arising from financial account activities.
A) balance of payments
B) monetary
C) asset market
D) law of one price

5) The ________ approach states that the exchange rate is determined by the supply and demand for national currency stocks, as well as the expected future levels and rates of growth of monetary stock.
A) balance of payments
B) monetary
C) asset market
D) law of one price

6) The ________ approach argues that exchange rates are determined by the supply and demand for a wide variety of financial assets
A) balance of payments
B) monetary
C) asset market
D) law of one price

7) The ________ approach to the determination of spot exchange rates hypothesizes that the most important factors are the relative real interest rate and a country’s outlook for economic growth and profitability.
A) balance of payments
B) parity conditions
C) managed float
D) asset market

8) The asset market approach to forecasting assumes that whether foreigners are willing to hold claims in monetary form depends on an extensive set of investment considerations. These include all but which of the following choices?
A) relative real interest rates
B) capital market liquidity
C) political safety
D) All of the above are considered by investors in their decision process.

9) ________ is defined as the spread of a crisis in one country to its neighboring countries and other countries with similar characteristics.
A) Speculation
B) Contagion
C) Capital market liquidity
D) Political science

10) Critics of the balance of payments approach to exchange rate determination point to the emphasis on ________ of currency and capital rather than ________ of money or financial assets.
A) flows; stocks
B) stocks; flows
C) import; export
D) export; import

11) Which of the following versions of PPP is thought to be the most relevant to possibly explaining what drives exchange rate values?
A) The Law of One Price
B) Absolute Purchasing Power Parity
C) Relative Purchasing Power Parity
D) The International Fisher Effect

True/False

1) It is safe to say that most determinants of the spot exchange rate are also affected by changes in the spot rate. i.e., they are linked AND mutually determined.

2) The balance of payments approach of exchange rate theory is largely dismissed by the academic community today, while the practitioner public still rely on different variations of the theory for their decision making.

3) Technical analysis of exchange rates developed in part due to the forecasting inadequacies of fundamental exchange rate theories.

4) The authors claim that theoretical and empirical studies appear to show that fundamentals do apply to the long-term for foreign exchange.

5) The authors claim that random events, institutional frictions, and technical factors may cause currency values to deviate significantly from their long-term fundamental path.

6) The asset market approach to forecasting is not applicable to emerging markets.

7) Most theories of technical analysis differentiate fair value from market value.

Essay

1) Describe the asset market approach to exchange rate determination. How is this consistent with economic theory of (say, security) prices in general?

9.2 Currency Market Intervention

Multiple Choice

1) ________ is the active buying and selling of the domestic currency against foreign currencies.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Federal Funding

2) Which of the following is NOT a technique used by governments or central banks to impact domestic currency valuation?
A) Indirect Intervention
B) Direct Intervention
C) Capital Controls
D) All of the above are techniques used to control currency valuation.

3) Which of the following is NOT a motivation for a government or central bank to manipulate domestic currency valuation?
A) fight inflation
B) slow too rapid economic growth
C) spur too slow economic growth
D) All of the above are motivations for the government or central bank to manipulate currency values.

True/False

1) Slow economic growth and continued unemployment problems are common reasons for central banks to hold currency values down.

2) The fall in the value of the domestic currency will sharply reduce the purchasing power of foreign tourists in the country whose currency values are falling.

3) The International Monetary Fund, as one of its basic principles (Article IV), encourages members to pursue “currency manipulation” to gain competitive advantages over other members as opposed to engaging in military action to achieve the same advantage.

4) If a central bank wishes to “defend its currency,” it might follow an expansive monetary policy, which would drive real rates of interest up.

5) A country wishing for its currency to fall in value, particularly when confronted with a continual appreciation of its value against major trading partner currencies, the central bank may work to lower real interest rates, reducing the returns to capital.

6) Indirect intervention for domestic currency valuation typically uses tools of monetary policy as opposed to using tools of fiscal policy.

7) Direct intervention for currency valuation involves limiting the ability to exchange domestic currency for foreign currency.

Essay

1) Explain how a central bank would engage in direct intervention to decrease the value of its domestic currency. Since the 1970s it has been difficult for central banks alone to engage in direct intervention to alter the value of their domestic currency. Identify and explain at least two other activities in which a central bank could engage to alter the value of their domestic currency.

9.3 Disequilibrium: Exchange Rates in Emerging Markets

Multiple Choice

1) Which of the following was NOT an international currency crisis in the 1990s and early 2000s?
A) the Asian Crisis
B) the Canadian Crisis
C) the Argentine Crisis
D) All of the above were currency crises in the 1990s and 2000s.

2) The Asian Currency crisis appeared to begin in:
A) South Korea.
B) Taiwan.
C) Thailand.
D) Japan.

3) The “tequila effect” is a slang term used to describe a form of financial panic called:
A) run on the market.
B) speculation.
C) contrary investing.
D) contagion.

4) Prior to July 2, 1997, the Thai government:
A) allowed the Thai Bhat to float against major currencies.
B) fixed the Bhat’s value against the Korean won only.
C) fixed the Bhat’s value against major currencies especially the U.S. dollar.
D) none of the above

5) The authors did NOT identify which of the following as a root of the Asian currency crisis?
A) the collapse of some Asian currencies
B) the rate of inflation in the United States
C) corporate socialism
D) banking stability and management

6) The authors refer to the practice of many Asian firms being largely controlled by families of groups related to the governing body of the country as:
A) illegal.
B) insider trading.
C) cronyism.
D) not in my back yard.

7) The principle focus of the IMF bailout efforts during the Asian financial crisis was:
A) banking liquidity.
B) shareholder’s wealth.
C) reestablishing fixed currency exchange rates in Asia.
D) dollarization of Asian currencies.

8) The ________ is the Argentine currency unit.
A) peso
B) dollar
C) real
D) peseta

9) A currency board is:
A) a structure, rather than a mere commitment, to limiting the growth of the money supply in the economy.
B) a recipe for conservative and prudent financial management.
C) designed to eliminate the power of politicians to exercise judgment by relying on an automatic and unbendable rule.
D) all of the above

10) Argentina’s economic performance in the 1990s while their peso was pegged to the U.S. dollar can be characterized as ________ rates of inflation and ________ rates of unemployment.
A) high; high
B) low; low
C) low; high
D) high; low

11) Which of the following did NOT contribute to the Russian currency crisis of 1998?
A) an accelerated flight of capital
B) generally deteriorating economic conditions
C) a surprisingly healthy government surplus that was neither funding internal investment nor external debt service
D) all of the above

True/False

1) In 1991 the Argentine peso was fixed to the value of the U.S. dollar on a one-to-one basis.

2) Leading up to the Russian currency collapse of 1998, Russia followed a currency policy of managed float that allowed their currency to slide daily at a 1.5% per month rate.

9.4 Forecasting in Practice

Multiple Choice

1) ________, traditionally referred to as chartists, focus on price and volume data to determine past trends that are expected to continue into the future.
A) Mappists
B) Trappist monks
C) Filibusters
D) Technical analysts

2) Examples of a business motivation for long-run exchange rate forecasts include all but which of the following?
A) a major capital investment in a foreign country
B) the desire to hedge a 90-day security
C) a portfolio manager considering investing in foreign securities
D) All of the above are examples of a business motivation for long-run exchange rate forecast.

3) Short-term foreign exchange forecasts are often motivated by such activities as ________ whereas long-term forecasts are more likely motivated by ________.
A) long-term investment; long-term capital appreciation
B) long-term capital appreciation; desire to hedge a receivable
C) the desire to hedge a payable; the desire for long-term investment
D) the desire for long-term investment; the desire to hedge a payable

4) A major U.S. multinational firm has forecast the euro/dollar rate to be €1.10/$ one year hence, and an exchange rate of $1.40 for the British pound (£) in the same time period. What does this imply the company’s expected rate for the euro per pound to be in one year?
A) €1.40/£
B) £1.40/€
C) £1.54/€
D) €1.54/£

True/False

1) The longer the time horizon of the technical analyst the more accurate the prediction of foreign exchange rates is likely to be.

Comment: The shorter the time horizon of the technical analyst the more accurate the prediction of foreign exchange rates is likely to be.

2) The single most important element of technical analysis is that future exchange rates are based on the current exchange rate.

3) The more efficient the foreign exchange market is, the more likely it is that exchange rate movements are random walks.

4) Technical analysts, traditionally referred to as chartists, focus on fundamental data to determine past trends that are expected to continue into the future.

Essay

1) Foreign exchange forecasting can be either long-term, or short-term in duration. Compare and contrast the motivation for and the techniques a forecaster might use for each of the time periods.
Answer: Short-run forecasts are usually more tactical in nature as a firm may desire to reduce exchange rate risk associated with foreign receivable or payables. Technical factors and short-term market expectations are often more important for short-run forecasters than long-run parity or fundamental economic conditions.
Long-run forecasts are more strategic in nature as firms make key decisions about entering new foreign markets. Longer time horizons tend to be less accurate but also require less accuracy. What forecasters typically desire is a general long-run understanding of the relationships between markets. Fundamental analysis and parity conditions tend to be more important than technical factors in this type of forecasting.

Chapter 10 Transaction Exposure

10.1 Types of Foreign Exchange Exposure

Multiple Choice

1) ________ exposure deals with cash flows that result from existing contractual obligations.
A) Operating
B) Transaction
C) Translation
D) Economic

2) ________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates.
A) Operating
B) Transaction
C) Translation
D) Accounting

3) Each of the following is another name for operating exposure EXCEPT:
A) economic exposure.
B) strategic exposure.
C) accounting exposure.
D) competitive exposure.

4) Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that ________ exposure deals with cash flows already contracted for, while ________ exposure deals with future cash flows that might change because of changes in exchange rates.
A) transaction; operating
B) operating; transaction
C) operating; accounting
D) none of the above

5) ________ exposure is the potential for accounting-derived changes in owner’s equity to occur because of the need to translate foreign currency financial statements into a single reporting currency.
A) Transaction
B) Operating
C) Economic
D) Accounting (aka translation)

6) Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses may reduce taxes over a series of years.
A) accounting; Operating
B) operating; Transaction
C) transaction; Operating
D) transaction; Accounting

7) Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses are not cash losses and therefore, are not tax deductible.
A) transaction; Operating
B) accounting; Operating
C) accounting; Transaction
D) transaction; Translation

8) MNE cash flows may be sensitive to changes in which of the following?
A) exchange rates
B) interest rates
C) commodity prices
D) all of the above

9) Assuming no transaction costs (i.e., hedging is “free”), hedging currency exposures should ________ the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should ________.
A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change

10) Which of the following is NOT cited as a good reason for hedging currency exposures?
A) Reduced risk of future cash flows is a good planning tool.
B) Reduced risk of future cash flows reduces the probability that the firm may not meet required cash flows.
C) Currency risk management increases the expected cash flows to the firm.
D) Management is in a better position to assess firm currency risk than individual investors.

11) Which of the following is cited as a good reason for NOT hedging currency exposures?
A) Shareholders are more capable of diversifying risk than management.
B) Currency risk management through hedging does not increase expected cash flows.
C) Hedging activities are often of greater benefit to management than to shareholders.
D) All of the above are cited as reasons NOT to hedge.

12) The stages in the life of a transaction exposure can be broken into three distinct time periods. The first time period is the time between quoting a price and reaching an actual sale agreement or contract. The next time period is the time lag between taking an order and actually filling or delivering it. Finally, the time it takes to get paid after delivering the product. In order, these stages of transaction exposure may be identified as:
A) backlog, quotation, and billing exposure.
B) billing, backlog, and quotation exposure.
C) quotation, backlog, and billing exposure.
D) quotation, billing, and backlog exposure.

13) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. The U.S. firm is at risk today of a loss if:
A) the exchange rate changes to $1.52/£.
B) the exchange rate changes to $1.58/£.
C) the exchange rate doesn’t change.
D) all of the above

14) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $1.58/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500

15) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $1.52/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500

16) ________ is NOT a commonly used contractual hedge against foreign exchange transaction exposure.
A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.

17) A ________ hedge refers to an offsetting operating cash flow such as a payable arising from the conduct of business.
A) financial
B) natural
C) contractual
D) futures

True/False

1) As a generalized rule, only realized foreign exchange losses are deductible for tax purposes.

2) Many MNE s manage foreign exchange exposure centrally, thus gains or losses are always matched with the country of origin.

3) Hedging, or reducing risk, is the same as adding value or return to the firm.

4) There is considerable question among investors and managers about whether hedging is a good and necessary tool.

5) The key arguments in opposition to currency hedging such as market efficiency, agency theory, and diversification do not have financial theory at their core.

6) The structure of a money market hedge is similar to a forward hedge. The difference is the cost of the money market hedge is determined by the differential interest rates, while the forward hedge is a function of the forward rates quotation.

7) In efficient markets, interest rate parity should assure that the costs of a forward hedge and money market hedge should be approximately the same.

8) Management often conducts hedging activities that benefit management at the expense of the shareholders. The field of finance called agency theory frequently argues that management is generally LESS risk averse than are shareholders.

9) Managers CAN outguess the market. If and when markets are in equilibrium with respect to parity conditions, the expected net present value of hedging should be POSITIVE.

10) Shareholders are LESS capable of diversifying currency risk than is the management of the firm.

11) Hedging can be advantageous to shareholders because management is in a better position than shareholders to recognize disequilibrium conditions and to take advantage of single opportunities to enhance firm value through selective hedging.

12) TRANSACTION exposure measures gains or losses that arise from the settlement of existing financial obligations whose terms are stated in a foreign currency.

13) Transaction exposure could arise when borrowing or lending funds when repayment is to be made in the firm’s domestic currency.

Essay

1) Does foreign currency exchange hedging both reduce risk and increase expected value? Explain, and list several arguments in favor of currency risk management and several against.

2) Currency risk management techniques include forward hedges, money market hedges, and option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the forward rate is $1.52/£ and the current spot rate is $1.48/£.)

10.2 Trident’s Transaction Exposure

Multiple Choice

Instruction 10.2:
Use the information for the following problem(s).

Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 3,000,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, CVT is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.

• The spot exchange rate is $1.250/euro
• The six month forward rate is $1.22/euro
• CVT’s cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December call options for euro 750,000; strike price $1.28, premium price is 1.5%
• CVT’s forecast for 6-month spot rates is $1.27/euro
• The budget rate, or the highest acceptable purchase price for this project, is
$3,900,000 or $1.30/euro

1) Refer to Instruction 10.2. If CVT chooses NOT to hedge their euro payable, the amount they pay in six months will be:
A) $3,500,000.
B) $3,900,000.
C) €3,000,000.
D) unknown today

2) Refer to Instruction 10.2. If CVT chooses to hedge its transaction exposure in the forward market, it will ________ euro 3,000,000 forward at a rate of ________.
A) buy; $1.22
B) buy; $1.25
C) sell; $1.22
D) sell; €1.25

3) Refer to Instruction 10.2. CVT chooses to hedge its transaction exposure in the forward market at the available forward rate. The required amount in dollars to pay off the accounts payable in 6 months will be:
A) $3,000,000.
B) $3,660,000.
C) $3,750,000.
D) $3,810,000.

4) Refer to Instruction 10.2. If CVT locks in the forward hedge at $1.22/euro, and the spot rate when the transaction was recorded on the books was $1.25/euro, this will result in a “foreign exchange accounting transaction ________ of ________.
A) loss; $90,000.
B) loss; €90,000.
C) gain; $90,000.
D) gain; €90,000.

5) Refer to Instruction 10.2. CVT would be ________ by an amount equal to ________ with a forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had been correct.
A) better off; $150,000
B) better off; €150,000
C) worse off; $150,000
D) worse off; €150,000

6) Refer to Instruction 10.2. What is the cost of a call option hedge for CVT’s euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm’s cost of capital as the appropriate interest rate for calculating future values.)
A) $57,600
B) $59,904
C) $62,208
D) $63,936

7) Refer to Instruction 10.2. The cost of a put option to CVT would be:
A) $52,500.
B) $55,388.
C) $58,275.
D) There is not enough information to answer this question.

8) ________ are transactions for which there are, at present, no contracts or agreements between parties.
A) Backlog exposure
B) Quotation exposure
C) Anticipated exposure
D) none of the above

9) According to a survey by Bank of America, the type of foreign exchange risk most often hedged by firms is:
A) translation exposure.
B) transaction exposure.
C) contingent exposure.
D) economic exposure.

True/False

1) When attempting to manage an account payable denominated in a foreign currency, the firm’s only choice is to remain unhedged.

2) The treasury function of most firms, the group typically responsible for transaction exposure management, is NOT usually considered a profit center.

3) According to the authors, firms that employ proportional hedges increase the percentage of forward-cover as the maturity of the exposure lengthens.

4) Remaining unhedged is NOT an option when dealing with foreign exchange transaction exposure.

5) A forward hedge involves a put or call option contract and a source of funds to fulfill that contract.

6) Like a forward market hedge, a money market hedge also involves a contract and a source of funds to fulfill that contract. In this instance, the contract is a loan agreement.

7) Hedging transaction exposure with option contracts allows the firm to benefit if exchange rates are favorable but protects the firm if exchange rates turn unfavorable.

8) A firm’s risk tolerance is a combination of management’s philosophy toward transaction exposure and the specific goals of treasury activities.

9) Although rarely acknowledged by the firms themselves, selective hedging is essentially speculation.

Chapter 11 Translation Exposure

11.1 Overview of Translation

Multiple Choice

1) Translation exposure may also be called ________ exposure.
A) transaction
B) operating
C) accounting
D) currency

2) ________ exposure is the potential for an increase or decrease in the parent company’s net worth and reported net income caused by a change in exchange rates since the last transaction.
A) Transaction
B) Operating
C) Currency
D) Translation

3) Translation exposure measures:
A) changes in the value of outstanding financial obligations incurred prior to a change in exchange rates.
B) the potential for an increase or decrease in the parent company’s net worth and reported net income caused by a change in exchange rates since the last consolidation of international operations.
C) an unexpected change in exchange rates impact on short run expected cash flows.
D) none of the above

4) According to your authors, the main purpose of translation is:
A) to prepare consolidated financial statements.
B) to help management assess the performance of foreign subsidiaries.
C) to act as an interpreter for managers without foreign language skills.
D) none of the above

5) Historical exchange rates may be used for ________, while current exchange rates may be used for ________.
A) fixed assets and current assets; income and expense items
B) equity accounts and fixed assets; current assets and liabilities
C) current assets and liabilities; equity accounts and fixed assets
D) equity accounts and current liabilities; current assets and fixed assets

6) If an imbalance results from the accounting method used for translation, the imbalance is taken either to ________ or ________.
A) the bank; the post office
B) depreciation; the market for foreign exchange swaps
C) current income; equity reserves
D) current liabilities; equity reserves

7) Generally speaking, translation methods by country define the translation process as a function of what two factors?
A) size; location
B) a firm’s functional currency; location
C) location; foreign subsidiary independence
D) foreign subsidiary independence; a firm’s functional currency

8) A/An ________ subsidiary is one in which the firm operates as an extension of the parent company with cash flows highly interrelated with the parent.
A) self-sustaining foreign
B) integrated foreign entity
C) foreign
D) none of the above

9) Consider two different foreign subsidiaries of Georgia-Pacific Wood Products Inc. The first subsidiary mills trees in Canada and ships its entire product to the Georgia-Pacific U.S. The second subsidiary is also owned by the parent firm but is located in Japan and retails tropical hardwood furniture that it buys from many different sources. The first subsidiary is likely a/an ________ foreign entity with most of its cash flows in U.S. dollars, and the second subsidiary is more of a/an ________ foreign entity.
A) domestic; integrated
B) self-sustaining; domestic
C) integrated; self-sustaining
D) self-sustaining; integrated

10) A foreign subsidiary’s ________ currency is the currency used in the firm’s day-to-day operations.
A) local
B) integrated
C) notational dollar
D) functional

11) The ________ determines accounting policy for U.S. firms.
A) Securities and Exchange Commission (SEC)
B) Federal Reserve System (Fed)
C) Financial Accounting Standards Board (FASB)
D) General Agreement on Tariffs and Trade (GATT)

True/False

1) It is possible to use different exchange rates for different line items on a financial statement.

2) If the same exchange rate were used to remeasure every line on a financial statement, then there would be no imbalances from remeasuring.

3) A foreign subsidiary”s functional currency is the currency of the primary economic environment in which the subsidiary operates and in which it generates cash flows.

4) It is highly unusual for a multinational firm to have both integrated foreign entities AND self-sustaining foreign entities.

11.2 Translation Methods

Multiple Choice

1) The two basic methods for the translation of foreign subsidiary financial statements are the ________ method and the ________ method.
A) current rate; temporal
B) temporal; proper timing
C) current rate; future rate
D) none of the above

2) Gains or losses caused by translation adjustments when using the current rate method are reported separately on the:
A) consolidated statement of cash flow.
B) consolidated income statement.
C) consolidated balance sheet.
D) none of the above

3) The basic advantage of the ________ method of foreign currency translation is that foreign nonmonetary assets are carried at their original cost in the parent’s consolidated statement while the most important advantage of the ________ method is that the gain or loss from translation does not pass through the income statement.
A) monetary; current rate
B) temporal; current rate
C) temporal; monetary
D) current rate; temporal

4) Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S. dollars:
A) translation is accomplished through the current rate method.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) the translation method to be used is not obvious.

5) Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in the local currency, and the local currency is the functional currency, then:
A) the translation method to be used is not obvious.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) translation is accomplished through the current rate method.

6) Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in the local currency, and the U.S. dollar is the functional currency, then:
A) translation is not required.
B) translation is accomplished through the current rate method.
C) translation is accomplished through the temporal method.
D) none of the above

7) If the European subsidiary of a U.S. firm has net exposed assets of €750,000, and the euro drops in value from $1.30/euro to $1.20/€ the U.S. firm has a translation:
A) gain of $75,000.
B) loss of $75,000.
C) gain of $625,000.
D) loss of €576,923.

8) If the European subsidiary of a U.S. firm has net exposed assets of €200,000, and the euro increases in value from $1.22/€ to $1.26/€ the U.S. firm has a translation:
A) gain of $8,000.
B) loss of $8,000.
C) gain of $252,000.
D) loss of €252,000.

9) If the British subsidiary of a European firm has net exposed assets of £125,000, and the pound increases in value from €1.40/£ to €1.44/£, the European firm has a translation:
A) gain of €5,000.
B) loss of €5,000.
C) gain of £5,000.
D) loss of £5,000.

10) If the British subsidiary of a European firm has net exposed assets of £250,000, and the pound drops in value from €1.35/£ to €1.30/£, the European firm has a translation:
A) gain of €12,500.
B) loss of €12,500.
C) loss of £12,500.
D) gain of £12,500.

True/False

1) Exchange rate imbalances that are passed through the balance sheet affect a firm’s reported income, but imbalances transferred to the income statement do not.

2) The current rate method is the most prevalent method today for the translation of financial statements.

3) The temporal rate method is the most prevalent method today for the translation of financial statements.

4) The biggest advantage of the current rate method of reporting translation adjustments is the fact that the gain or loss goes directly to the reserve account on the consolidated balance sheet and does not pass through the consolidated income statement.

5) Under the temporal rate method, specific assets and liabilities are translated at exchange rates consistent with the timing of the item’s creation.

6) The temporal method of foreign currency translation gains or losses resulting from remeasurement are carried directly to current consolidated income and thus introduces volatility to consolidated earnings.

7) : The current rate method and the temporal method are two basic methods for translation that are employed worldwide

Essay

1) The two methods for the translation of foreign subsidiary financial statements are the current rate and temporal methods. Briefly, describe how each of these methods translates the foreign subsidiary financial statements into the parent company’s consolidated statements. Identify when each technique should be used and the major advantage(s) of each.

11.3 U.S. Translation Procedures

Multiple Choice

1) Under U.S. accounting and translation practices, use of the current rate method is termed ________ while use of the temporal method is termed ________.
A) translation; the same
B) translation; remeasurement
C) remeasurement; the same
D) remeasurement; translation

2) Which of the following primary principles of U.S. translation procedures in NOT true?
A) If the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S. dollars, translation is not required.
B) If the financial statements of the foreign subsidiary are maintained in the local currency and the local currency is the functional currency, they are translated by the temporal method.
C) If the financial statements of the foreign subsidiary are maintained in the local currency and the U.S. dollar is the functional currency, they are remeasured by the temporal method.
D) All of the above are true.

True/False

1) Under U.S. accounting and translation practices, use of the current rate method is termed “translation” while use of the temporal method is termed “remeasurement.”

2) If the financial statements of the foreign subsidiary are maintained in the local currency and the U.S. dollar is the functional currency, they are remeasured by the temporal method.

11.4 Trident Corporation’s Translation Exposure

Multiple Choice

1) ________ occur as a result of changes in the value of currency, whereas ________ occur as a result of ongoing business activities.
A) Operating gains or losses; translation gains or losses
B) Swap losses; translation gains or losses
C) Translation gains or losses; operating gains or losses
D) all of the above

True/False

1) Translation gains or losses can be quite different from operating gains or losses not only in magnitude but also in sign.

11.5 Trident Corporation’s Translation Exposure: Income

Multiple Choice

1) The main technique to minimize translation exposure is called a/an ________ hedge.
A) balance sheet
B) income statement
C) forward
D) translation

2) A balance sheet hedge requires that the amount of exposed foreign currency assets and liabilities:
A) have a 2:1 ratio of assets to liabilities.
B) have a 2:1 ratio of liabilities to assets.
C) have a 2:1 ratio of liabilities to equity.
D) be equal.

3) If a firm’s balance sheet has an equal amount of exposed foreign currency assets and liabilities and the firm translates by the temporal method, then:
A) the net exposed position is called monetary balance.
B) the change is value of liabilities and assets due to a change in exchange rates will be of equal but opposite direction.
C) Both A and B are true.
D) none of the above

4) If a firm’s subsidiary is using the local currency as the functional currency, which of the following is NOT a circumstance that could justify the use of a balance sheet hedge?
A) The foreign subsidiary is about to be liquidated, so that the value of its Cumulative Translation Adjustment (CTA) would be realized.
B) The firm has debt covenants or bank agreements that state the firm’s debt/equity ratio will be maintained within specific limits.
C) The foreign subsidiary is operating is a hyperinflationary environment.
D) All of the above are appropriate reasons to use a balance sheet hedge.

5) If the parent firm and all subsidiaries denominate all exposed assets and liabilities in the parent’s reporting currency this will ________ exposure but each subsidiary would have ________ exposure.
A) maximize translation; no transaction
B) eliminate translation; transaction
C) maximize transaction; no translation
D) eliminate transaction; translation

6) A Canadian subsidiary of a U.S. parent firm is instructed to bill an export to the parent in U.S. dollars. The Canadian subsidiary records the accounts receivable in Canadian dollars and notes a profit on the sale of goods. Later, when the U.S. parent pays the subsidiary the contracted U.S. dollar amount, the Canadian dollar has appreciated 10% against the U.S. dollar. In this example, the Canadian subsidiary will record a:
A) 10% foreign exchange loss on the U.S. dollar accounts receivable.
B) 10% foreign exchange gain on the U.S. dollar accounts receivable.
C) Since the Canadian firm is a U.S. subsidiary, neither a gain nor loss will be recorded.
D) Any gain or loss will be recorded only by the parent firm.

7) ________ gains and losses are “realized” whereas ________ gains and losses are only “paper.”
A) Translation; transaction
B) Transaction; translation
C) Translation; operating
D) none of the above

True/False

1) It is possible that efforts to decrease translation exposure may result in an increase in transaction exposure.

2) One possible reason for a balance sheet hedge could be because the foreign subsidiary is about to be liquidated, so that value of its Cumulative Translation Adjustment (CTA)would be realized.

3) One possible reason for a balance sheet hedge could be because the firm has debt covenants or bank agreements that state the firm”s debt/equity ratios will be maintained within specific limits.

4) If management expects a foreign currency to depreciate, it could minimize translation exposure by increasing net exposed assets.

5) If management anticipates an appreciation of the foreign currency, it should decrease net exposed assets to benefit from a gain.

Essay

1) Describe a balance sheet hedge and give at least two examples of when such a hedge could be justified.
balance sheet hedge attempts to equalize the amount of assets and liabilities of a foreign subsidiary exposed to translation risk. Thus, the gain to the firm from a change in exchange rates will be perfectly offset by an equal and opposite loss. Firms may engage in balance sheet hedges under conditions of hyperinflation, or when the subsidiary is about to be liquidated and the value of the CTA account would be realized. The author on page 16 lists other examples.

Chapter 12 Operating Exposure

12.1 Trident Corporation: A Multinational’s Operating Exposure

Multiple Choice

1) Another name for operating exposure is ________ exposure.
A) economic
B) competitive
C) strategic
D) all of the above

2) What type of international risk exposure measures the change in present value of a firm resulting from changes in future operating cash flows caused by any unexpected change in exchange rates?
A) transaction exposure
B) accounting exposure
C) operating exposure
D) translation exposure

3) ________ cash flows arise from intracompany and intercompany receivables and payments, while ________ cash flows are payments for the use of loans and equity.
A) Financing; operating
B) Operating; financing
C) Operating; accounting
D) Accounting; financing

4) Which of the following is NOT an example of a financial cash flow?
A) parent invested equity capital
B) interest on intrafirm lending
C) payment for goods and services
D) intrafirm principal payments

5) Which of the following is NOT an example of an operating cash flow?
A) management fees and distributed overhead
B) royalties and license fees
C) rent and lease payments
D) dividend paid to parent company

6) ________ exposure is far more important for the long-run health of a business than changes caused by ________ or ________ exposure.
A) Operating; translation; transaction
B) Transaction; operating; translation
C) Accounting; translation; transaction
D) Translation; operating; transaction

7) Simpson Sign Company based in Frostbite Falls, Minnesota has a 6-month C$100,000 contract to complete sign work in Winnipeg, Manitoba, Canada. The current spot rate is $1.02/C$ and the forward rate is $1.01/C$. Under conditions of equilibrium, management would use ________ today when preparing operating budgets.
A) $102,000
B) $101,000
C) $100,000
D) none of the above

8) When considering the phases of adjustment and response to operating exposure in the LONG RUN, price changes tend to be ________ and volume changes tend to be ________.
A) fixed/contracted; contracted.
B) fixed/contracted; completely flexible.
C) completely flexible; completely flexible.
D) completely flexible; contracted.

True/False

1) The goal of operating exposure analysis is to identify strategic operating techniques the firm might adopt to enhance value in the face of unanticipated exchange rate changes.

2) Operating cash flows may occur in different currencies and at different times, but financing cash flows may occur only in a single currency.

Comment: Financing of cash flows may also be in several currencies.

3) Expected changes in foreign exchange rates should already be factored into anticipated operating results by management and investors.

4) Moral hazard may occur when a firm or individual takes on more risk when it knows that someone else will “pick up the tab.”

5) Even though contracts are often fixed in the short run, as time passes, prices and costs can be changed to reflect the new competitive realities caused by a change in exchange rates.

12.2 Measuring Operating Exposure: Trident Germany

Multiple Choice

1) Recently the British Pound suffered an unexpected depreciation in value. Which of the following actions being considered by Coventry Furniture of London, a purely domestic furniture manufacturer and retailer, would be considered a highly unlikely response to the depreciation of the pound?
A) Coventry might choose to maintain its domestic sales prices constant in pound terms.
B) Coventry might try to raise domestic prices because competing imports are now priced higher in England.
C) Coventry might try to lower domestic prices because competing imports are now priced higher in England.
D) none of the above

2) Recently the Canadian dollar realized an unexpected appreciation in value. Which of the following actions being considered by Tall Timber Exports, a Canadian logging firm specializing in exporting raw forest products, would be considered a highly unlikely response to the appreciation of the Canadian dollar?
A) Tall Timber Exports might lower export prices in an effort to maintain market share.
B) Tall Timber Exports might raise export prices only slightly in an effort to increase market share.
C) Tall Timber Exports might leave export prices as they are and wait to determine what actions to take if any in the future.
D) all of the above

3) For a firm that competes internationally to sell its products, a depreciation of its domestic currency relative to markets where the firm exports goods, should eventually result in ________ sales at home and ________ sales abroad, other things equal.
A) fewer; greater
B) fewer; fewer
C) greater; greater
D) greater; fewer

4) Brimmo Motorcycles Inc., a U.S.-based firm, manufactures and sells electric motorcycles both domestically and internationally. A sudden and unexpected appreciation of the U.S. dollar should allow sales to ________ at home and ________ abroad. (Assume other factors remain unchanged.)
A) increase; increase
B) decrease; decrease
C) increase; decrease
D) decrease; increase

True/False

1) The strategy management undertakes in response to unexpected changes in exchange rates depends to a large measure on their opinion about the price elasticity of demand.

2) Unexpected changes in exchange rates is never good news for a firm’s operating income.

12.3 Strategic Management of Operating Exposure

Multiple Choice

1) Which of the following is NOT an example of diversifying operations?
A) diversifying sales
B) diversifying location of operations
C) raising funds in more than one country
D) sourcing raw materials in more than one country

2) Which of the following is NOT an example of diversification in financing?
A) raising funds in more than one market
B) raising funds in more than one country
C) diversifying sales
D) All of the above qualify.

3) When disequilibria in international markets occur, management can take advantage by:
A) doing nothing if they are already diversified and able to realize beneficial portfolio effects.
B) recognizing disequilibria faster than purely domestic competitors.
C) shifting operational of financing activities to take advantage of the disequilibria.
D) all of the above

4) Purely domestic firms will be at a disadvantage to MNEs in the event of market disequilibria because:
A) domestic firms lack comparative data from its own sources.
B) international firms are already so large.
C) all of the domestic firm’s raw materials are imported.
D) None of the above; domestic firms are not at a disadvantage.

5) Which of the following is probably NOT an advantage of foreign exchange risk management?
A) the reduction of the variability of cash flows due to domestic business cycles
B) increased availability of capital
C) reduced cost of capital
D) All of the above are potential advantages of foreign exchange risk management.

6) Which of the following is NOT an example of a form of political risk that might be avoided or reduced by foreign exchange risk management?
A) expropriation of assets
B) destruction of raw materials through natural disaster
C) war
D) unfavorable legal changes

True/False

1) Management must be able to predict disequilibria in international markets to take advantage of diversification strategies.

2) If a firm diversifies its financing sources, it will be pre-positioned to take advantage of temporary deviations from the International Fisher Effect.

3) Diversifying the financing base means diversifying sales, location of production facilities, and raw material sources.

4) The variability of a firm’s operating cash flows is probably reduced by international diversification of its production, sourcing, and sales because exchange rate changes under disequilibrium conditions are likely to increase the firm”s competitiveness in some markets while reducing it in others.

Essay

1) Diversification is possibly the best technique for reducing the problems associated with international transactions. Provide one example each of international financial diversification and international operational diversification and explain how the action reduces risk.

12.4 Proactive Management of Operating Exposure

Multiple Choice

1) Which of the following is NOT identified by your authors as a proactive management technique to reduce exposure to foreign exchange risk?
A) matching currency cash flows
B) cross-currency swaps
C) remaining a purely domestic firm
D) parallel loans

2) Which one of the following management techniques is likely to best offset the risk of long-run exposure to receivables denominated in a particular foreign currency?
A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Increase sales to that country.
D) Increase sales in this country.

3) Which one of the following management techniques is likely to best offset the risk of long-run exposure to payables denominated in a particular foreign currency?
A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Rely on the Federal Reserve Board to enact monetary policy favorable to your exposure risk.
D) none of the above

4) The particular strategy of trying to offset stable inflows of cash from one country with outflows of cash in the same currency is known as:
A) hedging.
B) diversification.
C) matching.
D) balancing.

5) Which of the following is NOT an acceptable hedging technique to reduce risk caused by a relatively predictable long-term foreign currency inflow of Japanese yen?
A) Import raw materials from Japan denominated in yen to substitute for domestic suppliers.
B) Pay suppliers from other countries in yen.
C) Import raw materials from Japan denominated in dollars.
D) Acquire debt denominated in yen.

6) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the firm chooses to hedge by seeking out potential suppliers in Japan. This hedging strategy is referred to as:
A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.

7) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the firm chooses to hedge by paying for imports from Canada in Japanese yen. This hedging strategy is known as:
A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.

8) A U.S. timber products firm has a long-term contract to import unprocessed logs from Canada. To avoid occasional and unpredictable changes in the exchange rate between the U.S. dollar and the Canadian dollar, the firms agree to split between the two firms the impact of any exchange rate movement. This type of agreement is referred to as:
A) risk-sharing.
B) currency-switching.
C) matching.
D) a natural hedge.

9) A ________ occurs when two business firms in separate countries arrange to borrow each other’s currency for a specified period of time.
A) natural hedge loan
B) forward loan
C) currency switch loan
D) back-to-back loan

10) A Canadian firm with a U.S. subsidiary and a U.S. firm with a Canadian subsidiary agree to a parallel loan agreement. In such an agreement, the Canadian firm is making a/an ________ loan to the ________ subsidiary while effectively financing the ________ subsidiary.
A) indirect; U.S.; Canadian
B) indirect; Canadian; U.S.
C) direct; U.S.; Canadian
D) direct; Canadian; U.S.

11) Which of the following is NOT an important impediment to widespread use of parallel loans?
A) difficulty in finding an appropriate counterparty
B) the risk that one of the parties will fail to return the borrowed funds when agreed
C) the process does not avoid exchange rate risk
D) All of the above are significant impediments.

12) A ________ resembles a back-to-back loan except that it does not appear on a firm’s balance sheet.
A) forward loan
B) currency hedge
C) counterparty
D) currency swap

13) A ________ is the term used to describe a foreign currency agreement between two parties to exchange a given amount of one currency for another, and after a period of time, to give back the original amounts.
A) matched flow
B) currency swap
C) back-to-back loan
D) none of the above

14) A British firm and a U.S. Corporation each wish to enter into a currency swap hedging agreement. The British firm is receiving U.S. dollars from sales in the U.S. but wants pounds. The U.S. firm is receiving pounds from sales in Britain but wants dollars. Which of the following choices would best satisfy the desires of the firms?
A) The British firm pays dollars to a swap dealer and receives pounds from the dealer. The U.S. firm pays pounds to the swap dealer and receives dollars.
B) The U.S. firm pays dollars to a swap dealer and receives pounds from the dealer. The British firm pays pounds to the swap dealer and receives dollars.
C) The British firm pays pounds to a swap dealer and receives pounds from the dealer. The U.S. firm pays dollars to the swap dealer and receives dollars.
D) The British firm pays dollars to a swap dealer and receives dollars from the dealer. The U.S. firm pays pounds to the swap dealer and receives pounds.

15) Reinvoicing centers provide the following benefit(s):
A) aid in the management of foreign exchange exposure.
B) effectively guarantee the exchange rate for future orders.
C) help manage intra-subsidiary cash flows.
D) all of the above

16) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from the Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar against the Canadian dollar NRI is finding a continued relationship with ATC to be an increasingly difficult proposition. In response to NRI’s request, ATC has proposed the following risk-sharing arrangement. First, set the current spot rate as the base rate. As long as spot rates stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5% range, ATC will share equally with NRI the difference between the spot rate and the base rate. If the current spot rate is C$1.20/$, what are the upper and lower limits for trading to take place at C$1.20?
A) C$1.205/$ – C$1.195/$
B) C$1.15/$ – C$1.25/$
C) C$1.14/$ – C$1.26/$
D) none of the above

17) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from The Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar against the Canadian dollar NRI is finding a continued relationship with ATC to be an increasingly difficult proposition. In response to NRI’s request, ATC has proposed the following risk-sharing arrangement. First, set the current spot rate as the base rate. As long as spot rates stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5% range, ATC will share equally with NRI the difference between the spot rate and the base rate. If NRI has a payable of C$100,000 due today and the current spot rate is C$1.17/$, how much does LBC owe in U.S. dollars?
A) $83,333
B) $85,470
C) $85,837
D) $117,000

18) Costs associated with the purchase of sizeable put options positions include each of the following EXCEPT:
A) the purchase price of the options.
B) the opportunity cost of buying the options rather than diversifying operations to reduce risk.
C) executive salaries of having corporate offices in more than one country.
D) none of the above

True/False

1) Currency swaps are exclusively for periods of time under one year.

2) Most swap dealers arrange swaps so that each firm that is a party to the transaction does not know who the counterparty is.

3) Most swap dealers arrange swaps so that each firm that is a party to the transaction knows who the counterparty is.

4) Swap agreements are treated as off-balance sheet transactions via U.S. accounting methods.

5) Swap agreements are treated as line items on the balance sheet via U.S. accounting methods.

6) After being introduced in the 1980s, currency swaps have remained a relatively insignificant financial derivative instrument.

7) After being introduced in the 1980s, currency swaps have gained increasing importance as financial derivative instruments.

8) The empirical evidence strongly supports the proposition that contractual hedges can effectively eliminate operating exposure.

Essay

1) A British firm has a subsidiary in the U.S., and a U.S. firm, known to the British firm, has a subsidiary in Britain. Define and then provide an example for each of the following management techniques for reducing the firm’s operating cash flows. The following are techniques to consider:
a) matching currency cash flows
b) risk-sharing agreements
c) back-to-back or parallel loans

Chapter 13 The Global Cost and Availability of Capital

13.1 Financial Globalization and Strategy

Multiple Choice

1) If a firm lies within a country with ________ or ________ domestic capital markets, it can achieve lower global cost and greater availability of capital with a properly designed and implemented strategy to participate in international capital markets.
A) liquid; segmented
B) liquid; large
C) illiquid; segmented
D) large; illiquid

2) Other things equal, a firm that must obtain its long-term debt and equity in a highly illiquid domestic securities market will probably have a:
A) relatively low cost of capital.
B) relatively high cost of capital.
C) relatively average cost of capital.
D) cost of capital that we cannot estimate from this question.

3) Relatively high costs of capital are more likely to occur in:
A) highly illiquid domestic securities markets.
B) highly liquid domestic securities markets.
C) unsegmented domestic securities markets.
D) none of the above

4) Reasons that firms may find themselves with relatively high costs of capital include:
A) The firms reside in emerging countries with undeveloped capital markets.
B) The firms are too small to easily gain access to their own national securities market.
C) The firms are family owned and they choose not to access public markets and lose control of the firm.
D) all of the above

5) Which of the following is NOT a contributing factor to the segmentation of capital markets?
A) excessive regulatory control
B) perceived political risk
C) anticipated foreign exchange risk
D) All of the above are contributing factors.

6) Which of the following is NOT a contributing factor to the segmentation of capital markets?
A) lack of transparency
B) asymmetric availability of information
C) insider trading
D) All of the above are contributing factors.

7) The weighted average cost of capital (WACC) is:
A) the required rate of return for all of a firm’s capital investment projects.
B) the required rate of return for a firm’s average risk projects.
C) not applicable for use by MNE.
D) equal to 13%.

8) The capital asset pricing model (CAPM) is an approach:
A) to determine the price of equity capital.
B) used by marketers to determine the price of saleable product.
C) that can be applied only to domestic markets.
D) none of the above

9) Which of the following is NOT a key variable in the equation for the capital asset pricing model?
A) the risk-free rate of interest
B) the expected rate of return on the market portfolio
C) the marginal tax rate
D) All are important components of the CAPM.

10) ________ risk is a function of the variability of expected returns of the firm’s stock relative to the market index and the measure of correlation between the expected returns of the firm and the market.
A) Systematic
B) Unsystematic
C) Total
D) Diversifiable

11) Systematic risk:
A) is the standard deviation of a security’s return.
B) is measured with beta.
C) is measured with standard deviation.
D) none of the above

12) Which of the following is generally unnecessary in measuring the cost of debt?
A) a forecast of future interest rates
B) the proportions of the various classes of debt a firm proposes to use
C) the corporate income tax rate
D) All of the above are necessary for measuring the cost of debt.

13) The after-tax cost of debt is found by:
A) dividing the before-tax cost of debt by (1 – the corporate tax rate).
B) subtracting (1 – the corporate tax rate) from the before-tax cost of debt.
C) multiplying the before-tax cost of debt by (1 – the corporate tax rate).
D) subtracting the corporate tax rate from the before-tax cost of debt.

14) A firm whose equity has a beta of 1.0:
A) has greater systematic risk than the market portfolio.
B) stands little chance of surviving in the international financial market place.
C) has less systematic risk than the market portfolio.
D) None of the above is true.

15) The difference between the expected (or required) return for the market portfolio and the risk-free rate of return is referred to as:
A) beta.
B) the geometric mean.
C) the market risk premium.
D) the arithmetic mean.

16) In general the geometric mean will be ________ the arithmetic mean for a series of returns.
A) less than
B) greater than
C) equal to
D) greater than or equal to

17) The beginning share price for a security over a three-year period was $50. Subsequent year-end prices were $62, $58 and $64. The arithmetic average annual rate of return and the geometric average annual rate of return for this stock was:
A) 9.30% and 8.58% respectively.
B) 9.30% and 7.89% respectively.
C) 9.30% and 7.03% respectively.
D) 9.30% and 6.37% respectively.

18) If a company fails to accurately predict it’s cost of equity, then:
A) the firm’s wacc will also be inaccurate.
B) the firm may not be using the proper interest rate to estimate NPV.
C) the firm may incorrectly accept or reject projects based on decisions made using the cost of capital computed with an incorrect cost of equity.
D) All of the above are true.

19) Which of the following statements is NOT true regarding beta?
A) Beta will have a value of less than 1.0 if the firm’s returns are less volatile than the market.
B) Beta will have a value of greater than 1.0 if the firm’s returns are more volatile than the market.
C) Beta will have a value of equal to 1.0 if the firm’s returns are of equal volatility to the market.
D) All of the statements above are true.

20) Which of the following will NOT affect a firm’s beta?
A) the choice of the market portfolio against which to compare the variability of a firm’s returns
B) the choice of the risk-free security
C) the choice of the time period used to calculate the firm’s beta
D) None of the above, because each of them affects the calculation of a firm’s beta.

True/False

1) A national securities market is segmented if the required rate of return on securities in that market differs from comparable securities traded in other, unsegmented markets.

2) Other things equal, an increase in the firm’s tax rate will increase the WACC for a firm that has both debt and equity financing.

3) If a firm’s expected returns are more volatile than the expected return for the market portfolio, it will have a beta less than 1.0.

4) The WACC is usually used as the risk-adjusted required rate of return for new projects that are of the same average risk as the firm’s existing projects.

5) One of the elegant beauties of international equity markets is that over the last 100 or so years, the average market risk premium is almost identical across major industrial countries.

6) Firms acquire debt in either the form of loans from commercial banks, or by selling new common stock.

7) When estimating an average corporate after-tax cost of capital, the component cost of equity is multiplied by (1-t) to allow for the tax-deductibility of dividend payments.

8) International CAPM (ICAPM) assumes that there is a global market in which the firm’s equity trades, and estimates of the firm’s beta, and the market risk premium, must then reflect this global portfolio.

9) Use of the International CAPM (ICAPM) assures that the WACC will be lower than if a purely domestic market portfolio had been used in the estimation of the cost of equity.

10) A global portfolio is an index of all the securities in the world, whereas a world portfolio represents those securities actually available to an investor.

11) The CAPM has now become very widely accepted in global business as the preferred method of calculating the cost of equity for a firm. As a result of this, there is now little debate over what numerical values should be used in its application.

12) The geometric mean will, in all but a few extreme circumstances, yield a larger return than the arithmetic mean return.

Essay

1) What are the components of the weighted average cost of capital (WACC) and how do they differ for an MNE compared to a purely domestic firm?

13.2 The Demand for Foreign Securities: The Role of International Portfolio Investors

Multiple Choice

1) The primary goal of both domestic and international portfolio managers is:
A) to maximize return for a given level of risk, or to minimize risk for a given level of return.
B) to minimize the number of unique securities held in their portfolio.
C) to maximize their WACC.
D) all of the above

2) Which of the following is NOT a portfolio diversification technique used by portfolio managers?
A) diversify by type of security
B) diversify by the size of capitalization of the securities held
C) diversify by country
D) All of the above are diversification techniques.

3) If all capital markets are fully integrated, securities of comparable expected return and risk should have the same required rate of return in each national market after adjusting for:
A) time of day and language requirements.
B) political risk and time lags.
C) foreign exchange risk and political risk.
D) foreign exchange risk and the spot rate.

4) Capital market segmentation is a financial market imperfection caused mainly by:
A) government constraints.
B) institutional practices.
C) investor perceptions.
D) all of the above

5) Capital market imperfections leading to financial market segmentation include:
A) asymmetric information between domestic and foreign-based investors.
B) high securities transaction costs.
C) foreign exchange risks.
D) all of the above

6) Capital market imperfections leading to financial market segmentation include:
A) political risks.
B) corporate governance differences.
C) regulatory barriers.
D) all of the above

7) The authors refer to companies that have access to a ________ as MNEs, and firms without such access are identified as ________.
A) global cost and availability of capital; domestic firms.
B) large domestic capital market; geographically challenged.
C) world financial markets; antiquated.
D) none of the above

8) The MNE can ________ its ________ by gaining access to markets that are more liquid and/or less segmented than its own.
A) increase; MCC.
B) decrease; MCC.
C) maintain; MRR.
D) none of the above

True/False

1) Internationally diversified portfolios often have a lower rate of return and almost always have a higher level of portfolio risk than their domestic counterparts.

2) Empirical tests of market efficiency fail to show that most major national markets are reasonably efficient.

3) A MNEs marginal cost of capital is constant for considerable ranges in its capital budget, but this statement cannot be made for most domestic firms.

4) Capital market segmentation is a financial market imperfection caused mainly by government constraints, institutional practices, and investor perceptions.

5) Since the 1980s and 1990s, segmentation in global financial markets has been reduced. As a result of this, the correlation among securities markets has increased, thereby reducing, but not eliminating, the benefits of international portfolio diversification.

13.3 The Cost of Capital for MNEs Compared to Domestic Firms

Multiple Choice

1) Theoretically, most MNEs should be in a position to support higher ________ than their domestic counterparts because their cash flows are diversified internationally.
A) equity ratios
B) debt ratios
C) temperatures
D) none of the above

2) According to your authors, diversifying cash flows internationally may help MNEs reduce the variability of cash flows because:
A) of a lack of competition among international firms.
B) of an offset to cash flow variability caused by exchange rate variability.
C) returns are not perfectly correlated between countries.
D) none of the above

3) Which of the following statements is NOT true regarding MNEs when compared to purely domestic firms?
A) MNEs tend to rely more on short and intermediate term debt.
B) MNEs have greater foreign exchange risk.
C) MNEs have greater costs of asymmetric information.
D) MNEs have higher agency costs.

4) Empirical research has found that systematic risk for MNEs is greater than that for their domestic counterparts. This could be due to:
A) the fact that the increase in the correlation of returns between the market and the firm is less than the increase in the standard deviation of returns of the firm.
B) the fact that the decrease in the correlation of returns between the market and the firm is greater than the increase in the standard deviation of returns of the firm.
C) the reduction in the correlation of returns between the firm and the market is less than the increase in the variability of returns caused by factors such as asymmetric information, foreign exchange risk, and the like.
D) None of the above; systematic risk is less for MNEs than for their domestic counterparts.

5) The optimal capital budget:
A) occurs where the marginal cost of capital equals the marginal rate of return of the opportunity set of projects.
B) is typically larger for purely domestic firms than for MNEs.
C) is an illusion found only in international finance textbooks.
D) none of the above

6) Empirical studies indicate that MNEs have higher costs of capital than purely domestic firms. This could be due to higher levels of:
A) political risk.
B) exchange rate risk.
C) agency costs.
D) all of the above

7) Despite the theoretical elegance of this hypothesis, empirical studies have come to the opposite conclusion.Despite the favorable effect of international diversification of cash flows, bankruptcy risk was only about the same for MNEs as for domestic firms. However, MNEs faced higher costs for each of the following EXCEPT:
A) agency costs.
B) political risk.
C) asymmetric information.
D) In fact, each of these costs were higher for the MNE than for the domestic firm.

True/False

1) Because of the international diversification of cash flows, the risk of bankruptcy for MNEs is significantly lower than that for purely domestic firms.

2) The opportunity set of projects is typically smaller for MNEs than for purely domestic firms because international markets are typically specialized niches.

3) Surprisingly, empirical studies find that MNEs have a higher level of systematic risk than their domestic counterparts.

Essay

1) What do theory and empirical evidence say about capital structure and the cost of capital for MNEs versus their domestic counterparts?

13.4 The Riddle: Is the Cost of Capital Higher for MNEs?

Multiple Choice

1) Empirical studies indicate that WACC for an MNE is higher than for their domestic competitors. Reasons cited for this increased cost include all of the following EXCEPT:
A) agency costs.
B) foreign exchange risk.
C) political risk.
D) All of the above are cited as reasons for an MNE’s increased WACC.

True/False

1) Empirical studies indicate that MNEs have a lower debt/capital ratio than domestic counterparts, indicating that MNEs have a lower cost of capital.

Chapter 14 Raising Equity and Debt Globally

14.1 Designing a Strategy to Source Capital Globally

Multiple Choice

1) The choice of when and how to source capital globally is usually aided early on by the advice of:
A) an investment banker.
B) your stock broker.
C) a commercial banker.
D) an underwriter.

2) Investment banking services include which of the following?
A) advising when a security should be cross-listed
B) preparation of stock prospectuses
C) help to determine the price of the issue
D) all of the above

3) Which of the following is the typical order of sourcing capital abroad?
A) an international bond issue, then cross listing the outstanding issues on other exchanges, then an international bond issue in the target market
B) an international bond issue in the target market, then cross listing the outstanding issues on other exchanges, then an international bond issue
C) an international bond issue in less prestigious markets, then an international bond issue in the target market, and ultimately a eurobond issue
D) cross listing the outstanding issues on other exchanges, then an international bond issue, then an international bond issue in the target market

4) By cross listing and selling its shares on a foreign stock exchange, a firm typically tries to accomplish which of the following?
A) improve the liquidity of its existing shares
B) increase its share price
C) increase the firm’s visibility
D) all of the above

True/False

1) Most firms raise their initial capital in foreign markets.

14.2 Optimal Financial Structure

Multiple Choice

1) Which financial economists are most closely associated with the financial theory of optimal capital structure?
A) Modigliani and Miller
B) Fama, Fisher, Jensen, and Roll
C) Black and Scholes
D) Markowitz and Sharpe

2) For most firms, the cost of capital decreases to a low point as the firm ________ debt financing. At some point beyond this optimal level, the cost of capital increases as the amount of debt ________.
A) decreases; increases
B) decreases; decreases
C) increases; increases
D) increases; decreases

3) One of the most important factors in making debt less expensive than equity is:
A) the tax deductibility of depreciation.
B) the tax deductibility of equity.
C) the tax deductibility of dividends.
D) the tax deductibility of interest.

4) One of the most important factors in making debt less expensive than equity is:
A) the seniority of equity obligations to debt claims.
B) the tax deductibility of dividends.
C) the tax deductibility of equity.
D) the seniority of debt obligations to equity claims.

5) Which of the following is NOT a factor offsetting the tax advantage of debt as a source of financing?
A) increased agency costs
B) increased probability of financial distress (bankruptcy) due to fixed interest payments
C) alternative tax shields to those supplied by interest payments
D) All of the above offset the tax advantage of debt as a source of financing.

6) Most financial theorists believe that the optimal capital structure is a ________ with a debt to total value ratio somewhere around ________.
A) point; 50%
B) point; 25%
C) range; 30%-60%
D) range; 10%-40%

7) Not all firms have the same optimal capital structure. Factors that might influence a firm’s capital structure include:
A) the industry in which it operates.
B) the volatility of its sales and operating income.
C) the collateral value of its assets.
D) all of the above

8) MNEs situated in countries with small illiquid and segmented markets are most like:
A) small domestic U.S. firms in that they must rely on internally generated funds and bank borrowing.
B) large U.S. MNEs in that they are all MNEs and have worldwide markets and sources of financing.
C) small domestic U.S. firms in that they have a strong niche market in the U.S.
D) None of the above is true.

9) In theory, the MNE should support ________ debt ratios than a purely domestic firm because their cash flows are ________.
A) lower; more stable due to international diversification
B) lower; less stable due to international diversification
C) higher; more stable due to international diversification
D) higher; less stable due to international diversification

10) TropiKana Inc., a U.S firm, has just borrowed $1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 6.00% per year, how much interest will they pay in the first year?
A) $6,000
B) $60,000
C) $600,000
D) €60,000

11) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro depreciates against the dollar from $1.40/€ at the time the loan was made to $1.35/€ at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?
A) $55,000
B) €74,250
C) $74,250
D) $77,000

12) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?
A) $55,000
B) $79,750
C) $77,000
D) $37,931

13) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)?
A) $1,529,750
B) €1,529,750
C) $1,055,000
D) $1,477,000

14) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro depreciates against the dollar from $1.40/€ at the time the loan was made to $1.35/€ at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)?
A) $1,477,000
B) $1,055,000
C) €1,424,250
D) $1,424,250

15) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, what is the before tax cost of capital if the firm repays the entire loan plus interest (rounded)?
A) 1.73%
B) 5.50%
C) 10.50%
D) 9.27%

True/False

1) Financial theory has at last provided us with a single optimal capital structure for domestic firms.

2) Financial practice suggests that there is a range for an optimal capital structure for a firm within an industry rather than a specific optimal ratio of debt to equity.

3) In part because of access to global markets, MNEs are better able than their domestic counterparts to maintain their desired debt ratio even when raising new capital.

4) When a firm borrows in a foreign currency, the effective cost is the foreign interest rate plus an adjustment for changes in the exchange rate.

5) The domestic theory of optimal capital structure does not need to be modified for MNEs.

6) Portfolio diversification of domestic firms reduces risk because cash flows are not perfectly correlated. The same reasoning is often argued for MNEs diversifying into international markets.

7) A significant advantage of borrowing foreign currency-denominated bonds is that the borrower need not worry about relative changes in the value of the home currency.

8) For firms to raise capital in international markets, it is more important to adhere to capital structure ratios similar to those found in the United States and United Kingdom than to those in the firm’s home country.

14.3 Raising Equity Globally

Multiple Choice

1) The stock exchange with the greatest value of shares traded is:
A) NYSE.
B) Tokyo.
C) Nasdaq.
D) London.

2) The number of foreign firms traded on the London exchange is ________ than the number traded on the NYSE, and the costs of listing and disclosure in London are ________ those for the NYSE.
A) less than; less than
B) less than; greater than
C) greater than; less than
D) greater than; greater than

True/False

1) The Tokyo exchange is the number one choice of firms looking to gain liquidity by cross-listing their equity securities.

2) The least liquid stock markets as identified by the authors offer little liquidity for their own domestic firms, and are of little value to foreign firms.

14.4 Depositary Receipts

Multiple Choice

1) ________ are negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank.
A) Negotiable CDs
B) International mutual funds
C) Depositary receipts
D) Eurodeposits

2) Depositary receipts traded outside the United States are called ________ depositary receipts.
A) Euro
B) Global
C) American
D) none of the above

3) Each ADR represents ________ of the shares of the underlying foreign stock.
A) a multiple
B) 100
C) 1
D) ADRs have nothing to do with foreign stocks.

4) Which of the following is NOT an advantage of ADRs to U.S. shareholders?
A) Transfer of ownership is done in the U.S. in accordance with U.S. laws.
B) In the event of the death of the shareholder, the estate does not go through a foreign court.
C) Settlement for trading is generally faster in the United States.
D) All of the above are advantages of ADRs.

5) ADRs that are created at the request of a foreign firm wanting its shares traded in the United States are:
A) facilitated.
B) unfacilitated.
C) sponsored.
D) unsponsored.

6) Who pays the costs of creating a sponsored ADR?
A) the foreign firm whose stocks underlie the ADR
B) the U.S. bank creating the ADR
C) both the U.S. bank and the foreign firm
D) the SEC since they require the regulation

7) Level I ADRs trade primarily:
A) on the New York Stock Exchange.
B) on the American Stock Exchange.
C) over the counter or pink sheets.
D) Level I ADRs typically do not trade at all, but instead are privately issued and held until maturity.

8) Level II ADRs must meet:
A) U.S. GAAP standards.
B) home country accounting standards.
C) both U.S. GAAP and home country standards.
D) none of the above

9) Level ________ is the easiest standard to satisfy for issuing ADRs.
A) 144a
B) III
C) II
D) I

10) Level III ADR commitment applies to:
A) firms that want to list existing shares on the NYSE.
B) banks issuing foreign mutual funds.
C) ADR issues of under $25,000.
D) the sale of a new equity issued in the United States.

True/False

1) ADRs cannot be exchanged for the underlying shares of the foreign stock, therefore, arbitrage cannot keep the prices in line with the foreign price of the stock.

2) An unsponsored ADR may be initiated without the approval of the foreign firm with the underlying stock.

3) ADRs are considered an effective way for firms to improve the liquidity of their stock, especially if the home market is small and illiquid.

Essay

1) ADRs are a popular investment tool for many U.S. investors. In recent years several alternatives for investing in foreign equity securities have become available for U.S. investors, yet ADRs remain popular. Define what an ADR is and provide at least three examples of the advantages they may hold over alternative foreign investment vehicles for U.S. investors.

14.5 Private Placement

Multiple Choice

1) Which of the following were NOT identified by the authors as an alternative instrument to source equity in global markets?
A) sale of a directed public share issue to investors in a target market
B) private placements under SEC rule 144a
C) sale of shares to private equity funds
D) All of the above are alternatives to source equity instruments.

2) A/An ________ is defined as one that is targeted at investors in a single country and underwritten in whole or part by investment institutions from that country.
A) SEC rule 144a placement
B) directed public share issue
C) Euroequity public issue
D) strategic alliance

3) The term “euro” as used in the euro equity market implies:
A) the issuers are located in Europe.
B) the investors are located in Europe.
C) both A and B
D) none of the above

4) Private equity funds (PEF) differ from traditional venture capital (VC) funds in that:
A) VC operates mainly in lesser-developed countries while PEF do not.
B) VC typically invests in family business whereas PEF do not.
C) VC is almost unavailable to emerging markets while PEF capital is available.
D) All of the above are true.

5) Strategic alliances are normally formed by firms that expect to gain synergies from which of the following?
A) economies of scale
B) economies of scope
C) complementary marketing
D) all of the above

True/False

1) SEC rule 144A permits institutional buyers to trade privately placed securities without the previous holding periods restrictions and without requiring SEC registration.

14.6 Foreign Equity Listing and Issuance

Multiple Choice

1) Your authors note several empirical studies that have found:
A) no share price effect for foreign firms that cross-list on major U.S. exchanges.
B) a positive share price effect for foreign firms that cross-list on major U.S. exchanges.
C) a negative share price effect for foreign firms that cross-list on major U.S. exchanges.
D) none of the above

2) Empirical evidence shows that new issues of equity by domestic firms in the U.S. market typically has a ________ stock price reaction and new equity issues in the U.S. markets by foreign firms with segmented domestic markets have a ________ stock price reaction.
A) negative; negative
B) positive; negative
C) negative; positive
D) positive; positive

3) In addition to gaining liquidity, which of the following could also be considered a legitimate reason for cross-listing equity?
A) enhance a firm’s local image
B) become more familiar with the local financial community
C) get better local press coverage
D) all of the above

4) Another school of thought about the worldwide trend toward fuller and more standardized disclosure rules is that the cost of U.S. level equity capital disclosure:
A) chases away potential listers of equity.
B) is an onerous costly burden.
C) leads to fewer foreign firms cross listing in U.S. equity markets.
D) all of the above

5) According to the U.S. school of thought, the worldwide trend toward fuller and more standardized disclosure rules should ________ the cost of equity capital.
A) increase
B) decrease
C) have no impact on
D) none of the above

6) For the most part, U.S. SEC disclosure requirements are ________ other, non-U.S. equity market rules.
A) more stringent than
B) less stringent than
C) equally stringent to
D) none of the above

True/False

1) The combined impact of a new equity issue undertaken simultaneously with a cross-listing has a more favorable impact on stock price than cross-listing alone.

2) Because of stringent SEC rules, American companies typically do not find foreign disclosure rules to be overly onerous.

Essay

1) What are the two schools of thought regarding the worldwide trend toward increased financial disclosure by publicly traded firms. Explain which school of thought you hold to and why.

14.7 Raising Debt Globally

Multiple Choice

1) ________ are domestic currencies of one country on deposit in a second country.
A) LIBORs
B) Eurocurrencies
C) Federal funds
D) Discount window deposits

2) Of the following, which was NOT cited by the authors as a valuable function provided by the Eurocurrency market?
A) Eurocurrency deposits are an efficient and convenient money market device for holding excess corporate liquidity.
B) Eurocurrency deposits are a tool used by the Federal Reserve to regulate the money supply of countries that peg their currency against the U.S. dollar.
C) The Eurocurrency market is a major source of short-term bank loans to finance corporate working capital needs.
D) All of the above were cited by the authors.

3) Eurobanks are:
A) banks where Eurocurrencies are deposited.
B) major world banks that conduct a Eurocurrency business in addition to normal banking activities.
C) financial intermediaries that simultaneously bid for time deposits in and make loans in a currency other than that of the currency of where it is located.
D) All of the above are descriptions of a Eurobank.

4) Eurocredits are:
A) bank loans to MNEs and others denominated in a currency other than that of the country where the bank is located.
B) typically variable rate and tied to the LIBOR.
C) usually for maturities of six months or less.
D) All of the above are true.

5) In general, which has the shorter maturity and is more appropriate for funding short-term inventory needs?
A) commercial paper
B) Euro-Medium-Term notes (EMTNs)
C) the international bond market
D) all of the above

6) Foreign bonds sold in the United States are nicknamed “Yankee bonds,” foreign bonds sold in Japan are called “Samurai bonds.” What are foreign bonds sold in the United Kingdom nicknamed?
A) “Union Jacks”
B) “Royalty”
C) “Bulldogs”
D) “Churchill’s”

7) A ________ is a bond underwritten by a syndicate from a single country, sold within in that country, denominated in that country’s currency, but the issuer is from outside that country.
A) foreign bond
B) Eurobond
C) domestic bond
D) none of the above

True/False

1) Eurocurrencies are NOT the same as the euro developed for the common European currency.

2) The Eurocurrency market continues to thrive because it is a large international money market relatively free of governmental regulation and interference.

3) Moody’s rates international bonds at the request of the issuer with the stipulation that Moody’s will publish the ratings even if the ratings are unfavorable.

Essay

1) The Euro-medium-term-note (EMTN) has filled a substantial niche market in global financing. What are the distinguishing characteristics of the EMTN and why is it such a popular form of financing for MNEs?

Chapter 15 Multinational Tax Management

15.1 Tax Principles

Multiple Choice

1) The issue of ethics in the reporting of income and the payment of taxes is a considerable one. The authors state that most MNEs operating in foreign countries tend to follow the general principle of:
A) “when in Rome, do as the Romans do.”
B) full disclosure to the tax authorities.
C) maintain a competitive playing field by cheating as much as the local competition, no more, no less.
D) none of the above

2) Which of the following is an unlikely objective of U.S. government policy for the taxation of foreign MNEs?
A) to raise revenues
B) to provide an incentive for U.S. private investment in developing countries
C) to improve the U.S. balance of payments
D) All of the above are objectives.

3) A ________ tax policy is one that has no impact on private decision-making, while a ________ policy is designed to encourage specific behavior.
A) flat; tax incentive
B) neutral; flat
C) neutral; tax incentive
D) none of the above

4) Which of the following is NOT an example of a tax incentive policy?
A) The federal government gives a tax credit to MNEs that make domestic capital improvements but not foreign capital improvements.
B) Corporations are allowed to take a direct tax credit for each dollar of matching donations they make to institutions of higher education.
C) A tax law is passed that makes interest on property non tax-deductible, but interest payments on durable goods are.
D) All are examples of a tax incentive policy.

5) Toyota Motor Company operates in many different countries and pays taxes at many different rates. However, they always pay the same rate as their local competitors. Toyota Motor Company is operating in an environment of ________ tax policy.
A) domestic neutrality
B) foreign neutrality
C) territorial approach
D) none of the above

6) The United States taxes the domestic and remitted foreign earnings of U.S. based MNEs no matter where the earnings occurred. This is an example of a/an ________ approach to levying taxes.
A) worldwide
B) territorial
C) neutral
D) equitable

7) The United States taxes all earnings on U.S. soil by both domestic and foreign firms. This is an example of a ________ approach to levying taxes.
A) worldwide
B) neutral
C) territorial
D) none of the above

8) Bacon Signs Inc. is based in a country with a territorial approach to taxation but generates 100% of its income in a country with a worldwide approach to taxation. The tax rate in the country of incorporation is 25%, and the tax rate in the country where they earn their income is 50%. In theory, and barring any special provisions in the tax codes of either country, Bacon should pay taxes at a rate of:
A) 75%.
B) 62.5%.
C) 0%.
D) 50%.

9) The territorial approach to taxation policy is also termed the ________ approach.
A) source
B) ethical
C) greedy
D) location

10) A tax that is effectively a sales tax at each stage of production is defined as a/an ________ tax.
A) flat
B) equitable
C) value-added tax
D) none of the above

11) What is the total value of taxes paid in the following example if the value added tax is 10%? A farmer raises wheat that he sells for $1.50 to the grain company. The grain company sells to the processor for $2.00 per bushel. The processor turns the wheat into a breakfast cereal and wholesales it for $3.00 per bushel. The retailer sells the cereal for $4.00 per bushel.
A) $0.15
B) $0.20
C) $0.30
D) $0.40

TABLE 15.1
Use the information to answer following question(s).

BayArea Designs Inc., located in Northern California, has two international subsidiaries, one located in the Ukraine, the other in Korea. Consider the information below to answer the next several questions.

12) Refer to Table 15.1. If BayArea pays out 50% of its earnings from each subsidiary, what are the additional U.S. taxes due on the foreign sourced income from the Ukraine and Korea respectively.
A) Ukraine = $0; Korea = ($30,000)
B) Ukraine = $100,000; Korea = $0
C) Ukraine = $0; Korea = $66,250
D) none of the above

13) Refer to Table 15.1. The additional U.S. taxes due on the repatriation of income from the Ukraine to the United States, alone, assuming a 50% payout rate, is:
A) excess foreign tax credits of $110,000.
B) additional U.S. taxes due of $97,000.
C) additional U.S. taxes due of $36,500.
D) excess foreign tax credits of $18,500.

14) Refer to Table 15.1. How much in additional U.S. taxes would be due if BayArea averaged the tax credits and liabilities of the two foreign units, assuming a 50% payout rate from each?
A) $3,750
B) $13,750
C) $2,500
D) $0

15) Refer to Table 15.1. If BayArea set the payout rate from the Ukraine subsidiary at 25%, how should BayArea set the payout rate of the Korean subsidiary (approximately) to more efficiently manage its total foreign tax bill?
A) 28.5%
B) 24.5%
C) 42.6%
D) 82.3%

16) Refer to Table 15.1. What is the minimum effective tax rate that BayArea can achieve on its foreign-sourced income?
A) 26%
B) 35%
C) 40%
D) 0%

17) Tax-haven subsidiaries are typically established in a country that can meet the following requirements:
A) a low tax on foreign investment or sales income earned by resident corporations and a low dividend withholding tax on dividends paid to the parent firm.
B) the facilities to support financial services, for example, good communications, professional qualified office workers, and reputable banking services.
C) a stable government that encourages the establishment of foreign-owned financial and service facilities within its borders.
D) all of the above

18) A tax that is a form of social redistribution of income is defined as a/an ________ tax.
A) un-American
B) transfer
C) flat
D) none of the above

19) A ________ is a direct reduction of taxes whereas a ________ reduces the taxable income before taxes.
A) foreign tax credit; domestic tax credit
B) tax deduction; tax credit
C) tax credit; tax deduction
D) none of the above

Instruction 15.1:
Use the information to answer the following question(s).

Green Valley Exporters USA has $100,000 of before tax foreign income. The host country has a corporate income tax rate of 25% and the U.S. has a corporate income tax rate of 35%.

20) Refer to Instruction 15.1. If the U.S. has no bilateral trade agreement with the host country, what is the total amount of income taxes Green Valley Exporters will pay?
A) $25,000
B) $35,000
C) $51,250
D) $60,000

21) Refer to Instruction 15.1. If the U.S. has a bilateral trade agreement with the host country that calls for the total tax paid to be equal to the maximum amount that could be paid in the highest taxing country, what is the total amount of income taxes Green Valley Exporters will pay to the host country, and how much will they pay in U.S income taxes on the foreign earned income?
A) $25,000; $10,000
B) $25,000; $26,250
C) $35,000; $0
D) none of the above

22) Refer to Instruction 15.1. If the U.S. treated the taxes paid on income earned in the host country as a tax-deductible expense, then Green Valley’s total U.S. corporate tax on the foreign earnings would be:
A) $10,000.
B) $26,250.
C) $35,000.
D) $51,250.

23) Refer to Instruction 15.1. If the U.S. treated the taxes paid on income earned in the host country as a tax-credit, then Green Valley’s total U.S. corporate tax on the foreign earnings would be:
A) $51,250.
B) $35,000.
C) $26,250.
D) $10,000.

24) Tax treaties typically result in ________ between the two countries in question.
A) lower property taxes for U.S. citizens overseas
B) elimination of differential tax rates
C) increased double taxation
D) reduced withholding tax rates

25) Transfer pricing is a strategy that may be used by MNEs to:
A) reduce consolidated corporate income taxes.
B) partially finance a subsidiary in another country.
C) transfer funds from a subsidiary to the parent corporation.
D) all of the above

26) ________ is the pricing of goods, services, and technology between related companies.
A) Among pricing
B) Retail pricing
C) Transfer pricing
D) Wholesale pricing

True/False

1) The primary objective of multinational tax planning is to minimize the firm’s worldwide tax burden.

2) A country CANNOT have both a territorial and a worldwide approach as a national tax policy.

3) Tax treaties generally have the effect of increasing the withholding taxes between the countries that are negotiating the treaties.

4) A value-added tax has gained widespread usage in Western Europe, Canada, and parts of Latin America.

5) All indications are that the value-added tax will soon be the dominant form of taxation in the U.S.

6) Among the G7 nations, the U.S. has a below average corporate income tax rate that makes it attractive for other countries to invest in the U.S.

7) In the mid 1980s the U.S. led the way to higher corporate income tax rates worldwide. Today, most of the G7 nations have surpassed the U.S. and have higher corporate income tax rates than the U.S.

8) The ideal tax should not only raise revenue efficiently but also have as few negative effects on economic behavior as possible.

9) The worldwide approach, also referred to as the residential or national approach to tax policy, levies taxes on the income earned by firms that are incorporated in the host country, regardless of where the income was earned (domestically or abroad).

10) The territorial approach, also referred to as the source approach to tax policy, levies taxes on the income earned by firms that are incorporated in the host country, regardless of where the income was earned (domestically or abroad).

11) Of the OECD 30 countries, most employ a worldwide approach to tax policy, but a few, including the United States, use the worldwide approach.

12) FEW governments rely on income taxes, both personal and corporate, for their primary revenue source.

13) Between 2006 – 2012, global corporate tax rates have trended upward.

14) Tax credits are LESS valuable on a dollar-for-dollar basis than are deductible expenses.

15) Tax treaties typically result in reduced withholding tax rates between the two signatory countries.

16) Tax credits are less valuable on a dollar-for-dollar basis than are tax-deductible expenses.

17) The U.S. Internal Revenue Service can reallocate revenues and expenses between parent corporations and their subsidiaries to more clearly reflect a proper allocation of income. In such instances it is the responsibility of the corporation to prove that the IRS has been arbitrary in its decision-making, thus establishing a “guilty until proved innocent” tax approach.

18) Tax haven subsidiaries of MNEs are categorically referred to as international offshore financial centers.

Essay

1) Explain the worldwide and territorial approaches of national taxation. The authors state that the United States uses both approaches. How can this be? Give an example of each taxation approach.

2) What is a value-added tax? Where is this type of tax in wide usage? Why do you suppose this form of taxation has NOT been widely accepted in the United States?

Chapter 16 International Portfolio Theory and Diversification

16.1 International Diversification and Risk

Multiple Choice

1) Beta may be defined as:
A) the measure of systematic risk.
B) a risk measure of a portfolio.
C) the ratio of the variance of the portfolio to the variance of the market.
D) all of the above

2) ________ risk is measured with beta.
A) Systematic
B) Unsystematic
C) International
D) Domestic

3) A fully diversified domestic portfolio has a beta of:
A) 0.0
B) 1.0
C) -1.0
D) There is not enough information to answer this question.

4) Unsystematic risk:
A) is the remaining risk in a well-diversified portfolio.
B) is measured with beta.
C) can be diversified away.
D) all of the above

5) A well-diversified portfolio has about ________ of the risk of the typical individual stock.
A) 8%
B) 19%
C) 27%
D) 52%

6) An internationally diversified portfolio:
A) should result in a portfolio with a lower beta than a purely domestic portfolio.
B) has the same overall risk shape as a purely domestic portfolio.
C) is only about 12% as risky as the typical individual stock.
D) all of the above

7) In some respects, internationally diversified portfolios are the same in principle as a domestic portfolio because:
A) the investor is attempting to combine assets that are perfectly correlated.
B) investors are trying to reduce systematic risk.
C) investors are trying to reduce the total risk of the portfolio.
D) all of the above

8) In some respects, internationally diversified portfolios are different from a domestic portfolio because:
A) investors may also acquire foreign exchange risk.
B) international portfolio diversification increases expected return but does not decrease risk.
C) investors must leave the country to acquire foreign securities.
D) all of the above

Instruction 16.1:
Use the information to answer the following question(s).

In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.

9) Refer to Instruction 16.1. How many euros will the U.S. investor acquire with his initial $500,000 investment?
A) €650,000
B) €370,370
C) €500,000
D) €384,615

10) Refer to Instruction 16.1. At an average price of €60/share, how many shares of stock will the investor be able to purchase?
A) 8333 shares
B) 6410 shares
C) 6173 shares
D) 10,833 shares

11) Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor’s average rate of return before converting the stock back into dollars?
A) 5.0%
B) -3.0%
C) -5.0%
D) 3.0%

12) Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor’s average rate of return after converting the stock back into dollars?
A) -1.35%
B) 5.0%
C) -5.0%
D) -7.24%

13) A U.S. investor makes an investment in Britain and earns 14% on the investment while the British pound appreciates against the U.S. dollar by 8%. What is the investor’s total return?
A) 22.00%
B) 23.12%
C) 6.00%
D) 4.88%

14) Which of the following statements is NOT true?
A) International diversification benefits induce investors to demand foreign securities.
B) An international security adds value to a portfolio if it reduces risk without reducing return.
C) Investors will demand a security that adds value.
D) All of the above are true.

True/False

1) Portfolio diversification can eliminate 100% of risk.

2) Increasing the number of securities in a portfolio reduces the unsystematic risk but not the systematic risk.

3) International diversification benefits may induce investors to demand foreign securities.

4) If the addition of a foreign security to the portfolio of the investor aids in the reduction of risk for a given level of return, then the security adds value to the portfolio.

5) If the addition of a foreign security to the portfolio of the investor decreases the expected return for a given level of risk, then the security adds value to the portfolio.

16.2 Internationalizing the Domestic Portfolio

Multiple Choice

1) Portfolio theory assumes that investors are risk-averse. This means that investors:
A) cannot be induced to make risky investments.
B) prefer more risk to less for a given return.
C) will accept some risk, but not unnecessary risk.
D) All of the above are true.

2) The efficient frontier of the domestic portfolio opportunity set:
A) runs along the extreme left edge of the opportunity set.
B) represents optimal portfolios of securities that represent minimum risk for a given level of expected portfolio return.
C) contains the portfolio of risky securities that the logical investor would choose to hold.
D) all of the above

3) The addition of foreign securities to the domestic portfolio opportunity set shifts the efficient frontier:
A) down and to the left.
B) up and to the right.
C) up and to the left.
D) down and to the right.

4) Relative to the efficient frontier of risky portfolios, it is impossible to hold a portfolio that is located ________ the efficient frontier.
A) to the left of
B) to the right of
C) on
D) to the right or left of

5) The ________ connects the risk-free security with the optimal domestic portfolio.
A) security market line
B) capital asset pricing model
C) capital market line
D) none of the above

Instruction 16.2:
Use the information to answer the following question(s).

A U.S. investor is considering a portfolio consisting of 60% invested in the U.S. equity index fund and 40% invested in the British equity index fund. The expected returns for the funds are 10% for the U.S. and 8% for the British, standard deviations of 20% for the U.S. and 18% for the British, and a correlation coefficient of 0.15 between the U.S. and British equity funds.

6) Refer to Instruction 16.2. What is the expected return of the proposed portfolio?
A) 9.2%
B) 9.0%
C) 19.2%
D) 19%

7) Refer to Instruction 16.2. What is the standard deviation of the proposed portfolio?
A) 38.00
B) 19.20
C) 19.00
D) 14.45

True/False

1) The graph for the efficient frontier has beta on the vertical axis and standard deviation of the horizontal axis.

2) The portfolio with the least risk among all those possible in the domestic portfolio opportunity set is called the minimum risk domestic portfolio.

3) The optimal domestic portfolio of risky securities is always the portfolio of minimum risk.

4) The standard deviation of a portfolio is the sum of the weighted average standard deviations of the individual assets.

5) The optimal domestic portfolio combines the risk-free asset and a portfolio of domestic securities found on the efficient frontier.

6) The internationally diversified portfolio opportunity set shifts TO THE RIGHT of the purely domestic opportunity set.

Essay

1) Draw the curve representing the Optimal Domestic Efficient Frontier. Be sure to draw and label the following: The vertical axis and the horizontal axis, the risk-free security, the minimum risk portfolio, the domestic portfolio opportunity set, the optimal domestic portfolio, and the capital market line. Choose a point along the domestic portfolio opportunity set between the optimal domestic portfolio and the minimum risk domestic portfolio and explain why that point is not the optimal risky domestic portfolio for investors to hold.

16.3 National Markets and Asset Performance

Multiple Choice

1) The authors present a comparison of correlation coefficients between major global equity markets over a variety of different periods. The comparison yields a number of conclusions listed here EXCEPT:
A) the correlation between equity markets for the full twentieth century shows quite low levels of correlation between some of the largest markets (close to 0.50 in some cases).
B) that same century of data, however, yields a high correlation between the U.S. and Canada (0.80).
C) the correlation coefficients between those same equity markets for selected sub periods over the last quarter of the twentieth century, however, show significantly different correlation coefficients.
D) None of the answers listed are inaccurate conclusions.

True/False

1) Capital markets around the world are on average less integrated today than they were 20 years ago.

2) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) determined that the equity returns in the United States out-performed the other 15 countries in the study.

3) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) found that just under one-half of the 16 countries in the study had negative average returns in their equity markets.

4) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) determined that due to high levels of correlation or returns between countries, there is almost NO BENEFIT to international portfolio diversification.

5) Of the major trading partners with the United States, Canada has among the LOWEST correlation of returns with the U.S.

Essay

1) If an investor is able to determine a global beta for his portfolio and holds a portfolio that is well-diversified with international investments, which performance measure is more appropriate, the Sharpe Measure or the Treynor Measure? Why? Explain each performance measure.

16.4 Market Performance Adjusted for Risk: The Sharpe and Treynor Performance Measures

Multiple Choice

1) The Sharpe measure uses ________ as the measure of risk and the Treynor measure uses ________ as the measure of risk.
A) standard deviation; variance
B) beta; variance
C) standard deviation; beta
D) beta; standard deviation

TABLE 16.1
Use the information to answer following question(s).

2) Refer to Table 16.1. What is the value of the Sharpe Measure for France?
A) 0.113
B) 0.0071
C) either A or B
D) neither A nor B

3) Refer to Table 16.1. What is the value of the Treynor Measure for the Netherlands?
A) 0.197
B) 0.0109
C) either A or B
D) neither A nor B

4) Refer to Table 16.1. ________ appears to have the greatest amount of risk as measured by monthly standard deviation, but ________ has the best return per unit of risk according to the Sharpe Measure.
A) United States; Austria
B) France; Austria
C) United States; Netherlands
D) France; Netherlands

5) The Sharpe and Treynor Measures tend to be consistent in their ranking of portfolios when the portfolios:
A) are poorly diversified.
B) are properly diversified.
C) contain only U.S. equity investments.
D) none of the above

True/False

1) The Sharpe and Treynor measures are each measures of return per unit of risk.

2) Good financial advice would suggest that investors should examine returns by the amount of return per unit of risk accepted, rather than in isolation.

3) The denominator of the Treynor measure is portfolio risk as measured by the standard deviation of the portfolio.

4) The denominator of the Sharpe measure is portfolio risk as measured by the standard deviation of the portfolio.

5) The denominator of the Sharpe measure is the portfolio’s beta, the systematic risk of the portfolio, as measured against the world market portfolio.

6) The denominator of the Treynor measure is the portfolio’s beta, the systematic risk of the portfolio, as measured against the world market portfolio.

Chapter 17 Foreign Direct Investment and Political Risk

17.1 Sustaining and Transferring Competitive Advantage

Multiple Choice

1) An example of economies of scale in financing include:
A) being able to access the Euroequity, Eurobond, and Eurocurrency markets.
B) being able to ship product in shiploads or carloads.
C) being able to use large-scale plant and equipment.
D) all of the above

2) Which of the following is NOT a factor of Porter’s “diamond of national advantage”?
A) factor conditions
B) demand conditions
C) related and supporting industries
D) All of the above are factors of the diamond of national advantage.

3) The OLI paradigm is an attempt to create a framework to explain why MNEs choose ________ rather than some other form of international venture.
A) licensing
B) joint ventures
C) foreign direct investment
D) strategic alliances

4) The O in OLI refers to an advantage in a firm’s home market that is:
A) operator independent.
B) owner-specific.
C) open-market.
D) official designation.

5) The owner-specific advantages of OLI must be:
A) firm-specific.
B) not easily copied.
C) transferable to foreign subsidiaries.
D) all of the above

6) A/An ________ would be an example of an owner-specific advantage for an MNE.
A) patent
B) economy of scale
C) economy of scope
D) all of the above

7) The L in OLI refers to an advantage in a firm’s home market that is a:
A) liability in the domestic market.
B) location-specific advantage.
C) longevity in a particular market.
D) none of the above

8) A/An ________ would be an example of a location-specific advantage for an MNE.
A) patent
B) economy of scale
C) unique source of raw materials
D) possession of proprietary information

9) The I in OLI refers to an advantage in a firm’s home market that is an:
A) internalization.
B) industry-specific advantage.
C) international abnormality.
D) none of the above

10) A/An ________ would be an example of an internalization advantage for an MNE.
A) patent
B) economy of scale
C) unique source of raw materials
D) possession of proprietary information

True/False

1) MNEs that are resident in liquid and unsegmented capital markets are more likely to be able to demonstrate financial strength by achieving and maintaining a global cost and availability of capital.

2) A strongly competitive home market tends to dull the competitive advantage relative to firms located in less competitive home markets.

3) The authors were unable to identify in lesser developed countries specific firms that are nearing the status of global MNE.

Essay

1) List and explain three strategic motives why firms become multinationals and give an example of each.

2) What does the OLI Paradigm propose to explain? Define each component and provide an example of each.

17.2 Deciding Where to Invest

Multiple Choice

1) Which of the following is NOT true regarding behavioral observations of firms making a decision to invest internationally?
A) MNEs initially invest in countries with a similar “national psychic.”
B) Firms eventually take greater risks in terms of the national psychic of countries in which they invest.
C) Initial investments tend to be much larger than subsequent ones.
D) All of the above have been observed.

True/False

1) In practice, when expanding into other countries, firms have been observed to follow a sequential search pattern as described in the behavioral theory of the firm.

2) As a general rule, the decision about where to invest abroad for the first time is the same as the decision about where to reinvest abroad.

17.3 How to Invest Abroad: Modes of Foreign Involvement

Multiple Choice

1) Which of the following is NOT an advantage to exporting goods to reach international markets rather than entering into some form of FDI?
A) fewer political risks
B) greater agency costs
C) lower front-end investment
D) All of the above are advantages.

2) Which of the following is an advantage to exporting goods to reach international markets rather than entering into some form of FDI?
A) fewer agency costs
B) fewer direct advantages from research and development
C) a greater risk of losing markets to copycat goods producers
D) an inability to exploit R&D as effectively as if also invested abroad

3) Which of the following is NOT a form of FDI?
A) wholly-owned affiliate
B) joint venture
C) exporting
D) greenfield investment

4) With licensing the ________ is likely to be lower than with FDI because of lower profits; however, the ________ is likely to be higher due to a greater return per dollar invested.
A) IRR; NPV
B) NPV; IRR
C) cost of capital; NPV
D) IRR; cost of capital

5) Which of the following is NOT a potential disadvantage of licensing relative to FDI?
A) possible loss of quality control
B) establishment of a potential competitor in third-country markets
C) possible improvement of the technology by the local licensee, which then enters the original firm’s home market
D) All of the above are potential disadvantages to licensing.

6) A ________ is a shared ownership in a foreign business.
A) licensing agreement
B) greenfield investment
C) joint venture
D) wholly-owned affiliate

7) Which of the following is NOT an advantage to a joint venture?
A) Possible loss of opportunity to enter the foreign market with FDI later.
B) The local partner understands the customs and mores of the foreign market.
C) The local partner can provide competent management at many levels.
D) May be a realistic alternative when 100% foreign ownership is not allowed.

8) Greenfield investments are typically ________ and ________ than cross-border acquisition.
A) slower; more uncertain
B) faster; of greater certainty
C) slower; of greater certainty
D) faster; more uncertain

9) All of the following may be justification for a strategic alliance EXCEPT:
A) takeover defense.
B) a joint venture to pool resources for research and development.
C) joint marketing and serving agreements.
D) All of the above are legitimate reasons for strategic alliances.

True/False

1) Licensing is a popular form of foreign investment because it does not need a sizable commitment of funds, and political risk is often minimized.

2) MNEs typically used licensing with independent firms rather than with their own foreign subsidiaries.

3) Joint ventures are a more common FDI than wholly owned subsidiaries.

4) Local partners in a foreign country and in a joint venture with an MNE are likely to make decisions that maximize the value of the subsidiary. Such actions probably will not maximize the value of the entire firm.

17.4 Political Risk

Multiple Choice

1) ________ risks are those that affect the MNE at the local or project level, but originate at the country level.
A) Country-specific
B) Firm-specific
C) Global-specific
D) none of the above

2) Which of the following is NOT an example of a country-specific risk?
A) transfer risk
B) war and ethnic strife
C) cultural and religious heritage
D) All of the above are examples of country-specific risk.

3) According to your authors, MNEs can anticipate government regulations that are discriminatory or wealth depriving from a/an ________ or ________ level view.
A) foreign; domestic
B) micro; macro
C) internal; external
D) local; global

4) ________ is the ability to exercise effective control over a foreign subsidiary within a country’s legal and political environment.
A) Political risk
B) Portfolio risk
C) Interest rate risk
D) Governance risk

5) Of the following, which would NOT be considered an issue for an investment agreement prior to investing in a foreign country?
A) the basis for setting transfer prices
B) the right to export to third-country markets
C) provision for arbitration of disputes
D) All of the above could be negotiated prior to investing.

6) OPIC stands for:
A) Organization for the Prevention of Insufficient Capitalization.
B) Organization of Petroleum Importing Countries.
C) Overseas Private Investment Corporation.
D) Overseas Public Insurance Commission.

7) ________ is a type of political risk that OPIC does NOT cover.
A) Inconvertibility
B) Expropriation
C) War
D) OPIC covers all of the above.

8) ________ is the risk that the host government will take specific steps that prevent the foreign affiliate from exercising control over the firm’s assets.
A) Inconvertibility
B) Expropriation
C) Business income risk
D) none of the above

9) ________ is NOT one of the three main country-specific risks as outlined by your authors.
A) Transfer risk
B) Cultural differences
C) Thin equity base
D) Protectionism

10) Of the following, which was NOT identified by the authors as a type of cultural difference that MNEs must consider when expanding to foreign countries?
A) differences in human resource norms
B) differences in religious heritage
C) differences in allowable ownership structures
D) All of the above must be considered.

11) An alternative strategy to engaging in bribery in international investments include:
A) refuse bribery outright.
B) retain local advisors to diffuse requests for bribes.
C) educate management and local employees about the firm’s bribery policy.
D) all of the above

12) ________ industries are NOT typically “protected” by government policy.
A) Textiles
B) Defense
C) Agriculture
D) “Infant” industries

13) Forming regional alliances is one way to help mitigate the practice of government protectionism. Which of the following is NOT a regional trade organization formed by government treaty?
A) EU
B) NAFTA
C) NATO
D) MERCOSUR

14) Terrorism, cyber attacks, and the anti-globalization movement are each examples of ________ risks.
A) firm-specific
B) country-specific
C) institutional
D) global-specific

15) Governance risk due to goal conflict between an MNE and its host government is the main political ________ risk.
A) firm-specific
B) country-specific
C) global-specific
D) cultural-specific

16) The speed at which inventory moves through a manufacturing process is known as:
A) supply chain management.
B) working capital management.
C) inventory velocity.
D) warp speed.

17) As a result of the terrorist attacks of September 11, 2001, many firms have employed a wide range of tactics to ensure continued flow of inventory in the face of government steps to curb terrorism. Which of the following is an inventory sourcing strategy response (as opposed to an inventory management response, or a transportation response)?
A) carrying more inventory on-hand
B) minimizing cross-border exposure from suppliers
C) shifting to air cargo shipments instead of co-habitation of products and passengers on commercial air flights
D) increasing the on-hand supply of critical parts

18) Blocked funds are cash flows that:
A) come in regular intervals in standardized amounts or blocks.
B) have been restricted in transfer out of a local country.
C) come from a certain sector or region of the world.
D) none of the above

19) A ________ loan, also known as ________ is a parent-to-affiliate loan channeled through a financial intermediary such as a large commercial bank.
A) fronting; link financing
B) parallel; a back-to-back loan
C) fronting; a back-to-back loan
D) link financing; parallel loan

20) Which of the following is NOT a typical characteristic of a fronting loan made to an international subsidiary?
A) The parent makes a deposit equal to the size of the desired loan into a large commercial bank.
B) The bank lends to the subsidiary firm an amount equal to the parent deposit at a slightly higher interest rate.
C) The lending bank is located in the subsidiary’s country.
D) All of the above are typical characteristics of a fronting loan.

21) Which of the following could be considered an example of forced reinvestment if the blockage of funds was expected to be temporary?
A) vertical reinvestment by an automobile manufacturer to buy parts suppliers and showrooms
B) A lumber cutting company subsequently builds a paper mill with blocked funds.
C) purchase of local money market instruments and short-term loans
D) all of the above

True/False

1) When faced with additional risk from a foreign investment, firms typically account for the additional risk by adjusting the discount rates or by adjusting cash flows.

2) A number of institutional services provide updated country risk ratings on a regular basis. This is an example of micro-risk information for MNEs using this data.

3) A country can react to the potential for blocked funds prior to making an investment, during operations, or by investing in the local country in assets than maintain their value.

4) Banks are very hesitant to engage in fronting loans because of the low probability of repayment and thus their risk exposure up to a 100% loss.

5) Many problems such as poverty, environmental concerns, and cyber attacks are beyond the capabilities of MNEs alone to correct and require government participation as well.

6) Business risk can be measured through sensitivity analysis but from only the project viewpoint.

Essay

1) What are blocked funds? List and explain two of the three methods the authors list in this chapter for dealing with blocked funds.

Chapter 18 Multinational Capital Budgeting and Cross-Border Acquisitions

18.1 Complexities of Budgeting for a Foreign Project

Multiple Choice

1) The traditional financial analysis applied to foreign or domestic projects, to determine the project’s value to the firm is called:
A) cost of capital analysis.
B) capital budgeting.
C) capital structure analysis.
D) agency theory.

2) Which of the following is NOT a basic step in the capital budgeting process?
A) Identify the initial capital invested.
B) Estimate the cash flows to be derived from the project over time.
C) Identify the appropriate interest rate at which to discount future cash flows.
D) All of the above are steps in the capital budgeting process.

3) Of the following capital budgeting decision criteria, which does NOT use discounted cash flows?
A) net present value
B) internal rate of return
C) accounting rate of return
D) All of these techniques typically use discounted cash flows.

4) Which of the following is NOT a reason why capital budgeting for a foreign project is more complex than for a domestic project?
A) Parent cash flows must be distinguished from project cash flows.
B) Parent firms must specifically recognize remittance of funds due to differing rules and regulations concerning remittance of cash flows, taxes, and local norms.
C) Differing rates of inflation exist between the foreign and domestic economies.
D) All of the above add complexity to the international capital budgeting process.

5) For purposes of international capital budgeting, which of the following statements is NOT true?
A) Managers must evaluate political risk because political events can drastically reduce the value or availability of expected cash flows.
B) Parent cash flows must be distinguished from project cash flows. Each of these two types of flows contributes to a different view of value.
C) An array of nonfinancial payments can generate cash flows from subsidiaries to the parent, including payment of license fees and payments for imports from the parent.
D) All of the above are true statements.

True/False

1) When engaged in international capital budgeting, the analyst must identify the initial amount of capital invested or put at risk.

2) In international capital budgeting, the appropriate discount rate for determining the present value of the
expected cash flows is always the firm’s domestic WACC.

3) For purposes of international capital budgeting, it is NOT important to distinguish between parent and total project cash flows.

4) For purposes of international capital budgeting, parent cash flows often depend on the form of financing. Thus, we cannot clearly separate cash flows from financing decisions, as we can in domestic capital budgeting.

18.2 Project Versus Parent Valuation

Multiple Choice

1) Project evaluation from the ________ viewpoint serves some useful purposes and/but should ________ the ________ viewpoint.
A) local; be subordinated to; parent’s
B) local; not be subordinated to; parent’s
C) parent’s; be subordinated to; local
D) none of the above

2) For financial reporting purposes, U.S. firms must consolidate the earnings of any subsidiary that is over ________ owned.
A) 20%
B) 40%
C) 50%
D) 75%

3) A foreign firm that is 20% to 49% owned by a parent is called a/an:
A) subsidiary.
B) affiliate.
C) partner.
D) rival.

4) Affiliate firms are consolidated on the parent’s financial statements on a ________ basis.
A) pro rated
B) 50%
C) 75%
D) 100%

True/False

1) There are no important differences between domestic and international capital budgeting methods.

2) It is important that firms adopt a common standard for the capital budgeting process for choosing among foreign and domestic projects.

3) The only proper way to estimate the NPV of a foreign project is to discount the appropriate cash flows first and then convert them to the domestic currency at the current spot rate.

4) When dealing with international capital budgeting projects, the value of the project is NOT sensitive to the firm’s cost of capital.

5) For purposes of international capital budgeting, evaluation of a project from the PARENT viewpoint serves some useful purposes, but it should be subordinated to evaluation from the LOCAL’s viewpoint.

6) Multinational firms should invest only if they can earn a risk-adjusted return greater than locally based competitors can earn on the same project.

Essay

1) The authors highlight a strong theoretical argument in favor of analyzing any foreign project from the viewpoint of the parent. Provide at least three reasons why the parent’s viewpoint is superior to the local viewpoint and give an example of when the local viewpoint fails to maximize the value of the firm.

2) Explain how political risk and exchange rate risk increase the uncertainty of international projects for the purpose of capital budgeting.

18.3 Illustrative Case: Cemex Enters Indonesia

Multiple Choice

1) Which of the following is NOT an example of political risk?
A) Expropriation of cash flows by a foreign government.
B) The U.S. government restricts trade with a foreign country where your firm has investments.
C) The foreign government nationalizes all foreign-owned assets.
D) All of the above are examples of political risk.

2) Real option analysis allows managers to analyze all of the following EXCEPT:
A) the option to defer.
B) the option to abandon.
C) the option to alter capacity.
D) All of the above may be analyzed using real option analysis.

3) Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of 6% in Norway and 3% per annum in the U.S., use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.
A) 7.87 krone per dollar
B) 8.10 krone per dollar
C) 8.34 krone per dollar
D) There is not enough information to answer this question.

4) When evaluating capital budgeting projects, which of the following would NOT necessarily be an indicator of an acceptable project?
A) an NPV > $0
B) an IRR > the project’s required rate of return
C) an IRR > $0
D) All of the above are correct indicators.

5) Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of 3% in Norway and 6% per annum in the U.S., use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.
A) 7.87 krone per dollar
B) 8.10 krone per dollar
C) 8.34 krone per dollar
D) There is not enough information to answer this question.

6) When determining a firm’s weighted average cost of capital (wacc) which of the following terms is NOT necessary?
A) the firm’s tax rate
B) the firm’s cost of debt
C) the firm’s cost of equity
D) All of the above are necessary.

7) When determining a firm’s weighted average cost of capital (WACC) which of the following terms is NOT necessary?
A) the firm’s weight of equity financing
B) the risk-free rate of return
C) the firm’s weight of debt financing
D) All of the above are necessary to determine a firm’s WACC.

Instruction 18.1:
Use the information to answer the following question(s).

The Velo Rapid Revolutions Inc., a company that produces bicycles, elliptical trainers, scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm’s required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.

8) Refer to Instruction 18.1. What is the initial investment for the Velo Rapid Revolutions project?
A) $1,500,000
B) €1,600,000
C) $1,600,000
D) €1,500,000

9) Refer to Instruction 18.1. What are the annual after-tax cash flows for the Velo Rapid Revolutions project?
A) €400,000
B) €240,000
C) €120,000
D) €360,000

10) Refer to Instruction 18.1. What is the NPV of the European expansion if Velo Rapid Revolutions first computes the NPV in euros and then converts that figure to dollars using the current spot rate?
A) $1,520,000
B) $1,684,210
C) -$75,310
D) -$71,544

11) Refer to Instruction 18.1. In euros, what is the NPV of the Velo Rapid Revolutions expansion?
A) €1,524,690
B) $1,611,317
C) -€75,310
D) -€111,317

12) Refer to Instruction 18.1. What is the IRR of the Velo Rapid Revolutions expansion?
A) 14.4%
B) 10.3%
C) 12.0%
D) 8.6%

13) If a firm undertakes a project with ordinary cash flows and estimates that the firm has a positive NPV, then the IRR will be:
A) less than the cost of capital.
B) greater than the cost of capital.
C) greater than the cost of the project.
D) cannot be determined from this information

14) When estimating a firm’s cost of equity capital using the CAPM, you need to estimate:
A) the risk-free rate of return.
B) the expected return on the market portfolio.
C) the firm’s beta.
D) all of the above

15) ________ is the risk that a foreign government will place restrictions such as limiting the amount of funds that can be remitted to the parent firm, or even expropriation of cash flows earned in that country.
A) Exchange risk
B) Foreign risk
C) Political risk
D) Unnecessary risk

16) Generally speaking, a firm wants to receive cash flows from a currency that is ________ relative to their own, and pay out in currencies that are ________ relative to their home currency.
A) appreciating; depreciating
B) depreciating; depreciating
C) appreciating; appreciating
D) depreciating; appreciating

17) When assessing the additional risk that can occur from investing abroad firms may choose to account for risk via:
A) adjusting the cash flows.
B) adjusting the discount rates.
C) adjusting both cash flows and discount rates.
D) adjusting all of the above.

True/False

1) When a multinational firm invests abroad, it is common to develop two capital budgets: one from the project viewpoint, and one from the parent viewpoint.

2) When estimating a capital budget, it is common to separate cash flows into: 1) the initial investment, 2) incremental cash flows over the life of the project, and 3) a terminal value.

3) Because international capital budgeting is so difficult, time consuming, expensive, and uncertain, firms generally forego any type of additional sensitivity analysis after completing a base-case scenario.

4) A criticism of adjusting the discount rate to account for political risk is that adjusting the discount rate for political risk penalizes early cash flows too heavily while not penalizing distant cash flows enough.

18.4 Project Financing

Multiple Choice

1) Which of the following is NOT a factor critical to the success of project financing?
A) separability of the project from its investors
B) long-lived and capital intensive singular projects
C) cash flow predictability from third part commitments
D) All of the above are critical factors for project financing.

2) Which of the following is NOT a characteristic of international long-term capital project financing?
A) The projects are large in scale.
B) The projects are long in life.
C) The projects are generally high in risk.
D) The projects may be all of the above.

3) Which of the following is NOT a reason given for international mergers and acquisitions?
A) gaining access to strategic proprietary assets
B) gaining market power and dominance
C) diversifying and spreading their risks wider
D) All of the above are commonly cited reasons for international mergers and acquisitions.

4) The process of acquiring an enterprise anywhere in the world has three common elements EXCEPT:
A) identification and valuation of the target.
B) execution of the acquisition offer and purchase—the tender.
C) management of the post-acquisition transition.
D) All of the above are common elements in acquiring an enterprise anywhere in the world.

True/False

1) Project financing is the arrangement of financing for very large individual long-term capital projects.

2) Currency risk is a concern for any international merger and acquisition activity. For instance, the initial bid, if denominated in a foreign currency, creates a contingent foreign currency exposure for the bidder.

3) Currency risk is a concern for any international merger and acquisition activity. For instance, once the bidder has successfully won the acquisition, the exposure evolves from a transaction exposure to a contingent exposure.

4) The drivers of international merger and acquisitions are only MACRO in scope.

5) As opposed to greenfield investment, a cross-border acquisition is typically quicker.

Chapter 19 Working Capital Management

19.1 Trident Brazil’s Operating Cycle

Multiple Choice

1) Working capital management involves the management of:
A) current and long-term assets.
B) current assets and current liabilities.
C) current liabilities and long-term assets.
D) current liabilities and long-term debt and equity.

2) The cash conversion cycle:
A) is a subset of the operating cycle.
B) occurs in the latter stages of the operating cycle.
C) is a subset of the accounts receivable period.
D) all of the above.

3) The proper order of events for the operating cycle is:
A) input serving period, accounts receivable period, inventory period, quotation period.
B) quotation period, accounts receivable period, inventory period, input servicing period.
C) quotation period, input servicing period, inventory period, accounts receivable period.
D) accounts receivable period, input servicing period, quotation period, inventory period.

4) TrinityApps Corporation (US) has bid a price on a project for a Korean firm, but the Korean firm has not yet placed an order. This portion of the operating cycle is best described as the:
A) quotation period.
B) input sourcing period.
C) cash conversion cycle.
D) accounts payable cycle.

5) The period in the cash cycle where the customer places the order, and the firm determines what materials for manufacture are NOT in inventory is called the ________ period.
A) quotation
B) input sourcing
C) accounts payable
D) accounts receivable

6) The accounts payable period of the operating cycle:
A) is equal to the inventory period.
B) may run concurrently but shorter than the inventory period.
C) may run concurrently but longer than the inventory period.
D) Any one of the above may be true.

True/False

1) Typically, the inventory period and the accounts payable period at least partially overlap in the firms operating cycle.

2) Typically, the inventory period and the accounts receivable period at least partially overlap in the firms operating cycle.

3) The operating cycle begins with the quotation period and ends with the accounts payable period.

19.2 Trident’s Repositioning Decisions

Multiple Choice

1) Of the following, which would NOT be a significant decision-making factor in a multinational firm’s repositioning decision-making?
A) the subsidiary’s tax environment (high or low)
B) the stability of the local currency
C) the ability to move capital in and out of the subsidiary’s country
D) All of the above are significant factors.

True/False

1) In a country with a relatively high tax rate, it make sense the the MNE to reposition cash flows TO that country.

2) The MNE would prefer to leave capital with a firm in a country with high growth prospects over the alternative of leaving capital with a firm in a country with low growth prospects (other factors equal).

19.3 Constraints on Repositioning Funds

Multiple Choice

1) Each of the following is listed by your authors as a constraint on repositioning funds by an MNE EXCEPT:
A) political constraints.
B) tax constraints.
C) transaction costs.
D) All of the above are listed by your authors.

True/False

1) Local liquidity needs sometimes impact a firm’s worldwide optimal cash position.

2) The constraints on repositioning of funds that occur when exchanging one currency for another are considered to be primarily political constraints.

3) Political constraints can block the transfer of funds either overtly or covertly. OVERT blockage occurs when dividends or other forms of fund remittances are severely limited, heavily taxed, or excessively delayed by the need for bureaucratic approval.

19.4 Conduits for Moving Funds by Unbundling Them

Multiple Choice

1) ________ allows a multinational firm to recover funds from subsidiaries without piquing host country sensitivities over large dividend drains.
A) Unbundling funds
B) Bundling funds
C) Coordinating funds
D) none of the above

2) Unbundling of funds by an MNE may be a useful practice for which of the following reasons?
A) An increase in the funds flow (charges) in any of the before-tax categories reduces the taxable profits of the foreign subsidiary if the host-country tax authorities acknowledge the charge as a legitimate expense.
B) An item-by-item matching of remittance to input, such as royalties for intellectual property, and fees for patents and advice, is equitable to the host country and foreign investor alike.
C) Unbundling facilitates allocation of overhead from a parent”s international division, so-called shared services, to each operating subsidiary in accordance with a predetermined formula.
D) All of the reasons listed above

True/False

1) If all investment inputs are unbundled, part of what might have been classified as residual profits may turn out to be tax-deductible expenses related to a specific purchased benefit.

2) The before-tax/after-tax distinction is quite significant to a parent company attempting to repatriate funds in the most tax-efficient method if it is attempting to manage its own foreign tax credit/deficits between foreign units.

19.5 International Dividend Remittances

Multiple Choice

1) In anticipation of a foreign exchange loss, an MNE may speed up the transfer of funds out of the company via dividends. When undertaking such an activity the MNE must be concerned with all of the following EXCEPT:
A) interest rate differences between the two countries.
B) the negative impact on host country relations.
C) defection on the part of executives in the home headquarters.
D) MNEs must be concerned with all of the above.

True/False

1) Political risk may motivate parent firms to require foreign subsidiaries to remit all locally generated funds above that required to internally finance growth in sales and planned capital expansions.

19.6 Net Working Capital

Multiple Choice

1) One possible definition of net working capital (NWC) provided by your authors is:
A) NWC = A/R + inventory – A/P.
B) NWC = cash + A/P – inventory.
C) NWC = A/P + A/R – short-term loans.
D) NWC = A/R + inventory – long-term debt.

2) Which of the following actions will result in an increase in NWC?
A) an increase in A/P that exceeds an increase in A/R
B) a reduction in inventory
C) a reduction in A/P plus a smaller reduction in A/R
D) an increase in A/P and a smaller reduction in inventory

3) Which of the following statements is true?
A) A/R provide part of the funding for inventory.
B) A/P provide part of the funding for A/R and inventory.
C) Inventory pays for A/R and A/P.
D) None of the above is true.

TABLE 19.1
Use the information to answer following question(s).

TrinityApps Corporation Balance Sheet December 31, 20xx

4) Refer to Table 19.1. The NWC for TrinityApps is:
A) $80,000
B) $680,000
C) $35,000
D) $45,000

5) Refer to Table 19.1. If TrinityApps increases inventory by $10,000 and A/P also by $10,000, the net change in NWC is:
A) $20,000
B) $10,000
C) $0
D) none of the above

6) Refer to Table 19.1. NWC currently makes up what percentage of total firm value for TrinityApps?
A) 6.6%
B) 5.1%
C) 11.8%
D) 9.2%

Instruction 19.1:
Use the information to answer the following question(s).

Sunny Manufacturing Systems Inc. is supplied with plastic chips for their plastic injection molding manufacturing process. Their supplier, Sun Chemical, Inc. offers financing terms of a 2% discount if the accounts payable are paid in 10 days or less with the full balance due in 45 days. Short-term financing available to Sunny Manufacturing is available at an annual rate of 9.6%. Sunny Manufacturing has just purchased $400,000 of plastic chips from Sun Chemical.

7) Refer to Instruction 19.1. What is the amount of money Sunny Manufacturing will save on accounts payable if they accept the discount?
A) $400,000
B) $8,000
C) $33,333
D) $20,000

8) Refer to Instruction 19.1. What is the effective annual interest cost of supplier financing offered by Sun Chemical?
A) 7.3%
B) 9.5%
C) 10.4%
D) 22.9%

9) Refer to Instruction 19.1. Should Sunny Manufacturing take the discount offered by Sun Chemical?
A) Yes, Sunny Manufacturing will get to use their raw materials 35 days earlier than if they waited to pay at the end of the 45 days.
B) No, Sunny Manufacturing will not have to pay any interest if they just pay in 45 days.
C) Yes, Sunny Manufacturing’s short term borrowing rate of 9.6% is less than Sun’s offered cost of carry of 22.9%.
D) No, it costs Sunny Manufacturing 22.9% to accept the discount and they are better off paying the full amount in 45 days.

10) Days working capital is equal to:
A) days payables + days receivables – days inventory.
B) days inventory + days receivables – days payables.
C) days payables + days inventory + days receivables.
D) none of the above

11) Amundsen of Norway receives raw materials from their corporate parent in the U.S. with payment terms of net 60 days. Most of their sales are to firms in Norway where normal payment terms are net 30 days. This causes a problem for the subsidiary with working capital management because:
A) accounts receivable are so much longer than accounts payable.
B) accounts payable are so much longer than accounts receivable.
C) accounts receivable and accounts payable are equal.
D) This doesn’t really cause a problem; in fact it is to the benefit of the Norwegian subsidiary.

True/False

1) In principle, the firm tries to minimize its NWC balance.

2) Other things equal, managers prefer a lower “days working capital” to a higher one.

3) The authors present empirical evidence that shows the days sales basis for working capital to be 30 days GREATER in the U.S. compared to a similar industry in Europe.

Essay

1) What is a free-trade zone? Identify three techniques and provide examples of how firms and countries can benefit from having free trade zones.

19.7 International Cash Management

Multiple Choice

1) Other things equal, a firm would rather have ________ in a depreciating currency, and ________ in an appreciating currency.
A) accounts receivable; accounts payable
B) accounts receivable; accounts receivable
C) accounts payable; accounts receivable
D) none of the above

2) Which of the following is NOT a precautionary motive for holding cash?
A) Anticipated funds to be remitted from several Middle East countries are in question due to unrest in the region.
B) The firm has several short-term obligations in unhedged foreign currency-denominated contracts.
C) The firm must pay ordinary wages in two days.
D) All are precautionary motives.

3) Increases to cash flows can be anticipated if which of the following occurs?
A) A receivables contract is denominated in an appreciating foreign currency.
B) Sales are less than anticipated.
C) Days in accounts receivable increase by 15 days.
D) none of the above

4) A centralized depository benefits the firm primarily by:
A) reducing the cost of repatriating funds.
B) positioning profits where taxes are lowest.
C) reducing the total amount of capital employed within the total firm.
D) earning a higher rate of return than in domestic banking deposits.

5) The Clearing House Interbank Payment System (CHIPS) is:
A) the largest publicly operated payments system in the world.
B) owned and operated by the world’s seven largest central banks.
C) a computerized network that connects banks globally.
D) none of the above

6) An organizational structure employed by an MNE to reduce its use of bank lending for the support of operations is:
A) a centralized depository.
B) a reinvoicing center.
C) a cost center.
D) a syndicated bank.

7) ________ is the process that cancels via offset all, or part, of the debt owed by one entity to another related entity.
A) Syndicated banking
B) Centralized depositing
C) Multilateral netting
D) Debt cancellation

True/False

1) In an inflationary economy, demand for credit usually exceeds supply.

2) For disbursement purposes, it is to the benefit of the firm to minimize float.

3) Regarding wire transfers, CHIPS actually clears transactions whereas SWIFT does not.

4) A significant problem with centralized cash depositories is that they are isolated from the rest of the firm and tend to be at an information disadvantage.

5) A reason for holding all precautionary balances in a central pool is that the total pool, if centralized, can be reduced in size without any loss in the level of protection.

6) A disadvantage of a centralized cash management system is that managers will not be able to get the lowest average rate available for the firm. Instead, it misses out on the really low borrowing rates.

Essay

1) Central depositories are used for international cash management. What is a central depository? Identify and provide examples of at least three advantages to MNEs of having a central depository.

19.8 Financing Working Capital

Multiple Choice

1) A precautionary cash balance:
A) is used to replace spoiled or damaged inventory.
B) is held to facilitate cash disbursements when receipts slow down.
C) is used for normal day-to-day operations.
D) is held for the benefit of a sister affiliate.

2) An in-house bank:
A) is a separate bank chartered to operate within a business firm.
B) is in fact a set of functions performed by the firm’s existing treasury department.
C) assesses the credit standing of the bank’s customers.
D) provides banking services for employees.

3) A foreign banking office that is separately incorporated in the host country is:
A) a correspondent bank.
B) a representative office.
C) a bank subsidiary.
D) an Edge Act corporation.

True/False

1) An Edge Act corporation is a subsidiary of a U.S. bank located outside of the U.S. and incorporated to engage in international banking and financing operations.

2) Because they are direct payments, dividends are among the most efficient way for foreign subsidiaries to remit funds back to the parent.

3) Even though dividends are cash payments, firms typically must consider both cash flow and net income when making dividend distribution decisions.

Chapter 20 International Trade Finance

20.1 The Trade Relationship

Multiple Choice

1) The exporter-importer relationship to a corporation of a foreign importer that has not previously conducted business with the firm would be an:
A) unaffiliated known.
B) affiliated party.
C) unaffiliated unknown.
D) any of the above

2) Which of the following relationships between importing and exporting parties would require the least detailed contract to conduct business?
A) affiliated party
B) unaffiliated unknown party
C) known unaffiliated party
D) domestic supplier

3) Polaris Corporation has made an agreement to ship goods to a foreign firm with whom they have not entered into a contract for three years. However, the firms have communicated regularly since the last sale three years ago. This is an example of an:
A) unaffiliated known party transaction.
B) unaffiliated unknown party transaction.
C) affiliated party transaction.
D) none of the above

True/False

1) Today, international trade is dominated by transactions between unaffiliated parties (known or unknown).

2) Because most international transactions are between affiliated parties, international transaction contracts are less complex, but the management of the total value of the MNE is more complex.

3) An advantage of trading with an affiliated party for an MNE, compared to an unaffiliated party, could be reduced contracting costs and less to even no need to protect against nonpayment.

20.2 The Trade Dilemma

Multiple Choice

1) Which of the following is NOT a financial instrument that may be included in an international trade transaction?
A) Letter of Credit
B) Sight Draft
C) Order bill of lading
D) Federal funds transaction

True/False

1) The fundamental dilemma of foreign trade is being unwilling to trust a stranger in a foreign land.

20.3 Benefits of the System

Multiple Choice

1) The combination of a letter of credit, a sight draft, and an order bill of lading protect both parties in international transactions from which of the following?
A) the risk of noncompletion
B) the risk of foreign exchange risk (when combined with a various hedging techniques)
C) the risk that financing will not be available due to foreign exchange risk
D) All of these risks are reduced when using these trade implements.

True/False

1) If a foreign exchange transaction calls for payment in the importer’s currency, the exporter has the foreign exchange risk.

2) If a foreign exchange transaction calls for payment in the exporter’s currency, the importer has the foreign exchange risk.

3) In the case of international trade, the risk of nonpayment is essentially eliminated with the use of a letter of credit issued through a trustworthy bank.

20.4 Key Documents

Multiple Choice

1) Which of the following is NOT true regarding a letter of credit?
A) The importer and exporter agree on a transaction.
B) The importer applies to its local bank for the issuance of a letter of credit.
C) The exporter applies to its local bank for the issuance of a letter of credit.
D) The importer’s bank cuts a sales contract based on its assessment of the creditworthiness of the importer.

2) A/An ________ letter of credit is intended to serve as a means of arranging payment, but not as a guarantee of payment.
A) irrevocable
B) revocable
C) confirmed
D) unconfirmed

3) A/An ________ letter of credit is an obligation only of the issuing bank whereas other banks honor a/an ________ letter of credit.
A) irrevocable; unconfirmed
B) revocable; confirmed
C) confirmed; irrevocable
D) unconfirmed; confirmed

4) A letter of credit that is confirmed in the ________ country has the additional advantage of eliminating the problem of ________.
A) exporter’s; portfolio risk
B) importer’s; blocked foreign exchange
C) exporter’s; blocked foreign exchange
D) none of the above

5) The draft is the instrument normally used in international commerce to:
A) transfer product.
B) prove ownership.
C) transfer title.
D) initiate the sale.

6) The ________ is the instrument normally used to actually effect payment in international commerce.
A) banker’s acceptance
B) bill of exchange
C) bill of lading
D) letter of credit

7) The person or company initiating the draft or bill of exchange is known as the:
A) maker.
B) drawer.
C) originator.
D) any of the above

8) The person or company to whom the draft or bill of exchange is addressed is the:
A) drawee.
B) drawer.
C) maker.
D) originator.

9) Drafts that have been accepted by banks become:
A) clean drafts.
B) nonmarketable.
C) banker’s acceptances.
D) none of the above

10) Which of the following purposes is NOT served by the bill of lading?
A) It acts as a receipt.
B) It acts as a contract.
C) It acts as a document of title.
D) It acts as all of the above.

11) The ________ is issued to the exporter by a common carrier transporting the merchandise.
A) bill of lading
B) draft
C) banker’s acceptance
D) line of credit

12) A straight bill of lading is most likely to be used under which of the following circumstances?
A) when the merchandise has not been paid for in advance
B) when the transaction is being financed by a bank
C) when the shipment is to an affiliate
D) none of the above

13) To become a negotiable instrument, a draft must conform to the following requirements EXCEPT:
A) it must be in writing and signed by the maker or drawer.
B) it must be payable to order or to bearer.
C) it must be written in English.
D) it must be payable on demand or at a fixed or determinable future date.

True/False

1) A letter of credit is an agreement by the bank to pay against documents rather than the actual merchandise.

2) The primary advantage of a letter of credit is that it reduces risk.

3) The major advantage of a letter of credit to the exporter is that the exporter does not receive any funds until the documents have arrived at a local port or airfield.

4) To constitute a true letter of credit transaction, the issuing bank must receive a fee or other valid business consideration for issuing the L/C.

5) To constitute a true letter of credit transaction, the bank’s L/C must contain a specified expiration date or a definite maturity.

6) To constitute a true letter of credit transaction, the bank’s commitment must be open-ended and cannot have a stated maximum amount of money.

7) A revocable L/C is intended to serve as a means of arranging payment but not as a guarantee of payment.

8) A sight draft is payable on presentation to the drawee; a time draft allows a delay in payment.

9) A draft is sometimes called a revocable letter of credit.

10) A time draft is payable on presentation to the drawee; the drawee must pay at once or dishonor the draft. A sight draft, allows a delay in payment.

11) The bill of lading is issued to the exporter by a common carrier transporting the merchandise. It serves three purposes: a receipt, a contract, and a document of title.

Essay

1) Explain what a letter of credit (L/C) is, who the principle parties are, what the principle advantage is, and how the L/C facilitates international trade.

20.5 Example: Documentation in a Typical Trade Transaction

Multiple Choice

1) In a typical international trade transaction, the order of activity would be which of the following?
A) The foreign buyer places an order; The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The buyer’s bank submits payment to the manufacturer’s bank.
B) The domestic manufacturer ships to the buyer; The buyer’s bank submits payment to the manufacturer’s bank; The foreign buyer places an order; The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance.
C) The foreign buyer places an order; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The domestic manufacturer ships to the buyer; The buyer’s bank submits payment to the manufacturer’s bank.
D) The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The foreign buyer places an order; The buyer’s bank submits payment to the manufacturer’s bank.

True/False

1) Because of the risks involved in international trade, most transactions follow conventional methods and rarely require flexibility or creativity on the part of management.

Comment: Few international transactions are typical and often require flexibility or creativity on the part of management.

20.6 Government Programs to Help Finance Exports

Multiple Choice

1) The Export-Import Bank is an independent agency of the U.S. government established in 1934 to:
A) ship money abroad.
B) import agricultural products during the recession.
C) facilitate and stimulate foreign trade of the United States.
D) none of the above

2) In the United States, the Foreign Credit Insurance Corporation:
A) is a subsidiary of the Export-Import Bank.
B) provides letters of credit for U.S. importers.
C) provides letters of credit for U.S. exporters.
D) provides policies that protect U.S. exporters against default by foreign importers.

Instruction 20.1:
Use the information to answer the following question(s).

Cypress Systems Inc., of Florida, agrees to sell specialized hydroponic growing equipment to Landcaster’s of Australia. Because the two companies have never done business with each other, Cypress requires a banker’s acceptance as payment for the $1,000,000 order. The banker’s acceptance carries a 1.4% commission per annum and payment is to be received in 6 months. If Cypress Inc. chooses to discount or sell the bankers acceptance to its bank, the discount rate is 1.00% per annum.

3) Refer to Instruction 20.1. What is the size of the discount (not including the commission fee) Cypress must take for receiving the proceeds of the sale today rather than waiting for six months?
A) $7,000
B) $5,000
C) $12,000
D) $14.000

4) Refer to Instruction 20.1. What is the size of the commission Cypress will pay the bank for the banker’s acceptance?
A) $7,000
B) $5,000
C) $12,000
D) $14,000

5) Refer to Instruction 20.1. What is the total Cypress can expect to receive if the firm takes payment today?
A) $993,000
B) $995,000
C) $988,000
D) $996,000

6) Refer to Instruction 20.1. ________ is an unsecured promissory note.
A) A banker’s acceptance
B) An overdraft
C) A securitized loan
D) Commercial paper

7) Rogue Spices Inc. has a Canadian receivables contract for $200,000 due in 270 days. The firm has been approached by a factoring firm that offers to purchase the receivables at a 12% per annum discount plus a 1% charge for a nonrecourse clause. What is the annualized percentage all-in-cost of this factoring alternative?
A) 14.82%
B) 13.00%
C) 12.00%
D) 9.09%

True/False

1) The Foreign Credit Insurance Association is a branch of the U.S. federal government.

2) The Export-Import Bank (also called Eximbank) is an independent agency of the U.S. government, established in 1934 to stimulate and facilitate the foreign trade of the United States.

3) Essentially, the Eximbank lends dollars to borrowers inside the United States for the purchase of U.S. goods and services.

4) Banker’s acceptances can be used to finance only international trade receivables but not domestic trade receivables.

Essay

1) What is a banker’s acceptance? How are they initiated? Why are they desirable for the exporter?

20.7 Forfaiting: Medium- and Long-Term Financing

Multiple Choice

1) ________ is a specialized technique to eliminate the risk of nonpayment by importers in instances where the importing firm and/or its government is perceived by the exporter to be too risky for open account credit.
A) Forfeiting
B) Marketable Bank Shares
C) Forfaiting
D) Banker’s Acceptances

True/False

1) In effect, the forfaiter functions both as a money market firm and a specialist in packaging financial deals involving country risk.