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MKT 475 Week 11 Quiz – Strayer University New

MKT/475 Week 11 Quiz – Strayer

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Quiz 10 Chapter 15

Strategic Marketing Implementation and Control

True/False Questions

1. The analytical dimension of marketing planning process is concerned with the organizational structure in which planning is carried out, along with the associated information resources and corporate culture.

2. Internal marketing involves developing programs to win line management support for new strategies.

3. External marketing involves changing the attitudes and behavior of employees working at key points of contact with customers.

4. Internal marketing goals include promoting the external marketing strategy.

5. The balanced scorecard method is used to implement marketing plans.

6. The balanced scorecard method formally includes an assessment of the strategy component across all aspects of the business unit at the same time.

7. A benefit of the balanced scorecard methodology is that it is feasible for any business unit level strategy and provides a means to link performance evaluation to strategy implementation.

8. The second step in marketing evaluation and control is determining performance metrics and standards.

9. When monitoring a firm’s effectiveness of marketing activities, external information sources must be excluded.

10. Marketing metrics should be chosen to reflect issues most closely linking marketing investments with value chain requirements.

Multiple Choice Questions

11. The _____ indicates marketing objectives and the strategy and tactics for accomplishing the objectives, and guides implementation and control. 
A. strategic marketing plan
B. traditional marketing design
C. integrated marketing communications
D. market positioning strategy

12. Which of the following techniques guides short-term marketing activities?
A. Strategic marketing plan
B. Annual marketing plan
C. Situation analysis
D. Positioning strategy

13. Which of the following marketing planning process dimensions is concerned with an organization’s structure, associated information resources, and corporate culture?
A. Analytical process dimension
B. Behavioral process dimension
C. Organizational process dimension
D. Cognitive process dimension

14. Which of the following marketing planning process dimensions is concerned with managerial perceptions, participation, and strategic assumptions?
A. Analytical process dimension
B. Cognitive process dimension
C. Organizational process dimension
D. Behavioral process dimension

15. Which of the following marketing planning process dimensions is concerned with techniques, procedures, systems, and planning models?
A. Analytical process dimension
B. Cognitiveprocess dimension
C. Organizational process dimension
D. Behavioral process dimension

16. Which of the following is true about internal marketing?
A. It positions the marketing strategy in the customer marketplace.
B. Its goals include promoting the external marketing strategy.
C. It aims at providing superior external customer service to support internal strategy.
D. Its aim is to better align internal market objectives with external capabilities.

17. Which of the following is true about internal marketing?
A. It positions the marketing strategy in the customer marketplace.
B. It involves changing the attitudes and behavior of customers at key points of contact with employees.
C. It is aimed at the potential customers within the company.
D. It is targeted at particular market segments and niches.

18. _____ is a formalized management control system that implements a given business unit strategy by means of activities across four areas: financial, customer, internal business process, and learning and growth (or innovation).
A. Benchmarking
B. Internal strategy-organization fit
C. Strategic marketing audit
D. Balanced scorecard method

19.Which of the following is true of the balanced scorecard method?
A. It translates aggregate and broadly defined strategies to very specific actions.
B. It provides a means to link customer satisfaction with value orientation.
C. It is not feasible for business unit level strategies.
D. It does not assess the strategy component across all aspects of the business unit.

20. The _____ approach allows consideration of specific activities which will accomplish the objective, but also formally includes an assessment of the strategy component across all aspects of the business unit at the same time. 
A. vertical assessment
B. balanced scorecard
C. strategic marketing audit
D. benchmarking

21. Which of the following is the initial step in setting up a strategic marketing evaluation program?
A. Obtaining and analyzing information for performance-gap identification
B. Selecting performance criteria and choosing relevant marketing metrics
C. Conducting strategic marketing audit
D. Assessing performance and taking necessary action

22. Which of the following is the strategic marketing audit used for?
A. To translate broadly defined marketing strategy into very specific actions
B. To provide a means to link performance evaluation to strategy implementation
C. To ensure that activities in one area do not interfere with activities in another area
D. To initiate a formal strategic marketing planning program

23. The results of the _____ provide the basis for selecting performance criteria and choosing relevant marketing metrics to assess actual performance against plans and tactical intent.
A. strategic marketing audit
B. integrated marketing communications
C. balanced scorecard
D. customer relationship analysis

24. _____ use both internal and external information sources to provide a structure for monitoring the effectiveness of marketing activities and strategies.
A. Marketing segmentation strategies
B. Balanced scorecard methods
C. Marketing metrics
D. Salesforce strategies

25. The choice of the most relevant marketing metrics should be made in the light of the need to:
A. track performance relative to alliances.
B. track performance relative to suppliers.
C. track performance over investment capabilities.
D. measure performance relative to strategy.

26. Which of the following is a danger of using a marketing dashboard?
A. The dashboard contains metrics only relevant to assessing past performance.
B. The dashboard contains metrics which only give insight into present performance.
C. The dashboard contains metrics which only give insight into future developments.
D. The dash board contains only metrics related to the main business drivers.

27. Which of the following approaches is a quality control technique useful in determining when operating results are fluctuating normally or instead are disorderly?
A. Value chain analysis
B. Statistical process-control methods
C. Benchmarking
D. Data-control processes

28. _____ is/are used to analyze and improve results in marketing performance measures such as the number of orders processed, customer complaints, and territory sales.
A. Value chain analysis
B. Benchmarking
C. Quality-control charts
D. Cluster analysis

29. A _____ indicates when the process is experiencing normal variation and when the process is out of control.
A. data-control process
B. value chain analysis
C. BCG matrix
D. control-chart analysis

30. Which of the following is true of a control-chart analysis?
A. It cannot be used to detect randomness in operating results.
B. Its control boundaries are set using historical data.
C. It can only be used to establish average and upper limits of the measure.
D. It can only be used to establish average and lower limits of the measure.

Essay Questions

31. What are the core tasks of a CMO?

32. Explain the dimensions of the marketing planning process.

33. Discuss factors that influence the implementation of a marketing strategy.

34. Discuss how organizational designs help implement a strategic marketing plan.

35. What guiding points should be considered when selecting relevant marketing metrics?

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

FIN 317 Week 11 Final Exam – Strayer University New

FIN/317 Week 11 Final Exam – Strayer

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Chapters 7 Through 15

Part 1: Chapters 7 Through 11
Part 2: Chapters 12 Through 15

CHAPTER 7

TYPES AND COSTS OF FINANCIAL CAPITAL

True-False Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Multiple-Choice Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CHAPTER 8

SECURITIES LAW CONSIDERATIONS WHEN OBTAINING VENTURE FINANCING

True-False Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Multiple-Choice Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CHAPTER 9

PROJECTING FINANCIAL STATEMENTS

True-False Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Multiple-Choice Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CHAPTER 10

VALUING EARLY-STAGE VENTURES

True–False Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Multiple-Choice Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CHAPTER 11

VENTURE CAPITAL VALUATION METHODS

True–False Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Multiple-Choice Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CHAPTER 12

PROFESSIONAL VENTURE CAPITAL

True–False Questions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

28. Two typical issues addressed in a term sheet are valuation and the size and staging of financing.

29. Term sheets may contain demands regarding the voting rights of shares issued to venture investors.

30. Once the venture capital firm has received exit proceeds from a venture in the form of cash or securities, some method of returning the proceeds (less the carried interest) must be determined.

31. Annual VC investments, as indicated in Figure 12.1, reached an all-time high in the year 2000.

32. According to Figure 12.4, individuals and families were the largest supplier of venture capital in 2009.

Multiple-Choice Questions

1. The beginning of professional venture capitalists is considered to have occurred:
a. prior to World War II
b. 1946
c. 1956
d. 1966
e. after the Vietnam War

2. The beginning of professional venture capitalists is considered to have begun with the establishment or formation of:
a. Small Business Administration
b. Small Business Investment Companies
c. American Research and Development organization
d. Professional Venture Capitalists organization

3. Which of the following was the largest source of venture capital funds in 2009 (as reported in Figure 12.4)?
a. pension funds and corporations
b. individuals and families
c. endowments and foundations
d. finance and insurance

4. Venture Capital firms tend to specialize in publicly identified niches because of the potential for value-added investing by venture capitalists. Which is not one of these niches?
a. industry type
b. venture stage
c. size of investment
d. management style
e. geographic area

5. As venture firms attract money from investors, it is placed in a fund. Important issues that must be put in place with the establishment of the fund include all of the following except:
a. determine the general partners
b. establishing a fee structure
c. a profit sharing arrangement
d. establish its governance
e. the management team assigned to each borrower

6. All of the following are typically part of a venture fund’s typical compensation and incentive structure except:
a. some percent annual fee on invested capital
b. a percent share of any profits to the managing general partner
c. carried interest
d. salary for the general partners

7. When evaluating the prospects of a new venture, venture capital firms consider which of the following?
a. characteristics of the proposal
b. characteristics of the entrepreneur/team
c. nature of the proposed industry
d. both b and c
e. all of the above

8. When screening prospective new ventures, venture capital firms consider their own funds’ requirements. Which of the following is not one of the venture firm’s requirements relating to its own funds?
a. investor control
b. rate of return
c. size of investment
d. probable stock listing exchange for the mature venture
e. financial provisions for investors

9. When evaluating the prospects of a new venture, venture capital firms consider the characteristics of the entrepreneur and its team. Which of the following is not part of the review of the entrepreneur/team?
a. its background and experience
b. its managerial capabilities
c. management’s stake in the firm
d. the VC firms’ ability to cash out
e. the capability to sustain an effort

10. When screening prospective new ventures, venture capital firms must consider the nature of the proposed industry. Which of the following is not part of the screening of the proposed industry?
a. market attractiveness
b. managerial references
c. potential size
d. technology
e. threat resistance

11. Professional venture investing usually involves setting up a venture capital firm as a:
a. proprietorship
b. corporation
c. partnership
d. S corporation

12. After a new professional venture capital fund is organized, the fund managers:
a. conduct due diligence and actively invest
b. solicit investments and obtain commitments
c. arrange harvest or liquidation
d. identify prospective venture investments and then solicit investments

13. After determining the next fund’s objectives and policies, the “professional venture investing cycle’s” next step is:
a. solicit investments in new fund
b. organize the new fund
c. obtain commitments for a series of capital calls
d. conduct due diligence and actively invest
e. arrange harvest or liquidation

14. The term “carried interest” refers to:
a. interest not currently paid but which must be paid in the future by a professional venture capitalist
b. interest transported directly to a bank
c. interest owed on a loan in default
d. the portion of profits paid to the professional venture capitalist as incentive compensation

15. If an investment management firm is known to be a “two and twenty shop”, this implies that the firm:
a. receives an annual 2% fee on invested capital, and a 20% carried interest
b. receives an annual 20% fee on invested capital, and a 2% carried interest
c. receives an annual 2% fee on gross operating profits, and a 20% carried interest
d. receives an annual 20% fee on gross operating profits, and a 2% carried interest

16. A venture fund calls upon its investors to deliver their investment funds. This is known as:
a. due diligence
b. deal flow
c. a capital call
d. carried interest
e. a SLOR

17. All of the following are typical issues addressed in a term sheet except?
a. valuation
b. board structure
c. registration rights
d. management fees
e. employment contracts

18. Term sheets are usually drafted by:
a. the mangers of the venture seeking VC funding
b. the VC fund seeking to fund the venture
c. management and founders
d. it is usually done by an third party, in order to
ensure the fair treatment of both parties

19. In a syndicate of venture investors, the investor who is responsible for governing the process of due diligence is:
a. the primary investor
b. the lead investor
c. a small group of secondary investors
d. the investor in charge of issuing SLORs for the syndicate
e. it is a democratic process that is shared by all investors in the group

20. A summary of the investment terms and conditions accompanying an investment is referred to as a:
a. term sheet
b. business plan
c. fund created by professional venture capitalists
d. due diligence in venture investing
e. capital call

21. When screening possible investments, a venture capital firm might issue an SLOR which stands for:
a. standard letter of rejection
b. standing letter of reconciliation
c. standard letter of reassessment
d. senior letter of reference

22. Which of the following is not one of the four likely outcomes of the venture firm’s screening process?
a. seek the lead investor position
b. seek a non-lead investor position
c. close the capital fund
d. refer the venture to more appropriate financial market participants
e. issue a standard letter of rejection

Note: The following MC questions relate to Figure 12.3 Elements of a Venture Capital Fund Placement Memorandum

1. In a Venture Capital Fund Placement Memorandum, which of the following is not a front matter declaration?
a. description of limited manner of the offering
b. targeted fund size
c. imposition of confidentiality
d. notice of lack of SEC registration
e. declaration of the highly risky nature of investment

2. In a Venture Capital Fund Placement Memorandum, which of the following is not part of the offering summary?
a. objective of formation
b. declaration of general partner
c. management fee
d. minimum capital restrictions
e. targeted fund size

3. In a Venture Capital Fund Placement Memorandum, which of the following is not part of the fund overview?
a. fund size
b. investment focus
c. fund management
d. portfolio size
e. general partners’ capital contributions

4. In a Venture Capital Fund Placement Memorandum, all of the following are part of the executive summary except?
a. special limited partners
b. general partners’ capital contributions
c. limitation of liability
d. allocation of gains and losses
e. imposition of confidentiality

5. In a Venture Capital Fund Placement Memorandum, all of the following are included in the summary of terms except?
a. indemnification
b. objective
c. liquidation
d. valuation
e. expenses

CHAPTER 13

OTHER FINANCING ALTERNATIVES

True–False Questions

1. Despite the high risk and costs of using a facilitator or up-front fee solicitor to obtain financing, many start-ups never-the-less seek them as a source of funds due to the length of time it takes to raise new funds.

2. Collateral plays an important role in determining the willingness to lend and the amount and terms of the loan, making it the most important factor in the lending process.

3. Commercial loan officers have the expertise to project new venture’s business successes, and thus are as willing to make funds available to entrepreneurs on the same basis as other businesses.

4. Because investors and commercial lenders both seek returns on the funds given to start-up firms, entrepreneurs can obtain financing as easily from either source.

5. Because of loan restrictions, obtaining funding from commercial lenders is prohibitive for entrepreneurs.

6. Unlike traditional commercial banks, venture banks typically provide debt to start-ups that have already received equity financing from professional venture capital firms.

7. Among start-ups, it is widely understood that bank debt (outside of Small Business Administration loans), is not a very realistic source of financing for ventures with less than two years operating results.

8. Compensation received by commercial loan officers makes them more likely to finance early-stage ventures.

9. Warrants allow lenders to buy equity at a specified price.

10. Warrants are a debt instrument frequently used by commercial banks when financing entrepreneurial ventures.

11. Credit cards issued to start-ups have proven to be an alternative source of start-up financing.

12. The returns to venture bank lenders are generated solely from interest payments made by borrowers plus the return of the loan principal.

13. Commercial banks receive a portion of their returns from warrants in addition to the receipt of interest and the repayment of the principal that was len

14. By an act of Congress, the Small Business Administration (SBA) was created for the purpose of fostering the initiation and growth of small businesses.

15. The Small Business Administration was created by an Act of Congress in 2003.

16. Microloans in the SBA credit program are intended for very small businesses with a maximum amount of $35,000 to be used for general purposes.

17. The SBA’s role in its microloan credit program is to approve the loans and guarantee up to 85% of the loan value.

18. Microloans in the SBA credit program are made by not-for-profit or government-affiliated Community Development Financial Institutions (CDFIs).

19. The SBA’s venture capital credit program works through Community Development Financial Institutions (CDFIs).

20. The 7(a) loan traditionally has been the SBA’s primary loan program

21. SBA 7(a) loans are made usually for 1 to 3 years in amounts up to $5,000,000, require collateral, and can be used for most business purposes.

22. The SBA approves the standard 7(a) loan and guarantees up to 85% of the loan value.

23. For the 504 loan, the SBA approves and guarantees the development company’s portion of the debt but does not guaranteed the debt of the participating commercial bank.

24. Factoring is the sale of payables to a third party at a discount to their face value.

25. In a factoring arrangement, the third party makes its money by purchasing the receivables at a discount from the total amount due on the receivables.

26. With venture leasing, one component of the return to the lessor is the opportunity to take an equity interest in the venture.

27. Receivables lending is the use of receivables as collateral for an equity issue.

28. Factoring is the selling of receivables to a third party at a discount from their face value.

29. Direct public offerings have recently become a serious challenge to traditional venture capital firms.

30. The Immigration and Nationality Act (INA) of 1990 provided an opportunity for foreign nationals to obtain a “green card” through the EB-5 immigrant visas program.

31. A foreign national may seek Lawful Permanent Resident (LPR) status by investing $1 million in the U.S. that will preserve or create at least 100 jobs for U.S. workers.

Multiple-Choice Questions

1. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The ability of the entrepreneur to repay borrowed funds is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

2. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The money the entrepreneur has invested in the business, which is an indication how much is at risk if the business should fail is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

3. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The guarantees, or additional forms of security (such as assets), the entrepreneur can provide the lender is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

4. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The focus on the intended purpose of the loan is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

5. When assessing the creditworthiness of new entrepreneurs, lending institutions review the “Five C’s”. The general impression the entrepreneur makes on the potential lender or investor is known as:
a. capacity
b. capital
c. collateral
d. conditions
e. character

6. All of the following are common loan restrictions except?
a. limits on total debt
b. limits on total equity
c. restrictions on dividends or other payments to owners and/or investors
d. restrictions on additional capital expenditures
e. performance standards on financial ratios

7. Unlike traditional commercial banks, venture banks typically provide debt to start-ups that have already received equity financing from professional venture capital firms. In return for providing additional debt financing, these venture banks receive in return all of the following except?
a. interest payments
b. repayment of principal
c. implementation of loan restrictions
d. tax breaks on the interest
e. right to buy equity at a specific price

8. Bank debt is not a realistic source of financing for start-ups due to all of the following reasons except?
a. a large portion of the assets are intangible and provide no collateral
b. payables either don’t yet exist or its history is inadequate
c. the start-up’s dependence on a small number of irreplaceable people is not a good match to demand deposits or other bank liabilities
d. receivables collection track record is incomplete
e. in the event of a default, it is now plausible for the bank to install a management team to help right the operations

9. A provision that allows lenders to acquire equity at a specific price is known as a(n):
a. factor
b. warrant
c. venture lease
d. equity carve-out

10. Personal credit cards have proven to be a source of financing for start-up firms for all of the following reasons except?
a. credit card debt is not based on the firm’s ability to repay, but rather the individual card holder’s ability to repay
b. teaser rates afford initial low cost borrowing
c. balance transfer at below-prime rates
d. credit card debt can create problems if the firm doesn’t generate cash flows to cover credit card payments once low introductory rates expire

11. In the context of new ventures, what does SBA stand for?
a. Standard Business Arrangement
b. Small Business Association
c. Small Business Administration

12. By an act of Congress, the Small Business Administration (SBA) was created in which one of the following years?
a. 1953
b. 1968
c. 1973
d. 1985
e. 1993

13. Which is not a duty of the Small Business Administration?
a. provide capital and credit to entrepreneurial start-ups
b. guaranteeing general business loans
c. provide equity financing for start-ups
d. help create new jobs in small businesses
e. help small firms obtain Federal contracts

14. Which of the following is not a Small Business Administration program?
a. loan guaranty programs
b. certified and preferred lender programs
c. low documentation loan programs
d. energy and conservation loan programs
e. certified financial planner funding programs

15. Which of the following is not a source of debt funding for a start-up firm?
a. accounts payable
b. vendor financing
c. factoring
d. trade notes
e. leasing

16. Venture banks seek loan returns from:
a. interest received
b. principal repayments
c. warrants being exercised
d. all of the above
e. none of the above

17. Which one of the following is not a current Small Business Administration (SBA) credit program?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

18. In which of the following credit programs does the SBA approve and guarantee a not-for-profit Certified Development Company’s portion of the debt?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

19. In which of the following credit programs does the SBA approve a loan and guarantees up to 85% of loan value?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

20. In which of the following credit programs is the SBA role in the loan one of providing a direct loan to a community organization, which reloans the funds in small amounts?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

21. In which of the following credit programs does the SBA borrow money to be lent Small Business Investment Companies (SBICs) and guarantees payment to investors?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

22. Commercial banks, credit unions, and/or financial services firms are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

23. Commercial banks, jointly with not-for-profit Certified Development Companies, are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

24. Not-for-profit or government-affiliated Community Development Financial Institutions (CDFIs) are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

25. Small Business Investment Companies (SBICs) are lenders in which of the following SBA credit programs?
a. 7(a) loan
b. 504 loan
c. microloan
d. venture capital loan
e. credit card loan

26. Concerning factoring, all of the following are true except:
a. factors prefer business over consumer accounts
b. factoring is done at a discount to the third party purchaser
c. factoring discounts are often a function of the riskiness of the receivables
d. factoring speeds the inflow of cash to the seller of the receivables
e. receivable lending is the process of factoring

27. The use of receivables as collateral for a loan is known as:
a. capital leasing
b. warehouse financing
c. receivables lending
d. a microloan
e. venture leasing

28. Selling receivables to a third party at a discount from their face value is referred to as:
a. factoring
b. receivables lending
c. venture banking
d. vendor financing
e. mortgage lending

29. Which of the following is/are not a type of leasing arrangement?
a. factoring
b. capital lease
c. venture lease
d. mortgage lease
e. both a and d

30. Arranging for partial ownership as a component of the expected return to a lessor is known as:
a. venture leasing
b. capital leasing
c. investment leasing
d. none of the above

CHAPTER 14

SECURITY STRUCTURES AND DETERMINING ENTERPRISE VALUES

True–False Questions

1. Preferred stock is the equity claim senior to common stock providing preference on dividends but not liquidation proceeds.

2. For preferred noncumulative stock, all previously unpaid preferred dividends must be paid before any common stock dividend is paid.

3. Convertible preferred stockholders have the right to convert a preferred share into a specified number of common shares at any time after the expiration date.

4. If a share of preferred stock has a $10 par value, and the stock has a 2:1 conversion ratio, then the conversion price would be $5.

5. By issuing preferred stock, and thus forfeiting bankruptcy rights from the use of debt, the venture and its investors can benefit by committing to an internal reorganization as opposed to bankruptcy reorganization.

6. A call option is the obligation to purchase a specific asset at a pre-determined price.

7. Options generally have no effect on the value of a venture capital investmen

8. For American and Bermudan embedded options, the exercise price can change over time as specified in the security agreemen

9. An American-style option is an option that can be exercised only at the expiration date

10. A European-Style Option may only be exercised on a specific date.

11. A warrant is a call option issued by a company granting the holder the right to buy common stock at a specific price at a specific time.

12. An option granting the right to sell a stock at $10 when that stock currently has a market price $8 is “in the money.”

13. If a call option can be bought for $12 and the stock’s market value is $12, it’s said to be “at the money”.

14. As the underlying stock price increases in value, a put option to sell it becomes more valuable.

15. The value of a warrant can be directly derived from the value of a call option.

16. A preemptive right is a right for existing owners to buy sufficient shares to preserve their ownership share.

17. Convertible debt is debt that converts into preferred stock.

18. An option is a right to buy or sell additional shares of stock.

19. A warrant is a type of call option.

20. An option not currently worth exercising is said to be an out of the money option.

21. Owning a put option on a stock is the same as selling a call option on that same stock.

22. The enterprise method of valuation can be executed with either an after-tax or before-tax weighted cost of capital as long as the rate is applied to the appropriate enterprise cash flows.

23. Entity valuation allows us to answer the question of how much debt a venture needs to issue to achieve a target capital structure (D/V).

24. The concept of an enterprise value is that it is the combined value of all of venture’s financing, typically equity plus all of the deb

25. The enterprise value includes the value of the debt, equity, and warrant pieces of a venture.

Note: The following TF questions relate to Learning Supplements 14A and 14B:

1. An alternative approach to the Enterprise Valuation method adds the tax shield from paying interest back into the flows and discounts at a before-tax weighted average cost of capital.

2. Warrant valuation (as presented in this text) is similar to option valuation except that one applies a dilution factor to the option value to arrive at a warrant value.

3. The unadjusted Black and Scholes model is a model for determining the value of a warrant to buy a new share.

4. The Black and Scholes model requires the stock price as an inpu

5. The Black and Scholes model requires the inflation rate as an inpu

6. The Black and Scholes model requires an exercise price as an inpu

Multiple-Choice Questions

1. Which of the following have the least senior claim on a venture’s asset?
a. common Stock
b. preferred stock
c. convertible preferred stock
d. convertible debt
e. American-style option

2. The right for existing owners to maintain their ownership share by purchasing sufficient shares to keep their percentage share of the firm is called:
a. stock option
b. stock warrant
c. preemptive right
d. participating stock
e. paid-in-kind preferred stock

3. Which of the following stock can be structured to assure the shareholder that they will share in the payment of any dividends to common stockholders?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

4. Which of the following provides the option to transform preferred stock into common stock?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

5. Which of the following offers the option where the dividend obligation can be satisfied in cash or by issuing additional par amounts of the preferred security?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

6. Which of the following requires that all previously unpaid preferred dividends must be paid prior to any common dividend?
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non-cumulative preferred stock

7. Which of the following is never a component of a preferred stock’s security structure?
a. the right to participate in any dividends paid to common stock shareholders
b. payment of dividends in the form of additional shares of preferred stock
c. the option for the holder to convert preferred stock into common stock
d. the option for the venture to call outstanding preferred stock
e. none of the above; all of these may be included in the structure of
preferred stock

8. A round of financing where shares sell for a lower price than previous rounds is known as a:
a. down round
b. recessive round
c. reset round
d. a and c

9. Which of the following are components of common equity?
a. common stock
b. preferred stock
c. a and b
d. none of the above

10. Convertible debt has all of the following except:
a. bankruptcy rights
b. regular dividend payments
c. it can be structured to provide senior interest in specific assets
d. a tax shield due to interest expense
e. a security interest in the firms’ assets

11. Which of the following is not a type of option?
a. call option
b. put option
c. warrant
d. LBO

12. The right to buy a specified asset at a specified price on a specified date is called:
a. a forward contract
b. an American-style put option
c. an American-style call option
d. a European-style call option
e. a European style put option

13. The right to sell a specified asset at a specified price up until a specified date is called:
a. a forward contract
b. an American-style put option
c. an American-style call option
d. a European-style call option
e. a European style put option

14. An option that can be exercised at any time until its expiration is called a:
a. forward contract
b. lookback option
c. American-style option
d. European-style option
e. Bermuda-style option

15. An option that can be exercised only at its expiration date is called a:
a. forward contract
b. lookback option
c. American-Style option
d. European-Style option
e. Bermuda-Style option

16. An option that can be exercised only at a specific set of dates is called a:
a. forward contract
b. lookback option
c. American-Style option
d. European-Style option
e. Bermuda-Style option

17. Which of the following is an example of a call option which is out of the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

18. Which of the following is an example of a call option which is in the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

19. Which of the following is an example of a put option which is out of the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

20. Which of the following is an example of a put option which is in the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to buy at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12.

21. Which of the following is an example of a put option which is at the money?
a. The option to sell at $11, the stock is worth $12.
b. The option to buy at $13, the stock is worth $12.
c. The option to sell at $12, the stock is worth $12.
d. The option to sell at $13, the stock is worth $12.
e. The option to buy at $11, the stock is worth $12

22. Generally speaking, warrants are call options that allow the holder to purchase what type of security at a specific price?
a. common stock
b. preferred stock
c. convertible debt
d. none of the above

23. To calculate the enterprise valuation cash flow, one begins with which of the following items from the income statement?
a. net sales
b. operating profit
c. (earnings before interest and taxes) × (1 – enterprise tax rate)
d. net income
e. net income times the enterprise tax rate

24. When consistent assumptions are used, we
a. get the same value for equity under the enterprise and equity methods of valuation
b. we get a higher value of equity under the equity method of valuation
c. we get a lower value of equity under the equity method of valuation
d. we get equity values that cannot be compared across the equity and enterprise methods of valuation

Note: The following MC questions relate to Learning Supplement 14B:

1. The Black and Scholes model is intended to be used to value
a. stocks
b. bonds
c. options
d. futures contracts

2. Which of the following is not an input to the Black and Scholes model?
a. earnings per share
b. stock price
c. risk free rate
d. volatility

3. N(h) in the Black and Scholes model involves the use of
a. the number of shares issued
b. the next time that a venture capitalist will invest money
c. the normal distribution cumulative density function
d. the number of times that the venture will have to raise money

CHAPTER 15

HARVESTING THE BUSINESS VENTURE INVESTMENT

True–False Questions

1. The process of exiting the privately held business venture to unlock the owners’ investment value is known as harvesting.

2. When harvesting a venture, the methodical distribution of assets directly to the owners is known as a systematic liquidation.

3. When harvesting a venture, the outright purchase of the going concern by managers, employees, or external buyers is known as going public.

4. When harvesting a venture, the two-step public equity registration and sale is known as an outright sale.

5. When an initial business plan is prepared, attention should be paid to the investors’ and founders’ desire for eventual liquidity by anticipating a harvest for the venture investors.

6. An advantage of an exit strategy that pays out the venture’s investment value over several years can make it more difficult for entrepreneurs to start a new venture because adequate capital has not been released from the existing venture.

7. When an industry is in decline, systematic liquidation is typically the most attractive harvest strategy.

8. Exit values for many mature ventures are usually determined by (1) discounted cash flow (DCF) methods or (2) relative valuation models based on some form of multiples analysis.

9. In determining a harvest value, non-monetary items such as culture, managerial succession, and employee retention are not factored in.

10. Harvesting is the process of exiting the privately held business venture to unlock the owners’ investment value.

11. Valuation methods that estimate a firm’s worth using value-related multiples of comparable firms are sometimes known as “relative value methods.”

12. The two discounted cash flow (DCF) methods covered in this text are the enterprise method and the debt funds method.

13. One method of harvesting a venture is through systematic distribution of assets directly to the owners.

14. One method of harvesting a successful venture is through systematic distribution of assets directly to lenders.

15. Other than when the venture is operating in a declining industry, it is difficult to think of cases where the disadvantages of liquidation outweigh the advantages.

16. A special type of harvesting process where the firm’s top management continues to run the firm and has a substantial equity position in the reorganized firm is known as a leveraged buyou

17. A leveraged buyout (LBO) takes place when the purchase price of a firm is financed largely with debt financial capital.

18. Ultimately for harvesting purposes, we need to decide on the venture’s value at exit and how that exit value pie will be divided up among investors.

19. An “initial public offering” is the only method used by entrepreneurs when exiting a venture.

20. A management buyout (MBO) is a special type of leveraged buyout (LBO).

21. A leveraged buyout (LBO) is a special type of management buyout (MBO).

22. ESOP stands for “employee stock ownership plan.”

23. An obligatory disclaimer disavowing any intent to act as an offer to sell, or solicit an offer to buy securities is known as a red herring.

24. The sale of new shares of common stock is a secondary offering.

25. The sale of used shares of common stock is a secondary market offering.

26. Most companies choose “best efforts” agreements in order to minimize the inherent risks of going public.

27. IPO underpricing results in a direct loss to the venture’s owners.

28. While not a direct loss to a venture, underpricing can represent a significant opportunity cost to the venture’s owners.

29. A “lockup provision” prohibits insiders from selling their existing shares for a specified period of time.

30. In a typical venture’s life cycle, the rapid-growth stage involves managing ongoing operations, maintaining and adding value, and obtaining seasoned financing.

31. In a typical venture’s life cycle, the examining of exit opportunities often occur during the rapid-growth stage.

Multiple-Choice Questions

1. Which of the following is not a way to harvest a venture?
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

2. When registering equity and selling it via an IPO of new shares followed by a secondary offering of existing shares, this venture harvesting process is known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

3. The acquisition of the venture by family members, managers, or outside buyers is a venture harvesting process known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

4. The distribution of the venture’s cash flows directly to the owners is a venture harvesting process known as:
a. systematic liquidation
b. outright sale
c. chapter 11 bankruptcy
d. going public

5. Which of the following is not an advantage of a systematic liquidation?
a. maintaining control throughout the harvest period
b. harvesting of the investment value can be spread out over a number of years
c. the taxation treatment of liquidation proceeds as ordinary income
d. the time, effort, and costs of finding a buyer for the venture can be avoided

6. Which of the following is not a disadvantage of a systematic liquidation?
a. the treatment and taxation of liquidation proceeds as ordinary income rather than capital gains
b. the commitment of the entrepreneur’s resources and focus on a dying venture rather than on other more lucrative ventures
c. the harvesting of the investment gets spread out over a number of years
d. the acceleration of the venture’s rate of decline as other industry participants respond to the reduction in investment

7. A venture can be harvested in which of the following ways?
a.. systematic liquidation, outright sale, going public
b. outright sale, going public, acquisition
c. going public, acquisition
d. acquisition, systematic liquidation

8. Which of the following is not a candidate for a leveraged buyout?
a. a venture with stable and adequate operating cash flows
b. a venture with a high amount of equity relative to debt
c. a venture with the ability to protect market share
d. a venture with a high debt ratio

9. Which of the following is the premium that would be applied to venture valuation due to an investor’s majority ownership of a venture?
a. proxy premium
b. control premium
c. influence premium
d. liquidity premium
e. illiquidity premium

10. Shares registered with the Securities and Exchange Commission and state securities regulators and sold to the public are known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

11. In an outright sale of a venture, the venture can be sold to:
a. family members
b. managers
c. employees
d. outside (external) buyers
e. all of the above

12. The sale of new securities is known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

13. The sale of used shares is known as:
a. primary offering
b. secondary offering
c. initial public offering
d. shelf offering

14. The NYSE participates in:
a. the sale of new securities to private investors
b. primary offerings
c. secondary offerings
d. b and c

15. In the investment banking process, which of the following is a duty of the investment bank?
a. to be the targeted investors for a firm’s securities
b. to provide banking services such as checking accounts to firms
c. to find buyers for a firm’s securities
d. both a and b
e. all of the above

16. Based on the following information, estimate the percentage appreciation on stock bought by the venture investors: founders’ purchase price $.50; venture investors’ purchase price $2.00; current stock price $10.00; founders holding period = 5 years; venture investors holding period = 3 years.
a. 100%
b. 400%
c. 600%
d. 800%

17. Based on the following information, estimate the percentage appreciation on stock bought by the founders: founders’ purchase price $1.00; venture investors’ purchase price $2.00; current stock price $10.00; founders holding period = 5 years; venture investors holding period = 3 years.
a. 100%
b. 400%
c. 600%
d. 900%

18. Assume that a venture is expected to have an EBITDA of $1,500,000 at the end of five years from now. If the venture’s value is expected to be $12,000,000, what “valuation multiple” was being assumed?
a. 1 time
b. 4 times
c. 8 times
d. 10 times
e. 12 times

19. A venture is expected to have an exit value of $10,000,000 two years from now. If venture investors invest $2,000,000 now, and expect a 20% compounded rate of return on their investment, what portion of the exit value would they need?
a. 10%
b. 20.2%
c. 25%
d. 28.8%
e. 32%

20. A venture is expected to have an exit value of $10,000,000 five years from now. If venture investors invest $1,000,000 now, and expect a 20% compounded rate of return on their investment, what portion of the exit value would they need?
a. 10.5%
b. 20.1%
c. 24.9%
d. 28.8%
e. 32.5%

21. If venture investors invest $1,000,000 now, will receive 50% of the exit value, and expect a 20% compounded rate of return on their investment, what will be the amount of the exit value at the end of two years?
a. $1,000,000
b. $1,440,000
c. $2,880,000
d. $5,000,000
e. $5,760,000

22. If venture investors invest $1,000,000 now, will receive 25% of the exit value, and expect a 20% compounded rate of return on their investment, what is the approximate expected exit value at the end of five years?
a. $1,000,000
b. $2,490,000
c. $4,980,000
d. $7,470,000
e. $9,950,000

23. If venture investors invest $6,750,000 now, will receive 32% of the exit value, and expect a 22% compounded rate of return on their investment, what is the exit value at the end of seven years?
a. $27,153,298
b. $39,931,321
c. $69,552,505
d. $84,854,057
e. $103,521,949

24. The difference between what the investment bank gets from selling securities to public investors and what they pay to the issuing firm is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

25. A type of agreement with an investment bank employing only marketing and distribution efforts without the actual transfer of securities ownership to the investment banking syndicate is called:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

26. An agreement with an investment bank that involves the purchase and distribution of new securities is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

27. The investment banks process of ascertaining, to the extent possible, an issuing firm’s financial condition and investment intent is known as:
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

28. The arrangement where an underwriter has the option of selling additional shares when the issue is heavily oversubscribed is known as
a. green shoe
b. red herring
c. best efforts
d. lockup

29. Which of the following describes when a syndicate’s offering price is less than the market price immediately following the offering?
a. IPO underpricing
b. due diligence
c. firm commitment
d. best efforts
e. underwriting spread

30. In the aftermarket trading for the venture’s securities, an order that is to be executed as soon as possible at the prevailing market price is known as a:
a. put order
b. market order
c. limit order
d. stop order

31. In the aftermarket trading for the venture’s securities, an order that converts to a market order once a certain price is achieved is known as a:
a. put order
b. market order
c. limit order
d. stop order

32. An order to purchase stock that can be executed only at a specified price or better is called a:
a. market order
b. limit order
c. stop order
d. stock order
e. private order

33. Which of the following is not a type of trading order?
a. market order
b. limit order
c. stop order
d. none of the above

34. The letters IPO stand for:
a. investment pricing organization
b. initial public offering
c. institutional pricing overhead
d. immediate pricing opportunity

35. The negotiated period around an equity securities offering during which insiders are prohibited from selling their existing shares is called:
a. a seasoned offering
b. an unseasoned offering
c. underpricing
d. an underwriting spread
e. a lockup provision

36. An initial public offering (IPO) involves:
a. sale of new securities to private investors
b. sale of used securities to the public
c. a venture’s first offering of SEC-registered securities to the public
d. all of the above
e. none of the above

37. The type of agreement with an investment bank involving the investment bank’s underwritten purchase and resale of securities is called:
a. firm commitment
b. best efforts commitment
c. due diligence
d. making a red herring disclaimer
e. a private placement

ECO 450 Week 11 Final Exam – Strayer University New

ECO/450 Week 11 Final Exam – Strayer

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Chapters 8 Through 18

ECO 450 Week 6 Quiz

CHAPTER 8
Social Security and
Social Insurance
TRUE/FALSE QUESTIONS
1. The Social Security pension system is a fully funded retirement plan.
2. Social Security pension benefits are transfers from workers to retirees.
3. Social Security pensions are financed by voluntary contributions by workers.
4. The gross replacement rate measures the ratio of taxes paid per year by workers to their annual Social Security pension when they retire.
5. In the year prior to retirement, a worker earned $20,000 and paid $5,000 in taxes on those earnings. His annual Social Security pension is $10,000 per year. Then it follows that his net replacement rate is 50 percent.
6. The gross replacement rate for Social Security pensions is the same for all workers independent of their preretirement earnings.
7. The annual growth in wages subject to Social Security taxes is 3 percent. Given the payroll tax rate, the growth in funds available to pay pension benefits is also 3 percent.
8. The asset-substitution effect of Social Security pensions discourages saving.
9. The availability of Social Security pensions to workers over normal retirement age results in an income effect unfavorable to work but no substitution effect.
10. The bequest effect of Social Security encourages workers to save less.
11. The normal retirement age for Social Security old-age pensions is 67 for people born in the United States in 1960 or later.
12. Workers in the United States can retire under Social Security at age 62 with lower pensions than they would receive at their normal retirement age.
13. As of 2009, retired workers between the ages of 62 and their normal retirement age were subject to an “earnings test” that reduced their pension by $1 for each $2 of earnings after a certain minimum level of earnings.
14. Reducing the replacement rate will have no effect on the tax rate necessary to finance pensions under a pay-as-you-go, tax-financed pension system.
15. Workers who quit their jobs are eligible for unemployment insurance benefits in the United States.
16. By 2050, the expected percentage of the U.S. population that is considered elderly will be less than 20%.
17. Social Security was created in 1965.
18. On average, the elderly are less likely to be poor when compared to the rest of the U.S. population.
MULTIPLE CHOICE QUESTIONS
1. The Social Security retirement system:
a. is a fully funded pension system.
b. is a tax-financed system that pays benefits from taxes that are invested to return principal and interest to workers when they retire.
c. is a tax-financed retirement system that finances pensions by taxing workers each year and transferring the bulk of revenues obtained directly to retirees.
d. does not use taxes on workers to pay pensions to retirees.
2. The gross replacement rate:
a. measures a worker’s monthly retirement benefit divided by monthly earnings before taxes in the year prior to retirement.
b. measures a worker’s monthly retirement benefit divided by monthly earnings after taxes in the year prior to retirement.
c. is an increasing function of gross monthly earnings prior to retirement.
d. is independent of gross monthly earnings prior to retirement.
3. A worker earns $2,000 per month before taxes. He pays $140 per month payroll tax on those wages. In addition, the income taxes on those wages are $360 per month. On retirement, the worker receives a Social Security pension of $750 per month. Which of the following statements is true?
a. The worker’s gross replacement rate is 50 percent.
b. The worker’s net replacement rate is 50 percent.
c. The worker’s net replacement rate is 38 percent.
d. The worker’s net replacement rate is 75 percent.
4. The growth in hourly wages over the past 50 years has averaged about 2 percent per year. How¬ever, the growth in Social Security pensions has far exceeded this 2-percent rate. The growth in tax revenue to finance Social Security benefits in excess of 2 percent per year can be accounted for by:
a. increases in payroll tax rates.
b. use of other taxes beside the payroll tax to pay Social Security benefits.
c. an increase in the number of workers paying Social Security taxes.
d. either (a) or (b)
e. either (a) or (c)
5. Given the structure and level of gross replacement rates and the expected future growth of labor earnings subject to the payroll tax, the tax rates used to tax payrolls were increased in the 1980s because:
a. the number of retirees per worker will increase.
b. the number of retirees per worker will decrease.
c. wages are expected to decline.
d. the size of the work force is expected to increase.
6. Which of the following is likely to increase the net federal debt as a share of GDP?
a. a federal budget surplus.
b. a federal budget deficit.
c. a recession.
d. either b or c.
7. The asset-substitution effect of the Social Security retirement system leads all workers to:
a. save more for retirement.
b. save less for retirement.
c. save absolutely nothing for retirement.
d. work more
8. Which of the following is a consequence of a growing federal budget deficit in the United States?
a. A decrease in the federal debt outstanding.
b. An increase in the federal debt outstanding.
c. A decrease in the portion share of federal government expenditures that must be allocated to interest in the future.
d. An increase in national saving.
9. The induced-retirement effect of the Social Security pension system induces workers to:
a. save less for retirement.
b. save more for retirement.
c. reduce savings for retirement to zero.
d. work more after retirement.
10. Unemployment insurance benefits are:
a. financed by payroll taxes levied on workers.
b. financed by payroll taxes levied on employers.
c. both (a) and (b)
d. financed by sales taxes.
11. Which of the following is true about the Social Security pension system in the United States?
a. Pensions received by retired workers are based entirely on their contributions to the Social Security pension trust fund and the investment return on that fund.
b. Pensions received by married retirees with dependents are greater than that received by those without dependents.
c. Gross replacement rates are inversely related to preretirement earnings.
d. both (b) and (c)
12. Which of the following can decrease tax rates necessary to pay pensions for a pay-as-you-go pension system?
a. an increase in replacement rates
b. a decrease in the retirement age
c. an increase in the size of the work force
d. an increase in the number of retirees
13. Unless legislation is introduced to change the normal retirement age, people born in 1960 or later will be able to retire with full Social Security benefits at age:
a. 62.
b. 65.
c. 66.
d. 67.
14. The earnings test for retirees:
a. increases their incentive to work.
b. is applied to all retirees.
c. is applied only to retirees below normal retirement age.
d. reduces pension benefits by $1 for each $2 of earnings.
e. both (c) and (d)
15. A nation has 40 million current retirees and a work force of 100 million. Which of the following is true?
a. The replacement rate is 40 percent.
b. The replacement is 2.5.
c. The dependency ratio is 0.4.
d. The dependency ratio is 2.5.
16. Social Security tax rates can be reduced if:
a. taxable wages decline.
b. the retirement age is lowered.
c. the retirement age is raised.
d. the work force decreases in size.
17. A retiree subject to the earnings test under Social Security:
a. can earn as much as he or she chooses without losing Social Security pension benefits.
b. has his or her Social Security pension benefits reduced by one dollar for each dollar of labor earnings.
c. has his or her Social Security pension benefits reduced immediately by one dollar for each three dollars of labor earnings.
d. has his or her Social Security pension benefits reduced by one dollar for each two dollars of earnings after a certain minimum amount per year.
18. A pay-as-you-go social security retirement system is:
a. exemplified by the current U.S. social security system.
b. exemplified by the current Chilean social security system.
c. designed to have retirees set aside a contribution specifically for themselves during their earlier working life.
d. both (a) and (b).
19. Approximately, what percentage of beneficiaries of U.S. Social Security are retired workers?
a. 50%
b. 60%
c. 70%
d. 80%
20. The Social Security Act was implemented in the United States in:
a. 1927.
b. 1935.
c. 1947.
d. 1965.

CHAPTER 9
Government and Health Care

TRUE/FALSE QUESTIONS
1. In the United States the government pays the health bills of 90 percent of the population.
2. The American system of health care is financed by a mix of private and government insurance programs that pay over 80 percent of the health care bills for U.S. citizens.
3. Spending per person on health care in the United States is less than in the United Kingdom where national health insurance finances health expenditures.
4. Government spending on health care is declining as a percent of total government spending.
5. Medicare is a government program of health insurance for the elderly.
6. Exclusion of employer-provided health insurance to employees is an indirect subsidy to private provision of health insurance.
7. Third-party payments for health care services increase the quantity of health care demanded by reducing out-of-pocket costs to patients.
8. An increase in coinsurance and deductibles for health insurance can contribute to a reduction in expenditures on health care.
9. Half of Americans do not have health insurance coverage.
10. Under national health insurance in Great Britain, the price system is used to ration health care.
11. Approximately 16 percent of GDP was allocated to provision of health care in the United States as of 2006.
12. Individuals in the United States, on average, pay 50 percent of their health care costs out-of-pocket, and the remaining 50 percent is paid by insurance, governments, and charity.
13. Asymmetric information in the market for health care occurs when sellers of medical care are better informed about cost and quality of care than buyers.
14. Because of third-party payment for services in the market for health care, the price paid by buyers is less than the payment sellers receive, and the marginal social cost of health care exceeds its mar¬ginal social benefit.
15. Medicaid costs are paid entirely by the federal government.
16. Healthcare expenditures in the U.S. are projected to be 20% of GDP by 2017.
17. Asymmetric information can occur when the provider of a service is better informed than the consumer of the service.
18. A risk averse individual prefers to pay certain modest costs in exchange for possible unforeseen high costs.
MULTIPLE CHOICE QUESTIONS
1. Most of the medical bills of Americans in the United States are paid by:
a. the patients.
b. private and government health insurance.
c. charities.
d. Medicaid.
2. Since 1960, expenditures on health care as a percent of GDP has:
a. been cut in half.
b. nearly tripled.
c. remained the same.
d. doubled.
3. The government program that provides the health insurance to the poor in the United States is called:
a. national health insurance.
b. Medicare.
c. Medicaid.
d. employer-provided health insurance.
4. Which of the following programs accounts for the greatest amount of government expenditures on public health in the United States?
a. Medicare
b. worker’s compensation
c. the Public Health Service
d. medical research
5. Which of the following subsidizes private provision of health insurance?
a. Medicare
b. Medicaid
c. the Public Health Service
d. tax exclusion of the value of employer-provided health insurance to workers
6. Which of the following could help decrease the rate of increase of spending on health care in the United States?
a. a reduction in the deductibles on private health insurance policies
b. an increase in the coinsurance rate on health insurance and subjecting a larger volume of ser¬vices to coinsurance
c. extension of Medicaid insurance to all persons who are poor
d. a reduction in the coinsurance rate on health insurance and subjecting a smaller volume of ser¬vices to coinsurance
7. Which of the following is an example of the “moral hazard of health insurance”?
a. an increase in the number of surgeries prescribed for benign prostate disease beyond the point at which the marginal benefit equals the marginal cost
b. a decreased willingness of individuals to go to the doctor for minor ailments because of increases in coinsurance rates
c. an underallocation of resources to medical care because of monopoly power of hospitals
d. experience rating of health insurance groups by health insurers
8. A third-party payment system for health care:
a. results because of externalities in the production of health care services.
b. encourages more than the efficient amount of resources to be allocated to health care.
c. encourages patients and health care providers to economize on the use of health care resources.
d. means that patients pay the full price for health care services they consume.
9. Which of the following services is typically not covered under private health insurance and Medicare in the United States?
a. treatment for heart attack
b. surgery
c. office visits to physicians
d. long-term care services
10. Under national health insurance as operated in Great Britain,
a. the British system pays fees equal to half of the costs of services provided to them.
b. general practice physicians are paid on a per-patient rather than on a per-unit-of-service basis.
c. patients requiring surgery can pick their surgeons and can usually obtain the surgery in a matter of days, even if it is not an emergency.
d. there are no government limits on health care spending by hospitals.
11. Which of the following is true about the Medicaid program in the United States?
a. It is a program of health insurance for the elderly.
b. Its costs are paid entirely by the federal government.
c. It is a program of health insurance for the poor.
d. Its costs have been declining in recent years.
12. In the United States, individuals pay approximately what percent of the cost of their medical care directly to providers?
a. 100 percent
b. 50 percent
c. 15 percent
d. zero
13. The percent of total health care costs in the United States paid for by governments is approximately:
a. 90 percent.
b. 45 percent.
c. 25 percent.
d. 10 percent.
14. The system of third-party payment for medical care in the United States has which of the following effects in the market for health care?
a. It improves efficiency in the market.
b. It causes the marginal social benefit of health care to exceed its marginal social cost.
c. It causes the marginal social cost of health care to exceed its marginal social benefit.
d. It results in less than the efficient quantity of health care services.
15. Which of the following is true about the Medicare program in the United States?
a. It is only available to those who pass a means test.
b. It is available to all citizens over the age of 65.
c. The costs are completely financed by fees paid by insurees.
d. It places no limits on reimbursement to medical care providers.
16. What would be the effect of having no health insurance available?
a. The quantity of healthcare would be set at where the marginal benefit and marginal cost are equal.
b. Excess demand for healthcare would be the result because the quantity supplied would be at a level where the marginal benefit exceeds the marginal cost.
c. Excess supply for healthcare would be the result because the quantity supplied would be at a level where the marginal benefit would be below the marginal cost.
d. the quantity of healthcare would be at an inefficient level.
17. The elderly are what proportion of beneficiaries of Medicare?
a. 95%
b. 85%
c. 77%
d. 70%
18. What is the moral hazard associated with third party payment for health services?
a. The recipient of the service is not as informed as the provider of the service.
b. The recipient of services tends to decline more services than they should.
c. The recipient of services tends to have more services than what is needed relative to the efficient level of services.
d. There is no moral hazard.
19. Which is not reason for excalating healthcare costs in the U.S.?
a. Increase in malpractice insurance.
b. Cross-subsidization of patients who cannot pay for healthcare or insurance.
c. Overuse of new technology.
d. Both (b) and (c).
20. If the quantity of healthcare is more than the efficient quantity, what is the consequence?
a. Some will not have access to healthcare that would have access at the efficient level.
b. The healthcare will suffer in quality.
c. Capital could be more efficiently spent elsewhere leading to less overall productivity.
d. Lower marginal costs and marginal benefits.

ECO 450 Week 7 Quiz

CHAPTER 10
Introduction to
Government Finance
TRUE/FALSE QUESTIONS
1. Taxes simultaneously ration and finance government goods and services.
2. The federal government finances only half of its expenditures with taxes.
3. The benefit principle argues that the means of financing government goods and services should be linked to the benefits received from those goods and services.
4. Horizontal equity is achieved when individuals of the same economic capacity pay the same amount of taxes over a given period.
5. A flat-rate income tax is a proportional tax on an income base.
6. The marginal tax rate will eventually exceed the average tax rate if the tax rate structure is propor¬tional.
7. The marginal tax rate for a payroll tax is 7 percent on all wages up to $60,000 per year. The marginal tax rate for wages in excess of $60,000 per year is zero. The payroll tax is therefore a regressive tax.
8. Tax evasion would be less of a problem if tax rates were lowered.
9. The user charge for a congestible public good should be zero at all times.
10. Zero prices for price-excludable government services provide benefits only to the poor.
11. The gasoline tax is an example of a general tax on consumption.
12. For a proportional tax, the marginal tax rate is always equal to the average tax rate.
13. Tax avoidance is an illegal activity in the United States.
14. An increase in marginal tax rates is likely to increase tax evasion.
15. Most studies indicate that state-run lotteries are equivalent to a progressive tax on gambling.
16. Government activity requires the reallocation of resources from government to private use.
17. A flat income tax (i.e. a fixed amount paid by every taxpayer) is an example of a selective tax.
18. The average tax rate and marginal tax rate are the same under a progressive tax rate structure.
MULTIPLE CHOICE QUESTIONS
1. According to the benefit principle,
a. taxes should be distributed according to ability to pay.
b. user charges are an ideal source of finance for government goods and services.
c. the progressive income tax represents the ideal way of distributing taxes among citizens.
d. flat-rate taxes are always the best kind.
2. If horizontal equity is achieved in taxation,
a. vertical equity will also be achieved.
b. individuals of equal economic capacity will pay equal taxes.
c. a flat-rate tax will be used.
d. the tax system will not result in losses in efficiency in markets.
3. The tax base of a payroll tax is:
a. consumer expenditures.
b. interest income.
c. labor income.
d. both (b) and (c)
4. A 5-percent retail sales tax on all consumer purchases in a state is imposed. The sales tax is:
a. a flat-rate tax.
b. a tax with a regressive rate structure.
c. levied on an income base.
d. all of the above
5. A tax on the value of real estate holdings is a:
a. selective tax on wealth.
b. general tax on wealth.
c. general tax on income.
d. selective tax on income.
6. An excise tax is a:
a. general consumption tax.
b. selective consumption tax.
c. general wealth tax.
d. selective tax on wealth.

7. A proportional income tax has an average tax rate that:
a. always is less than the marginal tax rate.
b. always exceeds the marginal tax rate.
c. equals the marginal tax rate at first and then becomes less than the marginal tax rate.
d. always equals the marginal tax rate.
8. A payroll tax taxes a worker’s wages at 14 percent until the worker earns $60,000 per year. All labor earnings in excess of $60,000 are not subject to tax. The tax rate structure of the payroll tax is therefore:
a. proportional.
b. progressive.
c. regressive.
d. flat-rate.
9. A bridge becomes congested after 100 vehicles per hour use it on any day. To achieve efficiency, a toll:
a. that charges all users of the bridge, no matter how many vehicles use it per hour, should be imposed.
b. on additional users in excess of 100 per hour should be imposed.
c. on all users should be imposed, if more than 100 users per hour are expected.
d. is not required.
10. A government prints money to finance its expenditures. As a result,
a. the economy can operate at a point outside its production possibility curve.
b. inflation will occur.
c. consumers will give up private goods to finance the increased government expenditures.
d. both (b) and (c)
11. Taxes are likely to affect:
a. market equilibrium.
b. political equilibrium.
c. the distribution of income.
d. all of the above
12. Taxes:
a. are voluntary payments to governments.
b. are unlikely to affect market supply and demand.
c. never affect efficiency in the allocation of resources.
d. are compulsory payments associated with certain activities.
13. A tax on real estate is a:
a. general wealth tax.
b. general consumption tax.
c. selective wealth tax.
d. selective income tax.
14. The marginal tax rate will eventually exceed the average tax rate for a:
a. proportional tax.
b. regressive tax.
c. progressive tax.
d. flat-rate tax.
15. Marginal tax rates were reduced in 2001. Other things being equal, this is likely to:
a. increase tax evasion.
b. decrease tax evasion.
c. have no effect on tax evasion.
d. increase tax avoidance.

16. What is an example of a normative criterion that a government must trade-off in its method of
taxation?
a. Equity
b. Efficiency
c. Administrative ease
d. all of the above
17. Tax avoidance is:
a. a means of tax evasion.
b. a means of decreasing taxes paid by adjusting behavior.
c. a political process explicitly for the reduction of taxation.
d. a means to avoid tax owed.
18. If the marginal tax rate is 20% under a proportional tax rate structure, the average tax rate:
a. should be 20%.
b. should be above 20%.
c. should be below 20%.
d. cannot be determined.
19. If the average tax rate under a progressive tax rate structure is 35%, a possible marginal tax rate is:
a. 30%.
b. 25%.
c. 42%.
d. not able to be determined.
20. Which of the following countries has the highest average tax rate relative to GDP?
a. Japan
b. Sweden
c. Iceland
d. United Kingdom

ECO 450 Week 8 Quiz

CHAPTER 11
Taxation, Prices, Efficiency,
and the Distribution of Income
TRUE/FALSE QUESTIONS
1. A lump-sum tax results in both income and substitution effects.
2. A consumer currently pays $500 a year retail sales taxes. She would be better off if she paid the same amount annually as a lump-sum tax.
3. Clothing is sold in perfectly competitive markets where no externalities prevail. An excise tax on clothing will result in a market price for clothing that equals the marginal social benefit and mar¬ginal social cost of service.
4. Assuming that the income effects are negligible and that beer is sold in a competitive market, a 10 cent per can tax on beer that causes a 10,000 can per month decline in sales will result in an excess burden of $1,000 per month.
5. A tax on land results in an income effect on landlords but no substitution effect. Then it follows that the excess burden of a tax on land will be zero.
6. The excess burden of a tax on interest income is $5 billion per year. Total interest income per year is $50 billion. The tax currently collects $15 billion in revenue per year. The efficiency-loss ratio of the tax is therefore 0.33.
7. A payroll tax results in a difference between the gross wages paid by employers and the net wages received by workers.
8. If the market supply of labor services is perfectly inelastic, a tax on labor income will reduce the net wages received by workers by the full amount of the tax per labor hour.
9. If a $10 per unit tax is levied on the output of a monopolist, more of that tax will be shifted to con¬sumers than would be the case if the same good were produced by a competitive industry.
10. A study indicates that taxes in the United States reduce the Gini coefficient for the nation by 10 percent. This implies that taxes make the income distribution more equal.
11. A lump-sum tax only results in income effects.
12. An income tax is an example of a price-distorting tax.
13. The more price-elastic the demand of a taxed item, the lower the excess burden of a tax on the sale of that item.
14. If the tax on the sale of gasoline is doubled from 20 cents per gallon to 40 cents per gallon, the excess burden of the tax will quadruple.
15. If the compensated elasticity of supply of labor is zero, then a tax on labor earnings will have zero excess burden.
16. Lump-sum taxes do not prevent prices from equaling the marginal social cost and benefit of any goods and services.
17. Lump-sum taxes can vary in amount based on income level.
18. A lump-sum tax can distort prices and affect consumption behavior.
MULTIPLE CHOICE QUESTIONS
1. A lump-sum tax:
a. distorts market prices so that they do not simultaneously equal MSB and MSC.
b. can result in price changes but does not prevent prices from simultaneously being equal to MSB and MSC.
c. results in substitution effects that change prices.
d. results in both substitution effects and income effects that change prices.
2. The current price of compact discs, which are traded in perfectly competitive markets, is $10. A $1 per unit tax is levied on the discs. Annual record sales decline from five million to four million as a result of the tax. Assuming that the income effect of the tax-induced price change is negligible, the excess burden of the tax will be:
a. $500,000 per year.
b. $1 million per year.
c. $2 million per year.
d. $2.5 million per year.
3. The elasticity of supply of land is zero. A tax on land results only in an income effect to landlords. Then it follows that a 10-percent tax on land rents will:
a. have a positive excess burden.
b. be shifted forward to tenants.
c. be paid entirely by landlords.
d. have zero excess burden.
e. both (c) and (d)
4. Currently, a 10-cent per gallon tax is levied on gasoline consumption. The tax is increased to 20 cents per gallon. The excess burden of the tax will:
a. remain the same.
b. double.
c. increase four times.
d. decline.
5. The supply of new cars is perfectly elastic. A $400 per car tax is levied on buyers. As a result of the tax,
a. the price received by sellers will fall by $400.
b. the price paid by buyers, including the tax, will increase by $400.
c. the quantity of cars sold per year will be unchanged.
d. the excess burden of the tax will be zero.
e. both (c) and (d)
6. Other things being equal, the more inelastic the demand for a taxed good,
a. the greater the portion of the tax paid by sellers.
b. the greater the excess burden of the tax.
c. the greater the portion of the tax paid by buyers.
d. the less the portion of a tax on sellers that can be shifted to buyers.
7. The market supply of labor is perfectly inelastic. However, the income effect of tax-induced wage changes are believed to be substantial. Then it follows that a tax on labor income will:
a. have zero excess burden.
b. have positive excess burden.
c. be paid entirely by workers as a reduction in net wages.
d. both (a) and (c)
e. both (b) and (c)
8. Suppose an economy is comprised of only two markets: one for food and the other for housing. A tax on food used to finance transfer payments is likely to:
a. decrease the price of food.
b. increase the price of housing.
c. decrease the price of housing.
d. have no effect on either the price of food or housing.
9. Differential tax incidence measures the effect:
a. that a tax and the expenditures it finances have on the distribution of income.
b. that one tax alone has on the distribution of income.
c. on the distribution of income of substituting one tax for another while holding the size and composition of the budget fixed.
d. on the distribution of income of substituting one tax for another while changing the kinds of government services financed.
10. Most studies of tax incidence assume that taxes on labor income and other input services are borne entirely by the workers and other input owners that supply the services. This implies that the:
a. supply of those input services is very elastic.
b. supply of those input services is of unitary elasticity.
c. supply of those input services is perfectly inelastic.
d. demand for those input services is perfectly elastic.
11. Most studies show that the price elasticity of demand for gasoline is –0.2. If the price elasticity of supply is 2, then a tax on gasoline will:
a. have no effect on the market equilibrium price of gasoline.
b. cause the market equilibrium price of gasoline to fall.
c. cause the market equilibrium price paid by buyers to rise.
d. cause the net price received by sellers to fall.
e. both (c) and (d)
12. The demand for medical care is very inelastic. If a 10-percent tax is levied on the sale of medical services and is collected from medical-care providers, then:
a. the incidence of the tax is likely to be borne entirely by medical-care providers.
b. most of the tax is likely to be shifted to those who purchase medical care.
c. the market equilibrium price of medical care will fall.
d. the excess burden of the tax is likely to be very high.
13. Which of the following is true about a lump-sum tax?
a. It prevents efficiency from being attained in competitive markets.
b. It causes substitution effects.
c. It causes income effects.
d. It causes both income effects and substitution effects.
14. Housing construction is generally believed to be an industry of constant costs. In the long run, which of the following is true if a $10 per square foot tax on housing construction is collected directly from builders?
a. The incidence of the tax will be borne by builders.
b. The excess burden of the tax will be zero.
c. The quantity of new construction supplied will be unaffected.
d. The tax will be fully shifted to buyers of new construction.
15. If the price elasticity of supply of labor is equal to 0.5 and the price elasticity of demand for labor is –2, then which of the following is likely to result from a tax on labor earnings?
a. The tax will be fully borne by workers.
b. Some of the tax will be shifted to employers as market equilibrium wages increase.
c. Market equilibrium wages will decline.
d. There will be no effect on market equilibrium wages.
16. If a lump-sum tax is imposed, the slope of the new budget line relative to the budget line prior to the tax:
a. remains unchanged.
b. increases.
c. decrease.
d. can increase and decrease in different regions.
17. Viewed from origin a price distorting tax creates a new budget line with a ______ slope relative to the budget line without the tax.
a. less steep
b. more steep
c. similar
d. varying
18. A $0.30 per unit tax is imposed on a good that reduces the quantity supplied and demanded by 1000 units. What is the deadweight loss (ignore price elasticities)?
a. $300.00
b. $100.00
c. $150.00
d. Cannot be determined.
19. If a per unit tax is imposed, but the quantity supplied and demanded does not change then:
a. the demand is perfectly inelastic.
b. the supply is perfectly inelastic.
c. there is no deadweight loss.
d. All of the above.
20. The efficiency-loss ratio relative to tax is:
a. the deadweight loss less the tax revenue.
b. the deadweight loss divided by the tax revenue reduced by one.
c. the excess burden divided by the tax revenue.
d. None of the above.

CHAPTER 12
Budget Balance and
Government Debt
TRUE/FALSE QUESTIONS
1. From 1950 to 2009, the federal government budget has been in balance in most years.
2. The high employment budget deficit implies that increases in economic activity will not eliminate the actual deficit.
3. Other things being equal, an increase in government borrowing is likely to increase interest rates.
4. If taxpayers anticipate future tax increases when government borrows to finance deficits, increased government borrowing will increase interest rates.
5. As of 2008, the amount of federal debt outstanding was equal to twice the annual GDP.
6. From 1950 to 1980, the value of the federal debt as a percent of GDP declined.
7. More than 50 percent of the federal debt in recent years has been outside debt.
8. An increase in market rates of interest tends to decrease the market value of outstanding govern¬ment debt.
9. Deficit finance postpones taxation from the present to the future.
10. The burden of the debt is borne by those who purchase government bonds.
11. The federal government budget recorded surpluses between 1998 and 2001.
12. State and local governments are usually required by state law to keep the budgets in balance.
13. If business and personal saving are constant, then a federal budget deficit will have no impact on national saving.
14. Other things being equal, a government surplus increases the supply of loanable funds available for investment.
15. State revenue bonds are backed by the taxing power of state governments.
16. A federal budget surplus can lead to more credit being available for productive activity.
17. A federal budget deficit can strain credit markets forcing the real rate of interest to decrease.
18. The U.S. deficit in the 1980s was structural in the sense that federal spending would exceed federal revenue even at a level of full employment.
MULTIPLE CHOICE QUESTIONS
1. The outstanding federal debt will decline in value if:
a. budget deficits continue.
b. the government runs a budget surplus.
c. the market rate of interest increases.
d. either (b) or (c)
2. The federal budget has been in deficit:
a. for every year between 1970 and 1997.
b. for every year between 1950 and 1997.
c. only since 1980.
d. for every year between 1960 and 1997.
3. The high employment deficit is estimated at $100 billion. Assuming that the economy is operating below full employment and that it will not overheat during the year,
a. the actual budget is not in deficit.
b. increasing GDP will eliminate the deficit.
c. increasing GDP will not eliminate the deficit.
d. the actual budget is in surplus.
4. An increase in government borrowing has no effect on the willingness of citizens to save or on the demand for credit. Increased borrowing to cover deficits will therefore:
a. reduce interest rates.
b. increase interest rates.
c. have no effect on interest rates.
d. not require increased taxes in the future.
5. As a result of government borrowing to cover deficits, citizens increase the supply of savings to provide themselves with funds to pay anticipated increases in future taxes. Then it follows that increased government borrowing will:
a. reduce private investment.
b. increase private investment.
c. have no effect of private investment.
d. increase interest rates.
e. both (a) and (d)
6. The total dollar value of the federal debt outstanding is:
a. more than 50 percent of GDP.
b. more than 100 percent of GDP.
c. less than 50 percent of GDP.
d. less than 10 percent of GDP.
7. The federal government, its agencies, and the Federal Reserve System:
a. are not permitted to hold outstanding federal debt.
b. hold 50 percent of the outstanding federal debt.
c. hold between 15 and 25 percent of the outstanding federal debt.
d. hold 75 percent of the outstanding federal debt.
8. The largest portion of the net federal debt outstanding is owed to:
a. foreigners.
b. U.S. citizens and companies.
c. federal government agencies.
d. state and local governments.
9. The debt of state and local governments is mostly:
a. internal.
b. external.
c. owed to citizens of other nations.
d. worthless.
10. Government borrowing will:
a. postpone taxation to the future.
b. increase government interest cost.
c. both (a) and (b)
d. eliminate taxes.
11. Which of the following is true about the federal government budget balance in the United States?
a. The federal budget has never had a surplus.
b. The federal budget had a surplus every year from 1970 to 2008.
c. The federal budget had a surplus from 1998 until 2001.
d. The federal budget had a deficit from 1998 until 2001.
12. Which of the following can contribute to a decrease in national saving?
a. a federal budget deficit
b. an increase in the state and local government aggregate surplus
c. a federal budget surplus
d. an increase in personal saving
13. Other things being equal, a government budget surplus:
a. increases the demand for loanable funds.
b. increases the supply of loanable funds.
c. is likely to increase market equilibrium interest rates.
d. is unlikely to affect market equilibrium interest rates.
14. If the federal government runs a surplus consistently, then which of the following is likely to occur?
a. National saving will decline.
b. The gross federal debt will increase.
c. The gross federal debt will decrease.
d. Market equilibrium interest rates are likely to rise as a result of the surpluses.
15. General obligation bonds of state and local governments are:
a. backed by revenue from public facilities such as sports stadiums.
b. backed by the taxing power of state and local governments.
c. usually used to finance transfer payments.
d. usually used to finance capital expenditures.
e. both (b) and (d)
16. A bond that is backed by the tolls collected from a bridge to be constructed from the proceeds of the bond is an example of:
a. a general obligation bond.
b. a non-obligation bond.
c. a revenue bond.
d. none of the above.
17. Evidence of “crowding out” in the market for loanable funds at a rate of 8% could be:
a. private investors who will borrow only at a rate lower than 8%.
b. private investors who are willing to accept a rate higher than 8% for borrowing.
c. a government surplus.
d. a social security surplus.
18. High-employment deficit or surplus is:
a. an extreme economic situation requiring emergency measures.
b. the amount of deficit or surplus available assuming current employment levels.
c. the amount of deficit or surplus available when employment is at its approximately full capacity.
d. the amount of deficit or surplus available when unemployment is at a relatively high level.
19. A government’s internal debt is:
a. debt owed to other government agencies.
b. debt owed to other governments.
c. debt owed to its citizens.
d. both (a) and (c).
20. The National Income and Product Accounts budget balance reflects:
a. an inflation-adjusted budget balance less social security surplus.
b. new debt resulting from a federal budget deficit.
c. the real budget balance.
d. the nominal budget balance.

ECO 450 Week 9 Quiz

CHAPTER 13
The Theory of Income Taxation
TRUE/FALSE QUESTIONS
1. The actual federal income tax currently taxes all income irrespective of its source or use at the same tax rate.
2. Comprehensive income excludes unrealized capital gains.
3. Under a comprehensive income tax, transfer payments received by Social Security recipients would be fully taxable.
4. Homeowners earn rental income-in-kind from their home that would be taxable under a compre¬hensive income tax.
5. A comprehensive income tax is a lump-sum tax.
6. A comprehensive income tax will result in a divergence between gross wages paid by employers and net wages received by workers.
7. A comprehensive income tax will always reduce work effort by taxpayers.
8. The substitution effect of a tax-induced decline in wages always leads workers to work less.
9. The market wage elasticity of labor is zero. If this is the case, the excess burden of a tax on labor income will also be zero.
10. Points on a compensated labor supply curve are always more elastic than points for corresponding wage levels on a regular labor supply curve.
11. Comprehensive income is the sum of annual consumption and the change in net worth.
12. A tax on interest income does not prevent credit market from efficiently allocating resources.
13. If an individual is subject to a 30-percent income tax, then the net interest on a certificate of deposit yielding 5 percent would be 3.5 percent after taxes.
14. Because a tax on interest income results in income and substitution effects, it is not possible to pre¬dict the effect it will have on saving.
15. Most empirical studies indicate that the interest elasticity of supply of savings is close to zero.
16. Income tax became a permanent fixture in the United States starting in the early nineteenth century.
17. The Haig-Simons definition of income is different from comprehensive income.
18. Comprehensive income equals consumption plus the change in net worth.
MULTIPLE CHOICE QUESTIONS
1. Comprehensive income:
a. is the sum of annual consumption and realized capital gains.
b. is the sum of annual consumption and changes in net worth.
c. excludes corporation income.
d. is the sum of annual consumption and net worth.
2. A tax on labor income:
a. results only in an income effect that always decreases hours worked per year.
b. results in a substitution effect that always decreases hours worked per year.
c. results in an income effect that increases hours worked per year if leisure is a normal good.
d. both (a) and (b)
e. both (b) and (c)
3. The market supply of labor is perfectly inelastic. Then it follows that:
a. the substitution effect of wage changes is zero.
b. the income effect of wage changes is zero.
c. leisure is a normal good and the income effect of wage changes exactly offsets the substitution effect.
d. the excess burden of a tax on labor income will be zero.
4. The compensated labor supply curve:
a. will always be vertical.
b. will always be upward sloping.
c. will always be downward sloping.
d. reflects both the income and substitution effects of wage changes.
5. Using a regular labor supply curve instead of a compensated supply curve to calculate the excess burden of a tax on labor income will:
a. result in an accurate estimate of the excess burden.
b. overestimate the excess burden.
c. underestimate the excess burden.
d. accurately estimate the excess burden only if the market supply of labor is perfectly inelastic.
6. Most empirical research indicates that the market supply curve of labor hours by prime-age males is:
a. very elastic.
b. almost perfectly inelastic.
c. always upward sloping.
d. perfectly elastic.
7. A flat-rate tax on labor income will:
a. always reduce hours worked per year.
b. always increase hours worked per year.
c. either increase or decrease hours worked per year.
d. never have any effect on the amount of leisure hours per year.
8. A tax on interest income:
a. causes the gross interest rate paid by investors to exceed the net interest rate received by savers.
b. will always reduce saving.
c. will always increase saving.
d. is equivalent to a lump-sum tax.
9. If the market supply curve of savings is upward sloping, a tax on interest income will:
a. increase the amount of saving.
b. increase the market rate of interest.
c. decrease the market rate of interest.
d. have no effect on the market rate of interest.
10. If the supply of labor is perfectly inelastic, then the incidence of a payroll tax levied entirely on employers will be:
a. borne by employers as a reduction in profits.
b. split between workers and employers.
c. paid entirely by workers.
d. shifted forward to consumers.
11. Which of the following is true about comprehensive income?
a. Only labor income is included.
b. Only capital income is included.
c. Capital gains are not included.
d. Both realized and unrealized capital gains are included.
12. Which of the following will increase a person’s comprehensive income?
a. an increase in the market value of the person’s home
b. a decrease in the value of the person’s stock portfolio
c. a decrease in labor income
d. a decrease in consumption
13. A tax on labor income will:
a. increase the net wage received by workers.
b. decrease the net wage received by workers.
c. cause that net wage received by workers to decline below the gross wage paid by employers.
d. both (b) and (c)
14. If the return to savings, r, is subject to taxation at rate t, then in equilibrium a saver’s marginal rate of time preference will equal:
a. r
b. t
c. (1 + r)
d. [1 + r(1 – t)]
15. The higher the compensated elasticity of supply of savings,
a. the lower the excess burden of a tax on capital income.
b. the higher the excess burden of a tax on capital income.
c. the higher the excess burden of a tax on labor income.
d. both (b) and (c)
16. The Haig-Simons definition of income:
a. is the sum of annual consumption and realized capital gains.
b. is the sum of annual consumption and changes in net worth.
c. excludes corporation income.
d. is the sum of annual consumption and net worth.
17 Comprehensive income:
a. includes realized capital gains, but not unrealized capital gains
b. includes both realized and unrealized capital gains.
c. excludes cash from the sale of assets.
d. excludes increases in the value of assets.
18. Income-in-kind:
a. is exemplified by nonpecuniary returns.
b. is generally non-taxable because there is no monetary transaction.
c. is generally taxable.
d. both (a) and (b).
19. An example of a nonpecuniary return is:
a. job satisfaction.
b. unemployment benefits.
c. employer contributions to a retirement plan.
d. both (b) and (c).

20. Income from labor services (wages) account for what percentage of gross income in the U.S.?
a. 90%
b. 75%
c. 60%
d. 50%

CHAPTER 14
Taxation of Personal Income
in the United States
TRUE/FALSE QUESTIONS
1. Taxable income in the United States exceeds adjusted gross income.
2. Taxable income in the United States includes all capital gains earned, whether or not they are realized.
3. Taxable income in the United States amounts to less than 50 percent of personal income.
4. Tax preferences are really subsidies to certain activities.
5. A tax deduction allowed for an activity for which positive externalities are not likely to exist (such as home ownership) is likely to cause the marginal social cost of the activity to exceed its marginal social benefit.
6. The value of a personal exemption to a taxpayer varies with his or her marginal tax rate.
7. The U.S. personal income tax is not a progressive tax.
8. The highest statutory marginal tax rate under the federal personal income tax is 50 percent.
9. Under current rules, only real interest earned is subject to income tax.
10. Realized, long-term capital gains that reflect inflation are currently exempt from taxation.
11. The tax base under the personal income tax in the United States is the Haig-Simons definition of comprehensive income.
12. Tax credits vary with a person’s marginal tax rate.
13. The cuts in marginal tax rates initiated in 2001 are likely to reduce the excess burden of tax pref¬erences.
14. The earned income tax credit is a negative tax the subsidizes the earnings of low-income workers.
15. If a progressive income tax is replaced with an equal-yield, flat-rate tax, then work effort will unequivocally increase.
16. As of 2009, there is no marriage penalty for an adjusted gross income of $60,000.
17. Tax preferences are exclusions, exemptions, and deductions from the tax base.
18. Income-in-kind is not considered a tax preference.
MULTIPLE CHOICE QUESTIONS
1. Adjusted gross income, as defined by the United States Tax Code,
a. exceeds taxable income.
b. equals taxable income.
c. is less than taxable income.
d. is greater than comprehensive income.
2. Tax preferences:
a. are exclusions, exemptions, and deductions from the tax base.
b. are in the tax code by accident.
c. are extra taxes on certain taxpayers.
d. increase the amount of income that is taxable.
e. both (a) and (d)
3. Currently, the tax treatment of capital gains in the United States is such that:
a. all capital gains are taxed.
b. all realized capital gains are taxed.
c. most realized capital gains are taxed.
d. only capital gains adjusted for inflation are taxed.
4. The exclusion of interest of state and local bonds from taxation by the federal government:
a. decreases interest costs for state and local governments.
b. increases interest costs for state and local governments.
c. benefits lower-income taxpayers more than upper-income taxpayers.
d. discourages borrowing by local governments.
5. The value of personal exemptions in terms of taxes saved:
a. is the same for all taxpayers.
b. varies with family size.
c. varies with taxpayers’ marginal tax rates.
d. both (b) and (c)
6. A taxpayer is in a 33-percent tax bracket and itemizes deductions. He obtains a mortgage from a bank at 9-percent interest. The actual rate of interest he pays is:
a. 6 percent.
b. 9 percent.
c. 20 percent.
d. 25 percent.
7. Tax expenditures are:
a. expenditures made to collect taxes.
b. losses in revenue due to tax preferences.
c. less than 1 percent of tax revenue.
d. both (b) and (c)
8. Under the federal personal income tax rules prevailing as of 2009,
a. all interest expense is tax deductible.
b. the interest expense for mortgages on first and second homes is tax deductible.
c. the interest expense for mortgages only on first homes is tax deductible.
d. no interest is tax deductible.
9. The reduction in marginal tax rates will:
a. increase the excess burden of tax preferences.
b. increase tax expenditures.
c. decrease the excess burden of tax preferences.
d. have no effect of tax expenditures.
10. “Bracket creep” is no longer a problem in the United States because:
a. the tax brackets are indexed.
b. capital gains are now fully taxable.
c. only real interest is taxed.
d. capital gains are indexed.
11. Which of the following is true for the federal income tax in the United States?
a. All income irrespective of its source or use is taxed at the same rate.
b. Comprehensive income is the tax base.
c. The tax base is less than 50 percent of comprehensive income.
d. All realized and unrealized capital gains are included in the tax base.
12. Because of the Earned Income Tax Credit, the effective tax rate for the lowest-income taxpayers in the United States is:
a. only 15 percent.
b. higher than that paid by upper-income taxpayers.
c. zero.
d. negative.
13. The excess burden of tax preferences:
a. depends on average tax rates.
b. will be higher, the higher the marginal tax rate is.
c. will be lower, the higher the marginal tax rate is.
d. is independent of marginal tax rates.
14. A shift to an equal-yield, flat-rate personal income tax from the current progressive income tax rate structure will:
a. reduce the tax burden on upper-income groups.
b. increase the tax burden on upper-income groups.
c. increase the share of taxes paid by lower-income groups.
d. both (a) and (c)
15. Removing savings from the tax base of the personal income tax is likely to:
a. increase work effort.
b. decrease work effort.
c. lower market equilibrium interest rates by increasing the supply of loanable funds.
d. increase market equilibrium interest rates, thereby increasing the demand for loanable funds.
16. Which is a justification for tax preferences?
a. administrative difficulties
b. improving equity
c. encouraging private expenditures that create external benefits
d. all of the above
17. If the excess burden from tax is $10 million, lowering marginal tax rates should make the excess burden:
a. more than $10 million.
b. less than $10 million.
c. remain at $10 million.
d. none of the above is certain to occur
18. Which of the following is the result of The Economic Growth and Tax Relief Reconciliation Act enacted in 2001?
a. reduction of the highest marginal tax rate
b. increased the marriage penalty
c. created a new 40% tax bracket
d. both (a) and (c)
19. As of 2009, the highest marginal tax rate is:
a. 39.6%
b. 38%
c. 35%
d. 32.5%
20. Which is an example of an itemized deduction under the U.S. code as of 2009?
a. state and local income tax
b. state and local property tax
c. all medical expenses
d. both (a) and (b)

CHAPTER 17
Taxes on Wealth,
Property, and Estates
TRUE/FALSE QUESTIONS
1. Wealth is a flow.
2. A wealth tax is equivalent to a tax on the return to saving.
3. If the supply of savings is perfectly inelastic, a comprehensive wealth tax will increase the market rate of interest.
4. Assuming that the supply curve of savings is upward sloping, a comprehensive wealth tax will reduce annual investment.
5. As administered in the United States, the local property tax is mainly a tax on real estate.
6. The property tax in the United States is likely to reduce the equilibrium return to investment.
7. The town of Oz has raised its property tax rates considerably above the national average. Other things being equal, capital is likely to flow into Oz in the long run because of the tax.
8. If a real estate tax causes rents to rise, it cannot be fully capitalized.
9. A tax on the value of land is likely to be fully capitalized.
10. The local property tax is likely to result in less than the efficient amount of investment in real estate.
11. A general tax on wealth will cause efficiency loss in labor markets.
12. The local property tax, as administered in the United States, is a general tax on wealth.
13. The local property tax in the United States will reduce the return to real estate only in the long run.
14. Other things being equal, if the property tax rate is above the national average for a jurisdiction, capital can be expected to flow out of the region in that area.
15. If a local property tax increase is fully capitalized, property owners at the time of the increase can¬not shift any of the current or future tax increase to buyers if they sell the property.
16. A person who never saves any income and receives no gifts and inheritances will never accumulate wealth.
17. Wealth taxes are a relatively new form of taxation.
18. Total wealth definitions never include intangible personal property.
MULTIPLE CHOICE QUESTIONS
1. Wealth is:
a. a flow.
b. a stock.
c. the market value of accumulated assets.
d. both (b) and (c)
2. A comprehensive wealth tax base includes:
a. all real tangible, intangible, and human wealth, less any claims against those assets.
b. only real property.
c. only intangible assets.
d. only tangible assets.
3. If the interest elasticity of supply of savings is zero, a comprehensive wealth tax will:
a. increase the market rate of interest.
b. reduce the income of savers.
c. reduce the income of workers.
d. both (b) and (c)
4. If the supply curve of savings is upward sloping, a comprehensive wealth tax will:
a. increase the market rate of interest.
b. reduce the market rate of interest.
c. have zero excess burden.
d. have no effect on investment.
5. A comprehensive wealth tax will:
a. impair efficiency in labor markets.
b. impair efficiency in investment markets.
c. both (a) and (b)
d. have no excess burden.
6. Assuming that investors seek to maximize the return on their investment, the long-run effect of a national tax on real estate will be to:
a. reduce the return to investment in real estate only.
b. reduce the return to investment in all assets.
c. reduce wages only.
d. increase the return to all investors.
7. A local property tax, such as that used in the United States, is likely to:
a. increase investment in the economy.
b. cause a flow of investment among jurisdictions.
c. decrease the return to saving in all uses.
d. both (b) and (c)
8. If a property tax on real estate is capitalized,
a. the price of real estate will rise.
b. the price of real estate will fall.
c. the price of real estate will be unaffected.
d. the burden of the tax will be transferred to buyers of real estate.
e. both (b) and (d)
9. Suppose that the current market rate of interest is 10 percent. The market rent on a parcel of land is $6,000 per year. A 10-percent land tax is imposed. As a result of the tax, the price of the land parcel:
a. falls from $60,000 to $30,000.
b. increases from $30,000 to $60,000.
c. falls 10 percent.
d. falls 20 percent.
10. If a tax on real estate results in a decrease in the supply of housing, the tax will be:
a. fully capitalized.
b. only partially capitalized.
c. not capitalized at all.
d. borne entirely by renters.
11. If the supply of saving is not perfectly inelastic in the nation, then which of the following taxes will cause efficiency loss in capital markets?
a. a general wealth tax
b. a national tax on real estate
c. a consumption tax
d. both (a) and (b)
12. The local property tax in the United States is levied primarily on:
a. personal property.
b. intangible property.
c. business property.
d. real estate.
13. Which of the following would not be included in a comprehensive wealth tax base?
a. real estate
b. personal property
c. intangible assets
d. residential rents
14. If the supply of real estate is not perfectly inelastic, then the local real estate property tax differentials:
a. cannot be shifted to tenants.
b. can be shifted to tenants through increases in rents.
c. will be fully capitalized.
d. both (a) and (c)
15. If the supply of saving is not perfectly inelastic, then substituting a value-added tax for an equal-yield general wealth tax will:
a. decrease market equilibrium interest rates.
b. increase the efficiency loss in labor markets.
c. decrease the efficiency loss in labor markets.
d. decrease efficiency in capital markets.
e. both (a) and (b)
16. Intangible personal property includes:
a. stock in companies.
b. corporate bonds.
c. cash.
d. all of the above
17. If the annual amount of savings is $10 billion, what is the effect of a wealth tax assuming supply is perfectly inelastic?
a. annual savings remains $10 billion
b. annual savings increases above $10 billion
c. annual savings falls below $10 billion
d. no particular effect is guaranteed to happen
18. If the annual amount of savings is $10 billion, what is the effect of a wealth tax assuming supply is responsive?
a. annual savings remains $10 billion
b. annual savings increases above $10 billion
c. annual savings falls below $10 billion
d. no particular effect is guaranteed to happen
19. From the point of view of the locality, increasing property taxes:
a. increases the price of locally produced goods.
b. decreases income of owners of land in the associated community.
c. does not affect buyers of locally produced goods fro outside of the community.
d. both (a) and (b)
20. Tax capitalization is:
a. a decrease in the value of a taxed asset at a level related to the discounted value of the future tax liability.
b. partially recognized when the supply of taxed asset is perfectly inelastic.
c. only partially recognized on assets like land.
d. both (b) and (c)

CHAPTER 18
Fiscal Federalism and State and
Local Government Finance
TRUE/FALSE QUESTIONS
1. A federal system of government allows a wider diversity of preferences for government-provided services to be accommodated when compared to nonfederal, centralized government.
2. Income redistribution is a service likely to be most effectively administered by the federal govern¬ment.
3. Economic stabilization can be easily supplied to citizens by local governments.
4. When each local government supplies goods and services to its citizens, the political equilibrium in each jurisdiction corresponds to the median most-preferred outcome of all national voters.
5. A federal system of government allows both centralized and decentralized collective choices.
6. Local tax bases are less elastic than national tax bases.
7. Tax exporting occurs if the price of goods produced in the state and purchased by out-of-state residents rises as a result of in-state taxes.
8. Matching categorical grants can be used to internalize interjurisdictional positive externalities.
9. Matching grants only result in income effects.
10. A matching grant will increase local government expenditures by more than an equal-value, general purpose grant.
11. A federal system of government only has a central government that supplies all public goods and services.
12. According to the Tiebout model of fiscal federalism, a system of many local governments improves the efficiency of allocation of resources to and among public goods.
13. If a local jurisdiction’s tax base is elastic, an increase in tax rates will decrease tax revenue.
14. Taxing hotel rooms and restaurant meals in a city with lots of tourism is an example of tax exporting.
15. Financing local schooling with the local property tax can guarantee equality of opportunity in education.
16. According to Tiebout, individuals will self-select into communities where the government budget best satisfies their own personal preferences.
17. Mobility between communities is not critical to the Tiebout model.
18. Interjurisdictional externalities are costs or benefits of local government goods and services to residents in other political jurisdictions.
MULTIPLE CHOICE QUESTIONS
1. Under a federal system of government,
a. all government goods and services are supplied by a central government.
b. all government goods and services are supplied by local governments.
c. both central and noncentral governments supply goods and services.
d. all public choices are made nationally.
2. Economic stabilization is most effectively provided by:
a. a central government.
b. state governments.
c. local governments.
d. regional governments.
3. A decentralized system of government:
a. tends to result in uniformity in the quantity and quality of government services in all jurisdic¬tions.
b. allows diversity in the quantity and quality of government goods and services.
c. conducts national elections on all issues.
d. is undemocratic.
4. The political equilibrium in a local jurisdiction for a given public good corresponds to the median most-preferred outcome of:
a. all national voters.
b. the President.
c. local voters.
d. both (a) and (c)
5. In general, local tax bases tend to be:
a. less elastic than national tax bases.
b. more elastic than national tax bases.
c. equally elastic when compared with national tax bases.
d. very inelastic.
6. According to the Tiebout model of local government expenditure,
a. all local governments will supply the same kinds and amounts of services.
b. mobile citizens respond to differences in taxes and expenditures by moving to the jurisdiction that maximizes their well-being.
c. the average costs of government services is constant.
d. tax rates do not influence a citizen’s choice of residence.
7. A categorical grant:
a. does not restrict the use of transferred funds.
b. usually specifies the use to which the funds must be applied.
c. is used rarely in the United States.
d. is not used at all in the United States.
8. A federal highway grant will provide funds for roads supplied by state and local governments if these governments pay 50 percent of the cost of the roads. This grant is an example of:
a. revenue sharing.
b. a matching categorical grant.
c. a general purpose grant.
d. a nonmatching block grant.
9. A grant received by a local government will:
a. not affect the political equilibrium in that jurisdiction.
b. change the political equilibrium in that jurisdiction.
c. always increase government expenditures in the recipient jurisdiction by the amount of grant.
d. both (b) and (c)
10. Matching grants:
a. will not increase government spending in recipient jurisdictions.
b. increase government expenditures in recipient jurisdictions more than nonmatching grants of an equal amount.
c. increase government expenditures in recipient jurisdictions less than nonmatching grants of an equal amount.
d. increase tax rates in recipient jurisdictions.
11. Which of the following is true about a federal system of government?
a. There is only one level of government.
b. There are several levels of government.
c. A central government directs local governments to supply all public goods at levels determined nationally.
d. There are only local governments.
12. The central economic problem of fiscal federalism is:
a. the division of taxing and expenditure functions among different levels of government.
b. the choice of the collective choice rule for central governments only.
c. the level of public goods to be provided by a central government only.
d. how to achieve an equitable distribution of income.
13. Which of the following is best supplied by local governments?
a. national defense
b. income redistribution
c. money
d. fire protection
14. Local public goods:
a. are pure public goods for the entire nation.
b. are those whose benefits are nonrival only for the population of a particular geographical area.
c. have benefits that are subject to exclusion by pricing for local consumers.
d. are best provided by a central government.
15. An increase in the local retail sales tax rate will increase revenue collected by a local government:
a. if the tax base is elastic.
b. if the tax base is unit elastic.
c. if the tax base in inelastic.
d. no matter what the value of the elasticity of the tax base.
16. Which is an example of a interjurisdictional externality?
a. residential property tax
b. local sales tax
c. wage tax on all workers in a community
d. both (b) and (c)
17. Mobility:
a. is not essential to the Tiebout model.
b. can hamper a jurisdiction’s ability to raise revenues.
c. may be part of the reason for the reliance on local property taxes for the raising of local government revenue.
d. both (b) and (c)
18. A local wage tax can:
a. create tax competition if a neighboring jurisdiction does not have such a tax.
b. export tax onto workers in the local jurisdiction who live outside of the local jurisdiction.
c. prevent tax competition among other local jurisdictions.
d. both (a) and (b)
19. Fiscal capacity:
a. decreases with the ability of the jurisdiction to export tax.
b. is a measure of the ability of a jurisdiction to finance government-provided services.
c. is always enhanced by mobility.
d. is not dependent on the wealth of the community.
20. What is generally the best measure of fiscal capacity for local governments?
a. income per capita
b. per capita retail sales
c. assessed valuation per capita
d. per capita expenditure

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.

ECO 405 Week 11 Quiz – Strayer University New

ECO/405 Week 11 Quiz – Strayer

Click on the Link Below to Purchase A+ Graded Course Material

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Quiz 10 Chapter 14 and 15

Government Spending, Taxation, And The National Debt: Who Wins And Who Loses?

Multiple Choice Questions

1. The Fears Of People Concerning The Size Of Government Are
A. Always Without Any Foundation
B. Well-Founded In Some Instances And Not Well-Founded In Some Instances
C. Difficult To Appreciate
D. Due To Low Income And Low Educational Levels Of Many People
E. Based Solely On Economic Efficiency

2. The Fears Of People Concerning Distribution Of Taxes Are Related To
A. Equity Or Justice In Taxation
B. Ample Evidence That There Are Tax Inequities In The Tax System At All Levels Of Government
C. The Complete Lack Of Understanding That People Have About The Purpose Of Taxes
D. Both (A) And (B)
E. All Of The Above

3. Total Government Expenditures Currently Represent Approximately What Percentage Of Gdp?
A. 20%
B. 30%
C. 40%
D. 50%
E. 10%

4. A Cash Payment From The Government To An Individual, Based On Need, Is An Example Of A
A. Transfer Payment
B. Government Purchase Of A Service
C. Government Purchase Of A Good
D. Transaction Payment
E. Government Receipt

5. A Payment From The Government To A Federal Employee Is A
A. Transfer Payment
B. Government Purchase Of A Service
C. Government Purchase Of A Good
D. Transaction Payment
E. Government Receipt

6. An Efficient Level Of Government Expenditures Is That Level Where
A. Total Costs Are Minimized
B. Total Benefits Are Maximized
C. Marginal Benefits Are Equal To Marginal Costs
D. Marginal Benefits Are Greater Than Marginal Costs
E. Marginal Benefits Are Less Than Marginal Costs

7. Public Goods And Services Have Characteristics That Make Them
A. Possible To Exclude People From Consuming Them
B. Less Available For One Person When Another Consumes Them
C. Easy To Provide Through Private Markets
D. All Of The Above
E. None Of The Above

8. The Size Of Government Is Growing At
A. A Slower Rate Than The Rest Of The Economy
B. Approximately The Same Rate As The Rest Of The Economy
C. A Faster Rate Than The Rest Of The Economy
D. Twice The Rate Of The Rest Of The Economy
E. A Negative Rate

9. Assuming Negative Externalities In Production, The Type Of Government Action That Could Bring About An Efficient Level Of Production Would Be
A. A Tax Levied On Each Unit Produced Equal To Marginal External Costs
B. A Tax Levied On Each Unit Produced Greater Than Marginal External Costs
C. A Subsidy To Consumers Equal To Marginal External Benefits
D. A Subsidy To Consumers Greater Than Marginal External Benefits
E. None Of The Above

10. Assuming Positive Externalities In Consumption, The Type Of Government Action That Could Bring About An Efficient Level Of Production Would Be
A. A Tax Levied On Each Unit Produced Equal To Marginal External Costs
B. A Tax Levied On Each Unit Produced Greater Than Marginal External Costs
C. A Subsidy On Each Unit Consumed Equal To Marginal External Benefits
D. A Subsidy On Each Unit Consumed Greater Than Marginal External Benefits
E. None Of The Above

11. Shifting Income From Those Who Are Relatively Productive To Those Who Are Relatively Unproductive, Say Through Taxes And Subsidies, Must Be Based On
A. Sound Economic Principles
B. The Laws Of Demand And Supply
C. The Values Of People As To What Constitutes A “Fair” Distribution Of Income
D. Marginal Cost And Marginal Benefit
E. Both (A) And (D)

12. A National Crime Lab Used To Prevent Criminal Activity Nationwide Is An Example Of A
A. Negative Externality
B. Positive Externality
C. Transfer Payment
D. Public Good
E. Private Good

13. Tax Equity Means That
A. All People Should Pay Equal Taxes
B. Only The “Rich” Should Pay Taxes
C. People In The Same Economic Circumstances Should Pay Equal Taxes, And People In Different Economic Circumstances Should Pay Unequal Taxes
D. The Distribution Of Income After Taxes Should Be Equal
E. None Of The Above

14. An Efficient Tax Would Be A Tax For Which
A. The Excess Burden” From Taxes Is Zero
B. Taxes Should Have A Neutral Effect On The Operation Of The Economy
C. Taxes Should Be Levied At Progressive Rates
D. (A) And (B)
E. All Of The Above

15. According To The Equimarginal Principle, The Efficient Level Of Government Expenditures Occurs When The Benefit Of The Last Dollar Spent For Each Government Purchase Is
A. Greater Than The Benefit Of The Last Dollar Spent In The Private Sector
B. Less Than The Benefit Of The Last Dollar Spent In The Private Sector
C. Equal To The Benefit Of The Last Dollar Spent In The Private Sector
D. Paid For Out Of Current Tax Collections
E. None Of The Above

16. An Efficient Level Of Government Expenditures Is That Level At Which
A. Marginal Benefits Exceed Marginal Costs
B. Total Benefits Equal Total Costs
C. The Net Benefits To Society Are Maximized
D. The Total Costs Are Minimized
E. None Of The Above

17. Where Marginal Benefits Are Greater Than The Marginal Costs, Government Expenditures Should
A. Be Increased
B. Remain The Same
C. Be Decreased Then Increased To Their Original Level
D. Be Increased Then Decreased To Their Original Level
E. Do None Of The Above

18. Characteristics Of Public Goods And Services Include Which Of The Following?
A. The Demand For These Goods And Services Is Divisible On The Basis Of Individual Quantity Demanded
B. The Supply Of These Goods And Services Is Generally Not Divisible Into Small Units
C. These Goods And Services Are Easily Provided By The Market System
D. The Costs Of These Goods Fall On Other Than The Buyer
E. None Of The Above

19. Which Of The Following Is An Example Of A Public Good Or Service?
A. A Public Highway
B. Free Cheese Offered By The Government
C. Food Stamps
D. Social Security
E. Automobiles

Questions 20 – 24 Refer To The Graph Below.

20. Assuming No External Benefits Or Costs, The Efficient Price And Quantity Would Be
A. P2, Q2
B. P2, Q1
C. P1, Q1
D. P0, Q0
E. P0, Q2

21. Suppose There Are External Benefits Associated With The Production Of The Good. The Efficient Price And Quantity Are
A. P2, Q2
B. P2, Q1
C. P1, Q1
D. P0, Q0
E. P0, Q2

22. If External Benefits Are Associated With The Consumption Of The Good, Consumers Could Be Induced To Purchase The Efficient Quantity If The Price Were Set At
A. P2
B. P1
C. P0
D. 0
E. None Of The Above

23. To Assure Consumers Purchase The Efficient Quantity When There Are Positive External Benefits, The Government Would Lower Price To
A. P2
B. P1
C. P2- P1
D. P0- P1
E. P0

24. Marginal External Benefits Are Represented On The Graph As The Distance
A. Ab
B. Q2a
C. Ea
D. Cf
E. Af

25. Which Of The Following Is The Major Tax Source Of The Federal Government?
A. Income Taxes
B. Excise Taxes
C. Property Taxes
D. Wealth Taxes
E. Sales Taxes

26. A Progressive Tax Rate Means That The Ratio Of Tax Collections To Income
A. Falls As Income Rises
B. Rises As Income Rises
C. Remains The Same As Income Rises
D. Either (A) And (B)
E. May Fall, Rise, Or Remain The Same As Income Rises

27. In The Us, Major Sources Of Tax Revenues Are:
A. Income Taxes At The Federal Level, Property Taxes At The State Level
B. Sales Taxes At The Federal Level And Income Taxes And Property Taxes At The State Level
C. Income Taxes At The Federal Level And Income And Sales Taxes At The State Level
D. Income Taxes At The Federal Level And Payroll Taxes At The State Level

28. The Ability To Pay The Principle Of Taxation Suggests That People With More Income Should Pay More Taxes. This Means That
A. Progressive Income Rates Are Consistent With The Ability To Pay Principle
B. Proportional Income Rates Are Consistent With The Ability To Pay Principle
C. Regressive Income Rates May Or May Not Be Consistent With The Ability To Pay Principle Depending On The Rate Of Regression
D. Sales Taxes Are Consistent With The Ability To Pay Principle
E. None Of The Above

Questions 29 – 33 Refer To The Graph Below.

29. The Demand Curve For This Product Can Be Described As
A. Perfectly Elastic
B. Perfectly Inelastic
C. Unitary Elastic
D. Hyper Elastic
E. Price Elastic

30. Given Demand Curve D, If An Output Tax Per Unit Of P- P2 Is Levied On This Good, How Much Of The Tax Will Be Shifted Forward?
A. None
B. One-Fourth
C. Half
D. All
E. It Can Not Be Determined

31. Which Of The Following Shifts Represents The Effect Of An Output Tax Levied On This Good?
A. D To D1
B. D1 To D
C. S To S1
D. S1 To S
E. None Of The Above

32. Which Of The Following Shifts Represents The Effect Of A Tax On This Good Levied Independent Of Output?
A. D To D1
B. D1 To D
C. S To S1
D. S1 To S
E. None Of The Above

33. Given Demand Curve D, If A Tax Independent Of Output Is Levied On This Good, How Much Of The Tax Will Be Shifted Forward?
A. None
B. One-Fourth
C. Half
D. All
E. Cannot Be Determined

Questions 34 – 38 Refer To The Graph Below.

34. The Demand Curve For This Product Can Be Described As
A. Perfectly Elastic
B. Perfectly Inelastic
C. Unitary Elastic
D. Hyper Elastic
E. Price Elastic

35. Given Demand Curve D, If An Output Tax Per Unit Of P- P1 Is Levied On This Good, How Much Of The Tax Will Be Shifted Forward?
A. None
B. One-Fourth
C. Half
D. All
E. Cannot Be Determined

36. Which Of The Following Shifts Represents The Effect Of An Output Tax Levied On This Good?
A. D To D1
B. D1 To D
C. S To S1
D. S1 To S
E. None Of The Above

37. Which Of The Following Shifts Represents The Effect Of A Tax On This Good Levied Independent Of Output?
A. D To D1
B. D1 To D
C. S To S1
D. S1 To S
E. None Of The Above

38. Given Demand Curve D, If A Tax Independent Of Output Is Levied On This Good, How Much Of The Tax Will Be Shifted Forward?
A. None
B. One-Fourth
C. Half
D. All
E. Cannot Be Determined

39. An Output Tax Will Be Shifted Completely
A. Backward If Demand Is Price Inelastic
B. Forward If Demand Is Perfectly Price Inelastic
C. Forward If Demand Is Price Elastic
D. Backward, Regardless Of Elasticity
E. All Of The Above

40. A Tax Levied Independent Of Output, Such As A Tax Levied On Net Income Of Corporations, Will
A. Be Shifted If Demand Is More Elastic Than Supply
B. Be Shifted If Supply Is More Elastic Than Demand
C. Not Be Shifted In The Short Run If The Most Profitable Output Has Been Selected Before The Tax
D. Be Shifted In The Short Run If The Most Profitable Output Has Been Selected Before The Tax
E. Do None Of The Above

41. Government Borrowing Is Argued To Have The Effect Of Raising Interest Rates—The “Crowding-Out Effect.” In Conjunction With Government Spending, Does Government Spending And Borrowing Have A Positive Or Negative Impact On The Economy?
A. Negative, Since Borrowing Exceeds Spending
B. A Positive Impact, Since Expenditures Often Exceed Borrowing
C. A Neutral Effect, Since The Budget Is Always In Balance
D. Government Spending And Borrowing Have A Minimal Effect On The Economy
E. Government Spending And Borrowing Must Be Considered Separately

42. The Gasoline Tax Is Often Used To Illustrate The Benefits Received Principle Of Taxation Because
A. Everyone Benefits From The Gasoline Tax
B. Those Who Pay The Tax Receive Benefits, Since The Revenues Are Used For Road And Highway Construction And Maintenance
C. The Amount We Pay Is Consistent With Our Incomes
D. Everyone Knows When They Pay The Tax
E. The Gasoline Tax Is A Poor Example Of The Benefits Received Principle

43. Vertical Equity Implies That
A. People In Different States Should Pay The Same Taxes
B. People With Comparable Incomes Should Pay The Same Taxes
C. People In Different Economic Circumstances Should Pay Different Amounts
D. Taxes Should Rise As The Size Of Your Family Increases
E. Taxes Should Be Based Upon How Tall The Taxpayer Is

44. Proportional Tax Rates Mean That The Ratio Of Tax Collection To Income
A. Falls As Income Rises
B. Rises, As Income Rises
C. Remains The Same As Income Rises
D. Rises As Income Falls
E. Falls As Income Falls

45. Regressive Tax Rates Mean That The Ratio Of Tax Collections To Income
A. Falls As Income Rises
B. Rises As Income Rises
C. Remains The Same As Income Rises
D. Remains The Same As Income Falls
E. Falls As Income Falls

46. The Us Federal Personal Income Tax Is An Example Of A(N)
A. Regressive Tax Rate Structure
B. Proportional Tax Rate Structure
C. Progressive Tax Rate Structure
D. More Regressive Than Proportional Tax Rate Structure
E. Equitable Tax Rate Structure

47. If Demand For A Product Is Perfectly Inelastic, An Output Tax Will Be Shifted
A. Completely Backward
B. Completely Forward
C. Completely To The Poor
D. Completely To The Rich
E. Completely To The Producer

48. A Tax That Is Shifted Forward Is A Tax That Falls On
A. The Consumer In The Form Of Higher Prices
B. The Producer Through Lower Sales
C. The Government
D. Foreign Investors
E. None Of The Above

49. A Tax That Is Shifted Backward Is A Tax That Falls On
A. The Consumer In The Form Of Higher Prices
B. The Owners Of Resources In The Form Of Lower Resource Prices
C. The Government
D. Foreign Investors
E. None Of The Above

50. At The Federal Level, The Largest Revenue Generating Tax Is The
A. Corporate Income Tax
B. Personal Income Tax
C. Property Tax
D. Sales Tax
E. Customs Duty

51. If The Ratio Of Tax Collections To Income Rises As Income Rises, Then The Tax Rate Is
A. Regressive
B. Proportional
C. Progressive
D. Regressive Then Proportional
E. None Of The Above

52. The Federal Government Lowered Tax Rates In
A. 1986 And 2001
B. 1986
C. 2001
D. Neither Year
E. 1909 And Has Raised Them Ever Since

53. Suppose There Are Two Individuals Who Each Earn $25,000 Per Year. One Individual Pays $2,500 In Taxes And The Other Pays $2,000. This Is A Violation Of
A. The Benefits Received Principle
B. The Ability To Pay Principle
C. Vertical Equity
D. Horizontal Equity
E. None Of The Above

54. Suppose One Individual Earns $25,000 Per Year And Another Individual Earns $15,000 Per Year. If The Individual Earning $25,000 Per Year Pays $750 More Per Year In Taxes Than The Person Earning $15,000, This Is An Illustration Of
A. The Benefits Received Principle
B. The Ability To Pay Principle
C. The Equal Tax Treatment Principle
D. The Equitable Payment Doctrine
E. None Of The Above

55. If We Levy A Tax On Profits That Is Neither Shifted Neither Forward Nor Backward, It Is
A. An Output Tax
B. An Input Tax
C. A Tax Independent Of Output
D. A Tax Dependent On Output
E. None Of The Above

56. The Federal Tax System In The United States Can Be Described As
A. Regressive
B. Highly Progressive
C. Slightly Progressive
D. Proportional
E. None Of The Above

57. A Tax System That Will Not Alter The Distribution Of Income Is
A. Proportional
B. Regressive
C. Slightly Progressive
D. Very Progressive
E. None Of The Above
58. Which Of The Following Countries Has The Lowest Taxes Collected (As A Percent Of Gdp)?
A. The United States
B. Germany
C. Italy
D. France
E. The United Kingdom

59. The Highest Effective Federal Tax Rate In The United States Is Approximately
A. 10%
B. 15%
C. 20%
D. 24%
E. 34%
60. The Highest Effective Federal Tax Rate In The United States Falls On Which Income Category?
A. The Lowest Quintile
B. The Middle Quintile
C. The Top 10%
D. The Top 5%
E. The Top 1%

61. The Single Most Important Source Of Tax Revenue For The Local Governments In The United States Is The
A. Real Property Tax
B. Personal Income Tax
C. National Sales Tax
D. Cigarette Tax
E. Inheritance Tax

62. Enforcement And Collection Of Personal Income Taxes Is The Responsibility Of The
A. Treasury Department
B. Individual State Governments
C. Federal Reserve System
D. Internal Revenue Service
E. Department Of Labor

63. The Federal Government Uses Taxes To
A. Generate Revenue
B. Encourage Saving For Education And Retirement
C. Discourage Certain Behaviors
D. Promote The Purchase Of Houses
E. Do All Of The Above

64. The 1986 Tax Reform Act ________ The Number Of Tax Brackets And _______ The Highest Tax Bracket.
A. Increased; Increased
B. Increased; Decreased
C. Decreased; Increased
D. Decreased; Decreased
E. Decreased; Did Not Change

65. Since 2004, The Highest Personal Income Tax Bracket Has Been
A. 10%
B. 15%
C. 25%
D. 28%
E. 35%

66. The Economic Growth And Taxpayer Relief Reconciliation Act Passed By Congress And Signed By President George W. Bush Did Which Of The Following?
A. Immediately Cut Federal Tax Rates By One-Third
B. Gave A $300 Check To Each Taxpayer
C. Decreased The Tax On Income From Financial Investments
D. Decreased The Federal Budget Deficit
E. Increased The Number Of Personal Income Tax Brackets

67. The First Budget Surplus Since 1969 Occurred In
A. 1993
B. 1995
C. 1998
D. 1999
E. 2000

68. The Budget Surpluses Of The Late 1990’s And The Early 2000’s Could Be Attributed To Which Of The Following Government Policies?
A. The Value Added Tax Act
B. The Tax Reform Act Of 1986
C. The Economic Growth And Taxpayer Relief Reconciliation Act
D. Increased Government Debt
E. All Of The Above

69. If A Government Bond With A Maturity Value Of $10,000 Sells For $9,000 And Pays Annual Interest Of $1,000, What Is The Rate Of Interest On The Bond?
A. 1%
B. 10%
C. 11.1%
D. 88.9%
E. 90%

70. An Increase In Government Borrowing Will Cause Which Of The Following?
A. A Decrease In The Demand For Loanable Funds
B. A Decrease In The Supply Of Bonds
C. An Increase In The Interest Rate
D. An Increase In The Price Of Bonds
E. All Of The Above

71. Federal Debt Reduction Will Cause Which Of The Following?
A. A Decrease In The Interest Rate
B. An Increase In Private Investment
C. A Decrease In The Supply Of Bonds
D. An Increase In The Price Of Bonds
E. All Of The Above

72. The Federal Government Ended Its Most Recent Period Of Budget Surpluses And Returned To Deficits In
A. 1999
B. 2000
C. 2001
D. 2002
E. 2003

73. The Federal Deficit Was Increased In 2002 As A Result Of
A. The 2001 Recession
B. The War On Terrorism
C. The 2001 Tax Cut
D. Increased Defense Spending
E. All Of The Above

74. Retiring The Federal Debt Will
A. Decrease The Supply Of Government Bonds
B. Increase Government Bond Prices
C. Lower The Interest Rate On Government Bonds
D. Decrease The Demand For Money
E. Do All Of The Above

True / False Questions

75. The Fears That People Have Concerning Government Are Related To The Size Of Government And The Distribution Of Taxes.

76. Some Of The Fears That People Have Concerning Government Are Well-Founded And Some Are Not.

77. Government Expenditures Have Grown Faster Than The Gdp Since 1958, Representing About Fifty Percent Of Gdp Today.

78. Government Transfer Payments, Such As Public Assistance Payments And Social Security Payments, Have Been A Constant Percentage Of The Gdp Since 1960.

79. Government Purchases Of Goods And Services Have Remained A Constant Percentage Of The Gdp For The Last Two Decades.

80. Before An Intelligent Decision Can Be Made About Whether Government Is Too Large Or Small, The Benefits And Costs Must Be Weighed.

81. An Efficient Level Of Government Expenditures Is That Level Where Net Benefits To Society Are Maximized.

82. Public Goods And Services Can Be Supplied In The Market Because They Are Easily Divisible Into Small Units And Can Be Priced To The Individual Demander.

83. The Existence Of Externalities In Production Or Consumption Does Not Negate The Possibility That These Goods And Services Can Be Supplied Efficiently In The Market.

84. A Great Deal Of Government Activity Is Based On The Idea That People In Society Should Determine The Extent To Which The Distribution Of Income Should Be Altered.

85. The Major Tax Source Of The Federal Government Is The Highly Regressive Sales Tax.

86. The Federal Income Tax System Results In A Mildly Progressive Tax Structure.

87. The Major Tax Source Of State Governments Is The Property Tax.

88. Progressive Income Tax Rates Are Consistent With The Ability To Pay Principle Of Taxation But Are Inconsistent With The Tax Criterion Of Economic Efficiency.

89. The Relative Tax Treatment Doctrine Would Call For All Taxpayers To Pay Equal Taxes.

90. Since Gasoline Taxes Are Used Primarily To Finance Highways, Gasoline Taxes Can Be Defended On The Benefits Received Principle Of Taxation.

91. The Excess Tax Burden Is In The Form Of The Loss In Private Production That May Take Place If Incentives To Work And To Produce Are Discouraged.

92. A Tax Levied On Each Unit Produced Will Likely Be Shifted Forward And Backward Depending Upon The Elasticities Of Demand And Supply.

93. If An Output Tax Is Levied On A Product That Has A Perfectly Elastic Demand, The Tax Will Be Shifted Completely To The Consumer In The Form Of Higher Prices.

94. Federal Budget Deficits Occurred Throughout The 1970’s And 1980’s But In The Late 1990’s Deficits Turned Into Budget Surpluses.

95. The Tax Reform Act Of 1986 Increased The Highest Marginal Tax Rate To 50% From 38%.

96. In General, A Tax Levied On Net Income Of A Corporation Would Be Shifted To Consumers In The Short Run.

97. Tax Equity Would Probably Be Reduced If Federal Tax Exclusions, Such As Interest On State And Local Government Securities, Were Eliminated.

98. Demand For Public Goods And Services Is Not Generally Divisible On The Basis Of Individual Quantity Demanded.

99. The Tax Base Is What A Tax Is Levied On, Such As Income, Sales, Or The Value Of Property.

100. Regressive Tax Rates Mean That The Ratio Of Tax Collection To Income Rises As Income Rises.

101. Tax Equity Means That All People Should Pay Equal Taxes.

102. An Output Tax Will Be Shifted Completely Forward If Demand Is Price Elastic.

103. According To The Equimarginal Principle, The Efficient Level Of Government Expenditures Occurs When The Benefit Of The Last Dollar Spent For Each Purchase Is Greater Than The Last Dollar Of Cost.

104. When Marginal Benefits Equal Marginal Costs Then Net Benefits Are Maximized.

105. Horizontal Equity Means That People In Identical Economic Positions Should Pay Equal Taxes.

106. Transfer Payments Are Government Expenditures For Currently Produced Goods And Services.

107. In The Absence Of Externalities, Government Actions Are Needed To Ensure The Efficiency Of The Market System.

108. According To The Equal Tax Treatment Doctrine, People In Identical Economic Circumstances Should Pay Equal Taxes.

109. The Equal Tax Treatment Doctrine Pertains To Vertical Equity.

110. The Federal Tax System Is Much More Progressive Than Is Generally Believed.

111. The Economic Growth And Taxpayer Relief Reconciliation Act, The Job Creation And Worker Assistance Act, And The Jobs And Growth Tax Relief Act Each Reduced Effective Tax Rates On Income.

112. The United States Has Not Had A Federal Budget Surplus Since The 1960s.

113. The Personal Income Tax Is The Single Most Important Source Of Tax Revenue For The Federal Government Of The United States.

114. The Enforcement And Collection Of The Personal Income Tax Is The Responsibility Of The Internal Revenue Service.

115. There Are Currently 14 Tax Brackets Ranging From 11% To 50%.

116. The Federal Government Uses The Tax Code To Encourage Certain Behaviors.

117. Bond Prices And Interest Rates Are Inversely Related.

118. The First Budget Surplus Since 1969 Occurred In 1998.

119. A Budget Deficit Occurs When Tax Revenues Exceed Government Spending.

120. A Lower Interest Rate Encourages Private Investment Spending.

121. The National Debt Is The Sum Of Past Budget Deficits.

122. The Government Owes Almost One Third Of The National Debt To Itself.

123. An Increase In Government Borrowing Increases The Demand For Loanable Funds.

124. An Increase In Government Borrowing Increases The Supply Of Loanable Funds.

125. The Federal Budget Has Been In Deficit Each Year Since The Beginning Of The 1970s.

Chapter 15

Social Security And Medicare: How Secure Is Our Safety Net For The Elderly?

Multiple Choice Questions

1. Government Programs That Guarantee Citizens Financial Benefits For Events Beyond Their Personal Control And That Are Financed Through Tax Revenues Are Called
A. Social Insurance Programs
B. Entitlement Programs
C. Private Insurance Programs
D. Welfare Programs
E. Transfer Programs

2. The Largest Social Insurance Program In The United States Is
A. Temporary Assistance For Needy Families
B. Social Security
C. Medicaid
D. Federal Flood Insurance
E. Job Corps

3. The Most Significant Factor That Threatens The Financial Stability Of The Social Security System Is The
A. Increasing Number Of Young Workers
B. Relatively High Rates Of Social Security Taxes
C. Population Bulge Created By The “Baby Boom” Generation
D. Generosity Of Current Social Security Benefits
E. Threat Of Foreign Workers Entering The U.S. Due To Nafta

4. Which Of The Following Nations Was The First To Offer Its Citizens A Modern Social Insurance Program?
A. United States
B. Great Britain
C. Russia
D. Germany
E. Japan

5. In The United States, Social Security Was Established In When President Signed The Social Security Act Into Law.
A. 1903; Theodore Roosevelt
B. 1929; Herbert Hoover
C. 1965; Lyndon Johnson
D. 1865; Abraham Lincoln
E. 1935; Franklin Roosevelt

6. Which Of The Following Statements Is Concerning The Scope Of The Social Security Program?
A. Social Security Has Narrowed Its Scope Over Time To Focus On The Economic Stability Of The Individual
B. The Scope Of Social Security Has Remained Constant Throughout Its History
C. Social Security Has Broadened Its Scope Over Time To Focus On The Economic Stability Of The Family
D. The Scope Of Social Security Has Always Focused On The Family Unit
E. None Of The Above

7. How Many Americans Receive A Monthly Check From The Social Security Administration?
A. Fewer Than 10 Million
B. More Than 50 Million
C. About 27 Million
D. Roughly 38 Million
E. More Than 100 Million

8. As Originally Designed, Social Security Was To Be Financed As A
A. Private Insurance Program
B. Pure Income Transfer Program
C. Pay-As-You-Go Insurance Program
D. Fully-Funded Insurance Program
E. Means-Tested Benefits Program

9. How Are Social Security Tax Revenues Allocated Today?
A. They Are Used To Pay Today’s Social Security Beneficiaries, And Any Extra Is Placed Into The Social Security Trust Fund
B. All Of Today’s Revenues Are Placed In The Social Security Trust Fund To Pay For Tomorrow’s Beneficiaries
C. Tax Revenues Are Placed Into Accounts For Each Worker Who Will Draw Upon The Balance When They Retire
D. The Revenues Are Invested In Government Securities And In The Stock Market
E. No One Really Knows

10. Current Projections Estimate That The Social Security Trust Fund Will Be Completely Depleted
A. In Late 2003
B. During 2010-2020
C. In About 100 Years
D. Around 2100
E. Before 2040

11. Given The Way Social Security Is Financed, Which Of The Following Is ?
A. Social Security Results In A Transfer Of Income From The Old To The Young
B. Social Security Results In A Transfer Of Income From The Young To The Old
C. Social Security Has A Neutral Effect On The Nation’s Income Distribution
D. The Purchasing Power Of The Elderly Has Been Diminished By Social Security Taxes
E. (A) And (D)

12. Social Security Taxes Are
A. Paid Only By Workers
B. Levied On Salaries And Wages
C. Paid Only By Employers
D. Paid By Both Workers And Employers
E. (B) And (D)

13. Currently, The Total Combined Tax Rate Collected By Social Security Is
A. 21.6% Of Earnings
B. 15.3% Of Earnings
C. 7.65% Of Earnings
D. 6.20% Of Earnings
E. 1.45% Of Earnings

14. Which Of The Following Is Concerning Social Security’s Retirement Benefit Structure?
A. All Eligible Retired Workers Are Entitled To The Same Benefits
B. High Wage Workers Receive A Greater Percentage Of Past Earnings In Benefits Than Low Wage Workers
C. Retired Female Workers Are Entitled To Higher Benefits Than Retired Male Workers
D. Low Wage Workers Receive A Greater Percentage Of Past Earnings In Benefits Than Do High Wage Workers
E. Retired Workers Living In Cities Receive Larger Benefits Than Those Living In Rural Areas

15. Most Of Today’s College Student Population Will Be Eligible To Receive Full Social Security Retirement Benefits When They Reach The Age Of
A. 62
B. 65
C. 67
D. 70
E. 72

16. The Cost Of Living Adjustment (Cola) Employed By Social Security Is Based On The
A. Current Level Of Gdp
B. Local Rate Of Inflation
C. Consumer Price Index
D. Producer Price Index
E. Annual Poverty Threshold

17. How Many Elderly Households Receive Social Security Benefits?
A. More Than 90%
B. Less Than 50%
C. About 75%
D. Only About 15%
E. None Of The Above

18. Which Of The Following Statements Is ?
A. 20% Of Elderly Households Receive Social Security As Their Only Source Of Income
B. Approximately 90% Of Elderly Households Receive Social Security Benefits
C. Just Under 30% Of Elderly Households Receive Private Pension Benefits
D. For Nearly Two Thirds Of Elderly Households, Social Security Represents More Than 50% Of Total Income
E. None Of The Above. All Are

19. If People Choose To Work Fewer Hours Because The Social Security Tax Reduces Their Real Wage, Their Behavior Is Dominated By The
A. Substitution Effect
B. Bequest Effect
C. Income Effect
D. Wealth Effect
E. Real Wage Effect

20. If People Choose To Work More Hours Because The Social Security Tax Reduces Their Real Wage, Their Behavior Is Dominated By The
A. Substitution Effect
B. Bequest Effect
C. Income Effect
D. Wealth Effect
E. Real Wage Effect

21. Empirical Evidence Suggests That Social Security Has _______ The Overall Supply Of Labor.
A. Had No Effect On
B. Reduced
C. Increased
D. Stimulated
E. Done None Of The Above To

22. Social Security May Increase The Level Of Personal Saving Due To
A. The Retirement Effect
B. The Bequest Effect
C. The Wealth Substitution Effect
D. (A) And (B)
E. (B) And (C)

23. Empirical Studies Indicate That Social Security Has
A. Increased The Level Of Personal Savings
B. Had A Neutral Effect On The Level Of Personal Savings
C. Reduced The Level Of Personal Savings
D. Increased The Number Of Older Workers
E. Raised The Average Age At Which Workers Choose To Retire

24. The Effect Of Social Security On Personal Savings Is Important Because
A. The Level Of Savings Determines The Pool Of Investment Funds
B. Savings Are Necessary To Finance The Social Security Trust Fund
C. Personal Savings Are Negatively Related To Economic Growth
D. Savings Are A Major Source Of Income For All Elderly Households
E. The Level Of Savings Reflects The Magnitude Of Future Consumption

25. Why Can’t Social Security Rely On A Strict Pay-As-You-Go Financial Structure?
A. The Current Generation Of Workers Is Too Small To Support Future Retirees
B. A Pay-As-You-Go Financial Structure Is Inherently Unstable
C. The Current Generation Of Retirees Will Bankrupt The System Before The “Baby Boom” Retires
D. Inflation Erodes The Value Of Contributions That Must Be Saved To Pay Future Retirees
E. None Of The Above

26. The Most Simple And Direct Way To Postpone The Looming Social Security Financial Crisis Is To
A. Invest Social Security Taxes In The Stock Market
B. Raise Social Security Taxes And/Or Lower Benefits
C. Privatize The Social Security Administration
D. Eliminate The Social Security System And Force Everyone To Buy Private Insurance
E. Subsidize Social Security With General Tax Revenues

27. The Most Significant Argument Against Privatizing Social Security Is That
A. Benefits Would Have To Be Cut
B. It Has Not Worked In Other Countries
C. Future Benefits Levels Cannot Be Guaranteed
D. It Is Too Complicated To Be Practical
E. Taxes Would Have To Be Raised

28. Why Do Some People Favor Investing The Social Security Trust Fund In The Stock Market?
A. Because For Most Beneficiaries The Historic Return On Their Social Security Taxes Has Been Less Than What Would Have Been Earned If Those Dollars Were Invested In The Stock Market
B. Because Investment In The Stock Market Will Guarantee Higher Rates Of Return Over The Long Run For All Retirees
C. Because Investments In The Stock Market Carry Very Little Risk And Offer The Potential For Excessive Short-Run Gains With Little Or No Potential For Loss
D. Because The Stock Market Offers The Safest Form Of Investment
E. All Of The Above

Questions 29 – 33 Refer To The Graph Below.

29. The Results Of The Retirement Effect Are Illustrated On The Graph As A Movement From Point
A. E To F
B. A To C
C. E To G
D. F To E
E. None Of The Above

30. The Results Of The Bequest Effect Are Illustrated On The Graph As A Movement From Point
A. E To F
B. A To C
C. E To G
D. F To E
E. None Of The Above

31. The Results Of The Wealth Substitution Effect Are Illustrated On The Graph As A Movement From Point
A. E To F
B. A To C
C. E To G
D. F To E
E. None Of The Above

32. A Change In Consumption From Ce To Cf Could Be Caused By Which Of The Following?
A. The Bequest Effect
B. The Retirement Effect
C. The Wealth Substitution Effect
D. All Of The Above
E. None Of The Above

33. A Movement From Point E To Point F As A Result Of Social Security Would Result In Which Of The Following Costs To Society? A Long-Run Movement To
A. Ppc Cd Rather Than Gh
B. Ppc Gh Rather Than Cd
C. Point B Rather Than Point A
D. Point A Rather Than Point B
E. If To Cf

34. If I Start Saving More During My Working Life Because I Anticipate Retiring Earlier Thanks To Social Security, I Am Exhibiting Which Of The Following Effects?
A. Retirement
B. Bequest
C. Wealth Substitution
D. Opportunity Cost
E. None Of The Above

35. If I Spend More Each Year Because I Know That I Will Receive Social Security Payments When I Retire, I Am Exhibiting Which Of The Following Effects?
A. Retirement
B. Bequest
C. Wealth Substitution
D. Opportunity Cost
E. None Of The Above

36. If I Put Extra Into A Savings Account So That I Can Leave Assets To My Children To Compensate Them For Their Payments Into The Social Security System, I Am Exhibiting Which Of The Following Effects?
A. Retirement
B. Bequest
C. Wealth Substitution
D. Opportunity Cost
E. None Of The Above

37. If Inflation Increases, What Will Happen To The Social Security Cola? It Will
A. Expire
B. Increase
C. Decrease
D. Be Divided Among Social Security Recipients
E. Be Added To The Social Security Trust Fund

38. “An Agreement To Pay A Premium To A Company In Return For A Guarantee Of Financial Benefits In The Event Of An Undesired Circumstance” Defines
A. Social Insurance
B. Private Insurance
C. Private Investment
D. Asset Management
E. Retirement Savings

39. Social Insurance Uses Tax Revenues To Guarantee Citizens Financial Benefits For Events Including
A. Old Age
B. Disability
C. Poor Health
D. Death Of A Spouse
E. All Of The Above

40. If A Program’s Benefits Are Funded By Interest Earned On Accumulated Payments, It Is Which Type Of System?
A. An Investment System
B. A Fully Funded Scheme
C. An Interest Scheme
D. A Pay-As-You-Go System
E. An Endowed System

41. If A Program’s Benefits Are Funded Out Of Current Payments, It Is Which Type Of System?
A. An Investment System
B. A Fully Funded Scheme
C. A Pyramid Scheme
D. A Pay-As-You-Go System
E. An Endowed System

42. When Was The Medicare Program Established?
A. 1935
B. 1945
C. 1955
D. 1965
E. 1975

43. Today, The Health Care Sector Of The U.S. Economy Accounts For About Percent Of National Income.
A. 3
B. 5
C. 8
D. 12
E. 18

44. A Person With Health Insurance Will Tend To
A. Have A Lower Demand For Health Care Services
B. Have A Much Greater Concern For Preventive Care
C. Buy A Lower Quantity Of Health Care At A Higher Price
D. Demand More Health Care Services Than A Person Without Insurance
E. Do None Of The Above

45. The Payment And Delivery Of Health Care Service Under A Managed Care System Is Based On
A. A Fee-For-Service Market Principle
B. A Prearranged Schedule Of Fixed Prices
C. The Ability To Pay Principle
D. Price Negotiation Between The Consumer And Provider
E. None Of The Above

46. The Medicare Program
A. Was Established As A Socialistic Takeover Of Health Care Providers
B. Has Reduced The Demand For Health Care Services
C. Affects Persons 65 And Older, Regardless Of Income
D. Enrolls All Poor People Regardless Of Age
E. Does None Of The Above

47. Part C Of The Medicare Program (Medicare + Choice)
A. Provides Health Care Plan Choices To The Beneficiaries Of Medicare
B. Restricts Medicare Beneficiaries To A Simple Fee-For-Service Health Care Plan
C. Provides Comprehensive Health Insurance Coverage For All Poor People
D. Is Only Available To Disabled Retirees Receiving Social Security
E. Does None Of The Above

48. A Potential Benefit Of Managed Care Plans To Medicare Enrollees Is That These Plans
A. Typically Require Less Cost Sharing
B. Provide A Higher Quality Of Health Care
C. Provide A Greater Quantity Of Health Care
D. Require Less Paper Work
E. Do All Of The Above

49. Part A Of The Medicare Program (Hospital Insurance) Is Financed Primarily By
A. A Monthly Premium
B. A 2.9% Tax Levied On Wages And Salaries
C. An Allocation From General Tax Revenues
D. User Fees Paid By Patients
E. Insurance Deductibles

50. What Percent Of The Average Health Care Dollar Spent In The United States Comes Directly From The Consumer?
A. 100
B. 83
C. 50
D. 34
E. 12

51. Which Of The Following Factors Has Contributed Most To The Tremendous Increase In Health Care Expenditures Experience In The U.S. During The Past Fifty Years?
A. Health Care Inflation
B. The Aging Of The Population
C. Increased Public Support For Health Care
D. Private Health Insurance
E. Growth In Medicaid

52. Which Of The Following Receives The Largest Share Of Expenditures Made On Health Care In The United States?
A. Physicians
B. Nursing Homes
C. Hospitals
D. Personal Health Care Product And Service Providers
E. Pharmacies

53. In A Fee-For-Service Health Care System, Consumers Pay The
A. Insurance Company A Fee Every Time They Use A Service
B. Full Cost Of The Services They Receive
C. Hmo When They Receive Care
D. Doctor A Small Payment Called A “Co-Pay.”
E. Prearranged, Fixed Fee For Services They Receive

54. How Are Payments To Health Care Providers Determined Under A Managed Care System? By The
A. Government
B. Market
C. Insurance Company And The Provider
D. Provider And The Consumer
E. Ama (American Medical Association)

55. Which Of The Following Is An Example Of A Managed Health Plan?
A. Hmo
B. Ppo
C. Pos
D. Physicians Network
E. All Of The Above

Questions 56 – 59 Refer To The Graph Below.

56. With A Market Allocation Of Medical Services, Equilibrium Quantity Will Be
A. 0
B. 50
C. 2,000
D. 2,800
E. 4,000

57. If Medical Care Is Provided Free Of Charge, What Quantity Will Be Demanded?
A. 0
B. 2,000
C. 2,800
D. 4,000
E. An Infinite Amount

58. If Medical Care Is Provided Free Of Charge, What Quantity Will Be Supplied?
A. 0
B. 50
C. 2,000
D. 2,800
E. 4,000

59. The Supply Of Medical Services In This Market Is
A. Elastic
B. Inelastic
C. Unit Elastic
D. Price Elastic
E. Infinite

60. Under Most Insurance Systems, Patients Are Responsible For Which Of The Following Payments For Health Care Services?
A. Deductible
B. Co-Insurance
C. Fee-For-Service Charges
D. All Of The Above
E. None Of The Above

61. A Patient May Be Required To Pay A Percentage Of The Cost Of Their Health Care Above The Fixed Fee They Pay. This Is Known As
A. The Deductible
B. Co-Insurance
C. Fee-For-Service
D. The Health Care Tax
E. Medicare Tax

62. If Your Insurance Company Agrees To Pay A Fixed Fee For You To Receive A Given Treatment (For Example, $5,000 For An Appendectomy), The Company Is Using Which Of The Following?
A. A Fee-For-Service System
B. A Managed Care System
C. A Co-Insurance System
D. A Prospective Payment System
E. A Social Insurance System

63. If Your Deductible Is $200 And You Pay Co-Insurance Of 20%, How Much Will You Have To Pay For A $3,000 Hospital Stay?
A. $200
B. $560
C. $600
D. $760
E. $800

64. If Your Deductible Is $400 And You Have Co-Insurance Of 25%, How Much Will You Have To Pay For A $5,000 Hospital Stay?
A. $400
B. $1,150
C. $1,250
D. $1,550
E. $1,650

Questions 65 – 69 Refer To The Graph Below.

65. If Patients Pay The Full Price For Office Visits, What Price Will Be Charged In The Market?
A. $0
B. $25
C. $50
D. $75
E. More Than $75

66. If Patients Pay The Full Price For Of Office Visits, How Many Office Visits Will They Make?
A. 0
B. 30
C. 50
D. 70
E. More Than 70

67. If A Third Party Guarantees A Maximum Patient Price Of $25, What Quantity Of Office Visits Will Patients Demand?
A. 0
B. 30
C. 50
D. 70
E. More Than 70

68. If A Third Party Guarantees A Maximum Patient Price Of $25, What Total Price Must Be Paid Per Office Visit To Assure The Quantity Of Office Visits Demanded Will Be Provided?
A. $0
B. $25
C. $50
D. $75
E. More Than $75

69. If A Third Party Guarantees A Maximum Patient Price Of $25, How Much Must The Third Party Pay Per Office Visit?
A. $0
B. $25
C. $50
D. $75
E. More Than $75

70. Health Insurance Results In
A. An Increase In The Quantity Of Health Care Demanded
B. An Increase In The Quantity Of Health Care Provided
C. An Increase In The Total Cost Of Providing Health Care
D. All Of The Above
E. None Of The Above

71. The Medicare Modernization Act, Passed In 2003, Established
A. The First Long Term Care Coverage For Medicare Recipients
B. Lowered Deductibles For Most Medicare Recipients
C. Added A Prescription Drug Benefit To The Medicare Program
D. Instituted Stringent Price Controls On The Fees Doctors And Hospitals Can Charge
E. Restricted The Benefits That High Income Medicare Recipients Can Receive

72. The Prescription Drug Benefit That Is Part Of The Medicare Modernization Act Of 2003 Requires That Recipients Pay:
A. A Monthly Premium
B. A Co-Pay
C. A Deductible
D. All Of The Above
E. None Of The Above, These Benefits Are Provided To Recipients At No Charge

True / False Questions

73. Social Insurance Is Private Insurance Purchased By The Government.

74. Programs That Provide Citizens With Benefits For Events That Are Beyond An Individual Person’s Control Are Called Social Insurance Programs.

75. Both Social Security And Medicare Are Social Insurance Programs.

76. The Major Underlying Factor That Endangers Social Security’s Financial Stability Is The Population Bulge Created By The “Baby Boom” Generation.

77. The United States Was The First Nation To Provide Social Insurance Programs For Its Citizens.

78. The Original Design Of The Social Security System Called For A Pay-As-You-Go Financing Scheme.

79. The Social Security Act Was Signed Into Law By President Franklin Roosevelt In 1935.

80. Over Time, Social Security Has Evolved To Focus More On The Family And Less On The Individual.

81. Currently, About 20 Million Americans Receive Social Security Benefits.

82. All American Citizens Are Entitled To Receive Social Security And Medicare Benefits When They Retire.

83. Today, Social Security Is Financed Under A Pay-As-You-Go Financial System.

84. All Current Social Security Taxes Collected By The Government Are Used To Pay Current Beneficiaries, With Nothing Left Over.

85. Social Security And Medicare Are Financed Through A Flat Tax On Wages Paid Up To A Predetermined Limit.

86. Workers And Their Employers Share The Burden Of Social Security Taxes.

87. The Social Security Trust Fund Currently Has A Negative Balance.

88. Social Security Benefits Are Adjusted Each Year For Inflation Using The Consumer Price Index (Cpi).

89. About 50% Of All Elderly Households Receive Some Form Of Social Security Benefits.

90. Today, In The Aggregate, Social Security Accounts For Over 35% Of Senior Citizens’ Income.

91. Without Social Security, Nearly 50 Percent Of Elderly Households Would Live Below The Poverty Threshold.

92. The Substitution Effect Of Social Security Taxes Causes Some People To Work More Hours.

93. The Income Effect Of Social Security Taxes Causes Some People To Work Less Hours.

94. Studies Show That Social Security Has Caused Some Workers To Retire Earlier Than They Would If Social Security Did Not Exist.

95. The Bequest Effect Of Social Security Causes Some People To Save Less During Their Lifetimes.

96. The Empirical Evidence Suggests That, Overall; Social Security Causes People To Increase Their Personal Savings.

97. Because Social Security Increases Savings, More Funds Are Available For Investment In The Overall Economy.

98. Current Estimates Indicate That The Social Security Trust Fund Will Be Depleted Before 2040.

99. A Modest Increase In Taxes Could Postpone Social Security’s Financial Crisis For Decades.

100. Privatization Of The Social Security System Would Reduce The Financial Risks Faced By Retiring Workers.

101. Chile And Other Nations Have Successfully Privatized All Or Part Of Their Social Insurance Programs.

102. Oasdi Is Social Security’s Medical Insurance Program.

103. The Most Important Factor Explaining The Growth In Personal Health Care Expenditures On Hospital And Physician Services Is Higher Prices For These Services.

104. Third-Party Payments Increase The Efficiency Of Medical Markets.

105. A Dominant Feature Of The U.S. Health Care Industry Is Price Competition Among Providers.

106. Medicare And Medicaid Have Reduced The Demand For Health Care Services.

107. The Purpose Of A Prearranged Payment And Delivery System, Such As A Managed Care Plan, Is To Take Away Any Incentive For The Provider To Supply Unnecessary Care.

108. The Demand For Health Services Is Characterized By Well-Informed Consumers.

109. The Medicare Program Affects Persons Aged 65 And Older, Regardless Of Their Income Level.

110. A Consumer With Health Insurance Is Likely To Buy More Health Services Than One Who Is Not Insured.

111. A Reduction In The Price Of Medical Services Will Cause The Demand Curve To Shift To The Right.

112. Health Care Providers Are Paid The Amount Of A Patient’s Deductible By The Health Insurance Company.

113. The Amount A Patient Must Pay Above The Deductible Is Known As Co-Insurance.

114. Projections Indicate That The Medicare Hi Program Will Be Depleted Of Funds By 2025.

115. More Than 70% Of All Privately Insured Employees Are Covered By Managed Care Plans.

116. The Medicare Program Could Be Secured By An Increase In The Payroll Tax That Supports The Program.

117. The Medicare Program Could Be Secured By Increasing Premiums, Deductibles And Co Payments.

118. Medicare’s Fee-For-Service Plan Provides Incentives For Supplying Excessive Services.

119. Managed Care Plans Provide Incentives For Supplying Excessive Services.

120. Third-Party Payments For Health Care Increase The Quantity Of Services Demanded.

121. Third-Party Payments For Health Care Decrease The Price Consumers Pay For Services.

122. The Fee-For-Service Delivery And Payment System Is The Primary Means By Which Most Elderly Americans Receive Their Health Care.

123. Third-Party Payments For Health Care Result In Less Usage Of The Health Care System.

124. Managed Care Leads To Higher Costs Of Providing Health Care Services.

125. Investments Of Social Security Tax Payments Result In High Returns On The Contributions Made By Taxpayers.

ECO 305 Week 11 Quiz – Strayer University New

ECO/305 Week 11 Quiz – Strayer

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Quiz 10 Chapter 16 and 17

MACROECONOMIC POLICY IN AN OPEN ECONOMY

MULTIPLE CHOICE

1. A nation experiences internal balance if it achieves:
a. Full employment
b. Price stability
c. Full employment and price stability
d. Unemployment and price instability

2. A nation experiences external balance if it achieves:
a. No net changes in its international gold stocks
b. Productivity levels equal to those of its trading partners
c. An increase in its money supply equal to increases overseas
d. Equilibrium in its balance of payments

3. A nation experiences overall balance if it achieves:
a. Balance-of-payments equilibrium, full employment, and price stability
b. Balance-of-payments equilibrium, maximum productivity, and price stability
c. Full employment, price stability and no change in its money supply
d. Full employment, price stability, and maximum productivity

4. Most industrial countries generally considered ____ as the most important economic goal.
a. External balance
b. Internal balance
c. Maximum efficiency for business
d. Maximum efficiency for labor

5. Which policies are expenditure-changing policies?
a. Currency devaluation and revaluation
b. Import quotas and tariffs
c. Monetary and fiscal policy
d. Wage and price controls

6. Which policy is an expenditure-switching policy?
a. Increase in the money supply
b. Decrease in government expenditures
c. Increase in business and household taxes
d. Decrease in import tariffs

7. An expenditure-increasing policy would consist of an increase in:
a. Import tariffs
b. Import quotas
c. Governmental taxes
d. The money supply

8. An expenditure-reducing policy would consist of a decrease in:
a. The par value of a currency
b. Government expenditures
c. Import duties
d. Business or household taxes

9. Given fixed exchange rates, assume Mexico initiates expansionary monetary and fiscal policies to combat recession. These policies will also:
a. Increase both imports and exports
b. Increase exports and reduce imports
c. Reduce a balance-of-payments surplus
d. Reduce a balance-of-payments deficit

10. Given fixed exchange rates, assume Mexico initiates contractionary monetary and fiscal policies to combat inflation. These policies will also:
a. Reduce a balance-of-payments surplus
b. Reduce a balance-of-payments deficit
c. Increases both imports and exports
d. Decrease both imports and exports

11. The appropriate expenditure-switching policy to correct a current account surplus is:
a. Currency revaluation
b. Currency devaluation
c. Expansionary monetary policy
d. Contractionary fiscal policy

12. The appropriate expenditure-switching policy to correct a current account deficit is:
a. Contractionary monetary policy
b. Expansionary fiscal policy
c. Currency devaluation
d. Currency revaluation

13. Suppose the United States faces domestic recession and a current account deficit. Should the United States devalue the dollar, one would expect the:
a. Recession to become less severe–deficit to become less severe
b. Recession to become more severe–deficit to become less severe
c. Recession to become less severe–deficit to become more severe
d. Recession to become more severe–deficit to become more severe

14. Suppose the United States faces domestic inflation and a current account surplus. Should the United States revalue the dollar, one would expect the:
a. Inflation to become more severe–surplus to become less severe
b. Inflation to become less severe–surplus to become less severe
c. Inflation to become less severe–surplus to become more severe
d. Inflation to become more severe–surplus to become more severe

15. Suppose Brazil faces domestic recession and a current account surplus. Should Brazil revalue its currency, one would expect the:
a. Recession to become less severe–surplus to become less severe
b. Recession to become more severe–surplus to become more severe
c. Recession to become more severe–surplus to become less severe
d. Recession to become less severe–surplus to become more severe

16. Suppose that Brazil faces domestic inflation and a current account deficit. Should Brazil devalue its currency, one would expect the:
a. Inflation to become more severe–deficit to become less severe
b. Inflation to become more severe–deficit to become more severe
c. Inflation to become less severe–deficit to become less severe
d. Inflation to become less severe–deficit to become more severe

17. In a closed economy, which of the following will cause the economy’s aggregate demand curve to shift to the right?
a. decreases and wages and salaries paid to employees
b. increases in the prices of oil and natural gas
c. decreases in income taxes for households
d. decreases in the productivity of labor

18. Given an open economy with high capital mobility and floating exchange rates, suppose an expansionary monetary policy is implemented to combat recession. The initial and secondary effects of the policy
a. cause aggregate demand to increase, thus strengthening the policy’s expansionary effect on real output
b. cause aggregate demand to decrease, thus eliminating the policy’s expansionary effect on real output
c. have conflicting effects on aggregate demand, thus weakening the policy’s expansionary effect on real output
d. have conflicting effects on aggregate demand, thus strengthening the policy’s expansionary effect on real output

19. A problem that economic policy makers confront when attempting to promote both internal and external balance for the nation is that monetary or fiscal policies aimed at the domestic sector also have impacts on:
a. Trade flows only
b. Capital flows only
c. both trade flows and capital flows
d. Neither trade flows nor capital flows

20. Given an open economy with high capital mobility and floating exchange rates, suppose an expansionary fiscal policy is implemented to combat recession. The initial and secondary effects of the policy
a. cause aggregate demand to increase, thus strengthening the policy’s expansionary effect on real output
b. cause aggregate demand to decrease, thus eliminating the policy’s expansionary effect on real output
c. have conflicting effects on aggregate demand, thus weakening the policy’s expansionary effect on real output
d. have conflicting effects on aggregate demand, thus strengthening the policy’s expansionary effect on real output

21. A system of fixed exchange rates and high capital mobility strengthens which policy in combating a recession:
a. Expansionary fiscal policy
b. Expansionary monetary policy
c. Contractionary fiscal policy
d. Contractionary monetary policy

22. A system of floating exchange rates and high capital mobility strengthens which policy in combating a recession:
a. Expansionary fiscal policy
b. Expansionary monetary policy
c. Contractionary fiscal policy
d. Contractionary monetary policy

23. Given an open economy with high capital mobility, all of the following statements are true except:
a. fiscal policy is strengthened under fixed exchange rates
b. monetary policy is weakened under fixed exchange rates
c. monetary policy is strengthened under floating exchange rates
d. fiscal policy is strengthened under floating exchange rates

24. Under a system of managed-floating exchange rates with heavy exchange rate intervention:
a. Fiscal policy is successful in promoting internal balance, while monetary policy is unsuccessful
b. Monetary policy is successful in promoting internal balance, while fiscal policy is unsuccessful
c. Both fiscal policy and monetary policy are successful in promoting internal balance
d. Neither fiscal policy nor monetary policy are successful in promoting internal balance

25. Given a system of floating exchange rates, an expansionary monetary policy by the Federal Reserve will cause
a. the dollar to appreciate and will decrease U.S. net exports
b. the dollar to appreciate and will increase U.S. net exports
c. the dollar to depreciate and will increase U.S. net exports
d. the dollar to depreciate and will decrease U.S. net exports

26. Given a system of floating exchange rates, a contractionary monetary policy by the Federal Reserve will cause
a. the dollar to appreciate and will decrease U.S. net exports
b. the dollar to appreciate and will increase U.S. net exports
c. the dollar to depreciate and will increase U.S. net exports
d. the dollar to depreciate and will decrease U.S. net exports

27. All of the following are obstacles to international economic policy coordination except:
a. Different national objectives and institutions
b. Different national political climates
c. Different phases in the business cycle
d. Different national currencies

28. Suppose a central bank prevents a depreciation of its currency by intervening in the foreign exchange market and buying its currency with foreign currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a rise in aggregate demand

29. At the ____, the Group-of-Five nations agreed to intervene in the currency markets to promote a depreciation in the U.S. dollar’s exchange value.
a. Plaza Agreement of 1985
b. Louvre Accord of 1987
c. Bonn Summit of 1978
d. Tokyo Summit of 1962

30. The Plaza Agreement of 1985 and Louvre Accord of 1987 are examples of:
a. Tariff trade barrier formation
b. Nontariff trade barrier formation
c. International economic policy coordination
d. Beggar-thy-neighbor policies

Exhibit 16.1

At the Plaza Accord of 1985, the Group-of-Five nations agreed to drive the value of the dollar downward (i.e., depreciation) so as to help reduce the U.S. trade deficit. Answer the following question(s) on the basis of this information.

31. Refer to Exhibit 16.1. To help drive the dollar’s exchange value downward, the Federal Reserve would:
a. Reduce taxes
b. Increase taxes
c. Decrease the money supply
d. Increase the money supply

32. Refer to Exhibit 16.1. The Federal Reserve might refuse to support the accord on the grounds that when helping to drive the dollar’s exchange value downward, it promotes an increase in the U.S.:
a. Rate of inflation
b. Budget deficit
c. Unemployment level
d. Economic growth rate

33. Under a fixed exchange-rate system and high capital mobility, an expansion in the domestic money supply leads to:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit

34. Under a fixed exchange-rate system and high capital mobility, a contraction in the domestic money supply leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit

35. Under a fixed exchange-rate system and high capital mobility, an expansionary fiscal policy leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit

36. Under a fixed exchange-rate system and high capital mobility, a contractionary fiscal policy leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit

37. Suppose a central bank prevents a depreciation of its currency by intervening in the foreign exchange market and buying its currency with foreign currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a fall in aggregate demand

38. Suppose a central bank prevents an appreciation of its currency by intervening in the foreign exchange market and selling its currency for foreign currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a fall in aggregate demand

39. Assume a system of floating exchange rates. In response to relatively high interest rates abroad, suppose domestic investors place their funds in foreign capital markets. The result would be
a. a depreciation of the domestic currency and a rise in net exports
b. a depreciation of the domestic currency and a fall in net exports
c. an appreciation of the domestic currency and a rise in net exports
d. an appreciation of the domestic currency and a fall in net exports

40. Assume a system of floating exchange rates. In response to relatively high domestic interest rates, suppose that foreign investors place their funds in domestic capital markets. The result would be
a. a depreciation of the domestic currency and a rise in net exports
b. a depreciation of the domestic currency and a fall in net exports
c. an appreciation of the domestic currency and a rise in net exports
d. an appreciation of the domestic currency and a fall in net exports

41. When a nation realizes external balance
a. it can have a current account deficit
b. it can have a current account surplus
c. it has neither a current account deficit nor a current account surplus
d. Both a and b

42. Direct controls may take the form of
a. Tariffs
b. Export subsidies
c. Export quotas
d. All of the above

43. With a fixed exchange rate system, internal balance is most effectively achieved by using
a. Expansionary monetary policy to combat recession
b. Expansionary fiscal policy to combat inflation
c. Contractionary monetary policy to combat recession
d. Contractionary fiscal policy to combat recession

44. Policy coordination is complicated by
a. Different economic objectives
b. Different national institutions
c. Different phases in the business cycle
d. All of the above

TRUE/FALSE

1. A nation realizes internal balance if economy achieves full employment and price stability.

2. Nations have typically placed greater importance to the goal of internal balance than to the goal of external balance.

3. A nation realizes external balance when its current account is in equilibrium.

4. A nation realizes overall balance when it achieves full employment and current account equilibrium.

5. Expenditure-changing policies modify the direction of aggregate demand, shifting it between domestic output and imports.

6. Expenditure-switching policies include fiscal policy and monetary policy.

7. Economic policymakers have typically adopted expenditure-increasing policies to combat inflation and expenditure-reducing policies to combat recession.

8. Expenditure-switching policies alter the level of total spending (aggregate demand) for goods and services produced domestically and those imported.

9. Currency devaluation and revaluation are considered to be expenditure-changing policies since they alter a country’s aggregate demand for goods and services.

10. Expenditure-switching policies include currency revaluation, currency devaluation, and direct controls such as tariffs, quotas, and subsidies.

11. Given an open economy with high capital mobility and floating exchange rates, suppose an expansionary monetary policy is implemented to combat recession. The initial and secondary effects of the policy have conflicting effects on aggregate demand, thus weakening the policy’s expansionary effect.

12. Given an open economy with high capital mobility and fixed exchange rates, suppose an expansionary fiscal policy is implemented to combat recession. The initial and secondary effects of the policy cause aggregate demand to increase, thus strengthening the policy’s expansionary effect.

13. When the economy is in deep recession or depression, it is operating on that portion of its aggregate supply curve that is horizontal.

14. Changes in a country’s net exports, investment spending, or government spending will cause its aggregate demand curve to shift.

15. Given an open economy with high capital mobility, fiscal policy is strengthened under fixed exchange rates.

16. Given an open economy with high capital mobility, monetary policy is strengthened under fixed exchange rates.

17. Under floating exchange rates and high capital mobility, an expansionary monetary policy would help a country resolve a recession and a current account deficit.

18. Exchange rate management policies require international policy coordination because a depreciation of one nation’s currency implies an appreciation of its trading partner’s currency.

19. Currency devaluation and revaluation primarily affect the economy’s current account and have secondary effects on domestic employment and inflation.

20. Fiscal and monetary policies are generally used to combat domestic recession and inflation and have secondary effects on the balance of payments.

21. The Group of five (G-5) nations include Japan, Germany, China, and Australia.

22. The Bonn Summit of 1978 and Plaza Accord of 1985 are examples of international policy coordination.

23. International policy coordination is plagued by differing national economic objectives, institutions, political climates, and phases in the business cycle.

24. The goals of the Plaza Agreement of 1985 were to combat protectionism in the U.S. Congress, promote world economic expansion by stimulating demand in Germany and Japan, and to ease the burden of the U.S. debt service.

SHORT ANSWER

1. What policy instrument should be used when demand-pull inflation exists?

2. What happens to the balance of payments under a fixed exchange rate system, when expansionary or contractionary monetary policy is used?

ESSAY

1. Was the Plaza Agreement of 1985 a success?

2. What is international economic policy coordination?

CHAPTER 17—INTERNATIONAL BANKING: RESERVES, DEBT, AND RISK

MULTIPLE CHOICE

1. Which of the following assets makes use of the basket valuation technique?
a. Swap agreements
b. Oil facility
c. Buffer stock facility
d. Special drawing rights

2. Swap agreements are generally conducted by the:
a. Federal Reserve with foreign central banks
b. Federal Reserve with foreign commercial banks
c. U.S. Treasury with foreign central banks
d. U.S. Treasury with foreign commercial banks

3. Which of the following is a main central bank function of the International Monetary Fund?
a. The conduct of open market operations
b. The issuance of gold certificates
c. The provision of monetary policy for member nations
d. The granting of loans to member nations

4. The Federal Reserve’s swap network represents:
a. Efforts to stabilize only the value of the dollar
b. Efforts to stabilize only the value of foreign currencies
c. Long-term borrowing among countries
d. Short-term borrowing among countries

5. International trade and investment are most frequently financed by the U.S. dollar and the:
a. Japanese yen
b. British pound
c. Australian dollar
d. Swiss franc

6. The purpose of international reserves is to finance:
a. Short-term surpluses in the balance of payments
b. Long-term surpluses in the balance of payments
c. Short-term deficits in the balance of payments
d. Long-term deficits in the balance of payments

7. The currencies generally referred to as “reserve currencies” are the:
a. Japanese yen and U.S. dollar
b. Swiss franc and Japanese yen
c. British pound and U.S. dollar
d. Swiss franc and British pound

8. Which of the following does not represent a form of international liquidity?
a. IMF reserve positions
b. General arrangements to borrow
c. U.S. government securities
d. Reciprocal currency arrangements

9. Which of the following is not considered an “owned” reserve?
a. National currencies
b. Gold
c. Special drawing rights
d. Oil facility

10. Which of the following is not considered a “borrowed” reserve?
a. Special drawing rights
b. Oil facility
c. IMF drawings
d. Reciprocal currency arrangement

11. Eurodollars are:
a. Dollar-denominated deposits in overseas banks
b. European currencies used to finance transactions in the United States
c. Dollars that U.S. residents spend in Europe
d. European currencies used to finance imports from the United States

12. Which of the following is not a characteristic of the Eurodollar market? It:
a. Is mainly located in the United Kingdom and continental Europe
b. Operates as a financial intermediary, bringing together lenders and borrowers
c. Deals in interest-bearing time deposits and loans to governments
d. Grew in response to the deregulation of interest rate ceilings on U.S. savings accounts

13. Which of the following assets was (were) created in 1970 to provide additional international liquidity, in the belief that increasing world trade requires more liquidity for larger expected payments imbalances?
a. Eurodollar market
b. Special drawing rights
c. Reciprocal currency arrangements
d. General arrangements to borrow

14. Which of the following constitute(s) the largest component of the world’s international reserves?
a. Gold
b. Special drawing rights
c. IMF drawings
d. Foreign currencies

15. With an international gold standard, if a country ended up with a deficit from the balances on its current and capital accounts, it would:
a. Import gold to settle the balance
b. Export gold to settle the balance
c. Officially decrease the price of gold
d. Officially increase the price of gold

16. Which of the following is not a condition of the international gold standard? That a nation must:
a. Convert gold into paper currency, and vice versa, at a stipulated rate
b. Permit gold to be freely imported and exported
c. Tolerate wide fluctuations in its exchange rate
d. Define its monetary unit in terms of a stipulated amount of gold

17. All of the following exchange-rate systems require international reserves to finance balance-of-payments disequilibriums except:
a. Pegged or fixed exchange rates
b. Managed floating exchange rates
c. Adjustable pegged exchange rates
d. Freely floating exchange rates

18. A dollar shortage would indicate that the dollar is:
a. Undervalued in international markets
b. Overvalued in international markets
c. Overvalued in terms of gold
d. Overvalued in terms of special drawing rights

19. The U.S. gold outflow that began in the late 1940s and continued through the 1960s was due in part to:
a. Crawling pegged exchange rates
b. Freely floating exchange rates
c. An undervalued dollar
d. An overvalued dollar

20. The U.S. dollar glut of the 1960s was due in part to:
a. An undervalued dollar
b. An overvalued dollar
c. Freely floating exchange rates
d. Crawling pegged exchange rates

21. For developing countries such as Mexico and Brazil, severe economic problems in the 1980s were caused by:
a. A fall in the world demand for products produced by developing countries
b. High prices of basic raw materials and other commodities
c. Low real interest rates in the United States
d. High levels of income and imports for the United States

22. In response to the international debt problem, the United States set up a special fund in 1986 to help make up for lost oil revenues. Under the plan, the United States would make more money available as world oil prices fell. This plan was designed to help:
a. Argentina
b. Saudi Arabia
c. Mexico
d. Brazil

23. Which indicator of international debt burden schedules interest and principal payments on long-term debt as a percent of export earnings?
a. Debt service ratio
b. Debt-to-export ratio
c. Ratio of external debt to gross domestic product
d. Ratio of external debt to gross national product

24. Which term best describes the process in which the International Monetary Fund provides loans to countries facing balance-of-payments difficulties provided that they initiate programs holding promise of correcting these difficulties?
a. Conditionality
b. Debt service
c. Reciprocal currency arrangement
d. Swap agreement

25. All of the following are major goals of the International Monetary Fund except:
a. Promoting international cooperation among member countries
b. Fostering a multilateral system of international payments
c. Making long-term development and reconstruction loans
d. Promoting exchange-rate stability and the elimination of exchange restrictions

26. Which international reserve asset was officially phased out of the international monetary system by the United States in the early 1970s?
a. Special drawing rights
b. Swap agreements
c. General arrangements to borrow
d. Gold

27. Bilateral agreements between central banks, which provide for an exchange of currencies to help finance temporary balance-of-payments disequilibriums, are referred to as:
a. IMF drawings
b. Special drawing rights
c. Buffer stock facility
d. Swap agreements

28. Which organization is largely intended to make long-term reconstruction loans to developing nations?
a. Export-Import Bank
b. World Bank
c. International Monetary Fund
d. United Nations

29. “Owned” international reserves consist of:
a. Special drawing rights
b. Oil facility
c. IMF drawings
d. Reciprocal currency arrangements

30. “Borrowed” international reserves consist of:
a. IMF drawings
b. Foreign currencies
c. Gold
d. Special drawing rights

31. Concerning international lending risk of commercial banks, ____ refers to the probability that part/all of the interest/principal of a loan will not be repaid.
a. Country risk
b. Credit risk
c. Currency risk
d. Presidential risk

32. Concerning international lending risk of commercial banks, ____ is closely related to political developments in a borrowing country, especially the government’s views concerning international investments and loans.
a. Economic risk
b. Credit risk
c. Country risk
d. Currency risk

33. Concerning international lending risk of commercial banks, ____ is associated with possible changes in the exchange value of a nation’s currency.
a. Political risk
b. Country risk
c. Credit risk
d. Currency risk

34. To reduce their exposure to developing country debt, lending commercial banks have practiced all of the following except:
a. Making outright loan sales to other commercial banks
b. Reducing their capital base as a cushion against losses
c. Dealing in debt-for-debt swaps with foreign governments
d. Dealing in debt/equity swaps with foreign governments

35. To reduce losses on developing country loans, commercial banks sometimes sell their loans, at a discount, to a developing country government for local currency which is then used to finance purchases of ownership shares in developing country industries. This practice is known as:
a. Debt forgiveness
b. Debt buyback
c. Debt-for-debt swap
d. Debt/equity swap

36. Concerning international debt, ____ refers to a negotiated reduction in the contractual obligations of the debtor country and includes schemes such as markdowns and write-offs of debt.
a. Debt/equity swap
b. Debt-for-debt swap
c. Debt forgiveness
d. Debt sales

37. The exchange of borrowing country debt for an ownership position in the borrowing country is known as:
a. Debt forgiveness
b. Debt-for-debt swap
c. Debt reduction
d. Debt/equity swap

38. “Country risk” analysis is concerned with all of the following except:
a. Depreciation of the borrowing country’s currency
b. Political instability in the borrowing country
c. Economic growth in the borrowing country
d. External debt of the borrowing country

39. Debt reduction
a. Refers to any voluntary scheme that lessens the burden on the debtor nation
b. May be accomplished through debt rescheduling
c. May be achieved through debt/equity swaps
d. All of the above

40. Most analysts feel that the financial difficulties in East Asia were triggered by
a. Misallocation of investment
b. Unavailability of cheap foreign labor
c. Lack of alignment of the exchange rate with the dollar
d. Surpluses in the trade accounts of the Asian countries

41. A nation may experience debt-servicing problems because of
a. Pursuit of improper macroeconomic policies
b. Inadequate borrowing
c. Adverse economic events
d. Both a and c

42. Swap arrangements
a. Are agreements between governments
b. Require repayment within a stipulated period
c. Are usually multilateral agreements
d. Are never initiated by telephone

TRUE/FALSE

1. Under a system of fixed exchange rates, international reserves are needed to bridge the gap between monetary receipts and monetary payments.

2. International reserves allow a country to finance disequilibria in its balance-of-payments position.

3. An advantage of international reserves is that they allow countries to sustain temporary balance-of-payments deficits until acceptable adjustment measures can operate to correct the disequilibrium.

4. With floating exchange rates, countries require sizable amounts of international reserves for the stabilization of exchange rates.

5. When exchange rates are fixed by central bankers, the need for international reserves disappears.

6. When exchange rates are fixed by central bankers, international reserves are necessary for financing payments imbalances and the stabilization of exchange rates.

7. There exists a direct relationship between the degree of exchange rate flexibility and the need for international reserves.

8. With floating exchange rates, payments imbalances tend to be corrected by market-induced fluctuations in the exchange rate, and the need for exchange-rate stabilization and international reserves disappears.

The diagram below represents the exchange market position of the United States in trade with the United Kingdom. Starting at the equilibrium exchange rate of $3 per pound, suppose the demand for pounds rises from D0 to D1.

Figure 17.1 Foreign Exchange Market

9. Refer to Figure 17.1. Under a fixed exchange rate system, U.S. monetary authorities would have to supply 8 million pounds in exchange for dollars to keep the exchange rate at $3 per pound.

10. Refer to Figure 17.1. If the exchange rate was allowed to rise to $4 per pound, U.S. monetary authorities would have to supply 6 million pounds to the foreign exchange market in exchange for dollars to maintain this rate.

11. Refer to Figure 17.1. Under a floating exchange rate system, the exchange rate would rise to $4 and U.S. monetary authorities would have to supply 4 million pounds to the foreign exchange market in exchange for dollars to maintain this rate.

12. To the extent that adjustments in prices, interest rates, and income levels promote balance-of-payments equilibrium, the demand for international reserves decreases.

13. The greater a nation’s propensity to apply tariffs and quotas to key sectors, the greater will be the need for international reserves.

14. The demand for international reserves is negatively related to the level of world prices and income.

15. The demand for international reserves tend to increase with the level of world income and trade activity.

16. If a nation with a balance-of-payments deficit is willing and able to initiate quick actions to increase export receipts and decrease import payments, the amount of international reserves needed will be relatively large.

17. The supply of international reserves consists of owned reserves and borrowed reserves.

18. Foreign currencies constitute the smallest component of the world’s international reserves.

19. Gold constitutes the largest component of the world’s international reserves.

20. The U.S. dollar has been considered a reserve (key) currency because trading nations have been willing to hold it as an international reserve asset.

21. The U.S. dollar, Japanese yen, British pound, and Mexican peso are the major reserve currencies of the international monetary system.

22. By the 1990s, the British pound had replaced the U.S. dollar as the world’s key currency.

23. A goal of the International Monetary Fund is to make short-term loans to member nations so as to allow them to correct balance of payments disequilibriums without resorting to measures that would destroy national prosperity.

24. When granting loans to financially troubled nations, the International Monetary Fund requires some degree of conditionality, meaning that the borrowing nation must agree to implement economic policies as mandated by the IMF.

25. The International Monetary Fund has sometimes demanded that financially-troubled nations, that borrow from the IMF, undergo austerity programs including slashing of public spending and private consumption.

26. The main purpose of the International Monetary Fund is to grant long-term loans to developing nations to help them finance the development of infrastructure such as roads, dams, and bridges.

27. Gold is currently the most widely used asset in the international monetary system.

28. In 1974 the United States revoked a 41-year ban on U.S. citizen’s ownership of gold.

29. In 1975 the official price of gold was abolished as the unit of account for the international monetary system. As a result, gold was demonetized as an international reserve asset.

30. In the 1970s, the major industrial countries abandoned the managed-floating exchange rate system and adopted a system of fixed exchange rates tied to the price of gold.

31. Created by the International Monetary Fund, special drawing rights (SDRs) are unconditional rights to draw currencies of other nations, thus enabling countries to finance their current-account deficits.

32. The value of the SDR is tied to a currency basket consisting of the U.S. dollar, German mark, Japanese yen, French franc, and British pound.

33. The SDR has replaced the dollar, yen, and mark as the key asset of the international financial system.

34. Because the value of the SDR is tied directly to the value of the U.S. dollar, a 10 percent dollar depreciation would result in a 10 percent decrease in the SDR’s value.

35. A main purpose of the International Monetary Fund is to make loans of foreign currencies to member countries which are experiencing current-account surpluses.

36. When a deficit nation borrows from the International Monetary Fund, it purchases with its currency the foreign currency required to help finance the payments deficit.

37. The so-called General Arrangements to Borrow provide a permanent increase in the supply of international reserves.

38. Swap arrangements are bilateral agreements between central banks to allow countries to temporarily borrow funds to ease current-account deficits and discourage speculative capital flows.

39. IMF drawings, swap arrangements, buffer stock facility, and compensatory financing for exports are classified as owned reserves rather than borrowed reserves.

40. Concerning international lending risk, credit risk refers to the probability that part or all of the interest rate or principal of a loan will not be repaid.

41. Concerning international lending risk, country risk refers to the risk that part or all of the interest or principal of a loan will not be repaid.

42. Concerning international lending risk, currency risk is the risk of asset losses due to changing currency values.

43. A country with a high debt/export ratio and a high debt service/export ratio would likely be considered as an attractive place in which to invest by foreign residents.

44. A debt buyback is a debt-reduction technique in which a government of a debtor nation buys loans from commercial banks at a discount.

45. Under a debt-for-debt swap, a commercial bank sells its loans at a discount to a developing country government for local currency which it then uses to finance an equity investment in the debtor country.

46. A debt-equity swap results in a trade surplus nation forgiving the loans made to a trade-deficit nation.

47. Eurocurrencies are deposits, denominated and payable in dollars and other foreign currencies, in banks outside the United States, primarily in London, the market’s center.

SHORT ANSWER

1. Why do countries hold international reserves?

2. How can a bank reduce its exposure to the debt of developing nations?

ESSAY

1. Describe the eurocurrency market.

2. Are international reserve needs different for different exchange rate regimes?

ECO 302 Week 11 Quiz – Strayer University New

ECO/302 Week 11 Quiz – Strayer

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Chapter 17 and 18

TRUE/FALSE

1. With an international sector real GNP is consumption plus gross investment plus government purchases plus net real asset income from abroad.

2. The balance of trade is net exports or imports less exports.

3. A higher current account deficit is caused by a declining domestic economy.

4. The real current account balance is real national saving less net domestic investment.

5. Tariffs and quotas lead to a higher real GDP growth rate in the country imposing them.

6. The law of one price says that there must be a unique price for a good in each location where it is sold.

7. If the home country has a real GNP which is greater than real domestic expenditure, then the home country has a current-account deficit.

8. Foreign direct investment occurs when the home country acquires additional ownership of capital located in the rest of the world.

9. If the home country has negative trade balance, then its real GDP is less than real domestic expenditure.

10. The equilibrium business-cycle model predicts that the real current-account balance will be countercyclical.

MULTIPLE CHOICE

1. The law of one price:
a. prohibits price discrimination. c. is a tax on imports.
b. is that markets work to ensure that the same good has the same price in all locations. d. prohibits price increases unless firms can show their are unusual circumstances.

2. The difference between real GDP in a closed economy and real GNP in a open economy is:
a. net real asset income from abroad. c. net international investment position.
b. net imports. d. the trade balance.

3. Real GNP in an open economy is:
a. the closed economy real output less net real asset income from abroad. c. the closed economy real output less gross real asset income from abroad.
b. the closed economy real output plus gross real asset income from abroad. d. the closed economy real output plus net real asset income from abroad.

4. Net real asset income from abroad is:
a. rt-1•Bft-1/P. c. (Bft – Bft-1)/P.
b. Yt – (Ct +It +Gt ). d. ((Bft – Bft-1)/P) – (rt-1•Bft-1/P).

5. Net real foreign investment is:
a. rt-1•Bft-1/P. c. (Bft – Bft-1)/P.
b. Yt – (Ct +It +Gt ). d. ((Bft – Bft-1)/P) – (rt-1•Bft-1/P).

6. The trade balance is:
a. rt-1•Bft-1/P. c. (Bft – Bft-1)/P.
b. Yt – (Ct +It +Gt ). d. ((Bft – Bft-1)/P) – (rt-1•Bft-1/P).

7. The balance on the current account:
a. rt-1•Bft-1/P. c. (rt-1•Bft-1/P) + ((Bft – Bft-1)/P).
b. Yt + (rt-1•Bft-1/P) – (Ct +It +Gt ). d. ((Bft – Bft-1)/P) – (rt-1•Bft-1/P).

8. The balance on the current account is:
a. real GNP less net foreign investment income. c. real GNP less the net international investment position.
b. real GNP less net foreign investment. d. real GNP less real domestic expenditure.

9. The real current-account balance is:
a. net real asset income from abroad less trade balance c. trade balance times the net real asset income from abroad.
b. trade balance plus the net real asset income from abroad. d. trade balance less the net real income from abroad.

10. The real current account balance equals:
a. net foreign investments. c. the trade balance plus net real asset income from abroad.
b. real GNP less real domestic expenditure. d. all of the above.

11. The real current account balance equals:
a. net foreign investments. c. the trade balance.
b. the net international investment position. d. all of the above.

12. The real current account balance equals:
a. the trade balance. c. the net international investment position.
b. real GNP less real domestic expenditure. d. all of the above.

13. The real current account balance equals
a. the net international investment position. c. the trade balance plus net real asset income from abroad.
b. the trade balance. d. all of the above.

14. The trade balance is:
a. the difference between exports and imports. c. the real current-account balance less net real asset income from abroad.
b. real GDP less real domestic expenditure. d. all of the above.

15. The trade balance is:
a. the difference between exports and imports. c. net foreign investment.
b. real asset income from abroad. d. all of the above.

16. The trade balance is:
a. the balance on the current account. c. net foreign investment.
b. real GDP less real domestic expenditure. d. all of the above.

17. The trade balance is:
a. net foreign investment. c. the real current-account balance less net real asset income from abroad.
b. the net international investment position. d. all of the above.

18. In the market clearing model with world markets for goods and credit, an increase in technology, A, in the home country causes:
a. an increase in the MPK. c. an increase in borrowing from foreigners.
b. an increase in home country gross domestic investment. d. all of the above.

19. In the market clearing model with world markets for goods and credit, an increase in technology, A, in the home country causes:
a. an increase in the MPK. c. an increase in lending to foreigners.
b. an decrease in home country gross domestic investment. d. all of the above.

20. In the market clearing model with world markets for goods and credit, an increase in technology, A, in the home country causes:
a. an decrease in the MPK. c. an increase in lending to foreigners.
b. an increase in home country gross domestic investment. d. all of the above.

21. In the market clearing model with world markets for goods and credit, an increase in technology, A, in the home country causes:
a. a decrease in the MPK. c. an increase in borrowing from foreigners.
b. a decrease in gross domestic investment. d. all of the above.

22. In the market clearing model with world markets for goods and credit, an increase in technology, A, in the home country causes:
a. a larger current account deficit. c. a lower MPK.
b. a smaller current account deficit. d. lower domestic gross investment.

23. In the market clearing model with world markets for goods and credit, a decrease in technology, A, in the home country causes:
a. a larger current account deficit. c. a higher MPK.
b. a smaller current account deficit. d. higher domestic gross investment.

24. The open economy equilibrium business-cycle model predicts that the real current account balance will be:
a. acyclical. c. countercyclical.
b. procyclical. d. exogenous.

25. The open economy equilibrium business-cycle model predicts that the real current account balance will be:
a. the same in expansions and recession. c. high in expansions and low in recessions.
b. low in expansions and high in recessions. d. invariant with the business cycle.

26. In US data the real current account balance is:
a. procyclical when the model predicts it will be countercyclical. c. countercyclical when the model predicts it will be procyclical.
b. procyclical as the model predicts. d. countercyclical as the model predicts.

27. In US data the real current account balance is:
a. procyclical. c. countercyclical.
b. weakly procyclical. d. weakly countercyclical.

28. While according to the model the current account balance will be countercyclical, the balance can also decline due to:
a. a temporary negative shock like a harvest failure. c. a temporary increase in government purchases as in war time.
b. a less developed country having a low capital stock. d. all of the above.

29. While according to the model the current account balance will be countercyclical, the balance can also decline due to:
a. a temporary negative shock like a harvest failure. c. a permanent decrease in government purchases.
b. a less developed country having poor institutions for growth. d. all of the above.

30. While according to the model the current account balance will be countercyclical, the balance can also decline due to:
a. a temporary positive shock like a good harvest. c. a permanent decrease in government purchases.
b. a less developed country having a low capital stock. d. all of the above.

31. While according to the model the current account balance will be countercyclical, the balance can also decline due to:
a. a temporary positive shock like a positive harvest c. a temporary increase in government purchases as in war time.
b. a less developed country having a high capital stock. d. all of the above.

32. In the Ricardian case, if the government budget deficit is increased, then the trade balance:
a. moves toward a deficit too. c. is unaffected.
b. moves toward a surplus. d. is exogenous.

33. The terms of trade are:
a. ($ per home good)/($ per foreign good). c. foreign good per home good.
b. the number of units of foreign goods that can be imported for each unit of home goods exported. d. all of the above.

34. The terms of trade are:
a. ($ per home good)/($ per foreign good). c. home good per foreign good.
b. the number of units of home goods that can be exported for each unit of foreign goods imported. d. all of the above.

35. The terms of trade are:
a. ($ per foreign good)/($ per home good). c. home good per foreign good.
b. the number of units of foreign goods that can be imported for each unit of home goods exported. d. all of the above.

36. The terms of trade are:
a. ($ per home foreign/($ per home good). c. foreign good per home good.
b. the number of units of home goods that can be exported for each unit of foreign goods imported. d. all of the above.

37. An increase in the terms of trade:
a. raises real GDP. c. increases real national saving if the change in terms of trade is less than fully permanent.
b. increases consumption. d. all of the above.

38. An increase in the terms of trade:
a. raises real GDP. c. lowers real national saving.
b. decreases consumption. d. all of the above.

39. An increase in the terms of trade:
a. reduces real GDP. c. lowers real national saving.
b. increases consumption. d. all of the above.

40. An increase in the terms of trade:
a. reduces real GDP. c. increases real national saving if the change in terms of trade is less than fully permanent.
b. decreases consumption. d. all of the above.

41. A decrease in the terms of trade:
a. reduces real GDP. c. decreases real national saving if the change in terms of trade is less than fully permanent.
b. decreases consumption. d. all of the above.

42. A decrease in the terms of trade:
a. reduces real GDP. c. increases real national saving if the change in terms of trade is less than fully permanent.
b. increases consumption. d. all of the above.

43. If the government reduces tariffs or quotas on imports, then:
a. real GDP will increase. c. net domestic investment will rise.
b. the real current account balance falls. d. all of the above.

44. If the government reduces tariffs or quotas on imports, then:
a. real GDP will increase. c. net domestic investment will fall.
b. the real current account balance rises. d. all of the above.

45. If the government reduces tariffs or quotas on imports, then:
a. real GDP will decrease. c. net domestic investment will fall.
b. the real current account balance falls. d. all of the above.

46. If the government reduces tariffs or quotas on imports, then:
a. real GDP will decrease. c. net domestic investment will rise.
b. the real current account balance rises. d. all of the above.

47. If the government imposes or increases tariffs or quotas on imports, then:
a. real GDP will decrease. c. net domestic investment will fall.
b. the real current account balance rises. d. all of the above.

48. If the government imposes or increases tariffs or quotas on imports, then:
a. real GDP will decrease. c. net domestic investment will rise.
b. the real current account balance falls. d. all of the above.

49. If the government imposes or increases tariffs or quotas on imports, then:
a. real GDP will increase. c. net domestic investment will rise.
b. the real current account balance rises. d. all of the above.

50. If the government reduces tariffs or quotas on imports, then:
a. real GDP will increase. c. net domestic investment will fall.
b. the real current account balance falls. d. all of the above.

51. If we observe that the price of a good is higher in one location than in another location, this observation
a. violates the law of one price. c. violates the law of one GDP.
b. validates the law of one price. d. validates the law of one GDP.

52. Foreign direct investment is
a. the home country’s additional supply of labor to the rest of the world. c. the home country’s additional demand for labor from the rest of the world.
b. the home country’s additional ownership of capital in the rest of the world. d. the foreign country’s additional demand for labor in the home country.

53. When the home country acquires additional ownership of capital located in the rest of the world, it has is
a. reduced foreign indirect investment. c. acquired foreign direct investment.
b. acquired foreign divested investment. d. reduced foreign direct intervention.

54. Real gross national product in an open economy includes
a. real GDP. c. net real labor costs from abroad.
b. net real asset income from abroad. d. (a) and (b).

55. If the home country has a real GNP which is greater than real domestic expenditure, then the home country has
a. a current-account suplus. c. balance on the current account.
b. a current-account deficit. d. none of the above.

56. If the home country has a real GNP which is less than real domestic expenditure, then the home country has
a. a current-account suplus. c. balance on the current account.
b. a current-account deficit. d. none of the above.

57. If the home country has a real GNP which is equal to real domestic expenditure, then the home country has
a. a current-account suplus. c. balance on the current account.
b. a current-account deficit. d. none of the above.

58. If the home country has a real GNP which is greater than net foreign investment, then the home country has
a. a current-account suplus. c. balance on the current account.
b. a current-account deficit. d. none of the above.

59. If the home country has a real GDP which is greater than real domestic expenditure, then the home country has
a. a trade balance that is positive. c. a trade balance that is zero.
b. a trade balance that is negative. d. none of the above.

60. If the home country has a real GDP which is less than real domestic expenditure, then the home country has
a. a trade balance that is positive. c. a trade balance that is zero.
b. a trade balance that is negative. d. none of the above.

61. Historical data on the U.S. current account balance show
a. a deficit from the turn of the twentieth century through the mid-1970s. c. a surplus for the twentieth century through the mid-1970s.
b. a surplus in most of the past two decades. d. a zero current account balance for most of the twentieth century.

62. Historical data on the U.S. current account balance show that one of the largest ratios for the current-account balance relative to GDP occurred
a. as a surplus, in the early 1970s. c. as a surplus, in the early 2000s.
b. as a deficit, in the early 1990s. d. as a deficit, in the early 2000s.

63. Historical data on the ratio of U.S. nominal exports and imports to GDP show
a. a generally rising ratio since 1950. c. a generally positive but steady ratio since 1950.
b. a generally falling ratio since 1950. d. a ratio hovering around zero since 1950.

64. Historical data on the ratio of U.S. net international investment to GDP show
a. a steady increase in the ratio since 1980. c. a steady ratio since 1980.
b. a steady decline in the ratio since 1980. d. no discernable pattern in the ratio since 1980.

65. Historical data on the ratio of U.S. net factor income from abroad to GDP show
a. a steady increase in the ratio since 1980. c. a peak in the ratio around 1980, followed by a decline through 1987.
b. a steady decline in the ratio since 1960. d. no discernable pattern in the ratio since 1980.

66. A developing country with good prospects means that the country’s current-account balance would likely be
a. negative. c. zero.
b. positive. d. impossible to determine.

SHORT ANSWER

1. What is the real current account balance?

2. What are the effects of a permanent increase in technology in the open market clearing model?

3. What does the open market clearing model predict about the association of the real current account balance and real GDP growth and what do the data on the US show?

4. Does a government budget deficit lead to a real current-account deficit?

5. What are the effects of reducing tariffs and quotas in the open market clearing model?

Chapter 18

TRUE/FALSE

1. If the dollar per yen exchange rate rises, then so does the value of the dollar.

2. When absolute purchasing power parity holds, the real exchange rate is 1.

3. Relative purchasing power parity says that the country with the higher inflation rate will see its currency depreciate.

4. The interest rate differential between two countries is the real interest rate.

5. If a country fixes its exchange rate, it gives up control of its money supply.

6. The nominal exchange rate is measured by quantities of currencies exchanged, while the real exchange rate is measured by quantities of goods exchanged.

7. Fixed exchange rates are determined by market forces.

8. Flexible exchange rates are determined by market forces.

9. Poorer countries tend to have high real exchange rates because the prices for nontradable goods is low in these countries.

10. The combination of interest rate parity and relative purchasing power parity implies that expected real incomes are the same in the home country and the foreign country.

MULTIPLE CHOICE

1. The nominal exchange rate is:
a. foreign good per home good. c. the number of units of foreign currency per one unit of the home currency.
b. the number of units of foreign currency per one unit of home currency divided by the ratio of the foreign price level to the home price level. d. all of the above.

2. The real exchange rate is:
a. foreign good per home good. c. the number of units of foreign currency per one unit of the home currency.
b. nominal exchange rate divided by the ratio of the foreign price level to the home price level. d. all of the above.

3. Flexible exchange rates are determined by:
a. the market. c. the UN.
b. the home country government. d. the International Monetary Fund.

4. Fixed exchange rates are determined by:
a. the market. c. the UN.
b. the governments of the two countries. d. the International Monetary Fund.

5. Purchasing power parity is the idea that:
a. the nominal exchange equals the ratio of the foreign price to the home price. c. the nominal exchange equals the home price less the foreign price.
b. the nominal exchange rate equals the foreign price time the home price. d. the nominal exchange equals the home price less the foreign price.

6. Purchasing power parity may not hold due to:
a. inflation. c. market clearing.
b. nontraded goods such as services. d. all of the above.

7. Purchasing power parity may not hold due to:
a. inflation. c. shifts in the terms of trade.
b. market clearing. d. all of the above.

8. Absolutely purchasing power parity means:
a. the quantity of goods that can be bought in the home country equals the quantity of good that can be bought in the foreign country. c. the nominal exchange rate is the ratio of the foreign price to the home price.
b. buying and selling goods looks equally attractive in both countries. d. all of the above.

9. Absolute purchasing power parity means:
a. the quantity of goods that can be bought in the home country equals the quantity of good that can be bought in the foreign country. c. the nominal exchange rate is the ratio of the home price to the world price.
b. buying and selling goods looks more attractive in the home country. d. all of the above.

10. Absolute purchasing power parity means:
a. the quantity of goods that can be bought in the home country is greater than the quantity of goods that can be bought in the foreign country. c. the nominal exchange rate is the ratio of the foreign price to the world price.
b. buying and selling goods looks equally attractive in both countries. d. all of the above.

11. Absolutely purchasing power parity means:
a. the quantity of goods that can be bought in the home country is greater than the quantity of goods that can be bought in the foreign country. c. the nominal exchange rate is the ratio of the foreign price to the home price.
b. buying and selling goods looks more attractive in the home country. d. all of the above.

12. Non-traded goods include:
a. personal services like haircuts. c. consumer goods like shirts.
b. durable goods like tv sets. d. all of the above.

13. Non-traded goods include:
a. commodities like wheat. c. consumer goods like shirts.
b. real estate. d. all of the above.

14. Relative purchasing power parity says that:
a. the growth rate of the nominal exchange rate is the foreign inflation rate less the home inflation rate. c. the growth rate of the nominal exchange rate is the home inflation rate plus the foreign inflation rate.
b. the growth rate of the nominal exchange rate is the foreign inflation rate times the home inflation rate. d. the growth rate of the nominal exchange rate is the foreign inflation rate divided by the home inflation rate.

15. Relative purchasing power parity implies a country will see its currency fall in value, if
a. its inflation rate is lower than the foreign inflation rate. c. its inflation rate is higher than the foreign inflation rate.
b. its price level is higher than the foreign price level. d. its price level is lower than the foreign price level.

16. Relative purchasing power parity implies a country will see its currency rise in value, if
a. its inflation rate is lower than the foreign inflation rate. c. its inflation rate is higher than the foreign inflation rate.
b. its price level is higher than the foreign price level. d. its price level is lower than the foreign price level.

17. Relative purchasing power parity implies a country will see its currency keep the same value, if
a. its inflation rate is lower than the foreign inflation rate. c. its inflation rate is equal to the foreign inflation rate.
b. its price level is higher than the foreign price level. d. its price level is equal to the foreign price level.

18. If the home inflation rate is 5% and the foreign inflation rate is 9%, then by relative purchasing power parity the home country would expect is exchange rate to:
a. rise in value by 5%. c. rise value by 4%.
b. fall in value by 5%. d. fall in value by 4%.

19. If the home inflation rate is 9% and the foreign inflation rate is 5%, then by relative purchasing power parity the home country would expect is exchange rate to:
a. rise in value by 5%. c. rise value by 4%.
b. fall in value by 5%. d. fall in value by 4%.

20. If the home inflation rate is 5% and the foreign inflation rate is 5%, then by relative purchasing power parity the home country would expect is exchange rate to:
a. rise in value by 5%. c. have no change in its value.
b. fall in value by 5%. d. fall in value by 10%.

21. Interest rate parity says that:
a. the interest rate differential is the growth rate of the nominal exchange rate. c. the interest rate differential is the growth rate of the real exchange rate.
b. the interest rate differential is ratio of the foreign price level to the home price level. d. the interest rate differential is ratio of the home price level to the foreign price level.

22. If the home interest rate is 5% and the foreign interest rate is 7%, then the expected growth of the nominal exchange rate is:
a. 2%. c. -2%.
b. 5%. d. -12%.

23. If the home interest rate is 5% and the foreign interest rate is 7%, then the difference in the expected inflation rates is:
a. 2%. c. -2%.
b. 5%. d. -12%.

24. If the home interest rate is 7% and the foreign interest rate is 5%, then the expected growth of the nominal exchange rate is:
a. 2%. c. -2%.
b. 7%. d. -12%.

25. If the home interest rate is 7% and the foreign interest rate is 5%, then the difference in the expected inflation rates is:
a. 2%. c. -2%.
b. 7%. d. -12%.

26. If absolute purchasing power parity holds, under fixed exchange rates:
a. the home interest rate equals the foreign interest rate. c. the growth rate of the nominal exchange rate is zero.
b. the home inflation rate equals the foreign inflation rate. d. all of the above.

27. If absolute purchasing power parity holds, under fixed exchange rates:
a. the home interest rate equals the foreign interest rate. c. the growth rate of the nominal exchange rate is positive.
b. the home inflation is lower than the foreign inflation rate. d. all of the above.

28. If absolute purchasing power parity holds, under fixed exchange rates:
a. the home interest rate is higher than the foreign interest rate. c. the growth rate of the nominal exchange rate is negative.
b. the home inflation rate equals the foreign inflation rate. d. all of the above.

29. If absolute purchasing power parity holds, under fixed exchange rates:
a. the home interest rate is higher than the foreign interest rate. c. the growth rate of the nominal exchange rate is zero.
b. the home inflation rate is lower than the foreign inflation rate. d. all of the above.

30. If a country with a fixed exchange rate tries to raise its money stock it will:
a. see its central bank gain domestic government bonds. c. see its money stock fall back to its initial level.
b. see its central bank lose international reserves. d. all of the above.

31. If a country with a fixed exchange rate tries to raise its money stock it will:
a. see its central bank gain domestic government bonds. c. see its money stock continue to rise.
b. see its central bank gain international reserves. d. all of the above.

32. If a country with a fixed exchange rate tries to raise its money stock:
a. see its central bank lose domestic government bonds. c. see its money stock continue to rise.
b. see its central bank lose international reserves. d. all of the above.

33. If a country with a fixed exchange rate tries to raise its money stock:
a. see its central bank lose domestic government bonds. c. see its money stock fall back to its initial level.
b. see its central bank gain international reserves. d. all of the above.

34. A revaluation is when a country:
a. allows its currency’s value to float. c. lowers the fixed value of its currency.
b. raises the fixed value of its currency. d. allows its currency value to be set by the market.

35. A devaluation is when a country:
a. allows its currency’s value to float. c. lowers the fixed value of its currency.
b. raises the fixed value of its currency. d. allows its currency value to be set by the market.

36. A depreciation is when the value of a country’s currency:
a. is fixed by the government. c. falls in value in the exchange market.
b. rises in value in the exchange market. d. is fixed in relationship to gold.

37. An appreciation is when the value of a country’s currency:
a. is fixed by the government. c. falls in value in the exchange market.
b. rises in value in the exchange market. d. is fixed in relationship to gold.

38. Under a fixed exchange rate regime, losses of international reserves imply that:
a. the pressure on a country that needs to devalue it currency is greater. c. countries are not under much pressure to change the value of their currency.
b. the pressure on a country that needs to revalue its currency is greater. d. countries can not change the value of their currencies.

39. Fixed exchange rates:
a. facilitate transactions between countries compared to floating exchange rates. c. constrain monetary policy officials.
b. make monetary policy interdependent between the countries fixing their exchange rate. d. all of the above.

40. Fixed exchange rates:
a. facilitate transactions between countries compared to floating exchange rates. c. give domestic monetary policy officials more autonomy.
b. make monetary policy independent between the countries fixing their exchange rate. d. all of the above.

41. Fixed exchange rates:
a. make transactions between countries riskier compared to floating exchange rates. c. give domestic monetary policy officials more autonomy.
b. make monetary policy interdependent between the countries fixing their exchange rate. d. all of the above.

42. Fixed exchange rates:
a. make transactions between countries riskier compared to floating exchange rates. c. constrain monetary policy officials.
b. make monetary policy independent between the countries fixing their exchange rate. d. all of the above.

43. Floating exchange rates:
a. make transactions between countries more difficult. c. provide autonomy for monetary policy authorities.
b. make monetary policy independent. d. all of the above.

44. Floating exchange rates:
a. make transactions between countries more difficult. c. constrain monetary policy officials.
b. make monetary policy interdependent between the countries. d. all of the above.

45. Floating exchange rates:
a. make transactions between countries easier. c. constrain monetary policy officials.
b. make monetary policy independent. d. all of the above.

46. Floating exchange rates:
a. make transactions between countries easier. c. provide autonomy for monetary policy authorities.
b. make monetary policy interdependent between the countries. d. all of the above.

47. Under fixed exchange rates a country’s:
a. money supply is fixed. c. monetary policy makers are not independent.
b. inflation rate is fixed. d. all of the above.

48. Under fixed exchange rates a country’s:
a. money supply is fixed. c. monetary policy makers are independent.
b. inflation rate will rise. d. all of the above.

49. Under fixed exchange rates a country’s:
a. money supply is domestically controlled. c. monetary policy makers are independent.
b. inflation rate is fixed. d. all of the above.

50. Under fixed exchange rates a country’s:
a. money supply is domestically controlled. c. monetary policy makers are not independent.
b. inflation rate will rise. d. all of the above.

51. Suppose the exchange rate between the U.S. dollar and the Argentinian peso is 3 pesos per dollar today. It rises to 3.1 pesos per dollar the next day. This means the dollar has
a. appreciated and the peso has depreciated. c. appreciated, and the peso has appreciated.
b. depreciated and the peso has appreciated. d. depreciated, and the peso has depreciated.

52. In 1950, one U.S. dollar bought 361 Japanese yen, and in 2006, one U.S. dollar bought 117 yen. The U.S. dollar
a. gained over half of its value in terms of yen. c. appreciated relative to the yen.
b. lost over half of its value in terms of yen. d. appreciated relative to most of the world’s currencies.

53. If a country’s government intervenes often in the exchange rate market, then the country
a. is operating closer to a flexible exchange-rate model than a fixed exchange-rate model. c. is operating closer to a fixed exchange-rate model than a flexible exchange-rate model.
b. will experience repeated appreciations of its currency. d. is not a member of the International Monetary Fund (IMF).

54. At a simplified level, purchasing power parity makes sense because, if it did not, housefholds would
a. want to purchase all of their goods in one place, the more expensive country. c. not want to purchase any goods from either country.
b. want to purchase equal portions of their goods in each country. d. want to purchase all of their goods in one place, the cheaper country.

55. The real exchange rate is measured in units of
a. goods bought in the foreign country relative to goods bought in the home country. c. labor supply in the foreign country relative to labor supply in the home country.
b. prices in the foreign country relative to prices in the home country. d. none of the above.

56. If you can buy one pound of flour for $1.25 in the U.S. and one pound of flour for 0.75 £ (pounds) in the U.K., then purchasing power parity implies the
a. real exchange rate is 1.25 £ per $. c. nominal exchange rate is 1.67 £ per $.
b. nominal exchange rate is 0.6 £ per $. d. real exchange rate is 0.6 £ per $.

57. Purchasing power parity implies the
a. nominal exchange rate equals one. c. real exchange rate equals one.
b. nominal exchange is greater than one. d. real exchange rate is less than one.

58. The Balassa-Samuelson hypothesis identifies a pattern of poor countries having
a. low nominal exchange rates. c. low real exchange rates.
b. high nominal exchange rates. d. high real exchange rates.

59. The pattern of real exchange rates across countries that is identified by the Balassa-Samuelson hypothesis occurs because
a. low-income countries tend to have low prices for nontradable goods. c. low-income countries tend to have low prices for tradable goods.
b. low-income countries tend to have high prices for nontradable goods. d. low-income countries tend to have low real exchange rates.

60. The combination of interest-rate parity and relative purchasing power parity leads to the conclusion that the
a. foreign expected real interest rate is greater than the home expected real interest rate. c. foreign expected nominal interest rate equals the home expected real interest rate.
b. foreign expected real interest rate equals the home expected real interest rate. d. foreign expected nominal interest rate equals the home expected nominal interest rate.

61. The Bretton Woods System refers to
a. the flexible exchange-rate system that the International Monetary Fund (IMF) prefers. c. the fixed exchange-rate regime which linked other currencies to the dollar and the dollar to gold.
b. the flexible exchange-rate regime introduced just after World War II that gave France the major role in stabilizing currencies. d. the fixed exchange-rate regime which linked the U.S. and other currencies to silver.

62. Under the Bretton Woods System, the U.S. dollar
a. was allowed to vary around a wide band compared to other participating countries. c. was not fixed, but the U.S. nominal interest rate was fixed relative to other participating countries.
b. varied according to market conditions, but the other participating countries did not allow their currencies to vary. d. was the only participating currency linked directly to gold.

63. If the country of Colombia decides to fix its nominal exchange rate with the U.S. dollar, then in the long run, it will have
a. roughly the same inflation rate as the U.S. c. roughly the same real GDP as the U.S.
b. a higher inflation rate than the inflation rate for the U.S. d. a higher real GDP than the real GDP in the U.S.

64. One reason that a country with a record of high inflation might want to fix its nominal exchange rate with the U.S. dollar is that
a. the country will, in the long run, have about the same inflation rate as the U.S. c. the fixed exchange-rate will act as a monetary-policy rule which prevents the country from reneging on a pledge of low inflation.
b. the fixed exchange-rate will help the country gain credibility in fighting high inflation. d. all of the above.

65. In exchange rate policy, sterilization refers to
a. the market’s ability to clear excess quantities of currency supplied rapidly. c. anti-crime laws the U.S. passed to prevent “money laundering.”
b. the central bank’s attempt to offset an initial intervention in the exchange market. d. the process the International Monetary Fund (IMF) uses to lend to a country in need.

66. In a fixed exchange-rate regime, the money supply is
a. exogenous. c. endogenous.
b. interdependent. d. highly skewed.

SHORT ANSWER

1. What is a nominal exchange rate?

2. What is absolute purchasing power parity, what does it imply and why might it not hold?

3. What is relative purchasing power parity and when does it say the home country will see its currency lose value?

4. What is interest-rate parity and what does this imply about when the exchange rate will be stable?

5. What are the advantages of fixed and floating exchange rates?

ACC 555 Week 11 Final Exam – Strayer University New

ACC/555 Week 11 Final Exam – Strayer New

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Chapters 7 Through 14

Prentice Hall’s Federal Taxation 2015 Comprehensive, 28e (Pope)
Chapter 7 Itemized Deductions

1) For individuals, all deductible expenses must be classified as deductions for AGI or deductions from AGI.

2) In 2014, medical expenses are deductible as a from AGI deduction to the extent that they exceed 7.5 percent of the taxpayer’s AGI.

3) Medical expenses paid on behalf of an individual who could be the taxpayer’s dependent except for the gross income or joint return tests are deductible as itemized deductions.

4) Medical expenses incurred on behalf of children of divorced parents are deductible by the parent who pays the expenses but only if that parent also is entitled to the dependency exemption.

5) The definition of medical care includes preventative measures such as routine physical examinations.

6) Due to stress on the job, taxpayer Charlie began to experience chest pains. In order to relax and relieve the pains, he and his spouse went on an ocean cruise. The cost of the cruise to alleviate this medical condition is tax deductible.

7) Expenditures for a weight reduction program are deductible if recommended by a physician to treat a specific medical condition such as hypertension caused by excess weight.

8) In order for a taxpayer to deduct a medical expense, the amount must be paid to a certified medical doctor (M.D.).

9) Jeffrey, a T.V. news anchor, is concerned about the wrinkles around his eyes. Because it is job-related, the cost of a face lift to eliminate these wrinkles is a deductible medical expense.

10) Expenditures for long-term care insurance premiums qualify as a medical expense deduction subject to an annual limit based upon the age of an individual.

11) Capital expenditures for medical care which permanently improve or better the taxpayer’s property are deductible to the extent the cost exceeds the increase in fair market value to the property attributable to the capital expenditure.

12) Expenditures incurred in removing structural barriers in the home of a physically handicapped individual are deductible only to the extent the cost exceeds the increase in fair market value to the property attributable to the capital expenditure.

13) If the principal reason for a taxpayer’s presence in an institution is the need and availability of medical care, the entire cost of lodging and meals is considered qualified medical expenditures.

14) A medical expense is generally deductible only in the year in which the expense is actually paid.

15) If a prepayment is a requirement for the receipt of the medical care, the payment is deductible in the year paid rather than the year in which the care is rendered.

16) If a medical expense reimbursement is received in a year after a deduction has been taken on a previous year’s return, the previous year’s return must be amended to eliminate the reimbursed expense.

17) Assessments or fees imposed for specific privileges or services are not deductible as taxes.

18) Foreign real property taxes and foreign income taxes are not deductible as itemized deductions.

19) A personal property tax based on the weight of the property is deductible.

20) Assessments made against real estate for the purpose of funding local improvements are not deductible in the year paid but rather should be added to the cost basis of the property.

21) Self-employed individuals may deduct the full self-employment taxes paid as a for AGI deduction.

22) Finance charges on personal credit cards are considered interest and are, therefore, deductible.

23) In general, the deductibility of interest depends on the purpose for which the indebtedness is incurred.

24) Interest expense incurred in the taxpayer’s trade or business is deductible as a for AGI deduction without limitation if the taxpayer materially participates in the business.

25) Investment interest expense which is disallowed because it exceeds the taxpayer’s net investment income may be carried over and treated as incurred in subsequent years.

26) Investment interest includes interest expense incurred to purchase tax-exempt securities.

27) Taxpayers may elect to include net capital gain as part of investment income.

28) Taxpayers may not deduct interest expense on most personal debt, including credit card debt, car loans, and other consumer debt.

29) Qualified residence interest consists of both acquisition indebtedness and home equity interest.

30) Acquisition indebtedness for a personal residence includes debt incurred to substantially improve the residence.

31) A taxpayer is allowed to deduct interest expense incurred on home equity indebtedness limited to the lesser of $100,000 or the home equity (FMV of the residence less the acquisition indebtedness).

32) While points paid to purchase a residence are deductible as interest in the period paid, points associated with the refinancing of a residence must be amortized and deducted over the life of the loan.

33) Christopher, a cash basis taxpayer, borrows $1,000 from ABC Bank by issuing a 3-month note on December 1, 2014. Christopher receives $940 but must repay $1,000 on the due date. The amount of interest expense deductible in 2014 is $20.

34) Charitable contributions made to individuals are deductible if the individuals can show extreme financial need.

35) For charitable contribution purposes, capital gain property includes property which, if sold, would produce a long-term capital gain.

36) A charitable contribution deduction is allowed for the FMV of services rendered to a qualified charitable organization.

37) A charitable contribution in excess of the deduction limit for one taxable year can be carried forward five years.

38) If a taxpayer makes a charitable contribution to a university and in return receives the right to purchase tickets to athletic events, the taxpayer may deduct only 80% of the payment.

39) An accrual-basis corporation can only deduct contributions made by year-end.

40) Corporate charitable deductions are limited to 10% of the corporation’s taxable income for the year.

41) Legal fees for drafting a will are generally deductible.

42) A taxpayer can deduct a reasonable amount for small out-of-pocket (i.e. cash) donations.

43) Van pays the following medical expenses this year:
• $1,500 for doctor bills for Van’s son who is claimed as a dependent by Van’s former spouse.
• $300 for Van’s eyeglasses.
• $900 for Van’s dental work.
• $3,800 for Van’s face lift. Van, a newscaster, is worried about the wrinkles around his eyes.

How much can Van include on his return as qualified medical expenses before limitation?
A) $1,200
B) $2,400
C) $2,700
D) $6,500

44) All of the following are deductible as medical expenses except
A) vitamins and health foods that improve a taxpayer’s general health.
B) payments for a vision exam and contact lenses.
C) payments to a hospital for laboratory fees and X-rays for diagnosis of a medical problem.
D) cosmetic surgery necessary to correct a deformity arising from a congenital abnormality.

45) All of the following payments for medical items are deductible with the exception of the payment for
A) insulin.
B) general appointment for teeth cleaning.
C) acupuncture for specific medical purposes.
D) nonprescription medicine for treatment of a specific medical condition.

46) In 2014 Sela traveled from her home in Flagstaff to San Francisco to seek medical care. Because she was unable to travel alone, her mother accompanied her. Total expenses included:

Hotel room en route ($150 × 2 rooms × 3 nights) $900
Mileage, 1,000 miles
Doctors bills in San Francisco 1,600

The total medical expenses deductible before the 10% limitation are
A) $1,600.
B) $2,135.
C) $2,500.
D) $2,460.

47) Leo spent $6,600 to construct an entrance ramp and to widen doorways in his personal residence to make the home accessible for his wife, who is disabled and confined to a wheelchair. The $6,600 expenditure increased the value of the residence by $2,000. How much of the $6,600 is a deductible medical expense (before considering limits based on AGI)?
A) $0
B) $2,000
C) $4,600
D) $6,600

48) Linda had a swimming pool constructed at her house. Her physician advised and prescribed to her that the pool would slow the effects of her degenerative disease. The pool was not suitable for recreational use. Prior to the construction of the pool, the fair market value of her house was $172,000. After the construction of the pool, the appraised fair market value of the house was $181,000. The cost of the pool was $13,000. What is the amount of Linda’s qualified medical expense (before considering limits based on AGI)?
A) $0
B) $4,000
C) $9,000
D) $13,000

49) Alan, who is a security officer, is shot while on the job. As a result, Alan suffers from a chronic leg injury and must use a wheelchair and undergo therapy to regain and retain strength. Alan’s physician recommends that he install a whirlpool bath in his home for therapy. During the year, Alan makes the following expenditures:

Wheelchair $ 1,200
Whirlpool bath 2,000
Maintenance of the whirlpool 250
Increased utility bills associated with whirlpool 450
Entrance ramp, various home modifications 7,200

A professional appraiser tells Alan that the whirlpool has increased the value of his home by $1,000. Alan’s deductible medical expenses (before considering limitations based on AGI) will be
A) $6,000.
B) $10,100.
C) $7,000.
D) $7,700.

50) Mitzi’s medical expenses include the following:

Medical premiums $10,850
Doctors fees 2,000
Hospital fees 3,350
Prescription drugs 600
Eyeglasses 350
General purpose vitamins 100

Mitzi’s AGI for the year is $33,000. She is single and age 49. None of the medical costs are reimbursed by insurance. After considering the AGI floor, Mitzi’s medical expense deduction is
A) $12,900.
B) $13,850.
C) $14,675.
D) $16,325.

51) Caleb’s medical expenses before reimbursement for the year include the following:

Medical premiums $11,000
Doctors, hospitals 3,500
Prescriptions 600

Caleb’s AGI for the year is $50,000. He is single and age 58. Caleb also receives a reimbursement for medical expenses of $1,000. Caleb’s deductible medical expenses that will be added to the other itemized deduction will be
A) $10,350.
B) $9,100.
C) $14,500.
D) $15,100.

52) A review of the 2014 tax file of Gregory, a single taxpayer who is age 40, provides the following information regarding Gregory’s 2014 tax status:

Adjusted gross income $40,000
Medical expenses (before percentage limit) 5,000
Itemized deductions other than medical 5,400
2014 potential standard deduction 6,200

In 2015, Gregory receives a reimbursement for last year’s medical expenses of $1,200. As a result, Gregory must
A) include $200 in gross income for 2015.
B) include $1,200 in gross income for 2015.
C) reduce 2015’s medical expenses by $1,200.
D) amend the 2014 return.

53) Mr. and Mrs. Thibodeaux, who are filing a joint return, have adjusted gross income of $75,000. During the tax year, they paid the following medical expenses for themselves and for Mrs. Thibodeaux’s mother, Mrs. Watson (age 63). Mrs. Watson provided over one-half of her own support.

Prescription drugs for Mr. Thibodeaux $3,600
General vitamins for Mrs. Thibodeaux $ 100
Doctor bill for Mr. Thibodeaux $1,800
Doctor bill for Mrs. Thibodeaux $4,000
Hospital bill for Mrs. Watson $2,200

Mr. and Mrs. Thibodeaux received no reimbursement for the above expenditures. What is the amount of their deductible itemized medical expenses?
A) $1,900
B) $2,000
C) $4,100
D) $9,400

54) Mr. and Mrs. Gere, who are filing a joint return, have adjusted gross income of $50,000. During the tax year, they paid the following medical expenses for themselves and for Mrs. Gere’s mother, Mrs. Williams. The Gere’s could claim Mrs. Williams as their dependent, but she has too much gross income.

Insulin for Mr. Gere $1,000
Health insurance premiums for Mrs. Gere $3,100
Hospital bill for Mrs. Williams $5,200
Doctor bill for Mrs. Gere $4,000

Mr. and Mrs. Gere received no reimbursement for the above expenditures. What is the amount of their deductible itemized medical expenses?
A) $5,200
B) $8,300
C) $4,300
D) $13,300

55) The following taxes are deductible as itemized deductions with the exception of
A) state income taxes.
B) federal income taxes.
C) foreign real property taxes.
D) local personal property taxes.

56) Matt paid the following taxes in 2014:

Real estate taxes on rental property he owns $4,000
Real estate taxes on his own residence 3,600
Federal income taxes 8,000
State income taxes 3,400
Local city income taxes 500
State sales taxes 700

What amount can Matt deduct as an itemized deduction on his tax return?
A) $7,500
B) $11,500
C) $15,500
D) $19,500

57) In 2014, Carlos filed his 2013 state income tax return and paid taxes of $800. Also in 2014, Carlos’s employer withheld state income tax of $750 from Carlos’s salary. In 2015, Carlos filed his 2014 state income tax return and paid an additional $600 of state income tax due for 2014. How much state income tax can Carlos deduct on his 2014 federal income tax return for state income tax?
A) $1,350
B) $1,400
C) $1,550
D) $2,150

58) Doug pays a county personal property tax on his automobile of $1,500. The $1,500 includes $800 based on the weight of the car and $700 based on the value of the car. How much of the tax can Doug deduct on his tax return?
A) $0
B) $700
C) $800
D) $1,500

59) During the year Jason and Kristi, cash basis taxpayers, paid the following taxes:

State gift tax $1,000
Property tax on home in the United States 4,100
State income tax (withholdings) 3,000
Estimated federal income tax 4,500
Estimated state income tax (paid by check) 800
Special assessment by city for sidewalks and street lighting
on their street 2,000

What amount can Kristi and Jason claim as an itemized deduction for taxes on their federal income tax return in the current year?
A) $7,900
B) $8,900
C) $10,900
D) $15,400

60) In February of the current year (assume a non-leap year), Ken and Kelsey received their property tax statement for last calendar-year taxes of $1,600, which they paid to the taxing authority on March 1 of the current year. They had purchased their home on May 1 last year. What amount of property tax on this statement may they claim as an itemized deduction this year?
A) $0
B) $1,069
C) $1,074
D) $1,600

61) On September 1, of the current year, James, a cash-basis taxpayer, sells his farm to Bill, also a cash-basis taxpayer, for $100,000. James’ basis in the farm is $65,000. The real property tax year is the calendar year. Real estate taxes on the property for the year are $3,650 and are payable in November of the current year. The sales agreement does not provide for apportionment of real estate taxes between the buyer and seller. Assume Bill pays all of the real estate taxes in the current year. The effects of this sales structure will be:

A)
Taxes allocated to James Taxes allocated to Bill Effect on James’ Gain
$0 $3,650 no effect on gain

B)
Taxes allocated to James Taxes allocated to Bill Effect on James’ Gain
$3,650 $0 decrease gain by $1,220

C)
Taxes allocated to James Taxes allocated to Bill Effect on James’ Gain
$2,430 $1,220 increase gain by $2,430

D)
Taxes allocated to James Taxes allocated to Bill Effect on James’ Gain
$1,220 $2,430 increase gain by $1,220

62) On September 1, of the current year, Samuel, a cash-basis taxpayer, sells his farm to Edward, also a cash-basis taxpayer for $100,000. Samuel’s basis in the farm is $65,000. The real property tax year is the calendar year. Real estate taxes on the property for the year are $3,650 and are payable on April 1 of the following year. The sales agreement does not provide for apportionment of real estate taxes between the buyer and seller. Assume Samuel pays all of the real estate taxes prior to the sale. The effects of this sales structure will be:

A)
Taxes allocated to Samuel Taxes allocated to Edward Effect on Samuel’s Gain
$1,220 $2,430 increase gain by $1,220

B)
Taxes allocated to Samuel Taxes allocated to Edward Effect on Samuel’s Gain
$2,430 $1,220 increase gain by $2,430

C)
Taxes allocated to Samuel Taxes allocated to Edward Effect on Samuel’s Gain
$2,430 $1,220 decrease gain by $1,220

D)
Taxes allocated to Samuel Taxes allocated to Edward Effect on Samuel’s Gain
$1,220 $2,430 decrease gain by $1,220

63) Peter is assessed $630 for street improvements in front of his house. Which of the following statements is correct?
A) Peter must deduct the assessment as a tax.
B) Peter must reduce the property basis by $630.
C) Peter must increase the property basis by $630.
D) Peter can elect to deduct the $630 currently or increase the basis in the property.

64) Hui pays self-employment tax on her sole proprietorship income, supplemental Medicare surtaxes on excess wages and self-employment income (the .09% tax) and supplemental Medicare taxes on investment income (the 3.8% tax). Which of the following statements is correct regarding the deductibility of these taxes?
A) All three of the taxes are deductible as itemized deductions.
B) One-half of the self-employment tax is deductible for AGI, and the .09% and 3.8% taxes are itemized deductions.
C) None of the taxes are allowed as a deduction.
D) One-half of the self-employment tax is deductible for AGI, but the .09% and 3.8% taxes are not allowed as deductions.

65) Which of the following is deductible as interest expense?
A) personal credit card interest
B) interest to purchase tax-exempt bonds
C) bank service charges on personal account
D) interest on a home equity loan to purchase a car

66) Riva borrows $10,000 that she intends to use for purchasing supplies for her business. She temporarily deposits the funds in her personal checking account. Prior to the deposit, the checking account held $40,000 of personal funds. Riva books a vacation for $6,000 and writes a check to the travel agency from her personal account. Later in the month, the business supplies bill arrives and Riva writes a check for $10,000 from the personal account. With respect to the interest expense on the $10,000 loan,
A) it will all be treated trade or business expense.
B) 60 percent will be treated as personal interest expense and 40 percent as trade or business expense.
C) it will all be treated as personal expense.
D) 20 percent will be treated trade or business expense.

67) When both borrowed and owned funds are mingled in the same account, for purposes of categorizing interest expense, a repayment of the debt is allocated first to
A) personal expenditures.
B) trade or business expenditures.
C) investment expenditures.
D) passive activity expenditures in real estate.

68) All of the following statements are true except
A) investment interest expense is deductible to the extent of a taxpayer’s net investment income.
B) short-term capital gains meet the definition of net investment income.
C) investment interest expense includes interest expense to purchase or carry tax-exempt securities.
D) net investment income is the taxpayer’s investment income in excess of investment expenses.

69) In the current year, Julia earns $9,000 in net investment income and incurs $14,000 of investment interest expense. What is the maximum amount of investment interest expense she is allowed to deduct this year?
A) $0
B) $3,000 deductible this year; $11,000 carried forward to next year
C) $9,000 deductible this year; $5,000 carried forward to next year
D) $14,000 deductible this year; nothing to be carried forward to next year

70) Ted pays $2,100 interest on his automobile loan, $120 interest on a loan to purchase a computer for personal use, $630 interest on credit cards, and $1,100 investment interest expense. Ted has net investment income of $850. Ted’s deductible interest is
A) $850.
B) $1,100.
C) $2,950.
D) $3,200.

71) Takesha paid $13,000 of investment interest expense in a year in which she earned $4,500 in dividends, $5,400 in interest income, and had a short-term capital gain of $1,000 and a long-term capital gain of $2,200. The capital gains resulted from the sale of stock held as an investment. She has no other investment-related expenses. What is her maximum deduction for investment interest expense, assuming Takesha does not make any elections?
A) $5,400
B) $6,400
C) $13,100
D) $13,000

72) Dana paid $13,000 of investment interest expense in a year in which she earned $4,500 in dividends, $5,400 in interest income, and had a short-term capital gain of $1,000 and a long-term capital gain of $2,200. The capital gains resulted from the sale of stock held as an investment. She has no other investment-related expenses. What is her maximum deduction for investment interest expense if Dana makes the proper elections to raise her ceiling as high as possible?
A) $5,400
B) $9,900
C) $13,100
D) $13,000

73) Faye earns $100,000 of AGI, including $90,000 of salary and $10,000 of interest income. Faye does itemize her deductions. The miscellaneous category of her itemized deductions consists of $1,500 of unreimbursed employee business expenses and a $900 fee paid for investment advice. Faye has paid $11,000 of interest expense on a loan used to purchase stocks. How much of the $11,000 interest expense can be deducted this year?
A) $11,000
B) $10,000
C) $9,100
D) $9,600

74) Teri pays the following interest expenses during the year:

Home mortgage interest on personal residence $8,500
Credit card interest on personal purchases 550
Interest on loans used to purchase investments (Net investment
income is $2,000) 2,400
Interest on loans used for a business conducted as a sole proprietorship 3,800
Interest on a credit card used exclusively in the business 470

What is the amount of interest expense that can be deducted as an itemized deduction?
A) $10,500
B) $10,900
C) $14,300
D) $14,700

75) On July 31 of the current year, Marjorie borrows $120,000 to purchase a new fishing boat. The loan is secured by her personal residence. On the date of the loan, the outstanding balance on the original debt incurred to purchase the residence is $300,000 and the FMV of the home is $450,000. What is the total amount of debt on which Marjorie can deduct interest in the current year?
A) $300,000
B) $400,000
C) $420,000
D) $450,000

76) Wayne and Maria purchase a home on April 1 of the current year. In order to obtain a thirty-year mortgage, they are required to pay $7,200 in points at closing. Charging points is a customary business practice in the area. In addition, they pay $4,400 of interest during the year. What is their current year deduction related to their home?
A) $4,400
B) $4,580
C) $7,200
D) $11,600

77) Claudia refinances her home mortgage on June 1 of the current year. She obtains a 30 year mortgage at 5%. As part of the refinancing, she pays points of $3,600 (a customary practice in her location). What amount, if any, of the points are deductible?
A) $0
B) $70
C) $120
D) $3,600

78) Leslie, who is single, finished graduate school this year and began repaying her student loan. The proceeds of the loan were used to pay her qualified higher education expenses. She has not received any type of educational assistance or scholarships. The amount of interest paid during the year amounted to $3,800. What is the amount and classification of her student loan interest education deduction if her modified AGI is $40,000?
A) $2,500 for AGI
B) $2,500 from AGI
C) $3,800 for AGI
D) $3,800 from AGI

79) Marcia, who is single, finished graduate school this year and began repaying her student loan. The proceeds of the loan were used to pay her qualified higher education expenses. She has not received any type of educational assistance or scholarships. The amount of interest paid during the year amounted to $3,000. What is the amount and classification of her student loan interest deduction if her AGI is $68,000?
A) $500 for AGI
B) $2,000 for AGI
C) $2,500 for AGI
D) $3,000 for AGI

80) Don’s records contain the following information:
1. Donated stock having a fair market value of $3,600 to a qualified charitable organization. He acquired the stock five months previously at a cost of $2,400.
2. Paid $700 to a church school as a requirement for the enrollment of his daughter.
3. Paid $200 for annual homeowner’s association dues.
4. Drove 400 miles in his personal auto at 14 cents per mile. The travel was directly related to volunteer services he performed for his church (actual costs were not available).

What is Don’s charitable contribution deduction?
A) $2,456
B) $3,156
C) $3,356
D) $3,656

81) Erin’s records reflect the following information:

1. Paid $200 dues to a fraternal organization (such as the Elks Club)
2. Donated stock having a fair market value of $3,500 to a qualified charitable organization. She purchased the stock 2 years earlier for $3,000.
3. Paid $1,600 cash to qualified public charitable organizations

Erin’s adjusted gross income for this year was $50,000. What is the amount of her charitable contribution deduction for the year?
A) $4,600
B) $4,800
C) $5,100
D) $5,300

82) Sacha purchased land in 2010 for $35,000 that she held as a capital asset. This year, she contributed the land to the Boy Scouts of America (a charitable organization) for use as a site for a summer camp. The market value of the land at the date of contribution is $40,000. Sacha’s adjusted gross income is $90,000. Assuming no special elections, Sacha’s maximum deductible contribution this year is
A) $13,000.
B) $27,000.
C) $35,000.
D) $40,000.

83) Doris donated a diamond brooch recently appraised at $25,000 to her local church. Doris had purchased it many years ago for $10,000. The church sold the brooch to provide funding for church programming. Doris’ AGI is $40,000. Doris will be able to take a charitable deduction of
A) $10,000.
B) $25,000.
C) $12,000.
D) $20,000.

84) Clayton contributes land to the American Red Cross for use as a future site for a new building. His AGI is $50,000. Clayton paid $20,000 for the land eight months ago but its market value at the date of contribution is $25,000. With no special elections, Clayton’s deductible contribution this year is
A) $7,000.
B) $18,000.
C) $20,000.
D) $25,000.

85) Carl purchased a machine for use in his trade or business two years ago for $30,000. During the current year, Carl donates the machine to the local community college. At the time of the contribution, the machine’s adjusted basis is $10,000 and its FMV is $15,000. Carl’s AGI for the year is $48,000. What is the amount of his charitable contribution deduction?
A) $10,000
B) $14,000
C) $15,000
D) $25,000

86) During the current year, Jane spends approximately 90 hours of her time in developing computer software for a church. As a programmer and data analyst, Jane normally bills her clients at $130 per hour for her time. Jane also drives her car a total of 800 miles in performing her voluntary work. Jane’s deductible contribution is
A) $0.
B) $112.
C) $11,700.
D) $11,812.

87) Carol contributes a painting to a local museum for display. Her AGI is $60,000. Carol paid $22,000 for the painting in 2006, but its market value at the date of the contribution is $25,000. With no special elections, Carol’s deductible contribution this year is
A) $ 7,000.
B) $18,000.
C) $22,000.
D) $25,000.

88) Hugh contributes a painting to a local museum for display. His AGI is $35,000. Hugh paid $16,000 for the painting in 2000, but its market value at the date of the contribution is $22,000. If Hugh makes the election to maximize the current year deduction, his deductible contribution for this year will be
A) $10,500.
B) $16,000.
C) $17,500.
D) $22,000.

89) Patrick’s records for the current year contain the following information. He donated stock having a fair market value of $5,000 to a qualified charitable organization. Patrick acquired the stock two years ago at a cost of $3,000. He paid $1,000 for membership in an athletic scholarship program maintained by the university. The only benefit of the membership is that Patrick is entitled to purchase a season ticket to the university’s home football games. He also donated $7,500 cash to a qualified charitable organization. Patrick’s adjusted gross income for the year is $100,000. What is the amount of his charitable contribution deduction?
A) $11,300
B) $11,500
C) $13,300
D) $13,500

90) Grace has AGI of $60,000 in 2013 and 2014. She makes cash contributions to public charities of $34,000 in 2013 and $31,000 in 2014. Grace’s charitable contribution carryover to 2015 is
A) $0.
B) $1,000.
C) $4,000.
D) $5,000.

91) Daniel had adjusted gross income of $60,000, which consisted of $55,000 in wages and $5,000 in dividend income from taxable domestic corporations. His expenses include:

Investment counseling fee $800
Attorney fee for preparing a will 200
Union dues 350
Tax return preparation fee 450

What is the net amount deductible by Daniel for the above items?
A) $400
B) $600
C) $1,000
D) $1,600

92) Wang, a licensed architect employed by Skye Architects, incurred the following unreimbursed expenses this year:

Subscription to architectural journals $800
Dues to Professional Architecture Society 400
Tax return preparation 600
Investment advice 500

Wang’s AGI is $75,000. What is his net deduction for miscellaneous itemized deductions?
A) $0
B) $1,900
C) $800
D) $1,500

93) Tasneem, a single taxpayer has paid the following amounts in 2014:

State income taxes $10,000
Property taxes on home 4,000
Mortgage interest on home 12,000
Charitable contributions 14,000

Tasneem’s AGI is $360,000. What is her net itemized deduction allowed?
A) $40,000
B) $38,352
C) $36,826
D) None of the above.

94) Christa has made a $25,000 pledge to the American Red Cross (a public charity). Christa expects AGI of $200,000 this year. Which of the following assets should she donate?
A) $25,000 of cash
B) stock purchased three years ago for $18,000 with a current FMV of $25,000
C) stock purchased six months ago for $28,000 with a current FMV of $25,000
D) Christa should be indifferent among the three choices.

95) Which of the following is not required substantiation for a noncash charitable contribution?
A) name and address of charitable organization
B) method used to determine the donated property’s fair market value
C) date and location of property donated
D) use of donation by charitable organization

96) During the current year, Deborah Baronne, a single individual, paid the following amounts:

Federal income tax $10,000
State income tax $4,000
Real estate taxes on land in France $1,500
Real estate taxes on land in U.S. $1,700
State sales taxes $2,000
State occupational license fee $ 600

How much can Deborah deduct in taxes as itemized deductions?

97) Phoebe’s AGI for the current year is $120,000. Included in this AGI is $100,000 salary and $20,000 of interest income. In earning the investment income, Phoebe paid investment interest expense of $30,000. She also incurred the following expenditures subject to the 2% of AGI limitation:

Investment expenses:
Subscriptions to investment journals $ 500
Investment counseling 1,500
Safe-deposit box rental for stock certificates 100
Noninvestment expenses:
Unreimbursed employee business expenses $1,800
Tax return preparation fees (non-business-related) 500

What is Phoebe’s investment interest expense deduction for the year?

98) On December 1, 2014, Delilah borrows $2,000 from her credit union to use in her business. Under the terms of the contract, Delilah actually receives $1,940 but is required to repay $2,000 in three months.
a. What amount may Delilah deduct as interest expense in 2014 and in 2015 if she is a cash basis taxpayer?
b. What amount may Delilah deduct as interest expense in 2014 and in 2015 if she is an accrual basis taxpayer?

99) During 2014 Richard and Denisa, who are married and have two dependent children, have the following income and losses:

Total salaries $150,000
Bank account interest 25,000
Short-term capital gains 4,000
Short-term capital losses ( 1,500)

They also incurred the following expenses:
Qualified medical expenses $ 8,000
State income taxes paid 12,000
Property taxes on home 2,300
Qualified residence interest 9,000
Investment interest expense 7,500
Cash charitable contributions 15,000
Tax return preparation fees 3,600
Unreimbursed employee business expenses 4,000

Compute Richard and Denisa’s taxable income for the year. (Show all calculations in good form.)

100) Hope is a marketing manager at a local company. Information about her 2014 income and expenses is as follows:

Income received
Salary $150,000
Taxes withheld from salary:
Federal income tax $30,000
State income tax 8,000
Social Security tax 7,254
Medicare tax 2,175

Interest income from bank 6,000
Dividend income from U.S. stocks 4,000
Short-term capital gain 2,000
Long-term capital gain 3,000
State income tax refund from last year 500
Expenses paid:
Unreimbursed dental and eyecare costs $1,800
Property taxes on her home 3,900
Fees paid to town for garbage pick-up 400
Stock donated to American Red Cross; FMV $5,000; purchased three years ago for $3,100
Dues paid to American Marketing Association 600
Subscription to professional marketing journals 300
Fee for preparation of 2013 tax return and IRS audit assistance 2,000
Investment advisor fee 1,000
Home mortgage interest 10,000
Interest on borrowing to purchase investment assets 11,000
Interest on car loan 1,100

Compute Hope’s taxable income for the year in good form. Show all supporting computations. Hope is single, and she elects to itemize her deductions each year. Assume she does not make any elections regarding the investment interest expense. Also assume that her tax profile was similar in the preceding year.

101) Explain under what circumstances meals and lodging en route to a medical facility may be deductible.

102) Explain when the cost of living in an institution other than a hospital may be deductible.

103) Discuss the timing of the allowable medical expense deduction.

104) Patrick and Belinda have a twelve year old son, Aidan, who is autistic. Patrick and Belinda pay tuition of $20,000 annually for Aidan to attend a school for autistic children. What tax issues should be considered? What additional information would you need?

105) Discuss what circumstances must be met for personal property taxes to be deductible.

106) Explain why interest expense on investments is limited to net investment income.

107) When are points paid on a loan deductible as interest expense?

108) Sharif is planning to buy a new car for personal use and will need to take out a loan. His sources of the financing include (1) a loan from the car dealership charging 6% interest, (2) a loan from his brokerage firm secured against his stock portfolio charging 6.2% and (3) a home equity bank loan secured against his home charging 7%. Sharif has AGI of $150,000 and does itemize his deductions. He is in the 28% tax bracket. Discuss how income taxes can influence his decision regarding the source of financing.

109) May an individual deduct a charitable contribution for services rendered to a charitable organization?

110) What is the result if a taxpayer makes a contribution to a college or university and in return receives the right to purchase tickets to athletic events?

111) What is the treatment of charitable contributions in excess of the applicable limits for the current year?

112) Explain how tax planning may allow a deduction of qualified medical expenses.

113) Explain what types of tax planning are available for taxpayers making charitable contributions.

114) Jill is considering making a donation to her church. She wants to give $50,000 for the new church building. She has some stock with a FMV of $50,000 and an adjusted basis of $10,000 that she has held for 3 years. She is planning to sell the stock and donate the $50,000 proceeds to the church. What should she consider before taking that action?

Chapter 8 Losses and Bad Debts

1) In order to be recognized and deducted on a tax return, a loss must first be realized.

2) The amount of loss realized on the sale of property is computed by subtracting adjusted basis from amount realized.

3) A loss incurred on the sale or exchange of property is deductible only if the property is used in a trade or business or held for investment.

4) The sale of inventory at a loss results in an ordinary loss.

5) Losses incurred in the sale or exchange of personal-use property are deductible as capital losses.

6) A loss on business or investment property which is abandoned is deductible as an ordinary loss to the extent of the property’s adjusted basis on the date of abandonment.

7) The total worthlessness of a security generally results in an ordinary loss.

8) A capital loss may arise from the sale or exchange of a capital asset.

9) The destruction of a capital asset by a casualty gives rise to a capital rather than ordinary loss.

10) One of the requirements which must be met for stock to be considered Section 1244 stock is that the stock must be owned by an individual or a partnership.

11) One of the requirements which must be met for stock to be considered Section 1244 stock is that the corporation cannot have more than $10 million of total capital and paid in surplus as of the stock issuance.

12) When applying the limitations of the passive activity rules, a taxpayer’s AGI is classified into active income, portfolio income and passive income. For this purpose, portfolio income includes dividends, interest, annuities, and royalties.

13) Losses from passive activities that cannot be deducted currently are carried over for up to 5 subsequent years.

14) Individual taxpayers can offset portfolio income with passive losses.

15) If a taxpayer disposes of an interest in a passive activity, unused carryover losses are available to the purchaser of the interest.

16) A taxpayer may deduct suspended losses of a passive activity when the taxpayer completely terminates his or her ownership of the activity.

17) Once an activity has been classified as passive, it is considered passive with regard to that taxpayer until it is sold.

18) A passive activity includes any rental activity or any trade or business in which the taxpayer does not materially participate.

19) Two separate business operations conducted at the same location may be treated as separate activities under the passive activity rules.

20) Partnerships and S corporations must identify their business and rental activities by applying the passive activity rules at the partnership or S corporation level and then must report the results of their operations by activity to the partners or shareholders.

21) Material participation by a taxpayer in a passive activity is satisfied if the individual participates in the activity for more than 500 hours during the year.

22) For purposes of the application of the passive loss limitations, a closely held C corporation is a C corporation where more than 50 percent of the stock is owned by five or fewer individuals at any time during the last half of the taxable year.

23) A closely held C Corporation’s passive losses may offset its active income.

24) Individuals who actively participate in the management of rental real property may deduct up to $25,000 in losses, subject to AGI limitations.

25) For purposes of applying the passive loss limitations for rental real estate, active participation requires a greater time commitment by the taxpayer than does material participation.

26) Taxpayers are allowed to recognize net passive losses from all activities up to a ceiling of $25,000.

27) A taxpayer may deduct a loss resulting from the theft of business and investment property but not a theft of personal-use property.

28) When business property involved in a casualty is totally destroyed, the amount of the loss is limited to the lesser of the taxpayer’s adjusted basis in the property or the reduction in FMV.

29) In the case of casualty losses of personal-use property, the losses sustained in each separate casualty are reduced by both $100 and 10 percent of the taxpayer’s AGI for the year.

30) A theft loss is deducted in the year in which the theft is discovered.

31) When personal-use property is covered by insurance, no deduction is available for a casualty loss of the property unless the taxpayer timely files an insurance claim for the loss.

32) When the taxpayer anticipates a full recovery on a casualty loss of personal-use property but receives less than full recovery in a subsequent year, the unrecovered portion may be deducted.

33) If a taxpayer suffers a loss attributable to a disaster in an area subsequently declared a disaster area, the casualty loss may be deducted in the year preceding the year in which the loss actually occurs.

34) For a bad debt to be deductible, the taxpayer must have a basis in the debt.

35) A bona fide debtor-creditor relationship can never exist in the case of related parties.

36) A taxpayer guarantees another person’s obligation and is forced to pay the debt under the terms of the guarantee. The original debtor does not repay the taxpayer. The taxpayer/guarantor may deduct the loss.

37) Lisa loans her friend, Grace, $10,000 to finance a new business. If Grace defaults on the loan, Lisa may take a deduction for a business bad debt in the year of total worthlessness.

38) A business bad debt gives rise to an ordinary deduction while a nonbusiness bad debt is treated as a short-term capital loss.

39) No deduction is allowed for a partially worthless nonbusiness debt.

40) A net operating loss (NOL) occurs when taxable income for any year is negative because itemized deductions and total exemptions exceed business income.

41) A net operating loss can be carried back three years or carried forward five years.

42) All of the following losses are deductible except
A) decline in value of securities.
B) total worthlessness of securities.
C) sale or exchange of business property.
D) destruction of personal use property by fire, storm, or casualty.

43) The amount realized by Matt on the sale of property to Caitlin includes all of the following with the exception of
A) cash received by Matt.
B) mortgage on the property that is assumed by Caitlin.
C) mortgage on the property paid off by Matt prior to the sale.
D) the FMV of any other property received by Matt in the transaction.

44) In 2000, Michael purchased land for $100,000. Over the years, economic conditions deteriorated, and the value of the land declined to $60,000. Michael sells the property in this year, when it is subject to a $30,000 nonrecourse mortgage. The buyer pays Michael $34,000 cash and takes the property subject to the mortgage. Michael incurs $5,000 in real estate commissions. Michael’s gain or loss on the sale is
A) $4,000 gain.
B) $1,000 loss.
C) $36,000 loss.
D) $41,000 loss.

45) Lucia owns 100 shares of Cronco Inc. which she purchased on December 1 of last year for $10,000. The stock is not Sec. 1244 stock. On July 1 of the current year, Lucia receives notice from the bankruptcy court that Conco Inc. has been liquidated, and there are no assets remaining for shareholders. As a result, Lucia will have
A) a short-term capital loss of $10,000.
B) a long-term capital loss of $10,000.
C) an ordinary loss of $10,000.
D) no loss allowed.

46) Jamie sells investment real estate for $80,000, resulting in a $15,000 loss. Jamie’s loss is
A) an ordinary loss.
B) a capital loss.
C) a Sec. 1231 loss.
D) a Sec. 1244 loss.

47) Juan has a casualty loss of $32,500 on investment property after receiving an insurance settlement. This is Juan’s only casualty transaction this year. Juan’s loss is
A) an ordinary loss.
B) a capital loss.
C) a Sec. 1231 loss.
D) a Sec. 1244 loss.

48) All of the following are true of losses from the sale or worthlessness of small business corporation (Section 1244) stock with the exception of
A) the stock must be owned by an individual or a partnership.
B) the stock must have been issued by a domestic corporation.
C) the stock must have been issued for cash or property other than stock or securities.
D) a single taxpayer may deduct, as ordinary losses, up to a maximum of $100,000 per tax year with the remainder treated as capital losses.

49) Stacy, who is married and sole shareholder of ABC Corporation, sold all of her stock in the corporation for $100,000. Stacy had organized the corporation in 2009 by contributing $225,000 and receiving all of the capital stock of the corporation. ABC Corporation is a domestic corporation engaged in the manufacturing of ski boots. The stock in ABC Corporation qualified as Sec. 1244 stock. The sale results in a(n)
A) ordinary loss of $125,000.
B) long-term capital loss of $125,000.
C) long-term capital loss of $100,000 and ordinary loss of $25,000.
D) ordinary loss of $100,000 and long-term capital loss of $25,000.

50) Amy, a single individual and sole shareholder of Brown Corporation, sold all of the Brown stock for $30,000. The stock basis was $150,000. Amy had owned the stock for 3 years. Brown Corporation meets the Section 1244 requirements. Amy has
A) a $50,000 ordinary loss and $70,000 LTCL.
B) a $50,000 STCL and a $70,000 LTCL.
C) a $100,000 ordinary loss and a $20,000 LTCL.
D) a $100,000 LTCL and a $20,000 ordinary loss.

51) Sarah had a $30,000 loss on Section 1244 stock, a $15,000 loss on sale of a personal use automobile and a $8,000 loss on stock that is not classified as Section 1244. Without regard to net capital loss limitations, Sarah should recognize
A) a ordinary loss of $38,000.
B) a capital loss of $53,000.
C) an ordinary loss of $30,000 and a capital loss of $8,000.
D) an ordinary loss of $30,000 and a capital loss of $23,000.

52) During the year, Mark reports $90,000 of active business income from his law practice. He also owns two passive activities. From Activity A, he earns $20,000 of income, and from Activity B, he incurs a $30,000 loss. As a result, Mark
A) reports AGI of $80,000.
B) reports AGI of $90,000 with a $10,000 passive loss carryover.
C) reports AGI of $90,000 with a $30,000 passive loss carryover.
D) reports AGI of $110,000 with a $30,000 passive loss carryover.

53) Joy reports the following income and loss:

Salary $ 120,000
Income from activity A 60,000
Loss from activity B ( 35,000)
Loss from activity C ( 55,000)

Activities A, B, and C are all passive activities.

Based on this information, Joy has
A) adjusted gross income of $90,000.
B) salary of $120,000 and deductible net losses of $30,000.
C) salary of $120,000 and net passive losses of $30,000 that will be carried over.
D) salary of $120,000, passive income of $60,000, and passive loss carryovers of $90,000.

54) Jana reports the following income and loss:

Salary $ 120,000
Income from activity A 60,000
Loss from activity B ( 30,000)
Loss from activity C ( 70,000)

Activities A, B, and C are all passive activities.
Based on this information, Joy has the following suspended losses:

A)
Activity B Activity C
$30,000 $70,000

B)
Activity B Activity C
$0 $0

C)
Activity B Activity C
$18,000 $42,000

D)
Activity B Activity C
$12,000 $28,000

55) Jeff owned one passive activity. Jeff sold the activity and realized a $2,000 gain on the sale. Prior to the sale, he realized a current year loss from the activity of $6,000. In addition, he has suspended losses from prior years of $7,000. What is the net impact on Jeff’s AGI this year due to the passive activity?
A) increase of $2,000
B) no net change
C) decrease of $4,000
D) decrease of $11,000

56) Nancy reports the following income and loss in the current year.

Salary $ 60,000
Income from activity A 18,000
Loss from activity B ( 9,000)
Loss from activity C ( 13,000)

All three activities are passive activities with respect to Nancy. Nancy also has $21,000 of suspended losses attributable to activity C carried over from prior years. During the year, Nancy sells activity C and realizes a $15,000 taxable gain. What is Nancy’s AGI as a result of these transactions?
A) $50,000
B) $55,000
C) $64,000
D) $71,000

57) Lewis died during the current year. Lewis owned passive activity property with a FMV of $61,000 and a basis of $48,000. Suspended losses of $15,000 were attributable to the property. How much of the suspended loss is deductible on Lewis’s final income tax return?
A) $0
B) $2,000
C) $13,000
D) $15,000

58) Mara owns an activity with suspended passive losses from prior years of $13,000. In the current year, Mara becomes a material participant in the activity. This year the activity generates $6,000 of income. The net effect of this activity on Mara’s current year AGI is a(n)
A) increase of $6,000.
B) decrease of $13,000.
C) 0.
D) decrease of $7,000.

59) Charlie owns activity B which was considered a passive activity and generated a $17,000 suspended loss. Charlie increases his involvement with activity B so that this year activity B is not considered passive for Charlie. During this year, activity B produces a $9,000 loss. In addition, Charlie acquires an investment in activity X, a passive activity, this year. Charlie’s share of activity X’s income is $13,000. Charlie’s salary this year is $70,000. As a result, this year Charlie must
A) offset B’s loss carryover against X’s current income and carry over $9,000 loss from activity B to next year.
B) offset B’s carryover loss and current loss against X’s income first and then offset any remaining loss against salary.
C) offset B’s $9,000 loss against X’s $13,000 income and offset B’s loss carryover against the remaining $4,000 of X’s income.
D) offset B’s current $9,000 loss against his salary and offset B’s loss carryover against X’s income and carry over $4,000 of loss to next year.

60) Jorge owns activity X which produced a $20,000 passive loss last year. Jorge’s only income last year was wages of $30,000. Jorge is a material participant in activity X this year when it produces a $14,000 loss. This year, Jorge’s wages are $40,000. This year, Jorge also has passive activity income from activity Y of $16,000. What is the total passive activity loss carryover to next year?
A) $0
B) $3,000
C) $4,000
D) $18,000

61) Which of the following is not generally classified as a passive activity?
A) an activity in which the taxpayer does not materially participate
B) a limited partnership interest
C) rental real estate
D) a business in which the taxpayer owns an interest and works 1,000 hours a year

62) An individual is considered to materially participate in an activity if any of the following tests are met with the exception of
A) the individual participates in the activity for more than 500 hours during the year.
B) the individual participates in the activity for 75 hours during the year, and that participation is more than any other individual’s participation for the year.
C) the individual has materially participated in the activity in any five years during the immediate preceding 10 taxable years.
D) the individual’s participation in the activity for the year constitutes substantially all of the participation in the activity by all individuals.

63) Tom and Shawn own all of the outstanding stock of Brady Corporation (a retail store operated as a C corporation). This year, Brady generates taxable income of $20,000 from active business operations, and also reports investment interest of $22,000 and losses of $28,000 from a passive activity. As a result, Brady Corporation reports
A) net income of $42,000.
B) interest income of $22,000 and a passive loss carryover of $8,000.
C) business income of $20,000 and a passive loss carryover of $6,000.
D) business income of $20,000, interest income of $22,000, and a passive loss carryover of $28,000.

64) A taxpayer’s rental activities will be considered a trade or business, rather than a passive activity, if
A) the taxpayer performs more than 750 hours of work during the year managing the rental properties
B) the taxpayer performs more than 500 hours of work during the year managing the rental properties.
C) more than half of the taxpayers personal services performed in all business activities during the year are spent managing the rental properties.
D) conditions A and C, but not B, are satisfied.

65) Justin has AGI of $110,000 before considering his $30,000 loss from rental property, which he actively manages. How much of the rental loss can Justin deduct this year?
A) $10,000
B) $20,000
C) $25,000
D) $30,000

66) Joseph has AGI of $170,000 before considering the $20,000 rental loss for property which he actively manages. How much of the rental loss can he deduct?
A) $0
B) $10,000
C) $20,000
D) $25,000

67) Shaunda has AGI of $90,000 and owns rental property generating a $27,000 loss. She actively manages the property. Her deductible loss is
A) $0.
B) $13,500.
C) $25,000.
D) $27,000.

68) Brandon, a single taxpayer, had a loss of $48,000 from a rental real estate activity in which he actively participated. He also had $27,000 of income from another rental real estate activity in which he actively participated. He acquired both investments in 2014. If Brandon has no other passive income or losses and has adjusted gross income of $84,000 before considering passive activities, how much loss from rental activities can he use to offset his nonpassive income?
A) $21,000
B) $24,000
C) $25,000
D) $45,000

69) Which of the following is most likely not considered a casualty?
A) fire loss
B) water damage caused by a busted water heater
C) death of a pine tree due to a two-day infestation of pine beetles
D) water damage to the walls and ceiling of a taxpayer’s personal residence as the result of gradual deterioration of the roof

70) Nicole has a weekend home on Pecan Island that she purchased in 2005 for $250,000. Recently, the home was appraised at $260,000. After the appraisal, a hurricane hit Pecan Island, severely damaging Nicole’s home. An appraisal placed the value of the home at $140,000 after the hurricane. Because of its prohibitive cost, Nicole had no hurricane insurance. Before any reductions or limitations, Nicole’s casualty loss amount is
A) $0.
B) $10,000.
C) $120,000.
D) $140,000.

71) A fire totally destroyed office equipment and furniture which Monica uses in her business. The equipment had an adjusted basis of $15,000 and a FMV of $10,000 before the fire. The furniture’s adjusted basis was $5,000 and its FMV was $2,000 before the fire. Monica’s AGI for the year is $60,000. Monica does not have insurance on the destroyed assets. How much is Monica’s deductible casualty loss?
A) $5,900
B) $12,000
C) $13,900
D) $20,000

72) Lena owns a restaurant which was damaged by a tornado. The following assets were partially destroyed:

Basis Reduction in FMV Insurance Payment
Building $150,000 $200,000 $100,000
Equipment $30,000 $20,000 $10,000

Lena has AGI of $50,000. What is the amount of Lena’s deductible casualty loss?
A) $54,900
B) $60,000
C) $70,000
D) $180,000

73) Leonard owns a hotel which was damaged by a hurricane. The hotel had an adjusted basis of $1,000,000 before the hurricane. A recent appraisal determined that the hotel’s FMV was $1,500,000 before the hurricane and $700,000 afterwards. Leonard received insurance proceeds of $500,000. His AGI is $60,000. What is the amount of his deductible casualty loss?
A) $293,900
B) $300,000
C) $793,900
D) $800,000

74) Jarrett owns a mountain chalet that he purchased in 2008 for $175,000. This year, the home appraised at $300,000. Shortly after the appraisal, a blizzard hit the area in spring of the current year, destroying trees and severely damaging several homes, including Jarrett’s chalet. Its value was reduced to $135,000. Jarrett does not have insurance. Jarrett’s AGI is $200,000. Jarrett’s deductible loss after limitations is
A) $135,000.
B) $144,900.
C) $164,900.
D) $165,000.

75) Hope sustained a $3,600 casualty loss due to a severe storm. She also incurred a $800 loss from a theft in the same year. Both the casualty and theft involved personal-use property. Hope’s AGI for the year is $25,000 and she does not have insurance coverage. Hope’s deductible casualty loss is
A) $1,700.
B) $1,800.
C) $4,200.
D) $4,300.

76) In the current year, Marcus reports the following casualty gains and losses on personal-use property. Assets X and Y are destroyed in the first casualty while Z is destroyed in a second casualty.

Asset Reduction
in FMV Adjusted Basis Insurance Holding Period
X $8,000 $2,000 $7,000 2 years
Y 3,000 5,000 2,000 10 months
Z 2,500 1,300 1,000 8 months

As a result of these losses and insurance recoveries, Marcus must report
A) a net gain of $3,700.
B) a long-term gain of $4,900 on asset X; a short-term capital loss of $900 on asset Y; and a short-term capital loss of $200 on asset Z.
C) a long-term capital gain of $5,000 on asset X; a short-term capital loss of $900 on asset Y; and a short-term capital loss of $200 on asset Z.
D) a long-term capital gain of $5,000 on asset X; a short-term capital loss of $900 on asset Y; and a short-term capital loss of $300 on asset Z.

77) Wesley completely demolished his personal automobile in a car accident. Damage to the auto was estimated at $35,000. Wesley had purchased the car a few years ago for $60,000. He received an insurance reimbursement of $28,000. His adjusted gross income this year was $55,000 and he incurred no other losses during the year. What amount can he deduct as a casualty loss on his income tax return after limitations?
A) $1,400
B) $1,500
C) $6,900
D) $7,000

78) A flood damaged an auto owned by Mr. and Mrs. South on June 15 of this year. The car was only used for personal purposes.

Fair market value before the flood $18,500
Fair market value after the flood 2,000
Cost basis 20,000
Insurance proceeds 13,000
Adjusted gross income for this year 25,000
Business use of auto 0

Based on these facts, what is the amount of the South’s casualty loss deduction after limitations for this year?
A) $900
B) $1,000
C) $4,400
D) $4,500

79) In February 2014, Amelia’s home, which originally cost $150,000, is damaged by a windstorm. Amelia had refinanced the home shortly before the storm, and it was appraised at $200,000. After the storm, the home appraised at $120,000. Amelia has received no insurance reimbursement by December 31, but expects to recover 90 percent of the loss. In the subsequent year, the insurance company pays Amelia $50,000. Amelia’s AGI is $85,000 in 2014, and her 2015 AGI is $80,000. Amelia suffers no other casualty losses in either year. Amelia may deduct
A) $7,900 in 2014.
B) $22,000 in 2015.
C) $13,900 in 2015.
D) $14,000 in 2015.

80) This summer, Rick’s home (which has a basis of $80,000) is damaged by a tornado. An appraisal by a realtor placed the FMV of the home at $120,000 before the tornado and at $85,000 after the tornado. Rick estimates that the insurance company will reimburse him for 60% of the loss. Next year, the insurance company pays Rick $20,000. Rick’s current year’s AGI is $50,000 and his next year’s AGI is $55,000. Rick suffers no other casualty losses in either year. After limitations, Rick may deduct a casualty loss this year of
A) $ 8,900.
B) $ 9,900.
C) $15,000.
D) $35,000.

81) Juanita, who is single, is in an automobile accident in 2014 and her car sustains $6,200 in damages. Because both drivers received tickets in the accident, Juanita does not expect to recover any of the loss from her insurance company. Juanita’s 2014 AGI is $31,000, and she deducts a $3,000 loss on her 2014 tax return. Her other itemized deductions in 2014 exceed $12,000. In 2015, Juanita’s insurance company reimburses her $2,800. Juanita’s 2015 AGI is $28,000. As a result, Juanita must
A) amend 2014 to show a $200 loss.
B) do nothing and simply keep the $2,800.
C) do nothing to the 2014 return but report $2,800 of income on her 2015 return.
D) amend the 2014 return to show $0 loss and file her 2015 return to show a $200 loss.

82) Constance, who is single, is in an automobile accident in 2014, and her car sustains $6,200 in damages. Because both drivers received tickets in the accident, Constance does not expect to recover any of the loss from her insurance company. Constance’s 2014 AGI is $31,000. Her casualty loss is $3,000; she has other itemized deductions of $1,200. In 2015, Constance’s insurance company reimburses her $2,800. Constance’s 2015 AGI is $28,000. As a result, Constance must
A) amend the 2015 return to show the $200 loss.
B) do nothing and simply keep the $2,800.
C) amend the 2014 return to show $0 loss and file her 2015 return to show $200 loss.
D) do nothing to the 2014 return but report $2,800 of income on her 2015 return.

83) Last year, Abby loaned Pat $10,000 as a gesture of their friendship. Although Pat had signed a note payable that contained interest payments and a maturity date, the loan had not been repaid this year when Pat died insolvent. For this year, assuming that the loan was bona fide, Abby should account for nonpayment of the loan as a(n)
A) itemized deduction.
B) ordinary loss.
C) long-term capital loss.
D) short-term capital loss.

84) In October 2014, Jonathon Remodeling Co., an accrual-method taxpayer, remodels and renovates an office building for Dale and bills him $30,000. Dale signs a note for the debt. Dale keeps delaying payment and files bankruptcy in 2015. Creditors are informed that no assets are available for payment. Jonathon Remodeling Co. will report
A) $0 income in both years.
B) $30,000 income in 2014 and a bad debt deduction of $30,000 in 2015.
C) $30,000 income in 2014 and a STCL of $30,000 in 2015 limited to $3,000 after netting.
D) $30,000 income in 2014 and then must amend last year’s return to show $0 income when advised of the bankruptcy.

85) Martha, an accrual-method taxpayer, has an accounting practice. In 2013, she performs tax analyses for Arnold and sends him an invoice for $10,000. In 2014, Martha sells her practice and all accounts to David. Arnold’s debt becomes worthless that year after David has purchased the practice. The result is
A) Martha deducts a nonbusiness bad debt in 2014.
B) Martha deducts a business bad debt in 2014.
C) David deducts a business bad debt in 2014.
D) David deducts a nonbusiness bad debt in 2014.

86) Vera has a key supplier for her business who was facing cash flow problems which would impair Vera’s ability to get shipments of key components for her production. Vera made a $10,000 loan to the supplier. Unfortunately the supplier filed for bankruptcy and has gone out of business without repaying Vera. Vera will be able to recognize a loss of
A) $10,000.
B) $3,000.
C) $7,000.
D) 0.

87) In 2013 Grace loaned her friend Paula $12,000 to invest in various stocks. Paula signed a note to repay the principal with interest. Unfortunately the market for that industry sector plunged, and Paula incurred large losses. In 2014 Paula declared personal bankruptcy and Grace was unable to collect any of her loan. Grace had no other gains or losses last year or this year. The result is
A) Grace deducts a business bad debt of $12,000 in 2014.
B) Grace deducts a $12,000 nonbusiness bad debt as a short-term capital loss in 2014.
C) Grace deducts a $3,000 nonbusiness bad debt as a short-term capital loss in 2014 and carries $9,000 over to subsequent years.
D) Grace deducts a business bad debt of $3,000 in 2014 and carries $9,000 over to subsequent years.

88) Which of the following expenses or losses could create a net operating loss for an individual taxpayer?
A) large losses on sales of investment assets
B) an operating loss from a sole proprietorship
C) large charitable contributions
D) all of the above

89) An individual taxpayer has negative taxable income for the year. In calculating the net operating loss created, which of the following expenses or losses will be added back to the negative taxable income?
A) capital losses
B) personal and dependency exemptions
C) nonbusiness deductions in excess of nonbusiness income
D) all of the above

90) A taxpayer incurs a net operating loss in the current year. With respect to the application of the NOL,
A) the taxpayer will carry back the NOL three years first, then carry forward any balance for five years.
B) the taxpayer must carry forward the loss and has up to 20 years to use it.
C) the taxpayer can carry forward the loss indefinitely until there is sufficient taxable income to use it up.
D) the taxpayer will first carry back the NOL for two years, then carryforward the balance for a period of 20 years, or the taxpayer can elect to only carry forward the loss for the 20-year allowable period.

91) Kendal reports the following income and loss:

Salary $120,000
Income from activity A 36,000
Loss from activity B ( 30,000)
Loss from activity C ( 60,000)

Activities A, B, and C are all passive activities, but none are rental properties. What is the amount of the suspended loss attributable to each activity?

92) During the year, Patricia realized $10,000 of taxable income from activity A, $4,000 loss from activity B, and $6,000 of taxable income from activity C. All three activities are passive activities with regard to Patricia, but are not rental properties. In addition, $32,000 of passive losses from activity C is carried over from prior years. During the current year, Patricia sells activity C for an $18,000 taxable gain. Patricia’s salary for the year is $100,000. What is the amount of Patricia’s deduction against salary income?

93) Hersh realized the following income and loss this year:

Net taxable income from chocolate shop $50,000
Interest income 10,000
Loss from passive activity (not a rental property) (58,000)

a. Assume Hersh is an individual taxpayer and the chocolate shop is his sole proprietorship. Determine Hersh’s AGI and any carryovers.
b. Assume the taxpayer is Hersh Inc., a C corporation, owned 100% by the Hersh family. Determine Hersh Inc.’s taxable income and any carryovers.

94) Adam owns interests in partnerships A and B, both of which are Publicly Traded Partnerships. During the current year, Adam’s share of the income from A is $12,000. Adam’s share of B’s loss is $3,500. B also generates portfolio income of which Adam’s share is $2,000. What are the tax consequences of these income and loss items?

95) Parveen is married and files a joint return. He reports the following items of income and loss for the year:

Salary $ 135,000
Activity A (passive) 13,000
Activity B (nonbusiness rental real estate) ( 45,000)

If Parveen actively participates in the management of Activity B, what is his AGI for the year and what is the passive loss carryover to next year?

96) Aretha has AGI of less than $100,000 and a 25% marginal tax rate. During the year, she reports a $36,000 loss from Activity A and a $24,000 loss from Activity B. Additionally, Activity A generates $8,000 of tax credits. Both activities A and B are passive real estate rental activities in which Anita actively participates and owns over 10% of each activity.
a. How much loss can be recognized from each activity?
b. What is the amount of Aretha’s suspended loss from each activity?
c. How much of the tax credits can be applied this year?

97) Wes owned a business which was destroyed by fire in May 2014. Details of his losses follow:

Adj. FMV FMV Insurance
Asset Basis Before After Reimbursement
A $1,000 $2,000 $ 0 $2,000
B 15,000 10,000 3,000 2,000
C 2,400 5,000 2,500 1,000

His AGI without consideration of the casualty is $45,000.

What is Wes’s net casualty loss deduction for 2013?

98) Determine the net deductible casualty loss on the Schedule A for Alan Michael when his adjusted gross income was $40,000 in 2014 and the following occurred:

Adj. FMV FMV Insurance
Asset Basis Before After Reimbursement
A $1,200 $2,000 $ 500 $ 100
B 14,000 12,000 5,000 1,100
C 600 3,000 2,775 125

A and B were destroyed in the same casualty in March. C was destroyed in a separate casualty in July.

All casualty losses were nonbusiness personal use property losses and none occurred in a federally declared disaster area.

What is the amount of the net deductible casualty loss?

99) Frank loaned Emma $5,000 in 2012 with the agreement that the loan would be repaid in three years. In 2013, Emma filed for bankruptcy and based on available information from the bankruptcy court, it was estimated that Frank could expect to receive $.65 on the dollar. In 2014, final settlement was made and Frank received $600.
a. Assuming the loan is a business bad debt, what is the amount of and the nature of Frank’s deduction in 2013?
b. Assuming the loan is a business bad debt, what is the amount of and the nature of Frank’s deduction in 2014?
c. Assuming instead that the loan is a nonbusiness bad debt, what is the amount of and the nature of Frank’s deduction in 2013 and 2014?

100) Becky, a single individual, reports the following taxable items in 2014:

Gross income from business $ 93,000
Minus: Business expenses ( 105,000)
($ 12,000)
Interest income 1,500
AGI ($ 10,500)

Itemized deductions:
Interest expense $ 3,100
State Income Taxes 1,900
Casualty 3,000
Total itemized deductions ( 8,000)
Minus: Personal exemption ( 3,950)
Taxable income ($22,450)

What is Barbara’s NOL for the year?

101) Harley, a single individual, provided you with the following information for this year:

Income:
Salary from part-time employment $ 16,000
Interest income from savings 1,000
Net long-term capital gain from investment property 3,000

Deductions:
Net business loss
(sales of $100,000 less expenses of $130,000) ($30,000)
Personal exemption ( 3,950)
Standard deduction ( 6,200)
Net-operating loss carryover from last year ( 3,000)

What is the amount of Harley’s net operating loss for this year?

102) Businesses can recognize a loss on abandoned property. What types of factors would indicate that property had been abandoned?

103) What must an individual taxpayer prove to receive a worthless security deduction?

104) Erin, a single taxpayer, has 1,000 shares of 1244 stock she purchased directly from AAA Corporation for $120,000 five years ago. The stock has a FMV of $30,000, and Erin is thinking of selling the stock. She has no other capital gains or losses for the year. Discuss the tax consequences and planning opportunities relating to selling the stock.

105) Why was Section 1244 enacted by Congress? Specifically, consider and discuss some of the individual qualifying requirements of Sec. 1244.

106) Why did Congress enact restrictions and limitations on losses from passive activities?

107) What is required for an individual to be considered as actively participating in a real estate activity for purposes of utilizing the $25,000 ceiling on rental real estate losses?

108) What is or are the standards that must be present to warrant a casualty loss deduction?

109) A taxpayer suffers a casualty loss on personal-use property for which he has insurance coverage. However, to avoid a premium adjustment, the taxpayer fails to make a timely claim. In this situation is the full deduction for the casualty, after the normal floors, available to the taxpayer? Why or why not?

110) If a loan has been made to a related party, what are some considerations for determining whether the loan is a bona fide debt or is, in fact, merely a gift?

111) Distinguish between the accrual-method taxpayer and the cash-method taxpayer with regard to basis in a receivable.

112) What are some factors which indicate that a debt may be worthless?

113) If an NOL is incurred, when would a taxpayer elect to forgo the carryback period and only carry the loss deduction forward?

114) How is a claim for refund of taxes filed by an individual who carries an NOL deduction back to a prior year?

Chapter 9 Employee Expenses and Deferred Compensation

1) Deferred compensation refers to methods of compensating employees based upon their current service where the benefits are deferred until future periods.

2) If an individual is self-employed, business-related expenses are deductions for AGI.

3) Unreimbursed employee business expenses are deductions for AGI.

4) An employer-employee relationship exists where the employer has the right to control and direct the individual providing services with regard to the end result and the means by which the result is accomplished.

5) A nondeductible floor of 2% of AGI is imposed on unreimbursed employee business expenses, investment expenses, and many other miscellaneous itemized deductions such as tax preparation fees.

6) Gambling losses are miscellaneous itemized deductions subject to the 2% of AGI floor.

7) Personal travel expenses are deductible as miscellaneous itemized deductions subject to the 2% of AGI floor.

8) The deduction for unreimbursed transportation expenses for employees is subject to the 2% of AGI floor.

9) If an individual is not “away from home,” expenses related to local transportation are never deductible.

10) Jason, who lives in New Jersey, owns several apartment buildings in Baltimore. His travel expenses to Baltimore to inspect his property are tax deductible.

11) According to the IRS, a person’s tax home is the location of the family residence regardless of the location of the taxpayer’s principal place of employment.

12) In determining whether travel expenses are deductible, a general rule is that if a person is reassigned for an indefinite period, the individual’s tax home shifts to the new location and travel expenses are not deductible.

13) Travel expenses related to temporary work assignments of one year or less are deductible.

14) If the purpose of a trip is primarily personal and only secondarily related to business, the transportation costs to and from the destination are deductible.

15) Incremental expenses of an additional night’s lodging and additional day’s meals that are incurred to obtain “excursion” air fare rates with respect to employees whose business travel extends over Saturday night are not deductible business expenses.

16) Travel expenses for a taxpayer’s spouse are deductible if the spouse is an employee, the travel is for a bona fide purpose, and the expenses are otherwise deductible.

17) Travel expenses related to foreign conventions are disallowed unless the meeting is directly related to the taxpayer’s business or is employment related and it is reasonable for the meeting to be held outside of North America.

18) Commuting to and from a job location is a deductible expense.

19) Transportation expenses incurred to travel from one job to another are deductible if a taxpayer has more than one job.

20) Taxpayers may use the standard mileage rate method when five vehicles are used simultaneously for business.

21) If the standard mileage rate is used in the first year, the actual expense method may not be used in future years.

22) A taxpayer goes out of town to a business convention. The 50% reduction applies to the cost of food, entertainment and transportation expenses.

23) Self-employed individuals receive a for AGI deduction for 50% of entertainment expenses paid or incurred in the trade or business.

24) If an employee incurs business-related entertainment expenses that are fully reimbursed, it is the employer who is subject to the 50% limitation.

25) A tax adviser takes a client to a major league hockey game following the conclusion of a meeting involving the signing of a major planning engagement. As it is not “directly related,” the entertainment cannot be deductible.

26) “Associated with” entertainment expenditures generally must occur on the same day that business is discussed.

27) Dues paid to social or athletic clubs are deductible if they meet a primary-use test, requiring that more than 50% of the use of the facility be for business purposes.

28) Generally, 50% of the cost of business gifts is deductible up to $25 per donee per year.

29) A gift from an employee to his or her superior does not qualify as a business gift.

30) An accountant takes her client to a hockey game following a business meeting. Because it is a playoff game, and the tickets were purchased that day, a premium was paid. The deduction for the tickets is limited to 50% of the face value.

31) If an employee incurs travel expenditures and is fully reimbursed by the employer, neither the reimbursement nor the deduction is reported on the employee’s tax return if reporting is pursuant to an accountable plan.

32) Kim currently lives in Buffalo and works in Rochester, a 60-mile commute each way. Kim accepts a new job in a town outside of Rochester, and the new commute is 75-miles each way. Kim decides the commute for the new job is too long, and she moves to Rochester. Kim is eligible to deduct her moving expenses.

33) Deductible moving expenses include the cost of moving household goods and personal effects as well as temporary living expenses.

34) When a public school system requires advanced education for a teacher to continue employment, the teacher’s expenses are a deductible education expense.

35) Educational expenses incurred by a CPA for courses necessary to meet continuing education requirements are fully deductible.

36) Educational expenses incurred by a bookkeeper for courses necessary to sit for the CPA exam are fully deductible.

37) In-home office expenses are deductible if the office is used exclusively on a regular basis as the principal place of business for any trade or business of the taxpayer.

38) In addition to the general requirements for in-home office expenses, employees must also prove that the exclusive use of the office is for the convenience of the employer.

39) In-home office expenses for an office used by the taxpayer for administrative or management activities of the taxpayer’s trade or business are never deductible.

40) In-home office expenses which are not deductible in the year in which the costs were incurred due to limitations may be carried forward to subsequent years.

41) An employer receives an immediate tax deduction for pension and profit-sharing contributions made on behalf of employees.

42) In a defined contribution pension plan, fixed amounts are contributed based upon a specific formula and retirement benefits are based on the value of a participant’s account at the time of retirement.

43) A qualified pension plan requires that employer-provided benefits must be 100 percent vested after five years of service.

44) Under a qualified pension plan, the employer’s deduction is usually deferred until the employee recognizes income.

45) Nonqualified deferred compensation plans can discriminate in favor of highly compensated executives.

46) Corporations issuing incentive stock options receive a tax deduction for compensation expense.

47) Employees receiving nonqualified stock options recognize ordinary income at the grant date or exercise date if there is a readily ascertainable fair market value.

48) A sole proprietor establishes a Keogh plan. The highest effective percentage of earned income she can contribute is 25 percent.

49) SIMPLE retirement plans allow a higher level of employer contributions than do SEP IRAs.

50) The maximum tax deductible contribution to a traditional IRA in 2014 is $5,500 ($6,500 for a taxpayer age 50 or over).

51) The maximum tax deductible contribution to a Roth IRA in 2014 is $5,500 ($6,500 for a taxpayer age 50 or over).

52) A contributor may make a deductible contribution to a Coverdell Education Savings Account for a qualified designated beneficiary of up to $2,000.

53) All taxpayers are allowed to contribute funds to Health Savings Accounts to supplement their health insurance.

54) In which of the following situations is the individual is an independent contractor rather than an employee?
A) a nurse who is directly supervised by doctors in an office
B) a computer programmer who is instructed as to what projects to undertake, programming language and format, and hours of work
C) a nurse who travels to several different patients. She sets her own hours and is responsible for the delivery of nursing care and end result
D) a teacher whose hours, classroom responsibilities, content and methods of instruction are established by the school

55) Which of the following statements regarding independent contractors and employees is true (ignore temporary provisions)?
A) Independent contractors pay Social Security and Medicare tax of 15.3%.
B) Employees must pay unemployment taxes.
C) Independent contractors and employees pay the same Social Security and Medicare tax rates.
D) Independent contractors deduct their business expenses “from AGI.”

56) West’s adjusted gross income was $90,000. During the current year he incurred and paid the following:

Publications (unreimbursed and related to employment) $2,000
Tax return preparation fee 1,000
Dues to professional organizations 1,500
Fees for will preparation (no tax advice) 800
Life insurance premiums 1,400

Assuming he can itemize deductions, how much should West claim as miscellaneous itemized deductions (after limitations have been applied)?
A) $2,700
B) $4,500
C) $3,500
D) $5,300

57) Allison, who is single, incurred $4,000 for unreimbursed employee expenses, $10,000 for mortgage interest and real estate taxes on her home, and $500 for investment counseling fees. Allison’s AGI is $80,000. Allison’s allowable deductions from AGI are (after limitations have been applied)
A) $10,500.
B) $12,900.
C) $14,000.
D) $14,500.

58) All of the following are allowed a “For AGI” deduction except:
A) Cora owns her own CPA firm and travels from Lafayette, LA. to Washington, D.C. to attend a tax conference.
B) Jennifer, who lives in Houston, is the owner or several apartment buildings in Salt Lake City and travels there to inspect and manage her investments.
C) Alan is self-employed and is away from home overnight on job-related business.
D) Alison is an employee who is required to travel to company facilities throughout the U.S. in the conduct of her management responsibilities. She is not reimbursed by her employer.

59) Ron is a university professor who accepts a visiting position at another university for six months and
obtains a leave of absence from his current employer. Ron rents an apartment near the university and purchases his food. These living expenses incurred by Ron while visiting the university will be
A) deductible for AGI.
B) deductible from AGI, without application of a floor.
C) deductible from AGI, subject to the 2% of AGI floor.
D) nondeductible.

60) Gwen traveled to New York City on a business trip for her employer. Gwen spent 4 days in business meetings and conferences and then spent 2 days sightseeing in the area. Gwen’s plane fare for the trip was $250. Meals cost $160 per day. Hotels and other incidental expenses amounted to $250 per day. Gwen was not reimbursed by her employer for any expenses. Her AGI for the year is $50,000 and she itemizes but has no other miscellaneous itemized deductions. Gwen may deduct (after limitations)
A) $570.
B) $890.
C) $1,890.
D) $1,570.

61) Norman traveled to San Francisco for four days on vacation, and while there spent another two days conducting business for his employer. Norman’s plane fare for the trip was $500; meals cost $150 per day; hotels cost $300 per day; and a rental car cost $150 per day that was used for all six days. Norman was not reimbursed by his employer for any expenses. Norman’s AGI for the year is $40,000 and he did not have any other miscellaneous itemized deductions. Norman may deduct (after limitations)
A) $250.
B) $800.
C) $1,050.
D) $1,200.

62) Gayle, a doctor with significant investments in the stock market, traveled on a cruise ship to Bermuda. Investment specialists provided daily seminars which Gayle attended. The cost of the cruise for four days is $2,500. Gayle can deduct (before application of any floors)
A) $0.
B) $1,250.
C) $2,000.
D) $2,500.

63) Chelsea, who is self-employed, drove her automobile a total of 20,000 business miles in 2014. This represents about 75% of the auto’s use. She has receipts as follows:

Parking (business only) $500
Tolls (business only) 200
Repairs $1,000

Chelsea has an AGI for the year of $50,000. Chelsea uses the standard mileage rate method. After application of any relevant floors or other limitations, she can deduct
A) $10,900.
B) $11,900.
C) $11,750.
D) $12,900.

64) Brittany, who is an employee, drove her automobile a total of 20,000 business miles in 2014. This represents about 75% of the auto’s use. She has receipts as follows:

Parking (business only) $500
Tolls (business only) 200
Repairs $1,000

Brittany’s AGI for the year of $50,000, and her employer does not provide any reimbursement. She uses the standard mileage rate method. After application of any relevant floors or other limitations, Brittany can deduct
A) $10,900.
B) $11,900.
C) $10,750.
D) $12,900.

65) Rajiv, a self-employed consultant, drove his auto 20,000 miles this year, 15,000 to meetings with clients and 5,000 for commuting and personal use. The cost of operating the auto for the year was as follows:

Gasoline and repairs $7,000
Insurance 1,000
Depreciation 4,000

Rajiv’s AGI is $100,000 before considering the auto costs. Rajiv has used the actual cost method in the past. What is Rajiv’s deduction for the use of the auto after application of all relevant limitations?
A) $8,325
B) $9,000
C) $6,325
D) $7,000

66) Jordan, an employee, drove his auto 20,000 miles this year, 15,000 to meetings with clients and 5,000 for commuting and personal use. The cost of operating the auto for the year was as follows:

Gasoline and repairs $7,000
Insurance 1,000
Depreciation 4,000

Jordan submitted appropriate reports to his employer, and the employer paid a reimbursement of $ .50 per mile. Jordan has used the actual cost method in the past. Jordan’s AGI is $50,000. What is Jordan’s deduction for the use of the auto after application of all relevant limitations?
A) $1,500
B) $500
C) $1,000
D) $8,000

67) Sarah incurred employee business expenses of $5,000 consisting of $3,000 business meals and $2,000 customer entertainment. She provided an adequate accounting to her employer’s accountable plan and received reimbursement for one-half of the total expenses. How much of the meals and entertainment will be deductible by Sarah without consideration of the 2% of AGI limit?
A) $0
B) $1,250
C) $2,500
D) $5,000

68) Austin incurs $3,600 for business meals while traveling for his employer, Tex, Inc. Austin is reimbursed in full by Tex pursuant to an accountable plan. What amounts can Austin and Tex deduct?

A)
Austin Tex
$0 $1,800

B)
Austin Tex
$0 $3,600

C)
Austin Tex
$1,800 $1,800

D)
Austin Tex
$3,600 $0

69) Joe is a self-employed tax attorney who frequently entertains his clients at his country club. Joe’s club expenses include the following:

Annual dues $ 5,400
Initiation fees 1,200
Charges for personal meals with his family 3,100
Meal and entertainment charges related to business use 4,000

Assuming the business meals and entertainment qualify as deductible entertainment expenses, Joe may deduct
A) $2,000.
B) $4,700.
C) $5,300.
D) $4,000.

70) Shane, an employee, makes the following gifts, none of which are reimbursed:

Shane’s manager $30
Shane’s personal assistant 40
4 customers ($27 each) 108

What amount of the gifts is deductible before application of the 2% of AGI floor for miscellaneous itemized deductions?
A) $125
B) $150
C) $75
D) $178

71) Steven is a representative for a textbook publishing company. Steven attends a convention which will also be attended by many potential customers. During the week of the convention, Steven incurs the following costs in entertaining potential customers.

Meal costs $ 1,500
Entertainment of customers 3,500

Having recently been to a company seminar on the new tax laws, Steven makes sure that business is discussed at the various dinners, and that the entertainment is on the same day as the meetings with customers. Steven is reimbursed $2,000 by his employer under an accountable plan. Steven’s AGI for the year is $50,000, and while he itemizes deductions, he has no other miscellaneous itemized deductions. What is the amount and character of Steven’s deduction after any limitations?
A) $500 from AGI
B) $500 for AGI
C) $2,000 from AGI
D) $2,000 for AGI

72) Matt is a sales representative for a local company. He entertains customers as part of his job. During the current year he spends $3,000 on business entertainment. The company provides him an expense allowance of $2,000 under a nonaccountable plan. How will Matt treat the $2,000 partial reimbursement and the $3,000 entertainment expense?
A) He will deduct the $1,000 net expense as a miscellaneous itemized deduction, subject to the 2% of AGI floor.
B) He will deduct $500 of the net expense as a miscellaneous itemized deduction, subject to the 2% of AGI floor.
C) He will recognize $2,000 of income and deduct $3,000 as a miscellaneous itemized deduction, subject to the 2% of AGI floor.
D) He will recognize $2,000 of income and deduct $1,500 as a miscellaneous itemized deduction, subject to the 2% of AGI floor.

73) Donald takes a new job and moves to a new residence. The distances are as follows:

Old residence to new job 70 miles
Old residence to old job 8 miles

By how many miles does the move exceed the minimum distance requirement for the moving expense deduction?
A) 12 miles
B) 20 miles
C) 62 miles
D) none of the above

74) In which of the following situations is the taxpayer not allowed a deduction for moving expenses?
A) Pam moves from Phoenix to Los Angeles to take a new job. She works at the Los Angeles job for 45 weeks before starting a new job in Las Vegas.
B) Paul moves from Boston to Miami to start a new business selling t-shirts. The business is not successful and Paul returns to Boston after 52 weeks.
C) Phyllis opens a coffee bar after moving from Seattle to San Francisco. She still owns the coffee bar and lives in San Francisco 90 weeks after her move.
D) Marva moves from Dallas to Washington D.C. in her job as an IRS agent. She is still working at the IRS Washington office after one year.

75) Bill obtained a new job in Boston. He incurred the following moving expenses:

Transportation of household goods and personal effects $2,600
Cost of transporting Bill’s family 2,000
House-hunting trip 1,700
Payments to lessor to cancel a lease 500

Assuming Bill is entitled to deduct moving expenses, what is the amount of the deduction?
A) $2,600
B) $4,600
C) $6,300
D) $6,800

76) Ron obtained a new job and moved from Houston to Washington. He incurred the following moving expenses:

Transportation of household goods $3,200
House-hunting trips 1,500
Temporary living expenses (20 days) 3,400
Commissions on new lease 500
Costs of settling old lease 250
Mileage for personal automobile 1,400 miles

Assuming Ron is eligible to deduct his moving expenses, what is the amount of the deduction?
A) $3,529
B) $6,600
C) $9,179
D) $3,984

77) Edward incurs the following moving expenses:

Direct moving expenses $4,000
Indirect moving expense 6,000

The employer reimburses Edward for the full $10,000. What is the amount to be reported as income by Edward?
A) $0
B) $4,000
C) $6,000
D) $10,000

78) All of the following may deduct education expenses except:
A) Richard is a self-employed dentist who incurs expenses to attend a convention on new techniques in oral surgery.
B) Paige is an accountant who incurs expenses to take a CPA exam review course.
C) Hope is a business executive who incurs expenses to pursue an MBA degree.
D) Marvin is a high school teacher who incurs expenses for education courses to meet new course requirements to maintain his job.

79) The following individuals maintained offices in their home:
(1) Dr. Austin is a self-employed surgeon who performs surgery at four hospitals. He uses his home for administrative duties as he does not have an office in any of the hospitals.
(2) June, who is a self-employed plumber, earns her living in her customer’s homes. She maintains an office at home where she bills clients and does other paperwork related to her plumbing business.
(3) Cassie, who is an employee of Montgomery Electrical, is provided an office at the work but does significant administrative work at home. Her employer does not require her to do extra work but she feels it is necessary.

Who is entitled to a home office deduction?
A) Dr Austin
B) Dr. Austin and June
C) Cassie and June
D) All of the taxpayers are entitled to a deduction.

80) Alex is a self-employed dentist who operates a qualifying office in his home. Alex has $180,000 gross income from his practice and $160,000 of expenses directly related to the business, i.e., non-home office expenses. Alex’s allocable home office expenses for mortgage interest expenses and property taxes are $14,000 and other home office expenses are $9,000. What is Alex’s total allowable home office deduction?
A) $9,000
B) $14,000
C) $20,000
D) $23,000

81) Charles is a self-employed CPA who maintains a qualifying office in his home. Charles has $110,000 gross income from his practice and incurs $88,000 in salaries, supplies, computer services, etc. Charles’s mortgage interest and real estate taxes allocable to the office total $10,000. Other expenses total $14,000 and consist of depreciation, utilities, insurance, and maintenance. What is Charles’ total home office expense deduction?
A) $10,000
B) $14,000
C) $22,000
D) $24,000

82) In a contributory defined contribution pension plan, all of the following are true with the exception of
A) a separate account is established for each participant.
B) both the employee and employer can make contributions to the plan.
C) amounts are contributed to the plan based upon a specific formula.
D) retirement benefits are a fixed amount based on the level of compensation earned by the employee during the working years.

83) Characteristics of profit-sharing plans include all of the following with the exception of:
A) A predetermined formula is used to allocate employer contributions to individual employees and to establish benefit payments.
B) Forfeitures of benefits under the plan may be reallocated to the remaining participants.
C) The company must make contributions to the plan if it has profits during the year.
D) Annual employer contributions are not required, but substantial, recurring contributions must be made to satisfy the requirement that the plan be permanent.

84) Ross works for Houston Corporation, which has a contributory defined contribution pension plan. The employer’s monthly contribution to the plan is 8 percent of each participating employee’s monthly salary, while the employee contributes only 6 percent. Ross’s monthly salary is $3,000. Which of the following statements best describes the benefits of the plan?
A) Houston receives a deduction for its contributions to the plan when Ross receives a distribution from the plan.
B) While Ross is taxed on the employer’s contributions to the plan, his own contributions are not taxed until he receives a distribution from the plan.
C) Ross may deduct his own contributions to the pension plan, and Ross reports income from the plan each year until he receives distributions from the plan.
D) The earnings on amounts contributed to the plan are not taxed to Ross until he retires or receives a distribution from the plan.

85) Sam retired last year and will receive annuity payments for life from his employer’s qualified
retirement plan of $30,000 per year starting this year. During his years of employment, Sam contributed $130,000 to the plan on an after-tax basis. Based on IRS tables, his life expectancy is 260 months. All of the contributions were on a pre-tax basis. This year, Sam will include what amount in income?
A) 0
B) $6,000
C) $24,000
D) $30,000

86) Hunter retired last year and will receive annuity payments for life from his employer’s qualified retirement plan of $30,000 per year starting this year. During his years of employment, Hunter contributed $130,000 to the plan. Based on IRS tables, his life expectancy is 260 months. All of the contributions were on a pre-tax basis. This year, Hunter will include what amount in income?
A) $0
B) $6,000
C) $24,000
D) $30,000

87) Which of the following statements is incorrect regarding unfunded deferred compensation plans?
A) The employee is not taxed on the compensation amount when it is deposited in an escrow account.
B) An accrual-basis employer can deduct the compensation amount when it is accrued in the year service.
C) An employee is taxed when the amount is actually paid or made available.
D) A 20% excise tax will apply if the employee can voluntarily elect to receive payment early.

88) Tobey receives 1,000 shares of YouDog! stock as part of his compensation package. Tobey’s employment contract with YouDog!, Inc. states that if he leaves before completion of three years of employment, he will forfeit the stock. The stock currently has a fair market value of $12 per share. Which of the following statements regarding Tobey’s choices is not true?
A) Tobey does not have to recognize any income from receiving the stock until his rights to the stock are fully vested.
B) Tobey must report $12,000 as income due to the receipt of the stock in the current year.
C) Tobey may elect to report the $12,000 FMV of the stock as ordinary income in the current year.
D) If Tobey elects to report $12,000 as income in the current year and the stock price falls to $5 per share when his rights to the stock are vested, Tobey is not allowed to deduct a loss.

89) All of the following characteristics are true of an incentive stock option with the exception of
A) the option price must be equal to or greater than the stock’s FMV on the option’s grant date.
B) the employee cannot own more than ten percent of the voting power of the employer corporation’s stock immediately prior to the option’s grant date.
C) the option must be granted within ten years from the date the plan is adopted and the employee must exercise the stock option within ten years from the grant date.
D) there is no limit to the value of the options that become exercisable to an employee in a single year.

90) Wilson Corporation granted an incentive stock option to Reva on January 1, two years ago. The option price was $300, and the FMV of the Wilson stock was also $300 on the grant date. The option allowed Reva to purchase 150 shares of Wilson stock. Reva exercised the option on August 1, this year, when the stock’s FMV was $400. Unless otherwise stated, assume Reva is a qualifying employee. The results of the above transactions to Reva will be
A) no income to Reva on the grant date or exercise date but there is an alternative minimum tax adjustment item to Reva of $15,000.
B) no income tax or alternative minimum tax effect for Reva.
C) ordinary income to Reva on the exercise date of $15,000.
D) capital gain to Reva on the exercise date of $15,000.

91) Mirasol Corporation granted an incentive stock option to employee Josephine two years ago. The option price was $150 and the FMV of the Mirasol stock was also $150 on the grant date. The option allowed Josephine to purchase 160 shares of Mirasol stock. Josephine exercised the option this year when the stock’s FMV was $250. Unless otherwise stated, assume Josephine is a qualifying employee. The results of the above transactions to Mirasol Corporation will be
A) no compensation deduction.
B) a compensation deduction of $16,000 on the grant date.
C) a tax preference item of $16,000 on the exercise date.
D) a compensation deduction of $16,000 on the exercise date.

92) Martin Corporation granted an incentive stock option to employee Caroline on January 1, 2011. The option price was $150, and the FMV of the Martin stock was also $150 on the grant date. The option allowed Caroline to purchase 160 shares of Martin stock. Caroline exercised the option on August 1, 2013 when the stock’s FMV was $250. Unless otherwise stated, assume Caroline is a qualifying employee. If Caroline sells the stock on September 5, 2014 for $350 per share, she must recognize (ignore alternative minimum tax)
A) 0. No gain or loss is recognized at exercise or sale with incentive stock options.
B) long-term capital gain of $16,000 in 2014.
C) ordinary income of $16,000 on the exercise date and a long-term capital gain of $16,000 in 2014.
D) long-term capital gain of $32,000 in 2014.

93) Jackson Corporation granted an incentive stock option to employee Caroline on January 1, two years ago. The option price was $150, and the FMV of the Jackson stock was also $150 on the grant date. The option allowed Caroline to purchase 160 shares of Jackson stock. Caroline exercised the option on August 1, 2013, when the stock’s FMV was $250. Unless otherwise stated, assume Caroline is a qualifying employee. If Caroline sells the stock on July 5, 2014 for $400 per share, she must recognize
A) long-term capital gain of $40,000 in the year of sale.
B) long-term capital gain of $24,000 in the year of sale.
C) ordinary income of $16,000 on the exercise date and a long-term capital gain of $24,000 in the year of sale.
D) ordinary income of $16,000 and a short-term capital gain of $24,000 in the year of sale.

94) Martin Corporation granted a nonqualified stock option to employee Caroline on January 1, 2011. The option price was $150, and the FMV of the Martin stock was also $150 on the grant date. The option allowed Caroline to purchase 1,000 shares of Martin stock. The option itself does not have a readily ascertainable FMV. Caroline exercised the option on August 1, 2014 when the stock’s FMV was $250. If Caroline sells the stock on September 5, 2015 for $300 per share, she must recognize

A)
2014 2015
$100,000 ordinary income $50,000 LTCG

B)
2014 2015
0 $150,000 LTCG

C)
2014 2015
$100,000 ordinary income $50,000 ordinary income

D)
2014 2015
0 $150,000 ordinary income

95) Martin Corporation granted a nonqualified stock option to employee Caroline on January 1, 2011. The option price was $150, and the FMV of the Martin stock was also $150 on the grant date. The option allowed Caroline to purchase 1,000 shares of Martin stock. The option itself does not have a readily ascertainable FMV. Caroline exercised the option on August 1, 2014 when the stock’s FMV was $250. Caroline sells the stock on September 5, 2015 for $300 per share. Martin Corporation will be allowed a deduction of
A) $150,000 in 2011.
B) $100,000 in 2014.
C) $50,000 in 2015.
D) $100,000 in 2014 and $50,000 in 2015.

96) A partnership plans to set up a retirement plan to benefit the partners and the employees. All of the following retirement plans are appropriate except
A) an H.R. 10 (Keogh) plan.
B) a SEP IRA.
C) a SIMPLE plan.
D) a Solo 401(k).

97) Frank is a self-employed CPA whose 2014 net earnings from his trade or business (before the H.R. 10 plan contribution but after the deduction for one-half of self-employment taxes) is $240,000. What is the maximum contribution that Frank can make on his behalf to his H.R. 10 (Keogh) plan in 2014?
A) $65,000
B) $48,000
C) $52,000
D) $60,000

98) Tessa is a self-employed CPA whose 2014 net earnings from her business (before the H.R. 10
plan contribution but after the deduction for one-half of self-employment taxes) is $400,000. What is the maximum contribution that Tessa can make on her behalf to her H.R. 10 (Keogh) plan in 2014?
A) $100,000
B) $80,000
C) $65,000
D) $52,000

99) Which of the following is true about H.R.10 (Keogh) plans?
A) The plan must be established before the end of the tax year, and contributions must be made before the due date of the tax return, plus extensions.
B) The plan must be established and contributions must be made before the end of the tax year.
C) The plan must be established and contributions must be made before April 1.
D) The plan must be established and contributions must be made before the due date of the tax return, plus extensions.

100) Which of the following statements is incorrect regarding the SEP IRA?
A) Both employers and employees can contribute to the plan.
B) Contributions made by the due date of the tax return can be treated as made on the last day of the related tax year.
C) Employer contributions must be nondiscriminatory.
D) The maximum contribution for 2014 is $52,000.

101) Which statement is correct regarding SIMPLE retirement plans?
A) SIMPLE plans are not subject to nondiscrimination rules.
B) This plan can only be adopted by employers with 50 or fewer employees.
C) Only the employer can contribute to the plan.
D) Employer contributions must vest within three years.

102) Tyne is a 48-year-old an unmarried taxpayer who is not an active participant in an employer-sponsored qualified retirement plan. Before IRA contributions, her AGI is $63,000 in 2014. What is the maximum amount she may contribute to a tax deductible IRA?
A) $ 0
B) $4,400
C) $5,500
D) $6,500

103) Hannah is a 52-year-old an unmarried taxpayer who is not an active participant in an employer-sponsored qualified retirement plan. Before IRA contributions, her AGI is $63,000 in 2014. What is the maximum amount she may contribute to a tax deductible IRA?
A) $4,400
B) $5,200
C) $5,500
D) $6,500

104) H (age 50) and W (age 48) are married but only W is employed. She is not covered by a retirement plan at work. She earns $75,000 during the year and they have combined AGI of $78,000 before any IRA contribution. In 2014, the maximum amount together they may contribute to tax deductible IRAs is
A) $5,500.
B) $6,500.
C) $11,000.
D) $12,000.

105) Tyler (age 50) and Connie (age 48) are a married couple. Tyler is covered under a qualified retirement plan at his job and earned $175,000 in 2014. Connie is employed as a lab technician and earned $30,000 but is not covered under a qualified retirement plan. They file a joint return; have interest and dividend income of $30,000. What is their maximum for AGI deduction for contributions to a traditional IRA?
A) $0
B) $5,500
C) $6,500
D) $12,000

106) Tucker (age 52) and Elizabeth (age 48) are a married couple. Tucker is covered under a qualified retirement plan at his job and earned $90,000 in 2014. Elizabeth is employed as a lab technician and earned $30,000 but is not covered under a qualified retirement plan. They file a joint return; have interest and dividend income of $25,000. What is the maximum amount of tax deductible contributions may be made to a traditional IRA?
A) $0
B) $11,000
C) $5,500
D) $12,000

107) During 2014, Marcia, who is single and is covered under a pension plan at work, contributes $5,500 into a Roth IRA. If her AGI is $64,000, which of the following is true?
A) All of the contribution is deductible.
B) None of the contribution is deductible.
C) She must withdraw all of the contribution immediately since she is covered under a plan at work.
D) Only 60% of the contribution is deductible since her AGI exceeds $60,000 by $4,000 and her maximum contribution is phased out by 40%.

108) Feng, a single 40 year old lawyer, is covered by a qualified retirement at work. His salary is $109,000, and his total AGI is $123,000. The maximum contribution he can make to a Roth IRA in 2014 is
A) 0.
B) $3,300.
C) $2,200.
D) $5,500.

109) Which of the following is true about future qualified distributions from a Roth IRA by a person who will be 65 years old at the time the distributions begin? Assume the individual opened the account before age 60.
A) The entire amount of the distributions will be tax-free.
B) Only the accumulated earnings will be tax-free.
C) Only the previous contributions will be tax-free.
D) The entire amount of the distribution will be taxable.

110) All of the following are true with regard to a Roth IRA except
A) contributions to Roth IRAs are subject to special modified AGI limitations that are higher than those for traditional IRAs.
B) contributions to Roth IRAs are never tax deductible.
C) contributions to Roth IRAs must cease after the owner has reached age 70 1/2.
D) contributions to existing Roth IRAs must be made by the due date of the return.

111) Which of the following statements regarding Coverdell Education Savings Accounts is incorrect, disregarding any AGI limits?
A) Distributions cannot be used for elementary and secondary education expenses.
B) Distributions to the beneficiary are not taxable as long as they are used for tuition, fees, room and board.
C) Contributions can be made until the beneficiary reaches 18.
D) Contributors can make nondeductible contributions of up to $2,000 for each beneficiary.

112) Which of the following statements regarding Health Savings Accounts is incorrect?
A) Taxpayers are allowed to deduct contributions to a health savings account for AGI.
B) All taxpayers are eligible to establish a health savings account.
C) Distributions from a health savings account are excluded from gross income if used to pay qualified medical expenses.
D) Health savings account contributions are limited to the lesser of 100% of annual deductible under high deductible health plan or $3,300 for taxpayers without family coverage.

113) Which of the following conditions would generally not favor the rollover of an untaxed retirement fund (e.g. traditional IRA or 401(k) plan) to a Roth account?
A) expected higher tax rates at retirement
B) significant after-tax funds available to pay taxes
C) an advanced age of the taxpayer
D) All of the above create favorable conditions for a rollover to a Roth.

114) Richard traveled from New Orleans to New York for both business and vacation. He spent 4 days conducting business and some days vacationing. He incurred the following expenses:

Airfare $460
Lodging-per day 175
Meals-per day 100
Business Entertainment 800

What is his miscellaneous itemized deduction (before the floor), assuming Richard is an employee and is not reimbursed, under the following two circumstances?

a. He spends three days on vacation, in addition to the business days.
b. He spends six days on vacation, in addition to the business days.

115) David acquired an automobile for $30,000 for use in his unincorporated business in 2011 and used the standard mileage rate method in 2012 and 2013. He switches to the actual expense method for 2014. The automobile was used 25,000 miles in 2012 and 20,000 miles in 2013. What is the amount of the adjusted basis of the automobile for purposes of computing depreciation in 2014?

116) Sarah purchased a new car at the beginning of the year. She makes an adequate accounting to her employer and receives a $2,400 (12,000 miles × 20 cents per mile) reimbursement in 2014 for employment-related business miles. She incurs the following expenses related to both business and personal use:

Gas and oil $6,000
Repairs and maintenance 2,500
Depreciation 3,000
Insurance 1,800
Total $13,300

She also spent $200 on parking and tolls that were related to business. During the year she drove a total 20,000 miles.

What are the possible amounts of Sarah’s deductible transportation expenses?

117) Rita, a single employee with AGI of $100,000 before consideration of the items below, incurred the following expenses during the year, all of which were unreimbursed unless otherwise indicated:

Transportation expenses for business trip $3,000
Registration fees for business conference 700
Business-related meals and entertainment 700
Country club dues (used 60% for business) 4,000
Local meals eaten alone during regular business hours after visiting client 400
Qualified moving expenses 1,000
Tax return preparation fees 900
Safe deposit box rental for stock certificates 50

In addition, Rita paid $300 for dues to her professional business association. The company reimbursed her after she submitted the appropriate documentation. What is Rita’s net miscellaneous itemized deduction for the year after application of all relevant limitations?

118) Ellie, a CPA, incurred the following deductible education expenses to maintain or improve her skills:

Travel and transportation $1,700
Tuition 6,000
Books 800
Ellie’s AGI for the year is $60,000.

a. If Ellie is self-employed, what are the amount of and the nature of the deduction for these expenses?
b. If, instead, Ellie is an employee who is not reimbursed by his employer, what are the amount of and the nature of the deduction for these expenses (after limitations)?

119) Dighi, an artist, uses a room in his home (250 square feet) as a studio exclusively to paint. The studio meets the requirements for a home office deduction. (Painting is considered his trade or business.) The following information appears in Dighi’s records:

Revenue from sale of paintings $4,000
Expenses attributable to business of painting such as supplies 1,800
Expenses related to home office:
Property taxes on portion of home where he paints 900
Utilities, insurance, etc 700
Depreciation of portion of home 800

(a) What is the amount of Dighi’s home office deduction if he is self-employed?
(b) If some amount is not allowed under the tax law, how is the disallowed amount treated?
(c) Assume all of Dighi’s records of expenses relating to the room were destroyed in a major paint spill. How much of a home office deduction, if any, will he be allowed?

120) Ruby Corporation grants stock options to Iris on February 1, 2013. The options do not have a readily ascertainable value. The option price is $100, and the FMV of the Ruby stock is also $100 on the grant date. The option allows Iris to purchase 200 shares of Ruby stock. Iris exercises the option on August 1, 2014, when the stock’s FMV is $150. Iris sells the stock on December 5, 2015 for $400. Determine the amount and character (i.e. ordinary, LTCG or STCG) of income recognized by Iris and the deduction allowed Ruby Corporation in 2013, 2014 and 2015 under the following assumptions:

a. The stock option is an incentive stock option.
b. The stock option is a nonqualified stock option.

121) Tia is a 52-year-old an unmarried taxpayer who is an active participant in an employer-sponsored qualified retirement plan. Before IRA contributions, her AGI is $64,000 in 2014.
a. What is the maximum amount she can contribute and the maximum deduction she can receive for a contribution to a traditional IRA?
b. What is the maximum amount she can contribute and the maximum deduction she can receive for a contribution to a Roth IRA?
Answer:

122) Raul and Jenna are married and are both working. They are both over age 50. Jenna participates in her employer’s Sec. 401(k) plan and makes the maximum contribution and enjoys a company matching contribution. Raul’s employer does not maintain a retirement plan so he would like to save as much as possible in a tax-advantaged manner for retirement. They expect to report $185,000 of AGI for 2014.
a. What is the maximum amount that Raul can contribute to a traditional IRA and how much can he deduct?
b. What is the maximum amount that Raul can contribute to a Roth IRA and how much can he deduct?
c. How could Raul contribute to both the traditional IRA and Roth IRA to maximize current and future tax savings?

123) Jack takes a $7,000 distribution from his Health Savings Account. $2,000 is used to pay for X-rays and dental surgery. The other $5,000 to make a down payment on a new car. What are the tax consequences to Jack?

124) What factors are considered in determining whether an expense is a deductible travel expense?

125) What two conditions are necessary for moving expenses to be deductible?

126) Explain when educational expenses are deductible for an employee.

127) When are home-office expenses deductible?

128) Gina is an instructor at State University in Birmingham. Her university has asked her if she would be interested in taking a temporary assignment at their Montgomery campus. In addition to her salary, the University would pay her living expenses while in Montgomery. What should Gina consider with regard to taxes in deciding whether or not to accept the offer?

129) Fiona is about to graduate college with a management degree. She has been offered a job as a sales representative for a pharmaceutical company. The job will require significant travel and entertainment expenses for which she will be given a salary supplement. What tax issues should Fiona consider in her decision?

130) Chuck, who is self-employed, is scheduled to fly from Minneapolis to London on a business trip. His flight schedule included a connection through New York City. When Chuck arrived in New York City, he learned that his flight to London had been cancelled due to a volcanic eruption in Iceland. All air travel to Europe was delayed for five days because of significant amounts of ash in the air, causing Chuck to incur costs for hotel and meals in New York City. Since Chuck had never been to New York City before, he spent the time sightseeing. What tax issues are present?

131) Josiah is a human resources manager of a large software company. He is considering asking for a leave of absence to pursue an MBA degree. Josiah will pay for his MBA tuition of $45,000 a year without any employer assistance. Josiah will incur a large debt if he pursues an MBA. Upon completing his MBA, he would want to consider various job opportunities. Discuss the tax issues affecting Josiah’s decision?

132) Daniel has accepted a new job and is reviewing the retirement plan information. He has a choice of participating in the company’s conventional Sec. 401(k) plan or a Roth 401(k) plan. Explain the difference between the two plans in terms of employee contributions and retirement distributions from the plan.

133) Discuss the tax treatment of a nonqualified stock option plan.

134) Johanna is single and self-employed as a technology consultant. She wants to set money aside for her retirement. What tax and financial issues should she consider?

135) Why did Congress establish Health Savings Accounts (HSAs)? How do HSAs operate?

Chapter 10 Depreciation, Cost Recovery, Amortization, and Depletion

1) On its tax return, a corporation will use the same depreciation, amortization and depletion methods used in its financial statements issued to shareholders.

2) Depreciable property includes business, investment, and personal-use assets.

3) In order for an asset to be depreciated in the year of purchase, it must be placed in service before year’s end.

4) The basis of an asset must be reduced by the depreciation allowable.

5) Land, buildings, equipment, and stock are examples of tangible property.

6) If personal-use property is converted to trade or business use, the basis for depreciation is the lesser of adjusted basis or FMV on the date of conversion.

7) Under the MACRS rules, salvage value is not considered in the computation of the cost-recovery or depreciation amount.

8) Under the MACRS system, depreciation rates for real property must always use the mid-month convention in the year of acquisition.

9) Under MACRS, tangible personal property used in trade or business purchased and placed into service on March 1, 2014 should be depreciated for 10 months in 2014. Assume the business uses a calendar tax year.

10) MACRS recovery property includes tangible personal and real property that is used in a trade or business.

11) Under the MACRS system, automobiles and computers are classified as seven-year property.

12) In computing MACRS depreciation in the year of disposition of personal property used in a trade or business, the half-year convention must be applied to the amounts in the tables if the half-year convention was used in the year the asset was placed into service.

13) Intangible assets are subject to MACRS depreciation.

14) Section 179 allows taxpayers to immediately expense up to $25,000 (for 2014), subject to limitations, of the cost of real and personal property placed into service in a trade or business.

15) The Section 179 expensing election is available on an annual basis for property purchased during the year.

16) Personal property used in a rental activity held for investment qualifies for the Section 179 expensing election.

17) Sec. 179 tax benefits are recaptured if at any time an asset is converted to personal use.

18) Any Section 179 deduction that is not allowed currently due to the taxable income limitation may be carried over and deducted in future years.

19) Under the MACRS system, if the aggregate basis of all personal property placed in service during the last three months of the year exceeds 40% of the cost of all personal property placed in service during the tax year, the mid-quarter convention is required.

20) The mid-quarter convention applies to personal and real property.

21) Under the MACRS system, the same convention that applies in the year of acquisition (e.g., half-year, mid-quarter, or mid-month) also applies in the year of disposition.

22) Residential rental property is defined as property from which more than 80% of the gross rental income is rental income from dwelling units.

23) The MACRS system requires that residential real property and nonresidential rental property be depreciated using the straight-line method.

24) Capital improvements to real property must be depreciated over the remaining life of the property on which the improvements were made.

25) Expenditures that enlarge a building, any elevator or escalator, any structural component that benefits a common area or the internal structural framework are not considered qualified leasehold improvement property.

26) The straight-line method may be elected for depreciating tangible personal property placed in service after 1986.

27) The election to use ADS is made on a year-by-year, property-class by property-class basis for real and personal property.

28) If the business use of listed property is 50% or less of the total usage, the alternative depreciation system must be used.

29) If the business use of listed property decreases to 50% or less of the total usage, the property is subject to depreciation recapture.

30) Once the business use of listed property falls to 50% or below, the alternative depreciation system must be used for the current year and all subsequent years, even if the business use percentage increases to more than 50% in a subsequent year.

31) If a new luxury automobile is used 100% for business and placed in service in 2014, the maximum MACRS depreciation on the vehicle for 2014 is $3,160.

32) A large SUV is place in service in 2014. MACRS depreciation on an SUV weighing over 6,000 pounds is limited to $3,160 for the first year placed in service.

33) When a taxpayer leases an automobile for 100% business purposes, the entire lease payment is deductible.

34) If a company acquires goodwill in connection with the acquisition of a business, the goodwill is amortizable over a 60-month period.

35) Amounts paid in connection with the acquisition of a business which represent a covenant not to compete are amortizable over the covenant’s remaining life.

36) Unless an election is made to expense or defer and amortize research and experimental expenditures, these costs must be capitalized.

37) Most taxpayers elect to expense R&E expenditures because of the immediate tax benefit.

38) Off-the-shelf computer software that is purchased for use in the taxpayer’s trade or business is amortized over 36 months, or it can be immediately expensed under a Sec. 179 election.

39) Taxpayers are entitled to a depletion deduction if they have an economic interest in the natural resource property.

40) A taxpayer owns an economic interest in an oil and gas property. She is allowed to deduct the smaller of cost depletion or percentage depletion.

41) Intangible drilling and development costs (IDCs) may be deducted as an expense or may be capitalized.

42) Joan bought a business machine for $15,000 on January 1, 2013, and later sold the machine for $12,800 when the total allowable depreciation is $8,500. The depreciation actually taken on the tax returns totaled $8,000. Joan must recognize a gain (or loss) of
A) no gain or loss.
B) ($3,200).
C) $6,800.
D) $6,300.

43) In April 2014, Emma acquired a machine for $60,000 for use in her business. The machine is classified as 7-year property. Emma does not expense the asset under Sec. 179. Emma’s depreciation on the machine this year is
A) $30,000.
B) $60,000.
C) $6,428.
D) $8,574.

44) In May 2014, Cassie acquired a machine for $30,000 to use in her business. The machine is classified as 5-year property. Cassie does not expense the property under Sec. 179. Cassie’s depreciation on the machine this year is
A) $3,000.
B) $6,000.
C) $12,000.
D) $15,000.

45) On January 3, 2011, John acquired and placed into service business tools costing $10,000. The tools have a 3-year class life. No other assets were purchased during that year. The depreciation in 2014 for those tools is (Sec. 179 and bonus depreciation were not applied)
A) $0.
B) $741.
C) $1,920.
D) $3,333.

46) When depreciating 5-year property, the final year of depreciation will be year
A) 3.
B) 4.
C) 5.
D) 6.

47) Prithi acquired and placed in service $190,000 of equipment on August 1, 2014 for use in her sole proprietorship. The equipment is 5-year recovery property. No other acquisitions are made during the year. Prithi elects to expense the maximum amount under Sec. 179. Prithi’s total deductions for the year (including Sec. 179 and depreciation) are
A) $38,000.
B) $25,000.
C) $63,000.
D) $58,000.

48) Fred purchases and places in service in 2014 personal property costing $221,000. What is the maximum Sec. 179 deduction that Fred can deduct, ignoring any taxable income limitation?
A) $25,000
B) $21,000
C) $4,000
D) $200,000

49) Cate purchases and places in service property costing $150,000 in 2014. She wants to elect the maximum Sec. 179 deduction allowed. Her business income is $20,000. What is the amount of her allowable Sec. 179 deduction and carryover, if any?

A)
179 deduction Carryover
$25,000 0

B)
179 deduction Carryover
$150,000 0

C)
179 deduction Carryover
$20,000 $130,000

D)
179 deduction Carryover
$20,000 $5,000

50) Ilene owns an unincorporated manufacturing business. In 2014, she purchases and places in service $206,000 of qualifying five-year equipment for use in her business. Her taxable income from the business before any Sec. 179 deduction is $17,000. Elaine takes the maximum allowable deduction under section 179. Which of the following statements is true regarding the Sec. 179 election?
A) Ilene can deduct $25,000 as a section 179 deduction in 2014, with no carryover to next year.
B) Ilene can deduct $19,000 as a section 179 deduction in 2014.
C) IIene can deduct $17,000 as a section 179 deduction in 2014; $2,000 may be carried over to next year.
D) Ilene can deduct $17,000 as a section 179 deduction in 2014 ,with no carryover to next year.

51) Terra Corporation, a calendar-year taxpayer, purchases and places into service machinery with a 7-year life that cost $125,000. The mid-quarter convention does not apply. Terra elects to depreciate the maximum under Sec. 179. Terra’s taxable income for the year before the Sec. 179 deduction is $700,000. What is Terra’s total depreciation deduction related to this property?
A) $17,863
B) $42,863
C) $25,000
D) $39,290

52) Tessa owns an unincorporated manufacturing business. In 2014, she purchases and places in service $207,000 of qualifying five-year equipment for use in her business. Her taxable income from the business before any Sec. 179 deduction is $15,000. Tessa elects to expense the maximum under Sec. 179. What is Tessa’s maximum total cost recovery deduction for 2014?
A) $53,400
B) $52,800
C) $15,000
D) $41,400

53) Which of the following statements regarding Sec. 179 is true?
A) If a taxpayer places in service property costing more than the Sec. 179 ceiling on the amount of property placed in service, the excess can be carried over to subsequent years.
B) Amounts of the Sec. 179 election in excess of the taxable income limitation are carried forward.
C) Sec. 179 carryforwards expire after five years.
D) All of the above statements are true.

54) In November 2014, Kendall purchases a computer for $4,000. She does not use Sec. 179 expensing. She only uses the most accelerated depreciation method possible. The computer is the only personal property which she places in service during the year. What is her total depreciation deduction for 2014?
A) $200
B) $572
C) $800
D) $1,000

55) On October 2, 2014, Dave acquired and placed into service 5-year business equipment costing $70,000. No other acquisitions were made during the year. Dave does not use Sec. 179 expensing. The depreciation for this year is using the most accelerated method possible is
A) $0.
B) $3,500.
C) $7,000.
D) $10,003.

56) On November 3, this year, Kerry acquired and placed into service 7-year business equipment costing $80,000. In addition, on May 5th of this year, Kerry had also placed in business use 5-year recovery property costing $15,000. Kerry did not elect Sec. 179 immediate expensing. No other assets were purchased during the year. The depreciation for this year is
A) $3,606.
B) $6,606.
C) $13,576.
D) $14,432.

57) Paul bought a computer for $15,000 for business use on March 18, 2012. This was his only purchase for that year. Paul used the most accelerated depreciation method available, but did not elect Sec. 179. Bonus depreciation was not available. Paul sells the machine in 2014. The depreciation on the computer for 2014 is
A) $0.
B) $1,440.
C) $1,500.
D) $2,880.

58) On April 12, 2013, Suzanne bought a computer for $20,000 for business use. This was the only purchase for that year. Suzanne used the most accelerated depreciation method available but did not elect Sec. 179. Bonus depreciation was not available. Suzanne sells the machine in 2014. The depreciation on the computer for 2014 is
A) $2,000.
B) $3,200.
C) $4,000.
D) $6,400.

59) Harrison acquires $65,000 of 5-year property in June 2012 that is required to be depreciated using the mid-quarter convention (because of other purchases that year). He did not elect Sec. 179 immediate expensing. Bonus depreciation was not available. If Harrison sells the property on August 23, 2014, what is the amount of depreciation claimed in 2014?
A) $6,500.00
B) $7,312.50
C) $11,700.00
D) $9,289.00

60) For real property placed in service after 1986, depreciation under the MACRS system is calculated using the
A) straight-line method and a half-year convention in the year of acquisition and in the year of disposition.
B) straight-line method and a mid-month convention in the year of acquisition and in the year of disposition.
C) 200% DB method and a mid-month convention in the year of acquisition and in the year of disposition.
D) 200% DB method and a half-year convention in the year of acquisition and in the year of disposition.

61) On August 11, 2014, Nancy acquired and placed into service residential rental property, which cost $430,000; the cost of the land has been excluded. Nancy annually elects the maximum allowed Sec. 179 deduction. The total depreciation for the year is (rounded)
A) $5,865.
B) $4,141.
C) $5,117.
D) $15,636.

62) Lincoln purchases nonresidential real property costing $300,000 and places it in service in March 2013. What is Lincoln’s 2014 depreciation on the property?
A) $6,099
B) $7,692
C) $8,637
D) $10,908

63) Atiqa took out of service and sold a residential rental property on October 31 of this year. She had originally acquired the property ten years ago. The building (excluding the value of the land) cost $1,000,000. How much is her current year depreciation deduction?
A) $30,300
B) $36,360
C) $18,182
D) $28,785

64) All of the following are true with regard to the alternative depreciation system except
A) the principal type of property for which ADS is required is any tangible property which is used predominantly outside of the United States.
B) the ADS election is available to real property on a property by property basis.
C) the ADS election is available to personal property on a property by property basis.
D) once the ADS election is made for specified property, it is irrevocable.

65) If the business usage of listed property is less than or equal to 50% of its total usage, depreciation is calculated using the
A) regular MACRS tables.
B) alternative depreciation system.
C) it may not be depreciated.
D) regular MACRS tables and a mid-month convention.

66) Eric is a self-employed consultant. In May of the current year, Eric acquired a computer system (5-year property) for $6,000 and used the computer 80% for business and 20% for personal purposes. Eric does not take any Sec. 179 deduction. The maximum depreciation deduction for is
A) $600.
B) $800.
C) $960.
D) $1,200.

67) Eric is a self-employed consultant. In May of the current year, Eric acquired a computer system (5-year property) for $7,000 and used the computer 30% for business. Eric does not use Sec. 179. The maximum depreciation deduction for is
A) $210.
B) $420.
C) $700.
D) $2,100.

68) In the current year George, a college professor, acquired a computer system (5-year property) for $1,000 and used the computer 80% for teaching and research-related activities and the remaining 20% for personal use. Because George’s employer provides him with a computer in his office at the university, the employer does not require him to have a computer at home. No election was made regarding Sec. 179. The maximum depreciation deduction is
A) $0.
B) $200.
C) $160.
D) $800.

69) In April of 2013, Brandon acquired five-year listed property (not an automobile) for $30,000 and used it 70% for business. No election was made regarding Sec. 179 and bonus depreciation was not available. In 2014, his business use of the property dropped to 40%. Which of the following statements is true?
A) The change does not affect Brandon’s previous depreciation.
B) Brandon must recapture $2,100 as ordinary income.
C) Brandon must recapture $4,200 as ordinary income.
D) Brandon must amend the previous tax return and recompute depreciation.

70) In July of 2014, Pat acquired a new automobile for $28,000 and used the automobile 80% for business. No election is made regarding Sec. 179. Assuming her business use remains at 80%, Pat can take a maximum depreciation deduction in 2014 of
A) $2,528.
B) $3,160.
C) $5,600.
D) $4,480.

71) On January l Grace leases and places into service an automobile with a FMV of $39,000. The business use of the automobile is 60%. The “inclusion amount” for the initial year of the lease from the IRS tables is $20. The annual lease payments are $8,000. What are the tax consequences of this lease?
A) deduction for lease payments of $4,782
B) deduction for lease payments of $4,800
C) deduction for lease payments of $6,000
D) deduction for lease payment of $8,982

72) On January 1, 2014, Charlie Corporation acquires all of the net assets of Rocky Corporation for $2,000,000. The following intangible assets are included in the purchase agreement:

Assets Acquisition Cost
Goodwill and going concern value $105,000
Licenses $ 45,000
Patents $ 60,000
Covenant not to compete for five years $120,000

What is the total amount of amortization allowed in 2014?
A) $15,000
B) $22,000
C) $31,000
D) $38,000

73) In accounting for research and experimental expenditures, all of the following alternatives are available with the exception of
A) expense R&E costs in the year paid or incurred.
B) expense R&E costs in the year in which a product or process becomes marketable.
C) defer and amortize R&E costs as a ratable deduction over a period of 60 months or more.
D) capitalize and write off R&E costs only when the research project is abandoned or is worthless.

74) Costs that qualify as research and experimental expenditures include all of the following except
A) depreciation of laboratory equipment.
B) management studies.
C) costs incurred in developing product improvements.
D) costs of obtaining a patent such as attorney fees.

75) This year Bauer Corporation incurs the following costs in development of new products:

Laboratory supplies $ 55,000
Laboratory equipment purchased
(5-year recovery property) 50,000
Salaries (lab personnel) 90,000
Utilities 20,000
Total $215,000

No benefits are realized from the research expenditures until next year. If Bauer Corporation elects to expense the research expenditures, the deduction is
A) $10,000 this year and $175,000 next year.
B) $175,000 next year.
C) $175,000 this year.
D) $215,000 this year.

76) Galaxy Corporation purchases specialty software from a software development firm for use in its business as of January 1 of the current year at a cost of $90,000. No hardware was acquired. How much of the cost can Galaxy deduct this year?
A) $18,000
B) $15,000
C) $30,000
D) $90,000

77) In calculating depletion of natural resources each period,
A) cost depletion must be used.
B) percentage depletion must be used.
C) the greater of cost depletion or percentage depletion must be used.
D) the smaller of cost depletion or percentage depletion must be used.

78) J.R. acquires an oil and gas property interest for $300,000. J.R. expects to recover 50,000 barrels of oil. Intangible drilling and development costs are $80,000 and are charged to expense. Other expenses are $20,000. During the year, 13,000 barrels of oil are sold for $170,000. J.R.’s depletion deduction is
A) $25,500.
B) $35,000.
C) $70,000.
D) $78,000.

79) Everest Corp. acquires a machine (seven-year property) on January 10, 2014 at a cost of $212,000. Everest makes the election to expense the maximum amount under Sec. 179.
a. Assume that the taxable income from trade or business is $500,000.
(1) What is the amount of the Section 179 expensing deduction for the current year?
(2) What is the amount of the Section 179 carryover to the next tax year?
(3) What is the amount of depreciation allowed?
b. Assume instead that the taxable income from trade or business is $10,000.
(1) What is the amount of the Section 179 expensing deduction for the current year?
(2) What is the amount of the Section 179 carryover to the next tax year?
(3) What is the amount of depreciation allowed this year?

80) In August 2014, Tianshu acquires and places into service 7-year business equipment (tangible personal property qualifying under Sec. 179) for $70,000. This is the only asset that she purchased during the year; her taxable income from her trade or business is $23,000. She decides to limit her 179 election to the maximum amount currently deductible in her business for the current year. What is her maximum cost recovery (Sec. 179 and depreciation) deduction for 2014?

82) Mehmet, a calendar-year taxpayer, acquires 5-year tangible personal property in 2014 and does not use Sec. 179. Mehmet places the property in service on the following schedule:

Date placed in service Acquisition Cost
January 15 $50,000
May 25 $100,000
November 8 $200,000

What is the total depreciation for 2012?

83) Greta, a calendar-year taxpayer, acquires 5-year tangible personal property in 2014 and places the property in service on the following schedule:

Date placed in service Acquisition Cost
January 15 $ 7,000
May 25 $10,000
November 8 $33,000

Greta elects to expense the maximum under Section 179, and selects the property placed into service on November 8. Her business ‘s taxable income before section 179 is $190,000. What is the total cost recovery deduction (depreciation and Sec. 179) for 2014?

84) During the year 2014, a calendar year taxpayer, Marvelous Munchies, a chain of specialty food shops, purchased equipment as follows:

Date Asset Cost
March 3 Refrigerators 600,000
October 9 Equipment 1,200,000

Assume the property is all 5-year property. What is the maximum depreciation that may be deducted for the assets this year, 2014, assuming the alternative depreciation system is not chosen?

85) On May 1, 2008, Empire Properties Corp., a calendar year taxpayer, purchased an apartment building for $1,000,000, of which $400,000 was allocable to the land. The corporation sold the property this year on September 23, 2013.
a. What was the corporation’s depreciation for the building, using statutory percentages under MACRS for 2008?
b. What was the corporation’s depreciation for the building, using statutory percentages under MACRS for 2013?

86) On May 1, 2012, Empire Properties Corp., a calendar year taxpayer, purchased an office building for $1,000,000, of which $400,000 was allocable to the land. The corporation sold the property this year on September 23, 2014.
a. What was the corporation’s depreciation for the building, using statutory percentages under MACRS for 2012?
b. What was the corporation’s depreciation for the building, using statutory percentages under MACRS
for 2014?

87) In January of 2014, Brett purchased a Porsche for $100,000 to be used in his business. Brett drove the car 83 percent of the time for business. What is the maximum amount that Brett may deduct in 2014?

88) Stellar Corporation purchased all of the assets of Bellavia Company as of January 1 this year for $1 million. Included in the assets acquired are the following intangible assets:

Asset Useful Life Cost
Patent 10 year $120,000
Covenant not to complete 3 years 30,000
Goodwill Indefinite 300,000

What is Stellar’s maximum amortization deduction for the year?

89) Jack purchases land which he plans on developing as a golf course. The land costs $20,000,000 and the cost of clearing the land, earthmoving, constructing hazards, bunkers and greens, and installing irrigation systems will cost an additional $6,000,000. What tax issues should Jack consider?

90) Bert, a self-employed attorney, is considering either purchasing or leasing a $50,000 automobile for use in his business. What are the issues he should consider in making his decision?

91) Why would a taxpayer elect to capitalize and amortize intangible drilling costs (IDCs) rather than expense such costs?

92) Discuss the options available regarding treatment of an amount paid in excess of the FMV of an acquired company’s net assets in a business combination.

93) Why would a taxpayer elect to use the alternative depreciation system rather than the MACRS rules?

Chapter 11 Accounting Periods and Methods

1) A taxpayer’s tax year must coincide with the year used to keep the taxpayer’s books and records.

2) A fiscal year is a 12-month period that ends on the last day of any month other than December.

3) A partnership must generally use the same tax year of the partners who own the majority of partnership income and capital.

4) If the majority of the partners do not have the same tax year, the partnership must use the tax year of its principal partners.

5) All C corporations can elect a tax year other than a calendar year.

Explanation: Personal service corporations are generally required to use a calendar year.

6) An improper election to use a fiscal year automatically places the taxpayer on the calendar year.

7) If Jett Corporation receives a charter in 2012 but does not begin operations and file its first tax return until 2014, Jett may elect a fiscal year on the 2014 return.

8) Partnerships, S corporations, and personal service corporations may elect a taxable year which results in a tax deferral of four months or less.

9) An S corporation elects a September 30 taxable year. The S corporation, as a pass-through entity does not need to make tax payments to the IRS.

10) Except in a few specific circumstances, once adopted, an accounting period may be changed without IRS approval.

11) A newly married person may change tax years to conform to that of his or her spouse so that a joint return may be filed.

12) Generally, an income tax return covers an accounting period of 12 months.

13) A subsidiary corporation filing a consolidated return with its parent corporation must change its accounting period to conform with its parent’s tax year.

14) Misha, a single taxpayer, died on July 31, 2014. Her final income tax return (ignoring extensions) is due November 15, 2014.

15) Taxpayers who change from one accounting period to another must annualize their income for the resulting short period.

16) Generally, if inventories are an income-producing factor to the business, the accrual method must be used for sales and cost of goods sold.

17) Alvin, a practicing attorney who also owns an office supplies store, may use the cash basis for his legal practice and the accrual basis for his office supplies store.

18) A taxpayer must use the same accounting method on the personal tax return that the taxpayer uses in the taxpayer’s trade or business.

19) C corporations and partnerships with a corporate partner may use the cash method of accounting if average annual gross receipts for the three preceding tax years do not exceed $10 million.

20) Under the cash method of accounting, income is reported for the tax year in which payments are actually or constructively received.

21) Under the cash method of accounting, all expenses are deductible when paid.

22) Points paid on a mortgage to buy a personal residence are deductible in the year paid.

23) Under the cash method of accounting, payment by credit card entitles the taxpayer to deduct the expenditure at the time the charge is made.

24) If a cash basis taxpayer gives a note in payment of an expense, the deduction may not be taken until the note is paid.

25) The all-events test requires that the accrual-basis taxpayer report income when all events have occurred that fix the taxpayer’s right to the income and when the amount can be determined with reasonable accuracy.

26) Under the accrual method of accounting, the two tests to determine when income must be reported and expenses deducted are the all-events test and the economic performance test.

27) One criterion which will permit a deduction for an expenditure by the accrual-basis taxpayer prior to economic performance is that either the amount is not material or the earlier accrual of the item results in a better matching of income and expense.

28) A taxpayer who uses the cash method in computing gross income from his or her business must use the cash method in computing expenses of such business.

29) A business which provides a warranty on goods sold will deduct a reserve for warranty expense consistent with the reporting on its financial statements.

30) A taxpayer may use a combination of accounting methods as long as income is clearly reflected.

31) A taxpayer who uses the LIFO method of inventory valuation may use the lower of cost or market method.

32) The uniform capitalization rules (UNICAP) require the capitalization of some overhead costs that are expensed for financial accounting purposes.

33) Many taxpayers use the LIFO method of inventory valuation because during inflationary periods, LIFO normally results in the lowest inventory value and hence the lowest taxable income.

34) A taxpayer may use the FIFO or average cost methods for financial statement purposes, while using the LIFO method for tax purposes.

35) For tax purposes, the lower of cost or market method must ordinarily be applied to each separate inventory item.

36) For tax purposes, “market” for purposes of applying the lower of cost or market method means the price at which the taxpayer can sell the inventory item.

37) Contracts for services including accounting, legal and architectural services do not qualify for long-term contract treatment.

38) A taxpayer must use the same accounting method, either percentage of completion or completed contract method, for all long-term contracts in the same trade or business.

39) The installment method is not applicable to sales of inventory and marketable securities.

40) The installment sale method may be used on the sale of property at a loss.

41) Interest is not imputed on a gift loan between two individuals totaling $14,000 except when the borrowed funds are used to purchase income-producing property.

42) Interest is not imputed on a gift loan between two individuals totaling $100,000 except when the borrowed funds are used to purchase income-producing property.

43) In general, a change in accounting method must be approved by the IRS.

44) Vector Corporation has been using an incorrect method in accounting for supplies expense. It can change to the correct method without filing 3115.

45) A corporation is starting to produce glasses with smart phone capabilities. Generally, a business producing this type of product will want to elect the LIFO inventory method.

46) A new business is established. It is not a seasonal business. All of the following are acceptable accounting tax years with the exception of
A) an S corporation year ending October 31.
B) a C corporation (not a personal service corporation) tax year ending on February 15.
C) a C corporation (not a personal service corporation) tax year ending on April 30.
D) a partnership tax year ending on October 31 with three equal partners whose tax years end on September 30, October 31, and November 30.

47) When preparing a tax return for a short period, the taxpayer should annualize the income if the short period return
A) is the last return for a decedent who died on June 15.
B) is the first return for a corporation created on June 1.
C) is the last return for a partnership, which was terminated on October 12.
D) is a return for June 1 to December 31, for a corporation changing from a fiscal year to a calendar year.

48) Emma, a single taxpayer, obtains permission to change from a calendar year to a fiscal year ending June 30, 2014. During the six months ending June 30, 2014, she earns $40,000 and has $8,000 of itemized deductions. What is the amount of her annualized income?
A) $30,025
B) $64,000
C) $60,050
D) $64,300

49) All of the following statements are true except:
A) once adopted, an accounting period normally cannot be changed without approval by the IRS.
B) taxpayers who change from one accounting period to another must annualize their income for the resulting short period.
C) taxpayers filing an initial tax return are required to annualize the year’s income and prorate exemptions and credits.
D) an existing partnership can change its tax year without prior approval if the partners with a majority interest have the same tax year to which the partnership changes.

50) Which of the following partnerships can elect the cash basis method of accounting?
A) a CPA firm with average revenues of $20 million
B) a chocolate manufacturer with average revenues of $3 million
C) a cleaning service partnership generating average revenues of $5.5 million whose partners are Joe, Larry and Smith Inc.
D) None of the above.

51) Under the cash method of accounting, all of the following are true with the exception of:
A) Fixed assets are always expensed as the taxpayer pays for the assets.
B) Gross income includes the value of property received.
C) To some extent, a taxpayer may control the year in which an expense is deductible by choosing when to make the payment.
D) Income is reported in the tax year in which payments are actually or constructively received.

52) For purposes of the accrual method of accounting, the economic performance test is met when
A) the property or services are actually provided.
B) the amount of the item can be reasonably estimated.
C) all events have occurred that establish the fact of a liability.
D) all events have occurred that fix the taxpayer’s right to receive income.

53) Under UNICAP, all of the following overhead costs are included in inventory except
A) factory utilities, rent, insurance and depreciation.
B) officers’ salaries and factory administration.
C) research and experimentation.
D) factory payroll, purchasing and warehouse costs.

54) Which of the following statements regarding UNICAP is incorrect?
A) The UNICAP rules result in more costs being included in inventory for tax purposes than for financial accounting.
B) Taxpayers with gross receipts averaging more than $10,000,000 or more for the prior three years must apply the UNICAP provisions.
C) Interest must be included in inventory if the property produced is real property or long-lived property.
D) UNICAP requires that advertising and selling costs be allocated between inventory and cost of sales.

55) In 2014, Richard’s Department Store changes its inventory method from FIFO to LIFO. Richard’s uses the simplified LIFO method. Richard’s year-end inventory under FIFO is as follows: 2013 – $300,000; 2014 – $350,000. The 2013 price index is 110% and the 2014 index is 120%. The 2014 layer is
A) $19,097.
B) $20,833.
C) $22,727.
D) $50,000.

56) Inventory may be valued on the tax return at the lower of cost or market unless
A) replacement cost is higher than historical cost.
B) the taxpayer determines inventory cost using the LIFO method.
C) the taxpayer determines inventory cost using the FIFO method.
D) the cash method of accounting is used by the taxpayer.

57) When accounting for long-term contracts (other than those for services), all of the following accounting methods may be acceptable with the exception of
A) the cash method of accounting.
B) the completed contract method.
C) the percentage of completion method.
D) the modified percentage of completion method.

58) Under the percentage of completion method, gross income is reported
A) when the contract is completed.
B) using a percentage that is determined by dividing current year costs by the expected total revenue.
C) based on the portion of work that is incomplete.
D) based on the portion of work that has been completed.

59) This year, Hamilton, a local manufacturer of off-shore drilling platforms, entered into a contract to construct a drilling platform that will be placed in the North Atlantic Ocean. The total contract price is $5,000,000, and Hamilton estimates the total construction cost at $3,000,000. Actual costs incurred this year are $600,000. If Hamilton uses the percentage of completion method, the gross profit for this year is
A) $0.
B) $400,000.
C) $600,000.
D) $2,000,000.

60) Bergeron is a local manufacturer of off-shore drilling platforms. This year, Bergeron entered into a contract to construct a drilling platform, which will be placed in the North Atlantic Ocean. The total contract price is $5,000,000, and Bergeron estimates the total construction cost at $2,000,000. Actual costs incurred this year are $600,000. If Bergeron uses the completed contract method, the gross profit for this year is
A) $0.
B) $400,000.
C) $600,000.
D) $2,000,000.

61) In year 1 a contractor agrees to build a building for $2,500,000 by the end of year 2. The builder’s cost is estimated to be $1,800,000. The actual costs year 1 are $900,000 and year 2’s actual costs are $1,300,000. Under the completed contract method the gross profit for year 1 is
A) $0.
B) $300,000.
C) $350,000.
D) $700,000.

62) In year 1 a contractor agrees to build a building for $2,500,000 by the end of year 2. The builder’s cost is estimated to be $1,800,000. The actual costs year 1 are $900,000 and year 2’s actual costs are $1,300,000. Under the completed contract method the gross profit for year 2 is
A) $0.
B) $300,000.
C) $350,000.
D) $700,000.

63) In year 1 a contractor agrees to build a building for $2,500,000 by the end of year 2. The builder’s cost is estimated to be $1,800,000. The actual costs year 1 are $900,000 and year 2’s actual costs are $1,100,000. Under the percentage of completion method year 1’s gross profit is
A) $0.
B) $300,000.
C) $350,000.
D) $700,000.

64) In year 1 a contractor agrees to build a building for $2,500,000 by the end of year 2. The builder’s cost is estimated to be $1,800,000. The actual costs year 1 are $900,000 and year 2’s actual costs are $1,100,000. Under the percentage of completion method year 2’s gross profit is
A) $150,000.
B) $500,000.
C) $700,000.
D) $350,000.

65) The look-back interest adjustment involves the
A) calculation of interest on an installment sale.
B) calculation of gross profit on an installment sale collection.
C) calculation of additional tax due if actual cost rather than estimated cost had been used on the percentage of completion method.
D) calculation of interest on additional tax that would have been due if actual cost rather than estimated cost had been used on the percentage of completion method.

66) This year, a contractor agrees to build a building for $2,000,000, which will be completed by the end of next year. The builder’s cost is estimated to be $1,700,000. The actual costs this year are $800,000 and next year’s actual costs are $800,000. If the tax rate is 20% and the interest rate is 10%, the look back interest for the percentage of completion method is
A) $ 0.
B) $1,176.
C) $2,000.
D) $6,000.

67) An installment sale is best defined as
A) any disposition of property in which at least three payments are received.
B) any disposition of property in which the installment method is elected by the taxpayer.
C) any disposition of property where at least one payment is received after the close of the taxable year in which disposition occurs.
D) any disposition of publicly traded property or inventory where at least one payment is received after the close of the taxable year in which disposition occurs.

68) The installment method may be used for sales of all kinds of property with the exception of
A) real property.
B) personal property.
C) capital assets.
D) marketable securities.

69) The installment sale method can be used for all of the following transactions except
A) the sale of an antique by a collector.
B) the sale of shares of publicly-traded corporate stock.
C) the sale of farmland used in a farming business.
D) the sale of a boat held for personal use.

70) The installment sale method can be used for all of the following transactions except
A) the sale of an painting by an art collector.
B) the sale of a sole proprietor’s office building.
C) the sale of an individual’s personal car.
D) the sale of a yacht by a shipbuilder.

71) Freida is an accrual-basis taxpayer who owns a furniture store. The furniture store had the following sales of inventory:

Year of sale Installment sales Profit Collections in 2014
2012 $60,000 $30,000 $20,000
2013 100,000 50,000 30,000
2014 250,000 125,000 40,000

For tax purposes, Freida should report gross profit for 2014 of
A) $40,000.
B) $65,000.
C) $90,000.
D) $125,000.

72) Which of the following conditions are required for the use of the installment method?
A) The taxpayer must realize a gain on the sale of the property.
B) The taxpayer cannot be on the cash method.
C) The value of the obligations received is determinable at the date of sale.
D) All of the above are required.

73) Kyle sold land on the installment basis for $100,000. His basis in the land was $70,000. Kyle received a $40,000 down payment and a real estate installment sale contract calling for $60,000 in additional payments in future years. In addition, Kyle paid $6,000 in commissions on the sale. What is the gross profit to be recognized in the current year?
A) $0
B) $9,600
C) $12,000
D) $24,000

74) Kevin sold property with an adjusted basis of $58,000. The buyer assumed Kevin’s existing mortgage of $40,000 and agreed to pay an additional $60,000 consisting of a cash down payment of $40,000, and payments of $4,000, plus interest, per year for the next 5 years. Kevin paid selling expenses totaling $2,000. What is Kevin’s gross profit percentage?
A) 33 1/3%
B) 40%
C) 60%
D) 66 2/3%

75) This year, John purchased property from William by assuming an existing mortgage of $40,000 and agreed to pay an additional $60,000, plus interest, in the 3 years following the year of sale (i.e. $20,000 annual payments for three years, plus interest). William had an adjusted basis of $44,000 in the building. What are the sales price and the contract price in this transaction?

A)
Sales Price Contract Price
$40,000 $60,000

B)
Sales Price Contract Price
$100,000 $40,000

C)
Sales Price Contract Price
$100,000 $60,000

D)
Sales Price Contract Price
$100,000 $100,000

76) On July 25 of this year, Raj sold land with a cost of $15,000 for $40,000. Raj collected $20,000 this year and is scheduled to receive $5,000 each year for four years starting next year plus an acceptable rate of interest. Raj’s gain recognized this year is
A) $7,500.
B) $12,500.
C) $20,000.
D) $25,000.

77) On June 11, of last year, Derrick sold land with a cost of $15,000 for $45,000. Derrick collected $20,000 last year and is scheduled to receive $5,000 each year for five years starting this year plus an acceptable rate of interest. Derrick receives the $5,000 installment required this year. Derrick’s recognized gain this year is
A) $0.
B) $1,667.
C) $3,333.
D) $5,000.

78) Sela sold a machine for $140,000. The machine originally cost $90,000 and $10,000 of MACRS depreciation had been allowable. The buyer assumed an existing loan of $40,000, paid $20,000 cash down and agreed to pay $10,000 per year for eight years plus interest. Selling expenses are $10,000. The total gross profit for installment sale recognition purposes is
A) $30,000.
B) $40,000.
C) $50,000.
D) $60,000.

79) Malea sold a machine for $140,000. The machine originally cost $90,000 and $10,000 of MACRS depreciation had been allowable. The buyer assumed an existing loan of $40,000, paid $20,000 cash down and agreed to pay $10,000 per year for eight years plus interest. Selling expenses are $10,000. The contract price is
A) $40,000.
B) $80,000.
C) $100,000.
D) $130,000.

80) On June 11, two years ago, Gia sold land with a cost of $15,000 for $45,000. Gia collected $20,000 initially and is scheduled to receive $5,000 each year for five years starting last year plus an acceptable rate of interest. This year, Gia decided to sell one installment note to a bank that agreed to pay $4,100. As a result of the sale of the note, Gia must report
A) $0.
B) $1,667 gain.
C) $2,433 gain.
D) ($900) loss.

81) On May 18, of last year, Carter sells unlisted stock with a cost of $24,000 for $60,000. Carter collects $20,000 initially and is scheduled to receive $10,000 each year for four years starting this year plus an acceptable rate of interest. After receiving the first $10,000 scheduled installment payment, Carter is unable to collect any further payments. After incurring legal fees of $1,000, Carter recovers a portion of the stock valued at $26,000. As a result of the repossession, Carter must report
A) ordinary income of $9,000.
B) capital gain of $9,000.
C) ordinary income of $13,000.
D) capital gain of $13,000.

82) On May 18, of last year, Yuji sold unlisted stock with a cost of $12,000 for $30,000. Yuji collected $10,000 initially and is scheduled to receive $5,000 each year for four years starting this year plus an acceptable rate of interest. After receiving the first scheduled $5,000 payment, Yuji was unable to collect any further payments. After incurring legal fees of $500, Yuji recovered a portion of the stock valued at $13,000. Yuji’s basis in the recovered stock is
A) $6,500.
B) $7,000.
C) $12,500.
D) $13,000.

83) Andrew sold land to Becca, Andrew’s daughter. The fair market value of the land was $300,000 (basis $250,000). Becca agreed to pay Andrew $300,000 over 8 years. Becca immediately sold the land to Olga for $300,000 cash. The gain of $50,000 must be recognized
A) by Becca in installments.
B) by Becca when Becca sells to Olga.
C) by Andrew when Andrew sells to Becca.
D) by Andrew when Becca sells to Olga.

84) On September 2, of this year, Keshawn sold land to Rex, his nephew, for $400,000. Keshawn’s basis in the land was $100,000. Rex agreed to pay his uncle $40,000 this year, and $60,000 each year for the next six years plus interest. One month later, Rex sold the land to Theo, an unrelated party, for $450,000. Based on this information, Keshawn must report
A) $0. Rex reports gain of $300,000.
B) gain of $225,000 this year.
C) gain of $225,000 this year plus interest in following six years.
D) gain of $30,000 this year, and gain in each of the following six years of $45,000 plus interest.

85) All of the following are considered related for purposes of Section 453(e) installment sales except
A) parents.
B) children.
C) sister.
D) controlled corporation.

86) All of the following transactions are exempt from rules regarding imputed interest with the exception of
A) taxpayer purchases newly issued bond for $700 (face value of $1,000).
B) taxpayer sells land for $135,000 with payment due in 5 years and no stated interest.
C) taxpayer sells his home gym equipment for $2,800 with payment due in one year and no stated interest.
D) taxpayer purchases a sailboat costing $2,500 for week-end boating trips; the full price payable in five months and no stated interest.

87) Jennifer made interest-free gift loans to each of her four children as follows:
(1) John borrowed $9,500 to purchase an automobile. His net investment income is $1,500.
(2) Rick borrowed $50,000 to purchase a trailer. His net investment income is $900.
(3) Bert borrowed $25,000 to purchase stock. His net investment income is $1,200.
(4) Elizabeth borrowed $110,000 to purchase a home. Her net investment income is $800.

Assuming a 5% interest rate, on which loans must interest be imputed?
A) loan to John and Bert
B) loan to Bert and Elizabeth
C) loan to Rick, Bert, and Elizabeth
D) All of the loans are subject to the imputed interest rules.

88) Imputation of interest could be required on all of the following loans with the exception of
A) a loan between a partnership and a 55% partner.
B) a loan between a mother and son.
C) a loan between an employer and employee.
D) a loan between two best friends.

89) Prior Corp. plans to change its method of accounting for supplies. Both the old and new methods are acceptable. Which of the following statements is correct regarding the change?
A) The taxpayer will need to amend prior returns to reflect the new method.
B) The taxpayer will report the full amount of change in the current tax return.
C) The taxpayer will report the net adjustment over four years.
D) The taxpayer will report the net adjustment and pay the tax when it files the Form 3115.

90) Which of the following businesses is most likely to benefit from an election to account for its inventory under LIFO?
A) a company producing the newest version of a tablet with ultra-long battery life. It believes it has a one-year lead over the competition.
B) a company producing products with copper as a key component. Copper prices fluctuate widely.
C) a company producing parts for the auto industry. Costs in this field tend to steadily climb.
D) None of the above.

91) Lloyd Corporation, a calendar year accrual basis taxpayer, pays its insurance premium each year on June 1, the anniversary of the policy. The premium paid this year is $9,600 while last year’s was $9,000. How much of is Lloyd’s deduction for insurance this year?

92) In 2013 Anika Co. adopted the simplified dollar-value LIFO method. Inventory under FIFO in 2013 and 2014 is $400,000 and $600,000, respectively. The Consumer Price Index for 2013 is 115 and the Consumer Price Index in 2014 is 125 percent. How much is Anika’s inventory at the end of year 2014 under simplified LIFO?

93) In 2014, Modern Construction Company entered into a contract to construct a building for $5,000,000. The estimated cost to complete the building is $4,000,000 and the project will be completed in 2015. Modern incurred actual construction costs of $1,600,000 and $1,800,000 in 2014 and 2015, respectively. How much gross profit is recognized using the percentage-of-completion method in 2014 and 2015?

94) Tonya sold publicly-traded stock with an adjusted basis of $76,000 for $90,000. Tonya received a down payment of $15,000 with the balance due in equal payments over the next four years. What is the amount of gross profit to be recognized in the year of sale?

95) Natalie sold a machine for $140,000. The machine originally cost $95,000 and $15,000 of MACRS depreciation had been allowable. The buyer assumed an existing loan of $40,000, paid $30,000 cash down and agreed to pay $10,000 per year for seven years plus interest. Selling expenses are $10,000. What is the amount of gain to be reported in the year of sale?

96) Marissa sold stock of a non-publicly traded corporation with an adjusted basis of $36,000 for $48,000. Marissa received a down payment of $12,000 with the balance due in equal payments over the next two years.
a. What is the amount of gross profit to be recognized in the year of sale?
b. Assume that the buyer defaulted on the final payment. Marissa sued and was able to repossess the stock. The fair market value of the stock on the date of repossession is $36,000; legal fees were $1,500. What is the gain or loss on the repossession?

97) Nick sells land with a $7,000 adjusted basis for $10,000. Nick receives a $2,000 down payment with the balance of $8,000 due the following year. Nick is unable to collect the remaining $8,000 and, after incurring legal fees of $500, he repossesses the land when it has a fair market value of $9,000.
a. What is the amount of gain that Nick must report in the first year?
b. What is the amount of gain that Nick must report in the second year?
c. What is the basis in the repossessed stock?

98) Emily made the following interest free loans to her children:
(1) $10,000 to Erin for a down payment on a new home. Her net investment income for the year is $1,300.
(2) $50,000 to Sasha to purchase stock. Her net investment income for the year is $800.
(3) $60,000 to Tim to purchase a new boat. His net investment income for the year is $2,800.

The applicable federal interest rate on similar loans is 5%. What is the amount of interest income that Emily must report from these transactions?

99) Winnie made a $70,000 interest-free loan to her son, Tod, who used the money to retire a mortgage on his personal residence. Tod’s only source of income was salary of $35,000 and $990 interest income on a savings account. The relevant Federal interest rate was 5% and the loan was outstanding all year long.

What amount must Winnie include as interest income as a result of this transaction?

100) Which entities may elect a fiscal year? Discuss how certain tax entities may circumvent the requirement of using a calendar year.

101) Generally, economic performance must occur before an expense may be deducted. In some cases, this requirement of economic performance may be waived. Discuss the conditions under which economic performance may be waived and an earlier deduction may be allowed.

102) What is the significance of the Thor Power Tool Co. case?

103) Xerxes Manufacturing, in its first year of operations, produces solar panels which are sold through large building supply and home improvement stores. Xerxes’ year-end results include the following:

Office rent and utilities $15,000
Salaries of office staff 100,000
Salaries of factory workers 500,000
Direct materials used in production of solar panels 400,000
Factory rent 30,000
Factory utilities 10,000

You are preparing Xerxes’ first year tax return. Xerxes has elected a calendar year as its tax accounting period and the accrual method. What additional information would you need to prepare the tax return?

104) Doug is going to sell land for $100,000. The terms of the sale include $20,000 down and $20,000 plus interest for the next 4 years. He wishes to recognize income using the installment method. Both his brother and his son wish to buy the land from him. What are the tax considerations?

105) Discuss the purpose of the imputed interest rules.

106) Arnie is negotiating the sale of land to Phil. Arnie’s basis in the land is $3,000,000, and it currently has a fair market value of $5,000,000. Phil wants to pay the purchase price over three years. Arnie suggests that Phil pays $2,000,000 at closing, then pay $1,200,000 each of the next three years. Arnie would not require that Phil pay any interest under these terms. Discuss the tax issues that Arnie should consider.

107) Jared wants his daughter, Jacqueline, to learn about the stock market. He loans Jacqueline $30,000, but does not require Jacqueline to pay interest. Jared tells Jacqueline that she can repay him from the proceeds of future stock sales. Discuss the tax issues that Jared should consider.

Chapter 12 Property Transactions: Nontaxable Exchanges

1) Realized gain or loss must be recognized unless a specific Code section provides for nonrecognition treatment.

2) In a like-kind exchange, both the property transferred and the property received must be held by the taxpayer either for productive use in a trade or business or for investment.

3) The exchange of a personal-use automobile for stock in an automobile manufacturer held as an investment qualifies for like-kind treatment.

4) If an exchange qualifies as a like-kind exchange, nonrecognition of gain or loss is elective.

5) Real property exchanged for personal property qualifies as a like-kind exchange.

6) An investor exchanges an office building located in Niagara Falls, NY for an office building located in Niagara Falls, Ontario. The exchange does not qualify as like-kind.

7) An exchange of inventory for inventory of a like kind qualifies as a like-kind exchange.

8) The exchange of a partnership interest for an interest in another partnership qualifies as a like-kind exchange.

9) A sale of property and subsequent purchase of like-kind property may be treated as a like-kind exchange if the two transactions are interdependent.

10) For purposes of nontaxable exchanges, cash and non-like-kind property constitute boot.

11) The receipt of boot as part of a nontaxable exchange causes a realized loss to be recognized.

12) Where non-like-kind property other than cash is received as boot, the amount of the boot is the property’s fair market value.

13) If each party in a like-kind exchange assumes a liability of the other party, only the net liability given or received is boot.

14) The basis of non-like-kind property received is the basis in the hands of the transferor at the date of the exchange.

15) If related taxpayers exchange property qualifying for a like-kind exchange, the properties must be retained for three years after the exchange to prevent recognition of gain resulting from the original exchange on a subsequent disposition of the property.

16) The holding period of like-kind property received in a nontaxable exchange begins on the day of the exchange.

17) The holding period for boot property received begins on the day after the date of the exchange.

18) The involuntary conversion provisions which allow deferral of gain are mandatory.

19) If a gain is realized on the involuntary conversion of property, the gain may be deferred if qualifying replacement property is acquired within a specified time period at a cost equal to or greater than the amount realized on the involuntary conversion.

20) All or part of gain realized on an involuntary conversion is deferred but not permanently excluded if qualifying replacement property is acquired within the requisite period of time.

21) In an involuntary conversion, the basis of replacement property is its cost reduced by the gain deferred.

22) A taxpayer may elect to defer recognition of a loss resulting from an involuntary conversion.

23) If the threat of condemnation exists and the taxpayer has reasonable grounds to believe that the property will be condemned, the taxpayer may elect to defer gain even if the taxpayer sells the property to a party other than the governmental unit that is threatening to condemn the property.

24) When the cost of replacement property is less than the amount realized on an involuntary conversion, gain will be recognized. The recognized gain will be equal to the amount realized over the cost of the replacement property, but not more than the total realized gain.

25) If property is involuntarily converted into similar property, the basis and holding period of the converted property carry over to the basis and holding period of the replacement property.

26) If the taxpayer elects to defer the gain on an involuntary conversion, the holding period of the replacement property begins on the date of purchase.

27) Replacing a building with land qualifies as replacement property under the involuntary conversion rules relevant to a casualty.

28) If real property used in a trade or business or held for investment is condemned, it must be replaced with property having a similar functional use.

29) Vector Inc.’s office building burns down on October 31, 2014. Vector, a calendar year taxpayer, finally settles with the insurance company on February 3, 2015. In order to defer the gain realized on the building, Vector must acquire another office building by February 3, 2017.

30) When an involuntary conversion is due to the condemnation of real property held for productive use in a trade or business or for investment, the replacement period will end three years after the close of the first tax year in which any part of the gain is realized.

31) A loss on the sale of a taxpayer’s personal residence is deductible if the taxpayer owned and lived in the home for two of five years.

32) In order for the gain on the sale of a personal residence to be excluded under Section 121, a replacement residence must be purchased within two years.

33) In the case of married taxpayers, an individual may claim the Sec. 121 exclusion even if the individual’s spouse used the exclusion within the past two years.

34) The taxpayer must be occupying the residence at the time of the sale in order for Sec. 121 to apply.

35) If a taxpayer owns more than one home, she can designate the home that will be considered her principal residence for purposes of the Sec. 121 exclusion.

36) If a principal residence is sold before satisfying the ownership and use tests, part of the gain may be excluded if the sale is due to a change in employment, health, or unforeseen circumstances.

37) Ron and Fay live in Buffalo. They also own a condominium in Orlando (purchased in 2009) which they rent to vacationers. Ron and Fay will be retiring. They plan to live in the Orlando property for two and a half years. When they sell it, they will be able to exclude the full gain which is expected to be about $200,000.

38) All of the following qualify as a like-kind exchange except
A) an apartment building held for investment for farmland used in a trade or business.
B) a printer used in trade or business for a computer used in trade or business.
C) improved real estate held for investment for unimproved real estate held for investment.
D) an airplane used in trade or business for a general purpose truck used in trade or business.

39) Which of the following statements with respect to a like-kind exchange is false?
A) Property of one class must be exchanged for property of the same class.
B) An exchange of inventory does not qualify as a like-kind exchange.
C) Personal property must be exchanged for personal property.
D) Sale of property and subsequent purchase of like-kind property will always qualify as a like-kind exchange.

40) A owns a ranch in Wyoming, which B offers to purchase. A is not willing to sell the ranch but is willing to exchange the ranch for an apartment complex in Louisiana. The complex is available for sale. B purchases the apartment complex in Louisiana from C and transfers it to A in exchange for A’s ranch. The ranch and the complex each have a $1,000,000 fair market value. Which of the following is true?
A) The transaction qualifies as a like-kind exchange for B but not for A.
B) The transaction qualifies as a like-kind exchange for both B and A.
C) The transaction qualifies as a like-kind exchange for A but not for B.
D) The transaction does not qualify as a like-kind exchange for either B or A.

41) Landry exchanged land with an adjusted basis of $50,000 for another parcel of land worth $35,000 plus $10,000 of cash. Landry held the original land for investment purposes and will do the same with the new parcel. Due to the exchange, Landry will recognize
A) $10,000 gain.
B) $5,000 gain.
C) $5,000 loss.
D) $0.

42) Dean exchanges business equipment with a $120,000 adjusted basis for $40,000 cash and business equipment with a $140,000 FMV. What is the amount of gain which Dean recognizes on the exchange?
A) $0
B) $20,000
C) $40,000
D) $60,000

43) Daniella exchanges business equipment with a $100,000 adjusted basis for $10,000 cash and business equipment with a $96,000 FMV. What is the amount of gain recognized on the exchange?
A) $0
B) $4,000
C) $6,000
D) $10,000

44) Gena exchanges land held as an investment with a $60,000 basis for other land with a $80,000 FMV and a motorcycle with a $10,000 FMV. The acquired land is to be held for investment and the motorcycle is for personal use. What is the amount of recognized gain?
A) $0
B) $10,000
C) $20,000
D) $30,000

45) Pamela owns land for investment purposes. The land is worth $300,000 (basis of $260,000 to Pamela). Pamela exchanges the land, plus $20,000 cash, for a warehouse to be used in her business. The FMV of the warehouse is $400,000, but the warehouse is subject to a mortgage of $80,000, which is assumed by Pamela. Pamela must recognize a gain of
A) $ 0.
B) $ 40,000.
C) $ 120,000.
D) $ 140,000.

46) Bob owns a warehouse that is used in business while Rebecca owns land. Bob exchanges the warehouse for the land, which will be held for investment. The FMV of the warehouse is $440,000 (basis $240,000), but the warehouse is subject to a mortgage of $80,000, which is assumed by Rebecca. Bob receives $40,000 cash and the land, which has a FMV of $320,000. Bob realizes a gain (loss) on the exchange of
A) $80,000.
B) $120,000.
C) $190,000.
D) $200,000.

47) Emily owns land for investment purposes that has a FMV of $300,000 (basis of $260,000). She exchanges the land, plus $40,000 cash, for a warehouse to be used in her business. The warehouse is worth $420,000, but is subject to a mortgage of $80,000 which Emily will assume. The gain realized by Emily on the exchange is
A) $40,000.
B) $80,000.
C) $120,000.
D) $160,000.

48) Glen owns a building that is used in business. The building is worth $200,000, but is subject to a mortgage of $40,000. Glen’s basis in the building is $120,000. Glen exchanges the building for investment land worth $150,000 plus $10,000 cash. In addition, the other party assumes the mortgage which will be held for investment. Glen must recognize a gain of
A) $0.
B) $10,000.
C) $50,000.
D) $80,000.

49) Kai owns an apartment building held for investment purposes. The apartment building is worth $500,000, although it is subject to a mortgage of $100,000. Kai’s basis in the apartment building is $380,000. Kai exchanges the apartment building for an office building. The office building has an FMV of $350,000. Kai receives $50,000 cash in addition to receiving the office building, and the other party assumes the apartment building mortgage. What is Kai’s recognized gain on this exchange?
A) $0
B) $50,000
C) $120,000
D) $150,000

50) In a nontaxable exchange, Henri traded in a truck having an adjusted basis of $8,500 and a FMV of $10,000, for a new truck having a FMV of $15,000. In addition, Henri paid cash of $5,000. What is Henri’s basis in the new truck?
A) $5,000
B) $8,500
C) $13,500
D) $15,000

51) Bobbie exchanges business equipment (adjusted basis $160,000) for other business equipment that has a FMV of $140,000. Bobbie also receives $30,000 cash. Bobbie’s basis in the new equipment is
A) $130,000.
B) $140,000.
C) $160,000.
D) $170,000.

52) Jason owns a warehouse that is used in business. The FMV of the warehouse is $200,000 (basis $120,000), and the warehouse is subject to a mortgage of $40,000. Jason exchanges the warehouse for land valued at $150,000. The other party also pays him $10,000 cash and assumes the mortgage on the warehouse. Jason’s basis in the land received will be
A) $120,000.
B) $150,000.
C) $180,000.
D) $200,000.

53) Laurie owns land held for investment. The land’s FMV is $150,000. Laurie’s basis in the land is $130,000. Laurie exchanges the land, plus $20,000 of cash, for a warehouse owned by Trey. The warehouse is worth $210,000, but is subject to a mortgage of $40,000 which Laurie will assume. Trey’s basis in the warehouse is $120,000. Laurie’s basis in the warehouse received will be
A) $150,000.
B) $170,000.
C) $190,000.
D) $210,000.

54) Rosa exchanges business equipment with a $60,000 adjusted basis for a like-kind piece of equipment with a $100,000 FMV and $20,000 of marketable securities. What is Rosa’s basis for the new equipment?
A) $60,000
B) $80,000
C) $100,000
D) $120,000

55) If there is a like-kind exchange of property between related parties, how long do they have to wait to dispose of the property received in order to avoid having to recognize any gain on the exchange?
A) 6 months
B) 1 year
C) 2 years
D) no waiting period

56) Rolf exchanges an office building worth $150,000 for investment land worth $175,000. He also provided stock worth $25,000. Rolf’s adjusted basis in the building and stock is $130,000 and $11,000, respectively. How much gain will Rolf recognize on the exchange?
A) $0
B) $14,000
C) $20,000
D) $34,000

57) Yael exchanges an office building worth $150,000 for investment land worth $175,000. He also provided
stock worth $25,000. Yael’s adjusted basis in the building and stock is $180,000 and $11,000, respectively. How much gain or loss will Yael recognize on the exchange?
A) $0
B) ($30,000)
C) ($16,000)
D) $14,000

58) Which of the following statements is not true with regard to like-kind exchanges?
A) Nonrecognition of gains and losses is mandatory if the exchange is a like-kind exchange.
B) The holding period of like-kind property received includes the holding period of the property exchanged.
C) A loss is always recognized if the taxpayer transfers non-like-kind personal use property (e.g. a personal use car) in an otherwise like-kind exchange.
D) The basis of property received in an exchange is equal to the basis of the property exchanged less the boot received plus the gain recognized and less any loss recognized.

59) All of the following are true except:
A) A nonsimultaneous exchange may never qualify as a like-kind exchange.
B) Nonrecognition of gains and losses is mandatory if the exchange is a like-kind exchange.
C) A loss may be recognized on non-like-kind property (boot) if the taxpayer transfers the boot in an otherwise like-kind exchange.
D) The holding period of like-kind property received includes the holding period of the property exchanged.

60) Cassie owns a Rembrandt painting she acquired on June 1, 2008 as an investment. She exchanges the painting on September 5, 2014, for a Picasso sculpture and marketable securities to be held as an investment. On what date does the sculpture’s holding period begin?
A) June 1, 2008
B) June 2, 2008
C) September 5, 2014
D) September 6, 2014

61) Juan’s business delivery truck is destroyed in an accident. He paid $40,000 for the truck, and $30,000 of depreciation has been deducted during its period of use. The insurance company pays Juan $32,000 due to the accident. What is the minimum amount that Juan must spend on a new truck to avoid any gain recognition?
A) $40,000
B) $32,000
C) $10,000
D) $22,000

62) Stephanie’s building, which was used in her business, was destroyed in a fire. Stephanie’s adjusted basis in the building was $175,000, and its FMV was $210,000. Stephanie filed an insurance claim and was reimbursed $200,000. In that same year, Stephanie invested $180,000 of the insurance proceeds in another business building. If the proper election is made, Stephanie will recognize gain of
A) $ 0.
B) $15,000.
C) $20,000.
D) $25,000.

63) Stephanie’s building, which was used in her business, was destroyed in a fire. Stephanie’s adjusted basis in the building was $175,000, and its FMV was $210,000. Stephanie filed an insurance claim and was reimbursed $200,000. In that same year, Stephanie invested $180,000 of the insurance proceeds in another business building. Assuming the proper election is made to defer gain, Stephanie’s basis in the new building will be
A) $175,000.
B) $180,000.
C) $200,000.
D) $210,000.

64) Ron’s building, which was used in his business, was destroyed in a fire. Ron’s adjusted basis in the building was $210,000, and its FMV was $330,000. Ron filed an insurance claim and was reimbursed $300,000. In that same year, Ron invested $240,000 of the insurance proceeds in another business building. Ron will recognize gain of
A) $0.
B) $30,000.
C) $60,000.
D) $90,000.

65) Ron’s building, which was used in his business, was destroyed in a fire. Ron’s adjusted basis in the building was $210,000, and its FMV was $330,000. Ron filed an insurance claim and was reimbursed $300,000. In that same year, Ron invested $240,000 of the insurance proceeds in another business building. Ron’s basis in the new building is
A) $180,000.
B) $210,000.
C) $240,000.
D) $330,000.

66) Which of the following statements is false regarding involuntary conversions?
A) A taxpayer must replace the destroyed property within the same tax year in which the gain is realized.
B) A taxpayer cannot elect to defer recognition of a loss resulting from an involuntary conversion.
C) If deferral of gain is elected, the holding period of the converted property carries over to the replacement property.
D) Gain may be deferred if the property is involuntarily converted into property that is similar or related in service or use to the converted property.

67) The building used in Tim’s business was condemned by the city of Lafayette. Tim received a condemnation award of $125,000. He paid $1,200 in lawyer’s fees and $800 for an appraisal of the property. Tim’s adjusted basis in the building was $60,000. Tim reinvests in similar property costing $110,000, and Tim makes the proper election regarding the property. What is the amount of Tim’s realized (not recognized) gain on the condemnation?
A) $ 0
B) $50,000
C) $63,000
D) $65,000

68) The building used in Terry’s business was condemned by the city of St. Louis. Terry received a condemnation award of $125,000. He paid $1,200 in lawyer’s fees and $800 for an appraisal of the property. Terry’s adjusted basis in the building was $60,000. Terry reinvests in similar property costing $110,000, and Terry makes the proper election regarding the property. What is the amount of Terry’s recognized gain on the condemnation?
A) $15,000
B) $13,000
C) $50,000
D) $63,000

69) Ed owns a racehorse with a $600,000 basis used for breeding purposes. The racehorse is killed in a tornado, and Ed collects $1,000,000 from the insurance company. He purchases another horse for $550,000. What is the amount of gain recognized on the transaction?
A) $0
B) $50,000
C) $350,000
D) $400,000

70) The building used in Manuel’s business was condemned by the city of Mobile. Manuel received a condemnation award of $220,000. He paid $800 in lawyer’s fees and $600 for an appraisal of the property. Manuel’s adjusted basis in the building was $120,000. Manuel reinvests in similar property costing $200,000, and Manuel makes the proper election regarding the property. Manuel’s basis in the new building is
A) $102,400.
B) $121,400.
C) $120,000.
D) $200,000.

71) Which of the following statements regarding involuntary conversions is incorrect?
A) With some exceptions, the replacement property must be similar or related in service or use to the property converted.
B) The functional-use test is more restrictive than the like-kind test.
C) The taxpayer-use test applies to the involuntary conversion of rental property owned by an investor.
D) Real property used in a trade or business that is condemned must be replaced with property which has the same functional use as the converted property.

72) Each of the following is true of deferral of gain attributable to the involuntary conversion of personal property with the exception of
A) gain deferral is elective, except for direct conversions.
B) the replacement property may be acquired by gift, inheritance, or purchase.
C) qualifying replacement property must be acquired within a specified time period.
D) replacement property must be similar or related in service or use to the converted property.

73) Alex owns an office building which the state condemns on January 15, 2014. Alex receives the condemnation award on April 1, 2014. In order to qualify for nonrecognition of gain on this involuntary conversion, what is the last date for Alex to acquire qualified replacement property?
A) January 15, 2016
B) January 15, 2017
C) December 31, 2016
D) December 31, 2017

74) According to Sec. 121, individuals who sell or exchange their personal residence may exclude part or all of the gain if the house was owned and occupied as a principal residence for
A) at least five years immediately before the sale date.
B) at least one year of the three-year period before the sale date.
C) at least two years of the five-year period before the sale date.
D) at least five years of the ten-year period before the sale date.

75) Mitchell and Debbie, both 55 years old and married, sell their personal residence to Sophie. Sophie pays $225,000 and assumes their $70,000 mortgage. To make the sale they pay $4,000 in commissions and $1,000 in legal costs. They have owned and lived in the house for seven years and their tax basis is $125,000. What is the amount of gain recognized on the sale?
A) $0
B) $100,000
C) $165,000
D) $170,000

76) Bob and Elizabeth, both 55 years old and married, sell their personal residence to Wolfgang. Wolfgang pays $660,000 and assumes their $90,000 mortgage. To make the sale they pay $20,000 in commissions and $10,000 in legal costs. They have owned and lived in the house for seven years and their tax basis is $200,000. What is the amount of gain recognized on the sale?
A) $0
B) $20,000
C) $50,000
D) $520,000

77) Frank, a single person age 52, sold his home this year. He had lived in the house for 10 years.
He signed a contract on March 4 to sell his home and closed the sale on May 3.

Sales price $202,000
Selling expenses 12,000
Replaced and paid for a broken window on March 2 200
Basis of old home before repairs and improvements 150,000

Based on these facts, what is the amount of his recognized gain?
A) $0
B) $39,800
C) $40,000
D) $52,000

78) Pierce, a single person age 60, sold his home this year. He had lived in the house for 10 years. He signed a contract on March 4 to sell his home.

Sales price $600,000
Selling expenses 15,000
Replaced and paid for a broken window on March 2 800
Basis of old home before repairs and improvements 310,000

Based on these facts, what is the amount of his recognized gain?
A) $0
B) $25,000
C) $40,000
D) $275,000

79) On May 1 of this year, Ingrid sold her personal residence for $250,000. Commissions on the sale were $20,000. Ingrid also incurred $10,000 of costs for painting and repairs, which were all completed and paid for two weeks prior to the sale of her home. Ingrid’s basis in her old home was $180,000. Ingrid’s realized gain upon the sale of her first home is
A) $ 0.
B) $40,000.
C) $50,000.
D) $70,000.

80) William and Kate married in 2014 and purchased a new home together. Each had owned and lived in separate residences for the past 5 years. William’s adjusted basis in his old residence was $200,000; Kate’s adjusted basis in her old residence was $120,000. In late 2014, William sells his residence for $500,000 while Kate sells her residence for $190,000. What is the total gain to be excluded from these transactions in 2014?
A) $0
B) $250,000
C) $320,000
D) $370,000

81) All of the following statements are true with regard to personal residences except:
A) Temporarily renting property that was formerly the taxpayer’s principal residence does not automatically preclude the use of Sec. 121.
B) To qualify for favorable tax treatment under Sec. 121, the residence must be either the taxpayer’s principal residence or a secondary residence.
C) In the case of married taxpayers, an individual may claim the exclusion even if the individual’s spouse used the exclusion within the past two years.
D) Houseboats, house trailers, and condominium apartments may qualify as a principal residence.

82) Generally, a full exclusion of gain under Sec. 121 upon the sale of a personal residence applies to only one sale or exchange every
A) six months.
B) year.
C) two years.
D) five years.

83) Jenna, who is single, sold her principal residence on December 1, 2013, and excluded the $150,000 gain because she met the ownership and usage requirements under Sec. 121. Jenna purchased another residence in Pensacola on January 1, 2014 that she occupied until July 1, 2014 when she receives a new job offer from an employer in Miami. She sells the Pensacola residence on October 1, 2014 and realizes a gain of $40,000. Jenna may exclude what amount of the gain from the sale on October 1, 2014?
A) $0
B) $10,000
C) $20,000
D) $40,000

84) Which of the following statements is false with regard to the ownership and use tests under Sec. 121?
A) The taxpayer must be occupying the residence at the time of the sale in order for Sec. 121 to apply.
B) If a principal residence is sold before satisfying the ownership and use tests, part of the gain may be excluded if the sale is due to a change in employment, health, or unforeseen circumstances.
C) For purposes of the two-year ownership rule, a taxpayer’s period of ownership includes the period during which the taxpayer’s deceased spouse owned the residence.
D) When a taxpayer receives a residence from a spouse or an ex-spouse incident to a divorce, the taxpayer’s period of owning the property includes the time the residence was owned by the spouse or ex-spouse.

85) Under what circumstances can a taxpayer obtain a partial exclusion if a home is sold before the use and ownership tests are satisfied?
A) change in employment that meets the requirement for a moving expense deduction
B) increased traffic due to widening of a road
C) birth of one child
D) divorce

86) Which of the following is not an unforeseen circumstance for purposes of obtaining a partial exclusion of a gain on the sale of a home?
A) loss of employment by the qualified individual if the individual is eligible for unemployment compensation
B) natural or man-made disaster resulting in a casualty to the residence
C) birth of one child
D) divorce or legal separation

87) Sometimes taxpayers should structure a transaction to avoid the application of like-kind provisions. Which of the following conditions is likely to cause a taxpayer to avoid like-kind treatment?
A) Expected higher tax rates in the future.
B) Less accelerated depreciation provisions expected in the future.
C) A decline in the value of the asset being disposed of.
D) None of the above.

88) Which of the following statements in not correct regarding the compliance requirements of an involuntary conversion?
A) The taxpayer elects the deferral by not reporting the gain as income for the first year in which the gain is realized although all relevant information regarding the vent will be reported.
B) A taxpayer who recognized the full gain and paid the taxes can later file a refund claim to elect the deferral if qualified property is acquired before the expiration of the replacement period.
C) A taxpayer elects to defer the full gain in the year the gain is realized (year one), and no gain is reported on that year’s tax return. Qualified replacement property is acquired in the following year (year two), but the full insurance proceeds are not spent so some gain must be recognized. The partial gain recognition will be reported on the tax return for year two.
D) A taxpayer properly elected to defer the full realized gain in year one and provides appropriate information on the replacement property. The taxpayer cannot later revoke the election and designate a different property as the replacement property.

89) Indicate with a “yes” or a “no” which of the following are like-kind exchanges.
a. Computer used in trade or business for office furniture used in trade or business.
b. Apartment building held as an investment for an office building used in trade or business.
c. Land used in trade or business for equipment used in trade or business.
d. Printer used in trade or business for printer used for personal purposes.
e. Exchange of improved real estate held for investment for unimproved real estate held for investment.

90) Indicate with a “yes” or a “no” which of the following are like-kind exchanges (assume all assets are held for business or investment purposes).
a. Exchange of common stock held as an investment for land held as an investment.
b. Exchange of farmland for an apartment building.
c. Exchange of office furniture used in trade or business for computer used in a trade or business
d. Exchange of unimproved real estate for improved real estate.
e. Exchange of automobile used in trade or business for office building used in trade or business

91) Amelia exchanges an office building with a $350,000 adjusted basis for an airplane with a $560,000 fair market value to be used in business.
a. What is the amount of gain or loss realized by Amelia?
b. What is the amount of gain or loss recognized by Amelia?

92) Cheryl owns 200 shares of Cornerstone Corporation common stock which has an adjusted basis of $60,000 and a fair market value of $75,000. John owns 200 shares of Cable Corporation with a $75,000 fair market value.
a. If Cheryl and John exchange their stock, what is the amount of Cheryl’s realized gain?
b. If Cheryl and John exchange their stock, what is the amount of Cheryl’s recognized gain?

93) Kevin exchanges an office building used in his business for another office building worth $200,000 plus $30,000 cash. The FMV of Kevin’s old building is $280,000 (basis $150,000) and it is subject to a mortgage of $50,000. The mortgage is assumed by the other party.
a. What is the amount of gain realized by Kevin?
b. What is the amount of gain recognized by Kevin?
c. What is the basis of the new building to Kevin?

94) Summer exchanges an office building used in her business for another office building. Summer’s office building has a FMV of $250,000 (basis of $180,000). The FMV of the new building is $300,000, and it is subject to a mortgage of $60,000, which is assumed by Summer. Summer also pays the other party $40,000 cash.
a. What is the amount of gain realized by Summer?
b. What is the amount of gain recognized by Summer?
c. What is the basis of the new building to Summer?

95) Trent, who is in the business of racing horses, exchanges a racehorse with a basis of $80,000 for $40,000 cash and a trotter (another racehorse) with a $150,000 fair market value.
a. What is the amount of gain realized by Trent?
b. What is the amount of gain recognized by Trent?
c. What is the adjusted basis of the trotter?

96) Patricia exchanges office equipment with an adjusted basis of $20,000 for $5,000 cash and office equipment with a fair market value of $12,000.
a. What is the gain or loss realized?
b. What is the gain or loss recognized?
c. What is the adjusted basis of the new office equipment?

97) Eric exchanges a printing press with an adjusted basis of $64,000 for a smaller model with a $100,000 fair market value. In addition, he receives $20,000 of marketable securities.
a. What is the amount of gain realized by Eric?
b. What is the amount of gain recognized by Eric?
c. What is Eric’s basis in the new printing press?
d. What is Eric’s basis in the marketable securities?

98) Olivia exchanges land with a $50,000 basis plus marketable securities with a $20,000 basis for a larger parcel of land worth $110,000 in a transaction that otherwise qualifies as a like-kind exchange. The FMV of the land and marketable securities exchanged by Olivia is $75,000 and $35,000 respectively.
a. What is the amount of gain realized and recognized by Olivia on each asset?
b. What is the amount of Olivia’s basis in the new land?

99) Whitney exchanges timberland held as an investment for undeveloped land with a $300,000 FMV. Whitney’s basis for the timberland is $150,000. She also transfers her tractor with a $15,000 basis and a $10,000 FMV as part of the exchange.
a. What is the amount, if any, of gain or loss recognized on the transaction?
b. What is the basis of the undeveloped land?

100) Marinda exchanges an office building worth $800,000 (basis is $820,000) for a warehouse worth $850,000. A part of the exchange she also transfers $50,000 worth of securities which she purchased for $40,000.
a. What are Marinda’s realized and recognized gains (losses) on the two assets exchanged?
b. What is Marinda’s basis in the warehouse acquired?

101) Luke’s offshore drilling rig with a $700,000 adjusted basis is destroyed by a hurricane. He collects $620,000 from the insurance company and purchases a new drilling rig for $600,000.
a. What are the tax consequences of these transactions?
b. What is the basis of the new rig?

102) An office building owned by Abby and used in her business was destroyed in a fire. Abby’s adjusted basis in the building was $145,000 and its FMV was $180,000. Abby filed an insurance claim and she was reimbursed $160,000. In that same year, Abby invested $150,000 of the insurance proceeds in another business building.
a. Assume Abby made the proper election with regard to the involuntary conversion. What is the amount of gain to be recognized by Abby?
b. What is Abby’s basis in the new building?

103) Mick owns a racehorse with a $500,000 basis used for breeding purposes. The racehorse is killed in an accident and Mick receives $750,000 from the insurance company. Mick purchases another racehorse for $400,000.
a. What is the amount of Mick’s realized gain?
b. What is the amount of Mick’s recognized gain?

104) Theresa owns a yacht that is held for personal use and has a $100,000 basis. The yacht is destroyed by a storm and Theresa collects $120,000 from the insurance company. She purchases a new $150,000 yacht for personal use and elects to defer any gain on the transaction. What is the basis of the new yacht?

105) Kareem’s office building is destroyed by fire on April 11, 2014. Settlement is reached with the insurance company on November 1, 2014 when he receives a check for $900,000. The property had recently been appraised for $920,000. Kareem’s adjusted basis in the building was $800,000.
a. What is Kareem’s realized gain or loss?
b. Assume Kareem wishes to defer the maximum amount of gain. Indicate:
(1) the minimum amount that must be spent on a new property.
(2) any restrictions on the new property in order for it to qualify.
(3) the deadline for placing the new property in service.
c. Assume that instead of a fire, the state forces Kareem to sell the property. Indicate how your responses to part b would differ.

106) Nicki is single and 46 years old. She sells her principal residence (adjusted basis $200,000) that she purchased ten years ago for $435,000.
a. What is the amount of Nicki’s recognized gain on the sale?
b. Assume instead that Nicki sells the residence for $485,000. What is the amount of Nicki’s recognized gain on the sale?
c. Assume instead that Nicki has been married to Mike for the entire time they have owned and lived in the home. If they sell the home for $485,000, what is the amount of their recognized gain on the sale?

107) In 1997, Paige paid $200,000 to purchase a new residence. She paid a realtor $5,000 to help locate the house and paid legal fees of $3,000 to make certain that the seller had legal title to the property. Under the provisions of tax law in effect at the time of the purchase, she deferred a gain of $30,000 from the sale of a former residence in 1996. In 1999, she added a new porch to the house at a cost of $15,000 and installed central air conditioning at a cost of $12,000. Since purchasing the house, she has paid $2,000 in repairs. What is the adjusted basis of the home?

108) James and Ellen Connors, who are both 50 years old and married, sell their personal residence on July 25, 2014 for $950,000. They have lived in the home for 20 years. The basis of the home is $350,000. They purchased a new home for $1,000,000 in August 2014. After living in that home for 219 days, the Connors were forced to sell their new home in 2015 for $1,300,000 and move to another climate due to Ellen’s severe health problems.
a. What is the amount of gain recognized on the home sale in 2014?
b. What is the amount of the gain recognized on the home sale in 2015?

109) Amber receives a residence ($750,000 FMV, $500,000 adjusted basis) owned for eight years by Jonathan, her former spouse, as part of a divorce settlement. Amber and Jonathan had lived in the home for the four years before the divorce. Seven months after the transfer of the residence, Amber sells it for $790,000. What is the amount of Amber’s recognized gain on the sale of the home?

110) The Smiths owned and used their principal residence, with an adjusted basis of $250,000, for ten years. The house is destroyed by a tornado and the Smiths receive insurance proceeds of $800,000. Six months later, they purchase another residence for $850,000.
a. What is the amount of gain the Smiths must recognize?
b. What is the basis of the new residence?

111) Discuss the basis rules of property received in a nontaxable like-kind exchange.

112) Discuss the rules regarding the holding period for like-kind property received in a nontaxable exchange.

113) May a taxpayer elect under Sec. 1033 to defer recognition of loss resulting from an involuntary conversion?

114) Ike and Tina married and moved into their new home (purchase price $800,000) 18 months ago. They are thinking of selling the home which is now worth $1,300,000. They plan to reinvest in a smaller home costing approximately $600,000. What should they consider before selling their home?

115) Discuss why a taxpayer would want to avoid like-kind exchange provisions.

Chapter 13 Property Transactions: Section 1231 and Recapture

1) Mark owns an unincorporated business and has $20,000 of Section 1231 gains and $22,000 of Section 1231 losses. He must report a capital loss of $2,000 on his tax return.

2) A net Sec. 1231 gain is treated as ordinary income to the extent of any nonrecaptured net Sec. 1231 losses for the preceding five years.

3) In 2014, Thomas, who has a marginal tax rate of 15%, sells land that is Sec. 1231 property at a gain of $4,000. If he has no other 1231 transactions or capital asset transactions and has no nonrecaptured 1231 gain, Thomas will pay no tax on the $4,000 gain.

4) Sec. 1231 property must satisfy a holding period of more than one year.

5) Depreciable property used in a trade or business for one year or less is considered Sec. 1231 property.

6) Any gain or loss resulting from the sale or disposition of depreciable property used in trade or business and held one year or less is considered ordinary.

7) The sale of inventory results in ordinary gain or loss.

8) Gains and losses from involuntary conversions of property used in a trade or business generally are classified as capital gains and losses.

9) Gains and losses resulting from condemnations of Sec. 1231 property and capital assets held more than one year are classified as ordinary gains and losses.

10) If the recognized losses resulting from involuntary conversions arising from casualty or theft exceed the recognized gains from such events (i.e. a net loss from the casualty), all of the involuntary conversions are treated as ordinary gains and losses.

11) If realized gain from disposition of business equipment exceeds total depreciation or cost recovery, a portion of the gain will receive Sec. 1231 treatment if the equipment’s holding period is more than one year.

12) The purpose of Sec. 1245 is to eliminate the advantage taxpayers would have if they were able to reduce ordinary income by depreciation deductions and also receive favorable Sec. 1231 treatment when the asset was sold.

13) Sec. 1245 applies to gains on the sale of depreciable personal property, but it generally does not apply to depreciable real property.

14) If a taxpayer has gains on Sec. 1231 assets, Secs. 1245 and 1250 must be applied first to determine any amounts recaptured as ordinary income, and any excess gain may then be netted with Sec. 1231 losses for possible long-term capital gain treatment.

15) Sec. 1245 ordinary income recapture can apply to buildings placed in service prior to 1987.

16) Sec. 1245 can increase the amount of gain recognized on an asset.

17) Section 1250 could convert a portion of Sec. 1231 gain into ordinary income if the real property was placed in service prior to 1987 and accelerated depreciation was used.

18) For noncorporate taxpayers, depreciation recapture is not required on real property placed in service after 1986.

19) When corporate and noncorporate taxpayers sell real property placed in service after 1986, all depreciation taken will be taxed at a maximum rate of 25%.

20) Unrecaptured 1250 gain is the amount of long-term capital gain which would be taxed as ordinary income if Sec. 1250 provided for the recapture of all depreciation and not just additional depreciation.

21) The amount recaptured as ordinary income under either Sec. 1245 or Sec. 1250 can never exceed the realized gain.

22) Section 1250 does not apply to assets sold or exchanged at a loss.

23) In addition to the normal recapture rules of Sec. 1250, corporations which sell depreciable real estate are subject to additional recapture rules of Sec. 291.

24) The additional recapture under Sec. 291 is 25% of the difference between the amount that would have been recaptured if the property was Sec. 1245 property and the actual recapture under Sec. 1250.

25) Frisco Inc., a C corporation, placed a building in service in 2002 and deducted straight-line depreciation under the MACRS system in the normal manner. It sold the building this year for a substantial gain. Because straight-line depreciation was used, Frisco will not need to recognize any ordinary gain.

26) Gifts of appreciated depreciable property may trigger recapture of depreciation or cost-recovery deductions to the donor.

27) When a donee disposes of appreciated gift property, the recapture amount for the donee is computed by including the recapture amount attributable to the donor.

28) When appreciated property is transferred at death, the recapture potential carries over to the person who receives the property from the decedent.

29) If no gain is recognized in a nontaxable like-kind exchange involving Sec. 1245 or Sec. 1250 property, the recapture potential carries over to the replacement property.

30) When gain is recognized on an involuntary conversion, gain is subject to recapture under Sec. 1245 or Sec.1250.

31) Installment sales of depreciable property which result in recaptured income under Secs. 1245 or 1250 require that the recaptured income be recognized in the year of sale.

32) Costs of tangible personal business property which are expensed under Sec. 179 are subject to recapture if the property is converted to nonbusiness use before the end of the MACRS recovery period.

33) Gain recognized on the sale or exchange of property between related parties is capital if the property is subject to depreciation in the hands of the transferee.

34) Why did Congress establish favorable treatment for 1231 assets?
A) to encourage the mobility of capital
B) to allow a larger deduction for losses
C) to help business owners replace assets which had declined in value
D) All of the above

35) Jeremy has $18,000 of Section 1231 gains and $23,000 of Section 1231 losses. The gains and losses are characterized as

A)
Capital Gain Capital Loss Ordinary Income Ordinary Loss
$18,000 $23,000

B)
Capital Gain Capital Loss Ordinary Income Ordinary Loss
$18,000 $23,000

C)
Capital Gain Capital Loss Ordinary Income Ordinary Loss
$18,000 $23,000

D)
Capital Gain Capital Loss Ordinary Income Ordinary Loss
$18,000 $3,000 $20,000

36) Pierce has a $16,000 Section 1231 loss, a $12,000 Section 1231 gain, and a salary of $50,000. What is the treatment of these items in Pierce’s AGI?
A) Pierce has a LTCG of $12,000 and a net ordinary income of $34,000.
B) The 1231 gains and losses are treated as ordinary gains and losses making Pierce’s AGI for the year $46,000.
C) Pierce has a $3,000 LTCL which is deductible for AGI making AGI $47,000. He also has a $1,000 LTCL carryover.
D) Pierce has net LTCG of $9,000 and $37,000 of net ordinary income.

37) Daniel recognizes $35,000 of Sec. 1231 gains and $25,000 of Sec. 1231 losses during the current year. The only other Sec. 1231 item was a $4,000 loss three years ago. This year, Daniel must report
A)
NLTCG Ordinary Income
$10,000 $ 0

B)
NLTCG Ordinary Income
$ 6,000 $ 4,000

C)
NLTCG Ordinary Income
$ 4,000 $ 6,000

D)
NLTCG Ordinary Income
$ 4,000 $10,000

38) During the current year, Danika recognizes a $30,000 Section 1231 gain and a $22,000 Section 1231 loss. Prior to this, Danika’s only Section 1231 item was a $15,000 loss two years ago. Danika must report a(n)
A) $8,000 net LTCG.
B) $8,000 ordinary income.
C) $15,000 ordinary income.
D) $8,000 ordinary income and $7,000 net LTCG.

39) During the current year, George recognizes a $30,000 Section 1231 gain on sale of land and a $18,000 Section 1231 loss on the sale of land. Prior to this, George’s only Section 1231 item was a $14,000 loss six years ago. George must report a
A) $12,000 net LTCG.
B) $12,000 ordinary income.
C) $14,000 ordinary income.
D) $10,000 ordinary income and $2,000 net LTCG.

40) During the current year, Kayla recognizes a $40,000 Section 1231 gain on sale of land and a $22,000 Section 1231 loss on the sale of land. Prior to this, Kayla’s only Section 1231 item was a $10,000 loss six years ago. Kayla is in the 28% marginal tax bracket. The amount of tax resulting from these transactions is
A) $2,700.
B) $3,600.
C) $4,000.
D) $5,040.

41) Blair, whose tax rate is 28%, sells one tract of land at a gain of $29,000 and another tract of land at a gain of $11,000. Both tracts of land are Sec. 1231 property. She has never had any other Sec. 1231 transactions. How are the gains taxed?
A) ordinary income of $40,000 taxed at 28%
B) a net capital gain of $40,000 which is not taxed
C) a net capital gain of $40,000 taxed at 15%
D) ordinary income of $40,000 taxed at 25%

42) For a business, Sec. 1231 property does not include
A) timber, coal, or domestic iron ore.
B) inventory purchased 24 months ago.
C) an office building purchased five years ago.
D) land used in the business that was purchased two years ago.

43) Which of the following assets is 1231 property?
A) a machine used in the company’s manufacturing operations
B) an investment in corporate stock
C) land held for investment
D) items held for resale by a retailer

44) Section 1231 property will generally have all the following characteristics except
A) real or depreciable property.
B) used in trade or business.
C) held for sale to customers.
D) held for more than one year.

45) A corporation owns many acres of timber, which it acquired three years ago, and which has a $120,000 basis. The timber was cut last year for use in the corporation’s business. The FMV of the timber on the first day of last year was $270,000. The corporation made the appropriate election to treat the cutting as a sale or exchange. The timber is sold for $300,000 this year. The tax result this year is
A) recognition of capital gain of $30,000.
B) recognition of Sec. 1231 gain of $30,000.
C) recognition of ordinary income of $30,000.
D) no income recognized since all recognition occurs in the year of the cutting of the timber.

46) A corporation owns many acres of timber, which it acquired three years ago, and which has a $150,000 basis for depletion. The timber is cut during the current year for use in the corporation’s business. The FMV of the timber on the first day of the current year is $280,000. If the corporation makes the appropriate election, the tax result is
A) recognition of a Sec. 1231 gain of $130,000.
B) no recognition of gain or loss since the timber is used in the business.
C) recognition of a gain at the time of sale if the timber is later sold with the gain equal to the sales price less the basis in the timber.
D) recognition of a gain if the timber is later sold with the gain equal to the sales price less $280,000 (FMV on the first day of the year of the cutting).

47) In order to be considered Sec. 1231 property, all of the following livestock must be held for 12 months or more from date of acquisition except
A) goats.
B) hogs.
C) sheep.
D) cattle.

48) For livestock to be considered Section 1231 property,
A) the livestock must be held for draft, breeding or dairy purposes, but not for sport.
B) cattle and horses must be held for at least 12 months from the date of acquisition.
C) cattle and horses must be held for at least 24 months from the date of acquisition.
D) livestock other than cattle and horses must be held for at least 24 months from the date of acquisition.

49) If Section 1231 applies to the sale or exchange of an unharvested crop sold with land, the costs of producing the crop are
A) capitalized.
B) deducted as an expense of operations when incurred and also deducted from the sales price at the time of the sale.
C) deducted when incurred if the land is sold but capitalized if the land is exchanged.
D) deducted as an expense of operations when incurred.

50) Dinah owned land with a FMV of $130,000 (adjusted basis $120,000) which is investment property (a capital asset). Dinah owned a second tract of land, a 1231 asset, with a FMV of $46,000 (adjusted basis $50,000). Both tracts were acquired in 2001 and condemned by the state this year. The state paid an amount equal to FMV. If there are no other transactions involving capital assets or 1231 assets, Dinah must report on her current year return
A) $6,000 net ordinary income.
B) $6,000 net section 1231 gain treated as a net capital gain.
C) a LTCG of $10,000 and a 1231 loss of $4,000.
D) a LTCG of $10,000 and a nondeductible loss of $4,000.

51) Emma owns a small building ($120,000 basis and $123,000 FMV) and equipment ($35,000 basis and $22,000 FMV). Both assets were acquired three years ago, are used in Emma’s business, and are depreciated using straight-line depreciation. Both are destroyed by fire. Insurance proceeds were equal to their FMVs. Only one other transfer of an asset occurs during the year, and a $3,000 LTCL is recognized. After considering all transactions, the tax result to Emma is a
A) $13,000 NLTCL.
B) $13,000 ordinary loss.
C) $3,000 LTCG; $3,000 LTCL; and $13,000 ordinary loss.
D) $10,000 net ordinary loss and a $3,000 NLTCL.

52) Cassie owns equipment ($45,000 basis and $30,000 FMV) and a building ($152,000 basis and $158,000 FMV), which are used in Cassie’s business. Cassie has used straight-line depreciation for both assets, which were acquired two years ago. Both the equipment and the building are destroyed in a fire, and Cassie collects insurance proceeds equal to the assets’ FMV. The tax result to Cassie for this transaction is a
A) $15,000 Sec. 1231 loss and a $6,000 ordinary gain.
B) $15,000 ordinary loss and a $6,000 ordinary gain.
C) $15,000 ordinary loss and a $6,000 Sec. 1231 gain.
D) $15,000 Sec. 1231 loss and a $6,000 Sec. 1231 gain.

53) Harry owns equipment ($50,000 basis and $38,000 FMV) and a building ($140,000 basis and $156,000 FMV), which are used in his business. Harry uses straight-line depreciation for both assets, which were acquired several years ago. Both the equipment and the building are destroyed in a fire, and Harry collects insurance proceeds equal to the assets’ FMV. The tax result to Harry for this transaction is
A) the involuntary conversions are treated as ordinary gains and losses.
B) the involuntary conversions are treated as Sec. 1231 gains and losses.
C) the loss on involuntary conversion is treated as a Sec. 1231 loss while the gain is treated as an ordinary gain.
D) the loss on involuntary conversion is treated as an ordinary loss while the gain is treated as a Sec. 1231 gain.

54) Terry has sold equipment used in her business. She acquired the equipment three years ago for $50,000 and has recognized $30,000 of depreciation across the years in use. In order to recognize any Sec. 1231 gain, she must sell the equipment for more than
A) $0.
B) $20,000.
C) $30,000.
D) $50,000.

55) During the current year, Hugo sells equipment for $150,000. The equipment cost $175,000 when placed in service two years ago, and $55,000 of depreciation deductions were allowed. The results of the sale are
A) LTCG of $30,000.
B) Sec. 1231 gain of $30,000.
C) Sec. 1245 ordinary income $30,000.
D) Sec. 1250 ordinary income of $30,000.

56) During the current year, a corporation sells equipment for $300,000. The equipment cost $270,000 when purchased and placed in service two years ago and $60,000 of depreciation deductions were allowed. The results of the sale are
A) ordinary income of $90,000.
B) Sec. 1231 gain of $90,000.
C) ordinary income of $60,000 and LTCG of $30,000.
D) ordinary income of $60,000 and Sec. 1231 gain of $30,000.

57) Section 1245 recapture applies to all the following except
A) depreciable personal property.
B) assets sold or exchanged at a loss.
C) total depreciation or amortization allowed or allowable.
D) amortizable intangible personal property.

58) All of the following statements are true regarding Sec. 1245 are true except
A) Sec. 1245 does not apply to any buildings placed in service after 1986.
B) Sec. 1245 applies to assets sold or exchanged at a gain or at a loss.
C) Sec. 1245 property includes nonresidential real estate that qualified as recovery property under the ACRS rules unless the taxpayer elected to use the straight-line method of cost recovery.
D) Sec. 1245 ordinary applies to total depreciation or amortization allowed or allowable but not more than the realized gain.

59) An unincorporated business sold two warehouses during the current year. The straight-line depreciation method was used for the first building and the accelerated method (ACRS) was used for the second building. Information about those buildings is presented below.

Building No. 1 Building No. 2
Date acquired 1986 1986
Cost $800,000 $900,000
Accum. Depreciation
Straight-line 800,000
ACRS depreciation 900,000
Selling Price 80,000 400,000

How much gain from these sales should be reported as section 1231 gain and ordinary income due to depreciation recapture by the owner of the business?

A)
Section 1231 Gain Ordinary Income
$480,000 $0

B)
Section 1231 Gain Ordinary Income
$ 80,000 $400,000

C)
Section 1231 Gain Ordinary Income
$ 0 $480,000

D)
Section 1231 Gain Ordinary Income
$400,000 $ 80,000

60) A building used in a business for more than a year is sold. Sec. 1250 will not cause depreciation recapture if
A) the building is fully depreciated.
B) the building was placed in service after 1986.
C) straight-line depreciation was used.
D) all of the above.

61) With respect to residential rental property
A) 80% or more of the gross rental income from the building or structure must be rental income from dwelling units in order for it to be classified as residential rental property.
B) hotels are not included in this category if less than half of the units are used on a transient basis.
C) 80% or more of the net rental income from the building or structure must be rental income from dwelling units in order for it to be classified as residential rental property.
D) gain is not subject to the depreciation recapture provisions if the property is held more than one year.

62) Marta purchased residential rental property for $600,000 on January 1, 1985. Total ACRS deductions for 1985 through the date of sale amounted to $600,000. If the straight-line method of depreciation had been used, depreciation would have been $600,000. The property is sold for $750,000 on January 1 of the current year. The amount and character of the gain is
A) $750,000 Sec. 1231 gain.
B) $150,000 Sec. 1231 gain and $600,000 ordinary income.
C) $750,000 ordinary gain due to Sec 1245.
D) $750,000 ordinary gain due to Sec. 1250.

63) Emily, whose tax rate is 28%, owns an office building which she purchased for $900,000 on March 18 of last year. The building is sold for $950,000 on February 20 of this year when the adjusted basis of the building was $876,000. The tax results to Emily are
A) $74,000 1231 gain taxed at 15%.
B) $74,000 ordinary income taxed at 28%.
C) $24,000 1250 unrecaptured gain taxed at 25% and $50,000 1231 gain taxed at 15%.
D) $24,000 1231 gain taxed at 15% and $50,000 ordinary income taxed at 28%.

64) In 1980, Mr. Lyle purchased a factory building to use in business for $480,000. When Mr. Lyle sells
the building for $580,000, he has taken depreciation of $470,000. Straight-line depreciation would have been $400,000. Mr. Lyle must report
A) $570,000 of ordinary gain.
B) $570,000 of Sec. 1231 gain.
C) $70,000 of ordinary income and $500,000 of Sec. 1231 gain.
D) $470,000 of ordinary gain and $100,000 of Sec. 1231 gain.

65) Ross purchased a building in 1985, which he uses in his manufacturing business. Ross uses the ACRS statutory rates to determine the cost-recovery deduction for the building. Ross’s original cost for the building is $500,000 and cost-recovery deductions allowed are $500,000. If the building is sold for $340,000, the tax results to Ross are
A) $340,000 LTCG.
B) $340,000 Sec. 1231 gain.
C) $340,000 Sec. 1245 ordinary income.
D) $340,000 Sec. 1250 ordinary income.

66) Eric purchased a building in 2003 that he uses in his business. Eric uses the straight-line method for the building. Eric’s original cost for the building is $420,000 and cost-recovery deductions are $120,000. Eric is in the top tax bracket and has never sold any other business assets. If the building is sold for $560,000, the tax results are
A) $260,000 Sec. 1231 gain, all taxable at 20%.
B) $260,000 unrecaptured Sec. 1250 gain, all taxable at 25%.
C) $260,000 Sec. 1231 gain, of which $120,000 is unrecaptured Sec. 1250 gain taxable at 25% and the $140,000 balance is taxable at 20%.
D) $120,000 Sec. 1245 ordinary income, $140,000 Sec. 1231 gain taxable at 20%.

67) With regard to noncorporate taxpayers, all of the following statements are true regarding Sec. 1250 recapture except
A) Sec. 1250 affects the character of the gain, not the amount of the gain.
B) Sec. 1250 applies to assets sold or exchanged at either a gain or a loss.
C) Sec. 1250 ordinary income does not exist if the straight-line method of depreciation is used.
D) Sec. 1250 ordinary income is never more than the additional depreciation allowed.

68) In 1980, Artima Corporation purchased an office building for $400,000 for use in its business. The
building is sold during the current year for $550,000. Total depreciation allowed for the building was $350,000; straight-line would have been $320,000. As result of the sale, how much section 1231 gain will Artima Corporation report?
A) $350,000
B) $406,000
C) $320,000
D) $500,000

69) A corporation sold a warehouse during the current year. The straight-line depreciation method was used. Information about the building is presented below:

Date acquired 1984
Cost $800,000
Accumulated Depreciation – Straight-line 620,000
Selling Price 890,000

How much gain should the corporation report as section 1231 gain?
A) $124,000
B) $620,000
C) $586,000
D) $710,000

70) Octet Corporation placed a small storage building in service in 1999. Octet’s original cost for the building is $800,000 and the cost recovery deductions are $300,000. This year the building is sold for $1,100,000. The amount and character of the gain are
A) Ordinary gain of $60,000 and Sec. 1231 gain of $540,000.
B) Ordinary gain of $300,000 and Sec. 1231 gain of $300,000.
C) Ordinary gain of $600,000.
D) Sec. 1231 gain of $600,000.

71) Maura makes a gift of a van to a local food bank run by a charity. Maura had used the van in her trade or business. The van has a FMV of $6,500; a cost of $31,000; and $27,000 depreciation claimed. What is the amount of Maura’s charitable contribution deduction?
A) $6,500
B) $31,000
C) $4,000
D) $2,500

72) A taxpayer purchased a factory building in 1985 for $800,000. After claiming ACRS-accelerated depreciation of $800,000, she sells the asset for $1,000,000 during the current year. No payment is received during the current year, and the $1,000,000 balance to be paid with interest at the interest rate in four annual payments beginning one year from date of sale. The installment sales method is adopted. How much ordinary income is recognized in the current year?
A) $ 0
B) $200,000
C) $800,000
D) $1,000,000

73) Douglas bought office furniture two years and four months ago for $25,000 to use in his business and elected to expense all of it under Sec. 179. Depreciation of $3,500 would have been taken under the MACRS rules. If Douglas converts the furniture to nonbusiness use today, Douglas must
A) amend the prior two years tax returns.
B) include $3,500 in gross income in year of conversion.
C) include $21,500 in gross income in year of conversion.
D) include $25,000 in gross income in year of conversion.

74) Clarise bought a building three years ago for $180,000 to use in her business. The straight-line method of depreciation was used and $15,000 of depreciation deductions were allowed. During the current year, Clarise sells the building to her wholly-owned corporation for $235,000. The tax results to Clarise are
A) $70,000 ordinary income.
B) $70,000 of Sec. 1231 gain.
C) $55,000 ordinary income and $15,000 Sec. 1231 gain.
D) $15,000 of ordinary income and $55,000 Sec. 1231 gain.

75) All of the following are considered related parties for purposes of Sec. 1239 recapture with the exception of
A) an individual and a partnership where the individual has a one-fourth interest in the partnership.
B) an individual and a corporation where the individual owns more than 50% of the value of the outstanding stock of the corporation.
C) an individual and a corporation where the individual’s spouse owns more than 50% of the value of the outstanding stock of the corporation.
D) an individual and a partnership where the individual owns more than 50% of the capital of the partnership.

76) Cobra Inc. sold stock for a $25,000 loss five years ago. It has been carrying over the capital loss for five years, and the loss will expire at the end of this year because Cobra has not had any capital gains. Earlier this year Cobra sold a parcel of land held four years for business use and will recognize a $30,000 gain. Cobra is thinking about selling some machinery used in its business for the past three years. During this time technology has dramatically changed so Cobra will recognize a $32,000 loss on the sale of the machinery. Cobra is trying to decide whether to sell the machinery at year-end or early next year. Cobra is profitable and has a consistent marginal tax rate of 35%. When should Cobra sell the equipment?
A) current year
B) early next year
C) current year, but arrange an installment sale to spread the loss recognition over the two years
D) either the current year or next year

77) Lucy, a noncorporate taxpayer, experienced the following Section 1231 gains and losses during the years 2009 through 2014. Her first disposition of a Sec. 1231 asset occurred in 2009. Assuming Lucy had no capital gains and losses during that time period, what is the tax treatment in each of the years listed?

Section 1231 Gains Section 1231 Losses
2009 $10,000 $ 8,000
2010 $18,000 $23,000
2011 $ 9,000 $13,000
2012 $22,000 $16,000
2013 $25,000 $17,000
2014 $11,000 $18,000

78) Jillian, whose tax rate is 39.6%, had the following sales of Section 1231 property this year:

Sale of land at a gain of $15,000
Sale of land at a gain of $12,000
Sale of land at a loss of $8,000

a. What is the amount of her resulting tax liability?
b. Assume instead that Jillian has a 15% marginal tax rate. What is the amount of her resulting tax liability?
c. Assume instead that Jillian has a 28% marginal tax rate. What is the amount of her resulting tax liability?

79) Hilton, a single taxpayer in the 28% marginal tax bracket, has $16,000 of nonrecaptured net Sec. 1231 losses, at the beginning of a year in which he had the following transactions:

-Sale of Asset A at a $10,000 1231 gain, all of which is unrecaptured Sec. 1250 gain
-Sale of Asset B at a $13,000 1231 gain

How are the items reported this year and at which rate(s) are the amounts taxed?

80) Indicate whether each of the following assets are capital assets, Sec. 1231 assets, or ordinary income property (property which, if sold, results in ordinary income). Assume that all of the property is held for more than one year.
a. XYZ Corporation owns land used as an employee parking lot. How is the parking lot classified for tax purposes?
b. Montana Corporation owns land held as an investment. How is the land classified for tax purposes?
c. John, a self-employed electrician, owns an automobile he uses strictly for personal use. How is the automobile classified for tax purposes?
d. Jan, a self-employed contractor, owns a truck she uses exclusively in her trade or business. How is the truck classified for tax purposes?
e. Leslie owns an office building where her accounting practice is located. What is the classification of the building?
f. Yvonne owns a computer for use in her job as a sales representative. She does not use the computer for personal purposes. How is the computer classified for tax purposes?

81) Sarah owned land with a FMV of $150,000 (adjusted basis $135,000) which is investment property (a capital asset). Sarah owned a second tract of land, a 1231 asset, with a FMV of $38,000 (adjusted basis $55,000). Both tracts were acquired in 2000 and condemned by the state this year. The state paid an amount equal to FMV. If there are no other transactions involving capital assets or 1231 assets, what is the amount that Sarah must report on her current year return?

82) Elaine owns equipment ($23,000 basis and $15,000 FMV) and a building ($136,000 basis and $148,000 FMV), which are used in her business. Elaine uses straight-line depreciation for both assets, which were acquired several years ago. Both the equipment and the building are destroyed in a fire, and Elaine collects insurance proceeds equal to the assets’ FMV.
a. What is the tax treatment of these two transactions?
b. Assume that Elaine is only able to collect $3,000 from the insurance company for the equipment loss. What is the tax treatment of the two transactions (assume the basis and insurance reimbursement remain the same for the building).

83) The following gains and losses pertain to Jimmy’s business assets that qualify as Sec. 1231 property. Jimmy does not have any nonrecaptured net Sec. 1231 losses from previous years, and the portion of gain recaptured as ordinary income due to the depreciation recapture provisions has been eliminated.

Gain due to insurance reimbursement for hurricane damage $24,000
Loss due to condemnation $21,000
Gain due to the sale of Sec. 1231 property $18,000

Describe the specific tax treatment of each of these transactions.

84) The following gains and losses pertain to Arnold’s business assets that qualify as Sec. 1231 property. Arnold does not have any nonrecaptured net Sec. 1231 losses from previous years, and the portion of gain recaptured as ordinary income due to the depreciation recapture provisions has been eliminated.

Loss from hurricane damage $25,000
Loss due to condemnation $20,000
Gain due to the sale of Sec. 1231 property $16,000

Describe the specific tax treatment of each of these transactions.

85) The following are gains and losses recognized in 2014 on Ann’s business assets that were held for more than one year. The assets qualify as Sec. 1231 property.

Gain due to insurance reimbursement for casualty $20,000
Gain due to a condemnation 30,000
Loss due to the sale of Sec. 1231 property 17,000

A summary of Ann’s net Sec. 1231 gains and losses for the previous five-year period is as follows:

Cumulative Nonrecaptured
Year Sec. 1231 Gain Sec. 1231 Loss Net 1231 Losses
2009 $5,000 $0
2010 $3,000 $3,000
2011 $17,000 $20,000
2012 $12,000 $8,000
2013 $10,000 $18,000

Describe the specific tax treatment of each of the current year transactions.

86) Network Corporation purchased $200,000 of five-year equipment on March 24, 2012. They elected to expense $60,000 of the cost under Sec. 179 in effect that year. After depreciating the equipment $28,000 in 2012 and $22,400 in 2013, the equipment was sold for $190,000.
a. What is the amount of the realized gain (or loss) on the sale?
b. How is the gain or loss taxed?

87) On June 1, 2011, Buffalo Corporation purchased and placed in service 7-year MACRS tangible property costing $100,000. On November 10, 2014, Buffalo sold the property for $102,000 after having taken MACRS $47,525 in depreciation deductions. What is the amount and character of Buffalo’s gain?

88) An unincorporated business sold two warehouses during the current year. The straight-line depreciation method was used for Building No. 1 and the accelerated method (ACRS) was used for Building No. 2. Information about those buildings is presented below.

Building No. 1 Building No. 2
Date acquired 1984 1984
Cost $510,000 $650,000
Accum. Depreciation
Straight-line 510,000
ACRS depreciation 650,000
Selling Price 750,000 825,000

How much gain from these sales should be reported as section 1231 gain and ordinary income due to depreciation recapture?

89) Jed sells an office building during the current year for $800,000. The building was purchased in 1980 for $350,000. Jed had depreciated the building under an accelerated method, but it is now fully depreciated. Jed has never had any other Sec. 1231 transactions.
a. What is the recognized gain or loss on the sale of the building and the character of the gain?
b. How will the gain be taxed?

90) Pam owns a building used in her trade or business that was placed into service in 2002. The building cost $450,000 and depreciation to date amounts to $200,000. Pam sells the building for $380,000. It is the only asset she sells this year, and she has no nonrecaptured Sec. 1231 losses. What is the amount of recognized gain and the nature of the gain? How will the gain be taxed?

91) Julie sells her manufacturing plant and land originally purchased in 1980. Accelerated depreciation had been taken on the building, but the building is now fully depreciated. Julie is in the 39.6% marginal tax bracket. Other information is as follows:

Property Original cost Total depreciation Adjusted basis Selling price
Plant $2,800,000 $2,800,000 $0 $3,000,000
Land $ 500,000 $500,000 $800,000

She has not sold any other assets this year. A review of her file indicates that the only asset dispositions in the past five years was a truck sold for a $10,000 loss last year. What are the tax consequences of the sale (type of gain; rates at which taxed)?

92) Connors Corporation sold a warehouse during the current year for $980,000. The building had been acquired in 1980 at a cost of $830,000. The building is fully depreciated.

What is the amount and nature of the gain or loss on the sale of the warehouse?

93) WAM Corporation sold a warehouse during the current year for $830,000. The building had been acquired in 1989 at a cost of $730,000 and had total straight-line depreciation of $510,000.

What is the amount and nature of the gain or loss on the sale of the warehouse?

94) Describe the tax treatment for a noncorporate taxpayer in the 39.6% marginal tax bracket who sells each of the first two assets for $500,000 and each of the second two assets for $750,000. Each asset was purchased in 2010 and is used in a trade or business. There are no other gains and losses and no nonrecaptured Section 1231 losses.

Original Basis Adjusted Basis
Land $350,000 $350,000
Equipment $600,000 $450,000
Equipment $600,000 $500,000
Building $550,000 $450,000

95) Jacqueline dies while owning a building with a $1,000,000 FMV. The building is classified as Sec. 1245 property acquired in 1985 for $850,000. Cost-recovery deductions of $850,000 have been claimed. Pam inherits the property.
a. What is the amount of Pam’s basis in the property?
b. What is the amount of cost-recovery deductions that Pam must recover if she immediately sells the building?

96) Melissa acquired oil and gas properties for $600,000. During 2013 she elected to expense the $180,000 of IDC. Total depletion allowed was $50,000. During the current year, Melissa sells the property for $700,000.
a. What is the amount of and nature of her gain using the facts above?
b. What is the amount of and nature of her gain assuming that she sold the property for $850,000?

97) Pete sells equipment for $15,000 to Marcel, his son. The equipment cost $20,000 and has accumulated depreciation of $12,000. Marcel will use the equipment in his business.
a. What is the amount and character of Pete’s gain on the sale?
b. How does your answer change if the sales price is $22,000?

98) What is the purpose of Sec. 1245 and what is its significance?

99) Jesse installed solar panels in front of his office building in 2013. The panels are not attached to the building. After using the solar panels for 13 months, Jesse decided to replace them with a newer model to obtain a greater savings on electricity costs. Jesse sold the old solar panels for an amount greater than his original purchase price. What tax issues should be considered with purchase, use and sale of the original solar panels?

100) Brian purchased some equipment in 2014 which he intends to use in his trade or business. He approaches you to assist him in planning for the ultimate disposal of the asset—whether it be by sale, charitable contribution to the local university, gift to his sister for use in her business, or some other means. Discuss the tax considerations.

Chapter 14 Special Tax Computation Methods, Tax Credits, and Payment of Tax

1) The alternative minimum tax applies to individuals, corporations, estates, and trusts.

2) The alternative minimum tax applies to individuals only if it exceeds the taxpayer’s regular income tax liability.

3) For purposes of the AMT, the standard deduction, but not the personal and dependency exemptions, is allowed.

4) An example of an AMT tax preference is the excess of MACRS depreciation on equipment over depreciation computed by using the the 150% declining balance method.

5) All tax-exempt bond interest income is classified as an AMT preference.

6) Casualty and theft losses in excess of 10% of AGI are deductible for AMT purposes.

7) Medical expenses in excess of 10% of AGI are deductible when computing AMT.

8) For purposes of the AMT, only the foreign tax credit and refundable personal credits are allowed to reduce the tentative minimum tax.

9) A taxpayer who paid AMT in prior years, but is not subject to the AMT in the current year, may be entitled to an AMT credit against his regular tax liability in the current year.

10) If an individual is classified as an employee, the employer is required to withhold the employee’s share of the FICA tax and to provide a matching amount.

11) Self-employed individuals are subject to the self-employment tax if their net earnings are more than the personal exemption amount.

12) One-half of the self-employment tax imposed is allowed as a for AGI deduction.

13) If an individual is an employee and also has self-employment income, the maximum tax base for computing self-employment tax is reduced by the wages that are subject to the FICA tax.

14) A self-employed individual has earnings from his business of $300,000. For the earnings in excess of the $117,000, he will only have to pay the 2.9% Medicare tax.

15) When a husband and wife file a joint return and both have self-employment income, the self-employment tax must be computed separately.

16) Nonrefundable credits may offset tax liability but may not result in additional payments to the taxpayer.

17) The child and dependent care credit provides relief for working taxpayers who pay for care for younger children or an incapacitated dependent or spouse.

18) For purposes of the child and dependent care credit, qualifying employment-related expenses cannot include payments to a relative.

19) For purposes of the limitation on qualifying expenses for the child and dependent care credit, a spouse who is either a full-time student or is incapacitated is deemed to have earned income of $250 per month, or $500 per month if there are two or more qualifying individuals in the household.

20) The adoption credit based on qualified adoption expenses is generally allowed in the year the adoption is finalized.

21) Taxpayers with income below phase-out amounts are allowed a child credit of $1,000 for each qualifying child under age 17.

22) Qualified tuition and related expenses eligible for the American Opportunity Tax Credit are limited to those incurred the first two years of postsecondary education.

23) Brad and Shelly’s daughter is starting her freshman year of college. Brad and Shelly will be able to claim the American Opportunity Tax Credit for a percentage of the cost of tuition and room and board.

24) To claim the Lifetime Learning Credit, a student must take at least one-half of a full-time course load during the year.

25) The qualified retirement savings contributions credit is based on a maximum contribution of $2,000.

26) In lieu of a foreign tax credit, a taxpayer may elect to take a deduction for foreign taxes paid or accrued.

27) The foreign tax credit is equal to the smaller of foreign taxes paid or accrued in the tax year or the portion of the U.S. income tax liability attributable to the income earned in all foreign countries.

28) The general business credits are refundable credits.

29) A credit for rehabilitation expenditures is available to a business for the purchase price of a building originally placed in service before 1936.

30) The nonrefundable disabled access credit is available to eligible small businesses for expenditures incurred to make existing business facilities accessible to disabled individuals.

31) Research expenses eligible for the research credit include costs that are incident to the development or improvement of a product or component.

32) A taxpayer’s tentative minimum tax exceeds his net income tax so he will be paying the alternative minimum tax this year. The taxpayer has a sole proprietorship through which he has earned general business credits. The taxpayer can reduce his AMT to the extent of his general business credits.

33) The earned income credit is refundable only if a tax has been withheld.

34) The earned income credit is available only to taxpayers with qualifying children.

35) The health insurance premium assistance credit is designed to help lower and middle income taxpayers who purchase their own health insurance insurance directly from an insurance company or through a state or federal exchange.

36) If an employee has more than one employer during the year, all employers must withhold federal income taxes but only one employer must withhold FICA tax.

37) If estimated tax payments equal or exceed 100% of the actual tax liability for the prior year, there is generally (assuming AGI less than or equal to $150,000) no penalty for underpayment of estimated taxes.

38) Bob’s income can vary widely from year-to-year because much of his compensation comes from sales commissions and bonuses. It generally is in the $200,000 to $300,000 range. To minimize the risk of underpayment penalties for estimated tax he should pay in, through payroll withholding and estimated tax payments, 100% of the prior year tax liability.

39) Nonrefundable personal tax credits are allowed against the taxpayer’s tax liability before other credits are claimed.

40) Jake and Christina are married and file a joint return for 2014 with taxable income of $100,000 and tax preferences and adjustments of $20,000 for AMT purposes. Their regular tax liability is $16,713. What is the amount of their total tax liability?
A) $6,859
B) $9,854
C) $16,713
D) $26,567

41) In computing the alternative minimum taxable income, no deduction is allowed for
A) alimony.
B) moving expenses.
C) personal exemptions.
D) individual retirement account contributions.

42) Harley’s tentative minimum tax is computed by multiplying the AMT tax rates by her
A) taxable income.
B) alternative minimum tax base.
C) alternative minimum taxable income.
D) tentative alternative taxable income.

43) In 2014 Charlton and Cindy have alternative minimum taxable income of $130,000 and file a joint return. For purposes of computing the alternative minimum tax, their exemption is
A) $0.
B) $7,900.
C) $52,800.
D) $82,100.

44) Reva and Josh Lewis had alternative minimum taxable income of $350,000 in 2014 and file a joint return. For purposes of computing the alternative minimum tax, their exemption is
A) $33,725.
B) $52,800.
C) $48,375.
D) $82,100.

45) In computing AMTI, tax preference items are
A) excluded.
B) added only.
C) subtracted only.
D) either added or subtracted.

46) In computing AMTI, adjustments are
A) limited.
B) added only.
C) subtracted only.
D) either added or subtracted.

47) All of the following are allowable deductions under the alternative minimum tax except
A) charitable contributions.
B) gambling losses.
C) qualified housing interest.
D) personal property taxes.

48) Suzanne, a single taxpayer, has the following tax information for the current year.
• Charitable contribution of real property with a FMV of $25,000 (adjusted basis $20,000) for which a $25,000 deduction was taken.
• Research and experimental expenses of $40,000 deducted in full for regular tax.

Suzanne’s total tax preferences and adjustments equals
A) $5,000.
B) $36,000.
C) $41,000.
D) $45,000.

49) Rex has the following AMT adjustments:
-Depreciation of real property acquired in 1996 using MACRS is $22,000 while depreciation for AMT purposes is $15,000.
-R&E expenditures amounting to $60,000 are expensed.

The net adjustment is
A) $7,000.
B) $54,000.
C) $61,000.
D) $67,000.

50) Lavonne has a regular tax liability of $13,356 on taxable income of $70,000. She also has tax preferences of $25,000 and positive adjustments attributable to limitations on itemized deductions of $15,000. Lavonne is single and takes a $3,950 personal exemption for herself only. Lavonne’s alternative minimum tax for 2014 is
A) $0.
B) $2,543.
C) $16,271.
D) none of the above.

51) Self-employment taxes include components for
A) Medicare hospital insurance and SUTA.
B) Social Security and FUTA.
C) FICA and FUTA.
D) Social Security and Medicare hospital insurance.

52) A wage cap does not exist for which of the following self-employment taxes?
A) Social Security tax
B) FICA
C) FUTA
D) Medicare hospital insurance

53) If an individual is liable for self-employment tax, a portion of the self-employment tax is
A) a for AGI deduction.
B) from AGI as an itemized deduction.
C) a Schedule C business expense.
D) nondeductible.

54) John has $55,000 net earnings from a sole proprietorship. John is also employed by a major corporation and is paid $25,000. John’s self-employment tax (rounded) for 2014 is
A) $3,886.
B) $4,208.
C) $7,771.
D) $8,415.

55) Joe has $130,000 net earnings from a sole proprietorship. Joe’s self-employment tax (rounded) for 2014 is
A) $17,990.
B) $18,368.
C) $19,890.
D) None of the above.

56) Hong earns $127,300 in her job as a physician’s assistant. She also has her own business selling cosmetics. This business generated $10,000 of earnings. What is Hong’s self-employment tax for 2014?
A) $268
B) $290
C) $1,412
D) $1,530

57) Ava has net earnings from self-employment of $125,000. She also earned salary of $170,000 from a job held earlier in the year. How much Additional Medicare Tax will be owed on the self-employment income?
A) $0
B) $769
C) $855
D) $3,625

58) All of the following statements regarding self-employment income/tax are true except:
A) The self-employment tax is imposed on net earnings from self-employment over $400.
B) Self-employment tax is computed separately for married individuals filing joint returns.
C) Independent contractors are subject to self-employment tax on the amount of net earnings from the self-employment activity.
D) Employees who have a business in addition to their regular employment are not subject to the self-employment tax since FICA is withheld on their wages.

59) All of the following are self-employment income except
A) net income of a sole proprietorship.
B) dividends received by a corporate shareholder.
C) fees received for serving as a director of a corporation.
D) distributive share of partnership income from a partnership operating a business.

60) Nonrefundable tax credits
A) only offset a taxpayer’s tax liability.
B) may only be used if the taxpayer is receiving a refund.
C) can be carried back two years and carried forward 15 years if they exceed tax liability in the current year.
D) allow the excess over the taxpayer’s tax liability to be paid to the taxpayer.

61) Refundable tax credits
A) only offset a taxpayer’s tax liability.
B) may only be used if the taxpayer is receiving a refund.
C) have all expired but may be reinstated with new tax legislation.
D) allow the excess over the taxpayer’s tax liability to be paid to the taxpayer.

62) Which statement is correct?
A) Tax credits reduce tax liability on a dollar-for-dollar basis.
B) Tax deductions reduce tax liability on a dollar-for-dollar basis.
C) The benefit of a tax credit depends on the taxpayer’s marginal tax rate.
D) Tax deductions are less v