1. Which of the following statements is CORRECT?
a. One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt.
b. Sole proprietorships are subject to more regulations than corporations.
c. In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner.
d. Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones.
e. Corporations of all types are subject to the corporate income tax.
2. Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a regular corporation. Which of the following statements is CORRECT?
a. Assuming Cheers is profitable, less of its income will be subject to federal income taxes.
b. Cheers will now be subject to fewer regulations.
c. Cheers’ shareholders (the ex-partners) will now be exposed to less liability.
d. Cheers’ investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.
e. Cheers will find it more difficult to raise additional capital.
3. Money markets are markets for
a. Foreign stocks.
b. Consumer automobile loans.
c. U.S. stocks.
d. Short-term debt securities.
e. Long-term bonds.
4. Which of the following is a primary market transaction?
a. You sell 200 shares of IBM stock on the NYSE through your broker.
b. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.
c. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker--you just give him cash and he gives you the stock.
d. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction.
e. You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of IBM shares on the NYSE.
5. Which of the following statements is CORRECT?
a. If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction.
b. If you purchased 100 shares of Disney stock from your brother-in-law, this would be an example of a primary market transaction.
c. The IPO market is a subset of the secondary market.
d. Only institutions, and not individuals, can participate in derivatives market transactions.
e. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.
6. Which of the following statements is CORRECT?
a. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders’ equity.
b. The balance sheet gives us a picture of the firm’s financial position at a point in time.
c. The income statement gives us a picture of the firm’s financial position at a point in time.
d. The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.
e. The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.
7. Which of the following items is NOT included in current assets?
a. Accounts receivable.
e. Short-term, highly liquid, marketable securities.
8. Which of the following items cannot be found on a firm’s balance sheet under current liabilities?
a. Accounts payable.
b. Short-term notes payable to the bank.
c. Accrued wages.
d. Cost of goods sold.
e. Accrued payroll taxes.
9. Which of the following statements is CORRECT?
a. The focal point of the income statement is the cash account, because that account cannot be manipulated by “accounting tricks.”
b. The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).
c. The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC).
d. If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow.
e. The income statement for a given year, say 2007, is designed to give us an idea of how much the firm earned during that year.
10. Below are the 2008 and 2009 year-end balance sheets for Wolken Enterprises:
Assets: 2009 2008
Cash $ 200,000 $ 170,000
Accounts receivable 864,000 700,000
Inventories 2,000,000 1,400,000
Total current assets $ 3,064,000 $2,270,000
Net fixed assets 6,000,000 5,600,000
Total assets $ 9,064,000 $7,870,000
Liabilities and equity:
Accounts payable $ 1,400,000 $1,090,000
Notes payable 1,600,000 1,800,000
Total current liabilities $ 3,000,000 $2,890,000
Long-term debt 2,400,000 2,400,000
Common stock 3,000,000 2,000,000
Retained earnings 664,000 580,000
Total common equity $ 3,664,000 $2,580,000
Total liabilities and equity $ 9,064,000 $7,870,000
Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year non-callable, long-term debt in 2008. As of the end of 2009, none of the principal on this debt had been repaid. Assume that the company’s sales in 2008 and 2009 were the same. Which of the following statements must be CORRECT?
a. Wolken increased its short-term bank debt in 2009.
b. Wolken issued long-term debt in 2009.
c. Wolken issued new common stock in 2009.
d. Wolken repurchased some common stock in 2009.
e. Wolken had negative net income in 2009.
11. On its 2010 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?
a. If the company lost money in 2010, they must have paid dividends.
b. The company must have had zero net income in 2010.
c. The company must have paid out half of its earnings as dividends.
d. The company must have paid no dividends in 2010.
e. Dividends could have been paid in 2010, but they would have had to equal the earnings for the year.
12. Below is the common equity section (in millions) of Teweles Technology’s last two year-end balance sheets:
Common stock $2,000 $1,000
Retained earnings 2,000 2,340
Total common equity $4,000 $3,340
Teweles has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?
a. The company’s net income in 2009 was higher than in 2008.
b. Teweles issued common stock in 2009.
c. The market price of Teweles' stock doubled in 2009.
d. Teweles had positive net income in both 2008 and 2009, but the company’s net income in 2009 was lower than it was in 2008.
e. The company has more equity than debt on its balance sheet.
13. Which of the following statements is CORRECT?
a. Typically, a firm’s DPS should exceed its EPS.
b. Typically, a firm’s EBIT should exceed its EBITDA.
c. If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.
d. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.
e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.
14. Considered alone, which of the following would increase a company’s current ratio?
a. An increase in net fixed assets.
b. An increase in accrued liabilities.
c. An increase in notes payable.
d. An increase in accounts receivable.
e. An increase in accounts payable.
15. Which of the following would, generally, indicate an improvement in a company’s financial position, holding other things constant?
a. The TIE declines.
b. The DSO increases.
c. The EBITDA coverage ratio increases.
d. The current and quick ratios both decline.
e. The total assets turnover decreases.
16. A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
a. Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
b. Use cash to repurchase some of the company’s own stock.
c. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
d. Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
e. Use cash to increase inventory holdings.
17, Which of the following statements is CORRECT?
a. A reduction in inventories held would have no effect on the current ratio.
b. An increase in inventories would have no effect on the current ratio.
c. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
d. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
e. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.
18. A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?
a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2)lead to an increase in accounts receivable.
b. Issue new common stock and use the proceeds to increase inventories.
c. Speed up the collection of receivables and use the cash generated to increase inventories.
d. Use some of its cash to purchase additional inventories.
e. Issue new common stock and use the proceeds to acquire additional fixed assets.
19. Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)?
20. Beranek Corp. has $410,000 of assets, and it uses no debt--it is financed only with common equity. The new CFO wants to employ enough debt to bring the debt/assets ratio to 40%, using the proceeds from the borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?
21. Which of the following statements is CORRECT?
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are useful for visualizing complex problems prior to doing actual calculations.
c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods.
e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
22. Which of the following statements is CORRECT?
a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.
c. The cash flows for an annuity due must all occur at the beginning of the periods.
d. The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month.
e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.
23. Suppose you have $1,500 and plan to purchase a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures?
24. You deposit $500 today in a savings account that pays 3.5% interest, compounded annually. How much will your account be worth at the end of 25 years?
25. Suppose a U.S. treasury bond will pay $2,500 five years from now. If the going interest rate on 5-year treasury bonds is 4.25%, how much is the bond worth today?
26. Suppose an ExxonMobil Corporation bond will pay $4,500 ten years from now. If the going interest rate on safe 10-year bonds is 4.25%, how much is the bond worth today?
27. Suppose the U.S. Treasury offers to sell you a bond for $747.25. No payments will be made until the bond matures 5 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond at the offer price?
28. Suppose the U.S. Treasury offers to sell you a bond for $3,000. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $5,000. What interest rate would you earn if you bought this bond at the offer price?
29. Ten years ago, Spielberg Inc. earned $0.50 per share. Its earnings this year were $2.20. What was the growth rate in earnings per share (EPS) over the 10-year period?
30. Five years ago, Greenery Inc. earned $1.50 per share. Its earnings this year were $3.20. What was the growth rate in earnings per share (EPS) over the 5-year period?
31. Wendy has $5,000 invested in a bank that pays 3.8% annually. How long will it take for her funds to triple?
32. You want to buy a new ski boat 2 years from now, and you plan to save $8,200 per year, beginning one year from today. You will deposit your savings in an account that pays 6.2% interest. How much will you have just after you make the 2nd deposit, 2 years from now?
33. You want to quit your job and go back to school for a law degree 4 years from now, and you plan to save $3,500 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. Under these assumptions, how much will you have 4 years from today?
34. Suppose you inherited $275,000 and invested it at 8.25% per year. How much could you withdraw at the end of each of the next 20 years?
35. Your grandmother just died and left you $100,000 in a trust fund that pays 6.5% interest. You must spend the money on your college education, and you must withdraw the money in 4 equal installments, beginning immediately. How much could you withdraw today and at the beginning of each of the next 3 years and end up with zero in the account?
36. Your father's employer was just acquired, and he was given a severance payment of $375,000, which he invested at a 7.5% annual rate. He now plans to retire, and he wants to withdraw $35,000 at the end of each year, starting at the end of this year. What is the maximum number of whole payments that can be withdrawn before the account is exhausted; i.e., before the account balance would become negative? (Hint: Round down to the nearest whole number.)
37. Your girlfriend just won the Florida lottery. She has the choice of $15,000,000 today or a 20-year annuity of $1,050,000, with the first payment coming one year from today. What rate of return is built into the annuity?
38. Which of the following statements is CORRECT?
a. You hold two bonds. One is a 10-year, zero coupon, issue and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the larger percentage decline.
b. The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates.
c. You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline.
d. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates.
e. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates.
39. Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?
a. The company’s bonds are downgraded.
b. Market interest rates rise sharply.
c. Market interest rates decline sharply.
d. The company's financial situation deteriorates significantly.
e. Inflation increases significantly.
40. A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?
a. If the yield to maturity remains constant, the bond’s price one year from now will be higher than its current price.
b. The bond is selling below its par value.
c. The bond is selling at a discount.
d. If the yield to maturity remains constant, the bond’s price one year from now will be lower than its current price.
e. The bond’s current yield is greater than 9%.
41. Which of the following statements is CORRECT?
a. All else equal, senior debt generally has a lower yield to maturity than subordinated debt.
b. An indenture is a bond that is less risky than a mortgage bond.
c. The expected return on a corporate bond will generally exceed the bond's yield to maturity.
d. If a bond’s coupon rate exceeds its yield to maturity, then its expected return to investors exceeds the yield to maturity.
e. Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated.
42. Quigley Inc.'s bonds currently sell for $1,080 and have a par value of $1,000. They pay a $100 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,125. What is their yield to maturity (YTM)?
43. Garvin Enterprises’ bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and a par value of $1,000. What is their current yield?
44. Assume that you are considering the purchase of a 15-year bond with an annual coupon rate of 9.5%. The bond has face value of $1,000 and makes semiannual interest payments. If you require an 11.0% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
45. If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?
46. Wachowicz Corporation issued 15-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 14 years to maturity?
47. McCue Inc.'s bonds currently sell for $1,250. They pay a $120 annual coupon, have a 15-year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM.)
48. Taussig Corp.'s bonds currently sell for $1,150. They have a 6.75% annual coupon rate and a 15-year maturity, but they can be called in 6 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds, the YTC or the YTM?
49. Moerdyk Corporation's bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond’s price?
50. Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?
a. Variance; correlation coefficient.
b. Standard deviation; correlation coefficient.
c. Beta; variance.
d. Coefficient of variation; beta.
e. Beta; beta.
51. A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?
a. Either A or B, i.e., the investor should be indifferent between the two.
b. Stock A.
c. Stock B.
d. Neither A nor B, as neither has a return sufficient to compensate for risk.
e. Add A, since its beta must be lower.
52. Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?
a. The fact that a security or project may not have a past history that can be used as the basis for calculating beta.
b. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta.
c. The beta of an "average stock," or "the market," can change over time, sometimes drastically.
d. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.
e. All of the statements above are true.
53. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?
a. If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
b. Stock Y's realized return during the coming year will be higher than Stock X's return.
c. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
d. Stock Y's return has a higher standard deviation than Stock X.
e. If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.
54. Which of the following statements is CORRECT?
a. An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.
b. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
c. It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
d. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
e. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well diversified portfolio of stocks.
55. Which of the following statements is CORRECT?
a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
b. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one.
c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.
d. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.
e. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.
56. Inflation, recession, and high interest rates are economic events that are best characterized as being
a. systematic risk factors that can be diversified away.
b. company-specific risk factors that can be diversified away.
c. among the factors that are responsible for market risk.
d. risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.
e. irrelevant except to governmental authorities like the Federal Reserve.
57. Maxwell Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?
58. Preston Inc.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return?
59. Wei Inc. is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%. What is the project's coefficient of variation?
60. Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y’s beta is 0.70. What is the portfolio's beta?
61. Calculate the required rate of return for Climax Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.
62. Moerdyk Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?
63. Desreumaux Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?
64. Choudhary Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock?
State of of State Expected
the Economy Occurring Return
Boom 0.45 25%
Normal 0.50 15%
Recession 0.05 5%
65. Jim Angel holds a $200,000 portfolio consisting of the following stocks:
Stock Investment Beta
A $ 50,000 0.95
B 50,000 0.80
C 50,000 1.00
D 50,000 1.20
What is the portfolio's beta?