Quiz 5 Updated -- Official A2L Quiz Questions

A lesson of the Enron collapse is that government regulation ________.

Can reduce but not eliminate asymmetric information.

Equity contracts ________.

Are claims to a share in the profits and assets of a business.

The name economists give the process by which stockholders gather information by frequent monitoring of the firm's activities is ________.

Costly state verification.

Government regulations require publicly traded firms to provide information, reducing ________.

The adverse selection problem.

That only large, well-established corporations have access to securities markets ________.

Explains why indirect finance is such an important source of external funds for businesses.

Collateralized debt is also known as ________.

Secured debt.

Of the sources of external funds for nonfinancial businesses in Canada, stocks account for approximately ________ of the total.

12 percent.

Which of the following is not one of the eight basic puzzles about financial structure?

1) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower.

2) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.

3) Collateral is a prevalent feature of debt contracts for both households and business.

4) There is very little regulation of the financial system.

There is very little regulation of the financial system.

Stocks and bonds supply less than ________ of the external funds for Canadian corporations need to finance their activities.

One-third.

If all the students in your class pool their money in order to buy one bond and share its return accordingly, in order to eliminate transaction costs, this is an example of ________.

Economies of scale.

One financial intermediary in our financial structure that helps to reduce the moral hazard from arising from the principal-agent problem is the ________.

Venture capital firm.

The reduction in transactions costs per dollar of investment as the size of transactions increases is known as ________.

Economies of scale.

If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of ________.

Adverse selection.

Managers (________) may act in their own interest rather than in the interest of the stockholder-owners (________) because the managers have less incentive to maximize profits than the stockholder-owners do.

Agents; principals.

That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries ________.

Are able to prevent potential competitors from free-riding off the information that they provide.

Which of the following is false?

1) There are two potential sources of cash flows from owning a stock.

2) An investor will be willing to pay a price today for a share of stock up to the point that this transaction has a zero NPV.

3) An investor might generate cash by choosing to sell the shares at some future date.

4) Because the cash flows from stock are known with certainty, we can discount them using the risk-free interest rate.

4) Because the cash flows from stock are known with certainty, we can discount them using the risk-free interest rate.

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1) short-term interest rates are expected to rise in the future

When yield curves are flat, ________.

1) long-term interest rates are above short-term interest rates

2) short-term interest rates are above long-term interest rates

3) short-term interest rates are about the same as long-term interest rates

4) medium-term interest rates are above both short-term and long-term interest rates

3) Short-term interest rates are about the same as long-term interest rates.

Von Bora Corporation is expected to pay a dividend of $1.40 per share at the end of this year and $1.50 per share at the end of the second year. You expect Von Bora's stock price to be $25.00 at the end of two years. Von Bora's equity cost of capital is 10%. Suppose you plan to hold Von Bora stock for one year. The price you would expect to be able to sell a share of Von Bora stock at in one year is closest to:

23.17

Which of the following statements is true?

1) A liquid asset is one that can be quickly and cheaply converted into cash.

2) The demand for a bond declines when it becomes less liquid, decreasing the interest rate spread between it and relatively more liquid bonds.

3) The differences in bond interest rates reflect differences in default risk only.

4) The corporate bond market is the most liquid bond market.

1) A liquid asset is one that can be quickly and cheaply converted into cash.

According to the liquidity premium theory of the term structure ________.

The interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.

If the expected path of one-year interest rates over the next five years is 4 percent, 5 percent, 7 percent, 8 percent, and 6 percent, then the expectations theory predicts that today's interest rate on the five-year bond is ________.

6%

When short-term interest rates are expected to fall sharply in the future, the yield curve will ________.

be inverted

Which of the following statements is correct?

1) There is one potential source of cash flows from owning a stock.

2) There are two potential sources of cash flows from owning a stock.

3) There are three potential sources of cash flows from owning a stock.

4) There are more than three potential sources of cash flows from owning a stock.

2) There are two potential sources of cash flows from owning a stock.

Which of the following statements regarding profitable and unprofitable growth is false?

1) If a firm wants to increase its share price, it must cut its dividend and invest more.

2) If the firm retains more earnings, it will be able to pay out less of those earnings, which means that the firm will have to reduce its dividend.

3) A firm can increase its growth rate by retaining more of its earnings.

4) Cutting the firm's dividend to increase investment will raise the stock price if, and only if, the new investments have a positive NPV.

1) If a firm wants to increase its share price, it must cut its dividend and invest more.

The analysts predict that the price of corporation's XYZ stock one year from now will be $22. XYZ announced that is not going to pay dividends next year. You decide that you would be satisfied to earn a 10 percent on the investment on this stock, thus, this stock is worth ________ for you now.

$20

A decrease in the liquidity of corporate bonds, other things being equal, shifts the demand curve for corporate bonds to the ________ and the demand curve for Canada bonds shifts to the ________.

left, right

Von Bora Corporation (VBC) is expected to pay a $2.00 dividend at the end of this year. If you expect VBC's dividend to grow by 5% per year forever and VBC's equity cost of capital is 13%, then the value of a share of VBC stock is closest to:

$25.00

Which of the following statements is false?

1) As firms mature, their earnings exceed their investment needs and they begin to pay dividends.

2) Total return equals earnings multiplied by the dividend payout rate.

3) Cutting the firm's dividend to increase investment will raise the stock price if, and only if, the new investments have a positive NPV.

4) We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.

2) Total return equals earnings multiplied by the dividend payout rate.

According to the expectations theory of the term structure ________.

Interest rates on bonds of different maturities move together over time.

The interest rate on tax-exempt bonds falls relative to the interest rate on U.S. Treasury securities when ________.

Income tax rates are raised.

General Electric announces that it is going to cut its dividends by $0.02 per share in the future. This, everything else remaining the same, will cause its current stock price to ________.

decrease

in actual practice, short-term interest rates and long-term interest rates usually move together; this is the major shortcoming of the ________.

segmented markets theory

Default risk arises from the fact that

Borrowers differ in their ability to repay in full the principal and interest required by a loan agreement.

If a corporation begins to suffer large losses, then the default risk on the corporate bond will ________, everything else held constant.

Increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall.

In the Gordon growth model, a decrease in the required rate of return on equity ________.

increases the current stock price

If 1-year interest rates for the next five years are expected to be 4, 2, 5, 4, and 5 percent, and the 5-year term premium is 1 percent, than the 5-year bond rate will be ________.

5%

In the one-period valuation model, an increase in the required return on investments in equity ________.

reduces the current price of a stock

The price earnings ratio (PE) is a measure of how much the market is willing to pay for $1 of ________ from a firm.

earnings

Von Bora Corporation is expected to pay a dividend of $1.40 per share at the end of this year and $1.50 per share at the end of the second year. You expect Von Bora's stock price to be $25.00 at the end of two years. Von Bora's equity cost of capital is 10%. Suppose you plan on purchasing Von Bora stock in one year, right after the $1.40 dividend is paid. You then plan on selling your stock at the end of year two, right after the $1.50 dividend is paid. The capital gain rate that you will receive on your investment is closest to:

3.75%

When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant.

increases, decreases, falls

Everything else held constant, an increase in expected inflation, lowers the expected return on ________ compared to ________ assets.

bonds, real assets

In the bond market, the market equilibrium shows the market-clearing ________ and market-clearing ________.

price, interest rate

When the interest rate on a bond is above the equilibrium interest rate, in the bond market there is excess ________ and the interest rate will ________.

demand, fall

________ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant

an decrease, demand for, fall

Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the ________.

liquidity effect

Everything else held constant, if the expected return on RST stock declines from 12 to 9 percent and the expected return on XYZ stock declines from 8 to 7 percent, then the expected return of holding RST stock ________ relative to XYZ stock and demand for XYZ stock ________.

falls, rises

In Keynes's liquidity preference framework, ________.

an excess supply of bonds implies an excess demand for money.

In Keynes's liquidity preference framework, as the expected return on bonds increases (holding everything else unchanged), the expected return on money ________, causing the demand for ________ to fall.

falls, money

During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________, everything else held constant.

rises, right

Everything else held constant, when bonds become less widely traded, and as a consequence the market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest rate ________.

left, rises

When the interest rate is above the equilibrium interest rate, there is an excess ________ money and the interest rate will ________.

supply of, fall

an increase in income.

liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation.

expectations of more profitable investment opportunities.