Finance Exam #1

Identify a true statement about the financial services provided by organizations.

Identify a true statement about the financial services provided by organizations.

Financial services organizations help individuals and companies determine how to invest money to achieve their financial goals.

The credit manager is supervised by the _____.

treasurer

Which of the following statements is correct?

The riskiness of projected EPS can impact the firm's value.

Which of the following is true of corporations that operate in several different countries?

A nation may expropriate the assets of multinational corporations without compensation.

Which of the following statements is correct?

Maximizing the income statement item "net income" might not be the best goal for a corporation if the managers are interested in maximizing the economic welfare of the firm's stockholders (that is, the firm's stock price).

Which of the following statements is true of a hostile takeover?

A hostile takeover is most likely to occur when a firm's stock is undervalued relative to its potential.

The treasurer of a company is a key subordinate of the _____.

financial vice president

The 11 sections (titles) in the Sarbanes-Oxley Act of 2002 establish standards for accountability and responsibility in reporting financial information for publicly-traded corporations. Which of the following activities does the act provide that a corporation must abide by?

The corporation must provide additional information about the procedures used to construct and report financial statements.

The 11 sections (titles) in the Sarbanes-Oxley Act of 2002 _____.

establish standards for accountability and responsibility in reporting financial information

Actions that help a firm increase the price of its stock also _____.

require the development of products that consumers want and need

The success of financial institutions depends on the _____.

understanding of the factors that cause interest rates and other returns in the financial markets to rise and fall

Which of the following is true of shareholders in continental Europe?

Banks are major shareholders of corporations in continental Europe.

The Sarbanes-Oxley Act of 2002 requires the chief executive officer of a publicly-traded corporation to _____.

certify financial reports that are submitted to the Securities and Exchange Commission

In the United States, the most common form of business is the _____, and the form of business that generates most of the sales and profits is the _____.

proprietorship; corporation

Which of the following statements concerning the complexity of the manager's task in a multinational corporation is correct?

The currency values of different countries in which a multinational corporation operates often experience fluctuations.

Compared to corporations, what is the primary disadvantage of partnerships as a form of business organization?

The owners of a partnership, that is, the partners, have unlimited liability when it comes to business obligations whereas the owners of a corporation have limited liability.

Which of the following is true of a general partner of a limited liability partnership (LLP)?

a. A general partner of a limited liability partnership (LLP) is fully personally liable for all business debts.

Which of the following mathematical expressions computes earnings per share (EPS)?

Earnings per share = Net Income ÷ Number of outstanding shares of common stock

Which of the following statements is true of agency problems?

One of the best means to control agency problems is to require the managers and other important decision-makers of the firm to also be owners of the firm.

The management's primary goal is stockholder wealth maximization, which translates into _____.

maximizing the value of the firm as measured by the price of its common stock

All else equal, in which of the following forms of business would the possibility of an agency problem be the greatest?

A U.S. corporation in which individual stockholders own extremely small proportions of the company.

Identify the internal factor that influences the stock price of a firm.

Capital structure

The primary goal of a publicly-owned firm interested in serving its stockholders should be to _____.

maximize the stock price per share

Which of the following actions is consistent with social responsibility and is not necessarily inconsistent with stockholder wealth maximization?

Investing in a smokestack filter to reduce sulphur-dioxide emissions to decrease the tax being levied on the firm by the state for pollution it produces each year.

Institutional investors can ensure that a corporation pursues goals that are in their best interest by _____.

monitoring its financial performance to ensure that managers pursue the goal of wealth maximization

Bicksler Corporation has a current ratio of 2.0 on July 21 of the current year. On July 22, Bicksler purchased (and
received) raw materials on credit from its supplier. Assuming all other things are equal, how will this transaction affect the
current ratio of Bicksler?

The value of the current ratio will decrease.

Suppose a firm has a growth rate equal to 8 percent, return on assets (ROA) of 10 percent, a debt ratio of 20 percent,
and a current stock price of $36. What is the firm's return on equity (ROE)?

12.5%

Using the information below for WAM Inc., what is the market value per share?
Earnings after interest and taxes = $200,000
Earnings per share = $2.00
Stockholders' equity = $2,000,000
Market/Book ratio = 0.20

$4.00

If a company has a quick ratio of 1.0 and a current ratio of 2.0, then the value of _____.

current liabilities is equal to the value of inventory

Alumbat Corporation has $800,000 in debt outstanding, and pays an interest rate of 10 percent annually on its bank
loan. Alumbat's annual sales are $3,200,000, its average tax rate is 40 percent, and its net profit margin on sales is 6
percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and
bankruptcy will result. What is Alumbat's current times interest earned ratio?

5.0 times

Which of the following transactions will not affect the quick ratio of a company?

Accounts receivable collected

Pearl Automotive Ltd. has a current ratio of 2. The company wants to window dress its financial statements. Which of
the following transactions will increase the current ratio of Pearl Automotive, assuming all other variables remain
constant?

Repayment of short-term loan

If a firm's existing quick ratio is 1.2, and all other variables remain unchanged, the quick ratio can be increased by
_____.

receiving interest income

Selzer Inc. sells all of its merchandise on credit. It has a profit margin of 4 percent, days sales outstanding equal to 60
days, receivables of $150,000, total assets of $3 million, and a debt ratio of 0.64. What is the firm's return on equity
(ROE)?

3.3%

A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40 percent, and a net profit
margin of 6 percent. What is the firm's times interest earned ratio?

11 times

The statement of retained earnings for Redwood Systems Ltd. shows a retained earnings balance of $300 million on
December 31. During the year, Redwood generated net income of $60 million and paid dividends of $20 million to its
stockholders. What was the beginning balance of retained earnings at the start of this year?

$260 million

Emerald Corporation's current ratio is 0.5, while Ruby (Emerald's competitor) Company's current ratio is 1.5. Both
firms want to "window dress" their coming end-of-year financial statements. As part of their window dressing strategy,
each firm will double its current liabilities by adding short-term debt and placing the funds obtained in the cash account.
Which of the statements below best describes the actual results of these transactions?

Only Emerald Corporation's current ratio will be increased.

Assume that Meyer Corporation is 100 percent equity financed, and has the following information:
(1) Earnings before taxes = $1,500;
(2) Sales = $5,000;
(3) Dividend payout ratio = 60%;
(4) Total assets turnover = 2.0;
(5) Applicable tax rate = 30%
What is the firm's return on equity?

42%

Determine the increase or decrease in cash for Rinky Supply Company for last year, given the following information.
(Assume no other changes occurred during the past year.)
Dividend payment $25
Increase in accounts receivables $50
Increase in notes payable $30
Decrease in accounts payable $20
Increase in accrued wages and taxes $15
Increase in inventories $35
Addition to retained earnings $5

–$80

Other things held constant, which of the following will not affect the current ratio, assuming an initial current ratio
greater than 1.0?

Accounts receivable are collected.

Which of the following ratios shows the relationship between a firm's current assets and its current liabilities?

Liquidity ratios

Which of the following provides information about a firm's performance during the past year and also provides
information regarding new developments that will affect the future performance of the firm?

The annual report

Market value ratios indicate _____.

what investors think of the company's future prospects based on its past performance

Which of the following ratios indicate how much investors are willing to pay for a firm's stock for each dollar of
reported profits?

Price/earnings ratio

Which of the following is an example of a current asset?

Inventory

Which of the following statements is true about net worth?

A firm's net worth is equal to total assets minus total liabilities.

A firm has a profit margin of 15 percent on sales of $20,000,000. If the firm has a debt of $7,500,000, total assets of
$22,500,000, and an interest cost on a total debt of 5 percent, what is the firm's return on total assets (ROA)? (Round
answer to two decimal places.)

13.33%

The book value per share of Topaz General Ltd. is $10 per share and the company has a total of 4 million shares.
Calculate the total book value of common equity of the company.

$40 million

A firm's total equity is $10 million and total liabilities is $5 million. During the year, its sales equaled $75 million.
Based on the given information, what is the firm’s total assets turnover ratio?

5 times

Which of the following is considered by analysts when comparing the operations of two firms that are financed
differently?

Earnings before interest and taxes

The form of informational market efficiency that states that current market prices fully reflect all information contained in past price movements is known as the _____.

weak-form efficiency

Primary markets are the financial markets where _____.

corporations and governments raise funds by issuing new securities

When a corporation wants to raise funds by issuing new stocks or bonds, it generally uses the services of _____.

an investment banker

The difference between the issuing price of a debt or equity issue and the net proceeds of the issue received by the issuing firm is known as the _____.

underwriter's spread

A depository institution that is owned by its depositors, who are often members of a common organization or
association, such as an occupation, a religious group, or a community, is called a(n) _____.

credit union

The expenditure incurred by a company in connection with its initial public offer is called the _____.

flotation cost

During the past decade, the areas of greatest worldwide growth in the financial markets have occurred in _____.

China, the United States, and Saudi Arabia

Which of the following is true about the process of setting the offering price of a security issue?

If the company is already publicly owned, the offering price will be based on the existing market price of the
stock or the yield on the firm's existing bonds.

Listing requirements of a security refer to the _____.

quantitative and qualitative characteristics a firm must possess to be listed on a stock exchange

An agreement for the sale of securities in which the investment bank handling the transaction gives no assurance that the entire issue will be sold is called a(n) _____.

best-efforts arrangement

In the trading of a security, the dealer's spread refers to the _____.

difference between the bid and asked prices of a security, which represents the dealer's markup, or profit from a security transaction

When a business sells its stocks or bonds to investors without going through any type of intermediary or financial institution, this process is known as a(n) _____.

direct transfer

Which of the following is true about financial institutions in the United States compared to those in other countries?

a. U.S. financial institutions have been much more heavily regulated than their foreign counterparts with regard to expansion (branching) and the services that could be offered.

Which of the following agreements is included in the Basel III Accord (2010)?

Agreement to increase banks' capital (owners' equity) requirements in an effort to reduce the risk that mega
bank failures will cause future financial crises

Credit unions, mutual funds, and thrift institutions are all examples of _____.

financial intermediaries

Which of the following equations is used to compute the dollar amount of common stock or debt that a company must issue after taking into account the flotation costs?

Amount of issue = (Net proceeds + Other flotation costs in dollars) / (1 – Flotation costs in decimal form)

A stock with a dual listing is registered to be traded in _____.

more than one stock market

Organizations that create various loans and investments from funds provided by depositors are known as _____.

financial intermediaries

Which form of market efficiency states that it does no good to scrutinize such publicly available information as a company's financial statements to seek abnormal returns, because market prices will adjust to any good news or bad news contained in such reports as soon as they are made public?

Semistrong-form efficiency

Which of the following acts limits the salaries of executives whose companies received Troubled Asset Relief Program (TARP) funds?

Emergency Economic Stabilization Act of 2008

Zync Corporation offers a block of its securities for sale to the investment banker that submits the highest price of all interested investment bankers. This procedure is known as a _____.

competitive bid

Welsh Corporation wants to issue debt of $525,000 to invest in a new project. Welsh is required to pay its investment banker 5 percent of the issue's total value. There are no other floatation costs. Compute the amount of debt that the firm must issue to net $525,000 after flotation costs.

$552,632

Zinc Corporation, a large, well-known public company that frequently issues securities, filed a master registration statement with the Securities and Exchange Commission (SEC). This master statement is updated with a short-form statement just prior to each individual security offering. What is this arrangement called?

Shelf registration

Investment companies that use the money provided by savers to invest in various types of financial assets, including stocks and bonds, are called _____.

mutual funds

Which of the following plans is administered primarily by the trust departments of commercial banks or by life
insurance companies?

Pension plans

Following is information about three bonds:
Issuer Yield Time to Maturity
Treasury 2.0% 6 months
Company A 5.0 5 years
Company B 5.3 8 years
Although none of the bonds has a liquidity premium, any bond with a maturity equal to one year or greater has a maturity risk premium (MRP). Except for their terms to maturity, the characteristics of the Company A and Company B bonds are the same (including their default risk). The average inflation rate is expected to remain constant during the next 10 years.
What is the default risk premium (DRP) associated with the bonds issued by Company A and Company B?

2.5%

Assume that the current interest rate on a one-year bond is 8 percent, the current rate on a two-year bond is 10 percent,
and the current rate on a three-year bond is 12 percent. If the expectations theory of the term structure is correct, what is
the one-year interest rate expected during Year 3? (Base your answer on an arithmetic average rather than a geometric
average.)

16%

Your uncle would like to restrict his interest rate risk and his default risk, but he would still like to invest in corporate
bonds. Which of the bonds listed below best satisfies your uncle's criteria?

An AAA bond with 5 years to maturity

Assume that a three-year Treasury note (T-note) has no maturity premium, and that the real risk-free rate of interest is 3
percent. If the T-note carries a nominal risk-free rate of return of 13 percent and if the expected average inflation rate over
the next two years is 9 percent, what is the implied expected inflation rate during Year 3?

12%

Assume that real risk-free rate (r*) = 1.00%; the maturity risk premium is found as MRP = 0.20% × (t – 1), where t = years to maturity; the default risk premium for AT&T bonds is found as DRP = 0.07% × (t – 1); the liquidity premium (LP) is 0.50 percent for AT&T bonds but zero for Treasury bonds; and inflation is expected to be 7 percent, 6 percent, and 5 percent during the next three years and then 4 percent thereafter. What is the difference in interest rates between 10-year AT&T bonds and 10-year Treasury bonds? (Round answer to two decimal places.)

1.13%

Assume that the real risk-free rate is 4 percent, and that inflation is expected to be 9 percent in Year 1, 6 percent in Year
2, and 4 percent thereafter. Also, assume that all Treasury bonds are highly liquid and free of default risk. If 2-year and 5- year Treasury bonds both yield 12 percent, what is the difference in the maturity risk premiums (MRPs) on the two bonds, i.e., what is MRP5 – MRP2? (Round answer to one decimal place.)

2.1%

Following are the yields on selected Treasury securities:
Maturity Yield
2 years 1.6%
3 years 2.2
4 years 2.4
Using the expectations theory, compute the expected one-year interest rate in Year 3. That is, compute the rate that is expected to exist only during Year 3. (Base your answer on an arithmetic average rather than a geometric average.)

3.4%

Treasury securities that mature in 6 years currently have an interest rate of 8.50 percent. Inflation is expected to be 5 percent in each of the next three years and 6 percent each year thereafter. The maturity risk premium is estimated to be 0.10% × (t – 1), where t is equal to the maturity of the bond (i.e., the maturity risk premium of a one-year bond is zero). The real risk-free rate is assumed to be constant over time. What is the real risk-free rate of interest?

2.50%

Following is information about three bonds:
Issuer Yield Time to Maturity
Treasury 2.0% 6 months
Company A 5.0 5 years
Company B 5.3 8 years
Although none of the bonds has a liquidity premium, any bond with a maturity equal to one year or greater has a maturity risk premium (MRP). Except for their terms to maturity, the characteristics of the Company A and Company B bonds are the same (including their default risk). The average inflation rate is expected to remain constant during the next 10 years. What is the annual MRP?

0.1%

A bond purchased for $950 was sold for $980 after one year. The interest received during the year is $25. Which of the following is the bond's yield?

5.79%

Securities that can be easily converted into cash on short notice at a price that is close to the original cost generally
have a _____.

low liquidity premium

_____ is the tendency of prices to increase over time.

Inflation

If a stock pays a dividend of $10, and the investors need 8 percent return on their investment, then the investors should
pay _____ for the stock.

$125

A federal deficit occurs when _____.

the government's expenses are greater than its tax revenues

Which of the following is true of the market segmentation theory?

According to the market segmentation theory, the slope of the yield curve depends on supply/demand conditions of a security in the long- and short-term markets.

Which of the following is the yield of a bond that offers a risk-free rate of 4 percent and a risk premium of 2 percent?

6%

Which of the following statements describes a liquidity premium?

It is a premium that is added to the rate on a security if the security cannot be converted to cash on short notice at a price that is close to the original cost.

Assume that the expected rates of inflation over the next 5 years are 4 percent, 7 percent, 10 percent, 8 percent, and 6 percent, respectively. What is the average expected inflation rate over this 5-year period?

7%

The change in the market value of an asset over a particular time period is called the _____.

capital gain

Which of the following is true of the real risk-free rate of interest?

It is the rate of interest that would exist on default-free U.S. Treasury securities if no inflation were expected in the future.

If the Federal Reserve loosens the money supply to control growth in the economy, _____.

interest rates will decrease

You read in The Wall Street Journal that 30-day T-bills are currently yielding 8 percent. Your brother-in-law, a broker at Kyoto Securities, has given you the following estimates of current interest rate premiums:
Inflation premium 5%
Liquidity premium 1%
Maturity risk premium 2%
Default risk premium 2%
Based on these data, the real risk-free rate of return is

3 percent.

Which of the following bonds has the greatest default risk?

An AAA corporate bond with a 10-year maturity

Everything else equal, if the United States runs a large foreign trade deficit, the financing of the deficit will _____.

increase interest rates

You are given the following data:
r* = real risk-free rate 4%
Constant inflation premium (IP) 7%
Maturity risk premium (MRP) 1%
Default risk premium for AAA bonds (DRP) 3%
Liquidity premium for long-term Treasury
bonds (T-bonds) (LP) 2%
Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant. Given these conditions, the rate on long-term Treasury bonds is _____.

14 percent