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PHINMA EDUCATION NETWORK

COLLEGE OF MANAGEMENT AND ACCOUNTANCY
FIN 072 – FINANCIAL MARKETS
COMMON FINAL EXAMINATION

1. Your uncle would like to limit his interest rate risk and his default risk, but he would still like
to invest in corporate bonds. Which of the possible bonds listed below best satisfies your uncle’s
criteria?
a. AAA bond with 10 years to maturity.
b. BBB perpetual bond.
c. BBB bond with 10 years to maturity.
d. AAA bond with 5 years to maturity.

2. Which of the following statements is most correct?

a. If an investor sells 100 shares of Microsoft to his brother-in-law, this is a primary market
transaction.
b. Private securities are generally less liquid than publicly traded securities.
c. Money markets are where short-term, liquid securities are traded, whereas capital
markets represent the markets for long-term debt and common stock.
d. Statements b and c are correct.

3. Which of the following is a secondary market transaction?

a. You sell 200 shares of ABC stock in the open market.
b. You buy 200 shares of ABC stock from your brother.
c. ABC issues 2 million shares of new stock to the public.
d. Statements a and b are correct.

4. Which of the following statements is most correct?

a. Money markets are markets for long-term debt and common stocks.
b. Primary markets are markets where existing securities are traded among investors.
c. A derivative is a security whose value is derived from the price of some other
“underlying” asset.
d. Statements a and b are correct.

5. Money markets are markets for

a. Foreign currency exchange.
b. Consumer automobile loans.
c. Corporate stocks.
d. Long-term bonds.
e. Short-term debt securities.

6. You recently sold 200 shares of Disney stock to your brother. This is an example of:
a. A money market transaction.
b. A primary market transaction.
c. A secondary market transaction.

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d. A futures market transaction.

7. Which of the following statements is most correct?

a. Downward sloping yield curves are inconsistent with the expectations theory.
b. The shape of the yield curve depends only on expectations about future inflation.
c. If the expectations theory is correct, a downward sloping yield curve indicates that
interest rates are expected to decline in the future.
d. Statements a and c are correct.

8. Which of the following statements is most correct?

a. If the maturity risk premium (MRP) is greater than zero, the yield curve must be upward
sloping.
b. If the maturity risk premium (MRP) equals zero, the yield curve must be flat.
c. If interest rates are expected to increase in the future and the maturity risk premium
(MRP) is greater than zero, the yield curve will be upward sloping.
d. If the expectations theory holds, the yield curve will never be downward sloping.

9. Which of the following statements is most correct?

a. If companies have fewer productive opportunities, interest rates are likely to increase.
b. If individuals increase their savings rate, interest rates are likely to increase.
c. If expected inflation increases, interest rates are likely to increase.
d. All of the statements above are correct.

10. Which of the following is likely to increase the level of interest rates in the economy?
a. Households start saving a larger percentage of their income.
b. Corporations step up their plans for expansion and increase their demand for capital.
c. The level of inflation is expected to decline.
d. All of the statements above are correct.

11. You are interested in investing your money in a bank account. Which of the following banks
provides you with the highest effective rate of interest?
a. Bank 1; 8 percent with monthly compounding.
b. Bank 2; 8 percent with annual compounding.
c. Bank 3; 8 percent with quarterly compounding.
d. Bank 4; 8 percent with daily (365-day) compounding.

12. Which one of the following investments provides the highest effective rate of return?
a. An investment that has a 9.9 percent nominal rate and quarterly annual compounding.
b. An investment that has a 9.7 percent nominal rate and daily (365) compounding.
c. An investment that has a 10.2 percent nominal rate and annual compounding.
d. An investment that has a 10 percent nominal rate and semiannual compounding.

13. ABC Corp. recently obtained a 30-year (360-month), P250,000 mortgage with a 9 percent
nominal interest rate. What will be the remaining balance on the mortgage after five years (60
months)?
a. P239,024

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b. P249,307
c. P239,700
d. P237,056

14. ABC plans to deposit P200 into a bank account at the end of every month. The bank account
has a nominal interest rate of 8 percent and interest is compounded monthly. How much will Bill
have in the account at the end of 2½ years (30 months)?
a. P 6,617.77
b. P 502.50
c. P 6,594.88
d. P22,656.74

15. If it were evaluated with an interest rate of 0 percent, a 10-year regular annuity would have a
present value of P3,755.50. If the future (compounded) value of this annuity, evaluated at Year
10, is P5,440.22, what effective annual interest rate must the analyst be using to find the future
value?
a. 7%
b. 8%
c. 9%
d. 10%

16. Business risk is concerned with the operations of the firm. Which of the following is not
associated with (or not a part of) business risk?
a. Demand variability.
b. Sales price variability.
c. The extent to which operating costs are fixed.
d. Changes in required returns due to financing decisions.

17. Which of the following affects a firm’s business risk?

a. The level of uncertainty about future sales.
b. The degree of operating leverage.
c. The degree of financial leverage.
d. Statements a and b are correct.

18. Which of the following would increase risk?

a. Increase the level of working capital.
b. Change the composition of working capital to include more liquid assets.
c. Increase the amount of short-term borrowing.
d. Increase the amount of equity financing.

19. A firm’s financial risk is a function of how it manages and maintains its debt. Which one of
the following sets of ratios characterizes the firm with the greatest amount of financial risk?
a. High debt-to-equity ratio, high interest coverage ratio, stable return on equity.
b. Low debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
c. High debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
d. Low debt-to-equity ratio, high interest coverage ratio, stable return on equity.

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20. Which of the following statements is most correct?

a. A firm’s business risk is solely determined by the financial characteristics of its industry.
b. The factors that affect a firm’s business risk are determined partly by industry
characteristics and partly by economic conditions. Unfortunately, these and other factors
that affect a firm’s business risk are not subject to any degree of managerial control.
c. One of the benefits to a firm of being at or near its target capital structure is that financial
flexibility becomes much less important.
d. The firm’s financial risk may have both market risk and diversifiable risk components.

21. The risk of loss because of fluctuations in the relative value of foreign currencies is called
a. Expropriation risk.
b. Sovereign risk.
c. Multinational beta.
d. Exchange rate risk

22. A firm may seek to avoid exchange-rate risk by

a. Maintaining a net monetary debtor position in countries with strengthening currencies.
b. Maintaining a net monetary creditor position in countries with weakening currencies.
c. Avoiding diversification of foreign-currency transactions.
d. Buying forward exchange contracts to cover liabilities denominated in a foreign currency.

23. A 10-year bond with a 9 percent annual coupon has a yield to maturity of 8 percent. Which
of the following statements is most correct?

a. The bond is selling at a discount.

b. The bond’s current yield is greater than 9 percent.
c. If the yield to maturity remains constant, the bond’s price one year from now will be
lower than its current price.
d. Statements a and b are correct.

24. Which of the following statements is most correct?

a. Long-term bonds have more interest rate price risk, but less reinvestment rate risk than
short-term bonds.
b. Bonds with higher coupons have more interest rate price risk, but less reinvestment rate
risk than bonds with lower coupons.
c. If interest rates remain constant for the next five years, the price of a discount bond will
remain the same for the next five years.
d. Statements b and c are correct.

25. Which of the following statements is most correct?

a. Retiring bonds under a sinking fund provision is similar to calling bonds under a call
provision in the sense that bonds are repurchased by the issuer prior to maturity.
b. Under a sinking fund, bonds will be purchased on the open market by the issuer when the
bonds are selling at a premium and bonds will be called in for redemption when the
bonds are selling at a discount.

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c. The sinking fund provision makes a debt issue less risky to the investor.
d. Statements a and c are correct.

26. You just purchased a 15-year bond with an 11 percent annual coupon. The bond has a face
value of P1,000 and a current yield of 10 percent. Assuming that the yield to maturity of 9.7072
percent remains constant, what will be the price of the bond one year from now?
a. P1,000
b. P1,064
c. P1,097
d. P1,100

27. A bond that can be paid off early at the issuer's discretion is referred to as being which one of
the following?
a. zero coupon
b. callable
c. senior
d. collateralized

28. A sinking fund is managed by a trustee for which one of the following purposes?
a. paying interest payments
b. early bond redemption
c. converting bonds into equity securities
d. paying preferred dividends

29. A bond that is payable to whomever has physical possession of the bond is said to be in:
a. new-issue condition.
b. registered form.
c. bearer form.
d. debenture status.

30. An indenture is:

a. another name for a bond's coupon.
b. the written record of all the holders of a bond issue.
c. a bond that is past its maturity date but has yet to be repaid.
d. a bond that is secured by the inventory held by the bond's issuer.
e. the legal agreement between the bond issuer and the bondholders.

31. The current yield is defined as the annual interest on a bond divided by which one of the
following?
a. coupon
b. face value
c. market price
d. call price

32. If markets are in equilibrium, which of the following will occur:

a. Each investment’s expected return should equal its realized return.

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b. Each investment’s expected return should equal its required return.

c. Each investment should have the same expected return.
d. Each investment should have the same realized return.

33. An increase in a firm’s expected growth rate would normally cause the firm’s required rate of
return to
a. Increase.
b. Decrease.
c. Fluctuate.
d. Remain constant.
e. Possibly increase, possibly decrease, or possibly remain unchanged.

34. If the expected rate of return on a stock exceeds the required rate,
a. The stock is experiencing supernormal growth.
b. The stock should be sold.
c. The company is probably not trying to maximize price per share.
d. The stock is a good buy.
e. Dividends are not being declared.

35. Which of the following statements is most correct?

a. The constant growth model takes into consideration the capital gains earned on a stock.
b. It is appropriate to use the constant growth model to estimate stock value even if the
growth rate never becomes constant.
c. Two firms with the same dividend and growth rate must also have the same stock price.
d. Statements a and c are correct.

36. A stock’s dividend is expected to grow at a constant rate of 5 percent a year. Which of the
following statements is most correct?
a. The expected return on the stock is 5 percent a year.
b. The stock’s dividend yield is 5 percent.
c. The stock’s price one year from now is expected to be 5 percent higher.
d. Statements a and c are correct.

37. Which of the following statements is most correct?

a. If a company has two classes of common stock, Class A and Class B, the stocks may pay
different dividends, but the two classes must have the same voting rights.
b. An IPO occurs whenever a company buys back its stock on the open market.
c. The preemptive right is a provision in the corporate charter that gives common
stockholders the right to purchase (on a pro rata basis) new issues of common stock.
d. Statements a and b are correct.

38. The preemptive right is important to shareholders because it

a. Allows management to sell additional shares below the current market price.
b. Protects the current shareholders against dilution of ownership interests.
c. Is included in every corporate charter.
d. Will result in higher dividends per share.

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e. The preemptive right is not important to shareholders.

39. Which of the following statements is most correct?

a. One of the advantages of common stock financing is that a greater proportion of stock in
the capital structure can reduce the risk of a takeover bid.
b. A firm with classified stock can pay different dividends to each class of shares.
c. One of the advantages of common stock financing is that a firm’s debt ratio will decrease.
d. Statements b and c are correct.

40. If two constant growth stocks have the same required rate of return and the same price, which
of the following statements is most correct?

a. The two stocks have the same per-share dividend.

b. The two stocks have the same dividend yield.
c. The two stocks have the same dividend growth rate.
d. The stock with the higher dividend yield will have a lower dividend growth rate.

41. Stocks A and B have the same price, but Stock A has a higher required rate of return than
Stock B. Which of the following statements is most correct?
a. Stock A must have a higher dividend yield than Stock B.
b. Stock B must have a higher dividend yield than Stock A.
c. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must
be higher than Stock B’s.
d. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must
be lower than Stock B’s.

42. Which one of the following relationships is stated correctly?

a. The coupon rate exceeds the current yield when a bond sells at a discount.
b. The call price must equal the par value.
c. An increase in market rates increases the market price of a bond.
d. Decreasing the time to maturity increases the price of a discount bond, all else constant.

43. A newly issued bond has a 7 percent coupon with semiannual interest payments. The bonds
are currently priced at par value. The effective annual rate provided by these bonds must be:
a. 3.5 percent.
b. greater than 3.5 percent but less than 7 percent.
c. 7 percent.
d. greater than 7 percent.

44. Which one of the following bonds is the least sensitive to interest rate risk?
a. 3-year; 4 percent coupon
b. 3-year; 6 percent coupon
c. 5-year; 6 percent coupon
d. 7-year; 6 percent coupon

45. As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:

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a. increases at an increasing rate.

b. increases at a decreasing rate.
c. increases at a constant rate.
d. decreases at an increasing rate.

46. A 6 percent, annual coupon bond is currently selling at a premium and matures in 7 years.
The bond was originally issued 3 years ago at par. Which one of the following statements is
accurate in respect to this bond today?
a. The face value of the bond today is greater than it was when the bond was issued.
b. The bond is worth less today than when it was issued.
c. The yield-to-maturity is less than the coupon rate.
d. The coupon rate is greater than the current yield.

47. Which one of the following statements related to corporate dividends is correct?
a. Dividends are nontaxable income to shareholders.
b. Dividends reduce the taxable income of the corporation.
c. The Chief Executive Officer of a corporation is responsible for declaring dividends.
d. The Chief Financial Officer of a corporation determines the amount of dividend to be
paid.
e. Corporate shareholders may receive a tax break on a portion of their dividend income.

48. ABC will pay an annual dividend of P1.46 a share next year with future dividends increasing
by 4.2 percent annually. What is the market rate of return if the stock is currently selling for
P38.90 a share?
a. 6.55 percent
b. 7.13 percent
c. 7.46 percent
d. 7.95 percent

49. An agent who maintains an inventory from which he or she buys and sells securities is called
a:
a. broker.
b. trader.
c. capitalist.
d. principal.
e. dealer.

50. A firm’s financial risk is a function of how it manages and maintains its debt. Which one of
the following sets of ratios characterizes the firm with the greatest amount of financial risk?
a. High debt-to-equity ratio, high interest coverage ratio, stable return on equity.
b. Low debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
c. High debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
d. Low debt-to-equity ratio, high interest coverage ratio, stable return on equity.

51. Cost of capital is

a. The amount the company must pay for its plant assets.

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b. The dividends a company must pay on its equity securities.

c. The cost the company must incur to obtain its capital resources.
d. The cost the company is charged by investment bankers who handle the issuance of
equity or long-term debt securities.

52. If the return on total assets is 10% and if the return on common stockholders’ equity is 12%
then
a. The after-tax cost of long-term debt is probably greater than 10%.
b. The after-tax cost of long-term debt is 12%.
c. Leverage is negative.
d. The after-tax cost of long-term debt is probably less than 10%.

53. A firm with a higher degree of operating leverage when compared to the industry average
implies that the
a. Firm has higher variable costs.
b. Firm's profits are more sensitive to changes in sales volume.
c. Firm is more profitable.
d. Firm is less risky.

54. ABC Corporation's stock has a market price of P20.00 and pays a constant dividend of P2.50.
What is the required rate of return on its stock?
a. 13.0%
b. 12.5%
c. 12.0%
d. 11.5%

55. ABC Corporation is expected to pay an upcoming dividend of P3.29. The company's
dividend is expected to grow at a steady, constant rate of 5% well into the future. ABC currently
has 1,600,000 shares of common stock outstanding. If the required rate of return for ABC is
12%, what is the best estimate for the current price of ABC's common stock?
a. P65.80
b. P62.51
c. P47.00
d. P27.41

56. ABC, Inc. paid a cash dividend to its common shareholders over the past 12 months of P2.20
per share. The current market value of the common stock is P40 per share, and investors are
anticipating the common dividend to grow at a rate of 6% annually. The cost to issue new
common stock will be 5% of the market value. The cost of a new common stock issue will be
a. 11.50%
b. 11.79%
c. 11.83%
d. 12.14%

57. What return on equity do investors seem to expect for a firm with a P50 share price, an
expected dividend of P5.50, a beta of .9, and a constant growth rate of 4.5%?

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a. 15.05%
b. 15.50%
c. 15.95%
d. 16.72%

58. If the return on the market portfolio is 10% and the risk-free rate is 5%, what is the effect on
a company's required rate of return on its stock of an increase in the beta coefficient from 1.2 to
1.5?
a. 3% increase
b. 1.5% increase
c. No change
d. 1.5% decrease

59. An investor was expecting a 15% return on his portfolio with beta of 1.25 before the market
risk premium increased from 6% to 9%. Based on this change, what return will now be expected
on the portfolio?
a. 15.00%
b. 18.00%
c. 18.75%
d. 22.50%

60. What happens to expected portfolio return if the portfolio beta increases from 1.0 to 2.0, the
risk-free rate decreases from 5% to 4%, and the market risk premium remains at 8%?
a. It increases from 12% to 19%.
b. It increases from 13% to 16%.
c. It increases from 13% to 20%.
d. It remains unchanged.

61. A company has P1 million in shareholders' equity and P2 million in debt equity (8% bonds).
Its after-tax weighted-average cost of capital is 12%, but it uses 15% as the hurdle rate in capital
budgeting decisions. During the past year, its operating income before tax and interest was
P500,000. Its tax rate is 40%. What is the company's cost of equity capital?
a. 8%
b. 12%
c. 15%
d. 26.4%

62. What is the weighted average cost of capital for a firm with 40% debt, 20% preferred stock,
and 40% common equity if the respective costs for these components are 8% after-tax, 13%
after-tax, and 17% before-tax? The firm's tax rate is 35%.
a. 10.22%
b. 10.52%
c. 11.48%
d. 12.60%

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63. This year, ABC Corp. increased earnings before interest and taxes (EBIT) by 17%. During
the same period, net income after tax increased by 42%. The degree of financial leverage that
existed during the year is
a. 1.70
b. 4.20
c. 2.47
d. 5.90

64. Which of the following statements is most correct?

a. When dealing with independent projects, discounted payback (using a payback
requirement of 3 or less years), NPV, IRR, and modified IRR always lead to the same
accept/reject decisions for a given project.
b. When dealing with mutually exclusive projects, the NPV and modified IRR methods
always rank projects the same, but those rankings can conflict with rankings produced by
the discounted payback and the regular IRR methods.
c. Multiple rates of return are possible with the regular IRR method but not with the
modified IRR method, and this fact is one reason given by the textbook for favoring
MIRR (or modified IRR) over IRR.
d. Statements a and c are correct.

65. Normal projects A and B are mutually exclusive. Project A has a higher net present value if
the WACC is less than 12 percent, whereas Project B has a higher net present value if the WACC
exceeds 12 percent. Which of the following statements is most correct?
a. Project B has a higher internal rate of return.
b. Project B is probably larger in scale than Project A.
c. Project A probably has a faster payback.
d. Statements a and c are correct.

66. Which of the following statements is incorrect?

a. Assuming a project has normal cash flows, the NPV will be positive if the IRR is less
than the cost of capital.
b. If the multiple IRR problem does not exist, any independent project acceptable by the
NPV method will also be acceptable by the IRR method.
c. If IRR = k (the cost of capital), then NPV = 0.
d. NPV can be negative if the IRR is positive.

67. A capital investment’s internal rate of return

a. Changes when the cost of capital changes.
b. Is equal to the annual net cash flows divided by one half of the project’s cost when the
cash flows are an annuity.
c. Must exceed the cost of capital in order for the firm to accept the investment.
d. None of the above

68. ABC Corp. is considering a project that has an up-front cost paid today at t = 0. The project
will generate positive cash flows of P60,000 a year at the end of each of the next five years. The

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project’s NPV is P75,000 and the company’s WACC is 10 percent. What is the project’s regular
payback?
a. 3.22 years
b. 1.56 years
c. 2.54 years
d. 2.35 years

69. Your company is planning to open a new gold mine that will cost P3 million to build, with
the expenditure occurring at the end of the year three years from today. The mine will bring
year-end after-tax cash inflows of P2 million at the end of the two succeeding years, and then it
will cost P0.5 million to close down the mine at the end of the third year of operation. What is
this project’s IRR?
a. 14.36%
b. 10.17%
c. 17.42%
d. 12.70%

70. ABC Corporation’s new project calls for an investment of P10,000. It has an estimated life
of 10 years and an IRR of 15 percent. If cash flows are evenly distributed and the tax rate is 40
percent, what is the annual before-tax cash flow each year? (Assume depreciation is a negligible
amount.)
a. P1,993
b. P3,321
c. P1,500
d. P4,983

71. To approximate annual cash inflow, depreciation is

a. Added back to net income because it is an inflow of cash.
b. Subtracted from net income because it is an outflow of cash.
c. Subtracted from net income because it is an expense.
d. Added back to net income because it is not an outflow of cash.

72. Which of the following best identifies the reason for using probabilities in capital budgeting
is
a. Different life of projects.
b. Cost of capital.
c. Uncertainty.
d. Time value of money.

73. An optimal capital budget is determined by the point where the marginal cost of capital is
a. Minimized.
b. Equal to the average cost of capital.
c. Equal to the rate of return on total assets.
d. Equal to the marginal rate of return on investment.

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74. When using one of the discounted-cash-flow methods to evaluate the feasibility of a capital
budgeting project, which of the following factors generally is not important?
a. The method of financing the project under consideration.
b. The impact of the project on income taxes to be paid.
c. The timing of cash flows relating to the project.
d. The amount of cash flows relating to the project.

75. The common assumption in capital budgeting analysis is that cash inflows occur in lump
sums at the end of individual years during the life of an investment project when in fact they
flow more or less continuously during those years
a. Results in understated estimates of NPV.
b. Is done because present value tables for continuous flows cannot be constructed.
c. Will result in inconsistent errors being made on estimating NPVs such that project cannot
be evaluated reliably.
d. Results in higher estimate for the IRR on the investment.

76. ABC Corporation is considering an investment proposal for P10 million yielding a net
present value of P450,000. The project has a life of 7 years with salvage value of P200,000. The
company uses a discount rate of 12%. Which of the following would decrease the net present
value?
a. Extend the project life and associated cash inflows.
b. Increase discount rate to 15%.
c. Decrease the initial investment amount to P9.0 million.
d. Increase the salvage value.

77. ABC Corporation is evaluating the purchase of a P500,000 equipment. The cash inflows
expected from the investment is P145,000 per year for five years with no equipment salvage
value. The cost of capital is 12%. The net present value factor for five (5) years at 12% is
3.6048 and at 14% is 3.4331. The internal rate of return for this investment is
a. 3.45%
b. 2.04%
c. 13.8%
d. 15.48%

78. ABC, Inc. is planning to purchase a new machine that will take six years to recover the cost.
The new machine is expected to produce cash flow from operations, net of income taxes, of
P4,500 a year for the first three years of the payback period and P3,500 a year of the last three
years of the payback period. Depreciation of P3,000 a year shall be charged to income of the six
years of the payback period. How much shall the machine cost?
a. P12,000
b. P18,000
c. P24,000
d. P36,000

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79. ABC Co. is considering an investment in a project that generates a profitability index of 1.3.
The present value of the cash inflows on the project is P44,000. What is the net present value of
this project?
a. P10,154
b. P13,200
c. P57,200
d. P33,846

80. ABC Corporation has implemented a new project that has an initial cost, and then generates
inflows of P10,000 a year for the next seven (7) years. The project has a payback period of 4.0
years. What is the project's internal rate of return (IRR)?
a. 14.79%
b. 16.33%
c. 18.54%
d. 15.61%

81. All else equal, the market value of a stock will tend to decrease by roughly the aftertax value
of the dividend on the:
a. dividend declaration date.
b. ex-dividend date.
c. date of record.
d. date of payment.

82. Which one of the following statements related to dividend policy is correct?
a. The primary question related to dividend policy is whether or not a firm should ever pay
a dividend.
b. Both dividends and dividend policy are irrelevant.
c. Dividend policy focuses on the timing of dividend payments.
d. Homemade dividends increase the importance of a firm's dividend policy decisions.

83. Which one of the following favors a low dividend policy?

a. the tax on capital gains is deferred until the gain is realized
b. few, if any, positive net present value projects are available to a firm
c. a majority of the shareholders has a low relevant tax rate
d. a majority of the shareholders has better investment opportunities with similar risks

84. An investor is more likely to prefer a high dividend payout if a firm:

a. has high flotation costs.
b. has few, if any, positive net present value projects.
c. has lower tax rates than the investor.
d. has a stock price that is increasing rapidly.

85. The information content of a dividend increase generally signals that:

a. the firm has a one-time surplus of cash.
b. the firm has few, if any, net present value projects to pursue.
c. management believes earnings growth will be strong going forward.

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d. the firm has more cash than it needs due to a decline in future orders.

86. The dividend market is in equilibrium when:

a. all firms adopt a low dividend policy.
b. half of the firms adopt a low dividend policy and half adopt a high dividend policy.
c. all clienteles are satisfied.
d. dividends remain constant and no special dividends are declared.

87. Which one of the following statements related to stock repurchases is correct?
a. An open market stock repurchase increases the total wealth of a shareholder if you ignore
taxes, costs, and market imperfections.
b. Targeted repurchases must be offered to all shareholders but can be done in steps such
that only a portion of the shareholders have the option to sell at any one point in time.
c. When a firm wishes to repurchase shares in the open market, it will do so in a special
trading session that is set up by the SEC.
d. A firm may spend more cash over the course of a year on stock repurchases than it does
on cash dividends.

88. A stock repurchase program:

a. requires all shareholders to sell a fraction of their shares.
b. is preferred over a high-dividend program only by tax-exempt shareholders.
c. decreases both the number of shares outstanding and the market price per share.
d. has no effect on a firm's financial statements.
e. is essentially the same as a cash dividend program provided there are no taxes or other
costs.

89. Which one of the following is a result of a stock repurchase?

a. increase in the number of shares outstanding
b. increase in the market price per share
c. increase in the total equity of the repurchasing firm
d. decrease in EPS
e. PE ratio equal to that resulting from a comparable cash dividend

90. Which of the following events is likely to decrease the value of call options on the common
stock of ABC Company?
a. An increase in ABC’s stock price.
b. An increase in the exercise price of the option.
c. An increase in the amount of time until the option expires.
d. An increase in the risk-free rate.

91. A riskless hedge can best be defined as

a. A situation in which aggregate risk can be reduced by derivatives transactions between
two parties.
b. A hedge in which an investor buys a stock and simultaneously sells a call option on that
stock and ends up with a riskless position.

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c. Standardized contracts that are traded on exchanges and are “marked to market” daily,
but where physical delivery of the underlying asset is virtually never taken.
d. Two parties agree to exchange obligations to make specified payment streams.

92. An investor who writes call options against stock held in his or her portfolio is said to be
selling .
a. In-the-money options.
b. Put options.
c. Naked options.
d. Covered options.

93. A swap is a method for reducing financial risk. Which of the following statements about
swaps, if any, is incorrect?
a. A swap involves the exchange of cash payment obligations.
b. The earliest swaps were currency swaps, in which companies traded debt denominated in
different currencies, say dollars and pounds.
c. Swaps are generally arranged by a financial intermediary, who may or may not take the
position of one of the counterparties.
d. A problem with swaps is the lack of standardized contracts, which limits the development
of a secondary market.

94. Which of the following statements is most correct?

a. One advantage of forward contracts is that they are default free.
b. Futures contracts generally trade on an organized exchange and are marked to market
daily.
c. Goods are never delivered under forward contracts, but are almost always delivered
under futures contracts.
d. Statements a and c are correct.

95. Which of the following statements is most correct?

a. An option’s value is determined by its exercise value, which is the market price of the
stock less its striking price. Thus, an option can’t sell for more than its exercise value.
b. As stock price rises, the premium portion of an option on a stock increases because the
difference between the price of the stock and the fixed striking price increases.
c. Issuing options provides companies with a low cost method of raising capital.
d. The market value of an option depends in part on the option’s time to maturity and on the
variability of the underlying stock’s price.

96. Which of the following statements concerning risk management is correct?

a. Risk management can reduce the volatility of cash flows, and this decreases the
probability of bankruptcy.
b. Risk management can reduce the likelihood of low cash flows, and therefore reduce the
probability of financial distress.
c. Companies with volatile earnings pay more taxes than more stable companies due to the
treatment of tax credits and the rules governing corporate loss carry-forwards and carry-
backs. Therefore, our tax system encourages risk management to stabilize earnings.

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d. Statements a, b, and c are correct.

97. Which of the following is an example of a derivative?

a. Futures.
b. Options.
c. Swaps.
d. All of the above are examples of derivatives.

98. The value of an option depends on the stock’s price, the risk-free rate, and the
a. Exercise price.
b. Variability of the stock price.
c. Option’s time to maturity.
d. All of the statements above are correct.

99. There are call options on the common stock of XYZ Corporation. Which of the following
best describes the factors affecting the value of these call options?
a. The price of the call options is likely to rise if XYZ’s stock price rises.
b. The higher the strike price on the call option, the higher the call option price.
c. Assuming the same strike price, a call option that expires in one month will sell for a
higher price than a call option that expires in three months.
d. All of the statements above are correct.

100. A commercial bank estimates that its net income suffers whenever interest rates increase.
The bank is looking to use derivatives to reduce its interest rate risk. Which of the following
strategies best protects the bank against rising interest rates?
a. Buying inverse floaters.
b. Entering into an interest rate swap where the bank receives a fixed payment stream, and
in return agrees to make payments that float with market interest rates.
c. Purchase principal only (PO) strips that decline in value whenever interest rates rise.
d. Enter into a short hedge in which the bank agrees to sell interest rate futures.

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