Module 1: Finance in business Multiple-choice questions 1.
Financial markets include:
A. bond market. B. cash market. C. share market. *D. all of the above. LO 1.1: Understanding finance, money and markets.
2.
_______________ refers to the study of how money is managed.
A. marketing. *B. finance. C. taxation. D. accounting. LO 1.1: Understanding finance, money and markets.
3.
The _____________ works out the best way to structure finances and make effective financial decisions.
*A. Finance manager. B. Controller. C. CEO. D. Risk manager. LO 1.1: Understanding finance, money and markets.
4.
The financial system includes:
A. financial regulation. B. money. C. financial markets. *D. all of the above. LO 1.1: Understanding finance, money and markets.
Module 1: Finance in business
5.
The importance of finance in society is driven by the economic principle of:
A. economic systems. B. rationality. *C. scarcity. D. opportunity cost. LO 1.1: Understanding finance, money and markets.
6.
Increased regulation and oversight of the finance sector:
A. encourage consumers to obtain independent advice. B. protect consumers. C. build consumer confidence in the system. *D. B and C. LO 1.1: Understanding finance, money and markets.
7.
Finances are of great economic and social importance. At the __________ level, they drive the operation and performance of the economy.
*A. macro. B. government. C. micro. D. all of the above. LO 1.1: Understanding finance, money and markets.
8.
At the ___________ level, finances influence the fiscal position of the nation and influence living standards.
A. macro. *B. government. C. micro. D. business entity. LO 1.1: Understanding finance, money and markets.
9.
For consumers, finance influences:
A. ability to make effective financial decisions. B. accumulation of wealth over the long term. C. profitability and living standards. *D. A and B. LO 1.1: Understanding finance, money and markets.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
10. Finance is used by businesses to: A. operate on a daily basis. B. start-up operations. C. expand and grow the business. *D. all of the above. LO 1.1: Understanding finance, money and markets.
11. _________________ with standing in the community access financial markets and financial institutions for funds. A. small partnerships. B. sole traders. *C. large entities. D. all of the above. LO 1.1: Understanding finance, money and markets.
12. Entities wanting to raise debt finance from the Australian market have _________ to choose from as methods of finance. A. corporate bonds. B. debentures. C. notes. *D. all of the above. LO 1.1: Understanding finance, money and markets.
13. Which party of a bond pays the repayment of the face value at maturity? *A. issuer. B. owner. C. financial intermediary. D. none of the above. LO 1.1: Understanding finance, money and markets.
14. _____________ are issued by all companies. A. debentures. B. bonds. C. preference shares. *D. ordinary shares. LO 1.1: Understanding finance, money and markets.
Module 1: Finance in business
15. The business entity which is likely to have the most owners is a: A. private company. B. sole trader. C. partnership. *D. listed public company. LO 1.1: Understanding finance, money and markets. 16. Why don’t many small businesses employ a financial manager? *A. costs outweigh benefits. B. high cost. C. limited benefits. D. none of the above. LO 1.1: Understanding finance, money and markets.
17. Business owners usually choose the structure of their business based on: A. the taxation of profits. B. the start-up size of its operations. C. the legal liability of owners. *D. all of the above. LO 1.2: Identify the basic forms of business structures.
18. Most start-up businesses operate as a ________________ because of their small operating scale and capital requirements. A. company. B. partnership. C. sole trader. *D. B or C. LO 1.2: Identify the basic forms of business structures.
19. Which of the following business organisational forms subjects the owner(s) to unlimited liability? A. Company. *B. Sole trader. C. Public company. D. Limited partnership. LO 1.2: Identify the basic forms of business structures.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
20. A ____________ is a business entity owned by one person, and typically consists of the trader and a small number of employees. *A. sole trader. B. partnership. C. public company. D. private company. LO 1.2: Identify the basic forms of business structures.
21. An advantage of forming as a sole trader is because: A. it is the most complex type of business structure. B. it is the most regulated form. *C. all profits from the business are kept by the owner. D. the owner is exposed to limited liability. LO 1.2: Identify the basic forms of business structures.
22. The _______________ organisational form best enables the owners of the business to monitor the actions of other owners of the same entity. A. sole trader. *B. partnership. C. public company. D. private company. LO 1.2: Identify the basic forms of business structures.
23. Which of the following cannot manage the operations of the business? A. A general partner. *B. A limited partner. C. A sole trader. D. None of the above. LO 1.2: Identify the basic forms of business structures.
24. _________________ have access to more capital, and pooling of knowledge, experience and skills than sole traders. A. Public companies. B. Private companies. *C. Partnerships. D. All of the above. LO 1.2: Identify the basic forms of business structures.
Module 1: Finance in business
25. A _______________ can sell its securities to the market. *A. public company. B. sole trader. C. private company. D. partnership. LO 1.2: Identify the basic forms of business structures.
26. The ______________ organisational form is subjected to the most legal regulations. A. partnership. B. sole trader. *C. public company. D. private company. LO 1.2: Identify the basic forms of business structures. 27. What form of business organisation is described in a legal sense as a ‘person’? *A. A company. B. A sole trader. C. A partnership. D. None of the above. LO 1.2: Identify the basic forms of business structures.
28. Which of the following organisational form(s) create(s) a tax liability on net profit at the personal income tax rate? A. Sole proprietorship. B. Corporation. C. Partnership. *D. A and C. LO 1.2: Identify the basic forms of business structures.
29. Which of the following business owners is protected by limited liability? *A. A limited partner. B. A sole proprietor. C. A general partner. D. None of the above. LO 1.2: Identify the basic forms of business structures.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
30. Which of the following is an independent legal entity that can sue and be sued? A. A partnership. *B. A corporation. C. A sole trader. D. None of the above. LO 1.2: Identify the basic forms of business structures.
31. All companies are registered with and regulated by the: A. Corporations Act 2001. B. ASX. C. government. *D. ASIC. LO 1.2: Identify the basic forms of business structures.
32. A major advantage of the company form of business structure is that: A. directors are personally liable under the Corporations Act 2001. *B. shareholders have limited liability for company debts. C. employees are personally liable under the Corporations Act 2001. D. all of the above. LO 1.2: Identify the basic forms of business structures.
33. When analysts and investors value a company's shares, they should consider the __________ of the expected cash flows. A. timing. B. riskiness. C. size. *D. all of the above. LO 1.3: Discuss the financial goals of a business.
34. Which of the following is an appropriate company goal? A. Tax minimisation. *B. Shareholder wealth maximisation. C. Profit maximisation. D. Revenue maximisation. LO 1.3: Discuss the financial goals of a business.
Module 1: Finance in business
35. The financial manager’s goal is to: A. grow the company. B. minimise risk. *C. maximise the value of the company’s shares. D. maximise profit. Feedback: All of the other goals have problems and thus maximising the value of the firm is the most appropriate. LO 1.3: Discuss the financial goals of a business. 36. Maximisation of the owners’ wealth: *A. takes risk into consideration. B. uses a short-term view. C. relies on accounting numbers. D. fails to consider the time value of money. Feedback: Managers must consider risk if they want to maximise the owners’ wealth as shareholders will expect to receive a higher rate of return to compensate for higher levels of risk. LO 1.3: Discuss the financial goals of a business.
37. The main financial goal of the firm is to: A. increase revenue growth. B. maximise profits. *C. maximise wealth. D. increase market share. Feedback: A large market share and high revenue growth does not necessarily lead to higher profits or wealth maximisation. Maximise profits takes a short-term view whereas wealth maximisation uses a long-run perspective of the business, and has many advantages over other goals. LO 1.3: Discuss the financial goals of a business.
38. Which of the following statements regarding wealth maximisation is true? A. Wealth maximisation uses a short-run perspective of the business. B. Wealth maximisation ignores future cash flows. *C. Wealth maximisation considers the time value of money. D. None of the above. LO 1.3: Discuss the financial goals of a business.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
39. Profit maximisation ignores: A. the risk associated with cash flows. B. the time value of money. C. the amount of cash flows. *D. A and B. LO 1.3: Discuss the financial goals of a business.
40. The time value of money: *A. is one of the most important concepts in finance. B. does not affect the value of cash flows. C. means a dollar today is worth less than a dollar in the future. D. none of the above. LO 1.3: Discuss the financial goals of a business.
41. Which of the following is true? A. Investors like taking on risk. *B. Investors expect to be compensated for bearing risk. C. The less risky an investment’s cash flows, the less it is worth. D. The more risky an investment’s cash flows, the more it is worth. LO 1.3: Discuss the financial goals of a business.
42. The goal for unlisted companies and partnerships can be stated as: A. maximise the current value of working capital. B. maximise the current value of non-current assets. *C. minimise the current value of equity. D. maximise the current value of non-current liabilities. LO 1.3: Discuss the financial goals of a business. 43. The goal to maximise the value of the company’s shares focuses on maximising the value of: A. profits. B. productive assets. C. revenues. *D. cash flows. LO 1.3: Discuss the financial goals of a business.
Module 1: Finance in business
44. Management decisions that directly affect the company’s expected cash flows include all of the following except: A. product quality and cost. *B. corporate laws. C. research and development. D. marketing and sales. LO 1.3: Discuss the financial goals of a business.
45. Share prices are affected by: A. The business environment. B. Management decisions. C. Economic shocks. *D. all of the above. LO 1.3: Discuss the financial goals of a business.
46. Economic shocks that affect share prices include: A. environmental regulations. *B. natural disasters. C. corporate laws. D. taxation. LO 1.3: Discuss the financial goals of a business.
47. The business environment that affects share prices excludes: A. corporate laws. B. environmental regulations. *C. capital budgeting decisions. D. procedural and safety regulations. LO 1.3: Discuss the financial goals of a business.
48. The only corporate objective that maximises the economic interests of all stakeholders over a long-term horizon is for management to: A. expand business operations. *B. make decisions that maximise the wealth of shareholders. C. maintain financial strength. D. retain financial flexibility. LO 1.3: Discuss the financial goals of a business.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
49. Which of the following statement(s) is (are) correct? A. Any residual cash flow is reinvested in the firm or paid as dividends. B. Managers and other employees receive salaries and wages. C. Cash is king. *D. All of the above. Feedback: This shows the importance of cash and how cash is used in a business. LO 1.4: Identify the key financial decisions facing the financial manager.
50. The decision-making process through which managers choose long-term productive assets is known as: A. productive decisions. B. financing decisions. *C. capital budgeting decisions. D. all of the above. Feedback: The capital budgeting decision process addresses which productive assets the company should purchase and how much money the company can afford to spend. LO 1.4: Identify the key financial decisions facing the financial manager.
51. The decision-making process through which managers choose to finance productive assets is known as: *A. financing decision. B. investing decision. C. capital budgeting. D. operating decision. Feedback: Financing decisions concern how companies raise cash to pay for their investments, as shown in figure 1.2. LO 1.4: Identify the key financial decisions facing the financial manager.
52. If you have loaned capital to a company, then you are: A. a partner. B. a shareholder. *C. a stakeholder. D. all of the above. Feedback: A stakeholder is someone other than an owner who has a claim on the cash flows of the company. Creditors are an example as they want to be paid interest and principal. LO 1.4: Identify the key financial decisions facing the financial manager.
Module 1: Finance in business
53. Which of the following are stakeholders? A. Lenders. B. Suppliers. C. Australian Taxation Office. *D. All of the above. Feedback: A stakeholder is someone other than an owner who has a claim on the cash flows of the company, such as, managers, creditors, employees, suppliers and the government. LO 1.4: Identify the key financial decisions facing the financial manager.
54. Which of the following is a productive asset? A. Patents. B. Plant. C. Equipment. *D. All of the above. Feedback: The different types of assets that a business uses to generate cash flows. LO 1.4: Identify the key financial decisions facing the financial manager.
55. Financial managers invest in capital projects where: *A. net cash flows exceed the initial outlay. B. expected sales are high. C. the expected profit exceeds their target profit. D. cash inflows are less than the cost of the project. Feedback: Sound investments are those where the value of the benefits exceeds their costs. LO 1.4: Identify the key financial decisions facing the financial manager.
56. In the financing decision process, managers decide whether to use: A. equity. *B. debt and equity. C. debt. D. none of the above. Feedback: The manager chooses the right combination of debt and equity to finance new acquisitions. LO 1.4: Identify the key financial decisions facing the financial manager.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
57. A working capital manager’s role is to manage: A. inventory and accounts receivable only. B. cash and inventory only. *C. cash, inventory, accounts receivable, accounts payable and risk management. D. accounts receivable and payable only. Feedback: Traditionally, the role of a working manager was to deal with cash, inventory, accounts receivable and accounts payable. After the recent global financial crisis, risk management became an important component of a business and in most cases working capital managers deal with risk management. LO 1.4: Identify the key financial decisions facing the financial manager.
58. Which of the following asset purchase decisions is the most important to the company? A. Purchasing an intangible asset. *B. Purchasing a tangible asset. C. How to finance the asset’s purchase. D. All of the above. LO 1.4: Identify the key financial decisions facing the financial manager.
59. The cash remaining after the company has met its operating expenses, payments to creditors, and tax is referred to as: *A. residual cash. B. earnings per share. C. dividends. D. capital contributed in excess of par. LO 1.4: Identify the key financial decisions facing the financial manager.
60. Cash dividends are paid out of: A. operating expenses. B. liquidated assets. C. long-term debt. *D. residual cash. LO 1.4: Identify the key financial decisions facing the financial manager.
Module 1: Finance in business
61. Where liquidation follows insolvency, the ___________ is/are always paid first. *A. secured creditors. B. owners. C. government. D. employees. LO 1.4: Identify the key financial decisions facing the financial manager.
62. Current liabilities are liabilities that: A. will be converted to equity within a year. B. will be converted to cash within a year. *C. must be paid within a year. D. none of the above. LO 1.4: Identify the key financial decisions facing the financial manager.
63. Capital budgeting involves: *A. which productive assets the company should use. B. how a company's day-to-day financial matters should be managed. C. how the company should finance its assets. D. all of the above. LO 1.4: Identify the key financial decisions facing the financial manager.
64. Working capital management decisions involve: A. how the company should finance its assets. B. which productive assets the company should employ. *C. how a company's day-to-day financial matters should be managed. D. all of the above. LO 1.4: Identify the key financial decisions facing the financial manager.
65. Capital budgeting decisions generally involve: A. the short-term asset portion of the balance sheet. B. the current liability portion of the balance sheet. *C. the fixed asset portion of the balance sheet. D. all of the above. LO 1.4: Identify the key financial decisions facing the financial manager.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
66. Financing decisions involve: A. trade-offs between advantages and disadvantages. B. long-term borrowing for productive assets. C. raising cash to pay for investments. *D. all of the above. LO 1.4: Identify the key financial decisions facing the financial manager. 67. Which of the following has the final decision-making authority among all the company’s executives? *A. CEO. B. CFO. C. Audit committee. D. Board of directors. LO 1.5: Describe the typical organisation of the financial function in a large company.
68. Which of the following reports directly to the board of directors? A. Treasurer. B. Internal auditor. *C. CEO. D. CFO. LO 1.5: Describe the typical organisation of the financial function in a large company.
69. Which of the following reports directly to the owners of the company (assume the company is a public company)? A. CEO. B. Audit committee. C. CFO. *D. Board of directors. LO 1.5: Describe the typical organisation of the financial function in a large company.
70. The _________________ is responsible for seeing that the best possible financial analysis is presented. *A. CFO. B. Audit committee. C. CEO. D. Board of directors. LO 1.5: Describe the typical organisation of the financial function in a large company.
Module 1: Finance in business
71. The CFO reports directly to the: A. Board of directors. B. Audit committee. *C. CEO. D. External auditor. LO 1.5: Describe the typical organisation of the financial function in a large company.
72. The _____________ reports directly to the CFO. A. External auditor. B. CEO. *C. Risk manager. D. Audit committee. LO 1.5: Describe the typical organisation of the financial function in a large company.
73. The ________________ does not report directly to the CFO. A. Internal auditor. B. Controller. C. Treasurer. *D. Audit committee. LO 1.5: Describe the typical organisation of the financial function in a large company.
74. Which of the following looks after the collection and disbursement of cash? A. Internal auditor. B. Risk manager. C. Controller. *D. Treasurer. LO 1.5: Describe the typical organisation of the financial function in a large company.
75. Which of the following is responsible for performing audits to determine where the company might incur substantial losses? A. Controller. B. Risk manager. *C. Internal auditor. D. Treasurer. LO 1.5: Describe the typical organisation of the financial function in a large company.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
76. The internal auditor reports directly to the: A. Controller. B. CFO. C. Board of directors. *D. B and C. LO 1.5: Describe the typical organisation of the financial function in a large company. 77. Which of the following is the company’s chief accounting officer? *A. Controller. B. Internal auditor. C. Risk manager. D. Treasurer. LO 1.5: Describe the typical organisation of the financial function in a large company.
78. The ___________ prepares the financial statements and tax returns. A. Treasurer. B. Risk manager. *C. Controller. D. Internal auditor. LO 1.5: Describe the typical organisation of the financial function in a large company. 79. Which of the following monitors and manages the company’s risk exposure in financial and commodity markets? A. Controller. *B. Risk manager. C. Treasurer. D. Internal auditor. LO 1.5: Describe the typical organisation of the financial function in a large company. 80. Which of the following manages the company’s relationships with insurance providers? A. Internal auditor. *B. Risk manager. C. Treasurer. D. Controller. LO 1.5: Describe the typical organisation of the financial function in a large company.
Module 1: Finance in business
81. Which of the following is responsible for performing an independent audit of the company's financial statements? A. Audit committee. *B. CPA company. C. CFO. D. CEO. LO 1.5: Describe the typical organisation of the financial function in a large company.
82. Which of the following does not require independent audits to be performed for large public companies? A. Creditors. B. Investors. *C. Debtors. D. ASIC. LO 1.5: Describe the typical organisation of the financial function in a large company.
83. Which of the following conducts investigations of significant fraud in the company when senior managers are involved? A. Controller. B. Internal auditor. C. Treasurer. *D. Audit committee. LO 1.5: Describe the typical organisation of the financial function in a large company.
84. During the global financial crisis, risk managers had to: A. manage insurance portfolio. B. design strategies for limiting risk. C. monitor the company’s risk exposure. *D. all of the above. Feedback: These are the main roles of risk managers. LO 1.5: Describe the typical organisation of the financial function in a large company.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
85. A society's ideas about what actions are right and wrong are: *A. ethics. B. laws. C. morals. D. unwritten laws. LO 1.6: Discuss the relevance of ethics in business.
86. In our society, ethical rules do not include: A. realising that we must follow the same rules we expect others to follow. B. considering the impact of our actions on others. *C. being unwilling to sometimes put the interest of others ahead of our own interests. D. all of the above. LO 1.6: Discuss the relevance of ethics in business.
87. The golden rule is an example of: A. a current law. *B. an ethical norm. C. a historical law. D. an unworkable rule in financial markets. LO 1.6: Discuss the relevance of ethics in business.
88. Corruption in business organisations: A. creates inefficiencies in an economy. B. inhibits growth in an economy. C. slows the rate of economic growth in a country. *D. all of the above. LO 1.6: Discuss the relevance of ethics in business.
89. An example of an economy that had trouble establishing a share market and attracting foreign investment is: A. China. B. Japan. *C. Russia. D. Greece. LO 1.6: Discuss the relevance of ethics in business.
Module 1: Finance in business
90. Most ethical problems that arise in business dealings are related to: A. agency obligations. B. conflicts of interest. C. information asymmetry. *D. all of the above. LO 1.6: Discuss the relevance of ethics in business.
91. Which corporate officer, when he or she is guilty of serious misconduct, can subject the company to the most serious losses in financial wealth? *A. CFO. B. CEO. C. Chief Risk Officer. D. Chief Technology Officer. LO 1.5: Describe the typical organisation of the financial function in a large company.
92. Which of the following would have the biggest impact on the share price? A. Revelations of honesty. B. A product recall. C. An environmental offence. *D. Revelations of deception and fraud. LO 1.6: Discuss the relevance of ethics in business.
93. Typically, conflicts of interest are resolved by: A. complete disclosure. B. nondisclosure. C. withdrawing from serving one of the parties. *D. A and C. LO 1.6: Discuss the relevance of ethics in business.
94. _____________occur(s) when one party in a business transaction has information that is not available to the other parties. A. Financial advantage. *B. Information asymmetry. C. Information efficiency. D. Profits. LO 1.6: Discuss the relevance of ethics in business.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
95. Information asymmetry occurs when: A. both parties have access to the same information. B. the seller has more information than the buyer. C. insider trading. *D. B and C. LO 1.6: Discuss the relevance of ethics in business.
96. Insider trading occurs when trading shares based on: *A. private information. B. public information. C. information readily available. D. none of the above. LO 1.6: Discuss the relevance of ethics in business.
97. Incentives to foster ethical behaviour in the business community include: A. solvency. *B. legal fines. C. financial gains. D. all of the above. LO 1.6: Discuss the relevance of ethics in business.
98. Incentives for ethical behaviour include: A. legislation. B. insolvency. C. market forces. *D. all of the above. LO 1.6: Discuss the relevance of ethics in business.
99. An unethical business culture can lead to adverse consequences for: A. general public. B. investors. C. management. *D. all of the above LO 1.6: Discuss the relevance of ethics in business.
Module 1: Finance in business
100.Incentives provided by law and market forces to foster ethical behaviour: *A. are not enough to ensure ethical behaviour. B. make an ethical business culture unnecessary. C. are sufficient to ensure ethical behaviour. D. none of the above. LO 1.6: Discuss the relevance of ethics in business.
Module 2: The financial system Multiple-choice questions 1. The functions of a financial system include: A. facilitating the flow of funds. B. providing means for the transfer and management of risks. C. providing the mechanism for the settlement of transactions. *D. all of the above. Feedback: The flow of funds refers to the channelling of funds from the units with financial surplus to units with financial deficit, either directly or through financial intermediaries. The settlement function is fulfilled by the payment system, which is part of the financial system. The financial system, through general insurance companies or life insurance companies, provide ways to alleviate risks. In addition the financial system provides means for insuring against the risks created by some financial claims. The list of functions could be completed with the following ones: “generating and disseminating information that assists decision making” and “providing ways of dealing with the incentive problems that arise in financial contracting”. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
2. A deficit spending unit is an economic unit: A. who has negative income. B. whose income is less than planned saving. C. who can provide funds to the financial system. *D. whose planned expenditure in a period exceeds current income. Feedback: In order to provide funds to the financial system, the economic unit needs to be a surplus spending unit (SSU), i.e. its income exceeds planned expenditure so there are funds left (called savings). The SSU may also decide to repay existing debt instead of acquiring new financial assets. The deficit spending unit (DSU) is in the opposite situation as planned expenditure exceeds income (negative savings) and therefore he/she needs to find funds in the financial system to pay for the expenditure as an alternative to liquidate existing assets. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
Module 2: The financial system
3. Which of the following statements best describes the concept of "two faces of debt"? A. Government debt requires higher taxation in the future to repay the principal and interests of the debt. B. Intermediaries issue financial claims to SSUs and own financial claims issued by DSUs. *C. Every financial asset is someone else’s liability/equity. D. DSUs in one period can be SSUs in another one. Feedback: Financial claims are liabilities (if debt) or equity (if shares) for recipients of funds and are assets to providers of funds. All the other statements are correct but are not related to the concept of “two faces of debt”. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
4. It is important to be able to resell financial claims in a secondary market because it allows: A. DSUs to finance a project with successive issues of financial claims. B. DSUs to implement projects with horizon shorter than the SSUs’ investment horizon. *C. SSUs to purchase financial claims with maturities that are longer than their investment horizon. D. SSUs to purchase financial claims with maturities that are shorter than their investment horizon. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
5. The functions of the financial system include: A. providing ways of dealing with the incentive problems that arise in financial contracting. B. generating and disseminating information that assists decision making. C. facilitating the flow of funds. *D. all of the above. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
6. Which of the following are NOT financial claims? *A. commodities. B. bonds. C. shares. D. loans. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
7. During 2017, Michael and Jenny Jones expect total income of $215,000 and are budgeting total expenditure of $195,000. For this budget period, the Jones family is most specifically a: A. deficit spending unit. B. a recipient of funds from the financial system. *C. surplus spending unit. D. financial intermediary. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
8. Which of the following financial claims does NOT belong to the capital market? A. Corporate bond. *B. Bank bill. C. Shares. D. Government bond. Feedback: Capital market refers to the market for financial claims with an original maturity larger than one year. Bonds issued by governments or corporations belong to that category as they are usually issued with an original maturity of 5 to 30 years. Shares have an unlimited maturity as they exist as long as the company operates. Shares therefore belong to capital market. Bank bills are issued by banks on behalf of a corporation and sold by banks to investors with an original maturity less than one year. They therefore belong to the money market. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
9. Corporate bonds: *A. provide funding for capital expenditure. B. have a very active secondary market. C. have a maturity less than one year. D. are issued by governments. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place. 10. Which one of the following statements is NOT true? A. Prices in the corporate bond market tend to be more volatile than the market for shares. *B. Corporate bonds are more marketable than the securities that have higher daily trading volumes. C. The market for corporate bonds is thin.
Module 2: The financial system
D. Life insurance companies and superannuation funds are the largest investors in corporate bonds. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
11. An economy with a large flow of funds requires: A. a tightly controlled central bank. *B. an efficient financial system. C. a lot of gold reserves. D. all of the above. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
12. The financial system's primary concern is funnelling money from ________ to _________. *A. SSUs, DSUs. B. DSUs, SSUs. C. wealthy individuals, individuals. D. the government, wealthy individuals. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
13. An important function of the financial system is: *A. to direct money to the best investment opportunities in the economy. B. to allow the federal government to view all financial transactions. C. to help state governments to coordinate state tax levies. D. all of the above. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
14. A surplus budget position means that an entity's: A. income and expenditures are the same. *B. income for the period exceeds expenses. C. expenditures for the period exceed revenues. D. none of the above. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
15. The major players in the direct financial markets are: A. regional banks. B. commercial banks. C. investment banks. *D. both B and C. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
16. Which of the following would most likely be involved in underwriting public securities? A. A broker. *B. A dealer. C. A regional commercial banker. D. None of the above are involved in underwriting. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
17. The ASX is an example of: A. an over-the-counter market exchange. *B. an electronic organised exchange. C. a physical exchange. D. all of the above. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
Module 2: The financial system
18. Which of the following is not a role of financial markets: A. matching borrowers and lenders. B. facilitation of business and trade. *C. to increase the poverty gap. D. facilitation of savings by individuals to allow for future consumption. LO 2.1: Discuss the primary role of the financial system in the economy, and how fund transfers take place.
19. A sale of an entire security issue to a small group of surplus spending units is: A. a dealer arrangement. *B. a private placement. C. an underwriting. D. indirect finance. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
20. An over-the-counter market: A. is a primary market. B. is regulated by the RBA. *C. has no central location. D. allows investors in financial claims to trade directly among themselves. Feedback: An organised security exchange has a central location whereas an over-the-counter market operates through a network of dealers located at various locations. Organised security exchanges and over-the-counter markets are secondary markets as their purpose is to assist in the change of ownership among investors over financial claims. Trade in the secondary market does not involve the issuer, except in the rare case of buybacks. All markets are regulated by ASIC, while the RBA focuses on the general stability of the financial system. Investors in an over-the-counter market trade with a dealer not with each other. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
21. Which of the following transactions occurs in the primary market? A. A managed fund sells some Optus shares it owns. B. Mr Grey buys Commonwealth Bank shares listed on the ASX. *C. The Federal government sells Treasury bonds to finance road infrastructure. D. Mrs Thompson sells government bonds to a dealer. Feedback: A primary market is the market in which financial claims are sold for the first time in order to provide funds to the issuer of the claim. When the government puts in circulation new Treasury bonds with the aim of raising funds, this transaction takes place in the primary market. The later transactions among investors who want to rearrange their portfolios will take place in the secondary market. When an investor sells an asset it had previously bought the transaction is necessarily in the secondary market and the transaction brings funds to the selling investor not the issuer of the financial claim. The managed funds selling Optus shares and Mrs Thompson selling the government bonds are good examples of investors trading in the secondary market. ASX, where shares trade among investors, is a famous example of a secondary market. New shares issued by corporations to raise funds are not put in circulation through the ASX but through an investment bank. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
22. A futures market is: A. a dealer market in which securities that are not sold on one of the organised exchanges are traded. B. an over-the-counter market in which people trade contracts for future delivery of securities, commodities or the value of securities sold in the spot market. *C. an organised market in which people trade contracts for future delivery of securities, commodities or the value of securities sold in the spot market. D. a dealer market for contracts to buy (or sell) a particular type of security or commodity from (or to) the futures exchange during a predetermined future time period. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
23. Which of the following statements is NOT correct? *A. Owners of financial claims can sell them in the primary market. B. Deficit spending units raise funds by issuing financial claims in the primary market. C. Owners of financial claims can sell them in the secondary market before maturity date. D. A financial claim has one issuer but possibly successive owners through the secondary market. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
24. An organised security exchange:
Module 2: The financial system
A. is a primary market. B. relies on dealers for trading. C. has no central location. *D. is accessible by authorised traders only. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
25. Which of the following statements is NOT correct? A. Money markets are operated by dealers. B. Money market securities have short-term maturities. C. Money market transactions are seldom below $1 million. *D. Money markets securities are issued to finance long-term projects. Feedback: Money markets are markets for managing liquidity. Governments and companies borrow short term to finance current operations, not long term investments, or lent to avoid holding idle cash in the short term. Money markets tend to be wholesale (i.e. large denominations) OTC markets made by dealers. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
26. Which of the following financial claims does NOT belong to the money market? A. Bank bill. B. Treasury note. *C. Corporate bond. D. Commercial paper. Feedback: Money markets refer to the markets for financial claims with an original maturity less than one year. Bonds are usually issued with an original maturity of 5 to 30 years and therefore do not belong to the money market. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
27. Which of the following is NOT a characteristic of money market instruments? A. Low default risk. B. High marketability. *C. Small denomination. D. Short term to maturity. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
28. The financial market where new securities are sold for the first time is: A. an indirect market. B. a secondary market. *C. a primary market. D. none of the above. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
29. Secondary financial markets are similar to: A. new-car markets. *B. used-car markets. C. direct auction markets. D. all of the above. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
30. The ease with which a security can be sold and converted into cash is referred to as: A. book value. *B. marketability. C. convertibility. D. none of the above. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
31. Highly liquid financial instruments with a maturities of 90 days would be traded in: A. the bond market. B. the share market. *C. the money market. D. all of the above. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
Module 2: The financial system
32. Which market would a company participate in if it needs to adjust its liquidity position? *A. The money market. B. The bond market. C. The share market. D. All of the above. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
33. If a company needs to finance a new corporate headquarters building, then it would most likely seek the funds in the: A. money market. *B. capital market. C. futures market. D. foreign exchange market. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
34. The most common reason that corporate companies use the futures and options markets is to: A. take risk. *B. hedge risk. C. make deposits. D. none of the above. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
35. Which of the following is not a way in which secondary markets support primary markets? A. Facilitating risk management. *B. Underwriting new issues of securities. C. Providing liquidity for holders of issued securities. D. Providing a price-discovery mechanism for primary markets when new issues are contemplated. Feedback: Secondary markets do not underwrite new issues of securities (underwriters do that). LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
Module 2: The financial system
36. Private placements are: A. issues of securities to the public. B. issues of securities directly onto the ASX. C. issues of securities made only by the government. *D. issues of securities made by negotiation directly with purchasers. LO 2.2: Describe the primary, secondary and money markets, and explain why these markets are so important to businesses.
37. Which of the following is NOT a comparative advantage of financial intermediaries over surplus spending units in providing funds to deficit spending units? A. Economies of scale. B. Lower transactions costs. C. Better management of credit risk. *D. Higher searching costs for credit information. Feedback: Financial intermediaries transform claims: the claims that link them to SSUs are different to the claims that link them to DSUs. Thanks to that differentiation financial intermediaries can reach a better outcome than what SSUs could do directly. Financial intermediaries are able to generate a profit out of this transformation because: (a) of economies of scale of production, (b) they reduce search costs for both DSUs and SSUs, and (c) they are able to obtain sensitive information, which allows them to manage credit risk better. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
38. Denomination transformation refers to the ability of financial institutions to: A. spread risk. B. raise short-term funds to lend for longer periods. *C. raise many small amounts to lend larger amounts. D. raise funds in one currency to lend in another currency. Feedback: The denomination is the amount of money lent associated to a given financial claim. Surplus spending units usually can provide only small amounts of funds while deficit spending units have often very large needs. Financial intermediaries can reconcile these opposite preferences. The other answers are related to other services provided by financial institutions. Raising short-term funds to lend for longer periods is called maturity transformation. Raising funds in one currency to lend funds in another currency is currency transformation. Spreading risks refers to risk diversification. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
39. Most financial intermediaries ________financial claims.
issue
_______financial
claims
and
purchase
A. direct; direct. *B. indirect; direct. C. direct; indirect. D. indirect; indirect. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
40. Credit risk diversification of a loan portfolio occurs when: A. loans from similar borrowers are combined in a portfolio. B. loans with similar payment patterns are combined in a single portfolio. *C. adding loans to the portfolio decreases the variability of the loan portfolio. D. adding loans to the portfolio increases the variability of the loan portfolio. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
41. Which of the following is NOT a comparative advantage of financial intermediaries over surplus spending funds in providing funds to deficit spending units? *A. Ability to increase credit risk. B. Ability to reduce transaction costs. C. Ability to achieve economies of scale. D. Ability to find confidential information. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
Module 2: The financial system
42. Which of the following financial institutions accepts deposits as liabilities? *A. Credit unions. B. Managed funds. C. Finance companies. D. Superannuation funds. Feedback: Credit unions and building societies are not commercial banks but accept deposits in their liabilities, like commercial banks. Finance companies do not take deposits and resort to the issue of short term debt to finance their loans. Superannuation funds collect funds through the contributions of employees and employers while managed funds raise funds through the issue of shares. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
43. Superannuation funds tend to invest in: A. government securities exclusively. *B. predominantly long-term securities. C. money market securities exclusively. D. predominantly lower-yielding securities. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
44. Which of the following activities is NOT performed by money-market corporations? A. Underwriting securities. *B. Offering insurance services. C. Marketing new issues of securities. D. Advising on mergers and acquisitions. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
45. Which of the following statements is NOT correct? Australian commercial banks: A. are highly regulated. B. take deposits and make loans. C. have various sources of funds. *D. have fewer assets than superannuation funds. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
46. _____________ risk is the risk that a company will not generate sufficient cash inflows to meet required cash outflows. *A. liquidity. B. credit. C. operational. D. political. Feedback: Credit risk is the risk that the borrower does not repay the principal or the interests. Operational risk refers to any dys-functioning in the organisation of the company. Political risk occurs when government changes regulation/policies or changes the terms of a financial contract by which it borrowed funds. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
47. The risk that a borrower may not repay the principal or the interest is called: *A. credit risk. B. political risk. C. liquidity risk. D. operational risk. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
Module 2: The financial system
48. ____________ risk is the risk that a government decides to change the terms of a financial contract by which it borrowed funds. A. credit. *B. political. C. liquidity. D. operational. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
49. The process of converting financial securities with one set of characteristics into securities with another set of characteristics is called: A. financial disintermediation. *B. financial intermediation. C. financial bundling. D. none of the above. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
50. A ______________ to a business is like a credit card to an individual. A. a bond. B. a term loan. *C. line of credit. D. none of the above. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
51. A superannuation fund would not include ______________ as a major proportion of their investment portfolio. *A. commercial papers. B. long-term corporate bonds. C. shares. D. none of the above. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
52. If a small business opts not to borrow from a commercial bank, then what is probably its next best alternative? *A. A finance company. B. An investment fund. C. An insurance company. D. A superannuation fund. LO 2.3: Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets, and describe how companies use the financial system.
53. Which international institution sets capital adequacy guidelines for banks that have been adopted by Australian regulatory authorities? A. The World Bank. B. The International Monetary Fund (IMF). *C. The Bank for International Settlements (BIS). D. The United Nations Organisation for Economic Cooperation and Development (OECD). Feedback: The BIS sets capital adequacy guidelines for banks that are adopted by many countries, including Australia. LO 2.4: Discuss the internationalisation of financial markets and the role played by the BIS in ensuring the global financial markets remain stable.
54. Which of the following is an important international financial market for Australian firms? A. The eurocurrency market. B. The short-term US market. C. The long-term Eurobond market. *D. All of the above. LO 2.4: Discuss the internationalisation of financial markets and the role played by the BIS in ensuring the global financial markets remain stable.
55. Which of the following conduct daily transactions between the Australian domestic markets and the international markets? A. Large financial institutions. B. Institutional investors. C. Business firms. *D. All of the above. LO 2.4: Discuss the internationalisation of financial markets and the role played by the BIS in ensuring the global financial markets remain stable.
Module 2: The financial system
56. Which international institution aims to reduce poverty and improve living conditions and quality of life in the Asia-Pacific region? A. The World Bank. *B. The Asian Development Bank (ADB). C. The International Monetary Fund (IMF). D. The Bank for International Settlements (BIS). LO 2.4: Discuss the internationalisation of financial markets and the role played by the BIS in ensuring the global financial markets remain stable.
57. Which international institution facilitates the expansion and balanced growth of international trade? A. The World Bank. B. The Asian Development Bank (ADB). *C. The International Monetary Fund (IMF). D. The Bank for International Settlements (BIS). LO 2.4: Discuss the internationalisation of financial markets and the role played by the BIS in ensuring the global financial markets remain stable.
58. In an efficient capital market: A. prices of securities adjust as new information becomes available to the market. B. security prices fully reflect the knowledge and expectations of all investors at a particular point in time. C. investors and financial managers have no reason to believe the securities are not priced at or near their true value. *D. All of the above are true. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
59. Which one of the following statements is NOT true? A. Operational efficiency focuses on bringing buyers and sellers together at the lowest possible cost. *B. If market prices reflect all relevant information about securities at a particular point in time, the market is operationally efficient. C. The overall efficiency of a capital market depends on its operational efficiency and its informational efficiency. D. All of the above are true. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
60. With strong-form market efficiency: *A. it would not be possible to earn abnormally high returns by trading on private information. B. investors who have access to inside or private information will be able to earn abnormal returns. C. the price of a security in the market reflects all public information only. D. None of the above. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
61. With semi-strong form market efficiency: *A. the price of a security in the market reflects all public information only. B. it would be possible to earn abnormally high returns by trading on public information. C. investors who have access to inside or private information will be unable to earn abnormal returns. D. None of the above. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
62. Which one of the following statements is NOT true? *A. Strong-form market efficiency implies that investors who have access to private information will be able to earn abnormal returns. B. Semi-strong form market efficiency implies that investors who have access to private information will be able to earn abnormal returns. C. Weak-form market efficiency implies that investors who have access private information will be able to earn abnormal returns. D. None of the above. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
63. What does operational efficiency refer to? A. Prices that quickly reflect important information. B. Sufficient securities to efficiently allocate risk. *C. Low transaction costs. D. Both B and C are correct. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
Module 2: The financial system
64. If markets were strong form efficient, which of the following situations would yield abnormal returns? A. Obtaining insider information. B. Analysing a company’s earnings report. C. Identifying a pattern in a company’s stock price. *D. None of the above would yield abnormal returns. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
65. Which of the following are forms of market efficiency? A. Weak form. B. Strong form. C. Semi-strong form. *D. All of the above. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
66. If markets were semi-strong form efficient, which of the following situations would yield abnormal returns? *A. Obtaining insider information. B. Analysing a company’s earnings report. C. Identifying a pattern in a company’s stock price. D. None of the above would yield abnormal returns. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
67. How are abnormal returns defined? A. Positive return. B. Returns in excess of the risk-free rate. C. Returns in excess of the market return. *D. Returns in excess of the risk-adjusted expected return. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
68. If markets were weak form efficient, which of the following situations would NOT yield abnormal returns? A. Obtaining insider information. B. Analysing a company’s earnings report. *C. Identifying a pattern in a company’s stock price. D. None of the above would yield abnormal returns. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers. 69. If a senior manager can consistently earn excess profits by trading her company’s stock, which form of efficiency is contradicted? A. Weak form. B. Semi-strong form. *C. Strong form. D. No form of efficiency is contradicted. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
70. If an investor consistently makes excess profits by following the advice provided on the Financial Guru public website, which form of efficiency is contradicted? A. Strong form. *B. Semi-strong form. C. Weak form. D. No form of efficiency is contradicted. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers. 71. A stock’s price rises 8 percent two days before the announcement of a large long-term project takes place. Which form of efficiency is contradicted? *A. Strong form. B. Weak form. C. Semi-strong form. D. No form of efficiency is contradicted. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
Module 2: The financial system
72. The announcement of the sudden accidental death of the CEO and principal scientist of a public company is associated with a 10% decrease in the company’s share price. Which form of market efficiency is contradicted? A. Weak form. B. Semi-strong form. C. Strong form. *D. No form of efficiency is contradicted. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
73. Technical analysis, which is defined as the analysis of historical trends of prices, is an important field in finance. Which form of efficiency is this field based on? A. Strong form inefficiency. *B. Weak form inefficiency. C. Semi-strong form inefficiency. D. It has nothing to do with efficiency. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
74. You purchased shares of a company in the automotive industry a year ago. Over the course of the past year, the economy began to slow down and the company faced declining sales. As a result, the stock price declined over your holding period. Which of the following is true? A. This is a violation of weak form market efficiency. B. This is a violation of strong form market efficiency. *C. This is not a violation of the efficient market hypothesis. D. This is a violation of semi-strong form market efficiency. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
75. If security markets are efficient, then: *A. the net present value of all securities should be zero. B. the net present value of all securities should be negative. C. the net present value of all securities should be positive. D. there are no implications on the net present value of securities. LO 2.5: Explain what an efficient capital market is and why market efficiency is important to financial managers.
Module 3: Financial markets Multiple-choice questions 1. Investors purchase Treasury Notes: A. in multiples of $10,000. B. at par value. *C. on a discount basis. D. both A and C. Feedback: Treasury Notes are sold to investors on a discount basis and pay no coupon interest. Thus, the interest income to the investors is the difference between the purchase price and face value of the note at maturity. LO 3.1: Explain the characteristics of money market instruments.
2. When a commercial bank issues a payment guarantee on behalf of an importer, that guarantee is a: A. documented transfer. *B. letter of credit. C. time draft. D. sight draft. Feedback: A letter of credit is a financial instrument issued by in importer’s bank that obligates the bank to pay the exporter a specified amount of money. LO 3.1: Explain the characteristics of money market instruments.
3. Which of the following statements is correct? A. Money market transactions are seldom over $1 million. B. Most money market transactions involve retail investors. *C. The money market is a dealer market linked by efficient communications systems. D. Market transactions in money market securities include more primary market trades than secondary market trades. LO 3.1: Explain the characteristics of money market instruments.
4. Low credit rated commercial companies typically raise funds using which money market instrument? A. Treasury notes. *B. Bank-accepted bills. C. Commercial paper. D. Negotiable CDs. LO 3.1: Explain the characteristics of money market instruments.
Module 3: Financial markets
5. Money market securities are: A. risk free assets. B. long-term securities. C. not traded before maturity date. *D. an alternative to bank borrowing for corporations’ funding. LO 3.1: Explain the characteristics of money market instruments.
6. In a bank-accepted bill, the bank is: A. the lender of funds. B. the issuer of the bill. *C. the payer of the face value to the investor if the issuer defaults. D. the borrower of funds. Feedback: The issuer/borrower is the commercial company not the bank. The lenders are the investors in the bill not the bank. LO 3.1: Explain the characteristics of money market instruments.
7. ________________ is (are) the largest class of participants in the Australian money markets. *A. Commercial banks. B. Non-financial corporations. C. The Commonwealth government. D. The Reserve Bank of Australia. LO 3.1: Explain the characteristics of money market instruments.
8. The cash rate is an interest rate prevailing on the: A. repo market. B. Treasury notes market. C. bank-accepted bills market. *D. unsecured interbank market. LO 3.1: Explain the characteristics of money market instruments.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
9. Which of the following securities is not a one-name paper? A. Treasury notes. B. Commercial paper. *C. Bank-accepted bills. D. Certificates of deposit. Feedback: Bank accepted bills imply that the bank will pay if the drawer of the bill cannot pay. The issuer and the bank have a joint liability. LO 3.1: Explain the characteristics of money market instruments.
10. If a security receives a bank acceptance, the instrument is a(n): A. equity paper. B. one-name paper. *C. two-name paper. D. commercial paper. Feedback: ‘Two names’ refers to the issuer and to the acceptor, who share the liability. LO 3.1: Explain the characteristics of money market instruments.
11. The price paid by investors to buy Treasury notes from a dealer is the: A. bid price. *B. ask price. C. face value. D. market-clearing price. Feedback: The ask price is the price asked by dealers for selling securities to customers while the bid price is the price that the dealer is ready to pay to buy from customers. The face value is the amount to be repaid at the maturity date and will always be higher than the trading price to account for interest. LO 3.1: Explain the characteristics of money market instruments.
12. Which of the following statements is NOT correct? In the bidding process in a Treasury notes auction, *A. the minimum bid is $1,000,000. B. the bidder specifies the quantity of notes desired. C. the bidder specifies the yield he/she is willing to get. D. only registered bidders can participate in the auction. Feedback: The minimum bid is $100,000 LO 3.1: Explain the characteristics of money market instruments.
Module 3: Financial markets
13. In a Treasury note offering, *A. the bidders with the lowest yield in their bid are allocated the notes first. B. AOFM is committed to buy the unsold Treasury notes. C. the yield is fixed and announced before the tender. D. bidders bid only quantities of securities. Feedback: Treasury notes are issued through a discriminatory auction, meaning that the bids are both yield and quantity, and the yields paid are the ones in the bids of the bidders with the lowest yields down to exhaustion of the notes on issue. LO 3.1: Explain the characteristics of money market instruments.
14. In Australia, transfer of ownership of Treasury notes is performed by: *A. Austraclear. B. RITS. C. the Reserve Bank of Australia. D. AOFM. LO 3.1: Explain the characteristics of money market instruments.
15. When firms issuing commercial paper (CP) use a backup line of credit offered by banks, it: A. has no impact on CP investors. B. decreases the marketability of CP. C. increases the credit risk for CP investors. *D. decreases the credit risk for CP investors. LO 3.1: Explain the characteristics of money market instruments.
16. In an underwritten offer, the firm issuing the commercial paper is guaranteed that: *A. the entire issue will be sold. B. the entire issue will be taken up by the investment bank. C. a discriminatory auction will be used to allocate the issue. D. the investment bank will attract enough investors to sell the entire issue. LO 3.1: Explain the characteristics of money market instruments.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
17. A _____________ is a discount security. A. share. B. debenture. *C. commercial bill. D. corporate bond. Feedback: A commercial bill is a discount security. A share is an equity security. Debentures and corporate bonds are coupon securities. LO 3.1: Explain the characteristics of money market instruments.
18. Which of the following is not an instrument traded in the money market? *A. Debentures. B. Promissory notes. C. Commercial bills. D. Certificates of deposit. Feedback: Debentures are traded in capital markets. LO 3.1: Explain the characteristics of money market instruments.
19. Convertible notes are hybrid securities that: A. can be converted into bonds at the discretion of the holder. B. can be converted into debentures at the discretion of the holder. C. can be converted into Treasury notes at the discretion of the holder. *D. can be converted into shares of common stock at the discretion of the holder. Feedback: Their convertibility feature permits the holder to share in the good fortune of the firm if the stock price rises above a certain level. That is, if the market value of the stock the holder receives at conversion exceeds the market value of the notes, it is to the investor’s advantage to exchange the notes for stock, thus making a profit. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
Module 3: Financial markets
20. Adjustable-rate preference shares are: *A. shares issued with adjustable rates. B. shares that can be converted into ordinary shares at a predetermined ratio. C. shares issued when partly paid for, so that there is an obligation on the holder to contribute the balance. D. shares in which the preference dividend remains constant regardless of any increase in the firm’s earnings. Feedback: The dividends are adjusted periodically in response to changing market interest rates. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
21. The term shareholder equity implies: A. a right to dividends. *B. an ownership claim. C. a prior claim on income and assets. D. a contractual relationship with a corporation. Feedback: In business and accounting, the shareholders' equity refers to the amount of assets that are owned by a company's shareholders. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
22. A _____________is not an example of a capital market security. A. Commonwealth government bond. B. Share. *C. Commercial paper. D. Corporate bond. Feedback: Commercial paper belongs to the money markets as its original maturity is shorter than one year. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
23. _____________ is (are) the biggest net supplier of funds in the capital markets. A. financial institutions. B. state and local governments. C. federal government. *D. individuals and households. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
24. A capital market financing is most likely used to finance: A. suppliers’ bills. B. the employees’ wages. *C. new plant and equipment. D. seasonal inventory needs. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
25. Australian Treasury bonds pay coupons: A. monthly. B. annually. C. at maturity. *D. semi-annually. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
26. The RBA is a large investor in Treasury bonds and notes due to its role: A. as the bank of the government. B. in the stability of the government. *C. in the conduct of monetary policy. D. as a supervisor of the financial system. Feedback: In order to influence the stock of central bank money in the banking system, the RBA conducts open market operations where the government securities are bought by the RBA from banks and then resold to banks at a later date (Reverse repos). The banks try to influence the stock of reserves in order to affect the cash rate, the overnight unsecured interbank rate. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
Module 3: Financial markets
27. In the tenders organised by the AOFM to issue Treasury bonds: A. bidders win if the quantity in their bid is among the highest. B. bidders win if the yield in their bid is among the highest. *C. AOFM serves the bidders with the lowest yields first and then accepts highest yields up to the exhaustion of the quantity on issue. D. bidders bid quantities at the yield announced by AOFM. Feedback: Treasury bonds are issued through discriminatory auctions where bidders (mainly banks) bid a yield and a quantity and the winners are the bidders with the lowest yields. Each winner pays the price implicit in the yield in its bid. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
28. Which of the following are features of some preference shares? A. Participating. B. Cumulativeness. C. Non-participating. *D. All of the above. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
29. Which of the following is not an advantage of issuing preference shares? *A. Ownership rights are diluted. B. Non-payment of dividends cannot pose a solvency risk of debt. C. The fixed cost of preference share capital allows firms to enhance earnings per ordinary share. D. Both A and B. LO 3.2: Explain the role and function of capital markets, and how their role differs from that of the money markets.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
30. Dealer panels are: A. similar to brokers in the stock market. B. a small set of bond dealers acting on behalf of the governments. C. a small set of bond dealers acting on behalf of the households and non-profit organisations. *D. a small set of bond dealers that agree to buy semis from state governments in either closed auctions or through agreeing to buy a given amount at a given price. Feedback: This is a small set of bond dealers of up to 12 members and agree to buy semis from state governments in either closed auctions (in which stock is assigned to the best bids) or through agreeing to buy a given amount at a given price. (see State government bonds) LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
31. Life insurance companies and superannuation funds buy corporate bonds for which two major reasons? A. low risk and liquidity. B. tax sheltering and high yield. C. liquidity and high after-tax returns. *D. liability maturity matching and high after-tax returns. Feedback: By investing in long-term corporate bonds, these firms are able to lock in high market yields with maturities that closely match the maturity structure of their liabilities, thereby reducing their interest rate risk. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
32. An unsecured note is a bond: *A. for which there is no underlying specified security as collateral in the case of default. B. for which there is some underlying specified security as collateral in the case of default. C. which has a call provision. D. with sinking fund. Feedback: An unsecured note is a bond that has no specified security attached as collateral in the case of default. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
Module 3: Financial markets
33. Fixed-charge debenture holders have the right to the proceeds of the sale of the assets: *A. specified in the debenture, should the bond default. B. specified in the debenture that is not already pledged against a fixed charge in any other debenture. C. specified in a trust. D. at all times. Feedback: Fixed-charge debenture holders have the right to the proceeds of the sale of the assets specified in the debenture, should the bond default. A floating-charge debenture holder has the right to the proceeds of sale of the assets specified in the debenture that are not already pledged against a fixed charge in any other debenture, in the case of default as well. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
34. State government bonds ________ than Commonwealth government bonds. *A. pay higher yields. B. have higher liquidity. C. have lower default risk. D. have higher marketability. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
35. Corporate bonds: A. are discount securities. B. do not need to be paid back. C. pay interest at maturity date. *D. make periodic payments of interest and repay principal at the maturity date. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
36. Everything else being equal, a corporate bond will sell at a higher yield if it: A. is senior debt. *B. has a call provision. C. has lower default risk. D. can be converted to shares. Feedback: Any feature in the bond that is detrimental to investors will sell at a higher yield. All features in the list except call provisions are beneficial to the investors and will require a lower yield. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
37. Hybrid securities are financial products that have characteristics of: *A. debt and equity. B. government bonds. C. discount securities. D. credit-wrapped bonds. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
38. Senior debt A. is debt issued by the Commonwealth government. B. has a higher probability of payment than junior debt. *C. is debt that has priority in the event of default of the issuer. D. is the debt issued by good credit rated companies. Feedback: Senior debt applies to unsecured corporate debt. It can exist even for not so good credit rated companies. The investors of senior debt have priority over the assets in case of default. Therefore they are more likely to receive payments in case of defaults than other investors in unsecured debt. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
39. Which of the following can best be described as a hybrid equity instrument with some characteristics of both equity and debt? A. Debentures. B. Partly paid shares. *C. Preference shares. D. Promissory notes. Feedback: Preference shares are a hybrid equity instrument with some characteristics of equity and some of debt. Debentures and promissory notes are debt instruments, while partly paid shares are an equity instrument. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
40. Interest on corporate bonds is usually paid: A. monthly. *B. six-monthly. C. annually. D. at maturity. Feedback: Interest on corporate bonds is usually paid six-monthly. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
Module 3: Financial markets
41. Unsecured notes usually pay ____________ coupons. *A. fixed. B. floating. C. no. D. fixed and floating. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
42. Generally, Commonwealth government bonds are assigned a ___________ rating. *A. AAA. B. AA. C. A. D. BBB. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
43. Assuming the only difference between bonds is their level of risk, we would expect bonds with a _______ rating to trade at the highest yields. A. AAA. B. AA. C. A. *D. BBB. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
44. Which of the following is not a feature of a debenture? *A. Unsecured. B. Fixed term. C. Regular coupons. D. Redemption at face value. Feedback: Debentures are usually secured. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
45. Which of the following statements is true? *A. Subordinated debt ranks above ordinary shareholders in the event of liquidation. B. Unsubordinated debt takes a lower ranking than other debt of similar characteristics. C. Subordinated debt ranks above other similar classes of debt in the event that a firm is liquidated. D. All of the above. LO 3.3: Differentiate treasury bonds, semis and corporate bonds.
46. The secondary markets for capital market securities have facilitated economic growth in general because: A. they make people more willing to invest because they can more easily diversify their risk. B. they help provide marketability for capital market claims. C. they have increased people's willingness to buy capital market claims. *D. all of the above. Feedback: The secondary market for capital markets securities is important because it allows investors to alter the risk exposure of their portfolios before maturity. Thus a working secondary market enhances the primary market. Investors are encouraged to buy new securities if a secondary market is present to provide liquidity. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
47. A dividend reinvestment scheme is: A. an offering of new issues of shares or bonds. B. the date on which a company ceases to effect transfers of its shares. C. the amount that must be paid per share to buy a new issue. *D. a scheme in which shareholders are allowed to reinvest dividends into shares. Feedback: The scheme allows shareholders to increase their shareholdings gradually by automatically reinvesting their dividends in extra shares as each dividend is ‘paid’. The issued shares are normally issued at either the market price averaged over several days’ trading or at a slight discount to this price. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
Module 3: Financial markets
48. Share amalgamations: A. try to prevent excessive speculation from destabilising the market. B. encompass the division of the entity’s shares into units of smaller value. C. is a system in which larger institutions submit bids for blocks of stock in an IPO. *D. are the revaluation and elimination of some of the firm’s issued shares, resulting in a smaller number of shares of a higher value, with the overall market capitalisation of the company remaining unchanged. Feedback: Share amalgamations, the revaluation and elimination of some of the firm’s issued shares, encompass the reduction of issued shares, accompanied by a rise in value. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
49. Nonparticipating preference shares imply that: A. the issuer has the right to buy back shares from the holders. B. the dividend adjusts in response to a change in market interest rates. *C. the preference dividend remains constant regardless of any increase in the firm's earnings. D. the firm cannot pay a dividend on its ordinary shares until it has paid the preference shareholders the dividends in arrears. Feedback: ‘The firm cannot pay a dividend on its ordinary shares until it has paid the preference shareholders the dividends in arrears’ is a description of the cumulative feature of preference shares. ‘The issuer has the right to buy back shares from the holders’ is a description of the redeemable feature of preference shares. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
50. Which of the following characteristics is not associated with ordinary shares? A. Vote by proxy. B. Limited liability. *C. Cumulative dividends. D. Residual claim on income and assets. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
51. When an investor buys convertible preference shares, the investor: A. can replace fixed dividends by coupons. B. is personally liable for the firm’s obligations. *C. has a set dividend rate usually for a five-year period. D. can convert into preference shares at a predetermined ratio. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
52. Which of the following statements is not correct? An ordinary shareholder in a troubled corporation: *A. may lose his/her house. B. does not receive dividends. C. records a decrease in the value of his/her assets. D. receives the proceeds from the sale of the assets after the creditors and the preference shareholders are paid, if the company goes bankrupt. Feedback: Limited liability implies that the personal assets of the shareholders cannot be claimed by the creditors of the defaulting company. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
53. An initial public offering of shares is: A. an issue of new shares to existing shareholders. B. an offering of new shares privately to a specific institutional investor. *C. an issue of shares that have never before been offered to the public. D. a rights issue. Feedback: The IPO is the very first issue of shares to the public so the ownership structure before that moment is private ownership. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
Module 3: Financial markets
54. Non-renounceable rights: A. trade in a secondary market until the exercise date. *B. cannot be sold on the market and shareholders have the option to subscribe to the rights issue or let the offer lapse. C. may be sold on the market if shareholders do not want to subscribe to a rights issue and increase their shareholdings. D. are rights given to an investor who acquired them from the issuer or from another investor to purchase additional shares at a slightly below-market price. Feedback: Non-renounceable rights have no secondary markets and must stay in the hands of the existing shareholders. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
55. The sale of securities to the public via an investment banker by a privately owned corporation raising funds is called: A. a seasoned offering. B. a secondary offering. C. a best efforts offering. *D. an initial public offering. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
56. In its capacity as the regulator of the financial markets, ASIC: A. supervises the entities listed on the ASX. B. conducts surveillance to detect insider trading on ASX. C. conducts surveillance to detect market manipulations on ASX. *D. investigates and prosecutes in case of illegal activities in the share market. Feedback: ASX is responsible for the surveillance of its market and the companies listed on it. When ASX suspects an illegal activity in its market it refers it to ASIC, which investigates the case and prosecute the offenders. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
57. A limit sell order at $20 for a particular share means that the investor: A. only accepts to sell for a price of $20. B. will not trade for prices higher than $20. C. accepts to sell for prices equal or lower than $20. *D. accepts to sell for prices equal or higher than $20. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
58. The extent to which orders exist both above and below the price at which the share currently trades reflects the share market’s: *A. depth. B. breadth. C. resilience. D. short position. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
59. Which of the following statements is not correct? A stock market crash can lead to an economic recession through: A. the decrease in wealth resulting in a decrease in consumption. B. the rise in the cost of raising capital resulting in a decrease in investment. *C. the decrease in share issuers’ equity resulting in a decrease in investment. D. the decrease in consumer confidence resulting in a decrease in consumption. Feedback: The decrease in shares prices does not affect the equity of the issuers. It affects the value of the assets of the investors and possibly through mark-to-market accounting the equity of these investors. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
60. Which of the following is not an equity instrument? *A. A debenture. B. A preference share. C. A fully paid ordinary share. D. A partly paid ordinary share. Feedback: A debenture is a debt instrument. The other three are types of equity instruments. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
Module 3: Financial markets
61. The listing requirements of the ASX apply to: *A. companies whose shares trade on the ASX. B. merchant bankers. C. stockbrokers. D. all of the above. LO 3.4: Explain how equity securities are traded in the secondary markets and discuss how the markets are operated.
62. Futures contracts differ from forward contracts in that: A. forward contracts always require a margin deposit. B. futures contracts are between the individual hedger and speculator. C. futures contracts are personalised, unique contracts; forwards are standardised. *D. futures contracts are marked to market daily with changes in value added or subtracted from buyer and seller. Feedback: Market participants post margin money (if necessary) to take account of gains or losses accruing from daily price fluctuations; we will come back to margins later and explain them in more detail. LO 3.5: Describe the most common types of derivative contracts.
63. A hedger in the financial futures market: A. only sells futures contracts. B. only buys futures contracts. *C. aims to reduce their price risk. D. either buys or sells future contracts in the expectation of earning a high return. LO 3.5: Describe the most common types of derivative contracts.
64. The purchase of one million dollars of Treasury Bonds, delivered in 60 days, from a government securities dealer is: A. a put. B. a call. C. a swap. *D. a forward contract. LO 3.5: Describe the most common types of derivative contracts.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
65. Futures contracts differ from forward contracts in all of the following ways except: A. delivery is made most often in forward contracts. B. futures markets are more formal than forward markets. *C. forward contracts involve an intermediary or exchange. D. futures contracts are standardised; forward contracts are not. LO 3.5: Describe the most common types of derivative contracts.
66. Settlement date in a forward contract means: A. forward prices are always higher than spot prices. B. spot prices are always higher than forward prices. *C. the future date on which the buyer pays the seller and the seller delivers the assets to the buyer. D. the contracted party that exchanges one item for another for a predetermined price at a predetermined point in time. LO 3.5: Describe the most common types of derivative contracts.
67. The forward price for an asset is the price that makes the forward contract: *A. have zero net present value. B. have negative net present value. C. have positive net present value. D. have zero or positive net present value. LO 3.5: Describe the most common types of derivative contracts.
68. Which of the following statements best describes marking to market? A. The process of personalising futures contracts. B. The final day on which trading occurs in a particular contract. *C. The requirement of a futures exchange for daily cash settlement of all contracts. D. The process of setting up a contract with a clearinghouse to operate as counterparty between the buyer and seller of a futures contract. LO 3.5: Describe the most common types of derivative contracts.
Module 3: Financial markets
69. Novation in futures exchange means: A. a place in which buyers and sellers can exchange futures contracts. The exchange keeps the books for buyers and sellers when contracts are initiated or liquidated. *B. the process of setting up a contract with a new party, such as occurs when clearinghouses insert themselves between the buyer and seller of a futures contract. C. a requirement that gains or losses on futures positions be taken into account in determining the value of all contracts each day. D. the back office that records, clears and settles contracts and acts as counterparty in futures trading. LO 3.5: Describe the most common types of derivative contracts.
70. An investor planning to buy NAB Bank shares in 30 days can protect himself against price risk by: A. selling a NAB Bank put option that matures in 30 days. *B. buying a NAB Bank call option that matures in 30 days. C. selling a NAB Bank call option that matures in 30 days. D. None of the above options are correct. LO 3.5: Describe the most common types of derivative contracts.
71. Put options: A. give the option buyer the right to buy a security at the strike price. *B. give the option buyer the right to sell a security at the strike price. C. give the option buyer the right to buy or sell a security at the strike price. D. give the option buyer the right to sell a security at the mark to market price. LO 3.5: Describe the most common types of derivative contracts.
72. Which of the following is not a derivative? *A. An ordinary share in a company. B. A futures contract. C. An options contract. D. A swap contract. Feedback: An ordinary share in a company is not a derivative. The other alternatives are all examples of derivatives. LO 3.5: Describe the most common types of derivative contracts.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
73. The part of a futures market that facilitates settlement of contracts and transfer of ownership between the parties to transactions is correctly referred to as a: *A. clearing house. B. counting house. C. central registry. D. settlement facility. Feedback: A clearing house facilitates settlement of contracts and transfer of ownership between the parties to transactions. LO 3.5: Describe the most common types of derivative contracts.
74.
_________________ is the first payment required for a futures contract.
A. a bond. B. a deposit. C. a premium. *D. an initial margin. Feedback: An initial margin is the first payment required for a futures contract. LO 3.5: Describe the most common types of derivative contracts.
75. If a futures trader fails to pay a margin call on a futures contract, the contract is: A. closed out by the counterparty. B. allowed to lapse. C. cancelled by the futures exchange. *D. closed out by the clearing house. Feedback: If a futures trader fails to pay a margin call on a futures contract, the contract is closed out by the clearing house. LO 3.5: Describe the most common types of derivative contracts.
76. ______________ are always obligations for the buyer. A. Call options. B. Put options. *C. Futures contracts. D. All of the above. LO 3.5: Describe the most common types of derivative contracts.
Module 3: Financial markets
77. Which of the following are always obligations for the seller: A. Put options. B. Futures contracts. C. Call options. *D. All of the above. LO 3.5: Describe the most common types of derivative contracts.
78. Which of the following statements regarding forward rate agreements (FRAs) is false: A. FRAs are settled by the payment of the difference in interest payable on a notional principal at the agreed rate and at the current market rate. *B. If the market has risen, the buyer must pay the seller of the FRA. C. FRAs are signed on the trade date. D. None of the above. LO 3.5: Describe the most common types of derivative contracts.
79. A put option written on a futures contract gives the buyer the right to: A. Sell the asset underlying the futures contract. B. Buy the asset underlying the futures contract. *C. Sell the futures contract underlying the option contract. D. Buy the futures contract underlying the option contract. LO 3.5: Describe the most common types of derivative contracts.
80. If a country experiences inflation, generally: A. its interest rates will fall. B. its exports will increase significantly. C. the forward exchange rate will fall relative to all other countries. *D. its forward exchange rate will fall relative to countries with lower inflation. Feedback: When people expect to have more inflation, they tend to buy from other country hence driving down the spot exchange rate. Because forward exchange rate partly based on spot rate, forward rate tend to fall as spot rate falls. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
81. A crawling peg is: A. an exchange rate that is allowed to float or move within a defined or set band relative to another currency. *B. a managed float where an exchange rate is allowed to appreciate in controlled steps over time. C. an exchange rate determined by the supply and demand factors in the FX markets. D. a constant rate of exchange between currencies. Feedback: For example, China applies a crawling peg foreign exchange regime that allows is currency to appreciate gradually over time within a limited range determined by its government. (see The operations of foreign exchange markets). LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
82. Investment flows from one country to another occur based on the investors' A. spot exchange rate when making the investment. B. nominal rate of return on the foreign investment. *C. expected real rate of return on the foreign investment. D. the realised real rate of return on the foreign investment. Feedback: Investment capital flows are either short-term money market flows motivated by differences in interest rates or long-term capital investments in a nation’s real or financial assets. (see Investment capital flows) LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
83. A base currency is: A. the rate at which one nation's currency can be exchanged for another's at the present time. B. the second-named currency in the foreign exchange quote used to express the value or price of the base currency. *C. the first-named currency in the foreign exchange quote where one unit expressed in terms of another currency being traded. D. none of the above. Feedback: A base currency is the first-named currency in the foreign exchange quote where one unit expressed in terms of another currency being traded. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
Module 3: Financial markets
84. Foreign exchange rates are best described as: A. the current interest rates of varying countries. B. the cost of a unit of foreign currency. C. the expected change in prices of international goods. *D. the cost of a unit of foreign currency in terms of another currency. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
85. A government that believes its currency is becoming overvalued may fear that currency appreciation will hinder its producers' abilities to export goods and will encourage imports. In this case, a government may: A. sell foreign currencies in the foreign exchange markets. B. buy foreign currencies in the foreign exchange markets. *C. buy assets from abroad. D. sell assets abroad. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
86. Countertrade in an international transaction is: A. passing the risk associated with changes in exchange rates to another. *B. the practice of accepting locally produced merchandise in lieu of money as payment for goods and services. C. a market in which parties agree to exchange a fixed amount of one currency for a fixed amount of a second currency. D. transferring purchasing power from those who normally deal in one currency to those who generally do business in another. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
87. An importer who must pay yen in 60 days may hedge the foreign exchange risk: A. in the spot market 60 days from now. B. in the spot market today. *C. in the forward market. D. all of the above. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
88. If the cost of yen per dollar changes from 100 to 110 yen per dollar, A. the cost of a yen has increased in terms of dollars. B. the yen has appreciated against the dollar. *C. the dollar has appreciated against the yen. D. the dollar has depreciated against the yen. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
89. Differences in real interest rates between countries produce the following type of capital flows: A. speculative capital flows. *B. investment capital flows. C. political capital flows. D. capital flight. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
90. If interest rates in Australia are high and Australian inflation is expected to be low: A. foreigners will not invest in Australia because of the uncertainty. *B. foreigners can expect to earn high real returns if they invest in Australia. C. foreigners can expect to earn low real returns if they invest in Australia. D. foreigners can expect to earn between high and low real returns if they invest in Australia. Feedback: A high interest rate (relative to other countries) coupled with low inflation will attract foreign investors. These investors will secure higher returns in Australia (due to the higher interest rates on offer). LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
91. The balance of payments financial account measures: A. any errors or omissions between a country’s current account and its long term trading account. B. both short term and long term capital flows into or out of the country. *C. long term capital flows into or out of the country. D. short term capital flows into or out of the country. Feedback: The balance of payments financial account measures capital flows into or out of the country. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
Module 3: Financial markets
92. Which of the following types of international capital flows can affect a currency’s exchange rate: A. political capital flows only and central banks’ foreign exchange market operations. *B. investment capital flows, political capital flows and central banks’ foreign exchange market operations. C. investment and political capital flows. D. investment capital flows only. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
93. To be admitted into the single currency community, a prospective EU member must meet: A. strict foreign exchange regulations. B. the European Central Bank directives. *C. strict fiscal and monetary qualifications. D. all of the above. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
94. The EU motivation for adopting a common currency is to: A. make member countries more competitive in global markets. B. to set a single monetary policy and interest rates for member countries. C. reduce the economic inefficiency caused by large fluctuations in foreign exchange rates. *D. both A and C. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
95. Which of the following is not a tool for managing foreign exchange risk? Feedback: Company-issued options cannot be used for managing foreign exchange risk, as can the other alternatives. A. Forward contracting. *B. Company-issued options. C. Futures contracts. D. Swaps. LO 3.6: Explain how the foreign exchange markets operate and facilitate international trade.
Module 4: The Reserve Bank of Australia and interest rates Multiple-choice questions 1. Which of the following is part of M1? A. Loans made by banks to the private nonbank sector. B. Bank term deposits held by the private nonbank sector. C. Bank saving deposits held by the private nonbank sector. *D. Bank current accounts held by the private nonbank sector. Feedback: M1 captures the transactional nature of money. It therefore includes the assets of the private nonbank sector that can easily be used as a means of payment, mainly current accounts in banks. Loans are assets for banks but liabilities for the private non-bank sector that borrows. As a consequence loans cannot be used as a means of payments (even though they are at the origin of the creation of deposits that are included in M1). Term deposits and savings cannot be directly used as means of payments and need to be transferred into the current account first; therefore they are store of value (savings for future consumption). LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
2. Which of the following is part of M1? *A. Bank current accounts held by the private nonbank sector. B. Accounts held by banks at the central bank. C. Loans made by banks to the private nonbank sector. D. Accounts held by the government at the central bank. Feedback: M1 captures the transactional nature of money. It therefore includes the assets of the private nonbank sector that can easily be used as a means of payment, mainly current accounts in banks. Loans are assets for banks but liabilities for the private non-bank sector that borrows. As a consequence loans cannot be used as a means of payments (even though they are at the origin of the creation of deposits that are included in M1). Accounts held by banks and government at the central bank are also used for transactions but they are NOT included in M1 or any larger measurement of the money supply because only means of payment of the private nonbank sector are considered for monetary aggregates. Instead accounts held by banks at the central bank are parts of the money base. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
3. _______________ is included as part of M1. *A. Currency held by nonbank businesses. B. Bank saving deposits held by nonbank businesses. C. Borrowing by nonbank businesses from banks. D. Bank term deposits held by nonbank businesses. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
Module 4: The Reserve Bank of Australia and interest rates
4. Which of the following is part of M1? A. Bank loans to the private nonbank sector. B. Interbank loans. C. Foreign currency held by the private nonbank sector. *D. Domestic currency held by the private nonbank sector. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
5. M1 includes: *A. Bank current accounts held by households. B. Bank saving deposits held by households. C. Bank term deposits held by households. D. Current accounts held by households in nonbank financial institutions. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
6. Which of the following does NOT belong to M1? A. Currency held by nonbank businesses. B. Currency held by households. C. Bank current accounts held by the private nonbank sector. *D. Bank saving accounts held by the private nonbank sector. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
7. Which of the following is included in M3? *A. Bank term deposits held by households. B. Bank saving deposits held by the government. C. Bank term deposits held by the government. D. Saving deposits held by households in nonbank financial institutions. Feedback: M3 captures both the transactional nature of money (like M1) and the store of value dimension of money (unlike M1). As a consequence M3 embeds M1 but also includes some financial assets that cannot be used for payment directly but are still easily convertible to M1, such as saving and term deposits. As for M1 the focus is on the assets of the private nonbank sector; that is the reason why the deposits owned by the government are not counted in M1 and in M3. Deposits held by households in nonbank financial institutions are part of Broad money but not M3. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
8. Which of the following is included in the money base? *A. Accounts held by the banks at the central bank. B. Accounts held by the government at the central bank. C. Bank term deposits held by the private nonbank sector. D. Bank current accounts held by the private nonbank sector. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
9. Broad money is: A. M3 plus borrowings by the private sector from non-bank financial institutions (NBFIs) less currency and bank deposits of NBFIs. *B. M3 plus borrowings from the private sector by non-bank financial institutions (NBFIs) less currency and bank deposits of NBFIs. C. M3 minus borrowings from the private sector by non-bank financial institutions (NBFIs) plus currency and bank deposits of NBFIs. D. M3 plus borrowings from the private sector by non-bank financial institutions (NBFIs) less currency and bank deposits held by the private sector. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
10. When the government provides social benefits to households: A. the currency held by banks increases. B. the money supply decreases. *C. the money supply increases. D. the currency held by banks decreases. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
11. The supply of ESF increases when: A. commercial banks pay back their loans to the central bank. B. the government sells foreign currencies to the private sector. *C. the government provides social benefits to Australian households. D. the government issues Treasury bonds that are bought by the private sector. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
Module 4: The Reserve Bank of Australia and interest rates
12. In order to reach its cash rate target, the Reserve Bank of Australia (RBA): *A. influences the supply of ESF. B. influences the demand for ESF. C. assists the government in its issuance of securities. D. imposes the interest rate on interbank overnight loans. LO 4.1: Explain how the Reserve Bank of Australia (RBA) measures the money supply.
13. A decrease in reserve requirements will definitely cause: A. an increase in the Fed Funds rate. B. inflation expectations to fall. *C. excess reserves to increase. D. expenditures to fall. Feedback: A decrease in reserve requirements increases excess reserves and increases the deposit expansion multiplier, which expands the money supply; reduces interest rates. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
14. The cash rate is the interest rate: A. on the balances of the ESAs. *B. on overnight interbank loans. C. on deposits at commercial banks. D. on the Reserve Bank of Australia (RBA) overnight provisions of ESF to commercial banks. Feedback: The cash rate (called federal funds rate in the US) is the overnight interbank interest rate, which is the interest rate on loans between banks. As banks make payments using ESF the loans among banks are also made with ESF. Thinking that the cash rate is the rate at which the RBA lends to commercial banks is a very common mistake sometimes found in the media. The rate at which the RBA lends to banks at the lending facility (called discount window in the US) is the cash rate target plus 25 basis points while the rate at which the RBA provides funds through repos, in its open market purchases, is the outcome of an auction. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
15. Which of the following statements is NOT correct? The cash rate A. is the result of the demand and supply of ESF. B. is the interest rate on overnight interbank loans. *C. is determined by a decree of the Reserve Bank of Australia (RBA). D. is used as a reference rate by banks for the determination of other interest rates. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
16. An increase in the supply of ESF: *A. decreases the cash rate. B. increases the cash rate. C. decreases the cash rate target. D. increases the cash rate target. Feedback: Although it is not drawn explicitly in the chapter all the reasoning about the cash rate resulting from the demand and supply of ESF relies on a diagram with the cash rate on the vertical axis and the quantity of ESF on the horizontal axis. The analysis is an analysis in stocks meaning that the supply of ESF is the existing stock of ESF as it can be observed and demand for ESF is the amount that banks would like to hold which may be different from what they actually have. The crucial properties are that the supply of ESF is a vertical line as the existing stock does not depend on the cash rate while the demand for ESF is decreasing in the cash rate as lending ESF to other banks is the alternative to keeping ESF in the ESA (the cash rate is an opportunity cost hence the negative relationship). A shift rightwards of the supply curve while the demand curve remains unchanged implies that the new intersection is for a higher quantity of ESF and for a lower cash rate. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
17. In order to reach its cash rate target, the Reserve Bank of Australia (RBA): A. lends to banks at the cash rate target. B. imposes the rate used by banks when they lend to each other. *C. brings the ESF supply to a level so that it intersects with the demand for ESF at the level of the cash rate target. D. brings the demand for ESF to a level so that it intersects with the supply of ESF at the level of the cash rate target. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
18. If the actions of the government bring the cash rate above the cash rate target, A. the RBA will sell securities from banks to make the cash rate decrease. *B. the RBA will buy securities from banks to make the cash rate decrease. C. the RBA will sell securities to banks to make the cash rate target increase. D. the RBA will buy securities from banks to make the cash rate target increase. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
Module 4: The Reserve Bank of Australia and interest rates
19. If the actions of the government bring the cash rate below the cash rate target, *A. the RBA will sell securities from banks to make the cash rate increase. B. the RBA will buy securities from banks to make the cash rate increase. C. the RBA will sell securities from banks to make the cash rate target decrease. D. the RBA will buy securities to banks to make the cash rate target decrease. Feedback: In this question the cash rate resulting from demand and supply of ESF would be spontaneously below the target announced by the RBA if the RBA did not intervene. The RBA needs to shift the supply curve to the left so that the new intersection with the manipulated supply is exactly located at the target. This reasoning is entirely dependent on the negative relationship that exists between the demand for ESF and the cash rate. The demand for ESF is decreasing in the cash rate as lending ESF to other banks is the alternative to keeping ESF in the ESA (the cash rate is an opportunity cost hence the negative relationship). When selling securities to banks the RBA make banks pay for the securities with the balances of their ESA and therefore makes the supply of ESF decrease. The money disappears from the system as the RBA cannot have an account with ESF as an asset as the RBA cannot hold its own liabilities! LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
20. Which of the following statements is NOT correct? In Australia open market operations are implemented: A. daily. B. through auctions. C. mainly through repos. *D. using exclusively Commonwealth government securities. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
21. Which of the following statements is not correct? When implementing Repos open market operations the Reserve Bank of Australia (RBA): *A. announces before the auction the interest rate that banks have to pay to acquire ESF. B. usually buys securities from banks with the commitment to resell them at an agreed later date. C. serves the banks with the best interest rates in their bids until the exhaustion of the amount of ESF it intended to inject in the banking sector. D. invites banks to bid to acquire ESF. Feedback: The interest rates paid by banks who win in the auction (those with an interest rate above the market clearing one where all ESF on offer are acquired) are the interest rates in their own bids. As a result winners may have to pay a different interest rate (discriminatory auction). The interest rates are the outcomes of the auction process and the bidding behaviour of banks and therefore cannot be announced before the auction. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
22. When making open market purchases the Reserve Bank of Australia (RBA) does not accept: A. ADI issued securities. B. State government securities. *C. Nonbank corporate securities. D. Commonwealth government securities (CGS). Feedback: Because historically Australia has not been running large government deficits the stock of Treasury securities (also called Commonwealth government securities CGS) is not sufficient to support open market operations. That is the reason why the RBA has widened the range of securities that are used for open market operations. The alternative securities are required to be with low risk hence the exclusion of corporate securities unless they have been issued by banks with high credit rating. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
23. When making open market purchases, the Reserve Bank of Australia (RBA) accepts: A. Shares. B. Nonbank corporate securities. C. Foreign government securities. *D. Commonwealth government securities. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
24. Monetarists believe that an increase in the money supply, all else equal, will cause: A. national income to fall. B. investment spending to fall. C. government expenditures to rise. *D. consumption expenditures to rise. LO 4.2: Explain how the RBA influences the level of interest rates in the economy.
25. Structural unemployment implies that: A. there is actually full employment. B. unemployed people are in transition between jobs. *C. people in search of work do not match the available jobs. D. only people who do not wish to work are unemployed. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
Module 4: The Reserve Bank of Australia and interest rates
26. Which of the following is not an aim for the Reserve Bank of Australia (RBA) stipulated in the Reserve Bank Act 1959? A. Full employment in Australia. B. Stability of the currency of Australia. *C. Equality of opportunity for the people of Australia. D. Economic prosperity and welfare of the people of Australia. Feedback: Equality of opportunity for the people of Australia is a social/political aim, not an economic aim. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
27. Which of the following is an official aim for the Reserve Bank of Australia (RBA) stipulated in the Reserve Bank Act 1959? A. Individual rights of the people of Australia. B. Equitable distribution of wealth in Australia. C. Equality of opportunity for the people of Australia. *D. Economic prosperity and welfare of the people of Australia. Feedback: All aims in the list except economic prosperity and welfare are social/political aims, not economic aims. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
28. Price stability implies that: A. the purchase power of a given amount of money significantly decreases. B. the purchase power of a given amount of money significantly increases. C. every price in the economy does not change or changes by a small percentage only. *D. the average price in the economy does not change or changes by a small percentage only. Feedback: Individual prices can go up or down depending on how successful they are in attracting demand provided that the average remains more or less the same. Price stability applies to an average of prices from goods and services in a selected basket reflecting the economy. Price stability means that there is no change in purchase power of a given amount of money. Of course if price stability is understood as being a small increase in price then there will be a negligible decrease in purchase power. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
29. Which of the following statements is not correct? Natural rate of unemployment is: A. the irreducible unemployment rate. B. the lowest rate of unemployment that can be reached. C. the unemployment rate that is tolerated by economic policy makers. *D. the unemployment rate capturing unemployed people that do not actually look for a job. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
30. In the short term, there are possible conflicts between the following monetary policy aims: A. Full employment versus economic prosperity. B. Stability of the currency versus low inflation. C. Economic prosperity versus economic welfare. *D. Full employment versus stability of the currency. Feedback: Economic prosperity goes hand in hand with employment as more economic activity requires more labour given that productivity gains take time. Low inflation is the condition for stability of the currency as it guarantees that the purchase power of money is maintained. Economic welfare is closely related to economic prosperity through the distribution of income generated by economic activity. The only potential conflict is between employment and stability of currency (i.e. stability of prices) at short term as captured by the Phillips curve. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
31. Unemployment should fall if: A. the money supply decreases. B. wages increase and people expect prices to rise. *C. wages increase and people expect prices to be stable. D. interest rates rise more than prices are expected to rise. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
32. The intended longer run goal of monetary policy is: A. to raise security prices. B. to lower interest rates. C. to reduce government spending. *D. to increase consumption and investment spending. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy. 33. The “tools” of monetary policy include all of the following except: A. open market operations. B. changing the discount rate. *C. changes in the government budget deficit. D. changes in reserve requirements. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
Module 4: The Reserve Bank of Australia and interest rates
34. Inflation is defined as: A. a one-time increase in prices. *B. a continuous increase in the average price level. C. changes in the relative prices of goods and services. D. the difference between the interest rate and the exchange rate. LO 4.3: Discuss the objectives of the RBA in conducting monetary policy.
35. An expansion in the Australian money supply: *A. will cause Australian exports to increase. B. will increase domestic interest rates C. will cause Australian imports to increase. D. will cause the exchange value of the dollar to increase. Feedback: When the Reserve Bank of Australia either increases the monetary base or reduces reserve requirements, depository institutions’ excess reserves increase. This expands the money supply while reducing interest rates. Reduction in interest rates decreases the value of the Australian dollar relative to the other currencies. This encourages exports to increase and discourages imports. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
36. Which of the following is not a consequence of a decrease in the cash rate target? a. A decrease in the interest rates in the Australian financial markets. b. An increase in the prices of fixed income securities. *c. An increase in the value of the Australian Dollar in foreign currencies. d. A decrease in the interest rates for financial products in the banking sector. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
37. Which of the following is NOT a consequence of a decrease in the cash rate target? *A. Imports increase. B. Exports increase. C. Consumption increases. D. Investment in housing increases. Feedback: The decrease in the cash rate propagates to the whole range of interest rates in banks products and in financial markets. Assuming that the interest rates overseas have not changed Australian financial instruments are now less attractive than the ones overseas due to a lower remuneration. Investors disinvest from Australia to invest overseas. They sell their Australian dollars to acquire foreign currencies needed to purchase the foreign securities. This weakens the value of the Australian dollar. Assuming that prices of goods and services have not changed, a weaker Australian dollar makes import prices more expensive when converted into Dollars therefore decreasing imports. Australian goods and services are now cheaper for foreign buyers and therefore the overseas demand for Australian products is increased, boosting Australian exports. With lower interest rates the cost of borrowing is smaller, encouraging mortgage loans for building new homes and personal loans for boosting consumption. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
38. Which of the following is not a consequence of a decrease in the cash rate target in an economy with unemployment and underused capital? A. Real GDP increases. *B. Net exports decrease. C. Business investment increases. D. Investment in housing increases. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
Module 4: The Reserve Bank of Australia and interest rates
39. Which of the following is NOT a consequence of a decrease in the cash rate target in an economy operating at full capacity? A. Inflation increases. *B. Real GDP increases. C. Consumption increases. D. Value of the dollar with respect to other currencies decreases. Feedback: The decrease in the cash rate propagates to the whole range of interest rates in banks products and in financial markets. Assuming that the interest rates overseas have not changed Australian financial instruments are now less attractive than the ones overseas due to a lower remuneration. Investors disinvest from Australia to invest overseas. They sell their Australian dollars to acquire foreign currencies needed to purchase the foreign securities. This weakens the value of the Australian dollar. Consumption increases due to the decrease in the borrowing costs. The increase in spending (consumption, investment, net exports) cannot be satisfied by an increase in production because there are no unused factors of production to add to the production process. This extra demand that cannot be satisfied creates pressure on the prices. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
40. A contraction in the Australian money supply should: A. cause Australian exports to increase. B. cause the exchange value of the Australian dollar to decrease. *C. increase domestic interest rates. D. all of the above. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
41. Monetary policies directed toward increased economic activity are likely to ________ the value of the domestic currency in relation to other currencies. A. have an ambiguous effect on. B. have no effect on. C. increase. *D. decrease. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
42. An increase in the money supply, all else equal, will cause: A. national income to fall. B. investment spending to fall. *C. consumption expenditures to rise. D. government expenditures to rise. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
43. Monetary policy is thought to affect the economy through: A. the business investment channel. B. the consumer spending channel. C. the net exports channel. *D. all of the above LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
44. Monetary policies directed toward increased economic growth may have what impact upon the value of the dollar in relation to other currencies? A. an unpredictable effect. B. no effect. *C. decrease. D. increase. LO 4.4: Explain how the RBA’s policies are transmitted through the economy and affect economic activity.
45. The price of borrowing money is called: A. return. *B. interest. C. inflation. D. all of the above. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
Module 4: The Reserve Bank of Australia and interest rates
46. The nominal rate of interest is: *A. the unadjusted return rate. B. the inflation adjusted cost rate. C. the inflation-adjusted return rate. D. a commodity cross-indexed return rate. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
47. At a basic level, the real rate of return can be justified by: A. compensation for the level of international borrowing. *B. compensation for deferring consumption. C. compensation for inflation. D. all of the above. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
48. If inflation is anticipated to be 5 per cent during the next year, while the real rate of interest for a one-year loan is 5 per cent, then what should the nominal rate of interest be for a risk-free one-year loan? A. 25 per cent. *B. 10 per cent. C. 5 per cent. D. none of the above. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
49. During an economic expansion, we would expect: A. interest rates to remain the same. B. the price of money to decrease. *C. interest rates to increase. D. interest rates to decrease. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
50. If the supply of loanable funds decreases relative to the demand for those funds, then we would expect: A. the price of money to remain unchanged. B. interest rates to decrease. *C. interest rates to increase. D. interest rates to remain unchanged. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
51. The allocative function of interest rates allocates between: A. between banks, non-banks institution and borrowers. B. banks and borrowers. *C. surplus spending units (SSUs) and deficit spending units (DSUs) and among financial markets. D. Both A and B. Feedback: For SSUs, the higher the rate of interest, the greater the reward for postponing current consumption and the greater the amount of saving in the economy. For DSUs, the higher the yield paid on a particular security, the greater the demand for that security (by SSUs) but the less willing they will be to supply the security. Therefore, SSUs want to buy financial claims with the highest returns whereas DSUs want to sell financial claims at the lowest possible interest rate. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
52. Which of the following factors influences the real rate of interest? A. the rate of inflation B. return on capital investments. C. investor's positive time preference. *D. both B and C. Feedback: The real rate of interest is determined at equilibrium between the demand for financing for productive real assets and the supply of savings. By definition it is the minimum rate of return necessary to offset the positive time preference for consumption in the absence of any transactional risk or expected change in purchasing power. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
Module 4: The Reserve Bank of Australia and interest rates
53. The _____________ is called the equilibrium rate of interest. A. market interest rate. B. nominal interest rate. *C. real rate of interest. D. bank lending rate. Feedback: It is called the ‘real’ rate of interest because it is determined by the real output of the economy. The real rate of interest, while not constant as assumed in some economic models, is estimated to be about 3 per cent on average, and varies because of changes in economic conditions, mostly between 2 per cent and 4 per cent. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
54. An increase in consumer saving caused by a tax cut in savings by the government would: A. increase wealth. B. increase spending. C. increase interest rate. *D. increase the supply of loanable funds and bring down interest rates. Feedback: As savings increase it will cause interest rates to decrease. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest. 55. The Consumer Price Index (CPI), used to calculate the ‘headline’ rate of inflation, is the most generally accepted measure of the: *A. price level. B. lending rate. C. real rate of interest. D. nominal interest rate. Feedback: various alternative measures that are designed to more accurately reflect the true inflation rate, called ‘underlying’, are also used in conjunction with the headline rate in matters of interest rate setting by the RBA Board in their monthly meetings. This is because it is argued that the headline rate often captures temporary or even one-off effects arising from unusual circumstances. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
56. If the actual rate of inflation is less than the rate expected during a period, A. both borrowers and lenders benefited. B. neither borrowers nor lenders benefited. C. borrowers benefited at the expense of lenders. *D. lenders benefited at the expense of borrowers. Feedback: If the actual rate of inflation is less than the rate expected during a period, then there would be an unintended transfer of purchasing power to the lenders from the borrowers. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
57. Which of the following statement is false? *A. The real rate of interest is the rate unadjusted for inflation. B. The nominal rate of interest is the rate of interest unadjusted for inflation. C. The real rate of interest is the interest rate that would exist in the absence of inflation. D. None of the above. Feedback: Real rate of interest is the interest rate that would exist in the absence of inflation and nominal rate of interest is unadjusted for inflation. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
58. Fluctuations in the real rate of interest occurs because of: A. monetary policies. B. changes in taxation system. C. technological changes. *D. all of the above. Feedback: In the supply and demand framework, any economic factor that causes a shift in desired lending or desired borrowing will cause a change in the equilibrium rate of interest. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
Module 4: The Reserve Bank of Australia and interest rates
59. Fisher’s equation states that: A. the nominal interest rate is equal to the real interest rate minus expected inflation rate. B. the nominal interest rate is equal to the real interest rate plus expected inflation rate. *C. the real interest rate is equal to the expected inflation rate plus nominal interest rate. D. the nominal interest rate is equal to real interest rate multiplied by the expected inflation rate. Feedback: The Fisher equation is: 1 + nominal interest rate = (1 + real interest rate) x (1 + expected annualised price level change) LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
60. The current 1-year Treasury rate is 10 per cent. It is predicted that the annual inflation rate is going to be 0.50 per cent higher than originally expected. The higher inflation forecasts reflect unexpectedly strong macroeconomic conditions. What is the current inflation premium? (Assume that the real rate of interest is 9.0 per cent.) A. 0.5%. *B. 1%. C. 1.5%. D. 11%. Feedback: You must first estimate the current inflation premium. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
61. The current 1-year Treasury rate is 10 per cent. It is predicted that the annual inflation rate is going to be 0.50 per cent higher than originally expected. The higher inflation forecasts reflect unexpectedly strong macroeconomic conditions. When the market opens tomorrow, what should the Treasury rate be? (Assume that the real rate of interest is 9.0 per cent.) A. 9%. B. 10%. *C. 10.5%. D. 11%. Feedback: You must first estimate the current inflation premium. You should then adjust this premium to reflect the expected beliefs. Finally, this revised inflation premium can be used in the Fisher equation to estimate what the Treasury rate will be tomorrow morning. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
62. The current 1-year Treasury rate is 10 per cent. It is predicted that the annual inflation rate is going to be 0.50 per cent lower than originally expected. The lower inflation forecasts reflect the unexpected drop in world prices. When the market opens tomorrow, what should the Treasury rate be? (Assume that the real rate of interest is 9.0 per cent.) *A. 9.5%. B. 10%. C. 10.5%. D. 11%. Feedback: You must first estimate the current inflation premium. You should then adjust this premium to reflect the expected beliefs. Finally, this revised inflation premium can be used in the Fisher equation to estimate what the Treasury rate will be tomorrow morning. LO 4.5: Explain how interest rates are determined and calculate the nominal and real rates of interest.
Module 5: Time value of money Multiple-choice questions 1. The time value of money refers to the issue of: *A. what the value of the stream of future cash flows is today. B. why a dollar received tomorrow is worth more than a dollar received today. C. why a dollar received tomorrow is worth the same as a dollar received today. D. None of the above. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
2. Which one of the following statements is not true? *A. A dollar received today is worth less than a dollar received tomorrow. B. A dollar received tomorrow is worth less than a dollar received today. C. A dollar received today is worth more than a dollar received tomorrow. D. The time value money refers to what the value of the stream of future cash flows is today. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
3. Which one of the following statements is not true? A. The further into the future you receive a dollar, the less it is worth today. *B. The further in the future you receive a dollar, the more it is worth today. C. The value of a dollar invested at a positive interest rate grows over time. D. A dollar in the hand today is worth more than a dollar to be received in the future. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
4. Future value measures: A. what one or more cash flows that is to be received in the future will be worth today. *B. what one or more cash flows are worth at the end of a specified period. C. both A and B. D. none of the above. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
Module 5: Time value of money
5. Which one of the following statements is true? A. The time of consumption is irrelevant to individuals. *B. Individuals prefer to consume goods right away rather than in the future. C. Individuals prefer to consume goods in the future rather than right away. D. None of the above. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
6. The time value of money is the concept that a dollar is worth: A. more the later it is paid. B. more the later it is received. *C. more the sooner it is received. D. less the sooner it is received. Feedback: A dollar is worth more the sooner it is received because it can bring interest for a longer period. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
7. According to the concept of time value of money, a dollar is worth more the sooner it is received because: A. the probability to be alive decreases with time. B. it loses purchase power with time. *C. it can earn a return. D. it can be destroyed with time. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
8. If Frank is indifferent between receiving $1,000 today and $1,100 in one year, his opportunity cost must be close to: A. 110%. B. 100%. C. 1.10%. *D. 10%. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
9. Which one of the following is/are an example(s) of an opportunity cost? A. Spending time caring for an elder in your family instead of working. B. Using a piece of land that you owned to build a house. C. Quitting your job to go to university. *D. All of the above are examples of opportunity costs. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
10. The present value is always ______ the future value if the opportunity cost is ______ zero. A. equal to; equal to. B. greater than; less than. C. less than; greater than. *D. All of the above are true. LO 5.1: Explain what the time value of money is and why it is so important in the field of finance.
11. The process of converting an amount given at the present time into a future value is called: *A. compounding. B. discounting. C. time value of money. D. None of the above. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
12. __________ is the process of converting future cash flows to what its present value is. *A. discounting. B. compounding. C. time value of money. D. none of the above. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
Module 5: Time value of money
13. Using higher interest rates will: A. decrease the future value of any investment. B. not affect the future value of the investment. *C. increase the future value of any investment. D. None of the above. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
14. Using lower interest rates will: A. not affect an investment’s future value. B. increase an investment’s future value. *C. decrease an investment’s future value. D. none of the above. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
15. You are interested in investing $10,000, a gift from your grandparents, for the next four years in a managed fund that will earn an annual return of 8 percent. What will your investment be worth at the end of four years? (Round to the nearest dollar.) A. $10,800. B. $12,400. C. $13,200. *D. $13,605. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions. 16. Lilian French is planning to buy a house in five years’ time. She is looking to invest $25,000 today in an index managed fund that will provide her a return of 12 percent annually. How much will she have at the end of five years? (Round to the nearest dollar.) A. $39,338. B. $40,000. *C. $44,059. D. $45,000. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
17. Michael Williams would like to buy an apartment in Melbourne in six years’ time. He is looking to invest $75,000 today in a share that is expected to earn a return of 18.3 percent annually. How much will he have at the end of six years? (Round to the nearest dollar.) A. $157,350. B. $173,774. C. $184,681. *D. $205,575. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions. 18. Linda Willis is looking to invest for retirement, which she hopes will be in 20 years’ time. She is looking to invest $22,500 today in an Australian fixed interest mutual fund that will earn interest at 6.25 percent annually. How much will she have at the end of 20 years? (Round to the nearest dollar.) A. $50,625. B. $68,870. C. $71,192. *D. $75,642. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
19. Your cousin has asked you to help him with choosing an investment. He has $5,000 to invest today for a period of two years. You identify a bank term deposit that pays an interest rate of 4.25 percent with the interest being paid quarterly. What will be the value of the investment in two years’ time? A. $5,107. B. $5,216. C. $5,434. *D. $5,441. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
Module 5: Time value of money
20. Just Fabrics had a cash inflow of $1 million, which it needs for a long-term investment at the end of one year. It plans to invest this money in a bank term deposit that pays daily interest at 3.75 percent. What will be the value of the investment at the end of the year? (Round to the nearest dollar.) A. $1,000,103. B. $1,037,500. *C. $1,038,210. D. $1,211,375. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
21. Your aunt is trying to choose one of the following bank term deposits to invest $10,000. Which one will have the highest future value if she plans to invest for three years? A. 3.25% compounded monthly. B. 3.4% compounded quarterly. *C. 3.5% compounded daily. D. 3.75% compounded annually. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
22. Georgina Johnson wants to invest $3,500 today in a money market fund that pays quarterly interest at 5.5 percent. She plans to fund a scholarship with the proceeds at Sunshine Coast University. How much will Georgina have at the end of seven years? (Round to the nearest dollar.) A. $3,548. *B. $5,130. C. $5,075. D. $5,091. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
23. Adrian started on his first job last year and plans to save for a down payment on a unit in 10 years’ time. He will be able to invest $12,000 today in a money market account that will pay him an interest of 6.25 percent on a monthly basis. How much will he have at the end of 10 years? A. $24,839. B. $12,640. *C. $22,383. D. None of the above. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
24. Noah Cyrus is investing $5,000 in an account paying 6.75 percent per annum. How much interest-on-interest will he have earned after three years, if interest is compounded annually? *A. $69.88. B. $82.38. C. $1,012.50. D. $1,082.38. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
25. Simple interest means that the interest is: A. paid only once. *B. calculated with respect to the original amount lent. C. paid at the beginning of the loan. D. calculated with respect to the original amount lent plus the interest already paid. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
Module 5: Time value of money
26. If you invest $20,000 today for five years at 8% per annum compounded quarterly how much will you have at the end of five years? A. $22,081.62. B. $28,000. C. $29,680.55. *D. $29,718.95. Feedback: $20,000 (1.02)20 = $29,718.95. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
27. The interest earned on both the original investment and the accumulated interest, over time is called: A. simple interest. B. growth rate. C. cost of capital. *D. compound interest. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
28. Lois has deposited $2,000 in an investment account that pays 5% compounded continuously. How much will she have in her account in two years? A. $1,809.67. B. $2,105.54. *C. $2,210.34. D. $2,205.00. Feedback: $2,000 x e05 x 2 = $2,210.34. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
29. Alexander will receive $25,000 in 3 years. His opportunity cost is 8% compounded continuously. The present value of this cash flow is closest to: *A. $19,665.70. B. $19,845.81. C. $31,492.80. D. $31,781.23. Feedback: $25,000 x e-.08 x 3 = $19,665.70 LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
30. You borrow $20,000 to be repaid in a lump sum five years from now. The interest rate is 7.2% per annum, payable quarterly. How much interest will you pay over the term of the loan? A. $3,993.09. B. $4,519.82. *C. $7,200.00. D. $8,574.96. Feedback: The interest payment each quarter is $20,000 (7.2% 4) = $360. There are 20 quarters in five years. Total interest paid will be $360 20 = $7,200. As we use simple interest, we can directly compute the total interest with the equation Pin = $20,000 0.018 20 = $7,200. b) is the case where the interest is paid at the end and compounding is quarterly. LO 5.2: Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions.
31. As interest rates fall, present values: A. decrease. *B. increase. C. cannot be determined; need compounding frequency. D. stay the same. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
Module 5: Time value of money
32. Using higher discount rates will: *A. decrease the present value of any future cash flow. B. not affect the present value of the future cash flow. C. increase the present value of any future cash flow. D. None of the above. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
33. Nicky Scarfe is considering an investment that pays 6.5 percent annually. How much must he invest today such that he will have $25,000 in seven years’ time? (Round to the nearest dollar.) *A. $16,088. B. $17,133. C. $23,474. D. $38,850. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions. 34. Jack Daniels is saving for a new car. He needs to have $ 21,000 for the car in three years’ time. How much will he have to invest today in an account paying 8 percent annually to achieve his target? (Round to nearest dollar.) *A. $16,670. B. $16,935. C. $19,444. D. $26,454. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
35. Damien's friend, John, is asking to borrow today with a promise to repay $7,418.87 in four years’ time. If Damien could earn 5.45 percent annually on the any investment he makes today, how much would he be willing to lend John today? (Round to nearest dollar.) *A. $6,000. B. $6,500. C. $7,035. D. $7,150. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
36. Rebecca Simpson wants to buy a house in six years’ time. She hopes to be able to put down $25,000 deposit at that time. If the bank term deposit she wants to invest in will pay 7.5 percent annually, how much will she have to invest today? (Round to the nearest dollar.) A. $13,987. *B. $16,199. C. $18,472. D. $23,256. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions. 37. Chung wants to start a business in 10 years’ time. He hopes to have $100,000 at that time to invest in the business. To reach his goal, he plans to invest a certain amount today in a bank term deposit that will pay him 9.5 percent annually. How much will he have to invest today to achieve his target? (Round to the nearest dollar.) A. $91,324. B. $63,837. C. $54,233. *D. $40,351. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions. 38. Daiki plans to invest some money today so that he will receive $7,500 in three years’ time. If the investment he is considering will pay 3.65 percent compounded daily, how much will he have to invest today? A. $7,140. *B. $6,722. C. $5,276. D. $6,897. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
Module 5: Time value of money
39. You need to have $15,000 in five years’ time to pay-off a home equity loan. You can invest in an account that pays 5.75 percent compounded quarterly. How much will you have to invest today to attain your target in five years? (Round to the nearest dollar.) a. $4,903. *b. $11,275. d. $12,250. c. $14,184. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions. 40. Keung wants to go on a cruise in three years’ time. He could earn 8.2 percent compounded monthly in an account if he were to deposit the money today. He needs to have $10,000 in three years’ time. How much will he have to deposit today? (Round to the nearest dollar.) A. $6,432. B. $7,763. *C. $7,826. D. $8,148. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
41. Using lower discount rates will: *A. increase the present value of any future cash flow. B. decrease the present value of any future cash flow. C. not affect the present value of the future cash flow. D. none of the above. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions. 42. Your father promises to give you $10,000 in 10 years’ time for your 25th birthday. If interest rates are 12% per annum, how much is that gift worth today? A. $1,000. *B. $3,220. C. $6,700. D. $9,000. Feedback: PV = $10,000 x (1+0.12)-10 = $10,000 x 0.3220 = $3,220 LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
43. What sum would you have to receive in 5 years’ time to make you indifferent between that sum and $1,000 in 10 years’ time? Assuming that the interest rate is 10% p.a. A. $500. *B. $621. C. $645. D. $710. Feedback: Have to find the PV of the $1,000 to be received in 10 years' time at Year 5 using the PV of a single sum formula PV = FV (1 + r)-n PV5 = $1,000 (1 + 0.10)-5 PV5 = $1,000 (0.6209) PV5 = $620.92 ≈ $621. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
44. What is the present value of $10,000 to be received in 5 years if the discount rate is 10% and compounding frequency is annual? A. $5,000.00. *B. $6,209.21. C. $6,666.67. D. $16,105.10. Feedback: $10,000/(1.1)5 = $6,209.21. LO 5.3: Explain the concept of present value and how it relates to future value, and use the present value formula to make business decisions.
45. Your tuition for the coming year is due today. You borrow $8,000 from your brother and agree to repay $9,250 in three years’ time. What is the interest rate on this loan? Round to the nearest per cent. *A. 5%. B. 6%. C. 7%. D. 8%. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
Module 5: Time value of money
46. Shen has $5,000 to invest in a small business venture. His partner has promised to pay him back $8,200 in five years’ time. What is the return earned on this investment? A. 8.7%. B. 9.3%. *C. 10.4%. D. 11.1%. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
47. Susan wants to invest $25,000 in a spa that her sister is starting. She will triple her investment in six years. What is the rate of return that Susan is being promised? (Rounded to the nearest per cent.) A. 12%. B. 18%. *C. 20%. D. 25%. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
48. Zhen has $3,000 to invest for three years. He wants to receive $5,000 at the end of the three years. What invest rate would his investment have to earn to achieve his goal? (Round to the nearest percent.) A. 13%. B. 16%. *C. 19%. D. 21%. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
49. Your brother is looking to double his investment of $10,000. He claims he can get earn 14 percent on his investment. How long will it be before he can double his investment? Round to the nearest year. *A. 5 years. B. 7 years. C. 10 years. D. 14 years. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
50. Chic Creators have generated sales of $625,000 for the current year. If they can grow their sales at a rate of 12 percent every year, how long will they take to triple their sales? (Round off to the nearest year.) A. 7 years. B. 8 years. C. 9 years. *D. 10 years. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
51. Asian Foods announced that its sales were $1,233,450 this year. The company forecasts a growth rate of 16 percent for the foreseeable future. How long will it take the company to produce earnings of $3 million? (Round off to the nearest year.) *A. 6 years. B. 7 years. C. 8 years. D. 10 years. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
52. Hunter James wants to deposit $4,500 in a bank account that pays 8.25 percent annually. How many years will it take for his investment to grow to $10,000? (Round off to the nearest year.) A. 8 years. *B. 10 years. C. 11 years. D. 12 years. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
53. Lilly wants to invest in a bank term deposit that will pay her 7.8 percent annually. If she is investing $11,500 today, when will she reach her goal of $15,000? (Round off to the nearest year.) A. 2 years. *B. 4 years. C. 5 years. D. 7 years. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
Module 5: Time value of money
54. You currently have $100 available to invest for a 21 year period. At what interest rate must you invest this amount in order for it to be worth $500 at maturity? A. 5%. B. 6.12%. *C. 7.97%. D. 10%. Feedback: r can be solved by one of two ways: Take the nth root of both sides of the equation: Use a financial calculator; Take the nth root of both sides of the equation 100 x(1+r)21 = 500 (1+r)21 = 500/100 = 5 (1+r)21 x 1/21 = 5 1/21 1+r = 1.0797 r = 7.97% LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
55. If I receive $49,199.33 from issuing a 90 day commercial bill of $50,000, what was its discount rate (assuming no fees)? A. 1.60%. B. 1.63%. *C. 6.49%. D. 6.51%. Feedback: [$50,000 − $49,199.33)/$50,000] 365/90 = 6.49%. LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
56. Sagar bought a house for $120,000 five years ago. He has just sold it for $180,000. What annual rate of return did he earn on this investment? A. 1.08%. B. 3.13%. *C. 8.45%. D. 10%. 180,000
Feedback: r = ( 120,000 )1/5 – 1 = 8.45% LO 5.4: Discuss how the future value formula can be used to make business decisions when the interest rate or number of periods is unknown.
Module 6: Discounted cash flows and valuation Multiple-choice questions 1. Suppose you put in $500 in a savings account today, another $400 in 1 years’ time. The interest rate on the savings account is 6%. How much money will you have in the savings account at the end of 2 years? A. $954.00. *B. $985.80. C. $1,484.00. D. None of the above. Not enough information has been provided. Feedback: Using the techniques from Topic 5 and keeping in mind that the initial $500 has been invested for 2 years and the $400 for only a year, we need to calculate the future values of these investments. The answer is $985.80 LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows. 2. Suppose you put in $500 in a savings account today, another $400 in 1 years’ time and $500 in 3 years’ time. The interest rate on the savings account is 6%. How much money will you have in the savings account at the end of 4 years? A. $2,268.88. B. $2,131.92. *C. $1,637.55. D. None of the above. Not enough information has been provided. Feedback: The same technique as Question 1 is being used. Students need to keep in mind that the initial $500 is being invested for 4 years, the $400 for 3 years and the other $500 for only a year. The final answer is $1,637.55. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
Module 6: Discounted cash flows and valuation
3. Suppose James wants to buy a car in 3 years’ time and estimates that he will need $25,000. The interest rate that he can earn from a savings account is 6% per annum. If James can put in $7,000 today, $6,000 in one year’s time and $5,000 in 2 years’ time, how much will he have to come up with at the end of the third year to buy his car? A. He does not require more money as the total amount earned from the savings account at the end of 3 years will be enough. *B. $4,621.29. C. $20,378.71. D. None of the above. Not enough information has been provided. Feedback: Once more, the same technique as the previous two questions is used. In this particular question, students need to calculate the total face value of the savings over three years and minus it from the cost of the car at the end of 3 years. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
4. An investment paying $1,000 in 1 year, $2,000 in 2 years and $7,000 in 3 years returning 10% per annum has a present value of: A. $6,002.54. B. $7,210.20. *C. $7,821.19. D. $8,129.39. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
5. An investment paying $2,000 in 2 years, $6,000 in 4 years and $5,000 in 12 years at an interest rate of 5% per annum has a present value of: A. $6,505.29. B. $7,354.21. *C. $9,534.46. D. $12,090.49. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
6. At an interest rate of 15% per annum, cash flows of $1,000 today, $2,000 in 1 year and $6,000 in 2 years have a future value in 2 years of: A. $10,200.46. B. $9,709.37. C. $8,700.00. *D. $9,622.50. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
7. At an interest rate of 12.5% per annum, cash flows of $2,000 in 2 years, $12,000 in 7 years and $8,000 in 20 years have a future value in 20 years of: A. $70,994.74. B. $71,593.52. C. $73,730.20. *D. $80,147.38. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
8. At an interest rate of 7% per annum, cash flows of $1,000 in 5 years and $50,000 in 20 years have a future value in 60 years of: A. *B. C. D.
$759,002.73. $790,037.89. $791,355.91. $799,838.49.
LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
9. Cash flows of $5,000 in 2 years and $7,000 in 4 years with a present value of $10,594.32 in 1 year are being discounted at an interest rate of: A. 8% per annum. *B. 6% per annum. C. 7% per annum. D. 5% per annum. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
Module 6: Discounted cash flows and valuation
10. Which one of the following steps is not involved in solving future value problems? A. First, draw a time line to make sure that each cash flow is placed in the correct time period. *B. Second, discount each cash flow for its time period. C. Third, add up all the future values. D. All of the above are necessary steps. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
11. Which one of the following steps is not involved in solving present value problems? A. First, draw a time line to make sure that each cash flow is placed in the correct time period. *B. Second, compound each cash flow for its time period. C. Third, add up all the present values. D. All of the above are necessary steps. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
12. The present value of multiple cash flows is: *A. less than the sum of the cash flows. B. greater than the sum of the cash flows. C. equal to the sum of all the cash flows. D. none of the above. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
13. Global Shipping Ltd, have forecast earnings of $1,233,400, $1,345,900, and $1,455,650 for the next three years. What is the future value of these earnings if the firm's opportunity cost is 13 per cent? (Round to the nearest dollar.) A. $3,900,865. B. $4,214,360. *C. $4,551,446. D. $4,875,212. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
14. Skylight Ltd has borrowed from their bank at a rate of 8 per cent and will repay the loan with interest over the next five years. Their scheduled payments, starting at the end of the year are as follows: $450,000, $560,000, $750,000, $875,000, and $1,000,000. How much did Skylight borrow? (Round to the nearest dollar.) A. $2,431,224. B. $2,615,432. C. $2,735,200. *D. $2,815,885. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
15. Sheetal has made an investment that will pay her $11,455, $16,376, and $19,812 at the end of the next three years. Her investment was to earn her a return of 14 per cent. How much did she invest? (Round to the nearest dollar.) A. $33,124. *B. $36,022. C. $39,208. D. $41,675. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
16. Angela is expecting cash flows of $50,000, $75,000, $125,000, and $250,000 from an inheritance over the next four years. If she can earn 11 per cent on any investment that she makes, what is the present value of her inheritance? (Round to the nearest dollar.) A. $309,432. *B. $361,998. C. $412,372. D. $434,599. LO 6.1: Explain why cash flows occurring at different times must be adjusted to reflect their value at a common date before they can be compared, and calculate the present value and future value for multiple cash flows.
Module 6: Discounted cash flows and valuation
17. Suppose you open an account into which you deposit $200 semi-annually for 10 years. If the account pays 13% compounded semi-annually, how much will be in the account at the end of the 10 year period? A. $2,698.88. *B. $7,765.06. C. $16,189.37. D. None of the above. Feedback: The account pays semi-annually compounding interest. As such, the n and i values in the future value of annuity formula need to be altered accordingly. Students should end up with $ 7765.06 as their final answer. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
18. If I invest $100 per month for two years at 6% per annum compounded monthly, how much will I have after four years? A. $2,543.20. B. $2,777.54. *C. $2,866.59. D. $5,409.78. Feedback: $100 {[(1.005)24 − 1]/0.005} (1.005)24 = $100 25.431955 1.12716 = $2866.59. a) is the future value of the annuity after 2 years. b) is the future value of an annuity where the $100 is invested for 4 years. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
19. What is the present value of an annuity due of $1,000 per month for 20 years discounted at 9% per annum (assuming monthly compounding)? A. $9,950.11. B. $109,978.54. C. $111,144.95. *D. $111,978.54. Feedback: $1,000 {[1 − (1.0075)−239]/0.0075 + 1} = $1,000 111.9785412 = $111,978.54. A is with annual compounding. B is by subtracting 1 instead of adding 1. C is for an ordinary annuity. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
20. What is the present value of an ordinary annuity of $200 per month for two years, discounted at 6% per annum? (Assume monthly compounding) *A. $ 4,512.57. B. $ 4,535.14. C. $4,800.00. D. $5,086.39. Feedback: $200 {[1 − (1.005)-24]/0.005} = $4512.57. B is the present value of an annuity due. C is the sum of all payments. D is the future value of the ordinary annuity. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
21. A philanthropist wishes to endow a scholarship of $10,000 per year for the next 20 years. The scholarship will be paid out of a trust fund at the end of each year, with the first payment occurring one year from now. How much would the philanthropist need to donate to the trust fund today if it is expected to earn 9% per annum? *A. $91,285.46. B. $93,315.45. C. $99,501.15. D. $200,000.00. Feedback: We need to compute the PV of an ordinary annuity: $10,000 {[1 − (1.09)20 ]/0.09} = $10,000 9.128546 = $91,285.46. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
22. The future value of an ordinary annuity paying $1,000 for 20 years at an interest rate of 7% per annum is: A. $10,594.01. B. $38,992.10. *C. $40,995.49. D. $42,300.74. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
Module 6: Discounted cash flows and valuation
23. The future value of an ordinary annuity paying $3,600 annually for 7 years at an interest rate of 12% per annum compounded annually is: A. $35,600.20. *B. $36,320.44. C. $37,826.98. D. $38,900.29. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
24. The present value of an ordinary annuity paying $100 for 12 years at an interest rate of 9.25% per annum is: *A. $707.14. B. $829.61. C. $843.05. D. $856.39. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
25. The present value of an ordinary annuity paying $5,000 annually for 6 years at an interest rate of 5.75% per annum compounded yearly is: *A. $24,780.93. B. $25,005.58. C. $26,205.84. D. $30,000.00. Feedback: C is the present value of the annuity due. D is the sum of the payments. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
26. If your investment pays the same amount at the end of each year for a period of six years, the cash flow stream is called: A. an annuity due. *B. an ordinary annuity. C. a perpetuity. D. a deferred annuity. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
27. If your investment pays the same amount at the beginning of each year for a period of 10 years, the cash flow stream is called: *A. an annuity due. B. an ordinary annuity. C. a perpetuity. D. a deferred annuity. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
28. Your inheritance will pay you $100,000 a year for five years beginning now. You can invest it in a bank account that will pay 7.75 per cent annually. What is the present value of your inheritance? (Round to the nearest dollar.) A. $401,916. B. $399,356. *C. $433,064. D. $467,812. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
29. Fraser is investing $2,500 today and will do so at the beginning of another six years for a total of seven payments. His investment can earn 12 per cent per year. How much will Jenny have at the end of seven years? (Round to the nearest dollar.) *A. $28,249. B. $29,460. C. $31,127. D. $25,223. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
30. Cash flows associated with annuities are considered to be: A. a mix of constant and uneven cash flow streams. B. an uneven cash flow stream. *C. a constant cash flow stream. D. none of the above. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
Module 6: Discounted cash flows and valuation
31. The annuity transformation method is used to transform: A. a perpetuity to an annuity. *B. an ordinary annuity to an annuity due. C. a present value annuity to a future value annuity. D. a present value annuity to a future value annuity. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
32. Motorways Ltd has made an investment in another company that will guarantee it a cash flow of $37,250 each year for the next five years. If the company uses a discount rate of 15 per cent on its investments, what is the present value of this investment? (Round to the nearest dollar.) A. $124,868. B. $101,766. C. $186,250. *D. $251,154. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
33. Coles Ltd, will be making annual lease payments of $3,895.50 for a 10-year period, starting at the end of this year. If the firm uses a 9 per cent discount rate, what is the present value of this annuity? (Round to the nearest dollar.) A. $20,000. B. $23,250. *C. $25,000. D. $29,000. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
34. Isabelle Johnson won a lottery. She will have a choice of receiving $25,000 at the end of each year for the next 30 years, or a lump sum today. If she can earn a return of 10 per cent on any investment she makes, what is the minimum amount she should be willing to accept today as a lump-sum payment? (Round to the nearest hundred dollars.) A. $212,400. *B. $235,700. C. $334,600. D. $750,000. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
35. You plan to save $1,250 at the end of each of the next three years to pay for a vacation. If you can invest it at 7 per cent, how much will you have at the end of three years? (Round to the nearest dollar.) A. $4,589. B. $3,918. *C. $4,019. D. $3,750. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
36. Julia is saving to buy a new car in four years. She will save $5,500 at the end of each of the next four years. If she invests her savings at 6.75 per cent, how much will she have after four years? (Round to the nearest dollar.) A. $23,345. B. $22,000. *C. $24,329. D. $27,556. LO 6.2: Describe how to calculate the present value and future value of an ordinary annuity, and how an ordinary annuity differs from an annuity due.
Module 6: Discounted cash flows and valuation
37. If the actual rate of inflation is less than the rate expected during a period, A. both borrowers and lenders benefited. B. neither borrowers nor lenders benefited. C. borrowers benefited at the expense of lenders. *D. lenders benefited at the expense of borrowers. Feedback: If the actual rate of inflation is less than the rate expected during a period, then there would be an unintended transfer of purchasing power to the lenders from the borrowers. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
38. What is the present value of a preference share that is expected to pay a dividend of 12 cents per year in a perpetuity if the discount rate is 7.5% per annum? A. $0.625. *B. $1.60. C. $1.72. D. $2.72. Feedback: $0.12/0.075 = $1.60. A has wrongly inverted the numerator and the denominator. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
39. If your investment pays the same amount at the end of each year forever, the cash flow stream is called: A. a growing perpetuity. *B. a perpetuity. C. an ordinary annuity. D. an annuity due. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
40. Your uncle is 60 years old and wants to set up a cash flow stream that will last forever. He would like to receive $20,000 every year, beginning at the end of this year. If he could invest in an account earning 9 per cent, how much would he have to invest today to receive his perpetual cash flow? (Round to the nearest dollar.) A. $189,000. B. $200,000. *C. $222,222. D. $235,200. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
41. Mathew Williamson wants to set up a scholarship at his local university. He is willing to invest $500,000 in an account earning 10 per cent. What will be the annual scholarship that can be given from this investment? (Round to the nearest dollar.) A. $5,000. *B. $50,000. C. $500,000. D. None of the above. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
42. Nadeen has funded a retirement investment with $250,000 earning a return of 5.75 per cent. What is the value of the payment that she can receive in a perpetuity? (Round to the nearest dollar.) A. $12,150. *B. $14,375. C. $14,900. D. $15,250. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
43. Richard wants to receive $25,000 in a perpetuity and will invest his money in an investment that will earn a return of 13.5 per cent annually. What is the value of the investment that he needs to make today to receive his perpetual cash flow stream? (Round to the nearest dollar.) A. $144,350. *B. $185,185. C. $252,325. D. $640,225. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
Module 6: Discounted cash flows and valuation
44. Geelong Financial Services Company offers a perpetuity of $50,000 per year with the first payment on January 1 next year. If your opportunity costs are constant over time, the price you are willing to pay for this perpetuity _________ over time. *A. stays the same. B. decreases. C. increases. D. can’t determine without the opportunity cost. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
45. Toowoomba Financial Services Company offers a perpetuity of $5,000 per year with the first payment in one year. If your opportunity cost is 8% compounded annually, the present value of the perpetuity today is: A. $125,000. B. $57,500. *C. $62,500. D. $67,500. Feedback: $5,000 /.08 = $62,500. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
46. Townsville Financial Services Company offers a perpetuity of $5,000 per year with the first payment immediately. If your opportunity cost is 8% compounded annually, the present value of the perpetuity today is: A. $57,500. B. $62,500. *C. $67,500. D. $125,000. Feedback: ($5,000 /0.08) + $5,000 = $67,500 LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
47. A pension fund pays out $50,000 a year in a perpetuity, based on a cost of capital of 5%, to retiring employees. Alternatively, the employee can take out a lump sum of $1 million payable immediately. The employee should choose: A. the lump sum, because it is available now. B. the pension fund, because its present value is $1.25 million. C. the pension fund, because it offers steady payments in a perpetuity. *D. indifferent as both options give the same value over time. Feedback: PV of fund = $50,000/0.05 = $1,000,000, so same value for either option LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities.
48. A lottery winner was given a perpetual payment of $11,444. She could invest the cash flows at 7 per cent. What is the present value of this perpetuity? (Round to the nearest dollar.) A. $201,356. *B. $163,486. C. $191,708. D. $112,344. LO 6.3: Explain what perpetuities are and where we see them in business, and calculate the present values of perpetuities. 49. Let’s suppose that you have purchased a house in Gladstone for $350,000 and you were able to provide $3,000 in deposit and successfully secured a 20 year home loan at 7% for the remaining balance. What are your monthly payments? A. $1,837.50. *B. $2,442.19. C. $22,050.00. D. $29,306.30. Feedback: We need to keep in mind, that the question asked monthly payments, so the Present value factor calculation has to be altered accordingly (n and i in the formula). Then, we need to calculate the PV annuity factor and finally the monthly payments. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
Module 6: Discounted cash flows and valuation
50. A 10% five-year ordinary annuity with a future value of $2,564.14 makes annual payments of: A. $370. B. $400. *C. $420. D. $700. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
51. A 7% per annum 10-year ordinary annuity with monthly compounding and a future value of $346,169.61 makes monthly payments of: A. $2,500. B. $1,500. *C. $2,000. D. $1,000. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
52. Which one of the following statements is true about amortisation? A. With an amortised loan, a bigger proportion of each month's payment goes toward interest in the later periods. B. With an amortised loan, a smaller proportion of each month's payment goes toward interest in the early periods. *C. With an amortised loan, a bigger proportion of each month's payment goes toward interest in the early periods. D. None of the above. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule. 53. Zelma needs to have $25,000 in five years’ time. If she can earn 8 per cent on any investment, what is the amount that she will have to invest every year for the next five years? (Round to the nearest dollar.) *A. $4,261. B. $4,445. C. $4,640. D. $5,000. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
54. Susanna wants to save for a trip to Australia. She will need $12,000 at the end of four years. How much will she have to invest annually at the beginning of each of the next four years to reach her target? Assume her bank account will earn 6.8 per cent annually. (Round to the nearest dollar.) *A. $2,538. B. $2,711. C. $2,980. D. $3,000. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
55. Lucke Plumbing has borrowed $27,850 from its bank at an annual rate of 8.5 per cent. It plans to repay the loan in eight equal instalments, beginning at the end of next year. What is its annual loan payment? (Round to the nearest dollar.) A. $4,708. B. $4,748. *C. $4,939. D. $5,134. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
56. Duong wants to have a million dollars at retirement, which is 15 years away. He already has $200,000 in an investment account earning 8 per cent annually. How much does he need to save each year, beginning at the end of this year to reach his target? Assume he could earn 8 per cent on any investment he makes. (Round to the nearest dollar.) A. $10,900. *B. $13,464. C. $14,273. D. $16,110. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
Module 6: Discounted cash flows and valuation
57. Nguyen has obtained a $250,000 mortgage. The mortgage is amortised over 25 years and the term of the mortgage is 25 years. The mortgage interest rate is 9% compounded annually. Nguyen will begin making annual payments of $25,451.56 at the end of the year. What is the principal outstanding immediately after Nguyen makes his third payment? A. $50,903.12. *B. $240,324.46. C. $173,645.32. D. $185,574.60. Feedback: PV of 22 remaining payments = $240,324.4577. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
58. Phuong has obtained a $250,000 mortgage. The mortgage is amortised over 25 years and the term of the mortgage is 25 years. The mortgage interest rate is 9% compounded annually. Phuong will begin making annual payments of $25,451.56 at the end of the year. How much of Phuong’s third payment is interest? A. $2,290.64. B. $18,470.51. *C. $21,944.81. D. $22,500.00. Feedback: 0.09 x PV of 23 payments = 0.09 x $243,831.2089 = $21,944.81. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
59. You borrow $50,000 on a line of credit to finance your start-up company, to be repaid in three equal, annual payments with 10% interest. Approximately how much of the principal is paid off on the first payment? A. $5,000.00. *B. $15,105.74. C. $16,666.67. D. $20,105.74. Feedback: PV = $50,000, I/Y = 10%, n = 3 →PMT = $20,105.74; interest paid in 1st year is $50,000 *0.1 = $5,000, so principal paid in 1st year is: $20,105.74 – $5,000 = $15,105.74. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
60. A lakefront cottage is selling at $100,000, with a $25,000 deposit, and the remainder mortgaged at 12 % per annum, to be amortised over 30 years. What is the monthly mortgage payment? A. $1,906.11. B. $792.90. *C. $771.46. D. $931.77. Feedback: Amount financed = $100,000 – $25,000 = $75,000. PV = $75,000, I/Y = 12%/12 = 1%, n = 12*30 = 360 → PMT = $771.46. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
61. You have currently accumulated $50,000 for retirement, and are planning to have $1,000,000 in 30 years’ time when you retire. If you can add $6,000 at the end of each year, what interest rate do you require your retirement fund to earn? A. 9.04%. B. 6.17%. C. 10.71%. *D. 7.24%. Feedback: PV = $50,000, n = 30, FV = –$1,000,000, PMT = $6,000 → I/Y = 7.24%. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
62. Xuan, having saved up a nest egg of $1.5 million, retires this year and looks forward to a 30-year retirement. If his nest egg is expected to earn 9% per annum and is compounded monthly, what will be his monthly income during retirement? *A. $12,069.34. B. $14,600.45. C. $17,205.12. D. $50,000.00. Feedback: PV = $1,500,000, I/Y = 9%/12 = 0.75%, n = 12 x 30 = 360 → PMT = $12,069.34. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
Module 6: Discounted cash flows and valuation
63. As the amortisation period of a mortgage increases, holding interest rates constant, the monthly payments will: A. increase. *B. decrease. C. stay the same. D. there is no connection between the amortisation period and the size of the payment. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
64. Which one of the following will increase the present value of an annuity? A. decreasing the number of payments. *B. lowering the discount rate. C. reducing the future value of the cash flow. D. lowering the payment amount. LO 6.4: Describe how to calculate the periodic payments, number of periods, and interest rate for a range of annuity problems and prepare a loan amortisation schedule.
65. Your firm is looking at expanding its operations and need to borrow $2 million for 5 years. Three banks have submitted their interest rate quotes (all Annual percentage rates): Bank A: 15% compounded daily; Bank B: 15% compounded weekly; and Bank C: 15% compounded monthly. Which bank should the firm borrow from? A. Bank A. B. Bank B. *C. Bank C. D. Any bank would do since the APR is the same across all banks. Feedback: To answer this particular question, we need to calculate the EARs (effective annual interest rate) for all 3 banks and choose the one giving us the lowest EAR (since we are borrowing). The answer is Bank C at 16.075% LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
66. Your firm has generated extra profits and decides to put some money in a savings account. Three banks have submitted their interest rate quotes (all Annual percentage rates): Bank A: 15% compounded daily; Bank B: 15% compounded weekly; and Bank C: 15% compounded monthly. Which bank should the firm borrow from? *A. Bank A. B. Bank B. C. Bank C. D. Any bank would do since the APR is the same across all banks. Feedback: To answer this particular question, we need to calculate the EARs (effective annual interest rate) for all 3 banks and choose the one giving us the highest EAR (since we are lending and expecting to earn interest). The answer is Bank A at 16.180% LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
67. If the nominal rate of interest is 6% per annum compounded monthly, what is the effective annual rate? A. 6.00%. *B. 6.17%. C. 6.60%. D. 7.20%. Feedback: (1.005)12 − 1 = 6.17%. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
68. If my bank manager offers me an overdraft at 9% per annum charged quarterly, the effective rate of interest is: A. 9.00%. B. 9.27%. *C. 9.31%. D. 9.38%. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
Module 6: Discounted cash flows and valuation
69. An interest rate is quoted as 8% per annum compounded quarterly. What is the effective annual rate? A. 8.34%. *B. 8.24%. C. 8.22%. D. 8.00%. Feedback: C is calculated 4 months not 3 months per compounding period. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
70. Which one of the following statements is not true? A. The APR is the annualised interest rate using simple interest. *B. The correct way to annualise an interest rate is to compute the annual percentage rate (APR). C. The correct way to annualise an interest rate is to compute the effective annual interest rate (EAR). D. You can find the interest rate per period by dividing the quoted annual rate by the number of compounding periods. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
71. ABC Ltd borrowed $152,300 from a bank for three years. If the quoted rate (APR) is 11.75 per cent, and the compounding is daily, what is the effective annual rate (EAR)? (Round to one decimal place.) A. 11.6% B. 11.7% *C. 12.5% D. 14.3% LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
72. To compare interest rates, we should compare the: *A. effective rates. B. periodic rates. C. quoted rates. D. nominal rates. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
73. For a given quoted rate, the effective annual rate ______ as the compounding frequency increases. A. decreases. B. does not change. *C. increases. D. there is no connection between the effective annual rate and the quoted rate. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
74. An effective annual rate of 10.5% is equivalent to: A. 10% compounded daily. *B. 10% compounded weekly. C. 10% compounded monthly. D. 10% compounded semi-annually. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
75. Your investment account has an interest rate of 10% compounded semi-annually. This is the equivalent of an effective annual interest rate of: A. 10%. B. 1.1025%. C. 5%. *D. 10.25%. Feedback: 1.052 – 1 = 10.25% LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
76. Your credit card has a quoted rate of 17% compounded weekly. What is the effective annual rate? A. 17.0%. *B. 18.5%. C. 24.5%. D. 32.7%. 52
Feedback: 1 + 0.17 − 1 = 18.4976%
52
LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
Module 6: Discounted cash flows and valuation
77. Thelma borrows $10,000 from “Jaw Breaker Joe” and promises to repay Joe a total of $10,500 in one month. What is the effective annual interest rate charged by Joe? *A. 79.6%. B. 5.0%. C. 60.0%. D. 179.6%. Feedback: ($10,500 – $10,000) / $10,000 = 5%. 1.0512 – 1 = 79.6%/ LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
78. ANZ Bank currently offers an investment account with an interest rate of 8% compounded semi-annually. ANZ wants to offer customers another account with interest compounded monthly. If ANZ wants the effective rates to be equal, what interest rate should ANZ quote for the second account? *A. 7.9%. B. 8.0%. C. 8.2%. D. 24.0%. Feedback: 1.0816 = 1 + X 12 X = 7.9%
12
LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
79. How much should a weekly compounded account with an EAR of 10% earn semiannually? A. 5.0%. B. 4.9%. *C. 5.1%. D. 5.4%. Feedback: ((1 + 10%)1/52)26 – 1 = 5.1% LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
80. How much should a monthly compounded account with an EAR of 18% earn semiannually? A. 2.77%. B. 2.80%. C. 3.00%. *D. 8.63%. Feedback: ((1 + 18%)1/12)6 – 1 = 8.63%. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
81. When comparing different investment opportunities (each with the same risk) with different interest rates reported in different ways you should convert each interest rate to: A. an annual nominal rate. B. a monthly nominal rate. *C. an effective annual rate. D. an APR. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
82. Your bank offers two options: Account A compounds semi-annually while account B compounds monthly. If both accounts have the same effective annual rate of interest, you should choose: A. account A because it is compounded less often. B. account A as it offers a higher APR. C. account B as it offers a higher APR. *D. either since you would be indifferent between the two. LO 6.5: Discuss why the effective annual interest rate (EAR) is the appropriate way to annualise interest rates and calculate EAR.
Module 7: Risk and return Multiple-choice questions 1.
Which of the following statements is false?
A. The greater the risk, the larger the return investors require for bearing that risk. B. The risk and return relationship is one of the most fundamental relationships in finance. C. The rate of return investors require for an investment depends on the risk associated with that investment. *D. None of the above. LO 7.1: Explain the relationship between risk and return.
2.
Which of the following statements is true?
A. Higher risk means you are more certain about your expected return. *B. Risk is a measure of how certain you are about your expected return. C. The rate of return is what you earn on an investment, stated in dollar terms. D. None of the above. LO 7.1: Explain the relationship between risk and return.
3.
If two investments have the same expected return, investors will prefer the __________ risky alternative.
A. risk is not important. B. more. *C. less. D. none of the above. LO 7.1: Explain the relationship between risk and return.
4.
When choosing between two investments that have the same level of risk, investors prefer the investment with the ____________ return.
A. more predictable return. B. lower. *C. higher. D. none of the above. LO 7.1: Explain the relationship between risk and return.
Module 7: Risk and return
5.
Share A has an expected return of 8% and a risk level of 10%. Share B has an expected return of 8% and a risk level of 14%. Which would you choose?
*A. A. B. B. C. Indifferent as expected return is the same. D. Neither as risk is too high. LO 7.1: Explain the relationship between risk and return.
6.
Share A has an expected return of 9% and risk level of 8%. Share B has an expected return of 9% and risk level of 12%. Share C has an expected return of 8% and risk level of 12%. Which would you choose?
*A. A. B. B. C. C. D. Either A or B as expected return is the same. LO 7.1: Explain the relationship between risk and return.
7.
Share A has an expected return of 12% and risk level of 10%. Share B has an expected return of 12% and risk level of 14%. Share C has an expected return of 10% and risk level of 14%. Rank them in order of your preference.
*A. A, B, C. B. B, C, A. C. C, B, A. D. B, A, C. LO 7.1: Explain the relationship between risk and return.
8.
A risk averse person will:
*A. have to be compensated to participate in a fair game. B. participate in fair game. C. pay to participate in a fair game. D. none of the above. LO 7.1: Explain the relationship between risk and return. 9.
A risk neutral investor will assess investment alternatives based on their:
*A. expected returns. B. relative expected risks. C. relative expected risks and returns. D. none of the above.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
Feedback: Risk neutral investors do not care about risk and therefore ignore it when comparing or ranking investments. LO 7.1: Explain the relationship between risk and return.
10. If a person chooses to take $100 in cash instead of betting it to win $210 on the toss of a coin, that person is: *A. risk averse. B. risk neutral. C. a risk seeker. D. indifferent to risk. Feedback: The expected outcome of betting $100 to win $110 on the toss of a coin is 0.5 $210 − 0.5 $100 = $5, which is better than a fair game. In the long run a person would gain from playing such a game, but on a single toss of a coin there is a 50% chance of losing $100 and a 50% chance of gaining $110. A person who decides not to play the game for fear of losing is described as risk averse. LO 7.1: Explain the relationship between risk and return. 11. 1 year ago, you bought a share from Bechtel Ltd for $110. Today it’s worth $115. Over the year, the company did not pay any dividend. What total return did you earn on this share over the past year? A. -4.35%. B. 4.35%. C. 4.45%. *D. 4.54%. Feedback: Using the total holding period return formula, the answer is 4.54% LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset. 12. Let’s suppose you recently bought a share of BHP Billiton for $110.00. You plan to sell the share next year. You estimate that there is a 25% chance that the shares will sell for $115 at the end of 1 year, 50% chance it will sell for $120 and 25% chance it will sell for $112. Moreover, you estimate that the company will pay a $3 dividend per share under any circumstances. What is your total expected return? A. 8.27%. *B. 8.86%. C. 22.25%. D. 23.64%. Feedback: Using the estimated return formula, the answer is 8.86% (you need to cater for the dividend per share of $3 in the calculation). LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset.
Module 7: Risk and return
13. Azzam purchased a share for $45 one year ago. The share is now worth $65. During the year, the share paid a dividend of $2.50. What is the total return to Azzam from owning the share? (Round your answer to the nearest whole per cent.) A. 5%. B. 35%. C. 44%. *D. 50%. LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset.
14. Sarah purchased a share one year ago for $27. The share is now worth $32, and the total return to Sarah for owning the share was 37 per cent. What is the dollar amount of dividends that she received for owning the share during the year? A. $4. *B. $5. C. $6. D. $7. LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset.
15. Frank purchased a share one year ago for $20, and it is now worth $24. The share paid a dividend of $3 during the year. What was the share's rate of return from capital appreciation during the year? (Round your answer to the nearest per cent.) A. 15%. *B. 20%. C. 29%. D. 35%. LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset.
16. Jarood earned a 62.5 per cent return on a share that he purchased one year ago. The share is now worth $12, and he received a dividend of $1 during the year. How much did Jarood originally pay for the share? A. $7.25. B. $7.50. *C. $8.00. D. $8.50.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset.
17. Moses purchased a share for $30 last year. He found out today that he had a -100 per cent return on his investment. Which of the following must be true? A. The share is worth $30 today. B. The share is worth $0 today. C. The share paid no dividends during the year. *D. Both B and C must be true. LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset.
18. Noah needs to capture a return of 40 per cent for his one-year investment in a property. He believes that he can sell the property at the end of the year for $150,000 and that the property will provide him with rental income of $25,000. What is the maximum amount that Noah should be willing to pay for the property? A. $112,500. *B. $125,000. C. $137,500. D. $150,000. LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset. 19. Abel Brothers shares were priced at $15 per share two years ago. The share sold for $13 last year and now it sells for $18. What was the total return for owning Abel Brothers shares during the most recent year? Assume that no dividends were paid and round to the nearest per cent. A. 17%. B. 20%. C. 23%. *D. 38%. LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset.
20. A share bought for $20 at the start of the period and sold for $15 at the end of the period which paid dividends of $2 and $3 in the interim generated a holding period return of: A. –50%. *B. 0%. C. 50%. D. 100%.
Module 7: Risk and return
LO 7.2: Describe the two components of a total holding period return, and calculate this return for an asset.
21. The expected return for a portfolio without borrowing or short selling: A. has a limited range of expected returns. B. should never be less than the expected return of the asset with lowest expected return. C. should never be greater than the expected return of the asset with highest expected return. *D. all of the above. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset.
22. In a game of chance, the probability of winning a $50 prize is 40 per cent, and the probability of winning a $100 prize is 60 per cent. What is the expected value of a prize in the game? A. $50. *B. $80. C. $83. D. $100. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset.
23. In a game of chance, the probability of winning a $50 prize is 60 per cent and the probability of losing a $50 prize is 40 per cent. What is the expected value of a prize in the game? A. –$10. B. $0. *C. $10. D. $25. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset.
24. What is the expected return from an asset having the following possible returns and associated probabilities? Possible return Probability 25% 20% 15% 50% 5% 30% A. 13.5%. *B. 14%. C. 15%.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
D. 16.5%. Feedback: The calculation is: 25% 0.2 + 15% 0.5 + 5% 0.3 = 14%. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset. 25. An investment’s expected return is: A. the most likely future return. B. based on past average returns. C. determined by the standard deviation of past returns. *D. the probability-weighted average of possible outcomes associated with the investment. Feedback: An investment’s expected return is the probability-weighted average of possible outcomes associated with the investment. Note that an investment’s most likely return is not necessarily its expected return. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset. 26. A stock which has possible returns of 40% and –5% each with equal likelihood has an expected return of: A. 10%. B. 15.5%. *C. 17.5%. D. 20%. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset. 27. Given that a stock has generated returns of 6%, 18%, –5% and 20% over the last four years, the average annual return on this stock over the period was: *A. 9.75%. B. 10.50%. C. 12.25%. D. 39%. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset. 28. Given the following series of annual returns for a managed fund: 5%, 6%, 23%, –15%, 20%, –29%, 40%, –40%, 23%, the average annual return over the period was: *A. 3.67%. B. 6.37%. C. 10.11%. D. 13.44%. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset.
Module 7: Risk and return
29. There are two probabilities of returns for Stock A. If the probability of a 10% return is 60%, what is the probability of a 12% return? *A. 40%. B. 60%. C. 100%. D. insufficient information provided. Feedback: total probabilities must equal 100%. Thus 100 – 60 = 40% probability. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset.
30. The sum of the probabilities of returns must be: A. more than 100 per cent. B. less than 100 per cent. *C. equal to 100 per cent. D. none of the above. LO 7.3: Explain what an expected return is, and calculate the expected return for an asset.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
31. You are considering investing in a share of ASX Ltd and you know that the share returns tend to be normally distributed, and you have calculated the expected return on the share to be 10% and the standard deviation to be around 15%. Based on those statistics, within what range would you expect the return on this share to fall during next year (calculate the range at 99% level of confidence). A. – 28.625% and 10%. *B. – 28.625% and 48.625%. C. 10% and 38.625%. D. 10% and 48.625%. Feedback: At 99% level of confidence, number of deviations from the mean is 2.575. Multiplying the value by the standard deviation of 15% gives you 38.625%. So the range of return will be in between -28.625% (10%- 38.625%) and 48.625% (10%+38.625%) at 99 per cent level of confidence. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
32. If a random variable is drawn from a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations larger than the mean? A. 3.75%. B. 1.25%. *C. 2.50%. D. 5.00%. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
33. If a random variable is drawn from a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations below the mean? A. 98.75%. B. 95.00%. C. 96.25%. *D. 97.50%. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
Module 7: Risk and return
34. Robert is making an investment with an expected return of 12 per cent. If the standard deviation of the return is 4.5 per cent, and if Robert is investing $100,000, then what dollar amount is Robert 95 per cent sure that he will have at the end of the year? A. $100,000.00. *B. $104,597.50. C. $116,500.00. D. $119,402.50. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
35. If you were to compare the returns of an individual share to a market index, select the answer below that is most true. A. The returns of the individual share will show less variability than those of the market index. *B. The returns of the individual share will show more variability than those of the market index. C. The returns of the individual share will show the same level of variability than those of the market index, if they have the same beta. D. None of the above. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
36. Which of the following is not a measure of risk? A. Standard deviation. B. Variance. *C. Expected return. D. Range. Feedback: An expected return in the probability-weighted average of possible outcomes associated with an investment. The standard deviation and variance are both measures of dispersion around an expected outcome, while the range refers to the range of possible outcomes, from the lowest possible value to the highest possible value. All three are measures of risk. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
37. Suppose a particular stock’s return is perfectly characterised by the normal distribution. This stock has a mean return of 10% and standard deviation of 3%. Within what range will approximately 95% of all possible returns on this stock lie: A. –2% to 22%. B. 2% to 18%. *C. 4% to 16%. D. 4% to 10%. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it. 38. Given that a stock has generated returns of 6%, 18%, –5% and 20% over the last four years, the variance of stock returns was: *A. 0.013492. B. 0.017423. C. 0.024930. D. 0.028970. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it. 39. Given that a stock has generated returns of 6%, 18%, –5% and 20% over the last four years, the standard deviation of stock returns was: A. 9.03%. B. 10.50%. *C. 11.62%. D. 12.46%. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
40. If returns are normally distributed, the expected return plus or minus one standard deviation will cover what percentage of all possible returns? *A. 68%. B. 90%. C. 95%. D. 99%. Feedback: If returns are normally distributed, the expected return plus or minus one standard deviation will cover 68% of all possible returns. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
Module 7: Risk and return
41. If returns are normally distributed, the expected return plus or minus 1.96 standard deviations will cover what percentage of all possible returns? A. 99%. B. 90%. C. 68%. *D. 95%. Feedback: If returns are normally distributed, the expected return plus or minus 1.96 standard deviations will cover 95% of all possible returns. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
42. If returns are normally distributed, the expected return plus or minus 1.64 standard deviations will cover what percentage of all possible returns? A. 99%. B. 68%. *C. 90%. D. 95%. Feedback: If returns are normally distributed, the expected return plus or minus 1.64 standard deviations will cover 90% of all possible returns. LO 7.4: Explain what the standard deviation of returns is, explain why it is especially useful in finance, and be able to calculate it.
43. Covariance measures: A. how the returns of two assets move in opposite directions. B. how the risks of two assets move in opposite directions. C. how the risks of two assets move together. *D. how the returns of two assets move together. Feedback: Covariance measures how the returns of two assets move together LO 7.5: Explain the concept of diversification.
44. You hold a portfolio of two assets. When the return on one asset is positive, the return on the other asset is negative. We can conclude that: *A. the correlation between the two assets in the portfolio is negative. B. there is no correlation between the two assets in the portfolio. C. the correlation between the two assets in the portfolio is positive. D. none of the above. Feedback: When returns on two assets have opposite signs like in this scenario, we deduce that the correlation is negative between the two assets. LO 7.5: Explain the concept of diversification.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
45. Domino’s shares have an expected return of 9 per cent and a variance of 0.25 per cent. What is the coefficient of variation for Domino’s? A. 0.0278. *B. 0.0556. C. 2.7778. D. 5.5556. LO 7.5: Explain the concept of diversification.
46. You have invested 40 per cent of your portfolio in an investment with an expected return of 12 per cent and 60 per cent of your portfolio in an investment with an expected return of 20 per cent. What is the expected return of your portfolio? *A. 16.8%. B. 15.2%. C. 16.0%. D. 17.6%. LO 7.5: Explain the concept of diversification.
47. You have invested 20 per cent of your portfolio in Homer Resources, 40 per cent in Marge Ltd, and 20 per cent in Bart Co. What is the expected return of your portfolio if Homer, Marge, and Bart have expected returns of 2 per cent, 18 per cent, and 3 per cent, respectively? A. 7.7%. B. 8.7%. *C. 8.2%. D. 9.2%. LO 7.5: Explain the concept of diversification.
48. You invested $3,000 in a portfolio with an expected return of 10 per cent and $2,000 in a portfolio with an expected return of 16 per cent. What is the expected return of the combined portfolio? A. 13.6%. B. 6.2%. *C. 12.4%. D. 13.0%. LO 7.5: Explain the concept of diversification.
Module 7: Risk and return
49. The covariance of the returns between Wildcat Shares and Sun Devil Shares is 0.09875. The variance of Wildcat is 0.2116, and the variance of Sun Devil is 0.1369. What is the correlation coefficient between the returns of the two shares? A. 0.293347. B. 0.340823. C. 0.578731. *D. 0.580200. LO 7.5: Explain the concept of diversification.
50. Beef Stock returns have exhibited a standard deviation of 0.57, whereas Sheep Stock returns have a standard deviation of 0.63. The correlation coefficient between the returns is 0.078042. What is the covariance of the returns? *A. 0.028025. B. 0.217327. C. 0.359100. D. 0.993094. LO 7.5: Explain the concept of diversification.
51. Aquamarine Stock has exhibited a standard deviation in share returns of 0.7, whereas Hurricane Lantern Stock has exhibited a standard deviation of 0.8. The correlation coefficient between the share returns is 0.1. What is the standard deviation of a portfolio composed of 70 per cent Aquamarine and 30 per cent Hurricane Lantern? A. 0.32122. B. 0.54562. *C. 0.56676. D. 0.75000. LO 7.5: Explain the concept of diversification.
52. Most of the risk-reduction benefits from diversification can be achieved in a portfolio consisting of: A. 5 to 10 shares. B. 10 to 15 shares. *C. 15 to 20 shares. D. 20 to 25 shares. LO 7.5: Explain the concept of diversification.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
53. Which of the following expressions best describes the concept of reducing risk through diversification? A. Look before you leap. B. A stitch in time saves nine. C. The early bird catches the worm. *D. Don’t put all your eggs in one basket. Feedback: Although the text doesn’t specifically refer to this adage, it should be clear that it accurately encapsulates the notion that risk is reduced by not putting all one’s eggs in one basket; i.e. by diversifying into different investments. LO 7.5: Explain the concept of diversification.
54. Risk is less effectively reduced through diversifying into different investments when the different investments: A. are in the same country. *B. are in the same industry. C. have zero correlation with the market. D. have negatively correlated returns. Feedback: Risk is less effectively reduced through diversifying into different investments in the same industry. LO 7.5: Explain the concept of diversification.
55. Within a portfolio, diversification leads to the reduction of: A. market risk. B. firm-specific and market risk. *C. firm-specific risk. D. None of the above. LO 7.5: Explain the concept of diversification.
56. Correlation is a measure of: A. dispersion. B. central tendency. C. the equity risk premium (ERP). *D. the way two variables move relative to each other. Feedback: Correlation is a measure of the way two variables move relative to each other. LO 7.5: Explain the concept of diversification.
Module 7: Risk and return
57. What does a beta of greater than one mean if you hold a bond? *A. The bond has greater systematic risk than the market. B. The bond has the same systematic risk as the market. C. The bond has greater non-diversifiable risk than the market. D. The bond has greater unsystematic risk than the market. Feedback: Beta is used in finance as a measure of systematic/market risk. A beta >1 means that the asset has a greater systematic risk than the market. LO 7.6: Discuss which type of risk matters to investors and why.
58. A portfolio with a level of systematic risk the same as that of the market has a beta that is: A. less than zero. B. equal to zero. C. less than the beta of the risk-free asset. *D. equal to one. LO 7.6: Discuss which type of risk matters to investors and why.
59. Which of the following is the best measure of the systematic risk in a portfolio? *A. Beta. B. Variance. C. Covariance. D. Standard deviation. LO 7.6: Discuss which type of risk matters to investors and why. 60. Beta is a measure of an asset’s: A. total risk. B. correlation with market returns. *C. systematic risk. D. unsystematic risk. Feedback: Note that although a share’s beta value is influenced by its correlation with the market, it is not determined by that factor alone. A share’s beta value is also determined by the standard deviation of its returns and the standard deviation of market returns. LO 7.6: Discuss which type of risk matters to investors and why.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
61. Total risk comprises: A. the difference between systematic risk and unsystematic risk. *B. both systematic and unsystematic risk. C. only unsystematic risk. D. only systematic risk. Feedback: Total risk comprises both systematic and unsystematic risk. LO 7.6: Discuss which type of risk matters to investors and why.
62. ______________ risk is the risk that is common to all businesses. *A. systematic. B. unique. C. firm-specific. D. unsystematic. LO 7.6: Discuss which type of risk matters to investors and why.
63. Diversification reduces _______________ risk. A. market. B. systematic. *C. unsystematic. D. all of the above. LO 7.6: Discuss which type of risk matters to investors and why.
64. A beta equal to one means the stock has: A. less systematic risk than the market. B. no systematic risk. *C. the same systematic risk as the market. D. more systematic risk than the market. LO 7.6: Discuss which type of risk matters to investors and why.
65. A beta of zero means the stock has: A. more systematic risk than the market. B. the same systematic risk as the market. *C. no systematic risk. D. less systematic risk than the market. LO 7.6: Discuss which type of risk matters to investors and why.
Module 7: Risk and return
66. A treasury bond has a systematic risk of: A. 1.5. *B. 0. C. 1. D. insufficient information provided. LO 7.6: Discuss which type of risk matters to investors and why.
67. A risk-free asset has a beta of: A. 1. *B. 0. C. 0.5. D. insufficient information provided. LO 7.6: Discuss which type of risk matters to investors and why.
68. Which of the following is false? A. Treasury bonds are viewed as risk-free. *B. Investing in the market will not earn compensation for taking on risk. C. Assets with a beta of 1.2 have more risk than the market. D. None of the above. LO 7.6: Discuss which type of risk matters to investors and why.
69. The beta of Haymans Electrical Ltd share is 1.6, whereas the risk-free rate of return is 8 per cent. If the expected return on the market is 15 per cent, then what is the expected return on Haymans Electrical? A. 11.20%. *B. 19.20%. C. 24.00%. D. 32.00%. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
70. The risk-free rate of return is currently 3 per cent, whereas the market risk premium is 6 per cent. If the beta of Kurtz Ltd share is 1.8, then what is the expected return on Kurtz? A. 8.40%. B. 10.80%. *C. 13.80%. D. 19.20%. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
71. The expected return on Astrabyte Computers shares is 16.6 per cent. If the risk-free rate is 4 per cent and the expected return on the market is 10 per cent, then what is Astrabyte 's beta? A. 1.26. *B. 2.10. C. 2.80. D. 3.15. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
72. The expected return on Fishermans Inn Ltd shares is 10.8 per cent. If the expected return on the market is 10 per cent and the beta for Fishermans Inn is 1.7, then what is the riskfree rate? A. 4.5%. B. 5.0%. C. 5.5%. *D. 6.0%. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
Module 7: Risk and return
73. The expected return on Rechenberg Ltd shares is 16.5 per cent. If the risk-free rate is 5 per cent and the beta of Rechenberg is 2.3, then what is the market risk premium? A. 2.5%. *B. 5.0%. C. 7.5%. D. 10.0%. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
74. Using the CAPM, calculate the expected rate of return for a share that has a beta of 2.3. The expected return on the market and risk-free rate are 6% and 5% respectively. A. 2.3%. B. 2.7%. *C. 7.3%. D. 6.3%. Feedback: Using the CAPM equation, the answer is 7.3%. E(Ri) = Rrf + Bi[E(Rm) - Rrf] LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
75. According to CAPM theory, shares lying below the security market line are: A. fairly priced. B. under-priced. *C. overpriced. D. none of the above. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
76. A share is priced to return 10% but according to the CAPM its expected return is 7%. According to CAPM theory, we can expect the price of this share to: A. fall. *B. rise. C. uncertain. D. stay the same. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
77. Assets with betas greater than one have: A. lower levels of systematic risk than the market portfolio. *B. higher levels of systematic risk than the market portfolio. C. lower levels of non-systematic risk than the market portfolio. D. none of the above. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
78. A risk-free rate of 5% and an expected market return of 12%, the CAPM predicts an expected return of which of the following, given a beta of 1.6: A. 17%. B. 21%. C. 15%. *D. 16.2%. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
79. Given only information on beta, which of the following stocks is considered the least risky: A. stock A beta = 1.37. B. stock B beta = 2.16. *C. stock C beta = 0.56. D. stock D beta = 0.85. Feedback: Lower beta implies lower risk. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
Module 7: Risk and return
80. The equity risk premium (ERP) is: *A. the difference between the return on the market and the risk-free rate. B. the difference between the return on the market and the bank-bill rate. C. the difference between the holding period return on a given share and the risk-free rate. D. the difference between the return on a portfolio of all risky assets and the risk-free rate. Feedback: The equity risk premium (ERP) is the difference between the return on the market and the risk-free rate. Remember that the return on the market is used as the benchmark for the performance of risky assets. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
81. If you expect a market return of 10% and a risk-free rate of 5%, the required rate of return on an investment with a beta value of 0.5 is: A. 5%. *B. 7.5%. C. 10%. D. 12.5%. Feedback: Using the Capital Asset pricing Model (CAPM), the required rate of return is 0.05 + 0.5 (0.1 − 0.05) = 0.05 + 0.025 = 0.075 or 7.5%. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
82. If the expected returns on an investment are uncorrelated with the market, its beta value is: A. −1. *B. 0. C. 1. D. equal to that of the market. Feedback: If the expected returns on an investment are uncorrelated with the market, its beta value is 0. LO 7.7: Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.
Module 8: Bond valuation Multiple-choice questions 1.
Which of the following statements is not correct? Treasury indexed bonds:
A. pay coupons semiannually. B. are issued in periods of deflation. *C. pay inflation-adjusted coupons. D. have an inflation-adjusted coupon rate. Feedback: The coupon rate of TIBs is fixed. It is the value of the principal amount that is used to compute the coupon payments that adjusts to inflation. TIBs pay coupons quarterly and they can only attract investors if inflation is likely to be relatively high. LO 8.1: Explain what Commonwealth government securities (CGS) and semi-government (semis) are, where they are issued and their relative liquidity.
2.
State government bonds ________ than Commonwealth government bonds.
*A. pay higher yields. B. have higher liquidity. C. have lower default risk. D. have higher marketability. LO 8.1: Explain what Commonwealth government securities (CGS) and semi-government (semis) are, where they are issued and their relative liquidity.
3.
Semis differ from CGS in important ways:
A. Semis trade at a par. B. Semis trade at a discount. *C. Semis trade at a higher yield. D. both A and B above. Feedback: The price semi trade at is lower than that for an otherwise identical CGS (see State government bonds) LO 8.1: Explain what Commonwealth government securities (CGS) and semi-government (semis) are, where they are issued and their relative liquidity.
Module 8: Bond valuation
4.
The RBA is a large investor in Treasury bonds and notes due to its role:
A. as a supervisor of the financial system. *B. in the conduct of monetary policy. C. in the stability of the government. D. as the bank of the government. Feedback: In order to influence the stock of central bank money in the banking system, the RBA conducts open market operations where the government securities are bought by the RBA from banks and then resold to banks at a later date (Reverse repos). The banks try to influence the stock of reserves in order to affect the cash rate, the overnight unsecured interbank rate. LO 8.1: Explain what Commonwealth government securities (CGS) and semi-government (semis) are, where they are issued and their relative liquidity.
5.
In the tenders organised by the AOFM to issue Treasury bonds:
A. bidders win if the yield in their bid is among the highest. *B. AOFM serves the bidders with the lowest yields first and then accepts highest yields up to the exhaustion of the quantity on issue. C. bidders bid quantities at the yield announced by AOFM. D. bidders win if the quantity in their bid is among the highest. Feedback: Treasury bonds are issued through discriminatory auctions where bidders (mainly banks) bid a yield and a quantity and the winners are the bidders with the lowest yields. Each winner pays the price implicit in the yield in its bid. LO 8.1: Explain what Commonwealth government securities (CGS) and semi-government (semis) are, where they are issued and their relative liquidity.
6.
A repurchase agreement calls for:
A. a firm to sell securities with the agreement to buy them back after a short period at a lower price. B. a firm to buy securities with the agreement to sell them back after a short period at a lower price. *C. a firm to sell securities with the agreement to buy them back after a short period at a higher price. D. a firm to buy securities with the agreement to sell them back after a short period at a higher price. LO 8.1: Explain what Commonwealth government securities (CGS) and semi-government (semis) are, where they are issued and their relative liquidity.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
7.
A repurchase agreement is like a secured loan because:
A. it is backed by the real estate property of the borrower. B. the Reserve Bank of Australia is the guarantor of the repo. C. it involves a commercial bank and the Reserve Bank of Australia. *D. it involves a collateral, which is the underlying security in the repo. LO 8.1: Explain what Commonwealth government securities (CGS) and semi-government (semis) are, where they are issued and their relative liquidity.
8.
Which of the following statements is not correct? In a repo:
A. the seller of the security is the borrower of funds. B. the price of repurchase is known from the beginning of the financial arrangement. C. the difference between the repurchase price and the selling price is the interest on the loan. *D. if the borrower defaults on the repayment of the loan he/she then has to deliver the underlying securities to the lender. Feedback: The underlying securities have already become the property of the lender from the beginning of the loan not when the default occurs. LO 8.1: Explain what Commonwealth government securities (CGS) and semi-government (semis) are, where they are issued and their relative liquidity.
9.
Corporate bonds:
A. are discount securities. B. do not need to be paid back. C. pay interest at maturity date. *D. make periodic payments of interest and repay principal at the maturity date. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
10. Everything else being equal, a corporate bond will sell at a higher yield if it: A. is senior debt. *B. has a call provision. C. has lower default risk. D. can be converted to shares. Feedback: Any feature in the bond that is detrimental to investors will sell at a higher yield. All features in the list except call provisions are beneficial to the investors and will require a lower yield. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
Module 8: Bond valuation
11. Hybrid securities are financial products that have characteristics of: *A. debt and equity. B. discount securities. C. government bonds. D. credit-wrapped bonds. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
12. Senior debt: A. is the debt issued by good credit rated companies. B. is debt issued by the Commonwealth government. C. has a higher probability of payment than junior debt. *D. is debt that has priority in the event of default of the issuer. Feedback: Senior debt applies to unsecured corporate debt. It can exist even for not so good credit rated companies. The investors of senior debt have priority over the assets in case of default. Therefore they are more likely to receive payments in case of defaults than other investors in unsecured debt. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
13. Some corporate bonds have sinking fund provisions or call provisions that: A. reset the terms of the bond. B. make the bond secured. C. allow the investors to convert the bond into shares. *D. require that the bond issuer provide funds to a trustee to retire a specific dollar amount (face value amount) of bonds each year. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
14. The insurer in a financial guarantee receives an upfront fee paid by: A. the investor. *B. the issuer of the bond. C. the bond market operator. D. the proceeds of the asset sales of the defaulting company. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
15. The credit rating of a credit-wrapped bond depends on the reputation and financial strength of: A. the issuer. B. the investor. *C. the guarantor. D. the borrower. Feedback: A credit-wrapped bond is a bond with a financial guarantor, who will pay investors if the issuer cannot. The credit rating of the issuer/borrower is therefore irrelevant. Only the credit rating of the guarantor matters as it is the entity that ultimately will be asked to repay the investor. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
16. Which of the following statements is not correct? *A. All bonds pay coupons. B. Par value of a bond is its face value. C. Bonds can be seen as annuities for the coupon payments. D. A bond that trades above its face value is said to be sold at a premium. Feedback: Zero coupon bonds pay no coupons. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
17. Which one of the following statements is true? A. Zero coupon bonds must sell for less than similar bonds that make coupon payments before maturity. B. Zero coupon bonds sell well below their face value (at a deep discount) because they offer no coupons. C. Zero coupon bonds have no coupon payments over its life and only offer a single payment at maturity. *D. All of the above are true. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
Module 8: Bond valuation
18. Convertible notes are hybrid securities that can be converted into: *A. shares of common stock at the discretion of the holder. B. bonds at the discretion of the holder. C. Treasury notes at the discretion of the holder. D. debentures at the discretion of the holder. Feedback: Their convertibility feature permits the holder to share in the good fortune of the firm if the stock price rises above a certain level. That is, if the market value of the stock the holder receives at conversion exceeds the market value of the notes, it is to the investor’s advantage to exchange the notes for stock, thus making a profit. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
19. Convertible bonds are: A. not long term IOUs. B. bonds with no coupon payments. C. the most common bonds issued by companies. *D. bonds that have the feature of convertibility into shares. Feedback: Unlike other bonds, convertible bonds have a convertibility feature that allows the bondholder to convert its bonds into shares. The convertible feature allows the bondholders to share in the good fortunes of the company if the company’s share price rises above a certain level, yielding a higher return than holding to the bonds. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
20. The quality of a financial guarantee depends on the reputation and financial strength of the: A. investor. B. Federal government. *C. guarantor. D. borrower. LO 8.2: Describe the features of corporate bonds and differentiate the three types of corporate bonds.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
21. In Australia, Treasury bonds pay coupons: A. monthly. *B. semiannually. C. annually. D. at maturity. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
22. Bonds sell at a discount off the par value when market rates for similar bonds are: A. less than the bond's coupon rate. B. equal to the bond's coupon rate. *C. greater than the bond's coupon rate. D. market rates are irrelevant in determining a bond's price. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
23. In calculating the current price of a bond paying semiannual coupons, one needs to: A. use half the annual coupon. B. use double the number of payments. C. use half the annual rate as the discount rate. *D. all of the above need to be done. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
24. Which one of the following statements about zero coupon bonds is not true? *A. Zero coupon bonds make coupon payments but no principal payment at maturity. B. Zero coupon bonds have no coupon payments but promise a single payment at maturity. C. Zero coupon bonds must sell for less than similar bonds that make periodic coupon payments. D. All of the above statements are true. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
Module 8: Bond valuation
25. Aletek Corp is issuing a 10-year bond with a face value of $1,000 and a coupon rate of 7 percent. The interest rate for similar bonds is currently 9 percent. Assuming annual payments, what is the present value of the bond? (Round to the nearest dollar.) *A. $872. B. $945. C. $990. D. $1,066. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
26. Your friend recommends that you invest in a three-year bond issued by Morgans Ltd that will pay annual coupons of 10 percent and has a face value of $1,000. Similar investments today will yield 6 percent. How much should you pay for the bond? (Round to the nearest dollar.) A. $886. B. $979. C. $1,024. *D. $1,107. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
27. Stanley Richards is interested in buying a five-year bond that pays a coupon of 10 percent on a semiannual basis and has a face value of $1,000. The current market rate for similar bonds is 8.8 percent. At what price should the bond be trading? (Round to the nearest dollar.) *A. $1,048. B. $965. C. $1,099. D. $982. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
28. When the bond is sold below face value, it is known as: *A. a discount bond. B. a premium bond. C. a par value bond. D. none of the above. Feedback: When a bond is sold below face value (price < face value), the bond is known to be a discount bond. Whenever, the market rate of interest (yield rate) is higher than the coupon rate for a particular bond, the bond will be known as a discount bond (as the price of the bond will be lower than the face value when working out the bond valuation). LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
29. For a 3 year bond with a face value of $50 and a coupon rate as well as a market rate of 8%: A. not enough information provided. B. the face value will be higher than the price of the bond. *C. the face value will equal the price of the bond. D. the face value will be lower than the price of the bond. Feedback: When the coupon rate on a bond equals the market rate, the price of the bond will equal the face value of the bond and thus the bond is known as a par value bond. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
30. Calculate the price of a 3 year bond with a face value of $50,000, an annual coupon rate of 8% and an annual market yield of 6%. Coupon payments are made semi-annually. A. $47,379. B. $52,673. *C. $52,709. D. $54,917. Feedback: Since coupon payments are made semi-annually, C is $2,000, i = 3%, m=2, n=3 and F=50,000. Using a financial calculator or using the bond valuation formula the answer is $52,709. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
Module 8: Bond valuation
31. Which of the following statements is false? A. When the prevailing market interest rate is higher than the coupon rate, the bond will be traded at a discount. B. When the prevailing market interest rate is lower than the coupon rate, the bond will be traded at a premium. C. The higher the coupon rate, the less sensitive the market price of the bond becomes to changes in prevailing market rates. *D. The longer the time to maturity, the less sensitive the market price of the bond becomes to changes in prevailing market rates. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
32. A ten-year bond has a par value of $1,000; a 7.5 percent coupon rate; and a yield to maturity of 8.25 percent. Assuming the coupons are paid semi-annually, the market price is closest to: *A. $949.60. B. $950.24. C. $1,051.48. D. $1,052.11. Feedback: N=20, I/Y=8.25/2, PMT = $75/2, FV = $1,000. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
33. A zero coupon bond with a face value of $1,000 is currently selling for $687.38. The bond has a market yield of 5.48 percent. What is the bond's term to maturity, assuming semi-annual compounding? A. 6.62 years. *B. 6.93 years. C. 7.03 years. D. 7.42 years. ln( F / B) ln($1, 000 / $687.38) = 0.5 = 6.93 years ln(1 + YTMs ) ln(1 + 5.48% / 2)
Feedback: n = 0.5
LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
34. Hitchcocks Ltd is issuing 20-year bonds that will pay coupons semiannually and have a face value of $1,000. The coupon rate on this bond is 7.8 percent. If the market rate for such bonds is 7 percent, what will the bonds sell for today? (Round to the nearest dollar.) A. $1,037. *B. $1,085. C. $861. D. $923. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
35. Jacqui has been offered a seven-year bond issued by Sunfam Ltd at a price of $943.22. The bond has a face value of $1,000 and a coupon rate of 9 percent and pays the coupon semi-annually. Similar bonds in the market will yield 10 percent today. Should she buy the bonds at the offered price? (Round to the nearest dollar.) A. Yes, the bond is worth more at $1,015. B. No, the bond is only worth $921. *C. Yes, the bond is worth more at $950. D. No, the bond is only worth $912. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
36. Jerry is planning to sell a bond that he owns. This bond has four years to maturity, a face value of $1,000 and pays a coupon of 10 percent on a semi-annual basis. Similar bonds in the current market will yield 12 percent. What will be the price that he will get for his bond? (Round to the nearest dollar.) A. $1,044. *B. $938. C. $970. D. $1,102. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
Module 8: Bond valuation
37. Bill wants to buy five-year zero coupon bonds with a face value of $1,000. His opportunity cost is 8.5 percent. Assuming annual compounding, what would be the current market price of these bonds? (Round to the nearest dollar.) *A. $665. B. $890. C. $1,023. D. $1,113. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
38. The Australian Treasury has issued 10-year zero coupon bonds with a face value of $1,000. Assume that coupon payments are normally semi-annual. What will be the current market price of these bonds if the opportunity cost for similar investments in the market is 6.75 percent? (Round to the nearest dollar.) *A. $515. B. $604. C. $684. D. $860. LO 8.3: Explain how to calculate the value of a bond and why bond prices vary negatively with interest rate movements.
39. If a bond's coupon rate is equal to the market rate, then the bond will sell: A. at a price less than its face value. *B. at a price equal to its face value. C. at a price greater than its face value. D. none of the above are true. LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
40. The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments: A. less than the price of the bond. B. equal to zero. *C. equal to the price of the bond. D. exceed the price of the bond. LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
41. A twenty-year zero coupon bond with a face value of $1,000 is currently selling for $326.50. Assume that coupon payments are normally semi-annual. What is the bond’s YTM? *A. 5.68%. B. 5.65%. C. 5.76%. D. 5.72%. 1 1 F 2n $1, 000 40 Feedback: YTM = 2 − 1 = 2 − 1 = 5.68% B $326.5
LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
42. A five-year zero coupon bond with a face value of $1,000 is currently selling for $826.50. Assume that coupon payments are normally semi-annual. What is the bond’s YTM? *A. 3.84% B. 1.92%. C. 3.88%. D. 1.94%. 1
1
𝐹 2𝑛 1,000 10 Feedback: 𝑌𝑇𝑀 = 2𝑥 [(𝐵) − 1] = 2𝑥 [(826.5) − 1] = 3.84%
LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
43. Coupon payments are: *A. the regular interest payments received by the holder of a bond. B. the regular interest payments received by the holder of an ordinary share. C. the regular interest payments received by the holder of a bank deposit. D. the regular interest payments received by the holder of a preference share. Feedback: Coupon payments are the regular interest payments received by the holder of a bond. (Note that although the holder of a preference share may receive regular dividends of a fixed amount per share, these are not ‘regular interest payments’ and are not normally referred to as coupon payments.) LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
Module 8: Bond valuation
44. What is the YTM of a four-year bond with a par value of $1,000 and a 4 percent coupon rate when the bond is priced at $932.35? Assume coupons are paid annually. A. 2.96%. B. 5.92%. *C. 5.95%. D. 6.22%. Feedback: N=4, PMT = $40, FV = $1,000, PV = $-932.35, solve for I/Y LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
45. What is the YTM of a four-year bond with a par value of $1,000 and a 4 percent coupon rate when coupons are paid annually and the bond is priced at $1,000? A 2%. *B. 4%. C. 6%. D. 8%. Feedback: N=4, PMT = $40, FV = 1000, PV = -932.35, solve for I/Y= 4 LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
46. A 5-year bond with 10% coupon rate and $1,000 face value is selling for $1,100. Calculate the yield to maturity on the bond assuming annual interest payments. *A. 7.53%. B. 7.56%. C. 8.53%. D. 8.62%. Feedback: N=5, PMT = 100, FV = 1,000, PV = 1,100, solve for I/Y= 7.53 LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
47. What is the YTM of a four-year bond with a par value of $1,000 and a 4 percent coupon rate when the bond pays coupons semi-annually and is priced at $932.35? A. 2.96%. *B. 5.92%. C. 5.95%. D. 11.84%. Feedback: N=8, PMT = $20, FV = $1,000, PV = $-932.35, YTM = 2*I/Y LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
48. A five-year bond is currently selling for $930.11. It has a face value of $1,000 and a market yield of 8 percent. Coupons are paid semi-annually. The coupon rate is closest to: A. 4.12%. B. 6.25%. *C. 6.28%. D. 7.48%. Feedback: N=10, I/Y = 4, FV=$1,000, PV=$-930.11, solve for PMT, then multiply by 2 and divide by FV. LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
49. BJL Painting Ltd has bonds that trade with a yield to maturity of 7 percent and a face value of $1,000. The bonds have a six-year term to maturity, pay semi-annual coupons and are currently selling for $1,067.20. The coupon rate of the bond is closest to: A. 4.20%. B. 4.95%. *C. 8.39%. D. 8.41%. Feedback: N=12, I/Y = 7/2, FV = $1,000, PV=$-1,067.20 solve for PMT, c=2*pmt/FV LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
50. The yield to maturity (YTM) is: A. the bond’s internal rate of return. B. the yield that an investor would expect to make if he or she bought the bond at the current price, held it to maturity, received all the promised payments on their scheduled dates, and reinvested all the cash flows received at the YTM. C. the discount rate used to evaluate bonds. *D. all of the above. LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
Module 8: Bond valuation
51. Five years ago, Peter Pander bought a 10-year bond that pays 8 percent semi-annually for $981.10. It has a face value of $1,000. Today, he sold it for $1,067.22. What is the realised yield on his investment? A. 6.41%. B. 4.78%. C. 8.72%. *D. 9.56%. LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
52. Rick Wemmerslager bought a 10-year bond for $921.77 seven years ago. The bond pays a coupon of 15 percent semi-annually. Today, the bond is priced at $961.92. If he sold the bond today, what would be his realised yield? (Round to the nearest percent.) *A. 16.62%. B. 16.86%. C. 7.6%. D. 16.95%. Feedback: N=14; PV=$921.77; FV=$961.92; PMT=$75; Solve for YTM then = 2*I/Y LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
53. Suppose an investor earned a semi-annual yield of 6.4 percent on a bond paying coupons twice a year. What is the effective annual yield (EAY) on this investment? A. 12.8%. B. 6.4%. *C. 13.2%. D. 13.0%. LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
54. Kevin Smart invested in a state government bond that promised an annual yield of 6.7 percent. The bond pays coupons twice a year and the face value is $1,000. What is the effective annual yield (EAY) on this investment? A. 13.6%. *B. 6.8%. C. 6.7%. D. None of the above. LO 8.4: Distinguish between a bond’s coupon rate, yield to maturity and effective annual yield, and be able to calculate their values.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
55. Which one of the following statements is not true? *A. As interest rates increase, bond prices increase. B. Interest rate changes and bond prices are inversely related. C. Interest rate risk is the risk that bond prices will change as interest rates change. D. Long-term bonds are more price volatile than short-term bonds of similar risk. LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
56. Which one of the following statements is true? A. Interest rate risk decreases as maturity increases. B. Long-term bonds have lower price volatility than short-term bonds. C. All other things being equal, short-term bonds are more risky than long-term bonds. *D. As interest rates decline, the prices of bonds rise; and as interest rates rise, the prices of bonds decline. LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
57. Marketability is the ability of an investor to sell: LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems. A. the security above its par value. B. at a profit under all circumstances. *C. a security quickly, at a low transaction cost, and at a price close to its fair market value. D. none of the above.
58. Which one of the following statements is true? A. The interest risk premium always adds a downward bias to the slope of the yield curve. *B. The longer the maturity of a security, the greater its interest rate risk. C. If investors believe inflation will be subsiding in the future, the prevailing yield will be upward sloping. D. The real rate of interest varies with the business cycle, with the lowest rates seen at the end of a period of business expansion and the lowest at the bottom of a recession. LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
Module 8: Bond valuation
59. A change in interest rates for two 10-year bonds with coupon rates of 6% and 10% respectively will: A. not impact on the prices of both bonds. B. cause a similar level of changes for both bonds. *C. cause a bigger change in the price for the bond with a lower coupon rate than the bond with a bigger coupon rate. D. cause a smaller change in the price of the bond with a lower coupon rate than the bond with a bigger coupon rate. Feedback: Two similar bonds (same maturity/number of years) will have different changes in their prices’ following a change in the interest rates. So, a change in interest rates will cause a bigger change in the price of the 10 year bond having a lower coupon rate. LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
60. Which one of the following increases the sensitivity of bond prices? A. A decrease in maturity. *B. An increase in maturity. C. An increase in the coupon payment. D. A decrease in the yield to maturity. LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
61. If market interest rates fall after a bond is issued, the: A. investor will sell the bond. B. face value of the bond increases. C. market value of the bond is decreasing. *D. market value of the bond is increasing. LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
62. In a fixed-rate bond, the variable which changes to give investors the market rate of return is the *A. price. B. face value. C. coupon rate. D. coupon amount. LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
63. A five-year bond paying 8 percent coupons semi-annually is trading on the market at a yield of 6.75 percent. It has a face value of $1,000. What is the percentage change in price if the market yield increases by 75 basis points? A 3.11%. B. –2.98% *C. –3.02%. D. –3.07% Feedback: N=10; FV=$1,000; PMT=$40; YTM=6.75%/2=3.375% PV= $1,052.31. Price after yield change: N=10; FV=$1,000; PMT=$40; YTM=7.5/2=3.75% PV=$1,020.53. Percentage change in price = (1,020.53 – 1,052.31)/1052.31 = -3.02% LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
64. A ten-year bond with a 5% coupon rate is trading with a market yield of 7.75 percent. Coupons are paid annually and the face value is $1,000. What is the percentage change in price if the market yield decreases by 75 basis points? A. 5.388%. B. 5.018%. *C. 5.675%. D. 5.774%. Feedback: Price before yield change: N=10; FV=$1,000; PMT=$50; YTM=7.75% PV= $813.37. Price after yield change: N=10; FV=$1,000; PMT=$50; YTM=7% PV=$859.53. Percentage change in price = (859.53–813.37)/813.37 = 5.675% LO 8.5: Explain why investors in bonds are subject to interest rate risk and why it is important to understand the bond theorems.
65. Which one of the following statements is not true? A. Australian government securities do not have any default risk and are the best proxy measure for the risk-free rate. *B. Investors must pay a premium to purchase a security that exposes them to default risk. C. The risk that the lender may not receive payments as promised is called default risk. D. All of the above are true statements. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
Module 8: Bond valuation
66. Securities with lower marketability have: A. lower borrowing costs than securities with high marketability. *B. higher borrowing costs than securities with high marketability. C. the same borrowing costs as securities with high marketability. D. none of the above. Feedback: Lower marketability means it's not easy for an investor to sell a security quickly and at low transaction cost. The higher risk associated with investing in lower marketable securities require a higher market yield to induce the investor and thus higher borrowing costs for the issuer/seller of the security. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
67. Which of the following risks may be included in the spread that compensates corporate bond investors for the assumption of additional risks over domestic government bond investors? A. Interest rate risk. *B. Default risk. C. Foreign exchange rate risk. D. All of these. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
68. Which of the following rated bonds has the least risk? A. A. B. AA. *C. AAA. D. BB. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
69. Debt ratings assigned by professional debt-rating services are a measure of the bond issuers’ *A. default risk. B. currency risk. C. interest rate risk. D. foreign exchange rate risk. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
70. Which one of the following is not true? *A. Inflation does not affect the interest rates of bonds. B. A bond issuer’s rating is affected by its default risk. C. An investor holding the bond until maturity expects to receive its par value. D. Rating agencies use financial statements to assess the default probability of firms. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
71. The risk premium of a company would increase with: A. An increase in earnings. B. An increase in the current ratio. C. A stable interest coverage ratio. *D. An increase in the debt to equity ratio. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
72. Corporate bonds are less marketable than money market instruments and corporate equities because: A. corporate bonds are not tax exempt and money market securities are. B. the former are for smaller denominations. C. corporate bonds are in fact not less marketable than money market instruments and corporate equities. *D. corporate bonds are long-term securities, which tend to be riskier and less marketable. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
73. Credit-rating agency ratings are associated with which of the following investor risks? *A. Default risk. B. Reinvestment risk. C. Interest rate risk. D. Exchange rate risk. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
74. Which of the following statements is true? A. Interest rates always rise before recessions. B. Treasury bond yields are always higher than Treasury bill yields. *C. Default risk premiums vary inversely with economic activity. D. Municipal bond yields are usually higher than similar risk corporate yields. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
Module 8: Bond valuation
75. Default risk premiums vary _______ with the ________ of the security. A. inversely; maturity. *B. directly; default risk. C. directly; marketability. D. inversely; default risk. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
76. Historically, high default premiums have been associated with: A. generally rising interest rates. *B. economic recessions. C. the number of bonds rated by Moody's and Standard & Poor's. D. economic boom periods. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
77. Which of the following is not considered when assigning a bond rating? A. the amount of the fixed contractual cash payments. B. the variability of earnings. C. the issuer’s expected cash flow. *D. the rating on the prior issue of securities sold. LO 8.6: Discuss the concept of default risk and know how to calculate a default risk premium.
78. Inverted yield curves are observed when: *A. the economy is in recession. B. the economy is stagnant. C. the economy is growing. D. none of the above. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
79. Which one of the following statements is not true? A. The shape of the yield curve is not constant over time. B. As the general level of interest rises and falls over time, the yield curve shifts up and down and has different slopes. C. Yield curves show graphically how market yields vary as term to maturity changes. *D. The relationship between yield and marketability is known as the term structure of interest rates. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
80. The three economic factors that determine the shape of the yield curve are: A. the real rate of interest, the nominal rate of interest, and interest rate risk. B. the real rate of interest, the expected rate of inflation, and marketability. *C. the real rate of interest, the expected rate of inflation, and interest rate risk. D. the nominal rate of interest, the expected rate of inflation, and interest rate risk. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
81. The fundamental determinant of interest rates is the: A. market price. B. interaction between banks and borrowers. C. interaction between lenders and borrowers. *D. interaction of the production opportunities facing society and the individual’s time preference for consumption. Feedback: Given people’s positive time preference, the interest rate offered to savers will determine how thrifty those persons are. At low interest rates, most people will postpone very little consumption for the sake of saving. To coax people to postpone additional current consumption and to save more, higher interest rates, or rewards, must be offered. However, as the interest rate rises, fewer business projects can earn an expected return high enough to cover the added interest expense related to financing the project. As a result, at higher interest rates, fewer investment projects are undertaken. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
82. Interest rates should decrease if: *A. inflationary expectations have decreased. B. business investment demand has decreased significantly. C. Central Bank has decreased M1 and the supply of loanable funds. D. the economy is in a boom. Feedback: Interest rates change in response to changes in inflation because inflation is a primary component of nominal interest rates. A decreased in expected inflation puts downward pressure on the interest rates. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
83. The refers to the relationship between interest rates and the term to maturity on underlying debt instruments. A. liquidity preference theory. B. market segmentation theory. *C. term structure of interest rates. D. expectations theory. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
Module 8: Bond valuation
84. A one-year bond offers a 12.5% yield to maturity and a two-year bond offers an 11% yield to maturity. Which of the following is true? A. The term structure is flat. B. The term structure is upward sloping. C. The term structure cannot be determined. *D. The term structure is downward sloping. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
85. The general level of interest rates tends to follow: A. deflation. *B. the business cycle. C. the default cycle. D. all of the above. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
86. The term structure of interest rates: A. plots coupons versus time to maturity. B. describes how interest rates vary over coupons. C. ranks security yield according to the default risk structure. *D. describes the relationship between maturity and yield for similar securities. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
87. An upward sloping yield curve indicates that security investors expect future interest rates to _____ and security prices to ______. LO 8.7: Describe the factors that determine the level and shape of the yield curve. A. fall; rise. B. fall; fall. *C. rise; fall. D. rise; rise. 88. What actions by bond investors, given their expectations of increasing interest rates, result in an upward sloping yield curve? A. Selling short-term securities and holding cash. B. Selling long-term securities and holding cash. *C. Selling long-term securities and buying short-term securities. D. Buying long-term securities and selling short-term securities. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
89. The slope of the yield curve is affected by: A. liquidity preferences. B. the comparative equilibrium of supply and demand in the short-term and long-term market segments. C. inflationary expectations. *D. all of the above. LO 8.7: Describe the factors that determine the level and shape of the yield curve.
Module 9: Share valuation Multiple-choice questions 1.
The largest holders of equity securities are:
*A. households. B. managed funds. C. foreign investors. D. superannuation funds. LO 9.1: Describe the four types of secondary markets.
2.
Which one of the following statements is true about secondary markets?
*A. In secondary markets, outstanding shares are bought and sold among investors. B. An active secondary market causes companies to sell their new debt or equity issues at a higher cost of funds. C. For an investor, the function of secondary markets is to provide profitability for the shares of securities they own. D. All of the above are true statements. LO 9.1: Describe the four types of secondary markets.
3.
Which one of the following statements is true about secondary markets?
A. The presence of active brokers increases market inefficiency. B. The ordinary shares of large companies often rely on word-of-mouth to find interested buyers. *C. Brokers bring buyers and sellers together to earn a fee. D. A specialist is a specific location on the floor of a securities exchange at which auctions for a particular security take place. LO 9.1: Describe the four types of secondary markets.
4.
Which one of the following statements is not true about secondary markets?
A. In Australia, most secondary equity market transactions take place on the ASX. B. In terms of the number of companies listed and shares traded on a daily basis, the NYSE is larger than the ASX. C. Companies listed on the NYSE tend to be, on average, larger in size and their shares trade more frequently than companies whose securities trade on ASX. *D. In terms of total volume of activity and total capitalisation of the companies listed, the ASX is the largest in the world and the NYSE is the second largest. LO 9.1: Describe the four types of secondary markets.
Module 9: Share valuation
5.
Direct search markets are characterised by:
A. a high level of efficiency. B. complete price information. C. extensive broker and dealer participation. *D. private placement transactions and sale of ordinary shares of small private companies. LO 9.1: Describe the four types of secondary markets.
6.
The least efficient of all the different types of secondary markets is the:
A. dealer market. B. brokered market. C. auction market. *D. direct search market. LO 9.1: Describe the four types of secondary markets.
7.
Which one of the following statements is not true about brokered markets?
*A. Brokers can guarantee an order because they have an inventory of securities. B. Brokers bring buyers and sellers together to earn a fee, called a commission. C. Investors have an incentive to hire a broker because they charge a commission that is less than the cost of direct search. D. Brokers' extensive contacts provide them with a pool of price information that individual investors could not economically duplicate themselves. LO 9.1: Describe the four types of secondary markets.
8.
In brokered markets:
A. buyers and sellers are brought together for a transaction fee. B. brokers build a pool of price information through their extensive contacts. C. the commission charged by brokers is a lower cost to buyers and sellers than the cost of direct search. *D. all of the above are true of broker markets. LO 9.1: Describe the four types of secondary markets. 9.
Which one of the following statements is true about dealer markets?
A. Dealers do not place capital at risk. *B. Dealers guarantee the sale or purchase of an order. C. The NYSE is the best known example of a dealer market. D. A dealer market involves time-consuming search for a fair deal. LO 9.1: Describe the four types of secondary markets.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
10. Which one of the following statements is not true about auction markets? A. Auctioneers can also act as dealers in the NYSE. *B. The auction for a security can take place anywhere on the trading floor. C. In an auction market, buyers and sellers face each other directly and bargain over price. D. The New York Stock Exchange is the best-known example of an auction market. LO 9.1: Describe the four types of secondary markets.
11. Which one of the following statements is not true about ordinary shares? A. Ordinary shareholders have limited liability. B. Ordinary shares are considered to have no fixed maturity. C. Ordinary shareholders have the right to vote on the selection of the board of directors for the company. *D. Owners of ordinary shares are guaranteed dividend payments by the company. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
12. Which one of the following statements is true about ordinary shares? A. Ordinary shareholders have unlimited liability. B. Ordinary Shares are considered to have a fixed maturity. C. Owners of ordinary shares are guaranteed dividend payment by the company. *D. Owners of ordinary shares have the lowest-priority claim on the company's assets in the event of insolvency. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security. 13. Which one of the following statements is not true about preference shares? *A. Owners of preference shares are not guaranteed dividend payments by the company. B. Preference shareholders have limited voting privileges relative to ordinary share owners. C. Preference share dividends are fixed financial obligations to the company just like bond coupon payments. D. Preference shares represent ownership in the company. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
14. Which of the following characteristics is not associated with ordinary shares? A. Vote by proxy.
Module 9: Share valuation
B. Limited liability. *C. Cumulative dividends. D. Residual claim on income and assets. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
15. Which of the following statements is not correct? An ordinary shareholder in a troubled corporation: *A. may lose his/her house. B. does not receive dividends. C. records a decrease in the value of his/her assets. D. receives the proceeds from the sale of the assets after the creditors and the preference shareholders are paid if the company goes bankrupt. Feedback: Limited liability implies that the personal assets of the shareholders cannot be claimed by the creditors of the defaulting company. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
16. The term shareholder equity implies: A. a right to dividends. *B. an ownership claim. C. a prior claim on income and assets. D. a contractual relationship with a corporation. Feedback: In business and accounting, the shareholders' equity refers to the amount of assets that are owned by a company's shareholders. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security. 17. Preference shares are sometimes regarded as a debt security because: A. legally preference shares are a debt security. B. preference shareholders receive a residual value and not a stated value. C. preference dividends are paid out of before-tax income just like interest payments on bonds. *D. preference share dividend payments, like bond interest payments are considered fixed obligations for the company. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
18. The intrinsic value of a preference share is calculated in a similar way to:
Testbank to accompany: Finance essentials 1e by Kidwell et al.
A. coupon bonds. B. annuities. C. zero coupon bonds. *D. perpetuities. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
19. Traditional preference shares: A. have a maturity date. B. pay dividends of various amounts. C. pay dividends at irregular intervals. *D. are often referred to as fixed-income investments. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
20. Which of the following is not a correct statement about equity securities? A. No fixed maturity date. B. Ownership interests in an underlying entity. *C. Dividends are a tax-deductible expense for the issuer. D. Shareholders pay lower taxes on dividends than they would on interest payments. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
Module 9: Share valuation
21. In case of bankruptcy and liquidation of assets, what is the order of the claimants? A. Debt holders, equity holders and preferred shareholders equally. *B. Debt holders, preferred shareholders, equity holders. C. Debt holders, equity holders, preferred shareholders. D. Equity holders, debt holders, preferred shareholders. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
22. Which of the following is a false statement about preference shares? *A. Always have voting rights. B. Provide the owner with a claim to a fixed amount of equity. C. Have preference over common shares with respect to income and assets. D. Dividends must be paid in entirety before the common shareholders can receive any payments. LO 9.2: Explain why many financial analysts treat preference shares as a special type of bond rather than as an equity security.
23. A security is worth buying when its: A. price-earnings ratio is negative. B. dividend growth rate is positive. C. book value is greater than its market price. *D. intrinsic value is greater than its market price. Feedback: A security is worth buying when its intrinsic value exceeds its market price. LO 9.3: Describe how the general dividend valuation model values a share.
24. Which one of the following statements is not true about the general dividend valuation model? A. The model does not assume any specific pattern for dividend growth. B. The model calls for forecasting an infinite number of dividends for a share. *C. It makes a specific assumption about when the share is going to be sold in the future. D. All of the above are true. LO 9.3: Describe how the general dividend valuation model values a share.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
25. What are the sources of uncertainties in the valuation of common equities? *A. Cash flow size, timing, and discount rate. B. Cash flow size, timing, and risk-free rate. C. Discount rate only. D. Cash flow size and timing only. LO 9.3: Describe how the general dividend valuation model values a share.
26. Dividend valuation models are best applied to: *A. bank stocks. B. internet stocks. C. oil exploration stocks. D. none of the above. LO 9.3: Describe how the general dividend valuation model values a share.
27. The value of a common stock today depends on: A. the industry analysts. *B. the expected future dividends and the discount rate. C. the expected future common earnings per share. D. the number of authorised shares LO 9.3: Describe how the general dividend valuation model values a share.
28. The value of a stock increases as: A. the required rate of return increases. B. the required rate of return decreases. C. the dividend growth rate increases. *D. B and C are both correct. LO 9.3: Describe how the general dividend valuation model values a share.
Module 9: Share valuation
29. Which of the following is false? A. Australian companies normally pay dividends semi-annually. B. Dividend valuation models are best applied to blue chip companies. C. Intrinsic value is the present value of expected future cash flows discounted at the investor’s required rate of return. *D. Dividend discount models tend to be robust to the choice of estimate for the relevant estimates used within the model. Feedback: It can be seen that the intrinsic value calculated according to a particular dividend discount model is sensitive to the choice of estimates used within the model. Hence, such valuation methodology tends not to be robust to the choice of estimates used within the model. LO 9.3: Describe how the general dividend valuation model values a share.
30. Which of the following is/are needed when the discounted cash flow approach is used to value equity securities? A. Estimate the expected future cash flows associated with the security. B. Estimate the size and timing of the expected cash flows associated with the security. C. Determine the appropriate discount rate based on an estimate of the risk associated with the security. *D. All of these. LO 9.3: Describe how the general dividend valuation model values a share.
31. Value is best defined as the: *A. worth of an asset to an individual. B. accounting measure of an asset’s worth. C. amount of money needed to acquire an asset. D. none of the above. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
32. Which of the following statements is true? A. Corporations generally pay all their earnings as dividends. B. A firm’s residual earnings technically belong to the preferred shareholders. C. Corporations typically reinvest none of their earnings to enhance future earnings. *D. The only cash flows that an investor will receive until he or she sells their shares will be the dividends. LO 9.3: Describe how the general dividend valuation model values a share.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
33. Lizzy’s Pet Parlour Ltd has not paid out any dividend in the last three years. It does not expect to pay dividends in the next two years either as it recovers from an economic slowdown. Three years from now it expects to pay a dividend of $2.50 and then $3.00 in the following two years. What is the present value of the dividends to be received over the next five years if the discount rate is 15 percent? *A. $4.85. B. $5.37. C. $5.50. D. $6.14. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
34. BlueSteel Manufacturing Company has been generating stable revenues but sees no growth in it for the foreseeable future. The company's last dividend was $3.25, and it is unlikely to change the amount paid out. If the required rate of return is 12 percent, what is the share worth today? A. $39.00. B. $3.69. *C. $27.08. D. $21.23. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
35. You are interested in investing in a company that expects to grow steadily at an annual rate of 6 percent for the foreseeable future. The company paid a dividend of $2.30 last year. If your required rate of return is 10 percent, what is the most you would be willing to pay for this share? (Round to the nearest dollar.) A. $23. B. $24. C. $58. *D. $61. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
Module 9: Share valuation
36. Johnson Co has just paid a dividend of $4.45. The company has forecasted a growth rate of 8 percent for the next several years. If the appropriate discount rate is 14 percent, what is the current price of this share? (Round to the nearest dollar.) A. $74. B. $32. *C. $80. D. $60. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
37. Cloud Storage Ltd is a fast growing technology company. The company projects a rapid growth of 40 percent for the next two years and then a growth rate of 20 percent for the following two years. After that, the company expects a constant-growth rate of 8 percent. The company expects to pay its first dividend of $1.25 a year from now. If your required rate of return on such shares is 20 percent, what is the current price of the share? *A. $15.63. B. $4.70. C. $30.30. D. $22.68. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
38. Kwik Lift Ltd will pay dividends of $4.75, $5.25, $5.75, and $7 for the next four years. Thereafter, the company expects its growth rate to be at a constant rate of 7 percent. If the required rate of return is 15 percent, what is the current market price of the share? *A. $69.42. B. $93.63. C. $57.54. D. $80.29. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
39. A share that pays $20 in dividends this year with an annual growth rate of 3% forever for a required return of 5% has a valuation of: A. $257. B. $412. C. $420. *D. $1,030. Feedback: P=20X(1+0.03)/(0.05-0.03)=1,030. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
40. A share that pays $20 in dividends next year with an annual growth rate of 3% forever for a required return of 5% has a valuation of: A. $412. B. $420. *C. $1,000. D. $1,030. Feedback: P=20/(0.05-0.03)=1,000. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
41. What is the estimated value of a share that paid a $5 dividend this year, has dividends expected to grow at 6 per cent every year, and requires a 20 per cent return? A. $20.38. B. $25.00. C. $35.71. *D. $37.86. Feedback: 5 (1+0.06) /(0.2-0.06)=37.857. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
Module 9: Share valuation
42. A company has just paid a dividend on 20 cents per ordinary share. If dividends are expected to grow indefinitely at the rate of 5% pa and an investor’s required rate of return is 15%, what is the share’s intrinsic value? A. $1.33. B. $1.40. C. $2.00. *D. $2.10. Feedback: Next year’s dividend is expected to be 21 cents per share. The denominator is re − g: i.e. 15% − 5% = 10%. $0.21 0.1 = $2.10. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
43. Which one of the following statements is not true about zero-growth shares? *A. Dividend payments are zero. B. Dividend stays constant over time. C. There is no growth in dividends over time. D. The cash flow pattern resembles a perpetuity with a constant cash flow. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
44. Rum City Foods Ltd is a wholesale company of frozen foods. The company pays a dividend of $7 per share per year, and the board of directors have no plan to change the dividend payouts. Investors within the company expect a return of 25% per share that they own. What is the price of one share? A. $0.25. B. $7.00 C. $7.25. *D. $28.00. Feedback: The board of directors follow the zero growth dividend model and since the cash dividend payments are constant, we simply calculate the price of shares by dividing the dividend per share by the expected return from the investors, i.e., $7/0.25=$28. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
45. Suppose that the current cash dividend of Capri Ltd is $0.30. Financial analysts expect the dividends to grow at a constant rate of 7 per cent per year, and investors require a 15 per cent return on this class of shares. What should be the current share price of Capri? *A. $4.01. B. $3.75. C. $13.37. D. $0.80. Feedback: The question looks at pricing the share under the constant growth model. Moreover, the question is asking about the current share price. To start with, we are required to calculate dividend payment in the coming year, i.e., D1. Applying the current share pricing formula within the book, the answer is $4.01 LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
46. Under the mixed growth dividend model, the assumption is: A. a firm experiences non-constant growth in dividend payments. *B. a firm experiences a mix of constant and non-constant growth in dividend payments. C. a firm experiences a mix of constant and non-constant dividend payments (dollar amounts). D. none of the above. Feedback: Companies typically go through life cycles which eventually result in different patterns over time. As such, under the mixed growth dividend model, it is assumed that a firm experiences a mix of constant and non-constant growth in dividend payments. As a consequence, modifications need to be made to the dividend growth model pricing of shares. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
47. Bundaberg Brewed Drinks Corporation has just announced a dividend of $0.80 for this year and $0.835 for the next year. Dividends are expected to grow at a constant rate indefinitely. What is the current stock price if the required return is 13.1 percent? A. $8.55. B. $9.35. *C. $9.57. D. $10.37. Feedback: Compute g = ($0.835/$0.80)–1 = 4.375%, then P0 = D1/kc–g = $0.835/13.1−4.375 = $9.57 LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
Module 9: Share valuation
48. Which of the following is not a correct statement of the Constant Growth Dividend Discount Model? *A. It holds only when kc < g. B. Only future estimated cash flows and estimated growth in these cash flows are relevant. C. It holds only when growth in dividends is expected to occur at the same rate indefinitely. D. It is a version of the dividend discount model for valuing common shares that assumes that dividends grow at a constant rate indefinitely. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares. 49. Matt’s Carpentry Services Inc. has just paid a dividend of $0.55 per share. The dividends are expected to grow at an annual rate of 5 percent indefinitely. What is today’s stock price if the required return is 12.5 percent? A. $4.62. B $7.33. *C. $7.70. D. $11.55. Feedback: kc = [$0.55(1+5%)]/(12.5%−5%) = $7.70 LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
50. Dave Amos Ltd pays a constant dividend of $2 every year. What will the stock sell for three years from now if the required rate of return is 9 percent? A. $21.30. *B. $22.22. C. $25.70. D. $28.78. Feedback: P3 = 2/9% LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
51. The common stock of Grunskies Ltd currently sells for $48 per share. The firm has a constant dividend growth rate of 6 percent. If the required rate of return is 15 percent, what is the expected dividend yield on the stock? A. 6.0%. B. 8.5%. *C. 9.0%. D. 15.0%. Feedback: Dividend yield = kc−g = 15%–6% = 9% LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
52. A share is expected to pay dividends of $1 in one year, $1.20 in two years and then $1.30 in three years with this amount lasting in perpetuity. The current intrinsic value of this share given a discount rate of 5% is: A. $25.10. *B. $25.62. C. $26.43. D. $38.43. LO 9.4: Discuss the assumptions necessary to make the general dividend valuation model easier to use, and use the model to calculate the value of a company’s ordinary shares.
53. Plumbwise Ltd issued 200,000 preferred shares with a book value of $10 million three years ago. If the required return is 8.42% and the current market value of these preferred shares is $9.5 million, what is the annual dividend? A. $2.50. *B. $4.00. C. $4.71. D. Cannot be calculated. Feedback: (9,500,000*8.42%)/200,000=$4.00. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
Module 9: Share valuation
54. Coral Coast Printers Ltd’s preferred stock is selling for $30 per share. What is the expected dividend of year four if the required rate of return is 7.5 percent? A. $3.25. B. $2.00. *C. $2.25. D. $3.00. Feedback: Dp = $30*7.5% = $2.25 LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
55. Bedrock Ltd is about to issue preference shares paying $5 per year. If preference shareholders have a required rate of return of 12%, the current price of Bedrock’s preference shares is: A. $5.60. *B. $42. C. $50. D. $100. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
56. If the required rate of return is higher than the dividend rate of a preferred share, the par value is _________________ the current market value of the preferred share. A. independent of. B. less than. C. equal to. *D. higher than. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
57. A preference share is known to be: A. a debt instrument. *B. a hybrid instrument. C. an equity instrument. D. none of the above. Feedback: A preference share is a hybrid instrument as it contains features of both debt (callable and sometimes have credit ratings) and equity instruments (ownership of company) . It is sometime referred as a special type of bond. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
58. Chameleon Company has issued perpetual preference shares with a par of $100 and a dividend of 5.5 percent. If the required rate of return is 7.75 percent, what is the share’s current market price? A. $12.90. B. $53.27. C. $62.14. *D. $70.97. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
59. The National Bank of Australia has issued perpetual preference shares with a $100 par value. The bank pays a quarterly dividend of $1.40 on this share. What is the current price of this preference share given a required rate of return of 8.5 percent? A. $23.06. B. $37.57. C. $43.25. *D. $65.88. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
Module 9: Share valuation
60. Just Us Realty Ltd has issued perpetual preference shares with a $100 par value. The company pays a quarterly dividend of $2.60 on this share. What is the current price of this preference share given a required rate of return of 12.5 percent? A. $20.80. B. $47.25. C. $80.00. *D. $83.20. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
61. Given that the required return on a preference share is 10% and that the preference share’s current price is $7.50, then the dividend payment per preference share is: *A. 7.5%. B. 5.5%. C. 75%. D. 10%. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions. 62. Bushman Sheds Ltd’s preference shares are trading at $33.33. Given that investor’s required return is 18%, the current dividend yield on Bushman Shed’s preference shares is: A. 6%. B. 24%. C. 16%. *D. 18%. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
63. Century 21 preferred shares have a par value of $60 and are selling for $50. What is the required rate of return if the preferred shares pay an annual dividend of 6 percent? A. 5.00%. B. 6.00%. *C. 7.2%. D. 11.11%. Feedback: k = Dp/Pps = 60*6%/50 = 7.2% LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
64. Determine the market price of a $50 par value preferred share that pays annual dividends based on a 4 percent dividend rate when the market rate is 5%? A. $35. *B. $40. C. $50. D. $60. Feedback: 50*0.04/0.05=$40 LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
65. Determine the required rate of return on preferred shares that provide a $10 annual dividend if they are selling for $60? A. 15.66%. *B. 16.66%. C. 17.14%. D. 18.14%. Feedback: 10/60 = 16.66% LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
Module 9: Share valuation
66. The preference share of Gainsite Ltd is selling currently at $110.35. If your required rate of return is 9.75 percent, what is the dividend paid by this share? A. $9.75. B. $11.32. *C. $10.76. D. $8.53. LO 9.5: Explain how valuing preference shares with a stated maturity differs from valuing preference shares with no maturity date, and calculate the price of a preference share under both conditions.
Module 10: Capital budgeting and cash flows Multiple-choice questions 1.
Capital budgeting is about:
*A. the search for the best capital projects. B. the search for projects with the least costs. C. the search for the next best alternative projects. D. all of the above. Feedback: Capital budgeting is about management’s search for the best capital projects — those that add the greatest value to the company. LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
2.
The cost of capital is defined as:
A. the rate of return that is below the market rate of return. B. the rate of return that is above the market rate of return. *C. the rate of return that a capital project must earn to be accepted by management. D. all of the above. Feedback: The cost of capital is the rate of return that a capital project must earn to be accepted by management LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
3.
The opportunity cost of capital is defined as:
A. the return that is lost on investing in assets. *B. the return that an investor gives up when their money is invested in one asset rather than the best alternative asset. C. the return that is ultimately recouped within the lifetime of the project. D. all of the above. Feedback: The return that an investor gives up when their money is invested in one asset rather than the best alternative asset LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
Module 10: Capital budgeting and cash flows
4.
Which of the following is not true about capital budgeting?
A. It involves large capital investments. *B. The large capital investments can be reversed at any time. C. It involves identifying projects that will add to the company's value. D. It allows the company's management to analyse potential business opportunities and decide on which ones to undertake. LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
5.
Which of the following are aspects of independent projects?
A. Selecting one would automatically eliminate accepting the other. B. Their cash flows are related. *C. Their cash flows are unrelated. D. None of the above. LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
6.
Two projects are considered to be mutually exclusive if:
A. the projects perform the same function. B. their cash flows are unrelated. C. selecting one would automatically eliminate accepting the other. *D. both A and C. LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
7.
Two projects are considered to be contingent projects if:
A. rejection of one project does not eliminate the selection of the other. B. selecting one would automatically eliminate accepting the other. *C. the acceptance of one project is dependent on the acceptance of the other. D. none of the above. LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management. 8.
A construction company is evaluating two value-adding projects. The first project deals with building access roads to a new terminal at the local airport. The second project is to build a parking garage on a piece of land that the company owns adjacent to the airport. If both projects are positive-NPV projects, then the company should:
Testbank to accompany: Finance essentials 1e by Kidwell et al.
A. not enough information is given to make a decision. B. accept both projects because they are contingent projects. *C. accept both projects because they are independent projects. D. select the higher NPV project because they are mutually exclusive. LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
9.
Capital expenditures are:
A. a firm’s investments in net working capital. B. a firm’s investments in financial securities. *C. a firm’s investments in long-lived tangible and non-tangible assets. D. all of the above. LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
10. Capital budgeting is: A. the process of raising capital in the financial markets. *B. the process through which a firm makes capital expenditure decisions. C. the process through which a firm makes investment in stocks. D. none of the above. LO 10.1: Discuss why capital budgeting decisions are the most important investment decisions made by a company’s management.
11. If NPV < 0, a project should be: *A. rejected. B. considered in future years. C. accepted. D. none of the above. Feedback: NPV<0, reject project LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods. 12. One of the key advantages of using the NPV is the use of a discounted cash flow valuation technique that: *A. adjusts for the time value of money. B. ignores the time value of money. C. minimises expenses. D. none of the above.
Module 10: Capital budgeting and cash flows
Feedback: NPV uses the discounted cash flow valuation technique to adjust for the time value of money. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
13. One of the drawbacks of the payback period is that: A. it is difficult to apply in real life. *B. it ignores the time value of money. C. it considers the time value of money. D. none of the above. Feedback: One of the drawbacks of the payback period is that it ignores the time value of money. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods. 14. The payback period is widely used because it measures a project’s: A. interest rate risk. B. operational risk. *C. liquidity risk. D. all of the above. Feedback: the standard payback period is widely used in business in part because it provides an intuitive and simple measure of a project’s liquidity risk. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
15. If the IRR > cost of capital, a project should be: A. rejected. *B. accepted. C. further analysed. D. none of the above. Feedback: IRR > Cost of capital then accept the project. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods. 16. A post-audit review is: A. an audit of the profits and losses involved in projects. *B. an audit to compare actual project results with the projected results. C. an audit of the condition of the assets at the end of the project. D. none of the above.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
Feedback: In a post-audit review, management compares the actual performance of a project with what was projected in the capital budgeting proposal. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
17. In computing the NPV of a capital budgeting project, one should not: *A. ignore the salvage value. B. estimate the cost of the project. C. make a decision based on the project's NPV. D. discount the future cash flows over the project's expected life. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
18. Earl Grey Enterprises plans to build a new plant at a cost of $3,250,000. The plant is expected to generate annual cash flows of $1,225,000 for the next five years. If the company's required rate of return is 18 percent, what is the NPV of this project? *A. $580,785. B. $2,122,875. C. $2,785,000. D. $3,830,785. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
19. Lemon Tree Passage Ltd is adding a new assembly line at a cost of $8.5 million. The company expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. What is the payback period for this project? A. 2.8 years. *B. 2.9 years. C. 3.1 years. D. 3.4 years. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods. 20. Avery’s Manufacturing Company is purchasing a production facility at a cost of $21 million. The company expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the net present value of this project? A. $777,713. *B. $890,197.
Module 10: Capital budgeting and cash flows
C. $905,888. D. $1,213,909. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
21. Bizarre Manufacturing Company is purchasing a production facility at a cost of $21 million. The company expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the payback period for this project? A. 2.8 years. *B. 3.0 years. C. 3.2 years. D. 3.4 years. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
22. Which one of the following statements about the payback method is true? A. The payback method is consistent with the goal of shareholder wealth maximisation *B. There is no economic rationale that links the payback method to shareholder wealth maximisation. C. The payback method represents the number of years it takes a project to recover its initial investment plus a required rate of return. D. None of the above statements are true. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
23. Lammi Bros is getting ready to produce a new line of gold clubs by investing $1.85 million. The investment will result in additional cash flows of $525,000, $812,500, and 1,200,000 over the next three years. What is the payback period for this project? A. 1.57 years. *B. 2.43 years. C. 3 years. D. More than 3 years. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
24. The ARR is not recommended as a capital expenditure tool because: A. it is based upon accounting numbers. B. it does not discount a project cash flow over time. C. it only provides numbers based upon average figures from the balance sheet. *D. all of the above. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
25. Allwired Autoelectrix has forecasted that over the next four years the average annual after-tax income will be $45,731. The average book value of the manufacturing equipment that is used is $167,095. What is the accounting rate of return? A. 22.3%. *B. 27.4%. C. 29.8%. D. 33.3%. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
26. The internal rate of return is: A. the discount rate that makes the NPV less than zero. *B. the discount rate that makes the NPV equal to zero. C. the discount rate that makes the NPV greater than zero. D. none of the above. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
Module 10: Capital budgeting and cash flows
27. When evaluating capital projects, the decisions using the NPV method and the IRR method will agree if: *A. the projects are independent. B. the cash flow pattern is unconventional. C. the projects are mutually exclusive. D. all of the above. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
28. Which one of the following cash flow patterns is not an unconventional cash flow pattern? *A. A negative initial cash flow is followed by positive future cash flows. B. A positive initial cash flow is followed by negative future cash flows. C. Future cash flows from a project could include both positive and negative cash flows. D. A cash flow stream looks similar to a conventional cash flow stream except for a final negative cash flow. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
29. Eastern Opal Property Development Company is refurbishing a 200-unit condominium complex at a cost of $1,875,000. It expects that this will lead to expected annual cash flows of $415,350 for the next seven years. What internal rate of return can the company earn from this project? (Round to the nearest percent.) A. 10%. *B. 12%. C. 14%. D. 16%. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
30. The National Broadband Network has been installing a fiber-optic network at a cost of $18 million. The company expects annual cash flows of $3.7 million over the next 10 years. What is this project's internal rate of return? (Round to the nearest percent.) A. 12%. B. 14%. *C. 16%. D. 18%. LO 10.2: Evaluate capital budgeting projects using the net present value (NPV), payback period, accounting rate of return and internal rate of return methods.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
31. The cash flows used in capital budgeting calculations are based on. A. forecasts of profit. B. historical estimates. C. forecasts of retained earnings available for financing projects. *D. forecasts of future cash revenues, expenses, and investment outlays. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
32. The term ___________ refers to the fact that these cash flows reflect the amount by which the company's total after-tax free cash flows will change if the project is adopted. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project. A. periodic. *B. incremental. C. ending cash flows. D. none of the above.
33. The idea that we can evaluate the cash flows from a project independently of the cash flows for the company is known as: A. the independent principle. *B. the stand-alone principle. C. the dependent principle. D. none of the above. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
34. Additions to tangible assets, intangible assets, and current assets can be described as: A. free cash flows. B. operating cash flows. *C. cash flows associated with investments. D. none of the above. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
Module 10: Capital budgeting and cash flows
35. The impact of a project on a company's overall value depends on: *A. a project's cash flow. B. a company's cash flow. C. a company's accounting earnings. D. none of the above. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
36. Which one of the following represents the change in net working capital? A. The level of inventory in the project. *B. The difference between current assets and current liabilities. C. The difference between the account receivables at the end and beginning of the project. D. The difference between the account payables at the end and beginning of the project. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
37. Capital budgeting is: A present looking. *B. forward looking. C. backward looking. D. none of the above. Feedback: In capital budgeting, we estimate the NPV of the cash flows that a project is expected to produce in the future. In other words, all of the cash flow estimates are forward looking. This is very different from the accounting statement of cash flows, which provides a record of historical cash flows. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
38. Incremental capital expenditure is defined as: A
the investments in short term assets property, plant and equipment and other long term assets that must be made if a project is pursued. *B. the investments in property, plant and equipment and other long term assets that must be made if a project is pursued. C. the investments in property, plant and equipment and other long term assets that must be made if a project is discontinued. D. none of the above. Feedback: The investments in property, plant and equipment and other long term assets that must be made if a project is pursued. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
39. Incremental depreciation and amortisation are: A. excluded at the end of a project. *B. charges that are associated with a project. C. charges that are ignored in a project. D. none of the above. Feedback: Incremental depreciation and amortisation are charges that are associated with a project LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
40. Which statement is true? A. Past FCF should be used for each year of the life of the project. *B. Expected FCF should be used for each year of the life of the project. C. Expected FCF should be not used for each year of the life of the project. D. None of the above. Feedback: It is very important to realise that in an NPV analysis we use the expected FCF for each year of the life of the project LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
Module 10: Capital budgeting and cash flows
41. In an NPV analysis, FCFs are: A. ignored. *B. discounted. C. not discounted. D. none of the above. Feedback: Not only are the FCFs that we discount forward looking, but they also reflect expected FCFs. Each FCF is a weighted average of the cash flows from each possible future outcome, where the cash flow from each outcome is weighted by the estimated probability that the outcome will be realised. The expected FCF represents the single best estimate of what the actual FCF will be. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
42. Incremental cash flows are of primary interest in capital budgeting decisions because: A. they are the easiest cash flows to identify. B. they are more relevant than intangible costs and benefits. *C. the change in the company’s future cash flows is what is being estimated. D. they are able to correct for a portion of the uncertainty due to the long time horizon. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
43. Which of the following is not an incremental cash flow? A. Cannibalisation. B. Proceeds from the sale of old equipment. *C. Research and development costs for the new product, which have already been undertaken. D. Reduction in sales of an existing product line as a result of the introduction of the new product line. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
44. Which of the following statements is correct? *A. Investment in net working capital is not depreciated because it is not a depreciable asset. B. Investment in net working capital is not depreciated because it is not an operating cash flow. C. Investment in net working capital is not depreciated because it is a sunk cost. D. All of the above. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
45. Which of the following is not relevant to the cash flow estimates that are associated with a project? A. The effect of inflation. B. The terminal cash flow. *C. The associated financing costs. D. The economic life of the project. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
46. Which of the following is correct with respect to working capital and capital budgeting? A. Working capital does not affect cash flow. B. Working capital has a different discount rate. C. Working capital is ignored in the capital budget. *D. Working capital is assumed to be recuperated at the end of the life of the project. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
47. If the asset is depreciated completely before the end of the life of the project, what happens to the salvage value? A. The asset’s life is extended. B. The salvage value is amortised further. C. The salvage value is ignored in the capital budget. *D. The after-tax salvage value is discounted at the date of the disposal of the asset. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
48. What is the difference between the initial cash flow and the purchase price of an asset? A. Capital costs. B. Set up costs only. *C. Other capital costs and net working capital. D. None of the above. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
Module 10: Capital budgeting and cash flows
49. Revived Designz is looking at an opportunity of setting up a new production facility, which requires the purchase of a new printing press that costs $1 million. The costs to install the machine are $60,000. The new facility is to be built on a piece of land that the company bought for $150,000 five years ago. The market value of the land is $250,000. The R&D costs associated with the investment opportunity were $50,000. In addition, the company will need to purchase $40,000 additional inventory for the project use. What is the initial after-tax cash flow associated with the investment opportunity? A. $1,250,000. B. $1,300,000. *C. $1,350,000. D. $1,400,000. Feedback: CF0 = $1,000,000 + $60,000 + $40,000 + $250,000 = $1,350,000 LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
50. Given the following information on a project: initial capital cost = $500,000; installation costs associated with the capital asset = $25,000; R&D costs associated with the project = $50,000; associated opportunity costs = $80,000; increase in raw materials inventory = $10,000, which of these amounts is included with working capital? *A. $10,000. B. $25,000. C. $50,000. D. $80,000. LO 10.3: Explain why incremental after-tax free cash flows are relevant in evaluating a project, and calculate them for a project.
51. Which of the following should not be included in a project's cash flow calculations? A. Cash revenues. B. Cash expenses. *C. Allocated expenses. D. None of the above. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
52. Corporate overhead allocations should only be taken into account on project analysis if: A. the overhead allocations involve cash expenditures. B. the company is currently covering all of its overhead allocations. C. the company is currently unable to cover all of its overhead allocations. *D. none of the above. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
53. Rover Mowers Ltd currently has two large manufacturing divisions that share a single plant. Rover Mowers owns the plant but has calculated that $6 million of overhead expenses should be allocated to the two equal-sized divisions. If Rover Mowers starts a third manufacturing division, of equal size to the other two divisions, then what overhead cost should the new division take into account on its capital budgeting cash flow analysis? *A. $0. B. $2 million. C. $3 million. D. $6 million. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
54. A company is considering taking a project that will produce $12 million of revenue per year. Cash expenses will be $5 million, and depreciation expenses will be $1 million per year. If the company takes that project, then it will reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the company is in the 40 percent marginal tax rate? A. $4.6 million. B. $2.4 million. *C. $3.4 million. D. $5.0 million. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
55. Whenever a project has a negative impact on an existing project's cash flows, then that effect should: A. be ignored. B. be included if the impact is limited to non-cash expenditures. C. be ignored if the project is evaluated using the correct cost of capital. *D. be included as a negative revenue amount on the new project's cash flow analysis. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
56. If a company has the option of leasing some factory space to another company or utilising it for another product line, then if the company chose the product line how should it handle the lost lease payments on the factory space? A. Include half of it as additional revenue for the project. B. Ignore it. *C. Include it as an opportunity cost. D. None of the above. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
Module 10: Capital budgeting and cash flows
57. Which of the following is the best example of a sunk cost? A. Historical non-cash expenses. B. Future payments on a leased building. C. Future research and development costs. *D. Historical research and development costs. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
58. _____________ represent dollars stated in terms of constant purchasing power. *A. Real dollars. B. Inflated dollars. C. Nominal dollars. D. None of the above. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
59. When compared to the straight-line depreciation method, reducing-balance method has: A. a lesser proportion of its depreciation early in the life of the asset. B. an equal proportion of its depreciation early in the life of the asset. *C. a greater proportion of its depreciation early in the life of the asset. D. none of the above. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
60. Sunk cost are: *A. Past investments that are irrelevant. B. Past investments that are relevant. C. Present investments that are relevant. D. Present investments that are irrelevant. Feedback: Sunk costs are costs that have already been incurred. All that matters when you evaluate a project at a particular point in time is how much you have to invest in the future and what you can expect to receive in return for that investment. Past investments are irrelevant. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
61. Which of the following should not be considered in the capital budgeting decision? *A. Sunk costs. B. Initial cash outlay. C. Opportunity costs. D. Working capital requirements. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations. 62. A company is considering taking over a firm that has a very good company image. The company image cannot be assessed in financial terms and has no direct link to the change in cash flows. How can we categorise the company’s image? A. Sunk Cost. *B. Intangible. C. Externality. D. Opportunity cost. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
63. A real estate company started the exploration of buying a piece of land for condos. The company bought the land and started breaking ground. The housing market crashed, and the amount spent may not be recovered completely. What do we call the costs involved with the development of the land? *A. A sunk cost. B. A financing cost. C. An opportunity cost. D. An incremental cost. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
64. A real estate company started the exploration of buying a piece of land for condos. The company bought the land and started breaking ground. The housing market crashed, and the amount spent may not be recovered completely. What do we call the costs involved with the purchase of the land? A. A sunk cost. B. A financing cost. *C. An opportunity cost. D. An incremental cost. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
Module 10: Capital budgeting and cash flows
65. A pharmaceutical company has discovered a new drug that treats gastrointestinal disorders. In the testing phase of this new drug, the company further discovered that the drug is effective against migraine headaches. The R&D costs for the drug were $3 million. When evaluating the capital budgeting decision for the migraine remedy, what portion of the R&D costs for the drug should be attributed to the migraine budget? A. 100 percent of the R&D costs. *B. 0 percent of the R&D costs. C. 50 percent of the R&D costs. D. It cannot be determined until the drug is further tested. There may be more uses for this drug and further testing is required. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
66. Which of the following would not be included in a capital budgeting evaluation? A. Taxes. *B. External benefits. C. Incremental cash flows. D. Effects of price level changes. LO 10.4: Discuss the five general rules for incremental after-tax free cash flow calculations.
Module 11: Cost of capital and working capital management Multiple-choice questions 1.
Companies have no way to directly estimate the discount rate that reflects the risk of:
A. its debt securities. *B. the incremental cash flows from a particular project. C. a publicly traded security. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
2.
A company's overall cost of capital is:
A. best measured by the cost of capital of the riskiest projects that the company is working on. B. equal to its cost debt. *C. a weighted average of the costs of capital for the collection of individual projects that the company is working on. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
3.
A balance sheet that uses market value of expected cash flows is referred to as a:
A. cash flow statement. *B. finance balance sheet. C. market value balance sheet. D. such balance sheet does not exist. Feedback: To understand how financial analysts estimate their companies’ costs of capital, you must be familiar with a concept that we call the finance balance sheet. The finance balance sheet is like the accounting balance sheet. The main difference is that it is based on market values rather than book values. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
Module 11: Cost of capital and working capital management
4.
The beta for a company can be estimated by:
*A. taking the weighted average of the beta for the individual projects of the company. B. taking the simple average of the beta for the individual projects of the company. C. adding up the betas of the individual projects of the company. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
5.
The company can be viewed as:
A. a collection of equity shares comprising it. B. a collection of debt instruments financing it. *C. a portfolio of individual projects, each with their own risks, cost of capital, and returns. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
6.
In order for a company to estimate its cost of debt capital by observing the price of its debt instruments,
A. the debt must be privately held. *B. the company must depend on markets being reasonably efficient. C. the beta of the debt must be greater than the beta of the company's equity. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
7.
When estimating the cost of debt capital for the company, we are primarily interested in,
A. the coupon rate of the debt. B. the cost of short-term debt. *C. the cost of long-term debt. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
8.
When analysing a company's cost of debt, we are typically interested in:
A. the risk-free rate plus half a percent. B. the coupon rate on the company's bonds. *C. the cost of the debt on the date that the analysis is being completed. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
9.
If a company has bonds outstanding and the company would like to calculate the current cost of debt for the bonds, then the company would:
A. use the current coupon yield of the bonds to estimate the cost. B. use the coupon rate of the bonds to estimate the cost. *C. use the current yield to maturity of the bonds to estimate the cost. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
10. Bond issuance costs include: A. legal fees. B. accountant fees. C. investment banking fees. *D. all of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
11. Income tax has the effect of: *A. decreasing the cost of debt. B. increasing the cost of debt. C. increasing the cost of capital for the company. D. both B and C are correct. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
Module 11: Cost of capital and working capital management
12. Leading Machinery Ltd has bonds outstanding with five years to maturity and are priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the bonds? (Assume $1,000 face value of bonds and semi-annual compounding.) A. 4.5%. B. 7.0% *C. 9.0%. D. 9.2%. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
13. Omo Ltd has bonds outstanding with 12 years to maturity and are currently priced at $1,080.29. If the bonds have a coupon rate of 8 percent, then what is the equivalent annual return (EAR) to the investor for purchasing the bonds at the described price? (Assume semi-annual interest and a face value of $1,000.) A. 3.5%. B. 7.00%. *C. 7.12%. D. 8.00%. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
14. Battery World has bonds outstanding with 13 years to maturity and are currently priced at $746.16. If the bonds have a coupon rate of 8.5 percent, then what is the after-tax cost of debt for Beckham if its company tax rate is 35%? A. 6.25%. *B. 8.16%. C. 12.50%. D. 12.89%. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
15. The appropriate risk-free rate to use when calculating the cost of equity for a company is: A. a short-term Treasury rate. B. a 50/50 mix of short-term and long-term Treasury rates. *C. a long-term Treasury rate. D. none of the above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
16. In order to use the WACC to evaluate a future project's flows, which of the following must hold? A. The project must be viable. B. The project will be financed with the same proportion of debt and equity as the company. C. The systematic risk of the project is the same as the overall systematic risk of the company. *D. B and C above. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
17. Erik Lye Drilling Ltd has a beta of 1.3 and is trying to calculate its cost of equity capital. If the risk-free rate of return is 8 percent and the expected return on the market is 12 percent, then what is the company's after-tax cost of equity capital if the company's company tax rate is 30 percent? A. 7.92%. *B. 13.20%. C. 15.57%. D. 23.60%. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects. 18. Bluescope Ltd is expected to pay a dividend of $2.10 one year from today. If the company's growth in dividends is expected to remain at a flat 3 percent forever, then what is the cost of equity capital for Gangland if the price of its ordinary shares is currently $17.50? A. 12.00%. B. 14.65%. *C. 15.00%. D. 15.36%. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
Module 11: Cost of capital and working capital management
19. Westco Ltd has a preference share issue outstanding with a current price of $38.89. The company last paid a dividend on the issue of $3.50 per share. What is the company's cost of preference shares? A. 7%. B. 8%. *C. 9%. D. 10%. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
20. Chapman Ltd has a preference share issue outstanding with a current price of $26.57. The company is expected to pay a dividend of $1.86 per share a year from today. What is the company's cost of preference shares? A. 6.50%. *B. 7.00%. C. 7.50%. D. 8.00%. LO 11.1: Explain how to calculate the overall cost of capital for a company which uses debt and equity financing for projects.
21. Gateway Motorcycles Ltd has 3 million shares outstanding at a current price of $15 per share. The book value of the shares is $10 per share. The company also has $30 million in par value of bonds outstanding. The bonds are selling at a price equal to 101 percent of par. What is the market value of the company? A. $30.0 million. B. $45.0 million. C. $75.0 million. *D. $75.3 million. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
22. The Rhapsody Day Spa Co has invested 40 percent of the company's assets in a project with a beta of 0.4 and the remaining assets in a project with a beta of 1.8. What is the beta of the company? A. 0.96. *B. 1.24. C. 1.28. D. None of the above. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
23. You are analysing the cost of capital for a company that is financed with 65 percent equity and 35 percent debt. The after-tax cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the company. What is the overall cost of capital for the company? A. 12.2%. B. 14.0%. *C. 15.8%. D. 20.0%. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project. 24. You are analysing the cost of capital for a company that is financed with $300 million of equity and $200 million of debt. The after-tax cost of debt capital for the company is 9 percent, while the cost of equity capital is 19 percent. What is the overall cost of capital for the company? A. 14.0%. *B. 15.0%. C. 16.0%. D. 16.5%. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
Module 11: Cost of capital and working capital management
25. The WACC for a company is 13.00 percent. You know that the company's cost of debt capital is 10 percent and the cost of equity capital is 20%. What proportion of the company is financed with debt? A. 33%. B. 50%. *C. 70%. D. 67%. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
26. Fernland Agencies Ltd has found that its cost of equity capital is 18 percent, and its cost of debt capital is 8 percent. If the company is financed with 60 percent ordinary shares and 40 percent debt, then what is the after-tax weighted average cost of capital for Fernland Agencies if it is subject to a 40 percent company tax rate? A. 10.37%. B. 12.00%. *C. 12.72%. D. 14.00%. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
27. Tropical Paradise Nursery Ltd has found that its cost of equity capital is 17 percent and its cost of debt capital is 6 percent. If the company is financed with $3,000,000 of ordinary shares (market value) and $2,000,000 of debt, then what is the after-tax weighted average cost of capital for Tropical Paradise Nursery if it is subject to a 40 percent company tax rate? A. 8.96%. B. 11.16%. *C. 11.64%. D. 12.60%. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
28. Barnyard Stockfeed Ltd has found that its cost of equity capital is 15 percent and its cost of debt capital is 12 percent. If the company is financed with $250,000,000 of ordinary shares (market value) and $750,000,000 of debt, then what is the after-tax weighted average cost of capital for Barnyard Stockfeed if it is subject to a 35 percent company tax rate? A. 6.05%. *B. 6.95%. C. 8.75%. D. 13.65%. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
29. Split Ends Hair Designs Ltd has found that its equity capital shares have a beta equal to 1.5 while the risk-free return is 8 percent and the expected return on the market is 14 percent. It has 7-year maturity bonds outstanding with a price of $767.03 that have a coupon rate of 7 percent. If the company is financed with $120,000,000 of ordinary shares (market value) and $80,000,000 of debt, then what is the after-tax weighted average cost of capital for Split ends Hair Designs if it is subject to a 35 percent company tax rate? A. 10.20%. B. 11.76%. C. 11.88%. *D. 13.32%. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
30. Which of the following statements is correct? A. The WACC is the appropriate discount rate to use for cash flows similar in risk to the firm. B. The WACC for a firm reflects the risk and the target capital structure to finance the firm’s existing assets as a whole. C. The WACC is the weighted average of the costs of the different types of capital (debt and equity) that have been used to finance a company; the cost of each type of capital is weighted by the proportion of the total capital that it represents. *D. All of the above. Feedback: All the statements are true. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
Module 11: Cost of capital and working capital management
31. Which of the following statement is false? A. The market value of debt is used in the calculation of WACC. B. Historical costs do not belong in WACC calculations. C. The current cost of long-term debt is what matters when calculating WACC. *D. None of the above. Feedback: All of them are true. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
32. Which of the following is not used as a capital base in the WACC calculation? A. Debentures. B. Bank overdraft. C. Preference shares. *D. Accounts receivables. Feedback: Only debts and equity are used as capital base. LO 11.2: Calculate the weighted average cost of capital (WACC) for a company, and explain the limitations of using a company’s weighted average cost of capital as the discount rate when evaluating a project.
33. Which one of the following statements is not true? A. Net working capital refers to the difference between current assets and current liabilities. *B. Gross working capital is the funds invested in a company's current liabilities. C. Working capital management involves making decisions regarding the use and sources of current assets. D. Working capital efficiency refers to the length of time between when a working capital asset is acquired and when it is converted into cash. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
34. The cash conversion cycle: A. shows how long the company keeps its inventory before selling it. B. estimates how long it takes on average for the company to collect its outstanding accounts receivable balance. C. begins when the company uses its cash to purchase raw materials and ends when the company collects cash payments on its credit sales. *D. begins when the company invests cash to purchase the raw materials that would be used to produce the goods that the company manufactures. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
35. Which one of the following statements is true when managing working capital accounts? A. Delay paying accounts payable as long as possible without suffering any penalties. B. Maintain minimal raw material inventories without causing manufacturing delays. C. Use as little labour as possible to manufacture the product while producing a quality product. *D. All of the above are true. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
36. The operating cycle: A. To measure operating cycle we need another measure called the days' payables outstanding. B. begins when the company uses its cash to purchase raw materials and ends when the company collects cash payments on its credit sales. *C. begins when the company receives the raw materials it purchased that would be used to produce the goods that the company manufactures. D. ends not with the finished goods being sold to customers and the cash collected on the sales; but when you take into account the time taken by the company to pay for its purchases. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
Module 11: Cost of capital and working capital management
37. Organic Foods distributes its products to more than 100 restaurants and delis. The company's collection period is 32 days, and it keeps its inventory for 10 days. What is Organic Food's operating cycle? A. 22 days. B. 32 days. *C. 42 days. D. None of the above. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
38. Stumpy Ltd has an operating cycle of 81 days and takes 47 days to collect on its receivables. What is its level of inventory if the company's cost of sales is $312,455? Round to the nearest dollar. A. $9,190. B. $14,685. *C. $29,105. D. $69,339. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
39. Bass Strait Ltd, a men's designer company, has an operating cycle of 123 days. The company's days' sales in inventory is 73 days. How much does the company have in receivables if it has credit sales of $433,450? Round to the nearest dollar. *A. $59,377. B. $71,252. C. $47,501. D. $64,233. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
40. All Stripes Ltd has inventory of $44,233 and cost of sales of $512,902. The company has an operating cycle of 74 days. What is the company's days' sales outstanding (DSO)? *A. 43 days. B. 32 days. C. 49 days. D. 26 days. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
41. John Sidorczuk Ltd estimates that it takes the company 31 days on average to pay off its suppliers. It also knows that it has days' sales in inventory of 54 days and days sales' outstanding of 34 days. What is its cash conversion cycle? A. 119 days. B. 34 days. *C. 57 days. D. 46 days. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management. 42. Terry O’Shea Ltd estimates that it takes the company 27 days on average to pay off its suppliers. It also knows that it has days' sales in inventory of 43 days and days sales' outstanding of 45 days. What is its cash conversion cycle? A. 46 days. B. 57 days. *C. 61 days. D. 115 days. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
43. Your boss asks you to calculate the company's cash conversion cycle. Looking at the financial statements, you see that the average inventory for the year was $126,300, accounts receivable were $97,900, and accounts payable were at $115,100. You also see that the company had sales of $324,000 and that cost of sales was $282,000. What is your company's cash conversion cycle? Round to the nearest day. A. 34 days. B. 57 days. C. 119 days. *D. 125 days. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
Module 11: Cost of capital and working capital management
44. East Coast Officeworks has net sales of $423,000 with 30 per cent of it being credit sales. Its cost of sales is $324,000. The company's cash conversion cycle is 47.9 days. The company's operating cycle is 86.3 days. What is the company's accounts payable? Round to the nearest dollar. *A. $34,087. B. $56,322. C. $71,203. D. $126,900. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management. 45. Which one of the following statements about working capital trade-off is true? A. If shortage costs dominate carrying costs, the company will need to move toward a more flexible policy. B. Financial managers need to balance shortage costs against carrying costs to find an optimal strategy. C. If carrying costs are larger than shortage costs, then the company will maximise value by adopting a more restrictive strategy. *D. All of the above. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
46. Which of the following terms is not a working capital account? A. Receivables. B. Cash. *C. Profit. D. Inventory. Feedback: The working capital accounts that are the focus of most working capital management activities are as follows: 1. Cash 2. Receivables 3. Inventory 4. Payables. LO 11.3: Define and calculate net working capital and discuss the importance of working capital management.
47. Which one of the following statements about matching maturity strategy is true? A. All fixed assets are funded with long-term financing. B. All working capital is funded with short-term borrowing. C. As the level of sales varies seasonally, short-term borrowing fluctuates between some minimum and maximum level. *D. All of the above. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
48. Which one of the following statements is not true? A. A formal line of credit is also known as "revolving credit." B. Accounts payable (trade credit), bank loans, and commercial paper are common sources of short-term financing. *C. An informal line of credit is also known as "revolving credit." D. An informal line of credit is a verbal agreement between the company and the bank, allowing the company to borrow up to an agreed-upon upper limit. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing. 49. Concept Travels has borrowed $50,000 at a stated APR of 8.5 per cent. The loan calls for a compensating balance of 8 per cent. What is the effective interest rate for this company? *A. 9.24%. B. 8.50%. C. 8.00%. D. 16.50%. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing. 50. Tuff ‘n’ Nuff Panel & Paint is borrowing $375,000. The loan requires an 8 per cent compensating balance, and the effective interest rate on the loan is 10.326 per cent. What is the stated APR on this loan? Round to one decimal place. *A. 9.5%. B. 8.5%. C. 7.4%. D. 10.0%. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
51. Which of the following is not a source of short-term finance? A. Bank accepted commercial bills. B. Factoring. *C. Bonds. D. Accrued wages. Feedback: Bonds are a source of long-term finance. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
Module 11: Cost of capital and working capital management
52. Which of the following is most likely to account for business failure in Australia? A. Civil disturbance. B. Uninsured cyclone damage. *C. Insufficient working capital. D. Loss of funds due to failure of local bank. Feedback: Cyclones only affect a small part of Australia. Australia is noted for its political stability: arguably there have been no major civil disturbances since the Eureka Stockade. No Australian bank has failed since federation. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
53. Which of the following is not a source of informal short-term finance? *A. Factoring. B. Accrued wages. C. Trade credit. D. Superannuation and taxes. Feedback: Factoring is a formal source of short-term finance. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
54. Which of the following is not a source of formal short-term finance? A. Factoring. *B. Trade credit. C. Bank overdrafts. D. Commercial bills. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
55. In managing the level of working capital, which of the following is generally not a concern: A. the need to maintain liquidity. B. the need to earn the required rate of return on the assets. *C. the cost and risk of long-term funding. D. none of the above. Feedback: It is the cost and risk of short-term funding which is of concern. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
56. To maintain liquidity, firms may: A. use cash budgeting. B. use a bank overdraft. C. keep an overestimate of cash required on hand at all times. *D. all of the above. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
57. Which of the following statements relates to the matching principle? A. Permanent assets should be financed with short-term sources of funding. *B. Permanent assets should be sourced with permanent sources of funding. C. Temporary assets should be sourced with permanent sources of funding. D. None of the above. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
58. Which of the following regarding trade credit is false? A. Trade credit is an informal source of finance. *B. Trade credit is generally secured. C. Sometimes, discounts are offered for early repayment. D. Trade credit is most usually offered on a ‘net 30 days’ or ‘net 7 days’ basis. Feedback: Trade credit is generally unsecured. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
59. Factoring businesses normally require client firms to satisfy which of the following? A. Have a spread of debtors. B. Have efficient debtors’ ledgers. C. Sell goods on normal, credit terms. *D. All of the above. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
Module 11: Cost of capital and working capital management
60. Which is not a part of good working capital management? *A. the extension of long-term debt. B. the maintenance of optimal cash balances. C. the proper management of accounts receivable. D. the investment of any excess liquid funds in marketable securities that provide the best return possible, considering any liquidity or default-risk constraints. LO 11.4: Identify three current asset financing strategies and discuss the main sources of short-term financing.
Module 12: Capital structure and dividend policy Multiple-choice questions 1.
Which of the following statements is correct?
*A. People behave differently towards a company in financial distress, and this increases insolvency costs. B. People behave differently towards a company in financial distress, and this reduces insolvency costs. C. People behave differently towards a company in financial distress, and this reduces insolvency costs. D. People behave similarly towards a company in financial distress, and this increases insolvency costs. Feedback: People behave differently towards a company in financial distress, and this increases insolvency costs. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice.
2.
The managers and shareholders of a company also often behave in ways that reduce a company’s value when the company becomes financially distressed. The resulting costs are a type of:
*A. Agency cost. B. Shareholder –lender agency costs. C. Shareholder–manager agency costs. D. None of the above. Feedback: The managers and shareholders of a company also often behave in ways that reduce a company’s value when the company becomes financially distressed. The resulting costs are a type of agency cost. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice.
Module 12: Capital structure and dividend policy
3.
It is important to note that without financial leverage, there would be no:
A. Underinvestment problems. B. Asset substitution. *C. Both A and B. D. None of the above. Feedback: It is important to note that without financial leverage, there would be no asset substitution or underinvestment problems. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice. 4.
Which of the following statements is incorrect?
A. The interests of managers are normally similar to those of the shareholders. B. When a company gets into financial distress, the interests of managers and shareholders begin to differ. *C. When a company gets into financial distress, the actions managers and shareholders take to protect their interests often increase company value. D. Indirect insolvency costs are costs associated with changes in the behaviour of people who deal with a company when it becomes financially distressed. Feedback: Indirect insolvency costs are costs associated with changes in the behaviour of people who deal with a company when it becomes financially distressed. The interests of many people who deal with a company are normally similar to those of the shareholders — they all want to maximise the company’s value. However, when a company gets into financial distress, the interests of these people begin to differ, and the actions they take to protect their interests often reduce company value. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice.
5.
It is important to note that without financial leverage, there would be no:
A. Shareholder –lender agency costs. B. Shareholder–manager agency costs. *C. Asset substitution or underinvestment problems. D. All of the above. Feedback: It is important to note that without financial leverage, there would be no asset substitution or underinvestment problems. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
6.
Which of the following statements is incorrect?
A. The regulatory requirements of government agencies are greater. *B. The share market tends to react positively to announcements that companies are selling shares. C. The out-of-pocket costs of selling equity are much higher than the comparable costs for bonds. D. None of the above. Feedback: The out-of-pocket costs of selling equity are much higher than the comparable costs for bonds. In addition, the regulatory requirements of government agencies are greater, and the share market tends to react negatively to announcements that companies are selling shares. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice. 7.
Which of the following statement is consistent with the trade-off theory?
*A. More profitable companies pay more tax, so they should use more debt to take advantage of the interest tax shield. B. The more profitable a company is, the less debt it tends to have. C. None of the above. D. All of the above. Feedback: Under the trade-off theory, more profitable companies pay more tax, so they should use more debt to take advantage of the interest tax shield. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice. 8.
Which one of the following statements is consistent with the pecking order theory?
A. In an average year, public companies actually repurchase more shares than they sell. B. The more profitable a company is, the less debt it tends to have. *C. All of the above. D. None of the above. Feedback: More general evidence also indicates that the more profitable a company is, the less debt it tends to have. Instead, this evidence is consistent with the pecking order theory. Highly profitable companies have plenty of cash on hand that can be used to finance their projects and, over time, using this cash will drive down their debt ratios. The pecking order theory is also supported by the fact that, in an average year, public companies actually repurchase more shares than they sell. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice.
Module 12: Capital structure and dividend policy
9.
The trade-off theory of capital structure says that managers will increase debt to the point at which:
*A. the costs of adding another dollar of debt is equal to the benefits. B. the costs of adding another dollar of debt is smaller than the benefits. C. the costs of adding another dollar of debt is greater than the benefits. D. none of the above. Feedback: The trade-off theory of capital structure says that managers will increase debt to the point at which the costs and benefits of adding another dollar of debt are exactly equal because this is the capital structure that maximises company value. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice.
10. A company's capital structure is the mix of financial securities used to finance its activities and can include all of the following except: A. bonds. B. preference shares. C. shares. *D. equity options. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice. 11. A company's enterprise value is given by: A. the value of equity minus the value of debt plus the value of future projects. B. the value of equity minus the value of debt. *C. the value of equity plus the value of debt. D. none of the above. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
12. Which of the following supports the trade-off theory of capital structure? A. A company's capital structure is the result of past equity and debt issuance decisions. B. Companies use cash on hand first, since issuing equity and debt is expensive. *C. Companies have a target capital structure. D. A and B. LO 12.1: Discuss some of the practical considerations that managers are concerned with when they choose a company’s capital structure and describe the trade-off and pecking order theories of capital structure choice.
13. The weighted average cost of capital (WACC) includes: *A. the cost of any debt and the cost of equity. B. the cost of any debt and required return on underlying company assets. C. the required return on equity and required return on underlying company assets. D. none of the above. LO 12.2: Discuss the benefits and costs of using debt financing. 14. Barloo Plumbing Company produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 per cent equity and 25 per cent debt. Your analysis tells you that the appropriate discount rates are 10 per cent for the cash flows, and 7 per cent for the debt. You currently own 10 per cent of the shares. How much is Barloo Plumbing worth today? A. $1,765. *B. $1,500. C. $2,143. D. $1,125. LO 12.2: Discuss the benefits and costs of using debt financing.
15. Century 21 Realty produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 per cent equity and 25 per cent debt. Your analysis tells you that the appropriate discount rates are 10 per cent for the cash flows, and 7 per cent for the debt. You currently own 10 per cent of the shares. What transaction do you need to take in order to undo the restructuring? A. Sell $22.50 of equity. B. Sell $10.80 worth of equity. *C. Buy $22.50 worth of debt. D. Buy $10.80 worth of debt. LO 12.2: Discuss the benefits and costs of using debt financing.
Module 12: Capital structure and dividend policy
16. Hodges Company produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 per cent equity and 25 per cent debt. Your analysis tells you that the appropriate discount rates are 10 per cent for the cash flows, and 7 per cent for the debt. You currently own 10 per cent of the shares. What are the interest payments that you receive after you undo the restructuring, and what are your total cash flows? *A. $1.57, $12.38. B. $23.55, $75. C. $1.13, $12.38. D. $1.24, $11.25. LO 12.2: Discuss the benefits and costs of using debt financing.
17. Ray White Ltd currently has a capital structure that is 40% debt and 60% equity. If the company's cost of equity is 12%, the cost of debt is 8%, and the risk-free rate is 3%, what is the appropriate WACC? A. 8.4%. B. 9.6%. *C. 10.4%. D. 9.2%. LO 12.2: Discuss the benefits and costs of using debt financing.
18. Raine & Horne Ltd has a debt-to-equity ratio of 0.5. If the company's cost of debt is 7% and its cost of equity is 13%, what is the appropriate WACC? A. 9%. B. 10%. *C. 11%. D. 13%. LO 12.2: Discuss the benefits and costs of using debt financing.
19. Sutton Nationwide Realty has a capital structure with 30% debt and 70% equity. Its pretax cost of debt is 6%, and its cost of equity is 10%. The company's marginal corporate income tax rate is 35%. What is the appropriate WACC? *A. 8.17%. B. 6.35%. C. 8.80%. D. 7.44%. LO 12.2: Discuss the benefits and costs of using debt financing.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
20. In order to calculate the present value of debt tax savings, the _______ is used as the discount rate. *A. required rate of return on debt. B. WACC. C. risk-free rate. D. none of the above. LO 12.2: Discuss the benefits and costs of using debt financing.
21. The use of debt financing: A. allows managers to make discretionary interest payments. *B. limits the ability of managers to waste shareholder money. C. is more expensive than issuing equity due to the use of covenants. D. may cause a manager to take on riskier projects in order to make interest payments. LO 12.2: Discuss the benefits and costs of using debt financing.
22. Which of these statements about direct insolvency costs is not true? A. Direct insolvency costs are less than indirect costs. B. Negotiating with lenders may help a company reduce direct insolvency costs. C. Direct insolvency costs include the hiring of additional accountants, lawyers, and consultants. *D. Suppliers requiring cash on delivery forms part of a company's direct insolvency costs. LO 12.2: Discuss the benefits and costs of using debt financing. 23. The use of debt financing: A. increases agency costs between the shareholders and management by limiting the amount of risk the managers take. B. increases agency costs since managers prefer to keep more retained earnings rather than pay a dividend. C. reduces agency costs between the shareholders and management by increasing the amount of risk the managers take. *D. A and B. LO 12.2: Discuss the benefits and costs of using debt financing.
Module 12: Capital structure and dividend policy
24. The asset substitution problem occurs when: A. managers substitute riskier assets for less risky ones to the detriment of equity holders. *B. managers substitute riskier assets for less risky ones to the detriment of bondholders. C. managers substitute less risky assets for riskier ones to the detriment of equity holders. D. managers substitute less risky assets for riskier ones to the detriment of bondholders. LO 12.2: Discuss the benefits and costs of using debt financing.
25. The underinvestment problem occurs in a financially distressed company when: A. issuing equity becomes difficult due to increased risk. B. management invests in negative-NPV projects to reduce their own risk. *C. the value of investing in a positive-NPV project is likely to go to debt holders instead of equity holders. D. the value of investing in a positive-NPV project is likely to go to equity holders instead of debt holders. LO 12.2: Discuss the benefits and costs of using debt financing.
26. A company has a WACC of 8.5%, a pre-tax cost of debt of 5%, a cost of equity of 12%, and a marginal corporate income tax rate of 35%. What per cent of the company is financed with equity? A. 42.5%. B. 50%. *C. 60%. D. 70%. LO 12.2: Discuss the benefits and costs of using debt financing.
27. Santalucia Ltd has a required rate of return on its assets of 12% and a cost of debt of 6.25%. Their current debt-to-equity ratio is 1/5. What is the required rate of return on their equity? A. 12.15%. *B. 13.15%. C. 14.15%. D. 10.4%. LO 12.2: Discuss the benefits and costs of using debt financing.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
28. Just Us Realty has a required rate of return on its assets of 12% and a cost of debt of 6.25%. Their current debt-to-equity ratio is 1/5. What is its required return on equity if its debt-to-equity ratio changes to 2/5 and this increases the required rate of return on their debt to 7%? *A. 14%. B. 14.25%. C. 14.50%. D. 15%. LO 12.2: Discuss the benefits and costs of using debt financing. 29. A company plans to issue $1 million worth of debt at a YTM of 9%. The debt is trading at par. The company's marginal corporate tax rate is 25%, while its average tax rate is 15%. By how much will this debt issuance reduce the company's annual tax liability? A. $32,500. B. $13,500. *C. $22,500. D. None of the above. LO 12.2: Discuss the benefits and costs of using debt financing.
30. A company plans to issue $1 million worth of debt at a YTM of 9%. The debt is trading at par. The company's marginal corporate tax rate is 35%. What is the present value of the tax savings in perpetuity? A. $20,475. B. $11,025. C. $227,500. *D. $350,000. LO 12.2: Discuss the benefits and costs of using debt financing.
31. Suppose that Donemans Ltd has $100m invested in 8% risk-free bonds that mature in one-year. The company also has $80m in debt outstanding that will also mature in a year. Donemans shareholders are considering selling the $100m in debt and investing in a project that has a 60% chance of returning $200m and a 40% chance of returning $2m. What is the expected value of the bonds if the shareholders sell the debt? A. $100m. B. $88.8m. *C. $48.8m. D. None of the above. LO 12.2: Discuss the benefits and costs of using debt financing.
Module 12: Capital structure and dividend policy
32. Suppose that Oceanlink Ltd has $100m invested in 8% risk-free bonds that mature in one-year. The company also has $80m in debt outstanding that will also mature in a year. Oceanlink shareholders are considering selling the $100m in debt and investing in a project that has a 60% chance of returning $200m and a 40% chance of returning $2m. What is the expected value of the equity if the shareholders sell the debt? A. $175m. B. $97.5m. C. $51m. *D. None of the above. LO 12.2: Discuss the benefits and costs of using debt financing.
33. Which type of dividend is most likely to be used to distribute the revenue from a onetime sale of a large asset? A. Interim dividend. B. Regular cash dividend. C. Unusual dividend. *D. Special dividend. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments. 34. Which of the following is the dividend at the end of the first half of the financial year? *A. Interim dividend. B. Regular cash dividend. C. Unusual dividend. D. Special dividend. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
35. Which of the following is not correct regarding taxation in Australia? *A. The imputation tax system allows double taxation of dividends. B. Franking credits can be used to offset the investor's other sources of taxable income. C. Australian companies have greater incentives to initiate dividends and raise existing dividend payouts under the imputation tax system. D. Under the classical tax system, a company's profits were first taxed at the company tax rate, and dividends paid were taxed again at the investor's marginal tax rate. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
36. Which step in the dividend payment process for a public company usually results in a change in the company's share price? Assume the dividend has changed from the last dividend paid. A. Payable date. B. Public announcement. C. Ex-dividend date. *D. Both B and C. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
37. The shares of Hemmingway Financial Ltd fell sharply today after the company announced that it is increasing its regular cash dividend distributions. Which one of the following explanations may explain investors' negative reaction? A. Share prices regularly fall upon announcement of the cash dividend distributions. B. Changes in regular cash dividends are made frequently so that the company's management can adjust for changes in short-term earnings. The decrease in the share price is probably related to some other negative event. *C. Investors previously believed the company had many lucrative growth opportunities. By announcing higher regular cash dividends, the company is sending a signal that it doesn't have enough positive-NPV projects to use all the money. D. Investors expected that the company would announce a share buy-back rather than a cash dividend increase. Since a change in dividend policy is commonly viewed as a weaker signal than a share buy-back, the share price fell on the news of the dividend increase. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments. 38. Gold Coast Brewing Co. has announced it will pay its regular cash dividend of $0.45 per share. If dividends are taxed at 15 per cent, about how much do you expect the price of Gold Coast Brewing to drop on the ex-dividend day? A. $0.07. *B. $0.38. C. $0.45. D. $0.52. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
Module 12: Capital structure and dividend policy
39. You own 10,000 shares of Global Traffic Management Ltd which is currently trading for $11.50 per share. The company has announced that it will soon pay a special dividend of $1.50 per share. Tomorrow is the ex-dividend day. Ignoring tax, what do you expect your block of shares will be worth tomorrow? A. $15,000. *B. $100,000. C. $115,000. D. $130,000. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
40. You own 20,000 shares in Acacia Motor Inn, which has just sold one of its large resort hotels for $300 million. Management intends to return the entire revenue from the sale to shareholders by issuing a special dividend. If Acacia Motor Inn has 20 million shares outstanding, how large a dividend payment do you expect to receive? A. $20,000. B. $200,000. *C. $300,000. D. $13,333. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
41. Which of the following statements is not a possible benefit of dividend reinvestment programs (DRPs)? A. DRPs allow a company to preserve its cash flows and receive a low cost source of capital. B. A company will sell new shares normally at a discount of 2.5 - 10 per cent off the market price. C. Owners of shares that pay dividends do not have to pay brokerage fees if they want to reinvest the proceeds. *D. Shareholders who choose not to participate in the DRP will find that their proportional ownership is eroded over time. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
42. Which of the following explanations is not a possible benefit of dividends? A. Dividends can be used to manage the capital structure of the company. *B. Paying dividends reduces the probability that the company will enter financial distress. C. Some investors prefer dividend-paying shares and will be willing to pay a higher price for shares with regular dividends. D. Paying out large regular dividends can force management to regularly raise more capital. The extra scrutiny involved in raising capital can increase the incentives of management to run the company efficiently. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
43. CQ Building Worx is currently trading for $10 with 1 million shares outstanding. Which of the following actions would be the most credible signal that management believes that the long-term prospects for a company has improved? *A. Increase the company's regular quarterly dividend from $0.20 to $0.40. B. Initiate an on-market share buy-back of 2 per cent of the company's shares. C. Initiate an equal access buy-back to buy-back for 2 per cent of the company's shares. D. Pay a $0.20 special dividend in addition to the company's $0.20 regular quarterly dividend. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
44. How can dividends be distributed? A. Discounts on company products. B. Cash. C. Assets or more shares. *D. All of the above Feedback: A dividend can involve the distribution of cash, assets or something else, such as discounts on the company’s products that are available only to shareholders. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
Module 12: Capital structure and dividend policy
45. A special dividend is different to a regular cash dividend because: A. It is paid out of retained cash, not company profits. B. Special dividend is a terminology used by finance professionals to describe the first time a company issues a dividend. C. It is only paid to some shareholders, not all shareholders. *D. It is a one-time payment outside of the company’s normal dividend schedule. Feedback: A special dividend is a one -time payment to shareholders LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
46. What is the name of the tax system that was introduced to avoid double taxation? *A. Imputation tax system. B. The franking system. C. The neo-classical tax system. D. Tax credit system. Feedback: The introduction of the imputation tax system allowed the double taxation problem to be eliminated. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
47. The initial decision of whether or not to pay a dividend comes from: A. shareholder vote. *B. the Board of Directors' vote. C. the CEO and the executive management team. D. is written as part of the company’s constitution. Feedback: The process begins with a vote by a company’s board of directors to pay a dividend. As shareholder representatives, the board must approve any distribution of value to shareholders. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
48. Changing the amount paid for cash dividends implies which of the following: A. the value of the company will increase/decrease. B. the share price of the company will increase/decrease. *C. the company has had a fundamental change in their business. D. all of the above. Feedback: It is important to recognise that we cannot interpret these studies as proof that changes in dividend policies cause changes in share prices. Rather, the cash flow identity suggests that management change dividend polices when something fundamental has changed in the business. LO 12.3: Describe the different types of dividends and the dividend payment process, and discuss the benefits and cost associated with dividend payments.
49. Which of the following is not a possible result of a share buy-back? *A. The company will decrease its leverage ratio (debt-to-equity ratio). B. If the number of remaining shares is relatively small, the remaining shares will be less liquid. C. Removing a large number of shares from circulation can change the ability of certain shareholders to control the company. D. By repurchasing shares when they are undervalued, managers can effectively transfer value from selling shareholders to shareholders who don't take part in the buy-back. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
50. Redundant Capital Ltd is being liquidated. The company's assets can be sold for $20 million. It will cost $18 million for the company to meet all its previous obligations and to pay-off debt holders. The company has 30 million shares outstanding. If you own 2,000 shares, how much do you expect to receive in dividends? Ignore tax. A. $1,333.33. B. $266.66. *C. $133.33. D. $0.00. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
Module 12: Capital structure and dividend policy
51. Lizzy’s Parlour Ltd has 3 million shares outstanding. The shares are currently selling for $40. If the company buy-backs $10 million at market prices, approximately how much will the shares be worth after the buy-back? Ignore tax. *A. $40. B. $38. C. $42. D. $36. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
52. Which of the following statements about the relative advantages of share buy-backs over dividends is not true? A. Historically, tax on dividend payment have been higher than those on share buy-backs. *B. Share buy-backs send a stronger signal than dividends to the market about management's belief that the company's prospects are good. C. Share buy-backs allow shareholders to choose whether or not to participate in the share buy-back. This allows shareholders to have more control over their tax burden. D. On-market share purchases allow management more flexibility because investors are less likely to react if the management cuts back or ends a share buy-back as compared to cutting back on dividend payments. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
53. Generally, management undertakes a bonus share issue to: A. reduce the administrative costs associated with investor relations. B. send a signal to investors that the company is expected to perform poorly. *C. increase the liquidity of shares by increasing the number of shares available. D. increase the liquidity of shares by decreasing the number of shares available. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
54. Which one of these actions could by itself have an impact on the control of the company? A. A share split. *B. A selective buy-back. C. A special dividend payment. D. A regular cash dividend payment. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
55. Split Endz Ltd has announced a 4-to-1 share split. If the company currently has 1 million shares outstanding, how many outstanding shares will it have after the split? A. 250,000. B. 1 million. C. 2 million. *D. 4 million. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
56. You own 3,000 shares of Split Fortunes Co. The shares are currently selling for $48. The company has just announced a 4-for-1 share split. How many shares will you own after the split, and approximately what will your holdings in Split Fortunes Co be worth? *A. 12,000 shares worth about $144,000. B. 12,000 shares worth about $576,000. C. 3,000 shares worth about $144,000. D. 3,000 shares worth about $576,000. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ. 57. You own 1,200 shares of Osborne’s Plastering Ltd. The company has recently announced a 1-for-3 bonus share issue. How many shares will you own after the bonus issue? A. 400 shares. *B. 1600 shares. C. 3,600 shares. D. 1,200 shares. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ. 58. Duffy’s Production Ltd’s shares are currently trading for $54. Assume there is no new information about the company. If the company does a 10 per cent bonus share issue, what will the approximate price of the share be after the issue? A. $59.40 per share. B. $48.60 per share. *C. $49.09 per share. D. $54.00 per share. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
Module 12: Capital structure and dividend policy
59. Why are share buy-backs not subject to tax imputation? *A. It is not a dividend. Share buy-backs can be subject to Capital Gains Tax. B. Because it is optional whether or not to sell your shares in a share-buy back. C. Because the money used to purchase shares through share buy-backs are not from company profits. D. None of the above. Feedback: Share buy-backs are taxed differently to dividends. As we saw in the discussion earlier, the total value of dividends is effectively taxed at an investors’ marginal personal tax rate under the imputation tax system. In contrast, when a shareholder sells shares back to the company, the shareholder may incur capital gains tax. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
60. The 10/12 limit means: A. A minimum of 10 percent of shareholders must accept the share buy-back offer. B. Companies can offer a minimum of 10 percent and a maximum 12 percent premium for the share buy-back. C. Only shareholders who have held their shares for a minimum of 10 months can sell up to 12 percent of their shareholding. *D. Companies can only buy back 10 per cent or less of their total shares within a 12monthperiod. This rule is known as the 10/12 limit. Feedback: Companies can only buy back 10 per cent or less of their total shares within a 12month period. This rule is known as the 10/12 limit. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ. 61. What are share buy backs used for? A. Removing shareholders. B. Signalling to the market. C. Improving capital structure. *D. All of the above. Feedback: In terms of the motivation for share buy-backs, the on-market method was most popular to signal undervaluation. On-market buy-backs were also used for improving capital structure, signalling improving earnings per share and using surplus capital. The selective buy-backs method was most commonly used for improving capital structure and signalling improving earnings per share, as well as a method of removing shareholders. The equal access buy-back method was mainly used as a substitution for paying dividends. This method was also used to signal both undervaluation and improving earnings per share. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
62. Which of the following sentences are correct about share splits? *A. A share split is when shareholders are issued with additional shares. B. A share split is another way to distribute value to shareholders. C. None of the above. D. All of the above. Feedback: Share split is a pro –rata distribution of new shares to existing shareholders that is not associated with any change in the assets held by the company. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
63. Bonus share issues and share splits have which of the following effects? A. Always decreases the trading price of a company’s shares. *B. Improves liquidity of the shares. C. Always increases the trading price of a company’s shares. D. B and C. Feedback: liquidity reasons. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
64. How does a bonus share issue differ from a share split? A. They do not differ; they are both issuing new shares to existing shareholders. B. Bonus share issues distribute value to existing shareholders; share splits remove value from existing shareholders. *C. Bonus share issues are usually issued as a percentage of existing shares, whereas a share split is usually issued as a multiples of existing shares. D. None of the above. Feedback: A share split is quite similar to a bonus share issue, but it involves the distribution of a larger multiple of the outstanding shares. When a company pays a bonus share, it distributes new shares on a pro-rata basis to existing shareholders. LO 12.4: Define share buy-backs, bonus share issues and share splits, and explain how they differ.
Module 12: Capital structure and dividend policy
65. Which one of the following statements describes the finding from academic studies on corporate dividend policy? A. Managers tend to increase regular cash dividends in response to unexpectedly high earnings. B. Dividend policy doesn't matter because investors can re-create dividends by selling a fraction of their shares. C. Managers tend to focus on dividends rather than share buy-backs because institutional investors tend to prefer regular dividends. *D. Managers tend to maintain a level dividend payment at an amount that they are relatively certain they can maintain in the future. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies. 66. Which of the following considerations should not be related to management's concerns when setting a dividend or share buy-back policy? A. Can the company quickly raise equity capital if necessary? *B. Are the shares currently undervalued? Can the management add value to the company by initiating a share buy-back? C. Over the long term, how much does the company's level of earnings exceed its investment requirements? How certain is this level? D. Does the company have enough financial reserves to maintain the dividend policy in periods when earnings are down or investment requirements are up? LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies.
67. You purchased 2,000 shares of Spanline Ltd several years ago at $50 per share. The company does not pay a regular cash dividend. You want to manufacture your own dividend by selling a little bit of shares each quarter. The company's shares are currently trading at $75. If capital gains are taxed at 15 per cent, how many shares would you have to sell to receive $3,420 in cash? A. 27 shares. B. 46 shares. *C. 48 shares. D. 51 shares. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
68. You purchased 4,000 shares of Bugg’s Pest Control Company several years ago at $50 per share. The company has decided to pay a special dividend of $2.00 per share. Dividend payments are taxed at 15 per cent. You intend to reinvest in the company through the dividend reinvestment program. If the company's shares are trading at $48.20 following the dividend payment, how many additional shares can you buy through the dividend reinvestment program? A. 125 shares. *B. 141 shares. C. 134 shares. D. 166 shares. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies.
69. Dividend policy is based on: A Last year’s dividend. B. Company management discretion. C. Profits/losses and future forecasts. *D B and C. Feedback: Profits/losses and future forecasts and company management discretion. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies.
70. Publicly listed companies distribute dividends in some form or another: A. bi-annually. B. only when the company has made a profit. C. every year. *D. sometimes. Feedback: When it is appropriate. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies.
Module 12: Capital structure and dividend policy
71. When a company issues dividends, whether it is share buy-backs, cash dividends or special dividends, what implications will it have on the control of the company? A Shareholders will lose some control over the company. B. Shareholders will gain more control over the company. *C. It depends on the dividend policy and how the dividend is distributed. D. None of the above. Feedback: It depends on the dividend policy. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies. 72. Which of the following is least likely to be a dividend policy of an Australian company earning profits and paying taxes in Australia? *A. Zero payout policy. B. Stable dividend policy. C. Residual dividend policy. D. Constant payout ratio policy. Feedback: An Australian company earning profits and paying taxes in Australia would be able to pay fully franked dividends to its Australian resident shareholders. It would be most unlikely that such a company would never pass on the imputation tax credits to its shareholders. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies. 73. Which of the following factors is least likely to influence a company’s dividend policy? A. Liquidity. B. Balance of its franking account. C. Stage of the company’s life cycle. *D. The company’s effective rate of income tax. Feedback: The rate of income tax paid by a company is unlikely to influence its dividend policy, particularly if the company is an Australian company of which most of its shareholders are Australian residents able to benefit from imputation tax credits. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies.
Testbank to accompany: Finance essentials 1e by Kidwell et al.
74. Which of the following are types of commonly used dividend policies? A. A constant payout ratio policy. B. A residual dividend policy. C. A fluctuating dividend policy. *D. Both A and B. LO 12.5: Describe factors that managers consider when setting the dividend policies for their companies.