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CIS 562 Week 5 Midterm Exam – Strayer NEW
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Chapters 1 Through 6
Chapter 1: Computer Forensics and Investigations as a Profession
TRUE/FALSE
1. By the 1970s, electronic crimes were increasing, especially in the financial sector.
2. To be a successful computer forensics investigator, you must be familiar with more than one computing platform.
3. Computer investigations and forensics fall into the same category: public investigations.
4. The law of search and seizure protects the rights of all people, excluding people suspected of crimes.
5. After a judge approves and signs a search warrant, it’s ready to be executed, meaning you can collect evidence as defined by the warrant.
MULTIPLE CHOICE
1. The FBI ____ was formed in 1984 to handle the increasing number of cases involving digital evidence.
a.
Federal Rules of Evidence (FRE)
b.
Department of Defense Computer Forensics Laboratory (DCFL)
c.
DIBS
d.
Computer Analysis and Response Team (CART)
2. ____ involves recovering information from a computer that was deleted by mistake or lost during a power surge or server crash, for example.
a.
Data recovery
c.
Computer forensics
b.
Network forensics
d.
Disaster recovery
3. ____ involves preventing data loss by using backups, uninterruptible power supply (UPS) devices, and off-site monitoring.
a.
Computer forensics
c.
Disaster recovery
b.
Data recovery
d.
Network forensics
4. The ____ group manages investigations and conducts forensic analysis of systems suspected of containing evidence related to an incident or a crime.
a.
network intrusion detection
c.
incident response
b.
computer investigations
d.
litigation
5. By the early 1990s, the ____ introduced training on software for forensics investigations.
a.
IACIS
c.
CERT
b.
FLETC
d.
DDBIA
6. In the Pacific Northwest, ____ meets monthly to discuss problems that law enforcement and corporations face.
a.
IACIS
c.
FTK
b.
CTIN
d.
FLETC
7. In a ____ case, a suspect is tried for a criminal offense, such as burglary, murder, or molestation.
a.
corporate
c.
criminal
b.
civil
d.
fourth amendment
8. In general, a criminal case follows three stages: the complaint, the investigation, and the ____.
a.
litigation
c.
blotter
b.
allegation
d.
prosecution
9. Based on the incident or crime, the complainant makes a(n) ____, an accusation or supposition of fact that a crime has been committed.
a.
litigation
c.
blotter
b.
allegation
d.
prosecution
10. In a criminal or public case, if you have enough information to support a search warrant, the prosecuting attorney might direct you to submit a(n) ____.
a.
blotter
c.
litigation report
b.
exhibit report
d.
affidavit
11. It’s the investigator’s responsibility to write the affidavit, which must include ____ (evidence) that support the allegation to justify the warrant.
a.
litigation
c.
exhibits
b.
prosecution
d.
reports
12. The affidavit must be ____ under sworn oath to verify that the information in the affidavit is true.
a.
notarized
c.
recorded
b.
examined
d.
challenged
13. Published company policies provide a(n) ____ for a business to conduct internal investigations.
a.
litigation path
c.
line of allegation
b.
allegation resource
d.
line of authority
14. A ____ usually appears when a computer starts or connects to the company intranet, network, or virtual private network (VPN) and informs end users that the organization reserves the right to inspect computer systems and network traffic at will.
a.
warning banner
c.
line of authority
b.
right of privacy
d.
right banner
15. A(n) ____ is a person using a computer to perform routine tasks other than systems administration.
a.
complainant
c.
end user
b.
user banner
d.
investigator
16. Without a warning banner, employees might have an assumed ____ when using a company’s computer systems and network accesses.
a.
line of authority
c.
line of privacy
b.
right of privacy
d.
line of right
17. In addition to warning banners that state a company’s rights of computer ownership, businesses should specify a(n) ____ who has the power to conduct investigations.
a.
authorized requester
c.
line of right
b.
authority of line
d.
authority of right
18. Most computer investigations in the private sector involve ____.
a.
e-mail abuse
c.
Internet abuse
b.
misuse of computing assets
d.
VPN abuse
19. Corporations often follow the ____ doctrine, which is what happens when a civilian or corporate investigative agent delivers evidence to a law enforcement officer.
a.
silver-tree
c.
silver-platter
b.
gold-tree
d.
gold-platter
20. Your ____ as a computer investigation and forensics analyst is critical because it determines your credibility.
a.
professional policy
c.
line of authority
b.
oath
d.
professional conduct
21. Maintaining ____ means you must form and sustain unbiased opinions of your cases.
a.
confidentiality
c.
integrity
b.
objectivity
d.
credibility
COMPLETION
1. ____________________ involves obtaining and analyzing digital information for use as evidence in civil, criminal, or administrative cases.
2. The ____________________ to the U.S. Constitution (and each state’s constitution) protects everyone’s rights to be secure in their person, residence, and property from search and seizure.
3. The term ____________________ refers to large corporate computing systems that might include disparate or formerly independent systems.
4. When you work in the ____________________ group, you test and verify the integrity of standalone workstations and network servers.
5. The ____________________ provides a record of clues to crimes that have been committed previously.
MATCHING
Match each item with a statement below:
a.
Computer forensics
f.
HTCIA
b.
Network forensics
g.
Affidavit
c.
Litigation
h.
Industrial espionage
d.
Xtree Gold
i.
Line of authority
e.
Case law
1. the legal process of proving guilt or innocence in court
2. recognizes file types and retrieves lost or deleted files
3. investigates data that can be retrieved from a computer’s hard disk or other storage media
4. sworn statement of support of facts about or evidence of a crime that is submitted to a judge to request a search warrant before seizing evidence
5. allows legal counsel to use previous cases similar to the current one because the laws don’t yet exist
6. specifies who has the legal right to initiate an investigation, who can take possession of evidence, and who can have access to evidence
7. organization that exchanges information about techniques related to computer investigations and security
8. yields information about how a perpetrator or an attacker gained access to a network
9. involves selling sensitive or confidential company information to a competitor
SHORT ANSWER
1. Briefly describe the triad that makes up computer security.
2. Briefly describe the main characteristics of public investigations.
3. Briefly describe the main characteristics of private investigations.
4. What questions should an investigator ask to determine whether a computer crime was committed?
5. What are the three levels of law enforcement expertise established by CTIN?
6. What are some of the most common types of corporate computer crime?
7. What is embezzlement?
8. Briefly describe corporate sabotage.
9. What text can be used in internal warning banners?
10. Mention examples of groups that should have direct authority to request computer investigations in the corporate environment.
Chapter 2: Understanding Computer Investigations
TRUE/FALSE
1. Chain of custody is also known as chain of evidence.
2. Employees surfing the Internet can cost companies millions of dollars.
3. You cannot use both multi-evidence and single-evidence forms in your investigation.
4. Many attorneys like to have printouts of the data you have recovered, but printouts can present problems when you have log files with several thousand pages of data.
5. A bit-stream copy is a bit-by-bit duplicate of the original disk. You should use the original disk whenever possible.
MULTIPLE CHOICE
1. The ____ is the route the evidence takes from the time you find it until the case is closed or goes to court.
a.
acquisition plan
c.
evidence path
b.
chain of custody
d.
evidence custody
2. When preparing a case, you can apply ____ to problem solving.
a.
standard programming rules
c.
standard systems analysis steps
b.
standard police investigation
d.
bottom-up analysis
3. The list of problems you normally expect in the type of case you are handling is known as the ____.
a.
standard risk assessment
c.
standard problems form
b.
chain of evidence
d.
problems checklist form
4. The basic plan for your investigation includes gathering the evidence, establishing the ____, and performing the forensic analysis.
a.
risk assessment
c.
chain of custody
b.
nature of the case
d.
location of the evidence
5. A(n) ____ helps you document what has and has not been done with both the original evidence and forensic copies of the evidence.
a.
evidence custody form
c.
initial investigation form
b.
risk assessment form
d.
evidence handling form
6. Use ____ to secure and catalog the evidence contained in large computer components.
a.
Hefty bags
c.
paper bags
b.
regular bags
d.
evidence bags
7. ____ prevents damage to the evidence as you transport it to your secure evidence locker, evidence room, or computer lab.
a.
An antistatic wrist band
c.
An antistatic pad
b.
Padding
d.
Tape
8. ____ investigations typically include spam, inappropriate and offensive message content, and harassment or threats.
a.
VPN
c.
E-mail
b.
Internet
d.
Phone
9. To conduct your investigation and analysis, you must have a specially configured personal computer (PC) known as a ____.
a.
mobile workstation
c.
forensic lab
b.
forensic workstation
d.
recovery workstation
10. You can use ____ to boot to Windows without writing any data to the evidence disk.
a.
a SCSI boot up disk
c.
a write-blocker
b.
a Windows boot up disk
d.
Windows XP
11. To begin conducting an investigation, you start by ____ the evidence using a variety of methods.
a.
copying
c.
opening
b.
analyzing
d.
reading
12. A ____ is a bit-by-bit copy of the original storage medium.
a.
preventive copy
c.
backup copy
b.
recovery copy
d.
bit-stream copy
13. A bit-stream image is also known as a(n) ____.
a.
backup copy
c.
custody copy
b.
forensic copy
d.
evidence copy
14. To create an exact image of an evidence disk, copying the ____ to a target work disk that’s identical to the evidence disk is preferable.
a.
removable copy
c.
bit-stream image
b.
backup copy
d.
backup image
15. ____ from Technology Pathways is a forensics data analysis tool. You can use it to acquire and analyze data from several different file systems.
a.
Guidance EnCase
c.
DataArrest SnapCopy
b.
NTI SafeBack
d.
ProDiscover Basic
16. Forensics tools such as ____ can retrieve deleted files for use as evidence.
a.
ProDiscover Basic
c.
FDisk
b.
ProDelete
d.
GainFile
17. When analyzing digital evidence, your job is to ____.
a.
recover the data
c.
copy the data
b.
destroy the data
d.
load the data
18. ____ can be the most time-consuming task, even when you know exactly what to look for in the evidence.
a.
Evidence recovery
c.
Data analysis
b.
Data recovery
d.
Evidence recording
19. When you write your final report, state what you did and what you ____.
a.
did not do
c.
wanted to do
b.
found
d.
could not do
20. In any computing investigation, you should be able to repeat the steps you took and produce the same results. This capability is referred to as ____.
a.
checked values
c.
evidence backup
b.
verification
d.
repeatable findings
21. After you close the case and make your final report, you need to meet with your department or a group of fellow investigators and ____.
a.
critique the case
c.
present the case
b.
repeat the case
d.
read the final report
COMPLETION
1. When you are dealing with password protected files, you might need to acquire ____________________ or find an expert who can help you crack the passwords.
2. During the ____________________ design or approach to the case, you outline the general steps you need to follow to investigate the case.
3. A(n) ____________________ lists each piece of evidence on a separate page.
4. A(n) ____________________ is usually conducted to collect information from a witness or suspect about specific facts related to an investigation.
5. A(n) ____________________ is where you conduct your investigations and where most of your equipment and software are located, including the secure evidence containers.
MATCHING
Match each item with a statement below
a.
FTK’s Internet Keyword Search
f.
Norton DiskEdit
b.
Data recovery
g.
MS-DOS 6.22
c.
Free space
h.
Multi-evidence form
d.
Interrogation
i.
Self-evaluation
e.
Forensic workstation
1. an essential part of professional growth
2. extracts all related e-mail address information for Web-based e-mail investigations
3. process of trying to get a suspect to confess to a specific incident or crime
4. a type of evidence custody form
5. also known as a computer forensics workstation
6. is the more well-known and lucrative side of the computer forensics business
7. can be used for new files that are saved or files that expand as data is added to them
8. the least intrusive (in terms of changing data) Microsoft operating system
9. an older computer forensics tool
SHORT ANSWER
1. What should you do to handle evidence contained in large computer components?
2. What is required to conduct an investigation involving Internet abuse?
3. What is required to conduct an investigation involving e-mail abuse?
4. What are the differences between computer forensics and data recovery?
5. Describe some of the technologies used with hardware write-blocker devices. Identify some of the more commonly used vendors and their products.
6. What are the items you need when setting up your workstation for computer forensics?
7. What additional items are useful when setting up a forensic workstation?
8. What items are needed when gathering the resources you identified in your investigation plan?
9. Describe the process of creating a bit-stream copy of an evidence disk.
10. Mention six important questions you should ask yourself when critiquing your work.
Chapter 3: The Investigator's Office and Laboratory
TRUE/FALSE
1. Performing a forensic analysis of a disk 200 GB or larger can take several days and often involves running imaging software overnight and on weekends.
2. Requirements for taking the EnCE certification exam depend on taking the Guidance Software EnCase training courses.
3. If damage occurs to the floor, walls, ceilings, or furniture on your computer forensics lab, it does not need to be repaired immediately.
4. A good working practice is to use less powerful workstations for mundane tasks and multipurpose workstations for the higher-end analysis tasks.
5. Computing systems in a forensics lab should be able to process typical cases in a timely manner.
MULTIPLE CHOICE
1. A ____is where you conduct your investigations, store evidence, and do most of your work.
a.
forensic workstation
c.
storage room
b.
computer forensics lab
d.
workbench
2. Lab costs can be broken down into daily, ____, and annual expenses.
a.
weekly
c.
bimonthly
b.
monthly
d.
quarterly
3. ____ are generated at the federal, state, and local levels to show the types and frequency of crimes committed.
a.
HTCN reports
c.
Uniform crime reports
b.
IDE reports
d.
ASCLD reports
4. Windows hard disks can now use a variety of file systems, including FAT16, FAT32, ____, and Windows File System.
a.
NTFS
c.
FAT24
b.
ext3
d.
ext2
5. ____ was created by police officers who wanted to formalize credentials in computing investigations.
a.
HTCN
c.
TEMPEST
b.
NISPOM
d.
IACIS
6. IACIS requires recertification every ____ years to demonstrate continuing work in the field of computer forensics.
a.
2
c.
4
b.
3
d.
5
7. What HTCN certification level requires candidates have three years of investigative experience in any discipline from law enforcement or corporate or have a college degree with one year of experience in investigations?
a.
Certified Computer Crime Investigator, Basic Level
b.
Certified Computer Crime Investigator, Advanced Level
c.
Certified Computer Forensic Technician, Basic
d.
Certified Computer Forensic Technician, Advanced
8. To preserve the integrity of evidence data, your lab should function as an evidence locker or safe, making it a ____or a secure storage safe.
a.
secure workstation
c.
protected PC
b.
secure workbench
d.
secure facility
9. The EMR from a computer monitor can be picked up as far away as ____ mile.
a.
1/4
c.
3/4
b.
1/2
d.
1
10. Defense contractors during the Cold War were required to shield sensitive computing systems and prevent electronic eavesdropping of any computer emissions. The U.S. Department of Defense calls this special computer-emission shielding ____.
a.
TEMPEST
c.
NISPOM
b.
RAID
d.
EMR
11. A secure storage container or cabinet should be made of ____ and include an internal cabinet lock or external padlock.
a.
gypsum
c.
wood
b.
steel
d.
expanded metal
12. Floors and carpets on your computer forensic lab should be cleaned at least ____ a week to help minimize dust that can cause static electricity.
a.
once
c.
three times
b.
twice
d.
four times
13. One way to investigate older and unusual computing systems is to keep track of ____ that still use these systems.
a.
AICIS lists
c.
SIGs
b.
uniform reports
d.
Minix
14. A ____ plan also specifies how to rebuild a forensic workstation after it has been severely contaminated by a virus from a drive you’re analyzing.
a.
disaster recovery
c.
configuration management
b.
risk management
d.
security
15. You should have at least one copy of your backups on site and a duplicate copy or a previous copy of your backups stored in a safe ____ facility.
a.
in-site
c.
off-site
b.
storage
d.
online
16. In addition to performing routine backups, record all the updates you make to your workstation by using a process called ____ when planning for disaster recovery.
a.
configuration management
c.
recovery logging
b.
risk assessment
d.
change management
17. For labs using high-end ____ servers (such as Digital Intelligence F.R.E.D.C. or F.R.E.D.M.), you must consider methods for restoring large data sets.
a.
RAID
c.
WAN
b.
ISDN
d.
TEMPEST
18. ____involves determining how much risk is acceptable for any process or operation, such as replacing equipment.
a.
Risk configuration
c.
Configuration management
b.
Change management
d.
Risk management
19. Computing components are designed to last 18 to ____ months in normal business operations.
a.
24
c.
36
b.
30
d.
42
20. In the ____, you justify acquiring newer and better resources to investigate computer forensics cases.
a.
risk evaluation
c.
configuration plan
b.
business case
d.
upgrade policy
21. By using ____ to attract new customers or clients, you can justify future budgets for the lab’s operation and staff.
a.
pricing
c.
budgeting
b.
marketing
d.
changing
COMPLETION
1. The ______________________________ provides guidelines for managing a forensics lab and for acquiring official crime-lab certification.
2. The lab ____________________ sets up processes for managing cases and reviews them regularly.
3. For daily work production, several examiners can work together in a large open area, as long as they all have ____________________ level of authority and access need.
4. ____________________ Chapter 5, Section 3 (http://nsi.org/Library/Govt/Nispom.html) describes the characteristics of a safe storage container.
5. A(n) ____________________ plan ensures that you can restore your workstations and file servers to their original condition if a catastrophic failure occurs.
MATCHING
Match each item with a statement below
a.
FireWire
f.
SIG
b.
Guidance Software
g.
MAN
c.
Business case
h.
Norton Ghost
d.
F.R.E.D.C.
i.
Disaster recovery plan
e.
ASCLD/LAB
1. sponsors the EnCE certification program
2. a high-end RAID server from Digital Intelligence
3. a plan you can use to sell your services to your management or clients
4. stands for Metropolitan Area Network
5. tool for directly restoring files
6. addresses how to restore a workstation you reconfigured for a specific investigation
7. ruled by the IEEE 1394B standard
8. can be a valuable source of support for recovering and analyzing uncommon systems
9. certification program that regulates how crime labs are organized and managed
SHORT ANSWER
1. What are the duties of a lab manager?
2. Provide a brief explanation of how to plan a lab budget.
3. What are the four levels of certification offered by HTCN?
4. What are the minimum requirements for a computer investigation and forensics lab?
5. Illustrate a proper way of disposing materials on your computer investigation lab.
6. Give a brief explanation of a computer forensics lab auditing process.
7. Briefly outline the process of selecting workstations for a police computer investigation lab.
8. What peripheral devices should be stocked in your computer forensics lab?
9. Discuss the use of a laptop PC as a forensic workstation.
10. What are the questions you need to ask when planning the justification step of a business case?
Chapter 4: Data Acquisition
TRUE/FALSE
1. One advantage with live acquisitions is that you are able to perform repeatable processes.
2. The most common and time-consuming technique for preserving evidence is creating a duplicate copy of your evidence image file.
3. Many acquisition tools don’t copy data in the host protected area (HPA) of a disk drive.
4. FTK Imager requires that you use a device such as a USB or parallel port dongle for licensing.
5. Unlike RAID 0, RAID 3 stripes tracks across all disks that make up one volume.
MULTIPLE CHOICE
1. For computer forensics, ____ is the task of collecting digital evidence from electronic media.
a.
hashing
c.
lossy compression
b.
data acquisition
d.
lossless compression
2. One major disadvantage of ____ format acquisitions is the inability to share an image between different vendors’ computer forensics analysis tools.
a.
proprietary
c.
AFF
b.
raw
d.
AFD
3. Typically, a(n) ____ acquisition is done on a computer seized during a police raid, for example.
a.
live
c.
real-time
b.
online
d.
static
4. If the computer has an encrypted drive, a ____ acquisition is done if the password or passphrase is available.
a.
passive
c.
live
b.
static
d.
local
5. The most common and flexible data-acquisition method is ____.
a.
Disk-to-disk copy
c.
Disk-to-image file copy
b.
Disk-to-network copy
d.
Sparse data copy
6. SafeBack and SnapCopy must run from a(n) ____ system.
a.
UNIX
c.
Linux
b.
MS-DOS
d.
Solaris
7. If your time is limited, consider using a logical acquisition or ____ acquisition data copy method.
a.
lossless
c.
sparse
b.
disk-to-disk
d.
disk-to-image
8. Image files can be reduced by as much as ____% of the original.
a.
15
c.
30
b.
25
d.
50
9. Microsoft has recently added ____ in its Vista Ultimate and Enterprise editions, which makes performing static acquisitions more difficult.
a.
whole disk encryption
c.
recovery wizards
b.
backup utilities
d.
NTFS
10. Linux ISO images are referred to as ____.
a.
ISO CDs
c.
Forensic Linux
b.
Live CDs
d.
Linux in a Box
11. The ____ command displays pages from the online help manual for information on Linux commands and their options.
a.
cmd
c.
inst
b.
hlp
d.
man
12. The ____ command creates a raw format file that most computer forensics analysis tools can read, which makes it useful for data acquisitions.
a.
fdisk
c.
man
b.
dd
d.
raw
13. The ____ command, works similarly to the dd command but has many features designed for computer forensics acquisitions.
a.
raw
c.
dcfldd
b.
bitcopy
d.
man
14. Current distributions of Linux include two hashing algorithm utilities: md5sum and ____.
a.
rcsum
c.
hashsum
b.
shasum
d.
sha1sum
15. The ____ DOS program En.exe requires using a forensic MS-DOS boot floppy or CD and a network crossover cable.
a.
ProDiscover
c.
DIBS USA
b.
ILook
d.
EnCase
16. EnCase Enterprise is set up with an Examiner workstation and a Secure Authentication for EnCase (____) workstation
a.
ILook
c.
Incident Response
b.
SAFE
d.
Investigator
17. SnapBack DatArrest runs from a true ____ boot floppy.
a.
UNIX
c.
Mac OS X
b.
Linux
d.
MS-DOS
18. SnapBack DatArrest can perform a data copy of an evidence drive in ____ ways.
a.
two
c.
four
b.
three
d.
five
19. ____ is the only automated disk-to-disk tool that allows you to copy data to a slightly smaller target drive than the original suspect’s drive.
a.
SafeBack
c.
SnapCopy
b.
EnCase
d.
SMART
20. SafeBack performs a(n) ____ calculation for each sector copied to ensure data integrity
a.
SHA-1
c.
SHA-256
b.
MC5
d.
MC4
21. ____ has developed the Rapid Action Imaging Device (RAID) to make forensically sound disk copies.
a.
DIBS USA
c.
ProDiscover
b.
EnCase
d.
ILook
COMPLETION
1. Bit-stream data to files copy technique creates simple sequential flat files of a suspect drive or data set. The output of these flat files is referred to as a(n) ____________________ format.
2. ____________________ is the default format for acquisitions for Guidance Software EnCase.
3. Popular archiving tools, such as PKZip and WinZip, use an algorithm referred to as ____________________ compression.
4. Dr. Simson L. Garfinkel of Basis Technology Corporation recently developed a new open-source acquisition format called ____________________.
5. There are two types of acquisitions: static acquisitions and ____________________ acquisitions.
MATCHING
Match each item with a statement below
a.
SafeBack
f.
fdisk -l
b.
WinZip
g.
Lossy compression
c.
Data acquisition
h.
Jaz disk
d.
AFF
i.
EnCase
e.
IXimager
1. shows the known drives connected to your computer
2. forensic tool developed by Guidance Software
3. example of a disk-to-disk copy maker tool
4. open source data acquisition format
5. used with .jpeg files to reduce file size and doesn’t affect image quality when the file is restored and viewed
6. ILook imaging tool
7. process of copying data
8. type of SCSI drive
9. example of a lossless compression tool
SHORT ANSWER
1. What are the advantages and disadvantages of using raw data acquisition format?
2. What are some of the features offered by proprietary data acquisition formats?
3. What are some of the design goals of AFF?
4. Explain the sparse data copy method for acquiring digital evidence.
5. What are the considerations you should have when deciding what data-acquisition method to use on your investigation?
6. Explain the use of hash algorithms to verify the integrity of lossless compressed data.
7. What are the advantages and disadvantages of using Windows acquisition tools?
8. What are the steps to update the Registry for Windows XP SP2 to enable write-protection with USB devices?
9. What are some of the main characteristics of Linux ISO images designed for computer forensics?
10. What are the requirements for acquiring data on a suspect computer using Linux?
Chapter 5: Processing Crime and Incident Scenes
TRUE/FALSE
1. ISPs can investigate computer abuse committed by their customers.
2. If a corporate investigator follows police instructions to gather additional evidence without a search warrant after you have reported the crime, you run the risk of becoming an agent of law enforcement.
3. A judge can exclude evidence obtained from a poorly worded warrant.
4. The reason for the standard practice of securing an incident or crime scene is to expand the area of control beyond the scene’s immediate location.
5. Corporate investigators always have the authority to seize all computers equipments during a corporate investigation.
MULTIPLE CHOICE
1. Most federal courts have interpreted computer records as ____ evidence.
a.
conclusive
c.
hearsay
b.
regular
d.
direct
2. Generally, computer records are considered admissible if they qualify as a ____ record.
a.
hearsay
c.
computer-generated
b.
business
d.
computer-stored
3. ____ records are data the system maintains, such as system log files and proxy server logs.
a.
Computer-generated
c.
Computer-stored
b.
Business
d.
Hearsay
4. The FOIA was originally enacted in the ____.
a.
1940s
c.
1960s
b.
1950s
d.
1970s
5. Investigating and controlling computer incident scenes in the corporate environment is ____ in the criminal environment.
a.
much easier than
c.
as difficult as
b.
as easy as
d.
more difficult than
6. Every business or organization must have a well defined process that describes when an investigation can be initiated. At a minimum, most corporate policies require that employers have a ____ that a law or policy is being violated.
a.
confirmed suspicion
c.
court order stating
b.
proof
d.
reasonable suspicion
7. Confidential business data included with the criminal evidence are referred to as ____ data.
a.
commingled
c.
public
b.
exposed
d.
revealed
8. ____ is facts or circumstances that would lead a reasonable person to believe a crime has been committed or is about to be committed.
a.
Reasonable cause
c.
A subpoena
b.
Probable cause
d.
A warrant
9. Law enforcement investigators need a(n) ____ to remove computers from a crime scene and transport them to a lab.
a.
evidence custody form
c.
affidavit
b.
FOIA form
d.
warrant
10. Environmental and ____ issues are your primary concerns when you’re working at the scene to gather information about an incident or a crime.
a.
legal
c.
corporate
b.
safety
d.
physical
11. When recovering evidence from a contaminated crime scene, if the temperature in the contaminated room is higher than ____ degrees, you should take measures to prevent a hard disk from overheating to prevent damage.
a.
80
c.
95
b.
90
d.
105
12. With a(n) ____ you can arrive at a scene, acquire the data you need, and return to the lab as quickly as possible.
a.
bit-stream copy utility
c.
initial-response field kit
b.
extensive-response field kit
d.
seizing order
13. A(n) ____should include all the tools you can afford to take to the field.
a.
initial-response field kit
c.
forensic lab
b.
extensive-response field kit
d.
forensic workstation
14. Courts consider evidence data in a computer as ____ evidence.
a.
physical
c.
virtual
b.
invalid
d.
logical
15. Evidence is commonly lost or corrupted through ____, which involves police officers and other professionals who aren’t part of the crime scene processing team.
a.
onlookers
c.
FOIA laws
b.
HAZMAT teams
d.
professional curiosity
16. When seizing computer evidence in criminal investigations, follow the ____ standards for seizing digital data.
a.
Homeland Security Department
c.
U.S. DoJ
b.
Patriot Act
d.
U.S. DoD
17. During an investigation involving a live computer, do not cut electrical power to the running system unless it’s an older ____ or MS-DOS system.
a.
Windows XP
c.
Windows NT
b.
Windows 9x
d.
Windows Me
18. Certain files, such as the ____ and Security log in Windows XP, might lose essential network activity records if the power is terminated without a proper shutdown.
a.
Password log
c.
Io.sys
b.
Word log
d.
Event log
19. One technique for extracting evidence from large systems is called ____.
a.
RAID copy
c.
large evidence file recovery
b.
RAID imaging
d.
sparse acquisition
20. Real-time surveillance requires ____data transmissions between a suspect’s computer and a network server.
a.
poisoning
c.
blocking
b.
sniffing
d.
preventing
21. The most common computer-related crime is ____.
a.
homicide
c.
car stealing
b.
check fraud
d.
sniffing
COMPLETION
1. _____________________ can be any information stored or transmitted in digital form.
2. Private-sector organizations include businesses and _________________________ that aren’t involved in law enforcement.
3. If a company does not publish a policy stating that it reserves the right to inspect computing assets at will or display a warning banner, employees have a(n) _________________________.
4. When an investigator finds a mix of information, judges often issue a(n) _________________________to the warrant, which allows the police to separate innocent information from evidence.
5. Some computer cases involve dangerous settings. For these types of investigations, you must rely on the skills of _________________________ teams to recover evidence from the scene.
MATCHING
Match each item with a statement below
a.
Innocent information
f.
Low-level investigations
b.
AFIS
g.
Hearsay
c.
EnCase Enterprise Edition
h.
Spector
d.
FOIA
i.
HAZMAT
e.
IOCE
1. covert surveillance product
2. you should rely on this when dealing with a terrorist attack
3. secondhand or indirect evidence, such as an overheard conversation
4. what most cases in the corporate environment are considered
5. agencies must comply with these laws and make documents they find and create available as public records
6. sets standards for recovering, preserving, and examining digital evidence
7. fingerprints can be tested with these systems
8. information unrelated to a computing investigation case
9. a data-collecting tool
SHORT ANSWER
1. Why should companies publish a policy stating their right to inspect computing assets at will?
2. Illustrate with an example the problems caused by commingled data.
3. Briefly describe the process of obtaining a search warrant.
4. What is the plain view doctrine?
5. How can you determine who is in charge of an investigation?
6. Describe the process of preparing an investigation team.
7. How can you secure a computer incident or crime scene?
8. Give some guidelines on how to video record a computer incident or crime scene.
9. Describe how to use a journal when processing a major incident or crime scene.
10. What should you do when working on an Internet investigation and the suspect’s computer is on?
Chapter 6: Working with Windows and DOS Systems
TRUE/FALSE
1. The type of file system an OS uses determines how data is stored on the disk.
2. One way to examine a partition’s physical level is to use a disk editor, such as Norton DiskEdit, WinHex, or Hex Workshop.
3. As data is added, the MFT can expand to take up 75% of the NTFS disk.
4. The first 5 bytes (characters) for all MFT records are MFTR0.
5. Data streams can obscure valuable evidentiary data, intentionally or by coincidence.
MULTIPLE CHOICE
1. A ____ is a column of tracks on two or more disk platters.
a.
cylinder
c.
track
b.
sector
d.
head
2. ____ is how most manufacturers deal with a platter’s inner tracks being shorter than its outer tracks.
a.
Head skew
c.
ZBR
b.
Cylinder skew
d.
Areal density
3. ____ refers to the number of bits in one square inch of a disk platter.
a.
Head skew
c.
Cylinder skew
b.
Areal density
d.
ZBR
4. ____ is the file structure database that Microsoft originally designed for floppy disks.
a.
NTFS
c.
VFAT
b.
FAT32
d.
FAT
5. ____ was introduced when Microsoft created Windows NT and is the primary file system for Windows Vista.
a.
FAT32
c.
NTFS
b.
VFAT
d.
HPFS
6. On an NTFS disk, immediately after the Partition Boot Sector is the ____.
a.
FAT
c.
MBR
b.
HPFS
d.
MFT
7. Records in the MFT are referred to as ____.
a.
hyperdata
c.
inodes
b.
metadata
d.
infodata
8. In the NTFS MFT, all files and folders are stored in separate records of ____ bytes each.
a.
1024
c.
2048
b.
1512
d.
2512
9. The file or folder’s MFT record provides cluster addresses where the file is stored on the drive’s partition. These cluster addresses are referred to as ____.
a.
virtual runs
c.
metaruns
b.
metada
d.
data runs
10. When Microsoft introduced Windows 2000, it added built-in encryption to NTFS called ____.
a.
EFS
c.
LZH
b.
VFAT
d.
RAR
11. The purpose of the ____ is to provide a mechanism for recovering encrypted files under EFS if there’s a problem with the user’s original private key.
a.
certificate escrow
c.
administrator certificate
b.
recovery certificate
d.
root certificate
12. When Microsoft created Windows 95, it consolidated initialization (.ini) files into the ____.
a.
IniRecord
c.
Registry
b.
Inidata
d.
Metadata
13. ____, located in the root folder of the system partition, specifies the Windows XP path installation and contains options for selecting the Windows version.
a.
Boot.ini
c.
NTDetect.com
b.
BootSec.dos
d.
NTBootdd.sys
14. ____ is a 16-bit real-mode program that queries the system for device and configuration data, and then passes its findings to NTLDR.
a.
Hal.dll
c.
NTDetect.com
b.
Boot.ini
d.
BootSect.dos
15. ____, located in the root folder of the system partition, is the device driver that allows the OS to communicate with SCSI or ATA drives that aren’t related to the BIOS.
a.
Hal.dll
c.
Boot.ini
b.
NTBootdd.sys
d.
Ntoskrnl.exe
�� 16. ____ contain instructions for the OS for hardware devices, such as the keyboard, mouse, and video card, and are stored in the %system-root%\Windows\System32\Drivers folder.
a.
Hal.dll
c.
Ntoskrnl.exe
b.
Pagefile.sys
d.
Device drivers
17. ____ is a hidden text file containing startup options for Windows 9x.
a.
Pagefile.sys
c.
Msdos.sys
b.
Hal.dll
d.
Ntoskrnl.exe
18. The ____ file provides a command prompt when booting to MS-DOS mode (DPMI).
a.
Io.sys
c.
Config.sys
b.
Autoexec.bat
d.
Command.com
19. ____ is a text file containing commands that typically run only at system startup to enhance the computer’s DOS configuration.
a.
Autoexec.bat
c.
BootSect.dos
b.
Config.sys
d.
Io.sys
20. ____ is a batch file containing customized settings for MS-DOS that runs automatically.
a.
Autoexec.bat
c.
Io.sys
b.
Config.sys
d.
Command.com
21. A ____ allows you to create a representation of another computer on an existing physical computer.
a.
virtual file
c.
logic machine
b.
logic drive
d.
virtual machine
COMPLETION
1. ____________________ refers to a disk’s structure of platters, tracks, and sectors.
2. In Microsoft file structures, sectors are grouped to form ____________________, which are storage allocation units of one or more sectors.
3. On Windows and DOS computer systems, the ____________________ stores information about partitions on a disk and their locations, size, and other important items.
4. Drive slack includes RAM slack (found primarily in older Microsoft OSs) and ____________________ slack.
5. On an NTFS disk, the first data set is the ____________________, which starts at sector [0] of the disk.
MATCHING
Match each item with a statement below:
a.
File system
f.
NTFS
b.
Tracks
g.
Unicode
c.
Track density
h.
Data streams
d.
Partition gap
i.
BitLocker
e.
Drive slack
1. Microsoft’s move toward a journaling file system
2. the space between each track
3. ways data can be appended to existing files
4. the unused space between partitions
5. an international data format
6. Microsoft’s utility for protecting drive data
7. gives an OS a road map to data on a disk
8. unused space in a cluster between the end of an active file and the end of the cluster
9. concentric circles on a disk platter where data is located
SHORT ANSWER
1. How can you make sure a subject’s computer boots to a forensic floppy disk or CD?
2. What are some of the components of a disk drive?
3. How are disk clusters numbered by Microsoft file structures?
4. Summarize the evolution of FAT versions.
5. Briefly describe how to delete FAT files.
6. What are logical cluster numbers (LCNs)?
7. Briefly explain NTFS compressed files.
8. What are some of the features offered by current whole disk encryption tools?
9. What are BitLocker’s current hardware and software requirements?
10. Describe some of the open source whole disk encryption tools.
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ECO 302 Week 5 Quiz – Strayer
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Chapters 6 and 7
Chapter 6
TRUE/FALSE
1. Bond holdings and interest income are zero for the whole economy.
2. The household real budget constraint shows that household real consumption is equal to household real income plus household real saving.
3. In the Barro model prices like the real wage adjust to clear markets like the labor market.
4. In the Barro model the nominal rate of return on capital, (R/P) - is greater than the nominal return on bonds, i, because capital is viewed by households as more risky than bonds.
5. Real profit equals real output plus spending on capital and labor inputs.
6. In the bond market, a higher interest rate means that borrowing is less expensive than before.
7. Household decisions depend on the nominal values for wages and rent rather than the real values for wages and rent.
8. In the Barro model, households use money as a means for trading goods and services.
9. In the Barro market model, gold serves as money.
10. The market-clearing interest rate depends on the marginal productivity of capital.
MULTIPLE CHOICE
1. The market clearing approach assumes that:
a. people are not able to affect prices that influence their decisions. c. firms are not able to affect prices that influence their decisions.
b. prices adjust to clear markets. d. all of the above.
2. The market clearing approach assumes that:
a. people are not able to affect prices that influence their decisions. c. firms are able to affect prices that influence their decisions.
b. prices change very slowly. d. all of the above.
3. The market clearing approach assumes that:
a. people are able to affect prices that influence their decisions. c. firms are able to affect prices that influence their decisions.
b. prices adjust to clear markets. d. all of the above.
4. The market clearing approach assumes that:
a. people are able to affect prices that influence their decisions. c. firms are not able to affect prices that influence their decisions.
b. prices change very slowly. d. all of the above.
5. The labor market clears when:
a. the real wage causes LS = LD. c. the marginal product of labor is zero.
b. the real wage causes LS to be minimized. d. the real wage causes LS to be as large as possible.
6. In the goods market in the Barro model households can buy:
a. bonds. c. labor services.
b. goods to increase their stock of capital. d. all of the above.
7. The goods market the price, P, is:
a. the price level. c. the price of a particular good.
b. the rental price of goods. d. the interest rate.
8. In the rental market in the Barro model, households buy and sell:
a. real estate. c. the use of capital for one period.
b. consumer durables like cars. d. all of the above.
9. A bond that is traded in the bond market in the Barro model is piece of paper that:
a. is the lenders claim to the amount owed by the borrower. c. is the lenders claim to ownership in the company.
b. is the borrowers claim to the amount owed by the lender. d. assures the person is who they say they are.
10. Money in the Barro model is held because:
a. for its own sake. c. to earn interest.
b. to trade fairly soon for something else. d. all of the above.
11. Money in the Barro model is:
a. gold. c. interest earning.
b. a medium of exchange. d. all of the above.
12. One unit of money in the Barro model has a purchasing power of:
a. the price level time that one unit, P. c. the interest rate, i.
b. the price level over the interest rate, (P/i). d. one over the price level, (1/P)
13. If a household has $2,000 in money and the price level is 10, then the real value of its money is:
a. $10. c. 200 goods.
b. $20,000. d. 1,900 goods.
14. The real wage is:
a. hourly earning after taxes. c. the value of a worker’s time in goods received.
b. wages plus fringe benefits. d. the price level divided by the nominal wage rate.
15. If the nominal wage rate is $10 per hour and the price level is 2, then the real wage a worker earns is:
a. five units of goods per hour. c. twenty units of goods per hour.
b. eight units of goods per hour. d. one-fifth unit of goods per hour.
16. If the rental price of a capital good is $100 and the price level is 25, then when renting the capital the owner’s real earnings are:
a. 4 units of output per period. c. seventy five units of output per period.
b. 2,500 units of output per period. d. one-forth unit of output per period.
17. The rental price of capital is:
a. a dollar amount per unit of capital. c. a nominal interest rate
b. a real interest rate. d. profit.
18. Over all households bonds, B, must total zero because:
a. there are no bonds in the model. c. bonds are not important in the model.
b. for every dollar loaned a dollar is borrowed in the bond market. d. bonds are illegal in most economies.
19. The profit in the model is:
a. output - (wages times labor hired + the rental price times capital rented). c. (price times output) - (wages times labor hired + the rental price times capital rented).
b. (price times output) divided by (wages times labor hired + the rental price times capital rented). d. (wages times labor hired + the rental price times capital rented) - (price times output).
20. The rate of return from owning capital is:
a. the rental price of capital, R. c. the net nominal rental income, (R/P)•PK - PK.
b. the value of depreciation, PK. d. the real rental price less depreciation, (R/P) - .
21. The principal of a bond is:
a. the amount of interest paid each period. c. the amount of interest paid over the term of the bond.
b. the initial amount borrowed. d. the total amount to be paid back including the amount borrow and the amount of interest paid over the term of the bond.
22. The maturity of a bond is:
a. the amount of interest paid each period. c. the amount of interest paid over the term of the bond.
b. the amount borrowed. d. the time at which the lender must be paid back.
23. If the principal of a bond is $100, it matures in a year and the interest rate is 4%, then at the interest payment on this bond will be:
a. $100. c. $4.
b. $96. d. $400.
24. If the principal of a bond is $1000, it matures in a year and the interest rate is 6%, then at the end of the year the lender will receive:
a. $1000. c. $60.
b. $1060. d. $940.
25. In the market clearing model, for the whole economy interest income is:
a. bonds minus the interest rate. c. the interest rate divided by bonds.
b. zero. d. bonds divided by the interest rate.
26. Individual household nominal income includes:
a. nominal interest income, iB. c. nominal wage income, wL.
b. nominal net rental income, [(R/P) - PK]•PK. d. all of the above.
27. In the model the nominal interest rate equals the nominal net return on capital, i = (R/P) - , because:
a. other than rates of return bonds and capital look the same to households as assets. c. bonds are riskier than capital.
b. capital is riskier than bonds. d. bonds are zero in the aggregate.
28. In the model the nominal interest rate equals the nominal net return on capital, i = (R/P) - , because:
a. bonds are zero in the aggregate. c. bonds are riskier than capital.
b. capital is riskier than bonds. d. if bonds offered a higher return than capital households would hold no capital.
29. According to the household nominal budget constraint, PC+ B+P• K = + wL + i(B + PK), households can use their income to:
a. purchase consumption goods. c. purchase capital goods.
b. acquire more bonds. d. all of the above.
30. Interest income is:
a. positive for net bond holders. c. negative for net bond issuers.
b. zero for the whole economy. d. all of the above.
31. According to the household nominal budget constraint, PC+ B+P• K = + wL + i(B + PK), households can use their income to:
a. purchase consumption goods. c. acquire more money.
b. hire more workers. d. all of the above.
32. According to the household nominal budget constraint, PC+ B+P• K = + wL + i(B + PK), households can use their income to:
a. acquire more money. c. pay more wages.
b. acquire more bonds. d. all of the above.
33. According to the household nominal budget constraint, PC+ B+P• K = + wL + i(B + PK), households can use their income to:
a. hire more workers. c. purchase capital goods.
b. acquire more money. d. all of the above.
34. If a household this week produces 20 of its product at a cost of 50 cents each, sells them for $1, works 40 hours at $10 per hour, must pay $10 in interest owed on its borrowing and rents out 10 units of capital at $100 for the week, the household’s, nominal income is:
a. $1,440 this week. c. $1,420 this week.
b. $1,400 this week. d. none of the above.
35. The household real budget constraint C + ( B/P) + K = ( /P)+ (w/P)•L + i•((B/P) + K).
shows that in our model:
a. households get income only from labor. c. households can spend their income only on consumption.
b. households can spend their income on consumption or acquiring more capital and bonds. d. households view bonds as riskier than capital.
36. The household’s budget constraint shows that:
a. sources of fund = uses of funds. c. labor income is the largest part of income.
b. profits are the largest part of income d. consumption is the largest part of spending.
37. The household real budget constraint C + ( B/P) + K = ( /P) + (w/P)•L + i•((B/P) + K).
shows that in our model:
a. households get income only from labor. c. households get income from profits from production, labor and interest on bonds and capital.
b. households can spend their income only on consumption. d. households view bonds as riskier than capital.
38. To maximize profit a firm should hire labor:
a. until it can produce no more of its product. c. until the marginal product of labor equal the real wage rate.
b. until the marginal product of labor begins to fall. d. until the marginal product of labor is zero.
39. An investment in the Barro model is:
a. the purchase of a bond. c. the purchase of a capital good used for production.
b. the purchase of ownership in a firm. d. all of the above.
40. To maximize profit a firm should hire capital:
a. until it can produce no more of its product. c. until the marginal product of capital equal the real rental price of capital.
b. until the marginal product of labor begins to fall. d. until the marginal product of capital is zero.
41. In the market for capital services:
a. the supply of capital adjusts to create market clearing. c. the demand for capital adjusts to create market clearing.
b. the real rental price of capital adjusts to create market clearing. d. all of the above.
42. In the market clearing model, depreciation, , is:
a. the rate at which capital disappears. c. the rate at which bonds lose value.
b. the rate at which money loses value. d. all of the above.
43. In the market clearing model:
a. households can owe pay interest. c. for the whole economy interest income is zero.
b. households can earn interest. d. all of the above.
44. In the market clearing model, nominal saving is:
a. the change in money + the change in bonds + the change in the nominal value of capital. c. + wL + i(B + PK) - PC.
b. nominal income less nominal consumption. d. all of the above.
45. In the market clearing model, nominal saving is:
a. the change in money + the change in bonds. c. + wL + i(B + PK) - PC.
b. nominal income plus nominal consumption. d. all of the above.
46. In the market clearing model, nominal saving is:
a. always zero. c. nominal income - depreciation of capital.
b. nominal income less nominal consumption. d. all of the above.
47. In the market clearing model, nominal saving is:
a. the change in money + the change in bonds + the change in the nominal value of capital. c. always zero.
b. nominal income plus nominal saving. d. all of the above.
48. Real saving is:
a. + wL + i(B + PK) - PC. c. ( /P) + (w/P)L + i((B/P) + K) - C.
b. output plus consumption. d. all of the above.
49. Figure 6.1
In Figure 6.1 an increase in real income is shown by:
a. a shift of the curve up and to the right. c. a shift of the curve inward and to the left.
b. rotating the curve out the real consumption axis. d. rotating the curve up the real saving axis.
50. In the market clearing model, the demand for capital and labor come from:
a. the tastes of people. c. the objective of profit maximizing.
b. rental and labor markets. d. all of the above.
51. In the goods market, production of goods comes from
a. large corporate firms. c. households.
b. technology-related businesses. d. large partnerships.
52. Households buy goods on the goods market because they wish to
a. consume. c. export.
b. invest. d. both (a) and (b).
53. Households provide to the rental market
a. all available capital services, so that no capital remains idle. c. none of their capital services, since households do not own capital.
b. some of their capital services, leaving a fraction of capital idle. d. none of their capital services, so that only businesses own capital.
54. In the Barro market model, currency is used
a. to earn interest income. c. only in the bond market.
b. as a medium of exchange. d. only in the labor market.
55. Households earn interest from
a. holding bonds and holding money. c. holding bonds, but not from holding money.
b. holding money, but not from holding bonds. d. none of the above.
56. To simplify the analysis of the bond market, the Barro bond market model initially assumes that
a. each bond has a different risk level. c. bond maturities are long.
b. a bond has no principal amount. d. the inflation rate is zero.
57. A household views the real rental price for capital (R/P) as
a. the rate of return on capital only after it is adjusted for depreciation. c. the profit from its production of goods and services.
b. the rate of return on capital only after it is adjusted for inflation. d. the profit from its holdings of bonds and money.
58. In the Barro markets model, the medium(s) of exchange
a. is bonds. c. are both bonds and money.
b. is money. d. are bonds, money, and labor services.
59. If bonds offer a higher rate of return than capital does, then households would
a. hold neither bonds nor capital. c. hold bonds only.
b. hold capital only. d. hold both bonds and capital.
60. In the market for capital services, if the real rental price is below the market-clearing rental price, then
a. suppliers of capital services would compete by bidding down the real rental price. c. the market for capital services would be in equilibrium.
b. suppliers of capital services would compete by bidding up the real rental price. d. demanders of capital services would compete by bidding up the real rental price.
SHORT ANSWER
1. How is profit calculated in the model?
2. What is the household real budget constraint and what does it tell us?
3. In the model why does the return on bonds, i, equal the return on capital, (R/P) - ?
4. What is real profit in the Barro model?
5. What causes the labor and capital markets to clear in the Barro model?
6. In the Barro market-clearing model, on what variable does the interest rate depend? Explain briefly.
7. Why does the Barro model assume that the labor and capital market clear? Explain briefly.
8. In the Barro market model, why are equilibrium profits equal to zero?
Chapter 7
TRUE/FALSE
1. If the value of initial assets increases, then a household will change consumption or present value of asset at the end of period 2 due to an income effect.
2. $100 a year from now is equal in worth to $100 today.
3. A discount factor is used to deflate nominal consumption to real consumption.
4. If wages rises by $10 per worker just this period, we would expect to see consumption rise by much less than $10 this period.
5. The aggregate household budget constraint is consumption plus net investment is real GDP less depreciation.
6. In the multiyear household budget constraint, wage incomes from each year are added together without further adjustments.
7. In the multiyear household budget constraint, initial asset values are excluded.
8. An increase in the interest rate leads to an income effect and an intertemporal-substitution effect on consumption which offset each other.
9. An increase in the interest rate leads to an income effect which increases consumption and saving in year 1.
10. An increase in the interest rate leads to an intertemporal substitution effect which decreases consumption and increases saving in year 1.
MULTIPLE CHOICE
1. Real profit is zero when:
a. the interest rate is zero. c. the labor and capital markets clear.
b. the depreciation rate is high. d. the labor and capital markets do not clear.
2. When the labor and capital markets clear:
a. depreciation is zero. c. a dollar today is worth more than a dollar in the future.
b. real profit is zero. d. all of the above.
3. Real household saving is:
a. B + K c. ( B/P) + K
b. B + ( K/P) d. ( B/P) + ( K/P)
4. Real income is:
a. wL + i(B+K) c. (w/P)L + i((B/P)+(K/P))
b. (w/P)L + i((B/P)+ K) d. (w/P)L + i(B+ K)
Figure 7.1
5. In Figure 7.1 if the household opts to consume all its income it will be at point:
a. F c. H
b. G d. I
6. In Figure 7.1 if the household decides to save all of its income, it would be at point:
a. F c. H
b. G d. I
7. In Figure 7.1 if the household moves from point G to point H on its budget, it would be:
a. saving and consuming more. c. saving more and consuming less.
b. saving less and consuming more. d. saving and consuming less.
8. In Figure 7.1 if the household moves from point I to point H on its budget, it would be:
a. saving and consuming more. c. saving more and consuming less.
b. saving less and consuming more. d. saving and consuming less.
9. In Figure 7.1 if the household moves from point F to point H on its budget, it would be:
a. saving and consuming more. c. saving more and consuming less.
b. saving less and consuming more. d. saving and consuming less.
10. In Figure 7.1 if the household moves from point H to point G on its budget, it would be:
a. saving and consuming more. c. saving more and consuming less.
b. saving less and consuming more. d. saving and consuming less.
11. In Figure 7.1 if the household moves from point H to point G on its budget, it would be:
a. gaining one unit of saving and one unit of consumption. c. gaining one unit of saving for giving up five units of consumption.
b. giving up one unit of saving for one unit of consumption. d. giving up one unit of saving and five units of consumption.
12. Real saving in year one is:
a. real bonds plus capital in year 1 minus real bonds and capital in year 0. c. bonds plus capital in period 1.
b. bonds plus capital plus money period 1. d. interest times the sum of bonds plus capital in period 1.
13. The household’s year one budget constraint is:
a. real assets at the end of year zero plus real income in year one less consumption in year one equals real assets at the end of year one. c. real assets at the end of year zero plus real income in year one plus consumption in year one equals real assets at the end of year one.
b. real income in year one less real assets at the end of year zero less consumption in year one equals real assets at the end of year one. d. real income in year one plus consumption in year one less real assets at the end of year zero equals real assets at the end of year one.
14. In the one period budget constraint sources of funds include:
a. labor income. c. income from bonds.
b. income from capital. d. all of the above.
15. In the one period budget constraint sources of funds include:
a. labor income. c. capital gains.
b. interests bearing money. d. all of the above.
16. In the one period budget constraint sources of funds include:
a. capital gains. c. income from rising prices.
b. income from capital. d. all of the above.
17. In the one period budget constraint sources of funds include:
a. capital gains. c. income from bonds.
b. inflation. d. all of the above.
18. In the one period budget constraint the uses of funds include:
a. purchases of consumption goods. c. purchases of bonds.
b. purchases of capital goods. d. all of the above.
19. In the one period budget constraint the uses of funds include:
a. purchases of consumption goods. c. payment profits.
b. payment of wages. d. all of the above.
20. In the one period budget constraint the uses of funds include:
a. payment of transfers. c. payment of wages.
b. purchases of capital goods. d. all of the above.
21. In the one period budget constraint the uses of funds include:
a. payment of transfers. c. purchases of bonds.
b. payment of wages. d. all of the above.
22. The measure used to reduce future consumption to today’s values is called:
a. an implicit deflator. c. an escalator.
b. a discount factor. d. a future value.
23. When a discount factor is multiplied times a future period variable it creates a:
a. future value. c. a real variable.
b. a present value. d. a nominal variable.
24. A dollar today is worth more than a dollar a year from now as long as:
a. the interest rate is negative. c. the depreciation rate is negative.
b. the interest rate is positive. d. the depreciation rate is positive.
25. An income effect is the response of households to changes in the present value of:
a. relative prices. c. uses of funds.
b. sources of funds. d. assets at the end of year two.
26. If the interest rate is greater than zero, then the concept of present value is that a dollar today:
a. is worth more than a dollar a year from now. c. will be worthless a year from now.
b. is worth less than a dollar a year from now. d. is worth the same as a year from now.
27. If the present value of assets at the end of year two is constant, an increase in the present value of sources of funds must cause:
a. consumption in periods one and two to rise. c. consumption to rise in period one and fall in period two.
b. consumption in periods one and two to fall. d. consumption to fall in period one and rise in period two.
28. The present value of sources of funds is:
a. the value of intial assets plus the present value of wage income plus the present value of assets at the end of year two. c. the present value of wage income plus the present value of assets at the end of year two.
b. the value of initial assets plus the present value of assets at the end of year two. d. the value of intial assets plus the present value of wage income.
29. An increase in the interest rate:
a. makes consumption in period two relatively more expensive compared to consumption in period one. c. makes consumption in period two relatively cheaper compared consumption in period one.
b. does not change relative cost of consuming in either period. d. discourages savings in each period.
30. If a household consumes one less unit in period 1, they can consume:
a. on more unit in period two. c. one less unit in period two.
b. (1 + i) more units in period two. d. no more in period two.
31. Utility in economics is:
a. a product with a derived demand like electricity. c. satisfaction or happiness.
b. usefulness. d. all of the above.
32. Utility in economics:
a. used to mean happiness. c. is what a person gets from a good.
b. used to mean satisfaction. d. all of the above.
33. An increase in the interest rate can cause an income effect by:
a. making future consumption cheaper. c. making present consumption cheaper.
b. changing real income in year two. d. all of the above.
34. An increase in the interest rate:
a. makes future consumption cheaper. c. makes present consumption more expensive.
b. increases future income. d. all of the above.
35. An increase in the interest rate:
a. makes future consumption cheaper. c. makes present consumption cheaper.
b. decreases future income. d. all of the above.
36. An increase in the interest rate:
a. makes future consumption more expensive. c. makes present consumption more expensive.
b. decreases future income. d. all of the above.
37. An increase in the interest rate:
a. makes future consumption more expensive. c. makes present consumption cheaper.
b. increases future income. d. all of the above.
38. An intertemporal substitution effect is caused by a change in:
a. a price from one period to another. c. income.
b. wealth. d. all of the above.
39. The marginal propensity to save out of a temporary change in income is approximately:
a. 1 c. 0
b. 0.5 d. none of the above.
40. The marginal propensity to save out of a permanent change in income is approximately:
a. 1 c. 0
b. 0.5 d. none of the above.
41. The marginal propensity to consume out of a permanent change in income is approximately:
a. 1 c. 0
b. 0.5 d. none of the above.
42. The marginal propensity to consume out of a temporary change in income is approximately:
a. 1 c. 0
b. 0.5 d. none of the above.
43. If a worker receives a one time bonus we would expect them to:
a. save most of it. c. consume most of it.
b. refuse it. d. consume half and save half of it.
44. If a worker receives a bonus every Christmas, we would expect them to:
a. save most of it. c. consume most of it.
b. reject it. d. consume half of it and save half of it.
45. If a person wins $500 in a scratch-off lottery game, we would expect them to:
a. save most of it. c. consume most of it.
b. refuse it. d. consume half and save half of it.
46. If a worker gets a promotion that doubles their salary, with the increase in salary we would expect them to:
a. save most of it. c. consume most of it.
b. reject it. d. consume half of it and save half of it.
47. If the household budget constraint is aggregated over all household, it shows that:
a. consumption plus net investment equal net national product. c. C + K = Y - K
b. consumption plus net investment equals real GDP less depreciation. d. all of the above.
48. If the household budget constraint is aggregated over all household, it shows that:
a. consumption plus net investment equal net national product. c. C - K = Y + K.
b. consumption less net investment equals real GDP less depreciation. d. all of the above.
49. If the household budget constraint is aggregated over all household, it shows that:
a. consumption less net investment equal net national product. c. C - K = Y + K
b. consumption plus net investment equals real GDP less depreciation. d. all of the above.
50. If the household budget constraint is aggregated over all household, it shows that:
a. profit is zero. c. C + K = Y - K
b. PC+ B+P• K = + wL + i(B + PK), d. all of the above.
51. In the multi-year budget constraint the present value of consumption equals the value of initial assets plus the:
a. present value of savings. c. present value of wage incomes.
b. present value of final assets. d. the present value of time.
52. In the two-year household budget constraint, each unit of initial assets is adjusted by
a. multiplying by (1 + io). c. dividing by (1 + io).
b. multiplying by (1 + i1). d. dividing by (1 + i1).
53. In the two-year household budget constraint, each unit of labor in year 2 is adjusted by
a. multiplying by (1 + io). c. dividing by (1 + io).
b. dividing by (1 + i1). d. multiplying by (1 + i1).
54. In the two-year household budget constraint, each unit of conumption in year 2 is adjusted by
a. multiplying by (1 + io). c. dividing by (1 + i1).
b. multiplying by (1 + i1). d. dividing by (1 + i0).
55. For a household budget over two years, suppose the dollar wage rate in year 1 and year 2 equals $12, the price level in year 1 and year 2 equals 2, and the nominal interest rate in year 1 and year 2 equals 3 percent. The total present value of wage income over two years is
a. 24 c. 12
b. 12.18 d. 5.83
56. For a household budget over two years, suppose the dollar wage rate in year 1 and year 2 equals $8, the price level in year 1 and year 2 equals 2, and the nominal interest rate in year 1 and year 2 equals 3 percent. The present value of wage income in year two only is
a. 3.88 c. 4.12
b. 4 d. 5.83
57. Suppose that the present value of a household’s wage income rises. The effect on consumption most likely is
a. zero. c. more consumption in year 2 only.
b. more consumption in both year 1 and 2. d. more consumption in year 1 only.
58. An increase in the interest rate in year 1 leads to
a. an intertemporal substition effect which lowers C1 and lowers C2. c. an intertemporal substition effect which lowers C1 and raises C2.
b. an interpersonal effect which lowers C1 and lowers C2. d. an interpersonal effect which lowers C1 and lowers C2.
59. An increase in the interest rate in year 1 leads to
a. an intertemporal substition effect which raises consumption and saving in year 1. c. an intertemporal substition effect which lowers consumption and raises saving in year 1.
b. an income effect which lowers consumption and saving in year 1. d. an income effect which raises consumption and lowers saving in year 1.
60. For a 2-year household budget constraint, an increase in the interest rate in year 1 leads to which combined effect on consumption?
a. An increase in consumption in year 1. c. A decrease in consumption in year 1.
b. A decrease in consumption in year 1 and an increase in year 2. d. An ambiguous effect.
SHORT ANSWER
1. Derive the household’s two period real budget constraint.
2. What is an intertemporal substitution effect and what can cause one?
3. What is an income effect and what can cause one?
4. What are the effects of an increase in the interest rate on the choice of consumption over time?
5. Show the relationship between the household budget constraint and net national product.
6. Does an increase in permanent income affect household consumption differently than an increase in temporary income?
7. What is the marginal propensity to consume? When would you predict its value to be close to zero?
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ECO 305 Week 5 Quiz – Strayer
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Week 5 Quiz 4 Chapter 7
CHAPTER 7
TRADE POLICIES FOR THE DEVELOPING NATIONS
MULTIPLE CHOICE
1. Which of the following is not a major factor that encourages developing nations to form international commodity agreements?
a. Inelastic commodity supply schedules
b. Inelastic commodity demand schedules
c. Export markets that tend to be unstable
d. Secular increases in their terms of trade
2. International commodity agreements do not:
a. Consist of consuming and producing nations who desire market stability
b. Levy export cutbacks so as to offset rising commodity prices
c. Utilize buffer stocks to generate commodity price stability
d. Increase the supply of commodities to prevent rising prices
3. Concerning the price elasticities of supply and demand for commodities, empirical estimates suggest that most commodities have:
a. Inelastic supply schedules and inelastic demand schedules
b. Inelastic supply schedules and elastic demand schedules
c. Elastic supply schedules and inelastic demand schedules
d. Elastic supply schedules and elastic demand schedules
4. If the demand schedule for bauxite is relatively inelastic to price changes, an increase in the supply schedule of bauxite will cause a:
a. Decrease in price and a decrease in sales revenue
b. Decrease in price and an increase in sales revenue
c. Increase in price and a decrease in sales revenue
d. Increase in price and an increase in sales revenue
5. A primary goal of international commodity agreements has been the:
a. Maximization of members' revenues via export taxes
b. Nationalization of corporations operating in member nations
c. Adoption of tariff protection against industrialized nation sellers
d. Moderation of commodity price fluctuations when markets are unstable
6. Which device has the International Tin Agreement utilized as a way of stabilizing tin prices?
a. Multilateral contracts
b. Export subsidies
c. Buffer stocks
d. Export tariffs
7. Which method has not generally been used by the international commodity agreements to stabilize commodity prices?
a. Production quotas applied to the level of commodity output
b. Buffer stock arrangements among producing nations
c. Export restrictions applied to international sales of commodities
d. Measures to nationalize foreign-owned production operations
8. The OPEC nations during the 1970s manifested their market power by utilizing:
a. Export tariffs levied for revenue purposes
b. Export tariffs levied for protective purposes
c. Import tariffs levied for protective purposes
d. Import tariffs levied for revenue purposes
9. One factor that has prevented the formation of cartels for producers of commodities is that:
a. The demand for commodities tends to be price inelastic
b. Substitute products exist for many commodities
c. Commodity produces have been able to dominate world markets
d. Production of most commodities is capital intensive
10. Which device has been used by the International Wheat Agreement to stipulate the minimum prices at which importers will buy stipulated quantities from producers and the maximum prices at which producers will sell stipulated quantities to importers?
a. Buffer stocks
b. Export controls
c. Multilateral contracts
d. Production controls
11. If the bauxite exporting countries form a cartel to boost the price of bauxite so as to increase sales revenue, they believe that the demand for bauxite:
a. Is inelastic with respect to price changes
b. Is elastic with respect to price changes
c. Will increase in response to a price increase
d. Will not change in response to a price change
12. If the supply schedule for tin is relatively inelastic to price changes, a decrease in the demand schedule for tin will cause a:
a. Decrease in price and an increase in sales revenue
b. Decrease in price and a decrease in sales revenue
c. Increase in price and an increase in sales revenue
d. Increase in price and a decrease in sales revenue
13. Which of the following could partially explain why the terms of trade of developing countries might deteriorate over time?
a. Developing-country exports mainly consist of manufactured goods
b. Developing-country imports mainly consist of primary products
c. Commodity export prices are determined in highly competitive markets
d. Commodity export prices are solely determined by developing countries
14. Which terms-of-trade concept emphasizes a nation's capacity to import?
a. Income terms of trade
b. Commodity terms of trade
c. Barter terms of trade
d. Price terms of trade
15. Which trade strategy have developing countries used to restrict imports of manufactured goods so that the domestic market is preserved for home producers, who thus can take over markets already established in the country?
a. International commodity agreement
b. Export promotion
c. Multilateral contract
d. Import substitution
16. Which trade strategy have developing countries used to replace commodity exports with exports such as processed primary products, semi-manufacturers, and manufacturers?
a. Multilateral contract
b. Buffer stock
c. Export promotion
d. Export quota
17. To help developing countries expand their industrial base, some industrial countries have reduced tariffs on designated manufactured imports from developing countries below the levels applied to imports from industrial countries. This scheme is referred to as:
a. Generalized system of preferences
b. Export-led growth
c. International commodity agreement
d. Reciprocal trade agreement
18. Which nation accounts for the largest amount of OPEC's oil reserves and production?
a. Iran
b. Libya
c. Iraq
d. Saudi Arabia
19. Assuming identical cost and demand curves, OPEC as a cartel will, in comparison to a competitive industry:
a. Produce greater output and charge a lower price
b. Produce greater output and charge a higher price
c. Produce less output and charge a higher price
d. Produce less output and charge a lower price
20. Which of the following situations reduces the likelihood of successful operation of a cartel?
a. Cartel sales experience a rapid expansion
b. The demand for cartel output is price inelastic
c. The number of firms in the cartel is large
d. It is very difficult for new firms to enter the market
21. Which industrialization policy used by developing countries places emphasis on the comparative advantage principle as a guide to resource allocation?
a. Export promotion
b. Import substitution
c. International commodity agreements
d. Multilateral contract
22. A widely used indicator to differentiate developed countries from developing countries is:
a. International trade per capita
b. Real income per capita
c. Unemployment per capita
d. Calories per capita
23. Concerning the hypothesis that there has occurred a long-run deterioration in the developing countries' terms of trade, empirical studies provide:
a. Mixed evidence that does not substantiate the deterioration hypothesis
b. Overwhelming support for the deterioration hypothesis
c. Overwhelming opposition to the deterioration hypothesis
d. None of the above
24. For the oil-importing countries, the increases in oil prices in 1973-1974 and 1979-1980 resulted in all of the following except:
a. Balance of trade deficits
b. Price inflation
c. Constrained economic growth
d. Improving terms of trade
25. Hong Kong and South Korea are examples of developing nations that have recently pursued industrialization policies.
a. Import substitution
b. Export promotion
c. Commercial dumping
d. Multilateral contract
26. Stabilizing commodity prices around long-term trends tends to benefit importers at the expense of exporters in markets characterized by:
a. Demand-side disturbances
b. Supply-side disturbances
c. Demand-side and supply-side disturbances
d. None of the above
27. Stabilizing commodity prices around long-term trends tends to benefit exporters at the expense of importers in markets characterized by:
a. Demand-side disturbances
b. Supply-side disturbances
c. Demand-side and supply-side disturbances
d. None of the above
28. To be considered a good candidate for an export cartel, a commodity should:
a. Be a manufactured good
b. Be a primary product
c. Have a high price elasticity of supply
d. Have a low price elasticity of demand
29. To be considered a good candidate for an export cartel, a commodity should:
a. Be a manufactured good
b. Be a primary product
c. Have a low price elasticity of supply
d. Have a high price elasticity of demand
30. To help developing nations strengthen their international competitiveness, many industrial nations have granted nonreciprocal tariff reductions to developing nations under the:
a. International commodity agreements program
b. Multilateral contract program
c. Generalized system of preferences program
d. Export-led growth program
The diagram below illustrates the international tin market. Assume that producing and consuming countries establish an international commodity agreement under which the target price of tin is $5 per pound.
Figure 7.1. Defending the Target Price in Face of Changing Demand Conditions
31. Consider Figure 7.1. Suppose the demand for tin increases from D0 to D1. Under a buffer stock system, the buffer-stock manager could maintain the target price by:
a. Selling 15 pounds of tin
b. Selling 30 pounds of tin
c. Buying 15 pounds of tin
d. Buying 30 pounds of tin
32. Consider Figure 7.1. Suppose the demand for tin decreases from D0 to D2. Under a buffer stock system, the buffer-stock manager could maintain the target price by:
a. Selling 15 pounds of tin
b. Selling 30 pounds of tin
c. Buying 15 pounds of tin
d. Buying 30 pounds of tin
33. Consider Figure 7.1. Suppose the demand for tin decreases from D0 to D2. Under a system of export quotas, the tin producers could maintain the target price by:
a. Increasing the quantity of tin supplied by 15 pounds
b. Increasing the quantity of tin supplied by 30 pounds
c. Decreasing the quantity of tin supplied by 15 pounds
d. Decreasing the quantity of tin supplied by 30 pounds
The diagram below illustrates the international tin market. Assume that the producing and consuming countries establish an international commodity agreement under which the target price of tin is $5 per pound.
Figure 7.2. Defending the Target Price in Face of Changing Supply Conditions
34. Consider Figure 7.2. Suppose the supply of tin increases from S0 to S1. Under a buffer stock system, the buffer-stock manager could maintain the target price by:
a. Purchasing 15 pounds of tin
b. Purchasing 30 pounds of tin
c. Selling 15 pounds of tin
d. Selling 30 pounds of tin
35. Consider Figure 7.2. Suppose the supply of tin decreases from S0 to S2. Under a buffer stock system, the buffer-stock manager could maintain the target price by:
a. Purchasing 15 pounds of tin
b. Purchasing 30 pounds of tin
c. Selling 15 pounds of tin
d. Selling 30 pounds of tin
36. Consider Figure 7.2. Assume there exists a cartel of several producers that is maximizing total profit. If one producer cheats on the cartel agreement by decreasing its price and increasing its output, rational action of the other producers is to:
a. Increase their price in order to regain sacrificed profits
b. Decrease their price as well
c. Keep on selling at the agreed-upon price
d. Give the product away for free
37. A reason why it is difficult for producers to maintain a cartel is that:
a. The elasticity of demand for the cartel's output decreases over time
b. Producers in the cartel have the economic incentive to cheat
c. Economic profits discourage other producers from entering the industry
d. Producers in the cartel have the motivation to lower price but not to raise price
38. Once a cartel establishes its profit-maximizing price:
a. Entry into the industry of new competitors will not affect the cartel's profits
b. Output changes by cartel members have no effect on the market price
c. Each cartel member is tempted to cheat on the cartel price in order to add to its profit
d. All cartel members have a strong incentive to adhere to the agreed-upon price
Figure 7.3. World Oil Market
39. Consider Figure 7.3. Under competitive conditions, the quantity of oil produced equals:
a. 40 barrels
b. 70 barrels
c. 90 barrels
d. 110 barrels
40. Consider Figure 7.3. Under competitive conditions, the price of a barrel of oil equals:
a. $7
b. $11
c. $12
d. $16
41. Consider Figure 7.3. Under competitive conditions, producer profits total:
a. $0
b. $140
c. $200
d. $280
42. Consider Figure 7.3. Under a profit-maximizing cartel, the quantity of oil produced equals:
a. 40 barrels
b. 70 barrels
c. 90 barrels
d. 110 barrels
43. Consider Figure 7.3. Under a profit-maximizing cartel, the price of a barrel of oil equals:
a. $7
b. $11
c. $16
d. $19
44. Consider Figure 7.3. Under a profit-maximizing cartel, producers realize:
a. Profits totaling $280
b. Profits totaling $360
c. Losses totaling $140
d. Losses totaling $180
45. Import substitution policies make use of:
a. Tariffs that discourage goods from entering a country
b. Quotas applied to goods that are shipped abroad
c. Production subsidies granted to industries with comparative advantages
d. Tax breaks granted to industries with comparative advantages
46. Export-led growth tends to:
a. Exploit domestic comparative advantages
b. Discourage competition in the global economy
c. Lead to unemployment among domestic workers
d. Help firms benefit from diseconomies of large-scale production
47. All of the following nations except ____ have recently utilized export-led (outward oriented) growth policies.
a. Hong Kong
b. South Korea
c. Argentina
d. Singapore
48. The characteristics that have underlaid the economic success of the "high-performing Asian Economies" have included all of the following except:
a. High rates of domestic investment
b. Diseconomies of scale occurring at low output levels
c. Large endowments of human capital
d. High levels of labor productivity
49. The development of countries like South Korea and Singapore has been underlaid by all of the following except:
a. High domestic interest rates
b. R&D and product innovation
c. Education and on-the-job training
d. High levels of saving and investment
50. For most developing countries:
a. Productivity is high among domestic workers
b. Population-growth and illiteracy rates are low
c. Saving and investment levels are high
d. Agricultural goods and raw materials constitute much of domestic output
51. East Asian economies have performed well by
a. Obtaining foreign technology
b. Remaining open to international trade
c. Investing in their people
d. All of the above
52. East Asian economies started enacting export-push strategies
a. By late 1950s and 1960s
b. Immediately after World War II
c. In the late 1980s
d. In the early 2000s
53. Prior to the formation of the Organization of Petroleum Exporting Countries, individual oil producing nations,
a. Operated like sellers in a competitive market
b. Behaved like individual sellers in a monopoly market
c. Had considerable control over the price of oil
d. Both b and c.
54. A key factor underlying the instability of primary product prices and export receipts of developing nations is the
a. Low price elasticity of the demand of primary products
b. High price elasticity of supply of primary products
c. High price elasticity of demand of primary products
d. None of the above
TRUE/FALSE
1. The developing nations are most of those in Africa, Asia, North America, and Western Europe.
2. Most developing-nation exports go to industrial nations while most developing-nation imports originate in industrial nations.
3. The majority of developing-nation exports are primary products such as agricultural goods and raw materials; of the manufactured goods exported by developing nations, most are labor-intensive goods.
4. Developing nations overwhelmingly acknowledge that they have benefited from international trade according to the principle of comparative advantage.
5. Among the economic problems facing developing countries have been low dependence on primary-product exports, unstable export markets, and worsening terms of trade.
6. For developing countries, a key factor underlying the instability of primary-product prices and export receipts is the high price elasticity of demand for products such as tin and copper.
7. Empirical research indicates that the demand and supply schedules for most primary products are relatively inelastic to changes in price.
8. If the demand for coffee is price inelastic, an increase in the supply of coffee leads to falling prices and rising sales revenues.
9. Not only do changes in demand induce relatively wide fluctuations in price when supply is inelastic, but changes in supply induce relatively wide fluctuations in price when demand is inelastic.
10. Developing countries have complained that because their commodity terms of trade has deteriorated in recent decades, they should receive preferential tariff treatment from industrialized countries.
11. To promote stability in commodity markets, International Commodity Agreements have utilized production and export controls, buffer stocks, and multilateral contracts.
12. During periods of falling demand for coffee, an International Commodity Agreement could offset downward pressure on price by implementing policies to increase the supply of coffee.
13. To prevent the market price of tin from rising above the target price, the manager of a buffer stock will purchase excess supplies of tin from the market.
14. To prevent the market price of tin from falling below the target price, the manager of a buffer stock would purchase any excess supply of tin that exists at the target price.
15. Prolonged defense of a price ceiling tends to increase the supply of a commodity held by a buffer stock manager, thus putting downward pressure on price.
16. Rather than conduct massive stabilization operations, buffer stock officials will periodically revise target prices should they move out of line with long-term price trends.
17. A multilateral contract stipulates the maximum price at which importing nations will purchase guaranteed quantities from producing nations and the minimum price at which producing nations will sell guaranteed amounts to importing nations.
18. It is widely agreed that import-substitution policies have been a main contributor to above-average growth rates in developing countries.
19. Under the Generalized System of Preferences program, the major industrial countries agree to temporarily reduce tariffs on designated imports from other industrial countries.
20. The "newly industrializing countries" of East Asia have emphasized the implementation of import-substitution policies to insulate their industries from international competition.
21. In recent decades, the East Asian "newly industrializing countries" have pursued export-led growth (outward orientation) as an industrialization strategy.
22. The purpose of a cartel is to support prices higher than would occur under more competitive conditions, thus increasing the profits of cartel members.
23. A cartel tends to be most successful in maximizing the profits of its members when there are a large number of producers in the cartel and these producers' cost and demand conditions greatly differ from each other.
24. When cartel members agree to restrict output to increase the price of their product, a single member of the cartel has an economic incentive to violate the agreement by increasing its output so as to increase profits.
25. Developing countries have often felt that it is easier to protect their manufacturers, via import-substitution policies, against foreign competitors than to force industrial nations to reduce trade restrictions on products exported by developing countries.
26. Import-substitution policies are supported by the fact that many developing countries have small domestic markets and thus their producers enjoy the benefits of diseconomies of small-scale production.
27. Export-led growth industrialization suffers a major problem: it depends on the willingness and ability of foreign nations to absorb the goods exported by the country pursuing such a policy.
28. The so-called Four Tigers include Australia, South Korea, Taiwan, and Hong Kong.
29. By the 1990s, China had departed from a capitalistic economy and shifted to a Soviet-type economy encompassing small-scale, labor-intensive industry.
30. During the late 1980s and early 1990s, China dismantled much of its centrally-planned economy and permitted free enterprise to replace it.
31. In its transition toward capitalism, by the 1990s China permitted free enterprise as well as democracy for its people.
32. Most of China's manufactured exports have constituted labor-intensive goods.
33. In 1999 the United States revoked the normal-trade-relations (most-favored-nation) status it provided China in retaliation for China's suppression of human rights.
34. A multilateral contract specifies the maximum price at which exporting countries agree to sell a product and the minimum price at which importing countries agree to buy a product.
35. As a profit-maximizing cartel, the Organization of Petroleum Exporting Countries would produce a greater output and charge a lower price than what would occur in a competitive market.
36. The success of buffer stocks is limited by the fact that stockpiles of a product may be exhausted after prolonged sales, while funds may be exhausted after prolonged purchases.
37. The United Nation Conference on Trade and Development in 1964 was successful in convincing developing countries to switch from export-led industrialization to import-substitution industrialization.
38. Under the Generalized System of Preferences program, the industrialized countries agree to maintain lower tariffs on imports of natural resources and higher tariffs on imports of manufactured goods.
39. The replacement of imports of one nation with imports of another nation is known as "import substitution."
40. During periods of weak demand, the Organization of Petroleum Countries has implemented production (export) quotas to ensure that excess oil supplies be kept off the market.
SHORT ANSWER
1. What are some major trade problems faced by developing nations?
2. Are economic downturns helpful to cartels?
ESSAY
1. What are some of the growth strategies that have been employed by the developing nations? How successful are these strategies?
2. Describe the flying-geese pattern of economic growth? What countries have pursued this strategy?
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ECO 405 Week 5 Quiz – Strayer
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Week 5 Quiz 4 Chapter 6
Chapter 06
The Economics Of Education: Crisis And Reform
Multiple Choice Questions
1. According To The Census Bureau, High School Graduates Can Expect To Earn How Much During Their Working Years? A. $45,000 B. $1.2 M C. $2.1 M D. $2.5 M E. $4.4 M
2. According To The Census Bureau, A College Education Adds How Much To Earnings Over A Person's Work-Life? A. Nearly $1m B. $2.1 M C. $2.5m D. $4.4 M E. Over $5 M
3. According To The Census Bureau, Someone With A Professional Degree Can Earn Approximately How Much During A Typical Work-Life? A. $1 M B. $1.2 M C. $2.5 M D. $4.4 M E. Over $5m
4. Where Did U.S. Eighth Grade Students Rank Internationally In Terms Of Average Math Scores In 2007? A. At The Top B. Second C. Near The Middle D. Next To The Bottom E. At The Bottom
5. Where Did U.S. Eighth Grade Students Rank Internationally In Terms Of Average Science Scores In 2007? A. At The Top B. Second C. In The Middle D. In The Bottom Half E. At Bottom
6. Which Of The Following Is An Important Difference Between The United States And Other Countries In Terms Of Their K-12 Education System? A. The United States Spends Less On Education Per Pupil Than Most Other Countries B. The United States Spends A Higher Percentage Of Its Gdp On Education Than Other Countries C. The United States Has A Shorter School Year Than Most Other Countries D. The United States Has A Purely Private Market For Education E. All Of The Above
7. About How Much Does The United States Spend On Education, Per Pupil? A. $6,000 B. $7,000 C. $8,000 D. $9,000 E. $10,000
8. Approximately What Percent Of Its Gdp Does The United States Spend On Education? A. 2.0 B. 3.0 C. 3.9 D. 4.2 E. 5.3
9. Which Of The Following Best Describes The U.S. K-12 Educational System? A. It Is Largely Private B. It Is Mainly Private With Some Public Education C. It Is About Half Public And Half Private D. It Is Predominantly Public E. It Is Exclusively Public
10. Which Of The Following Is Of The U.S. K-12 Education System Relative To The K-12 Education System Of Other Developed Countries? A. It Has Lower Expenditures Per Pupil And Lower Achievement B. It Has Lower Expenditures Per Pupil And Higher Achievement C. It Has Higher Expenditures Per Pupil And Lower Achievement D. It Has Higher Expenditures Per Pupil And Higher Achievement E. It Has Equivalent Expenditures Per Pupil And Achievement
11. In 2003, Approximately What Percent Of School Aged Children Attended Public Schools? A. 90% B. 75% C. 50% D. 25% E. 10%
Questions 12 - 17 Refer To The Graph Below.
12. What Assumption Is Shown By The Fact That Mpc = Msc On The Graph? A. This Graph Is For Public Education B. There Are No Positive Externalities Associated With Education C. Education Has Positive Spillover Benefits For Society D. The Market Will Produce The Socially Optimal Quantity Of Education E. This Graph Illustrates A Private Market For Education
13. What Is This Family's Willingness To Pay For A First Year Of Education? A. $0 B. $4,000 C. $6,000 D. $8,000 E. $10,000
14. What Is The Equilibrium Level Of Education In This Market? A. 0 Years B. 1 Year C. 12 Years D. 16 Years E. Between 12 And 16 Years
15. What Tuition Would Result In The Family Demanding 16 Years Of Education? A. $0 B. Less Than $4,000 C. $4,000 D. $6,000 E. $10,000
16. Which Of The Following Is For The First Years Of Education? A. Mpb < Mpc B. Mpb > Mpc C. Msb > Msc D. Msb < Msc E. Mpb = Msb
17. Which Of The Following Is For The 16th Year Of Education? A. Mpb < Mpc B. Mpb > Mpc C. Msb > Msc D. Msb < Msc E. Mpb = Msb
Questions 18 - 23 Refer To The Graph Below.
18. For Which Level Of Education Is The Family's Mpb > Mpc? A. 1 Year B. Between 0 And E1 Years C. Between E1 And E* Years D. Exactly E1 Years E. Exactly E* Years
19. The Negative Slope Of The Demand Curve Shows That A. The Marginal Cost Of Education Increases As More Is Purchased B. The Marginal Benefit Of Education Increases As More Is Purchased C. The Marginal Benefit Of Each Additional Year Of Education Decreases D. There Are Positive Spillover Benefits Of Education E. Tuition Can Be Raised Above T1 Dollars
20. The Socially Optimal Level Of Education A. Is 0 Years B. Is 1 Year C. Is E1 Years D. Is E* Years. E. Cannot Be Determined From The Diagram.
21. For Which Year Of Education Is The Family's Mpb < Mpc? A. 0 Years B. 1 Year C. E1 Years D. E* Years E. None Of The Above
22. The Slope Of The Supply Curve Indicates That The A. Marginal Cost Of A Year Of Education Is Constant B. Marginal Benefit Of An Additional Year Of Education Increases C. Marginal Benefit Of An Additional Year Of Education Is Constant D. Marginal Benefit Of An Additional Year Of Education Increases E. Cost Of Education Is Subsidized By The Public
23. In The Diagram, The Equilibrium Level Of Education Is A. 0 Years B. 1 Year C. E1 Years D. E* Years E. Between E1 And E* Years
24. What Happens To The Marginal Benefit Of Education As A Child Gets More Schooling? It Will A. Increase B. Decrease C. Stay The Same D. Become Infinite E. Become Negative
25. Which Of The Following Is A Benefit Of Increased Education? A. Improved Literacy B. Increased Earnings C. Improved Health D. Greater Satisfaction E. All Of The Above
26. A Family's Demand For Education For A Child Reflects The Family's A. Income B. Preferences For Education C. Mpb Received From The Education D. Opportunity Cost Of Tuition E. All Of The Above
27. Which Of The Following Happens As Tuition Increases? A. The Demand For Education Increases B. The Demand For Education Decreases C. The Supply Of Education Increases D. The Years Of Education Demanded Fall E. The Cost Of Education Increases
28. The Supply Of Private Education Is Represented By A. The Mpb Curve B. The Mpc Curve C. The Msc Curve D. The Msb Curve E. None Of The Above
29. An Increase In The Demand For Education Will A. Increase The Supply Of Education B. Decrease The Equilibrium Tuition C. Decrease The Equilibrium Quantity Of Education D. Increase The Equilibrium Quantity Of Education E. Shift The Demand Curve For Education To The Left
30. A Decrease In The Cost Of Education Will A. Increase The Supply Of Education B. Increase The Equilibrium Tuition C. Decrease The Equilibrium Quantity Of Education D. Increase The Equilibrium Quantity Of Education E. Shift The Demand Curve For Education To The Left
31. Which Of The Following Will Decrease The Equilibrium Quantity Of Education In A Market? A. An Increase In The Demand For Education B. A Decrease In The Demand For Education C. A Decrease In Production Costs D. An Increase In The Supply Of Education E. None Of The Above
32. An Increase In Family Income Will A. Increase The Demand For Education B. Decrease The Demand For Education C. Increase The Quantity Of Education Supplied D. Increase The Quantity Of Education Demanded E. Decrease The Equilibrium Level Of Tuition
33. An Increase In The Marginal Benefit Of Education Will Cause Which Of The Following? A. The Demand Curve For Education Shifts Right B. The Demand Curve For Education Shifts Left C. The Supply Curve For Education Shifts Right D. The Supply Curve For Education Shifts Left E. The Equilibrium Number Of Years Of Education Will Decrease
34. The Creation Of New Learning Technologies Will Cause Which Of The Following To Decrease? A. The Demand For Education B. The Supply Of Education C. The Cost Of Education D. The Equilibrium Quantity Of Education E. The Number Of Children In School
35. If The Earnings Expected From A College Education Increase, It Will Lead To An Increase In A. The Demand For K-12 Education B. The Supply Of K-12 Education C. The Cost Of Education D. The Teacher Salaries E. All Of The Above
36. Education Is Said To Be Which Of The Following? A. Individually Consumed B. Individually Produced C. A Semi-Private Good D. A Private Good E. A Public Good
37. I Benefit Because You Become More Educated. This Is An Example Of A A. Negative Externality In Consumption B. Spillover Cost C. Positive Externality In Production D. Positive Externality In Consumption E. Negative Externality In Production
38. As The Number Of Years Of Education Increases, The Spillover Benefits Will A. Increase B. Decrease C. Stay The Same D. Become Negative E. None Of The Above
39. Which Of The Following Is An Example Of A Possible Spillover Benefit From Education? A. An Improved Democratic Process B. Improved Health C. Improved Public Safety D. More Charitable Giving E. All Of The Above
40. Students Learn About Health And Nutrition In School. This Provides A A. Positive Externality In Production B. Positive Externality In Consumption C. Negative Externality In Production D. Negative Externality In Consumption E. Cost To Society
41. Marginal Social Benefits Equal A. Mpb + Spillover Benefits B. Mpb - Spillover Benefits C. Mpcs D. Total Benefits + Positive Externalities In Consumption E. None Of The Above
42. With Positive Externalities In Consumption, The Market Equilibrium Quantity Will Be A. Greater Than Socially Optimal B. Less Than Socially Optimal C. Equal To The Socially Optimal Level D. Higher Than Otherwise E. None Of The Above
43. Educated Citizens Are More Likely To Be Informed Voters. This Is An Example Of A A. Positive Externality In Production B. Positive Externality In Consumption C. Negative Externality In Production D. Negative Externality In Consumption E. Cost To Society.
44. To Be Socially Optimal, Education Should Be Provided To The Point Where A. Mpb = Mpc B. Mpb = Msc C. Msb = Mpc D. Msb = Msc E. Mpb = Msb
45. The Existence Of Spillover Benefits Results In An Equilibrium Quantity In The Market That Is Socially Optimal. A. Higher Than B. Lower Than C. Equal To D. Better Than E. More Expansive Than
46. The Argument For Government Provision Of Education Hinges On The Existence Of A. Spillover Costs. B. Spillover Benefits. C. Voucher Programs. D. Negative Externalities In Production. E. Negative Externalities In Consumption
Questions 47 - 50 Refer To The Graph Below.
47. The Socially Optimal Years Of Education Is A. 1 B. Between 1 And 11 C. 11 D. 12 E. 16
48. What Is The Equilibrium Number Of Years Of Education The Market Will Provide? A. 0 B. 1 C. 11 D. 12 E. 16
49. Which Of The Following Government Actions Will Move The Market Equilibrium To The Socially Optimal Number Of Years Of Education? A. A Tax On Education Equal To $1,000 B. A Tax On Education Equal To $3,000 C. A Tuition Subsidy Equal To $1,000 D. A Tuition Subsidy Equal To $3,000 E. Government Provision Of All Education
50. A Tuition Subsidy Of $6,000 Would Lead To A. The Socially Optimal Quantity Of Education B. Greater Than The Socially Optimal Quantity Of Education C. Less Than The Socially Optimal Quantity Of Education D. More Public Education E. A Budget Surplus
Questions 51 - 54 Refer To The Graph Below.
51. The Socially Optimal Level Of Education Is A. 0 B. Between 0 And E1 C. E1 D. E2 E. E3
52. The Market Equilibrium Level Of Education Is A. 0 B. Between 0 And E1 C. E1 D. E2 E. E3
53. A Tuition Subsidy Equal To How Much Will Move The Market To The Socially Optimal Level Of Education? A. T3 - T2 B. T2 - T1 C. T3 - T1 D. T1 E. T2
54. A Tuition Subsidy Equal To T3 Would Result In Which Of The Following? A. The Socially Optimal Quantity Of Education B. Greater Than The Socially Optimal Quantity Of Education C. Less Than The Socially Optimal Quantity Of Education D. More Public Education E. A Budget Surplus
55. Greater Segregation Along Racial Lines Is A Likely Result Of A. Purely Private K-12 Education B. No Public K-12 Education C. Voucher Programs D. Tuition Subsidies E. All Of The Above
56. A Purely Private K-12 System Will Lead To A. Lower Private Costs B. Increased Public Costs C. Decreased Racial Segregation D. Increased Inequality E. Greater Social Benefits
57. In A Purely Private K-12 Education System, Spaces Would Be Allocated Based On A. Ability B. Equity C. Income D. Geographic Boundaries E. None Of The Above
58. In The Existing Public K-12 Education System, Spaces Are Allocated Based On A. Ability B. Equity C. Income D. Geographic Boundaries E. None Of The Above
59. A Program To Provide Public Funding For Students In Poor Performing Public Schools To Attend Other Schools Is Known As A. A Voucher Program B. A Charter School C. A Tuition Tax D. A Welfare Program E. Privatization
60. The Current K-12 Education System Can Be Described As A. Private B. Centralized C. Decentralized D. State Owned E. None Of The Above
61. Centralized Planning Leads To Which Of The Following? A. Limited Consumer Choice B. Decreased Quality C. Increased Prices D. Lack Of Responsiveness E. All Of The Above
62. Schools In Which Parents Or Other Groups Were Permitted To Create A New School With State Funding And Were Given Control Over Operations Are Known As A. Private Schools B. Voucher Schools C. Magnet Schools D. Experimental Schools E. Charter Schools
63. The Empirical Evidence Of The Effectiveness Of Voucher Programs Is Best Described As A. Positive B. Negative C. Inconsistent D. Substantial E. Nonexistent
64. Which Of The Following Is An Argument Against Voucher Programs? A. Cream Skimming B. Reduced Social Segregation C. Decreased Efficiency D. Increased Special Education E. All Of The Above
65. The Cream Skimming Argument Says That The Students Who Choose A Voucher Program Will Be A. Higher Income B. Lower Income C. Higher Achieving D. Non-Minority E. None Of The Above
66. Poor Students Are Less Likely To Participate In Voucher Programs Because Of A. Less Information B. Higher Transportation Costs C. Fewer Financial Resources D. A Weaker Tradition Of Education E. All Of The Above
67. Private School Cost Per Pupil Is Lower Because Of A. Fund Raising B. Private Contributions C. Student Fees D. Volunteer Labor E. All Of The Above
68. What Is The Relationship Between School Funding And Student Achievement? A. Positive B. Negative C. Mixed D. Unrelated E. Inverse
69. What Is The Relationship Between Student Achievement And Teacher Pay? A. Positive B. Negative C. Mixed D. Unrelated E. Inverse
70. What Is The Relationship Between Teacher Pay And A Shortage Of Teachers? A. Positive B. Negative C. Mixed D. Unrelated E. Direct
71. Public Schools Must Pay For Which Of The Following Expenses That Private Schools Do Not? A. Transportation B. Food C. Special Education D. All Of The Above E. None Of The Above
72. A Reduction In Class Size Should Be Undertaken As Long As The Marginal Benefit Of The Decrease Is A. Positive B. Negative C. Greater Than The Marginal Cost D. Less Than The Marginal Cost E. Increasing
73. Decreasing Average Class Size Without Changing Teacher Pay Leads To A. Lower Quality Teachers B. A Surplus Of Teachers C. Lower Costs Per Pupil D. Increased Segregation E. All Of The Above
74. Which Of The Following Statements Does Not Enjoy Widespread Agreement? A. Achievement Per Dollar In U.S. Education Is Too Low B. Reform Of The U.S. Education System Is Necessary To Maintain High Level Human Capital C. Smaller Class Sizes Can Improve Student Performance D. Voucher Programs Are The Most Effective Way To Improve The U.S. Education System E. Increased Teacher Pay Increases Teacher Quality
75. Education Could Be Considered A Semi-Private Good, Since A. There Are Spillover Benefits To Other Members Of Society Resulting From The Education Of A Child B. Education Of The Population Improves Everyone's Lives Since It Results In Greater Productivity And Income For All Members Of Society C. There Are Benefits To Society From Education, Since It Reduces The Crime Rate D. Education Produces Positive Externalities To Society E. All Of The Above
76. If Government Wishes To Increase The Quantity Of Higher Education Consumed, What Can Be Done To Accomplish This? A. Charge Tuition That Is Below The Full Costs Of Providing The Educational Services B. Operate Public Colleges C. Provide Reduced Tuition To Students D. Any Of The Above Alternatives Would Increase The Consumption Of Education E. The Government Should Not Attempt To Increase Education, Since It Is A Private Good
77. Studies Of Voucher Programs Indicate That The Effects Of Vouchers On Student Achievement
A. Are Small But Have Negative Impact On Student Performance
B. Are Received Primarily By African-American And Economically Disadvantaged Children C. Have Yet To Be Examined In Large-Scale Programs
D. Both B And C
E. None Of The Above
78. Research On The Effects Of Charter Schools Show
A. There Are Significantly Positive Impacts On Student Performance
B. There Are Significantly Negative Impacts On Student Performance
C. There Are Mixed Results, With Positive Impacts In Some Schools And Negative In Others
D. Research Has Yet To Be Undertaken On These New Types Of Schools
E. None Of The Above
True / False Questions
79. A College Education Does Not Improve Earnings Over A High School Degree.
80. A Master's Degree Increases Lifetime Earnings Over A Bachelor's Degree By $2.5m Over High School Graduates.
81. More Education Will Increase The Revenue A Worker Adds To A Firm.
82. Improved Education Will Lead To Higher Economic Growth In A Country.
83. American High School Graduates Outperform All Other Countries On Math And Science Exams.
84. The Length Of The School Year In The United States Is Longer Than In Most Other Developed Countries.
85. The United States Spends Over $8,000 Per Pupil On Secondary Education.
86. The United States Is Toward The Middle Of Countries In Rankings Of Percent Of Gdp Per Capita Spent On Education.
87. Ninety Percent Of School-Aged Children Attend Public Schools In The United States.
88. There Are Approximately 50 Million School-Aged Children In The United States.
89. The Marginal Benefit Of Education Increases As A Student Completes More Years Of Education.
90. More Education Leads To Improved Decision-Making In Families.
91. The Move From Illiteracy To Literacy Has High Marginal Benefits.
92. A Family's Demand For Education Comes From Its Marginal Private Benefits.
93. The Demand Curve For Education Has A Positive Slope.
94. Lower Tuition Rates Lead To Less Education.
95. Without Public Schools, There Would Be No K-12 Education.
96. Without Market Provision Of Education, There Is No Mechanism For Quality Control.
97. A Family Will Purchase Private Education As Long As The Mpb > Mpc.
98. Increased Income Will Increase The Demand For Education.
99. New Learning Technologies Will Increase The Cost Of Providing K-12 Education.
100. Everyone Agrees That Education Provides Significant Positive Spillover Benefits.
101. Years Of Education Completed Are Negatively Related To Criminal Activities.
102. The Greatest Positive Externalities Accrue In The Early Years Of K-12 Education.
103. Msb Of Education = Mpb + Positive Externalities.
104. If There Are Positive Externalities From Education, The Market Will Not Produce The Socially Optimal Level Of Education.
105. The Government Can Increase The Equilibrium Quantity Of Education In A Market Through Tuition Subsidies.
106. A Significant Positive Externality Of Education Would Support The Argument Against Public Education.
107. Public K-12 Education Facilitates Equal Opportunity.
108. A Purely Private K-12 Education System Would Increase Existing Segregation.
109. Markets Ration Education Based On A Price/Quality Trade-Off.
110. Public Schools Ration Education Based On A Price/Quality Tradeoff.
111. Voucher Programs Fund Students To Attend Poor Performing Schools.
112. Charter Schools Are Privately Funded And Community Controlled.
113. High-Income Students And Their Families Are More Likely To Benefit From Voucher Programs.
114. Voucher Programs Have Been Accused Of "Cream Skimming."
115. The Costs Of Private Schools Are Greater Than Their Tuition.
116. Private Schools Must Pay Some Types Of Costs That Public Schools Do Not.
117. Economists Agree That Voucher Programs Improve K-12 Education.
118. Smaller Class Size Increases Student Achievement.
119. Higher Teacher Salaries Do Not Change Student Achievement.
120. The Achievement Of Low-Income Students Improves More With Smaller Class Sizes, Relative To Higher Income Students.
121. Smaller Class Size Is Always Cost-Effective.
122. Increased School Funding Increases Student Achievement.
123. Increasing Teachers' Salaries Does Not Affect Student Achievement.
124. The Opportunity Cost Of Becoming A Teacher Is The Salary Of Similarly Trained Professionals.
125. Increased Spending On K-12 Education Is Certain To Be Cost-Effective.
126. The United States' K-12 Education System Has An Efficient Level Of Achievement Per Dollar Spent.
127. Increased Competition In K-12 Education Can Lead To An Improved Education System.
128. Targeting Increased Funding To Programs For Disadvantaged Children Is The Most Cost-Effective.
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ECO 410 Week 5 Quiz – Strayer
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Week 5 Quiz 4 Chapter 7 and 8
Chapter 7
International Parity Conditions
7.1 Prices and Exchange Rates
Multiple Choice
1) If an identical product can be sold in two different markets, and no restrictions exist on the sale or transportation costs, the product's price should be the same in both markets. This is known as:
A) relative purchasing power parity.
B) interest rate parity.
C) the law of one price.
D) equilibrium.
2) The Economist publishes annually the "Big Mac Index" by which they compare the prices of the McDonald's Corporation's Big Mac hamburger around the world. The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and therefore, the price should be the same. If a Big Mac costs $2.54 in the United States and 294 yen in Japan, what is the estimated exchange rate of yen per dollar as hypothesized by the Hamburger index?
A) $0.0086/¥
B) ¥124/$
C) $0.0081/¥
D) ¥115.75/$
3) If the current exchange rate is 113 Japanese yen per U.S. dollar, the price of a Big Mac hamburger in the United States is $3.41, and the price of a Big Mac hamburger in Japan is 280 yen, then other things equal, the Big Mac hamburger in Japan is:
A) correctly priced.
B) under priced.
C) over priced.
D) There is not enough information to determine if the price is appropriate or not.
4) The price of a Big Mac in the U.S. is $3.41 and the price in Mexico is Peso 29.0. What is the implied PPP of the Peso per dollar?
A) Peso 8.50/$1
B) Peso 10.8/$1
C) Peso 11.76/$1
D) None of the above
5) Assume the implied PPP rate of exchange of Mexican Pesos per U.S. dollar is 8.50 according to the Big Mac Index. Further, assume the current exchange rate is Peso 10.80/$1. Thus, according to PPP and the Law of One Price, at the current exchange rate the peso is:
A) overvalued.
B) undervalued.
C) correctly valued.
D) There is not enough information to answer this question.
6) According to the Big Mac Index, the implied PPP exchange rate is Mexican peso 8.50/$1 but the actual exchange rate is peso10.80/$1. Thus, at current exchange rates the peso appears to be ________ by ________.
A) overvalued; approximately 21%
B) overvalued; approximately 27%
C) undervalued; approximately 21%
D) undervalued; approximately 27%
7) Other things equal, and assuming efficient markets, if a Honda Accord costs $24,682 in the U.S., then at an exchange rate of $1.57/£, the Honda Accord should cost ________ in Great Britain.
A) £24,682
B) £38,751
C) £10,795
D) £15,721
8) One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be approximately:
A) $0.96/C$
B) $1/C$
C) $1.04/C$
D) Relative PPP provides no guide for this type of question.
9) ________ states that differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate.
A) The Fisher Effect
B) The International Fisher Effect
C) Absolute Purchasing Power Parity
D) Relative Purchasing Power Parity
10) Two general conclusions can be made from the empirical tests of purchasing power parity (PPP):
A) PPP holds up well over the short run but poorly for the long run, and the theory holds better for countries with relatively low rates of inflation.
B) PPP holds up well over the short run but poorly for the long run, and the theory holds better for countries with relatively high rates of inflation.
C) PPP holds up well over the long run but poorly for the short run, and the theory holds better for countries with relatively low rates of inflation.
D) PPP holds up well over the long run but poorly for the short run, and the theory holds better for countries with relatively high rates of inflation.
11) A country's currency that strengthened relative to another country's currency by more than that justified by the differential in inflation is said to be ________ in terms of PPP.
A) overvalued
B) over compensating
C) undervalued
D) under compensating
12) If we set the real effective exchange rate index between Canada and the United States equal to 100 in 1998, and find that the U.S. dollar has risen to a value of 112.6, then from a competitive perspective the U.S. dollar is:
A) overvalued.
B) undervalued.
C) very competitive.
D) There is not enough information to answer this question.
13) If we set the real effective exchange rate index between the United Kingdom and the United States equal to 100 in 2005, and find that the U.S. dollar has changed to a value of 91.4, then from a competitive perspective the U.S. dollar is:
A) overvalued.
B) undervalued.
C) equally valued.
D) There is not enough information to answer this question.
14) The government just released international exchange rate statistics and reported that the real effective exchange rate index for the U.S. dollar vs the Japanese yen decreased from 105 last year to 95 currently and is expected to fall still further in the coming year. Other things equal U.S. ________ to/from Japan think this is good news and U.S. ________ to/from Japan think this is bad news.
A) importers; exporters
B) importers; importers
C) exporters; exporters
D) exporters; importers
True/False
1) If a market basket of goods cost $100 is the US and €70 in France, then the PPP exchange rate would be $.70/€.
2) The assumptions for relative PPP are more rigid than the assumptions for absolute PPP.
3) Empirical tests prove that PPP is an accurate predictor of future exchange rates.
4) Consider the price elasticity of demand. If a product has price elasticity less than one it is considered to have relatively elastic demand.
Essay
1) The authors state that empirical tests of purchasing power parity "have, for the most part, not proved PPP to be accurate in predicting future exchange rates." The authors then state that PPP does hold up reasonably well in two situations. What are some reasons why PPP does not accurately predict future exchange rates, and under what conditions might we reasonably expect PPP to hold?
7.2 Exchange Rate Pass-Through
Multiple Choice
1) ________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.
A) Absolute PPP
B) Relative PPP
C) The Law of One Price
D) The Fisher Effect
2) In its approximate form the Fisher effect may be written as ________. Where: i = the nominal rate of interest, r = the real rate of return and π = the expected rate of inflation.
A) i = (r)(π)
B) i = r + π + (r)(π)
C) i = r + π
D) i = r + 2π
3) Assume a nominal interest rate on one-year U.S. Treasury Bills of 2.60% and a real rate of interest of 1.00%. Using the Fisher Effect Equation, what is the approximate expected rate of inflation in the U.S. over the next year?
A) 2.10%
B) 2.05%
C) 1.60%
D) 1.00%
4) Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation in the U.S. over the next year?
A) 1.84%
B) 1.80%
C) 1.76%
D) 1.72%
5) The relationship between the percentage change in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets is known as:
A) absolute PPP.
B) the law of one price.
C) relative PPP.
D) the international Fisher Effect.
6) According to the international Fisher Effect, if an investor purchases a five-year U.S. bond that has an annual interest rate of 5% rather than a comparable British bond that has an annual interest rate of 6%, then the investor must be expecting the ________ to ________ at a rate of at least 1% per year over the next 5 years.
A) British pound; appreciate
B) British pound; revalue
C) U.S. dollar; appreciate
D) U.S. dollar; depreciate
7) ________ states that the spot exchange rate should change in an equal amount but in the opposite direction to the difference in interest rates between two countries.
A) Fisher-open
B) Fisher-closed
C) The Fisher Effect
D) none of the above
8) Exchange rate pass-through may be defined as:
A) the bid/ask spread on currency exchange rate transactions.
B) the degree to which the prices of imported and exported goods change as a result of exchange rate changes.
C) the PPP of lesser-developed countries.
D) the practice by Great Britain of maintaining the relative strength of the currencies of the Commonwealth countries under the current floating exchange rate regime.
9) Phillips NV produces DVD players and exports them to the United States. Last year the exchange rate was $1.25/euro and Plillips charged 120 euro per player in Euroland and $150 per DVD player in the United States. Currently the spot exchange rate is $1.45/euro and Phillips is charging $160 per DVD player. What is the degree of pass through by Phillips NV on their DVD players?
A) 92%
B) 33.3%
C) 41.7%
D) 4.1%
10) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the amount the company will receive in pounds at the new exchange rate?
A) £22,803
B) £25,581
C) £27,363
D) £55,000
11) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the percentage margin the company will realize given the new exchange rate?
A) 20.0%
B) 15.3%
C) 12.4%
D) 7.2%
12) The price elasticity of demand for DVD players manufactured by Sony of Japan is greater than one. If the Japanese yen appreciates against the U.S. dollar by 10% and the price of the Sony DVD players in the U.S also rises by 10%, then other things equal, the total dollar sales revenues of Sony DVDs would:
A) decline.
B) increase.
C) stay the same.
D) insufficient information
True/False
1) The final component of the equation for the Fisher Effect, (r)(π), where r = the real rate of return and π = the expected rate of inflation, is often dropped from the equation because the number is simply too large for most Western economies.
2) Empirical studies show that the Fisher Effect works best for short-term securities.
3) The current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange rate is ¥127/$ then the yen is at a forward premium.
4) The premium or discount on forward currency exchange rates between any two countries is visually obvious when you plot the interest rates of each country on the same yield curve. The currency of the country with the higher yield curve should be selling at a forward discount.
5) Use interest rate parity to answer this question. A U.S. investor has a choice between a risk-free one-year U.S. security with an annual return of 4%, and a comparable British security with a return of 5%. If the spot rate is $1.43/£, the forward rate is $1.44/£, and there are no transaction costs, the investor should invest in the U.S. security.
6) Both covered and uncovered interest arbitrage are risky operations in the sense that even without default in the securities, the returns are unknown until all transactions are complete.
7) All that is required for a covered interest arbitrage profit is for interest rate parity to not hold.
Essay/Short Answer
1) The authors describe an application of uncovered interest arbitrage (UIA) known as "yen carry trade." Define UIA and describe the example of yen carry trade. Why would an investor engage in the practice of yen carry trade and is there any risk of loss or lesser profit from this investment strategy?
2) The Fisher Effect is a familiar economic theory in the domestic market. In words, define the Fisher Effect and explain why you think it is also appropriately applied to international markets.
7.3 The Forward Rate
Multiple Choice
1) If the forward rate is an unbiased predictor of the expected spot rate, which of the following is NOT true?
A) The expected value of the future spot rate at time 2 equals the present forward rate for time 2 delivery, available now.
B) The distribution of possible actual spot rates in the future is centered on the forward rate.
C) The future spot rate will actually be equal to what the forward rate predicts.
D) All of the above are true.
2) Which of the following is NOT an assumption of market efficiency?
A) Instruments denominated in other currencies are perfect substitutes for one another.
B) Transaction costs are low or nonexistent.
C) All relevant information is quickly reflected in both spot and forward exchange markets.
D) All of the above are true.
3) Empirical tests have yielded ________ evidence about market efficiency with a general consensus that developing foreign markets are ________.
A) conflicting; not efficient
B) conflicting; efficient
C) consistent; inefficient
D) none of the above
4) A ________ is an exchange rate quoted today for settlement at some time in the future.
A) spot rate
B) forward rate
C) currency rate
D) yield curve
5) Assume the current U.S. dollar-British spot rate is 0.6993£/$. If the current nominal one-year interest rate in the U.S. is 5% and the comparable rate in Britain is 6%, what is the approximate forward exchange rate for 360 days?
A) £1.42/$
B) £1.43/$
C) £0.6993/$
D) £0.7060/$
6) Assume the current U.S. dollar-yen spot rate is 90 ¥/$. Further, the current nominal 180-day rate of return in Japan is 1% and 2% in the United States. What is the approximate forward exchange rate for 180 days?
A) ¥89.12/$
B) ¥89.55/$
C) ¥90.89/$
D) ¥90.45/$
7) The current U.S. dollar-yen spot rate is 125¥/$. If the 90-day forward exchange rate is 127 ¥/$ then the yen is selling at a per annum ________ of ________.
A) premium; 1.57%
B) premium; 6.30%
C) discount; 1.57%
D) discount; 6.30%
8) The theory of ________ states that the difference in the national interest rates for securities of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or premium for the foreign currency, except for transaction costs.
A) international Fisher Effect
B) absolute PPP
C) interest rate parity
D) the law of one price
9) With covered interest arbitrage:
A) the market must be out of equilibrium.
B) a "riskless" arbitrage opportunity exists.
C) the arbitrageur trades in both the spot and future currency exchange markets.
D) all of the above
10) Covered interest arbitrage moves the market ________ equilibrium because ________.
A) toward; purchasing a currency on the spot market and selling in the forward market narrows the differential between the two
B) toward; investors are now more willing to invest in risky securities
C) away from; purchasing a currency on the spot market and selling in the forward market increases the differential between the two
D) away from; demand for the stronger currency forces up interest rates on the weaker security
True/False
1) If exchange markets were not efficient, it would pay for a firm to spend resources on forecasting exchange rates.
2) If the forward exchange rate is an unbiased predictor of future spot rates, then future spot rates will always be equal to current forward rates.
3) COVERED interest arbitrage (CIA), is where investors borrow in countries and currencies exhibiting relatively low interest rates and convert the proceeds into currencies that offer much higher interest rates. The transaction is "covered," because the investor does not sell the higher yielding currency proceeds forward.
7.4 Prices, Interest Rates, and Exchange Rates in Equilibrium
Multiple Choice
1) According to the International Fisher Effect, the forecast change in the spot rate between two countries is equal to:
A) the current spot rate multiplied by the ratio of the inflation rates in the respective countries.
B) but the opposite sign to the difference between nominal interest rates.
C) but the opposite sign to the difference between inflation rates.
D) but the opposite sign to the difference between real interest rates.
True/False
1) In their approximate form, PPP, IRP, and forward rates as an unbiased predictor of the future spot rate lead to similar forecasts of the future spot rate.
Multinational Business Finance, 13e (Eiteman/Stonehill/Moffett)
Chapter 8 Foreign Currency Derivatives and Swaps
8.1 Foreign Currency Futures
Multiple Choice
1) Financial derivatives are powerful tools that can be used by management for purposes of:
A) speculation.
B) hedging.
C) human resource management.
D) A and B above
2) A foreign currency ________ contract calls for the future delivery of a standard amount of foreign exchange at a fixed time, place, and price.
A) futures
B) forward
C) option
D) swap
3) Which of the following is NOT a contract specification for currency futures trading on an organized exchange?
A) size of the contract
B) maturity date
C) last trading day
D) All of the above are specified.
4) About ________ of all futures contracts are settled by physical delivery of foreign exchange between buyer and seller.
A) 0%
B) 5%
C) 50%
D) 95%
5) Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is called a:
A) collateralized deposit.
B) marked market sum.
C) margin.
D) settlement.
6) A speculator in the futures market wishing to lock in a price at which they could ________ a foreign currency will ________ a futures contract.
A) buy; sell
B) sell; buy
C) buy; buy
D) none of the above
7) A speculator that has ________ a futures contract has taken a ________ position.
A) sold; long
B) purchased; short
C) sold; short
D) purchased; sold
8) Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month currency futures contract is available today at a rate of $1.44/£. If Peter was to speculate in the currency futures market, and his expectations are correct, which of the following strategies would earn him a profit?
A) Sell a pound currency futures contract.
B) Buy a pound currency futures contract.
C) Sell pounds today.
D) Sell pounds in six months.
9) Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the dollar appreciate to a value of $1.4250 at which time he sold the pound futures. If each pound futures contract is for an amount of £62,500, how much money did Jack gain or lose from his speculation with pound futures?
A) $937.50 loss
B) $937.50 gain
C) £937.50 loss
D) £937.50 gain
10) Which of the following statements regarding currency futures contracts and forward contracts is NOT true?
A) A futures contract is a standardized amount per currency whereas the forward contact is for any size desired.
B) A futures contract is for a fixed maturity whereas the forward contract is for any maturity you like up to one year.
C) Futures contracts trade on organized exchanges whereas forwards take place between individuals and banks with other banks via telecom linkages.
D) All of the above are true.
11) Which of the following is NOT a difference between a currency futures contract and a forward contract?
A) The futures contract is marked to market daily, whereas the forward contract is only due to be settled at maturity.
B) The counterparty to the futures participant is unknown with the clearinghouse stepping into each transaction, whereas the forward contract participants are in direct contact setting the forward specifications.
C) A single sales commission covers both the purchase and sale of a futures contract, whereas there is no specific sales commission with a forward contract because banks earn a profit through the bid-ask spread.
D) All of the above are true.
12) A foreign currency ________ gives the purchaser the right, not the obligation, to buy a given amount of foreign exchange at a fixed price per unit for a specified period.
A) future
B) forward
C) option
D) swap
13) A foreign currency ________ option gives the holder the right to ________ a foreign currency, whereas a foreign currency ________ option gives the holder the right to ________ an option.
A) call, buy, put, sell
B) call, sell, put, buy
C) put, hold, call, release
D) none of the above
14) The price at which an option can be exercised is called the:
A) premium.
B) spot rate.
C) strike price.
D) commission.
15) An ________ option can be exercised only on its expiration date, whereas a/an ________ option can be exercised anytime between the date of writing up to and including the exercise date.
A) American; European
B) American; British
C) Asian; American
D) European; American
16) An ________ option can be exercised only on its expiration date, whereas a/an ________ option can be exercised anytime between the date of writing up to and including the exercise date.
A) American; European
B) American; British
C) Asian; American
D) European; American
17) A call option whose exercise price exceeds the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) over-the-spot.
18) A call option whose exercise price is less than the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) under-the-spot.
19) An option whose exercise price is equal to the spot rate is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) on-the-spot.
20) The main advantage(s) of over-the-counter foreign currency options over exchange traded options is (are):
A) expiration dates tailored to the needs of the client.
B) amounts that are tailor made.
C) client desired expiration dates.
D) all of the above
21) As a general statement, it is safe to say that businesses generally use the ________ for foreign currency option contracts, and individuals and financial institutions typically use the ________.
A) exchange markets; over-the-counter
B) over-the-counter; exchange markets
C) private; government sponsored
D) government sponsored; private
TABLE 8.1
Use the table to answer following question(s).
April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).
22) Refer to Table 8.1. What was the closing price of the British pound on April 18, 2009?
A) $1.448/£
B) £1.448/$
C) $14.48/£
D) none of the above
23) Refer to Table 8.1. The exercise price of ________ giving the purchaser the right to sell pounds in June has a cost per pound of ________ for a total price of ________.
A) 1460; 0.68 cents; $425.00
B) 1440; 1.06 cents; $662.50
C) 1450; 1.02 cents; $637.50
D) 1440; 1.42 cents; $887.50
24) Refer to Table 8.1. The May call option on pounds with a strike price of 1440 mean:
A) $88/£ per contract.
B) $0.88/£.
C) $0.0088/£.
D) none of the above
25) Dash Brevenshure works for the currency trading unit of ING Bank in London. He speculates that in the coming months the dollar will rise sharply vs. the pound. What should Dash do to act on his speculation?
A) Buy a call on the pound.
B) Sell a call on the pound.
C) Buy a put on the pound.
D) Sell a put on the pound.
26) A put option on yen is written with a strike price of ¥105.00/$. Which spot price maximizes your profit if you choose to exercise the option before maturity?
A) ¥100/$
B) ¥105/$
C) ¥110/$
D) ¥115/$
27) A call option on euros is written with a strike price of $1.30/euro. Which spot price maximizes your profit if you choose to exercise the option before maturity?
A) $1.20/euro
B) $1.25/euro
C) $1.30/euro
D) $1.35/euro
28) A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the break-even price for the option?
A) $2.03/£
B) $2.07/£
C) $2.05/£
D) The answer depends upon if this is a long or a short call option.
29) Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To protect yourself against unexpected changes in the dollar/pound exchange rate you should:
A) buy a pound put option.
B) sell a pound put option.
C) buy a pound call option.
D) sell a pound call option.
30) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. Jasper should ________ at ________ to profit from changing currency values.
A) buy yen; the forward rate
B) buy dollars; the forward rate
C) sell yen; the forward rate
D) There is not enough information to answer this question.
31) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper buys $100,000 worth of yen at today's spot price and sells within the next six months at ¥128/$, he will earn a profit of:
A) $146.09
B) $101,460.94
C) $1460.94
D) nothing; he will lose money
32) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper buys $100,000 worth of yen at today's spot price her potential gain is ________ and her potential loss is ________.
A) $100,000; unlimited
B) unlimited; unlimited
C) $100,000; $100,000
D) unlimited; $100,000
33) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper's expectations are correct, then he could profit in the forward market by ________ and then ________.
A) buying yen for ¥128.00/$; selling yen at ¥128.53/$
B) buying yen for ¥128.53/$; selling yen at ¥128.00/$
C) There is not enough information to answer this question
D) He could not profit in the forward market.
34) The maximum gain for the purchaser of a call option contract is ________ while the maximum loss is ________.
A) unlimited; the premium paid.
B) the premium paid; unlimited.
C) unlimited; unlimited.
D) unlimited; the value of the underlying asset.
35) The buyer of a long call option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has an unlimited maximum gain potential.
D) all of the above
36) Which of the following is NOT true for the writer of a call option?
A) The maximum loss is unlimited.
B) The maximum gain is unlimited.
C) The gain or loss is equal to but of the opposite sign of the buyer of a call option.
D) All of the above are true.
37) Which of the following is NOT true for the writer of a put option?
A) The maximum loss is limited to the strike price of the underlying asset less the premium.
B) The gain or loss is equal to but of the opposite sign of the buyer of a put option.
C) The maximum gain is the amount of the premium.
D) All of the above are true.
38) The buyer of a long put option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has maximum gain potential limited to the difference between the strike price and the premium paid.
D) all of the above
39) The value of a European style call option is the sum of two components:
A) the present value plus the intrinsic value.
B) the time value plus the present value.
C) the intrinsic value plus the time value.
D) the intrinsic value plus the standard deviation.
True/False
1) Currency futures contracts have become standard fare and trade readily in the world money centers.
2) The major difference between currency futures and forward contracts is that futures contracts are standardized for ease of trading on an exchange market whereas forward contracts are specialized and tailored to meet the needs of clients.
3) The writer of the option is referred to as the seller, and the buyer of the option is referred to as the holder.
4) Foreign currency options are available both over-the-counter and on organized exchanges.
5) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper would earn a higher rate of return by buying yen and a forward contract than if he had invested her money in 6-month US Treasury securities at an annual rate of 2.50%.
6) Most option profits and losses are realized through taking actual delivery of the currency rather than offsetting contracts.
Essay
1) Why are foreign currency futures contracts more popular with individuals and banks while foreign currency forwards are more popular with businesses?
2) Compare and contrast foreign currency options and futures. Identify situations when you may prefer one vs. the other when speculating on foreign exchange.
8.2 Option Pricing and Valuation
Multiple Choice
1) Which of the following is NOT a factor in determining the premium price of a currency option?
A) the present spot rate
B) the time to maturity
C) the standard deviation of the daily spot price movement
D) All of the above are factors in determining the premium price.
2) The ________ of an option is the value if the option were to be exercised immediately. It is the option's ________ value.
A) intrinsic value; maximum
B) intrinsic value; minimum
C) time value; maximum
D) time value; minimum
3) Assume that a call option has an exercise price of $1.50/£. At a spot price of $1.45/£, the call option has:
A) a time value of $0.04.
B) a time value of $0.00.
C) an intrinsic value of $0.00.
D) an intrinsic value of -$0.04.
4) The single largest interest rate risk of a firm is:
A) interest sensitive securities.
B) debt service.
C) dividend payments.
D) accounts payable.
5) ________ is the possibility that the borrower's creditworthiness is reclassified by the lender at the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
D) Credit risk; Repricing risk
Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
6) Refer to Instruction 8.1. Choosing strategy #1 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
7) Refer to Instruction 8.1. Choosing strategy #2 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
8) Refer to Instruction 8.1. Choosing strategy #3 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
9) Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?
A) Strategy #1
B) Strategy #2
C) Strategy #3
D) Strategies #1 and #2
10) Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at worst, remain at current levels, and were very confident about the firm's credit rating for the next 10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)
A) Strategy #3
B) Strategy #2
C) Strategy #1
D) Strategy #1, #2, or #3; you are indifferent among the choices.
11) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #2 is: (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above
12) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above
13) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
14) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
15) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
True/False
1) The time value is asymmetric in value as you move away from the strike price (i.e., the time value at two cents above the strike price is not necessarily the same as the time value two cents below the strike price).
8.3 Interest Rate Derivatives
Multiple Choice
1) An interbank-traded contract to buy or sell interest rate payments on a notional principal is called a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above
2) A/an ________ is a contract to lock in today interest rates over a given period of time.
A) forward rate agreement
B) interest rate future
C) interest rate swap
D) none of the above
3) An agreement to exchange interest payments based on a fixed payment for those based on a variable rate (or vice versa) is known as a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above
4) The financial manager of a firm has a variable rate loan outstanding. If she wishes to protect the firm against an unfavorable increase in interest rates she could:
A) sell an interest rate futures contract of a similar maturity to the loan.
B) buy an interest rate futures contract of a similar maturity to the loan.
C) swap the adjustable rate loan for another of a different maturity.
D) none of the above
5) An agreement to swap a fixed interest payment for a floating interest payment would be considered a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above
6) An agreement to swap the currencies of a debt service obligation would be termed a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above
7) Which of the following would be considered an example of a currency swap?
A) exchanging a dollar interest obligation for a British pound obligation
B) exchanging a eurodollar interest obligation for a dollar obligation
C) exchanging a eurodollar interest obligation for a British pound obligation
D) All of the above are examples of a currency swap.
8) A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.
9) A firm with variable-rate debt that expects interest rates to rise may engage in a swap agreement to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.
10) The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is to:
A) do nothing.
B) pay floating and receive fixed.
C) receive floating and pay fixed.
D) none of the above
11) The potential exposure that any individual firm bears that the second party to any financial contract will be unable to fulfill its obligations under the contract is called:
A) interest rate risk.
B) credit risk.
C) counterparty risk.
D) clearinghouse risk.
12) Which of the following is an unlikely reason for firms to participate in the swap market?
A) To replace cash flows scheduled in an undesired currency with cash flows in a desired currency.
B) Firms may raise capital in one currency but desire to repay it in another currency.
C) Firms desire to swap fixed and variable payment or receipt of funds.
D) All of the above are likely reasons for a firm to enter the swap market.
True/False
1) Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.
2) Unlike the situation with exchange rate risk, there is no uncertainty on the part of management for shareholder preferences regarding interest rate risk. Shareholders prefer that managers hedge interest rate risk rather than having shareholders diversify away such risk through portfolio diversification.
3) Interest rate futures are relatively unpopular among financial managers because of their relative illiquidity and their difficulty of use.
4) A basis point is one-tenth of one percent.
5) A swap agreement may involve currencies or interest rates, but never both.
6) Some of the world's largest and most financially sound firms may borrow at variable rates less than LIBOR.
7) Counterparty risk is greater for exchange-traded derivatives than for over-the-counter derivatives.
8) Swap rates are derived from the yield curves in each major currency.
Essay
1) Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.
2) How does counterparty risk influence a firm's decision to trade exchange-traded derivatives rather than over-the-counter derivatives?
Answer: With exchange-traded derivatives, the exchange is the clearinghouse. Thus, firms do not need to worry about the other party making good on its obligations and it is easier to trade the derivative products.
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ECO 450 Week 5 Mid-Term Exam – Strayer
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Chapters 1 Through 7
ECO 450 Week 2 Quiz – Strayer
Chapter 1
Individuals and Government
True/False Questions
1. On average, persons in the United States devote more of their annual budgets to taxes than they do to food.
2. A universally observed function of government is the establishment of property rights.
3. The total share of GDP accounted for by government spending in the United States has declined significantly since 1980.
4. In 1929, the federal government spent more than was spent by state and local governments.
5. Since 1930, the percent of GDP devoted to government expenditures has more than tripled.
6. The costs imposed by government regulations on business firms are included in budget data on government expenditures.
7. Government consumption does not require resources to be reallocated from private to government use.
8. Since 1959, the percent of federal government expenditures devoted to transfers has increased by more than 50 percent.
9. Transfer payments, including Social Security and welfare and medical assistance, account for nearly 60 percent of federal government expenditures.
10. Interest on the federal government’s debt accounts for about 20 percent of federal government expenditure.
11. Federal grants-in-aid to state and local governments finance about 20 percent of annual spending by these governments.
12. The federal government allocates about 10 percent of its budget to Social Security.
13. State and local governments in the United States spend a bit more than one-third of their budgets on education.
14. Sales taxes account for about 22 percent of state and local government revenue in the United States.
15. The federal government obtains about half of its revenue annually from retail sales taxes.
16. State governments do not fund any part of Medicaid.
17. The social compact is an 18th century idea by political theorists.
18. The proportion of revenue received by the federal government from payroll taxes is higher than the proportion of revenue received by state and local governments from payroll taxes.
Multiple Choice Questions
1. The real cost of government goods and services is:
a. money.
b. taxes.
c. the private goods and services foregone.
d. inflation.
2. If the economy is currently operating on a point on the production possibility curve for government goods and services versus private goods and services,
a. an annual increase in government goods and services can be obtained without any sacrifice of annual private goods and services.
b. it will be impossible to increase annual output of government goods and services.
c. a decrease in the annual output of government goods and services will have no effect on the annual output of private goods and services.
d. a decrease in the annual output of government goods and services will allow an increase in annual output of private goods and services.
3. Government goods and services are usually:
a. not rationed by prices.
b. sold in markets.
c. made available to persons according to their willingness and ability to pay.
d. financed by revenue obtained from sales.
4. Taxes:
a. are prices paid for the right to consume government goods and services.
b. are compulsory payments not directly related to the benefits received from government goods and services.
c. never affect economic incentives.
d. are used by private firms to raise revenue.
5. A mixed economy is one in which:
a. there are no markets.
b. government activity accounts for a significant proportion of the value of goods and services produced.
c. there is no government.
d. all goods and services are sold in markets.
6. Government purchases for consumption and investment:
a. are made to acquire resources necessary to producegovernment goods and services.
b. are designed to redistribute purchasing power among citizens.
c. have increased in importance as a percent of federal spending since 1959.
d. do not withdraw resources from private use.
7. Transfer payments by the federal government in the United States account for about:
a. 25 percent of federal government expenditures.
b. 10 percent of federal government expenditures.
c. 40 percent of GDP.
d. 60 percent of federal government expenditures.
8. Total annual expenditures by federal, state, and local governments in the United States in the 1990s accounted for roughly:
a. 20 percent of annual GDP.
b. 30 percentof annual GDP.
c. 50 percentof annual GDP.
d. 75 percent of annual GDP.
9. Federal government expenditures in the United States account for about:
a. 23 percent of annual GDP.
b. 33 percent of annual GDP.
c. 43 percent of annual GDP.
d. 53 percent of annual GDP.
10. About 80 percent of federal receipts are accounted for by:
a. corporate profits taxes.
b. sales taxes.
c. excise taxes.
d. payroll and personal income taxes.
11. If the economy is operating at full employment and using resources efficiently, then an increase in spending for homeland security this year will:
a. require that resources be reallocated to homeland security services without sacrificing any alternative goods and services.
b. be possible if resources are reallocated to homeland security services, but it will also mean that the output of some other goods and services will have to fall.
c. be impossible.
d. be possible only if there is an improvement in technology or more resources made available.
12. Which of the following is an example of a political institution?
a. a market
b. elections with winners determined by majority rule
c. representative government
d. both (b) and (c)
13. Nonmarket rationing means that:
a. those willing to pay can buy as much of a product as they choose.
b. prices are used to sell products.
c. goods and services are not rationed by prices.
d. willingness to pay is not a factor in determining who can enjoy a good or service.
e. both (c) and (d)
14. The U.S. economy is best characterized as a:
a. pure market economy.
b. socialist economy.
c. pure capitalistic, free-enterprise system.
d. mixed economy.
15. State and local government expenditure in the United States accounts for about:
a. 32 percent of GDP.
b. 22 percent of GDP.
c. 12 percent of GDP.
d. 7 percent of GDP.
16. Following the circular flow of a mixed economy, firms receive a flow of dollars from and send goods and services to:
a. Output Markets.
b. Input Markets.
c. Households.
d. Government.
17. Following the circular flow of a mixed economy, which entity or entities distribute resources?
a. Firms only.
b. Input Markets only.
c. Government and Households.
d. Households and Input Markets.
18. When has the U.S. experienced government expenditures in the range of 40% to 50% of GDP?
a. 2000 to 2009.
b. 1950 to 1959.
c. 1940 to 1949.
d. It has never happened.
19. In 2008, which country listed below has the highest percentage of government spending relative to GDP?
a. France.
b. Ireland.
c. Japan.
d. Canada.
20. The old-age dependency ratio is:
a. the proportion of the population that is 60 years or older over the proportion of the population that is less than 60 years of age.
b. the proportion of the population that is 65 years or older over the proportion of the population that is 15 to 64 years of age.
c. the proportion of the population that is 70 years or older over the proportion of the population that is 20 to 69 years of age.
d. the total government expenditure on programs for the elderly over the number of citizens that are 65 years or older.
ECO 450 Week 3 Quiz – Strayer
Chapter 2
Efficiency, Markets, and Government
True/False Questions
1. The normative approach to public finance prescribes certain actions to achieve predetermined criteria.
2. Positive economic analysis is based on underlying value judgments.
3. “The government should abolish tariffs to achieve efficiency” is a normative statement.
4. It is possible for efficiency not to be attained even if all production is carried on without waste.
5. Efficiency is attained when resources are used each year in such a way that no further net gain is possible.
6. The efficient annual output of any given good is attained if that good is made available in amounts up to the point at which the total social benefit of the good equals the total social cost.
7. If the marginal social benefit of smoke detectors exceeds its marginal social cost, then additional net gains are possible from an increased annual smoke detector production.
8. Monopoly power causes losses in efficiency because the marginal social benefit of output exceeds its marginal social cost at the monopoly output.
9. Government regulations that require airlines to serve routes for which the maximum price that passengers are willing to pay for a trip fall short of the minimum price that sellers are willing to accept are likely to cause losses in efficiency.
10. Points lying below a utility possibility curve are efficient.
11. Government programs can achieve efficiency when the gains to gainers from those policies exceed the losses to those who bear the costs.
12. If the marginal social cost of beer production exceeds its marginal social benefit, then more than the efficient about of beer is being produced.
13. Efficient outcomes are often viewed as inequitable.
14. If it is not possible to make someone better off without harming another, then resource allocation is efficient.
15. Compensation criteria are used to argue that changes in resource allocation should be made if the gains to some groups outweigh the losses to others, even though compensation for losses is not actually made.
16. All points on a utility possibility curve are efficient but differ in terms of the distribution of well-being.
17. A tax on a product shifts the demand curve.
18. A government subsidized price for a commodity that is higher than the market driven price results in oversupply relative to the efficient allocation.
19. When comparing the allocation of two goods relative to two consumers with individual utility functions, multiple points of Pareto efficiency can exist.
Multiple Choice Questions
1. Positive economics:
a. makes recommendations designed to achieve certain goals.
b. establishes cause-and-effect relationships between economic variables.
c. is based on value judgments.
d. can never be used to make predictions.
2. If the efficient output of a good is produced each week, then the:
a. marginal social benefit of the good equals its marginal social cost each week.
b. marginal social benefit of the good is at a maximum.
c. total social benefit of the good is at a maximum.
d. total social benefit of the good equals its total social cost.
3. If the marginal social benefit of a good exceeds the marginal social cost at the current monthly output, then:
a. it will be possible to make buyers of the good better off without harming sellers of the good.
b. it will be possible to make sellers of the good better off without harming buyers of the good.
c. either (a) or (b)
d. a reduction in monthly output will be required for efficiency.
4. The marginal social cost of bread exceeds the marginal social benefit at the current weekly output. Therefore,
a. the marginal net benefit of bread is positive.
b. the output of bread is efficient.
c. a reduction in weekly output of bread is necessary to achieve efficiency.
d. an increase in weekly output of bread is necessary to achieve efficiency.
5. The total social benefit of automobiles equals the total social cost at current annual output. Then it follows that:
a. the annual output of automobiles is efficient.
b. the annual output of automobiles exceeds the efficient amount.
c. less than the efficient annual output of automobiles is produced.
d. it is not possible to make buyers of automobiles better off without harming sellers.
e. both (a) and (d)
6. Eggs are sold in a perfectly competitive market. No persons other than the buyers and sellers of eggs are affected in any way when eggs are traded in the market. Then it follows that:
a. the price of eggs equals the marginal social cost of eggs.
b. the price of eggs equals the marginal social benefit of eggs.
c. the price of eggs exceeds the marginal social benefit of eggs.
d. both (a) and (b)
7. Diamonds are sold by a monopoly firm that maximizes profits. Then it follows that:
a. the marginal social benefit of diamonds exceeds its marginal social cost.
b. the marginal social cost of diamonds exceeds its marginal social benefit.
c. the price of diamonds equals its marginal social cost.
d. the price of diamonds exceeds its marginal social benefit.
e. both (c) and (d)
8. Points on a utility possibility curve represent:
a. a given distribution of well-being between two persons.
b. an efficient allocation of resources.
c. the maximum well-being of any one person, given the resources available and the well-being of another person.
d. all of the above
9. If efficiency has been attained,
a. it will be possible to make any one person better off without harming another.
b. it will not be possible to make any one person better off without harming another.
c. perfect competition must exist.
d. the opportunity cost of any change in resource use must be zero.
10. A move from an inefficient resource allocation to an efficient one:
a. will always be unanimously approved, even if gainers do not compensate losers.
b. will be unanimously opposed.
c. will be unanimously approved if gainers compensate losers.
d. can never result in losers.
11. Which of the following is a normative statement?
a. When interest rates rise, the quantity of loanable funds demanded for new mortgages will decline.
b. To achieve efficiency, governments should prevent monopoly in markets.
c. Unemployment increases during a recession.
d. When governments increase income tax rates, people work less.
12. Normative economics:
a. is not based on underlying value judgments.
b. makes recommendations to achieve efficient outcomes.
c. establishes cause-and-effect relationships between economic variables.
d. makes “if…then” type statements and checks them against the facts.
13. The extra benefit on one more unit of a good or service is its:
a. marginal cost.
b. marginal benefit.
c. total benefit.
d. total cost.
14. If the efficient output of computers is achieved this year, then market price of computers is equal to:
a. the marginal social benefit of computers.
b. the marginal social cost of computers.
c. the total social cost of computers.
d. the total social benefit of computers.
e. both (a) and (b)
15. Suppose the efficient output currently prevails in the market for ice cream. A tax on ice cream consumption will:
a. allow efficiency to continue to prevail in the market.
b. result in more than the efficient output in the market.
c. result in less than the efficient output in the market.
d. cause the marginal social cost of ice cream to exceed its marginal social benefit at the market equilibrium output.
16. Positive economics is:
a. an equity based approach in which income should be redistributed.
b. an objective approach without a particular goal based on underlying values.
c. a goal oriented approach based on desired policy outcomes.
d. a belief that governments can implement economic policies for the greater good of society.
17. Normative economics is:
a. completely free of any value system.
b. completely objective.
c. based on a a conscious effort to implement a particular social goal.
d. an approach that determines the effect of particular actions without judgment of the result being good or bad.
18. An efficient level of output means:
a. the total social benefit less the total social cost is maximized.
b. the total social benefit is below the total social cost.
c. the total social cost equals the total social benefit.
d. the total social benefit less the total social cost can be improved.
19. If a government desires to increase production beyond the current competitively determined efficient level, the government should:
a. tax the good.
b. subsidize the good at a price higher than its current price.
c. set the price below its current price.
d. impose a fixed fee whenever the good is purchased.
20. Pareto efficiency between two consumers is achieved:
a. only when the individual marginal rates of substitution are equal to the marginal rate of transformation.
b. only when the individual marginal rates of substitution are less than one, but not necessarily equal.
c. only when the individual marginal rates of substitution are greater than one and equal.
d. only when the individual marginal rates of substitution are equal.
Chapter 3
Externalities and Government Policy
True/False Questions
1. If a negative externality exists for sales of gasoline in a competitive market, more than the efficient amount of gasoline will be sold per year.
2. If the marginal external cost of pollution increases with the annual output of polluting goods, then the total external cost will increase at a constant rate with annual output.
3. When a positive externality exists, benefit to third parties other than the buyers and sellers of a good will result from market exchange of the good.
4. The marginal external benefit of the sale of smoke detectors in a city declines with annual output. The total external benefit of smoke detectors will therefore eventually become zero.
5. When a negative externality exists, the marginal social cost of annual output sold in a competitive market will exceed the marginal social benefit of that output in equilibrium.
6. If a negative externality is associated with the sale of wood stoves, then the marginal private cost of those stoves is less than their marginal social cost.
7. If a positive externality is associated with college enrollment, then when college instruction is provided in a competitive market, the marginal social benefit of enrollment will exceed its marginal social cost in equilibrium.
8. At the current level of annual supply of inoculations against polio, the marginal external benefit of an inoculation is zero. To achieve efficiency, a corrective subsidy must be provided to those being inoculated.
9. To internalize an externality, a corrective tax must be set equal to the marginal external cost.
10. According to the Coase theorem, corrective taxes are necessary to internalize negative externalities when the transactions costs of exchanging property rights to use resources are zero.
11. The efficient amount of pollution abatement is likely to be 100 percent.
12. Pollution rights can be used to price the right to emit pollutants and to provide incentives to reduce emissions by profit-maximizing firms.
13. Emissions standards allow businesses to emit waste at zero cost until the limits set by the standards are reached.
14. The market for sulfur dioxide allowance trading has lowered the cost of achieving a given reduction in sulfur dioxide emissions by electric power-generating plants.
15. Command-and-control regulation to reduce emissions is likely to be a less costly way of reducing a given amount of emissions than tradeable emissions permits.
16. When negative externalities exist, perfectly competitive markets produce less than the efficient output.
17. A toll road used to subsidize public transportation in an effort to reduce pollution is an example of a corrective tax.
18. Assuming no externalities and a competitive environment, the marginal private cost is equal to the marginal social cost.
19. Assuming a negative externality, the price of a good will be lower than if the price was set in a competitive environment without an externality.
Multiple Choice Questions
1. A negative externality results from the sale of firewood in competitive markets. Then it follows that:
a. the marginal private cost of firewood is less than its marginal social cost.
b. the marginal private cost of firewood exceeds its marginal social cost.
c. the marginal private benefit of firewood is less than its marginal social benefit.
d. the marginal private benefit of firewood exceeds its marginal social benefit.
2. If a negative externality prevails in a competitive market for air travel, then:
a. more than the efficient amount of annual air travel will be consumed in equilibrium.
b. less than the efficient amount of annual air travel will be consumed in equilibrium.
c. the marginal social cost of air travel will exceed its marginal social benefit in equilibrium.
d. both (a) and (c)
e. both (b) and (c)
3. A positive externality results from the purchase of smoke detectors. If smoke detectors are sold in a competitive market,
a. the marginal social benefit of smoke detectors is less than the marginal private benefit received by any consumer.
b. the marginal social benefit will exceed the marginal private benefit received by any consumer.
c. in equilibrium the marginal social cost of smoke detectors will equal the marginal social benefit.
d. in equilibrium the marginal social benefit of smoke detectors is zero.
4. The marginal external cost associated with air pollution increases with the annual output of a polluting industry. At the current competitive equilibrium level of output per year, the marginal external cost is $10 per unit of output. To achieve efficiency,
a. a corrective tax of $10 per unit of output is required.
b. a corrective tax of more than $10 per unit of output is required.
c. a corrective tax of less than $10 per unit of output is required.
d. a corrective subsidy of $10 per unit of output is required.
e. a corrective subsidy of less than $10 per unit of output is required
.
5. The marginal external cost associated with paper production is constant at $10 per ton per year. The competitive market equilibrium for paper production is currently 10 million tons per year. A corrective tax on paper production:
a. will collect $100 million annually.
b. will collect more than $100 million annually.
c. will collect less than $100 million annually.
d. will reduce annual damages to those other than buyers and sellers of paper to zero.
e. both (a) and (d)
6. The marginal external cost per unit of effluent discharged into a river by a perfectly competitive chemical industry is currently estimated to be $50 per ton per year. Which of the following statements is true?
a. Efficiency can be achieved with a $50 per ton annual effluent charge.
b. At the competitive equilibrium output, the marginal social benefit of discharging effluent is $50.
c. Efficiency can be achieved by banning discharge of effluent.
d. At the efficient output, the marginal social benefit of discharging effluent will be zero.
7. Electric power is produced by an unregulated monopoly in a certain region. The monopolistic electric power company’s production of electricity results in $10 per kilowatt hour of pollution damage to parties other than the buyers of electricity in the region. To achieve efficiency,
a. a $10 per kilowatt hour corrective tax is required.
b. more than $10 per kilowatt hour corrective tax is required.
c. a $10 corrective subsidy is required.
d. less than $10 per kilowatt hour corrective tax is required.
8. The competitive market equilibrium price of sanitation services in a small town with no government-supplied sanitation services is $2 per trash pickup. There is a $1 marginal external benefit associated with each trash pickup. The elasticity of supply of trash pickups is infinite in the long run, implying a horizontal supply curve. To achieve the efficient output of sanitation services,
a. a corrective subsidy must increase the price received by suppliers to $3 per pickup.
b. a corrective subsidy must decrease the price paid by consumers of sanitation services to $1 per pickup.
c. a corrective tax of $1 per pickup is required.
d. a corrective subsidy must increase the price paid by buyers to $3 per pickup.
9. The current competitive market price of fish is $3 per pound. A chemical producer emits effluent into a lake used by a commercial fishing firm. Each ton of chemical output causes a 20-pound reduction in the annual catch of the fishing firm. Assuming that transactions costs are zero and the chemical firm has the legal right to dump effluent into the lake,
a. the fishing firm would be willing to pay up to $60 per ton of chemicals per year to induce the chemical firm to reduce chemical output.
b. the fishing firm would be willing to pay up to $3 per ton of chemicals per year to induce the chemical firm to reduce chemical output.
c. the chemical firm would never consider the damage caused by its effluent.
d. government intervention is required to achieve efficiency.
10. According to the Coase theorem, externalities can be internalized when transactions costs are zero through:
a. corrective taxes and subsidies.
b. effluent fees.
c. assigning property rights to resource use but outlawing their exchange.
d. assignment of property rights to use resources and allowing free exchange of assigned property rights.
11. Which of the following is true if a negative externality is associated with the sale of gasoline?
a. Third parties other than the buyers and sellers of gasoline receive benefits.
b. Third parties other than the buyers and sellers of gasoline bear costs.
c. The marginal social cost of gasoline exceeds its marginal private cost.
d. both (b) and (c)
12. If a positive externality prevails in the market for smoke detectors, then when the market is in equilibrium,
a. the marginal social benefit of smoke detectors exceeds the marginal social cost.
b. the marginal social cost of smoke detectors exceeds the marginal social benefit.
c. the marginal social cost of smoke detectors is equal to the marginal social benefit.
d. more than the efficient amount of smoke detectors is sold.
13. Regulations require that emissions of carbon monoxide be limited to 1,000 tons per 100 square miles for all regions of the nation. If the marginal external cost of the emissions varies among regions in the nation, then the regulations will:
a. achieve the efficient amount of pollution abatement.
b. achieve more than the efficient amount of pollution abatement.
c. achieve less than the efficient amount of pollution abatement.
d. be likely to achieve more than the efficient amount of abatement in some regions, but less than the efficient amount in others.
14. If the marginal costs of reducing emissions varies among regions, then regulations requiring all regions in a nation to reduce emissions by the same amount will achieve:
a. the efficient amount of pollution abatement.
b. more than the efficient amount of pollution abatement.
c. less than the efficient amount of pollution abatement.
d. more than the efficient amount of pollution abatement in some regions, but less than the efficient amount in other regions.
15. Which of the following is true about command-and-control regulation that allows businesses to emit pollutants up to a certain point and bans emissions after that limit is reached?
a. They are equivalent to emissions charges.
b. They make firms pay the marginal cost of the damages done by their emissions, no matter what the level.
c. They allow firms to emit some pollutants at zero charge.
d. They are likely to minimize the cost of achieving any given reduction in emissions.
16. Assuming a product can be manufactured competitively without any externalities at an efficient quantity of 1,000 units and an efficient price of $100.00 per unit, what efficient quantity-price combination would be consistent with a negative externality?
a. 1,000 units, $95.00 per unit price.
b. 950 units, $102.00 per unit price.
c. 900 units, $90.00 per unit price.
d. 1,100 units, $105 per unit price.
17. The effect of a negative externality is similar to:
a. A supply curve (marginal social cost) shifting to the left.
b. A supply curve (marginal social benefit) shifting to the right.
c. A demand curve (marginal social cost) shifting to the left.
d. A demand curve (marginal social benefit) shifting to the right.
18. Assuming a product can be manufactured competitively without any externalities at an efficient quantity of 1,500 units and an efficient price of $50.00 per unit, what efficient quantity-price combination would be consistent with a positive externality?
a. 1,500 units, $60.00 per unit price.
b. 1,300 units, $45.00 per unit price.
c. 1,600 units, $40.00 per unit price.
d. 1,700 units, $56.00 per unit price.
19. The effect of a positive externality is similar to:
a. A supply curve (marginal social cost) shifting to the left.
b. A supply curve (marginal social benefit) shifting to the right.
c. A demand curve (marginal social cost) shifting to the left.
d. A demand curve (marginal social benefit) shifting to the right.
20. Assuming a product can be manufactured competitively without any externalities at an efficient quantity of 500 units and an efficient price of $150.00 per unit, what efficient quantity-price net subsidy combination would be consistent with a corrective subsidy for a positive externality?
a. 500 units, $150.00 per unit price net subsidy.
b. 300 units, $120.00 per unit price net subsidy.
c. 600 units, $160.00 per unit price net subsidy.
d. 700 units, $100.00 per unit price net subsidy.
ECO 450 Week 4 Quiz – Strayer
Chapter 4
Public Goods
True/False Questions
1. Bread is an example of a good that is nonrival in consumption.
2. A pure public good is one for which it is easy to exclude consumers from benefits if they refuse to pay.
3. The marginal social cost of producing another unit of a pure public good will always be positive.
4. To obtain a demand curve for a pure public good, the marginal benefit of each consumer must be summed for each possible quantity produced per time period.
5. If the efficient amount of a pure public good is produced, each person consumes it up to the point at which his or her marginal benefit equals the marginal social cost of the good.
6. In a Lindahl equilibrium, each consumer of a pure public good consumes the same quantity and pays a tax share per unit of the good equal to his or her marginal benefit.
7. If the marginal social cost of a pure public good exceeds its marginal social benefit, additional units of the good can still be financed by voluntary contributions.
8. The free-rider problem is less acute in small groups than it is in large groups.
9. A congestible public good is one for which the marginal cost of allowing an additional consumer to enjoy the benefits of a given quantity is always zero.
10. Television programming is a good example of a price-excludable public good.
11. It is possible to price a pure public good and sell it by the unit.
12. The demand curve for a pure public good is obtained by adding the quantities demanded by each individual consumer at each possible price.
13. A Lindahl equilibrium usually has each participant paying the same tax share per unit of a public good even though their marginal benefit of that unit varies.
14. Internet service is an example of a price-excludable public good.
15. Clubs are a means of providing congestible public goods through markets.
16. A common way to fund a public good is through a government that raises funds through taxation.
17. Private education is an example of a price-excludable public good.
18. A congestible good has no limits in how much it can be consumed.
Multiple Choice Questions
1. A pure public good is:
a. one that can easily be sold by the unit.
b. one that is nonrival in consumption.
c. one whose benefits are not subject to exclusion.
d. both (b) and (c)
2. The marginal cost of providing a certain quantity of a pure public good to an additional consumer after it is provided to any one consumer is:
a. zero.
b. positive and increasing.
c. positive and decreasing.
d. positive and constant.
3. The nonrival property of pure public goods implies that the:
a. benefits enjoyed by existing consumers decline as more consumers enjoy a given quantity of the good.
b. benefits enjoyed by existing consumers are unaffected as more consumers enjoy a given quantity of the good.
c. good cannot be priced.
d. marginal cost of producing the good is zero.
4. The demand curve for a pure public good is:
a. a horizontal line.
b. obtained by adding the quantities individual consumers would purchase at each possible price.
c. obtained by adding the marginal benefit obtained by each consumer at each possible quantity.
d. the marginal cost curve for the pure public good.
5. The efficient output of a pure public good is achieved at the point at which:
a. the marginal benefit obtained by each consumer equals the marginal social cost of producing the good.
b. the sum of the marginal benefits of all consumers equals the marginal social cost of producing the good.
c. the marginal benefit of each consumer equals zero.
d. the marginal social cost of producing the good is zero.
e. both (c) and (d)
6. The monthly rental rate for a satellite dish antenna is $200. The maximum marginal benefit that any resident of a condominium community will obtain per month from the antenna is $50. There are 100 residents in the community, none of whom values the antenna at less than $25 per month. Assuming that the antenna is a pure public good for residents of the community,
a. each resident of the community will rent his own antenna.
b. it is inefficient for the community to rent an antenna.
c. it is efficient for the members of the community to rent an antenna for their common use.
d. it is efficient for each resident to rent his own antenna.
7. In a Lindahl equilibrium,
a. each consumer purchases a pure public good up to the point at which his or her marginal benefit equals the marginal social cost of the good.
b. each person pays a tax per unit of the pure public good equal to his or her marginal benefit.
c. the sum of the marginal benefits of all consumers equals the marginal social cost of the good.
d. both (a) and (c)
e. both (b) and (c)
8. The free-rider problem:
a. becomes more serious as the number of persons involved in voluntarily financing a pure public good decreases.
b. becomes more serious as the number of persons involved in voluntarily financing a pure public good increases.
c. is independent of the number of persons involved in a scheme to voluntarily finance a pure public good.
d. does not prevent voluntary cooperation from efficiently providing pure public goods.
9. The marginal cost of making a given quantity of a congestible public good available to more consumers is:
a. always zero.
b. positive and increasing.
c. positive and decreasing.
d. zero at first but eventually becomes positive and increasing.
10. Cable TV programming is an example of a:
a. congestible public good.
b. price-excludable public good.
c. pure public good.
d. pure private good.
11. A major distinction between pure public goods and pure private goods is that:
a. pure private goods can easily be priced and sold in markets.
b. pure public goods can easily be divided into units.
c. pure public goods can only be collectively consumed.
d. both (a) and (c)
12. The principle of nonexclusion for pure public goods means that the benefits of the good:
a. are shared.
b. can be priced.
c. cannot be withheld from consumers even if they refuse to pay.
d. are not reduced to any one consumer when a given quantity is consumed by another.
13. Which of the following is true in a Lindahl equilibrium for cooperative supply of a pure public good?
a. The sum of the tax shares per unit paid by each consumer is equal to the marginal social cost of the public good.
b. The sum of the tax shares per unit paid by each consumer is equal to the marginal social benefit of the good.
c. The sum of the tax shares per unit paid by each consumer is maximized.
d. both (a) and (b)
14. Which of the following is a good example of a congestible public good?
a. TV programming
b. a road
c. a loaf of bread
d. homeland security
15. Education is:
a. a pure public good.
b. a pure private good.
c. a good that has characteristics of both public goods and private goods.
d. not subject to the exclusion principle.
16. An example of an undesirable public good (or public “bad”) is:
a. government.
b. private trash hauling.
c. poor air quality.
d. private property.
17. Public transportation is:
a. a congestible good.
b. a pure private good.
c. a good without limits to the number of consumers who desire to use it.
d. not subject to the exclusion principle.
18. A baseball field is:
a. a pure public good.
b. a pure private good.
c. a good that has characteristics of both public goods and private goods.
d. not subject to the exclusion principle.
19. A means of creating a price-excludable public good is:
a. allowing food and beverages when entering.
b. requiring costly tickets.
c. to fund through taxation.
d. requiring identification.
20. A free concert in a public arena is:
a. a non-congestible public good.
b. a good that can be consumed by all.
c. a private good.
d. subject to consumption limits.
Chapter 5
Public Choice and the Political Process
True/False Questions
1. A political equilibrium for a pure public good is generally independent of the collective choice rule used.
2. A voter’s most-preferred political outcome will change if, other things being equal, that person’s tax share per unit of the public good is changed.
3. A proposal is put forward to increase the number of police officers. You estimate that your marginal benefit from police protection just equals your tax per police officer at the number of officers that would constitute the police force if the proposal passes. You will therefore vote in favor of the proposal.
4. If all voters have the identical most-preferred political outcome, given their tax shares, then the political equilibrium under majority rule will be identical to the political equilibrium under unanimous consent.
5. The median voter is the one whose most-preferred political outcome is the median of the most-preferred outcome of all those voting.
6. If all voters have single-peaked preferences, a political equilibrium will not be possible under majority rule.
7. A person with multiple-peaked preferences is always made worse off as the quantity of a pure public good is increased, or decreased, once he or she attains his or her most-preferred political outcome.
8. Logrolling always succeeds in passing two paired issues that could not pass if voted on separately.
9. A bureaucrat who seeks to maximize the annual size of his budget each year will propose annual output levels corresponding to the amount for which MSB = MSC.
10. Political transactions costs are likely to be greater under unanimous consent than under majority rule.
11. Political externalities are likely to be negligible when collective choices are made under majority rule.
12. Unanimous consent is a collective choice rule that will protect the rights of minorities.
13. A person for whom the marginal benefit of a public good declines as more is made available has single-peaked preferences.
14. Cycling can occur in elections under majority rule if some voters have multiple-peaked preferences.
15. Special interest groups are more likely to gain income through the political process if they are a large percentage of the population.
16. A ration person’s most preferred political outcome is when the cost of the quantity of government-supplied goods is below the marginal benefit.
17. A budget-maximizing bureaucrat seeks funding levels where the total social cost equals the total social benefit.
18. Logrolling can allow more than one issue of minority interest to be passed.
Multiple Choice Questions
1. A community currently hires 10 security guards per week to patrol their neighborhood. Each security guard costs $300 per week. Assuming that the tax-sharing arrangement agreed to results in each of 300 voters paying the same tax share, each voter pays a weekly tax bill of:
a. $1.
b. $3.
c. $10.
d. $30.
2. A small community currently taxes residents to provide monthly community concerts. Voter A currently pays a tax per concert equal to $50 per month. This voter receives a marginal benefit of $75 at the current political equilibrium number of concerts per month. Voter A:
a. is the median voter.
b. would be made better off if the number of monthly concerts were increased.
c. would be made worse off if the number of monthly concerts were increased.
d. has achieved his most-preferred political outcome for monthly concerts.
3. A proposal to build new roads in a small town is up for a vote. Voter B estimates that his marginal benefit of roads at the proposed new level would be $80 per year. This voter will vote against the proposal:
a. no matter what her tax share.
b. if her tax share is $80.
c. if her tax share is less than $80.
d. if her tax share exceeds $80.
4. Currently eight security guards patrol a condominium community each week. The number of guards has been determined by majority rule. Each voter pays a tax share of $50 per guard. If Voter M is the median voter,
a. his marginal benefit from security guards is $50.
b. his marginal benefit exceeds that of any other voter.
c. the difference between his marginal benefit and $50 is at a maximum.
d. he would be made better off if more security guards were hired per week.
5. If all voters have single-peaked preferences, then under majority rule:
a. cycling of political outcomes can occur.
b. a political equilibrium exists.
c. the political equilibrium is the median most-preferred outcome.
d. both (b) and (c)
6. If a person has multiple-peaked preferences for a pure public good,
a. that person is always made worse off when moving away from his or her most-preferred political outcome.
b. that person will become worse off at first, but then become better off, when moving away from his or her most-preferred political equilibrium.
c. the marginal benefit of the pure public good always declines for that person as more is made available.
d. both (b) and (c)
7. Implicit logrolling results when:
a. any two issues are paired on a ballot.
b. two voters succeed in pairing two issues on a ballot that can pass together but would fail individually.
c. voters agree to trade votes on an issue.
d. the pairing of two issues on a ballot allows the achievement of efficiency.
8. Voter A will normally vote in favor of one security guard per week because his marginal benefit is $125 and his tax share is $100 per week. Voter A receives zero marginal benefit from one concert a week and would vote against it. Voter B receives $125 marginal benefit from one concert per week but no marginal benefit from one security guard. One concert per week also will fail to gain a majority when put to the vote. Assuming that both Voter A and Voter B will pay $100 per week in tax for each concert and each security guard,
a. they can both gain by engaging in logrolling on the two issues.
b. pairing the issues on one ballot will result in both Voter A and Voter B voting in favor of the combined issue.
c. pairing the issues on one ballot will result in both Voter A and Voter B voting against the combined issue.
d. implicit logrolling will result in Voter A voting in favor of the combined issue, but in Voter B voting against it.
9. A voter may choose not to vote in an election between two alternatives because:
a. he or she is indifferent between the two alternatives.
b. his or her probability of influencing the result is zero.
c. his or her most-preferred alternative is far from the two offered on the ballot.
d. all of the above
10. If bureaucrats seek to maximize the size of their budgets, they will:
a. seek to fund levels of services up to the point at which MSC = MSB.
b. seek to fund levels of services for which TSB > TSC.
c. seek to fund levels of services for which MSC > MSB.
d. both (b) and (c)
11. The demand curve for a pure public good is:
a. obtained by adding the quantity demanded at each possible price for all consumers.
b. obtained by summing the marginal benefits of each consumer for each possible quantity.
c. always upward sloping.
d. always a flat line.
12. A voter’s most-preferred political outcome will be that for which the:
a. marginal benefit of a pure public good is equal to the voter’s tax share per unit.
b. total benefit per unit of a pure public good is equal to the voter’s tax share per unit.
c. difference between the marginal benefit of a pure public good and the voter’s tax share per unit is maximized.
d. marginal benefit of a pure public good is equal to zero, no matter what the voter’s tax share per unit.
13. If all voters have single-peaked preferences for a pure public good, then the political equilibrium under majority rule:
a. cannot be defined.
b. is the median outcome.
c. is the median most-preferred outcome of all voter’s voting.
d. will not change if tax shares change.
14. Which of the following collective choice rules is likely to have the lowest political externalities?
a. two-thirds majority rule
b. simple majority rule
c. plurality rule
d. unanimous consent
15. Which of the following collective choice rules is likely to incur the highest political transactions costs?
a. two-thirds majority rule
b. simple majority rule
c. plurality rule
d. unanimous consent
16. If the marginal social benefit of one more unit of a good is 10 and the marginal social cost of one more unit of a good is 11, then:
a. the output of the good is efficient.
b. a bureaucrat can still increase the bureau’s budget.
c. a bureaucrat can increase the bureau’s budget if the total social cost exceeds the total social benefit.
d. a bureaucrat can increase the bureau’s budget if the total social cost is below the total social benefit.
17. The plurality rule is:
a. a collective bargaining rule.
b. a rule that is guaranteed to have majority decision.
c. a means of determining between only two possible outcomes.
d. a rule that cannot lead to a minority decision.
18. Arrow’s impossibility theorem states:
a. a unique political equilibrium for a public choice never exists.
b. a unique political equilibrium for a public choice cannot exist under majority rule.
c. a unique political equilibrium can exist if there is majority rule and multi-peaked preferences.
d. a unique political equilibrium for a public good cannot exist under unanimous consent.
19. Suppose tax shares are evenly distributed for a particular service at the amount of $100.00 per person. Which taxpayer suffers a political externality based on the taxpayer’s marginal benefit for the service?
a. Taxpayer A has a marginal benefit of $100.00.
b. Taxpayer B has a marginal benefit of $200.00.
c. Taxpayer C has a marginal benefit of $90.00.
d. Taxpayers B and C.
20. A public choice is:
a. free of any political interaction or process.
b. by majority rule only.
c. one made through political interaction of many people according to established rules.
d. by unanimous consent only.
Chapter 6
Cost-Benefit Analysis and Government Investments
True/False Questions
1. A cost-effective program mix is one that accomplishes a given mission at minimum cost.
2. Cost-benefit analysis is a technique for determining the net benefits of alternative government projects.
3. An increase in the profits of gasoline dealers on an improved road is a benefit of the road project.
4. If increases in agricultural land values are viewed as a benefit of an irrigation project, then the market value of projected increased crops should also be included as a benefit of the project.
5. The social rate of discount must equal the opportunity cost of funds used to finance a project.
6. If a project has a B/C ratio of 0.9, its approval will result in net benefits to citizens of the nation.
7. The benefits of widening a road consist only of the cost savings to existing users of the road.
8. If the benefits of a new bridge exceed the costs, then there will be a net social gain from building the bridge.
9. If the marginal social cost of a new road exceeds its marginal social benefit, then building the road will result in a net social gain.
10. The higher the social rate of discount, the more government projects for which benefits will exceed costs.
11. A lower discount rate favors more capital-intensive investments that yield net benefits further into the future.
12. The present value of a stream of net benefits for 20 years will be less than the sum of those benefits unless the social rate of discount is zero.
13. Building a new sports stadium results in food sales at the facility. These food sales should be considered a benefit of the new stadium.
14. Program budgeting seeks to group agencies with similar purposes for budgeting, independent of the government department to which they belong.
15. Cost-benefit analysis can be viewed as a way of minimizing the cost of any given government output.
16. Assuming costs are paid immediately, an increase in the social discount rate will lower the benefit-cost rate.
17. The marginal rate of technical substitution (where the slope of the isocost and isoquant lines are equal) is the ratio of the prices of the two goods.
18. The marginal rate of technical substitution is the slope of the isoquant line.
Multiple Choice Questions
1. In program budgeting, an agency’s program is:
a. its mission.
b. a combination of government activities designed to produce a distinguishable output.
c. its output.
d. the cost of its output.
2. Program budgeting differs from line budgeting in that:
a. all agencies with similar missions are budgeted for together, irrespective of the government department to which they belong.
b. proposed expenditures in a given government department are compared only with other programs in the same department.
c. a computer program is used.
d. the effect of programs on the distribution of income is explicitly considered.
3. The mission of a government agency is:
a. its program.
b. its output.
c. its cost.
d. a measure of the inputs it uses.
4. Assuming a full-employment economy, which of the following should not be included as a benefit of a government project to build a new highway when doing a cost-benefit analysis?
a. the income of construction workers employed to build the highway
b. the value of the time saved on trips between points to be served by the new highway
c. the increase in retail sales at sites bordering the highway
d. both (a) and (c)
5. A cost-benefit analysis of an irrigation project shows that the ratio of the discounted present value of benefits to costs is less than one. This implies that:
a. the net benefit of the project is positive.
b. the net benefit of the project is negative.
c. efficiency can be attained by undertaking the project.
d. the project will redistribute income to the poor.
6. The social rate of discount is currently 10 percent. This implies that:
a. all government projects will yield a 10-percent return.
b. the opportunity cost of funds for all government projects is 10 percent.
c. more capital-intensive projects will be ranked over less capital-intensive projects.
d. the opportunity cost of funds for all government projects is 20 percent.
7. The social rate of discount used in cost-benefit analysis measures the:
a. benefits of a project.
b. cost of a project.
c. rate of return on the project.
d. opportunity cost of displaced private saving or investment.
8. Suppose that a business investment is subject to a 50-percent tax but that the return to private savings is not taxed. The after-tax rate of return on business investment is currently 9 percent. If a proposed government project is predicted to displace business investment, then the social rate of discount is:
a. 9 percent.
b. 18 percent.
c. 36 percent.
d. infinite.
9. A proposed road improvement project is expected to increase pollution in an urban area. The pollution damage should:
a. be considered a cost of the project.
b. be considered a benefit of the project.
c. not be considered in evaluation of the project.
d. be used as a justification to increase the social rate of discount.
10. A new road will lower the cost of a trip between two cities from $20 to $10. Currently, 100,000 trips per year are made between the two points. The benefit of the new road will:
a. be $1 million per year.
b. exceed $1 million per year.
c. be less than $1 million per year.
d. accrue only to current users.
11. Program budgeting is a way to:
a. minimize the cost of producing a given amount of government services.
b. rank projects according to their marginal net benefits.
c. maximize the output of government.
d. increase government spending.
12. Cost-benefit analysis is a way to:
a. minimize the cost of producing a given amount of government services.
b. rank projects according to their marginal net benefits.
c. maximize the output of government.
d. increase government spending.
13. If the social rate of discount falls, then the efficient amount of government capital spending will:
a. increase.
b. decrease.
c. be unaffected.
d. fall to zero.
14. A government agency has a new hydroelectric project that will take 15 years to build before it provides any benefits. The net present value of the project will be highest under which of the following discount rates?
a. 0 percent
b. 1 percent
c. 3 percent
d. 5 percent
15. Which of the following techniques is used by economists to value years of life saved by a highway safety program?
a. measuring the increased income that it allows
b. trying to get those affected by the improved safety to reveal their willingness to pay for the reduced risk of death
c. either (a) or (b)
d. none of the above, because economists believe that it is impossible to put a value on life
16. If the quantity of good A is on the vertical axis and the quantity of good B is on the horizontal axis, the slope of the corresponding isocost line is:
a. the price of good B divided by the price of good A.
b. the negative of the price of good B divided by the price of good A.
c. the price of good A divided by the price of good B.
d. the negative of the price of good A divided by the price of good B.
17. If the quantity of good A is on the vertical axis and the quantity of good B is on the horizontal axis, the marginal rate of technical substitution of the corresponding isoquant line is:
a. the marginal product of good B divided by the marginal product of good A.
b. the negative of the marginal product of good B divided by the marginal product of good A.
c. the marginal product of good A divided by the marginal product of good B.
d. the negative of the marginal product of good A divided by the marginal product of good B.
18. If the quantity of good A is on the vertical axis and the quantity of good B is on the horizontal axis, then the cost-effective mix between the two goods occurs when:
a. the slope of the associated isoquant line equals the price of A divided by the price of B.
b. the marginal rate of technical substitution equals the price of A divided by the price of B.
c. the marginal rate of technical substitution equals the price of B divided by the price of A.
d. either (a) or (c).
19. The process of taking a previous period’s budget and making minor changes to produce the current year’s budget is called:
a. zero based budgeting.
b. enumerated budgeting.
c. developmental budgeting.
d. incremental budgeting.
20. The nominal interest rate is:
a. the real rate of interest when there is inflation.
b. less than the real rate of interest when there is inflation.
c. inflation adjusted.
d. not adjusted by inflation.
Chapter 7
Government Subsidies and Income Support for the Poor
True/False Questions
1. The poverty threshold is independent of the size of a family and the age of a household head.
2. The rate of poverty has increased in the United States since 1959.
3. In calculating the official poverty rate, cash transfers to the poor are included in their income, but in-kind transfers are not.
4. All persons in the United States with income below the poverty level are eligible for TANF or for SSI transfers designed to assist the poor.
5. The cash benefit and eligibility for payments under TANF varies considerably from state to state.
6. Cash transfers currently account for much less of the total transfers to the poor than in-kind transfers do.
7. Medicaid is likely to result in incentives for recipients to consume medical services up to a point at which the marginal social cost of such services exceeds their marginal benefit.
8. Supplemental Nutrition Assistance (formerly called food stamps) lower the price of food to recipients.
9. A person receiving a lump-sum annual transfer is likely to work less than would otherwise be the case.
10. The annual income guarantee under a negative income tax is $10,000 per family of four.This transfer declines by 50 cents for each dollar of annual earnings.The transfer received by a family of four will decline to zero when its annual earnings is $20,000.
11. The Earned Income Tax Credit (EITC) is a way of subsidizing those who are unable to work and have no earnings.
12. The Earned Income Tax Credit (EITC) is a form of wage-rate subsidy that increases the incomes of low-income people with earnings.
13. The Earned Income Tax Credit (EITC) is a form of negative tax that increases the incomes of workers with earnings but is eventually phased out to zero as earnings rise above a certain level.
14. Medicaid is jointly financed by the federal government and the state governments in the United States and now absorbs more than 20 percent of state government budgets.
15. Since TANF has been introduced in the United States, welfare caseloads have declined and labor force participation of less-skilled single mothers has increased.
16. A two-person household headed by a person over 65 is classified as poor at the same level as a two-person household not headed by an elderly person.
17. The poverty threshold stays constant from year to year.
18. Less than one-third of the people classified as poor in the United States are children.
Multiple Choice Questions
1. In the United States, the poverty threshold is:
a. the same for all households of a given size independent of the age of the household head.
b. the cost of a minimally accepted diet for persons in the family.
c. three times the cost of a minimally accepted diet for persons in the family, for families with household heads under the age of 65.
d. five times the cost of a minimally accepted diet for persons in the family, for families with household heads under the age of 65.
2. Government transfers to the poor in the United States:
a. are always in the form of cash.
b. are available to all persons whose income is below the poverty threshold.
c. succeed in eliminating poverty in the United States.
d. are available only to poor persons who fall into certain demographic categories.
3. The most expensive program of assistance to the poor in the United States in recent years has been:
a. TANF.
b. Supplemental Nutrition Assistance (formerly called food stamps).
c. Medicaid.
d. public housing.
4. Cash transfers are:
a. the dominant method of providing assistance to the poor in the United States.
b. included in the income of recipients when calculating the official poverty rate.
c. available only to the elderly in the United States.
d. both (a) and (b)
5. If the supply of medical services is perfectly elastic, then the effect of Medicaid is to:
a. increase the market price of medical services.
b. result in the efficient amount of medical services.
c. cause recipients to consume medical services beyond the point at which their marginal benefits per year equal the marginal social costs of medical services.
d. both (a) and (c)
6. The Supplemental Nutrition Assistance (formerly called food stamps):
a. reduces the market price of food to those eligible for Supplemental Nutrition Assistance.
b. is likely to increase the market price of food to all consumers.
c. is likely to increase food purchases by recipients but not other purchases.
d. is likely to increase both food and nonfood purchases by recipients.
7. The value of a price-distorting subsidy for a three-bedroom apartment is $100 per month.This means that the person choosing to live in an apartment of that size would have to pay an extra $100 per month at the market rent. Then it follows that:
a. that person would be worse off if she received a cash subsidy of $100 per month.
b. that person would be better off if she received a cash subsidy of $100 per month.
c. that person would be just as well off if she received a cash subsidy of less than $100 per month.
d. both (b) and (c)
8. Suppose a welfare recipient is given a cash grant that increases his monthly income.That grant will never be taken away no matter how much the recipient earns.The grant will result in a(n):
a. substitution effect favorable to work.
b. substitution effect unfavorable to work.
c. income effect favorable to work.
d. income effect unfavorable to work.
9. A welfare recipient receives a cash transfer of $100 per week.This grant is not reduced if the recipient earns less than $20 per week.However, after the recipient earns more than $20 per week, the grant is reduced by 66 cents for each dollar of earnings.The cash transfer will be reduced to zero if the recipient earns:
a. $151.52 per week.
b. $171.52 per week.
c. $131.52 per week.
d. $100.00 per week.
10. An income guarantee of $10,000 per year for all families is established with a phase-out rate of benefits of 50 cents per dollar of earnings. Then it follows that:
a. only families with earnings of less than $10,000 per year will receive transfers.
b. all families with earnings of less than $20,000 per year will receive transfers.
c. all families with income of less than $30,000 per year will receive transfers.
d. all families will receive transfers.
11. The Earned Income Tax Credit (EITC) is:
a. a transfer to low-income people who are unable to work.
b. a flat grant that increases by $4,000 the income of all workers below the poverty level.
c. a subsidy to the poor who have low earnings that increases as they earn more, reaches a maximum, and then is phased out to zero as earnings increase above a certain maximum.
d. available to all persons whose incomes are below the poverty level, whether they work or not.
12. The Earned Income Tax Credit (EITC):
a. is a negative tax that transfers income to the poor who have earnings.
b. can increase the incomes of those eligible by as much as 40 percent.
c. is never phased out as the earnings of the recipients increase.
d.both (a) and (b)
13. Which of the following is true about Temporary Assistance to Needy Families (TANF)?
a. It is an entitlement program administered by the federal government.
b. It provides temporary and limited support for poor families through federal grants to state governments.
c. State governmentsdetermine eligibility for its benefits and administer it.
d. both (b) and (c)
14. Under Temporary Assistance to Needy Families (TANF),
a. federal spending is capped and is allocated to states as a block grant.
b. federal spending is an open-ended entitlement program that requires federal payments to all eligible recipients who meet means and status tests.
c. the states do not determine eligibility and benefit levels; instead, the federal government sets these levels as national standards.
d. recipients are not required to work and will receive benefits as long as they meet a means test.
15. Which of the following is true about the Medicaid program in the United States?
a. It is entirely financed by the federal government.
b. It is a means-tested entitlement program that mandates payment for medical services, mainly to those with low incomes.
c. It is jointly financed by the federal and state governments and is absorbing a significant share of the state government budgets.
d. both (b) and (c)
16. In the United Stated, which of the following years had the highest poverty rate?
a. 2000
b. 1993
c. 1980
d. 1873
17. Temporary Assistance to Needy Families (TANF) replaced:
a. no existing programs.
b. one existing program.
c. two existing programs.
d. three existing programs.
18. Medicaid was enacted by Congress in:
a. 1965.
b. 1972.
c. 1977.
d. 1980.
19. Why rely on the government to aid the poor rather than private charities?
a. The government can establish uniform standards for eligibility.
b. Voluntary donations will most likely be inadequate.
c. The government will most likely be able to meet all needs to the satisfaction of all citizens.
d. both (a) and (b)
20. An EITC program is more likely to encourage working when compared to NIT program because:
a. participants are guaranteed income even if they are not working.
b. participants must work to receive benefits.
c. participants are eligible for work training.
d. participants receive a wage rate subsidy.
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ECO 550 Week 5 Discussion Question – Strayer New
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Week 5 Discussion
"Market Structures"
Managerial Economist awareness of consequences of Wealth Inequality across different states in U.S., across Canada, and across World. http://www.youtube.com/watch?v=cZ7LzE3u7Bw and Robert Reich trailer of film on the subject http://www.youtube.com/watch?v=YCbAyk8aRxI and this on heathcare "hotspots in the U,S. - the case of Camden NJ https://www.youtube.com/watch?v=0DiwTjeF5AU
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FIN 317 Week 5 Mid Term Exam – Strayer
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Chapters 1 Through 6
CHAPTER 1
INTRODUCTION TO FINANCE FOR ENTREPRENEURS
True-False Questions
1. Entrepreneurs provide the financing to individuals who think, reason, and act to convert ideas into commercial opportunities and create opportunities.
2. Entrepreneurship is the process of changing ideas into commercial opportunities and creating value.
3. An entrepreneur is an individual who thinks, reasons, and acts to convert ideas into commercial opportunities and to create value.
4. Mark Twain once said, “I was always able to see an opportunity before it became one.”
5. Small businesses, those with less than 500 employees, represent over 99 percent of all employers, and account for about one-half of the gross domestic product in the United States.
6. Small and growing enterprises are critical to the U.S. economy; small firms provide 20 to 30 percent of net new jobs.
7. Small high-technology firms are responsible for twice as many product innovations per employee and obtain more patents per sales dollar than large high-technology firms.
8. Phillips and Kirchhoff, using Dun & Bradstreet data, found that 24 percent of new firms were still in existence after two years of operation.
9. Nearly half of business failures are due to economic factors such as inadequate sales, insufficient profits, and industry weakness.
10. Although the risks associated with starting a new entrepreneurial venture are large, there is always room for one more success.
11. Studies by Phillips and Kirchhoff, and by Headd, found that about 38%-40% of new firms survived six years of operation.
12. One study of Inc. magazine’s 500 high-growth firms suggests that about 88 percent of founders feel their firms’ successes are due to extraordinary ideas, while the remaining 12 percent feel their firms’ successes are due to exceptional execution of ordinary ideas.
13. “Fads” are large societal, demographic, or technological trends or changes that are slow in forming but once in place continue for many years.
14. “Fads” are not predictable, have short lives, and do not involve macro changes.
15. Three major megatrends discussed in Chapter 1 include: societal trends or changes, demographic trends or changes, and technological trends or changes.
16. In 1982, Harry Dent identified several major or megatrends shaping U.S. society and the world.
17. The so-called “baby boom” generation applies to people born in the United States during the 1946-1964 time period.
18. Perhaps the most important invention shuttling us from an industrial society to an information society is the computer chip.
19. Environmental commerce, or e-commerce, involves the use of electronic means to conduct business online.
20. The Office of Advocacy of the U.S. Small Business Administration documents that “employer firm births” have exceeded 700,000 annually in recent years.
21. Reasonable estimates place nonemployer (e.g., single person or small family) business started each year at less than 100,000.
22. Bill Gates once said: “I was seldom able to see an opportunity, until it ceased to be one.”
23. A study by Phillips and Kirchhoff using Dun & Bradstreet data found that about three-fourths of new firms were still in existence after two years of operation.
24. Studies by Phillips and Kirchhoff, and by Headd, found that one-half of new firms or new employers were still in existence after four years of operation.
25. Nine principles of entrepreneurial finance are identified and explored in this entrepreneurial finance textbook,
26. The “time value of money” is an important component of the rent one pays for using someone else’s financial capital.
27. A venture’s financial objective is to survive.
28. Private financial markets are a place where standardized contracts or securities are traded on organized security exchanges with restrictions on how they can be transferred.
29. Free cash flow is the net income forecast to be available to the venture’s owners over time.
30. Free cash flows are adjusted for risk and the time value of money when used to calculate the value of a venture.
31. Free cash exists when cash exceeds that which is needed to operate, pay creditors, and invest in assets.
32. Free cash is all the cash available to cover operating expenses.
33. Owner-manager (agency) conflicts are differences between manager’s self-interest and that of the owners who hired the manager.
34. The owner-debtholder conflict is the divergence of the owners’ and lenders’ self-interest as the firm gets close to going “public.”
35. The financial objective of increasing value is inconsistent with developing positive character and reputation.
36. Entrepreneurial finance is the application and adaptation of financial tools and techniques to the planning, funding, operations, and valuation of an entrepreneurial venture.
37. Financial distress occurs when cash flow is insufficient to meet current debt obligations.
38. The second stage in a successful venture’s life cycle is the startup stage.
39. The rapid growth stage directly follows the startup stage.
40. Early-stage ventures include firms in their development, startup, or survival live cycle stages.
41. Business angels are wealthy individuals acting as informal or private investors, who provide venture financing for small businesses.
42. Mezzanine financing is temporary financing needed to keep the venture afloat until the next offering.
43. “Crises and bubbles” and “emerging economies and global change” are considered to be sources of entrepreneurial opportunities.
44. In Chapter I five mega-trend categories are identified as sources of entrepreneurial opportunities.
45. Entrepreneurial opportunities can occur only when there are societal changes in the world.
46. One principal of entrepreneurial finance is “risk and expected reward go hand in hand.
47. While cash is the language of business, accounting is the currency.
48. Venture character and reputation can be assets or liabilities.
Multiple-Choice Questions
1. Successful entrepreneurs exhibit which of the following traits?
a. recognize and seize commercial opportunities
b. economic pessimism
c. tend to be doggedly optimistic
d. both a and b
e. both a and c
2. While one must be careful to avoid too many generalizations about entrepreneurial traits or characteristics, which one of the following characteristics would not normally be associated with successful entrepreneurs?
a. being able to see and seize a commercial opportunity
b. planning for the venture’s future
c. only being able to see an opportunity after it ceases to be one
d. being optimistic about the venture’s success
3. About one-half of all newly created businesses in the U.S. are dissolved or cease operations within how many years after being started?
a. two years
b. four years
c. six years
d. eight years
4. About 60 percent of all newly created businesses in the U.S. are dissolved or cease operations within how many years after being started?
a. two years
b. four years
c. six years
d. eight years
5. “Fads” are:
a. not predictable
b. have short lives
c. do not involve macro changes
d. all of the above
6. Harry Dent documented major generation waves in the United States during the twentieth century in:
a. 1972
b. 1982
c. 1993
d. 2003
7. “E-commerce” refers to:
a. environmental commerce
b. electronic commerce
c. economic commerce
d. exploratory commerce
8. While entrepreneurial opportunities come from an almost unlimited number of sources, this textbook focuses on:
a. societal changes
b. demographic changes
c. technological changes
d. crises and bubbles
e. emerging economies and global changes
f. all of the above
9. Indicate the number of principles of entrepreneurial finance that are emphasized in this textbook:
a. one
b. three
c. five
d. seven
e. nine
10. Maximizing the value of the venture to its owners is the common financial goal of which of the following?
a. the entrepreneur
b. the debtholders
c. the venture equity investors
d. both a and b
e. both a and c
11. Which of the following is considered to be an “agency” conflict?
a. owner-manager conflict
b. stockholder-manager conflict
c. stockholder-debtholder conflict
d. manager-debtholder conflict
12. Which one of the following possible conflicts of interest is usually minimized through the use of equity incentives?
a. owner-manager conflicts
b. owner-employee conflicts
c. manager-employee conflicts
d. manager-debtholder conflicts
13. Which one of the following possible conflicts of interest increases in divergence at venture gets close to bankruptcy?
a. owner-manager conflict
b. owner-employee conflict
c. manager-employee conflict
d. manager-debtholder conflict
14. Which of the following is not a life cycle stage of a successful venture?
a. development stage
b. startup stage
c. survival stage
d. cash cow stage
e. early-maturity stage
15. Which of the following does not describe activity during the venture’s life cycle startup stage?
a. venture’s organization
b. venture’s development
c. operating cash flows are generated
d. initial revenue model is put in place
16. At which stage of the venture’s life cycle stage is best characterized by the period when revenues start to grow and when cash flows from operations begin covering cash outflows?
a. survival stage
b. startup stage
c. rapid growth stage
d. early-maturity stage
17. Which is not a major source of start-up financing for a venture’s startup stage?
a. entrepreneur’s assets
b. business operations
c. family and friends
d. business angels
e. venture capitalists
18. Obtaining bank loan, issuing bonds, and issuing stock is characteristic of which type of financing during the venture’s life cycle?
a. seed financing
b. second round financing
c. mezzanine financing
d. seasoned financing
e. liquidity stage financing
19. During a venture’s rapid growth stage, funds for plant expansion, marketing expenditures, working capital, and product or service improvements is obtained through?
a. seed financing
b. second round financing
c. mezzanine financing
d. seasoned financing
e. liquidity stage financing
20. Founder and venture investor shares are sold to the public after the initial offering to the public is called?
a. secondary market transaction
b. secondary stock offering
c. venture offering
d. bridge loan
21. Which of the following advise and assist corporations on the type, timing, and costs of issuing new debt and equity securities and facilitate the sale of firms?
a. brokerage firms
b. venture law firms
c. specialist firms
d. investment banking firms
22. Which stage in the venture life cycle is characterized by creating and building value, obtaining additional financing, and examining opportunities?
a. survival stage
b. startup stage
c. rapid growth stage
d. early-maturity stage
23. Which of these statements is correct?
a. The development stage occurs between the startup and survival stages of a venture’s life cycle
b. The early-maturity stage is the final stage of a new venture’s lifecycle
c. Firms typically begin to cover all expenses with internally-generated funds during the survival stage
d. During the startup stage, revenues grow much more rapidly than cash expenditures
e. None of the above
24. The last three stages of a successful venture’s life cycle occur in the following order:
a. startup, development, rapid growth
b. startup, survival, rapid growth
c. survival, rapid growth, early-maturity
d. development, startup, survival
25. The stage that precedes the middle stage in a successful venture’s life cycle is called the:
a. rapid growth stage
b. early-maturity stage
c. development stage
d. survival stage
e. startup stage
26. During the maturity stage of a venture’s life cycle, the primary source of funds is in the form of:
a. mezzanine financing
b. seed financing
c. startup financing
d. first round financing
e. seasoned financing
27. The type of financing that occurs during the development stage of a venture’s life cycle is typically referred to as:
a. seed financing
b. startup financing
c. first round financing
d. second round financing
e. mezzanine financing
28. Mezzanine financing is associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid growth stage
e. early-maturity stage
29. Entrepreneurial finance is the application and adaptation of financial tools and techniques to an entrepreneurial venture. Entrepreneurial finance involves:
a. planning
b. funding
c. operations
d. valuation
e. a and d above
f. all of the above
30. The first three stages of a successful venture’s life cycle occur in the following order:
a. development, rapid growth, survival
b. startup, development, rapid growth
c. startup, survival, rapid growth
d. survival, rapid growth, early-maturity
e. development, startup, survival
31. The last stage in a successful venture’s life cycle is called the:
a. rapid growth stage
b. early-maturity stage
c. development stage
d. survival stage
e. startup stage
32. The type of financing that occurs during the survival stage of a venture’s life cycle is typically referred to as the:
a. seed financing
b. startup financing
c. first round financing
d. second round financing
e. mezzanine financing
33. Which one of the following would not be considered a type of venture financing?
a.seed financing
b. startup financing
c.mezzanine financing
d. liquidity-stage financing
e.seasoned financing
34. One study of successful entrepreneurs indicated that a majority felt that the most important factor in the long-term success of their ventures was:
a. being greedy
b. having high ethical standards
c. working hard
d. taking frequent vacations
35. Financial markets where customized contracts or securities are negotiated, created, and held with restrictions on how they can be transferred are called:
a. private financial markets
b. public financial markets
c. domestic financial markets
d. international financial markets
e. all of the above
36. The time value of money concept is associated with which one of the following principles of entrepreneurial finance:
a. real, human, and financial capital must be rented from owners
b. risk and expected reward go hand in hand
c. while accounting is the language of business, cash is the currency
d. it is dangerous to assume that people act against their own self-interests
37. The goal of the entrepreneurial process is to:
a. develop opportunities
b. gather resources
c. manage and build operations
d. create value
38. Which of the following is not considered to be a mega-trend in this textbook?
a. societal, demographic, and technological changes
b. crises and bubbles
c. fads
d. emerging economies and global changes
Supplementary Questions (may require basic knowledge of probability and/or prior introductory accounting and business concepts)
1. You have the opportunity of making a $5,000 investmen The outcomes one year from now will be either $4,500 or $6,000 with an equal chance of either outcome occurring. What is the expected outcome?
a. $4,500
b. $6,000
c. $5,250
d. $5,750
e. $5,000
2. You have the opportunity of making a $5,000 investmen The outcomes one year from now will be either $5,000 or $6,000 with an equal chance of either outcome occurring. What is the expected rate of return?
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%
3. A project requires an initial investment of $1,000,000. In one year, there is a 40% chance of a $950,000 return; a 50% chance of a $1,200,000 return; and a 10% chance of a $2,000,000 return. What is the project’s expected return one year from now?
a. 12.8%
b. 15.5%
c. 18.0%
d. 38.3%
4. Lindsey and Tobias have the opportunity to invest in a project that requires an investment of $3,000. There is a 35% chance of a $2,900 return; a 40% chance of a $3,400 return; and a 25% chance of a $4,500 return one year from now. Lindsey requires a 15% return on the project after the first year, but Tobias requires a return of only 12%. Using the expected rate of return:
a. Lindsey and Tobias should both invest in the project
b. Only Tobias should invest in the project
c. Only Lindsey should invest in the project
d. Lindsey and Tobias should both reject the project
5. You are considering investing in two independent projects “A” and “B”. Project A requires an initial investment of $12,000. In one year, there is a 30% chance of a $10,500 return; a 50% chance of a $12,500 return; and a 20% chance of a $14,500 return. Project B requires an initial investment of $1,000. In one year, there is a 25% chance of a $950 return; a 25% chance of a $1,000 return; and a 50% chance of a $1,200 return. If you require a 7% return on your investment after one year, you should:
a. Accept A and reject B
b. Accept B and reject A
c. Accept both projects
d. Reject both projects
6. Assume that you can sell a new product at $5.00 per uni Your variable costs are $3.00 per unit and you fixed costs are $20,000. What is your breakeven point in sales units?
a. 5,000
b. 7,500
c. 10,000
d. 12,500
e. 15,000
7. Assume that you can sell a new product at $5.00 per uni Your variable costs are $3.00 per unit and you fixed costs are $20,000. What will be your profit before taxes if you sell 12,000 units next year?
a. $0
b. $1,000
c. $2,000
d. $4,000
e. $8,000
CHAPTER 2
DEVELOPING THE BUSINESS IDEA
True-False Questions
1. For ventures that first get to market or create intellectual property rights, it’s common to price new products or services at high markups or profit margins.
2. Lifestyle firms are growth-driven in terms of revenues, profits, and cash flows and also performance-oriented as reflected in rapid value creation over time.
3. “Salary-replacement” firms provide their owners with income levels comparable to what they could have earned working for much larger firms.
4. An entrepreneur may start a number of different types of businesses, including salary-replacement firms, lifestyle firms, and entrepreneurial firms or ventures.
5. “Entrepreneurial ventures” are firms that allow owners to pursue specific lifestyles while being paid for doing what they like to do.
6. Entrepreneurial ventures emphasize survival and providing an acceptable living for their owners with growth being a secondary goal.
7. A sound business model is a plan to generate investor interest, make profits, and grow asset investments.
8. A sound business model should provide a plan to generate revenues, make profits, and produce free cash flows.
9. Mark Twain said: “Like I tell anybody, if you fail to plan, you’re planning to fail.”
10. Best practices of high-growth, high-performance firms applied in the marketing practices area include “developing new products or services that are considered to be the bes”
11. Best practices of high-growth, high-performance firms applied in the marketing practices area include “preparing detailed monthly financial plans for the next year and annual financial plans for the next five years.
12. Best practices of high-growth, high-performance firms applied in the financial practices area include “preparing detailed monthly financial plans for the next year and annual financial plans for the next five years.
13. Best practices of high-growth, high-performance firms applied in the management practices area include “assembling a management team that is balanced in both functional area coverage and industry/market knowledge.”
14. Business opportunities, because they exist in real time, have a relatively narrow window of opportunity to become a successful business venture. However being the first to market does not guarantee success.
15. Ideas that are said to be “ahead of their time” are too early to become viable business opportunities for the inventor or innovator.
16. Once conceptualized, a new idea should be examined for its business feasibility.
17. A SWOT analysis is an examination of the strengths, weaknesses, opportunities, and threats to determine the business opportunity viability of an idea.
18. A SWOT analysis focuses on strengths (S), worries (W), opportunities (O), and treats (T).
19. A “venture opportunity screening” is the same thing as preparing a business plan.
20. A SWOT analysis should consider as potential strengths or weaknesses whether there are unfilled customer needs and the extent to which intellectual property rights exis
21. A SWOT analysis should consider the extent of existing competition and the likelihood of substitute products or services as potential strengths or opportunities.
22. Venture opportunity screening involves assessment of an idea’s commercial potential to produce revenue growth, financial performance, and value.
23. A venture with a low score on the VOS Indicator should always be abandoned.
24. The VOS Indicator is useful in assessing the commercial potential of a venture, but should not be used as the sole tool to determine a venture’s fate.
25. The VOS Indicator provides both qualitative and quantitative information about a venture’s commercial potential.
26. A venture opportunity-screening guide, called the VOS Indicator, is used to determine potential attractiveness of venture opportunities as business opportunities.
27. Asset intensity is the net after-tax profit divided by total assets.
28. One way to describe asset intensity is the dollar investment in assets needed to generate a dollar in sales.
29. Business changes resulting in higher net profit always increases ROA.
30. The compound rate of return that equates the present value of the cash inflows with the initial investment outlay is called the internal rate of return (IRR).
31. Bootstrapping refers to the process of minimizing resources such as the need for financial capital and finding unique sources for financing a new venture.
32. Free cash flow to equity is the cash flow from producing and selling a product or providing a service.
33. In a typical business plan, the section covering the management team does not need to disclose the expertise and experience of the managemen
34. The non-financial option available to managers as the venture progresses through its lifecycle is known as real options.
35. The process of moving from entrepreneurial opportunities to new businesses, products, or services begins with ideas, then moves to the preparation of a business plan, and finally ends with a feasibility study.
36. A well-designed entrepreneurial venture bins with an idea that survives an analysis of its feasibility and results in a business model/plan.
37. A successful, sound business model does not have to ultimately produce free cash flows.
38. The first component of a sound business model is the need to generate revenues.
Multiple-Choice Questions
1. Firms that allow owners to pursue specific lifestyles while being paid for doing what they like to do are referred to as:
a. salary-replacement firms
b. lifestyle firms
c. entrepreneurial ventures
d. rapid value creation firms
2. U.S. small businesses are predominately:
a. salary-replacement or entrepreneurial firms
b. lifestyle or entrepreneurial firms
c. entrepreneurial ventures
d. salary-replacement or lifestyle firms
3. The definition of an entrepreneurial firm is:
a. survival, high growth
b. high growth, high performance
c. survival, average performance
d. high, growth, average performance
4. A sound business model provides a plan which includes all of the following except?
a. generates revenues
b. makes profits
c. retains all its earnings
d. produces free cash flows
e. all of the above are included
5. A sound business model includes a plan to:
a. generate revenues, make profits
b. make profits, produce free cash flows
c. produce free cash flows for the owners of the venture
d. generate revenues, make profits, and produce free cash flows
6. Which one of the following components is not a standard component of a sound business model?
a. produce low-cost products
b. generate revenues
c. make profits
d. produce free cash flows
7. Free cash flows, which can be paid back to investors occurs when cash generated from operations exceeds all of the following except?
a. borrowing costs
b. non-cash depreciation
c. taxes
d. investment in assets
8. A venture’s value is determined by
a. the size and timing of its future free cash flows
b. time value of money
c. its net income
d. a and b
e. a and c
9. Developing new and delivering high-quality products or services that command higher prices and margins best describes strong
a. marketing practices
b. financial practices
c. operating practices
d. management practices
10. Effective entrepreneurial management teams should include all of the following except?
a. provide expertise in the areas of marketing, finance, and operations
b. have successful experience in the venture’s industry and markets
c. work collaboratively with each other
d. share the entrepreneurial spirit
e. in-house accounting, auditing, and tax professionals
11. A viable venture opportunity is characterized by all of the following except?
a. creating or meeting a customer need
b. has perceived attraction to prospective investors
c. provides an initial competitive advantage
d. is timely in terms of time-to-market
e. offers the expectation of added value to investors
12. A SWOT analysis does not focus on which of the following components or areas?
a. strengths
b. weaknesses
c. new ideas
d. opportunities
e. threats
13. A SWOT analysis focuses on which of the following components or areas?
a. strengths
b. weaknesses
c. opportunities
d. threats
e. all of the above
a, b, and d
14. When conducting a SWOT analysis, “unfilled customer needs” are examined in terms of:
a. strengths
b. weaknesses
c. opportunities
d. threats
e. a or b
c or d
15. SWOT analysis should at the very least consider which of the following areas:
a. experience/expertise
b. reputation value
c. first mover
d. a and b
e. a, b, and c
16. Which one of the following is not a part of the VOS indicator?
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations
e. location/profitability considerations
17. The evaluation of “entry barriers” occurs under which one of the following parts of the VOS indicator?
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations
18. A VOS indicator stands for:
a. venture opportunity screening indicator
b. viable opportunity statement indicator
c. venture only success indicator
d. viable assessment screening indicator
19. The factor categories in a VOS indicator are:
a. industry/market considerations
b. pricing/profitability considerations
c. financial/harvest considerations
d. management team considerations
e. all of the above
a, b, and d
20. A “score” in the range of 2.34-3.00 using the VOS IndicatorTMwould be considered a:
a. a low score
b. an average score
c. a high score
d. a very, very high score
21. An average score on using the VOS IndicatorTM would fall in the range:
a. 0.00-0.99
b. 1.00-1.66
c. 1.67-2.33
d. 2.34-3.00
22. At the end of a qualitative-based venture opportunity screening exercise, the interviewer prepares a subjective assessment and indicates one of the following except for:
a. natural commercial potential
b. high commercial potential
c. average commercial potential
d. low commercial potential
23. Direct costs of producing a product or providing a service is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin
e. cost of goods sold
24. Revenues minus the cost of goods sold is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin
25. Dollar profit left after all expenses, including financing costs and taxes have been deducted from the firm’s revenues is called
a. gross profit
b. gross profit margin
c. net profit
d. net profit margin
e. cost of goods sold
26. Return on assets can be stated as which of the following?
a. net after-tax profit divided by total assets
b. net profit margin times asset turnover
c. net cash flow divided by total assets
d. both a and b
e. both a and c
27. All else held constant, a higher asset turnover:
a. increases ROA
b. decreases ROA
c. has no effect on ROA
d. may raise or lower ROA, depending on how it affects revenues.
28. The return on assets (ROA) model measures:
a. revenues divided by net profit times the asset turnover
b. net profit margin times the equity multiplier
c. net profit margin times asset turnover
d. net profit divided by total assets multiplied by the asset turnover
29. Free cash flow to equity is the cash available to the entrepreneur and venture investors after all of the following except?
a. net cash flows
b. operating cash outflows
c. financing and tax cash flows
d. investment in assets needed to sustain the venture’s group
e. net increase in debt capital
30. The free cash flows to equity of an entrepreneurial firm includes cash flows to:
a. venture investors
b. creditors
c. the entrepreneur
d. a and b
e. a and c
fa, b, and c
31. Determine the cost of goods sold for a venture with the following financial information: revenues = $50,000; net profit margin = 20%;
gross profit margin = 70%
a. $40,000
b. $35,000
c. $15,000
d. $10,000
32. Determine gross profit of a venture with the following
financial information: cost of goods sold = $30,000; net profit = $17,000; asset turnover = 1.6; return on assets 32%
a. $85,000
b. $72,000
c. $55,000
d. $38,000
33. Determine the return on assets (ROA) for a venture with the following financial information: revenues = $500,000; net profit = $70,000; and asset turnover = 2.00 times.
a. 10%
b. 14%
c. 20%
d. 28%
e. 34%
34. Determine the dollar amount of total assets for a venture with the following financial information: revenues = $500,000; net profit = $70,000; and asset turnover = 2.00 times.
a. $100,000
b. $250,000
c. $375,000
d. $500,000
e. $650,000
35. Determine the dollar amount of net profit for a venture with the following financial information: revenues = $500,000; return on assets = 20%; and asset turnover = 2.00 times.
a. $10,000
b. $25,000
c. $50,000
d. $60,000
e. $75,000
36. Determine the dollar amount of revenues for a venture with the following financial information: net profit = $60,000; assets turnover = 1.5 times; and return on assets 30%.
a. $300,000
b. $500,000
c. $800,000
d. $1,000,000
e. $1,200,000
37. Determine the asset intensity of a venture with the following financial information: net profit = $22,000; revenues = $132,000; return on assets 30%. a. .05
b. .56
c. 1.8
d. 20
38. In the venture life cycle, moving from the development stage to the startup stage frequently begins with the preparation of a business plan. The business plan is a written document that describes the proposed venture in all of the following terms except:
a. the proposed product or service opportunity
b. the accounting data for the last five years
c. current resources available to the venture
d. financial projections
39. A typical business plan includes all of the following sections except:
a. executive summary
b. business description
c. marketing plan and strategy
d. disclosure of pending litigation
e. operations and support
40. When composing the financial plans and projections section of a business plan, all of the following should be included except:
a. income statements and balance sheets
b. statement of cash flows
c. past and present dividend per share information
d. breakeven analysis
e. funding needs and sources
41. A typical business plan includes all of the following except:
a. management team
b. financial plans and projections
c. risk and opportunities
d. timeline and milestones
e. initial public offering information
42. The first two requirements of a sound business model are:
a. generate revenues, make profits
b. make profits, produce free cash flows
c. produce free cash flows for creditors and owners of the venture
generate revenues and produce free cash flows
43. The process involving minimizing the need for financial capital and finding unique sources for financing a new venture is referred to as:
a. mezzanine financing
b. financial bootstrapping
c. seed financing
d. startup financing
44. A written document that describes the proposed venture in terms of the product or service opportunity, current resources, and financial projections is called a:
a. financial plan
b. business plan
c. entrepreneurial plan
d. survival plan
45. In the Kauffman Center study of best practices of high-growth, high-performance firms, which of the following practices was not included?
a. marketing practices
b. financial practices
c. management practices
d. production/operations practices
46. When moving from entrepreneurial opportunities to new businesses, products, or services, which one of the following is not considered a component?
a. ideas
b. feasibility
c. business plan
d. harvest of venture
47. A firm’s option to abandon a venture is an example of a:
a. bootstrapping option
b. financial option
c. survival option
d. real option
48. A venture’s value to its owners is determined by the:
a. size and timing of its future free cash flows (to equity)
b. level of its past revenues
c. prior losses and expenses
d. all of the above
49. A well-designed entrepreneurial venture typically includes:
a. generating ideas
b. analyzing the feasibility of ideas
c. producing business models/plans
d. only a and c above
e. a, b, and c above
50. Some venture investors like to draw analogies between baseball terms and venture performance. The baseball term used to reflect a total loss of an investment is:
a. home run
b. single
c. strikeout
d. double
CHAPTER 3
ORGANIZING AND FINANCING A NEW VENTURE
True-False Questions
1. The difference between a limited partnership and a general partnership is that the limited partnership has partners who actively manage the day-to-day operations but also has passive investors.
2. A limited partnership limits certain partners’ liabilities to pay the venture’s obligations to the amount each paid for their partnership interests.
3. In a corporate legal entity, the personal assets of the owners are separate from the business’ assets, but the personal liabilities of the owners are no
4. Limited liability in the corporate business structure means creditors can seize only some of the corporation’s assets.
5. The articles of incorporation are the basic legal declarations contained in the corporate charter.
6. Limited liability companies (LLCs) are owned by shareholders with limited liability and its earnings are taxed at the corporate rate.
7. Partnerships are treated with pass-through taxation. This means that profits and losses of the business pass directly through to investors on the basis specified in the partnership agreemen
8. An employment contract is an agreement between an employer and employee about the terms and conditions of employment including the employee’s agreement to keep confidential information secret and to assign ideas and inventions to the employer.
9. Financial bootstrapping maximizes the need for financial capital.
10. The income received by a proprietorship is taxed at personal tax rates.
11. The equity capital sources for a proprietorship are partners, families, and friends.
12. The maximum number of owners in a Subchapter S corporation is 150.
13. An S corporation provides unlimited liability for its shareholders.
14. Professional corporations (PCs) and service corporations (SCs) are corporate structures that “states” provide for professionals such as physicians, dentists, lawyers, and accountants.
15. The marginal tax rate for the first dollar of taxable income is higher for corporations than for individuals.
16. Based on 201209 tax laws, the highest possible marginal tax table rate is higher for corporations than for individuals.
17. The highest marginal income tax rate for taxable personal income is 45 percen
18. There are four types of “marks” that can be used to try to protect intellectual property.
19. Patents, trade secrets, trademarks, and copyrights are intangible assets.
20. “Certification marks” cover memberships in groups (e.g., a sorority or a labor union).
21. “Collective marks” cover memberships in groups (e.g., a sorority or a labor union).
22. Most trademarks take the form of names, words, or graphic designs.
23. A “color mark” is considered to be one four types of “marks” used to try to protect intellectual property.
24. A copyright must be registered with the U.S. Copyright Office in order for a work to be protected.
25. A work does not need to be registered to receive copyright protection; the work’s creation is enough to provide copyright protection.
26. There are four kinds of patents.
27. “Business method” is one kind of paten
28. An idea is enough to be patented.
29. “Design patents” cover most inventions pertaining to new products, services, and processes.
30. “Business method” patents protect a specific way of doing business and the underlying computer codes, programs, and technology.
31. “Patents” are intellectual property rights granted for inventions that are useful, novel, and obvious.
32. Nondisclosure agreements prohibit the creator of an idea or other form of intellectual property from sharing it with others once it has been presented the first time.
33. Confidential disclosure agreements are used to protect intellectual property when disclosure must be made to an outside individual or organization.
34. “Certification marks” are intellectual property rights in the form of inventions and information (e.g., formulas, processes, customer lists, etc.) not generally known to others.
35. “Trademarks” are intellectual property rights that allow firms to differentiate their products and services through the use of unique marks.
36. A trademark must be novel in order to receive protection.
37. Business angels are wealthy individuals who invest in early-stage ventures in exchange for the excitement of launching the business, as well as a share of the firm’s financial gains.
38. “Service marks” refer to services such as those provided by a sorority or a labor union.
39. “Certification marks” provide indications of quality.
40. Copyrights are intellectual property rights to writings in printed and electronically stored forms.
Multiple-Choice Questions
1. In which form of business organization are the owners not offered the protection of limited liability?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. limited liability corporation
2. In which form of business organization is the taxation effects characterized by the income flowing to shareholders taxed at personal tax rates?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. general partnership
3. Which form of business organization is characterized by having the shortest start-up time and lowest legal costs?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. limited liability corporation
4. Which form of business organization typically offers the easiest transfer of ownership?
a. proprietorship
b. limited partnership
c. corporation
d. subchapter S corporation
e. general partnership
5. Which form of business organization is characterized as having unlimited life?
a. proprietorship
b. limited partnership
c. limited liability corporation
d. subchapter S corporation
e. general partnership
6. Which of the following is not a right or a duty of general partners?
a. participation in profits and losses
b. some liability for partnership obligations
c. veto right on new partners
d. eventual return of capital
e. access to partnership books
7. The rules and procedures established to govern the corporation are called the
a. corporate charter
b. articles of incorporation
c. corporate bylaws
d. confidentiality disclosure agreements
e. partnership agreements
8. In a general partnership, legal action that treats all partners equally as a group is called:
a. joint and several liability
b. joint liability
c. limited liability
d. accrued liability
e. general liability
9. Which of the following business organizational forms provides the owners with limited investor liability and passes its income before taxes through to the owners?
a. partnership
b. subchapter S (or S) corporation
c. regular or (C ) corporation
d. limited liability company (LLC)
e. both a and b
f. both b and d
10. Which of the following numbers of shareholders is allowed in a Subchapter S (or S) corporation business form?
a. 74
b. 125
c. 130
d. 500
11. Based on 2012 tax schedules, the first dollar of personal taxable income is taxed at which of the following marginal tax rates:
a. 05.0%
b. 10.0%
c. 15.0%
d. 20.0%
e. 25.0%
12. Based on 2012 tax schedules, the first dollar of corporate income is taxed at which of the following marginal tax rates:
a. 05.0%
b. 10.0%
c. 15.0%
d. 20.0%
e. 25.0%
13. Based on 2012 tax schedules, the highest marginal tax rate on personal taxable income is:
a. 25.0%
b. 28.0%
c. 33.0%
d. 35.0%
e. 40.0%
14. Based on 2012 tax schedules, the highest marginal tax rate on corporate taxable income is:
a. 25.0%
b. 28.0%
c. 35.0%
d. 38.0%
e. 39.0%
Note: The following information should be used for multiple choice questions 15-19. Following is a partial 2012 personal income tax schedule for a single filer:
Taxable Income
Beginning Ending Bracket Marginal
Amount Amount Amount Tax Rate
$1 $8,700 $8,700 0.10
$8,700 $35,350 $26,650 0.15
$35,350 $85,650 $50,300 0.25
15. The dollar amount of income taxes paid by a single filer who has taxable income of $8,700 would be:
a. $150
b. $870
c. $3,840
d. $4,675
e. $10,385
16. The cumulative dollar amount of income taxes paid by a single filer who has taxable income of $35,350 would be:
a. $150
b. $835
c. $3,840
d. $4,867.50
e. $10,385
17. The maximum dollar amount of income taxes in the $35,350-$85,650 “bracket” paid by a single filer with taxable income of $85,650 would be:
a. $150
b. $870
c. $3,997.50
d. $4,675
e. $12,575
18. The average tax rate for a single filer with taxable income of $35,350 would be:
e. 10.0%
f. 13.8%
g. 15.0%
h. 16.7%
i. 20.0%
19. The average tax rate for a single filer with taxable income of $85,650 would be:
a. 14.7%
b. 16.7%
b. 20.0%
c. 20.4%
d. 25.0%
Note: The following information should be used for multiple choice questions 20-36. Following is a partial 2012 corporate income tax schedule:
Taxable Income
Beginning Ending Bracket Marginal
Amount Amount Amount Tax Rate
$1 $50,000 $50,000 0.15
$50,000 $75,000 $25,000 0.25
$75,000 $100,000 $25,000 0.34
20. The dollar amount of income taxes paid by a corporation with taxable income of $50,000 would be:
a. $1,500
b. $6,250
c. $7,500
d. $8,500
e. $10,850
21. The cumulative dollar amount of income taxes paid by a corporation with taxable income of $75,000 would be:
a. $6,250
b. $7,500
c. $8,500
d. $13,750
e. $22,250
22. The maximum dollar amount of income taxes in the $75,000-$100,000 bracket paid by a corporation with taxable income of $100,000 would be:
a. $6,250
b. $7,500
c. $8,500
d. $13,750
e. $22,250
23. The average tax rate for a corporation with taxable income of $75,000 would be:
a. 15.0%
b. 18.3%
c. 20.0%
d. 22.7%
e. 25.0%
24. The average tax rate for a corporation with taxable income of $100,000 would be:
a. 15.0%
b. 16.75%
c. 20.0%
d. 22.25%
e. 25.0%
25. Intellectual property can be protected by all of the following except:
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets
26. Which of the following are intellectual property rights granted for inventions that are useful, novel, and non-obvious?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets
27. Which of the following are intellectual property rights in the form of inventions and information such as formulas, processes, and customer lists that are not generally known to others and which convey economic advantage to the holders?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets
28. Which of the following are intellectual property rights that allow firms to differentiate their products and services through the use of unique marks which allow consumers to easily identify the source and quality of the products and services?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets
29. Which of the following are intellectual property rights to writings in written and electronically stored forms?
a. patents
b. trademarks
c. legal disclaimers
d. copyrights
e. trade secrets
30. Which of the following are not sources of seed and start-up financing?
a. family and friends
b. the entrepreneur’s physical and financial assets
c. business angels
d. venture capitalists
e. stock and bond markets
31. Wealthy individuals who invest in early stage ventures in exchange for the excitement of launching a business and a share in any financial rewards are known as:
a. creditors
b. white knights
c. corporate raiders
d. business angels
e. stakeholders
32. Business angels typically initiate their investments during the:
a. early stages of a venture’s lifecycle
b. middle stages of a venture’s lifecycle
c. maturity stage of a venture’s lifecycle
d. all of the above
33. Which of the following forms of protecting intellectual property had its protection limit increased from 17 to 20 years?
a. copyrights
b. trademarks
c. patents
d. trade secrets
34. Patents are intellectual property rights granted for inventions that are:
a. not useful, novel, and non-obvious
b. not useful, not novel, and obvious
c. useful, novel, and non-obvious
d. useful, not novel, and obvious
35. Patents that cover most inventions pertaining to new products, services, and processes, are referred to as:
a. design patents
b. plant patents
c. utility patents
d. electrical patents
e. mechanical patents
36. Intellectual property rights to “writings” in written and electronically-stored forms are protected by:
a. Patents
b. copyrights
c. trade secrets
d. trademarks
37. Which of the following forms of protecting intellectual property currently has a protection limit of 20 years?
a. copyrights
b. patents
c. trade secrets
d. trademarks
38. Certification marks are typically used to:
a. indicate membership in a trade group
b. indicate a certain brand of service
c. indicate quality
d. are symbols used to associate products to a specific brand
39. Which of the following is not a “kind” of patent?
a. Utility
b. Design
c. Mark
d. Plant
e. Business method
40. Which of the following is not a “type” of mark?
a. Trademark
b. Service mark
c. Collective mark
d. Certification mark
e. Design mark
41. During the development stage, seed financing chiefly comprises:
a. funds from business angels and venture capitalists
b. the entrepreneur’s personal assets
c. funds from family and friends
d. a, b, and c
e. only b and c
42. The term that refers only to words, symbols, shapes, and similar items associated with products is:
a. trademarks
b. service marks
c. collective marks
d. certification marks
CHAPTER 4
PREPARING AND USING FINANCIAL STATEMENTS
True-False Questions
1. Assets are financial and physical items controlled or owned by the business.
2. GAAP stands for “General American Accounting Principles.”
3. GAAP stands for “Generally Accepted Accounting Principles.”
4. The practice of recording economic activity when realized is known as accrual accounting.
5. Accrual accounting is the practice of recording economic activity when recognized rather than waiting until realized.
6. The balance sheet equation is: Total Assets = Total Liabilities + Net Income.
7. On the balance sheet, Total Liabilities = Total Assets – Owners Equity.
8. How quickly an asset can be converted into cash is called liability.
9. Cash or other assets that are expected to be converted into cash in less than one year are known as current liabilities.
10. The reduction in value of a fixed asset over its expected life intended to reflect the usage or wearing out of the asset is called accumulated depreciation.
11. Amounts owed to another for purchase made on credit which come due in less than one year are known as receivables.
12. Long-term, non-cancelable leases whereby the owner receives payments that cover the cost of the equipment plus a return on investment in the equipment is known as a capital lease.
13. Operating income, or earnings before interest and taxes, reflects the firm’s profits after all operating expenses, excluding financing costs, have been deducted from net sales.
14. Net income, or profit, is the bottom line measure of what’s left from the firm’s net sales after operating expenses, financing costs, and taxes have been deducted.
15. Net cash burn occurs when the sum of cash flows from operations and investing is positive.
16. Net cash build occurs when the sum of cash flows from operations and investing is negative.
17. During the development stage in a new venture’s life cycle, the balance sheet reflects the acquisition of initial assets and the obtaining of seed financing.
18. During the development stage in a new venture’s life cycle, the income statement typically shows no sales but expenses such as rent, utilities, and a subsistence salary for the entrepreneur.
19. During the startup stage in a new venture’s life cycle, the income statement typically shows no sales but expenses including the production and market of products or services.
20. Production assets (e.g., inventories and equipment to produce products and give credit to customers) usually occurs during the development stage in a new venture’s life cycle.
21. Seed financing (e.g., financing from the entrepreneur’s assets, family, and friends) usually occurs during the development stage in a new venture’s life cycle.
22. Startup financing (e.g., financing from business angels and venture capitalists) usually occurs during the development stage in a new venture’s life cycle.
23. “Cost of goods sold” is the cost of materials, labor, and advertising incurred to produce the products that were sold.
24. “Variable expenses” are costs or expenses that vary directly with revenues.
25. “Variable expenses” are costs that are expected to remain constant over a range of revenues for a specific time period.
26. EBDAT is earnings before interest, taxes, depreciation, and amortization.
27. “Contribution profit margin” is the portion of the sale of a product that contributes to covering the cash fixed costs.
28. EBDAT stands for “Earnings Before Depreciation And Taxes”.
29. Cash fixed costs = survival revenues – variable cost revenue ratio × survival revenues.
True-false questions for Chapter 4, Appendix A:
1. “Economic value added” (EVA) measures a firm’s market value added over a specified time period.
2. Economic value added (EVA) is a measure of a firm’s economic profit over a specified time period.
3. NOPAT equals Net Sales multiplied by on minus the tax rate.
4. When EBIT is zero, a firm’s net operating profit after taxes (NOPAT) also is zero because no taxes are payable.
Multiple-Choice Questions
1. Financial statement that provides a snapshot of a business’ financial position as of a specific date is called the:
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows
2. Financial statement that reports the revenues generated and expenses incurred over an accounting period is called the
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows
3. Financial statement that shows how cash, as reflected in accrual accounting, flows into and out of a company during a specific period of operation is called the:
a. income statement
b. balance sheet
c. statement of retained earnings
d. statement of cash flows
4. The balance sheet equation states that total assets =
b. total liabilities + depreciation
c. total liabilities + owners’ equity
d. owners’ equity + net income
e. owners’ equity + current liabilities
f. total liabilities + net income
5. Which one of the following is not considered to be a current asset?
a. cash
b. receivables
c. inventories
d. fixed assets
6. “Retained earnings” is:
a. a corporate asset
b. part of owners’ equity
c. neither a or b
d. both a and b
7. Cash includes all of the following except:
a. coins
b. currency
c. checking accounts
d. certificates of deposit
8. Which of the following is not a characteristic of marketable securities?
a. short-term
b. illiquid
c. high-quality
d. interest-bearing
9. Which of the following is not a characteristic of inventories?
a. raw materials
b. finished products
c. goods sold but not yet shipped
d. work-in-process
10. Which of the following is not depreciated?
a. inventory
b. machinery
c. land
d. both a and b
e. both a and c
11. Which of the following is a use of cash?
a. a decrease in inventory
b. an increase in accrued liabilities
c. the sale of an asset for a gain
d. a drop in the amount owed on a bond
e. an increase in stock issued
12. Which of the following is a source of cash?
a. an increase in accounts receivable
b. a decrease in wages payable
c. the acquisition of land
d. an increase in the amount owed on a note payable
e. the repurchase of outstanding shares of stock
13. Which of the following is not a category on the statement of cash flows?
a. cash flow from operating activities
b. cash flow from equity activities
c. cash flow from investing activities
d. cash flow from financing activities
Note:Use the following data for the next three problems (14, 15, & 16).
Acme Pest Control has sales of $13,500, cost of goods sold of $4,000, selling expenses of $3,500, depreciation of $2,000, interest expense of $2,000, and a tax rate of 34%.
14. What is Acme’s operating income?
a. $4,000
b. $2,000
c. $9,500
d. $6,000
e. $1,320
15. What is Acme’s taxable income and tax expense?
a. $6,000; $2,040
b. $2,000; $1,320
c. $4,000; $1,360
d. $2,000; $680
e. $9,500; $3,230
16. What is Acme’s net income?
a. $2,720
b. $897.60
c. $6,460
d. $2,040
e. $1,320
17. Your venture has total assets of $690, net fixed assets of $500, long term debt of $80, and stockholders’ equity of $400. What is the amount of your venture’s current liabilities?
a. -$100
b. $100
c. $210
d. $290
e. $1,090
18. In breakeven analysis, solving for when EBITDA is equal to zero gives breakeven in terms of:
a. economic revenues
b. variable costs
c. survival revenues
d. fixed costs
19. A lease that provides maintenance in addition to financing and is also usually cancelable is called:
a. capital lease
b. liability lease
c. operating lease
d. asset lease
e. equity lease
20. Which one of the following is not considered to be an internal operating schedule?
a. income statement
b. cost of production schedule
c. cost of goods sold schedule
d. inventories schedule
21. “Net cash burn” occurs when the sum of which of the following items is negative?
a. cash flows from operations and financing
b. cash flows from investing and financing
c. cash flows from operations and investing
d. cash flows from net income and depreciation
e. cash flows from operations and net income
22. Expenses or costs that vary directly with revenues are said to be:
a. fixed expenses
b. semi-fixed expenses
c. semi-variable expenses
d. variable expenses
23. EBDAT is equal to:
a. revenues – variable costs – cash fixed costs
b. revenues + variable costs + cash fixed costs
c. revenues – variables costs – total fixed costs
d. revenues + variable costs – cash fixed costs
24. “Gross earnings” is equal to:
a. Revenue – After-Tax cost of financial capital used
b. net income ÷ sales
c. (net sales – the cost of production) × tax rate
d. net sales – the cost of production
25. According to Appendix A of Chapter 4, NOPAT is defined as:
a. revenues times (1 + tax rate)
b. revenues times (1 – tax rate)
c. EBITDA times (1 – tax rate)
d. EBIT times (1 – tax rate)
e. net income times (1 + tax rate)
26. Last year a firm had sales of $200,000. Its cost of goods sold was $75,000, and administrative and marketing expenses were $25,000 each. Depreciation expense was $10,000, while interest expense was $15,000. If the tax rate is 30%, what was the firm’s NOPAT last year?
a. $19,500
b. $35,000
c. $45,500
d. $52,500
e. $80,500
27. What is the survival revenues breakeven based on: cash fixed costs = $400,000 and a variable cost revenue ratio = .65?
a. $460,500
b. $615,385
c. $1,142,857
d. $2,000,334
e. $4,000,667
28. Use the following information to determine the cash fixed costs: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000.
e. $380,000
f. $400,000
g. $480,000
h. $500,000
i. $620,000
29. Find the “contribution profit margin” based on the following information: cash fixed costs = $60,000; variable costs = $70,000; and sales = $100,000.
a. 70%
b. 60%
c. 30%
d. 40%
e. 100%
30. Find the “survival revenues” (SR), also known as the EBDAT breakeven) based on the following information: cash fixed costs = $60,000; variable costs = $70,000; and sales = $100,000.
a. $85,714
b. $100,000
c. $116,667
d. $200,000
e. $300,000
31. What is the survival revenues breakeven based on the following: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000; and a variable cost revenue ratio = .50?
a. $400,000
b. $600,000
c. $800,000
d. $1,000,000
e. $1,200,000
32. A firm with constant variable costs has a survival revenue breakeven of $375,000. This year it had $250,000 in sales, $100,000 of which was a fixed cos What are the firm’s cash fixed costs?
a. $150,000
b. $225,000
c. $625,000
d. $937,500
33. Last year, Beth’s Baked Goods exactly broke even with cash fixed costs of $63,000. If its breakeven survival revenue level was $94,000, what was its variable cost revenue ratio (VCRR)?
a. .27
b. .30
c. .33
d. .67
34. In its first year, Joe’s Start-Up Company had revenues of $125,000 and cost of goods sold of $81,250, which was the only variable cos Depreciation was $20,000, and cash costs were $5,000 in financing costs, admin expenses of $50,000, and $45,000 in marketing expenses – all of which were fixed. What is the survival breakeven revenue?
a. $342,857
b. $285,714
c. $271,429
d. $184,615
e. $153,846
Multiple Choice Questions and Problems for Chapter 4, Appendix A:
1. Economic Value Added (EVA) is calculated as:
a. NOPAT plus after-tax dollar cost of financial capital used
b. ROE minus percentage cost of financial capital
c. NOPAT minus after-tax dollar cost of financial capital used
d. ROE plus the percentage cost of financial capital
2. A firm’s net operating profit after taxes (NOPAT) is calculated as:
a. net profit
b. EBIT times one minus the tax rate
c. EBT minus interest paid
d. EBIT times the tax rate
3. Total operating fixed costs (TOFC) equal:
a. cash operating fixed costs (excluding interest expenses)
b. noncash fixed costs (e.g., depreciation)
c. interest expenses
d. a plus b
e. a plus b plus c
4. Find the NOPAT given the following information: sales = $520,000, earnings before interest = $100,000; interest = $20,000; and the tax rate = 30%.
a. $70,000
b. $56,000
c. $30,000
d. $24,000
e. $10,000
5. Find the NOPAT breakeven revenues (NR) given the following information: total operating fixed costs = $75,000; variable costs = $150,000; and sales = $200,000.
a. $100,000
b. $240,000
c. $300,000
d. $400,000
e. $460,000
6. Determine the total operating fixed costs (TOFC) based on the following: Administrative expenses = $200,000; Marketing expenses = $180,000; Depreciation expenses = $100,000; and Interest expenses = $20,000.
a. $200,000
b. $380,000
c. $400,000
d. $480,000
e. $500,000
CHAPTER 5
EVALUATING OPERATING AND FINANCIAL PERFORMANCE
True-False Questions
1. Showing the relationships between two or more financial variable and/or time, financial ratios are useful means of summarizing large amounts of financial data for comparative purposes.
2. Second-round, mezzanine, and liquidity-stage financing generally occur during a venture’s survival stage.
3. Commercial banks are important users of financial ratios and measures during the development and startup stages of ventures.
4. Investment bankers are users of financial ratios and measures of ventures primarily during the rapid-growth stage relative to the development and startup stages.
5. Trend analysis is used to examine a venture’s performance over time.
6. Cross-sectional analysis is used to examine a venture’s performance over time.
7. “Cash burn” is the cash a venture expends on its operating, financing, and depreciation expenses.
8. “Net cash burn” occurs when cash burn exceeds cash build in a specified time period.
9. The “cash burn rate” is the cash burn for a fixed period of time, typically a month.
10. The term “cash build” as used in Chapter 5 is equal to net sales minus the change in receivables.
11. Liquidity ratios indicate the venture’s ability to pay short term assets from short-term liabilities.
12. Net working capital reflects current assets deducted from current liabilities.
13. “Net working capital” is calculated as fixed assets minus current liabilities.
14. A venture’s cash, marketable securities, and receivables comprise the venture’s “liquid assets”.
15. The current ratio and the quick ratio differ only because average inventories are subtracted in the numerator of the quick ratio.
16. For a venture with inventories, the quick ratio will always be greater than the current ratio.
17. Net working capital is a dollar amount measure of the cushion between current assets and current liabilities.
18. Leverage ratios indicate the extent to which the venture has used debt and its ability to meet debt obligations.
19. Total debt includes current liabilities, long-term debt, and retained earnings.
20. How efficiently a venture controls its expenses and uses its assets and debt is evaluated with profitability and efficiency ratios.
21. During the development and startup stages of a venture’s life cycle, important financial ratios and measures include cash burn rates and liquidity ratios.
22. During the development and startup stages of a venture’s life cycle, important users of financial ratios and measures include the entrepreneur, business angels, and venture capitalists (VCs).
23. Leverage ratios are generally considered to be more important during the survival and rapid-growth stages compared to the development and startup stages.
24. The equity multiplier is considered an efficiency ratio.
25. The extent to which a venture is in debt and in its ability to repay its debt obligations is indicated by leverage ratios.
26. The equity multiplier shows the extent by which assets are supported by equity and deb
27. Accounting rules require that the current maturities of long-term debt obligations be classified as short-term liabilities.
28. Profitability and efficiency ratios are generally considered to be more important during the development and startup stages compared to the survival and rapid-growth stages.
29. The part of a venture’s interest payment that is subsidized by the government because of the deductibility of interest is called the interest tax shield.
30. How efficiently a venture controls its expenses and uses its assets and debt is evaluated with profitability and efficiency ratios.
31. The Return on Assets model states: ROA = net profit margin × asset turnover × the equity multiplier.
32. If a firm has positive net income, a drop in a venture’s asset intensity ratio will increase its ROE.
Multiple-Choice Questions
1. Investment bankers and commercial banks are important users of financial ratios and measures during which of the following life cycle stages?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. All four stages
2. The entrepreneur, angels, and VCs are important users of financial ratios and measures during which of the following life cycle stages?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. All four stages
3. Which of the following is used to examine a venture’s performance over time?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis
4. Which of the following is used to compare a venture’s performance against another firm at the same point in time?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis
5. Which of the following is used to compare a venture’s performance against the average performance of other firms in the same industry?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis
6. Which one of the following is not a basic ratio techniques used to conduct financial analysis?
a. trend analysis
b. sensitivity analysis
c. cross-sectional analysis
d. industry comparables analysis
7. The term “cash build” is measured as:
a. net income plus depreciation
b. net sales minus expenses minus (plus) an increase (decrease) in inventories
c. net sales minus (plus) an increase (decrease) in receivables
d. net income plus depreciation minus (plus) an increase (decrease) in payables
8. “Net cash burn” is calculated as:
a. cash burn plus cash build
b. cash build minus cash burn
c. cash burn minus cash build
d. cash burn minus cash build squared
9. Using the following information, determine the average monthly net cash burn rate: annual net income = $20,000; annual interest = $10,000; annual cash build = $150,000; and annual cash burn = $186,000.
a. $1,000
b. $3,000
c. $4,000
d. $6,000
e. $7,000
10. Use the following information to determine a firm’s “cash build:” net sales = $150,000; net income = $15,000; beginning-of-period accounts receivable = $60,000; end-of-period accounts receivable = $90,000; and interest = $10,000.
a. $10,000
b. $15,000
c. $30,000
d. $60,000
e. $120,000
11. Average current assets minus average inventories when divided by average current liabilities is called which of the following ratios?
a. current ratio
b. quick ratio
c. net working capital ratio
d. current liabilities to total debt ratio
12. Dividing the average total assets by the average owners’ equity is called which of the following ratios?
a. equity multiplier
b. debt to equity ratio
c. current liabilities to total debt ratio
d. current ratio
13. Net sales minus cost of goods sold when divided by sales is called which of the following ratios?
a. gross profit margin
b. operating profit margin
c. net profit margin
d. net operating profit after taxes margin
14. Net income divided by net sales is called which of the following ratios?
a. net operating profit after taxes margin
b. net profit margin’
c. operating profit margin
d. gross profit margin
15. The difference between a venture’s ability to generate cash to pay interest and the amount of interest it has to pay is determined by which of the following ratios?
a. fixed charges coverage
b. debt to asset
c. equity multiplier
d. debt to equity
e. interest coverage
16. Which of the following is not a profitability and efficiency ratio?
a. sales-to-total-assets
b. return on equity
c. return on assets
d. inventory-to-total assets
e. NOPAT profit margin
17. Which of the following is true?
a. ROA is always greater than or equal to ROE
b. an increase in the asset turnover ratio implies a decrease in the asset
intensity ratio
c. a and b
d. none of the above
18. A firm has the following balance sheet information: total assets = $100,000; current assets = $30,000; inventories = $10,000; cash = $5,000; total liabilities = $30,000; current liabilities = $15,000; notes payable = $2,000. What are the firm’s quick and NWC-to-Total-Assets ratios?
a. 1.00 and .13
b. 1.33 and .13
c. 1.00 and .15
d. 1.33 and .15
19. Last year, Nemo’s Fish ‘n Chips recorded the following financial data: sales = $85,000; cost of goods sold = $45,000; selling and administrative expenses = $25,000; depreciation and amortization = $7,000; interest expense = $12,000. The tax rate was 30%. Find Nemo’s interest coverage for last year.
a. -.29 times
b. .66 times
c. .86 times
d. 1.25 times
e. 3.33 times
20. A venture has net sales of $400,000, cost of goods sold of $200,000, operating expenses (selling, general, and administrative) of $100,000, and interest expenses of $50,000. What is the operating profit margin?
a. 50.0%
b. 75%
c. 25%
d. 40%
21. Last year, Lenny’s Lemonade had $3,500 in sales, and cost of goods sold was $2,000. Depreciation expenses totaled $500 and interest expense was $700. If the tax rate is 25%, what is the net profit margin for Lenny’s Lemonade? What is its NOPAT margin?
a. 6.43% and 21.43%
b. 20.7% and 21.43%
c. 2.14% and 32.14%
d. 22.86% and 32.14%
Note: The following information should be used for the next eleven (22 through 32) problems.
In its closing financial statements for its first year in business, the Runs and Goses Company, had cash of $242, accounts receivable of $850, inventory of $820, net fixed assets of $3,408, accounts payable of $700, short-term notes payable of $740, long-term liabilities of $1,100, common stock of $1,160, retained earnings of $1,620, net sales of $2,768, cost of goods sold of $1,210, depreciation of $360, interest expense of $160, taxes of $312, addition to retained earnings of $508, and dividends paid of $218.
22. What is the return on equity for Runs and Goses?
a. 26.1%
b. 44.7%
c. 62.6%
d. 18.4%
e. 7.9%
23. What is Runs and Goses’ return on total assets?
a. 9.6%
b. 13.6%
c. 19.1%
d. 37.9%
e. 22.5%
24. What is the net profit margin for Runs and Goses?
a. 60.0%
b. 22.7%
c. 7.9%
d. 18.4%
e. 26.2%
25. Runs and Goses operating profit margin is?
a. 26.2%
b. 56.3%
c. 43.3%
d. 30.3%
e. 60.0%
26. The gross profit margin for Runs and Goses is?
a. 26.2%
b. 30.3%
c. 43.3%
d. 56.3%
e. 60.0%
27. What is Runs and Goses’ sales to total asset ratio?
a. 1.91
b. 0.25
c. 0.52
d. 0.23
e. 0.57
28. What is the current ratio for Runs and Goses?
a. 1.46
b. 1.33
c. 1.23
d. 1.21
e. 1.13
29. The total-debt-total-asset ratio for Runs and Goses is?
a. 0.48
b. 0.71
c. 0.27
d. 0.53
e. 0.82
30. What is Runs and Goses’ debt-to-equity ratio?
a. 0.91
b. 2.15
c. 0.48
d. 1.12
e. 2.32
31. What is the equity multiplier for Runs and Goses?
a. 4.59 times
b. 2.35 times
c. 0.48 times
d. 1.12 times
e. 1.91 times
32. The interest coverage ratio for Runs and Goses is:
a. 6.5 times
b. 4.5 times
c. 9.7 times
d. 3.5 times
e. 1.5 times
CHAPTER 6
MANAGING CASH FLOW
True-False Questions
1. The actions of screening business ideas, preparing a business model/plan, and obtaining seed financing occurs during a venture’s development stage.
2. The actions of monitoring financial performance, determining project cash needs, and obtaining first-round financing occurs during a venture’s survival stage.
3. “First-round financing” usually occurs during a venture’s rapid-growth life cycle stage.
4. Short-term financial planning is critical during the survival stage because operations not yet turning a profit and the associated cash burn often lead to a venture’s inability to pay its maturing liabilities.
5. Cash shortages during the rapid growth stage frequently derive from the lack of operating profits to fund working capital and fixed asset investments needed to support sales growth.
6. Due to the difficulty of projecting financial statements for a young firm, short-term financial forecasts are never required of early-stage ventures.
7. Early-stage ventures are defined as firms that are only operating in either their development or startup stages.
8. Even in a young, successful venture, restricted access to bank credit and with little to no access to short-term lending markets can hinder operations until the next round of financing.
9. “First-round financing” usually occurs during a venture’s rapid-growth life cycle stage.
10. Short-term cash planning tools include preparation of a: sales schedule, a purchases schedule, a wages and commissions schedule, and a cash budge
11. Short-term financial planning typically involves preparing monthly financial statements and focuses on identifying and planning for net income demands on the business.
12. A venture’s operating schedules typically include a: sales schedule, purchases schedule, and wages and commissions schedule.
13. A cash budget shows a venture’s projected revenues and expenses over a forecast period.
14. Preparing monthly cash budgets for a full year allows the entrepreneur to determine whether there will be a cash need, the maximum size of the cash need, and whether the need can be repaid during the year.
15. Conversion period ratios show the average time in days it takes to convert certain current assets and current liabilities into cash.
16. A venture’s operating cycle is the same as its cash conversion cycle.
17. The sum of the inventory-to-sale conversion period and the purchase-to-payment conversion period minus the sale-to-cash conversion period is called the cash conversion cycle.
18. The cash conversion cycle refers to the time it takes to convert a sale into net income.
19. The “cash conversion cycle” measures the time it takes to pay off the principal on a loan.
20. The sale-to-cash conversion period is calculated by dividing average revenues by net sales per day.
21. A venture’s cash conversion cycle will decrease if the purchase-to-payment conversion period increases.
Multiple-Choice Questions
1. A firm is said to be an early stage venture when it is in which of the following except?
a. rapid growth stage
b. startup stage
c. development stage
d. survival stage
e. early-maturity stage
2. Seed financing is generally associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage
3. First-round financing is generally associated with which one of the following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage
4. Which of the following is not part of the operating cycle?
a. time it takes to purchase products
b. time it takes to produce products
c. time it takes to sell the products
d. time it takes to pay suppliers
e. time it takes to collect receivables
5. Which one of the following “measures” the average days of sales committed to the extension of trade credit?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle period
6. Which of the following is measured by dividing the average daily cost of goods sold into the average inventory?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle
7. Which of the following measures the average time from purchase of materials and labor to actual cash payment?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle
8. Which of the following measures the average time it takes a firm to complete its operating cycle after deducting the days supported by trade credit and delayed payroll financing?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle
9. Which one of the following conversion periods operates to reduce the length of the cash conversion cycle?
a. inventory-to-sale conversion period
b. sale-to-cash conversion period
c. purchase-to-payment conversion period
d. fixed assets-to-usage conversion period
10. Which one of the following conversion periods is not a component in the cash conversion cycle?
a. inventory-to-sale conversion period
b. sale-to-cash conversion period
c. purchase-to-payment conversion period
d. fixed assets-to-usage conversion period
11. Calculate the inventory-to-sale conversion period based on the following information: average inventories = $120,000; average receivables = $90,000; average payables = $40,000; cost of goods sold = $182,500; and net sales = $365,000.
a. 240.0 days
b. 180.0 days
c. 90.0 days
d. 60.0 days
e. 45.0 days
12. Calculate the sale-to-cash conversion period based on the following information: average inventories = $120,000; average receivables = $90,000; average payables = $40,000; cost of goods sold = $182,500; and net sales = $365,000.
a. 240.0 days
b. 180.0 days
c. 90.0 days
d. 60.0 days
e. 45.0 days
13. Based on the following information, determine the venture’s cash conversion cycle: Inventory-to-sale conversion period = 112.9 days; Sale-to-cash conversion period= 57.1 days; and Purchase-to-payment conversion period = 76.8 days.
a. 170.0 days
b. 189.7 days
c. 93.2 days
d. 246.8 days
e. 133.9 days
14. Determine the cash conversion cycle based on the following information: inventory-to-sale conversion period = 112.9 days; sale-to-cash conversion period = 57.1 days; and purchase-to-payment conversion period = 76.8 days.
a. 93.2 days
b. 132.6 days
c. 170.0 days
d. 246.8 days
e. 365.0 days
15. Based on the following information, determine the average receivables (rounded to thousands of dollars) that were outstanding: Net sales = $575,000; Sale-to-cash conversion period = 57.1 days; Purchase-to-payment conversion period = 76.8 days; and Cost of goods sold = $380,000.
a. $90,000
b. $180,000
c. $121,000
d. $31,000
e. $41,000
16. Based on the following information, determine the venture’s inventory-to-sale conversion period: cash conversion cycle = 250 days; sale-to-cash conversion period = 60 days; and purchase-to-payment conversion period = 70 days.
a. 70 days
b. 140 days
c. 240 days
d. 260 days
e. 330 days
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FIN 320 Week 5 Mid-Term Exam – Strayer
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Chapters 1 Through 8
Chapter 1: ___________________________________________________________________________
1.
Financial assets represent _____ of total assets of U.S. households.
A.
over 60%
B.
over 90%
C.
under 10%
D.
about 30%
2.
Real assets in the economy include all but which one of the following?
A.
Land
B.
Buildings
C.
Consumer durables
D.
Common stock
3.
Net worth represents _____ of the liabilities and net worth of commercial banks.
A.
about 51%
B.
about 91%
C.
about 11%
D.
about 31%
4.
According to the Flow of Funds Accounts of the United States, the largest single asset of U.S. households is ___.
A.
mutual fund shares
B.
real estate
C.
pension reserves
D.
corporate equity
5.
According to the Flow of Funds Accounts of the United States, the largest liability of U.S. households is ________.
A.
mortgages
B.
consumer credit
C.
bank loans
D.
gambling debts
6.
____ is not a derivative security.
A.
A share of common stock
B.
A call option
C.
A futures contract
D.
None of these options (All of the answers are derivative securities.)
7.
According to the Flow of Funds Accounts of the United States, the largest financial asset of U.S. households is ____.
A.
mutual fund shares
B.
corporate equity
C.
pension reserves
D.
personal trusts
8.
Active trading in markets and competition among securities analysts helps ensure that: I. Security prices approach informational efficiency II. Riskier securities are priced to offer higher potential returns III. Investors are unlikely to be able to consistently find under- or overvalued securities
A.
I only
B.
I and II only
C.
II and III only
D.
I, II, and III
9.
The material wealth of society is determined by the economy's _________, which is a function of the economy's _________.
A.
investment bankers; financial assets
B.
investment bankers; real assets
C.
productive capacity; financial assets
D.
productive capacity; real assets
10.
Which of the following is not a money market security?
A.
U.S. Treasury bill
B.
6-month maturity certificate of deposit
C.
Common stock
D.
Bankers' acceptance
11.
__________ assets generate net income to the economy, and __________ assets define allocation of income among investors.
A.
Financial, financial
B.
Financial, real
C.
Real, financial
D.
Real, real
12.
Which of the following are financial assets? I. Debt securities II. Equity securities III. Derivative securities
A.
I only
B.
I and II only
C.
II and III only
D.
I, II, and III
13.
__________ are examples of financial intermediaries.
A.
Commercial banks
B.
Insurance companies
C.
Investment companies
D.
All of these options
14.
Asset allocation refers to _________.
A.
the allocation of the investment portfolio across broad asset classes
B.
the analysis of the value of securities
C.
the choice of specific assets within each asset class
D.
none of these options
15.
Which one of the following best describes the purpose of derivatives markets?
A.
Transferring risk from one party to another
B.
Investing for a short time period to earn a small rate of return
C.
Investing for retirement
D.
Earning interest income
16.
More than _____________ of currency is traded each day in the market for foreign exchange.
A.
$300 million
B.
$1 billion
C.
$30 billion
D.
$1 trillion
17.
Security selection refers to the ________.
A.
allocation of the investment portfolio across broad asset classes
B.
analysis of the value of securities
C.
choice of specific securities within each asset class
D.
top-down method of investing
18.
Which of the following is an example of an agency problem?
A.
Managers engage in empire building.
B.
Managers protect their jobs by avoiding risky projects.
C.
Managers over consume luxuries such as corporate jets.
D.
All of these options are examples of agency problems.
19.
_____ is a mechanism for mitigating potential agency problems.
A.
Tying income of managers to success of the firm
B.
Directors defending top management
C.
Antitakeover strategies
D.
The straight voting method of electing the board of directors
20.
__________ is (are) real assets.
A.
Bonds
B.
Production equipment
C.
Stocks
D.
Commercial paper
21.
__________ portfolio construction starts with selecting attractively priced securities.
A.
Bottom-up
B.
Top-down
C.
Upside-down
D.
Side-to-side
22.
In a market economy, capital resources are primarily allocated by ____________.
A.
governments
B.
the SEC
C.
financial markets
D.
investment bankers
23.
__________ represents an ownership share in a corporation.
A.
A call option
B.
Common stock
C.
A fixed-income security
D.
Preferred stock
24.
The value of a derivative security _________.
A.
depends on the value of another related security
B.
affects the value of a related security
C.
is unrelated to the value of a related security
D.
can be integrated only by calculus professors
25.
Commodity and derivative markets allow firms to adjust their _________.
A.
management styles
B.
focus from their main line of business to their investment portfolios
C.
ways of doing business so that they'll always have positive returns
D.
exposure to various business risks
26.
__________ portfolio management calls for holding diversified portfolios without spending effort or resources attempting to improve investment performance through security analysis.
A.
Active
B.
Momentum
C.
Passive
D.
Market-timing
27.
Financial markets allow for all but which one of the following?
A.
Shift consumption through time from higher-income periods to lower
B.
Price securities according to their riskiness
C.
Channel funds from lenders of funds to borrowers of funds
D.
Allow most participants to routinely earn high returns with low risk
28.
Financial intermediaries exist because small investors cannot efficiently _________.
A.
diversify their portfolios
B.
gather information
C.
monitor their portfolios
D.
all of these options
29.
Methods of encouraging managers to act in shareholders' best interest include: I. Threat of takeover II. Proxy fights for control of the board of directors III. Tying managers' compensation to stock price performance
A.
I only
B.
I and II only
C.
II and III only
D.
I, II, and III
30.
Firms that specialize in helping companies raise capital by selling securities to the public are called _________.
A.
pension funds
B.
investment banks
C.
savings banks
D.
REITs
31.
In securities markets, there should be a risk-return trade-off with higher-risk assets having _________ expected returns than lower-risk assets.
A.
higher
B.
lower
C.
the same
D.
The answer cannot be determined from the information given.
32.
When the market is more optimistic about a firm, its share price will ______; as a result, it will need to issue _______ shares to raise funds that are needed.
A.
rise; fewer
B.
fall; fewer
C.
rise; more
D.
fall; more
33.
Security selection refers to _________.
A.
choosing specific securities within each asset class
B.
deciding how much to invest in each asset class
C.
deciding how much to invest in the market portfolio versus the riskless asset
D.
deciding how much to hedge
34.
An example of a derivative security is _________.
A.
a common share of General Motors
B.
a call option on Intel stock
C.
a Ford bond
D.
a U.S. Treasury bond
35.
__________ portfolio construction starts with asset allocation.
A.
Bottom-up
B.
Top-down
C.
Upside-down
D.
Side-to-side
36.
Which one of the following firms falsely claimed to have a $4.8 billion bank account at Bank of America and vastly understated its debts, eventually resulting in the firm's bankruptcy?
A.
WorldCom
B.
Enron
C.
Parmalat
D.
Global Crossing
37.
Debt securities promise: I. A fixed stream of income II. A stream of income that is determined according to a specific formula III. A share in the profits of the issuing entity
A.
I only
B.
I or II only
C.
I and III only
D.
II or III only
38.
The Sarbanes-Oxley Act tightened corporate governance rules by requiring all but which one of the following?
A.
Required that corporations have more independent directors
B.
Required that the CFO personally vouch for the corporation's financial statements
C.
Required that firms could no longer employ investment bankers to sell securities to the public
D.
Required the creation of a new board to oversee the auditing of public companies
39.
The success of common stock investments depends on the success of _________.
A.
derivative securities
B.
fixed-income securities
C.
the firm and its real assets
D.
government methods of allocating capital
40.
The historical average rate of return on large company stocks since 1926 has been _____.
A.
5%
B.
8%
C.
12%
D.
20%
41.
The average rate of return on U.S. Treasury bills since 1926 was _________.
A.
less than 1%
B.
less than 3%
C.
less than 4%
D.
less than 7%
42.
An example of a real asset is: I. A college education II. Customer goodwill III. A patent
A.
I only
B.
II only
C.
I and III only
D.
I, II, and III
43.
The 2002 law designed to improve corporate governance is titled the _____.
A.
Pension Reform Act
B.
ERISA
C.
Financial Services Modernization Act
D.
Sarbanes-Oxley Act
44.
Which of the following is not a financial intermediary?
A.
a mutual fund
B.
an insurance company
C.
a real estate brokerage firm
D.
a savings and loan company
45.
The combined liabilities of American households represent approximately __________ of combined assets.
A.
11%
B.
19%
C.
25%
D.
33%
46.
In 2011 real assets represented approximately __________ of the total asset holdings of American households.
A.
32%
B.
42%
C.
48%
D.
55%
47.
In 2011 mortgages represented approximately __________ of total liabilities and net worth of American households.
A.
12%
B.
14%
C.
28%
D.
42%
48.
Liabilities equal approximately _____ of total assets for nonfinancial U.S. businesses.
A.
10%
B.
25%
C.
48%
D.
75%
49.
Which of the following is not an example of a financial intermediary?
A.
Goldman Sachs
B.
Allstate Insurance
C.
First Interstate Bank
D.
IBM
50.
Real assets represent about ____ of total assets for commercial banks.
A.
1%
B.
15%
C.
25%
D.
40%
51.
Money market securities are characterized by: I. Maturity less than 1 year II. Safety of the principal investment III. Low rates of return
A.
I only
B.
I and II only
C.
I and III only
D.
I, II, and III
52.
After much investigation, an investor finds that Intel stock is currently underpriced. This is an example of ______.
A.
asset allocation
B.
security analysis
C.
top-down portfolio management
D.
passive management
53.
After considering current market conditions, an investor decides to place 60% of her funds in equities and the rest in bonds. This is an example of _____.
A.
asset allocation
B.
security analysis
C.
top-down portfolio management
D.
passive management
54.
Suppose an investor is considering one of two investments that are identical in all respects except for risk. If the investor anticipates a fair return for the risk of the security he invests in, he can expect to _____.
A.
earn no more than the Treasury-bill rate on either security.
B.
pay less for the security that has higher risk.
C.
pay less for the security that has lower risk.
D.
earn more if interest rates are lower.
55.
The efficient market hypothesis suggests that _______.
A.
active portfolio management strategies are the most appropriate investment strategies
B.
passive portfolio management strategies are the most appropriate investment strategies
C.
either active or passive strategies may be appropriate, depending on the expected direction of the market
D.
a bottom-up approach is the most appropriate investment strategy
56.
In a perfectly efficient market the best investment strategy is probably _____.
A.
an active strategy.
B.
a passive strategy.
C.
asset allocation.
D.
market timing.
57.
Market signals will help to allocate capital efficiently only if investors are acting _____.
A.
on the basis of their individual hunches.
B.
as directed by financial experts.
C.
as dominant forces in the economy.
D.
on accurate information.
58.
Which of the following is (are) true about hedge funds? I. They are open to institutional investors. II. They are open to wealthy individuals. III. They are more likely than mutual funds to pursue simple strategies.
A.
I and II only
B.
I and III only
C.
II and III only
D.
I, II, and III
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FIN 350 Week 5 Quiz – Strayer
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Week 5 Quiz 4 Chapter 7 and 8
Chapter 7—Bond Markets
1. ____ require the owner to clip coupons attached to the bonds and send them to the issuer to receive coupon payments.
a.
Bearer
b.
Registered
c.
Treasury
d.
Corporate
2. The yield to maturity is the annualized discount rate that equates the future coupon and principal payments to the initial proceeds received from the bond offering.
a. True
b. False
3. Note maturities are usually ____, while bond maturities are ____.
a.
less than 10 years; 10 years or more
b.
10 years or more; less than 10 years
c.
less than 5 years; 5 years or more
d.
5 years or more; less than 5 years
4. Investors in Treasury notes and bonds receive ____ interest payments from the Treasury.
a.
annual
b.
semiannual
c.
quarterly
d.
monthly
5. The Treasury has relied heavily on ____-year bonds to finance the U.S. budget deficit.
a.
50
b.
70
c.
10
d.
5
6. Interest earned from Treasury bonds is
a.
exempt from all income tax.
b.
exempt from federal income tax.
c.
exempt from state and local taxes.
d.
subject to all income taxes.
7. Treasury bond auctions are normally conducted only at the beginning of each year.
a. True
b. False
8. ____ bids for Treasury bonds specify a price that the bidder is willing to pay and a dollar amount of securities to be purchased.
a.
Competitive
b.
Noncompetitive
c.
Negotiable
d.
Non-negotiable
9. Treasury bond dealers
a.
quote an ask price for customers who want to sell existing Treasury bonds to the dealers.
b.
profit from a very wide spread between bid and ask prices in the Treasury securities market.
c.
may trade Treasury bonds among themselves.
d.
make a primary market for Treasury bonds.
10. Under the STRIP program created by the Treasury, stripped securities are created and sold by the Treasury.
a. True
b. False
11. A ten-year, inflation-indexed bond has a par value of $10,000 and a coupon rate of 5 percent. During the first six months since the bond was issued, the inflation rate was 2 percent. Based on this information, the coupon payment after six months will be $____.
a.
250
b.
255
c.
500
d.
510
12. Bonds issued by ____ are backed by the federal government.
a.
the Treasury
b.
AAA-rated corporations
c.
state governments
d.
city governments
13. Municipal general obligation bonds are ____. Municipal revenue bonds are ____.
a.
supported by the municipal government's ability to tax; supported by the municipal government's ability to tax
b.
supported by the municipal government's ability to tax; supported by revenue generated from the project
c.
always subject to federal taxes; always exempt from state and local taxes
d.
typically zero-coupon bonds; typically zero-coupon bonds
14. In general, variable-rate municipal bonds are desirable to investors who expect that interest rates will ____.
a.
remain unchanged
b.
fall
c.
rise
d.
none of the above
15. Which of the following statements is not true regarding zero-coupon bonds?
a.
They are issued at a deep discount from par value.
b.
Investors are taxed on the total amount of interest earned at maturity.
c.
The issuing firm is permitted to deduct the amortized discount as interest expense for federal income tax purposes, even though it does not pay interest until maturity.
d.
Zero-coupon bonds are purchased mainly for tax-exempt investment accounts, such as pension funds and individual retirement accounts.
e.
All of the above are true.
16. A variable rate bond allows
a.
investors to benefit from declining rates over time.
b.
issuers to benefit from rising market interest rates over time.
c.
investors to benefit from rising market interest rates over time.
d.
none of the above.
17. Corporate bonds that receive a ____ rating from credit rating agencies are normally placed at ____ yields.
a.
higher; lower
b.
lower; lower
c.
higher; higher
d.
none of the above
18. A private bond placement has to be registered with the SEC.
a. True
b. False
19. Which of the following institutions is most likely to purchase a private bond placement?
a.
commercial bank
b.
mutual fund
c.
insurance company
d.
savings institution
20. A protective covenant may
a.
specify all the rights and obligations of the issuing firm and the bondholders.
b.
require the firm to retire a certain amount of the bond issue each year.
c.
restrict the amount of additional debt the firm can issue.
d.
none of the above
21. A call provision on bonds normally
a.
allows the firm to sell new bonds at par value.
b.
gives the firm to sell new bonds above market value.
c.
allows the firm to sell bonds to the Treasury.
d.
allows the firm to buy back bonds that it previously issued.
22. When would a firm most likely call bonds?
a.
after interest rates have declined
b.
if interest rates do not change
c.
after interest rates increase
d.
just before the time at which interest rates are expected to decline
23. Assume U.S. interest rates are significantly higher than German rates. A U.S. firm with a German subsidiary could achieve a lower financing rate, without exchange rate risk by denominating the bonds in
a.
dollars.
b.
euros and making payments from U.S. headquarters.
c.
euros and making payments from its German subsidiary.
d.
dollars and making payments from its German subsidiary.
24. Many bonds have different call prices: a higher price for calling the bonds to meet sinking-fund requirements and a lower price if the bonds are called for any other reason.
a. True
b. False
25. Bonds that are not secured by specific property are called
a.
a chattel mortgage.
b.
open-end mortgage bonds.
c.
debentures.
d.
blanket mortgage bonds.
26. Bonds that are secured by personal property are called
a.
chattel mortgage bonds.
b.
first mortgage bonds.
c.
second mortgage bonds.
d.
debentures.
27. The coupon rate of most variable-rate bonds is tied to
a.
the prime rate.
b.
the discount rate.
c.
LIBOR.
d.
the federal funds rate.
28. Assume that you purchased corporate bonds one year ago that have no protective covenants. Today, it is announced that the firm that issued the bonds plans a leveraged buyout. The market value of your bonds will likely ____ as a result.
a.
rise
b.
decline
c.
be zero
d.
be unaffected
29. During weak economic periods, newly issued junk bonds require lower risk premiums than in strong economic periods.
a. True
b. False
30. ____ bonds have the most active secondary market.
a.
Treasury
b.
Zero-coupon corporate
c.
Junk
d.
Municipal
31. Some bonds are "stripped," which means that
a.
they have defaulted.
b.
the call provision has been eliminated.
c.
they are transferred into principal-only and interest-only securities.
d.
their maturities have been reduced.
32. ____ are not primary purchasers of bonds.
a.
Insurance companies
b.
Finance companies
c.
Mutual funds
d.
Pension funds
33. Leveraged buyouts are commonly financed by the issuance of:
a.
money market securities.
b.
Treasury bonds.
c.
corporate bonds.
d.
municipal bonds.
34. When firms issue ____, the amount of interest and principal to be paid is based on specified market conditions. The amount of the repayment may be tied to a Treasury bond price index or even to a stock index.
a.
auction-rate securities
b.
structured notes
c.
leveraged notes
d.
stripped securities
35. Which of the following statements is true regarding STRIPS?
a.
they are issued by the Treasury
b.
they are created and sold by various financial institutions
c.
they are not backed by the U.S. government
d.
they have to be held until maturity
e.
all of the above are true regarding STRIPS
36. (Financial calculator required.) Lisa can purchase bonds with 15 years until maturity, a par value of $1,000, and a 9 percent annualized coupon rate for $1,100. Lisa's yield to maturity is ____ percent.
a.
9.33
b.
7.84
c.
9.00
d.
none of the above
37. (Financial calculator required.) Erin is, a private investor, who can purchase $1,000 par value bonds for $980. The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until maturity. Erin's yield to maturity is ____ percent.
a.
9.96
b.
10.00
c.
10.33
d.
10.24
e.
none of the above
38. Devin is, a private investor, purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Devin will hold the bonds until maturity. Thus, he will earn a return of ____ percent.
a.
12
b.
9
c.
10.5
d.
more information is needed to answer this question
39. Which of the following is not true regarding zero-coupon bonds?
a.
They are issued at a deep discount from par value.
b.
Investors are taxed annually on the amount of interest earned, even though the interest will not be received until maturity.
c.
The issuing firm is permitted to deduct the amortized discount as interest expense for federal income tax purposes, even though it does not pay interest.
d.
Zero-coupon bonds are purchased mainly for tax-exempt investment account, such as pension funds and individual retirement accounts.
e.
all of the above are true
40. Which of the following is not true regarding the call provision?
a.
It typically requires a firm to pay a price above par value when it calls its bonds.
b.
The difference between the market value of the bond and the par value is called the call premium.
c.
A principal use of the call provision is to lower future interest payments.
d.
A principal use of the call provision is to retire bonds as required by a sinking-fund provision.
e.
A call provision is normally viewed as a disadvantage to bondholders.
41. If interest rates suddenly ____, those existing bonds that have a call feature are ____ likely to be called.
a.
decline; more
b.
decline; less
c.
increase; more
d.
none of the above
42. Which of the following would not be a likely example of a protective covenant provision?
a.
a limit on the amount of dividends a firm can pay
b.
a limit on the corporate officers' salaries a firm can pay
c.
the amount of additional debt a firm can issue
d.
a call feature
43. Bonds are issued in the primary market through a telecommunications network.
a. True
b. False
44. Corporate bonds can be placed with investors through a public offering or a private placement.
a. True
b. False
45. When a corporation issues bonds, it normally hires a securities firm that targets large institutional investors such as pension funds, bond mutual funds, and insurance companies.
a. True
b. False
46. Rule 144A, which allows small individual investors to trade privately-placed bonds (and some other securities) with each other without requiring that the firms that issued the securities to register them with the SEC.
a. True
b. False
47. Rule 144A creates liquidity for securities that are privately placed.
a. True
b. False
48. Corporate bonds are more standardized than stocks.
a. True
b. False
49. Structured notes are issued by firms to borrow funds, and the repayment of interest and principal is based on specified market conditions.
a. True
b. False
50. Bonds issued by large well-known corporations in large volume are illiquid because most buyers hold these bonds until maturity.
a. True
b. False
51. The bond market is served by bond dealers, who can play a broker role by matching up buyers and sellers.
a. True
b. False
52. Bond dealers do not have an inventory of bonds.
a. True
b. False
53. Bond dealers specialize in small transactions (less than $100,000) in order to enable small investors to trade bonds.
a. True
b. False
54. Many bonds are listed on the New York Stock Exchange (NYSE).
a. True
b. False
55. The primary investors in bond markets are institutional investors such as commercial banks, bond mutual funds, pension funds, and insurance companies.
a. True
b. False
56. The key difference between a note and a bond is that note maturities are usually less than one year, while bond maturities are one year or more.
a. True
b. False
57. Treasury bonds are issued by state and local governments.
a. True
b. False
58. Stripped bonds are bonds whose cash flows have been transformed into a security representing the principal payment only and a security representing interest payments only.
a. True
b. False
59. Inflation-indexed Treasury bonds are intended for investors who wish to ensure that the returns on their investments keep up with the increase in prices over time.
a. True
b. False
60. Savings bonds are bonds issued by the Federal Reserve.
a. True
b. False
61. Corporate bonds usually pay interest on an annual basis.
a. True
b. False
62. The bond debenture is a legal document specifying the rights and obligations of both the issuing firm and the bondholders.
a. True
b. False
63. A sinking-fund provision is a requirement that the issuing firm retire a certain amount of the bond issue each year.
a. True
b. False
64. Subordinated indentures are debentures that have claims against the firm's assets that are junior to the claims of both mortgage bonds and regular debentures.
a. True
b. False
65. High-risk bonds are called trash bonds.
a. True
b. False
66. Zero-coupon bonds do not pay interest. Instead, they are issued at a discount from par value.
a. True
b. False
67. If interest rates suddenly decline, those existing bonds that have a call feature are less likely to be called.
a. True
b. False
68. Which of the following statements is not true regarding STRIPS?
a.
They are not issued by the Treasury.
b.
They are created and sold by various financial institutions.
c.
They are backed by the U.S. government.
d.
They have to be held until maturity.
e.
All of the above are true regarding STRIPS.
69. (Financial calculator required.) Paul can purchase bonds with 15 years remaining until maturity, a par value of $1,000, and a 9 percent annual coupon rate for $1,100. Paul's yield to maturity is ____ percent.
a.
9.33
b.
7.84
c.
9.00
d.
none of the above
70. (Financial calculator required.) Steven, a private investor, can purchase $1,000 par value bonds for $980. The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until maturity. Steven's yield to maturity is ____ percent.
a.
9.96
b.
10.00
c.
10.33
d.
10.24
e.
none of the above
71. Jim purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Jim will hold the bonds until maturity. Thus, he will earn a return of ____ percent.
a.
12.00
b.
9.00
c.
10.50
d.
More information is needed to answer this question.
72. Which of the following is not an example of a municipal bond?
a.
general obligation bond
b.
revenue bond
c.
Treasury bond
d.
All of the above are examples of municipal bonds.
73. Which of the following statements is incorrect?
a.
The municipal bond must pay a risk premium to compensate for the possibility of default risk.
b.
The Treasury bond must pay a slight premium to compensate for being less liquid than municipal bonds.
c.
The income earned from municipal bonds is exempt from federal taxes.
d.
All of the above are true.
74. Which of the following is not mentioned in your text as a protective covenant?
a.
a limit on the amount of dividends a firm can pay
b.
a limit on the corporate officers' salaries a firm can pay
c.
the amount of additional debt a firm can issue
d.
the appointment of a trustee in all bond indentures
e.
All of the above are mentioned in the text as protective covenants.
75. Everything else being equal, which of the following bond ratings is associated with the highest yield?
a.
Baa
b.
A
c.
Aa
d.
Aaa
76. A ____ has first claim on specified assets, while a ____ is a debenture that has claims against a firm's assets that are junior to the claims of mortgage bonds and regular debentures.
a.
first mortgage bond; second mortgage bond
b.
first mortgage bond; debenture
c.
first mortgage bond; subordinated debenture
d.
chattel mortgage bond; subordinated debenture
e.
none of the above
77. If a firm believes that it will have sufficient cash flows to cover interest payments, it may consider using ____ debt and ____ equity, which implies a ____ degree of financial leverage.
a.
more; less; lower
b.
more; less; higher
c.
less; more; higher
d.
none of the above
78. The yield to investors on Treasury bonds reflects the risk-free rate because these bonds are virtually free from credit (default) risk.
a. True
b. False
79. The issuance of municipal securities is regulated by:
a.
the Securities and Exchange Commission.
b.
the Consumer Financial Protection Bureau.
c.
their respective state governments.
d.
the Federal Reserve.
80. For bonds issued under a _______ arrangement, the underwriter guarantees the issuer that the bonds will be sold at a specified price.
a.
specific value
b.
fixed proceeds
c.
best efforts
d.
firm commitment
81. For bonds issued under a _______ arrangement, the underwriter attempts to sell the bonds at a specified price but makes no guarantee to the issuer.
a.
floating value
b.
variable proceeds
c.
best efforts
d.
firm commitment
82. Which of the following eurozone countries has not recently experienced debt repayment problems?
a.
Finland
b.
Greece
c.
Portugal
d.
Spain
83. The Financial Reform Act of 2010 established the __________ to provide oversight for credit rating agencies.
a.
Federal Ratings Bureau
b.
Office of Credit Ratings
c.
Office of Agency Supervision
d.
Ratings Oversight Commission
84. A credit rating agency is paid by:
a.
the purchasers of the bonds that the agency rates.
b.
the issuers of the bonds that the agency rates.
c.
the taxpayers, because the rating agencies are government agencies.
d.
the New York Stock Exchange or the over-the-counter market where the bonds are listed.
85. All of the bonds issued by a particular company will have the same maturity, price, and credit rating.
a. True
b. False
86. When purchasing bonds, individual investors can use a ________ to specify the maximum price they are willing to pay for a bond.
a.
limit order
b.
market order
c.
stop order
d.
price order
87. Online bond brokerage services offer several advantages including:
a.
pricing is more transparent because investors can easily compare bid and ask spreads.
b.
some services charge commissions, which may be more easily understood than bid and ask spreads.
c.
some brokers have narrowed their spreads so that they do not lose business to competitors.
d.
all of the above
Chapter 8—Bond Valuation and Risk
1. The appropriate discount rate for valuing any bond is the
a.
bond's coupon rate.
b.
bond's coupon rate adjusted for the expected inflation rate over the life of the bond.
c.
Treasury bill rate with an adjustment to include a risk premium if one exists.
d.
yield that could be earned on alternative investments with similar risk and maturity.
2. The valuation of bonds is generally perceived to be ____ the valuation of equity securities.
a.
more difficult than
b.
easier than
c.
just as difficult as
d.
none of the above
3. A bond with a $1,000 par value has an 8 percent annual coupon rate. It will mature in 4 years, and annual coupon payments are made at the end of each year. Present annual yields on similar bonds are 6 percent. What should be the current price?
a.
$1,069.31
b.
$1,000.00
c.
$9712
d.
$927.66
e.
none of the above
4. A bond with a ten percent coupon rate bond pays interest semi-annually. Par value is $1,000. The bond has three years to maturity. The investors' required rate of return is 12 percent. What is the present value of the bond?
a.
$1,021
b.
$1,000
c.
$981
d.
$951
e.
none of the above
5. A bond with a 12 percent quarterly coupon rate has a yield to maturity of 16 percent. The bond has a par value of $1,000 and matures in 20 years. Based on this information, a fair price of this bond is $____.
a.
1,302
b.
763
c.
761
d.
1,299
6. From the perspective of investing institutions, the most attractive foreign bonds offer a ____ and are denominated in a currency that ____ over the investment horizon.
a.
high yield; appreciates
b.
high yield; remains stable
c.
low yield; appreciates
d.
low yield; depreciates
7. The value of ____-risk securities will be relatively ____.
a.
high; high
b.
high; low
c.
low; low
d.
none of the above
8. The larger the investor's ____ relative to the ____, the larger the ____ of a bond with a particular par value.
a.
discount rate; required rate of return; discount
b.
required rate of return; discount rate; discount
c.
required rate of return; discount rate; premium
d.
none of the above
9. If the coupon rate equals the required rate of return, the price of the bond
a.
should be above its par value.
b.
should be below its par value.
c.
should be equal to its par value.
d.
is negligible.
10. When financial institutions expect interest rates to ____, they may ____.
a.
increase; sell bonds and buy short-term securities
b.
increase; sell short-term securities and buy bonds
c.
decrease; sell bonds and buy short-term securities
d.
B and C
11. For a given par value of a bond, the higher the investor's required rate of return is above the coupon rate, the
a.
greater is the premium on the price.
b.
greater is the discount on the price.
c.
smaller is the premium on the price.
d.
smaller is the discount on the price.
12. Zero coupon bonds with a par value of $1,000,000 have a maturity of 10 years, and a required rate of return of 9 percent. What is the current price?
a.
$363,212
b.
$385,500
c.
$422,400
d.
$424,100
e.
none of the above
13. If the coupon rate ____ the required rate of return, the price of a bond ____ par value.
a.
equals; equals
b.
exceeds; is less than
c.
is less than; is greater than
d.
B and C
e.
none of the above
14. As interest rates increase, long-term bond prices
a.
increase by a greater degree than short-term bond prices.
b.
increase by an equal degree as short-term bond prices.
c.
decrease by a greater degree than short-term bond prices.
d.
decrease by an equal degree as short-term bond prices.
e.
decrease by a smaller degree than short-term bond prices.
15. The prices of bonds with ____ are most sensitive to interest rate movements.
a.
high coupon payments
b.
zero coupon payments
c.
small coupon payments
d.
none of the above (The size of the coupon payment does not affect sensitivity of bond prices to interest rate movements.)
16. A(n) ____ in the expected level of inflation results in ____ pressure on bond prices.
a.
increase; upward
b.
increase; downward
c.
decrease; downward
d.
none of the above
17. Other things held constant, bond prices should increase when inflationary expectations rise.
a. True
b. False
18. An expected ____ in economic growth places ____ pressure on bond prices.
a.
increase; downward
b.
increase; upward
c.
decrease; downward
d.
none of the above
19. Assume that the price of a $1,000 zero coupon bond with five years to maturity is $567 when the required rate of return is 12 percent. If the required rate of return suddenly changes to 15 percent, what is the price elasticity of the bond?
a.
−.980
b.
+.980
c.
−.494
d.
+.494
e.
none of the above
20. If a financial institution's bond portfolio contains a relatively large portion of ____, it will be ____.
a.
high coupon bonds; more favorably affected by declining interest rates
b.
zero or low coupon bonds; more favorably affected by declining interest rates
c.
zero or low coupon bonds; more favorably affected by rising interest rates
d.
high coupon bonds; completely insulated from rising interest rates
21. The prices of ____-coupon and ____ maturities are most sensitive to changes in the required rate of return.
a.
low; short
b.
low; long
c.
high; short
d.
high; long
22. An insurance company purchases corporate bonds in the secondary market with six years to maturity. Total par value is $55 million. The coupon rate is 11 percent, with annual interest payments. If the expected required rate of return in 4 years is 9 percent, what will the market value of the bonds be then?
a.
$52,115,093
b.
$55,341,216
c.
$55,000,000
d.
$56,935,022
23. A $1,000 par bond with five years to maturity is currently priced at $892. Annual interest payments are $90. What is the yield to maturity?
a.
13 percent
b.
12 percent
c.
11 percent
d.
10 percent
24. A bank buys bonds with a par value of $25 million for $24,040,000. The coupon rate is 10 percent, and the bonds pay annual payments. The bonds mature in four years. The bank wants to sell them in two years, and estimates the required rate of return in two years will be 8 percent. What will the market value of the bonds be in two years?
a.
$24,113,418
b.
$24,667,230
c.
$25,000,000
d.
$25,891,632
25. The price of short-term bonds are commonly ____ those of long-term bonds.
a.
more volatile than
b.
equally volatile as
c.
less volatile than
d.
A and C occur with about equal frequency
26. Assume that the value of liabilities equals that of earning assets. If asset portfolio durations are ____ than liability portfolio durations, then the market value of assets are ____ interest-rate sensitive than the market value of liabilities.
a.
greater; more
b.
greater; equally
c.
greater; less
d.
less; equally
e.
B and D
27. As interest rates consistently rise over a specific period, the market price of a bond you own would likely ____ over this period. (Assume no major change in the bond's default risk.)
a.
consistently increase
b.
consistently decrease
c.
remain unchanged
d.
change in a direction that cannot be determined with the above information
28. As interest rates consistently decline over a specific period, the market price of a bond you own would likely ____ over this period. (Assume no major change in the bond's default risk.)
a.
consistently increase
b.
consistently decrease
c.
remain unchanged
d.
change in a direction that cannot be determined with the above information
29. If analysts expect that the demand for loanable funds will increase, and the supply of loanable funds will decrease, they would most likely expect interest rates to ____ and prices of existing bonds to ____.
a.
increase; increase
b.
increase; decrease
c.
decrease; decrease
d.
decrease; increase
30. If analysts expect that the demand for loanable funds will decrease, and the supply of loanable funds will increase, they would most likely expect interest rates to ____ and prices of existing bonds to ____.
a.
increase; increase
b.
increase; decrease
c.
decrease; decrease
d.
decrease; increase
31. Consider a coupon bond that sold at par value two years ago. If interest rates are much lower now than when this bond was issued, the coupon rate of that bond will likely be ____ the prevailing interest rates, and the present value of the bonds will be ____ its par value.
a.
above; above
b.
above; below
c.
below; below
d.
below; above
32. Consider a coupon bond that sold at par value two years ago. If interest rates are much higher now than when this bond was issued, the coupon rate of that bond will likely be ____ the prevailing interest rates, and the present value of the bonds will be ____ its par value.
a.
above; above
b.
above; below
c.
below; below
d.
below; above
33. If bond portfolio managers expect interest rates to increase in the future, they would likely ____ their holdings of bonds now, which could cause the prices of bonds to ____ as a result of their actions.
a.
increase; increase
b.
increase; decrease
c.
decrease; decrease
d.
decrease; increase
34. If bond portfolio managers expect interest rates to decrease in the future, they would likely ____ their holdings of bonds now, which could cause the prices of bonds to ____ as a result of their actions.
a.
increase; increase
b.
increase; decrease
c.
decrease; decrease
d.
decrease; increase
35. Which of the following will most likely cause bond prices to increase? (Assume no possibility of higher inflation in the future.)
a.
reduced Treasury borrowing along with anticipation that money supply growth will decrease
b.
reduced Treasury borrowing along with anticipation that money supply growth will increase
c.
an anticipated drop in money supply growth along with increasing Treasury borrowing
d.
higher levels of Treasury borrowing and corporate borrowing
36. If the United States announces that it will borrow an additional $10 billion, this announcement will normally cause the bond traders to expect
a.
higher interest rates in the future, and will buy bonds now.
b.
higher interest rates in the future, and will sell bonds now.
c.
stable interest rates in the future, and will buy bonds now.
d.
lower interest rates in the future, and will buy bonds now.
e.
lower interest rates in the future, and will sell bonds now.
37. The market value of long-term bonds is ____ sensitive to interest rate movements; as interest rates fall, the market value of long-term bonds ____.
a.
slightly; rises
b.
very; rises
c.
very; declines
d.
slightly; declines
38. The bonds that are most sensitive to interest rate movements have
a.
no coupon and a short-term maturity.
b.
high coupons and a short-term maturity.
c.
high coupons and a long-term maturity.
d.
no coupon and a long-term maturity.
39. When two securities have the same expected cash flows, the value of the ____ security will be higher than the value of the ____ security.
a.
high-risk; low-risk
b.
low-risk; high-risk
c.
high-risk; high-risk
d.
low-risk; low-risk
e.
none of the above
40. Morgan would like to purchase a bond that has a par value of $1,000, pays $80 at the end of each year in coupon payments, and has 10 years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Morgan pay for the bond?
a.
$1,000.00
b.
$1,147.20
c.
$856.80
d.
none of the above
41. Sioux Financial Corp. has forecasted its bond portfolio value for one year ahead to be $105 million. In one year, it expects to receive $10,000,000 in coupon payments. The bond portfolio today is worth $101 million. What is the forecasted return of this bond portfolio?
a.
10 percent
b.
8.82 percent
c.
4.32 percent
d.
13.86 percent
e.
none of the above
42. Hurricane Corp. recently purchased corporate bonds in the secondary market with a par value of $11 million, a coupon rate of 12 percent (with annual coupon payments), and four years until maturity. If Bullock intends to sell the bonds in two years and expects investors' required rate of return at that time on similar investments to be 14 percent at that time, what is the expected market value of the bonds in two years?
a.
$9.33 million
b.
$11.00 million
c.
$10.64 million
d.
$9.82 million
e.
none of the above
43. Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The duration of this bond is
a.
1.90 years.
b.
1.50 years.
c.
1.92 years.
d.
none of the above
44. Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The modified duration of this bond is
a.
1.73 years.
b.
1.71 years.
c.
1.90 years.
d.
none of the above
45. The relationship reflecting the actual response of a bond's price to a change in bond yields is
a.
concave.
b.
convex.
c.
linear.
d.
quadratic.
46. If the level of inflation is expected to ____, there will be ____ pressure on interest rates and ____ pressure on the required rate of return on bonds.
a.
increase; upward; downward
b.
decrease; upward; downward
c.
decrease; upward; upward
d.
increase; downward; upward
e.
increase; upward; upward
47. Using a(n) ____ strategy, investors allocate funds evenly to bonds in each of several different maturity classes.
a.
matching
b.
laddered
c.
barbell
d.
interest rate
e.
none of the above
48. With a(n) ____ strategy, funds are allocated to bonds with a short term to maturity and bonds with a long term to maturity. Thus, this strategy allocates some funds to achieving a relatively high return and other funds to covering liquidity needs.
a.
matching
b.
laddered
c.
barbell
d.
interest rate
e.
none of the above
49. Which of the following bonds is most susceptible to interest rate risk from an investor's perspective?
a.
short-term, high-coupon
b.
short-term, low-coupon
c.
long-term, high-coupon
d.
long-term, zero-coupon
50. Which of the following is most likely to cause a decrease in bond prices?
a.
a decrease in money supply growth and an increase in the demand for loanable funds
b.
a forecast of decreasing oil prices
c.
a forecast of a stronger dollar
d.
an increase in money supply growth and no change in the demand for loanable funds
51. If the Treasury issues an unusually large amount of bonds in the primary market, it places ____ on bond prices, and ____ on yields to be earned by investors that purchase bonds and plan to hold them to maturity.
a.
downward pressure; downward pressure
b.
downward pressure; upward pressure
c.
upward pressure; upward pressure
d.
upward pressure; downward pressure
52. Assume bond portfolio managers actively manage their portfolios. If they expect interest rates to ____, they would shift toward ____.
a.
increase; long-maturity bonds with zero-coupon rates
b.
decrease; short-maturity bonds with high-coupon rates
c.
increase; high-coupon bonds with long maturities
d.
decrease; long-maturity bonds with zero-coupon rates
53. The market price of a bond is partly determined by the timing of the payments made to bondholders.
a. True
b. False
54. The appropriate price of a bond is simply the sum of the cash flows to be received.
a. True
b. False
55. The valuation of bonds is generally perceived to be more difficult than the valuation of equity securities.
a. True
b. False
56. Bonds that sell below their par value are called premium bonds.
a. True
b. False
57. A zero-coupon bond makes no coupon payments.
a. True
b. False
58. If the coupon rate of a bond is above the investor's required rate of return, the price of the bond should be below its par value.
a. True
b. False
59. An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return and therefore causes bond prices to increase.
a. True
b. False
60. The long-term, risk-free interest rate is driven by inflationary expectations, economic growth, the money supply, and the budget deficit.
a. True
b. False
61. If the level of inflation is expected to decrease, there will be upward pressure on interest rates and on the required rate of return on bonds.
a. True
b. False
62. Foreign investors anticipating dollar depreciation are less willing to hold U.S. bonds because the coupon payments will convert to less of their home currency.
a. True
b. False
63. Any announcement that signals stronger than expected economic growth tends to increase bond prices.
a. True
b. False
64. Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return.
a. True
b. False
65. As interest rates increase, prices of short-term bonds will decline by a greater degree than prices on long-term bonds.
a. True
b. False
66. Duration is a measure of bond price sensitivity.
a. True
b. False
67. A bond portfolio containing a large portion of zero-coupon bonds will be more favorably affected by declining interest rates than a bond portfolio containing no zero-coupon bonds.
a. True
b. False
68. International diversification of bonds reduces the sensitivity of a bond portfolio to any single country's interest rate movements.
a. True
b. False
69. In a laddered strategy, investors create a bond portfolio that will generate periodic income that can match their expected periodic expenses.
a. True
b. False
70. Which of the following formulas best describes the value of a bond?
a.
b.
c.
d.
e.
none of the above
71. Stephanie would like to purchase a bond that has a par value of $1,000, pays $80 at the end of each year in coupon payments, and has ten years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Stephanie pay for the bond?
a.
$1,000.00
b.
$1,147.20
c.
$856.80
d.
none of the above
72. Julia just purchased a $1,000 par value bond with a 10 percent annual coupon rate and a life of twenty years. The bond has four years remaining until maturity, and the yield to maturity is 12 percent. How much did Julia pay for the bond?
a.
$1,063.40
b.
$1,000
c.
$939.25
d.
none of the above
73. To determine the present value of a bond that pays semiannual interest, which of the following adjustments should not be made to compute the price of the bond?
a.
The annualized coupon should be split in half.
b.
The annual discount rate should be divided by 2.
c.
The number of annual periods should be doubled.
d.
The par value should be split in half.
e.
All of the above adjustments have to be made.
74. A $1,000 par value bond, paying $50 semiannually, with an 8 percent yield to maturity and five years remaining to maturity should sell for
a.
$1,000.00.
b.
$1,081.11.
c.
$798.70.
d.
$880.22.
e.
none of the above.
75. If the level of inflation is expected to ____, there will be ____ pressure on interest rates and ____ pressure on the required rate of return on bonds.
a.
increase; upward; downward
b.
decrease; upward; downward
c.
decrease; upward; upward
d.
increase; upward; upward
e.
increase; downward; upward
76. An economic announcement signaling ____ economic growth in the future will probably cause bond prices to ____.
a.
weak; decrease
b.
strong; increase
c.
weak; increase
d.
strong; decrease
e.
Answers C and D are correct.
77. Because of a change in the required rate of return from 11 percent to 13 percent, the bond price of a zero-coupon bond will fall from $1,000 to $860. Thus, the bond price elasticity for this bond is
a.
0.77.
b.
−0.77.
c.
−0.90.
d.
−1.06.
e.
none of the above.
78. The required rate of return on a certain bond changes from 12 percent to 8 percent, causing the price of the bond to change from $900 to $1,100. The bond price elasticity of this bond is
a.
−0.36.
b.
−0.44.
c.
−0.55.
d.
−0.67.
e.
0.67.
79. Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The duration of this bond is ____ years.
a.
1.92
b.
1.50
c.
1.90
d.
none of the above
80. A bond has a $1,000 par value and an 8 percent coupon rate. The bond has four years remaining to maturity and a 10 percent yield to maturity. This bond's modified duration is ____ years.
a.
1.33
b.
1.27
c.
3.24
d.
1.31
e.
none of the above
81. If investors rely strictly on modified duration to estimate the percentage change in the price of a bond, they will tend to ____ the price decline associated with an increase in rates and ____ the price increase associated with a decrease in rates.
a.
underestimate; underestimate
b.
overestimate; overestimate
c.
underestimate; overestimate
d.
overestimate; underestimate
82. In the ____ strategy, funds are allocated to bonds with a short term to maturity and bonds with a long term to maturity.
a.
matching
b.
laddered
c.
barbell
d.
interest rate
e.
none of the above
83. Using a(n) ____ strategy, investors allocate funds evenly to bonds in each of several different maturity classes.
a.
matching
b.
laddered
c.
barbell
d.
interest rate
e.
none of the above
84. Which of the following is not a factor affecting the market price of a foreign bond held by a U.S. investor?
a.
foreign interest rate movements
b.
credit risk
c.
exchange rate fluctuations
d.
All of the above are factors affecting the market price of a foreign bond.
85. When holding other factors constant, increased borrowing by the Treasury can result in a _______ required return and therefore _______ prices on existing bonds.
a.
higher; lower
b.
higher; higher
c.
lower; higher
d.
lower; lower
86. Holding other factors constant, a higher budget deficit leads to ______ interest rates, and higher inflationary expectations lead to _______ interest rates.
a.
higher; lower
b.
higher; higher
c.
lower; higher
d.
lower; lower
87. The credit risk premium tends to be larger for bonds that have longer terms to maturity.
a. True
b. False
88. The ____________ was recently established to identify risks in the U.S. financial system and make regulatory recommendations that could reduce such risks.
a.
Financial Risk Assessment Commission
b.
Financial Markets Protection Agency
c.
Financial Stability Oversight Council
d.
Federal Bureau of Financial Markets
89. When the European Central Bank provides credit to a country that is experiencing debt repayment problems, the ECB commonly:
a.
allows the country’s government to conduct its own monetary policy.
b.
recommends that the country withdraw from the eurozone.
c.
urges the country’s government to increase spending and lower taxes to stimulate the economy.
d.
imposes austerity conditions to enable the government to reduce its budget deficit.
90. Although the European debt crisis has had substantial effects on European financial markets, the crisis has been contained and has not affected markets and financial institutions outside Europe.
a. True
b. False
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FIN 534 Homework Set 5 – Strayer
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Directions: Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. This homework assignment is worth 100 points.
Use the following information for Questions 1 through 3:
Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion. This one-time unusual earnings growth won’t be maintained, though, and after 2014 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%.
Calculate Boehm’s total dividends for 2014 under each of the following policies:
1. Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.
2. It continues the 2013 dividend payout ratio.
3. It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million investment is financed with debt).
4. It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy.
Use the following information for Questions 5 and 6:
Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm’s fixed costs, F, are $2 million, 50 earth stations are produced and sold each year, profits total $500,000, and the firm’s assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on all units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carry forwards that render its tax rate zero, its cost of equity is 16%, and it uses no debt.
5. What is the incremental profit? To get a rough idea of the project’s profitability, what is the project’s expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment? Why or why not?
6. Would the firm’s break-even point increase or decrease if it made the change?
Use the following information for Questions 7 and 8:
Suppose you are provided the following balance sheet information for two firms, Firm A and Firm B (in thousands of dollars).
Firm A Firm B
Current assets $150,000 $120,000
Fixed assets (net) 150,000 180,000
Total assets $300,000 $300,000
Current liabilities $20,000 $80,000
Long-term debt 80,000 20,000
Common stock 100,000 100,000
Retained earnings 100,000 100,000
Total liabilities and equity $300,000 $300,000
Earnings before interest and taxes for both firms are $30 million, and the effective federal plus-state tax rate is 35%.
7. What is the return on equity for each firm if the interest rate on current liabilities is12% and the rate on long-term debt is 15%?
8. Assume that the short-term rate rises to 20%, that the rate on new long-term debt rises to 16%, and that the rate on existing long-term debt remains unchanged. What would be the return on equity for Firm A and Firm B under these conditions?
9. In 1983 the Japanese yen-U.S. dollar exchange rate was 250 yen per dollar, and the dollar cost of a compact Japanese-manufactured car was $10,000. Suppose that now the exchange rate is 120 yen per dollar. Assume there has been no inflation in the yen cost of an automobile so that all price changes are due to exchange rate changes. What would the dollar price of the car be now, assuming the car’s price changes only with exchange rates?
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FIN 534 Week 5 Midterm Exam – Strayer New
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1 Which of the following statements is CORRECT?
<span style="font-size: 13px;"> </span>
The New York Stock Exchange is an auction market with a physical location.
Capital market transactions involve only the purchase and sale of equity securities, i.e., common stocks.
If an investor sells shares of stock through a broker, then this would be a primary market transaction.
Consumer automobile loans are evidenced by legal documents called "promissory notes," and these individual notes are traded in the money market.
While the distinctions are blurring as investment banks are today buying commercial banks, and vice versa, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.
2 Which of the following statements is CORRECT?
It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.
Corporate shareholders are exposed to unlimited liability.
Corporations generally face fewer regulations than sole proprietorships.
Corporate shareholders are exposed to unlimited liability, and this factor may be compounded by the tax disadvantages of incorporation.
Shareholders in a regular corporation (not an S corporation) pay higher taxes than owners of an otherwise identical proprietorship.
3 Which of the following statements is CORRECT?
While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.
A security whose value is derived from the price of some other "underlying" asset is called a liquid security.
Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks.
Money markets are markets for common stocks and long-term debt.
The NYSE operates as an auction market, whereas the Nasdaq is a dealer market.
4 Which of the following statements is CORRECT?
Capital market instruments include both long-term debt and common stocks.
An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.
The NYSE does not exist as a physical location; rather, it represents a loose collection of dealers who trade stocks electronically.
If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction.
While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors.
5 Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?
Corporations generally find it relatively difficult to raise large amounts of capital.
Less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership.
Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.
Corporate investors are exposed to unlimited liability.
Corporations generally face relatively few regulations.
6 You recently sold 100 shares of your new company, XYZ Corporation, to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following statements best describes this transaction?
This is an example of an exchange of physical assets.
This is an example of a primary market transaction.
This is an example of a direct transfer of capital.
This is an example of a money market transaction.
This is an example of a derivatives market transaction
7 Money markets are markets for
Foreign stocks.
Consumer automobile loans.
U.S. stocks.
Short-term debt securities.
Long-term bonds.
8 Which of the following statements is CORRECT?
If Apple issues additional shares of common stock through an investment banker, this would be a secondary market transaction.
If you purchased 100 shares of Apple stock from your sister-in-law, this would be an example of a primary market transaction.
The IPO market is a subset of the secondary market.
Only institutions, and not individuals, can participate in derivatives market transactions.
As they are generally defined, money market transactions involve debt securities with maturities of less than one year.
9 DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change?
The firm's reported net income would increase.
The firm's operating income (EBIT) would increase.
The firm's taxable income would increase.
The firm's net cash flow would increase.
The firm's tax payments would increase.
10 Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year, even though the cash on its balance sheet increased?
The company repurchased 20% of its common stock.
The company sold a new issue of bonds.
The company made a large investment in new plant and equipment.
The company paid a large dividend.
The company had high amortization expenses.
11 Which of the following statements is CORRECT?
The statement of cash flows shows how much the firm's cash⎯the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)⎯increased or decreased during a given year.
The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.
The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit.
The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.
The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.
12 Which of the following statements is CORRECT?
One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital.
If a firm reports positive net income, its EVA must also be positive.
One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free.
One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital.
Actions that increase reported net income will always increase net cash flow.
13 The LeMond Corporation just purchased a new production line. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
LeMond's tax liability for the year will be lower.
LeMond's taxable income will be lower.
LeMond's net fixed assets as shown on the balance sheet will be higher at the end of the year.
LeMond's cash position will improve (increase).
LeMond's reported net income after taxes for the year will be lower.
14 Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?
The company purchases a new piece of equipment.
The company repurchases common stock.
The company pays a dividend.
The company issues new common stock.
The company gives customers more time to pay their bills.
15 Which of the following statements is CORRECT?
All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income.
The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government receives no tax revenue from these businesses.
All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code.
Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm's income as personal income and pay taxes on that income.
Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends.
16 Which of the following statements is CORRECT?
The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses.
MVA gives us an idea about how much value a firm's management has added during the last year.
MVA stands for market value added, and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
EVA stands for economic value added, and it is defined as follows:
EVA = EBIT(1 - T) - (Investor-supplied op. capital) x (A - T cost of capital).
EVA gives us an idea about how much value a firm's management has added over the firm's life.
17 Which of the following items cannot be found on a firm's balance sheet under current liabilities?
Accrued payroll taxes.
Accounts payable.
Short-term notes payable to the bank.
Accrued wages.
Cost of goods sold.
18 Which of the following statements is CORRECT?
If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.
A reduction in inventories held would have no effect on the current ratio.
An increase in inventories would have no effect on the current ratio.
If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
19 Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?
The total assets turnover decreases.
The TIE declines.
The DSO increases.
The EBITDA coverage ratio increases.
The current and quick ratios both decline.
20 Cordelion Communications is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?
The times interest earned ratio will decrease.
The ROA will decline.
Taxable income will decrease.
The tax bill will increase.
Net income will decrease.
21 Which of the following would indicate an improvement in a company's financial position, holding other things constant?
The current and quick ratios both increase.
The inventory and total assets turnover ratios both decline.
The debt ratio increases.
The profit margin declines.
The EBITDA coverage ratio declines.
22 The Cavendish Company recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects would occur as a result of this action?
The company's debt ratio increased.
The company's current ratio increased.
The company's times interest earned ratio decreased.
The company's basic earning power ratio increased.
The company's equity multiplier increased.
23 If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?
Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.
The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.
Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.
24 Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)?
2.03
2.13
2.25
2.36
2.48
25 Companies A and C each reported the same earnings per share (EPS), but Company A's stock trades at a higher price. Which of the following statements is CORRECT?
Company A trades at a higher P/E ratio.
Company A probably has fewer growth opportunities.
Company A is probably judged by investors to be riskier.
Company A must have a higher market-to-book ratio.
Company A must pay a lower dividend.
FIN 534 Midterm Exam Part 2
1 Which of the following statements regarding a 20-year (240-month) $225,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)
The outstanding balance declines at a slower rate in the later years of the loan's life.
The remaining balance after three years will be $225,000 less one third of the interest paid during the first three years.
Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.
Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.
The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.
2 Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.
The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.
A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.
If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.
3 Ellen now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?
$205.83
$216.67
$228.07
$240.08
$252.08
4 You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?
The discount rate increases.
The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.
The discount rate decreases.
The riskiness of the investment's cash flows increases.
The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years.
5 Which of the following statements is CORRECT?
An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.
The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due.
If a loan has a nominal annual rate of 7%, then the effective rate will never be less than 7%.
If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.
The proportion of the payment that goes toward interest on a fully amortized loan increases over time.
6 A $150,000 loan is to be amortized over 6 years, with annual end-of-year payments. Which of these statements is CORRECT?
The proportion of interest versus principal repayment would be the same for each of the 7 payments.
The annual payments would be larger if the interest rate were lower.
If the loan were amortized over 10 years rather than 6 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 6-year amortization plan.
The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower.
The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.
7 Which of the following statements is CORRECT?
If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.
Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.
Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.
Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon.
If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value.
8 A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?
The bond is selling below its par value.
The bond is selling at a discount.
If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.
The bond's current yield is greater than 9%.
If the yield to maturity remains constant, the bond's price one year from now will be higher than its current price.
9 Which of the following statements is NOT CORRECT?
All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.
If a bond is selling at its par value, its current yield equals its yield to maturity.
If a bond is selling at a premium, its current yield will be greater than its yield to maturity.
All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.
If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.
10 A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is NOT CORRECT?
The bond's yield to maturity is 9%.
The bond's current yield is 9%.
If the bond's yield to maturity remains constant, the bond will continue to sell at par.
The bond's current yield exceeds its capital gains yield.
The bond's expected capital gains yield is positive.
11
Which of the following statements is CORRECT?
If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.
If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.
If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium.
If a coupon bond is selling at a premium, its current yield equals its yield to maturity.
If a coupon bond is selling at par, its current yield equals its yield to maturity.
12 A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?
If the yield to maturity remains at 8%, then the bond's price will decline over the next year.
The bond's coupon rate is less than 8%.
If the yield to maturity increases, then the bond's price will increase.
If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year.
The bond's current yield is less than 8%.
13 Bonds A and B are 15-year, $1,000 face value bonds. Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT?
One year from now, Bond A's price will be higher than it is today.
Bond A's current yield is greater than 8%.
Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price.
Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.
Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price.
14 Which of the following statements is CORRECT?
The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers.
Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future.
If investors become less risk averse, the slope of the Security Market Line will increase.
If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.
The slope of the SML is determined by the value of beta.
15 Which of the following statements is CORRECT?
A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.
A two-stock portfolio will always have a lower beta than a one-stock portfolio.
If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.
A stock with an above-average standard deviation must also have an above-average beta.
A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.
16 Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. Your portfolio consists of 50% A and 50% B. Which of the following statements is CORRECT?
The portfolio's expected return is 15%.
The portfolio's standard deviation is greater than 20%.
The portfolio's beta is greater than 1.2.
The portfolio's standard deviation is 20%.
The portfolio's beta is less than 1.2.
17 Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to the CAPM?
Stock Y's realized return during the coming year will be higher than Stock X's return.
If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
Stock Y's return has a higher standard deviation than Stock X.
If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.
If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
18 Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?
The required return on a stock with beta > 1.0 will increase.
The return on "the market" will remain constant.
The return on "the market" will increase.
The required return on a stock with beta < 1.0 will decline.
The required return on a stock with beta = 1.0 will not change.
19 Which of the following statements is CORRECT?
The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks.
Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.
An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks.
20 Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $32.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate?
6.01%
6.17%
6.33%
6.49%
6.65%
21 A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?
$23.11
$23.70
$24.31
$24.93
$25.57
22 Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT?
Stock B must have a higher dividend yield than Stock A.
Stock A must have a higher dividend yield than Stock B.
If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's.
Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.
If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's.
23 Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
A B
Price $25 $40
Expected growth 7% 9%
Expected return 10% 12%
The two stocks could not be in equilibrium with the numbers given in the question.
A's expected dividend is $0.50.
B's expected dividend is $0.75.
A's expected dividend is $0.75 and B's expected dividend is $1.20.
The two stocks should have the same expected dividend.
24 Which of the following statements is NOT CORRECT?
The corporate valuation model discounts free cash flows by the required return on equity.
The corporate valuation model can be used to find the value of a division.
An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements.
Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value.
The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends.
25 Which of the following statements is CORRECT?
Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.
The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.
One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free.
One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.
A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.
FIN 534 Midterm Exam Solution
CHAPTER 1—AN OVERVIEW OF FINANCIAL MANAGEMENT AND THE FINANCIAL ENVIRONMENT
TRUE/FALSE
1.The form of organization for a business is not an important issue, as this decision has very little effect on the income and wealth of the firm's owners.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: Knowledge
2.The major advantage of a regular partnership or a corporation as a form of business organization is the fact that both offer their owners limited liability, whereas proprietorships do not.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: Knowledge
3.There are three primary disadvantages of a regular partnership: (1) unlimited liability, (2) limited life of the organization, and (3) difficulty of transferring ownership. These combine to make it difficult for partnerships to attract large amounts of capital and thus to grow to a very large size.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:PartnershipKEY:Bloom’s: Knowledge
4.Two disadvantages of a proprietorship are (1) the relative difficulty of raising new capital and (2) the owner's unlimited personal liability for the business' debts.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:ProprietorshipKEY:Bloom’s: Knowledge
5.One key value of limited liability is that it lowers owners' risks and thereby enhances a firm's value.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Limited liabilityKEY:Bloom’s: Knowledge
6.If a firm's goal is to maximize its earnings per share, this is the best way to maximize the price of the common stock and thus shareholders' wealth.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 1-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Value maximizationKEY:Bloom’s: Knowledge
7.If Firm A's business is to obtain savings from individuals and then invest them in financial assets issued by other firms or individuals, Firm A is a financial intermediary.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Financial intermediariesKEY:Bloom’s: Knowledge
8.If an individual investor buys or sells a currently outstanding stock through a broker, this is a primary market transaction.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: Knowledge
9.Recently, Hale Corporation announced the sale of 2.5 million newly issued shares of its stock at a price of $21 per share. Hale sold the stock to an investment banker, who in turn sold it to individual and institutional investors. This is a primary market transaction.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: Knowledge
10.One of the functions of NYSE specialists is to facilitate trading by keeping an inventory of shares of the stocks in which they specialize, buying when investors want to sell and selling when they want to buy. They change the bid and ask prices of the securities so as to keep supply and demand in balance.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 1-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Stock market transactionsKEY:Bloom’s: Knowledge
11.The disadvantages associated with a proprietorship are similar to those under a partnership. One exception relates to the more formal nature of the partnership agreement and the commitment of all partners' personal assets. As a result, partnerships do not have difficulty raising large amounts of capital.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:PartnershipKEY:Bloom’s: Comprehension
12.The facts that a proprietorship, as a business, pays no corporate income tax, and that it is easily and inexpensively formed, are two key advantages to that form of business.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:ProprietorshipKEY:Bloom’s: Comprehension
MULTIPLE CHOICE
13.Which of the following statements is CORRECT?a.One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt.b.Sole proprietorships are subject to more regulations than corporations.c.In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner.d.Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones.e.Corporations of all types are subject to the corporate income tax.
ANS:D
PTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
14.Which of the following statements is CORRECT?a.One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.b.It is generally easier to transfer one's ownership interest in a partnership than in a corporation.c.One of the advantages of the corporate form of organization is that it avoids double taxation.d.One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote."e.Corporations of all types are subject to the corporate income tax.
ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
15.Which of the following statements is CORRECT?a.It is generally more expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required.b.Corporations face fewer regulations than sole proprietorships.c.One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation, at both the firm level and the owner level.d.One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership.e.If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business.
ANS:D
PTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
16.Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a regular corporation. Which of the following statements is CORRECT?a.Assuming Cheers is profitable, less of its income will be subject to federal income taxes.b.Cheers will now be subject to fewer regulations.c.Cheers' shareholders (the ex-partners) will now be exposed to less liability.d.Cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.e.Cheers will find it more difficult to raise additional capital.
ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
17.Which of the following statements is CORRECT?a.It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.b.Corporate shareholders are exposed to unlimited liability.c.Corporations generally face fewer regulations than sole proprietorships.d.Corporate shareholders are exposed to unlimited liability, and this factor may be compounded by the tax disadvantages of incorporation.e.Shareholders in a regular corporation (not an S corporation) pay higher taxes than owners of an otherwise identical proprietorship.
ANS:A
PTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
18.Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?a.Corporations generally find it relatively difficult to raise large amounts of capital.b.Less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership.c.Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.d.Corporate investors are exposed to unlimited liability.e.Corporations generally face relatively few regulations.
ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate form of organizationKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
19.You recently sold 100 shares of your new company, XYZ Corporation, to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following statements best describes this transaction?a.This is an example of an exchange of physical assets.b.This is an example of a primary market transaction.c.This is an example of a direct transfer of capital.d.This is an example of a money market transaction.e.This is an example of a derivatives market transaction
ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 1-4NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial transactionsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
20.Which of the following statements is CORRECT?a.If expected inflation increases, interest rates are likely to increase.b.If individuals in general increase the percentage of their income that they save, interest rates are likely to increase.c.If companies have fewer good investment opportunities, interest rates are likely to increase.d.Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.e.Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.
ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 1-6NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Interest ratesKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
21.Which of the following statements is CORRECT?a.In Europe and Asia hedge funds are legal, but they are not permitted to operate in the United States.b.Hedge funds have more in common with commercial banks than with any other type of financial institution.c.Hedge funds have more in common with investment banks than with any other type of financial institution.d.In the United States hedge funds are legal, but in Europe and Asia they are not permitted to operate.e.The justification for the "light" regulation of hedge funds is that only "sophisticated" investors with high net worths and high incomes are permitted to invest in these funds, and such investors supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.
ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 1-7NAT:BUSPROG: AnalyticSTA:DISC: Investments and hybrid financingLOC:TBATOP:Hedge fundsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
22.Money markets are markets fora.Foreign stocks.b.Consumer automobile loans.c.U.S. stocks.d.Short-term debt securities.e.Long-term bonds.
ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Investments and hybrid financingLOC:TBATOP:Money marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
23.Which of the following is a primary market transaction?a.You sell 200 shares of Johnson & Johnson stock on the NYSE through your broker.b.Johnson & Johnson issues 2,000,000 shares of new stock and sells them to the public through an investment banker.c.You buy 200 shares of Johnson & Johnson stock from your younger brother. You just give him cash and he gives you the stock⎯the trade is not made through a broker.d.One financial institution buys 200,000 shares of Johnson & Johnson stock from another institution. An investment banker arranges the transaction.e.You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of Johnson & Johnson shares on the NYSE.
ANS:
PTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
24.Which of the following statements is CORRECT?a.If Apple issues additional shares of common stock through an investment banker, this would be a secondary market transaction.b.If you purchased 100 shares of Apple stock from your sister-in-law, this would be an example of a primary market transaction.c.The IPO market is a subset of the secondary market.d.Only institutions, and not individuals, can participate in derivatives market transactions.e.As they are generally defined, money market transactions involve debt securities with maturities of less than one year.
ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
25.You recently sold 200 shares of Apple stock to your brother. The transfer was made through a broker, and the trade occurred on the NYSE. This is an example of:a.A futures market transaction.b.A primary market transaction.c.A secondary market transaction.d.A money market transaction.e.An over-the-counter market transaction.
ANS:C
PTS:1DIF:Difficulty: EasyOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
26.Which of the following statements is CORRECT?a.The New York Stock Exchange is an auction market with a physical location.b.Capital market transactions involve only the purchase and sale of equity securities, i.e., common stocks.c.If an investor sells shares of stock through a broker, then this would be a primary market transaction.d.Consumer automobile loans are evidenced by legal documents called "promissory notes," and these individual notes are traded in the money market.e.While the distinctions are blurring as investment banks are today buying commercial banks, and vice versa, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.
ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 1-9NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
27.Which of the following statements is CORRECT?a.Capital market instruments include both long-term debt and common stocks.b.An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.c.The NYSE does not exist as a physical location; rather, it represents a loose collection of dealers who trade stocks electronically.d.If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction.e.While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors.
ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 1-9NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
28.Which of the following statements is CORRECT?a.While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.b.A security whose value is derived from the price of some other "underlying" asset is called a liquid security.c.Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks.d.Money markets are markets for common stocks and long-term debt.e.The NYSE operates as an auction market, whereas the Nasdaq is a dealer market.
ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 1-9NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial marketsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
29.One drawback of switching from a partnership to the corporate form of organization is the following:a.It subjects the firm to additional regulations.b.It cannot affect the amount of the firm's operating income that goes to taxes.c.It makes it more difficult for the firm to raise additional capital.d.It makes the firm's investors subject to greater potential personal liabilities.e.It makes it more difficult for the firm's investors to transfer their ownership interests.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate form of organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
30.Which of the following statements is CORRECT?a.The main method of transferring ownership interest in a corporation is by means of a hostile takeover.b.Two key advantages of the corporate form over other forms of business organization are unlimited liability and limited life.c.A corporation is a legal entity that is generally created by a state; its life and existence is separate from the lives of its individual owners and managers.d.Limited liability of its stockholders is an advantage of the corporate form of organization, but corporations have more trouble raising money in financial markets because of the complexity of this form of organization.e.Although its stockholders are insulated by limited legal liability, the corporation's legal status does not protect the firm's managers in the same way; i.e., bondholders can sue its managers if the firm defaults on its debt, even if the default is the result of poor economic conditions.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate form of organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
31.Which of the following statements is CORRECT?a.In a regular partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business.b.Attracting large amounts of capital is more difficult for partnerships than for corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.c.A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company.d.The limited partners in a limited partnership have voting control, while the general partner has operating control over the business. Also, the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy.e.A major disadvantage of all partnerships compared to all corporations is the fact that federal income taxes must be paid by the partners rather than by the firm itself.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Partnership form of organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
32.Which of the following statements is CORRECT?a.Corporations are at a disadvantage relative to partnerships because they have to file more reports to state and federal agencies, including the Securities and Exchange Administration, even if they are not publicly owned.b.In a regular partnership, liability for the firm's debts is limited to the amount a particular partner has invested in the business.c.A fast-growth company would be more likely to set up as a partnership for its business organization than would a slow-growth company.d.Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership.e.A major disadvantage of a partnership relative to a corporation as a form of business organization is the high cost and practical difficulty of its formation.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Partnership form of organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
33.Which of the following statements is CORRECT?a.Most businesses (by number and total dollar sales) are organized as partnerships or proprietorships because it is easier to set up and operate in one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, mainly because corporations have important tax advantages over proprietorships and partnerships.b.Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations.c.Most business (measured by dollar sales) is conducted by corporations in spite of large corporations' often less favorable tax treatment, due to legal considerations related to ownership transfers and limited liability.d.Large corporations are taxed more favorably than sole proprietorships.e.Corporate stockholders are exposed to unlimited liability.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Firm organizationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
34.Jane Doe, who has substantial personal wealth and income, is considering the possibility of starting a new business in the chemical waste management field. She will be the sole owner, and she has enough funds to finance the operation. The business will have a relatively high degree of risk, and it is expected that the firm will incur losses for the first few years. However, the prospects for growth and positive future income look good, and Jane plans to have the firm pay out all of its income as dividends to her once it is well established. Which of the legal forms of business organization would probably best suit her needs?a.Proprietorship, because of ease of entry.b.S corporation, to gain some tax advantages and also to obtain limited liability.c.Partnership, but only if she needs additional capital.d.Regular corporation, because of the limited liability.e.In this situation, the various forms of organization seem equally desirable.
ANS:
35.Which of the following statements is CORRECT?a.The corporate bylaws are a standard set of rules established by the state of incorporation. These rules are identical for all corporations in the state, and their purpose is to ensure that the firm's managers run the firm in accordance with state laws.b.The corporate charter is a standard document prescribed by the state of incorporation, and its purpose is to ensure that the firm's managers run the firm in accordance with state laws. Procedures for electing corporate directors are contained in bylaws, while the declaration of the activities that the firm will pursue and the number of directors are included in the corporate charter.c.Companies must establish a home office, or domicile, in a particular state, and that state must be the one in which most of their business (sales, manufacturing, and so forth) is conducted.d.Attorney fees are generally involved when a company develops its charter and bylaws, but since these documents are voluntary, a new corporation can avoid these costs by deciding not to have either a charter or bylaws.e.The corporate charter is concerned with things like what business the company will engage in, whereas the bylaws are concerned with things like procedures for electing the board of directors.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-2NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate charter and bylawsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
36.With which of the following statements would most people in business agree?a.The short-run profits of a corporation will almost always increase if the firm takes actions the government has determined are in the nation's best interests.b.Government agencies and firms almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees.c.Although people's moral characters are probably developed before they get into a business school, it is still useful for business schools to cover ethics, including giving students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.d.Developing a formal set of rules defining ethical and unethical behavior is not useful for a large corporation. Such rules generally can't be applied in many specific instances, so it is better to deal with ethical issues on a case-by-case basis.e.Because of the courage it takes to blow the whistle, "whistle blowers" are generally promoted more rapidly than other employees.
ANS:
37.The primary operating goal of a publicly-owned firm interested in serving its stockholders should be toa.Maximize the stock price per share over the long run, which is the stock's intrinsic value.b.Maximize the firm's expected EPS.c.Minimize the chances of losses.d.Maximize the firm's expected total income.e.Maximize the stock price on a specific target date.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Goal of firmKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
38.Which of the following statements is CORRECT?a.The financial manager's proper goal should be to attempt to maximize the firm's expected cash flows, since that will add the most to the individual shareholders' wealth.b.The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected projected after-tax income over the relevant time horizon, generally the coming year.c.The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, and thus on the firm's assets. However, EPS is not affected by the manner in which those assets are financed.d.Potential agency problems can arise between managers and stockholders, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders.e.Large, publicly owned firms like IBM and GE are controlled by their management teams. Ownership is generally widely dispersed; hence managers have great freedom in how they run the firm. Managers may operate in stockholders' best interests, but they also may operate in their own personal best interests. As long as they stay within the law, there is no way to either force or motivate managers to act in the stockholders' best interests.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Corporate goals and controlKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
39.Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds. Assuming the announcement was not expected, what effect, other things held constant, would that have on bond prices and interest rates?a.Prices and interest rates would both rise.b.Prices would rise and interest rates would decline.c.Prices and interest rates would both decline.d.There would be no changes in either prices or interest rates.e.Prices would decline and interest rates would rise.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-6NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Security prices and interest ratesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
40.Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?a.Households start saving a larger percentage of their income.b.The economy moves from a boom to a recession.c.The level of inflation begins to decline.d.Corporations step up their expansion plans and thus increase their demand for capital.e.The Federal Reserve uses monetary policy in an attempt to stimulate the economy.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-6NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Interest ratesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
41.Which of the following factors would be most likely to lead to an increase in interest rates in the economy?a.Households reduce their consumption and increase their savings.b.The Federal Reserve decides to try to stimulate the economy.c.There is a decrease in expected inflation.d.The economy falls into a recession.e.Most businesses decide to modernize and expand their manufacturing capacity, and to install new equipment to reduce labor costs.
ANS:
42.Which of the following statements is CORRECT?a.If General Electric were to issue new stock this year it would be considered a secondary market transaction since the company already has stock outstanding.b.Capital market transactions only include preferred stock and common stock transactions.c.The distinguishing feature between spot markets versus futures markets transactions is the maturity of the investments. That is, spot market transactions involve securities that have maturities of less than one year, whereas futures markets transactions involve securities with maturities greater than one year.d.Both Nasdaq "dealers" and NYSE "specialists" hold inventories of stocks.e.An electronic communications network (ECN) is a physical location exchange.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-11NAT:BUSPROG: AnalyticSTA:DISC: Financial markets, institutions, and interest ratesLOC:TBATOP:Financial transactionsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
43.Which of the following statements is CORRECT?a.Corporations generally are subject to more favorable tax treatment and fewer regulations than partnerships and sole proprietorships, which is why corporations do most of the business in the United States.b.Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value than are managers who do not face the threat of hostile takeovers.c.One advantage of the corporate form of organization is that liability of the owners of the firm is limited to their investment in the firm.d.Because of their simplified organization, it is easier for sole proprietorships and partnerships to raise large amounts of outside capital than it is for corporations.e.Bond covenants are an effective way to resolve conflicts between shareholders and managers.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
44.Which of the following statements is CORRECT?a.A good goal for a firm's management is maximization of expected EPS.b.Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment.c.Because most stock ownership is concentrated in the hands of a relatively small segment of society, firms' actions to maximize their stock prices have little benefit to society.d.Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited.e.The potential exists for agency conflicts between stockholders and managers.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
45.Which of the following statements is CORRECT?a.One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than partners.b.There is no good reason to expect a firm's bondholders and stockholders to react differently to the types of new asset investments a firm makes.c.Bondholders are generally more willing than stockholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.d.Stockholders are generally more willing than bondholders to have managers invest in risky projects with high potential returns as opposed to safer projects with lower expected returns.e.Relative to sole proprietorships, corporations generally face fewer regulations, which makes raising capital easier for corporations.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 1-3NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
46.Which of the following statements is NOT CORRECT?a.When a corporation's shares are owned by a few individuals and are not traded on public markets, we say that the firm is "closely, or privately, held."b."Going public" establishes a firm's true intrinsic value, and it also insures that a highly liquid market will always exist for the firm's shares.c.When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market.d.Publicly owned companies have shares owned by investors who are not associated with management, and public companies must register with and report to a regulatory agency such as the SEC.e.It is possible for a firm to go public and yet not raise any additional new capital at the time.
ANS:BPTS:1DIF:Difficulty: ChallengingOBJ:LO: 1-8NAT:BUSPROG: AnalyticSTA:DISC: Goals of the firm, role of finance, and analysis of public informationLOC:TBATOP:Ownership and going publicKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
CHAPTER 2—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
TRUE/FALSE
1.The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash flows, and statement of stockholders' equity.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Annual reportKEY:Bloom’s: Knowledge
2.The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Annual report and expectationsKEY:Bloom’s: Knowledge
3.Consider the balance sheet of Wilkes Industries as shown below. Because Wilkes has $800,000 of retained earnings, the company would be able to pay cash to buy an asset with a cost of $200,000.
Cash$ 50,000Accounts payable$ 100,000Inventory200,000Accruals 100,000Accounts receivable 250,000Total CL$ 200,000Total CA$ 500,000Debt200,000Net fixed assets$ 900,000Common stock200,000_________Retained earnings 800,000Total assets$1,400,000Total L & E$1,400,000
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Retained earnings versus cashKEY:Bloom’s: Knowledge
4.On the balance sheet, total assets must always equal total liabilities and equity.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: Knowledge
5.Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be higher or lower than the values at which these assets are carried on the books.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheet: non-cash assetsKEY:Bloom’s: Knowledge
6.The income statement shows the difference between a firm's income and its costs⎯i.e., its profits⎯during a specified period of time. However, not all reported income comes in the form or cash, and reported costs likewise may not correctly reflect cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Income statementKEY:Bloom’s: Knowledge
7.Net operating working capital is equal to operating current assets minus operating current liabilities.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net operating working capitalKEY:Bloom’s: Knowledge
8.Total net operating capital is equal to net fixed assets.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Total net operating capitalKEY:Bloom’s: Knowledge
9.Net operating profit after taxes (NOPAT) is the amount of net income a company would generate from its operations if it had no interest income or interest expense.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 2-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net operating profit after taxes (NOPAT)KEY:Bloom’s: Knowledge
10.The fact that 70% of the interest income received by a corporation is excluded from its taxable income encourages firms to use more debt financing than they would in the absence of this tax law provision.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income taxes: interest incomeKEY:Bloom’s: Knowledge
11.If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income taxes: interest expenseKEY:Bloom’s: Knowledge
12.The interest and dividends paid by a corporation are considered to be deductible operating expenses, hence they decrease the firm's tax liability.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income taxes: interest expense and dividendsKEY:Bloom’s: Knowledge
13.The balance sheet is a financial statement that measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 2-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial statementsKEY:Bloom’s: Knowledge
14.Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid out to stockholders as dividends. Retained earnings are kept in cash or near cash accounts and, thus, these cash accounts, when added together, will always be equal to the firm's total retained earnings.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Retained earningsKEY:Bloom’s: Comprehension
15.The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of stockholders' claims against the firm's existing assets. This implies that retained earnings are in fact stockholders' reinvested earnings.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Retained earningsKEY:Bloom’s: Comprehension
16.In accounting, emphasis is placed on determining net income in accordance with generally accepted accounting principles. In finance, the primary emphasis is also on net income because that is what investors use to value the firm. However, a secondary financial consideration is cash flow, because cash is needed to operate the business.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Cash flow and net incomeKEY:Bloom’s: Comprehension
17.To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Statement of cash flowsKEY:Bloom’s: Comprehension
18.The current cash flow from existing assets is highly relevant to the investor. However, since the value of the firm depends primarily upon its growth opportunities, profit projections from those opportunities are the only relevant future flows with which investors are concerned.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Future cash flowsKEY:Bloom’s: Comprehension
19.Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income taxes: interest expense and dividendsKEY:Bloom’s: Comprehension
20.The time dimension is important in financial statement analysis. The balance sheet shows the firm's financial position at a given point in time, the income statement shows results over a period of time, and the statement of cash flows reflects changes in the firm's accounts over that period of time.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial stmts: time dimensionKEY:Bloom’s: Comprehension
MULTIPLE CHOICE
21.Which of the following statements is CORRECT?a.The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.b.The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders' equity.c.The balance sheet gives us a picture of the firm's financial position at a point in time.d.The income statement gives us a picture of the firm's financial position at a point in time.e.The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.
ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 2-1NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial statementsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
22.Which of the following statements is CORRECT?a.A typical industrial company's balance sheet lists the firm's assets that will be converted to cash first, and then goes on down to list the firm's longest lived assets last.b.The balance sheet for a given year, say 2012, is designed to give us an idea of what happened to the firm during that year.c.The balance sheet for a given year, say 2012, tells us how much money the company earned during that year.d.The difference between the total assets reported on the balance sheet and the debts reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP).e.For most companies, the market value of the stock equals the book value of the stock as reported on the balance sheet.
ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
23.Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?a.The company purchases a new piece of equipment.b.The company repurchases common stock.c.The company pays a dividend.d.The company issues new common stock.e.The company gives customers more time to pay their bills.
ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
24.Which of the following items is NOT included in current assets?a.Short-term, highly liquid, marketable securities.b.Accounts receivable.c.Inventory.d.Bonds.e.Cash.
ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current assetsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
25.Which of the following items cannot be found on a firm's balance sheet under current liabilities?a.Accrued payroll taxes.b.Accounts payable.c.Short-term notes payable to the bank.d.Accrued wages.e.Cost of goods sold.
ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current liabilitiesKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
26.Which of the following statements is CORRECT?a.The income statement for a given year, say 2012, is designed to give us an idea of how much the firm earned during that year.b.The focal point of the income statement is the cash account, because that account cannot be manipulated by "accounting tricks."c.The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).d.The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC).e.If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow.
ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 2-3NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Income statementKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
27.Below are the year-end balance sheets for Wolken Enterprises:
Assets:20132012Cash$ 200,000$ 170,000Accounts receivable864,000700,000Inventories 2,000,000 1,400,000 Total current assets$3,064,000$2,270,000Net fixed assets 6,000,000 5,600,000Total assets$9,064,000$7,870,000Liabilities and equity:Accounts payable$1,400,000$1,090,000Notes payable 1,600,000 1,800,000 Total current liabilities$3,000,000$2,890,000Long-term debt2,400,0002,400,000Common stock3,000,0002,000,000Retained earnings 664,000 580,000 Total common equity$3,664,000$2,580,000Total liabilities and equity$9,064,000$7,870,000
Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year non-callable, long-term debt in 2012. As of the end of 2013, none of the principal on this debt had been repaid. Assume that the company's sales in 2012 and 2013 were the same. Which of the following statements must be CORRECT?a.Wolken increased its short-term bank debt in 2013.b.Wolken issued long-term debt in 2013.c.Wolken issued new common stock in 2013.d.Wolken repurchased some common stock in 2013.e.Wolken had negative net income in 2013.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
28.On its 2012 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount was shown the following year in 2013. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?a.Dividends could have been paid in 2013, but they would have had to equal the earnings for the year.b.If the company lost money in 2013, they must have paid dividends.c.The company must have had zero net income in 2013.d.The company must have paid out half of its earnings as dividends.e.The company must have paid no dividends in 2013.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
29.Below is the common equity section (in millions) of Fethe Industries' last two year-end balance sheets:
20122011Common stock$2,000$1,000Retained earnings 2,000 2,340Total common equity$4,000$3,340
The company has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?a.The company's net income in 2011 was higher than in 2012.b.The company issued common stock in 2012.c.The market price of the company's stock doubled in 2012.d.The company had positive net income in both 2011 and 2012, but the company's net income in 2009 was lower than it was in 2011.e.The company has more equity than debt on its balance sheet.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Balance sheetKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
30.Which of the following statements is CORRECT?a.The more depreciation a firm has in a given year, the higher its EPS, other things held constant.b.Typically, a firm's DPS should exceed its EPS.c.Typically, a firm's EBIT should exceed its EBITDA.d.If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.e.If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-3NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:EPS, DPS, BVPS, and stock priceKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
31.Which of the following statements is CORRECT?a.Depreciation and amortization are not cash charges, so neither of them has an effect on a firm's reported profits.b.The more depreciation a firm reports, the higher its tax bill, other things held constant.c.People sometimes talk about the firm's net cash flow, which is shown as the lowest entry on the income statement, hence it is often called "the bottom line."d.Depreciation reduces a firm's cash balance, so an increase in depreciation would normally lead to a reduction in the firm's net cash flow.e.Net cash flow (NCF) is often defined as follows:Net Cash Flow = Net Income + Depreciation and Amortization Charges.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Depreciation, amortization, and net cash flowKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
32.Which of the following would be most likely to occur in the year after Congress, in an effort to increase tax revenue, passed legislation that forced companies to depreciate equipment over longer lives? Assume that sales, other operating costs, and tax rates are not affected, and assume that the same depreciation method is used for tax and stockholder reporting purposes.a.Companies' reported net incomes would decline.b.Companies' net operating profits after taxes (NOPAT) would decline.c.Companies' physical stocks of fixed assets would increase.d.Companies' net cash flows would increase.e.Companies' cash positions would decline.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
33.Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year, even though the cash on its balance sheet increased?a.The company repurchased 20% of its common stock.b.The company sold a new issue of bonds.c.The company made a large investment in new plant and equipment.d.The company paid a large dividend.e.The company had high amortization expenses.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net cash flowKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
34.Analysts following Armstrong Products recently noted that the company's operating net cash flow increased over the prior year, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation?a.The company issued new long-term debt.b.The company cut its dividend.c.The company made a large investment in a profitable new plant.d.The company sold a division and received cash in return.e.The company issued new common stock.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net cash flowKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
35.A security analyst obtained the following information from Prestopino Products' financial statements:
�Retained earnings at the end of 2011 were $700,000, but retained earnings at the end of 2012 had declined to $320,000.�The company does not pay dividends.�The company's depreciation expense is its only non-cash expense; it has no amortization charges.�The company has no non-cash revenues.�The company's net cash flow (NCF) for 2012 was $150,000.
On the basis of this information, which of the following statements is CORRECT?a.Prestopino had negative net income in 2012.b.Prestopino's depreciation expense in 2012 was less than $150,000.c.Prestopino had positive net income in 2012, but its income was less than its 2011 income.d.Prestopino's NCF in 2012 must be higher than its NCF in 2011.e.Prestopino's cash on the balance sheet at the end of 2012 must be lower than the cash it had on the balance sheet at the end of 2011.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net cash flow and net incomeKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
36.Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance?a.The company's operating income declined.b.The company's expenditures on fixed assets declined.c.The company's cost of goods sold increased.d.The company's depreciation and amortization expenses declined.e.The company's interest expense increased.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Net cash flow and net incomeKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
37.Which of the following statements is CORRECT?a.The statement of cash flows shows how much the firm's cash⎯the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)⎯increased or decreased during a given year.b.The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.c.The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit.d.The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.e.The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Statement of cash flowsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
38.Which of the following statements is CORRECT?a.In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.b.Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.c.In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.d.In the statement of cash flows, depreciation charges are reported as a use of cash.e.In the statement of cash flows, a decrease in inventories is reported as a use of cash.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Statement of cash flowsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
39.For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under Generally Accepted Accounting Principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations. Related to these modifications, which of the following statements is CORRECT?a.The standard statements make adjustments to reflect the effects of inflation on asset values, and these adjustments are normally carried into any adjustment that managers make to the standard statements.b.The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, for valuation purposes we need to discount cash flows, not accounting income. Moreover, since many firms have a number of separate divisions, and since division managers should be compensated on their divisions' performance, not that of the entire firm, information that focuses on the divisions is needed. These factors have led to the development of information that is focused on cash flows and the operations of individual units.c.The standard statements provide useful information on the firm's individual operating units, but management needs more information on the firm's overall operations than the standard statements provide.d.The standard statements focus on cash flows, but managers are less concerned with cash flows than with accounting income as defined by GAAP.e.The best feature of standard statements is that, if they are prepared under GAAP, the data are always consistent from firm to firm. Thus, under GAAP, there is no room for accountants to "adjust" the results to make earnings look better.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-7NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Modifying acct data for managerial purposesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
40.Which of the following statements is CORRECT?a.Net cash flow (NCF) is defined as follows: NCF = Net income - Depreciation and Amortization.b.Changes in working capital have no effect on free cash flow.c.Free cash flow (FCF) is defined as follows:FCF = EBIT(1 − T) + Depreciation and Amortization − Capital expenditures required to sustain operations − Required changes in net operating working capital.d.Free cash flow (FCF) is defined as follows:FCF = EBIT(1 − T)+ Depreciation and Amortization + Capital expenditures.e.Net cash flow is the same as free cash flow (FCF).
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-7NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Depreciation, amortization, and free cash flowKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
41.Which of the following statements is CORRECT?a.The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses.b.MVA gives us an idea about how much value a firm's management has added during the last year.c.MVA stands for market value added, and it is defined as follows:MVA = (Shares outstanding)(Stock price) + Book value of common equity.d.EVA stands for economic value added, and it is defined as follows:EVA = EBIT(1 − T) − (Investor-supplied op. capital) ⋅ (A − T cost of capital).e.EVA gives us an idea about how much value a firm's management has added over the firm's life.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-8NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:MVA and EVAKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
42.Which of the following statements is CORRECT?a.The maximum federal tax rate on personal income in 2010 was 50%.b.Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies' debt ratios to be lower than they would be if interest and dividends were both deductible.c.Interest paid to an individual is counted as income for tax purposes and taxed at the individual's regular tax rate, which in 2010 could go up to 35%, but dividends received were taxed at a maximum rate of 15%.d.The maximum federal tax rate on corporate income in 2010 was 50%.e.Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings. The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both of these costs are deductible from income when calculating income for tax purposes.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income tax systemKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
43.Which of the following statements is CORRECT?a.All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income.b.The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government receives no tax revenue from these businesses.c.All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code.d.Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm's income as personal income and pay taxes on that income.e.Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Federal income tax systemKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
44.Danielle's Sushi Shop last year had (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation?a.The company had a sharp increase in its depreciation and amortization expenses.b.The company had a sharp increase in its inventories.c.The company had a sharp increase in its accrued liabilities.d.The company sold a new issue of common stock.e.The company made a large capital investment early in the year.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-7NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:NCF, FCF, and cashKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
45.Assume that Congress recently passed a provision that will enable Barton's Rare Books (BRB) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or tax rate. Prior to the new provision, BRB's net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BRB's financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.a.Net fixed assets on the balance sheet will decrease.b.The provision will reduce the company's net cash flow.c.The provision will increase the company's tax payments.d.Net fixed assets on the balance sheet will increase.e.The provision will increase the company's net income.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
46.The LeMond Corporation just purchased a new production line. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.a.LeMond's tax liability for the year will be lower.b.LeMond's taxable income will be lower.c.LeMond's net fixed assets as shown on the balance sheet will be higher at the end of the year.d.LeMond's cash position will improve (increase).e.LeMond's reported net income after taxes for the year will be lower.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
47.Lucy's Music Emporium opened its doors on January 1, 2012, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 20 years, but in December 2012 management realized that the assets would last for only 15 years. The firm's accountants plan to report the 2012 financial statements based on this new information. How would the new depreciation assumption affect the company's financial statements?a.The firm's net liabilities would increase.b.The firm's reported net fixed assets would increase.c.The firm's EBIT would increase.d.The firm's reported 2012 earnings per share would increase.e.The firm's cash position in 2012 and 2013 would increase.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
48.DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change?a.The firm's reported net income would increase.b.The firm's operating income (EBIT) would increase.c.The firm's taxable income would increase.d.The firm's net cash flow would increase.e.The firm's tax payments would increase.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in depreciationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
49.Which of the following statements is CORRECT?a.If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance.b.Dividends paid reduce the net income that is reported on a company's income statement.c.If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.d.If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.e.Accounts receivable are reported as a current liability on the balance sheet.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial statementsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
50.Which of the following statements is CORRECT?a.One way to increase EVA is to achieve the same level of operating income but with more investor-supplied capital.b.If a firm reports positive net income, its EVA must also be positive.c.One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is free.d.One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital.e.Actions that increase reported net income will always increase net cash flow.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-8NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:EVA, CF, and net incomeKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
51.Which of the following statements is CORRECT?a.If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.b.Since depreciation is a source of funds, the more depreciation a company has, the larger its retained earnings will be, other things held constant.c.A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.d.Common equity includes common stock and retained earnings, less accumulated depreciation.e.The retained earnings account as shown on the balance sheet shows the amount of cash that is available for paying dividends.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 2-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Retained earningsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
52.Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur?a.The company would have to pay less taxes.b.The company's taxable income would fall.c.The company's interest expense would remain constant.d.The company would have less common equity than before.e.The company's net income would increase.
ANS:EPTS:1DIF:Difficulty: ChallengingOBJ:LO: 2-9NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Changes in leverageKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
53.Jessie's Bobcat Rentals' operations provided a negative net cash flow last year, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company's financial statements were prepared under generally accepted accounting principles?a.The company had high depreciation expenses.b.The company repurchased some of its common stock.c.The company dramatically increased its capital expenditures.d.The company retired a large amount of its long-term debt.e.The company sold some of its fixed assets.
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54.Tucker Electronic System's current balance sheet shows total common equity of $3,125,000. The company has 125,000 shares of stock outstanding, and they sell at a price of $52.50 per share. By how much do the firm's market and book values per share differ?a.$27.50b.$28.88c.$30.32d.$31.83e.$33.43
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55.Hunter Manufacturing Inc.'s December 31, 2012, balance sheet showed total common equity of $2,050,000 and 100,000 shares of stock outstanding. During 2013, Hunter had $250,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/13, assuming that Hunter neither issued nor retired any common stock during 2013?a.$20.90b.$22.00c.$23.10d.$24.26e.$25.47
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56.Companies generate income from their "regular" operations and from other sources like interest earned on the securities they hold, which is called non-operating income. Lindley Textiles recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and $1,000 of depreciation. The company had no amortization charges and no non-operating income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was Lindley's operating income, or EBIT?a.$3,462b.$3,644c.$3,836d.$4,038e.$4,250
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57.Frederickson Office Supplies recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and $1,250 of depreciation. The company had no amortization charges and no non-operating income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's taxable income, or earnings before taxes (EBT)?a.$3,230.00b.$3,400.00c.$3,570.00d.$3,748.50e.$3,935.93
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58.JBS Inc. recently reported net income of $4,750 and depreciation of $885. How much was its net cash flow, assuming it had no amortization expense and sold none of its fixed assets?a.$4,831.31b.$5,085.59c.$5,353.25d.$5,635.00e.$5,916.75
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59.Swinnerton Clothing Company's balance sheet showed total current assets of $2,250, all of which were required in operations. Its current liabilities consisted of $575 of accounts payable, $300 of 6% short-term notes payable to the bank, and $145 of accrued wages and taxes. What was its net operating working capital that was financed by investors?a.$1,454b.$1,530c.$1,607d.$1,687e.$1,771
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60.Over the years, Janjigian Corporation's stockholders have provided $15,250 of capital, part when they purchased new issues of stock and part when they allowed management to retain some of the firm's earnings. The firm now has 1,000 shares of common stock outstanding, and it sells at a price of $42.00 per share. How much value has Janjigian's management added to stockholder wealth over the years, i.e., what is Janjigian's MVA?a.$21,788b.$22,935c.$24,142d.$25,413e.$26,750
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61.Meric Mining Inc. recently reported $15,000 of sales, $7,500 of operating costs other than depreciation, and $1,200 of depreciation. The company had no amortization charges, it had outstanding $6,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income after taxes? Meric uses the same depreciation expense for tax and stockholder reporting purposes.a.$3,284.55b.$3,457.42c.$3,639.39d.$3,830.94e.$4,022.48
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62.On 12/31/2013, Heaton Industries Inc. reported retained earnings of $675,000 on its balance sheet, and it reported that it had $172,500 of net income during the year. On its previous balance sheet, at 12/31/2012, the company had reported $555,000 of retained earnings. No shares were repurchased during 2013. How much in dividends did Heaton pay during 2013?a.$47,381b.$49,875c.$52,500d.$55,125e.$57,881
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63.Ullrich Printing Inc. paid out $21,750 of common dividends during the year. It ended the year with $187,500 of retained earnings versus the prior year's retained earnings of $132,250. How much net income did the firm earn during the year?a.$77,000b.$80,850c.$84,893d.$89,137e.$93,594
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64.NNR Inc.'s balance sheet showed total current assets of $1,875,000 plus $4,225,000 of net fixed assets. All of these assets were required in operations. The firm's current liabilities consisted of $475,000 of accounts payable, $375,000 of 6% short-term notes payable to the bank, and $150,000 of accrued wages and taxes. Its remaining capital consisted of long-term debt and common equity. What was NNR's total investor-provided operating capital?a.$4,694,128b.$4,941,188c.$5,201,250d.$5,475,000e.$5,748,750
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65.Last year Tiemann Technologies reported $10,500 of sales, $6,250 of operating costs other than depreciation, and $1,300 of depreciation. The company had no amortization charges, it had $5,000 of bonds that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $750. By how much will net after-tax income change as a result of the change in depreciation? The company uses the same depreciation calculations for tax and stockholder reporting purposes.a.−463.13b.−487.50c.−511.88d.−537.47e.−564.34
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66.TSW Inc. had the following data for last year: Net income = $800; Net operating profit after taxes (NOPAT) = $700; Total assets = $3,000; and Total operating capital = $2,000. Information for the just-completed year is as follows: Net income = $1,000; Net operating profit after taxes (NOPAT) = $925; Total assets = $2,600; and Total operating capital = $2,500. How much free cash flow did the firm generate during the just-completed year?a.$383b.$425c.$468d.$514e.$566
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67.Rao Corporation has the following balance sheet. How much net operating working capital does the firm have?
Cash$ 10Accounts payable$ 20Short-term investmentsAccruals20Accounts receivable50Notes payable 50Inventory 40 Current liabilities$ 90 Current assets$130Long-term debt0Net fixed assets 100Common equity30Retained earnings 50Total assets$230Total liab. & equity$230
a.$54.00b.$60.00c.$66.00d.$72.60e.$79.86
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68.Bae Inc. has the following income statement. How much net operating profit after taxes (NOPAT) does the firm have?
Sales$2,000.00Costs1,200.00Depreciation 100.00EBIT$ 700.00Interest expense 200.00EBT$ 500.00Taxes (35%) 175.00Net income$ 325.00
a.$370.60b.$390.11c.$410.64d.$432.25e.$455.00
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69.EP Enterprises has the following income statement. How much net operating profit after taxes (NOPAT) does the firm have?
Sales$1,800.00Costs1,400.00Depreciation 250.00EBIT$ 150.00Interest expense 70.00EBT$ 80.00Taxes (40%) 32.00Net income$ 48.00
a.$81.23b.$85.50c.$90.00d.$94.50e.$99.23
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70.Tibbs Inc. had the following data for the year ending 12/31/12: Net income = $300; Net operating profit after taxes (NOPAT) = $400; Total assets = $2,500; Short-term investments = $200; Stockholders' equity = $1,800; Total debt = $700; and Total operating capital = $2,300. What was its return on invested capital (ROIC)?a.14.91%b.15.70%c.16.52%d.17.39%e.18.26%
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71.Zumbahlen Inc. has the following balance sheet. How much total operating capital does the firm have?
Cash$ 20.00Accounts payable$ 30.00Short-term investments50.00Accruals50.00Accounts receivable20.00Notes payable 30.00Inventory 60.00 Current liabilities$110.00 Current assets$150.00Long-term debt70.00Gross fixed assets$140.00Common stock30.00Accumulated deprec. 40.00Retained earnings 40.00Net fixed assets$100.00Total common equity$ 70.00Total assets$250.00Total liab. & equity$250.00
a.$114.00b.$120.00c.$126.00d.$132.30e.$138.92
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72.Barnes' Brothers has the following data for the year ending 12/31/12: Net income = $600; Net operating profit after taxes (NOPAT) = $700; Total assets = $2,500; Short-term investments = $200; Stockholders' equity = $1,800; Total debt = $700; and Total operating capital = $2,100. Barnes' weighted average cost of capital is 10%. What is its economic value added (EVA)?a.$399.11b.$420.11c.$442.23d.$465.50e.$490.00
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73.Edwards Electronics recently reported $11,250 of sales, $5,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had no amortization charges, it had $3,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was its net cash flow?a.$3,284.75b.$3,457.63c.$3,639.61d.$3,831.17e.$4,032.81
74.Wells Water Systems recently reported $8,250 of sales, $4,500 of operating costs other than depreciation, and $950 of depreciation. The company had no amortization charges, it had $3,250 of outstanding bonds that carry a 6.75% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to spend $750 to buy new fixed assets and to invest $250 in net operating working capital. How much free cash flow did Wells generate?a.$1,770.00b.$1,858.50c.$1,951.43d.$2,049.00e.$2,151.45
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75.HHH Inc. reported $12,500 of sales and $7,025 of operating costs (including depreciation). The company had $18,750 of investor-supplied operating assets (or capital), the weighted average cost of that capital (the WACC) was 9.5%, and the federal-plus-state income tax rate was 40%. What was HHH's Economic Value Added (EVA), i.e., how much value did management add to stockholders' wealth during the year?a.$1,357.13b.$1,428.56c.$1,503.75d.$1,578.94e.$1,657.88
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76.Last year, Michelson Manufacturing reported $10,250 of sales, $3,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had no amortization charges, it had $3,500 of bonds outstanding that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $725. By how much will the depreciation change cause the firm's net after-tax income and its net cash flow to change? Note that the company uses the same depreciation calculations for tax and stockholder reporting purposes.a.−$383.84; $206.68b.−$404.04; $217.56c.−$425.30; $229.01d.−$447.69; $241.06e.−$471.25; $253.75
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77.Bartling Energy Systems recently reported $9,250 of sales, $5,750 of operating costs other than depreciation, and $700 of depreciation. The company had no amortization charges, it had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net operating working capital. By how much did the firm's net income exceed its free cash flow?a.$673.27b.$708.70c.$746.00d.$783.30e.$822.47
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CHAPTER 3—ANALYSIS OF FINANCIAL STATEMENTS
TRUE/FALSE
1.Ratio analysis involves analyzing financial statements in order to appraise a firm's financial position and strength.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Ratio analysisKEY:Bloom’s: Knowledge
2.The current ratio and inventory turnover ratios both help us measure the firm's liquidity. The current ratio measures the relationship of a firm's current assets to its current liabilities, while the inventory turnover ratio gives us an indication of how long it takes the firm to convert its inventory into cash.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Liquidity ratiosKEY:Bloom’s: Knowledge
3.Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Liquidity ratiosKEY:Bloom’s: Knowledge
4.High current and quick ratios always indicate that a firm is managing its liquidity position well.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current ratioKEY:Bloom’s: Knowledge
5.The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its assets.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Asset management ratiosKEY:Bloom’s: Knowledge
6.A decline in a firm's inventory turnover ratio suggests that it is managing its inventory more efficiently and also that its liquidity position is improving, i.e., it is becoming more liquid.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 3-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Inventory turnover ratioKEY:Bloom’s: Knowledge
7.Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Debt management ratiosKEY:Bloom’s: Knowledge
8.The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:TIE ratioKEY:Bloom’s: Knowledge
9.Profitability ratios show the combined effects of liquidity, asset management, and debt management on operating results.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 3-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Profitability ratiosKEY:Bloom’s: Knowledge
10.Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects.
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11.Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of measuring changes in a firm's performance over time.
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12.The "apparent," but not the "true," financial position of a company whose sales are seasonal can differ dramatically, depending on the time of year when the financial statements are constructed.
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13.Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used similar accounting methods.
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14.The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.
ANS:F
15.The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.
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16.It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.
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17.Since the ROA measures the firm's effective utilization of assets (without considering how these assets are financed), two firms with the same EBIT must have the same ROA.
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18.Suppose firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. Under these conditions, then firms that have high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.
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19.Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than that of B.
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20.Firms A and B have the same current ratio, 0.75, the same amount of sales and cost of goods sold, and the same amount of current liabilities. However, Firm A has a higher inventory turnover ratio than B. Therefore, we can conclude that A's quick ratio must be smaller than B's.
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21.Suppose a firm wants to maintain a specific TIE ratio. It knows the amount of its debt, the interest rate on that debt, the applicable tax rate, and its operating costs. With this information, the firm can calculate the amount of sales required to achieve its target TIE ratio.
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22.Suppose Firms A and B have the same amount of assets, pay the same interest rate on their debt, have the same basic earning power (BEP), and have the same tax rate. However, Firm A has a higher debt ratio. If BEP is greater than the interest rate on debt, Firm A will have a higher ROE as a result of its higher debt ratio.
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23.If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.
ANS:24.One problem with ratio analysis is that relationships can be manipulated. For example, if our current ratio is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to increase.
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25.One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.
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MULTIPLE CHOICE
26.Considered alone, which of the following would increase a company's current ratio?a.An increase in accounts payable.b.An increase in net fixed assets.c.An increase in accrued liabilities.d.An increase in notes payable.e.An increase in accounts receivable.
ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current ratioKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
27.Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?a.The total assets turnover decreases.b.The TIE declines.c.The DSO increases.d.The EBITDA coverage ratio increases.e.The current and quick ratios both decline.
ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current ratioKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
28.A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?a.Use cash to increase inventory holdings.b.Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.c.Use cash to repurchase some of the company's own stock.d.Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.e.Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 3-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Current ratioKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
29.Which of the following statements is CORRECT?a.If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.b.A reduction in inventories held would have no effect on the current ratio.c.An increase in inventories would have no effect on the current ratio.d.If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.e.A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 3-3NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:InventoriesKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
30.Companies A and C each reported the same earnings per share (EPS), but Company A's stock trades at a higher price. Which of the following statements is CORRECT?a.Company A trades at a higher P/E ratio.b.Company A probably has fewer growth opportunities.c.Company A is probably judged by investors to be riskier.d.Company A must have a higher market-to-book ratio.e.Company A must pay a lower dividend.
ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 3-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Financial statement analysisKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
31.Which of the following statements is CORRECT?a.If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.b.If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.c.Other things held constant, the higher a firm's expected future growth rate, the lower its P/E ratio is likely to be.d.The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA).e.If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average.
ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 3-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Market value ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
32.Which of the following statements is CORRECT?a."Window dressing" is any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value.b.Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing."c.Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."d.Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of "window dressing."e.Using some of the firm's cash to reduce long-term debt is an example of "window dressing."
ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 3-1NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Window dressingKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
33.The Cavendish Company recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects would occur as a result of this action?a.The company's debt ratio increased.b.The company's current ratio increased.c.The company's times interest earned ratio decreased.d.The company's basic earning power ratio increased.e.The company's equity multiplier increased.
ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 3-6NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
34.A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger?a.Increase inventories while holding sales and cost of goods sold constant.b.Increase accounts receivable while holding sales constant.c.Increase EBIT while holding sales constant.d.Increase accounts payable while holding sales constant.e.Increase notes payable while holding sales constant.
ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 3-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
35.If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading" the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant.a.The division's DSO (days' sales outstanding) is 40, whereas the average for its competitors is 30.b.The division's basic earning power ratio is above the average of other firms in its industry.c.The division's total assets turnover ratio is below the average for other firms in its industry.d.The division's debt ratio is above the average for other firms in the industry.e.The division's inventory turnover is 6, whereas the average for its competitors is 8.
ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 3-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
36.Which of the following would indicate an improvement in a company's financial position, holding other things constant?a.The current and quick ratios both increase.b.The inventory and total assets turnover ratios both decline.c.The debt ratio increases.d.The profit margin declines.e.The EBITDA coverage ratio declines.
ANS:APTS:1DIF:Difficulty: EasyOBJ:LO: 3-5NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
37.If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?a.Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.b.The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.c.Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.d.Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.e.The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.
ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 3-4NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Miscellaneous ratiosKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
38.Which of the following statements is CORRECT?a.All else equal, increasing the debt ratio will increase the ROA.b.The use of debt financing will tend to lower the basic earning power ratio, other things held constant.c.A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.d.If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.e.Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.
ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 3-8NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Effects of leverageKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
39.A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?a.Issue new common stock and use the proceeds to acquire additional fixed assets.b.Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.c.Issue new common stock and use the proceeds to increase inventories.d.Speed up the collection of receivables and use the cash generated to increase inventories.e.Use some of its cash to purchase additional inventories.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 3-2NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Quick ratioKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
40.Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?a.Use cash to reduce accounts payable.b.Borrow using short-term notes payable and use the proceeds to reduce accruals.c.Borrow using short-term notes payable and use the proceeds to reduce long-term debt.d.Use cash to reduce accruals.e.Use cash to reduce short-term notes payable.
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41.Which of the following statements is CORRECT?a.If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.b.If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength.c.If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding (DSO) will increase.d.There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.e.A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.
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42.Which of the following statements is CORRECT?a.If two firms differ only in their use of debt⎯i.e., they have identical assets, sales, operating costs, and tax rates⎯but one firm has a higher debt ratio, the firm that uses more debt will have a higher profit margin on sales.b.If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses.c.A firm's use of debt will have no effect on its profit margin on sales.d.If two firms differ only in their use of debt⎯i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates⎯but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.e.The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable.
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43.Which of the following statements is CORRECT?a.If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same.b.If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the same.c.If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.d.If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio.e.If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also to be expected to grow at a faster rate.
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44.Which of the following statements is CORRECT?a.Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will decrease.b.Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will increase.c.Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Without additional information, we cannot tell what will happen to the ROE.d.The modified DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.e.Other things held constant, an increase in the debt ratio will result in an increase in the profit margin on sales.
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45.You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?a.Its total assets turnover must equal the industry average.b.Its total assets turnover must be above the industry average.c.Its return on assets must equal the industry average.d.Its TIE ratio must be below the industry average.e.Its total assets turnover must be below the industry average.
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46.Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company Heidee has the higher debt ratio. Which of the following statements is CORRECT?a.Company Heidee has a lower operating income (EBIT) than Company LD.b.Company Heidee has a lower total assets turnover than Company Leaudy.c.Company Heidee has a lower equity multiplier than Company Leaudy.d.Company Heidee has a higher fixed assets turnover than Company Leaudy.e.Company Heidee has a higher ROE than Company Leaudy.
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47.Cordelion Communications is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Cordelion pays, EBIT, or the tax rate. Which of the following is likely to occur if the company goes ahead with the stock issue?a.The times interest earned ratio will decrease.b.The ROA will decline.c.Taxable income will decrease.d.The tax bill will increase.e.Net income will decrease.
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48.Which of the following statements is CORRECT?a.An increase in a firm's debt ratio, with no changes in its sales or operating costs, could be expected to lower the profit margin.b.The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio.c.If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE.d.An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio.e.An increase in the DSO, other things held constant, could be expected to increase the ROE.
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49.Heidee Corp. and Leaudy Corp. have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, Heidee uses more debt than Leaudy. Which of the following statements is CORRECT?a.Heidee would have the higher net income as shown on the income statement.b.Without more information, we cannot tell if Heidee or Leaudy would have a higher or lower net income.c.Heidee would have the lower equity multiplier for use in the DuPont equation.d.Heidee would have to pay more in income taxes.e.Heidee would have the lower net income as shown on the income statement.
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50.Other things held constant, which of the following alternatives would increase a company's cash flow for the current year?a.Increase the number of years over which fixed assets are depreciated for tax purposes.b.Pay down the accounts payables.c.Reduce the days' sales outstanding (DSO) without affecting sales or operating costs.d.Pay workers more frequently to decrease the accrued wages balance.e.Reduce the inventory turnover ratio without affecting sales or operating costs.
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51.Companies Heidee and Leaudy have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes. Company Heidee has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?a.Company Heidee has more net income.b.Company Heidee pays less in taxes.c.Company Heidee has a lower equity multiplier.d.Company Heidee has a higher ROA.e.Company Heidee has a higher times interest earned (TIE) ratio.
ANS:
52.Companies Heidee and Leaudy have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Company Heidee has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?a.Company Heidee has a lower times interest earned (TIE) ratio.b.Company Heidee has a lower equity multiplier.c.Company Heidee has more net income.d.Company Heidee pays more in taxes.e.Company Heidee has a lower ROE.
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53.Lincoln Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's current ratio?a.Use cash to reduce long-term bonds outstanding.b.Borrow using short-term notes payable and use the cash to increase inventories.c.Use cash to reduce accruals.d.Use cash to reduce accounts payable.e.Use cash to reduce short-term notes payable.
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54.Lofland's has $20 million in current assets and $10 million in current liabilities, while Smaland's current assets are $10 million versus $20 million of current liabilities. Both firms would like to "window dress" their end-of-year financial statements, and to do so each plans to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts. Which of the statements below best describes the results of these transactions?a.The transaction would improve both firms' financial strength as measured by their current ratios.b.The transactions would raise Lofland's financial strength as measured by its current ratio but lower Smaland's current ratio.c.The transactions would lower Lofland's financial strength as measured by its current ratio but raise Smaland's current ratio.d.The transaction would have no effect on the firm' financial strength as measured by their current ratios.e.The transaction would lower both firm' financial strength as measured by their current ratios.
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55.Companies Heidee and Leaudy have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt. However, company Heidee has a higher debt ratio. Which of the following statements is CORRECT?a.If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company Heidee will have the higher ROE.b.Given this information, Leaudy must have the higher ROE.c.Company Leaudy has a higher basic earning power ratio (BEP).d.Company Heidee has a higher basic earning power ratio (BEP).e.If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then Company Heidee will have the higher ROE.
ANS:
56.Arshadi Corp.'s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)?a.2.03b.2.13c.2.25d.2.36e.2.48
ANS:
57.Hutchinson Corporation has zero debt⎯it is financed only with common equity. Its total assets are $410,000. The new CFO wants to employ enough debt to bring the debt/assets ratio to 40%, using the proceeds from the borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?a.$155,800b.$164,000c.$172,200d.$180,810e.$189,851
ANS:
58.Orono Corp.'s sales last year were $435,000, its operating costs were $362,500, and its interest charges were $12,500. What was the firm's times interest earned (TIE) ratio?a.4.72b.4.97c.5.23d.5.51e.5.80
ANS:
59.Rappaport Corp.'s sales last year were $320,000, and its net income after taxes was $23,000. What was its profit margin on sales?a.6.49%b.6.83%c.7.19%d.7.55%e.7.92%
ANS:
60.Branch Corp.'s total assets at the end of last year were $315,000 and its net income after taxes was $22,750. What was its return on total assets?a.7.22%b.7.58%c.7.96%d.8.36%e.8.78%
ANS:
61.Chambliss Corp.'s total assets at the end of last year were $305,000 and its EBIT was 62,500. What was its basic earning power (BEP)?a.18.49%b.19.47%c.20.49%d.21.52%e.22.59%
ANS:
62.Nikko Corp.'s total common equity at the end of last year was $305,000 and its net income after taxes was $60,000. What was its ROE?a.16.87%b.17.75%c.18.69%d.19.67%e.20.66%
ANS:
63.An investor is considering starting a new business. The company would require $475,000 of assets, and it would be financed entirely with common stock. The investor will go forward only if she thinks the firm can provide a 13.5% return on the invested capital, which means that the firm must have an ROE of 13.5%. How much net income must be expected to warrant starting the business?a.$52,230b.$54,979c.$57,873d.$60,919e.$64,125
ANS:
64.Vang Corp.'s stock price at the end of last year was $33.50 and its earnings per share for the year were $2.30. What was its P/E ratio?a.13.84b.14.57c.15.29d.16.06e.16.86
ANS:
65.Lindley Corp.'s stock price at the end of last year was $33.50, and its book value per share was $25.00. What was its market/book ratio?a.1.34b.1.41c.1.48d.1.55e.1.63
ANS:
66.Northwest Lumber had a profit margin of 5.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8. What was the firm's ROE?a.12.79%b.13.47%c.14.18%d.14.88%e.15.63%
ANS:
67.Bostian, Inc. has total assets of $625,000. Its total debt outstanding is $185,000. The Board of Directors has directed the CFO to move towards a debt-to-assets ratio of 55%. How much debt must the company add or subtract to achieve the target debt ratio?a.$158,750b.$166,688c.$175,022d.$183,773e.$192,962
ANS:
68.Emerson Inc.'s would like to undertake a policy of paying out 45% of its income. Its latest net income was $1,250,000, and it had 225,000 shares outstanding. What dividend per share should it declare?a.$2.14b.$2.26c.$2.38d.$2.50e.$2.63
ANS:
69.Aziz Industries has sales of $100,000 and accounts receivable of $11,500, and it gives its customers 30 days to pay. The industry average DSO is 27 days, based on a 365-day year. If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed-up by this change, how would that affect its net income, assuming other things are held constant?a.$267.34b.$281.41c.$296.22d.$311.81e.$328.22
ANS:
70.Heaton Corp. sells on terms that allow customers 45 days to pay for merchandise. Its sales last year were $425,000, and its year-end receivables were $60,000. If its DSO is less than the 45-day credit period, then customers are paying on time. Otherwise, they are paying late. By how much are customers paying early or late? Base your answer on this equation: DSO − Credit period = days early or late, and use a 365-day year when calculating the DSO. A positive answer indicates late payments, while a negative answer indicates early payments.a.6.20b.6.53c.6.86d.7.20e.7.56
ANS:
71.Harper Corp.'s sales last year were $395,000, and its year-end receivables were $42,500. Harper sells on terms that call for customers to pay 30 days after the purchase, but many delay payment beyond Day 30. On average, how many days late do customers pay? Base your answer on this equation: DSO − Allowed credit period = Average days late, and use a 365-day year when calculating the DSO.a.7.95b.8.37c.8.81d.9.27e.9.74
ANS:
72.Bonner Corp.'s sales last year were $415,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.4. Bonner's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant?a.$164,330b.$172,979c.$182,083d.$191,188e.$200,747
ANS:
73.A new firm is developing its business plan. It will require $565,000 of assets, and it projects $452,800 of sales and $354,300 of operating costs for the first year. Management is quite sure of these numbers because of contracts with its customers and suppliers. It can borrow at a rate of 7.5%, but the bank requires it to have a TIE of at least 4.0, and if the TIE falls below this level the bank will call in the loan and the firm will go bankrupt. What is the maximum debt-to-assets ratio the firm can use? (Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt ratio.)a.47.33%b.49.82%c.52.45%d.55.21%e.58.11%
ANS:
74.Ziebart Corp.'s EBITDA last year was $390,000 ( = EBIT + depreciation + amortization), its interest charges were $9,500, it had to repay $26,000 of long-term debt, and it had to make a payment of $17,400 under a long-term lease. The firm had no amortization charges. What was the EBITDA coverage ratio?a.7.32b.7.70c.8.09d.8.49e.8.92
ANS:
75.LeCompte Corp. has $312,900 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $620,000, and its net income after taxes was $24,655. Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15%. What profit margin would LeCompte need in order to achieve the 15% ROE, holding everything else constant?a.7.57%b.7.95%c.8.35%d.8.76%e.9.20%
ANS:
76.Last year Urbana Corp. had $197,500 of assets, $307,500 of sales, $19,575 of net income, and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE?a.9.32%b.9.82%c.10.33%d.10.88%e.11.42%
ANS:
77.Stewart Inc.'s latest EPS was $3.50, its book value per share was $22.75, it had 215,000 shares outstanding, and its debt-to-assets ratio was 46%. How much debt was outstanding?a.$3,393,738b.$3,572,356c.$3,760,375d.$3,958,289e.$4,166,620
ANS:
78.Last year Vaughn Corp. had sales of $315,000 and a net income of $17,832, and its year-end assets were $210,000. The firm's total-debt-to-total-assets ratio was 42.5%. Based on the DuPont equation, what was Vaughn's ROE?a.14.77%b.15.51%c.16.28%d.17.10%e.17.95%
ANS:
79.Last year Central Chemicals had sales of $205,000, assets of $127,500, a profit margin of 5.3%, and an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $21,000 without affecting either sales or costs. Had it reduced its assets in this amount, and had the debt-to-assets ratio, sales, and costs remained constant, by how much would the ROE have changed?a.1.81%b.2.02%c.2.22%d.2.44%e.2.68%
ANS:
80.Last year Mason Inc. had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $195,000 and its net income was $10,549. The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $5,250 without changing its sales, assets, or capital structure. Had it cut costs and increased its net income in this amount, by how much would the ROE have changed?a.5.66%b.5.95%c.6.27%d.6.58%e.6.91%
ANS:
81.Last year Rosenberg Corp. had $195,000 of assets, $18,775 of net income, and a debt-to-total-assets ratio of 32%. Now suppose the new CFO convinces the president to increase the debt ratio to 48%. Sales and total assets will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged. By how much would the change in the capital structure improve the ROE?a.4.36%b.4.57%c.4.80%d.5.04%e.5.30%
ANS:
82.Last year Altman Corp. had $205,000 of assets, $303,500 of sales, $18,250 of net income, and a debt-to-total-assets ratio of 41%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets to $152,500. Sales, costs, and net income would not be affected, and the firm would maintain the 41% debt ratio. By how much would the reduction in assets improve the ROE?a.4.69%b.4.93%c.5.19%d.5.45%e.5.73%
ANS:
83.Muscarella Inc. has the following balance sheet and income statement data:
Cash$ 14,000Accounts payable$ 42,000Receivables70,000Other current liabilities 28,000Inventories 210,000 Total CL$ 70,000 Total CA$294,000Long-term debt70,000Net fixed assets 126,000Common equity 280,000 Total assets$420,000 Total liab. and equity$420,000Sales$280,000Net income$ 21,000
The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.70, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change?a.4.28%b.4.50%c.4.73%d.4.96%e.5.21%
ANS:
84.Last year Swensen Corp. had sales of $303,225, operating costs of $267,500, and year-end assets of $195,000. The debt-to-total-assets ratio was 27%, the interest rate on the debt was 8.2%, and the firm's tax rate was 37%. The new CFO wants to see how the ROE would have been affected if the firm had used a 45% debt ratio. Assume that sales and total assets would not be affected, and that the interest rate and tax rate would both remain constant. By how much would the ROE change in response to the change in the capital structure?a.2.08%b.2.32%c.2.57%d.2.86%e.3.14%
ANS:
85.For the coming year, Crane Inc. is considering two financial plans. Management expects sales to be $301,770, operating costs to be $266,545, assets to be $200,000, and its tax rate to be 35%. Under Plan A it would use 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but the TIE ratio would have to be kept at 4.00 or more. Under Plan B the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure?a.3.83%b.4.02%c.4.22%d.4.43%e.4.65%
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86.Refer to Exhibit 3.1. What is the firm's current ratio?a.0.97b.1.08c.1.20d.1.33e.1.47
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87.Refer to Exhibit 3.1. What is the firm's quick ratio?a.0.49b.0.61c.0.73d.0.87e.1.05
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88.Refer to Exhibit 3.1. What is the firm's days sales outstanding? Assume a 360-day year for this calculation.a.48.17b.50.71c.53.38d.56.19e.59.14
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89.Refer to Exhibit 3.1. What is the firm's total assets turnover?a.0.90b.1.12c.1.40d.1.68e.2.02
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90.Refer to Exhibit 3.1. What is the firm's inventory turnover ratio?a.4.17b.4.38c.4.59d.5.82e.5.07
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91.Refer to Exhibit 3.1. What is the firm's TIE?a.1.94b.2.15c.2.39d.2.66e.2.93
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92.Refer to Exhibit 3.1. What is the firm's EBITDA coverage?a.3.29b.3.46c.3.64d.3.82e.4.01
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93.Refer to Exhibit 3.1. What is the firm's debt-to-assets ratio?a.45.93%b.51.03%c.56.70%d.63.00%e.70.00%
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94.Refer to Exhibit 3.1. What is the firm's ROA?a.2.70%b.2.97%c.3.26%d.3.59%e.3.95%
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95.Refer to Exhibit 3.1. What is the firm's ROE?a.8.54%b.8.99%c.9.44%d.9.91%e.10.41%
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96.Refer to Exhibit 3.1. What is the firm's BEP?a.6.00%b.6.32%c.6.65%d.6.98%e.7.33%
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97.Refer to Exhibit 3.1. What is the firm's profit margin?a.1.40%b.1.56%c.1.73%d.1.93%e.2.12%
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98.Refer to Exhibit 3.1. What is the firm's dividends per share?a.$2.62b.$2.91c.$3.20d.$3.53e.$3.88
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99.Refer to Exhibit 3.1. What is the firm's cash flow per share?a.$10.06b.$10.59c.$11.15d.$11.74e.$12.35
100.Refer to Exhibit 3.1. What is the firm's EPS?a.$5.84b.$6.15c.$6.47d.$6.80e.$7.14
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101.Refer to Exhibit 3.1. What is the firm's P/E ratio?a.12.0b.12.6c.13.2d.13.9e.14.6
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102.Refer to Exhibit 3.1. What is the firm's book value per share?a.$61.73b.$64.98c.$68.40d.$72.00e.$75.60
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103.Refer to Exhibit 3.1. What is the firm's market-to-book ratio?a.0.56b.0.66c.0.78d.0.92e.1.08
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104.Refer to Exhibit 3.1. What is the firm's equity multiplier?a.3.33b.3.50c.3.68d.3.86e.4.05
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CHAPTER 4—TIME VALUE OF MONEY
TRUE/FALSE
1.Starting to invest early for retirement increases the benefits of compound interest.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
2.Starting to invest early for retirement reduces the benefits of compound interest.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
3.A time line is meaningful even if all cash flows do not occur annually.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
4.A time line is not meaningful unless all cash flows occur annually.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
5.Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
6.Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
7.Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
8.Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
9.Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
10.Some of the cash flows shown on a time line can be in the form of annuity payments but none can be uneven amounts.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Knowledge
11.If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV versus FVKEY:Bloom’s: Knowledge
12.If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the present value of the same series.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV versus FVKEY:Bloom’s: Knowledge
13.Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV versus FVKEY:Bloom’s: Knowledge
14.Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV versus FVKEY:Bloom’s: Knowledge
15.If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effective annual rateKEY:Bloom’s: Knowledge
16.If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effective annual rateKEY:Bloom’s: Knowledge
17.A "growing annuity" is a cash flow stream that grows at a constant rate for a specified number of periods.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 4-18NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Growing annuityKEY:Bloom’s: Knowledge
18.A "growing annuity" is any cash flow stream that grows over time.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 4-18NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Growing annuityKEY:Bloom’s: Knowledge
19.The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-2NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Comprehension
20.The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the smaller the present value of a given lump sum to be received at some future date.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-2NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:CompoundingKEY:Bloom’s: Comprehension
21.Suppose Sally Smith plans to invest $1,000. She can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)
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22.Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)
ANS:23.The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV of a dollarKEY:Bloom’s: Comprehension
24.The present value of a future sum increases as either the discount rate or the number of periods per year increases, other things held constant.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV of a sumKEY:Bloom’s: Comprehension
25.All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.
ANS:
PTS:1DIF:Difficulty: ModerateOBJ:LO: 4-9NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV of an annuityKEY:Bloom’s: Comprehension
26.All other things held constant, the present value of a given annual annuity increases as the number of periods per year increases.
ANS:PTS:1DIF:Difficulty: ModerateOBJ:LO: 4-9NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:PV of an annuityKEY:Bloom’s: Comprehension
27.If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Periodic and nominal ratesKEY:Bloom’s: Comprehension
28.If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Periodic and nominal ratesKEY:Bloom’s: Comprehension
29.As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan).
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effective and nominal ratesKEY:Bloom’s: Comprehension
30.As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effective and nominal ratesKEY:Bloom’s: Comprehension
31.When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage declines in the loan's later years.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-17NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AmortizationKEY:Bloom’s: Comprehension
32.When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage increases in the loan's later years.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-17NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AmortizationKEY:Bloom’s: Comprehension
33.The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the greater the percentage of the payment that will be a repayment of principal.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-17NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AmortizationKEY:Bloom’s: Comprehension
34.The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the smaller the percentage of the payment that will be a repayment of principal.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-17NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AmortizationKEY:Bloom’s: Comprehension
35.Midway through the life of an amortized loan, the percentage of the payment that represents interest must be equal to the percentage that represents repayment of principal. This is true regardless of the original life of the loan or the interest rate on the loan.
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36.Midway through the life of an amortized loan, the percentage of the payment that represents interest could be equal to, less than, or greater than to the percentage that represents repayment of principal. The proportions depend on the original life of the loan and the interest rate.
ANS:
MULTIPLE CHOICE
37.Which of the following statements is CORRECT?a.Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.b.A time line is not meaningful unless all cash flows occur annually.c.Time lines are useful for visualizing complex problems prior to doing actual calculations.d.Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.e.Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:Time linesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
38.Which of the following statements is CORRECT?a.Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.b.A time line is not meaningful unless all cash flows occur annually.c.Time lines are not useful for visualizing complex problems prior to doing actual calculations.d.Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.e.Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:Time linesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
39.Which of the following statements is CORRECT?a.Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.b.A time line is not meaningful unless all cash flows occur annually.c.Time lines are not useful for visualizing complex problems prior to doing actual calculations.d.Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.e.Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:Time linesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
40.Which of the following statements is CORRECT?a.A time line is not meaningful unless all cash flows occur annually.b.Time lines are not useful for visualizing complex problems prior to doing actual calculations.c.Time lines cannot be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.d.Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.e.Time lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:Time linesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
41.You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?a.The discount rate decreases.b.The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.c.The discount rate increases.d.The riskiness of the investment's cash flows decreases.e.The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effects of factors on PVsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
42.You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?a.The discount rate increases.b.The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.c.The discount rate decreases.d.The riskiness of the investment's cash flows increases.e.The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-3NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Effects of factors on PVsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
43.Which of the following statements is CORRECT?a.If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.b.The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.c.If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.d.The cash flows for an annuity due must all occur at the ends of the periods.e.The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:AnnuitiesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
44.Which of the following statements is CORRECT?a.If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.b.The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.c.If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.d.The cash flows for an annuity due must all occur at the beginning of the periods.e.The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Time value of moneyLOC:TBATOP:AnnuitiesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
45.Your bank account pays a 5% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?a.The periodic rate of interest is 5% and the effective rate of interest is also 5%.b.The periodic rate of interest is 1.25% and the effective rate of interest is 2.5%.c.The periodic rate of interest is 5% and the effective rate of interest is greater than 5%.d.The periodic rate of interest is 1.25% and the effective rate of interest is greater than 5%.e.The periodic rate of interest is 2.5% and the effective rate of interest is 5%.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Quarterly compoundingKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
46.Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?a.The periodic rate of interest is 8% and the effective rate of interest is also 8%.b.The periodic rate of interest is 2% and the effective rate of interest is 4%.c.The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.d.The periodic rate of interest is 4% and the effective rate of interest is less than 8%.e.The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.
ANS:
47.A $250,000 loan is to be amortized over 8 years, with annual end-of-year payments. Which of these statements is CORRECT?a.The proportion of interest versus principal repayment would be the same for each of the 8 payments.b.The annual payments would be larger if the interest rate were lower.c.If the loan were amortized over 10 years rather than 8 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 8-year amortization plan.d.The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.e.The last payment would have a higher proportion of interest than the first payment.
ANS:
48.A $150,000 loan is to be amortized over 6 years, with annual end-of-year payments. Which of these statements is CORRECT?a.The proportion of interest versus principal repayment would be the same for each of the 7 payments.b.The annual payments would be larger if the interest rate were lower.c.If the loan were amortized over 10 years rather than 6 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 6-year amortization plan.d.The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower.e.The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.
ANS:
49.Which of the following statements regarding a 20-year (240-month) $225,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)a.The outstanding balance declines at a slower rate in the later years of the loan's life.b.The remaining balance after three years will be $225,000 less one third of the interest paid during the first three years.c.Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.d.Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.e.The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.
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50.Which of the following statements regarding a 15-year (180-month) $225,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)a.The outstanding balance declines at a faster rate in the later years of the loan's life.b.The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.c.Because the outstanding balance declines over time, the monthly payments will also decline over time.d.Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.e.The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.
ANS:51.Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 8% is CORRECT?a.Exactly 8% of the first monthly payment represents interest.b.The monthly payments will decline over time.c.A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment.d.The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity.e.The amount representing interest in the first payment would be higher if the nominal interest rate were 6% rather than 8%.
ANS:
52.Which of the following statements regarding a 20-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?a.Exactly 10% of the first monthly payment represents interest.b.The monthly payments will increase over time.c.A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.d.The total dollar amount of interest being paid off each month gets larger as the loan approaches maturity.e.The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%.
ANS:
53.At the end of 10 years, which of the following investments would have the highest future value? Assume that the effective annual rate for all investments is the same and is greater than zero.a.Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).b.Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).c.Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).d.Investment D pays $2,500 at the end of 10 years (just one payment).e.Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).
ANS:
54.Of the following investments, which would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero.a.Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments).b.Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).c.Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).d.Investment D pays $2,500 at the end of 10 years (just one payment).e.Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).
ANS:" section to see calculation requirements for this question.
55.A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?a.The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity.b.The periodic interest rate is greater than 3%.c.The periodic rate is less than 3%.d.The present value would be greater if the lump sum were discounted back for more periods.e.The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
56.A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?a.The PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity.b.The periodic interest rate is greater than 3%.c.The periodic rate is less than 3%.d.The present value would be greater if the lump sum were discounted back for more periods.e.The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
57.Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?a.Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.b.The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.c.A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.d.A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.e.If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
58.Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?a.Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.b.The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.c.A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.d.A bank loan's nominal interest rate will always be equal to or greater than its effective annual rate.e.If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
59.Which of the following statements is CORRECT?a.An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.b.The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity.c.If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%.d.If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.e.The proportion of the payment that goes toward interest on a fully amortized loan increases over time.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
60.Which of the following statements is CORRECT?a.An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.b.The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due.c.If a loan has a nominal annual rate of 7%, then the effective rate will never be less than 7%.d.If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.e.The proportion of the payment that goes toward interest on a fully amortized loan increases over time.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-15NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Time value conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
61.You are considering two equally risky annuities, each of which pays $15,000 per year for 20 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?a.If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.b.The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE.c.The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.d.The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.e.The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-9NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AnnuitiesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
62.You are considering two equally risky annuities, each of which pays $25,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?a.If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.b.A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.c.The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.d.The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.e.The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 4-9NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:AnnuitiesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
63.Which of the following statements is CORRECT?a.If CF0 is positive and all the other CFs are negative, then you cannot solve for I.b.If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0.c.If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost.d.To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the PV of the negative CFs. This is, essentially, a trial-and-error procedure that is easy with a computer or financial calculator but quite difficult otherwise.e.If you solve for I and get a negative number, then you must have made a mistake.
ANS:DPTS:1DIF:Difficulty: ChallengingOBJ:LO: 4-14NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Solving for I: uneven CFsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
64.Which of the following statements is CORRECT?a.If CF0 is positive and all the other CFs are negative, then you can still solve for I.b.If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0.c.If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost.d.To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the FV of the negative CFs. It is impossible to find the value of I without a computer or financial calculator.e.If you solve for I and get a negative number, then you must have made a mistake.
ANS:APTS:1DIF:Difficulty: ChallengingOBJ:LO: 4-14NAT:BUSPROG: AnalyticSTA:DISC: Time value of moneyLOC:TBATOP:Solving for I: uneven CFsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Students may be able to correctly determine the answer to this question without [many] calculations. Please see the "Answers & Solutions" section to see calculation requirements for this question.
65.Which of the following bank accounts has the highest effective annual return?a.An account that pays 8% nominal interest with daily (365-day) compounding.b.An account that pays 8% nominal interest with monthly compounding.c.An account that pays 8% nominal interest with annual compounding.d.An account that pays 7% nominal interest with daily (365-day) compounding.e.An account that pays 7% nominal interest with monthly compounding.
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66.Which of the following bank accounts has the lowest effective annual return?a.An account that pays 8% nominal interest with daily (365-day) compounding.b.An account that pays 8% nominal interest with monthly compounding.c.An account that pays 8% nominal interest with annual compounding.d.An account that pays 7% nominal interest with daily (365-day) compounding.e.An account that pays 7% nominal interest with monthly compounding.
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67.You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest?a.Bank 1; 6.1% with annual compounding.b.Bank 2; 6.0% with monthly compounding.c.Bank 3; 6.0% with annual compounding.d.Bank 4; 6.0% with quarterly compounding.e.Bank 5; 6.0% with daily (365-day) compounding.
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68.Ellen now has $125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?a.$205.83b.$216.67c.$228.07d.$240.08e.$252.08
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69.How much would Roderick have after 6 years if he has $500 now and leaves it invested at 5.5% with annual compounding?a.$591.09b.$622.20c.$654.95d.$689.42e.$723.89
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70.JG Asset Services is recommending that you invest $1,500 in a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures?a.$1,781.53b.$1,870.61c.$1,964.14d.$2,062.34e.$2,165.46
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71.Your bank offers a 10-year certificate of deposit (CD) that pays 6.5% interest, compounded annually. If you invest $2,000 in the CD, how much will you have when it matures?a.$3,754.27b.$3,941.99c.$4,139.09d.$4,346.04e.$4,563.34
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72.Cyberhost Corporation's sales were $225 million last year. If sales grow at 6% per year, how large (in millions) will they be 5 years later?a.$271.74b.$286.05c.$301.10d.$316.16e.$331.96
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73.Cochrane Associate's net sales last year were $525 million. If sales grow at 7.5% per year, how large (in millions) will they be 8 years later?a.$845.03b.$889.51c.$936.33d.$983.14e.$1,032.30
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74.How much would $1, growing at 3.5% per year, be worth after 75 years?a.$12.54b.$13.20c.$13.86d.$14.55e.$15.28
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75.How much would $100, growing at 5% per year, be worth after 75 years?a.$3,689.11b.$3,883.27c.$4,077.43d.$4,281.30e.$4,495.37
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76.Your bank offers a savings account that pays 3.5% interest, compounded annually. If you invest $1,000 in the account, then how much will it be worth at the end of 25 years?a.$2,245.08b.$2,363.24c.$2,481.41d.$2,605.48e.$2,735.75
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77.Your bank offers a savings account that pays 3.5% interest, compounded annually. How much will $500 invested today be worth at the end of 25 years?a.$1,122.54b.$1,181.62c.$1,240.70d.$1,302.74e.$1,367.88
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78.Suppose a State of North Carolina bond will pay $1,000 ten years from now. If the going interest rate on these 10-year bonds is 5.5%, how much is the bond worth today?a.$585.43b.$614.70c.$645.44d.$677.71e.$711.59
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79.Suppose a State of New Mexico bond will pay $1,000 eight years from now. If the going interest rate on these 8-year bonds is 5.5%, how much is the bond worth today?a.$651.60b.$684.18c.$718.39d.$754.31e.$792.02
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80.How much would $20,000 due in 50 years be worth today if the discount rate were 7.5%?a.$438.03b.$461.08c.$485.35d.$510.89e.$537.78
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81.You expect to receive $5,000 in 25 years. How much is it worth today if the discount rate is 5.5%?a.$1,067.95b.$1,124.16c.$1,183.33d.$1,245.61e.$1,311.17
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82.The going rate of interest on a 5-year treasury bond is 4.25%. You have one that will pay $2,500 five years from now. How much is the bond worth today?a.$1,928.78b.$2,030.30c.$2,131.81d.$2,238.40e.$2,350.32
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83.Suppose a Google.com bond will pay $4,500 ten years from now. If the going interest rate on safe 10-year bonds is 4.25%, how much is the bond worth today?a.$2,819.52b.$2,967.92c.$3,116.31d.$3,272.13e.$3,435.74
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84.You have just purchased a U.S. Treasury bond for $747.25. No payments will be made until the bond matures 5 years from now, at which time it will be redeemed for $1,000. What interest rate will you earn on this bond?a.4.37%b.4.86%c.5.40%d.6.00%e.6.60%
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85.You have purchased a U.S. Treasury bond for $3,000. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $5,000. What interest rate will you earn on this bond?a.3.82%b.4.25%c.4.72%d.5.24%e.5.77%
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86.Ten years ago, Kronan Corporation earned $0.50 per share. Its earnings this year were $2.20. What was the growth rate in earnings per share (EPS) over the 10-year period?a.15.17%b.15.97%c.16.77%d.17.61%e.18.49%
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87.Wildwoods, Inc. earned $1.50 per share five years ago. Its earnings this year were $3.20. What was the growth rate in earnings per share (EPS) over the 5-year period?a.15.54%b.16.36%c.17.18%d.18.04%e.18.94%
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88.You have $5,000 invested in a bank that pays 3.8% annually. How long will it take for your funds to triple?a.23.99b.25.26c.26.58d.27.98e.29.46
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89.Your bank pays 4% interest annually. You have $2,500 invested in the bank. How long will it take for your funds to double?a.14.39b.15.15c.15.95d.16.79e.17.67
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90.Brockman Corporation's earnings per share were $3.50 last year, and its growth rate during the prior 5 years was 9.0% per year. If that growth rate were maintained, how many years would it take for Brockman's EPS to triple?a.9.29b.10.33c.11.47d.12.75e.14.02
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91.Your investment account pays 8.0%, compounded annually. If you invest $5,000 today, how many years will it take for your investment to grow to $9,140.20?a.5.14b.5.71c.6.35d.7.05e.7.84
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92.Your investment advisor has recommended your invest in bonds that pay 6.0%, compounded annually. If you invest $10,000 today, how many years will it take for your investment to grow to $30,000?a.12.37b.13.74c.15.27d.16.97e.18.85
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93.You are hoping to buy a new boat 3 years from now, and you plan to save $4,200 per year, beginning one year from today. You will deposit your savings in an account that pays 5.2% interest. How much will you have just after you make the 3rd deposit, 3 years from now?a.$11,973b.$12,603c.$13,267d.$13,930e.$14,626
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94.You want to buy new kitchen appliances 2 years from now, and you plan to save $8,200 per year, beginning one year from today. You will deposit your savings in an account that pays 6.2% interest. How much will you have just after you make the 2nd deposit, 2 years from now?a.$15,260b.$16,063c.$16,908d.$17,754e.$18,642
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95.You would like to travel in South America 5 years from now, and you can save $3,100 per year, beginning one year from today. You plan to deposit the funds in a mutual fund that you think will return 8.5% per year. Under these conditions, how much would you have just after you make the 5th deposit, 5 years from now?a.$18,369b.$19,287c.$20,251d.$21,264e.$22,327
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96.You want to purchase a motorcycle 4 years from now, and you plan to save $3,500 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. Under these assumptions, how much will you have 4 years from today?a.$16,112b.$16,918c.$17,763d.$18,652e.$19,584
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97.You want to open a sushi bar 3 years from now, and you plan to save $7,000 per year, beginning immediately. You will make 3 deposits in an account that pays 5.2% interest. Under these assumptions, how much will you have 3 years from today?a.$20,993b.$22,098c.$23,261d.$24,424e.$25,645
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98.What is the PV of an ordinary annuity with 10 payments of $2,700 if the appropriate interest rate is 5.5%?a.$16,576b.$17,449c.$18,367d.$19,334e.$20,352
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99.What is the PV of an ordinary annuity with 5 payments of $4,700 if the appropriate interest rate is 4.5%?a.$16,806b.$17,690c.$18,621d.$19,601e.$20,633
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100.Your friend offers to pay you an annuity of $2,500 at the end of each year for 3 years in return for cash today. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity?a.$5,493.71b.$5,782.85c.$6,087.21d.$6,407.59e.$6,744.83
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101.After receiving a reward for information leading to the arrest of a notorious criminal, you are considering investing it in an annuity that pays $5,000 at the end of each year for 20 years. You could earn 5% on your money in other investments with equal risk. What is the most you should pay for the annuity?a.$50,753b.$53,424c.$56,236d.$59,195e.$62,311
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102.An uncle of yours who is about to retire wants to sell some of his stock and buy an annuity that will provide him with income of $50,000 per year for 30 years, beginning a year from today. The going rate on such annuities is 7.25%. How much would it cost him to buy such an annuity today?a.$574,924b.$605,183c.$635,442d.$667,214e.$700,575
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103.What is the PV of an annuity due with 5 payments of $2,500 at an interest rate of 5.5%?a.$11,262.88b.$11,826.02c.$12,417.32d.$13,038.19e.$13,690.10
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104.What's the present value of a perpetuity that pays $250 per year if the appropriate interest rate is 5%?a.$4,750b.$5,000c.$5,250d.$5,513e.$5,788
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105.A perpetuity pays $85 per year and costs $950. What is the rate of return?a.8.95%b.9.39%c.9.86%d.10.36%e.10.88%
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106.A new investment opportunity for you is an annuity that pays $550 at the beginning of each year for 3 years. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity?a.$1,412.84b.$1,487.20c.$1,565.48d.$1,643.75e.$1,725.94
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107.Your father is considering purchasing an annuity that pays $5,000 at the beginning of each year for 5 years. He could earn 4.5% on his money in other investments with equal risk. What is the most he should pay for the annuity?a.20,701b.$21,791c.$22,938d.$24,085e.$25,289
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108.Because your mother is about to retire, she wants to buy an annuity that will provide her with $75,000 of income a year for 20 years, with the first payment coming immediately. The going rate on such annuities is 5.25%. How much would it cost her to buy the annuity today?a.$825,835b.$869,300c.$915,052d.$963,213e.$1,011,374
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109.Now that your uncle has decided to retire, he wants to buy an annuity that will provide him with $85,000 of income a year for 25 years, with the first payment coming immediately. The going rate on such annuities is 5.15%. How much would it cost him to buy the annuity today?a.$1,063,968b.$1,119,966c.$1,178,912d.$1,240,960e.$1,303,008
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110.A salt mine you inherited will pay you $25,000 per year for 25 years, with the first payment being made today. If you think a fair return on the mine is 7.5%, how much should you ask for it if you decide to sell it?a.$284,595b.$299,574c.$314,553d.$330,281e.$346,795
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111.Geraldine was injured in a car accident, and the insurance company has offered her the choice of $25,000 per year for 15 years, with the first payment being made today, or a lump sum. If a fair return is 7.5%, how large must the lump sum be to leave her as well off financially as with the annuity?a.$225,367b.$237,229c.$249,090d.$261,545e.$274,622
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112.What's the present value of a 4-year ordinary annuity of $2,250 per year plus an additional $3,000 at the end of Year 4 if the interest rate is 5%?a.$8,509b.$8,957c.$9,428d.$9,924e.$10,446
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113.Suppose you earned a $275,000 bonus this year and invested it at 8.25% per year. How much could you withdraw at the end of each of the next 20 years?a.$28,532b.$29,959c.$31,457d.$33,030e.$34,681
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114.Your aunt wants to retire and has $375,000. She expects to live for another 25 years and to earn 7.5% on her invested funds. How much could she withdraw at the end of each of the next 25 years and end up with zero in the account?a.$28,843.38b.$30,361.46c.$31,959.43d.$33,641.50e.$35,323.58
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115.Your aunt wants to retire and has $375,000. She expects to live for another 25 years, and she also expects to earn 7.5% on her invested funds. How much could she withdraw at the beginning of each of the next 25 years and end up with zero in the account?a.$28,243.21b.$29,729.70c.$31,294.42d.$32,859.14e.$34,502.10
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116.You were left $100,000 in a trust fund set up by your grandfather. The fund pays 6.5% interest. You must spend the money on your college education, and you must withdraw the money in 4 equal installments, beginning immediately. How much could you withdraw today and at the beginning of each of the next 3 years and end up with zero in the account?a.$24,736b.$26,038c.$27,409d.$28,779e.$30,218
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117.Suppose you inherited $275,000 and invested it at 8.25% per year. How much could you withdraw at the beginning of each of the next 20 years?a.$22,598.63b.$23,788.03c.$25,040.03d.$26,357.92e.$27,675.82
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118.Your uncle just won the weekly lottery, receiving $375,000, which he invested at a 7.5% annual rate. He now has decided to retire, and he wants to withdraw $35,000 at the end of each year, starting at the end of this year. What is the maximum number of whole payments that can be withdrawn before the account is exhausted, i.e., before the account balance would become negative? (Hint: Round down to the nearest whole number.)a.22b.23c.24d.25e.26
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119.Your uncle has $300,000 invested at 7.5%, and he now wants to retire. He wants to withdraw $35,000 at the end of each year, beginning at the end of this year. He also wants to have $25,000 left to give you when he ceases to withdraw funds from the account. What is the maximum number of $35,000 withdrawals that he can make and still have at least $25,000 left in the account? (Hint: If your solution for N is not an integer, round down to the nearest whole number.)a.12b.13c.14d.15e.16
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120.Your Aunt Elsa has $500,000 invested at 6.5%, and she plans to retire. She wants to withdraw $40,000 at the beginning of each year, starting immediately. What is the maximum number of whole payments that can be withdrawn before the account is exhausted, i.e., before the account balance would become negative? (Hint: Round down to the nearest whole number.)a.18b.19c.20d.21e.22
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121.Your aunt has $500,000 invested at 5.5%, and she now wants to retire. She wants to withdraw $45,000 at the beginning of each year, beginning immediately. When she makes her last withdrawal (at the beginning of a year), she also wants to have enough left in the account so that you can make a final withdrawal of $50,000 at the end of that year (her last withdrawal is at the beginning of the year, your withdrawal is at the end of that same year). What is the maximum number of $45,000 withdrawals that she can make and still have enough in the account so that you can make a $50,000 withdrawal at the end of the year of her last withdrawal? (Hint: If your solution for N is not an integer, round down to the nearest whole number.)a.13b.14c.15d.16e.17
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122.Suppose you just won the state lottery, and you have a choice between receiving $2,550,000 today or a 20-year annuity of $250,000, with the first payment coming one year from today. What rate of return is built into the annuity? Disregard taxes.a.7.12%b.7.49%c.7.87%d.8.26%e.8.67%
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123.Your girlfriend just won the Florida lottery. She has the choice of $15,000,000 today or a 20-year annuity of $1,050,000, with the first payment coming one year from today. What rate of return is built into the annuity?a.3.44%b.3.79%c.4.17%d.4.58%e.5.04%
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124.Assume that you own an annuity that will pay you $15,000 per year for 12 years, with the first payment being made today. You need money today to open a new restaurant, and your uncle offers to give you $120,000 for the annuity. If you sell it, what rate of return would your uncle earn on his investment?a.6.85%b.7.21%c.7.59%d.7.99%e.8.41%
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125.What annual payment must you receive in order to earn a 6.5% rate of return on a perpetuity that has a cost of $1,250?a.$77.19b.$81.25c.$85.31d.$89.58e.$94.06
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126.What is the present value of the following cash flow stream at a rate of 6.25%?
a.$411.57b.$433.23c.$456.03d.$480.03e.$505.30
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127.What is the present value of the following cash flow stream at a rate of 12.0%?
a.$9,699b.$10,210c.$10,747d.$11,284e.$11,849
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128.What is the present value of the following cash flow stream at a rate of 8.0%?
a.$7,917b.$8,333c.$8,772d.$9,233e.$9,695
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129.You sold your motorcycle and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 6.0%?
a.$5,987b.$6,286c.$6,600d.$6,930e.$7,277
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130.At a rate of 6.5%, what is the future value of the following cash flow stream?
a.$526.01b.$553.69c.$582.83d.$613.51e.$645.80
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131.Your sister paid $10,000 (CF at t = 0) for an investment that promises to pay $750 at the end of each of the next 5 years, then an additional lump sum payment of $10,000 at the end of the 5th year. What is the expected rate of return on this investment?a.6.77%b.7.13%c.7.50%d.7.88%e.8.27%
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132.You are offered a chance to buy an asset for $7,250 that is expected to produce cash flows of $750 at the end of Year 1, $1,000 at the end of Year 2, $850 at the end of Year 3, and $6,250 at the end of Year 4. What rate of return would you earn if you bought this asset?a.4.93%b.5.19%c.5.46%d.5.75%e.6.05%
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133.What's the future value of $1,500 after 5 years if the appropriate interest rate is 6%, compounded semiannually?a.$1,819b.$1,915c.$2,016d.$2,117e.$2,223
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134.What's the present value of $4,500 discounted back 5 years if the appropriate interest rate is 4.5%, compounded semiannually?a.$3,089b.$3,251c.$3,422d.$3,602e.$3,782
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135.What's the future value of $1,200 after 5 years if the appropriate interest rate is 6%, compounded monthly?a.$1,537.69b.$1,618.62c.$1,699.55d.$1,784.53e.$1,873.76
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136.What's the present value of $1,525 discounted back 5 years if the appropriate interest rate is 6%, compounded monthly?a.$969b.$1,020c.$1,074d.$1,131e.$1,187
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137.American Express and other credit card issuers must by law print the Annual Percentage Rate (APR) on their monthly statements. If the APR is stated to be 18.00%, with interest paid monthly, what is the card's EFF%?a.18.58%b.19.56%c.20.54%d.21.57%e.22.65%
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138.Southwestern Bank offers to lend you $50,000 at a nominal rate of 6.5%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Woodburn Bank also offers to lend you the $50,000, but it will charge an annual rate of 7.0%, with no interest due until the end of the year. How much higher or lower is the effective annual rate charged by Woodburn versus the rate charged by Southwestern?a.0.52%b.0.44%c.0.36%d.0.30%e.0.24%
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139.Suppose United Bank offers to lend you $10,000 for one year at a nominal annual rate of 8.00%, but you must make interest payments at the end of each quarter and then pay off the $10,000 principal amount at the end of the year. What is the effective annual rate on the loan?a.8.24%b.8.45%c.8.66%d.8.88%e.9.10%
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140.Suppose People's bank offers to lend you $10,000 for 1 year on a loan contract that calls for you to make interest payments of $250.00 at the end of each quarter and then pay off the principal amount at the end of the year. What is the effective annual rate on the loan?a.8.46%b.8.90%c.9.37%d.9.86%e.10.38%
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141.Pacific Bank pays a 4.50% nominal rate on deposits, with monthly compounding. What effective annual rate (EFF%) does the bank pay?a.3.72%b.4.13%c.4.59%d.5.05%e.5.56%
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142.Suppose your credit card issuer states that it charges a 15.00% nominal annual rate, but you must make monthly payments, which amounts to monthly compounding. What is the effective annual rate?a.15.27%b.16.08%c.16.88%d.17.72%e.18.61%
ANS:
143.Billy Thornton borrowed $20,000 at a rate of 7.25%, simple interest, with interest paid at the end of each month. The bank uses a 360-day year. How much interest would Billy have to pay in a 30-day month?a.$120.83b.$126.88c.$133.22d.$139.88e.$146.87
ANS:
144.Suppose you deposited $5,000 in a bank account that pays 5.25% with daily compounding based on a 360-day year. How much would be in the account after 8 months, assuming each month has 30 days?a.$5,178.09b.$5,436.99c.$5,708.84d.$5,994.28e.$6,294.00
ANS:
145.Suppose you borrowed $12,000 at a rate of 9.0% and must repay it in 4 equal installments at the end of each of the next 4 years. How large would your payments be?a.$3,704.02b.$3,889.23c.$4,083.69d.$4,287.87e.$4,502.26
ANS:
146.Suppose you are buying your first home for $145,000, and you have $15,000 for your down payment. You have arranged to finance the remainder with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal interest rate, with the first payment due in one month. What will your monthly payments be?a.$741.57b.$780.60c.$821.69d.$862.77e.$905.91
ANS:
147.Your cousin will sell you his coffee shop for $250,000, with "seller financing," at a 6.0% nominal annual rate. The terms of the loan would require you to make 12 equal end-of-month payments per year for 4 years, and then make an additional final (balloon) payment of $50,000 at the end of the last month. What would your equal monthly payments be?a.$4,029.37b.$4,241.44c.$4,464.67d.$4,699.66e.$4,947.01
ANS:
148.Suppose you borrowed $14,000 at a rate of 10.0% and must repay it in 5 equal installments at the end of each of the next 5 years. How much interest would you have to pay in the first year?a.$1,200.33b.$1,263.50c.$1,330.00d.$1,400.00e.$1,470.00
ANS:
149.You plan to borrow $35,000 at a 7.5% annual interest rate. The terms require you to amortize the loan with 7 equal end-of-year payments. How much interest would you be paying in Year 2?a.$1,994.49b.$2,099.46c.$2,209.96d.$2,326.27e.$2,442.59
ANS:
150.Your bank offers to lend you $100,000 at an 8.5% annual interest rate to start your new business. The terms require you to amortize the loan with 10 equal end-of-year payments. How much interest would you be paying in Year 2?a.$7,531b.$7,927c.$8,323d.$8,740e.$9,177
ANS:
151.You are considering investing in a European bank account that pays a nominal annual rate of 18%, compounded monthly. If you invest $5,000 at the beginning of each month, how many months would it take for your account to grow to $250,000? Round fractional months up.a.23b.27c.32d.38e.44
ANS:
152.You are considering investing in a bank account that pays a nominal annual rate of 7%, compounded monthly. If you invest $3,000 at the end of each month, how many months will it take for your account to grow to $150,000?a.39.60b.44.00c.48.40d.53.24e.58.57
ANS:
153.The store where you bought new home furnishings offers you two alternative payment plans. The first plan requires a $4,000 immediate up-front payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the monthly payment plan?a.12.31%b.12.96%c.13.64%d.14.36%e.15.08%
ANS:
154.Your Green Investment Tips subscription is about to expire. You plan to subscribe to the magazine for the rest of your life, and you can renew it by paying $85 annually, beginning immediately, or you can get a lifetime subscription for $850, also payable immediately. Assuming that you can earn 6.0% on your funds and that the annual renewal rate will remain constant, how many years must you live to make the lifetime subscription the better buy?a.7.48b.8.80c.10.35d.12.18e.14.33
ANS:
155.You just deposited $2,500 in a bank account that pays a 4.0% nominal interest rate, compounded quarterly. If you also add another $5,000 to the account one year (4 quarters) from now and another $7,500 to the account two years (8 quarters) from now, how much will be in the account three years (12 quarters) from now?a.$15,234.08b.$16,035.88c.$16,837.67d.$17,679.55e.$18,563.53
ANS:
156.Partners Bank offers to lend you $50,000 at a nominal rate of 5.0%, simple interest, with interest paid quarterly. An offer to lend you the $50,000 also comes from Community Bank, but it will charge 6.0%, simple interest, with interest paid at the end of the year. What's the difference in the effective annual rates charged by the two banks?a.1.56%b.1.30%c.1.09%d.0.91%e.0.72%
ANS:
157.Suppose you borrowed $15,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. By how much would you reduce the amount you owe in the first year?a.$2,404.91b.$2,531.49c.$2,658.06d.$2,790.96e.$2,930.51
ANS:
158.Suppose you borrowed $15,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. How much would you still owe at the end of the first year, after you have made the first payment?a.$10,155.68b.$10,690.19c.$11,252.83d.$11,845.09e.$12,468.51
ANS:
159.Your older brother turned 35 today, and he is planning to save $7,000 per year for retirement, with the first deposit to be made one year from today. He will invest in a mutual fund that's expected to provide a return of 7.5% per year. He plans to retire 30 years from today, when he turns 65, and he expects to live for 25 years after retirement, to age 90. Under these assumptions, how much can he spend each year after he retires? His first withdrawal will be made at the end of his first retirement year.a.$58,601b.$61,686c.$64,932d.$68,179e.$71,588
ANS:
160.You agree to make 24 deposits of $500 at the beginning of each month into a bank account. At the end of the 24th month, you will have $13,000 in your account. If the bank compounds interest monthly, what nominal annual interest rate will you be earning?a.7.62%b.8.00%c.8.40%d.8.82%e.9.26%
ANS:
161.Your business has just taken out a 1-year installment loan for $72,500 at a nominal rate of 11.0% but with equal end-of-month payments. What percentage of the 2nd monthly payment will go toward the repayment of principal?a.73.67%b.77.55%c.81.63%d.85.93%e.90.45%
ANS:
162.On January 1, 2012, your sister's pet supplies business obtained a 30-year amortized mortgage loan for $250,000 at a nominal annual rate of 7.0%, with 360 end-of-month payments. The firm can deduct the interest paid for tax purposes. What will the interest tax deduction be for 2012?a.$17,419.55b.$17,593.75c.$17,769.68d.$17,947.38e.$18,126.85
ANS:
163.You borrowed $50,000 which you must repay in 10 years. You plan to make an initial deposit today, then make 9 more deposits at the beginning of each the next 9 years, but with the deposits increasing at the inflation rate. You expect to earn 5% on your funds, and you expect a 3% inflation rate. To the nearest dollar, how large must your initial deposit be to enable you to reach your $50,000 target?a.$3,008b.$3,342c.$3,676d.$4,044e.$4,448
ANS:
164.Your 75-year-old grandmother expects to live for another 15 years. She currently has $1,000,000 of savings, which is invested to earn a guaranteed 5% rate of return. If inflation averages 2% per year, how much can she withdraw (to the nearest dollar) at the beginning of each year and keep the withdrawals constant in real terms, i.e., growing at the same rate as inflation and thus enabling her to maintain a constant standard of living?a.$65,632b.$72,925c.$81,027d.$89,130e.$98,043
ANS:
165.Julian and Jonathan are twin brothers (and so were born on the same day). Today, both turned 25. Their grandfather began putting $2,500 per year into a trust fund for Julian on his 20th birthday, and he just made a 6th payment into the fund. The grandfather (or his estate's trustee) will make 40 more $2,500 payments until a 46th and final payment is made on Julian's 65th birthday. The grandfather set things up this way because he wants Julian to work, not be a "trust fund baby," but he also wants to ensure that Julian is provided for in his old age.
Until now, the grandfather has been disappointed with Jonathan and so has not given him anything. However, they recently reconciled, and the grandfather decided to make an equivalent provision for Jonathan. He will make the first payment to a trust for Jonathan today, and he has instructed his trustee to make 40 additional equal annual payments until Jonathan turns 65, when the 41st and final payment will be made. If both trusts earn an annual return of 8%, how much must the grandfather put into Jonathan's trust today and each subsequent year to enable him to have the same retirement nest egg as Julian after the last payment is made on their 65th birthday?a.$3,726b.$3,912c.$4,107d.$4,313e.$4,528
ANS:
166.You plan to work for Strickland Corporation for 12 years after graduation and after that want to start your own business. You expect to save and deposit $7,500 a year for the first 6 years (t = 1 through t = 6) and $15,000 annually for the following 6 years (t = 7 through t = 12). The first deposit will be made a year from today. In addition, your grandmother just gave you a $25,000 graduation gift that you will deposit immediately (t = 0). If the account earns 9% compounded annually, how much will you have when you start your business 12 years from now?a.$238,176b.$250,712c.$263,907d.$277,797e.$291,687
ANS:
167.You are in negotiations to make a 7-year loan of $25,000 to DeVille Corporation. To repay you, DeVille will pay $2,500 at the end of Year 1, $5,000 at the end of Year 2, and $7,500 at the end of Year 3, plus a fixed but currently unspecified cash flow, X, at the end of each year from Year 4 through Year 7. You are confident the payments will be made, since DeVille is essentially riskless. You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year loan. What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X?a.$4,271.67b.$4,496.49c.$4,733.15d.$4,969.81e.$5,218.30
ANS:
168.Scott and Linda have been saving to pay for their daughter Casie's college education. Casie just turned 10 at (t = 0), and she will be entering college 8 years from now (at t = 8). College tuition and expenses at State U. are currently $14,500 a year, but they are expected to increase at a rate of 3.5% a year. Ellen should graduate in 4 years⎯if she takes longer or wants to go to graduate school, she will be on her own. Tuition and other costs will be due at the beginning of each school year (at t = 8, 9, 10, and 11).
So far, Scott and Linda have accumulated $15,000 in their college savings account (at t = 0). Their long-run financial plan is to add an additional $5,000 in each of the next 4 years (at t = 1, 2, 3, and 4). Then they plan to make 3 equal annual contributions in each of the following years, t = 5, 6, and 7. They expect their investment account to earn 9%. How large must the annual payments at t = 5, 6, and 7 be to cover Casie's anticipated college costs?a.$1,965.21b.$2,068.64c.$2,177.51d.$2,292.12e.$2,412.76
ANS:
CHAPTER 5—BONDS, BOND VALUATION, AND INTEREST RATES
TRUE/FALSE
1.If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Issuing bondsKEY:Bloom’s: Knowledge
2.A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Call provisionKEY:Bloom’s: Knowledge
3.Sinking funds are devices used to force companies to retire bonds on a scheduled basis prior to their maturity. Many bond indentures allow the company to acquire bonds for a sinking fund by either purchasing bonds in the market or selecting the bonds to be acquired by a lottery administered by the trustee through a call at face value.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Sinking fundsKEY:Bloom’s: Knowledge
4.A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells initially) at par. These bonds provide compensation to investors in the form of capital appreciation.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Zero coupon bondKEY:Bloom’s: Knowledge
5.The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Floating-rate debtKEY:Bloom’s: Knowledge
6.The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Discounted cash flowsKEY:Bloom’s: Knowledge
7.For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond prices and interest ratesKEY:Bloom’s: Knowledge
8.As a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Mortgage bondKEY:Bloom’s: Knowledge
9.Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Debt coupon rateKEY:Bloom’s: Knowledge
10.There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond ratings and required returnsKEY:Bloom’s: Knowledge
11.A bond that had a 20-year original maturity with 1 year left to maturity has more interest rate price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates, and they cannot be called.)
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 5-13NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: Knowledge
12.Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 5-13NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: Knowledge
13.Junk bonds are high risk, high yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 5-15NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Junk bondKEY:Bloom’s: Knowledge
14.A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond.
ANS:FThe callable bond will be called if rates fall far enough below the coupon rate, but it will not be called otherwise. Thus, the call provision can only harm bondholders. Therefore, callable bonds sell at higher yields than noncallable bonds, regardless of the slope of the yield curve.
PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Callable bondsKEY:Bloom’s: Comprehension
15.Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Income bondKEY:Bloom’s: Comprehension
16.You are considering 2 bonds that will be issued tomorrow. Both are rated triple B (BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10% coupon, neither can be called except for sinking fund purposes, and both are offered to you at their $1,000 par values. However, Bond SF has a sinking fund while Bond NSF does not. Under the sinking fund, the company must call and pay off 5% of the bonds at par each year. The yield curve at the time is upward sloping. The bond's prices, being equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would generally be expected to have a higher yield than Bond NSF.
ANS:FThe sinking fund would give Bond SF a lower average maturity, and it would also lower its risk. Therefore, Bond SF should have a lower, not a higher, yield.
PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Sinking fundsKEY:Bloom’s: Comprehension
17.Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts interest rate risk to companies, it offers no advantages to issuers.
ANS:FFloating rates can benefit issuers if rates decline, so a company that thinks rates are likely to fall would want to issue such bonds.
PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Floating-rate debtKEY:Bloom’s: Comprehension
18.A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if interest rates are below 10% and at a discount if interest rates are greater than 10%.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond premiums and discountsKEY:Bloom’s: Comprehension
19.You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.
ANS:TThe bonds expected return (YTM) is 13.81%, which exceeds the 12% required return, so buy the bond.
PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-3NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond value–annual paymentKEY:Bloom’s: Comprehension
20.If the required rate of return on a bond (rd) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Bond valueKEY:Bloom’s: Comprehension
21."Restrictive covenants" are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Restrictive covenantsKEY:Bloom’s: Comprehension
22.The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant.
ANS:TThe reason for this is that more of the cash flows of a low-coupon bond comes late in the bond's life (as the maturity payment), and later cash flows are impacted most heavily by changing market rates.
PTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Prices and interest ratesKEY:Bloom’s: Comprehension
MULTIPLE CHOICE
23.Which of the following statements is CORRECT?a.The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates.b.You hold two bonds. One is a 10-year, zero coupon, bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline.c.The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates.d.The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates.e.You hold two bonds. One is a 10-year, zero coupon, issue and the other is a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the larger percentage decline.
ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 5-4NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest ratesKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
24.Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?a.Market interest rates rise sharply.b.Market interest rates decline sharply.c.The company's financial situation deteriorates significantly.d.Inflation increases significantly.e.The company's bonds are downgraded.
ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 5-4NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Callable bondsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
25.A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?a.The bond is selling below its par value.b.The bond is selling at a discount.c.If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.d.The bond's current yield is greater than 9%.e.If the yield to maturity remains constant, the bond's price one year from now will be higher than its current price.
ANS:CPTS:1DIF:Difficulty: EasyOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
26.Which of the following statements is CORRECT?a.An indenture is a bond that is less risky than a mortgage bond.b.The expected return on a corporate bond will generally exceed the bond's yield to maturity.c.If a bond's coupon rate exceeds its yield to maturity, then its expected return to investors exceeds the yield to maturity.d.Under our bankruptcy laws, any firm that is in financial distress will be forced to declare bankruptcy and then be liquidated.e.All else equal, senior debt generally has a lower yield to maturity than subordinated debt.
ANS:EPTS:1DIF:Difficulty: EasyOBJ:LO: 5-16NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bonds, default riskKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
27.Ranger Inc. would like to issue new 20-year bonds. Initially, the plan was to make the bonds non-callable. If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return?a.There is no reason to expect a change in the required rate of return.b.The required rate of return would decline because the bond would then be less risky to a bondholder.c.The required rate of return would increase because the bond would then be more risky to a bondholder.d.It is impossible to say without more information.e.Because of the call premium, the required rate of return would decline.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Call provisionKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
28.Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?a.Adding a call provision.b.The rating agencies change the bond's rating from Baa to Aaa.c.Making the bond a first mortgage bond rather than a debenture.d.Adding a sinking fund.e.Adding additional restrictive covenants that limit management's actions.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-3NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond coupon rateKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
29.Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?a.20-year, 10% coupon bond.b.20-year, 5% coupon bond.c.1-year, 10% coupon bond.d.20-year, zero coupon bond.e.10-year, zero coupon bond.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
30.Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?a.A 1-year bond with a 15% coupon.b.A 3-year bond with a 10% coupon.c.A 10-year zero coupon bond.d.A 10-year bond with a 10% coupon.e.An 8-year bond with a 9% coupon.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: Conceptual
31.Which of the following bonds has the greatest interest rate price risk?a.A 10-year, $1,000 face value, zero coupon bond.b.A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.c.All 10-year bonds have the same price risk since they have the same maturity.d.A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
32.If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value?a.A 1-year bond with an 8% coupon.b.A 10-year bond with an 8% coupon.c.A 10-year bond with a 12% coupon.d.A 10-year zero coupon bond.e.A 1-year zero coupon bond.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
33.Which of the following statements is CORRECT?a.Most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature.b.A sinking fund provision makes a bond more risky to investors at the time of issuance.c.Sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time.d.If interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.e.Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Sinking fundsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
34.Nicholas Industries can issue a 20-year bond with a 6% annual coupon. This bond is not convertible, is not callable, and has no sinking fund. Alternatively, Nicholas could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Nicholas would have to pay on the convertible, callable bond?a.It could be less than, equal to, or greater than 6%.b.Greater than 6%.c.Exactly equal to 8%.d.Less than 6%.e.Exactly equal to 6%.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-2NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Convertible, callable bondsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
35.The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?a.Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.b.Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.c.Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.d.Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase.e.Bond A's current yield will increase each year.
ANS:
36.A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is NOT CORRECT?a.The bond's yield to maturity is 9%.b.The bond's current yield is 9%.c.If the bond's yield to maturity remains constant, the bond will continue to sell at par.d.The bond's current yield exceeds its capital gains yield.e.The bond's expected capital gains yield is positive.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
37.Which of the following statements is CORRECT?a.If a bond's yield to maturity exceeds its coupon rate, the bond will sell at par.b.All else equal, if a bond's yield to maturity increases, its price will fall.c.If a bond's yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.d.All else equal, if a bond's yield to maturity increases, its current yield will fall.e.A zero coupon bond's current yield is equal to its yield to maturity.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
38.Stephenson Co.'s 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?a.The bond's current yield exceeds its yield to maturity.b.The bond's yield to maturity is greater than its coupon rate.c.The bond's current yield is equal to its coupon rate.d.If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850.e.The bond's coupon rate exceeds its current yield.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
39.A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?a.If the yield to maturity remains at 8%, then the bond's price will decline over the next year.b.The bond's coupon rate is less than 8%.c.If the yield to maturity increases, then the bond's price will increase.d.If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year.e.The bond's current yield is less than 8%.
ANS:
40.Which of the following statements is CORRECT?a.On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.b.On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest.c.If a coupon bond is selling at par, its current yield equals its yield to maturity.d.The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B.e.If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
41.A 15-year bond has an annual coupon rate of 8%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 6%. Which of the following statements is CORRECT?a.The bond is currently selling at a price below its par value.b.If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.c.The bond should currently be selling at its par value.d.If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today.e.If market interest rates decline, the price of the bond will also decline.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-4NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rates and bond pricesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
42.An 8-year Treasury bond has a 10% coupon, and a 10-year Treasury bond has an 8% coupon. Both bonds have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?a.Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.b.The prices of both bonds would increase by the same amount.c.One bond's price would increase, while the other bond's price would decrease.d.The prices of the two bonds would remain constant.e.The prices of both bonds will decrease by the same amount.
ANS:
43.Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?a.The prices of both bonds will remain unchanged.b.The price of Bond A will decrease over time, but the price of Bond B will increase over time.c.The prices of both bonds will increase by 7% per year.d.The prices of both bonds will increase over time, but the price of Bond A will increase by more.e.The price of Bond B will decrease over time, but the price of Bond A will increase over time.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-4NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yields and pricesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
44.Assume that interest rates on 15-year noncallable Treasury and corporate bonds with different ratings are as follows:
T-bond = 7.72%A = 9.64%AAA = 8.72%BBB = 10.18%
The differences in rates among these issues were most probably caused primarily by:a.Tax effects.b.Default risk differences.c.Maturity risk differences.d.Inflation differences.e.Real risk-free rate differences.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-7NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest ratesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
45.Which of the following statements is CORRECT?a.All else equal, long-term bonds have less interest rate price risk than short-term bonds.b.All else equal, low-coupon bonds have less interest rate price risk than high-coupon bonds.c.All else equal, short-term bonds have less reinvestment rate risk than long-term bonds.d.All else equal, long-term bonds have less reinvestment rate risk than short-term bonds.e.All else equal, high-coupon bonds have less reinvestment rate risk than low-coupon bonds.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest vs. reinvestment rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
46.Which of the following statements is CORRECT?a.Long-term bonds have less interest rate price risk but more reinvestment rate risk than short-term bonds.b.If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less interest rate risk.c.Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more interest rate price risk but less reinvestment rate risk.d.Long-term bonds have less interest rate price risk and also less reinvestment rate risk than short-term bonds.e.One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest vs. reinvestment rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
47.Which of the following statements is CORRECT?a.Liquidity premiums are generally higher on Treasury than corporate bonds.b.The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.c.Default risk premiums are generally lower on corporate than on Treasury bonds.d.Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.e.If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-14NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Term structure of interest ratesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
48.Which of the following statements is CORRECT?a.If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.b.If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.c.If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium.d.If a coupon bond is selling at a premium, its current yield equals its yield to maturity.e.If a coupon bond is selling at par, its current yield equals its yield to maturity.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
49.A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?a.The bond has a current yield greater than 8%.b.The bond sells at a discount.c.The bond's required rate of return is less than 7.5%.d.If the yield to maturity remains constant, the price of the bond will decline over time.e.The bond sells at a price below par.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
50.Bonds A and B are 15-year, $1,000 face value bonds. Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT?a.One year from now, Bond A's price will be higher than it is today.b.Bond A's current yield is greater than 8%.c.Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price.d.Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.e.Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
51.Which of the following statements is NOT CORRECT?a.All else equal, bonds with longer maturities have more interest rate (price) risk than bonds with shorter maturities.b.If a bond is selling at its par value, its current yield equals its yield to maturity.c.If a bond is selling at a premium, its current yield will be greater than its yield to maturity.d.All else equal, bonds with larger coupons have greater interest rate (price) risk than bonds with smaller coupons.e.If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
52.Which of the following statements is CORRECT?a.If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.b.Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.c.Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.d.Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon.e.If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
53.Which of the following statements is CORRECT?a.The total yield on a bond is derived from dividends plus changes in the price of the bond.b.Bonds are riskier than common stocks and therefore have higher required returns.c.Bonds issued by larger companies always have lower yields to maturity (less risk) than bonds issued by smaller companies.d.The market value of a bond will always approach its par value as its maturity date approaches, provided the bond's required return remains constant.e.If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
54.Which of the following statements is CORRECT?a.If rates fall after its issue, a zero coupon bond could trade at a price above its par value.b.If rates fall rapidly, a zero coupon bond's expected appreciation could become negative.c.If a firm moves from a position of strength toward financial distress, its bonds' yield to maturity would probably decline.d.If a bond is selling at a premium, this implies that its yield to maturity exceeds its coupon rate.e.If a coupon bond is selling at par, its current yield equals its yield to maturity.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
55.You are considering three different bonds for your portfolio. Each bond has a 10-year maturity and a yield to maturity of 10%. Bond X has an 8% annual coupon, Bond Y has a 10% annual coupon, and Bond Z has a 12% annual coupon. Which of the following statements is CORRECT?a.Bond X has the greatest reinvestment rate risk.b.If market interest rates decline, all of the bonds will have an increase in price, and Bond Z will have the largest percentage increase in price.c.If market interest rates remain at 10%, Bond Z's price will be 10% higher one year from today.d.If market interest rates increase, Bond X's price will increase, Bond Z's price will decline, and Bond Y's price will remain the same.e.If the bonds' market interest rates remain at 10%, Bond Z's price will be lower one year from now than it is today.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
56.Bonds A, B, and C all have a maturity of 15 years and a yield to maturity of 9%. Bond A's price exceeds its par value, Bond B's price equals its par value, and Bond C's price is less than its par value. Which of the following statements is CORRECT?a.Bond A has the most interest rate risk.b.If the yield to maturity on the three bonds remains constant, the prices of the three bonds will remain the same over the next year.c.If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline.d.Bond C sells at a premium over its par value.e.If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its price.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
57.Which of the following statements is CORRECT?a.A 10-year, 10% coupon bond has less reinvestment rate risk than a 10-year, 5% coupon bond (assuming all else equal).b.The total return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year.c.The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10% bond.d.A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%.e.10-year, zero coupon bonds have higher reinvestment rate risk than 10-year, 10% coupon bonds.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
58.Which of the following statements is CORRECT?a.The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm has filed for bankruptcy.b.Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices.c.The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.d.On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.e.The yield to maturity for a coupon bond that sells at a premium consists entirely of a positive capital gains yield; it has a zero current interest yield.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
59.Which of the following statements is CORRECT?a.If a coupon bond is selling at a discount, then the bond's expected capital gains yield is negative.b.If a bond is selling at a discount, the yield to call is a better measure of the expected return than the yield to maturity.c.The current yield on Bond A exceeds the current yield on Bond B. Therefore, Bond A must have a higher yield to maturity than Bond B.d.If a coupon bond is selling at par, its current yield equals its yield to maturity.e.If a coupon bond is selling at a premium, then the bond's current yield is zero.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yieldsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
60.Which of the following statements is CORRECT?a.If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.b.Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.c.If the maturity risk premium (MRP) equals zero, the yield curve must be flat.d.The yield curve can never be downward sloping.e.If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the yield curve will have an upward slope.
ANS:
61.Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure thata.The economy is not in a recession.b.Long-term bonds are a better buy than short-term bonds.c.Maturity risk premiums could help to explain the yield curve's upward slope.d.Long-term interest rates are more volatile than short-term rates.e.Inflation is expected to decline in the future.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-14NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Yield curveKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
62.Which of the following statements is CORRECT?a.The most likely explanation for an inverted yield curve is that investors expect inflation to increase.b.The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.c.If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.d.Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.e.The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-14NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Yield curveKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
63.Bonds for two companies were just issued: Short Corp.'s bonds will mature in 5 years, and Long Corp.'s bonds will mature in 15 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further, assume that the Treasury yield curve is based only on expectations about future inflation, i.e., that the maturity risk premium is zero for T-bonds. Under these conditions, which of the following statements is correct?a.If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield.b.If the yield curve for Treasury securities is upward sloping, Long's bonds must under all conditions have a higher yield than Short's bonds.c.If the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as Long's bonds.d.If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal.e.If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have the lower yield.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-14NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Corporate yield curveKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
64.Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, and an 8% yield to maturity. Which of the following statements is CORRECT?a.Bond A trades at a discount, whereas Bond B trades at a premium.b.If the yield to maturity for both bonds remains at 8%, Bond A's price one year from now will be higher than it is today, but Bond B's price one year from now will be lower than it is today.c.If the yield to maturity for both bonds immediately decreases to 6%, Bond A's bond will have a larger percentage increase in value.d.Bond A's current yield is greater than that of Bond B.e.Bond A's capital gains yield is greater than Bond B's capital gains yield.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond rates and pricesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
65.Which of the following statements is CORRECT?a.A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.b.Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.c.Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.d.The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.e.Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Callable bondsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
66.Cornwall Corporation is planning to raise $1,000,000 to finance a new plant. Which of the following statements is CORRECT?a.If debt is used to raise the million dollars, but $500,000 is raised as first mortgage bonds on the new plant and $500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds.b.If two tiers of debt are used (with one senior and one subordinated debt class), the subordinated debt will carry a lower interest rate.c.If debt is used to raise the million dollars, the cost of the debt would be lower if the debt were in the form of a fixed-rate bond rather than a floating-rate bond.d.If debt is used to raise the million dollars, the cost of the debt would be higher if the debt were in the form of a mortgage bond rather than an unsecured term loan.e.The company would be especially eager to have a call provision included in the indenture if its management thinks that interest rates are almost certain to rise in the foreseeable future.
ANS:
67.Which of the following statements is CORRECT?a.Subordinated debt has less default risk than senior debt.b.Convertible bonds have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.c.Junk bonds typically provide a lower yield to maturity than investment-grade bonds.d.A debenture is a secured bond that is backed by some or all of the firm's fixed assets.e.Junior debt is debt that has been more recently issued, and in bankruptcy it is paid off after senior debt because the senior debt was issued first.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-15NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Types of debtKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
68.Which of the following statements is CORRECT?a.Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.b.Once a firm declares bankruptcy, it must then be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and lawyer fees.c.Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds.d.A firm with a sinking fund that gave it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.e.One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the debt until the bonds mature.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-16NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
69.Which of the following statements is CORRECT?a.All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required return for bonds of similar risk is 8%.b.The price of a discount bond will increase over time, assuming that the bond's yield to maturity remains constant.c.For a given firm, its debentures are likely to have a lower yield to maturity than its mortgage bonds.d.When large firms are in financial distress, they are almost always liquidated, whereas smaller firms are generally reorganized.e.The total return on a bond during a given year consists only of the coupon interest payments received.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-16NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Miscellaneous conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
70.Which of the following statements is NOT CORRECT?a.The expected return on a corporate bond must be less than its promised return if the probability of default is greater than zero.b.All else equal, senior debt has less default risk than subordinated debt.c.A company's bond rating is affected by its financial ratios and provisions in its indenture.d.Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off its debt according to the seniority of the debt as spelled out in the Act.e.All else equal, secured debt is less risky than unsecured debt.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 5-16NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Default and bankruptcyKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
71.Which of the following statements is CORRECT?a.A bond is likely to be called if its market price is below its par value.b.Even if a bond's YTC exceeds its YTM, an investor with an investment horizon longer than the bond's maturity would be worse off if the bond were called.c.A bond is likely to be called if its market price is equal to its par value.d.A bond is likely to be called if it sells at a discount below par.e.A bond is likely to be called if its coupon rate is below its YTM.
ANS:
72.Which of the following statements is CORRECT?a.A bond's current yield must always be either equal to its yield to maturity or between its yield to maturity and its coupon rate.b.If a bond sells at par, then its current yield will be less than its yield to maturity.c.If a bond sells for less than par, then its yield to maturity is less than its coupon rate.d.A discount bond's price declines each year until it matures, when its value equals its par value.e.Assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. The premium bond must have a lower current yield and a higher capital gains yield than the par bond.
ANS:
73.Assume that a 10-year Treasury bond has a 12% annual coupon, while a 15-year T-bond has an 8% annual coupon. Assume also that the yield curve is flat, and all Treasury securities have a 10% yield to maturity. Which of the following statements is CORRECT?a.If interest rates decline, the prices of both bonds will increase, but the 10-year bond would have a larger percentage increase in price.b.The 10-year bond would sell at a discount, while the 15-year bond would sell at a premium.c.The 10-year bond would sell at a premium, while the 15-year bond would sell at par.d.If the yield to maturity on both bonds remains at 10% over the next year, the price of the 10-year bond would increase, but the price of the 15-year bond would fall.e.If interest rates decline, the prices of both bonds will increase, but the 15-year bond would have a larger percentage increase in price.
ANS:MSC:TYPE: Multiple Choice: Conceptual
74.Listed below are some provisions that are often contained in bond indentures. Which of these provisions, viewed alone, would tend to reduce the yield to maturity that investors would otherwise require on a newly issued bond?
1.Fixed assets are used as security for a bond.2.A given bond is subordinated to other classes of debt.3.The bond can be converted into the firm's common stock.4.The bond has a sinking fund.5.The bond has a call provision.6.The indenture contains covenants that prevent the use of additional debt.
a.1, 4, 6b.1, 2, 3, 4, 6c.1, 2, 3, 4, 5, 6d.1, 3, 4, 5, 6e.1, 3, 4, 6
ANS:EPTS:1DIF:Difficulty: ChallengingOBJ:LO: 5-11NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond indentureKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
75.Suppose International Digital Technologies decides to raise a total of $200 million, with $100 million as long-term debt and $100 million as common equity. The debt can be mortgage bonds or debentures, but by an iron-clad provision in its charter, the company can never raise any additional debt beyond the original $100 million. Given these conditions, which of the following statements is CORRECT?a.If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of debentures.b.In this situation, we cannot tell for sure how, or whether, the firm's total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. The interest rate on each of the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result might well be such that the firm's total interest charges would not be affected materially by the mix between the two.c.The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures.d.If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds.e.The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm's total dollar interest charges will be.
ANS:
PTS:1DIF:Difficulty: ChallengingOBJ:LO: 5-11NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Types of debt and their relative costsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
76.Which of the following statements is CORRECT?a.If their maturities and other characteristics were the same, a 5% coupon bond would have more interest rate price risk than a 10% coupon bond.b.A 10-year coupon bond would have more reinvestment rate risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of reinvestment rate risk.c.A 10-year coupon bond would have more interest rate price risk than a 5-year coupon bond, but all 10-year coupon bonds have the same amount of interest rate price risk.d.If their maturities and other characteristics were the same, a 5% coupon bond would have less interest rate price risk than a 10% coupon bond.e.A zero coupon bond of any maturity will have more interest rate price risk than any coupon bond, even a perpetuity.
ANS:APTS:1DIF:Difficulty: ChallengingOBJ:LO: 5-13NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Interest rate and reinvestment rate riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
77.Which of the following statements is CORRECT?a.All else equal, an increase in interest rates will have a greater effect on the prices of short-term than long-term bonds.b.All else equal, an increase in interest rates will have a greater effect on higher-coupon bonds than it will have on lower-coupon bonds.c.If a bond's yield to maturity exceeds its coupon rate, the bond's price must be less than its maturity value.d.If a bond's yield to maturity exceeds its coupon rate, the bond's current yield must be less than its coupon rate.e.If two bonds have the same maturity, the same yield to maturity, and the same level of risk, the bonds should sell for the same price regardless of the bond's coupon rates.
ANS:CPTS:1DIF:Difficulty: ChallengingOBJ:LO: 5-6NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Bond yields and pricesKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
78.Assuming all else is constant, which of the following statements is CORRECT?a.For any given maturity, a 1.0 percentage point decrease in the market interest rate would cause a smaller dollar capital gain than the capital loss stemming from a 1.0 percentage point increase in the interest rate.b.From a corporate borrower's point of view, interest paid on bonds is not tax-deductible.c.Price sensitivity as measured by the percentage change in price due to a given change in the required rate of return decreases as a bond's maturity increases.d.For a bond of any maturity, a 1.0 percentage point increase in the market interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from a 1.0 percentage point decrease in the interest rate.e.A 20-year zero coupon bond has more reinvestment rate risk than a 20-year coupon bond.
ANS:
79.Kessen Inc.'s bonds mature in 7 years, have a par value of $1,000, and make an annual coupon payment of $70. The market interest rate for the bonds is 8.5%. What is the bond's price?a.$923.22b.$946.30c.$969.96d.$994.21e.$1,019.06
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80.Noncallable bonds that mature in 10 years were recently issued by Sternglass Inc. They have a par value of $1,000 and an annual coupon of 5.5%. If the current market interest rate is 7.0%, at what price should the bonds sell?a.$829.21b.$850.47c.$872.28d.$894.65e.$917.01
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81.Curtis Corporation's noncallable bonds currently sell for $1,165. They have a 15-year maturity, an annual coupon of $95, and a par value of $1,000. What is their yield to maturity?a.6.20%b.6.53%c.6.87%d.7.24%e.7.62%
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82.Sommers Co.'s bonds currently sell for $1,080 and have a par value of $1,000. They pay a $100 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,125. What is their yield to maturity (YTM)?a.8.56%b.9.01%c.9.46%d.9.93%e.10.43%
ANS:
83.Sentry Corp. bonds have an annual coupon payment of 7.25%. The bonds have a par value of $1,000, a current price of $1,125, and they will mature in 13 years. What is the yield to maturity on these bonds?a.5.56%b.5.85%c.6.14%d.6.45%e.6.77%
ANS:
84.Meacham Enterprises' bonds currently sell for $1,280 and have a par value of $1,000. They pay a $135 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,050. What is their yield to call (YTC)?a.6.39%b.6.72%c.7.08%d.7.45%e.7.82%
ANS:
85.Perry Inc.'s bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and a par value of $1,000. What is their current yield?a.7.39%b.7.76%c.8.15%d.8.56%e.8.98%
ANS:
86.Rogoff Co.'s 15-year bonds have an annual coupon rate of 9.5%. Each bond has face value of $1,000 and makes semiannual interest payments. If you require an 11.0% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?a.$891.00b.$913.27c.$936.10d.$959.51e.$983.49
ANS:
87.If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?a.1.90%b.2.09%c.2.30%d.2.53%e.2.78%
ANS:
88.One year ago Lerner and Luckmann Co. issued 15-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 14 years to maturity?a.$1,077.01b.$1,104.62c.$1,132.95d.$1,162.00e.$1,191.79
ANS:
89.Currently, Bruner Inc.'s bonds sell for $1,250. They pay a $120 annual coupon, have a 15-year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM.)a.2.11%b.2.32%c.2.55%d.2.80%e.3.09%
ANS:
90.Gilligan Co.'s bonds currently sell for $1,150. They have a 6.75% annual coupon rate and a 15-year maturity, and are callable in 6 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds, the YTC or the YTM?a.3.92%b.4.12%c.4.34%d.4.57%e.4.81%
ANS:
91.Haswell Enterprises' bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond's price?a.1,063.09b.1,090.35c.1,118.31d.1,146.27e.1,174.93
ANS:
92.CMS Corporation's balance sheet as of today is as follows:
Long-term debt (bonds, at par)$10,000,000Preferred stock2,000,000Common stock ($10 par)10,000,000Retained earnings 4,000,000Total debt and equity$26,000,000
The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is the current market value of the firm's debt?a.$5,276,731b.$5,412,032c.$5,547,332d.$7,706,000e.$7,898,650
ANS:
93.5-year Treasury bonds yield 5.5%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year bonds is 0.4%. What is the real risk-free rate, r*?a.2.59%b.2.88%c.3.20%d.3.52%e.3.87%
ANS:
94.The Gergen Group's 5-year bonds yield 6.85%, and 5-year T-bonds yield 4.75%. The real risk-free rate is r* = 2.80%, the default risk premium for Gergen's bonds is DRP = 0.85% versus zero for T-bonds, the liquidity premium on Gergen's bonds is LP = 1.25%, and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) ⋅ 0.1%, where t = number of years to maturity. What is the inflation premium (IP) on 5-year bonds?a.1.40%b.1.55%c.1.71%d.1.88%e.2.06%
ANS:
95.Chandler Co.'s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Chandler's bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) ⋅ 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Chandler's bonds?a.0.99%b.1.10%c.1.21%d.1.33%e.1.46%
ANS:
96.Squire Inc.'s 5-year bonds yield 6.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Squire's bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) ⋅ 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Squire's bonds?a.0.49%b.0.55%c.0.61%d.0.68%e.0.75%
ANS:
97.Field Industries' outstanding bonds have a 25-year maturity and $1,000 par value. Their nominal yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $850. What is the bond's nominal (annual) coupon interest rate?a.6.27%b.6.60%c.6.95%d.7.32%e.7.70%
ANS:
98.Jerome Corporation's bonds have 15 years to maturity, an 8.75% coupon paid semiannually, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,050. What is the bond's nominal yield to call?a.5.01%b.5.27%c.5.54%d.5.81%e.6.10%
ANS:
99.A 25-year, $1,000 par value bond has an 8.5% annual coupon. The bond currently sells for $875. If the yield to maturity remains at its current rate, what will the price be 5 years from now?a.$839.31b.$860.83c.$882.90d.$904.97e.$927.60
ANS:
100.McCurdy Co.'s Class Q bonds have a 12-year maturity, $1,000 par value, and a 5.75% coupon paid semiannually (2.875% each 6 months), and those bonds sell at their par value. McCurdy's Class P bonds have the same risk, maturity, and par value, but the P bonds pay a 5.75% annual coupon. Neither bond is callable. At what price should the annual payment bond sell?a.$943.98b.$968.18c.$993.01d.$1,017.83e.$1,043.28
ANS:
101.Reinegar Corporation is planning two new issues of 25-year bonds. Bond Par will be sold at its $1,000 par value, and it will have a 10% semiannual coupon. Bond OID will be an Original Issue Discount bond, and it will also have a 25-year maturity and a $1,000 par value, but its semiannual coupon will be only 6.25%. If both bonds are to provide investors with the same effective yield, how many of the OID bonds must Reinegar issue to raise $3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.a.4,228b.4,337c.4,448d.4,562e.4,676
ANS:
CHAPTER 6—RISK AND RETURN
TRUE/FALSE
1.The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Standard deviationKEY:Bloom’s: Knowledge
2.Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk aversionKEY:Bloom’s: Knowledge
3.When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Knowledge
4.Diversification will normally reduce the riskiness of a portfolio of stocks.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Knowledge
5.In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Knowledge
6.The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio returnKEY:Bloom’s: Knowledge
7.Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Market riskKEY:Bloom’s: Knowledge
8.An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Market riskKEY:Bloom’s: Knowledge
9.Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk and expected returnsKEY:Bloom’s: Knowledge
10.One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPM and riskKEY:Bloom’s: Knowledge
11.According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPM and riskKEY:Bloom’s: Knowledge
12.If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SML and risk aversionKEY:Bloom’s: Knowledge
13.If a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Stock market equilibriumKEY:Bloom’s: Knowledge
14.If a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Stock market equilibriumKEY:Bloom’s: Knowledge
15.For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Stock market equilibriumKEY:Bloom’s: Knowledge
16.Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.
ANS:FIf one condition holds, then the other must also hold.
PTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Stock market equilibriumKEY:Bloom’s: Knowledge
17.Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:VarianceKEY:Bloom’s: Comprehension
18."Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk aversionKEY:Bloom’s: Comprehension
19.If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the low standard deviation.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk aversionKEY:Bloom’s: Comprehension
20.Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities. Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Risk prem. and risk aversionKEY:Bloom’s: Comprehension
21.A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension
22.A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension
23.If the returns of two firms are negatively correlated, then one of them must have a negative beta.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension
24.A stock with a beta equal to −1.0 has zero systematic (or market) risk.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension
25.It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension
26.Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Comprehension
27.Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Comprehension
28.A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: Comprehension
29.The distributions of rates of return for Companies AA and BB are given below:
State of theProbability ofEconomyThis State OccurringAABBBoom0.230%−10%Normal0.610% 5%Recession0.2−5% 50%
We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.
ANS:FThe stocks have the same expected returns, but BB does badly in booms and well in recessions. Therefore, it would do more to reduce risk.
PTS:1DIF:Difficulty: ModerateOBJ:LO: 6-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: Comprehension
30.Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Cor. coefficient and riskKEY:Bloom’s: Comprehension
31.Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Company-specific riskKEY:Bloom’s: Comprehension
32.We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio betaKEY:Bloom’s: Comprehension
33.We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Portfolio betaKEY:Bloom’s: Comprehension
34.If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Diversification effectsKEY:Bloom’s: Comprehension
35.The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-11NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPMKEY:Bloom’s: Comprehension
36.Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Required returnKEY:Bloom’s: Comprehension
37.A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Changes in betaKEY:Bloom’s: Comprehension
38.Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Changes in betaKEY:Bloom’s: Comprehension
39.The slope of the SML is determined by the value of beta.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension
40.The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension
41.If you plotted the returns of a company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension
42.If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension
43.The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension
44.The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions.
ANS:FThe slope and intercept of the SML are determined by the market, generally not the actions of a single firm. However, managers can influence their firms' beta, and thus their firms' required returns.
PTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension
45.The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.
ANS:FPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: Comprehension
46.If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation, the risk-free rate will also increase. If there is no change in investors' risk aversion, then the market risk premium (rM − rRF) will remain constant. Also, if there is no change in stocks' betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPM and inflationKEY:Bloom’s: Comprehension
47.Since the market return represents the expected return on an average stock, the market return reflects a certain amount of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is required to compensate stock investors for assuming an average amount of risk.
ANS:TPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Market risk premiumKEY:Bloom’s: Comprehension
48.Assume that two investors each hold a portfolio, and that portfolio is their only asset. Investor A's portfolio has a beta of minus 2.0, while Investor B's portfolio has a beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then the two investors face the same amount of risk. However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some "normal" stocks with beta = 1.0.
ANS:TBoth portfolios would be twice as risky as a portfolio of average stocks. Their risks would decline if they added b = 1.0 stocks, as those stocks would move the portfolios' betas toward 1.0.
PTS:1DIF:Difficulty: ChallengingOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: Comprehension
49.The CAPM is a multi-period model that takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.
ANS:FThe CAPM is a single-period model, and it does not take account of securities' maturities.
PTS:1DIF:Difficulty: ChallengingOBJ:LO: 6-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Risk and returnLOC:TBATOP:CAPMKEY:Bloom’s: Comprehension
MULTIPLE CHOICE
50.If markets are in equilibrium, which of the following conditions will exist?a.Each stock's expected return should equal its required return as seen by the marginal investor.b.All stocks should have the same expected return as seen by the marginal investor.c.The expected and required returns on stocks and bonds should be equal.d.All stocks should have the same realized return during the coming year.e.Each stock's expected return should equal its realized return as seen by the marginal investor.
ANS:AStatement a is true, because if the expected return does not equal the required return, then markets are not in equilibrium.
PTS:1DIF:Difficulty: EasyOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Market equilibriumKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
51.You are considering investing in one of the these three stocks:
StockStandard DeviationBetaA20%0.59B10%0.61C12%1.29
If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.a.A; B.b.B; A.c.C; A.d.C; B.e.A; A.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk aversionKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
52.Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?a.Stock A.b.Stock B.c.Neither A nor B, as neither has a return sufficient to compensate for risk.d.Add A, since its beta must be lower.e.Either A or B, i.e., the investor should be indifferent between the two.
ANS:BWith only 4 stocks in the portfolio, unsystematic risk matters, and B has less.
PTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Standard deviationKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
53.Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?a.Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta.b.The beta of an "average stock," or "the market," can change over time, sometimes drastically.c.Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.d.All of the statements above are true.e.The fact that a security or project may not have a past history that can be used as the basis for calculating beta.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
54.Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securities? (Assume market equilibrium.)a.Stock B must be a more desirable addition to a portfolio than A.b.Stock A must be a more desirable addition to a portfolio than B.c.The expected return on Stock A should be greater than that on B.d.The expected return on Stock B should be greater than that on A.e.When held in isolation, Stock A has more risk than Stock B.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
55.Which of the following statements is CORRECT?a.If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio.b.The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.c.The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.d.It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.e.The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
56.Which of the following statements is CORRECT?a.Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.b.Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move.c.You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks.d.If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.e.Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
57.Which of the following statements is CORRECT?a.Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.b.The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically.c.If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.d.During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.e.If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
58.Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true, assuming the CAPM is correct.a.In equilibrium, the expected return on Stock B will be greater than that on Stock A.b.When held in isolation, Stock A has more risk than Stock B.c.Stock B would be a more desirable addition to a portfolio than A.d.In equilibrium, the expected return on Stock A will be greater than that on B.e.Stock A would be a more desirable addition to a portfolio then Stock B.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
59.Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to the CAPM?a.Stock Y's realized return during the coming year will be higher than Stock X's return.b.If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.c.Stock Y's return has a higher standard deviation than Stock X.d.If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.e.If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Beta coefficientsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
60.Consider the following average annual returns for Stocks A and B and the Market. Which of the possible answers best describes the historical betas for A and B?
YearsMarketStock AStock B1 0.030.160.052−0.050.200.053 0.010.180.054−0.100.250.055 0.060.140.05
a.bA > +1; bB = 0.b.bA = 0; bB = −1.c.bA < 0; bB = 0.d.bA < −1; bB = 1.e.bA > 0; bB = 1.
ANS:
61.Which of the following statements is CORRECT?a.The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.b.An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks.c.Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.d.An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.e.An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
62.Which of the following statements is CORRECT?a.If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one.b.If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.c.Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.d.A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.e.If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and betaKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
63.Recession, inflation, and high interest rates are economic events that are best characterized as beinga.company-specific risk factors that can be diversified away.b.among the factors that are responsible for market risk.c.risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.d.irrelevant except to governmental authorities like the Federal Reserve.e.systematic risk factors that can be diversified away.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Market riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
64.Which of the following statements is CORRECT?a.If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.b.The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.c.Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.d.A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.e.A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk and port. divers.KEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
65.Which of the following statements is CORRECT?a.Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.b.A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.c.A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.d.If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.e.A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk and port. divers.KEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
66.Which of the following statements is CORRECT?a.A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.b.A two-stock portfolio will always have a lower beta than a one-stock portfolio.c.If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.d.A stock with an above-average standard deviation must also have an above-average beta.e.A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-5NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. risk, return, and betaKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
67.Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1.
ExpectedStandardStockReturnDeviationBetaA10%20%1.0B10%10%1.0C12%12%1.4
Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT?a.Portfolio AB's coefficient of variation is greater than 2.0.b.Portfolio AB's required return is greater than the required return on Stock A.c.Portfolio ABC's expected return is 10.66667%.d.Portfolio ABC has a standard deviation of 20%.e.Portfolio AB has a standard deviation of 20%.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
68.Which of the following statements is CORRECT?a.A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.b.If a stock has a negative beta, its expected return must be negative.c.A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.d.According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.e.If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. return, CAPM, and betaKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
69.Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks?a.The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.b.The beta of the portfolio is less than the average of the betas of the individual stocks.c.The beta of the portfolio is equal to the average of the betas of the individual stocks.d.The beta of the portfolio is larger than the average of the betas of the individual stocks.e.The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-6NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
70.If you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect?a.Adding more such stocks will increase the portfolio's expected rate of return.b.Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.c.Adding more such stocks will have no effect on the portfolio's risk.d.Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.e.Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
71.Charlie and Lucinda each have $50,000 invested in stock portfolios. Charlie's has a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Lucinda's has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Charlie's and Lucinda's portfolios is zero. If Charlie and Lucinda marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?a.The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.b.The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.c.The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.d.The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.e.The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
72.The two stocks in your portfolio, X and Y, have independent returns, so the correlation between them, rXY is zero. Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. Which of the following statements best describes the characteristics of your 2-stock portfolio?a.Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.b.Your portfolio has a beta equal to 1.6, and its expected return is 15%.c.Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.d.Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.e.Your portfolio has a standard deviation of 30%, and its expected return is 15%.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
73.Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?a.The expected return of your portfolio is likely to decline.b.The diversifiable risk will remain the same, but the market risk will likely decline.c.Both the diversifiable risk and the market risk of your portfolio are likely to decline.d.The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.e.The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
74.Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?a.The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk.b.Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios.c.If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's.d.The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.e.Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
75.Stocks A and B are quite similar: Each has an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?a.Portfolio P has a standard deviation that is greater than 25%.b.Portfolio P has an expected return that is less than 12%.c.Portfolio P has a standard deviation that is less than 25%.d.Portfolio P has a beta that is less than 1.2.e.Portfolio P has a beta that is greater than 1.2.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
76.Stocks A, B, and C are similar in some respects: Each has an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another; i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another; i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT?a.Portfolio AC has an expected return that is greater than 25%.b.Portfolio AB has a standard deviation that is greater than 25%.c.Portfolio AB has a standard deviation that is equal to 25%.d.Portfolio AC has a standard deviation that is less than 25%.e.Portfolio AC has an expected return that is less than 10%.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
77.Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. Your portfolio consists of 50% A and 50% B. Which of the following statements is CORRECT?a.The portfolio's expected return is 15%.b.The portfolio's standard deviation is greater than 20%.c.The portfolio's beta is greater than 1.2.d.The portfolio's standard deviation is 20%.e.The portfolio's beta is less than 1.2.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
78.Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT?a.Portfolio P's expected return is equal to the expected return on Stock A.b.Portfolio P's expected return is less than the expected return on Stock B.c.Portfolio P's expected return is equal to the expected return on Stock B.d.Portfolio P's expected return is greater than the expected return on Stock C.e.Portfolio P's expected return is greater than the expected return on Stock B.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
79.In a portfolio of three randomly selected stocks, which of the following could NOT be true; i.e., which statement is false?a.The standard deviation of the portfolio is greater than the standard deviation of one or two of the stocks.b.The beta of the portfolio is lower than the lowest of the three betas.c.The beta of the portfolio is equal to one of the three stock's betas.d.The beta of the portfolio is equal to 1.e.The standard deviation of the portfolio is less than the standard deviation of each of the stocks if they were held in isolation.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio risk and returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
80.Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?a.If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.b.An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2.c.If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B.d.If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.e.Stock B's required return is double that of Stock A's.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. risk & ret. relationshipsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
81.Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $300,000 invested in Stock A and $100,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT?a.The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.b.The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued.c.Portfolio AB's expected return is 11.0%.d.Portfolio AB's beta is less than 1.2.e.Portfolio AB's standard deviation is 17.5%.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. risk & ret. relationshipsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
82.You have a portfolio P that consists of 50% Stock X and 50% Stock Y. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Given this information, which of the following statements is CORRECT?a.The required return on Portfolio P is equal to the market risk premium (rM − rRF).b.Portfolio P has a beta of 0.7.c.Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.d.Portfolio P has the same required return as the market (rM).e.Portfolio P has a standard deviation of 20%.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Port. risk & ret. relationshipsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
83.Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)a.The effect of a change in the market risk premium depends on the slope of the yield curve.b.If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.c.If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.d.The effect of a change in the market risk premium depends on the level of the risk-free rate.e.If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Market risk premiumKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
84.In historical data, we see that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?a.Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds.b.Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.c.U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks.d.Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.e.Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk & ret. relationshipsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
85.Suppose that during the coming year, the risk free rate, rRF, is expected to remain the same, while the market risk premium (rM − rRF), is expected to fall. Given this forecast, which of the following statements is CORRECT?a.The required return on all stocks will remain unchanged.b.The required return will fall for all stocks, but it will fall more for stocks with higher betas.c.The required return for all stocks will fall by the same amount.d.The required return will fall for all stocks, but it will fall less for stocks with higher betas.e.The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
86.The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?a.Stock B's required rate of return is twice that of Stock A.b.If Stock A's required return is 11%, then the market risk premium is 5%.c.If Stock B's required return is 11%, then the market risk premium is 5%.d.If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's.e.If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPMKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
87.Assume that in recent years both expected inflation and the market risk premium (rM − rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?a.The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.b.The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0.c.Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0.d.The required returns on all stocks have fallen by the same amount.e.The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
88.Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?a.If a stock's beta doubled, its required return under the CAPM would also double.b.If a stock's beta doubled, its required return under the CAPM would more than double.c.If a stock's beta were 1.0, its required return under the CAPM would be 5%.d.If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.e.If a stock has a negative beta, its required return under the CAPM would be less than 5%.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
89.Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?a.If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.b.If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount.c.Since the market is in equilibrium, the required returns of the two stocks should be the same.d.If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase.e.If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
90.Portfolio P has equal amounts invested in each of the three stocks, A, B, and C. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?a.The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.b.The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.c.The required returns on all three stocks will increase by the amount of the increase in the market risk premium.d.The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.e.The required return of all stocks will remain unchanged since there was no change in their betas.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
91.Which of the following statements is CORRECT?a.Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase.b.If a company's beta were cut in half, then its required rate of return would also be halved.c.If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.d.If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.e.If a company's beta doubles, then its required rate of return will also double.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM and required returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
92.Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?a.If a stock has a negative beta, its required return must also be negative.b.An index fund with beta = 1.0 should have a required return less than 11%.c.If a stock's beta doubles, its required return must also double.d.An index fund with beta = 1.0 should have a required return greater than 11%.e.An index fund with beta = 1.0 should have a required return of 11%.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:CAPM, beta, and req. returnKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
93.Which of the following statements is CORRECT?a.Lower beta stocks have higher required returns.b.A stock's beta indicates its diversifiable risk.c.Diversifiable risk cannot be completely diversified away.d.Two securities with the same stand-alone risk must have the same betas.e.The slope of the security market line is equal to the market risk premium.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
94.Which of the following statements is CORRECT?a.If the risk-free rate rises, then the market risk premium must also rise.b.If a company's beta is halved, then its required return will also be halved.c.If a company's beta doubles, then its required return will also double.d.The slope of the security market line is equal to the market risk premium, (rM − rRF).e.Beta is measured by the slope of the security market line.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
95.Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)a.Stock B has a higher required rate of return than Stock A.b.Portfolio P has a standard deviation of 22.5%.c.More information is needed to determine the portfolio's beta.d.Portfolio P has a beta of 1.0.e.Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
96.Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%. Which of the following statements is CORRECT?a.If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0.b.Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's.c.If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.d.If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0.e.If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
97.Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?a.Stock Y must have a higher expected return and a higher standard deviation than Stock X.b.If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount.c.If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.d.If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y.e.A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
98.Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?a.The required return would decrease by the same amount for both Stock A and Stock B.b.The required return would increase for Stock A but decrease for Stock B.c.The required return on Portfolio P would remain unchanged.d.The required return would increase for Stock B but decrease for Stock A.e.The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
99.Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?a.The required return on both stocks would increase by 1%.b.The required return on Portfolio P would remain unchanged.c.The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.d.The required return for Stock A would fall, but the required return for Stock B would increase.e.The required return on Portfolio P would increase by 1%.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
100.Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?a.The required return on a stock with beta > 1.0 will increase.b.The return on "the market" will remain constant.c.The return on "the market" will increase.d.The required return on a stock with beta < 1.0 will decline.e.The required return on a stock with beta = 1.0 will not change.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
101.Which of the following statements is CORRECT?a.The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers.b.Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future.c.If investors become less risk averse, the slope of the Security Market Line will increase.d.If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.e.The slope of the SML is determined by the value of beta.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
102.How would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse?a.The x-axis intercept would decline, and the slope would increase.b.The y-axis intercept would increase, and the slope would decline.c.The SML would be affected only if betas changed.d.Both the y-axis intercept and the slope would increase, leading to higher required returns.e.The y-axis intercept would decline, and the slope would increase.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
103.Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines, with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?a.The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0.b.Since the overall return on the market stays constant, the required return on each individual stock will also remain constant.c.The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.d.The required return of all stocks will fall by the amount of the decline in the market risk premium.e.The required return of all stocks will increase by the amount of the increase in the risk-free rate.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
104.Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRF. Meanwhile, investors are afraid of a recession, so the market risk premium, (rM − rRF), has increased. Under these conditions, with other things held constant, which of the following statements is most correct?a.The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0.b.Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices.c.The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.d.The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.e.The required return on all stocks would increase by the same amount.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SMLKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
105.Which of the following statements is CORRECT?a.The slope of the Security Market Line is beta.b.Any stock with a negative beta must in theory have a negative required rate of return, provided rRF is positive.c.If a stock's beta doubles, its required rate of return must also double.d.If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.e.If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SML, CAPM, and betaKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
106.Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur?a.The required rate of return will decline for stocks whose betas are less than 1.0.b.The required rate of return on the market, rM, will not change as a result of these changes.c.The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market riskd.The required rate of return on a riskless bond will decline.e.The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SML and risk aversionKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
107.Which of the following statements is CORRECT?a.The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.b.If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.c.If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.d.An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.e.A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
ANS:DPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:SML, CAPM, and port. riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
108.For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,a.The past realized rate of return must be equal to the expected future rate of return; that is, .b.The required rate of return must equal the past realized rate of return; that is, r = .c.The expected rate of return must be equal to the required rate of return; that is, = r.d.All of the above statements must hold for equilibrium to exist; that is = r = .e.None of the above statements is correct.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Market equilibriumKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
109.Which of the following statements is CORRECT?a.Portfolio diversification reduces the variability of returns on an individual stock.b.Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events.c.The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.d.A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio.e.When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
110.You observe the following information regarding Companies X and Y:
�Company X has a higher expected return than Company Y.�Company X has a lower standard deviation of returns than Company Y.�Company X has a higher beta than Company Y.
Given this information, which of the following statements is CORRECT?a.Company X has a lower coefficient of variation than Company Y.b.Company X has less market risk than Company Y.c.Company X's returns will be negative when Y's returns are positive.d.Company X's stock is a better buy than Company Y's stock.e.Company X has more diversifiable risk than Company Y.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Risk measuresKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
111.Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P has 50% invested in Stock A and 50% invested in B. Which of the following statements is CORRECT?a.Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium.b.Portfolio P has more market risk than Stock A but less market risk than B.c.Stock A should have a higher expected return than Stock B as viewed by the marginal investor.d.Portfolio P has a coefficient of variation equal to 2.5.e.Portfolio P has a standard deviation of 25% and a beta of 1.0.
ANS:BPTS:1DIF:Difficulty: ModerateOBJ:LO: 6-7NAT:BUSPROG: AnalyticSTA:DISC: Risk and returnLOC:TBATOP:Portfolio riskKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
112.For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, thena.the past realized return must be equal to the expected return during the same period.b.the required return must equal the realized return in all periods.c.the expected return must be equal to both the required future return and the past realized return.d.the expected future returns must be equal to the required return.e.the expected future return must be less than the most recent past realized return.
ANS:
113.Which of the following are the factors for the Fama-French model?a.The excess market return, a debt factor, and a book-to-market factor.b.The excess market return, a size factor, and a debt.c.A debt factor, a size factor, and a book-to-market factor.d.The excess market return, an industrial production factor, and a book-to-market factor.e.The excess market return, a size factor, and a book-to-market factor.
ANS:
114.Gretta's portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. The risk-free rate is 6% and the market risk premium is 5%. Which of the following statements is CORRECT?a.The required return on the market is 10%.b.The portfolio's required return is less than 11%.c.If the risk-free rate remains unchanged but the market risk premium increases by 2%, Gretta's portfolio's required return will increase by more than 2%.d.If the market risk premium remains unchanged but expected inflation increases by 2%, Gretta's portfolio's required return will increase by more than 2%.e.If the stock market is efficient, Gretta's portfolio's expected return should equal the expected return on the market, which is 11%.
ANS:
115.Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM − rRF, is 6%. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is CORRECT?a.Since the two stocks have zero correlation, Portfolio AB is riskless.b.Stock B's beta is 1.0000.c.Portfolio AB's required return is 11%.d.Portfolio AB's standard deviation is 25%.e.Stock A's beta is 0.8333.
ANS:
116.Portfolio AB was created by investing in a combination of Stocks A and B. Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?a.Stock A has more market risk than Stock B but less stand-alone risk.b.Portfolio AB has more money invested in Stock A than in Stock B.c.Portfolio AB has the same amount of money invested in each of the two stocks.d.Portfolio AB has more money invested in Stock B than in Stock A.e.Stock A has more market risk than Portfolio AB.
ANS:
117.Which of the following statements is CORRECT?a.If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change.b.An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk.c.There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.d.Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.e.If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.
ANS:
118.Freedman Flowers' stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a −28% return. What is the firm's expected rate of return?a.9.41%b.9.65%c.9.90%d.10.15%e.10.40%
ANS:
119.Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return. What is the firm's expected rate of return?a.7.72%b.8.12%c.8.55%d.9.00%e.9.50%
ANS:
120.Donald Gilmore has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?a.0.65b.0.72c.0.80d.0.89e.0.98
ANS:
121.Shirley Paul's 2-stock portfolio has a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is her portfolio's beta?a.1.17b.1.23c.1.29d.1.35e.1.42
ANS:
122.Ivan Knobel holds a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. He is in the process of buying 1,000 shares of Syngine Corp at $10 a share and adding it to his portfolio. Syngine has an expected return of 13.0% and a beta of 1.50. The total value of Ivan's current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Syngine stock?a.10.64%; 1.17b.11.20%; 1.23c.11.76%; 1.29d.12.35%; 1.36e.12.97%; 1.42
ANS:
123.Calculate the required rate of return for Everest Expeditions Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.a.10.29%b.10.83%c.11.40%d.12.00%e.12.60%
ANS:
124.Zacher Co.'s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?a.11.36%b.11.65%c.11.95%d.12.25%e.12.55%
ANS:
125.Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?a.5.80%b.5.95%c.6.09%d.6.25%e.6.40%
ANS:
126.Martin Ortner holds a $200,000 portfolio consisting of the following stocks:
StockInvestmentBetaA $50,0000.95B 50,0000.80C 50,0001.00D 50,0001.20Total$200,000
What is the portfolio's beta?a.0.938b.0.988c.1.037d.1.089e.1.143
ANS:
127.Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875.
StockInvestmentBetaA $50,0000.50B 50,0000.80C 50,0001.00D 50,0001.20Total$200,000
If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?a.1.07b.1.13c.1.18d.1.24e.1.30
ANS:
128.Megan Ross holds the following portfolio:
StockInvestmentBetaA$150,0001.40B 50,0000.80C 100,0001.00D 75,0001.20Total$375,000
What is the portfolio's beta?a.1.06b.1.17c.1.29d.1.42e.1.56
ANS:
129.Paul McLaren holds the following portfolio:
StockInvestmentBetaA$150,0001.40B 50,0000.80C 100,0001.00D 75,0001.20Total$375,000
Paul plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change?a.−0.190b.−0.211c.−0.234d.−0.260e.−0.286
ANS:
130.Jenna holds a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. Jenna plans to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?a.1.286b.1.255c.1.224d.1.194e.1.165
ANS:
131.Porter Plumbing's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)a.14.38%b.14.74%c.15.11%d.15.49%e.15.87%
ANS:
132.Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)a.2.75%b.2.89%c.3.05%d.3.21%e.3.38%
ANS:
133.Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)a.8.76%b.8.98%c.9.21%d.9.44%e.9.68%
ANS:
134.Barker Corp. has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Barker's required rate of return?a.9.43%b.9.67%c.9.92%d.10.17%e.10.42%
ANS:
135.Brodkey Shoes has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?a.13.51%b.13.86%c.14.21%d.14.58%e.14.95%
ANS:
136.Gardner Electric has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return?a.11.34%b.11.63%c.11.92%d.12.22%e.12.52%
ANS:
137.Consider the following information and then calculate the required rate of return for the Universal Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:
StockInvestmentBetaA$ 200,000 1.50B$ 300,000−0.50C$ 500,000 1.25D$1,000,000 0.75
a.9.58%b.10.09%c.10.62%d.11.18%e.11.77%
ANS:
138.Data for Atwill Corporation is shown below. Now Atwill acquires some risky assets that cause its beta to increase by 30%. In addition, expected inflation increases by 2.00%. What is the stock's new required rate of return?
Initial beta1.00Initial required return (rs)10.20%Market risk premium, RPM6.00%Percentage increase in beta30.00%Increase in inflation premium, IP2.00%
a.14.00%b.14.70%c.15.44%d.16.21%e.17.02%
ANS:
139.Fiske Roofing Supplies' stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)a.10.36%b.10.62%c.10.88%d.11.15%e.11.43%
ANS:
140.Suppose Stan holds a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose Stan decided to sell one of his stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be?a.1.17b.1.23c.1.29d.1.36e.1.43
ANS:
141.Returns for the Alcoff Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)
YearReturn2010 21.00%2009−12.50%2008 25.00%
a.20.08%b.20.59%c.21.11%d.21.64%e.22.18%
ANS:
142.Stuart Company's manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.)
EconomicConditionsProb.ReturnStrong30% 32.0%Normal40% 10.0%Weak30%−16.0%
a.17.69%b.18.62%c.19.55%d.20.52%e.21.55%
ANS:
143.Assume that your cousin holds just one stock, Eastman Chemical Bonding (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for Wilder's Creations and Buildings (WCB). Both companies have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would your cousin's risk have been reduced if he had held a portfolio consisting of 60% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.)
YearECBWCB2007 40.00% 40.00%2008−10.00% 15.00%2009 35.00% −5.00%2010 −5.00%−10.00%2011 15.00% 35.00%Average return = 15.00% 15.00%Standard deviation = 22.64% 22.64%
a.3.29%b.3.46%c.3.65%d.3.84%e.4.03%
ANS:
144.The $10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. Henry now receives another $5.00 million, which he invests in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)a.8.83%b.9.05%c.9.27%d.9.51%e.9.74%
ANS:
145.Hazel Morrison, a mutual fund manager, has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. Hazel expects to receive an additional $60 million, which she plans to invest in additional stocks. After investing the additional funds, she wants the fund's required and expected return to be 13.00%. What must the average beta of the new stocks be to achieve the target required rate of return?a.1.68b.1.76c.1.85d.1.94e.2.04
ANS:
146.Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect (and require) on this fund?
StockAmountBetaA$1,075,0001.20B 675,0000.50C 750,0001.40D 500,0000.75$3,000,000
a.10.56%b.10.83%c.11.11%d.11.38%e.11.67%
ANS:
147.DHF Company has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would DHF's new required return be?a.14.89%b.15.68%c.16.50%d.17.33%e.18.19%
ANS:
CHAPTER 7—VALUATION OF STOCKS AND CORPORATIONS
TRUE/FALSE
1.A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:ProxyKEY:Bloom’s: Knowledge
2.The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Preemptive rightKEY:Bloom’s: Knowledge
3.If a firm's stockholders are given the preemptive right, this means that stockholders have the right to call for a meeting to vote to replace the management. Without the preemptive right, dissident stockholders would have to seek a change in management through a proxy fight.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 7-1NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Preemptive rightKEY:Bloom’s: Knowledge
4.Classified stock differentiates various classes of common stock, and using it is one way companies can meet special needs such as when owners of a start-up firm need additional equity capital but don't want to relinquish voting control.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Classified stockKEY:Bloom’s: Knowledge
5.Founders' shares are a type of classified stock where the shares are owned by the firm's founders, and they generally have more votes per share than the other classes of common stock.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-2NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Founders' sharesKEY:Bloom’s: Knowledge
6.The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 7-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Total stock returnsKEY:Bloom’s: Knowledge
7.The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Common stock cash flowsKEY:Bloom’s: Knowledge
8.According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 7-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Value: investment horizonKEY:Bloom’s: Knowledge
9.When a new issue of stock is brought to market, it is the marginal investor who determines the price at which the stock will trade.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-4NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Marginal investor and priceKEY:Bloom’s: Knowledge
10.The constant growth DCF model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-5NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Constant growth modelKEY:Bloom’s: Knowledge
11.According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash flows during the subsequent constant growth period.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-6NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Nonconstant growth modelKEY:Bloom’s: Knowledge
12.Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the value of its operations.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Free cash flows and valuationKEY:Bloom’s: Knowledge
13.The corporate valuation model cannot be used unless a company doesn't pay dividends.
ANS:FPTS:1DIF:Difficulty: EasyOBJ:LO: 7-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Corporate valuation modelKEY:Bloom’s: Knowledge
14.Free cash flows should be discounted at the firm's weighted average cost of capital to find the value of its operations.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-7NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Free cash flows and valuationKEY:Bloom’s: Knowledge
15.Preferred stock is a hybrid⎯a sort of cross between a common stock and a bond⎯in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.
ANS:FPreferred dividends don't normally grow, and they are not guaranteed.
PTS:1DIF:Difficulty: EasyOBJ:LO: 7-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Preferred stockKEY:Bloom’s: Knowledge
16.From an investor's perspective, a firm's preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer's standpoint, these risk relationships are reversed: Bonds are the most risky for the firm, preferred is next, and common is least risky.
ANS:TPTS:1DIF:Difficulty: EasyOBJ:LO: 7-9NAT:BUSPROG: Reflective ThinkingSTA:DISC: Stocks and bondsLOC:TBATOP:Preferred stockKEY:Bloom’s: Knowledge
MULTIPLE CHOICE
17.Which of the following statements is CORRECT?a.If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.b.The stock valuation model, P0 = D1/(rs − g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.c.The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.d.The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.e.The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.
ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Constant growth modelKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
18.If a firm's expected growth rate increased then its required rate of return woulda.decrease.b.fluctuate less than before.c.fluctuate more than before.d.possibly increase, possibly decrease, or possibly remain constant.e.increase.
ANS:DPTS:1DIF:Difficulty: EasyOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Required returnKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
19.You, in analyzing a stock, find that its expected return exceeds its required return. This suggests that you thinka.the stock should be sold.b.the stock is a good buy.c.management is probably not trying to maximize the price per share.d.dividends are not likely to be declared.e.the stock is experiencing supernormal growth.
ANS:BPTS:1DIF:Difficulty: EasyOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Required returnKEY:Bloom’s: ComprehensionMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
20.The preemptive right is important to shareholders because ita.will result in higher dividends per share.b.is included in every corporate charter.c.protects the current shareholders against a dilution of their ownership interests.d.protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.e.allows managers to buy additional shares below the current market price.
ANS:CPTS:1DIF:Difficulty: ModerateOBJ:LO: 7-1NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Preemptive rightKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
21.Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?a.All common stocks, regardless of class, must have the same voting rights.b.All firms have several classes of common stock.c.All common stock, regardless of class, must pay the same dividend.d.Some class or classes of common stock are entitled to more votes per share than other classes.e.All common stocks fall into one of three classes: A, B, and C.
ANS:
22.Which of the following statements is CORRECT?a.Two firms with the same expected dividend and growth rates must also have the same stock price.b.It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant.c.If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.d.The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.e.The constant growth model takes into consideration the capital gains investors expect to earn on a stock.
ANS:
23.A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = −5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?a.The company's dividend yield 5 years from now is expected to be 10%.b.The constant growth model cannot be used because the growth rate is negative.c.The company's expected capital gains yield is 5%.d.The company's expected stock price at the beginning of next year is $9.50.e.The company's current stock price is $20.
ANS:
24.If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.a.The stock's dividend yield is 5%.b.The price of the stock is expected to decline in the future.c.The stock's required return must be equal to or less than 5%.d.The stock's price one year from now is expected to be 5% above the current price.e.The expected return on the stock is 5% a year.
ANS:
25.Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
ABRequired return10%12%Market price$25$40Expected growth7%9%
a.These two stocks must have the same dividend yield.b.These two stocks should have the same expected return.c.These two stocks must have the same expected capital gains yield.d.These two stocks must have the same expected year-end dividend.e.These two stocks should have the same price.
ANS:
26.Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
ABPrice$25$40Expected growth7%9%Expected return10%12%
a.The two stocks could not be in equilibrium with the numbers given in the question.b.A's expected dividend is $0.50.c.B's expected dividend is $0.75.d.A's expected dividend is $0.75 and B's expected dividend is $1.20.e.The two stocks should have the same expected dividend.
ANS:
27.Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
ABPrice$25$25Expected growth (constant)10%5%Required return15%15%
a.Stock A has a higher dividend yield than Stock B.b.Currently the two stocks have the same price, but over time Stock B's price will pass that of A.c.Since Stock A's growth rate is twice that of Stock B, Stock A's future dividends will always be twice as high as Stock B's.d.The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.e.Stock A's expected dividend at t = 1 is only half that of Stock B.
ANS:
28.Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
XYPrice$30$30Expected growth (constant)6%4%Required return12%10%
a.Stock Y has a higher dividend yield than Stock X.b.One year from now, Stock X's price is expected to be higher than Stock Y's price.c.Stock X has the higher expected year-end dividend.d.Stock Y has a higher capital gains yield.e.Stock X has a higher dividend yield than Stock Y.
ANS:
29.Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT?
Expected dividend, D1$3.00Current Price, P0$50Expected constant growth rate6.0%
a.The stock's expected dividend yield and growth rate are equal.b.The stock's expected dividend yield is 5%.c.The stock's expected capital gains yield is 5%.d.The stock's expected price 10 years from now is $100.00.e.The stock's required return is 10%.
ANS:
30.Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
XYPrice$25$25Expected dividend yield5%3%Required return12%10%
a.Stock X pays a higher dividend per share than Stock Y.b.One year from now, Stock X should have the higher price.c.Stock Y has a lower expected growth rate than Stock X.d.Stock Y has the higher expected capital gains yield.e.Stock Y pays a higher dividend per share than Stock X.
ANS:A
31.Merrell Enterprises' stock has an expected return of 14%. The stock's dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT?a.The stock's dividend yield is 8%.b.The current dividend per share is $4.00.c.The stock price is expected to be $54 a share one year from now.d.The stock price is expected to be $57 a share one year from now.e.The stock's dividend yield is 7%.
ANS:
32.Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT?a.Stock B must have a higher dividend yield than Stock A.b.Stock A must have a higher dividend yield than Stock B.c.If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's.d.Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.e.If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's.
ANS:E
PTS:1DIF:Difficulty: ModerateOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Dividend yield and gKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
33.Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT?a.If one stock has a higher dividend yield, it must also have a lower dividend growth rate.b.If one stock has a higher dividend yield, it must also have a higher dividend growth rate.c.The two stocks must have the same dividend growth rate.d.The two stocks must have the same dividend yield.e.The two stocks must have the same dividend per share.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Dividend yield and gKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
34.Which of the following statements is CORRECT, assuming stocks are in equilibrium?a.Assume that the required return on a given stock is 13%. If the stock's dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.b.A stock's dividend yield can never exceed its expected growth rate.c.A required condition for one to use the constant growth model is that the stock's expected growth rate exceeds its required rate of return.d.Other things held constant, the higher a company's beta coefficient, the lower its required rate of return.e.The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.
ANS:EPTS:1DIF:Difficulty: ModerateOBJ:LO: 7-5NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Dividend yield and gKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
35.Which of the following statements is NOT CORRECT?a.The corporate valuation model discounts free cash flows by the required return on equity.b.The corporate valuation model can be used to find the value of a division.c.An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements.d.Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value.e.The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 7-7NAT:BUSPROG: AnalyticSTA:DISC: Financial statements, analysis, forecasting, and cash flowsLOC:TBATOP:Corporate valuation modelKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: Conceptual
36.Which of the following statements is CORRECT?a.The preferred stock of a given firm is generally less risky to investors than the same firm's common stock.b.Corporations cannot buy the preferred stocks of other corporations.c.Preferred dividends are not generally cumulative.d.A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.e.Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.
ANS:APTS:1DIF:Difficulty: ModerateOBJ:LO: 7-9NAT:BUSPROG: AnalyticSTA:DISC: Stocks and bondsLOC:TBATOP:Preferred stock conceptsKEY:Bloom’s: AnalysisMSC:TYPE: Multiple Choice: ConceptualNOT:Question may require calculations to find the correct answer.
37.Which of the following statements is CORRECT?a.Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.b.The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.c.One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free.d.One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.e.A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.
ANS:
38.Which of the following statements is CORRECT?a.The preemptive right gives stockholders the right to approve or disapprove of a merger between their company and some other company.b.The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm's common stock.c.The stock valuation model, P0 = D1/(rs − g), cannot be used for firms that have negative growth rates.d.The stock valuation model, P0 = D1/(rs − g), can be used only for firms whose growth rates exceed their required returns.e.If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but under all state charters the two classes must have the same voting rights.
ANS:
39.The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT?a.If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X.b.If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price.c.The stocks must sell for the same price.d.Stock Y must have a higher dividend yield than Stock X.e.If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.
ANS:
40.Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
ABBeta1.100.90Constant growth rate7.00%7.00%
a.Stock A must have a higher dividend yield than Stock B.b.Stock B's dividend yield equals its expected dividend growth rate.c.Stock B must have the higher required return.d.Stock B could have the higher expected return.e.Stock A must have a higher stock price than Stock B.
ANS:
41.A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock's current price?a.$17.39b.$17.84c.$18.29d.$18.75e.$19.22
ANS:
42.A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?a.$23.11b.$23.70c.$24.31d.$24.93e.$25.57
ANS:
43.A share of Lash Inc.'s common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 11.4%, what is the stock price?a.$16.28b.$16.70c.$17.13d.$17.57e.$18.01
ANS:
44.Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $32.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate?a.6.01%b.6.17%c.6.33%d.6.49%e.6.65%
ANS:
45.$35.50 per share is the current price for Foster Farms' stock. The dividend is projected to increase at a constant rate of 5.50% per year. The required rate of return on the stock, rs, is 9.00%. What is the stock's expected price 3 years from today?a.$37.86b.$38.83c.$39.83d.$40.85e.$41.69
ANS:
46.Kelly Enterprises' stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 4.75% per year. The required rate of return on the stock, rs, is 11.50%. What is the stock's expected price 5 years from now?a.$40.17b.$41.20c.$42.26d.$43.34e.$44.46
ANS:
47.If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $26.00, what is the stock's expected dividend yield for the coming year?a.4.12%b.4.34%c.4.57%d.4.81%e.5.05%
ANS:
48.If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock's expected dividend yield for the coming year?a.4.42%b.4.66%c.4.89%d.5.13%e.5.39%
ANS:
49.If D1 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock's expected capital gains yield for the coming year?a.6.50%b.6.83%c.7.17%d.7.52%e.7.90%
ANS:
50.If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock's expected total return for the coming year?a.7.54%b.7.73%c.7.93%d.8.13%e.8.34%
ANS:
51.If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock's expected total return for the coming year?a.8.37%b.8.59%c.8.81%d.9.03%e.9.27%
ANS:
52.Barnette Inc.'s free cash flows are expected to be unstable during the next few years while the company undergoes restructuring. However, FCF is expected to be $50 million in Year 5, i.e., FCF at t = 5 equals $50 million, and the FCF growth rate is expected to be constant at 6% beyond that point. If the weighted average cost of capital is 12%, what is the horizon value (in millions) at t = 5?a.$719b.$757c.$797d.$839e.$883
ANS:
53.Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at t = 3?a.$840b.$882c.$926d.$972e.$1,021
ANS:
54.Young & Liu Inc.'s free cash flow during the just-ended year (t = 0) was $100 million, and FCF is expected to grow at a constant rate of 5% in the future. If the weighted average cost of capital is 15%, what is the firm's value of operations, in millions?a.$948b.$998c.$1,050d.$1,103e.$1,158
ANS:
55.The projected cash flow for the next year for Minesuah Inc. is $100,000, and FCF is expected to grow at a constant rate of 6%. If the company's weighted average cost of capital is 11%, what is the value of its operations?a.$1,714,750b.$1,805,000c.$1,900,000d.$2,000,000e.$2,100,000
ANS:
56.Carby Hardware has an outstanding issue of perpetual preferred stock with an annual dividend of $7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the preferred stock sell?a.$104.27b.$106.95c.$109.69d.$112.50e.$115.38
ANS:
57.Dyer Furniture is expected to pay a dividend of D1 = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is Dyer's current stock price?a.$28.90b.$29.62c.$30.36d.$31.12e.$31.90
ANS:
58.The Jameson Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company's beta is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is Jameson's current stock price, P0?a.$18.62b.$19.08c.$19.56d.$20.05e.$20.55
ANS:
59.National Advertising just paid a dividend of D0 = $0.75 per share, and that dividend is expected to grow at a constant rate of 6.50% per year in the future. The company's beta is 1.25, the required return on the market is 10.50%, and the risk-free rate is 4.50%. What is the company's current stock price?a.$14.52b.$14.89c.$15.26d.$15.64e.$16.03
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60.Kellner Motor Co.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per share. Kellner's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend, D0?a.$0.95b.$1.05c.$1.16d.$1.27e.$1.40
ANS:
61.Hirshfeld Corporation's stock has a required rate of return of 10.25%, and it sells for $57.50 per share. The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-end dividend, D1?a.$2.20b.$2.44c.$2.69d.$2.96e.$3.25
ANS:
62.Connolly Co.'s expected year-end dividend is D1 = $1.60, its required return is rs = 11.00%, its dividend yield is 6.00%, and its growth rate is expected to be constant in the future. What is Connolly's expected stock price in 7 years, i.e., what is ?a.$37.52b.$39.40c.$41.37d.$43.44e.$45.61
ANS:
63.Alcott's preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $45.00, what is its nominal (not effective) annual rate of return?a.8.03%b.8.24%c.8.45%d.8.67%e.8.89%
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64.Connor Publishing's preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share. What is its effective annual (not nominal) rate of return?a.6.62%b.6.82%c.7.03%d.7.25%e.7.47%
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65.Burke Tires just paid a dividend of D0 = $1.32. Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What is the best estimate of the stock's current market value?a.$41.59b.$42.65c.$43.75d.$44.87e.$45.99
ANS:
66.Kinkead Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be −$10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14%, what is the firm's value of operations, in millions?a.$158b.$167c.$175d.$184e.$193
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67.The free cash flows (in millions) shown below are forecast by Parker & Sons. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments).
Year:12Free cash flow:−$50$100
a.$1,456b.$1,529c.$1,606d.$1,686e.$1,770
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68.Heath and Logan Inc. forecasts the free cash flows (in millions) shown below. The weighted average cost of capital is 13%, and the FCFs are expected to continue growing at a 5% rate after Year 3. Assuming that the ROIC is expected to remain constant in Year 3 and beyond, what is the Year 0 value of operations, in millions?
Year:123Free cash flow:−$15$10$40
a.$315b.$331c.$348d.$367e.$386
ANS:
69.Reynolds Construction's value of operations is $750 million based on the corporate valuation model. Its balance sheet shows $50 million of short-term investments that are unrelated to operations, $100 million of accounts payable, $100 million of notes payable, $200 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?a.$429b.$451c.$475d.$500e.$525
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70.Based on the corporate valuation model, the value of Weidner Co.'s operations is $1,200 million. The company's balance sheet shows $80 million in accounts receivable, $60 million in inventory, and $100 million in short-term investments that are unrelated to operations. The balance sheet also shows $90 million in accounts payable, $120 million in notes payable, $300 million in long-term debt, $50 million in preferred stock, $180 million in retained earnings, and $800 million in total common equity. If Weidner has 30 million shares of stock outstanding, what is the best estimate of the stock's price per share?a.$24.90b.$27.67c.$30.43d.$33.48e.$36.82
ANS:
71.The value of Broadway-Brooks Inc.'s operations is $900 million, based on the corporate valuation model. Its balance sheet shows $70 million in accounts receivable, $50 million in inventory, $30 million in short-term investments that are unrelated to operations, $20 million in accounts payable, $110 million in notes payable, $90 million in long-term debt, $20 million in preferred stock, $140 million in retained earnings, and $280 million in total common equity. If the company has 25 million shares of stock outstanding, what is the best estimate of the stock's price per share?a.$23.00b.$25.56c.$28.40d.$31.24e.$34.36
ANS:
72.Based on the corporate valuation model, Bizzaro Co.'s value of operations is $300 million. The balance sheet shows $20 million of short-term investments that are unrelated to operations, $50 million of accounts payable, $90 million of notes payable, $30 million of long-term debt, $40 million of preferred stock, and $100 million of common equity. Bizzaro has 10 million shares of stock outstanding. What is the best estimate of the stock's price per share?a.$13.72b.$14.44c.$15.20d.$16.00e.$16.80
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73.McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0. The company's last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?a.$26.77b.$27.89c.$29.05d.$30.21e.$31.42
ANS:
74.Orwell Building Supplies' last dividend was $1.75. Its dividend growth rate is expected to be constant at 25% for 2 years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best estimate of the current stock price?a.$41.58b.$42.64c.$43.71d.$44.80e.$45.92
ANS:
75.The last dividend paid by Wilden Corporation was $1.55. The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (rs) is 12.0%. What is the best estimate of the current stock price?a.$37.05b.$38.16c.$39.30d.$40.48e.$41.70
ANS:
76.The last dividend paid by Coppard Inc. was $1.25. The dividend growth rate is expected to be constant at 15% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If the firm's required return (rs) is 11%, what is its current stock price?a.$30.57b.$31.52c.$32.49d.$33.50e.$34.50
ANS:
77.Sawchuck Consulting has been profitable for the last 5 years, but it has never paid a dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's forecast of the future dividend stream, along with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value?
Year0123456Growth rateNANANANA50.00%25.00%8.00%Dividends$0.000$0.000$0.000$0.250$0.375$0.469$0.506
a.$9.94b.$10.19c.$10.45d.$10.72e.$10.99
ANS:
78.The free cash flows (in millions) shown below are forecast by Simmons Inc. If the weighted average cost of capital is 13% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is the Year 0 value of operations, in millions?
Year:123Free cash flow:−$20$42$45
a.$586b.$617c.$648d.$680e.$714
ANS:
79.The required return for Williamson Heating's stock is 12%, and the stock sells for $40 per share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D4 = $1.00(1.30)4 = $2.8561. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock's expected constant growth rate after t = 4, i.e., what is X?a.5.17%b.5.44%c.5.72%d.6.02%e.6.34%
ANS:
80.Julia Saunders is your boss and the treasurer of Foster Carter Enterprises (FCE). She asked you to help her estimate the intrinsic value of the company's stock. FCE just paid a dividend of $1.00, and the stock now sells for $15.00 per share. Julia asked a number of security analysts what they believe FCE's future dividends will be, based on their analysis of the company. The consensus is that the dividend will be increased by 10% during Years 1 to 3, and it will be increased at a rate of 5% per year in Year 4 and thereafter. Julia asked you to use that information to estimate the required rate of return on the stock, rs, and she provided you with the following template for use in the analysis:
Julia told you that the growth rates in the template were just put in as a trial, and that you must replace them with the analysts' forecasted rates to get the correct forecasted dividends and then the estimated TV. She also notes that the estimated value for rs, at the top of the template, is also just a guess, and you must replace it with a value that will cause the Calculated Price shown at the bottom to equal the Actual Market Price. She suggests that, after you have put in the correct dividends, you can manually calculate the price, using a series of guesses as to the Estimated rs. The value of rs that causes the calculated price to equal the actual price is the correct one. She notes, though, that this trial-and-error process would be quite tedious, and that the correct rs could be found much faster with a simple Excel model, especially if you use Goal Seek. What is the value of rs?a.11.84%b.12.21%c.12.58%d.12.97%e.13.36%
ANS:
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FIN 535 Week 5 Midterm Exam – Strayer New
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Chapter 1 Through 7
Chapter 1—Multinational Financial Management: An Overview
1. The commonly accepted goal of the MNC is to:
a.
maximize short-term earnings.
b.
maximize shareholder wealth.
c.
minimize risk.
d.
A and C.
e.
maximize international sales.
PTS: 1 DIF: Easy OBJ: INFM.MADU.15.01.01
NAT: BUSPROG.INFM .MADU.15.03 STA: DISC.INFM.MADU.15.02
KEY: Bloom's: Knowledge
2. With regard to corporate goals, an MNC is mostly concerned with maximizing ____, and a purely domestic firm is mostly concerned with maximizing ____.
a.
shareholder wealth; short-term earnings
b.
shareholder wealth; shareholder wealth
c.
short-term earnings; sales volume
d.
short-term earnings; shareholder wealth
PTS: 1 DIF: Easy OBJ: INFM.MADU.15.01.01
NAT: BUSPROG.INFM .MADU.15.03 STA: DISC.INFM.MADU.15.02
KEY: Bloom's: Knowledge
3. For the MNC, agency costs are typically:
a.
non-existent.
b.
larger than agency costs of a small purely domestic firm.
c.
smaller than agency costs of a small purely domestic firm.
d.
the same as agency costs of a small purely domestic firm.
PTS: 1 DIF: Easy OBJ: INFM.MADU.15.01.01
NAT: BUSPROG.INFM .MADU.15.03 STA: DISC.INFM.MADU.15.02
KEY: Bloom's: Knowledge
4. Which of the following could reduce agency problems for an MNC?
a.
stock options as managerial compensation.
b.
hostile takeover threat.
c.
investor monitoring.
d.
all of the above are forms of corporate control that could reduce agency problems for an MNC.
PTS: 1 DIF: Moderate OBJ: INFM.MADU.15.01.01
NAT: BUSPROG.INFM .MADU.15.03 STA: DISC.INFM.MADU.15.02
KEY: Bloom's: Comprehension
5. The valuation of an MNC should rise when an event causes the expected cash flows from foreign to ____ and when foreign currencies denominating these cash flows are expected to ____.
a.
decrease; appreciate
b.
increase; appreciate
c.
decrease; depreciate
d.
increase; depreciate
PTS: 1 DIF: Easy OBJ: INFM.MADU.15.01.04
NAT: BUSPROG.INFM .MADU.15.03 STA: DISC.INFM.MADU.15.02
KEY: Bloom's: Comprehension
6. Which of the following theories identifies specialization as a reason for international business?
a.
theory of comparative advantage.
b.
imperfect markets theory.
c.
product cycle theory.
d.
none of the above
PTS: 1 DIF: Easy OBJ: INFM.MADU.15.01.02
NAT: BUSPROG.INFM .MADU.15.03 STA: DISC.INFM.MADU.15.02
KEY: Bloom's: Knowledge
7. Which of the following theories identifies the non-transferability of resources as a reason for international business?
a.
theory of comparative advantage.
b.
imperfect markets theory.
c.
product cycle theory.
d.
none of the above
PTS: 1 DIF: Easy OBJ: INFM.MADU.15.01.02
NAT: BUSPROG.INFM .MADU.15.03 STA: DISC.INFM.MADU.15.02
KEY: Bloom's: Knowledge
8. Which of the following theories suggests that firms seek to penetrate new markets over time?
a.
theory of comparative advantage.
b.
imperfect markets theory.
c.
product cycle theory.
d.
none of the above
PTS: 1 DIF: Easy OBJ: INFM.MADU.15.01.02
NAT: BUSPROG.INFM .MADU.15.03 STA: DISC.INFM.MADU.15.02
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FIN 540 Week 5 Midterm Exam – Strayer NEW
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Midterm Exam Chapter 18 Through 23
CHAPTER 18—PUBLIC AND PRIVATE FINANCING: INITIAL OFFERINGS, SEASONED OFFERINGS, AND INVESTMENT BANKS
TRUE/FALSE
1. If its managers make a tender offer and buy all shares that were not held by the management team, this is called a private placement.
2. Going public establishes a market value for the firm's stock, and it also ensures that a liquid market will continue to exist for the firm's shares. This is especially true for small firms that are not widely followed by security analysts.
3. The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.
4. The term "leaving money on the table" refers to the situation where an investment banking house makes a very low bid for the right to underwrite a firm's new stock offering. The banker is, in effect, "buying the job" with the low bid and thus not getting all the money his firm would normally earn on the job.
5. Whereas commercial banks take deposits from some customers and make loans to other customers, the principal activities of investment banks are (1) to help firms issue new stock and bonds and (2) to give firms advice with regard to mergers and other financial matters. However, financial corporations often own and operate subsidiaries that operate as commercial banks and others that are investment banks. This was not true some years ago, when the two types of banks were required by law to be completely independent of one another.
6. The term "equity carve-out" refers to the situation where a firm's managers give themselves the right to purchase new stock at a price far below the going market price. Since this dilutes the value of the public stockholders, it "carves out" some of their value.
7. Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.
8. The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.
9. If the firm uses the after-tax cost of new debt as the discount rate when analyzing a refunding decision, and if the NPV of refunding is positive, then the value of the firm will be maximized if it immediately calls the outstanding debt and replaces it with an issue that has a lower coupon rate.
10. When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.
MULTIPLE CHOICE
11. Which of the following is generally NOT true and an advantage of going public?
a.
Increases the liquidity of the firm's stock.
b.
Makes it easier to obtain new equity capital.
c.
Establishes a market value for the firm.
d.
Makes it easier for owner-managers to engage in profitable self-dealings.
e.
Facilitates stockholder diversification.
12. Which of the following statements about listing on a stock exchange is most CORRECT?
a.
Any firm can be listed on the NYSE as long as it pays the listing fee.
b.
Listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do more business.
c.
Listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather than with the SEC.
d.
The OTC is the second largest market for listed stock, and it is exceeded only by the NYSE.
e.
Listing is a decision of more significance to a firm than going public.
13. Which of the following statements is most CORRECT?
a.
Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
b.
Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
c.
The SEC requires that all private placements be handled by a registered investment banker.
d.
Private placements can generally bring in funds faster than is the case with public offerings.
e.
In a private placement, securities are sold to private (individual) investors rather than to institutions.
14. Which of the following statements is most CORRECT?
a.
The key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity.
b.
The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.
c.
If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen.
d.
Suppose a firm is considering refunding and interest rates rise during time when the analysis is being done. The rise in rates would tend to lower the expected price of the new bonds, which would make them cheaper to the firm and thus increase the expected interest savings.
e.
If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.
15. Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?
a.
A provision in the bond indenture lowers the call price on specific dates, and yesterday was one of those dates.
b.
The flotation costs associated with issuing new bonds rise.
c.
The firm's CFO believes that interest rates are likely to decline in the future.
d.
The firm's CFO believes that corporate tax rates are likely to be increased in the future.
e.
The yield to maturity on the company's outstanding bonds increases due to a weakening of the firm's financial situation.
16. Which of the following statements concerning common stock and the investment banking process is NOT CORRECT?
a.
If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market.
b.
Listing a large firm's stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm.
c.
Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with management's performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.
d.
The announcement of a large issue of new stock could cause the stock price to fall. This loss is called "market pressure," and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue.
e.
The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.
17. Which of the following statements is NOTCORRECT?
a.
"Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.
b.
Publicly owned companies have sold shares to investors who are not associated with management, and they must register with and report to a regulatory agency such as the SEC.
c.
When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market.
d.
It is possible for a firm to go public and yet not raise any additional new capital.
e.
When a corporation's shares are owned by a few individuals who own most of the stock or are part of the firm's management, we say that the firm is "closely, or privately, held."
18. In its negotiations with its investment bankers, Patton Electronics has reached an agreement whereby the investment bankers receive a smaller fee now (6% of gross proceeds versus their normal 10%) but also receive a 1-year option to purchase an additional 200,000 shares at $5.00 per share. Patton will go public by selling $5,000,000 of new common stock. The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly one year, when the stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12.00 per share one year from now. If the $12 price occurs, what would the present value of the entire underwriting compensation be? Assume that the investment banker's required return on such arrangements is 15%, and ignore taxes.
a.
$1,235,925
b.
$1,300,973
c.
$1,369,446
d.
$1,441,522
e.
$1,517,391
19. To finance its ongoing construction project, Bowen-Roth Inc. will need $5,000,000 of new capital during each of the next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 40% debt and 60% equity, and it wants to be at that structure in 3 years, when the project has been completed. Debt flotation costs for a single debt issue would be 1.6% of the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt would be 3.0% of the gross amount. Ignoring time value effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in 3 separate issues?
a.
$79,425
b.
$83,606
c.
$88,006
d.
$92,406
e.
$97,027
20. 10 years ago, the City of Melrose issued $3,000,000 of 8% coupon, 30-year, semiannual payment, tax-exempt muni bonds. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be 6% of the face amount. New 20-year, 6%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2% of the amount of bonds sold. What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.
a.
$453,443
b.
$476,115
c.
$499,921
d.
$524,917
e.
$551,163
21. Five years ago, the State of Oklahoma issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds. The bonds had 5 years of call protection, but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refunding? Because these are tax-exempt bonds, taxes are not relevant.
a.
$278,606
b.
$292,536
c.
$307,163
d.
$322,521
e.
$338,647
22. Palmer Company has $5,000,000 of 15-year maturity bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0%. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations⎯assume that the firm's tax rate is zero.
The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?
a.
9.57%
b.
10.07%
c.
10.60%
d.
11.16%
e.
11.72%
23. Stanovich Enterprises has 10-year, 12.0% semiannual coupon bonds outstanding. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?
a.
9.29%
b.
9.78%
c.
10.29%
d.
10.81%
e.
11.35%
24. Refer to Exhibit 18.1. What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?
a.
$5,049,939
b.
$5,315,725
c.
$5,595,500
d.
$5,890,000
e.
$6,200,000
25. Refer to Exhibit 18.1. What will the after-tax annual interest savings for NWW be if the refunding takes place?
a.
$664,050
b.
$699,000
c.
$768,900
d.
$845,790
e.
$930,369
26. Refer to Exhibit 18.1. The amortization of flotation costs reduces taxes and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?
a.
$6,480
b.
$7,200
c.
$8,000
d.
$8,800
e.
$9,680
27. Refer to Exhibit 18.1. What is the NPV if NWW refunds its bonds today?
a.
$1,746,987
b.
$1,838,933
c.
$1,935,719
d.
$2,037,599
e.
$2,241,359
CHAPTER 19—LEASE FINANCING
TRUE/FALSE
1. Many leases written today combine the features of operating and financial leases. Such leases are often called "combination leases."
2. A sale and leaseback arrangement is a type of financial, or capital, lease.
3. Operating leases help to shift the risk of obsolescence from the user to the lessor.
4. Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor.
5. The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines.
6. Leasing is often referred to as off-balance sheet financing because lease payments are shown as operating expenses on a firm's income statement and, under certain conditions, leased assets and associated liabilities do not appear on the firm's balance sheet.
7. Leasing is typically a financing decision and not a capital budgeting decision. Thus, the availability of lease financing cannot affect the size of the capital budget.
8. A leveraged lease is more risky from the lessee's standpoint than an unleveraged lease.
9. A synthetic lease is a combination of derivative securities and asset purchases that mimic the cash flows of an operating lease.
10. In a synthetic lease a special purpose entity (SPE) is set up by a corporation that wants to acquire the use of an asset. The SPE borrows up to 97% of its capital, uses its funds to buy the asset, and then leases it to the sponsoring corporation on a short-term basis. This keeps both the asset and the debt off the sponsoring company's books.
11. If a leased asset has a negative residual value, for example, as a result of a statutory requirement to dispose of an asset in an environmentally sound manner, the lessee of the asset could reasonably expect to pay a lower lease rate because the asset does not have a positive residual value.
12. Assume that a piece of leased equipment has a relatively high rather than low expected residual value. From the lessee's viewpoint, it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.
MULTIPLE CHOICE
13. From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's
a.
capital budgeting project cash flows.
b.
debt cash flows.
c.
pension fund cash flows.
d.
sales.
e.
equity cash flows.
14. Operating leases often have terms that include
a.
full amortization over the life of the lease.
b.
very high penalties if the lease is canceled.
c.
restrictions on how much the leased property can be used.
d.
much longer lease periods than for most financial leases.
e.
maintenance of the equipment by the lessor.
15. Which of the following statements is most CORRECT?
a.
Capitalizing a lease means that the firm issues equity capital in proportion to its current capital structure, in an amount sufficient to support the lease payment obligation.
b.
The fixed charges associated with a lease can be as high as, but never greater than, the fixed payments associated with a loan.
c.
Capital, or financial, leases generally provide for maintenance by the lessor.
d.
A key difference between a capital lease and an operating lease is that with a capital lease, the lease payments provide the lessor with a return of the funds invested in the asset plus a return on the invested funds, whereas with an operating lease the lessor depends on the residual value to realize a full return of and on the investment.
e.
Firms that use "off balance sheet" financing, such as leasing, would show lower debt ratios if the effects of their leases were reflected in their financial statements.
16. Financial Accounting Standards Board (FASB) Statement #13 requires that for an unqualified audit report, financial (or capital) leases must be included in the balance sheet by reporting the
a.
residual value as a liability.
b.
present value of future lease payments as an asset and also showing this same amount as an offsetting liability.
c.
undiscounted sum of future lease payments as an asset and as an offsetting liability.
d.
undiscounted sum of future lease payments, less the residual value, as an asset and as an offsetting liability.
e.
residual value as a fixed asset.
17. Heavy use of off-balance sheet lease financing will tend to
a.
make a company appear less risky than it actually is because its stated debt ratio will appear lower.
b.
affect a company's cash flows but not its degree of risk.
c.
have no effect on either cash flows or risk because the cash flows are already reflected in the income statement.
d.
affect the lessee's cash flows but only due to tax effects.
e.
make a company appear more risky than it actually is because its stated debt ratio will be increased.
18. In the lease versus buy decision, leasing is often preferable
a.
because, generally, no down payment is required, and there are no indirect interest costs.
b.
because lease obligations do not affect the firm's risk as seen by investors.
c.
because the lessee owns the property at the end of the least term.
d.
because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.
e.
because it has no effect on the firm's ability to borrow to make other investments.
19. A lease versus purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased
a.
is financed with long-term debt.
b.
is financed with debt whose maturity matches the term of the lease.
c.
is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC.
d.
is financed with retained earnings.
e.
is financed with short-term debt.
20. Stanley Inc. must purchase $6,000,000 worth of service equipment and is weighing the merits of leasing the equipment or purchasing. The company has a zero tax rate due to tax loss carry-forwards, and is considering a 5-year, bank loan to finance the equipment. The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments. Stanley can also lease the equipment for 5 end-of-year payments of $1,790,000 each. How much larger or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment.
a.
$177,169
b.
$196,854
c.
$207,215
d.
$217,576
e.
$228,455
21. To finance some manufacturing tools it needs for the next 3 years, Waldrop Corporation is considering a leasing arrangement. The tools will be obsolete and worthless after 3 years. The firm will depreciate the cost of the tools on a straight-line basis over their 3-year life. It can borrow $4,800,000, the purchase price, at 10% and buy the tools, or it can make 3 equal end-of-year lease payments of $2,100,000 each and lease them. The loan obtained from the bank is a 3-year simple interest loan, with interest paid at the end of the year. The firm's tax rate is 40%. Annual maintenance costs associated with ownership are estimated at $240,000, but this cost would be borne by the lessor if it leases. What is the net advantage to leasing (NAL), in thousands? (Suggestion: Delete 3 zeros from dollars and work in thousands.)
a.
$96
b.
$106
c.
$112
d.
$117
e.
$123
22. Delamont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC's tax rate is 40%. What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)
a.
$849
b.
$896
c.
$945
d.
$999
e.
$1,047
23. Carmichael Cleaners needs a new steam finishing machine that costs $100,000. The company is evaluating whether it should lease or purchase the machine. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment after 3 years is $30,000. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $29,000 per year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 20% tax bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the equipment at a before-tax cost of 10%. If there is a positive Net Advantage to Leasing the firm will lease the equipment. Otherwise, it will buy it. What is the NAL? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741.)
a.
$5,734
b.
$6,023
c.
$6,324
d.
$6,640
e.
$6,972
CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, WARRANTS, AND CONVERTIBLES
TRUE/FALSE
1. The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.
2. Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.
3. A warrant is an option, and as such it cannot be used as a "sweetener."
4. A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.
5. The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.
6. A detachable warrant is a warrant that can be detached and traded separately from the bond with which it was issued. Most traded warrants are originally attached to bonds or preferred stocks.
7. The owner of a convertible bond owns, in effect, both a bond and a call option.
8. A convertible debenture can never sell for more than its conversion value or less than its bond value.
9. Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.
10. Firms generally do not call their convertibles unless the conversion value is greater than the call price.
11. Many preferred stocks extend voting rights to preferred shareholders if the preferred dividend has been omitted for some specified period, for example, 4 quarters.
12. Preferred stockholders have priority over common stockholders with respect to dividends, because dividends must be paid on preferred stock before they can be paid on common stock. However, preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy.
13. Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.
14. Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.
15. Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, which is desirable for liquidity portfolios, and they also benefit from the 70% tax exemption on preferred dividends received.
MULTIPLE CHOICE
16. Which of the following statements is most CORRECT?
a.
By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firm's common stock.
b.
From the issuer's point of view, preferred stock is less risky than bonds.
c.
Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally 25 years or less.
d.
Unlike bonds, preferred stock cannot have a convertible feature.
e.
Preferred stock generally has a higher component cost of capital to the firm than does common stock.
17. Which of the following statements about convertibles is most CORRECT?
a.
One advantage of convertibles over warrants is that the issuer receives additional cash money when convertibles are converted.
b.
Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt because convertibles are less risky than straight debt.
c.
At the time it is issued, a convertible's conversion (or exercise) price is generally set equal to or below the underlying stock's price.
d.
For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm's otherwise similar straight debt and the expected return on its common stock.
e.
The coupon interest rate on a firm's convertibles is generally set higher than the market yield on its otherwise similar straight debt.
18. Which of the following statements concerning warrants is correct?
a.
Warrants are long-term put options that have value because holders can sell the firm's common stock at the exercise price regardless of how low the market price drops.
b.
Warrants are long-term call options that have value because holders can buy the firm's common stock at the exercise price regardless of how high the stock's price has risen.
c.
A firm's investors would generally prefer to see it issue bonds with warrants than straight bonds because the warrants dilute the value of new shareholders, and that value is transferred to existing shareholders.
d.
A drawback to using warrants is that if the firm is very successful, investors will be less likely to exercise the warrants, and this will deprive the firm of receiving any new capital.
e.
Bonds with warrants and convertible bonds both have option features that their holders can exercise if the underlying stock's price increases. However, if the option is exercised, the issuing company's debt declines if warrants were used but remains the same if it used convertibles.
19. Which of the following statements is most CORRECT?
a.
One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds.
b.
The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt.
c.
The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant.
d.
Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual.
e.
Warrants have an option feature but convertibles do not.
20. The common stock of Southern Airlines currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2025. What is the conversion value of the bond?
a.
$707.33
b.
$744.56
c.
$783.75
d.
$825.00
e.
$866.25
21. Convertible debentures for Kulik Corporation were issued at their $1,000 par value in 2012. At any time prior to maturity on February 1, 2032, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?
a.
$40.00
b.
$42.00
c.
$44.10
d.
$46.31
e.
$48.62
22. Mariano Manufacturing can issue a 25-year, 8.1% annual payment bond at par. Its investment bankers also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.0%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?
a.
6.66%
b.
6.99%
c.
7.34%
d.
7.71%
e.
8.09%
23. Preissle Company, wants to sell some 20-year, annual interest, $1,000 par value bonds. Its stock sells for $42 per share, and each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm's straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?
a.
7.83%
b.
8.24%
c.
8.65%
d.
9.08%
e.
9.54%
24. McGovern Enterprises is interested in issuing bonds with warrants attached. The bonds will have a 30-year maturity and annual interest payments. Each bond will come with 20 warrants that give the holder the right to purchase one share of stock per warrant. The investment bankers estimate that each warrant will have a value of $10.00. A similar straight-debt issue would require a 10% coupon. What coupon rate should be set on the bonds-with-warrants so that the package would sell for $1,000?
a.
6.75%
b.
7.11%
c.
7.48%
d.
7.88%
e.
8.27%
25. Potter & Lopez Inc. just sold a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?
a.
$3.76
b.
$3.94
c.
$4.14
d.
$4.35
e.
$4.56
26. Mikkleson Mining stock is selling for $40 per share and has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. The company is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.00%. What is the estimated floor price of the convertible at the end of Year 3?
a.
$794.01
b.
$835.81
c.
$879.80
d.
$926.10
e.
$972.41
27. Refer to Exhibit 20.1. What is the bond's conversion ratio?
a.
27.14
b.
28.57
c.
30.00
d.
31.50
e.
33.08
28. Refer to Exhibit 20.1. What is the bond's conversion value?
a.
$698.15
b.
$734.89
c.
$773.57
d.
$814.29
e.
$857.14
29. Refer to Exhibit 20.1. What is the bond's straight-debt value?
a.
$684.78
b.
$720.82
c.
$758.76
d.
$798.70
e.
$838.63
30. Refer to Exhibit 20.1. What is the minimum price (or "floor" price) at which the Neuman's bonds should sell?
a.
$698.15
b.
$734.89
c.
$773.57
d.
$814.29
e.
$857.14
CHAPTER 21—DYNAMIC CAPITAL STRUCTURES
TRUE/FALSE
1. In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.
2. According to MM, in a world without taxes the optimal capital structure for a firm is approximately 100% debt financing.
3. MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.
4. MM showed that in a world without taxes, a firm's value is not affected by its capital structure.
5. The Miller model begins with the MM model with taxes and then adds personal taxes.
6. The Miller model begins with the MM model without corporate taxes and then adds personal taxes.
7. Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.
8. The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.
9. The MM model is the same as the Miller model, but with zero corporate taxes.
10. In the MM extension with growth, the appropriate discount rate for the tax shield is the unlevered cost of equity.
11. In the MM extension with growth, the appropriate discount rate for the tax shield is the WACC.
12. In the MM extension with growth, the appropriate discount rate for the tax shield is the after-tax cost of debt.
13. When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.
14. When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity.
MULTIPLE CHOICE
15. The major contribution of the Miller model is that it demonstrates that
a.
personal taxes decrease the value of using corporate debt.
b.
financial distress and agency costs reduce the value of using corporate debt.
c.
equity costs increase with financial leverage.
d.
debt costs increase with financial leverage.
e.
personal taxes increase the value of using corporate debt.
16. Which of the following statements concerning capital structure theory is NOT CORRECT?
a.
Under MM with zero taxes, financial leverage has no effect on a firm's value.
b.
Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt.
c.
Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing.
d.
Under MM with corporate taxes, the effect of business risk is automatically incorporated because rsL is a function of rsU.
e.
The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.
17. Which of the following statements concerning the MM extension with growth is NOT CORRECT?
a.
The value of a growing tax shield is greater than the value of a constant tax shield.
b.
For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions.
c.
For a given D/S, the WACC is less than the WACC under MM's original (with tax) assumptions.
d.
The total value of the firm increases with the amount of debt.
e.
The tax shields should be discounted at the unlevered cost of equity.
18. Which of the following statements concerning the MM extension with growth is NOT CORRECT?
a.
The value of a growing tax shield is greater than the value of a constant tax shield.
b.
For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions.
c.
For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions.
d.
The total value of the firm increases with the amount of debt.
e.
The tax shields should be discounted at the cost of debt.
19. Which of the following statements concerning the MM extension with growth is NOT CORRECT?
a.
The value of a growing tax shield is greater than the value of a constant tax shield.
b.
For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions.
c.
For a given D/S, the WACC is greater than the WACC under MM's original (with tax) assumptions.
d.
The total value of the firm is independent of the amount of debt it uses.
e.
The tax shields should be discounted at the unlevered cost of equity.
20. The market value of Firm L's debt is $200,000 and its yield is 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is Firm L's cost of equity?
a.
11.4%
b.
12.0%
c.
12.6%
d.
13.3%
e.
14.0%
21. The market value of Firm L's debt is $200,000 and its yield is 9%. The firm's equity has a market value of $300,000, its earnings are growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what would Firm L's total value be if it had no debt?
a.
$358,421
b.
$377,286
c.
$397,143
d.
$417,000
e.
$437,850
22. A local firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is the value of your firm's tax shield, i.e., how much value does the use of debt add?
a.
$92,571
b.
$102,857
c.
$113,143
d.
$124,457
e.
$136,903
23. Refer to Exhibit 21.1. What is the value of the firm according to MM with corporate taxes?
a.
$475,875
b.
$528,750
c.
$587,500
d.
$646,250
e.
$710,875
24. Refer to Exhibit 21.1. What is the firm's cost of equity?
a.
21.0%
b.
23.3%
c.
25.9%
d.
28.8%
e.
32.0%
25. Refer to Exhibit 21.1. Assume that the firm's gain from leverage according to the Miller model is $126,667. If the effective personal tax rate on stock income is TS = 20%, what is the implied personal tax rate on debt income?
a.
16.4%
b.
18.2%
c.
20.2%
d.
22.5%
e.
25.0%
26. Refer to Exhibit 21.2. According to the MM extension with growth, what is the value of Kitto's tax shield?
a.
$156,385
b.
$164,616
c.
$173,280
d.
$182,400
e.
$192,000
27. Refer to Exhibit 21.2. According to the MM extension with growth, what is Kitto's unlevered value?
a.
$1,296,000
b.
$1,440,000
c.
$1,600,000
d.
$1,760,000
e.
$1,936,000
28. Refer to Exhibit 21.2. According to the MM extension with growth, what is Kitto's value of equity?
a.
$1,492,000
b.
$1,529,300
c.
$1,567,533
d.
$1,606,721
e.
$1,646,889
29. Refer to Exhibit 21.3. What is the value (in millions) of Wilson Dover's equity if it is viewed as an option?
a.
$228.77
b.
$254.19
c.
$282.43
d.
$313.81
e.
$345.19
30. Refer to Exhibit 21.3. What is the value (in millions) of Wilson Dover's debt if its equity is viewed as an option?
a.
$167.57
b.
$186.19
c.
$204.81
d.
$225.29
e.
$247.82
31. Refer to Exhibit 21.3. What is the yield on Wilson Dover's debt?
a.
6.04%
b.
6.36%
c.
6.70%
d.
7.05%
e.
7.42%
CHAPTER 22—MERGERS AND CORPORATE CONTROL
TRUE/FALSE
1. In a merger with true synergies, the post-merger value exceeds the sum of the separate companies' pre-merger values.
3. A spin-off is a type of divestiture in which the assets of a division are sold to another firm.
4. A conglomerate merger occurs when two firms with either a horizontal or a vertical business relationship combine.
5. Merger activity is likely to heat up when interest rates are high because target firms can expect to receive an especially high premium over the pre-announcement stock price.
6. Most defensive mergers occur as a result of managers' actions to maximize shareholders' wealth.
7. Post-merger control and the negotiated price paid by the acquirer are two of the most important issues in agreeing on the terms of a merger.
8. A company seeking to fight off a hostile takeover might employ the services of an investment banking firm to develop a defensive strategy.
9. Since the primary rationale for any operating merger is synergy, in planning such mergers, the development of accurate pro forma cash flows is the single most important action.
10. Currently (2012), mergers can be accounted for using either the purchase method or the pooling method.
11. Borrowing funds on terms that would require immediate repayment of all funds if the firm is acquired, selling off valuable assets, and granting huge "golden parachutes" that open if the firm is acquired are three procedures used to defend against hostile takeovers. These strategies are known as "poison pills."
12. A joint venture is one in which two, or sometimes more, independent companies agree to combine resources in order to achieve a specific objective, usually limited in scope.
13. The two principal advantages of holding companies are (1) the holding company can control a great deal of assets with limited equity and (2) the dividends received by the parent from the subsidiary are not taxed if the parent holds at least 50% of the subsidiary's stock.
14. The purchase of assets at below their replacement cost and tax considerations are two factors that motivate mergers.
15. The primary reason managers give for most mergers is to acquire more assets so as to increase sales and market share.
16. Since managers' central goal is to maximize stock price, managerial control issues do not interfere with mergers that would benefit the target firm's stockholders.
17. One of the main reasons why foreign firms are interested in buying U.S. companies is to gain entrance to the U.S. market. A decline in the value of the dollar relative to most foreign currencies makes this competitive strategy especially attractive.
18. If a petrochemical firm that used oil as feedstock merged with an oil producer that had large oil reserves and a drilling subsidiary, this would be a vertical merger.
19. A congeneric merger is one where the merging firms operate in related businesses but do not necessarily produce the same products or have a producer-supplier relationship.
20. Since a manager's central goal is to maximize the firm's stock price, any merger offer that provides stockholders with significant gains over the current stock price will be approved by the current management team.
21. Only if a target firm's value is greater to the acquiring firm than its market value as a separate entity will a merger be financially justified.
22. Discounted cash flow methods are not appropriate for evaluating mergers because the cash flows are uncertain and the discount rate can only be determined after the merger is consummated.
23. In a financial merger, the relevant post-merger cash flows are simply the sum of the expected cash flows of the two companies, measured as if they were operated independently.
24. Coca-Cola's acquisition of Columbia Pictures and its announcement that it would operate its new subsidiary separately could be described as primarily a financial merger.
25. A two-tier merger offer is one where the acquiring company offers to purchase the target company in a two-part transaction. Cash is paid to some stockholders, bonds are issued to others, but the total values of each part of the transaction are equal.
26. The distribution of synergistic gains between the stockholders of two merged firms is almost always based strictly on their respective market values before the announcement of the merger.
27. The rate used to discount projected merger cash flows should be the cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.
28. Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting purposes.
29. Although goodwill created in a merger may not be amortized for shareholder reporting purposes, it may be amortized for Federal tax purposes.
30. The three main advantages of holding companies are (1) control with fractional ownership, (2) taxation benefits, and (3) isolation of operating risks.
31. If the capital structure is stable, and free cash flows are expected to be growing at a constant rate at the horizon date, then the horizon value is calculated by discounting the free cash flows plus the expected future tax shields at the weighted average cost of capital.
32. The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.
MULTIPLE CHOICE
33. Which of the following are legal and acceptable reasons for the high level of merger activity in the U.S. during the 1980s?
a.
A profitable firm acquires a firm with large accumulated tax losses that may be carried forward.
b.
Attempts to stabilize earnings by diversifying.
c.
Purchase of assets below their replacement costs.
d.
Reduction in competition resulting from mergers.
e.
Synergistic benefits arising from mergers.
34. Firms use defensive tactics to fight off undesired mergers. These tactics do not include
a.
getting a white squire to purchase stock in the firm.
b.
getting white knights to bid for the firm.
c.
repurchasing their own stock.
d.
changing the bylaws to eliminate supermajority voting requirements.
e.
raising antitrust issues.
35. Which of the following statements is most CORRECT?
a.
Regulations in the United States prohibit acquiring firms from using common stock to purchase another firm.
b.
Defensive mergers are designed to make a company less vulnerable to a takeover.
c.
Hostile mergers always create value for the acquiring firm.
d.
In a tender offer, the target firm's management always remain after the merger is completed.
e.
A conglomerate merger is one where a firm combines with another firm in the same industry.
36. Which of the following statements is most CORRECT?
a.
The smaller the synergistic benefits of a particular merger, the greater the scope for striking a bargain in negotiations, and the higher the probability that the merger will be completed.
b.
Since mergers are frequently financed by debt rather than equity, a lower cost of debt or a greater debt capacity are rarely relevant considerations when considering a merger.
c.
Managers who purchase other firms often assert that the new combined firm will enjoy benefits from diversification, including more stable earnings. However, since shareholders are free to diversify their own holdings, and at what's probably a lower cost, diversification benefits is generally not a valid motive for a publicly held firm.
d.
Operating economies are never a motive for mergers.
e.
Tax considerations often play a part in mergers. If one firm has excess cash, purchasing another firm exposes the purchasing firm to additional taxes. Thus, firms with excess cash rarely undertake mergers.
37. Which of the following statements is most CORRECT?
a.
Financial theory says that the choice of how to pay for a merger is really irrelevant because, although it may affect the firm's capital structure, it will not affect its overall required rate of return.
b.
The basic rationale for any financial merger is synergy and, thus, the estimation of pro forma cash flows is the single most important part of the analysis.
c.
In most mergers, the benefits of synergy and the premium the acquirer pays over the market price are summed and then divided equally between the shareholders of the acquiring and target firms.
d.
The primary rationale for most operating mergers is synergy.
e.
The acquiring firm's required rate of return in most horizontal mergers will not be affected, because the 2 firms will have similar betas.
38. Which of the following statements about valuing a firm using the APV approach is most CORRECT?
a.
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt.
b.
The horizon value is calculated by discounting the expected earnings at the WACC.
c.
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the WACC.
d.
The horizon value must always be more than 20 years in the future.
e.
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity.
39. Which of the following statements about valuing a firm using the APV approach is most CORRECT?
a.
The value of equity is calculated by discounting the horizon value, the tax shields, and the free cash flows at the cost of equity.
b.
The value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows before the horizon date at the unlevered cost of equity.
c.
The value of equity is calculated by discounting the horizon value and the free cash flows at the cost of equity.
d.
The APV approach stands for the accounting pre-valuation approach.
e.
The value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows at the cost of equity.
40. Which of the following statements is most CORRECT?
a.
A defensive merger is one where the firm's managers decide to merge with another firm to avoid or lessen the possibility of being acquired through a hostile takeover.
b.
Acquiring firms send a signal that their stock is undervalued if they choose to use stock to pay for the acquisition.
c.
Cash payments are used in takeovers but never in ��mergers.
d.
Managers often are fired in takeovers, but never in mergers.
e.
If a company that produces military equipment merges with a company that manages a chain of motels, this is an example of a horizontal merger.
41. A parent holding company sells shares in its subsidiary such that the parent now owns only 65% of the subsidiary and, thus, the tax returns of the parent and its subsidiary can't be consolidated. The parent receives annual dividends from the subsidiary of $2,500,000. If the parent's marginal tax rate is 34% and if the exclusion on intercompany dividends is 70%, what is the effective tax rate on the intercompany dividends, and how much net dividends are received?
a.
10.2%; $2,245,000
b.
10.2%; $2,135,000
c.
23.8%; $1,905,000
d.
10.2%; $1,750,000
e.
34.0%; $1,650,000
42. A regional restaurant chain, Club Café, is considering purchasing a smaller chain, Sally's Sandwiches, which is currently financed using 20% debt at a cost of 8%. Club Café's analysts project that the merger will result in incremental free cash flows and interest tax savings of $2 million in Year 1, $4 million in Year 2, $5 million in Year 3, and $117 million in Year 4. (The Year 4 cash flow includes a horizon value of $107 million.) The acquisition would be made immediately, if it is to be undertaken. Sally's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8%, and the market risk premium is 4%. What is the appropriate rate for use in discounting the free cash flows and the interest tax savings?
a.
12.0%
b.
13.9%
c.
14.4%
d.
16.0%
e.
16.9%
43. The owners of Arthouse Inc., a national artist supplies chain, are contemplating purchasing Craftworks Inc, a smaller chain. Arthouse's analysts project that the merger will result in incremental free flows and interest tax savings with a combined present value of $72.52 million, and they have determined that the appropriate discount rate for valuing Craftworks is 16%. Craftworks has 4 million shares outstanding and no debt. Craftworks' current price is $16.25. What is the maximum price per share that Arthouse should offer?
a.
$16.25
b.
$16.97
c.
$17.42
d.
$18.13
e.
$19.00
44. Holland Auto Parts is considering a merger with Workman Car Parts. Workman's market-determined beta is 0.9, and the firm currently is financed with 20% debt, at an interest rate of 8%, and its tax rate is 25%. If Holland acquires Workman, it will increase the debt to 60%, at an interest rate of 9%, and the tax rate will increase to 35%. The risk-free rate is 6% and the market risk premium is 4%. What will Workman's required rate of return on equity be after it is acquired?
a.
7.4%
b.
8.9%
c.
9.3%
d.
9.6%
e.
9.7%
45. Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP). Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values:
Year
1
2
3
4
Free cash flow
$1
$3
$3
$7
Unlevered horizon value
75
Tax shield
1
1
2
3
Horizon value of tax shield
32
Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. What is the value of SGP to Raymond?
a.
$53.40 million
b.
$61.96 million
c.
$64.64 million
d.
$76.96 million
e.
$79.64 million
46. Juicers Inc. is thinking of acquiring Fast Fruit Company. Juicers expects Fast Fruit's NOPAT to be $9 million the first year, with no net new investment in operating capital and no interest expense. For the second year, Fast Fruit is expected to have NOPAT of $25 million and interest expense of $5 million. Also, in the second year only, Fast Fruit will need $10 million of net new investment in operating capital. Fast Fruit's marginal tax rate is 40%. After the second year, the free cash flows and the tax shields from Fast Fruit to Juicers will both grow at a constant rate of 4%. Juicers has determined that Fast Fruit's cost of equity is 17.5%, and Fast Fruit currently has no debt outstanding. Assume that all cash flows occur at the end of the year, Juicers must pay $45 million to acquire Fast Fruit. What it the NPV of the proposed acquisition? Note that you must first calculate the value to Juicers of Fast Fruit's equity.
a.
$45.0 million
b.
$68.2 million
c.
$86.5 million
d.
$113.2 million
e.
$133.0 million
47. Refer to Exhibit 22.1. What is Glassmakers' pre-merger WACC?
a.
9.02%
b.
9.50%
c.
9.83%
d.
10.01%
e.
11.29%
48. Refer to Exhibit 22.1. What discount rate should you use to discount Glassmakers' free cash flows and interest tax savings?
a.
10.01%
b.
10.06%
c.
11.29%
d.
11.44%
e.
13.49%
49. Refer to Exhibit 22.1. What is the value of Glassmakers' equity to Best? (Round your answer to the closest thousand dollars.)
a.
$16,019,000
b.
$17,111,000
c.
$18,916,000
d.
$22,111,000
e.
$22,916,000
CHAPTER 23—ENTERPRISE RISK MANAGEMENT
TRUE/FALSE
1. One objective of risk management can be to reduce the volatility of a firm's cash flows.
2. Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses.
3. Speculative risks are symmetrical in the sense that they offer the chance of a gain as well as a loss, while pure risks are those that can only lead to losses.
4. In theory, reducing the volatility of its cash flows will always increase a company's value.
5. The two basic types of hedges involving the futures market are long hedges and short hedges, where the words "long" and "short" refer to the maturity of the hedging instrument. For example, a long hedge might use Treasury bonds, while a short hedge might use 3-month T-bills.
MULTIPLE CHOICE
6. Which of the following are NOT ways risk management can be used to increase the value of a firm?
a.
Risk management can help a firm maintain its optimal capital budget.
b.
Risk management can reduce the expected costs of financial distress.
c.
Risk management can help firms minimize taxes.
d.
Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments.
e.
Risk management can increase debt capacity.
7. Which of the following statements about interest rate and reinvestment rate risk is CORRECT?
a.
Interest rate price risk exists because fixed-rate debt securities lose value when interest rates rise, while reinvestment rate risk is the risk of earning less than expected when interest payments or debt principal are reinvested.
b.
Interest rate price risk can be eliminated by holding zero coupon bonds.
c.
Reinvestment rate risk can be eliminated by holding variable (or floating) rate bonds.
d.
Interest rate risk can never be reduced.
e.
Variable (or floating) rate securities have more interest rate (price) risk than fixed rate securities.
8. A swap is a method used to reduce financial risk. Which of the following statements about swaps, if any, is NOT CORRECT?
a.
The earliest swaps were currency swaps, in which companies traded debt denominated in different currencies, say dollars and pounds.
b.
Swaps are very often arranged by a financial intermediary, who may or may not take the position of one of the counterparties.
c.
A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market.
d.
A company can swap fixed interest payments for floating interest payments.
e.
A swap involves the exchange of cash payment obligations.
9. Which of the following statements is most CORRECT?
a.
Futures contracts generally trade on an organized exchange and are marked to market daily.
b.
Goods are never delivered under forward contracts, but are almost always delivered under futures contracts.
c.
There are futures contracts for currencies but no forward contracts for currencies.
d.
Futures contracts don't have any margin requirements but forward contracts do.
e.
One advantage of forward contracts is that they are default free.
10. A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates?
a.
Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates.
b.
Purchase principal only (PO) strips that decline in value whenever interest rates rise.
c.
Enter into a short hedge where the bank agrees to sell interest rate futures.
d.
Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans.
e.
Buying inverse floaters.
11. Company A can issue floating-rate debt at LIBOR + 1% and can issue fixed rate debt at 9%. Company B can issue floating-rate debt at LIBOR + 1.5% and can issue fixed-rate debt at 9.4%. Suppose A issues floating-rate debt and B issues fixed-rate debt, after which they engage in the following swap: A will make a fixed 7.95% payment to B, and B will make a floating-rate payment equal to LIBOR to A. What are the resulting net payments of A and B?
a.
A pays a fixed rate of 9%, B pays LIBOR + 1.5%.
b.
A pays a fixed rate of 8.95%, B pays LIBOR + 1.45%.
c.
A pays LIBOR plus 1%, B pays a fixed rate of 9.4%.
d.
A pays a fixed rate of 7.95%, B pays LIBOR.
e.
None of the above answers is correct.
12. Suppose the September CBOT Treasury bond futures contract has a quoted price of 89'09. What is the implied annual interest rate inherent in this futures contract?
a.
6.32%
b.
6.65%
c.
7.00%
d.
7.35%
e.
7.72%
13. Suppose the December CBOT Treasury bond futures contract has a quoted price of 80'07. What is the implied annual interest rate inherent in the futures contract?
a.
6.86%
b.
7.22%
c.
7.60%
d.
8.00%
e.
8.40%
14. Suppose the December CBOT Treasury bond futures contract has a quoted price of 80'07. If annual interest rates go up by 1.00 percentage point, what is the gain or loss on the futures contract? (Assume a $1,000 par value, and round to the nearest whole dollar.)
a.
−$78.00
b.
−$82.00
c.
−$86.00
d.
−$90.00
e.
−$95.00
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HRM 500 Week 5 Discussion Questions – Strayer
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Week 5 D1
From the scenario, propose two approaches that a company can use to leverage a 360-degree performance appraisal system to evaluate individual performance. Support your answer with examples.
Week 5 D2
Describe two instances where performance pressure can lead to unethical behavior by employees in the effort to meet company goals. Propose two suggestions that HRM can take to limit unethical behavior by employees.
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HRM 510 Week 5 Midterm Exam – Strayer NEW
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Chapters 1 Through 7
CHAPTER 1
OVERVIEW OF EMPLOYMENT LAW
Online Quiz Questions
MULTIPLE CHOICE QUESTIONS
1. U.S. employment law is:
a. a complete body of federal law
b. a complete body of federal and state law
c. a fragmented work in progress
d. a fragmented body of common law
2. The best HR managers will:
a. be proactive
b. anticipate legal problems and try to avoid them
c. strictly enforce company policy when it conflicts with the law
d. a and b only
e. a through c
3. Sources of employment law include:
a. state and federal constitutions
b. state but not federal constitutions
c. executive orders
d. regulations
e. all of the above
f. a, c and d
4. The Employment at Will Doctrine means that:
a. an employer may fire an employee for any reason not prohibited by law
b. an employer may fire an employee only for cause
c. an employer may not fire an employee
d. none of these
5. The Employment at Will Doctrine is:
a. the starting point for any analysis of an employment issue
b. the rule, unless the parties have an employment contract
c. the rule, unless the parties have signed a collective bargaining agreement
d. all of the above
6. Employment law gives employees certain substantive rights. Among these are:
a. the right not to be fired except for cause
b. the right to vacation time and sick days
c. the right to an employer paid health insurance plan
d. none of these
7. In order to determine which employment laws apply to a certain business, one needs to consider:
a. the geographic location of the business
b. whether the business is public or private
c. how many employees the business has
d. all of these
e. two of these
8. An employee about to bring a claim for a violation of employment law must consider:
a. whether she has the right to bring a private cause of action
b. whether formal notice must be given before a claim can be made
c. whether the employee has worked for the employer for at least one year
d. all of these
e. a and b only
9. Tri-State Computers, Inc. decided to institute a mandatory arbitration agreement policy, so posted notice of the policy on its company website for all of the employees to see. The policy, as described is:
a. enforceable
b. unenforceable
10. The role of Human Resource managers in compliance with legal requirements regarding employment law includes:
a. recognizing and analyzing employment law issues
b. taking action to avoid or prevent employment disputes
c. enforcing legal requirements governing employment law
d. all of these
e. two of these
CHAPTER 1
OVERVIEW OF EMPLOYMENT LAW
MULTIPLE CHOICE QUESTIONS
1. William, aged 59, has been employed by your firm for more than 26 years, and has continually received above-average evaluations. Just before his 27th anniversary with the firm, you are ordered by your superior, the HR Manager, to tell him that his employment with the firm is terminated immediately. Given the facts, as presented, the issues most likely to be raised are:
a. legal
b. ethical
c. medical
d. contract
e. none of these
2. Under U.S. employment laws, employees have the right to:
a. not be fired, as long as they do a good job and the employer’s financial condition does not require that employment levels be cut
b. be treated fairly in all aspects of the workplace, including receiving fair compensation
c. have health insurance and other basic benefits, provided that they are full-time employees
d. all of the above
e. none of the above
3. In order to determine which employment laws apply to a certain employer, the employer should consider which of the following factors?
a. the number of employees that work for the company
b. whether the employer sells goods or services to the federal government
c. the state(s) in which the employer operates
d. all of the above
e. none of the above
4. Regarding the historical development of employment law in the U.S., which of the following statements is true?
a. Most federal employment laws were passed in the first half of the 19th century in response to growing industrialization
b. The earliest employment laws focused on wages and hours
c. Most employment laws were passed with little conflict, since the need for these laws was evident to employers, employees and legislators.
d. The importance of employment at will has increased over time.
e. None of the above.
5. Which of the following is generally true regarding the process of enforcing employment laws?
a. courts and government agencies hear cases only after employees come forward with complaints about violations of the law
b. employees are very likely to seize the opportunity to sue their employers, because all of the cost of employment litigation is borne by the employer
c. once a claim is brought, a company’s attorneys deal with it, and managers have little involvement in the case
d. all of the above
e. none of the above
6. In Nino v The Jewelry Exchange, plaintiff bank employee sued alleging discrimination, and his employer sought to dismiss the suit, stating that the employee had signed a mandatory arbitration agreement, so that the suit should go to arbitration. The employee responded that the mandatory arbitration agreement he had signed was unconscionable, and therefore, unenforceable. Among other things, the employee alleged that the arbitration agreement was unconscionable because gave him only 5 days to make a demand for arbitration. The court ruled:
a. for the Plaintiff employee, because the agreement was both procedurally and substantively unconscionable.
b. for the Plaintiff employee, because the arbitration agreement was procedurally unconscionable.
c. for the Defendant employer, because none of the provisions of the arbitration agreement was unconscionable.
d. for the Defendant employer because the unconscionable parts of the arbitration agreement could be stricken, and the arbitration could proceed.
7. Under the “payroll method” approved by the U.S. Supreme Court:
a. employers whose payrolls exceed $500,000 annually are covered by Title VII
b. employers are covered by Title VII if they had at least 20 employees on the payroll at the time of the alleged discrimination
c. employers are covered by Title VII if they had at least 15 employees working and being paid for each working day during at least 20 weeks in the same or the preceding year
d. employees are counted for each full week between when they are hired and when they leave employment, regardless of the number of days or hours worked.
e. none of the above
8. Which of the following statements is true of arbitration?
a. historically, arbitration has been used to resolve disputes over contractual rights
b. arbitrators’ decisions are usually advisory and not considered final
c. arbitrators have less control over the outcomes of disputes than do mediators.
d. arbitration is always more costly and time-consuming than litigation
e. none of these
9. Regarding the interrelationship of federal and state employment laws:
a. state laws must be identical to federal law or the state law is void
b. states may pass laws which reduce employee rights, but may not enact laws that expand employee protections granted in federal laws
c. states may pass laws which expand employee rights, but may not enact laws that reduce employee protections granted in federal laws
d. employment law is exclusively a federal domain, so states may not enact laws when federal law already exists
10. In Wal-Mart Stores v Dukes, Plaintiffs, all female employees, sued alleging discrimination in pay and promotions based on gender, and sought to represent a class of about 1 ½ million female employees, past and present. The case was certified as a class action, and Wal-Mart appealed, alleging that the certification did not comply with the Federal Rules of Civil Procedure in that the claimants had not suffered the same injury, and the claims did not have questions of law and fact in common. The court ruled:
a. for the Plaintiff employees, because they had all suffered the same injury – a violation of Title VII
b. for the Plaintiff employees, because Wal-Mart was guilty of a pattern or practice of discrimination based on its corporate culture
c. for Wal-Mart, because a lawsuit with 1.5 million plaintiffs was simply unwieldy
d. for Wal-Mart, because the claims did not have common questions of law and fact
11. In EEOC v Fed Ex, the EEOC sued Fed Ex on behalf of a deaf employee who was denied reasonable accommodation under the Americans with Disabilities Act (ADA) over a two year period. The court found for EEOC, and entered judgment for compensatory and punitive damages. Fed Ex appealed, in part based on the award of punitive damages, contending, among other things, that Fed Ex had made a good-faith effort to comply with the law. In particular, Fed Ex offered evidence of its ADA compliance policy set forth in the employee manual. The court ruled:
a. the establishment of an ADA compliance policy was sufficient to establish a good faith effort to comply with the ADA
b. the establishment of an ADA compliance policy was not sufficient by itself to establish a good faith effort to comply, in the absence of any affirmative steps to ensure the implementation of its policy
c. a good faith effort was not required
d. none of these
12. Which of the following is true regarding enforcement of employee rights and enforcement of employment laws?
a. finding a lawyer willing to take an employment law case is difficult because lawyers accept only about 50% of employment discrimination cases brought to them
b. if an employer has a complaint or grievance procedure, the employee is required to exhaust the remedies afforded under the internal procedure before taking the case to an enforcement agency or court
c. the EEOC encourages the parties to discrimination cases to use mediation
d. the EEOC encourages the parties to discrimination cases to use arbitration
13. An employer considering whether to use mandatory arbitration agreements should recognize which of the following limitations of their use?
a. the agreements probably won’t apply to any of its unionized employees
b. the agreements will not deter the EEOC from investigating and possibly litigating to recover remedies for individuals
c. the agreements may not be enforceable if they do not provide employees with the same remedies as those available through the courts
d. all of the above
e. none of the above
14. Which of the following is true of the enforcement process for discrimination charges brought under Title VII?
a. the plaintiff may choose to begin in the state civil rights agency, or may file directly with the EEOC as they wish
b. charges must be brought within 60 days of the alleged discriminatory act
c. a right to sue letter must be obtained from the EEOC before going to court
d. all of the above
e. none of the above
15. A mandatory arbitration agreement which provides that all claims be brought within 90 days of the date of the alleged violation would likely be:
a. enforceable
b. unenforceable
c. subject to amendment by the court
16. Dean got a job as a copyrighter for a publishing firm, and after working for the firm for two years, was told he was required to sign a mandatory arbitration agreement, submitting any employment disputes to binding arbitration, and that if he would not sign it as is, he would be fired. Dean:
a. will have to sign the agreement if he wants to keep his job
b. does not have to sign the agreement, and can still keep his job
17. The contract referred to in Question #16 above is:
a. procedurally unconscionable
b. substantively unconscionable
c. neither of these
d. both of these
18. Which of the following provisions, if included in a mandatory arbitration agreement, would be likely to render it unenforceable?
a. a provision that the employee pay the costs of the arbitrator’s services
b. a provision that gives the employer the right to choose any arbitrator
c. a provision that bars all discovery
d. a provision that requires the employee to prove his case
e. all of these
f. all of these except d
19. As the Human Resources manager of your firm, the task of putting into effect the firm’s new mandatory arbitration agreement has fallen to you. At a minimum, legally, which of the following actions are required to make the policy enforceable?
a. send email notice to all employees that a mandatory arbitration policy has been adopted
b. post the mandatory arbitration policy on the firm’s website, and ask employees to visit the site and review the policy
c. provide employees with a copy of the agreement, and ask them to sign it
d. make certain that the agreement provides, and the employees understand, that they are waiving their rights to sue
e. all of these are legally required
f. none of these are legally required
g. only c and d are legally required
20. Your firm has just gotten a contract with the U.S. government to build security gates for the new fence along the U.S.-Mexican border. In addition to the employment laws which already apply to your business, the following will now also apply:
a. Title IX
b. the Federal Security Fence Funding Act of 2008
c. EO # 11246
d. all of these
e. none of these
ESSAY QUESTIONS
1. Employment law arises from a variety of sources. Name and briefly discuss each of them.
2. Describe what the role of a good human resources manager should be in managing employment law issues.
CHAPTER 2
OVERVIEW OF EMPLOYMENT LAW
Online Quiz Questions
MULTIPLE CHOICE QUESTIONS
1. If an employment relationship exists, an employer must do this for its employee:
a. withhold income taxes from wages
b. provide workers’ compensation insurance
c. provide unemployment insurance
d. all of these
2. Who has the burden of proving the status of a hired worker whose status as either employee or independent contractor is disputed?
a. the hiring party
b. the worker hired
c. the agency before which the disputed case is pending
d. the judge presiding over the case in court
e. none of these
3. Of the following, which is considered in determining whether someone is an independent contractor or an employee?
a. who has the right to control how and where the work is done
b. does the worker work for one firm or many
c. who supplies necessary tools and supplies
d. whether benefits are provided to the worker
e. all of these
f. only a thru c
4. Which of the following statements is true?
a. an employer may be held liable for the actions of its employees outside the scope of employment
b. an employer may not be held liable for the actions of its employees outside the scope of employment
c. employers may limit their liability for the actions of its employees pursuant to contract
d. none of these
5. Which one of these is different from all the others?
a. independent contractor
b. employee
c. temp worker
d. partner
e. volunteer
f. students
g. interns
6. Match each term to its correct definition.
[c] 1. employee
[b] 2. employer
[e] 3. independent contractor
[a] 4. right of control
[f] 5. scope of employment
a. how the IRS distinguishes employees from independent contractors
b. one who hires another to work for him and directs the work
c. one who works regularly for an employer and is directed by the employer
d. principal and agent
e. one with his own business who offers his services to others
f. all of the services an employee performs for his employer are within this
g. agency
CHAPTER 2
THE EMPLOYMENT RELATIONSHIP
MULTIPLE CHOICE QUESTIONS
1. Distinguishing between employees and independent contractors is important because:
a. income tax must be withheld for employees, but not independent contractors
b. employers have fewer legal obligations to independent contractors
c. employers can defend their actions under employment laws by proving that persons performing work are independent contractors
d. all of the above
e. none of the above
2. Under the economic realities test:
a. if the hired party depends on the job for the majority of her income, that favors the conclusion that she is an employee
b. if the hired party performs tasks that are central to the hiring party’s business, that favors the conclusion that she is an independent contractor
c. if the hired party performs low-skilled work, that favors the conclusion that she is an independent contractor
d. if the hired party provides her own tools and materials, that favors the conclusion that she is an independent contractor
e. all of the above
3. In Narayan v EGL, Inc., the plaintiffs were drivers hired in California by a Texas firm, which had them sign independent contractor agreements under Texas law. They sued, contending they were employees, entitled to overtime pay and other benefits, and summary judgment was entered against them because of the independent contractor agreement. They appealed, and on appeal, the court ruled:
a. that they were independent contractors, because they signed the independent contractor agreement
b. that they were employees, because Texas law did not apply in California
c. that summary judgment was vacated, and the case remanded for trial, since a jury could determine from the evidence that they were employees
d. none of these
4. Which of the following is true of the common law test?
a. it is especially useful for distinguishing partners from employees
b. it focuses on the right of control
c. it focuses on the hired party’s ability to sell his services to a variety of hiring parties
d. it is especially useful for determining whether individuals should be covered as family members under benefit plans
e. none of the above
5. If a worker is an employee, the employer must:
a. withhold income taxes
b. pay the employer's share of Social Security and Medicare taxes
c. pay the employee's share of Social Security and Medicare taxes
d. all of these
e. a and b only
6. Which of the following is an accurate statement regarding independent contractor agreements?
a. they will usually be treated as indicators of independent contractor status, provided that they are signed and notarized
b. they are useless as indicators of independent contractor status
c. they can be renewed automatically and as often as necessary
d. they can support a claim to independent contractor status, but the actual relationship is the most important factor
e. a and c
7. The primary lesson to be learned from the lawsuit brought by Microsoft’s temporary workers in the 1990s is that:
a. it is safest legally to hire temp workers through a temporary staffing agency
b. employers must provide benefits to all of their employees
c. companies that use temp workers will often be deemed joint employers of those workers
d. employers cannot arbitrarily exclude some employees from benefit plans by labeling them as temporary workers
e. none of the above
8. If a worker is an employee, the employer must:
a. provide worker's compensation coverage for the employee
b. provide unemployment insurance for the employee
c. provide health insurance for the employee
d. all of the above
e. a and b only
9. Persons performing volunteer work are more likely to be deemed employees if:
a. their services are provided to non-profit agencies
b. they receive significant remuneration for their services
c. they retain control over their volunteer work schedule
d. all of the above
e. none of the above
10. A company has one office with nine employees and a second office with 12 employees. If an employee who works in the first office is harassed and attempts to sue under Title VII, which of the following questions becomes a relevant issue:
a. whether this is a single, integrated enterprise
b. whether these are joint employers
c. whether the multi-employer doctrine applies
d. whether the joint payroll method applies
e. whether Title VII applies extraterritorially
11. Which of the following statements regarding managers is most correct?
a. under most employment laws, managers are not deemed to be protected employees
b. managers are usually not individually liable when they violate employees’ rights
c. employers are liable for the actions of managers taken within the scope of their employment
d. a and c
e. none of the above
12. Employers may be liable for the actions of their employees within the scope of employment. With regard to the actions of employees outside the scope of employment, which of the following statements is true?
a. An employer can never be liable for the actions of its employee outside the scope of employment.
b. An employer is always liable for the actions of its employee outside the scope of employment.
c. An employer might be liable for the actions of its employee outside the scope of employment if the employer was negligent or reckless in allowing it to occur, or for other reasons.
d. None of these is true
13. You started your own business 2 years ago, and needed several part-time workers, but did not want and could not afford to pay them a minimum wage, or payroll taxes, so you classified them as independent contractors. At the time, a decent argument could be made that they were independent contractors, as there had been no rulings on your particular arrangement. Recently, for a business very similar to yours, the Department of Labor ruled that the workers of the business were employees, and not independent contractors. What should you do?
a. nothing, unless the Department of Labor challenges your arrangement
b. nothing, unless one of the workers complains
c. have all of the workers sign independent contractor agreements immediately
d. begin to treat them as employees, including paying a minimum wage, and withholding income taxes
14. The main reason employers would rather hire independent contractors than employees is:
a. its cheaper
b. the employer has more control over independent contractors
c. the independent contractor has fewer rights under law than an employee
d. all of these
e. a and c only
15. A worker who is not an employee is likely:
a. a partner
b. a volunteer
c. an independent contractor
d. any one of these
16. What test is used to determine whether a worker is an employee or an independent contractor?
a. The Economic Realities Test
b. The Right to Control Test
c. The Common Law Test
d. Each agency or entity having an interest in the question uses a different test
e. None of these
17. Your sister works at a large, well- known firm which has had trouble sustaining the kind of profit margins their shareholders want to see. In order to keep their numbers up over the years, they have tried every cost-cutting measure they could think of, including some that were of questionable legality. You know about this only because you and your sister talk regularly. You know that she is concerned about losing her job, as there have been many rounds of downsizing, and you have promised her that you would not disclose these matters to anyone. Yesterday, she told you that the firm has been using temp workers for about the last two years, and they are a continuing problem. They come from a temp agency, and there are new workers every month or so, whom she must train. They do little to no work all day, and they are seemingly accountable to no one, since the supervisors don’t make them work, yet they still get paid. Your sister knows you are taking this Employment Law course, and she wants you to tell her whether what the company is doing with the temp workers is illegal. Is it?
a. Yes
b. No
18. Regarding independent contractor (IC) agreements, which of the following statements is NOT true?
a. There is no point in using an independent contractor agreement.
b. A good, well-drafted independent contractor agreement can help avoid liability for the firm hiring the worker.
c. Independent contractor agreements can help the parties clarify their employment relationship.
d. A well-drafted IC agreement will address many issues that are used by agencies in determining the status of workers.
19. Which of the following items should NOT be included in a well-drafted independent contractor agreement?
a. a requirement that the worker hire his own assistants
b. a requirement that the firm provide health insurance for the worker
c. a flat fee payment arrangement for the work
d. a requirement that workers pay their own expenses
20. Regarding employees, actions within the scope of employment are those which:
a. relate to work the worker was hired to perform
b. occur on company time at the usual place of work
c. occur during work hours
d. serve only the interests of the employer
e. all of these
f. a thru c only
ESSAY QUESTIONS
1. Why is each of the following good legal advice?
a. When using independent contractors, firms must be prepared to relinquish most of their control over how work is done.
b. Firms should closely review the status of long-term independent contractors and not assign new projects to them without renewing agreements.
c. Independent contractor agreements should be used, but only when they document actual independent contractor relationships.
d. Be particularly cautious about changing the status of workers from employees to contingent workers or having workers with different statuses perform the same work for long periods of time.
e. Client companies should refrain from closely supervising agency temporary workers or selecting individual temp workers for hiring or firing.
2. Regarding undocumented workers (non-citizens in the US illegally), the policy of federal agencies has been to enforce employment laws for such workers without inquiring as to their legal status. However, the remedies available to such a worker may be limited because of his status. State and explain the policy reasons behind each of these decisions.
3. With regard to Question # 2 above, do you agree or disagree with each stated policy? Why or why not? State and explain what kind of policies as to enforcement of employment laws and remedies for violations of such laws you believe would most encourage compliance with employment laws, and describe what the incentives would be in your preferred policies to encourage the desired conduct.
CHAPTER 3
OVERVIEW OF EMPLOYMENT DISCRIMINATION
Online Quiz Questions
MULTIPLE CHOICE QUESTIONS
1. Which of the following is not a real federal anti-discrimination law?
a. Title VII of the Civil Rights Act of 1964
b. Equal Pay Act
c. Equal Opportunity Act
d. Rehabilitation Act
2. The protected classes under the current Title VII law and other federal non-discrimination laws are:
a. race, color, religion, sex, national origin
b. race, color, religion, sex, national origin, age, disability
c. race, color, religion, sex, national origin, disability, sexual orientation
d. race, color, religion, sex, national origin, age, disability, sexual orientation
3. Which of the following protected classes are recognized under some state laws, but not under federal law?
a. disability
b. sexual orientation
c. sexual discrimination
d. none of these
4. In this kind of claim, a seemingly neutral policy has a discriminatory effect.
a. disparate treatment
b. disparate impact
c. pattern or practice
d. none of these
5. In this kind of claim, a member of a protected class who was qualified was not hired, while a member of an unprotected class was hired.
a. disparate treatment
b. disparate impact
c. pattern or practice
d. none of these
6. “Retaliation” is:
a. an adverse action taken against plaintiff following plaintiff’s performance of a protected activity
b. a discriminatory remark made by a supervisor within hearing of the person discriminated against
c. hiring the plaintiff
d. none of these
7. The Age Discrimination in Employment Act makes it illegal to:
a. discriminate against workers over 40 and those under 20
b. discriminate against workers over 40 and under 75
c. discriminate against workers over 40
d. discriminate against workers over 50
e. none of these
8. The federal law that makes it illegal to discriminate in employment against a person based on religion is:
a. The Religious Discrimination Act
b. The Freedom of Religion Act
c. Title VII
d. there is no such federal law; the protection is based on the US Constitution
9. In a case in which an employer fires an employee for reasons that are partly legal and partly illegal, the kind of discrimination is called:
a. reverse discrimination
b. pattern or practice
c. harassment
d. mixed motive
10. Match each term to its correct definition.
[c] 1. pretext
[e] 2. protected class
[a] 3. disparate treatment
[d] 4. retaliation
[b] 5. adverse impact
a. intentional discrimination
b. discriminatory effect
c. a purported reason (but not the real one) for a discriminatory action
d. action taken against an employee for exercising legal rights
e. a group of people sharing a characteristic which has been the object of discrimination
f. a pattern or practice of discrimination
g. action taken to get even
CHAPTER 3
OVERVIEW OF EMPLOYMENT DISCRIMINATION
Test Bank Questions
MULTIPLE CHOICE QUESTIONS
1. Which of the following is true regarding discrimination?
a. the number of discrimination claims filed has decreased over the past decade as employers have paid more attention to promoting diversity in the workplace
b. discrimination has become more subtle and difficult to eliminate in recent years
c. the main challenge in confronting discrimination is to get women and persons of color into workplaces; they can take it from there
d. discrimination occurs anytime that persons are treated unequally or unfairly in the workplace
e. none of the above
2. Which of the following is a protected class characteristic?
a. religion
b. height
c. intelligence
d. management status
e. all of the above
3. Which of the following is true? Title VII of the Civil Rights Act:
a. protects employees against discrimination based on race, sex, national origin, and disability
b. applies to employers that have 15 or more employees
c. protects employees against discrimination based on sexual orientation
d. protects employees against discrimination based on height, weight and physical appearance
e. all of the above
4. In disparate treatment cases:
a. the focus is on proving the employer’s discriminatory intent
b. the focus is on showing the discriminatory effects of the employer’s actions
c. the focus is on showing that unfair treatment occurred
d. the focus is on showing that the employer holds racist or sexist views
e. the focus is on showing that the employer was trying to get back at the employee for something the employee did
5. Which of the following must be shown in order to establish a prima facie case of
retaliation?
a. that the employee was replaced by someone with differing protected class characteristics
b. that the employee lost an employment opportunity shortly after engaging in protected activity
c. that the employer’s action was based on the employee’s race, sex, or other protected class characteristic
d. that the employer’s action was based on a disagreement with a superior and that the firing was unrelated to quality of the employee’s job performance
e. all of the above
6. Three employees working for the same company were found to have stolen company cargo. Two of the employees were white, and one was black. The two white employees were fired, but not the black employee. If the white employees sue, the court will most likely decide:
a. for the employer, because the employees were guilty of theft
b. for the employer, because the employees were employees at will
c. for the employee, because the employer treated him differently based on his race
d. for the employee, because his employer was within its discretion to fire some, but not all employees guilty of theft
7. Regarding cases alleging disparate treatment and pretext, it is correct to say:
a. disparate treatment is unintentional or accidental
b. evidence in a pretext case can be either direct or circumstantial
c. the employer has violated Title VII if it would not have made the same decision absent the discriminatory motive
d. they are relatively rare and with current legislation are not likely to be significant in the future
8. Which of the following is among the things that a plaintiff must show in order to establish a prima facie case of disparate treatment in a pretext case?
a. proof that the employer intended to discriminate
b. proof that the employer’s stated motive is not credible
c. statistical evidence of discriminatory effects
d. all of the above
e. none of the above
9. The key element in disparate treatment is discriminatory intent. In this context, that means that:
a. the decision-maker made the decision with intent to harm
b. the decision-maker made the decision with intent to break the law
c. the decision-maker made the decision in whole or in part based on the protected class characteristic of the employee
d. none of these
10. A firm had been sued and found guilty of racial discrimination against African-Americans, and managers were instructed to be very careful to avoid another similar suit. To that end, African-American employees, but not others, were given raises. Of the following, what is the most correct assessment of this policy?
a. the policy is sound, both legally and ethically
b. the policy is sound legally, but not ethically
c. the policy is neither legally nor ethically sound
d. none of these
11. Which of the following is a type of disparate treatment?
a. adverse impact
b. retaliation
c. both of the above
d. none of the above
12. In an adverse impact case, if an employer can show that a challenged employment practice is job related and consistent with business necessity, the plaintiff can still win by showing that:
a. there is an alternative practice that would have less discriminatory effects, but the employer declines to use it
b. the employer has engaged in a pattern or practice of discrimination
c. the difference in selection rates across protected class groups is statistically significant
d. the four-fifth’s rule has been violated
e. there is additional evidence of a discriminatory motive
13. Which of the following is a neutral requirement that is likely to result in adverse impact?
a. race
b. language requirement
c. physical strength test
d. b and c
e. all of the above
14. Protected activity in a retaliation claim under Title VII includes:
a. peaceful protests opposing an employer’s alleged discrimination
b. testifying in court about another employee’s discrimination claim
c. knowingly filing a false discrimination charge against an employer
d. all of the above
e. none of the above
15. For a disparate treatment case involving pretext, which is the correct order of proof?
a. plaintiff’s prima facie case, defendant’s lawful motive, plaintiff’s additional evidence supporting discriminatory intent
b. plaintiff’s evidence supporting discriminatory intent, defendant’s lawful motive, plaintiff’s prima facie case
c. plaintiff’s primary evidence, defendant’s primary evidence, plaintiff’s rebuttal showing discriminatory motive
d. none of these
16. Of the elements necessary to prove a case of disparate treatment involving pretext, which of the following is NOT required?
a. plaintiff applied for the employment opportunity
b. plaintiff was qualified for the employment opportunity
c. plaintiff was not hired for the employment opportunity
d. plaintiff was as qualified for the employment opportunity as the person hired
17. In disparate impact cases:
a. the focus is on proving the employer’s discriminatory intent
b. the focus is on showing the discriminatory effects of the employer’s actions
c. the focus is on showing that unfair treatment occurred
d. the focus is on showing that the employer holds racist or sexist views
e. the focus is on showing that the employer was trying to get back at the employee for something the employee did
18. An experienced female crane operator just hired by a new firm was told it was company policy that crane operators urinate over the side of their cranes rather than stop work. The same policy applied to male crane operators. She objected to the policy, was offered alternative jobs, but none as a crane operator, and she quit. Does she have a valid claim for sex discrimination?
a. No, because practice is neutral, and therefore non-discriminatory.
b. No, because she was offered alternative positions.
c. Yes, because the practice was a form of disparate impact.
d. Yes, because the firm did not create a different rule for bathroom breaks for her.
19. Of the following, the most effective way for an employer to respond to an employee’s claim of retaliation would be:
a. to show that the employee is lying
b. to show that the employee was not retaliated against, but rather disciplined for poor performance or the like
c. to show that the employee should never have been hired in the first place.
d. none of these
20. In Collazo v. Bristol-Myers Squibb,, an employee was fired after he assisted another employee with her claim of sexual harassment. He sued alleging retaliation. The firm contended that no sexual harassment had occurred, so that it was not legally possible for him to sustain a claim of retaliation. On appeal, the court ruled:
a. against the employee, because no sexual harassment was proven, and so no claim for retaliation could be maintained
b. against the employee, because he could not prove retaliation
c. for the employee, because the public policy exception to employment at will applied
d. for the employee, because it was not necessary for him to prove a violation of Title VII in order to sustain a claim for retaliation
ESSAY QUESTIONS
1. Why is each of the following good legal advice?
a. Employers must not make employment decisions based, in whole or in part, on the protected class characteristics of employees.
b. Employers should have policies and be consistent in how they apply and enforce them.
c. Employment requirements and practices should be scrutinized for their potential to disadvantage protected class groups and for evidence of their job relatedness and business necessity.
d. Employers need to exercise particular care in making employment decisions regarding employees that have filed charges or spoken out about discrimination.
e. Employers need to maintain good documentation and be prepared to explain why particular employment decisions were made.
2. Certain protected classes are recognized under various state law but not under federal law. Name them.
CHAPTER 4
RECRUITMENT, APPLICATIONS AND INTERVIEWS
Online Quiz Questions
MULTIPLE CHOICE QUESTIONS
1. Word of mouth advertising for employees may be discriminatory because:
a. it reaches so few people
b. people tend to associate with others like themselves
c. it is not in writing
d. none of these
2. H1-B visas are granted to:
a. hardship cases
b. those with specialty occupations
c. agricultural workers
d. a and b
e. b and c
3. Employers conducting an interview for an open position:
a. may ask only job-related questions
b. must make a conditional offer of employment before asking health-related questions
c. may discriminate pre-hire
d. none of these
4. Regarding medical inquiries in an interview, it is correct to say that:
a. they may be made at any time during the job interview
b. they may be made after a conditional offer of employment
c. they may never be made
d. they may be made after the employee applies for insurance
5. During an interview, one may inquire about an applicant’s protected class status:
a. directly
b. indirectly only
c. not at all
6. Match each term to its correct definition.
[e] 1. relevant labor market
[c] 2. neutral wording
[b] 3. nepotism
[d] 4. word-of-mouth hiring
[a] 5. medical inquiries
a. questions about previous workers’ compensation claims would be one of these
b. hiring one’s relatives, or the relatives of one’s employees
c. want ads which do not mention any protected class have this
d. employees tell their friends, who tell their friends about job openings
e. qualified available workforce
f. the percentage of a protected class in the local labor market
g. women and minorities are encouraged to apply
CHAPTER 4
RECRUITMENT, APPLICATIONS, AND INTERVIEWS
Test Bank Questions
MULTIPLE CHOICE QUESTIONS
1. In Stewart v. Jackson & Nash, the court examined the issue of fraudulent inducement.
The court decided that:
a. actions for fraudulent inducement against an employer are never available when the employee is an employee at will
b. actions for fraudulent inducement against an employer are only available with regard to future promises
c. actions for fraudulent inducement against an employer are only available with regard to present facts
d. actions for fraudulent inducement against an employer are only available when the promises made to the employee are in writing
2. Which of the following is a difference between employing foreign nationals with work visas for work in the U.S. and employing U.S. citizens?
a. the eligibility of foreign nationals to work in the U.S. must be documented on an I-9 form, while this is not required for citizens
b. the duration of employment is limited for foreign nationals, but not for citizens
c. foreign nationals can be paid lower wages and offered fewer benefits than citizens
d. all of the above
e. none of the above
3. For purposes of determining discrimination in recruitment, the “relevant labor market” is defined as:
a. the protected class composition of the employer’s applicant pool
b. the population as a whole
c. the protected class composition of people qualified for the job, and living geographically close enough to be likely candidates
d. none of the above
4. Which of the following is true regarding want ads and job announcements?
a. employers are legally required to post written job announcements and ads
b. the wording of job announcements and ads must be neutral
c. job announcements and ads must not be placed in publications that are narrowly targeted toward particular protected class groups
d. all of the above
e. none of the above
5. Nepotism and word of mouth hiring:
a. are specifically prohibited by Title VII because of their potential to produce discriminatory effects
b. are not optimal recruiting procedures, but they raise no significant legal issues
c. tend to produce discriminatory effects, depending on how racially homogeneous an employer’s existing workforce is
d. have been subjected to numerous legal challenges, but have been consistently upheld under Title VII
e. none of the above
6. Determining whether discrimination has occurred regarding recruitment requires an analysis of:
a. the relevant labor market
b. the overall labor force
c. the national labor force
d. the international labor market
7. Which of the following would not create potential liability for the employer if asked
during an interview?
a. Have you ever filed a workers’ compensation claim for a work-related injury or illness?
b. Do you believe in God?
c. How often do you go out on dates?
d. Why do you want to work for this company?
e. Your accent is beautiful, where are you from?
8. Your new boss has asked you to advertise for a job opening at the firm, but said he did not want to hire any “foreigners,” by which he means, anyone who is not 100% a Caucasian, and a male. He also insists that you fill the position within one week. You know, from personal experience, that when you advertise this job for only a week, only white male applicants will apply. Given your legal and ethical obligations in this situation (and wanting to keep your job), the best course of action for you to take would be:
a. place the ad, and hire a white male for the position within one week
b. tell your boss that the law requires that you place the ad for two weeks; do that, then hire the best of the applicants who apply
c. place the ad, but also review your saved resumes for this position from previous applicants, knowing that they are a diverse group; start calling them in for interviews immediately, and hopefully, hire someone within a week
d. quit and go find another job
9. Which of the following inclusions in a want ad would be least likely to be considered
discriminatory:
a. young persons wanted
b. recent college graduates wanted
c. servers/waitstaff wanted
d. recent high school graduates wanted
e. all of the above would likely be considered discriminatory
10. In Harrison v. Benchmark Electronics, a temporary employee was asked by his supervisor to apply for the job as a permanent worker. He did so, and took a pre-employment drug test, which was positive. The Medical Review Officer, upon learning that the applicant had epilepsy, and his drugs were legally prescribed, cleared him to be hired, but his supervisor, who sat in on the Medical Review meeting, fired him. The court ruled that:
a. employers are permitted to make pre-employment medical inquiries prior to a conditional offer of employment
b. non-disabled applicants are not protected from pre-employment inquiries under the ADA
c. the firm had a legal right to ask questions about the drug use, but not to inquire about disability pre-employment
d. because the applicant had tested positive for drugs, the employer could lawfully proceed to ask questions regarding disability prior to making a conditional offer of employment
11. Of these possible means of recruitment, which has the greatest potential to be discriminatory?
a. use of an employment agency
b. nepotism or “word of mouth”
c. want ads
d. none of these
12. It is a violation of anti-discrimination laws to place a want ad indicating a preference based on:
a. race
b. religion
c. sex
d. national origin
e. all of these
f. none of these
13. Sex-linked job titles:
a. are always neutral
b. are never neutral
c. may be neutral, depending on the circumstances
d. none of these
14. Which of the following practices would be discriminatory?
a. placing an ad for a waitress
b. placing an ad for a waiter
c. placing an ad asking for “a recent college grad”
d. all of these
e. only a and b
15. Which of the following kinds of advertising is legally prohibited?
a. advertising a job opening in a foreign language newspaper
b. advertising a job opening inviting women and minorities to apply
c. advertising a job opening in a church bulletin
d. all of these
e. none of these
16. Which of the following statements is NOT true?
a. employers should advertise written job announcements to the public
b. anti-discrimination laws do not apply to employment agencies
c. an employer should preserve evidence, especially if it suspects a claim will be filed against it
d. word of mouth advertising is potentially discriminatory
17. Which of the following practices would be discriminatory?
a. using different kinds of application forms for different people applying for the same position
b. if an applicant seems an unlikely candidate, discouraging him from applying for the job
c. accepting applications for a position for only one week
d. all of these
e. a and b only
18. In order to prevent discrimination against applicants of protected classes, your colleague decides to note the protected class characteristic of the applicants on their applications. What would be your advice to her?
a. It’s a good idea. Noting the protected class characteristic of the applicant on the application which make sure that the firm takes extra care not to discriminate against these applicants.
b. It’s NOT a good idea. Noting the protected class characteristic of the applicant on the application could be construed as discriminatory.
c. As long as you do it in pencil, then erase it after you’ve made your hiring decision, you’ll be okay.
d. None of these
19. Which of the following is true regarding fraud claims?
a. they can be completely avoided by not saying anything
b. they differ from breach of contract claims primarily in the degree of harm suffered by the plaintiff
c. the false statement was made intentionally or with reckless disregard for the truth
d. if injury occurs, it doesn’t matter whether the false statement was made intentionally or unintentionally
20. Which of the following interview topics would be considered inquiries regarding an applicant’s medical condition?
a. previous injury
b. previous illness
c. current injury
d. previous workers’ compensation claims
e. all of these would be inquiries regarding a medical condition
ESSAY QUESTIONS
1. Why is each of the following good legal advice?
a. Use multiple recruiting mechanisms, rather than rely solely on one way of getting the word out about employment opportunities.
b. If applications are being accepted, then no individual wishing to apply should be discouraged from submitting an application.
c. For applicants that are not hired, application forms and other documents should be retained for at least one year from when the decision not to hire was made.
d. Whether on application forms, during interviews, or otherwise, employers should refrain from asking, directly or indirectly, about the protected class characteristics of job candidates.
e. Be careful not to present false or misleading information that a job candidate would reasonably rely on in accepting a job.
2. You have been hired by the owners of Brew & Beef, a local family owned restaurant. They would like to open a second restaurant (Brew & Beef II) across town and have asked your advice regarding the recruitment of employees. One of the owners and her sister will be managing the new site and they are transferring part of their chef staff to the new facility so they need your advice regarding the hiring of wait staff, bus staff, custodial help and kitchen help. Recent discrimination law suits have been in the news and they want things to go smoothly and legally. What advice would you give them?
CHAPTER 5
BACKGROUND CHECKS, REFERENCES, AND VERIFYING
Online Quiz Questions
MULTIPLE CHOICE QUESTIONS
1. Background checks may include all of these EXCEPT:
a. verifying past employment
b. checking driving records
c. obtaining prior health insurance claims information
d. confirming the candidate actually has required degrees, licenses, and the like
2. Under the common law doctrine of respondeat superior, employers are generally liable for the actions of their employees:
a. outside the scope of their employment
b. within the scope of their employment
c. if those actions are foreseeable
d. none of these
3. Regarding background checks, it is correct to say that:
a. no particular measure is required in all cases
b. employer should always follow their own procedures
c. inconsistencies and gaps in an applicant’s information must be tracked down
d. all of these are true
4. One defense to a claim of defamation is:
a. truth
b. falsity
c. negligence
d. careless hiring
5. Regarding references, which of the following statements is NOT true?
a. An employer has no duty to give a reference for a former employee.
b. An employer has a duty to give a reference for a former employee.
c. If an employer gives a reference, it must do so with due care.
d. All of these statements are true.
6. Match each term to its correct definition.
Respondeat superior the liability of an employer for the acts of its employee within the scope of the employment
Foreseeable reasonable anticipation of the possible results of an action
Qualified privilege an exemption from liability under certain conditions
Defamation a false statement which damages a person’s reputation
Consumer credit report a communication regarding a person’s credit standing and reputation
CHAPTER 5
BACKGROUND CHECKS, REFERENCES,
AND VERIFYING
MULTIPLE CHOICE QUESTIONS
1. Negligent hiring:
a. makes employers liable for harm that occurs when employees act within the scope of their employment
b. makes employers liable for any harm that is caused by their employees
c. makes employers liable for harm that occurs when employees who were not properly screened act outside the scope of their employment
d. all of the above
e. none of the above
2. In order to avoid liability for negligent hiring, the primary question an employer must consider is:
a. whether the employer’s own written hiring policies are adequate
b. whether placing an unfit person in the particular job could be expected to result in harm
c. whether there is evidence of a candidate’s unfitness that could be found through a thorough personal interview with the applicant
d. all of the above
e. none of the above
3. In D.D.N. v. FACE, a music-festival organizer hired a man who had a conviction for criminal sexual assault without doing a background check. The man was hired to be “camping staff, front.” He was given a “staff” T-shirt, and a wristband that gave him access to all parts of the concert venue. He sexually assaulted a concert-goer, and she sued for neghligent hiring. Although the hiring manager acknowledged an increased risk of sexual assault in that venue, the employer argued that they owed her no duty, and her injury was not foreseeable. The court ruled that:
a. the employer was liable under respondeat superior because the assault occurred on concert grounds, and was carried out by a management-level employee
b. the employer was liable for negligent hiring because employers are legally obligated to perform criminal background checks and contact references for all persons hired
c. the employer was liable for negligent hiring because sexual assault was an increased risk in this venue, it was foreseeable that an unfit person hired as for this position could harm others, and the employer failed to conduct an adequate background check
d. the employer was not liable for negligent hiring because even if it had undertaken a more thorough background check, clear evidence of unfitness for the job was not available
e. none of the above
4. A company hired a file clerk, but did not inquire into his criminal history. In fact, he has had several convictions for driving while intoxicated. On a lunch break, he got drunk and assaulted a waitress at a nearby restaurant. If the waitress sues the employer, a court would most likely decide that:
a. the employer is liable under respondeat superior for the harmful act of the employee because it occurred during the workday
b. the employer is liable for negligent hiring because the employer had an obligation to check his criminal background, it did not do so, and this led to him harming another person
c. the employer is not liable for negligent hiring because the employee did not assault the waitress on company property
d. the employer is not liable for negligent hiring because the job does not subject people to risk, and the evidence of unfitness was not related to the job
e. none of the above
5. A valid background check should NOT include:
a. checking an applicants marital status
b. verifying an applicants military service
c. checking an applicants driving record
d. verifying an applicants degrees and/or licenses
e. none of the above may be validly inquired into
6. Which of the following is a defense to a defamation claim against an employer?
a. the employee gave his consent to make the statement
b. the statement was within the employer’s qualified privilege
c. the statement was truthful
d. all of the above
e. none of the above
7. In Sigal Construction v. Stanbury, a project manager sued because statements made by his former employer in the course of providing a reference untruthfully minimized his abilities. The court ruled that:
a. the employer did not defame the former employee because its statements were merely opinions and did not purport to be factual
b. the employer did not defame the former employee because he had consented to having information about him shared with the prospective new employer
c. the employer did not defame the former employee because the statements, although harsh, were truthful
d. the employer defamed the former employee because statements made in references are not subject to qualified privilege
e. the employer defamed the former employee because the employer was recklessly indifferent to the truthfulness of the statements made
8. In M.P. v. City of Sacramento, a 24-year-old woman working as a photographer attended the “Porn Star Costume Ball.” A firefighter captain attended, and allowed other firefighters to attend, drive their trucks to the event, and “pick up” women. Some of the firefighters were on duty, and some were drinking. This was not the first time firefighters had been allowed to bring their fire trucks to bars and parties. The woman was asked to take pictures of the firefighters in the truck, and two of them (one of whom was on duty) sexually assaulted her. She sued, contending that the City of Sacramento was liable for the assault against her. The court ruled:
a. the city was not liable because under California law, a public employee who commits a sex crime on duty is not acting within the scope of employment, so that the employer is not vicariously liable
b. the city was liable because under California law, a public employee who commits a sex crime on duty is acting within the scope of employment, so that the employer is vicariously liable
9. Under the Fair Credit Reporting Act, employers must do which of the following?
a. notify an applicant that the employer plans to reject her based on information from a credit report
b. obtain the consent of an applicant before conducting any background check
c. verify that the information in a credit report reasonably appears to be accurate
d. all of the above
e. none of the above
10. Mike is the chair of the management department at a local university and Tom is an
ethics professor in that department. They dislike each other immensely due to a number
of professional and social disagreements. Mike calls Tom into his office and closes the
door. He then informs Tom that he believes that Tom is guilty of plagiarism and also
guilty of an improper sexual relationship with Kathy, a 19 year old management student.
In fact, Tom is a happily married man who is extremely well respected in the community
and has never committed adultery. Deeply believing in ethics, he has never committed
plagiarism in his life. Furthermore, he has always been absolutely professional with
regard to his student Kathy. Tom vehemently denies these charges and as he gets up to
leave, Mike states, “Give me any more trouble and I go public.” Tom goes right to his
attorney who files a defamation law suit that afternoon.
a. Tom will win because the statements are both lies, challenging his integrity and character
b. Tom will win because his reputation has been damaged
c. Mike will win because as chair, he has a qualified privilege to make these types of statements
d. Mike will win because the statements were not published
11. The Immigration Reform and Control Act:
a. requires that employers not hire or employ aliens
b. requires that employers not discriminate based on national origin and citizenship
c. allows employers to hire an unlimited number of foreign nationals under the H-1B visa program
d. all of the above
e none of the above
12. Which of the following is true regarding criminal background checks?
a. an employer is required to do a criminal background check for all applicants; otherwise, it may be deemed guilty of discrimination if it does checks for some types of jobs but not for others
b. a thorough criminal background check is required only when the applicant will be working with money
c. employers should consider the seriousness, recentness, and job-relatedness of convictions before denying employment on that basis
d. all of the above
e. none of the above
13. Which of the following is a true statement regarding employer compliance with the
Immigration Reform and Control Act?
a. employers must verify a person’s eligibility to work in the United States before the new employee begins work
b. employers are required to copy and retain copies of the documents used by the employee to prove eligibility to work in the United States
c. if they appear to be genuine, employers are not required to investigate or verify the authenticity of documents presented or supplied by the employee
d. employees must present certified copies of whatever documents they use to verify eligibility to work
e. all of the above
14. The Fair Credit Reporting Act refers to which two kinds of reports?
a. a consumer credit report, which reports only credit-worthiness, and an investigative report, which reports the results of interviews with neighbors, colleagues, and the like
b. a consumer credit report, which reports credit information and general character information, and an investigative report, which reports the results of interviews with neighbors, colleagues, and the like
c. a fair credit report, which guarantees accuracy, and a character reference report, based on personal interviews of neighbors, colleagues, and the like
15. After three weeks in your new position as Assistant Human Resources Director, the HR Director has asked you to take a candidate all the way through the process, from application to interview, to background check. The firm has an opening for an electrical engineer who is proficient with construction blueprints. The engineer will be helping to build the company’s new warehouse, which is about to begin construction. Which of the following steps would be necessary to take during the background check?
a. do a thorough criminal background check through all 50 states
b. check to see that the applicant has a degree in electrical engineering
c. check references at the applicant’s former places of employment
d. all of these
e. b and c only
16. You’ve now been on the job for a few months in your role as Assistant Human Resources Director, and have acquired some experience in interviewing and background checks. While doing a background check on a candidate for a secretarial position, you discover that the candidate was arrested several years ago while in college, and accused of damaging university property. What should you do?
a. disqualify the candidate for unfitness
b. talk to the candidate to find out what the report is all about
c. disregard the report, as it’s an arrest, and not a conviction
d. none of these
17. Which of the following steps could an employer take that would help to eliminate possible claims of defamation?
a. obtaining a signed consent from a former employee, authorizing the employer to provide information about her job performance
b. negotiating an agreed letter of reference for an employee who is leaving
c. giving only information that verifies that the former employee worked for the employer, the rate of pay, and the dates of employment
d. all of these
18. Which of the following statements is NOT true?
a. Employers must always perform a criminal background check before hiring an employee
b. Employers must always conduct a thorough and comprehensive background check of every applicant
c. Employers must obtain an applicant’s consumer credit report
d. all of these are true
e. none of these is true
19. "Knowledge" as an element of the tort of negligent hiring, means that:
a. the employer knew the employee was unfit
b. the employer should have known the employee was unfit
c. the employer would have known the employee was unfit if it had done an appropriate background check
d. any of these might constitute such “knowledge”
e. none of these constitutes such “knowledge”
20. While doing a background check on a candidate who is superbly qualified for the sales job for which he has applied, you learn that he was dishonorably discharged from the U.S. Army. When you ask him about it, he explains that he was 18 years old at the time, and the death of his father, whom he had only recently met, had a devastating impact on him. He began to drink to excess, often failed to report to his duty station. After his dishonorable discharge, he righted himself, started working, and got counseling. Everyone at your firm who has interviewed him found him to be very personable, and very able, and they’re eager for him to start. You’ve told them about the dishonorable discharge, and it’s made no difference to their decision. Should you tell other employees about the dishonorable discharge?
a. Yes
b. No
ESSAY QUESTIONS
1. Why is each of the following good legal advice?
a. Background checks must be more extensive when hiring for positions in which unfit employees could do serious harm to others.
b. Employers should document all efforts to obtain information on job candidates, even when those efforts are not successful.
c. Former employers should verify the identities of persons seeking information about former employees, such as by requiring that requests be made on company letterhead.
d. Employers should consider, on an individual basis, the seriousness, job relatedness, and recentness of any criminal convictions before using them as grounds for denying employment.
e. For all persons hired, employers must view documents establishing identity and eligibility to work in the U.S. and record the documents examined on I-9 forms.
Answer: Immigration Reform and Control Act – This is the mechanism through with the Act’s prohibition against hiring undocumented workers is implemented.
2. You have been hired as the assistant director of a company’s Human Resource Department. The director calls you in and tells you that she is considering a suggestion to the Board of Directors that the company adopt a policy of refusing to give substantive information on employee references. She asks you if adopting such a policy makes sense. What advice will you give to her?
CHAPTER 6
Employment Testing
Online Quiz Questions
MULTIPLE CHOICE QUESTIONS
1. Drug testing in employment is used:
a. prior to hiring
b. as part of medical exams
c. to verify that employees who have been through drug rehab programs are “clean”
d. all of the above
2. Regarding drug testing, which of the following statements is NOT true?
a. No one rule applies to employers uniformly.
b. Drug testing laws vary from state to state.
c. About 10 states grant employers the right to drug test at any time.
d. Random drug testing of union members is subject to their CBA.
3. With some exceptions for certain industries, public employers may not use random drug-testing because:
a. of their union collective bargaining agreement
b. it violates the U.S. Constitution’s 4th amendment
c. it is unfair
d. none of these; public employers may use random drug-testing
4. Pursuant to the Genetic Information Nondiscrimination Act of 2008:
a. Employers are required to genetically test their employees for insurance purposes.
b. Employers are forbidden from genetically testing their employees.
c. Employees must disclose their genetic information to their employers.
d. None of these
5. Polygraphs may be administered by employers:
a. pre-hire, to determine the honesty of the applicant
b. after a theft or other serious event
c. randomly
d. all of these statements are true
6. Match each term to its correct definition.
Medical examination for example, an HIV test
Chain of custody tracking the location of a sample from the time its taken
Four-fifths rule an EEOC rule of thumb
Banding grouping similar scores together and treating them similarly
Drug-Free Workplace Act a federal law which applies to firms that do business with the federal government
CHAPTER 6
EMPLOYMENT TESTING
MULTIPLE CHOICE QUESTIONS
1. Which of the following statements is most correct about the legality of drug testing?
a. drug testing will usually be upheld, provided that the employer had reasonable grounds for suspecting that the individual employee was under the influence of drugs
b. drug testing will usually not be upheld if it is legally challenged
c. drug testing will be upheld for private sector employees, but not for public employees
d. drug testing will usually be upheld, but random testing procedures are the most susceptible to challenge
2. Drug testing may include samples of all of the following EXCEPT:
a. blood
b. saliva
c. hair
d. fingernails
3. The Drug Free Workplace Act of 1988 requires that:
a. employees must be drug tested at the time of hire and whenever there is reasonable suspicion of drug use in the workplace
b. employers must develop and communicate polices prohibiting drug use, possession, or sale in the workplace
c. employers must terminate all employees who are found more than once to be using drugs in the workplace
d. all of the above
e. none of the above
4. Which of the following is considered a medical exam under the ADA?
a. drug test
b. genetic test
c. physical fitness/agility test
d. vision tests for ability to read or recognize objects
e. none of the above
5. Which of the following is true regarding medical exams under the ADA?
a. all medical exams must be voluntary
b. medical exams conducted following conditional offers of employment are unrestricted in scope
c. only if an employee’s condition makes him a direct threat to himself or others can he be denied an employment opportunity based on a medical exam
d. people who are disabled or look disabled may be singled out to receive medical exams based on their condition
e. none of the above
6. Which of the following is true regarding HIV tests?
a. they must not be given until after a conditional offer of employment has been made
b. forced testing of public employees will usually violate the Constitution
c. it will usually not be legal to deny an employment opportunity based on the fact that a job candidate or employee has tested positive
d. all of the above
e. none of the above
7. About half of the states have drug testing laws, some of which:
a. prohibit blood testing
b. require testing of certain employees, or under certain conditions
c. regulate more fully random drug testing
d. all of these
e. all of these except a
8. Employers must show that a test is job related and consistent with business necessity:
a. only if the test is having discriminatory effects
b. any time that a test is used
c. only if content validity cannot be established
d. none of the above
9. To determine if a test is having discriminatory effects:
a. see if the number of women and persons of color hired is at least four-fifth’s of the number of white males hired
b. see if the proportion of women and persons of color hired is roughly equal to the proportion of women and persons of color in the relevant labor market
c. compare the pass rates for different protected class groups and see if the pass rate for any group is less than four-fifth’s of the pass rate for the most successful group
d. compare the number of persons from different protected class groups that pass the test and see if the number of persons passing for any group is less than four-fifth’s of the number for the most successful group
e. examine the individual test questions looking for evidence of bias
10. Which of the following is NOT true regarding the Employee Polygraph Protection Act?
a. it applies to voice stress analyzers, mechanical and electronic truth determining devices as well as polygraphs
b. it only applies to private sector employers but not to governmental agencies
c. it prohibits the use of polygraphs by private sector employers for any reason
d. it does not apply to, or prohibit, pencil and paper honesty tests
11. Content validation studies:
a. examine whether behaviors and skills tested closely represent behaviors and skills used on the job
b. examine test items to ensure that they measure what they purport to measure and do not include irrelevant or biased questions
c. demonstrate a statistical association between test performance and job performance
d. all of the above
e. none of the above
12. In Lanning v. SEPTA, female applicants for transit police jobs failed the physical fitness test at a much higher rate than male applicants and were rarely hired. The major conclusion to be drawn from this case is that______:
a. employers should reasonably accommodate women when conducting physical fitness tests
b. if physical fitness tests are professionally developed, they will usually not produce discriminatory effects
c. cut-off scores on physical fitness tests should reflect the minimum level of physical ability needed to successfully perform the job
d. employers must not establish different cut-off scores for men and women on physical fitness tests
e. none of the above
13. A criterion validation study must:
a. be based on a thorough job analysis
b. include a representative sample
c. demonstrate a statistical association between test performance and job performance
d. all of the above
e. none of the above
14. Regarding drug tests:
a. the employer must perform a second confirmatory test if requested by the employee
b. the employer must allow the employee access to samples so that the employee can have her own test done
c. a and b
d. none of the above; if the test is done by an independent certified laboratory and there is no evidence that the test was compromised or invalid, the original test is all that needs to be done
15. For union employers, drug testing is:
a. prohibited
b. permitted only under certain conditions
c. a subject of mandatory bargaining
d. none of these
16. Drug testing laws, both state and federal, require that:
a. employers use due care in conducting tests and handling samples
b. employers refrain from drug testing unless required by law
c. employers routinely drug test all employees
d. none of these
17. You have just concluded an employment interview with an applicant you like, who is qualified for the inside sales job you have been interviewing for, and have made a conditional offer of employment. You tell the applicant that you want her to take a medical exam, and if she passes, she has the job. She is at first obviously happy and seemingly relieved, but then breaks down in tears. She tells you that a medical will show that she is HIV positive. What should you do?
a. Tell her not to worry, and that if she otherwise passes the medical exam, she has the job
b. Tell her that you’re sorry to hear about her affliction, and obviously, you cannot hire her
c. Report her to the County Health authorities
d. none of these
18. You are the HR Manager of your firm, and you pride yourself on being up to date with legal requirements, and on the cutting edge of your field. You’ve just gotten a mailer about a new test kit which would perform genetic testing by pricking a finger, dripping the blood sample onto a tab, and mailing it in to a lab. You think how this could be applied to your employees and applicants, and what you might be able to save on health insurance costs. What should you do?
a. Order a gross of the genetic testing kits as soon as possible.
b. Call the company attorney to ask how you could test the entire staff without their knowledge
c. Throw the mailer in the trash; it’s use in this context would be illegal
d. none of these
19. Your firm’s lunchroom has been a congenial gathering place for employees while they are taking their lunch breaks, but lately, lunches that employees have brought from home and put into the refrigerator in the morning have disappeared by lunch time. This has happened several times, and the employees have now started to accuse one another of stealing lunches. Morale has fallen, and you must do something. Of the following, which is your best option?
a. conduct polygraph tests of all of the employees
b. conduct polygraph tests of all employees who use the lunchroom
c. install a video camera, and train it on the refrigerator in the lunchroom
d. prohibit use of the refrigerator by anyone
20. You are in the process of revising your pre-employment tests, as your current test is out of date, and may have discriminatory effects. A new company offering a pre-employment test has given you a sample of their test, which they tell you has had great success in screening to acquire only honest employees. Applicants are to agree or disagree with several statements, including this one: “I believe God wants us to conduct ourselves with honesty in all things, including at work.” Which of the following statements is most correct?
a. The test will have no discriminatory effect, and will successfully screen for honest employees
b. The test may have a discriminatory effect, and should not be used
c. You should wait to see how the test performs for other companies, so that you can decide whether or not to adopt it
d. none of these
ESSAY QUESTIONS
1. Why is each of the following good legal advice?
a. Supervisors should be well-trained at identifying signs of drug use and impairment.
b. Information about medications taken should be sought only after positive drug test results occur.
c. Drug testing programs should require confirmatory tests to verify positive results, provide for documentation of the chain of custody, use reputable labs and monitor their performance, and use a Medical Review Officer.
d. Employers should have evidence of validity for all of their tests, but must do so for tests that have discriminatory effects.
e. Content valid tests should be used to the extent feasible, but not to assess intangible characteristics and not for tasks that could readily be learned on the job.
2. Non-medical tests used for making employment selection decisions must be scored in some way. Name and discuss the various legal and illegal methods that employers utilize.
CHAPTER 7
HIRING AND PROMOTION DECISiONS
Online Quiz Questions
MULTIPLE CHOICE QUESTIONS
1. A “facially discriminatory policy or practice” is:
a. one that is discriminatory on its face
b. one that uses face recognition software to identify employees
c. one that is necessary to conduct business
d. all of the above
2. One defense to a claim of discrimination is:
a. Age Discrimination in Employment Act (ADEA)
b. bona fide occupational qualification (BFOQ)
c. a thorough background check
d. a collective bargaining agreement (CBA)
3. One employer refused to hire women with children under age 5, but did hire men with children under age 5. This is an example of what kind of case?
a. disparate impact
b. sex plus
c. retaliation
d. none of these
4. A person who was interviewed and hired, but the job offer was withdrawn before he/she began may have a cause of action for:
a. breach of contract
b. negligent hiring
c. promissory estoppel
d. all of these
5. The artificial barriers based on attitudinal or organizational bias that prevent qualified individuals from advancing in their organization into upper management positions are known as:
a. luck of the draw
b. the glass ceiling
c. seniority
d. subjective criteria
6. Match each term to its correct definition.
Authenticity required for believability even though discriminatory
BFOQ discrimination which is reasonably necessary to the business
Sex-stereotyping for example, women as homemakers and men as fighters
Subjective criteria measures without clear standards, about which people may disagree
Promissory estoppel one who relies to his detriment may have this cause of action
CHAPTER 7
HIRING AND PROMOTION DECISIONS
MULTIPLE CHOICE QUESTIONS
1. The bona fide occupational qualification (BFOQ) defense:
a. applies to intentionally discriminatory policies but not to neutral policies that result in discrimination
b. permits race or color to be used as selection criteria, but only under circumstances where employers can make a very strong case for why that is necessary
c. is the only means by which employers can avoid liability for facially discriminatory policies or practices
d. all of the above
e. none of the above
2. Which of the following is most likely a proper application of a BFOQ?
a. transferring pregnant women out of a department that worked with chemicals known to be harmful to a fetus
b. not hiring women for the night shift because the factory is in a very dangerous part of town and the company parking lot requires a ½ mile walk to the site
c. requiring airline pilots to retire at 60 years old
d. all of the above
e. none of the above
3. The machinery in a plant is old and was designed for use by an “average-sized male.” Citing safety concerns, the company hires only average-sized males for jobs working in the plant. If a female applicant for a job at the plant is not hired and sues, a court would most likely rule that:
a. the employer violated Title VII by facially discriminating based on sex
b. the employer violated Title VII by not attempting to accommodate women so that they could work in the plant
c. the employer violated Title VII because the selection criterion of size has an adverse impact on women and is not job related and consistent with business necessity
d. the employer did not violate Title VII because the employer could establish a BFOQ based on its safety concerns
e. the employer did not violate Title VII because any adverse impact its hiring criterion created was justified as job related and consistent with business necessity
4. Which of the following would NOT be considered a sex-plus policy issue?
a. hiring women only after they have gone through menopause
b. requiring men, but not women, over 40 years old to have annual physicals
c. hiring male newlyweds but not hiring female newlyweds
d. asking men and women about childcare arrangements during a pre-employment interview
e. none of the above
5. xxA female teacher who worked for a school district alleged that she was discriminated against and denied tenure because she was a young mother who her superiors felt could not do a good job and be a good mother simultaneously.
a. the teacher was successful because they proved that in the year Back was hired, 85% of the teachers employed were women and 71% of these women had children
b. the school district was successful because Back did not prove or even allege that males with children were treated more favorably than she was treated
c. Back was successful because a jury could find that the justifications for the negative tenure recommendation and evaluation offered by Back’s superiors were pretextual and that discrimination was a motivating factor for the negative recommendation
d. Back was successful because Hastings did not establish that not having young children was a legitimate BFOQ for her administrative position
6. Which of the following is true regarding grooming and appearance standards for employees?
a. applying different standards to men and women does not automatically constitute sex-plus discrimination
b. standards that are sex-stereotypical in nature are likely to be discriminatory
c. dress requirements that result in harassment are likely to be discriminatory
d. all of the above
e. none of the above
7. The use of subjective criteria by employers:
a. is legal as long as the criteria can be systematically measured and quantified
b. tends to result in the hiring of fewer African-Americans and Latinos
c. requires a formal validation study to be conducted if the criteria produce adverse impact
d. all of the above
e. none of the above
8. Which of the following statements is most correct regarding the interviewing process:
a. the degree of subjectivity in interviewing applicants tends to be low
b. the use of a structured interview may provide more uniform results, and fewer charges of discrimination
c. the degree of subjectivity in interviewing applicants tends to be uniform
d. interviewers generally know when they are responding negatively based on stereotypes
9. Trends in jobs and hiring criteria raise new legal questions because:
a. increased emphasis on “soft skills” that are assessed subjectively limits employment opportunities for persons of color
b. increased emphasis on flexible job descriptions and teamwork limits employment opportunities for older workers
c. increased emphasis on organization-fit limits employment opportunities for disabled persons
d. all of the above
e. none of the above
10. The bona fide seniority system (BFSS) defense:
a. applies to facially discriminatory policies or practices
b. will not succeed if it results in the limitation of employment opportunities for lower seniority women or persons of color
c. is one of two statutory defenses to discrimination charges included in Title VII
d. all of the above
e. none of the above
11. Which of the following is an element necessary to establish the existence of a contract?
a. a written document signed by both parties and reviewed by lawyers
b. a written document signed by both parties and whether reviewed by lawyers or not
c. face to face negotiations over contract terms
d. a clear offer and acceptance of the offer
12. Promissory estoppel claims:
a. arise when employment contracts are breached
b. require evidence of intent to deceive
c. require reasonable reliance on a clear promise
d. all of the above
e. none of the above
13. xxIn Everson v. Michigan Department of Corrections, the defendant claimed that hiring
only female Corrections and Residential Housing Unit Officers was justified as a BFOQ.
The court:
a. agreed based on prisoner’s privacy concerns
b. agreed based on prisoner’s preference concerns
c. disagreed based on perceived security concerns
d. disagreed because there were reasonable alternatives shown that would allow both men and women to perform the officer positions without adversely affecting the institution or the prisoners
14. “Glass ceilings”:
a. are primarily a problem for women rather than persons of color
b. have been the focus of enforcement actions by the OFCCP
c. are primarily a problem in the financial sector
d. all of the above
e. none of the above
15. Regarding promotions, which of the following would NOT constitute good information and advice for managers?
a. assessing who is eligible for a promotion may begin with the jobs to which people are assigned when they are hired
b. training and development programs should be developed, and made available to all
c. since not all are qualified to be promoted, it is not advisable to post or announce possible promotion opportunities; rather one should advise only the people who may be qualified
d. one should consider applications for promotion from all who are interested, even if they do not appear to qualify.
16. Which of the following statements is NOT true as to discrimination against caregivers?
a. sex stereotyping is a common form of discrimination against caregivers
b. the EEOC has highlighted the issue of discrimination against caregivers
c. “caregiver” is a new protected class under EEOC guidelines
d. disparate treatment is the most common form of discrimination against caregivers
17. You are the manager of your division at a large technology firm, and have been waiting to get approval to hire a new person. You have someone in mind: your long-time friend and college roommate, who you know would be a terrific fit with your team. But you are also aware that the company wants to increase its diversity, especially with regard to women. You worry about this, since your team is all male, and adding a woman would change the dynamics considerably. You’ve now advertised the new position, as required, and the two best candidates are your friend, and a Latina woman you have never met before. Neither candidate has met your team. Of the following, which would be the best decision?
a. hire your friend; you know he’ll fit with the current team
b. hire the woman; the firm will be happy that you’ve improved diversity
c. have both candidates meet with your team, each one separately, and get their input on the candidates; then decide based on their preference
d. have both candidates meet with your team, each one separately, and get their input on the candidates; then make the decision on your own, objectively
18. Your firm has been repeatedly accused of discrimination, and your boss, knowing that you just graduated from college with a degree in Management, and a certificate in Human Resources Management, has asked you to review the company’s practices and procedures with regard to hiring and promotion, and eliminate those that could lead to discrimination. Which of the following practices would likely lead to discrimination?
a. evaluating candidates based upon technical skills (30%) and interviews (70%)
b. having the interviewers meet as a group to “coordinate” their interview scores
c. weighting the answers to some questions over others
d. all of these would likely lead to discrimination
e. none of these would likely lead to discrimination
19. With regard to the situation in # 18, above, which of the following practices would you recommend to help avoid discrimination, and what is the basis for your recommendation?
a. change the weight given to the evaluation of candidates to rely more heavily on technical skills than on the interview, because this would make the assessment more objective
b. do not allow the interviewers to change their scores developed during the interview, as this will remove score manipulation
c. continue to weight the answers to those questions which are more important, because this is necessary to acquiring compatible workers, and does not discriminate
d. all of these would help avoid discrimination
e. only a and b would help avoid discrimination
20. Your firm has been wanting to hire another engineer for some time, and your supervisor has just made an offer to someone from out of state. The hiree is in the process of selling his house, and moving his family to your city. But you are well aware that the economic downturn has sharply curtailed business, and you don’t see how the current level of business can support another engineer. In fact, you are all a little concerned about layoffs. You know that your supervisor also knows all of this, but he has told you that he won’t withdraw the offer until he absolutely has to. By that time, the hiree may well have sold his home and moved his family, but have no new job with your firm. If the offer is withdrawn under these circumstances, and the hiree sues, which causes of action, if any, might be successful?
a. breach of contract and promissory estoppel
b. promissory estoppel and fraud
c. fraud only
d. breach of contract only
e. none of these
ESSAY QUESTIONS
1. Why is each of the following good legal advice?
a. Rather than use protected class characteristics to identify persons with desired abilities, employers should find more individualized means of assessing job-related abilities.
b. Employers must not exclude older employees from safety-sensitive jobs based on assumptions about health status, unless there is evidence that older employees pose greater risk and it is not feasible to adequately assess the health of individuals.
c. Employers must not establish employment requirements that apply to one protected class group but not others.
d. Employers should give substantial weight to subjective assessments only if they are specific and clearly grounded in statements or actions of job candidates.
e. Employers should, with the help of legal counsel, put employment offers in writing.
2. What rules and procedures should employers establish with regard to interviews of job applicants?
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Chapters 1 Through 6
Chapter 1
1.Principlesare
a.lawsandregulationsthatguidebehaviorinthe worldofbusiness. b.mores,values,andcustomsthatguidebehavioringeneral.
c.specificandpervasiveboundariesforbehaviorthatareuniversalandabsolute.
d.theobligationsbusinessesassumeto maximizetheirpositiveimpactandminimizetheirnegativeimpacton stakeholders.
e.themores,values,andcustomsthatparentsteachtheirchildren.
2.Social responsibilityis
a.anorganization'sobligationtomaximizeitspositiveeffectsand minimizeitsnegativeeffectsonstakeholders. b.principlesandstandardsthatguidebehaviorinthe worldofbusiness.
c.abusiness'sresponsibilitynotto pollutetheenvironment.
d.a business'sresponsibilitytomanufactureproductsthatfunctionproperly. e.charitablecontributionsmadeby abusinesstoenhanceits image.
3.The
was/wereenactedtorestoreconfidenceinfinancialreportingandbusinessethicsaftertheaccounting
scandalsoftheearly2000s.
a.DefenseIndustryInitiativeon BusinessEthicsandConduct b.Sarbanes-OxleyAct
c.FederalSentencingGuidelinesforOrganizations d.ForeignCorruptPracticesAct
e.Dodd-FrankWallStreetReformandConsumerProtectionAct
4.Thetermbusinessethicsisbestdescribedbythe followingstatement:
a.Itisthestudyand philosophyofhumanconduct,withanemphasisondeterminingrightand wrong.
b.Itisan"inquiryintothe natureandgroundsofmoralitywherethe termmoralityistakentomeanmoral judgments,standardsandrulesofconduct."
c.Itisthe"studyof thegeneralnatureof moralsandof specificmoralchoices;moralphilosophy;andtherules orstandardsgoverningtheconductofthemembersofaprofession."
d.Itisanorganization'sobligationtomaximizeitspositiveeffectsand minimizeitsnegativeeffectson stakeholders.
e.Itcomprisesthe principles,values,andstandardsthatguidebehaviorinthe worldofbusiness.
5.Whichofthefollowingis notone oftherightsspelledout byJohnF.Kennedyinhis"Consumers'BillofRights"?
a.Therighttochoose b.Therightto safety
c.Therighttobeinformed d.Therighttobeethical
e.Therightto beheard
6.Duringthe1990stheinstitutionalizationofbusinessethicswas largelydrivenbywhichpieceoflegislation?
a.Sarbanes-OxleyAct
b.FederalSentencingGuidelinesforOrganizations
c.Dodd-FrankWallStreetReformandConsumerProtectionAct d.ForeignCorruptPracticesAct
e.Global SullivanPrinciples
7.Businessethics,asafield,haspassedthroughwhichofthefollowingstates?
a.Afieldofstudytotheologicaldiscussiontorecognitionofsocialissues b.Recognitionofsocialissuestoa fieldofstudytotheologicaldiscussion c.Afieldofstudytorecognitionofsocialissuestotheologicaldiscussion d.Recognitionofsocialissuestotheologicaldiscussiontoa fieldofstudy e.Theologicaldiscussiontorecognitionofsocialissuestoa fieldofstudy
8.The1960ssawariseofconsumerism.Whatis consumerism?
a.An increaseinconsumerrightsbyorganizationsandgovernments b.Thegrowthofinternationalretailchainstores
c.Activitiesundertakenbyindependentindividuals,and groupsto protecttheirrightsasconsumers d.Thewidespreadadoptionof consumerorientedmarketingstrategiesamongbusinesses
e.Organizations’tendencytoseekwaystotakeadvantageofconsumers
9.Ethicsisa partofdecisionmaking
a.atall levelsof workandmanagement.
b.primarilyatthe uppermanagementlevelsofanorganization. c.mostlyforpolicymakers.
d.thatislessimportantthanotherdecisionmakingprocesses. e.onlyatthatlowerlevelsoforganizationalmanagement.
10.Whichofthe followingwasdevelopedinthe 1980stoguidecorporatesupportfor ethicalconductbyestablishinga methodfordiscussingbestpractices?
a.FederalSentencingGuidelinesforOrganizations
b.DefenseIndustryInitiativeon BusinessEthicsandConduct c.Corporatecodesofconduct
d.UnitedStatesSentencingCommission e.MERCOSUR
11.The
focus(es)onfirmstakingactionto preventanddetectbusinessmisconductin cooperationwith
governmentregulation.
a.UnitedStatesSentencingCommission
b.DefenseIndustryInitiativeon BusinessEthicsandConduct c.WorldTradeOrganization
d.UnitedNationsGlobalCompact
e.FederalSentencingGuidelinesforOrganizations
12.Thestudyofbusinessethicsisimportanttobetterunderstandallofthe followingexcept
a.thata person'sownmoralphilosophiesanddecision-makingexperiencemaynotbesufficienttoguidehimor herinthebusinessworld.
b.howandwhypeoplemakeethicalorunethicaldecisions.
c.howto copewithconflictsbetweenaperson'sownvaluesandthoseoftheorganizationin whichheorshe works.
d.thatbusinessethicsisentirelyanextensionofanindividual'sownpersonalethics. e.howtoidentifyethicalissuesarisinginthebusinessworld.
13.Accordingto theroleofethicalculturein performance,allofthesearedriversofprofitexcept
a.trust.
b.investorloyalty.
c.employeecommitment. d.customersatisfaction.
e.opportunityformisconduct.
14.Morethana complianceprogram,businessethicsisbecoming a.amanagementissueto achievecompetitiveadvantage.
b.lessacceptedbysociety.
c.mainlyagovernmentregulatoryissue.
d.an initiativeledby nonprofitorganizations.
e.aprogramthatdecreasesprofitsbutincreasessocietalbenefits.
15.Havingacceptablepersonalethicsisprobablynotgoingto besufficientto handlecomplexbusinessethicalissues whenanindividualhas
a.familyconcerns. b.an unethicalboss.
c.limitedbusinessexperience. d.financialtraining.
e.a marketingbackground.
16.OneofthemajorethicalissuesPresidentObama’sadministrationfocusedonwas
a.decreasingenvironmentallegislation. b.deregulation.
c.taxdecreases.
d.incentivesto oilcompanies.
e.healthcareandconsumerprotection.
17.Whichof thefollowingisgenerallynotconsidereda businessethicsissue?
a.Harassment
b.Accountingfraud c.Employeetheft
d.Misuseoforganizationalresources e.Corporatehierarchy
18.Whichrepresenteda far-reachingchangetoorganizationalcontrolandaccountingsystems,makingsecuritiesfrauda criminaloffense?
a.CouncilonEconomicPrioritiesandSocialAccountability8000. b.Sarbanes-OxleyAct.
c.ConsumerProtectionAct.
d.DefenseIndustryInitiativeon BusinessEthicsandConduct.
e.Dodd-FrankWallStreetReformandConsumerProtectionAct.
19.TheForeignCorruptPracticesActoutlawed a.accountingfraud.
b.pricecollusion.
c.corruptioningovernment.
d.briberyofofficialsin othercountries. e.executivemisconduct.
20.WhichofthefollowingwasnotaprovisionoftheSarbanes-OxleyAct?
a.Itstiffenedpenaltiesforcorporatefraud.
b.It createdanaccountingoversightboardthatrequirescorporationsto establishcodesofethicsforfinancial reporting.
c.Itrequiredtopexecutivestosignoffon theirfirms'financialstatements. d.Itoutlawedbriberyofofficialsinothercountries.
e.Itmadesecuritiesfrauda criminaloffense.
21.Whichofthefollowingis notcitedas an exampleof a globalcollaborativeefforttoestablishstandardsof business conduct?
a.CouncilonEconomicPriorities'SocialAccountability8000 b.EthicalTradingInitiative
c.U.S.ApparelIndustryPartnership
d.UnitedStatesSentencingCommission e.WorldTradeOrganization
22.Becauseof Sarbanes-Oxley,publiclytradedcompaniesmustdevelop financialreporting.
a.ethicsofficers
b.ethicsprograms c.codesofethics d.legalcounsel
e.accountants
toassistinmaintainingtransparencyin
23. isessentialinbuildinglong-termrelationshipsbetweenbusinessesandconsumers. a.Profits
b.Dividends c.Trust
d.Hubris
e.Codesofethics
24.TheDodd-FrankWallStreetReformandConsumerProtectionAct a.wasverypopularamongWallStreetbankers.
b.representedonlymodestreform.
c.cameout oftheologicaldiscussionsin the1920s.
d.wasdesignedtomakethefinancialservicesindustrymoreresponsible. e.madeitmandatoryforpubliccorporationstohireethicsofficers.
25.IntheReagan/Busheras,themajorfocusofthebusinessworldwason a.self-regulationratherthanregulationbygovernment.
b.decreasingthenumberofmergers.
c.decreasingthemultinationalpresencein theU.S.marketplace. d.increasinggovernmentinfluenceon theeconomicarena.
e.improvingbusinessethics.
26.Thesixprinciplesof theDefenseIndustryInitiativeon BusinessEthicsandConductbecamethefoundationfor a.BetterBusinessBureauethicalguidelines.
b.theFederalSentencingGuidelinesforOrganizations. c.theEthicalTradingInitiative.
d.the FederalTradeCommissioncompliancerequirements. e.theSarbanes-OxleyAct.
27.Ethicalcultureisdefinedas
a.rules,standards,and moralprinciplesregardingwhatis rightorwrongin specificsituations. b.theestablishmentandenforcementof ethicalcodesthroughouttheorganization.
c.thedevelopmentofrulesandnormsthataresociallyenforced.
d.the codificationoflawstorewardorganizationsfor takingactiontopreventmisconduct. e.acceptablebehaviorasdefinedbythecompanyandindustry.
28.TheFederalSentencingGuidelinesfor Organizationsset the tonefor organizationalethicscomplianceprogramsby a.codifyingintolaw incentivesfororganizationstotakeactionsuchasdevelopingethicalcomplianceprograms
topreventmisconduct.
b.forcingallorganizationstodevelopmandatoryreportingsystems.
c.eliminatingmostofthefederallegislationthatcreatedinefficientand time-consumingactivitiesforbusinesses. d.providingastudyof moralphilosophies.
e.providinganexaminationofcompanycodesofethics.
29.WhichofthefollowingstatementsabouttheFederalSentencingGuidelinesforOrganizationsisfalse?
a.Theyusearoutinemechanicalapproachthatforcesallfirmstousethesamemeanstoavertserious penalties.
b.Theystrivetopreventmisconduct.
c.Theyencouragecompaniesto developstandardsandprocedurescapableofdetectingandpreventing misconduct.
d.Theyutilizea carrotandstickapproachbytakingpreventiveactionagainstmisconduct.
e.Theyencouragethe appointmentofhigh-levelpersonnelresponsiblefor oversightofthe complianceprogram.
30.Whichofthefollowingis notoneofthe benefitsofbeingethicalandsociallyresponsibleinbusiness?
a.Greateremployeecommitment
b.Ahighdegreeof employeedissent
c.Improvedcustomertrustandsatisfaction d.Increasedinvestorloyalty
e.Betterfinancialperformance
31.Employees'perceptionsof theirfirmas havingan ethicalclimateleadsto a.lackoffocusongoals.
b.greaterfocusoneducation.
c.increasedcommunityinvolvement.
d.improvedrelationshipswith competitors. e.enhancedperformance.
32.Employeesfeellesspressuretocompromiseethically,observelessmisconduct,aremoresatisfiedwiththeir organizations,andfeelmorevaluedwhen
a.theyarenewattheirjobs.
b.theyarepaidtoignoreproblemsintheworkplace. c.theydo notagreewithan organization’svalues.
d.theyhaveveryhighcompensation.
e.theyseehonesty,respect,andtrustappliedin theworkplace.
33.Investorsareconcernedaboutbusinessethicsbecausetheyknowthatmisconductcan a.fosterstability.
b.improveemployeecommitment. c.improvecustomerloyalty.
d.lowerstockvalueandprices.
e.complicatebusinessfinancialreporting.
34.Mostorganizationswithstrongethicalclimatesusuallyfocuson thecorevalueof placing interestsfirst. a.customers'
b.employees'
c.stockholders' d.suppliers'
e.distributors'
35.Whichofthefollowingis notsomethinga firmmightdotoencourageorganizationalethicsand compliance?
a.Employeeethicstraining
b.Hiringa complianceofficer
c.Ignoringpotentialethicalissues d.Writingacodeof ethics
e.Conductinganethicsand complianceaudit.
36.Howdoesethicscontributeto customersatisfaction?
37.Discusstheevolutionofbusinessethicsasafieldofstudyfrombefore1960to thepresent.
38.Whyisit importantthatbusinesspeoplestudybusinessethics?
39.Wealllearnvaluesfromsourcessuchasfamily,religion,andschool.Whymightthesesourcesofindividualvalues not proveveryhelpfulwhenmakingcomplexbusinessdecisions?
40.Discussthecurrentstateofbusinessethicsinthetwenty-firstcentury.
41.Howdo valuesandjudgmentsplayacriticalrolewhenwemakeethicaldecisions?
Chapter 2
1.Thosewhohaveaclaimin someaspectofafirm'sproducts,operations,markets,industry,andoutcomesareknown as
a. shareholders. b. stockholders. c. stakeholders. d.claimholders.
e.special-interestgroups.
2.Stakeholders'poweroverbusinessesstemsfromtheir a.abilitytowithdraworwithholdresources.
b.abilitytogenerateprofits. c.mediaimpact.
d.politicalinfluence. e.stockownership.
3.Whichofthefollowingdonottypicallyengageintransactionswithacompanyandthusarenotessentialforits survival?
a.Employees
b.Secondarystakeholders c.Primarystakeholders
d.Investors
e.Customers
4.Afirmthatmakesuseofa
recognizesotherstakeholdersbeyondinvestors,employees,andsuppliers,and
explicitlyacknowledgesthetwo-waydialogthatexistsbetweenafirm'sinternalandexternalenvironments. a.stakeholdermodelofcorporategovernance
b.stakeholderbias c.codeofethics
d.stakeholderinteractionmodel e.corporateinterfacemodel
5.Thedegreetowhichafirmunderstandsandaddressesstakeholderdemandscanbereferredtoas a.a stakeholderorientation.
b.a shareholderorientation.
c.the stakeholderinteractionmodel. d.atwo-waystreet.
e.acontinuum.
6.Whichof thefollowingindustriestendstogeneratea highleveloftrustfromconsumersandstakeholders?
a.Insurance
b.Technology c.Banks
d.Mortgagelenders e.Financialservices
7.Whichofthefollowingis nota benefitthatprimarystakeholderstendtoprovidetoorganizations?
a.Suppliesofcapitalandresources. b.Expertiseandleadership
c.Word-of-mouthpromotion d.Infrastructure
e.Pro-bonobookkeeping
8.A stakeholdergroupthatis absolutelynecessaryforafirm’ssurvivalis definedas
a.direct.
b.tertiary.
c.secondary.
d.special-interest. e.primary.
9.Whenunethicalactsarediscoveredin afirm,in mostinstances a.theyare causedbyunwillingparticipants.
b.thecauseisduetoexternalstakeholders.
c.theperpetratorsarecaughtandprosecuted.
d.therewasknowingcooperationorcomplicityfromwithinthecompany. e.thecauseisacorruptBoardofDirectors.
10.Whichofthefollowingis nota methodtypicallyemployedbyfirmswhenresearchingrelevantstakeholdergroups?
a.Surveys
b.Focusgroups
c.Internetsearches d.Pressreviews
e.Guessing
11.Astakeholderorientationcanbeviewedasa(n)
a.necessityforbusinesssuccess. b.continuum.
c.polarizingconcept.
d.good marketingploy. e.expensiveproposition.
12.Shareholdersprovideresourcestoan organizationthatarecriticaltolongtermsuccess.Whichof thefollowingdoes thebooksuggestthatsuppliersoffer?
a.Thepromiseofcustomerloyalty
b.Materialresourcesand/orintangibleknowledge c.Infrastructure
d.Revenue
e.Leadershipskills
13.Whichofthefollowingis notassociatedwiththestakeholderinteractionmodel?
a.Involvesatwo-wayrelationshipbetweenfirmandstakeholders b.Recognizestheinputofinvestors,employees,and suppliers
c.Explicitlyacknowledgesdialoguewith afirm'sinternalenvironment d.Explicitlyacknowledgesdialoguewithafirm'sexternalenvironment
e.Identifiesthemassmedia,specialinterestgroups,competitors,andtradeassociationsas primarystakeholders
14.Thefirstofthethreeactivitiesthatareassociatedwiththestakeholderorientationis the a.organization-widegenerationofdata.
b.organization'sresponsivenesstointelligence. c.setof consumerattributesidentified.
d.organizationalstrategyoftargetmarkets.
e.humanrelationsdepartment'ssetof priorities.
15.Publichealthandsafetyandsupportof localorganizationsareissuesmostrelevanttowhichstakeholdergroup?
a.Investors
b.Community c.Suppliers
d.Customers e.Employees
16.Minimizingtheuseof energyandreducingemissionsandwasteareissuesof importancetowhichstakeholder?
a.Environmentalgroups b.Suppliers
c.Employees
d.Industryleaders e.Investors
17.Theideathatthe missionofbusinessistoproducegoodsandservicesata profit,thusmaximizingitscontributionto societyisassociatedwith
a.AdamSmith.
b. TheodoreLevitt. c. Norman Bowie. d.HermanMiller
e.MiltonFriedman.
18.Theoriginatorof theideaof theinvisiblehand,whichis afundamentalconceptin freemarketcapitalism,was a.AdamSmith.
b. TheodoreLevitt. c. Norman Bowie. d.HermanMiller
e.MiltonFriedman.
19.Someeconomistsbelievethatifcompaniesaddresseconomicandlegalissues,theyaresatisfyingthedemandsof society,and thattryingto anticipateand meetadditionalneedswouldbealmostimpossible.Whicheconomist’s theoryaretheyfollowingmostcloselywiththis belief?
a.AdamSmith.
b. TheodoreLevitt. c. Norman Bowie. d.HermanMiller
e.MiltonFriedman.
20.Inascendingorder,Carroll'sfourlevelsofsocialresponsibilityare a.ethical,legal,economic,philanthropic.
b.economic,ethical philanthropic,legal. c.economic,legal, ethical,philanthropic. d.legal, ethical,economic,philanthropic. e.ethical,legal,moral,economic.
21.Thetermusedtoexpresshowa firmmeetsits stakeholderexpectationsof its economic,legal,ethical,and philanthropicresponsibilitiesis
a.reputation.
b.corporatecitizenship.
c.corporateethicalaudit. d.ethicalcitizenship.
e.fiduciaryduties.
22.In corporategovernance, istheprocessof auditingandimprovingorganizationaldecisionsandactions. a.profit
b.loyalty
c.accountability d.control
e.diligence
23.Accountability,oversight,andcontrolallfallunderthedefinitionandimplementationofcorporate a.profit.
b.loyalty. c.care.
d.governance. e.diligence.
24.Majorcorporategovernanceissuesnormallyinvolve decisions.(Choosetheresponsethatismostcorrect)
a.strategic-level b.tactical-level
c.divisional-level d.marketing-level e.accounting-level
25.Whichof thefollowingisamajorethicalconcernamongcorporateboardsof directors?
a.Compensation
b.The non-traditionaldirectorshipapproach c.Dividendreporting
d.Corporatesocialaudits e.Debtswaps
26.OnepolicytoaddresstheissueofexecutivepaywasimplementedbyJ.P.Morgan,itstatedthat
a.thereshouldbe no limiton whattopexecutivescanearn.
b.managersshouldearnnomorethantwentytimesthepayofotheremployees. c.topmanagersshouldmakethesameamountasotheremployees.
d.employeescandeterminehowmuchmanagersmake.
e.thegovernmentshoulddeterminetheworthofeachmanager’sservice.
27.Thespecificstepsfor implementingthe stakeholderperspectivedonotincludewhichofthe following?
a.Identifyingstakeholdergroups b.Identifyingstakeholderissues
c.Identifyingand gainingstakeholderfeedback d.Identifyingandgaininggovernmentfeedback
e.Assessingorganizationalcommitmentto socialresponsibilitygroups
28.Whatare the fourlevelsofsocialresponsibility?
a.Financial,religious,ethical,andphilanthropic
b.Ethical,philanthropic,selfish,andshort-sighted c.Economic,long-term,ethical,andphilanthropic. d.Legal,economic,ethical,andphilanthropic
e.Economic,compliance,legal,andphilanthropic
29.The modelisfoundedinclassiceconomicprecepts. a.economic
b. shareholder c. stakeholder d.board
e.ISO
30.Whichofthefollowingarenottypicallysecondarystakeholders?
a.Televisionnewsanchors b.Special-interestgroups
c.Customers
d.Tradeassociations e.Journalists
31.Whichofthefollowingarenottypicallyprimarystakeholders?
a.Customers
b.Tradeassociations c.Employees
d.Shareholders e.Suppliers
32.Whydo criticsarguethathighcompensationforboardsof directorsisabadthing?
a.Itistooexpensivefor the organization.
b.It couldcauseconflictsofinterestbetweenthedirectorsandtheorganization. c.Itisnotfairtopoorlycompensatedemployees.
d.Highpaywillrendertheboardlesscomplacent.
e.Boardof directorcompensationisnotamajorissue.
33.Boardmembersbeinglinkedtomorethanonecompanyisanexampleof a.strategicphilanthropy.
b.stakeholdercommitment. c.interlockingdirectorate.
d.conflictof interest. e.anillegalactivity.
34.Whatisthe firststepinimplementinga stakeholderperspectiveinanorganization?
a.Identifyingresourcesanddeterminingurgency b.Identifyingstakeholdergroups
c.Identifyingstakeholderissues
d.Assessingthecorporateculture
e.Assessingorganizationalcommitmentto socialresponsibility
35.Astakeholderorientationisnot completeunlessitincludes a.clearaccountingprocedures.
b.majorfinancingactivities. c.marketingstrategy.
d.feedbackfromspecial-interestgroups.
e.activitiesthatactuallyaddressstakeholderissues.
36.Compareandcontrastthestakeholderandshareholdermodelsofcorporategovernance.
37.Whyisethicalmisconductmoredifficulttoovercomethanpoorfinancialperformance?
38.Discussthedifferencebetweenprimaryandsecondarystakeholdersin thestakeholderinteractionmodelandgive examplesforeachtype.
39.Whydo somebusinesspeopleandscholarsquestionwhetherethicsshouldhavearoleinbusiness?
40.Discussthreecorporategovernanceissues,whytheyaredefinedasissues,andhowyouwouldsolvethem.Use examplesin youranswer.
Chapter 3
1.Anethicalissueisaproblem,situation,oropportunity a.thathasnocorrectanswer.
b.thatharmstheenvironment.
c.requiringsocietyasawholeto chooseamongseveralactionsthatmustbeevaluatedasrightorwrong.
d.requiringanindividual,group,ororganizationtochooseamongseveralactionsthatmustbeevaluatedasright orwrong,ethicalorunethical.
e.requiringanindividual,group,ororganizationto choosebetweenharmingconsumersortheenvironmentand earningmoreprofits.
2.Ethicalissuesinbusinesstypicallyarisebecauseofconflictsbetweenindividuals'personalmoralphilosophiesand valuesandthe
a.valuesandattitudesofthe organizationinwhichtheywork. b.valuesandattitudesof thesocietyinwhichtheylive.
c.valuesandattitudesofthe organizationinwhichtheyworkandthe societyinwhichtheylive. d.lawsandregulationsofthe countryinwhichtheylive.
e.valuesandattitudesof theirparentsandreligion.
3. isanimportantelementofvirtueandmeansbeingwhole,sound,andinunimpairedcondition. a.Optimization
b.Ethicalissue c.Honesty
d.Trust
e.Integrity
4.A courtfoundanoilcompanyguiltyofplacingprofitsoverthesafetyand well-beingofitsemployees.Thissituation canbeclassifiedas
a.ethical.
b.unethical.
c.anethicalissue. d.adilemma.
e.ajusticeissue.
5.A personuncomfortablewithhisemployer'sunspokenpolicyofhiringonlywhitemenisexperiencing a.aconflictofinterest.
b.anethicalissue. c.afeelingofguilt.
d.cognitivedissonance. e.amoralattribute.
6.Issuesrelatedtofairnessandhonestymayarisebecausebusinessissometimesregardedasa a.legalcase,whereeverythingmustbedonetotheletterofthelaw.
b.contest,withthemostethicalfirm"winning."
c.guerillawarwhereanythinggoesinthefightforconsumers'dollars. d.gamegovernedbyitsownrulesratherthanthoseofsociety.
e.gamegovernedbytherulesofsociety.
7.Warmetaphorsarecommonin business.Thiskindofmindsetcanbedangerousforbusinessleadersbecause a.it mayleadexecutivestobecomeviolent.
b.itmayfostertheideathathonestyis unnecessaryin business. c.itmayleadorganizationstobe excessivelyaggressive.
d.businessisnotlikewarfareandthemetaphorsarenotappropriate. e.businessismorelikea gamethana war.
8.Conflictsofinterestexistwhenemployeesmustchoosewhetherto
a.advancetheirownpersonalinterests,thoseoftheorganization,orthoseofsomeothergroup. b.advancetheinterestsoftheorganizationorthoseofsociety.
c.acceptbribesornot.
d.carryoutanassignmenttheyperceiveto beunethical. e.reportanunethicalcoworker.
9. istheofferingof somethingof valueinordertogainan illicitadvantage. a.Shouldersurfing
b.Hacking
c.Giftexchange
d.Conflictsofinterest e.Bribery
10.Concernsinvolvingcopyrightinfringementonbooks,moviesandmusic,andotherillegallyproducedgoodsrelateto whichtypeof ethicalissue?
a.Conflictofinterest b.Honesty
c.Communications d.Discrimination
e.Intellectualpropertyrights
11.
isdefinedasanypurposefulcommunicationthatdeceives,manipulates,orconcealsfactsinordertocreatea falseimpression.
a.Stealing b.Lying
c.Fraud
d.Misappropriation e.Accountingfraud
12.In marketingcommunications,lyingcausespredicamentsforcompaniesbecauseitdestroys a.trust.
b.honor.
c.confidence. d.integrity.
e.products.
13.Whena commercialstatesthata productissuperiortoanyotheronthemarket,themarketerrisksaccusationsof a.concealedfacts.
b.false labeling.
c.deceptiveadvertising. d.concealedfacts.
e.puffery.
14.Optimizationis definedas
a.thequalityofbeingjust,equitable,andimpartial. b.atrade-offbetweenequityandefficiency.
c.aninterchangeofgivingandreceivingin socialrelationships.
d.howwealthorincomeisdistributedbetweenemployeeswithinacompany.
e.alack ofintegrity,incompletedisclosure,andanunwillingnessto tellthetruth.
15.Whichof thefollowinghasbeenidentifiedby theEthicsResourceCenteras theleadingformof observed misconductinorganizations?
a.Discrimination b.Bullying
c.Lying
d.Misuseofcompanyresources e.Sexualharassment
16.Anactivityisprobablyethicalifit
a.is approvedofbymostindividualsin theorganizationandis customaryin theindustry.
b.isapprovedofbynooneinthe organization,buthasbeencarriedoutinthe industrybefore. c.is customaryin theindustry.
d.isnotillegal.
e.doesnotmakeconsumersfeelcheated,deceived,ormanipulated.
17.Thefirststeptowardunderstandingbusinessethicsis to a.knowyourcompany'sethicalpolicies.
b.knowyourownmoralsandphilosophies. c.knowsociety'sethicalpolicies.
d.developethical-issueawareness.
e.developa set ofdecision-makingrules.
18.Amongretailstores, isa largerproblemthancustomershoplifting. a.poorstockperformance
b.weakleadership
c.internalemployeetheft d.misuseof merchandise e.employeedissatisfaction
19.Theethicaldecision-makingprocessbegins a.withaconflictof interest.
b.whenan individualexperiencesa conflictbetweenhisor hervaluesandthoseof hisor herfirm. c.whenstakeholderstriggerethicalissueawarenessandindividualsopenlydiscussitwithothers. d.witha conflictinvalues.
e.whenanindividualexperiencesaconflictbetweenhisorhervaluesandthoseofsociety.
20.Whichofthefollowingis nota side-effectofbeingthe victimofworkplacebullying?
a.Increasedproductivity b.Sleepdisturbance
c.Depression
d.Increasedsickdays e.Stomachproblems
21.Accountantsmustabideby astrictcodeof ethicsthatdefinestheirresponsibilitiesto a.their clientsonly.
b.theirclientsandthe publicinterest. c.thepubliconly.
d.theirinvestorsandshareholders. e.governmentregulators.
22.Whichofthe followingstatementsismostcorrect?
a.Affirmativeactionprogramsrequirequotastogovernemploymentdecisions. b.Affirmativeactionprogramshave eliminateddiscriminationinemployment.
c.Affirmativeactionprogramsare requiredinallorganizationsbylaw.
d.Affirmativeactionprogramsinvolveeffortsto recruit,hire,train,andpromotequalifiedindividualsfromgroups thathavetraditionallybeendiscriminatedagainstonthebasisofrace,gender,orothercharacteristics.
e.Affirmativeactionprogramsinvolveeffortsto avoidrecruiting,hiring,training,andpromotingqualified individualsfromgroupsthathavetraditionallybeendiscriminatedagainstonthe basisofrace,gender,orother characteristics.
23.Whichofthefollowingis notaquestionyouneedto askwhenyoususpectthatworkplacebullyinghasoccurred?
a.Isyourbosstreatingyouwellandcompensatingyouadequately?
b.Is yourbossaskingobviouslyimpossiblethingsfromyou withouttrainingandstatingthat,oncecompleted,the workisnevergoodenough?
c.Aresurprisemeetingscalledwithoutyourknowledge?
d.Haveothersatworktoldyoutostopworking,talking,orsocializingwiththem?
e.Areyouneverleftalonetodo yourjobwithoutinterference?
24.isassociatedwitha hostileworkplacewheresomeoneconsidereda targetisthreatened,harassed,belittled, orverballyabused.
a.A codeof conduct b. Sexualharassment c.Coercivepower
d.Bullying e.Rewards
25.Whichofthefollowingis nota consequenceofethicalmisconduct?
a.Decreasedreputation
b.Shakencustomerloyalty
c.Reducedinvestorconfidence d.Increasedsales
e.Legalactionsby wrongedparties
26.TheAgeDiscriminationinEmploymentAct specificallyoutlawshiringpracticesthatdiscriminateagainstpeople a.whoareundertheageof18.
b.whoarebetween16and20. c.whoarebetween39-69.
d.whoarepastretirementage.
e.whoareyoungerthan18andolderthan49.
27.Abusiveorintimidatingbehavioris themostcommonethicalproblemforemployees.Whichofthefollowingis not
relatedtothisconcept?
a.Physicalthreats
b.Falseaccusations c.Being annoying
d.Profanity
e.Performanceprobation
28.The
makesitillegalfor individuals,firms,orthirdpartiesdoingbusinessinAmericanmarketsto“make
paymentsto foreigngovernmentofficialsto assistin obtainingorretainingbusiness.”
a.U.S.ForeignCorruptPracticesAct(FCPA)
b.KyotoProtocol
c.WorldTradeOrganization(WTO)
d.ConsumerProtectionAct e.Gramm-Leach-BlileyAct
29.Mr.Smithtoldhisclient,Mr.Jabar,whowasnotanITexpert,thatthenewsoftwaresystemsweremuchbetter thanhisexistingones.ToconvinceMr.Jabar,Mr.Smithusedagreatdealof technicaljargonthathisclientdidnot reallyunderstand.Mr.SmithdidthisintentionallytoconfuseMr.Jabar.Thisisanexampleof
a.false advertising. b. commissionlying. c.omissionlying.
d.noise.
e.surrogatelying.
30. involvestrickingindividualsintorevealingtheirpasswordsorothervaluablecorporateinformation. a.Shouldersurfing
b.Remotehacking
c.Socialengineering d.Physicalhacking e.Dumpsterdiving
31.WhenDevonlookedat whatanotheremployeewastypingin orderto getapassword,hecommitted a.shouldersurfing.
b.whacking
c.discrimination
d.passwordguessing e.hacking
32.Acompanycanbesuedfor discriminationifit a.hires minorities.
b.maintainsreasonableminoritystandards.
c.dischargesa minorityindividual,but has a just causefordoingso. d.usesageas ahiringor firingcriterion.
e.hasmorementhanwomenonstaff.
33.Affirmativeactionprograms
a.involvethepromotionof unqualifiedemployees. b.arenotimposedby federallawon employers.
c.arenotverycommonlyusedanymorebecausethereis noneedto protectminorities. d.onlyinvolvethe trainingofindividuals.
e.involvetherecruitment,hiring,promotion,andtrainingof qualifiedindividuals.
34.Whattypeoffraudinvolvesintentionaldeceptiononthepartofanindividualorgroupinordertoderiveanunfair economicadvantageoveranorganization?
a.Channel
b. Integrative c. Consumer d.Product
e.Conventional
35.Whattypeof fraudulentactivitycouldinvolvea consumerstagingan accidenttoseekdamages?
a.Whacking b.Duplicity c.Guile
d.Defamation e.Collusion
36.Whattypeof fraudulentactivityinvolvesan employeewhoassistsaconsumerinfraud?
a.Whacking b.Duplicity c.Guile
d.Defamation e.Collusion
37.Priortothefinancialmeltdown,bondratingsagencieswereaccusedofhaving
becausetheywerepaidbythe
organizationsthattheyrated.Theorganizationswouldshoparoundfortheagencythatgavethemthebestrating. a.highethicalstandards
b.excessivelycomplicatedsystems c.a hostileworkplace
d.conflictsof interest
e.agoodbusinessmodel
38. areusedto obtainorretainbusinessandarenotgenerallyconsideredillegalin theU.S. a.Facilitationpayments
b.Bribes c.Gifts
d.Coercivetechniques e.Threats
39.Discusshowonegoesaboutrecognizingan ethicalissue.
40.Listthreebusinessproblems,situations,oropportunitiesthatyoubelieveare ethicalissues.Explainwhy.
41.Describethe differentmethodsofobtainingcorporateintelligencethatcompetitorscommonlyuse.
42.Whatis aconflictofinterest?Provideanexample.
43.Whatarethedifferentdefinitionsof bribery?
44.Discussthefactorsthatgo intocreatinga hostileworkenvironment.Whyisthisa badthing?Givean exampleof a hostileworkenvironment.
Chapter 4
1.Whichofthefollowingis notanaspectoftheinstitutionalizationofsocialresponsibility?
a.Voluntarypractices b.Legal responsibilities c.Corepractices
d.Familialresponsibilities e.Strategicphilanthropy
2.Whichofthefollowingactscan beclassifiedasprocompetitivelegislation?
a.EqualPayActof1963 b.CivilRightsActof1964
c.McCarran-FergusonActof1944 d.ShermanAntitrustActof 1890
e.OccupationalSafetyandHealthActof1970
3.Whichofthefollowingactsexemptedtheinsuranceindustryfromantitrustlegislation?
a.EqualPayActof1963 b.CivilRightsActof1964
c.McCarran-FergusonActof1944 d.ShermanAntitrustActof 1890
e.OccupationalSafetyandHealthActof1970
4.Whichofthe followingacts,passedinresponsetopublicoutrageoverconditionsdescribedinUptonSinclair'sThe
Jungle,wasthe firstconsumerprotectionlegislation?
a.CivilRightsActof1964
b.ShermanAntitrustActof 1890
c.Magnuson-MossWarrantyActof1974 d.ConsumerProductSafetyActof1972 e.PureFoodandDrugActof1906
5.The
wasestablishedafterthelatestfinancialcrisis,inresponsetoa situationthatcausedmanyconsumersto
losetheirhomes.
a.EnvironmentalProtectionAgency b.WorldBank
c.ConsumerFinancialProtectionBureau d.WorldTradeOrganization
e.Sarbanes-OxleyAct
6.Whichofthefollowingis notaprovisionoftheSarbanes-OxleyAct?
a.Strengthenspenaltiesforcorporatefraud
b.Discouragesthecreationof ethicalandlegalcomplianceprograms c.Requirescodesofethicsfor financialreportingincorporations
d.Makesfraudulentfinancialreportinga criminaloffense e.Requiresgreatertransparencyinfinancialreporting
7.Whichof theforcesof thebusinessenvironmentinvolvestherivalryamongbusinessesforcustomersandprofits?
a.Theeconomicdimension b.Thelegaldimension
c.Thecompetitivedimension
d.Thetechnologicaldimension
e.Thevoluntaryresponsibilitiesdimension
8.The
regulatestobacco,dietarysupplements,vaccines,veterinarydrugs,medicaldevices,cosmetics,products
that giveoffradiation,andbiologicalproducts. a.WorldTradeOrganization
b.ConsumerFinancialProtectionAgency c.DepartmentofJustice
d.EnvironmentalProtectionAgency e.The FoodandDrugAdministration
9.Whichof thefollowinggroupsis notagroupthatreceivesspeciallegalprotections?
a.The elderly b.Children
c.Seniorcitizens
d.Thehighlyeducated e.Youngconsumers
10.The
wascalled“asweepingoverhaulofthefinancialregulatorysystem…onascalenotseensincethe
reformsthatfollowedtheGreatDepression.”
a.EqualPayAct
b.AmericanswithDisabilitiesAct
c.Dodd-FrankWallStreetReformandConsumerProtectionAct d.AgeDiscriminationin EmploymentAct
e.VIIofthe CivilRightsAct
11. lawdefinesthe rightsanddutiesofindividualsandorganizations(includingbusinesses). a.Civil
b.Criminal
c.Competitive
d.Administrative e.Regulatory
12.
lawnotonlyprohibitsspecificactionsinbusinesssuchasfraud,theft,orsecuritiestradingviolations,butalso imposesfinesorimprisonmentaspunishmentfor breakingthe law.
a.Civil
b.Criminal
c.Competitive
d.Administrative e.Regulatory
13.Whichofthefollowingis notaprovisionoftheDodd-FrankWallStreetReformandConsumerProtectionAct?
a.Increasestheaccountabilityandtransparencyof financialinstitutions b.Createsa bureautoeducateconsumersinfinancialliteracy
c.Createsanorganizationtopaythe billsoflow-incomeconsumers d.Createincentivesforwhistle-blowerstocomeforward
e.Increasesoversightof thefinancialindustry
14.
is thesynergisticandmutuallybeneficialuseofanorganization’scorecompetenciesandresourcesto deal
withkeystakeholderssoastobringaboutorganizationalandsocietalbenefits. a.Socialresponsibility
b.Businessethics
c.Corporatephilanthropy d.Strategicphilanthropy
e.Cause-relatedmarketing
15.Anticompetitivestrategiesthatfocusonweakeningordestroyinga competitorhavespurredantitrustlegislationand includeallofthe followingexcept
a.sustainedpricecuts. b.freesamples.
c.discriminatorypricing. d.pricecollusion.
e.corporateespionage.
16.Whichis notoneof thefoursourcesof criminalandcivillaws?
a.Judiciallaw
b.Commonlaw
c.Constitutionallaw d.Administrativelaw e.Statutorylaw
17.The
isanindependentagencywithintheFederalReserveSystemthat“regulate[s]theofferingandprovision
ofconsumerfinancialproductsorservicesundertheFederalconsumerfinanciallaws.”
a.ConsumerFinancialProtectionBureau b.FederalReserve
c.WorldTradeOrganization d.DepartmentofJustice
e.FederalTradeCommission
18.Theprimaryobjectiveof U.S.antitrustlawsisto
a.protectconsumersfromhighpricesandforeignproducts. b.protectdomesticbusinesses.
c.protectemployees.
d.promotestrategiesthatenhancebusinesswelfareoverconsumerwelfare.
e.distinguishcompetitivestrategiesthatenhanceconsumerwelfarefromthosethatreduceit.
19.Whatisa primaryreasonwhysomesmallbusinessesresisttheopeningof largechainretailerslikeWalmartor
HomeDepot?
a.Becausethelargesizecreateseconomiesofscaleandtheycanchargelowerprices b.Becausetheselectioninthestoresistoolarge
c.Becauselargeretailersattractcrimetoneighborhoodsinwhichtheyarebased d.Becausecommunityleadersdo notlikethetopmanagement
e.Becauselargeretailersalmostneverhirelocalworkersasemployees
20.
focus(es)ondevelopingsoundorganizationalpracticesandintegrityfor financialandnonfinancial
performancemeasures,ratherthanon an individual’smorals.
a.TheDodd-FrankWallStreetReformandConsumerProtectionAct b.Compliance
c.Organizationalethics d.Corepractices
e.TheSarbanesOxleyAct
21.Whichofthefollowingis notoneofthesevenstepsthattheU.S.SentencingCommissionrequiresforaneffective complianceprogram?
a.Developa codeofconduct
b.Provideoversightby high-rankingpersonnel
c.Createacommunicationsystemfordisseminatingstandardsandprocedures d.Monitorandauditsystemsdesignedtodetectmisconduct
e.ComplywithISO14000guidelines
22.TheSarbanes-OxleyActcreatedthe establishrulesandstandardsfor auditing.
tooverseetheaccountingfirmsthatauditpubliccorporationsandto
a.Public CompanyAccountingOversightBoard b. CorporateAccountingOversightCommission c.EnronAccountingFraudAdministration
d.OccupationalHealthandSafetyAdministration e.EqualEmploymentOpportunityCommission
23. responsibilitiesrelateto abusiness’scontributionsto stakeholders.
a.Economic b.Legal
c.Ethical
d.Voluntary
e.Socialresponsiveness
24.PassedbyCongressin 1991,the complianceprograms.
a.Sarbanes-OxleyAct
createdincentivesfororganizationsto developandimplementethical
b.U.S.SentencingCommission'sGuidelinesforEthicalCompliance c.EthicalComplianceAct
d.SocialResponsivenessComplianceAct
e.FederalSentencingGuidelinesforOrganizations
25.DonationofcomputerequipmenttoschoolsbyToshibawouldbeassociatedwith responsibilities. a.economic
b.voluntary c.legal
d.ethical
e.minimum
26.Byprohibitingaccountingfirmsfromprovidingbothauditingandconsultingservicesto thesamecorporateclients withoutpermission,theSarbanes-OxleyAct isattemptingtoeliminate
a.conflictsof interest. b.cronyism.
c.reportingtransparency. d.corporateespionage.
e.dual reporting.
27.Whichofthefollowingis nota benefittobusinessesofengaginginvoluntaryresponsibilities?
a.Helpcreateanethicalcultureandvaluesthatcanactasa buffertoorganizationalmisconduct b.Reducegovernmentinvolvementbyprovidingassistancetostakeholders
c.Developemployeeleadershipskills
d.Improveemployeecompensationandretention e.Improvethequalityoflifeincommunities
28.Companiesthat will mostlikelybefoundin violationofprocompetitivelegislation. a.pollutewaterways
b.knowinglyharmconsumers c.contractwithsweatshops
d.establishmonopolies e.helpconsumers
29. tie(s)anorganization’sproduct(s)directlyto asocialconcernthroughamarketingprogram.
a.Voluntarycontributions b.Cause-relatedmarketing c.Strategicphilanthropy
d.Corporategiving
e.Employeebenefits
30.TitleVII oftheCivilRightsAct of1964
a.prohibitsdiscriminationonthebasisofrace, color,sex,religion,ornationalorigin. b.penalizesthe topexecutivesinanorganizationfor misconduct.
c.isbasicallythesameastheSarbanes-OxleyAct.
d.discourageswhistle-blowersfromreportingmisconduct. e.prohibitspaydiscriminationonthebasisofgender.
31.Causerelatedmarketingcanaffectconsumer causeareseenasagoodfit.
a.individualethics b.tastes
c.perceptions d.budgets
e.buyingpatterns
,ifconsumersaresympathetictothecauseandthebrandand
32.Whoprovidesinformationtomanagers,investors,taxauthorities,andotherstakeholderswhomakeresource allocationdecisionsforcorporations?
a.Accountants
b.Federalregulators
c.TheSecuritiesandExchangeCommission d.TheDepartmentofJustice
e.HumanResourcesdepartments
33.The ofethicsinvolvesembeddingvalues,norms,andartifactsinorganizations,industries,andsociety. a.institutionalization
b.rationalization
c.commercialization d.mobilization
e.enforcement
34.Whichofthefollowingis notareasonwhytheinstitutionalizationof businessethicshasprogressedin recent decades?
a.Institutionalizationofethicsisnowmandatedforallorganizationsbygovernmentsaroundtheworld b.Stakeholdershaverecognizedthe needfor improvingbusinessethics
c.Thegovernmenthassteppedin whenscandalsandmisconducthavedamagedkeyconstituentsofbusinesses d.Gatekeepershavebeenquestionedasto theircontributionsto majorscandals
e.Highlyethicalcompaniestendtobemoreprofitablethanthosesufferingfrommisconductissues
35.Partofthe reasonwhycreditratingsfirmsdidnotcatchmajorproblemspriortothe globalfinancialmeltdownof
2008wasbecausetheywerepaidbythefirmsthattheyrank,whichcreates a.economiesofscale.
b.synergy.
c.aconflictofinterest. d.cooperation.
e.efficiency.
36.Investigationsinto thefinancialratingindustryafterthefinancialmeltdownof2008foundallofthefollowingexcept
a.analystscutcornerswhenfacedwithlesstimeto performduediligence. b.analysts’ratingswereinaccurate.
c.manyhighratingswerebasedon inadequatehistoricaldata.
d.analystswereoverwhelmedwiththevolumeandcomplexityof trades.
e.mostanalystswerecompletelyuntrainedandunpreparedtodo theirjobs.
37.Some,especiallythoseinbusiness,complainthattheSarbanes-OxleyAct and similarlegislation a.isexcessivelycomplexand financiallyburdensome.
b.isnotnecessary. c.isfair toallfirms.
d.hasreducedrestatementsoffinancialreports. e.istoosimplistic.
38.Anethicalorganizationalculturecreatesan environmentinwhichtostructurebehaviorthatisthenevaluatedby stakeholders.Thekey elementsofanorganizationalcultureincludeallofthefollowingexcept
a.values. b.norms.
c.artifacts.
d.legalcompliance.
e.employeecompensation
39.Whichofthefollowingprovideincentivesfordevelopingcorepracticeswithinafirmthatcouldhelpensureethical and legalcompliance?
a.Departmentof JusticeandOpenComplianceEthicsGroup b.DepartmentofJusticeandtheSarbanes-OxleyAct
c.FederalSentencingGuidelinesforOrganizationsandtheSarbanes-OxleyAct d.FoodandDrugAdministrationandtheSarbanes-OxleyAct
e.SecuritiesandExchangeCommissionandtheSarbanes-OxleyAct
40.Lawsandregulationschangeovertime;however,in theUnitedStatesthethrustofmostbusinesslegislationcanbe summedup as
a.anypracticeis permitted.
b.anypracticeispermittedthatdoesnotsubstantiallyreducecompetitionandharmconsumersor society.
c.anypracticeispermittedthatdoesnotsubstantiallyharmconsumersorsociety,butthisappliesonlywithinthe
UnitedStates.
d.anypracticeis permittedthatdoesnotharmtheenvironment. e.anypracticeispermittedthatdoesnotbreakthelaw.
41.Whydo youthinkthecostsof compliancewithSarbanesOxleygo downovertime?
42.Accordingtothetext,theopinionsof society,as expressedthroughlegislation,canchangeovertimeanddifferent courtsandgovernmentlegislaturesmaytakedifferentviewsabouttheacceptabilityof specificbusinessactivities. Whyisthisso?
43.Whatethicalissuesaffectingconsumersandsocietyasa wholearecreatedbyunfaircompetition?
44.Societyoftenexpectsalotfrombusiness.Doyouthinkthatitispossibletobalanceprofitandotherbusiness objectiveswiththegoalsanddesiresofsociety?Whyorwhynot?
Chapter 5
1.Whichofthe followingisthe firststepinthe ethicaldecisionmakingprocess?
a.Beingsocializedintothe firm'scorporateculture
b.Applyingapersonalmoralphilosophyin orderto individualizetheethicaldecisionmakingprocess
c.Recognizingthatanissuerequiresanindividualorworkgrouptomakea choicethatultimatelywillbejudged by stakeholdersas rightor wrong
d.Solicitingtheopinionsofothersina workgrouporintheoverallbusinessinordertogainfeedback e.Enforcingthefirm'sethicalstandardswithrewardsandpunishment
2.Whichofthefollowingis notoneofthe six "spheresofinfluence"towhichindividualsare subjectwhenconfronted withan ethicalissue?
a.Educationalattainment b.Workplace
c.Family
d.Legalsystem e.Community
3.Theperceivedrelevanceorimportanceofanethicalissuetothe individual,workgroup,ororganizationis a.organizationalculture.
b.immediatejobcontext. c.ethicalissueintensity. d.leadership.
e.locusofcontrol.
4.Studieshavefoundthatmorethanathirdof theunethicalsituationsthatlowerandmiddle-levelmanagersfacecome from_____.
a.stakeholderexpectationsandpressures. b.pressurestosatisfycustomers.
c.pressuresfromthegovernmentto performat ahighlevel.
d.internalpressuresandambiguitysurroundinginternalorganizationalrules. e.investorexpectations.
5.Accordingtotheethicaldecision-makingframework,theabsenceof punishmentprovidesa(n)
behavior. a.reason
b. significantother c.individual factor d.opportunity
e.ethicalissueintensity
forunethical
6. havebeenfoundtodecreaseunethicalpracticesandincreasepositiveworkbehavior. a.Higheducationalattainmentlevels
b.Highlevels ofcommunityinvolvement c.Charismaticleaders
d.Strongreligiousbeliefs e.Goodpersonalvalues
7. involvessubordinatessimplyfollowingthe directivesofa superiorwithoutquestion.Itdemonstratesthe influencethatsignificantotherscanexertin theworkplace.
a.Obediencetoauthority b.Locusofcontrol
c.Opportunity
d.Transactionalleadership e.Immediatejob context
8.Multipleelementsworkon individualstoaffecttheir behavior.Whilean individualmay intendtodo theright thing,
canalterthisintent. a.cognitivedissonance
b.familialexpectations c.religiousbeliefs
d.the desirefor financialgain
e.organizationalorsocialforces
9.If managementfailsto identifyandeducateemployeesaboutethicalproblemareas,ethicalissuesmaynotreachthe critical
a.awarenesslevel. b.aptitudelevel.
c.ethicallevel.
d.organizationallevel. e.individuallevel.
10.The
canbedefinedasasetofvalues,norms,andartifacts,includingwaysofsolvingproblemssharedby
membersofanorganization. a.corporateculture
b.intentionsof acorporate c.ethicalissueawareness
d.determinationofacorporation e.individualfactors
11.Whichof thefollowingwouldnotbeconsideredanegativereinforcementofemployeebehavior?
a.Demotions b.Firings
c.Ignoringthebehavior d.Reprimands
e.Paypenalties
12.Codes,rules,andcomplianceare essentialinorganizations.However,anorganizationbuilton todevelopa highintegritycorporateculture.
a.a charismaticleader
b.thepreferencesoftheCEO
c.thegrapevine
d.formalrelationships
e.informalrelationships
ismorelikely
13.Followingthe ethicaldirectivesofa superiorrelatesto a.aninternallocusofcontrol.
b.obediencetoauthority. c.moralintensity.
d.gender.
e.ethicalissueintensity.
14.Whichofthefollowingis notconsidereda significantothergroupinthe workplace?
a.Peers
b.Managers c.Spouses
d.Coworkers
e.Subordinates
15.Studieshaveshownthat thananyotherfactor.
a.significantothers b.religion
c.education
d.chiefexecutiveofficers e.ethicalissues
withintheorganizationhavemoreimpactonaworker'sdecisionsonadailybasis
16.Externalandinternalrewardsrelateto whichpartoftheethicaldecision-makingframework?
a.Individualfactors b.Significantothers
c.Cognitivemoraldevelopment d.Obediencetoauthority
e.Opportunity
17.Whichofthefollowingis notan issuethathelpsinbusinessethicsevaluationsanddecisions?
a.Ethicalissueintensity b.Individualfactors
c.Organizationalfactors d.Personalguilt
e.Opportunity
18. isthefirstsignthatanunethicaldecisionhasoccurred. a.Guilt
b.Reward
c.Punishment
d.Cognitivedissonance e.Happiness
19.Peoplewhobelievein , gowiththeflowbecausetheyfeeltheeventsin theirlivesareuncontrollable. a.ethicaldecisionmaking
b.internallocusofcontrol c.anethicalculture
d.externallocusofcontrol e.significantothers.
20.Whichofthefollowingis notanindividualfactorthataffectsbusinessethics?
a.Nationality b.Age
c.Religion
d.Significantothers e.Education
21.
isanorganizationalfactorthatgivesa companyspecificcharacteristics.Overtime,stakeholdersbegintosee thecompanyaslike alivingorganismwithamindandwill ofitsown.
a.Oversight
b.Significantothers c.Corporateculture d.Theethicalclimate e.The legalclimate
22.Anethicalcorporatecultureneeds
alongwith
toestablishanethicsprogramandmonitorthecomplex
ethicaldecisionsbeingmadebyemployees. a.individualethics;ethicalissue intensity
b.ethicalissueintensity;ethicstraining
c.organizationalfactors;individualfactors d.employeeevaluations;goodintentions
e.sharedvalues;properoversight
23.Thosewhohaveinfluencein aworkgrouparereferredto assignificantothersandinclude a.peers,managers,coworkers,andsubordinates.
b.familymembers,peers,andcoworkers. c.spousesandfriends.
d.employeesinsimilarjobsituations. e.employeeswhoholdthe samejob.
24.Researchconcerningnationalityandthe abilitytomakeethicaldecisions a.showsnorelationshipbetweenthetwo.
b.ishardtointerpretina businesscontextbecauseofculturaldifferences.
c.suggeststhatorganizationsshouldbeveryconcernedaboutanemployee'snationality. d.suggeststhatcorporationspaya lotofattentiontosuchresearch.
e.suggeststhatthe influenceofnationalityoncorporatecultureisgrowing.
25.Therelationshipbetweenbusinessethicsandage a.showsanegativecorrelation.
b.issimple.Greaterexperienceleadstobetterethicaldecisionmaking.
c.is complex,althoughexperiencehelpsolderemployeesmakeethicaldecisions.
d.suggeststhatemployeeswithlessexperiencehaveagreaterabilitytodealwithcomplexindustry-specific ethicalissues.
e.doesnotdemonstratea statisticallysignificantcorrelation.
26.Employeesthatseethemselvesasgoingwiththeflowbecausethat'salltheycandohavea(n)
a.externallocusofcontrol. b.moral intensity
c.obediencetoauthority d.opportunity
e.internallocusofcontrol.
27.For peoplewhobeginthevalueshiftthatleadsto unethicaldecisions,whichofthefollowingisnota usual justificationtoreduceandeliminateguilt?
a.I needa paycheckandcan'taffordtoquitrightnow. b.Thosearoundmearedoingitso whyshouldn'tI?
c.IfIdon'tdothis,Imightnotbeabletogeta goodreferencefrommybosswhenIleave. d.IfI don'tdo this,I mightneverbe promoted.
e.Thisisinkeepingwithmypersonalmoralsandthe codeofconduct,soit isokay.
28. istheabilitytoperceivewhethera situationor decisionhasan ethicaldimension. a.Ethicalissueintensity
b.Locusofcontrol
c.Ethicalawareness d.Moralintensity
e.Opportunity
29.
others.
relatestoindividuals'perceptionsof socialpressureandtheharmtheybelievetheirdecisionswillhaveon
a.Ethicalawareness b.Moralintensity
c.Individualfactors
d.Ethicalissueintensity e.Socialawareness
30.Theethicaldecisionmakingprocessin businessincludesallofthefollowingexcept
a.Individualfactors b.Opportunity
c.Ethicalissueintensity
d.Makingethicaldecisions e.Organizationalfactors
31.
cultureinvolvesvaluesandnormsthatprescribea widerangeof behaviorfororganizationalmembers,while culturereflectstheintegrityof decisionsmadeandisafunctionof manyfactors,includingcorporatepolicies,
topmanagement'sleadershipon ethicalissues,theinfluenceof coworkers,andtheopportunityforunethical behavior.
a.Ethical, corporate b. External,internal c. Corporate,ethical d.Positive,negative
e.Compromising,collaborative
32.Allof thefollowingaretruewithregardstoorganizationalfactorsexcept
a.Employeesapproachethicalissueson thebasisof whattheylearnedfromothersintheorganization. b.Analignmentbetweenaperson'sownvaluesandthevaluesoftheorganizationhelpcreatepositive
organizationaloutcomes.
c.Congruenceinpersonaland organizationalvaluesisrelatedtocommitment,satisfaction,motivation,ethics, workstress,andanxiety.
d.Ethicalchoicesin organizationsaremostoftenmadeindividually.
e.Justasa familyguidesanindividual,specificindustriesgivebehavioralcuestofirms.
33.The includesthemotivational"carrotsandsticks"superiorsusetoinfluenceemployeebehavior. a.Obediencetoauthority
b.Immediatejob context c.Locusofcontrol
d.Normativeapproach e.Descriptiveapproach
34.Allofthe followingare truewithregardstoopportunityandethicaldecisionmakingexcept
a.Despitetheexistenceof rules,misconductcanstilloccurwithoutproperoversight.
b.Theopportunitiesthatemployeeshaveforunethicalbehaviorinanorganizationcan beeliminatedthrough formalcodes,policies,andrulesadequatelyenforcedby management.
c.Opportunityalsocomesfromknowledge.
d.Theopportunityforunethicalbehaviorcanbe eliminatedwithaggressiveenforcementof codesandrules. e.Opportunityresultsfromconditionsthateitherproviderewardsor failtoerectbarriersagainstunethical
behavior.
35.Whenwediscuss issue.
a.Normative b.Individual
c.Descriptive
d.Organizational e.Values-based
approaches,wearetalkingabouthoworganizationaldecisionmakersshouldapproachan
36.Byincorporating objectivesintocorporatecorevalues,companiesbeginto view assignificant. a.shareholder,stakeholders
b.stakeholder,shareholders c.CEO,CEOs
d.customer,customers
e.stakeholder,stakeholders
37.Normativebusinessethicstakesintoaccountthe standards.
a.Descriptive b.Political
c.Social
d.Economic e.Normative
realitiesoutsidethelegalrealmin theformofindustry
38. institutionsincludereligion,education,andindividualssuchasthefamilyunit. a.Social
b.Conservative c.Economic
d.Liberal e.Political
39.Allofthefollowingaretrueregardinginstitutionsexcept
a.Stakeholderscloselyalignwith institutions.
b.Theregulatorysystemalignswith politicalinstitutions.
c.Thereisnoclearlinkbetweeninstitutionaltheoryandthe stakeholderorientationofmanagement. d.Competitionrelatesto economicinstitutions.
e.Personalvaluesandnormsderivefromsocialinstitutions.
40.Highlevelsof createahigherprobabilitythatfirmscutcornersbecausemarginsareusuallylow. a.Profit
b.Return
c. Cooperation d. Competition e.Loss
41.The thoughtexperimentusedbyJohnRawlsthat examinedhowindividualswouldformulateprinciplesif theydidnot knowwhattheirfuturepositioninsocietywouldbeiscalled
a.Equalityprinciple b.Utilitarianveil
c.Libertyprinciple
d.Universalprinciple e.Veilofignorance
42.The
statesthateconomicandsocialequalitiesshouldbearrangedtoprovidethemostbenefittotheleast-
advantagedmembersofsociety. a.Equalityprinciple
b.Differenceprinciple
c.Constitutionalprinciple d.Libertyprinciple
e.Justiceprinciple
43.Valueshaveallthe followingcharacteristicsexcept
a.Providesguidancetoorganizations b.Subjectiveandrelatedtochoice
c.Widelyaccepted
d.Usedtodevelopnorms
e.Differsacrossculturesandfirms
44.Companiestakebasic andtranslatethemintocore . a.Customs,values
b.Values,principles c.Cultures,principles d.Cultures,customs e.Principles,values
45.Organizationsthathaveethicsprogramsbasedona
orientationarefoundtomakea greatercontributionthan
thosebasedsimplyoncompliance,orobeyinglawsand regulations. a.Customer
b.Political
c.Principles d.Values
e.Social
Essay
46.Theethicaldecision-makingframeworkincludestheconceptsofethicalissueintensity,individualfactors, organizationalfactors,andopportunity.Discusshowtheseconceptsinfluencetheethicaldecision-makingprocess.
47.Tracethe ethicaldecision-makingprocess.Youmayfindit helpfultoapplythe modeltoa realbusinesssituationor toa hypotheticalethicalissueyoudevelopyourself.
48.Discusshowthe threecategoriesofinstitutions(political,economic,andsocial)are importantinestablishinga foundationfornormativevalues.
49.Describeanddemonstratesomeofthesimilaritiesanddifferencesbetweenprinciplesandvalues.Whyareprinciples andvaluesimportantnormativeconsiderationsin ethicaldecisionmaking?
50.Discuss,withexamples,at leastthreewaysthatopportunitycanaffectthedecisionmakingprocess.
Chapter 6
1.Moralphilosophyrefersto
a.asubjectthatmostbusinesspeopledo notconsiderveryimportant. b.themoralityofbusinessactivities.
c.theprinciplesor rulesthatpeopleusetodecidewhatisrightandwrong. d.thelegalityofbusinessactivities.
e.the principlesorrulesthatpolicymakersusetocreatelegislation.
2.Whichmoralphilosophyevaluatesthemoralityof an actionon thebasisof its consequencesforeveryoneaffected
(seeksthegreatestgoodforthegreatestnumber)?
a.Actdeontology b.Ruledeontology c.Egoism
d.Utilitarianism e.Hedonism
3.Whichmoralphilosophyconsidersanact tobemorallyrightoracceptableifit producessomedesiredresult?
a.Teleology
b.Deontology
c.Therelativistperspective d.Ethicalformalism
e.Hedonism
4.Whichmoralphilosophyfocusesontherightsofindividualsand ontheintentionsassociatedwithaparticular behavior,ratherthanitsconsequences?
a.Deontology
b.Therelativistperspective c.Teleology
d.Egoism
e.Utilitarianism
5. areperson-specific,whereas meetbusinessobjectives.
a.Organizationalfactors;businessethics b.Codesofconduct;individualfactors
c.Individualfactors;codesofconduct d.Businessethics;moralphilosophies
e.Moralphilosophies;businessethics
arebasedondecisionsmadebygroupsorwhencarryingouttasksto
6.AccordingtoKohlberg'smodel,as apersonprogressesthroughthestagesof moraldevelopment,andwithtime, education,andexperience,he/she
a.isunlikelytochangehis/hervaluesand ethicalbehavior. b.maychangehis/hervaluesandethicalbehavior.
c.willlikelybepromoted.
d.will dependmoreontheinputofsignificantothersin ethicaldecisionmaking. e.willexperiencelessopportunitytobehaveunethically.
7.Anindividualwhodefineswhatisrightbyconsideringhis/herdutytosociety,not just tootherspecificpeople,isin whichofKohlberg'sstagesofcognitivemoraldevelopment?
a.Punishmentandobedience
b.Individualinstrumentalpurposeandexchange
c.Mutualinterpersonalexpectations,relationships,andconformity d.Socialsystemandconsciencemaintenance
e.Priorrights,socialcontract,orutility
8.Whichisthe lastofKohlberg'sstagesofcognitivemoraldevelopment?
a.Individualinstrumentalpurposeandexchange b.Needachievement
c.Socialsystemandconsciencemaintenance d.Punishmentandobedience
e.Universalethicalprinciples
9.A personwhooffersafacilitationpaymentin orderto secureacontractthatwillkeephercompanyfromgoing bankruptandlayingoffhundredsof employeesmaybe a(n)
a.egoist.
b.teleologist. c.utilitarian. d.relativist.
e.humanitarian.
10.Whichmoralphilosophyevaluatesthemoralityofanactiononthebasisofitsconformitytogeneralmoralprinciples and respectforindividualrights?
a.Therelativistperspective b.Actutilitarianism
c.Ruleutilitarianism d.Actdeontology
e.Ruledeontology
11.
isconsideredthefatheroffreemarketcapitalism.Hebelievedthatbusinesswasandshouldbeguidedbythe moralsofgoodmen.
a.JohnMaynardKeynes b.HenryKissinger
c.GeorgeWashington d.AdamSmith
e.LawrenceKohlberg
12._____believethatnoonethingisintrinsicallygood. a.Hedonists
b.Pluralists c.Relativists
d.Deontologists e.Teleologists
13.Kant'scategoricalimperativeandthe GoldenRuleare examplesofwhichmoralphilosophy?
a.Teleology
b.Deontology
c.Therelativistperspective d.Egoism
e.Utilitarianism
14.Amarketingmanagerwhoordersthata manufacturingplantberefittedtomakeit saferforworkers,nomatterwhat thecost,maybea(n) becausehebelievesintherightsofallindividuals.
a.egoist
b.utilitarian
c.deontologist d.relativist
e.hedonist
15.Whichmoralphilosophyevaluatesthemoralityofanactiononthebasisofprinciplesorrulesdesignedtopromote thegreatestoverallutilityratherthan by examiningsituationsindividually?
a.Ruleutilitarianism b.Actutilitarianism c.Ruledeontology
d.Actdeontology e.Egoism
16.Whichmoralphilosophyevaluatesthemoralityofanactiononthebasisoftheequity,fairness,and impartialityofthe action,withrulesservingasguidelinesinthedecision-makingprocess?
a.Ruleutilitarianism b.Actutilitarianism c.Ruledeontology
d.Actdeontology
e.Therelativistperspective
17.Whichmoralperspectivedefinesethicalbehaviorsubjectivelyfromtheuniqueexperiencesofindividualsand groups?
a.Virtueethics b.Egoism
c.Therelativistperspective d.Absolutism
e.Justice
18.Throughtimeanact cancometobeviewedasunethicalunderwhichofthe followingphilosophiesand perspectives?
a.Therelativistperspective b.Teleology
c.Deontology d.Egoism
e.Ruledeontology
19.
typicallyfocusesontheendresultofactionsandhappinesscreatedbythem,whereas themeansandmotivesbywhichactionsare justified.
a.Pragmatism;hedonism
b.Deontology;pragmatism c.Utilitarianism;deontology
d.Utilitarianism;agoodnesstheory
e.Agoodnesstheory;anobligationtheory
emphasizes
20.An individualwhobelievesthatanactionisethicalbecauseotherswithinhis orhercompanyandindustryregularly engageinthe activityisprobablya(n)
a.utilitarian. b.relativist.
c.teleologist.
d.deontologist. e.egoist.
21.Enlightenedegoism
a.is whenanindividualputs spiritualfeelingsaboveallothers. b.centerscompletelyon theshort-termwell-beingof others. c.centersonone'sshort-termself-interest.
d.centersonone'slongtermselfinterestbuttakesothers’wellbeingintoaccount.
e.centerson thelong-termwell-beingof others.
22.Whichmoralphilosophyisbasedon thepremisethatequalrespectmustbe giventoall persons?
a.Therelativistperspective b.Deontology
c.Egoism
d.Teleology
e.Utilitarianism
23.
havelowerethicalissuesensitivity,meaningtheyarelesslikelyto detectethicalissues.Theymaybemore committedtocompletingprojectsandmorededicatedtogroupvaluesandobjectives.
a.Relativists b.Hedonists
c.Pragmatists
d.Deontologists e.Teleologists
24. justiceis basedontheevaluationofoutcomesorresultsofthebusinessrelationship. a.Procedural
b.Interactional c.Distributive d.Ethical
e.Egotistical
25.Kohlberg'ssixstagesofcognitivemoraldevelopmentcanbereducedto threelevelsofethicalconcern.Personsat thesecondlevel
a.definerightasthatwhichconformsto theexpectationsofgoodbehaviorofthelargersociety. b.see beyondthenorms,laws,and authorityofgroupsorindividuals.
c.areconcernedwiththeirimmediateinterestsandwithexternalrewardsandpunishments. d.areconcernedwiththeirlong-terminterestsandwithinternalrewardsandpunishments. e.areunethical.
26.
arguesthatethicalbehaviorinvolvesnotonlyadheringtoconventionalmoralstandardsbutalsoconsidering
whata maturepersonwitha “good”moralcharacterwoulddeemappropriate.
a.Actutilitarianism b.Virtueethics
c.Reciprocity d.Hedonism
e.Ruledeontology
27.Whenapersondefinesrightandwrongonthebasisoflegalcontracts,heorsheis usingwhichofKohlberg'sstages ofdevelopment?
a.Punishmentandobedience(1ststage)
b.Mutualinterpersonalexpectations,relationships,andconformity(3rdstage)
c.Socialsystemandconsciencemaintenance(4thstage)
d.Priorrights,socialcontract,orutility(5thstage)
e.Universalethicalprinciples(6thstage)
28.
dealswiththeissueof whatindividualsfeeltheyareduebasedontheirrightsandperformancein the workplace,and thereforeismorelikelytobebasedondeontologicalmoralphilosophiesthanonteleologicalor utilitarianones.
a.Rights
b.Virtueethics c.Justice
d.Relativism e.Egoism
29.A centralproblemwithrelativismis
a.thatitemphasizespeople’sdifferences,notsimilarities.
b.thatfewpeoplebelievethattheseprinciplesareimportant. c.thattheyareverycomplicated.
d.thattheyrepresentunattainablegoals.
e.thatmanyfeelthatvirtueethicsonlyworksintheory.
30.Whichis notconsidereda whitecollarcrime?
a.Corporatetaxevasion b.Creditcardfraud
c.Insidertrading d.Identitytheft
e.Muggingsomeone
31.Anindividualwhoemphasizesothersratherthanhimselforherselfinmakingdecisionsisinwhichofthefollowingof
Kohlberg'sstagesofdevelopment?
a.Universalethicalprinciples(6thstage)
b.Mutualinterpersonalexpectations,relationships,andconformity(3rdstage)
c.Socialsystemandconsciencemaintenance(4thstage)
d.Punishmentandobedience(1ststage)
e.Priorrights,socialcontract,orutility(5thstage)
32.Ericviewsanimalresearchinthepharmaceuticalindustryas awaytoimprovedrugsthatwillbenefitmankind.
Whichmoralphilosophymostcloselyrepresentshis viewpoint?
a.Egoism
b.Relativism
c.Humanitarianism d.Utilitarianism
e.Individualism
33.InKohlberg’smodel,the stageofmutualinterpersonalexpectations,relationships,andconformity(Stage3)differs fromthestageofindividualinstrumentalpurposeand exchange(Stage2)in termsoftheindividual’smotivesin
a.consideringfairnesstoothers. b.maintainingthesocialorder.
c.consideringdutytosociety.
d.upholdingthebasicvaluesofsociety. e.maintainingobediencetoauthority.
34.The elementsof and truthfulness. a.egoism
b.utilitarianism c.deontology
d.moralphilosophy
e.virtue
importantto businesstransactionshavebeendefinedastrust,self-control,empathy,fairness,
35. justiceconsiderstheprocessesandactivitiesthatproducetheoutcomeorresults. a.Disruptive
b.Procedural
c.Interactional
d.Communications e.Evaluative
36.Whatis whitecollarcrimeandwhyhasitbecomesuchawidespreadproblem?
37.Compareand contrastthetwoteleologicalphilosophies:egoismand utilitarianism.Includeadiscussionofthebases thateachtypeusesto evaluatethemoralityofactivities.
38.Compareandcontrastthe twomoralphilosophies:teleologyanddeontology.Discussthe baseseachphilosophytype usestoevaluatethemoralityof aparticularactivity.
39.Discussthe distinctionsbetweenthe ruleandact categoriesofutilitarianismanddeontology.Whydoyouthinksome peopleevaluatethemoralityofanactiononthebasisoftheactionitself,whereasothersevaluateitin termsofits conformitytoparticularmoralprinciplesorrulesofconduct?
40.Explainhowthe levelsofKohlberg'smodelofcognitivemoraldevelopmentmayinfluencea person'sperceptionof andresponsetoanethicalissue.
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