Exam 2

Question 1

Chapter 4

Financial ratios that measure a firm’s ability to pay its bills over the short run without undue
stress are known as _____ ratios.

a. asset management
b. long-term solvency
c. short-term solvency
d. profitability
e. market value

Answer 1

c. short-term solvency

Question 2

Chapter 4

2. Net income divided by sales is known as a firm’s:

a. profit margin.
b. return on assets.
c. return on equity.
d. asset turnover.
e. earnings before interest and taxes

Answer 2

a. profit margin.

Question 3

Chapter 4

3. Ratios that measure a firm’s financial leverage are known as _____ ratios.

a. asset management
b. long-term solvency
c. short-term solvency
d. profitability
e. book value

Answer 3

b. long-term solvency

Question 4

Chapter 4

4. If a firm’s debt ratio is greater than 0.5, then:

a. its current liabilities are quite high.
b. its debt-equity ratio exceeds 1.0.
c. it has too few total assets.
d. it has more long-term debt than equity.

Answer 4

b. its debt-equity ratio exceeds 1.0.

Question 5

Chapter 4

5. If a firm’s quick ratio is equal to its current ratio:

a. It has a low level of current liabilities.
b. It has no inventory.
c. It faces a potentially serious liquidity crisis.
d. It is in a loss-making position.

Answer 5

b. It has no inventory

Question 6

Chapter 6

Assume a bond is currently selling at par value. What will happen in the future if the yield
on the bond is lower than the coupon rate?

A. The price of the bond will increase.
B. The coupon rate of the bond will increase.
C. The par value of the bond will decrease.
D. The coupon payments will be adjusted to the new discount rate.

Answer 6

A. The price of the bond will increase.

Question 7

Chapter 6

Which of the following statements is correct for a 10% coupon bond that has a current
yield of 7%?

A. The face value of the bond has decreased.
B. The bond’s maturity value exceeds the bond’s price.
C. The bond’s internal rate of return is 7%.
D. The bond’s market value is higher than its face value.

Answer 7

D. The bond’s market value is higher than its face value.

Question 8

Chapter 6

The discount rate that makes the present value of a bond’s payments equal to its price is
termed the:

A. dividend yield.
B. yield to maturity.
C. current yield.
D. coupon rate.

Answer 8

B. yield to maturity.

Question 9

Chapter 6

Which one of the following bond values will change when interest rates change?

A. The expected cash flows
B. The present value
C. The coupon payment
D. The maturity value

Answer 9

B. The present value

Question 10

Chapter 6

What happens to the coupon rate of a $1,000 face value bond that pays $80 annually in
interest if market interest rates change from 9% to 10%?
A. The coupon rate increases to 10%.
B. The coupon rate remains at 9%.
C. The coupon rate remains at 8%.
D. The coupon rate decreases to 8%.

Answer 10

C. The coupon rate remains at 8%.

Question 11

Chapter 6

If a bond is priced at par value, then:

A. it has a very low level of default risk.
B. its coupon rate equals its yield to maturity.
C. it must be a zero-coupon bond.
D. the bond is quite close to maturity.

Answer 11

B. its coupon rate equals its yield to maturity.

Question 12

Chapter 6

If a bond offers a current yield of 5% and a yield to maturity of 5.45%, then the:

A. bond is selling at a discount.
B. bond has a high default premium.
C. promised yield is not likely to materialize.
D. bond must be a Treasury Inflation-Protected Security.

Answer 12

A. bond is selling at a discount.

Question 13

Chapter 6

When market interest rates exceed a bond’s coupon rate, the bond will:

A. sell for less than par value.
B. sell for more than par value.
C. decrease its coupon rate.
D. increase its coupon rate.

Answer 13

A. sell for less than par value.

Question 14

Chapter 6

What causes bonds to sell for a premium?

A. Investment-quality ratings
B. Long periods until maturity
C. Coupon rates that exceed market rates
D. Speculative-grade ratings

Answer 14

C. Coupon rates that exceed market rates

Question 15

Chapter 7

The statement that there are no free lunches on Wall Street suggests that:

A. the market is strong-form efficient.
B. there is no return to technical or fundamental analysis.
C. security prices reflect all available information.
D. food stocks offer the lowest rates of return

Answer 15

C. security prices reflect all available information.

Question 16

Chapter 7

If it proves possible to make abnormal profits based on information regarding past stock prices, then the
market is:

A. weak-form efficient.
B. not weak-form efficient.
C. semi strong-form efficient.
D. strong-form efficient

Answer 16

B. not weak-form efficient.

Question 17

Chapter 7

With respect to the notion that stock prices follow a random walk, many researchers have
concluded that:

A. stock prices reflect a majority of available information about the firm.
B. successive price changes are predictable.
C. past stock price changes provide little useful information about future stock price
changes.
D. stock prices always rise excessively in January

Answer 17

C. past stock price changes provide little useful information about future stock price
changes.

Question 18

Chapter 7

The semi-strong form of the efficient market hypothesis states that:

A. the efficient market hypothesis is only half true.
B. professional investors make superior profits but amateurs can’t.
C. stock prices do not follow a random walk.
D. prices reflect all publicly available information.

Answer 18

D. prices reflect all publicly available information.

Question 18

Chapter 7

If markets are efficient, when new information about a stock becomes available, the price
will:

A. remain unchanged because it already reflects this information.
B. accurately and rapidly adjust to include this new information.
C. adjust to accurately reflect this new information over the course of the next few days.
D. most likely increase because all new information has a positive effect on stock prices.

Answer 18

B. accurately and rapidly adjust to include this new information.

Question 19

Chapter 7

An analyst who relies on past cycles of stock pricing to make investment decisions is:

A. performing fundamental analysis.
B. relying on strong-form market efficiency.
C. assuming that the market is not even weak-form efficient.
D. relying on the random walk of stock prices

Answer 19

C. assuming that the market is not even weak-form efficient.

Question 20

Chapter 7

The expected return on a common stock is equal to:

A. [(1 + dividend yield) × (1 + capital appreciation rate)] − 1.
B. the capital appreciation rate + dividend yield.
C. (1 + capital appreciation rate)/(1 + dividend yield).
D. the capital appreciation rate − dividend yield

Answer 20

B. the capital appreciation rate + dividend yield.

Question 21

Chapter 7

Based on the random walk theory, if a stock’s price decreased last week, then this week the price:

A. will reverse last week’s loss and go up.
B. will continue last week’s decline.
C. will stand still until new information is released.
D. has an equal chance of going either up or down.

Answer 21

D. has an equal chance of going either up or down.

Question 22

Chapter 7

Someone says to you, “I can pick stocks as well as any professional stock analyst by just
throwing darts at the NYSE listings in the Wall Street Journal.” This philosophy is
____________ with the efficient markets hypothesis.

a. consistent
b. inconsistent
c. not related

Answer 22

a. consistent

Question 23

Chapters 11&12

The principle of diversification tells us that:

a. concentrating an investment in two or three large stocks will eliminate all of the unsystematic
risk.
b. concentrating an investment in three companies all within the same industry will greatly
reduce the systematic risk.
c. spreading an investment across five diverse companies will not lower the total risk.
d. spreading an investment across many diverse assets will eliminate all of the systematic risk.
e. spreading an investment across many diverse assets will eliminate some of the total risk

Answer 23

E. spreading an investment across many diverse assets will eliminate some of the total risk

Question 24

Chapters 11&12

Which one of the following is the slope of the security market line?

a. reward-to-risk ratio
b. portfolio weight
c. beta coefficient
d. risk-free interest rate
e. market risk premium

Answer 24

E. market risk premium

Question 25

Chapters 11&12

The equation of the SML which defines the relationship between the expected return and beta
is the:

a. capital asset pricing model.
b. time value of money equation.
c. risk-return model.
d. market equation.
e. expected risk formula.

Answer 25

A. capital asset pricing model.

Question 26

Chapters 11&12

Standard deviation measures _____ risk.

a. total
b. nondiversifiable
c. unsystematic
d. systematic
e. economic

Answer 26

A. total

Question 27

Chapters 11&12

Unsystematic risk:

A. can be effectively eliminated by portfolio diversification.
b. is compensated for by the risk premium.
c. is measured by beta.
d. is measured by standard deviation.
e. is related to the overall economy.

Answer 27

A. can be effectively eliminated by portfolio diversification.

Question 28

Chapters 11&12

The Dow Jones Industrial Average is:

A. the most representative of the stock market indexes.
B. an index of 500 largest corporate stocks in America.
C. an index of 30 major stocks.
D. an equally weighted index of all stocks traded on the New York Stock Exchange

Answer 28

C. an index of 30 major stocks.

Question 29

Chapters 11&12

The slope of the line fitted to a plot of a stock’s returns versus the market’s returns
measures the:

A. security market line.
B. beta of the stock.
C. market risk premium.
D. capital asset pricing model

Answer 29

B. beta of the stock.

Question 30

Chapters 11&12

The slope of the security market line equals:

A. one.
B. beta.
C. the market risk premium.
D. the expected return on the market portfolio

Answer 30

C. the market risk premium.

Question 31

Chapters 11&12

The slope of the fitted line that shows the relationship between a stock’s return and the market’s
return is the:

A. market’s beta.
B. stock’s beta.
C. market risk premium.
D. stock’s standard deviation

Answer 31

B. stock’s beta.

Question 32

Chapters 11&12

What will happen to the Security Market Line if the following events occur and assuming
everything else remains constant?

I. A decrease in the risk free rate.
II. An increase in the expected return on the market.

a. It will shift up and have a steeper slope.
b. It will shift up and have a flatter slope.
c. It will shift down and have the same slope.
d. It will shift down and have a steeper slope.
e. It will shift down and have a flatter slope

Answer 32

d. It will shift down and have a steeper slope.

Question 33

Chapters 11&12

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following
statements must be true about these securities? (Assume market equilibrium.)

a. When held in isolation, Stock A has greater risk than Stock B.
b. Stock B would be a more desirable addition to a portfolio than Stock A.
c. Stock A would be a more desirable addition to a portfolio than Stock B.
d. The expected return on Stock A will be greater than that on Stock B.
e. The expected return on Stock B will be greater than that on Stock A.

Answer 33

d. The expected return on Stock A will be greater than that on Stock B.