Final Exam

Question 1

Which of the following statements is most correct?
A) A hostile takeover is the main method of transferring ownership in a corporation.
B) The corporation is a legal entity created by the state and is a direct extension of the legal status of its owners and managers; that is, the owners and managers are the corporation
C) Unlimited liability and limited life are two key advantages of the corporate
form over other forms of business organization.
D) In part due to limited liability and ease of ownership transfer, corporations
usually have less trouble raising money in financial markets than other
organizational forms have.
E) None of the above answers is correct.

Answer 1

D

Question 2

Which of the following statements is most correct?
a. One of the advantages of the corporate form of organization is that there is no
double taxation.
b. The partnership form of organization has easy transfer of ownership.
c. One of the disadvantages of the sole proprietorship form of organization is
that there is unlimited liability.
d. Both b and c are correct.
e. None of the answers above is correct

Answer 2

Answer: c
Statement c is correct. The other statements are false. The
corporate form is subject to double taxation, and partnerships
are not easily transferred.

Question 3

Which of the following bank accounts has the highest effective annual rate?
a. An account which pays 10 percent nominal interest with monthly
compounding
b. An account which pays 10 percent nominal interest with daily compounding
c. An account which pays 10 percent nominal interest with annual compounding
d. An account which pays 9 percent nominal interest with daily compounding
e. All of the investments above have the same effective annual rate.

Answer 3

Answer: b
The bank account which pays the highest nominal rate with the
most frequent rate of compounding will have the highest EAR.
Consequently, statement b is the correct choice.

Question 4

The tighter the probability distribution of expected future returns is, the smaller
the risk is of a given investment as measured by the standard deviation.
a. True
b. False

Answer 4

True

Question 5

While the portfolio return is a weighted average of security returns, portfolio risk
is not necessarily a 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
actually reduce the riskiness of a portfolio.
a. True
b. False

Answer 5

True

Question 6

Even if the correlation between the returns on two different securities is perfectly
positive, if the securities are combined in the correct unequal proportions, the resulting
portfolio can have less risk than either security held alone.
a. True
b. False

Answer 6

False

Question 7

Which of the following statements is most correct?

a. The slope of the security market line is beta.
b. The slope of the security market line is the market risk premium, (rM – rR F).
c. If you double a company’s beta, its required return more than doubles.
d. Statements a and c are correct.
e. Statements b and c are correct

Answer 7

Answer: b
Statement b is true. Statement a is false, since the slope of
the SML is rM – rRF. Statement c is false, since
rs = rRF + (rM – rRF). The remaining statements are false.

Question 8

Which of the following statements is most correct?
a. Portfolio diversification reduces the variability of the returns on the individual
stocks held in the portfolio.
b. If an investor buys enough stocks, he or she can, through diversification,
eliminate virtually all of the non-market (or company-specific) risk inherent in
owning stocks. Indeed, if the portfolio contained all publicly traded stocks, it
would be riskless.
c. The required return on a firm’s common stock is determined by its systematic
(or market) risk. If the systematic 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.
d. A security’s beta measures risk relative to that of an average stock

Answer 8

Answer: d
A security’s beta does indeed measure risk relative to that of an
average stock. Diversification reduces the variability of the
overall portfolio’s return. An investor, through diversification,
can eliminate company-specific risk; however, a portfolio
containing all publicly traded stocks would still be exposed to
market risk. The CAPM specifies a stock’s required return as:
rs = rRF + (rM - rRF). Thus, the risk-free rate and the market
risk premium are needed along with a stock’s beta to determine
its required return.

Question 9

Which of the following statements is most correct?
a. If you add enough randomly selected stocks to a portfolio, you can
completely eliminate all of the market risk from the portfolio.
b. If you form a large portfolio of stocks each with a beta greater than 1.0, this
portfolio will have more relative risk than a single stock with a beta = 0.8.
c. Company-specific risk can be reduced by forming a large portfolio, but
normally even highly diversified portfolios are subject to market risk.
d. Answers a, b, and c are correct.
e. Answers b and c are correct.

Answer 9

E

Question 10

Which of the following best describes a bond that is issued by a local entity and
traded in a local market but may be purchased by foreigners?

Answer 10

Domestic Bond

Question 11

Which of the following best describes an international bond that is not denominated
in the local currency of the country in which it is issued?

Answer 11

Eurobond

Question 12

In a leveraged buyout (LBO), a group of investors purchases all of the equity of a
public corporation by financing this purchase primarily with debt.

Answer 12

True

Question 13

It is not correct to discount the cash flows of a levered firm with the cost of equity of
the unlevered firm, because
A) leverage decreases the risk of equity of the firm.
B) leverage changes the unlevered cost of equity.
C) leverage increases the risk of the equity of the firm.
D) cost of debt decreases in this setting

Answer 13

C

Question 14

The trade-off theory of optimal capital structure weighs the benefits of debt against the
costs of
A) financial distress.
B) interest payments.
C) dividend reinvestment.
D) input factors.

Answer 14

A

Question 15

Asymmetric information implies that ________ may have better information about a
firm’s cash flows than other stakeholders have

Answer 15

Managers

Question 16

Anyone who purchases the stock on or after the ________ date will not receive the
dividend.

Answer 16

Ex-dividend

Question 17

When a firm offers to buy its shares at a pre-specified price during a short time period,
it is also known as a(n)
A) open market purchase.
B) tender offer.
C) targeted repurchase.
D) greenmail

Answer 17

B) Tender Offer

Question 18

Tax rates on dividends and capital gains differ across investors for a variety of reasons
including
A) income.
B) investment horizon.
C) tax jurisdiction.
D) all of the above.

Answer 18

D

Question 19

Which form of the Efficient Markets Hypothesis states that one cannot profit from
only looking at past data but can profit from looking at publicly available information?

Answer 19

Weak-form EMH

Question 20

The asset and liability sides of a pro forma balance sheet projection will not balance,
in general, unless we make assumptions about how ________ and ________ will grow
with sales.
A) dividends; equity
B) coupons; debt
C) debt; equity
D) dividends; preferred stock

Answer 20

C

Question 21

Which of the following best describes a limited partnership that specializes in raising
money to invest in the private equity of young firms?
A) venture capital firms
B) institutional investors
C) corporate investors
D) family investors

Answer 21

A

Question 22

Which of the following best describes a firm commitment IPO?
A) The underwriter purchases the entire issue at a small discount and then resells it at the
offer price.
B) The underwriter sells new issues directly to the public in an online auction.
C) The underwriter tries to sell the stock for the best possible price but does not guarantee
that the stock will be sold.
D) The underwriter solicits bids from investors and chooses the highest price at which
there is sufficient demand to sell the entire issue

Answer 22

A

Question 23

Which of the following statements is FALSE?
A) Once the issue price (or offer price) is set, underwriters may invoke another
mechanism to protect themselves against a loss - the over-allotment allocation.
B) Before the offer price is set, the underwriters work closely with the company to come
up with a price range that they believe provides a reasonable valuation for the firm.
C) Before an IPO, the company prepares the final registration statement and final
prospectus containing all the details of the IPO, including the number of shares offered
and the offer price.
D) A “road trip” is where senior management and the lead underwriters travel around the
country (and sometimes around the world) promoting the company and explaining their
rationale for the offer price to the underwriters’ customers

Answer 23

D) A “road show” is where senior management and the lead underwriters
travel around the country (and sometimes around the world) promoting the company and
explaining their rationale for the offer price to the underwriters’ customers.

Question 24

Which of the following statements is FALSE?
A) Recently, shareholders have started organizing “no” votes. That is, when they are
dissatisfied with a board, they simply refuse to vote to approve the slate of nominees for
the board.
B) Target shareholders must approve merger agreements.
C) Shareholders’ only real role in governance is in electing the directors of the company.
D) Perhaps the most extreme form of direct action that disgruntled shareholders can take
is to hold a proxy contest and introduce a rival slate of directors for election to the board.

Answer 24

C) In addition to electing the directors of the company, shareholders must
approve many major actions taken by the board.

Question 25

While the Sarbanes-Oxley Act (SOX) contains many provisions, the overall intent of
the legislation was to improve the accuracy of information given to both boards and to
shareholders. SOX attempted to achieve this goal in all of the following ways except
A) overhauling incentives and independence in the auditing process.
B) mandating the separation of the positions of CEO and Chair of the Board.
C) stiffening penalties for providing false information.
D) forcing companies to validate their internal financial control processes

Answer 25

B

Question 26

Which of the following statements is FALSE?
A) Controlling shareholders pay for their control rights.
B) Many countries follow what is called the stakeholder model, giving explicit
consideration to other stakeholders - in particular, rank-and-file employees.
C) In a pyramid structure, a family first creates a company in which it has a controlling
interest.
D) A conflict of interest arises, because the family has an incentive to try to move profits
(and hence dividends) down the pyramid - that is, toward companies in which it has
fewer cash flow rights and away from firms in which it has more cash flow rights

Answer 26

D) A conflict of interest arises, because the family has an incentive to try to
move profits (and hence dividends) up the pyramid – that is, away from companies in
which it has fewer cash flow rights and toward firms in which it has more cash flow
rights. This process is called tunneling.