Test 3 Flashcards
Treasury bonds have original maturities from one to ten years, while Treasury notes have original maturities of
more than ten years.
False
Which of the following best describes the valuation principle?
The value of a commodity or an asset to a firm or its investors is determined by its
competitive market price.
Which of the following would be best considered to be an agency conflict problem in the
behavior of the following financial managers?
Bill chooses to pursue a risky investment for the company’s funds because his compensation
will substantially rise if it succeeds.
The chief advantage of debt financing over financing through raising equity capital is that the former does not
dilute the current owner’s share of the business.
True
T/F - Stock markets provide liquidity for a firm’s shares.
True
The Law of One Price states that if equivalent goods or securities are traded simultaneously
in different competitive markets, they will trade for the same price in each market.
True
If a bond’s coupon rate is less than its yield to maturity, the bond will trade at a
Discount
The present value (PV) of a stream of cash flows is just the sum of the present values of each
individual cash flow.
True
Capital Gains Yield
(Selling Price – Cost)/Cost
Which of the following investments offered the lowest overall return over the past eighty years?
Treasury bills
Calculate Growth
Total Cost of Equity Capital - Dividend Yield
Which of the following statements regarding perpetuities is FALSE?
PV of a perpetuity = r / C
The process of selling stock to the public for the first time is called a seasoned equity offering (SEO).
False
T/F - The annual percentage rate indicates the amount of interest, including the effect of any
compounding.
False
How do the shareholders of most corporations exercise their control of that corporation?
by electing members of a board of directors
Which of the following balance sheet equations is INCORRECT?
Assets - Current liabilities = Long-term liabilities
The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its
capital structure
Which of the following is/are TRUE?
I. The EAR can never exceed the APR.
II. The APR can never exceed the EAR.
III. The APR and EAR can never be equal.
Only II. is true - The APR can never exceed the EAR
An equity issue that raises new funds for a publicly traded company is called
a seasoned equity offering
T/F - According to researchers Modigliani and Miller, with perfect capital markets, the total value of a firm
should not depend on its capital structure
True
The beta of the market portfolio is
1
You are given two choices of investments, Investment A and Investment B. The investments
have identical cash flows. Investment A has a discount rate of 4%, and Investment B has a
discount rate of 5%. Which of the following is true?
The present value of cash flows in Investment A is higher than the present value of cash flows
in Investment B.
What type of risk is Volatility?
Total Risk
Which of the following is NOT a role of financial institutions?
impaling money for borrowers
Equity in a firm with debt is called
levered equity
How are investors in zero-coupon bonds compensated for making such an investment?
Such bonds are purchased at a discount to their face value
After a list of potential projects is compiled, capital budgeting process is continued by
forecasting the future consequences for the firm of each potential project
Dividend Yield
Divident / Purchase Price Per Share
Whose interests should a financial manager consider paramount when making a decision?
the stockholders’ interests
Total Cost of Equity Capital
Dividend Yield + Growth
) You expect General Motors (GM) to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM)
to be 0.9 over the next year. Also, you expect the volatility of General Motors to be 40% and that of Exxon Mobil to
be 50% over the next year. Which stock has more systematic risk? Which stock has more total risk?
GM, XOM
The Ontario Teachers’ Pension Plan is a pension fund for public school teachers in the province of Ontario. It
has a large and diverse portfolio of investments, both in Canada and internationally, and had net assets in
December 2007 of C$108.5 billion. Which of the following best describes the Ontario Teachers’ Pension Plan?
an institutional investor
Which of the following is NOT a limitation of the payback rule?
It is difficult to calculate.
A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market
interest rates imply a YTM of 6%, what should be the coupon rate offered if the bond is to trade at par?
6%
Capital Gain Rate
(Sell Price - Purchase Price) / Purchase Price
The credit spread of a bond shrinks if it is perceived that the probability of the issuer defaulting increases.
False
What type of risk is beta?
Systematic Risk
Bonds with a high risk of default generally offer high yields.
True
T/F - Cash flows from an annuity occur every year in the future.
False
Which of the following best defines incremental earnings?
the amount by which a firm’s earnings are expected to change as a result of an investment
decision
T/F - Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the costs of a project or investment.
True
Which of the following adjustments should NOT be made when computing free cash flow
from incremental earnings?
subtracting depreciation expenses from taxable earnings
By definition, preferred stock is a form of debt security.
False
The Capital Asset Pricing Model asserts that the expected return
is equal to the risk-free rate plus a risk premium for systematic risk
In most corporations, to whom does the chief financial officer typically report?
the chief executive officer
According to Graham and Harvey’s 2001 survey (Figure 8.2 in the text), the most popular
decision rules for capital budgeting used by CFOs are
IRR, NPV, Payback period
