Theory Questions

Question 1

Ratio analysis can provide important information to financial analysts when taking financial decisions. Which statement about financial ratios is FALSE?
A) Ratios can be useful to compare firms’ performance with their own past performance or with the performance of competing firms.
B) Interest coverage ratios can be interpreted as a measure of a corporation’s credit risk.
C) A corporation’s interest coverage ratio increases when it issues more interest-bearing debt (assume a constant EBIT or EBITDA over time).
D) Growth stocks typically have much higher P/E ratios than value stocks.

Answer 1

C

Question 2

Which statement on the use of net Present Value (NPV)for evaluating investments is FALSE?
A) Reject those projects with negative NPV because accepting them would reduce the wealth of investors.
B)When making an investment decision, one receives its NPV in cash today and this is true for both a positive as well as a negative NPV decision.
C) If the NPVis exactly zero, you will neither gain nor lose by accepting the project.
D) The NPV criterion is only applicable when current and future benefits and costs arrive at the same time points on the project’s timeline.

Answer 2

D

Question 3

The Internal Rate of Return (IRR) Rule has certain pitfalls. Which statement related to these pitfalls is TRUE?
A) The IRR rule can never be applied for selecting a project out of mutually exclusive projects.
B)The IRR rule does not take the time value of money into account.
C) The IRR rule does not apply when the NPV is a monotonicallydecreasing function of the opportunity cost of capital.
D) The IRR rule may not apply if there is only one single IRRfound

Answer 3

D

Question 4

How do you calculate the dividend yield?

Answer 4

Sum of dividends / First price

Question 5

Which of the following statements on portfolios and risk diversification is FALSE?
A) In small equally weighted portfolios (with a few stocks only), the portfolio variance both depends on the average variance of the portfolio securities as well as on the average covariance between the portfolio securities.
B) In large equally weighted portfolios with many securities the portfolio variance mainly depends on the average covariance between the portfolio securities.
C) It is impossible to construct a portfolio without systematic risk.
D) Diversification becomes less effective during periods of high volatility like financial crises.

Answer 5

C

Question 6

When talking about risk and (expected) return of individual securities vs. portfolios we studied the Modern Portfolio Theory (MPT) introduced by Markowitz and the Capital Asset Pricing Model (CAPM). The MPT is graphically represented by the Capital Market Line (CML) whereas the CAPM is graphically represented by the Security Market Line (SML). Which statement about these models is TRUE?
A) Stocks that lie below the CML are overvalued stocks.
B) A security with β<0 is expected to earn a return lower than the risk-free rate.
C) If a stock has β=1, this means that the stock’s return is perfectly positively correlated with the returns on the market portfolio.
D) Efficient portfolios on the CML should not necessarily be on the SML and can thus not be undervalued or overvalued.

Answer 6

B

Question 7

Option prices are determined by different factors. Which statement is TRUE?
A) A European put option is at least as expensive as an otherwise identical American put option (assumetwo options on the same underlying asset that have same strike price, remaining time to maturity)
B) An option’s time value increases when the option’s expiration date nears.
C) An increase in the standard deviation of the underlying security return increases both the price of a putand a call (assume a call, put on that same underlying security).
D) The value of a Europeancallishigher when the strike price is higher (keep all other factors affecting option prices constant).

Answer 7

C

Question 8

When discussing options, we considered different option ‘strategies’. Which statement isTRUE?
A) A portfolio consisting of a stock, a European call on that stock and a written European put on the stock such that this call, put have same strike price and time to maturity is a risk-free portfolio.
B) The downside for a short position in a put optionis limited to the strike price of the option whereas there is no limit to the downside for a short position in a call.
C) A straddle can be created by taking a short position in a call and put option with the same expiration date andexercise price.
D) A protective call implies combining a stock with a purchased call option on that stock.

Answer 8

B

Question 9

Which of the following statements regarding the legal nature of firms is FALSE?
A)In a limited partnership limited partners have no management authority.
B)In a limited partnership general partners are personally liable for the firm’s debt obligations.
C)Private equity funds and venture capital funds are two examples of industries dominated by Limited Liability Companies.
D)In a sole proprietorship there is no separation between ownership and control.

Answer 9

C

Question 10

Which of the following statements regarding the time value of money is FALSE?
A) The higher the interest rate, the higher the present value given a €100 future value
and holding the time period constant.
B) The longer the time period, the smaller the present value, given a €100 future value
and keeping the interest rate constant.
C) The time value of money is typically smaller in periods of economic recession.
D) The present value of a future cash flow of €1 is strictly smaller than €1 provided
the nominal interest rate for the considered investment period is strictly positive.

Answer 10

A

Question 11

Which of the following statements regarding the Law of One Price and arbitrage is FALSE?
A)We call the price of a security in a normal market the no-arbitrage price of a security.
B)The general formula for the no-arbitrage price of a security is Price(security) = PV(All cash flows paid by the security).
C)When a bond is underpriced the arbitrage strategy involves selling the bond and investing some of its proceeds.
D)In financial markets it is possible to sell a security you do not own by means of a ‘short sale’.

Answer 11

C

Question 12

A decreasein expected inflation is expected to shift the demand and supply curves for government bonds. Which of the following statements is TRUE?
A)The demand curve shifts to the right and the supply curve shifts to the left.
B)The demand curves shifts to the left and the supply curve shifts to the right.
C)Both demand and supply curves shift to the right.
D)Both demand and supply curves shift to the left.

Answer 12

A

Question 13

Suppose the economy slumps into recession. This is expected to shift the demand and supply curves of corporate bonds. Which statement is TRUE?
A)Both demand and supply curves shift to the right.
B)Both demand and supply curves shift to the left.
C)The demand curve shifts to the right and the supply curve shifts to the left.
D)The demand curves shifts to the left and the supply curve shifts to the right.

Answer 13

B

Question 14

Suppose rating agency Moody’s announces a change in Tesbix’s rating from AA to AAA. Which statement on the effects of this rating change on Tesbix’s bond price is TRUE?
A)The supply curve of Tesbix bonds shifts to the left because the government deficit has decreased due to the rating change.
B)The rating basically tells investors how volatile stocks are. In other words, it is a measure of volatility risk just like the standard deviation.
C)The demand curve for Tesbixbonds shifts to the left because investors assess that the credit risk of Tesbix has increased.
D)Tesbix bond yields and prices might not react to the rating change announcement if bond market investors already fully anticipated the rating change.

Answer 14

D

Question 15

We considered various ways to value companyequity. Which of the following statements is TRUE?
A)By repurchasing shares, the firm decreases its share count, which increases its earnings and dividends on a per-share basis.
B)In the dividend discount model with constant dividend growth and an infinite investment horizon, we need to assume that dividend growth is larger than the cost of equity.
C)The total payout model makes use of the company’s Free Cash Flows.
D)The total payout model focuses on dividends and/or share repurchases from the perspective of an individual shareholder

Answer 15

A

Question 16

We discussed different types of risk that exist in financial markets. Which statement is TRUE?A)Investors in more liquid stocks require a compensation (or risk premium) as compared to investors in less liquid stocks.
B)The risk of a global meltdown of the financial system is called systematic risk.
C)Credit risk can be assessed by looking at the sensitivity of bond prices to shocks in the bond’s yield to maturity.
D)Computer hacking and its resulting impact on the running of a business is an example of operational risk.

Answer 16

D

Question 17

Volatility can be caused by systematic newsor firm-specific news. Which statement is FALSE?A)Monetary policy announcements by the European Central Bank constitute an example of firm-specific risk (consider the ECB as a company)
B)If only news can move stock prices this also implies that past information can no longer impact current stock prices.
C)The death of a company’s CEO constitutes an example of firm-specific risk.
D)Systematic risk cannot be diversified away in contrast to firm-specific risk.

Answer 17

A

Question 18

Which statement is TRUE about the research on “giving behaviour of millionaires” of prof. Paul Smeets?
A) 90% of millionaires are purely selfish regardless of whether it is a giving situation
or a bargaining situation.
B) Millionaires are more generous in a giving situation than in a bargaining situation.
C) Millionaires re equally generous in a giving situation as in a bargaining situation.
D) Millionaires are more generous in a bargaining situation than in a giving situation.

Answer 18

B

Question 19

Which statement is true about the research on “Why do investors hold socially responsible mutual funds?” of prof. Paul Smeets? Investors hold socially responsible investments…
A) ..primarily because they expect those investments to realize better financial
performance.
B) ..because of financial reasons (financial performance) as well as social reasons.
C) For other reasons than financial or social ones.
D) ..primarily because of social reasons.

Answer 19

D

Question 20

The following statements are related to the so-called Capital Market Line (CML) developed by Harry Markowitz in his ‘Modern Portfolio theory’ (MPT). Which statement is FALSE?
A)Individual stocks can lie on the CML.
B)The intercept of the CML is the risk free interest rate.
C)For portfolios on the CML the standard deviation is an appropriate measure of systematic risk.
D)The slope of the CML is the Sharpe ratio of the market portfolio.

Answer 20

A

Question 21

Which statement on risk diversification is FALSE?
A)Risk diversification implies that the systematic risk of a portfolio is reduced relative to the systematic risk of the individual stocks in that portfolio. Stated otherwise, the systematic risk of the individual stocks cancels out by putting them together.
B)The portfolio variance is mainly dependent on the average covariance between the stocks.
C)The potential for risk diversification is inversely related to the height of the correlations between the stocks one puts in the portfolio.
D)In principle more risk is diversified when adding more stocks to the portfolio

Answer 21

A

Question 22

Assume the Capital Asset Pricing Model (CAPM) applies. Which statement is FALSE?
A) Real estate investments can also be valuated using this model.
B) Stocks that are on the Security Market Line (SML) automatically also lie on the
Capital Market Line (CML).
C) Stocks with β=0 are characterized by stock prices that only change due to firm-
specific news.
D) Savings deposits exhibit a β equal to zero.

Answer 22

B

Question 23

Which statement about so-called ‘efficient’ portfolios/frontiers is TRUE?
A)Efficient portfolios have the highest expected return for a given risk level and lie below the efficient frontier.
B)The efficient frontier is a straight line with the risk free rate as intercept, the expected return on the vertical axis and the standard deviation on the horizontal axis (assume saving or borrowing is not allowed and one can only invest into risky assets).
C)The efficient frontier encompasses those portfolios which provide the highest expected return for a given level of portfolio risk (standard deviation).
D)When adding risky assets to portfolios the efficient frontier can be further improved by further decreasing the systematic risk of the constituting stocks

Answer 23

C

Question 24

Suppose that the market portfolio is equally likely to increase by 24% or decrease by -8%. Individual stock Gamestart increases on average by 50% when the market portfolio increases and decreases by 17% when the market portfolio decreases. The beta of Gamestart lies closest to:
A) 1.0
B) 1.25 
C) 1.5 
D) 2.0

Answer 24

D

Slope=(0.5-(-0.17))/(0.24-(-0.08))=2.093

Question 25

Consider portfolios consisting of two stocks only. The stock with the highest expected return also exhibits the highest standard deviation. We are interested in plotting the expected portfolio return (vertical axis) against the portfolio standard deviation (horizontal axis) for each possible portfolio. Which statement about 2-stock portfolios is FALSE?
A) A two-stock portfolio that earns on average the risk free rate exists when the correlation is -1.
B) The expected portfolio return does not depend on the correlation between the returns.
C) The portfolio variance depends on the correlation between the returns.
D) The higher the correlation for a given pair of stocks, the lower will be the portfolio standard deviation given the expected portfolio return.

Answer 25

D

Question 26

Assume investors only trade on public information that is easy to interpret. Which of the following statements related to the processing of information in market prices and the efficient markets hypothesis is FALSE?
A) Corporate managers cannot systematically issue undervalued stocks to investors.
B) A positive Net Present Value of a financial investment can only exist for a short period of time.
C) Because of arbitrage stocks cannot exhibit different risk in equilibrium: the riskiest stocks will be sold and the safest stocks will be bought.
D) Corporate managers cannot fool the market by changing accounting rules.

Answer 26

C

Question 27

10. Which statement on the Net Present Value investment rule, Internal Rate of Return (IRR) and the IRR investment rule is TRUE?
    A) When the IRR investment rule contradicts the NPV investment rule, investment decisions should be based on the IRR investment rule.
    B) The NPV investment rule to evaluate a stand-alone project can only be used if all the project’s negative cash flows precede its positive cash flows.
    C) A project with a lifetime of 3 years can exhibit more than 3 IRR’s.
    D) A necessary (but insufficient) condition for the IRR investment rule to lead to the right investment decisions is that the project under consideration only exhibits one single IRR.

Answer 27

D

Question 28

Which of the following statements regarding the concepts of the valuation principle, the law of one price, arbitrage and the NPV criterion are FALSE?
A) If future cash flows are risk-free, we no longer have to discount these cash flows when applying NPV.
B) One of the differences between the NPV decision rule and the payback rule for valuing investments is that the latter does not take the time value of money into account.
C) Projects with a negative NPV should be rejected, as accepting them is reducing the firm value.
D) The decision to accept positive NPV projects increases the value of the firm and is a good decision regardless of your current cash needs or preferences regarding when to spend the money.

Answer 28

A

Question 29

When talking about the nature of volatility in financial markets, we distinguished between firm- specific and systematic sources of news and risk. Which of the following statements is FALSE?
A) When a corporation’s CEO is fired, this constitutes an example of firm-specific risk.
B) The discovery of a new Covid vaccine can both represent systematic risk and firm-specific risk.
C) Idiosyncratic risk is by definition unavoidable which implies one should be compensated for by means of a risk premium.
D) When Central Bank presidents express concern about the potential for a rise in future inflation, this announcement can be considered as systematic risk.

Answer 29

C

Question 30

Consider portfolios P consisting of two stocks only. The stock with the highest expected return also exhibits the highest standard deviation. We are interested in plotting the expected portfolio return (vertical axis) against the portfolio standard deviation (horizontal axis) for each possible 2-stock portfolio. Which statement is FALSE?
A) This curve can contain both efficient and inefficient portfolios. B)
C) A (2-stock) portfolio is efficient when no other (2-stock) portfolios can be found with equal
Corporate bankruptcy arises when corporations cannot fulfill their debt obligations to their
debtholders (bondholders, banks).
Suppose you save €1,000 per year and this for 30 consecutive years. If the account earns 6% interest
per year, the future value of the savings account (after 30 years) comes closest to:
The portfolio variance decreases when the correlation between the two stocks decreases (keeping
all other determinants of the portfolio variance constant).
expected return but with lower standard deviation.
D) When plotting expected portfolio returns vs. portfolio volatility the curve that contains all possible portfolios is a straight line if and only if the correlation between the two stocks is 0.

Answer 30

D

Question 31

Assume investors only trade on public information that is easy to interpret. Which of the following statements related to the processing of information in market prices and the efficient markets hypothesis is FALSE?
A) In efficient markets, investors expect the same returns for different stocks because otherwise this would represent an arbitrage opportunity.
B) In efficient markets, all past publically available information relevant for a stock cannot cause changes in the current stock price.
C) In efficient markets, it is possible that the announcement of a merger does not impact the stock price of the target and the acquirer.
D) In efficient markets, you expect that the Net Present Value of a financial investment will be equal to zero.

Answer 31

A

Question 32

A lot of accounting terms related to a corporation’s financial statements are used by financial analysts. Which statement is FALSE?
A) The book value of the firm’s assets can fall below the book value of the firm’s liabilities.
B) A rise in goodwill (all else equal on the balance sheet) leads to an increase in book value of equity.
C) One of the steps to calculate net income in the income statement is to add interest income to Earnings Before Interest and Taxes (EBIT).
D) The diluted Earnings per share are not calculated by using the actual number of outstanding shares.

Answer 32

C

Question 33

Coinbix Industries has 550 million shares outstanding and expects earnings at the end of this year of $800 million. Coinbix plans to pay out 70% of its earnings in total (30% as a dividend and 40% to repurchase shares). Coinbix’s earnings are expected to grow by 5% per year and the future pay out rates remain constant. The equity cost of capital is 8%. The total payout model suggests an intrinsic value of all Coinbix shares closest to:
A) $15,000 million 
B) $17,000 million 
C) $19,000 million 
D) $21,000 million

Answer 33

C

Question 34

32. (Stock) option prices can be affected by different factors. Which statement is TRUE?
    A) An American option cannot be worth less than a European option on the same underlying stock and with otherwise identical characteristics.
    B) Whereas an option’s time value can be zero, an option’s intrinsic value is always positive.
    C) An increase in the volatility of the underlying stock increases the intrinsic value of calls and puts on that stock (keep all other factors that influence option prices constant).
    D) If put options are out-of-the-money that means that you do not have to pay for the option when the stock price exceeds the exercise price. The option is basically for free.
    Ans: A

Answer 34

A

Question 35

Volatility in financial markets can be caused by firm-specific or systematic risk. Which of the
following statements is FALSE?
A) When a corporation announces quarterly earnings, it is possible that the stock price does not react to this announcement when the market already fully anticipated this news.
B) A stock’s standard deviation is a measure of the stock’s firm-specific risk.
C) Firm-specific risk can be diversified away by forming large portfolios.
D) When the government announces the quarterly unemployment rate, this constitutes an example of systematic risk.

Answer 35

B

Question 36

Stocks and bonds exhibit different types of risk. Which statement is FALSE?
A) Interest rate risk refers to changes in bond prices arising from changes in their yield to maturity. B) Corporations without debt do not have credit risk.
C) The credit risk of countries is not equal to zero. Only for the US government bond market, it is often assumed that debt is risk-free.
D) A company’s firm-specific risk is reflected in the corporation’s equity cost of capital.

Answer 36

D

Question 37

Different terms and concepts need to be distinguished when describing option markets. Which statement is TRUE?
A) A European call and put option on the same underlying stock, same strike price and same remaining time to expiration can both be in-the-money at the same time.
B) The time value of a put option on a stock can be expressed as P=Max(K-S, 0) with S the price of the underlying asset and K the exercise price.
C) In contrast to an option’s time value, an option’s intrinsic value is zero when it is out-of-the-money.
D) The holder of an option receives the premium from the writer. The latter buys the option right.

Answer 37

C