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Finance
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Feb 20, 2024
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1)
In an efficient capital market:
A)
security prices reflect all available information.
2)
The hypothesis that market prices reflect all publicly available information is called _____ form efficiency.
A)
Semistrong
2)
Financial markets fluctuate daily because they:
A)
are continually reacting to new information.
3)
Which term best applies to the situation where an investor cares less about losing $1 of his profits than he does about losing $1 of his original investment?
A)
House money effect
4)
Psychologists generally agree that irrational traits such as those related to behavioral finance are
generally:
A)
pervasive across individuals.
5)
Ultimately, it is the ________ who has (have) control over a corporation
A)
shareholders
6)
Shareholders obtain the right ________ when they are granted preemptive rights.
A)
of first refusal for their proportionate percentage of new shares offered
7)
________ grant the issuer the right to extinguish the debt prior to maturity.
A)
Debentures
8)
The ________ is the written agreement between a corporation and its bondholders.
A)
Indenture
9)
A subordinated debt:
A)
must give preference to the secured creditors in the event of default.
10) Sinking fund arrangements are least
likely to include which one of the following requirements?
A)
A one-time repayment of the entire principal and interest at maturity
11) Which one of the following statements applies to floating-rate bonds?
A)
Coupon payments are variable while the par value is fixed.
12) Arevalos, Incorporated, has cumulative preferred stock outstanding that calls for quarterly dividend payments of $2.25 per share. Unfortunately, the firm has not paid these preferred dividends for the past three quarters. What amount per share must be paid to the preferred shareholders this quarter if the firm also wants to pay a dividend on its common stock?
A)
$9.00
Preferred dividends in arrears = $2.25 x 3 quarters = $6.75 per share
Total preferred dividend payment = $6.75 + $2.25 = $9.00 per share
13) Analysts estimate that one year from today, a bond has a probability of 40 percent of being priced at $950 and a probability of 60 percent of being priced at $1,050. The bond is also callable at any time at $1,010. What is the expected value of this bond in one year?
A)
$986
Probability 1 (P1) = 40% Probability 2 (P2) = 60%
Price in probability 1 (V0) = $950
Price in probability 2 (V1) = $1050
Callable price (CP) = $1010
If market price reaches $1050, the bonds will be called at a callable price of $1010, so $1010 will be used:
E(BV)=P1*V0+P2*CP= .4*950$+.6*1010$=986$
14) Analysts estimate that a bond has an equal probability of being priced at either $940 or $1,050 one year from today. The bond is also callable at any time at $1,020. What is the expected value
of this bond in one year?
A)
$980
E(BV)=P1*V0+P2*V1
Here P1 and P2 denote probability.
V0 and V1 denote value or price of bond, current/callable bond in future.
Probability for getting each price = 50%
Current bond price = $1,050
Callable bond price = $940
E(BV)= $980
Answer: B
Expected value = (50%*$940 + 50%*1,020) = $980
they will call it at 1,020
15) A firm’s ________ is referred to as its capital structure.
A)
mix of debt and equity used to finance its assets
16) According to Modigliani & Miller, (or MM), Proposition I with no tax:
A)
it is completely irrelevant how a firm arranges its finances.
17) According to ________ the value of the levered firm equals the value of the unlevered firm.
A)
MM Proposition I with no tax
18) A levered firm is a company that has:
A)
some debt in its capital structure.
19) The increase in risk to shareholders when financial leverage is added is best evidenced by:
A)
a higher variability of EPS with partial debt financing than with all-equity financing.
20) The concept that the value of the firm is independent of its capital structure is called:
A)
MM Proposition I (no taxes).
21) According to MM Proposition II with no taxes, the:
A)
required return on equity is a linear function of the firm’s debt-equity ratio.
22) MM Proposition II with no taxes supports the argument that a firm’s:
A)
WACC remains constant even if the firm changes its capital structure.
23) Because interest expense is tax deductible, levered firms can benefit from the:
A)
tax shield from debt.
24) MM Proposition I without taxes does not hold when corporate taxes are introduced because:
A)
levered firms pay less in taxes than identical unlevered firms.
25) Assume an unlevered firm has total assets of $6,000, earnings before interest and taxes of $600, and 500 shares of stock outstanding. Further assume the firm decides to change 40 percent of its
capital structure to debt with an interest rate of 8 percent. Ignore taxes. What will be the amount of the change in the earnings per share as a result of this change in the capital structure?
A)
$.16
Interest Expense = Debt Amount * Interest Rate
Interest Expense = (0.40 * $6,000) * 0.08
Interest Expense = $192
New EBIT = Old EBIT - Interest Expense
New EBIT = $600 - $192
New EBIT = $408
New EPS = New Net Income / New Number of Shares
New EPS = $408 / [500*(1-0.4)]
New EPS = $1.36
Old EPS = Old Net Income / Old Number of Shares
Old EPS = $600 / 500
Old EPS = $1.20
Change in EPS = $1.36 - $1.20
Change in EPS = $0.16
26) A firm has a debt-equity ratio of .52, a pretax cost of debt of 6.5 percent, and a required return on assets of 12 percent. Ignoring taxes, what is the cost of equity?
A)
14.86 percent
Calculation of Cost of Equity:
Kd = 6.5%
Debt to Equity Ratio = 0.52
It Means Debt = 0.52 & Equity = 1
Required Return=12= Ke
*EQUweight/TOTweight + Kd*DEBweight/TOTWeight Cost of Equity= 14.86%
27) A firm has zero debt in its capital structure and has an overall cost of capital of 10 percent. The firm is considering a new capital structure with 60 percent debt at an interest rate of 8 percent. Assuming there are no taxes or other imperfections, what would be the cost of equity with the new capital structure?
A)
13 percent
Unlevered cost of capital, Ku = 10%
Cost of debt, Kd = 8%
Debt % = 60%
Equity= 1-0.6= 0.4
Debt to equity= D/E= 0.6/0.4= 1.5
Cost of equity= Ku + D/E *(Ku-Kd)= 0.13
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Related Questions
Ceteris paribus, current financial market returns will increase as _____.
Group of answer choices
a. the uncertainty about the productivity of capital goods increases and people become more risk averse
b. the uncertainty about the productivity of capital goods increases and people become less risk averse
c. the uncertainty about the productivity of capital goods decreases and people become more risk averse
d. the uncertainty about the productivity of capital goods decreases and people become less risk averse
arrow_forward
Firms will take investments only when expected risks are remunerated by expected profit. *
a. Incremental cash flows
b. Efficient capital markets
c. Risk-return trade-off
d. All risks are not equal
arrow_forward
Which of the following statements is correct?
A. Investors appreciate illiquid assets in their portfolios as they can easily sell them off to cover margin calls.
B. Liquid assets can quickly be converted into cash without changing prices too much.
O C. Corporate bonds are among the most liquid financial assets as they trade at a very high frequency.
D. Liquid assets tend to be cheaper as investors are not willing to pay for their liquidity benefits.
arrow_forward
The efficient markets hypothesis
True or False: The efficient markets hypothesis holds only if all investors are rational.
False
True
Almost all financial theory and decision models assume that the financial markets are efficient. The informational efficiency of financial markets determines the ability of investors to “beat” the market and earn excess (or abnormal) returns on their investments. If the markets are efficient, they will react rapidly as new relevant information becomes available. Financial theorists have identified three levels of informational efficiency that reflect what information is incorporated in stock prices.
Identify the form of capital market efficiency under the efficient market hypothesis described in the following statement:
Current market prices reflect all information contained in past price movements.
This statement is consistent with:
Strong form efficiency
Semistrong form efficiency
Weak form efficiency…
arrow_forward
“When the stock market rises, investment spending isincreasing.” Is this statement true, false, or uncertain?Explain your answer
arrow_forward
An increase in the riskiness of financial securities results in a_______ in the supply of loanable funds and hence shift in the supply curve to the_______
O Decrease, leftO Decrease, rightO Increase, left O Increase, right
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a. Why do investors believe that low price-earnings stocks are trading cheap in the market
b. An investment strategy that seeks to create a portfolio of stocks with low price-earnings ratios is believed to be able to earn excess market returns. Explain why this is not the case in perfect capital market under certainty.
c. Explain how in an imperfect capital market where there is risk, that a low price-earnings ratio strategy may be able to generate excess market returns.
arrow_forward
Discuss how the concept of pure security, short selling and no arbitrage profit help establish and understand the equilibrium from the capital markets. Discuss different economic determinants security prices.
Kindly answer the question as soon as possible.
arrow_forward
8. The efficient markets hypothesis
True or False: The efficient markets hypothesis holds only if all investors are rational.
O False
O True
Almost all financial theory and decision models assume that the financial markets are efficient. The informational efficiency of financial markets
determines the ability of investors to "beat" the market and earn excess (or abnormal) returns on their investments. If the markets are efficient, they
will react rapidly as new relevant information becomes available. Financial theorists have identified three levels of informational efficiency that reflect
what information is incorporated in stock prices.
Identify the form of capital market efficiency under the efficient market hypothesis described in the following statement:
Current market prices reflect all relevant information, whether it is known publicly or privately.
This statement is consistent with:
O Semistrong form efficiency
O Strong form efficiency
O Weak form efficiency
arrow_forward
What are efficient markets? Imagine if the price of a stock is going up and financial markets are efficient what can you tell us about the nature of the stock? What if the markets are inefficient then how would you react to increasing prices for a particular stock?
arrow_forward
According to the Random Walk hypothesis, security prices respond only to new information, which _________________.
must be available yesterday
must be released by an investment bank
cannot be predicted
must involve price or volume
arrow_forward
Explain these three
1. PURCHASING POWER RISK - is perhaps, more difficult to recognize than the other types of risk. It is easy to observe the decline in the price of a stock or bond, but it is often more difficult to recognize that the purchasing power of the return you have earned on investment has declined (risen) as a result of inflation (deflation).
2. INTEREST RATE RISK - Because money has time value, fluctuations in interest rates will cause the value of an investment to fluctuate also. Although interest rate risk is most commonly associated with bond price movements, rising interest rates cause bond prices to decline and declining interest rates cause bond prices to rise.
3. BUSINESS RISK - refers to the uncertainty about the rate of a return caused by the nature of the business. The most frequently discussed causes of business risk are uncertainty about the firm's sales and operating expenses.
arrow_forward
Why is the present value of an amount lesser than its value that is to be received (paid) in the future?
a.Deflation causes investors to lose purchasing power when their pesos are invested for greater than one year.
b.Investors have the opportunity to earn positive rates of return, so any amount invested today should grow to a larger amount in the future.
c.Investments generally are not as good as those who sell them suggest, so investors usually are not willing to pay full face value for such investments, thus the price is discounted.
d.Because investors are taxed on the income received from investments they never will buy an investment for the amount expected to be received in the future.
e.None of the choices is a correct answer.
arrow_forward
A very high degree of capital market efficiency
a. mispricing never occurs.
b. means share prices always correctly reflect all available information.
c. the capital markets anticipate and price correctly all possible future payoffs and states of the world.
d. means share prices react quickly, completely, and without bias once new value-relevant information is available to the market.
arrow_forward
1)
Please indicate whether the following statements are true or false. In case of a false statement, briefly specify why the statement is false.
1. A real asset is different from a financial asset because a real asset must take a physical form.
2. In the financial market, an investor buys financial securities from dealers at the ask price and sells financial securities to dealers at the bid price.
3. Mankowitz portfolio theory assumes average investors have a utility function as an increasing and concave function of future portfolio return.
4. According to CAPM, all well-diversified portfolios on the capital market line have the same Sharpe ratio.
5. The Markowitz portfolio theory assumes that investors hold homogenous expectations about risk and returns of financial securities.
arrow_forward
As an investor, how well do you think you could handle thevolatility of the stock market, knowing that the value of your investments could dropdramatically from time to time
arrow_forward
1. How can investors make decisions about financial instruments that involve future payoffs?
a) There is no uncertainty in market economies.
b) This can be done only when the future payoffs are certain.
c) Prices are determined by supply and demand which is always certain.
d) Investors can use probabilities and risk measurement procedures to account for all
possibilities.
arrow_forward
1. How do you think today's low interest rate environment is impacting the time value of money? How might this change the value of an asset or liability?
2. What is the relationship between the concepts of net present value and shareholder wealth maximization?
3. Offer some reasons that the intrinsic value that you might calculate with the methodologies learned might yield a price different than what the stock trades at in the stock market. You can reference any method of valuation models in offering thoughts on why there might be differences between intrinsic and market values.
arrow_forward
When the yield curve is upward sloping.
banks are rewarded for investing
more in short-term securities banks are rewarded for investing more in
longer-term securities there is no benefit in investing in short-term versus
long term (the yield is the same)
arrow_forward
All of the following statements about an efficient market are correct EXCEPT:
a. All financial transactions have an NPV of equal to zero
b. A skilled individual may have sustainable above market returns
c. The investor is compensated properly for risk borne
d. The investor does not receive abnormal returns consistently
arrow_forward
Arbitrage is the idea that one can (select the best answer):
Group of answer choices
Buy and Sell different assets or packages of assets at different prices such you can earn a riskless profit without investing any capital.
Earn rates of return greater than the average for the market by successfully “picking” stocks.
Earn abnormal returns above what CAPM would predict for a particular security.
arrow_forward
Applying the capital asset pricing model requires that one find appropriate inputs for the risk-free rate, the market rate of return (and market risk premium), and beta. Why is beta, in particular, difficult to pin down?
a.
People don't have ready access to financial data and won't have any source for this information in the near future.
b.
The major internet sources of financial data are notoriously unreliable.
c.
Hackers have been known to manipulate financial data for their own purposes.
d.
People must rely on historical performance information, and they have to assume that historical relationships continue into the future.
arrow_forward
The only way the investor can get above average profit through investment in different markets by taking advantage of any abnormality when they occur and abnormality can be exploited because there will never be full market efficiency. One more important point that is for most of the investors, a passive, buy-and-hold, long-term strategy is appropriate because capital markets are mostly unpredictable with random movements in price up and down. "and the investment mantra is: - If intrinsic value is more and market price is less buy the security and if it is opposite sell the security Do you think this statement is correct? write your views by giving some examples of different forms.
arrow_forward
Equity price risk is the risk that arises from security price Choose.
- the risk of a Choose..
v in the value of a Choose...
v or a portfolio. Equity
price risk can be either systematic or Choose.
v risk. In a global economic crisis, equity price risk is Choose..
because it affects multiple assets
Choose.
volatility
decline
classes.
increase
specific
systematic
security
arrow_forward
Which statement is TRUE regarding the riskiness of money market instruments and capital market instruments? *
Changing economic prospects can cause very large changes in current stock values.
Distant cash flows for stocks can be known with certainty, make them riskier than money market instruments.
Money market instruments have predictable cash flows and mature in one year or less, so they are much more risky.
The prices of long-term capital market instruments are less sensitive to changes in interest rates than prices of short-term instruments.
arrow_forward
SITIcation.
24. In the capital asset pricing model, the beta coefficient is a measure of
index of the degree of movement of an asset's return in response to a change in
risk and an
A) diversifiable; the prime rate
B) nondiversifiable; the Treasury bill rate
C) diversifiable; the bond index rate
D) nondiversifiable; the market return
5.
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