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Answers to various multiple choice questions

1. A stock's dividend is expected to grow at a constant rate of six percent a year. Which of the following statements is most correct?
The expected return on the stock is six percent a year.
The stock's price one year from now is expected to be six percent higher.
The stock's dividend yield is six percent.
Statements a and c are correct.
All of the statements above are correct.

2. Assume interest rates on 10-year government and corporate bonds were as follows: T-bond = 7.72%; AAA = 8.72%; A = 9.64%; BBB = 10.18%. The differences in rates among these issues are caused primarily by:
Inflation differences.
Default risk differences.
Maturity risk differences.
Liquidity premiums differences.
Both b and d.

3. Which of the following statements is most correct?
Preferred stockholders have priority over common stockholders.
A big advantage of preferred stock is that preferred stock dividends are tax deductible for the issuing corporation.
Most preferred stock is owned by corporations.
Statements a and c are correct.
Statements a and b are correct.

4. In terms of stocks valuation, if the expected rate of return on a stock exceeds the required rate,
The stock is experiencing supernormal growth.
The stock should be sold.
The company is probably not trying to maximize price per share.
Dividends are not being declared.
The stock is a good buy.

5. In terms of security market line (SML), other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift
Up and have less steep slope.
Up and keep same slope.
Down and keep same slope.
Down and have steeper slope.
Down and have less steep slope.

6. Which of the following statements is most correct?
An individual who has information about past stock prices should be able to profit from this information in a weak-form efficient market.
An individual who has inside information about a publicly traded company should be able to profit from this information in a strong-form efficient market.
Semistrong-form market efficiency means that stock prices reflect all public information.
Statements a and b are correct.
All the statements above are correct.

7. In Partnership, which of the following statements is most correct?
In a partnership, liability for other partners' misdeeds includes but is limited to the amount a particular partner has invested in the business.
Partnerships must be formed according to specific rules which include the filing of a formal written agreement with state authorities where the partnership does business.
A fast growth company would be more likely to set up a partnership for its business organization than would a slow-growth company.
A major disadvantage of a partnership as a form of business organization is the high cost and practical difficulty of its formation.
Partnerships have difficulty attracting capital in part because of the other disadvantages of the partnership form of business, including impermanence of the organization.

8. Which of the following statements is most correct?
Sinking fund provisions do not require companies to retire their debt; they only establish targets for the company to reduce its debt over time.
Sinking fund provisions sometimes work to the detriment of bondholders - particularly if interest rates have declined over time.
If interest rates have increased since the time a company issues bonds with a sinking fund provision, the company is more likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.
Statements b and c are correct.
Statements a and b are correct.

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

10. In terms of taxes, which of the following statements is most correct?
Corporations are allowed to exclude 70 percent of their interest income from corporate taxes.
Individuals pay taxes on only 30 percent of the income realized from municipal bonds.
Answers a and b are correct.
Corporations are allowed to exclude 70 percent of their dividend income from corporate taxes.
None of the answers above is correct.

11. In terms of various corporate forms, which of the following statements is most correct?
A hostile takeover is the main method of transferring ownership interest in a corporation.
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.
In part due to limited liability and ease of ownership transfer, corporations have less trouble raising money in financial markets than other organizational forms.
Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization.
Although stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way.

12. Which of the following best describes free cash flow?
Free cash flow is the amount of cash flow available for distribution to shareholders after all necessary investments in operating capital have been made.
Free cash flow is the net change in the cash account on the balance sheet.
Free cash flow is equal to net income plus depreciation.
Free cash flow is the amount of cash flow available for distribution to all investors after all necessary investments in operating capital have been made.
Free cash flow is equal to the cash flow from non-taxable transactions.

13. In terms of beta coefficient, 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 the market is in equilibrium.)
When held in isolation, Stock A has greater risk than Stock B.
Stock B would be a more desirable addition to a portfolio than Stock A.
The expected return on Stock A will be greater than that on Stock B.
Stock A would be a more desirable addition to a portfolio than Stock B.
The expected return on Stock B will be greater than that on Stock A.

14. Which of the following represents a significant disadvantage to the corporate form of organization?
Difficulty in transferring ownership.
Exposure to taxation of corporate earnings and stockholder dividend income.
Degree of liability to which corporate owners and managers are exposed.
Level of difficulty corporations face in obtaining large amounts of capital in financial markets.
All of the above are disadvantages to the corporate form of organization.

15. In terms of corporate charter and bylaws, which of the following statements is most correct?
The corporate bylaws are the set of rules drawn up by the state to enable managers to run the firm in accordance with state laws.
Procedures which govern changes in the bylaws of the corporation are contained in the corporate charter.
Although most companies design a charter, only the bylaws are legally required to be filed with the secretary of state in order for a corporation to be in official existence.
Procedures for electing corporate directors are contained in bylaws while the declaration of the activities that the firm will pursue and the number of directors are included in the corporate charter.
All of the statements above are false.

16. In a portfolio of three different stocks, which of the following could not be true?
The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation.
The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas.
The beta of the portfolio is less than the beta of each of the individual stocks.
None of the above (that is, they all could be true, but not necessarily at the same time).

17. Which of the following statements is most correct?
Retained earnings, as reported on the balance sheet, represents the amount of cash a company has available to pay out as dividends to shareholders.
70 percent of the interest received by corporations is excluded from taxable income.
70 percent of the dividends received by corporations is excluded from taxable income.
None of the answers above is correct.
Answers a and c are correct.

18. Inflation, recession, and high interest rates are economic events which are characterized as
Company-specific risk that can be diversified away.
Diversifiable risk.
Systematic risk that can be diversified away.
Market risk.
Unsystematic risk that can be diversified away.

19. Money markets are markets for
Long-term bonds.
Long-term debt securities.
Corporate stocks.
Short-term debt securities.
Foreign currency exchange.

20. In terms of bonds, which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?
The company's bonds are downgraded.
An increase in the call premium.
A reduction in market interest rates.
Answers a and b are correct.
Answers a, b, and c are correct.

21. In terms of carry back, carry forward, a loss incurred by a corporation
Must be carried forward unless the company has had 2 loss years in a row.
Can be carried back 5 years and forward 3 years.
Cannot be used to reduce taxes in other years except with special permission from the IRS.
Can be carried back 3 years or forward 10 years, whichever is more advantageous to the firm.
Can be carried back 2 years, then carried forward up to 20 years following the loss.

22. In terms of bonds valuation, all of the following may serve to reduce the coupon rate that would otherwise be required on a bond issued at par, except a
Sinking fund.
Restrictive covenant.
Change in rating from Aa to Aaa.
Call provision.
None of the answers above (all may reduce the required coupon rate).

23. Your uncle would like to restrict his interest rate risk and his default risk, but he would still like to invest in corporate bonds. Which of the possible bonds listed below best satisfies your uncle's criteria?
AAA bond with 10 years to maturity.
BBB perpetual bond.
AAA bond with 5 years to maturity.
BBB bond with 10 years to maturity.
BBB bond with 5 years to maturity.

24. Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership?
Corporations generally face fewer regulations.
Corporations generally face lower taxes.
Corporations enjoy unlimited liability.
Corporations generally find it easier to raise capital.
Statements c and d are correct.

25. Which of the following statements is most correct?
One of the advantages of financing with stock is that a firm's debt ratio will decrease.
One of the advantages of financing with stock is that a greater proportion of stock in the capital structure can reduce the risk of a takeover bid.
A firm with classified stock can pay different dividends to each class of shares.
All of the statements above are correct.
Both statements a and c are correct.

26. If the stock market is semistrong efficient, which of the following statements is most correct?
All stocks should have the same expected returns; however, they may have different realized returns.
In equilibrium, stocks and bonds should have the same expected returns.
If the stock market has been performing strongly over the past several months, stock prices are more likely to decline than increase over the next several months.
Investors can outperform the market if they have access to information which has not yet been publicly revealed.
None of the statements above is correct.

27. In terms of portfolio risk, which of the following statements is most correct?
Market participants are able to eliminate virtually all market risk if they hold a large diversified portfolio of stocks.
Market participants are able to eliminate virtually all company- specific risk if they hold a large diversified portfolio of stocks.
It is possible to have a situation where the market risk of a single stock is less than that of a well diversified portfolio.
Answers b and c are correct.
Answers a and c are correct.

28. As the discount rate increases without limit, the present value of a future cash inflow
Gets larger without limit.
Stays unchanged.
Approaches zero.
Gets smaller without limit; that is, approaches minus infinity.
Goes to ein.

29. If the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a 1-year T-bond?
The yield on a 10-year bond will always be higher than the yield on a 1-year bond because of maturity premiums.
It is impossible to tell without knowing the coupon rates of the bonds.
The yield on the 10-year bond is less than the yield on a 1-year bond.
The yields on the two bonds are equal.
It is impossible to tell without knowing the relative risks of the two bonds.

30.
Exercise value
The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.

True
False

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1. A stock's dividend is expected to grow at a constant rate of six percent a year. Which of the following statements is most correct? (Points: 5)
The expected return on the stock is six percent a year.
The stock's price one year from now is expected to be six percent higher.
The stock's dividend yield is six percent.
Statements a and c are correct.
All of the statements above are correct.

The growth g denotes the capital gains yield and so the stock price will increase every year by the growth rate

2. Assume interest rates on 10-year government and corporate bonds were as follows: T-bond = 7.72%; AAA = 8.72%; A = 9.64%; BBB = 10.18%. The differences in rates among these issues are caused primarily by: (Points: 5)
Inflation differences.
Default risk differences.
Maturity risk differences.
Liquidity premiums differences.
Both b and d.

All the bonds would be equally affected by the inflation and maturity risk and so the difference is due to default risk and liquidity premium.

3. Which of the following statements is most correct? (Points: 5)
Preferred stockholders have priority over common stockholders.
A big advantage of preferred stock is that preferred stock dividends are tax deductible for the issuing corporation.
Most preferred stock is owned by corporations.
Statements a and c are correct.
Statements a and b are correct.

Option c is correct because corporates get 70% tax rebate on dividend income and option a is correct.

4. In terms of stocks valuation, if the expected rate of return on a stock exceeds the required rate, (Points: 5)
The stock is experiencing supernormal growth.
The stock should be sold.
The company is probably not trying to maximize price per share.
Dividends are not being declared.
The stock is a good buy.

If we require a return of say 10% and the stock is expected to give a return of 12% then it is a good buy since it gives more return than required.

5. In terms of security market line (SML), other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift (Points: 5)
Up and have less steep slope.
Up and keep same slope.
Down and keep same slope.
Down and have steeper slope.
Down and have less steep slope.

A reduction in inflation rate will pull down the SML since less return is needed. An increase in risk aversion would make the slope steeper since more return is needed for each unit of risk.

6. Which of the following statements is most correct? (Points: 5)
An individual who has information about past stock prices should be able to profit from this information in a weak-form efficient market.
An individual who has inside information about a publicly traded company should be able to profit from this information in a strong-form efficient market.
Semistrong-form market efficiency means that stock prices reflect all public information.
Statements a and b are correct.
All the statements above are correct.

Strong form means that all information is reflected and semi-strong is all public information.

7. In Partnership, which of the following statements is most correct? (Points: 5)
In a partnership, liability for other partners' misdeeds includes but is limited to the amount a particular partner has invested in the business.
Partnerships must be formed according to specific rules which include the filing of a formal written agreement with state authorities where the partnership does business.
A fast growth company would be more likely to set up a partnership for its business organization than would a slow-growth company.
A major disadvantage of a partnership as a form of business organization is the high cost and practical difficulty of its formation.
Partnerships have difficulty attracting capital in part because of the other disadvantages of the partnership form of business, including impermanence of the organization.

The partnership has a limited life

8. Which of the following statements is most ...

Solution Summary

The solution provides explanations for various multiple choice questions in the area of finance

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