5: (184) Financial Markets and Financing

1: (32) Financial Markets and Securities Offerings

2: (27) Risk and Return
3: (40) Portfolio Management
4: (75) Short-Term Financing
5: (10) Long-Term Financing

1: (32) Financial Markets and Securities Offerings

Question: 1 Which of the following financial instruments can be traded in international money
markets?

A. Government treasury bonds.

B. Mortgages.

C. Preferred stocks.

D. Government treasury bills.

Question: 2 Which of the following economic functions is provided by the securities markets?

A. Unstable security prices because of frequent price changes.

B. Facilitation of the issuance and purchase of new securities.

C. A small number of transactions.

D. A marketplace in which inefficient and expensive investment transactions take place.

Question: 3The market for outstanding, listed common stock is called the
 A. Over-the-counter market.

B. Secondary market.

C. New issue market.

D. Primary market.

Question: 4 The semistrong form of the efficient markets hypothesis (EMH) states that current
market prices of securities reflect

A. All pertinent information.

B. Only information contained in past price movements.

C. No pertinent information.

D. Only publicly available information.

Question: 5 The financial markets that trade debt securities with maturities of less than 1 year and
are dealer-driven are

A. Capital markets.

B. Money markets.

C. Primary markets.

D. Secondary markets.

Question: 6An underwriting syndicate is a combination of

A. Leasing companies.

B. Investment banks.

C. Credit rating agencies.

D. Factoring companies.
Question: 7 Which of the following entities is most likely to assist investors in assessing the default
risk of a specific corporate bond?

A. Credit rating agencies.

B. Brokerage firms.

C. Bond dealers.

D. Investment banks.

Question: 8 The strong form of the efficient markets hypothesis (EMH) states that current market
prices of securities reflect

A. All publicly available information.

B. No relevant information.

C. All information whether it is public or private.

D. Only information found in past price movements.

Question: 9If a bond is rated below BBB, it is called

A. An income bond.

B. A junk bond.

C. An investment grade bond.

D. A zero-coupon bond.

Question: 10 A group of investment banks working together to offer new stock to the public is a

A. Syndicate.
 B. Spin-off.

C. Carve-out.

D. Hedge fund.

Question: 11 The efficient markets hypothesis states that it is impossible to obtain abnormal returns
consistently with either <List A> or <List B> analysis.
List A List B

A. Technical Diagnostic

B. Diagnostic Cost-Benefit

C. Technical Fundamental

D. Diagnostic Fundamental

Question: 12 The treasurer of a major multinational company needs to borrow $50 million to finance
new production facilities. The treasurer is deciding between direct financing or a public
offering. All of the following statements in regard to these two alternatives are
correct except that

A. Private debt is issued to sophisticated investors such as insurance companies.

B. The rating assigned by Standard & Poor’s or Moody’s is critical in pricing public
debt.

C. Public debt tends to have higher interest rates because of its lower liquidity.

D. Public debt needs to be registered with the SEC, a time-consuming and costly
process.

Question: 13 Confidential negotiations between Company A and Company B were completed this
morning. It was decided that in 1 week, it will be publicly announced that Company A
 will acquire Company B for a cash offer of a 30% premium over Company B’s current
market price. If the stock price of Company B does not react at all today but rises by
30% with the public announcement next week, this implies that the market is

A. Semi-strong form efficient but is not strong form efficient.

B. Weak form efficient but is not semi-strong form efficient.

C. Strong form efficient but is not weak form efficient.

D. Strong form efficient but is not semi-strong form efficient.

Question: 14 Which of the following statements is not correct with regard to initial public offerings
(IPOs)?

A. Best-efforts offerings provide the firm with the greater assurance that all offered
shares will be sold.

B. In an underwritten offering, the underwriter has an obligation to purchase all unsold

shares.

C. More risky stock offerings are done on a best-efforts basis.

D. In a best-efforts offering, the underwriter has no obligation to purchase unsold

shares.

Question: 15 Moody’s and Standard & Poor’s debt ratings depend on

A. The chances of default.

B. The size of the company.

C. The firm’s industry.

D. The size and the type of issue.

Question: 16 Which of the following is not true about financial markets?

A. Financial markets are the total supply and demand for securities.
 B. Financial markets change over time, causing people to adjust their pattern of
consumption.

C. Financial markets facilitate borrowing and lending of financial assets and

obligations.

D. In perfectly competitive markets, financial intermediaries act as price setters to clear

the market.

Question: 17The efficient markets theory implies that securities prices are

A. Not a good estimate of future cash flows.

B. Not the best benchmark for corporate financial decisions.

C. Fair and a reflection of all publicly available information.

D. Always less than their fair value.

Question: 18 Which of the following factors is not characteristic of the efficient markets hypothesis?

A. Investors are knowledgeable.

B. Capital market prices reflect underlying value.

C. Financial managers can benefit from timing the sales and purchases of securities.

D. Accounting changes do not influence the stock price.

Question: 19 The weak form of the efficient markets hypothesis (EMH) states that current market
prices of securities reflect

A. All public information.

B. No relevant information.

C. All past price movements.

D. All public and private information.

Question: 20 The term “underwriting spread” refers to the

A. Commission a broker receives for either buying or selling a security on behalf of an

investor.

B. Difference between the price the investment banker pays for a new security issue and
the price at which the securities are resold.

C. Discount investment bankers receive on securities they purchase from the issuing
company.

D. Commission percentage an investment banker receives for underwriting a security

issue.

Question: 21 The over-the-counter (OTC) market is

A. An auction market that trades the majority of stocks.

B. A dealer market where brokers and dealers are linked by telecommunications

equipment to trade securities.

C. A dealer market that trades securities on the stock exchanges due to the high dollar
volume of trading.

D. An auction market where trading takes place at a particular physical site like the New
York Stock Exchange.

Question: 22If a multinational firm were to raise equity capital on the London Stock Exchange, this would be
referred to as a

A. Mortgage market transaction.

B. Primary market transaction.

C. Money market transaction.

D. Secondary market transaction.

Question: 23An analyst is in the process of reviewing the following information on a publicly traded toy
manufacturer:

• Share price for the last 20 years

• 10-Q filings for the last 5 years
• 10-K filings for the last 15 years
• Website for the toy company
The above collection of data is an example of which of the following?

A. Semi-strong form of the efficient market theory.

B. Semi-weak form of the capital asset pricing theory.

C. Strong form of the efficient market theory.

D. Weak form of the capital asset pricing theory.

Question: 24 Stax, Inc., recently had its bonds rated by Standard & Poor’s for Year 2. In Year 1, the
rating agency classified the bonds as AA. However, in Year 2, the rating of these
bonds was downgraded to A–. What does this imply for Stax, Inc.?

A. Stax’s bonds are now classified as junk bonds.

B. Stax is less likely to default on its debt.

C. Stax’s interest costs will remain the same.

D. Stax will pay more in interest costs.

Question: 25 An agreement in which the underwriter attempts to sell as much as possible of an initial
public offering, but does not guarantee the sale of the entire offering is a

A. Best-efforts deal.

B. Firm commitment deal.

C. Carve-out deal.

D. Syndicate deal.
Question: 26The CEO of XYZ, Inc., bought 500,000 shares of treasury stock for $5 per share in Year 1. During
Year 2, the CEO decided to sell 100,000 shares of treasury stock when the shares were selling for $6 per share on
the market. What type of offering took place?

A. Subsequent offering.

B. Nondilutive secondary offering.

C. Private offering.

D. Initial public offering.

Question: 27 Which one of the options below best describes a public offering where there is less
price uncertainty due to the existence of a benchmark price?

A. A subsequent or secondary offering.

B. Shelf registration.

C. A red herring registration.

D. An initial public offering.

Question: 28 Money market funds generally invest in all of the following except

A. Certificates of deposit.

B. AAA corporate bonds.

C. Bankers’ acceptances.

D. Commercial paper.

Question: 29 The treasurer of a European company plans to raise $500 million to finance its new
business expansion into the Asia Pacific region. The treasurer is analyzing initial public
offerings. All of the following are correct except that

A. An initial public offering will increase the liquidity of the company’s stock and
establish the company’s value in the market.
 B. Under an underwritten offering, the investment bank will guarantee the sale of stock
at an offering price, however, the commission charged to the company will be higher
compared to a best efforts offering.

C. It is necessary for the company to file a registration statement with the SEC if it
decides to launch an initial public offering.

D. One of the advantages of an initial public offering is that stock price can accurately
reflect the true net worth of the company after it goes public.

Question: 30 In capital markets, the primary market is concerned with the provision of new funds for
capital investments through

A. The sale of forward or future commodities contracts.

B. Exchanges of existing bond and stock securities.

C. New issues of bond and stock securities.

D. New issues of bond and stock securities and exchanges of existing bond and stock
securities.

Question: 31 Which of the following is a financial intermediary?

A. Money markets.

B. The New York Stock Exchange.

C. Mutual funds.

D. The over-the-counter market.

Question: 32 In a market with semi-strong efficiency,

A. Investors use historical prices to predict market performance.

B. Security prices reflect all public information.

C. Investors earn more on dividend paying stocks.

D. Security prices reflect insider information.

2: (27) Risk and Return

Question: 1 The marketable securities with the least amount of default risk are

A. Repurchase agreements.

B. Commercial paper.

C. Federal government agency securities.

D. U.S. Treasury securities.

Question: 2 A firm is considering expanding its international operations. Which one of the following
conditions should the firm’s controller classify as political risk?

A. Expropriation of the plant after construction.

B. Different accounting methods between home and host countries.

C. Declining home-country currency values.

D. Accelerating inflation of the host country.

Question: 3 The following information pertains to Andrew Co. for the year ended December 31:

Sales $720,000

Operating income 120,000

Average capital investment 480,000

Which one of the following formulas generates Andrew’s return on investment?

A. (720,000 ÷ 480,000) × (720,000 ÷ 120,000)

B. (480,000 ÷ 720,000) × (120,000 ÷ 720,000)

C. (480,000 ÷ 720,000) × (720,000 ÷ 120,000)

D. (720,000 ÷ 480,000) × (120,000 ÷ 720,000)

Question: 4 Which of the following classes of securities are listed in order from lowest
risk/opportunity for return to highest risk/opportunity for return?

A. Common stock; corporate first mortgage bonds; corporate second mortgage bonds;
corporate income bonds.

B. U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds;
preferred stock.

C. Corporate income bonds; corporate mortgage bonds; convertible preferred stock;

subordinated debentures.

D. Preferred stock; common stock; corporate mortgage bonds; corporate debentures.

Question: 5 The risk of a single stock is

A. Security risk.

B. Portfolio risk.

C. Interest rate risk.

D. Market risk.

Question: 6 One type of risk to which investment securities are subject can be offset through
portfolio diversification. This type of risk is referred to as

A. Liquidity risk.

B. Unsystematic risk.

C. Undiversifiable risk.

D. Market risk.

Question: 7 The risk to which all investment securities are subject is known as
 A. Unsystematic risk.

B. Diversifiable risk.

C. Credit risk.

D. Systematic risk.

Question: 8 A U.S. company currently has domestic operations only. It is considering an equal-size
investment in either Canada or Britain. The data on expected rate of return and the risk
associated with each of these proposed investments are given below.

Proposed Investment Expected Rate of Return Standard Deviation

British Investment 22% 10%

Canadian Investment 28% 15%

The expected rate of return on the company’s current, domestic only, business is 20%
with a standard deviation of 15%. Using the above data and the correlation coefficients,
the company calculated the following portfolio risk and return (based on a ratio of 50%
U.S. domestic operations and 50% international operations).

Proposed Investment Expected Rate of Return Standard Deviation

U.S. and Britain 21% 3%

U.S. and Canada 24% 15%

The company plans to select the optimal combination of countries based on risk and
return for the domestic and international investments taken together. Because the
company is new to the international business environment, it is relatively risk averse.
Based on the above data, which one of the following alternatives provides
the best risk-adjusted return to the firm?

A. Unable to determine based on data given.

B. Do not undertake either investment.

C. Undertake the Canadian investment.

D. Undertake the British investment.

Question: 9 An investor is currently holding income bonds, debentures, subordinated debentures,
and first-mortgage bonds. Which of these securities traditionally is considered to have
the least risk?

A. Debentures.

B. Subordinated debentures.

C. First-mortgage bonds.

D. Income bonds.

Question: 10 The risk of loss because of fluctuations in the relative value of foreign currencies is
called

A. Undiversifiable risk.

B. Multinational beta.

C. Exchange rate risk.

D. Expropriation risk.

Question: 11 The risk that securities cannot be sold at a reasonable price on short notice is called

A. Liquidity risk.

B. Default risk.

C. Purchasing-power risk.

D. Interest-rate risk.

Question: 12A company issued common stock and preferred stock. Projected growth rate of the common stock is
5%. The current quarterly dividend on preferred stock is $1.60. The current market price of the preferred stock is
$80 and the current market price of the common stock is $95. What is the expected rate of return on the preferred
stock?

A. 13%
 B. 2%

C. 8%

D. 7%

Question: 13 Risk factors that cannot be eliminated through diversification include which of the
following?

I. Interest-rate fluctuations
II. General price-level changes
III. New product development
IV. Management turnover

A. I, II, and III only.

B. I, II, III, and IV.

C. II, III, and IV only.

D. I and II only.

Question: 14 Political risk may be reduced by

A. Making foreign operations dependent on the domestic parent for technology,

markets, and supplies.

B. Entering into a joint venture with another foreign company.

C. Refusing to pay higher wages and higher taxes.

D. Financing with capital from a foreign country.

Question: 15 An analyst in the accounting department gathered the following data on the stock
portfolio portion of a university’s endowment pool:

Security Amount Invested Expected Return Beta

Stock A €1,000,000 10% 0.80

 Stock B 250,000 15% 1.40
Stock C 3,000,000 8% 0.95
Stock D 450,000 12% 1.50
Stock E 2,500,000 4% 1.00
Based on the above data, the analyst calculated the expected return on the stock
portfolio to be

A. 7.4%

B. 58.6%

C. 49.0%

D. 9.8%

Question: 16 The best example of a marketable security with minimal risk would be

A. The common stock of a AAA-rated company.

B. Municipal bonds.

C. The commercial paper of a AAA-rated company.

D. Stock options of a AAA-rated company.

Question: 17 What type of risk is described when a bond issuer failed to make a required payment of
interest or principal?

A. Industry.

B. Credit.

C. Interest rate.

D. Market.

Question: 18 The following information pertains to Bala Co. for the year ended December 31:
 Sales $600,000

Income 100,000

Capital investment 400,000

Which of the following equations should be used to compute Bala’s return on
investment?

A. (4/6) × (1/6) = ROI

B. (4/6) × (6/1) = ROI

C. (6/4) × (1/6) = ROI

D. (6/4) × (6/1) = ROI

Question: 19 From the viewpoint of the investor, which of the following securities provides
the least risk?

A. Debentures.

B. Income bond.

C. Mortgage bond.

D. Subordinated debenture.

Question: 20 A stock began the year with a stock price of $60 per share. In the middle of the year, it
had a 3-for-2 stock split. The stock ended the year with a price of $50 per share. No
dividends were paid. What total return did investors earn on the stock during this year?

A. 25%

B. 15%

C. -20%

D. 30%
Question: 21 Prior to the introduction of the euro, a U.S. corporation was in possession of accounts
receivable denominated in Deutsche marks. To what type of risk were they exposed?

A. Price risk.

B. Exchange-rate risk.

C. Liquidity risk.

D. Business risk.

Question: 22When purchasing temporary investments, which one of the following best describes the risk
associated with the ability to sell the investment in a short period of time without significant price concessions?

A. Financial risk.

B. Liquidity risk.

C. Interest-rate risk.

D. Purchasing-power risk.

Question: 23 The type of risk that is not diversifiable and affects the value of a portfolio is

A. Purchasing-power risk.

B. Market risk.

C. Interest-rate risk.

D. Nonmarket risk.

Question: 24Which one of the following lists properly ranks financial instruments in order from the highest
risk/opportunity for return to the lowest risk/opportunity for return?

A. Common stock, preferred stock, income bonds, mortgage bonds, debentures, U.S. Treasury bonds.

B. Common stock, preferred stock, debentures, mortgage bonds, income bonds, U.S. Treasury bonds.

C. Preferred stock, common stock, income bonds, debentures, mortgage bonds, U.S. Treasury bonds.
 D. Common stock, preferred stock, income bonds, debentures, mortgage bonds, U.S. Treasury bonds.

Question: 25 Systematic risk explains why

A. Diversification increases overall risk.

B. Diversification reduces overall risk.

C. Stock values tend to move in the same direction.

D. Stock values move in different directions.

Question: 26 A company is evaluating its experience with five recent investments. The following data
are available:

Cost of Amount

Investment Investment Received

A $ 8,500 $ 8,390

B 4,200 4,610

C 12,100 12,400

D 7,900 8,220

E 11,000 11,400
Rank the investments in order from highest rate of return to lowest.

A. B, E, D, C, A.

B. A, C, D, E, B.

C. C, E, A, D, B.

D. B, D, E, C, A.

Question: 27 Which one of the following would be classified as a political risk?

A. A risk of theft when operating in a high-crime-rate country.

B. Discriminatory practices, such as higher taxes, higher utility charges, or requirements

to pay higher wages than local companies.

C. A downturn in the global economy.

D. Exposure to a difference between the functional currency and the parent company’s
reporting currency.
3: (40) Portfolio Management

Question: 1 A stock has an expected return of 16% using the capital asset pricing model (CAPM). If
the expected rate of return on the market is 12%, and the risk-free rate of return is 4%,
what is the beta (β) coefficient of this stock?

A. 1.50

B. 2.00

C. 0.75

D. 3.00

Fact Pattern: An investor is considering the purchase of one of two common stocks. The projected
returns for the two stocks and the probabilities for each are listed below:
Marcel Company Stock Gilberte Company Stock

Rate of Rate of

Return Probability Return Probability

6.0 % 10% 7.0 % 25%

4.0 % 40% 5.0 % 25%

2.0 % 40% 0.0 % 25%

(2.0)% 10% (1.0)% 25%

Question: 2 Based on an expected rate of return calculation, which stock should the investor
purchase?

A. Marcel Company’s, because its expected rate of return is slightly higher.

B. Marcel Company’s, because its weighted downside risk is lower.

C. Gilberte Company’s, because its expected rate of return is slightly higher.

D. Gilberte Company’s, because its weighted upside risk is higher.

Question: 3 If the return on the market portfolio is 10% and the risk-free rate is 5%, what is the
effect on a company’s required rate of return on its stock of an increase in the beta
coefficient from 1.2 to 1.5?

A. 3% increase.

B. 1.5% increase.

C. 1.5% decrease.

D. No change.

Question: 4 A company’s stock has a beta of 0.50. If the current risk-free rate of return is 2%, and
the market risk premium is 6%, what is the required return on the company’s stock
according to the capital asset pricing model?

A. 6%

B. 3%

C. 8%

D. 5%

Question: 5 Using the capital asset pricing model (CAPM), determine the expected market risk
premium from the following information.

Beta of Investment A 1.4

Risk-free return 3.0%
Expected return on Investment A 7.4%

A. 8.28%

B. 3.14%

C. 7.43%

D. 6.14%
Question: 6 An investor is evaluating the common stock of a technology company which has a beta
of 1.8. The expected return for the securities market as a whole is 8%. The investor
could receive a risk-free return of 2% on a U.S. Treasury bill. Based on the capital
asset pricing model (CAPM), what is the expected risk adjusted return of the
technology company’s common stock?

A. 12.8%

B. 10.8%

C. 20.0%

D. 16.4%

Question: 7 The difference between the required rate of return on a given risky investment and that
on a riskless investment with the same expected utility is the

A. Standard deviation.

B. Beta coefficient.

C. Coefficient of variation.

D. Risk premium.

Question: 8 Stock J has a beta of 1.2 and an expected return of 15.6%, and stock K has a beta of
0.8 and an expected return of 12.4%. What is the expected return on the market and
the risk-free rate of return, consistent with the capital asset pricing model?

A. Market is 14%; risk-free is 1.6%.

B. Market is 14%; risk-free is 6%.

C. Market is 12.4%; risk-free is 0%.

D. Market is 14%; risk-free is 4%.

Question: 9If a firm has a beta value of 1.0, then its

A. Return should equal the risk-free rate.

 B. Volatility is low.

C. Expected return should approximate the overall market.

D. Price is relatively stable.

Question: 10 The systematic risk of an individual security is measured by the

A. Standard deviation of the security’s returns and other similar securities.

B. Security’s contribution to the portfolio risk.

C. Standard deviation of the security’s rate of return.

D. Covariance between the security’s returns and the general market.

Question: 11 Assume that the probability distribution of NPVs is normal. The firm considers true risk
occurring if the project results in a NPV that is zero or less. If the expected NPV is
$1,000 and the standard deviation of NPV is $500, what is the probability that the
project has an NPV of 0 or less?

A. Greater than 3%, but less than 9%.

B. Greater than 9%, but less than 16%.

C. Greater than 16%.

D. Less than 3%.

Question: 12 A market analyst has estimated the equity beta of a company to be 1.4. This beta
implies that the company’s

A. Systematic risk is higher than that of the market portfolio.

B. Systematic risk is lower than that of the market portfolio.

C. Total risk is higher than that of the market portfolio.

D. Unsystematic risk is higher than that of the market portfolio.

Question: 13 Stock A and Stock B are combined into an equally weighted portfolio. If Stock A has a
standard deviation of return of 30%, Stock B has a standard deviation of return of 30%,
and the portfolio of the two stocks has a standard deviation of return of 30%, what is
the correlation coefficient of the returns between the two stocks?

A. 1.0

B. 0.5

C. –0.5

D. 0.0

Question: 14 In the context of the capital asset pricing model (CAPM), the beta coefficient of a stock
that has the same systematic risk as the market as a whole is equal to

A. 1

B. 0

C. 0.5

D. -1

Question: 15The returns on two stocks can be correlated in values except those that are

A. Positive.

B. Skewed.

C. Neutral.

D. Negative.

Question: 16 A firm has been growing at a rate of 10% per year and expects this growth to continue
and produce earnings per share of $4.00 next year. The firm has a dividend payout
 ratio of 35% and a beta value of 1.25. If the risk-free rate is 7% and the return on the
market is 15%, what is the expected current market value of the firm’s common stock?

A. $14.00

B. $16.00

C. $28.00

D. $20.00

Question: 17 The state of the economy has a strong effect on expected returns as shown below:

State of the Economy Probability Stock Returns

Recession .35 (10)%

Stable .40 10%

Expansion .25 30%

What is the expected rate of return?

A. 30%

B. 15%

C. 10%

D. 8%

Question: 18 An optimal portfolio of investments is

A. Any portfolio chosen from the efficient set of portfolios.

B. Efficient because it offers the highest expected return.

C. Any portfolio chosen from the feasible set of portfolios.

D. Tangential to the investor’s highest indifference curve.

Question: 19 The betas and expected returns for three investments being considered are given
below.

Expected

Investment Beta Return

A 1.4 12%

B 0.8 11%

C 1.5 13%
The return on the market is 11% and the risk-free rate is 6%. If the capital asset pricing
model (CAPM) is used for calculating the required rate of return, which investments
should management make?

A. B only.

B. B and C only.

C. A and C only.

D. A, B, and C.

Question: 20 A company uses the coefficient of variation to compare the returns and risks of
projects. The expected returns and standard deviations of returns for the Opal project
and the Pearl project are shown below.

Opal Pearl

Expected return 10% 12%

Standard deviation 40% 54%

The company would most likely judge the riskier project to be

A. Opal, with a coefficient of variation of 0.25.

B. Pearl, with a coefficient of variation of 0.22.

C. Opal, with a coefficient of variation of 4.00.

D. Pearl, with a coefficient of variation of 4.50.

Question: 21 If two projects are completely and positively linearly dependent (or positively related),
the measure of correlation between them is

A. 0

B. +1

C. +.5

D. –1

Question: 22 A mature firm is operating in a very stable market. Earnings growth has averaged
about 3.2% for the last dozen years, just staying in line with inflation. The firm’s
weighted-average cost of capital is 8%, much lower than most firms. The new CEO
wants to turn what he calls a “cash cow” into a “growth company.” The CEO wants to
reduce the dividend pay-out and use the resulting retained earnings to fund the firm’s
expansion into new product lines. The firm’s historical beta has been about 0.6. With
the CEO’s changes, what will most likely happen to the firm’s beta and the required
return on investment in its shares?

A. The beta will fall, and the required return will rise.

B. The beta will rise, and the required return will fall.

C. The beta will fall, and the required return will fall.

D. The beta will rise, and the required return will rise.

Question: 23An analyst of common stock estimates the following information for next year:

Expected return on the market portfolio 12%

Expected return on Treasury securities 5%

Expected beta of stock 2.2

Using the CAPM, the analyst’s estimate of next year’s risk premium for the stock is closest to

A. 15.4%

B. 7.0%

C. 21.4%
 D. 10.4%

Question: 24 At the beginning of the year, a portfolio manager who manages a portfolio with a mean
annual return of 8% and annual standard deviation of 25% wants to estimate the worst-
case expected loss at an 80% confidence level. The value of the portfolio today is $5
million. Which method would the portfolio manager use to estimate the probable
maximum loss that may be incurred at the end of the year?

A. Capital asset pricing model.

B. Value-at-risk.

C. Arbitrage pricing theory.

D. Covariance.

Question: 25 A measure that describes the risk of an investment project relative to other investments
in general is the

A. Coefficient of variation.

B. Beta coefficient.

C. Standard deviation.

D. Expected return.

Question: 26 Using the capital asset pricing model (CAPM), the required rate of return for a firm with
a beta of 1.25 when the market return is 14% and the risk-free rate is 6% is

A. 7.5%

B. 6.0%

C. 17.5%

D. 16.0%
Question: 27 A firm is considering a new investment project that will involve building a large office
block. The firm’s financial analysis department has estimated that the proposed
investment has the following estimated rate of return distributions:

Rate of Return Probability

(5)% 30%

10% 50%

20% 20%
Calculate the expected rate of return.

A. 11.7%

B. 7.5%

C. 10.5%

D. 5.5%

Question: 28 Which one of the following would have the least impact on a firm’s beta value?

A. Industry characteristics.

B. Payout ratio.

C. Operating leverage.

D. Debt-to-equity ratio.

Question: 29 A firm has $400,000 to invest in a two-stock portfolio. To obtain zero portfolio risk, the
two stocks must be

A. Perfectly positively correlated.

B. Equally-weighted.

C. From separate industry groups.

D. Perfectly negatively correlated.

Question: 30 The term “beta” can best be described as the

A. Investment return’s sensitivity to changes in interest rates.

B. Variability or standard deviation of the investment returns.

C. Weighted-average return of an investment portfolio.

D. Investment return’s sensitivity to changes in the market’s returns.

Question: 31Which of the following specifically measures the volatility of returns together with their correlation
with the returns of other securities?

A. Coefficient of variation.

B. Variance.

C. Standard deviation.

D. Covariance.

Question: 32 A company is considering investing in two of the following securities:

Expected Beta
Security Annual Return (Relative Risk Measure)

A 14% 1
B 8% -1
C 1% 0
Which two-security combination would best limit risk?

A. 50% B, 50% C.

B. 25% A, 75% C.

C. 50% A, 50% C.

D. 50% A, 50% B.
Question: 33 Based on the assumptions of the Capital Asset Pricing Model, the risk premium on an
investment with a beta of 0.5 is equal to

A. The risk premium on the market.

B. Half the risk premium on the market.

C. Twice the risk premium on the market.

D. The risk-free rate.

Question: 34 The stock of Company Z has a beta coefficient of 2.0 and an expected return of 16%
using the capital asset pricing model (CAPM). The stock of Company X has a beta
coefficient that is equal to 0.80. The risk-free rate of interest is 4%. The expected return
on Company X stock using the CAPM is

A. 8.8%

B. 8.0%

C. 9.6%

D. 6.4%

Question: 35 The common stock has a beta coefficient of 1.7. The following information about
overall market conditions is available.

Expected return on U.S. Treasury bonds 6%

Expected return on the market portfolio 8.5%

Using the capital asset pricing model (CAPM), what is the risk premium on the market?

A. 2.5%

B. 4.3%

C. 1.7%

D. 10.3%
Fact Pattern: DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ
plans to use the following combination of debt and equity to finance the investment.
• Issue $15 million of 20-year bonds at a price of $101, with a coupon rate of 8%, and flotation
costs of 2% of par.
• Use $35 million of funds generated from earnings.
• The equity market is expected to earn 12%. U.S. Treasury bonds are currently yielding 5%. The
beta coefficient for DQZ is estimated as .60. DQZ is subject to an effective corporate income tax rate of
40%.

Question: 36 The capital asset pricing model (CAPM) computes the expected return on a security by
adding the risk-free rate of return to the incremental yield of the expected market
return, which is adjusted by the company’s beta. Compute DQZ’s expected rate of
return.

A. 12.20%

B. 12.00%

C. 9.20%

D. 7.20%

Question: 37 Based on the following information about stock price increases and decreases, make
an estimate of the stock’s beta: July = Stock +1.5%, Market +1.1%; August = Stock
+2.0%, Market +1.4%; September = Stock –2.5%, Market –2.0%.

A. There is no consistent pattern of returns.

B. Beta is less than 1.0.

C. Beta is greater than 1.0.

D. Beta equals 1.0.

Question: 38 For a firm engaged in risk management, value-at-risk is defined as the

A. Most likely negative outcome at a given level of confidence.

B. Maximum value a company can lose.

 C. Worst possible outcome given the distribution of outcomes.

D. Maximum loss within a certain time period at a given level of confidence.

Question: 39Using the capital asset pricing model, an analyst has calculated an expected risk-adjusted return of
17% for the common stock of a company. The company’s stock has a beta of 2, and the overall expected market
return for equities is 10%. The risk-free return is 3%. All else being equal, the expected risk-adjusted return for the
company’s stock would increase if the

A. Risk-free return decreases.

B. Overall expected market return for equities decreases.

C. Beta of the company’s stock decreases.

D. Volatility of the company’s stock decreases.

Question: 40 An analyst uses the capital asset pricing model (CAPM) to measure the required return
on two stocks, X and Y. The expected market rate of return is 12%, the risk-free rate of
return is 4%, the beta (β) coefficient of stock X is 0.5, and the beta (β) coefficient of
stock Y is 2.0. The required returns of the two stocks are

A. 8% for stock X and 20% for stock Y.

B. 4% for stock X and 16% for stock Y.

C. 8% for stock X and 32% for stock Y.

D. 6% for stock X and 24% for stock Y.

4: (75) Short-Term Financing

Question: 1 On January 1, a C corporation received a $300,000 line of credit at an interest rate of

12% from a bank and drew down the entire amount on February 1. The line of credit
agreement requires that an amount equal to 15% of the loan be deposited into a
compensating balance account. What is the effective annual cost of credit for this loan
arrangement?

A. 12.94%

B. 12.00%

C. 14.12%

D. 11.00%

Question: 2 A firm is determining the most appropriate source of short-term funding. Trade credit
terms from suppliers are 2/30, net 90. The rate for borrowing at the bank is 12%. The
company has also been approached by an investment banker offering to issue the
firm’s commercial paper. The commercial paper would be issued quarterly in
increments of $9.1 million with net proceeds of $8.8 million. Which option should the
firm select?

A. Commercial paper, because it provides the lowest cost of funds.

B. Bank borrowing, because it provides the lowest cost of funds.

C. The costs are so similar that the decision is a matter of convenience.

D. The trade discount, because it provides the lowest cost of funds.

Fact Pattern: Skilantic Company needs to pay a supplier’s invoice of $60,000 and wants to take a cash
discount of 2/10, net 40. The firm can borrow the money for 30 days at 11% per annum plus a 9%
compensating balance

Question: 3 The amount Skilantic must borrow to pay the supplier within the discount period and
cover the compensating balance is

A. $58,800

B. $60,000
 C. $64,615

D. $65,934

Question: 4 A manufacturer needs a $100 million loan for 1 year. The manufacturer’s banker has
presented two alternatives as follows:

Option #1 Loan with a stated interest rate of 10.25%. No compensating balance required.
–

Option #2 Loan with a stated interest rate of 10.00%. Non-interest bearing compensating
– balance required.
Which of the following compensating balances, withheld from the loan proceeds, would
result in Option #2 having an effective interest rate equal to the 10.25% rate of Option
#1?

A. $10,250,000

B. $250,000

C. $2,500,000

D. $2,440,000

Fact Pattern: The Frame Supply Company has just acquired a large account and needs to increase its
working capital by $100,000. The controller of the company has identified the four sources of funds
given below.
1. Pay a factor to buy the company’s receivables, which average $125,000 per month and have an
average collection period of 30 days. The factor will advance up to 80% of the face value of
receivables at 10% and charge a fee of 2% on all receivables purchased. The controller estimates
that the firm would save $24,000 in collection expenses over the year. Assume the fee and interest
are not deductible in advance.
2. Borrow $110,000 from a bank at 12% interest. A 9% compensating balance would be required.
3. Issue $110,000 of 6-month commercial paper to net $100,000. (New paper would be issued every 6
months.)
4. Borrow $125,000 from a bank on a discount basis at 20%. No compensating balance would be
required.
Assume a 360-day year in all of your calculations.

Question: 5 The cost of Alternative 2 to Frame Supply Company is

A. 12.0%

B. 13.2%
 C. 21.0%

D. 9.0%

Question: 6Short-term, unsecured promissory notes issued by large firms are known as

A. Agency securities.

B. Bankers’ acceptances.

C. Commercial paper.

D. Repurchase agreements.

Question: 7 The effective annual interest rate to the borrower of a $100,000 1-year loan with a
stated rate of 7% and a 20% compensating balance is

A. 13.0%

B. 7.0%

C. 8.75%

D. 8.4%

Question: 8A company has a revolving credit arrangement with its bank that specifies that the company can
borrow up to $5 million at an annual interest rate of 9% payable monthly. In addition, the company must pay a
commitment fee of 0.25% per month on the unused portion of the line, payable in the following month. The
company expects to have a $2 million cash balance and no borrowings against this line of credit on April 1, net cash
from operations inflows of $2 million in April, net outflows from operations of $7 million in May, and net inflows
from operations of $4 million in June. If all cash flows occur at the end of the month, approximately how much will
the company pay to the bank during the second quarter related to this revolving credit arrangement?

A. $60,100

B. $62,500

C. $52,600

D. $47,600
Question: 9 The treasurer is making an analysis of the short-term financing options available for the
third quarter, as the company will need an average of $8 million for the month of July,
$12 million for August, and $10 million for September. The following options are
available:

I. Issue commercial paper on July 1 in an amount sufficient to net $12 million at

an effective rate of 7% per year. Any temporarily excess funds will be
deposited in an investment account and earn interest at an annual rate of 4%.
II. Utilize a line of credit with interest accruing monthly on the amount utilized at
the prime rate, which is estimated to be 8% in July and August and 8.5% in
September.

Based on this information, which one of the following actions should the treasurer
take?

A. Use the line of credit, since it is approximately $15,000 less expensive than issuing
commercial paper.

B. Issue commercial paper, since it is approximately $35,000 less expensive than the
line of credit.

C. Use the line of credit, since it is approximately $5,800 less expensive than issuing
commercial paper.

D. Issue commercial paper, since it is approximately $14,200 less expensive than the
line of credit.

Question: 10 The prime rate is the

A. Rate charged on business loans to borrowers with high credit ratings.

B. Effective cost of commercial paper.

C. Size of the commitment fee on a commercial bank loan.

D. Effective cost of a commercial bank loan.

Question: 11 A company has a temporary need for funds. Management is trying to decide between
not taking discounts from one of their three biggest suppliers, or a 14.75% per annum
 renewable discount loan from its bank for 3 months. The suppliers’ terms are as
follows:

F: 1/10, net 30

R: 2/15, net 60

S: 3/15, net 90
Using a 360-day year, the cheapest source of short-term financing in this situation is

A. S.

B. The bank.

C. F.

D. R.

Question: 12 A manufacturer with seasonal sales would be most likely to obtain which one of the
following types of loans from a commercial bank to finance the need for a fixed amount
of additional capital during the busy season?

A. Insurance company term loan.

B. Transaction loan.

C. Unsecured short-term term loan.

D. Installment loan.

Question: 13 A commercial bank offered a $100,000 one-year loan with an annual interest rate of
6% and a 10% compensating balance. What is the effective annual interest rate of this
loan?

A. 5.45%

B. 7.00%

C. 6.00%

D. 6.67%
Question: 14 Which of the following financing vehicles would a commercial bank be likely to offer to
its customers?

I. Discounted notes
II. Term loans
III. Lines of credit
IV. Self-liquidating loans

A. III and IV.

B. I, III, and IV.

V.

C. I and II.

D. I, II, III, and IV.

Question: 15 A corporation can issue 3-month commercial paper with a face value of $1,500,000 for
$1,450,000. Transaction costs will be $1,500. The effective annualized percentage cost
of the financing, based on a 360-day year, will be

A. 3.45%

B. 13.79%

C. 3.56%

D. 14.22%

Question: 16A corporation has an outstanding 1-year bank loan of $300,000 at a stated interest rate of 8%. In
addition, the corporation is required to maintain a 20% compensating balance in its checking account. Assuming the
company would normally maintain a zero balance in its checking account, the effective interest rate on the loan is

A. 8.0%

B. 6.4%

C. 10.0%

D. 20%
Question: 17 A company obtained a short-term bank loan of $250,000 at an annual interest rate of
6%. As a condition of the loan, the company is required to maintain a compensating
balance of $50,000 in its checking account. The checking account earns interest at an
annual rate of 2%. Ordinarily, the company maintains a balance of $25,000 in its
account for transaction purposes. What is the effective interest rate of the loan?

A. 7.00%

B. 6.44%

C. 5.80%

D. 6.66%

Question: 18 A retail store is considering forgoing sales discounts to delay using its cash. Supplier
credit terms are 2/10, net 30. Assuming a 360-day year, what is the annual cost of
credit if the cash discount is not taken?

A. 36.7%

B. 24.0%

C. 24.5%

D. 36.0%

Question: 19 A manufacturing firm wants to obtain a short-term loan and has approached several
lending institutions. All of the potential lenders are offering the same nominal interest
rate but the terms of the loans vary. Which of the following combinations of loan terms
will be most attractive for the borrowing firm?

A. Simple interest, 20% compensating balance required.

B. Discount interest, 20% compensating balance required.

C. Discount interest, no compensating balance.

D. Simple interest, no compensating balance.

Question: 20 A manufacturer carries an average credit balance of $25,000,000 with its supplier. The
supplier provides credit terms of 1/10 net 25. The nominal annual cost of the
manufacturer not taking the trade discount is closest to which one of the following?
Assume a 360-day year.

A. 14.4%

B. 24.2%

C. 24.0%

D. 14.5%

Question: 21 A company enters into an agreement with a firm that will factor the company’s
accounts receivable. The factor agrees to buy the company’s receivables, which
average $100,000 per month and have an average collection period of 30 days. The
factor will advance up to 80% of the face value of receivables at an annual rate of 10%
and charge a fee of 2% on all receivables purchased. The controller of the company
estimates that the company would save $18,000 in collection expenses over the year.
Fees and interest are not deducted in advance. Assuming a 360-day year, what is the
annual cost of financing?

A. 17.5%

B. 10.0%

C. 15.0%

D. 12.0%

Question: 22 Which one of the following statements concerning cash discounts is correct?

A. With trade terms of 2/15, net 60, if the discount is not taken, the buyer receives 45
days of free credit.

B. The cost of not taking a cash discount is generally higher than the cost of a bank
loan.

C. The cost of not taking the discount is higher for terms of 2/10, net 60 than for 2/10,
net 30.

D. The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.
Question: 23Which one of the following provides a spontaneous source of financing for a firm?

A. Debentures.

B. Mortgage bonds.

C. Accounts receivable.

D. Accounts payable.

Fact Pattern: The Frame Supply Company has just acquired a large account and needs to increase its
working capital by $100,000. The controller of the company has identified the four sources of funds
given below.
1. Pay a factor to buy the company’s receivables, which average $125,000 per month and have an average
collection period of 30 days. The factor will advance up to 80% of the face value of receivables at 10% and
charge a fee of 2% on all receivables purchased. The controller estimates that the firm would save $24,000 in
collection expenses over the year. Assume the fee and interest are not deductible in advance.
2. Borrow $110,000 from a bank at 12% interest. A 9% compensating balance would be required.
3. Issue $110,000 of 6-month commercial paper to net $100,000. (New paper would be issued every 6 months.)
4. Borrow $125,000 from a bank on a discount basis at 20%. No compensating balance would be required.
Assume a 360-day year in all of your calculations.

Question: 24 The cost of Alternative 3 to Frame Supply Company is

A. 20.0%

B. 9.1%

C. 18.2%

D. 10.0%

Question: 25 Corbin, Inc., can issue 3-month commercial paper with a face value of $1,000,000 for
$980,000. Transaction costs will be $1,200. The effective annualized percentage cost
of the financing, based on a 360-day year, will be

A. 2.00%
 B. 8.00%

C. 8.16%

D. 8.66%

Question: 26 A company has two outstanding accounts payable as shown below.

Vendor Name Invoice Amount Payment Terms

Jonah Corp. $20,000 1/15, net 45

Baker, Inc. $20,000 2/10, net 90

With regard to the effective annual interest cost of not taking the cash discount on the
above invoices, the annual interest cost for the

A. Baker invoice is 9.31%.

B. Baker invoice is 2%.

C. Jonah invoice is the same as the Baker invoice.

D. Jonah invoice is lower than the Baker invoice.

Question: 27 A firm is given terms of 2/10, net 45 by its suppliers. If the firm forgoes the cash
discount and instead pays the suppliers 5 days after the net due date with no penalty,
what is the annual interest rate cost (using a 360-day year)?

A. 21.0%

B. 18.4%

C. 18.0%

D. 24.5%

Question: 28 When a company offers credit terms of 2/10, net 30, the annual interest cost, based on
a 360-day year, is
 A. 35.3%

B. 24.0%

C. 36.0%

D. 36.7%

Question: 29 A corporation was recently quoted terms on a commercial bank loan of 7% discounted
interest with a 20% compensating balance. The term of the loan is 1 year and interest
is due at the beginning of the year. The effective cost of borrowing is (rounded to the
nearest hundredth)

A. 7.53%

B. 8.75%

C. 9.41%

D. 9.59%

Question: 30 A bank offered a 1-year loan to a commercial customer. The instrument is a discounted
note with a nominal rate of 12%. What is the effective interest rate to the borrower?

A. 13.64%

B. 13.20%

C. 12.00%

D. 10.71%

Question: 31 Which one of the following could be used to provide security to the lender in an
inventory financing situation?

A. Trust receipt.

B. Factoring.
 C. Lockbox.

D. Underwriting.

Question: 32 On June 30 of this year, a bank granted a corporation a $20 million 5-year term loan
with a floating rate of 200 basis points over Treasury Bill rates, payable quarterly. The
loan principal is to be repaid in equal quarterly installments over the term. If Treasury
Bills are expected to yield 6% for the rest of the year, how much will the corporation
pay to the bank in the last half of this year?

A. $1,800,000

B. $2,800,000

C. $3,170,000

D. $2,780,000

Question: 33 A company has a revolving line of credit of $300,000 with a 1-year maturity. The terms
call for a 6% interest rate and a 1/2% commitment fee on the unused portion of the line
of credit. The average loan balance during the year was $100,000. The annual cost of
this financing arrangement is

A. $6,000

B. $7,000

C. $7,500

D. $6,500

Question: 34If a firm borrows $500,000 at 10% and is required to maintain $50,000 as a minimum compensating
balance at the bank, what is the effective interest rate on the loan?

A. 10.0%

B. 11.1%

C. 12.2%
 D. 9.1%

Question: 35 A company’s bank requires a compensating balance of 20% on a $100,000 loan. If the
stated interest on the loan is 7%, what is the effective cost of the loan?

A. 7.00%

B. 8.75%

C. 5.83%

D. 8.40%

Question: 36 A corporation was recently quoted terms on a commercial bank loan of 6% discounted
interest with a 22% compensating balance. The term of the loan is 1 year. The effective
cost of borrowing is (rounded to the nearest hundredth)

A. 8.33%

B. 6.00%

C. 7.69%

D. 6.38%

Question: 37 Commercial paper

A. Has an interest rate lower than Treasury bills.

B. Ordinarily does not have an active secondary market.

C. Is usually sold only through investment banking dealers.

D. Has a maturity date greater than 1 year.

Question: 38 Which one of the following responses is not an advantage to a corporation that uses
the commercial paper market for short-term financing?

A. There are no restrictions as to the type of corporation that can enter into this market.

B. This market provides more funds at lower rates than other methods provide.

C. This market provides a broad distribution for borrowing.

D. The borrower avoids the expense of maintaining a compensating balance with a

commercial bank.

Question: 39 If a firm’s credit terms require payment within 45 days but allow a discount of 2% if paid
within 15 days (using a 360-day year), the approximate cost or benefit of the trade
credit terms is

A. 48%

B. 2%

C. 24%

D. 16%

Question: 40 When a company offers credit terms of 3/10, net 30, the annual interest cost based on
a 360-day year is

A. 37.1%

B. 24.5%

C. 55.6%

D. 36.7%

Fact Pattern: Skilantic Company needs to pay a supplier’s invoice of $60,000 and wants to take a cash
discount of 2/10, net 40. The firm can borrow the money for 30 days at 11% per annum plus a 9%
compensating balance.

Question: 41 If Skilantic fails to take the discount and pays on the 40th day, what effective rate of
annual interest is it paying the vendor?
 A. 24.49%

B. 24%

C. 2%

D. 36.73%

Question: 42 If a firm purchases materials from its supplier on a 2/10, net 40, cash discount basis,
the equivalent annual interest rate (using a 360-day year) of forgoing the cash discount
and making payment on the 40th day is

A. 18.36%

B. 24.49%

C. 36.72%

D. 2%

Question: 43 A small retail business would most likely finance its merchandise inventory with

A. Commercial paper.

B. A chattel mortgage.

C. A line of credit.

D. A terminal warehouse receipt loan.

Question: 44 A chief financial officer follows the policy of matching the maturity of assets with the
maturity of financing. The implications of this policy include all of the
following, except that

A. The seasonal expansion of cash, receivables, and inventory should be financed by

short-term debt, such as vendor payables and bank debt.

B. The minimum level of cash, receivables, and inventory required to stay in business
can be considered permanent and financed with long-term debt or equity.
 C. Long-term assets, like plant and equipment, should be financed with long-term debt
or equity.

D. Cash, receivables, and inventory should be financed with long-term debt or equity.

Question: 45 A firm has a cost of borrowing of 12%. One of the firm’s suppliers has just offered new
terms for purchases. The old terms were cash on delivery and the new terms are 2/10,
net 45. Should the firm pay within the first 10 days?

A. The answer depends on whether the firm borrows money.

B. No, the use of debt should be avoided if possible.

C. No, the cost of trade credit exceeds the cost of borrowing.

D. Yes, the cost of not taking the trade discount exceeds the cost of borrowing.

Question: 46 A company receives $25,000 worth of merchandise from its major supplier on the 15th
and 30th of each month. The goods are sold on terms of 1/15, net 45, and the
company has been paying on the net due date and forgoing the discount. A local bank
offered the company a loan at an interest rate of 10%. Using a 360-day year, what will
be the net annual savings to the company if it borrows from the bank and utilizes the
funds to take advantage of the trade discount?

A. $7,050

B. $2,250

C. $1,050

D. $(950)

Question: 47 An entity needs $150,000 of additional funds over the next year in order to satisfy a
significant increase in demand. A commercial bank has offered the entity a 1-year loan
at a nominal rate of 8%, which requires a 15% compensating balance. How much
would the entity have to borrow, assuming it would need to cover the compensating
balance with the loan proceeds?

A. $176,471
 B. $194,805

C. $172,500

D. $130,435

Question: 48A corporation is considering borrowing $100,000 from a bank for 1 year at a stated interest rate of
9%. What is the effective interest rate if this borrowing is in the form of a discounted note?

A. 9.81%

B. 9.89%

C. 8.10%

D. 9.00%

Question: 49 What is the effective annual interest rate for a 1-year $100 million loan with a stated
interest rate of 8.00%, if the lending bank requires a non-interest bearing compensating
balance in the amount of $5 million?

A. 13.00%

B. 8.42%

C. 8.00%

D. 7.62%

Question: 50 If a retailer’s terms of trade are 3/10, net 45 with a particular supplier, what is the cost
on an annual basis of not taking the discount? Assume a 360-day year.

A. 24.00%

B. 31.81%

C. 37.11%

D. 36.00%
Question: 51 With respect to the use of commercial paper by an industrial firm, which one of the
following statements is most likely to be true?

A. The commercial paper is secured by the issuer’s assets.

B. The commercial paper has a maturity of 60-270 days.

C. The commercial paper is issued through a bank.

D. The commercial paper issuer is a small company.

Question: 52 A company needs to borrow $500,000 to meet its working capital requirements for next year. A
bank has offered the company a 9.5% simple interest loan that has a 16% compensating balance
requirement. Determine the effective interest rate for the loan.

A. 12.75%

B. 11.31%

C. 11.02%

D. 19.00%

Question: 53 A firm is given payment terms of 3/10, net 90 and forgoes the discount and pays on the
net due date. Using a 360-day year and ignoring the effects of compounding, what is
the effective annual interest rate cost?

A. 12.4%

B. 12.0%

C. 13.5%

D. 13.9%
Question: 54 A company has just borrowed $2 million from a bank. The stated rate of interest is
10%. If the loan is discounted and is repayable in 1 year, the effective rate on the loan
is approximately

A. 9.09%

B. 8.89%

C. 11.11%

D. 10.00%

Question: 55 A company has a $100 invoice with payment terms of 2/10, net 60. The company can
either take the discount or place the funds in a money market account paying 6%
interest. Using a 360-day year, the company’s cost of not taking the cash discount is

A. 8.7%

B. 12.2%

C. 6.4%

D. 6.2%

Question: 56Approximately what amount of compensating balance would be required for a stated interest rate of
10% to equal an effective interest rate of 10.31% on a $100,000,000 1-year loan?

A. $3,100,000

B. $3,000,000

C. $310,000

D. Not enough information is given.

Fact Pattern: The Frame Supply Company has just acquired a large account and needs to increase its
working capital by $100,000. The controller of the company has identified the four sources of funds
given below.
 1. Pay a factor to buy the company’s receivables, which average $125,000 per month and have an
average collection period of 30 days. The factor will advance up to 80% of the face value of
receivables at 10% and charge a fee of 2% on all receivables purchased. The controller estimates
that the firm would save $24,000 in collection expenses over the year. Assume the fee and interest
are not deductible in advance.
2. Borrow $110,000 from a bank at 12% interest. A 9% compensating balance would be required.
3. Issue $110,000 of 6-month commercial paper to net $100,000. (New paper would be issued every 6
months.)
4. Borrow $125,000 from a bank on a discount basis at 20%. No compensating balance would be
required.
Assume a 360-day year in all of your calculations.

Question: 57 The cost of Alternative 4 to Frame Supply Company is

A. 40.0%

B. 25.0%

C. 50.0%

D. 20.0%
A company obtained a short-term bank loan of $500,000 at an annual interest rate of
8%. As a condition of the loan, the company is required to maintain a compensating
Question: 58 balance of $100,000 in its checking account. The checking account earns interest at an
annual rate of 3%. Ordinarily, the company maintains a balance of $50,000 in its
account for transaction purposes. What is the effective interest rate of the loan?

A. 9.25%

B. 8.22%

C. 8.56%

D. 7.77%

Question: 59 A company has received a 1-year commercial bank loan of 7.5% discounted interest
with a 12.5% compensating balance. The effective annual cost of the bank loan is
closest to

A. 8.57%

B. 9.38%

C. 8.11%

D. 9.27%
Fact Pattern: Morton Company needs to pay a supplier’s invoice of $50,000 and wants to take a cash
discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10%
compensating balance.

Question: 60 The amount Morton Company must borrow to pay the supplier within the discount
period and cover the compensating balance is

A. $54,444

B. $55,556

C. $55,056

D. $55,000

Question: 61Which one of the following is not a form of short-term credit?

A. Commercial paper.

B. Accrued wages.

C. Corporate bonds.

D. Bankers’ acceptances.

Fact Pattern: Skilantic Company needs to pay a supplier’s invoice of $60,000 and wants to take a cash
discount of 2/10, net 40. The firm can borrow the money for 30 days at 11% per annum plus a 9%
compensating balance.
Question: 62 Assuming Skilantic borrows the money on the last day of the discount period and
repays it 30 days later, the effective interest rate on the loan is

A. 9.90%

B. 10%

C. 11%

D. 12.09%
Question: 63 Which one of the following is a spontaneous source of financing?

A. Prepaid interest.

B. Trade credit.

C. Long-term debt.

D. Notes payable.

Question: 64 A company has arranged a revolving line of credit for the upcoming year with a
commercial bank. The arrangement is for $20 million, with interest payable monthly on
the amount utilized at the bank’s prime rate and an annual commitment fee of one-half
of 1 percent, computed and payable monthly on the unused portion of the line. The
company estimates that the prime rate for the upcoming year will be 8%, and expects
the following average amount to be borrowed by quarter:

Quarter Amount Borrowed

First $10,000,000

Second 20,000,000

Third 20,000,000

Fourth 5,000,000
How much will the company pay to the bank next year in interest and fees?

A. $1,118,750

B. $1,131,250

C. $1,200,000

D. $1,168,750

Fact Pattern: CyberAge Outlet, a relatively new store, is a cafe that offers customers the opportunity to
browse the Internet or play computer games at their tables while they drink coffee. The customer pays a
fee based on the amount of time spent signed on to the computer. The store also sells books, tee-shirts,
and computer accessories. CyberAge has been paying all of its bills on the last day of the payment
period, thus forfeiting all supplier discounts. Shown below are data on CyberAge’s two major vendors,
including average monthly purchases and credit terms.
Average

Monthly

Vendor Purchases Credit Terms

Web Master $25,000 2/10, net 30

Softidee 50,000 5/10, net 90

Question: 65 Assuming a 360-day year and that CyberAge continues paying on the last day of the
credit period, the company’s weighted-average annual interest rate for trade credit
(ignoring the effects of compounding) for these two vendors is

A. 30.2%

B. 27.0%

C. 3.5%

D. 25.2%

Question: 66 The prime lending rate of commercial banks is an announced rate and is often
understated from the viewpoint of even the most credit-worthy firms. Which one of the
following requirements always results in a higher effective interest rate?

A. The absence of a charge for any unused portion in the line of credit.

B. A covenant that restricts the issuance of any new unsecured bonds during the
existence of the loan.

C. The imposition of a compensating balance with an absolute minimum that cannot be

met by current transaction balances.

D. A floating rate for the loan period.

Question: 67 A seasonal business has decided to finance seasonal variations in current assets with
short-term debt while financing the permanent component of current assets and all
fixed assets with long-term debt or equity. Which one of the following best describes
this type of financing?
 A. Hedging.

B. Capital rationing.

C. Leveraged financing.

D. Spontaneous financing.

Question: 68 Which one of the following financial instruments generally provides the largest source
of short-term credit for small firms?

A. Installment loans.

B. Commercial paper.

C. Bankers’ acceptances.

D. Trade credit.

Question: 69 A treasury analyst has estimated the cash flows for the first half of next year (ignoring
any short-term borrowings) as follows:

Cash (millions)

Inflows Outflows

January $2 $1

February 2 4

March 2 5

April 2 3

May 4 2

June 5 3
The company has a line of credit of up to $4 million on which it pays interest monthly at
a rate of 1% of the amount utilized. The company is expected to have a cash balance
of $2 million on January 1 and no amount utilized on its line of credit. Assuming all
cash flows occur at the end of the month, approximately how much will the company
pay in interest during the first half of the year?
 A. $0

B. $80,000

C. $61,000

D. $132,000

Question: 70 A firm has a zero-balance account with a commercial bank. The bank sweeps any excess cash into a commercia
rate of 4% per year, payable monthly. When the firm has a cash deficit, a line of credit is used that has an interes
on the amount used. The firm expects to have a $2 million cash balance on January 1 of next year. Net cash flow
effects of interest received or paid, are forecasted (in millions of dollars) as follows:

Jan Feb Mar Apr May Jun

Net cash inflows ($) +2 +1 –5 –3 –2 +6

Assuming all cash flows occur at the end of each month, approximately how much interest will the firm incur fo

A. $53,000 net interest paid.

B. $16,000 net interest paid.

C. $195,000 net interest paid.

D. $76,000 net interest paid.

Question: 71 Which one of the following statements about trade credit is correct? Trade credit is

A. A source of long-term financing to the seller.

B. Not an important source of financing for small firms.

C. Subject to risk of buyer default.

D. Usually an inexpensive source of external financing.

Question: 72 A firm has been offered a 1-year loan by its commercial bank. The instrument is a
discounted note with a stated interest rate of 9%. If the firm needs $300,000 for use in
the business, what should the face value of the note be?

A. $300,000

B. $275,229

C. $329,670

D. $327,000

Question: 73 The following forms of short-term borrowing are available to a firm:

• Floating lien

• Factoring

• Revolving credit

• Chattel mortgages

• Bankers’ acceptances

• Lines of credit

• Commercial paper
The forms of short-term borrowing that are unsecured credit are

A. Floating lien, revolving credit, chattel mortgage, and commercial paper.

B. Revolving credit, bankers’ acceptances, line of credit, and commercial paper.

C. Factoring, chattel mortgage, bankers’ acceptances, and line of credit.

D. Floating lien, chattel mortgage, bankers’ acceptances, and line of credit.

Fact Pattern: Morton Company needs to pay a supplier’s invoice of $50,000 and wants to take a cash
discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10%
compensating balance.

Question: 74 Assuming Morton Company borrows the money on the last day of the discount period
and repays it 30 days later, the effective interest rate on the loan is
 A. 13.20%

B. 13.48%

C. 12.00%

D. 13.33%

Fact Pattern: CyberAge Outlet, a relatively new store, is a cafe that offers customers the opportunity to
browse the Internet or play computer games at their tables while they drink coffee. The customer pays a
fee based on the amount of time spent signed on to the computer. The store also sells books, tee-shirts,
and computer accessories. CyberAge has been paying all of its bills on the last day of the payment
period, thus forfeiting all supplier discounts. Shown below are data on CyberAge’s two major vendors,
including average monthly purchases and credit terms.
Average

Monthly

Vendor Purchases Credit Terms

Web Master $25,000 2/10, net 30

Softidee 50,000 5/10, net 90

Question: 75 Should CyberAge use trade credit and continue paying at the end of the credit period?

A. Yes, if the cost of alternative short-term financing is greater.

B. Yes, if the cost of alternative short-term financing is less.

C. No, if the cost of alternative long-term financing is greater.

D. Yes, if the firm’s weighted-average cost of capital is equal to its weighted-average

cost of trade credit.
5: (10) Long-Term Financing

Question: 1 Compared with another bond with the same risk and maturity but without a conversion
feature, a convertible bond has a

A. Higher face amount.

B. Lower coupon rate.

C. Higher coupon rate.

D. Lower face amount.

Question: 2 All of the following may allow a firm to set a lower coupon rate on a bond issued at
par except a

A. Sinking fund.

B. Call provision.

C. Higher rating from a bond rating agency.

D. Conversion option.

Question: 3 A major use of warrants in financing is to

A. Lower the cost of debt.

B. Permit the buy-back of bonds before maturity.

C. Avoid dilution of earnings per share.

D. Maintain managerial control.

Question: 4 The decision whether to finance acquisition of a long-term asset using debt financing or
lease financing most likely is determined by

A. The form of the lease.

 B. The advantages of off-balance sheet financing.

C. Tax benefits and present value analysis.

D. Maximizing cash inflows.

Question: 5 Which of the following statements characterizes convertible debt?

A. The holder of the debt must be repaid with shares of the issuer’s stock.

B. No value is assigned to the conversion feature when convertible debt is issued.

C. The transaction should be recorded as the issuance of stock.

D. The issuer’s stock price is less than market value when the debt is converted.

Question: 6 The right to use property for a stated period in exchange for a stated payment is
associated with

A. Leases.

B. Retained earnings.

C. Convertible securities.

D. Stock purchase warrants.

Question: 7 Which of the following items provides the lowest-cost form of capital?

A. Retained earnings.

B. Convertible debt.

C. Common stock.

D. Preferred stock.
Question: 8 The following excerpt was taken from a company’s financial statements: “ . . . 10%
convertible participating . . . $10,000,000.” What is most likely being referred to?

A. Common shares.

B. Bonds.

C. Share options.

D. Preferred shares.

Question: 9 Securities that contain a provision allowing the holder to exchange the securities for
some specified number of common shares are

A. Convertible securities.

B. Stock purchase warrants.

C. Retained earnings.

D. Leases.

Question: 10 In general, as a company increases the amount of short-term financing relative to long-
term financing, the

A. Leverage of the firm increases.

B. Likelihood of having idle liquid assets increases.

C. Greater the risk that it will be unable to meet principal and interest payments.

D. Current ratio increases.