1. The CEO of High Tech International decides to change an accounting method at the end of
the current year. The change results in reported profits increasing by 5%, but the company’s
cash flows are not changed. If capital markets are efficient, then:
a. The stock price will increase only if the accounting change will also result in higher
profits in the next year.
b. The stock price will increase due to higher profits.
c. The stock price will decrease because accounting method changes are not permitted
under generally accepted accounting principles.
d. The stock price will not be affected by the accounting change.
2. S-type corporations have all of the following advantages EXCEPT
a. The owners have limited liability.
b. All owners must be people, no corporations.
c. Distributions are taxed twice, similar to corporate dividend payments.
d. They are taxed as partnerships.
3. Assume that you went to Las Vegas and hit the jackpot for $5 million. Further assume that
you were offered a choice to receive the $5 million today, or receive it in two years. According
to one of the principles of finance, which would you take?
a. You would be indifferent as to when you would receive the $5 million.
b. $5 million in two years because you would be afraid of spending it all right away
c. $5 million today because it would be worth more than if you would receive it in two years
d. $5 million in two years because it would be worth more than if you would receive it today
4. In terms of the costs to organize each, which of the following sequences is correct, moving
from highest to lowest cost?
a. corporation, limited partnership, general partnership, sole proprietorship
b. sole proprietorship, general partnership, corporation, limited partnership
c. general partnership, sole proprietorship, limited partnership, corporation
d. sole proprietorship, general partnership, limited partnership, corporation
5. Which form of organization is free of initial legal requirements?
a. general partnership
b. sole proprietorship
d. both a and b
6. Which of the statements below are true?
a. The sole proprietorship and the general partnership both feature unlimited liability.
b. The corporation and the limited partnership both provide at least some owners with
c. A corporation is the business form that is typically the most complicated (legally) to
d. all of the above
7. Capital budgeting is concerned with:
a. planning sales of a corporation’s equity capital
b. what long-term investments a firm should undertake
c. whether a company’s assets should be financed with debt or equity
d. managing a firms cash budgeting procedures
8. Which of the following is an advantage of organized stock exchanges?
a. increased stock price volatility
b. only profitable companies may issue new securities on an organized exchange
c. screening companies to ensure only low risk stocks are sold
d. providing a continuous market
9. What is the term for a graphical representation of the relationship between interest rates and
the maturities of debt securities?
a. yield curve
b. maturity chart
c. term curve
d. inflationary expectations
10. The one-year interest rate is 4%. The interest rate for a two-year security is 6%. The one-year
interest rate one year from now is 8.34%. According to the liquidity preference theory, the
risk premium for the second one-year investment is:
11. An example of a primary market transaction involving a money market security is:
a. a new issue of a security with a very long maturity
b. the transfer of a previously-issued security with a very long maturity
c. a new issue of a security with a very short maturity
d. the transfer of a previously-issued security with a very short maturity
12. You are considering an investment in a U.S. Treasury bond but you are not sure what rate of
interest it should pay. Assume that the real risk-free rate of interest is 1.0%; inflation is
expected to be 1.5%; the maturity risk premium is 2.5%; and, the default risk premium for
AAA rated corporate bonds is 3.5%. What rate of interest should the U.S. Treasury bond pay?
13. A life insurance company purchases $1 billion of corporate bonds from premiums collected
on its life insurance policies. Therefore:
a. the corporate bonds are direct securities and the life insurance policies are direct
b. the corporate bonds are direct securities and the life insurance policies are indirect
c. the corporate bonds are indirect securities and the life insurance policies are direct
d. the corporate bonds are indirect securities and the life insurance policies are indirect
14. A commitment fee is:
a. paid by investors to guarantee that a company will borrow from them
b. paid by bondholders to secure the right to convert bonds into common stock
c. an amount paid by an investment banker to ensure the sale of securities
d. an amount paid on the unused portion of a loan in a private placement
15. You plan to go to Asia to visit friends in three years. The trip is expected to cost a total of
$10,000 at that time. Your parents have deposited $5,000 for you in a Certificate of Deposit
paying 6% interest annually, maturing three years from now. Uncle Lee has agreed to pay for
all remaining expenses. If you are going to put Uncle Lee’s gift in an investment earning
10% over the next three years, how much must he deposit today, so you can visit your
friends three years from today?
16. What is the present value of an annuity of $120 received at the end of each year for 11
years? Assume a discount rate of 7%. The first payment will be received one year from today
(round to nearest $1).
17. You won the lottery and can receive either (1) $60,000 today, or (2) $10,000 one year from
today plus $25,000 two years from today plus $35,000 three years from today. You plan to
use the money to pay for your child’s college education in 15 years. You should:
a. take option two because you get $70,000 rather than $60,000 regardless of current
b. take the $60,000 today because of the time value of money regardless of current
c. take the $60,000 today only if the current interest rate is at least 16.67%
d. take the $60,000 today if you can earn 6.81% per year or more on your investments
18. You deposit $5,000 per year at the end of each of the next 25 years into an account that
pays 8% compounded annually. How much could you withdraw at the end of each of the 20
years following your last deposit if all withdrawals are the same dollar amount? (The
twenty-fifth and last deposit is made at the beginning of the 20-year period. The first
withdrawal is made at the end of the first year in the 20-year period.)
19. Your son is born today and you want to make him a millionaire by the time he is 50 years
old. You deposit $10,700 in an investment account and want to know what annual interest
rate must you earn in order to have the account value equal to $1,000,000 on your son’s
20. You sell valuable artifacts from your household estate for $200,000 and want to use the
money to supplement your retirement. You receive the money on your 60th birthday, the day
you retire. You want to withdraw equal amounts at the end of each of the next 25 years.
What constant amount can you withdraw each year and have nothing remaining at the end of
20 years if you are earning 7% interest per year?
Stock W has the following returns for various states of the economy:
State of the Economy Probability Stock W’s Return
Recession 9% -72%
Below Average 16% -15%
Average 51% 16%
Above Average 14% 35%
Boom 10% 85%
21. Stock W’s standard deviation of returns is:
22. Which of the following types of risk is diversifiable?
a. betagenic, or ecocentric risk
b. unsystematic, or company-unique risk
c. systematic risk
d. market risk
23. You are considering buying some stock in Continental Grain. Which of the following are
examples of non-diversifiable risks?
I. Risk resulting from a general decline in the stock market.
II. Risk resulting from a possible increase in income taxes.
III. Risk resulting from an explosion in a grain elevator owned by Continental.
IV. Risk resulting from a pending lawsuit against Continental.
a. II, III, and IV
b. I and II
c. III and IV
d. I only
24. Decker Corp. common stock has a required return of 17.5% and a beta of 1.75. If the
expected risk free return is 3%, what is the expected return for the market based on the
25. The return on the market portfolio is currently 12%. Mobile Phone Corporation stockholders
require a rate of return of 30% and the stock has a beta of 3.2. According to CAPM,
determine the risk-free rate.