Whether real seignorage revenue increases when the rate of money growth increases depends on whether

Whether real seignorage revenue increases when the rate of money growth increases depends on whether

a. the rise in the real supply of currency outweighs the decline in inflation.
b. the rise in inflation ratio outweighs the decline in the real supply of currency.
c. the rise in inflation outweighs the decline in real money holdings.
d. the rise in real money holdings outweighs the decline in inflation.


Answer: C

Consider an economy that has the following monetary data.

Consider an economy that has the following monetary data.

Currency held by the nonbank public = $300
Bank reserves = $50
Monetary base = $350
Deposits = $700
Money supply = $1000

The monetary base and the money supply are expected to grow at a constant rate of 20% per year. Inflation and expected inflation are 20% per year. Suppose that bank reserves and currency pay no interest, all currency is held by the public, and bank deposits pay no interest. What is the nominal value of seignorage over the year?

a. $70
b. $10
c. $60
d. $200




Answer: A

Consider an economy that has the following monetary data.

Consider an economy that has the following monetary data.

Currency held by the nonbank public = $300
Bank reserves = $50
Monetary base = $350
Deposits = $700
Money supply = $1000

The monetary base and the money supply are expected to grow at a constant rate of 20% per year. Inflation and expected inflation are 20% per year. Suppose that bank reserves and currency pay no interest, all currency is held by the public, and bank deposits pay no interest. What is the cost to the public of the inflation tax?



a. $140
b. $60
c. $200
d. $190




Answer: C

Real money demand in the economy is given by L = 0.5Y - 2500i, where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 1000 and the real interest rate is 0.02. What is the maximum amount of seignorage revenue?

Real money demand in the economy is given by
L = 0.5Y - 2500i,
where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 1000 and the real interest rate is 0.02. What is the maximum amount of seignorage revenue?

a. 22.25
b. 20.25
c. 24.75
d. 11.11



Answer: B

Real money demand in the economy is given by L = 0.5Y - 2500i, where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 1000 and the real interest rate is 0.02. At what rate of inflation is seignorage maximized?

Real money demand in the economy is given by
L = 0.5Y - 2500i,
where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 1000 and the real interest rate is 0.02. At what rate of inflation is seignorage maximized?

a. 0.10
b. 0.075
c. 0.05
d. 0.09



ANS: D

Assume that in an all-currency economy the real interest rate is 4%, the expected rate of inflation is 8%, and the nominal interest rate is 12%. The real monetary base equals $50 billion. The real seignorage revenue collected by the government would equal

Assume that in an all-currency economy the real interest rate is 4%, the expected rate of inflation is 8%, and the nominal interest rate is 12%. The real monetary base equals $50 billion. The real seignorage revenue collected by the government would equal

a. $4 billion.
b. $12 billion.
c. $8 billion.
d. $6 billion.



Answer: A

The real seigniorage collected by the government in an all-currency economy is the product of

The real seigniorage collected by the government in an all-currency economy is the product of

a. the debt/GDP ratio and the rate of inflation.
b. the rate of inflation and the real money supply.
c. the rate of inflation and the real supply of government bonds.
d. the debt/GDP ratio and the real money supply.



Answer: B

In an all-currency economy in which real output and the real interest rate are fixed and the rates of money growth and inflation are constant, the inflation rate equals

In an all-currency economy in which real output and the real interest rate are fixed and the rates of money growth and inflation are constant, the inflation rate equals

a. the nominal interest rate.
b. the level of real seignorage revenue.
c. the real interest rate.
d. the growth rate of the nominal money supply.

Answer: D

State governments in the United States can raise revenue by all the following means except

State governments in the United States can raise revenue by all the following means except

a. increasing the money supply.
b. increasing sales taxes.
c. increasing income taxes.
d. increasing taxes on corporate profits.



Answer: A

In which case would you be most likely to expect inflation to occur?

In which case would you be most likely to expect inflation to occur?

a. The government runs a sustained government deficit by increasing purchases.
b. The government runs a sustained government deficit by lowering taxes.
c. The government funds its sustained deficit by increasing the money supply.
d. The government runs a sustained primary deficit by increasing purchases.



Answer: C

The relationship between the government deficit and the change in the monetary base is

The relationship between the government deficit and the change in the monetary base is

a. deficit equals change in government debt held by the public plus change in monetary base.
b. deficit equals change in government debt outstanding plus change in monetary base.
c. deficit equals change in government debt held by the public minus change in monetary base.
d. deficit equals change in government debt outstanding minus change in monetary base.




Answer: A

Seigniorage is the revenue a government raises by

Seigniorage is the revenue a government raises by

a. borrowing money.
b. charging fees for services.
c. taxation.
d. printing money.



Answer: D

Deficits are a burden on future generations if they

Deficits are a burden on future generations if they 

a. are always a primary government deficit.
b. are not used for government capital formation.
c. cause national saving to fall.
d. cause higher rates of inflation to occur.



Answer: C

According to the Ricardian equivalence proposition, current deficits

According to the Ricardian equivalence proposition, current deficits

a. will affect both consumption and national saving.
b. will not affect consumption or national saving.
c. will affect national saving but not consumption.
d. will affect consumption but not national saving.



Answer: B

A decreased government deficit created by a lump-sum tax increase will increase national saving if

A decreased government deficit created by a lump-sum tax increase will increase national saving if

a. the real interest rate is less than the growth rate of real GNP.
b. it causes consumption to fall.
c. the government runs a primary surplus as a result.
d. the value of government bonds outstanding grows slower than the public's wealth.





Answer: B

If the deficit is 0.02 times GDP, the existing debt/GDP ratio is 0.5, and the growth rate of nominal GDP is 0.03, then the change in the debt-GDP ratio is

If the deficit is 0.02 times GDP, the existing debt/GDP ratio is 0.5, and the growth rate of nominal GDP is 0.03, then the change in the debt-GDP ratio is

a. +0.05
b. -0.025.
c. 0.0
d. +0.025.




Answer: A

Increases in the debt-GDP ratio are primarily caused by

Increases in the debt-GDP ratio are primarily caused by

a. a high government deficit relative to GDP.
b. a high growth rate of GDP.
c. increases in interest rates.
d. increases in government borrowing through bonds.




Answer: A

The total value of government bonds outstanding at any particular time is called the

The total value of government bonds outstanding at any particular time is called the

a. government debt.
b. seignorage revenue.
c. yield curve.
d. government deficit.




Answer: A

The average cost of the distortion created by taxes

The average cost of the distortion created by taxes

a. increases proportionately with the tax rate.
b. is higher when the tax rate is constant than when it fluctuates.
c. is lower when the tax rate is constant than when it fluctuates.
d. equals the square root of the tax rate.



Answer: C

Assume that the lost output due to tax distortions is proportional to the square of the tax rate. If the average cost of the distortion created by taxes is currently $1000, and the tax rate is increased from 40% to 50%, the average cost of the distortion created by taxes will increase to

Assume that the lost output due to tax distortions is proportional to the square of the tax rate. If the average cost of the distortion created by taxes is currently $1000, and the tax rate is increased from 40% to 50%, the average cost of the distortion created by taxes will increase to

a. $640.
b. $383.33.
c. $450.00.
d. $1562.50.



Answer: D

Taxes distort economic behavior because they

Taxes distort economic behavior because they

a. change the composition of income and spending.
b. change the composition of consumption, investment, government spending, and net exports.
c. change the balance between private and public expenditures.
d. cause deviations in economic behavior from the efficient, free-market outcome.

Answer: D

Suppose that all workers place a value on their leisure of 40 goods per day. The production function relating output per day Y to the number of people working per day N is

Suppose that all workers place a value on their leisure of 40 goods per day. The production function relating output per day Y to the number of people working per day N is 

Y = 200N - N^2
and the marginal product of labor is
MPN = 200 - 2N.
A 20% tax is levied on wages. In terms of lost output, what is the cost of the distortion introduced by this tax?


a. 75
b. 150
c. 225
d. 25




Answer: C

Suppose that all workers place a value on their leisure of 40 goods per day. The production function relating output per day Y to the number of people working per day N is

Suppose that all workers place a value on their leisure of 40 goods per day. The production function relating output per day Y to the number of people working per day N is

Y = 200N - N^2
and the marginal product of labor is
MPN = 200 - 2N.
A 20% tax is levied on wages. Output per day would be



a. 9,375.
b. 11,250.
c. 7,250.
d. 5,625.




Answer: A

A decrease in the average tax rate, with the marginal tax rate held constant, will

A decrease in the average tax rate, with the marginal tax rate held constant, will

a. not affect the amount of labor supplied at any real wage.
b. increase the amount of labor supplied at any real wage.
c. decrease the amount of labor supplied at any real wage.
d. increase the amount of labor supplied at any real wage if the average tax rate is above the marginal tax rate, but decrease the amount of labor supplied at any real wage if the average tax rate is below the marginal tax rate.

Answer: C

An increase in the marginal tax rate, with the average tax rate held constant, will

An increase in the marginal tax rate, with the average tax rate held constant, will

a. increase the amount of labor supplied at any real wage.
b. increase the amount of labor supplied at any real wage if the average tax rate is above the marginal tax rate, but decrease the amount of labor supplied at any real wage if the average tax rate is below the marginal tax rate.
c. not affect the amount of labor supplied at any real wage.
d. decrease the amount of labor supplied at any real wage.



Answer: D

The marginal tax rate is

The marginal tax rate is

a. the total amount of taxes paid divided by after-tax income.
b. the fraction of an additional dollar of income that must be paid in taxes.
c. the average amount of government spending that is financed by taxes.
d. the total amount of taxes paid divided by before-tax income.




Answer: B

The total amount of taxes paid divided by before-tax income is the

The total amount of taxes paid divided by before-tax income is the

a. rate of hysteresis.
b. median taxpayer rate.
c. average tax rate.
d. marginal tax rate.

Answer: C

All of the following can be government capital EXCEPT

All of the following can be government capital EXCEPT

a. mass-transit systems.
b. Treasury securities.
c. roads.
d. schools.





Answer: B

Government capital consists of

Government capital consists of

a. money owned by the government.
b. securities owned by the government.
c. long-lived physical assets owned by the government.
d. the buildings owned by the government in Washington, D.C.



Answer: C

The amount the government budget deficit would be if the economy were at full employment is known as the

The amount the government budget deficit would be if the economy were at full employment is known as the

a. primary deficit.
b. natural deficit.
c. current deficit.
d. full-employment deficit.




Answer: D

Because of automatic stabilizers, in recessions the government budget deficit ________, while in expansions the deficit ________.

Because of automatic stabilizers, in recessions the government budget deficit ________, while in expansions the deficit ________.

a. rises; rises
b. falls; rises
c. rises; falls
d. falls; falls




Answer: C

Which of the following would not act as an automatic stabilizer?

Which of the following would not act as an automatic stabilizer?

a. Government purchases
b. Unemployment insurance
c. Corporate income taxes
d. Personal income taxes



Answer: A

Provisions in the budget that cause government spending to rise or taxes to fall without legislation when GDP falls are known as

Provisions in the budget that cause government spending to rise or taxes to fall without legislation when GDP falls are known as 

a. automatic stabilizers.
b. non-political fiscal policy.
c. primary deficit enhancers.
d. expansionary fiscal stimulus.



Answer: A

The political process by which fiscal policy is made

The political process by which fiscal policy is made

a. is relatively rapid, contributing to the effectiveness of fiscal policy.
b. is efficient in reaching a decision within a year.
c. is slow and results in a long time lag for fiscal policy.
d. requires only that the president approve changes to the budget, a decision that takes several months.

Answer: C

Classical economists think that lump-sum tax changes

Classical economists think that lump-sum tax changes

a. should be used to smooth business cycles.
b. have no effect because of Ricardian equivalence.
c. have a powerful effect on the economy.
d. affect aggregate demand after a lag.




Answer: B

The current deficit minus net interest is called the

The current deficit minus net interest is called the

a. primary deficit.
b. current surplus.
c. net current deficit.
d. primary current deficit.





Answer: D

The primary current deficit is

The primary current deficit is

a. current expenditures - net interest - tax revenues.
b. current expenditures + transfers - tax revenues.
c. current expenditures - tax revenues.
d. current expenditures + transfers + net interest - tax revenues.

Answer: A

The current deficit is

The current deficit is

a. outlays minus tax revenues.
b. the deficit minus depreciation.
c. the deficit plus net interest payments.
d. current expenditures minus tax revenues.



Answer: D

The current deficit is

The current deficit is

a. the deficit plus net interest payments.
b. the deficit minus government investment.
c. the deficit minus depreciation.
d. the deficit minus current expenditures.


Answer: B

The amount by which government purchases and transfers exceed tax revenues is known as the

The amount by which government purchases and transfers exceed tax revenues is known as the

a. primary current deficit.
b. primary deficit.
c. government debt.
d. primary surplus.




Answer: B

The deficit is

The deficit is

a. the amount by which government purchases, transfers, and net interest exceed tax revenues.
b. total tax revenues minus net interest minus government expenditures.
c. the primary deficit minus net interest payments.
d. the amount by which government purchases and transfers exceed tax revenues.






Answer: A

The primary deficit is equal to

The primary deficit is equal to

a. government purchases + transfers + net interest - tax revenues.
b. outlays + net interest - tax revenues.
c. outlays - tax revenues.
d. government purchases + transfers - tax revenues.



Answer: D

The largest source of tax receipts for the government in the U.S. is

The largest source of tax receipts for the government in the U.S. is

a. personal taxes.
b. corporate taxes.
c. contributions for social insurance.
d. taxes on production and imports.



Answer: A

The three main categories of government outlays are

The three main categories of government outlays are 

a. government purchases, transfer payments, and net interest payments.
b. net interest payments, government investment, and government consumption expenditures.
c. net government subsidies, the government deficit, and government purchases.
d. government consumption expenditures, government investment, and transfer paymen
s.


Answer: A

Subtracting government investment from government purchases gives us the amount of government

Subtracting government investment from government purchases gives us the amount of government

a. consumption expenditures.
b. primary expenditures.
c. secondary spending.
d. outlays.



Answer: A

If a firm is planning to borrow money in the future, the rate it is trying to lock in is

If a firm is planning to borrow money in the future, the rate it is trying to lock in is

a. the current forward rate
b. the current spot rate
c. the difference between the spot rate and the forward rate
d. the forward rate at the termination of the hedge
e. none of the above

Answer: C

The implied repo rate is similar to the

The implied repo rate is similar to the

a. internal rate of return
b. cost of hedging
c. yield on the futures contract
d. all of the above
e. none of the above

Answer: A

The transaction designed to exploit mispricing in the relationship between futures and spot prices is called

The transaction designed to exploit mispricing in the relationship between futures and spot prices is called 

a. a repurchase agreement
b. a hedge
c. speculation
d. carry arbitrage
e. none of the above

Answer: D

Which of the following statements does NOT accurately reflect the relationship between securities and synthetic forward contracts?

Which of the following statements does NOT accurately reflect the relationship between securities and synthetic forward contracts?

A) Forward = stock - zero coupon bond
B) Zero coupon bond = stock - forward
C) Prepaid forward = forward - zero coupon bond
D) Stock = forward + zero coupon bond

Answer: C

When selecting among various put options with different strike prices, in order to hedge a long asset position, which of the following statements is true?

When selecting among various put options with different strike prices, in order to hedge a long asset position, which of the following statements is true?

A) Higher strike puts cost more and provide higher floors
B) Higher strike puts cost less and provide higher floors
C) Lower strike puts cost more and provide higher floors
D) Lower strike puts cost less and provide higher floors

Answer: A

All of the positions listed will benefit from a price decline, except:

All of the positions listed will benefit from a price decline, except:

A) Short put
B) Long put
C) Short call
D) Short stock

Answer: A

The spot price of the market index is $900. After 3 months, the market index is priced at $920. An investor has a long call option on the index at a strike price of $930. After 3 months, what is the investor's profit or loss?

The spot price of the market index is $900. After 3 months, the market index is priced at $920. An investor has a long call option on the index at a strike price of $930. After 3 months, what is the investor's profit or loss?

A) $10 loss
B) $0
C) $10 gain
D) $20 gain

Answer: B

The spot price of the market index is $900. A 3-month forward contract on this index is priced at $930. What is the profit or loss to a short position if the spot price of the market index rises to $920 by the expiration date?

The spot price of the market index is $900. A 3-month forward contract on this index is priced at $930. What is the profit or loss to a short position if the spot price of the market index rises to $920 by the expiration date?

A) $20 gain
B) $20 loss
C) $10 gain
D) $10 loss

Answer: C

A firm provides a service that benefits from decreasing employment. This firm has a risk exposure to macro event. All other variables being equal, which of the following derivative securities is the firm most likely use to hedge its exposure?

A firm provides a service that benefits from decreasing employment. This firm has a risk exposure to macro event. All other variables being equal, which of the following derivative securities is the firm most likely use to hedge its exposure?

A) Short position in an economic futures
B) Long position in an economic futures
C) Short position in an interest rate futures
D) Long position in an interest rate futures

Answer: B

According to trading volume data tabulated by the Wall Street Journal for April 15, 2010, which index futures contact experienced the highest total open interest?

According to trading volume data tabulated by the Wall Street Journal for April 15, 2010, which index futures contact experienced the highest total open interest?

A) DJ Industrial Average
B) S&P 500 Index
C) Mini S&P 500
D) Mini Nasdaq 100




Answer: C

Assume that you open a 100-share short position in Jiffy, Inc. common stock at the bid-ask price of $32.00 - $32.50. When you close your position, the bid-ask prices are $32.50 - $33.00. If you pay a commission rate of 0.5%, what is your profit or loss on the short investment?

Assume that you open a 100-share short position in Jiffy, Inc. common stock at the bid-ask price of $32.00 - $32.50. When you close your position, the bid-ask prices are $32.50 - $33.00. If you pay a commission rate of 0.5%, what is your profit or loss on the short investment?

A) $32.50 gain
B) $16.25 loss
C) $132.50 loss
D) $100.00 gain

Answer: C

Assume that you purchase 100 shares of Jiffy, Inc. common stock at the bid-ask prices of $32.00 - $32.50. When you sell, the bid-ask prices are $32.50 - $33.00. If you pay a commission rate of 0.5%, what is your profit or loss?

Assume that you purchase 100 shares of Jiffy, Inc. common stock at the bid-ask prices of $32.00 - $32.50. When you sell, the bid-ask prices are $32.50 - $33.00. If you pay a commission rate of 0.5%, what is your profit or loss?

A) $0
B) $16.25 loss
C) $32.50 gain
D) $32.50 loss



Answer: D

What is the cost of 100 shares of Jiffy, Inc. stock given that the bid-ask prices are $31.25 - $32.00 and a $15.00 commission per transaction exists?

What is the cost of 100 shares of Jiffy, Inc. stock given that the bid-ask prices are $31.25 - $32.00 and a $15.00 commission per transaction exists?

A) $3215
B) $3140
C) $3125
D) $3200

Answer: A

Select the family member who is offering the most diversification to the rest of the family.

Select the family member who is offering the most diversification to the rest of the family.

A) Dad works for General Motors
B) Mom works for Goodyear
C) Daughter works for Jiffy Lube
D) Son works for Eli Lilly & Company

Answer: D

All of the following are financially engineered products, except:

All of the following are financially engineered products, except:

A) Mortgage
B) Mortgage backed security
C) Interest only
D) Principal only

Answer: A

During the growing season, a corn farmer sells short corn futures contracts in an amount equal to her crop. If upon harvesting and selling her crop she maintains the contracts, she is then considered a(n):

During the growing season, a corn farmer sells short corn futures contracts in an amount equal to her crop. If upon harvesting and selling her crop she maintains the contracts, she is then considered a(n):

A) Hedger
B) Speculator
C) Arbitrager
D) None of the above

Answer: B

A mutual fund is engaged in the short term and temporary purchase of index futures, for purposes of minimizing its cash exposures. Which "use" most closely explains their actions?

A mutual fund is engaged in the short term and temporary purchase of index futures, for purposes of minimizing its cash exposures. Which "use" most closely explains their actions?

A) Risk management
B) Speculation
C) Reduced transaction costs
D) Regulatory arbitrage

Answer: C

Who from the following list would be considered a speculator by entering into a futures or options contract on commodities?

Who from the following list would be considered a speculator by entering into a futures or options contract on commodities?

A) Farmer
B) Corn delivery truck driver
C) Food manufacturer
D) None of the above



Answer: B

Which of the following is not a derivative instrument?

Which of the following is not a derivative instrument?

A) Contract to sell corn
B) Option agreement to buy land
C) Installment sales agreement
D) Mortgage backed security

Answer: C

Option payoffs: What is the payoff for a put option with a strike price of $20 if the price of the underlying stock at expiration is $18?

Option payoffs: What is the payoff for a put option with a strike price of $20 if the price of the underlying stock at expiration is $18?

A) $0
B) $2
C) $18
D) $20





Answer: B

Option payoffs: You have sold a call option on ABC Co. stock with a strike price of $40. You do not intend to make any other transactions before the options expiration date. The current stock price is $20. Which of the following statements best describes your hopes for the stock?

Option payoffs: You have sold a call option on ABC Co. stock with a strike price of $40. You do not intend to make any other transactions before the options expiration date. The current stock price is $20. Which of the following statements best describes your hopes for the stock?

A) You want the stock price to fall.
B) You want the stock price to rise.
C) You are indifferent, as long as the stock price stays under $40.
D) It doesn't matter; you are indifferent to changes in the stock price.

Answer: C

Option payoffs: You own a put option on ABC. Co. stock with a strike price of $40. The current stock price is $40. You will benefit if

Option payoffs: You own a put option on ABC. Co. stock with a strike price of $40. The current stock price is $40. You will benefit if

A) the stock price goes up.
B) the stock price goes down.
C) the stock price stays the same.
D) It doesn't matter; you are indifferent to changes in the stock price.

Answer: B

Option payoffs: What is the payoff for a call option with a strike price of $45 if the underlying stock price at expiration is $75?

Option payoffs: What is the payoff for a call option with a strike price of $45 if the underlying stock price at expiration is $75?

A) $30
B) $45
C) $75
D) None of the above




Answer: A

A local city government has awarded a contract to sequentially build five new elementary schools over the next 10 years. The price for each school has been spelled out in the contract, but at the beginning of each year the city can cancel the order for the remaining schools. The city government is concerned that if the population of the town does not grow as expected it may not need all of the schools. What sort of financial option does the option to cancel the order resemble?

A local city government has awarded a contract to sequentially build five new elementary schools over the next 10 years. The price for each school has been spelled out in the contract, but at the beginning of each year the city can cancel the order for the remaining schools. The city government is concerned that if the population of the town does not grow as expected it may not need all of the schools. What sort of financial option does the option to cancel the order resemble?

A) Owning a call option on the value of the new schools
B) Owning a put option on the value of the new schools
C) Selling a call option on the value of the new schools
D) Selling a put option on the value of the new schools

Answer: A

RealEstates LLP is considering the construction of a new development of condominiums in downtown Austin, Texas. The site for the new development is currently occupied by an office building owned by the city. The project's profitability will depend largely on the population increase in Austin over the next several years. Rather than buy the site, RealEstates has entered into an agreement with the city to pay $200,000 for the right to purchase the site for $10 million two years from now. The real option embedded in this contract is best described as

RealEstates LLP is considering the construction of a new development of condominiums in downtown Austin, Texas. The site for the new development is currently occupied by an office building owned by the city. The project's profitability will depend largely on the population increase in Austin over the next several years. Rather than buy the site, RealEstates has entered into an agreement with the city to pay $200,000 for the right to purchase the site for $10 million two years from now. The real option embedded in this contract is best described as

A) the option to defer investment.
B) the option to make follow-on investments.
C) the option to change operations.
D) the option to abandon projects.

Answer: A

Suppose you own a put option on a stock with a strike price of $35 that expires today. The price of the underlying stock is $25. If you purchase the stock and exercise the put option,

Suppose you own a put option on a stock with a strike price of $35 that expires today. The price of the underlying stock is $25. If you purchase the stock and exercise the put option,

A) you will earn $10.
B) you will lose $10.
C) you will earn $25.
D) you will lose $25.






Answer: A

Suppose you own a call option on a stock with a strike price of $20 that expires today. The price of the underlying stock is $15. If you exercise the option and immediately sell the stock,

Suppose you own a call option on a stock with a strike price of $20 that expires today. The price of the underlying stock is $15. If you exercise the option and immediately sell the stock,

A) you will earn $5.
B) you will lose $5.
C) you will lose $15.
D) you will earn $15.



Answer: B

Which one of the following statements about the sustainable growth rate (SGR) is NOT true?

Which one of the following statements about the sustainable growth rate (SGR) is NOT true?

A) The higher a firm's ROE, the higher the SGR.
B) The higher the plowback ratio, the larger the proportion of net income retained in the firm and the greater the firm's SGR.
C) Both a and b are true
D) None of the above.

Answer: C

Which one of the following statements about the sustainable growth rate (SGR) is NOT true?

Which one of the following statements about the sustainable growth rate (SGR) is NOT true?

A) The SGR is a function of the plowback ratio and the ROE.
B) The SGR determines the rate of growth that the firm can sustain without selling additional shares of equity.
C) The SGR helps management determine whether they can avoid issuing new debt.
D) All of the above are true of the SGR.



Answer: C

The sustainable growth rate (SGR)

The sustainable growth rate (SGR)

A) is a function of the plowback ratio and the ROE.
B) the rate of growth that the firm can sustain without selling additional shares of equity.
C) helps management determine whether they can avoid issuing new equity.
D) All of the above are true of the SGR.




Answer: D

Firms that achieve higher growth rates without seeking external financing

Firms that achieve higher growth rates without seeking external financing

A) have a low plowback ratio.
B) have less equity and/or are able to generate high net income leading to a high ROE.
C) are highly leveraged.
D) None of the above.

Answer: B

Firms that achieve higher growth rates without seeking external financing

Firms that achieve higher growth rates without seeking external financing

A) have a high plowback ratio.
B) have less equity and/or are able to generate high net income leading to a high ROE.
C) are not highly leveraged.
D) All of the above are true.

Answer: D

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) The internal growth rate (IGR) is defined as the maximum growth rate that a firm can achieve without external financing.
B) The higher the retained earnings generated by a firm, the higher the growth possible without using external funding.
C) Given the same level of retained earnings, a firm that has the higher amount of total assets, the higher the growth possible without using external funding.
D) All of the above are true.





Answer: C

External funding needed (EFN) is

External funding needed (EFN) is

A) the additional debt or equity a firm needs to issue so that it can purchase additional assets to support an increase in sales.
B) the additional funds raised by a firm to pay off existing short-term debt.
C) the additional funds raised by a firm to pay off existing long-term debt.
D) None of the above are true.




Answer: A

In accounting for changes in fixed assets, which one of the following statements is NOT true?

In accounting for changes in fixed assets, which one of the following statements is NOT true?

A) When a firm is not operating at full capacity, sales may be increased without adding any new fixed assets.
B) Since it requires time to get new assets operational, they are added as the firm nears full capacity.
C) Fixed assets are added in large discrete amounts called lumpy assets.
D) All of the above are true.




Answer: D

In accounting for changes in fixed assets, which one of the following statements is NOT true?

In accounting for changes in fixed assets, which one of the following statements is NOT true?

A) When a firm is not operating at full capacity, sales may be increased without adding any new fixed assets.
B) Since it requires time to get new assets operational, they are added in small discrete quantities.
C) Fixed assets are added in large discrete amounts called lumpy assets.
D) All of the above are true.

Answer: B

Some weaknesses in financial planning models include:

Some weaknesses in financial planning models include:

A) Interest expense is not accounted for.
B) All working capital accounts do not necessarily vary directly with sales, especially cash and inventory.
C) How fixed assets are adjusted.
D) All of the above are weaknesses.



Answer: D

In using more sophisticated planning models, which one of the following statements is NOT true?

In using more sophisticated planning models, which one of the following statements is NOT true?

A) Current liabilities are likely to vary directly with sales.
B) Long-term liabilities and equity accounts change as a direct result of managerial decisions.
C) Retained earnings will vary as sales changes but not directly as it is affected by the firm's dividend payout policy.
D) All of the above are true



Answer: D

In using more sophisticated planning models, which one of the following statements is NOT true?

In using more sophisticated planning models, which one of the following statements is NOT true?

A) Current liabilities are likely to vary directly with sales.
B) Long-term liabilities and equity accounts change as a direct result of managerial decisions.
C) Retained earnings will vary directly as sales changes.
D) All of the above are true



Answer: C

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) The ratio of total assets to sales is called the capital intensity ratio.
B) The ratio of sales to total assets is called the capital intensity ratio.
C) The higher the ratio, the more capital a firm needs to generate sales.
D) Firms that are highly capital intensive are more risky than those that are not.

Answer: B

Which statement is NOT true for a firm that is operating at full capacity?

Which statement is NOT true for a firm that is operating at full capacity?

A) Fixed assets vary directly with sales.
B) Fixed assets can never vary directly with sales.
C) Fixed assets can be incrementally changed.
D) All of the above are true



Answer: B

One statement that is NOT true about more sophisticated financial planning model is that:

One statement that is NOT true about more sophisticated financial planning model is that:

A) only fixed costs change directly with sales.
B) working capital accounts like inventory, accounts receivables, and accounts payables vary directly with sales.
C) fixed assets do not always vary directly with sales.
D) All of the above are true

Answer: A

Planning models that are more sophisticated than the percent of sales method have

Planning models that are more sophisticated than the percent of sales method have

A) all variable costs change directly with sales.
B) working capital accounts like inventory, accounts receivables, and accounts payables vary directly with sales.
C) fixed assets that do not always vary directly with sales.
D) All of the above are true.



Answer: D

Which one of the following statements is NOT true about financial planning models?

Which one of the following statements is NOT true about financial planning models?

A) Financial statements serve as the first major input and become the baseline to compare the projected financial statements.
B) Macroeconomic forecasts and their impact on the firm's sales are also included.
C) Investment and financing decisions are not considered as inputs.
D) Changes in the firm's balance sheet and income statement items as a result of the growth in sales are also used in these models.

Answer: C

Which one of the following is NOT an input in financial planning models?

Which one of the following is NOT an input in financial planning models?

A) Financial statements
B) Pro forma financial statements
C) Investment decisions
D) Financing decisions

Answer: B

The inputs used in building financial planning models include

The inputs used in building financial planning models include

A) financial statements, sales forecasts, and the firm's investment decisions.
B) pro forma statements, sales forecasts, and macroeconomic variables.
C) pro forma statements, sales forecasts, and financing decisions.
D) none of the above.





Answer: A

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Sales forecasts models are typically very basic and use no complicated analysis.
B) are generated within the firm.
C) utilize macroeconomic variables as input.
D) All of the above are true.

Answer: A

The sales forecasts used in financial planning

The sales forecasts used in financial planning

A) are developed using a variety of techniques.
B) are generated within the firm.
C) utilize macroeconomic variables as input.
D) All of the above are true.

Answer: D

Financial planning models

Financial planning models

A) help management make investment decisions.
B) help management make financing decisions.
C) make the process speedy and accurate.
D) all of the above are true.

Answer: D

The financial plan focuses on

The financial plan focuses on

A) the inventory accounting method decision and the accounts payables decision.
B) the current assets decision and the current liabilities decision.
C) the investment decision and the financing decision.
D) none of the above.

Answer: C

The financial plan includes

The financial plan includes

A) the strategic plan, financing plan, and options plan.
B) the strategic plan, investment plan, and financing plan.
C) the financing plan, investment plan, and options plan.
D) none of the above.

Answer: B

Which one of the following is NOT part of a financing plan?

Which one of the following is NOT part of a financing plan?

A) The dollar amount of funds that has to be raised externally and the sources of funds available to the firm
B) The desired capital structure for the firm
C) The firm's dividend policy
D) All of the above are part of a financial plan.

Answer: D

The financing plan of a firm will indicate

The financing plan of a firm will indicate

A) the dollar amount of funds that has to be raised externally and the sources of funds available to the firm, the desired capital structure for the firm, and the firm's dividend policy.
B) the dollar amount of funds that has to be raised externally and the sources of funds available to the firm, the desired capital structure for the firm, and the firm's working capital policy.
C) the dollar amount of funds that has to be raised externally and the sources of funds available to the firm, the firm's dividend policy, and the firm's working capital policy.
D) the firm's dividend policy, the desired capital structure for the firm, and the firm's working capital policy.

Answer: A

Which one of the following is NOT true about the capital budgeting process?

Which one of the following is NOT true about the capital budgeting process?

A) Management identifies a list of potential projects that are consistent with the business strategy and ranks them according to the value they would create for the shareholders.
B) Senior management reviews the list.
C) Once the list is made, no management review can change it.
D) All of the above are true of the capital budgeting process.

Answer: C

Which one of the following is NOT true about the capital budgeting process?

Which one of the following is NOT true about the capital budgeting process?

A) Management identifies a list of potential projects that are consistent with the business strategy and ranks them according to the value they would create for the shareholders.
B) Senior management reviews the list.
C) The list is revised to comply with the firm's budget constraints.
D) All of the above are true of the capital budgeting process.

Answer: D

Which one of the following is true about capital expenditures?

Which one of the following is true about capital expenditures?

A) It is part of a firm's investment plan.
B) Once a capital investment is made, they are almost always impossible to reverse.
C) Capital expenditures can be one-time investments or routine investments that
allow the firm to continue its operations.
D) All of the above are true of capital investments.

Answer: D

The strategic plan does NOT identify

The strategic plan does NOT identify

A) major areas of investment in real assets.
B) future mergers, alliances, and divestitures.
C) working capital strategies.
D) the lines of business a firm will compete in.

Answer: C

The strategic plan identifies

The strategic plan identifies

A) the lines of business in which a firm will compete.
B) major areas of investment in real assets.
C) capital expenditures, acquisitions. and new lines of business.
D) All of the above.

Answer: D

According to the text, the financial plan covers a period of

According to the text, the financial plan covers a period of

A) one year.
B) three to five years.
C) ten years.
D) None of the above

Answer: B

All but one of the following issues are addressed in the financial plan.

All but one of the following issues are addressed in the financial plan.

A) What is the growth rate for a firm's main competitor?
B) Where is the company headed?
C) What capital resources does the management need to get there?
D) How is the firm going to pay for the resources needed?

Answer: A

The financial plan addresses the following issue(s):

The financial plan addresses the following issue(s):

A) Where is the company headed?
B) What capital resources does the management need to get there?
C) How is the firm going to pay for the resources needed?
D) All of the above.

Answer: D

Which of the following components make up a financial plan

Which of the following components make up a financial plan

A) the strategic plan.
B) the investment plan.
C) the financing plan.
D) All of the above.

Answer: D

Good Signal Co. is currently trading for $10 with 1 million shares outstanding. Which of the following actions would be the most credible signal that management believes that the long-term prospects for a company has improved?

Good Signal Co. is currently trading for $10 with 1 million shares outstanding. Which of the following actions would be the most credible signal that management believes that the long-term prospects for a company has improved?

A) Pay a $0.20 extra dividend in addition to the company's $0.20 regular quarterly dividend.
B) Increase the company's regular quarterly dividend from $0.20 to $0.40.
C) Initiate an open-market stock repurchase of 2 percent of the company's stock.
D) Initiate a Dutch auction tender offer stock repurchase for 2 percent of the company's stock.

Answer: B

GHI Co. has just announced that the board has reached a targeted stock repurchase agreement with a large stockholder. The company will repurchase all of the large investor's stock for 90 percent of the current market value. When the stock repurchase was announced, the shares of GHI Co. fell by 7 percent. Which one of these explanations could reasonably explain the drop in share price?

GHI Co. has just announced that the board has reached a targeted stock repurchase agreement with a large stockholder. The company will repurchase all of the large investor's stock for 90 percent of the current market value. When the stock repurchase was announced, the shares of GHI Co. fell by 7 percent. Which one of these explanations could reasonably explain the drop in share price?

A) The willingness of the large investor to accept the targeted stock repurchase signals that the large investor believes the company will not do well in the future.
B) A targeted stock repurchase essentially transfers value from the average investor to the targeted investor.
C) Investors believe that the company's management is entrenching itself by buying off any large block shareholders.
D) Both a and c are possible explanations.

Answer: C

Which one of these actions could by itself have an impact on the control of the firm?

Which one of these actions could by itself have an impact on the control of the firm?

A) A tender offer stock repurchase
B) A special dividend payment
C) A stock split
D) A regular cash dividend payment

Answer: A

Which of the following considerations should NOT be related to management's concerns when setting a dividend or stock repurchase policy?

Which of the following considerations should NOT be related to management's concerns when setting a dividend or stock repurchase policy?

A) Over the long term, how much does the company's level of earnings exceed its investment requirements? How certain is this level?
B) Is the stock currently undervalued? Can the management add value to the company by initiating a stock repurchase?
C) Does the firm have enough financial reserves to maintain the dividend policy in periods when earnings are down or investment requirements are up?
D) Can the firm quickly raise equity capital if necessary?

Answer: B

Which one of the following statements describes the finding from academic studies on corporate dividend policy?

Which one of the following statements describes the finding from academic studies on corporate dividend policy?

A) Managers tend to increase regular cash dividends in response to unexpectedly high earnings.
B) Managers tend to maintain a level dividend payment at an amount that they are relatively certain they can maintain in the future.
C) Managers tend to focus on dividends rather than stock repurchases because institutional investors tend to prefer regular dividends.
D) Dividend policy doesn't matter because investors can re-create dividends by selling a fraction of their shares.

Answer: B

Generally, management undertakes a reverse stock split to

Generally, management undertakes a reverse stock split to

A) send a signal to investors that the company is expected to perform poorly.
B) meet the minimum requirements to be listed on one of the major stock exchanges.
C) increase the liquidity of shares by decreasing the number of share available.
D) reduce the administrative costs associated with investor relations.

Answer: B

Suppose you own shares of ThreeFor, Inc., which has just announced a 3-for-1 stock split. Immediately after the announcement, the price of the company's shares rose by 5 percent. You don't expect any new information about the company until after the stock split. Ignoring any discounting for time, if you intend to sell your shares soon, you should

Suppose you own shares of ThreeFor, Inc., which has just announced a 3-for-1 stock split. Immediately after the announcement, the price of the company's shares rose by 5 percent. You don't expect any new information about the company until after the stock split. Ignoring any discounting for time, if you intend to sell your shares soon, you should

A) sell the stock now—the single share you have now is likely to be worth more than the three shares you'll have after the split.
B) sell the stock after the split—typically, the marker reacts positively to stock splits. The three shares you'll have after the split will be worth more than the single share you have now.
C) sell the stock now—the stock is likely to be more liquid before the split when there are fewer shares.
D) It doesn't matter when the stock is sold. If there is no new information about the stock, then the value of three shares after the split should be the same as the value of the single share you hold now.

Answer: D

Suppose you are advising a retiree who holds 2,000 shares of LargeDiv Corp. The company is largely held by tax-paying institutional investors and has announced that it will shortly be issuing a large dividend. Because the shares are held in the retiree's Roth IRA, she will not incur taxes on either capital gains or dividends. The retiree has decided to sell the shares sometime this year, and use the money for living expenses. You expect the only upcoming change in the stock price will result from the dividend. Ignoring any discounting for time, what advice should you give?

Suppose you are advising a retiree who holds 2,000 shares of LargeDiv Corp. The company is largely held by tax-paying institutional investors and has announced that it will shortly be issuing a large dividend. Because the shares are held in the retiree's Roth IRA, she will not incur taxes on either capital gains or dividends. The retiree has decided to sell the shares sometime this year, and use the money for living expenses. You expect the only upcoming change in the stock price will result from the dividend. Ignoring any discounting for time, what advice should you give?

A) Sell the stock now—the stock price is likely to decrease more than just the dividend amount.
B) Sell the stock ex-dividend—the stock price is likely to decline, but by less than the dividend amount.
C) It doesn't matter when the stock is sold.
D) Sell the stock now—it is always better to sell the stock immediately regardless of the tax consequences.

Answer: B

In early 2003, the U.S. government cut the tax rate on dividends to a flat 15 percent instead of treating dividend payments as other income. All else being equal, how would we expect the number of companies paying dividends to change.

In early 2003, the U.S. government cut the tax rate on dividends to a flat 15 percent instead of treating dividend payments as other income. All else being equal, how would we expect the number of companies paying dividends to change.

A) We would expect the number of dividend-paying companies to increase.
B) We would expect the number of dividend-paying companies to decrease.
C) We would expect the number of dividend-paying companies to stay relatively constant.
D) None of the above.

Answer: A

Which of the following statements about the relative advantages of stock repurchases over dividends is NOT true?

Which of the following statements about the relative advantages of stock repurchases over dividends is NOT true?

A) Stock repurchases send a stronger signal than dividends to the market about management's belief that the firm's prospects are good.
B) Open-market stock purchases allow management more flexibility because investors are less likely to react if the management cuts back or ends a stock repurchase as compared to cutting back on dividend payments.
C) Stock repurchases allow stockholders to choose whether or not to participate in the stock repurchase. This allows stockholders to have more control over their tax burden.
D) Historically, taxes on dividend payment have been higher than those on stock repurchases.

Answer: A

Which of the following explanations is NOT a possible benefit of dividends?

Which of the following explanations is NOT a possible benefit of dividends?

A) Some investors prefer dividend-paying stocks and will be willing to pay a higher price for stocks with regular dividends.
B) Paying out large regular dividends can force management to regularly raise more capital. The extra scrutiny involved in raising capital can increase the incentives of management to run the company efficiently.
C) Dividends can be used to manage the capital structure of the company.
D) Paying dividends reduces the probability that the firm will enter financial distress.

Answer: D

Which type of stock repurchase allows management to set the repurchase price at the lowest level necessary to repurchase the desired number of shares?

Which type of stock repurchase allows management to set the repurchase price at the lowest level necessary to repurchase the desired number of shares?

A) Open-market repurchase
B) Fixed-price tender offer repurchase
C) Dutch auction tender offer repurchase
D) All of the above will generate the same purchase price.

Answer: C

Which type of stock repurchase often takes place at a price below the current market price of the stock?

Which type of stock repurchase often takes place at a price below the current market price of the stock?

A) Open-market repurchase
B) Fixed-price tender offer repurchase
C) Dutch auction tender offer repurchase
D) Targeted stock repurchase

Answer: D

Which of the following is NOT a possible result of a stock repurchase?

Which of the following is NOT a possible result of a stock repurchase?

A) Removing a large number of shares from circulation can change the ability of certain shareholders to control the firm.
B) If the number of remaining shares is relatively small, the remaining shares will be less liquid.
C) The company will decrease its leverage ratio (debt-to-equity ratio).
D) By repurchasing stock when it is undervalued, managers can effectively transfer value from selling stockholders to stockholders who don't take part in the repurchase.

Answer: C

Which one of these examples does NOT meet the strict definition for a dividend?

Which one of these examples does NOT meet the strict definition for a dividend?

A) Steel Gen Corp regularly distributes $0.05 to each shareholder for every share they own.
B) Chalone Vineyards once offered their investors discounts on wine in proportion to the number of shares they owned.
C) Churchill Downs, Inc., which operates several horse racing tracks, including the location for the Kentucky Derby, distributes two free general admission tickets to every investor who holds more then 100 shares in the company (as of 2008).
D) Both b and c do not meet the definition for a dividend.

Answer: C

The shares of ABC, Inc., fell sharply today after the company announced that it is increasing its regular cash dividend distributions. Which one of the following explanations may explain investors' negative reaction?

The shares of ABC, Inc., fell sharply today after the company announced that it is increasing its regular cash dividend distributions. Which one of the following explanations may explain investors' negative reaction?

A) Changes in regular cash dividends are made frequently so that the company's management can adjust for changes in short-term earnings. The decrease in the stock price is probably related to some other negative event.
B) Investors previously believed the company had many lucrative growth opportunities. By announcing higher regular cash dividends, the company is sending a signal that it doesn't have enough positive-NPV projects to use all the money.
C) Investors expected that the company would announce a stock repurchase rather then a cash dividend increase. Since a change in dividend policy is commonly viewed as a weaker signal than a stock repurchase, the share price fell on the news of the dividend increase.
D) None of the above explanations can possibly explain investor's reaction.

Answer: B

Which step in the dividend payment process for a public company usually results in a change in the company's stock price? Assume the dividend has changed from the last dividend paid.

Which step in the dividend payment process for a public company usually results in a change in the company's stock price? Assume the dividend has changed from the last dividend paid.

A) Public announcement
B) Ex-dividend date
C) Payable date
D) Both a and b

Answer: D

Consider a company that had unexpectedly higher earnings last quarter and intends to pay out some additional value to shareholders. Which type of dividend is the company likely to use?

Consider a company that had unexpectedly higher earnings last quarter and intends to pay out some additional value to shareholders. Which type of dividend is the company likely to use?

A) Regular cash dividend
B) Extra dividend
C) Special dividend
D) Liquidating dividend

Answer: B

Which type of dividend is used to distribute any remaining value when the company's assets are being sold as the company is terminated?

Which type of dividend is used to distribute any remaining value when the company's assets are being sold as the company is terminated?

A) Regular cash dividend
B) Extra dividend
C) Special dividend
D) Liquidating dividend

Answer: D

Which type of dividend is most likely to be used to distribute the revenue from a one-time sale of a large asset?

Which type of dividend is most likely to be used to distribute the revenue from a one-time sale of a large asset?

A) Regular cash dividend
B) Extra dividend
C) Special dividend
D) Liquidating dividend


Answer: C

Which of the following will limit the asset abuse problem for the lessor?

Which of the following will limit the asset abuse problem for the lessor?

A) Track the total services obtained from the asset and charge the lessee based on usage
B) Bundle the lease contract with a service contract
C) Provide the lessee with the right to buy the asset when the lease expires
D) All of the above

Answer: D

Which of the following arises because the lessee can have the incentive to use the asset more than the lessor would prefer?

Which of the following arises because the lessee can have the incentive to use the asset more than the lessor would prefer?

A) Operating lease conflict
B) Capital lease conflict
C) Intensity of use conflict
D) Maintenance conflict

Answer: C

Which of the following should a company consider when deciding to buy or lease an asset?

Which of the following should a company consider when deciding to buy or lease an asset?

A) Taxes
B) Information or transaction costs
C) If the choice would affect the real investment policy of the firm
D) All of the above

Answer: D

Which of the following supports the trade-off theory of capital structure?

Which of the following supports the trade-off theory of capital structure?

A) Firms use cash on hand first, since issuing equity and debt is expensive.
B) A firm's capital structure is the result of past equity and debt issuance decisions.
C) Firms have a target capital structure.
D) a and b.

Answer: C

The underinvestment problem occurs in a financially distressed firm when

The underinvestment problem occurs in a financially distressed firm when

A) the value of investing in a positive-NPV project is likely to go to debt holders instead of equity holders.
B) the value of investing in a positive-NPV project is likely to go to equity holders instead of debt holders.
C) management invests in negative-NPV projects to reduce their own risk.
D) issuing equity becomes difficult due to increased risk.

Answer: A

The asset substitution problem occurs when

The asset substitution problem occurs when

A) managers substitute riskier assets for less risky ones to the detriment of bondholders.
B) managers substitute less risky assets for riskier ones to the detriment of bondholders.
C) managers substitute riskier assets for less risky ones to the detriment of equity holders.
D) managers substitute less risky assets for riskier ones to the detriment of equity holders.

Answer: A

The use of debt financing

The use of debt financing

A) reduces agency costs between the stockholders and management by increasing the amount of risk the managers take.
B) increases agency costs between the stockholders and management by limiting the amount of risk the managers take.
C) increases agency costs since managers prefer to keep more retained earnings rather than pay a dividend.
D) b and c.

Answer: D

Which of these is not an example of indirect bankruptcy costs?

Which of these is not an example of indirect bankruptcy costs?

A) A firm's customers become concerned about whether or not warranties will be honored.
B) Employees begin to leave the firm.
C) New accountants are brought in to help with the bankruptcy process.
D) A bankruptcy judge orders new projects to be halted.

Answer: C

Which of these statements about direct bankruptcy costs is not true?

Which of these statements about direct bankruptcy costs is not true?

A) Direct bankruptcy costs include the hiring of additional accountants, lawyers, and consultants.
B) Direct bankruptcy costs are less than indirect costs.
C) Suppliers requiring cash on delivery is part of a firm's direct bankruptcy costs.
D) Negotiating with lenders may help a firm reduce direct bankruptcy costs.

Answer: C

The use of debt financing

The use of debt financing

A) may cause a manager to take on riskier projects in order to make interest payments.
B) is more expensive than issuing equity due to the use of covenants.
C) allows managers to make discretionary interest payments.
D) limits the ability of managers to waste stockholder money.

Answer: D

Academic studies have estimated that the tax benefit of debt realized by firms is approximately

Academic studies have estimated that the tax benefit of debt realized by firms is approximately

A) 10% of firm value.
B) a 10% reduction in WACC.
C) a 10% reduction in the cost of debt
D) 10% of debt value.

Answer: A

In order to calculate the present value of debt tax savings, the _______ is used as the discount rate.

In order to calculate the present value of debt tax savings, the _______ is used as the discount rate.

A) WACC
B) risk-free rate
C) required rate of return on debt
D) none of the above

Answer: C

The interest tax shield

The interest tax shield

A) does not affect the WACC.
B) makes it less costly to distribute cash to the security holder through interest payments than through dividends.
C) is given by D × (1 - t).
D) b and c.

Answer: B

Which of the following is a reason financial policy might matter?

Which of the following is a reason financial policy might matter?

A) Firms must pay corporate income taxes.
B) Capital structure choices can affect investment decisions, such as R&D and PP&E.
C) Issuing equity is expensive.
D) All of the above.

Answer: D

Financial risk

Financial risk

A) refers to the effect that a firm's financing decisions has on the riskiness to cash flows that investors will receive.
B) increases a firm's business risk.
C) decreases a firm's business risk.
D) is related to how debt affects the business decisions of a firm.

Answer: A

According to M&M Proposition 2, the cost of a firm's equity

According to M&M Proposition 2, the cost of a firm's equity

A) increases with the debt-to-equity ratio.
B) decreases with the debt-to-equity ratio.
C) increases and then falls with the debt-to-equity ratio.
D) decreases and then increases with the debt-to-equity ratio.

Answer: A

M&M Proposition 2 states that the cost of a firm's common stock is related to

M&M Proposition 2 states that the cost of a firm's common stock is related to

A) the debt-to-equity ratio.
B) the required rate of return on the firm's underlying assets.
C) the return of the market index.
D) a and b.

Answer: D

The weighted average cost of capital (WACC) includes

The weighted average cost of capital (WACC) includes

A) the required return on equity and required return on underlying firm assets.
B) the cost of any debt and the cost of equity.
C) the cost of any debt and required return on underlying firm assets.
D) none of the above.

Answer: B

A financial restructuring

A financial restructuring

A) will not change the value of a firm's real assets under M&M Proposition 1.
B) includes financial transactions that change the capital structure of the firm.
C) means that a firm has issued equity to retire debt.
D) both a and b.

Answer: D

A firm's enterprise value is given by

A firm's enterprise value is given by

A) the value of equity plus the value of debt.
B) the value of equity minus the value of debt.
C) the value of equity minus the value of debt plus the value of future projects.
D) none of the above.

Answer: A

M&M Proposition 1 assumes all of the following except that

M&M Proposition 1 assumes all of the following except that

A) there are no taxes.
B) there are no costs to acquiring information.
C) there are no transactions costs.
D) the real investment policy of the firm is affected by its capital structure decisions.

Answer: D

The optimal capital structure of a firm

The optimal capital structure of a firm

A) minimizes the cost of financing a firm's projects.
B) minimizes interest payments to creditors.
C) maximizes firm value.
D) both a and c.

Answer: D

A firm's capital structure is the mix of financial securities used to finance its activities and can include all of the following except

A firm's capital structure is the mix of financial securities used to finance its activities and can include all of the following except

A) stock.
B) bonds.
C) equity options.
D) preferred stock.

Answer: C

Why is the total cost of bringing a general cash offer to the market lower than issuing an IPO?

Why is the total cost of bringing a general cash offer to the market lower than issuing an IPO?

a. They do not include a large underpricing
b. Underwriting spreads are smaller
c. There is less risk involved with a general cash offer than an IPO
d. all of the above

Answer: D

The most likely reason that underpricing of new issues occurs more frequently than overpricing is the:

The most likely reason that underpricing of new issues occurs more frequently than overpricing is the:

A) Underwriters' desire to reduce the risk of a firm commitment.
B) Demand for a new issue is typically too high.
C) Underwriters earn low rates of return
D) Issuing firms demand that equity be underpriced.

Answer: A

Which ONE of the following statements is true?

Which ONE of the following statements is true?

A) Under federal securities law, they can be resold to investors in the public markets immediately even if they are not registered.
B) As part of the PIPE contract, the company often agrees to register the restricted securities with the SEC, usually within 90 days of the PIPE closing.
C) As part of the PIPE contract, the company often agrees to register the restricted securities with the SEC after 90 days of the PIPE closing.
D) PIPE transactions involving a healthy firm can also be executed without the use of an investment bank but result in a cost increase of 7 to 8 percent of the proceeds.

Answer: B

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) PIPE transactions are registered with the SEC.
B) PIPE transactions are not registered with the SEC.
C) In a PIPE transaction, investors purchase securities (equity or debt) directly from a publicly traded company in a private placement.
D) The securities are virtually always sold to the investors at a discount to the price at which they would sell in the public markets.

Answer: A

Private equity firms improve the performance of firms in which they invest by:

Private equity firms improve the performance of firms in which they invest by:

A) making sure that the firms have the best possible management teams.
B) closely monitoring each firm's performance and providing advice and counsel to the firm's management team.
C) facilitating mergers and acquisitions that help improve the competitive positions of the companies in which they invest.
D) All of the above.

Answer: D

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Private equity firms pool money from wealthy investors, pension funds, insurance companies, and other sources to make investments.
B) Private equity firms invest in more mature companies.
C) Private equity firms invest in new companies.
D) Private equity investors focus on firms that have stable cash flows because they use a lot of debt to finance their acquisitions.

Answer: C

Advantages of private placements include:

Advantages of private placements include:

A) Cost of funds may be lower.
B) Private lenders are more willing to negotiate changes to a bond contract.
C) The speed of private placement deals and flexibility in issue size.
D) All of the above.

Answer: D

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Private placement occurs when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals.
B) All corporate debt is sold through the private placement market.
C) About half of all corporate debt is sold through the private placement market.
D) Investment banks and money center banks often assist firms with private placements.

Answer: B

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) For many smaller firms and firms of lower credit standing that have limited access, or no access, to the public markets, the cheapest source of external funding is often the private markets.
B) Bootstrapping and venture capital financing are not part of the private market.
C) Bootstrapping and venture capital financing are part of the private market.
D) Many private companies that are owned by entrepreneurs, families, or family foundations and are sizable companies of high credit quality prefer to sell their securities in the private markets.

Answer: B

Benefits from shelf registration include all EXCEPT:

Benefits from shelf registration include all EXCEPT:

A) Greater flexibility in bringing securities to market.
B) Shelf registration allows firms to periodically sell small amounts of securities and raise capital as needed.
C) A shelf registration statement can cover multiple securities, but there is a penalty if authorized securities are not issued.
D) Costs associated with selling the securities are reduced because only a single registration statement is required.

Answer: C

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Shelf registration gives firms less flexibility in bringing securities to market.
B) During a two-year window, the firm can take the securities ?off the shelf? and sell them as needed.
C) Shelf registration allows firms to periodically sell small amounts of securities.
D) A shelf registration statement can cover multiple securities, and there is no penalty if authorized securities are not issued.

Answer: A

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) In a competitive sale, the firm specifies the type and amount of securities it wants to sell.
B) In a negotiated sale, the issuer selects the underwriter at the beginning of the origination process.
C) In a general cash offer, management must decide whether to sell the securities on a competitive or a negotiated basis.
D) For equity securities, competitive sales generally provide the lowest-cost method of sale.

Answer: D

Data from the marketplace show that the shares sold in an IPO are typically

Data from the marketplace show that the shares sold in an IPO are typically

A) priced between 2 and 5 percent below the price at which they close at the end of first day of trading.
B) priced between 10 and 15 percent above the price at which they close at the end of first day of trading.
C) priced between 10 and 15 percent below the price at which they close at the end of first day of trading.
D) priced between 2 and 5 percent above the price at which they close at the end of first day of trading.

Answer: C

The three basic costs associated with issuing stock in an IPO are

The three basic costs associated with issuing stock in an IPO are

A) price premium, out-of-pocket expenses, and underpricing.
B) underwriting spread, out-of-pocket expenses, and underpricing.
C) underwriting spread, price premium, and underpricing.
D) None of the above.

Answer: B

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) In a best-efforts offering, the underwriters will suffer a financial loss if the offer price is set too high.
B) In a best-efforts agreement, the issuing firm will lose if the offer price is set too high.
C) If the underpricing is significant, the investment banking firm will suffer a loss of reputation for failing to price the new issue correctly and raising less money for its client than it could have.
D) Underpricing is defined as offering new securities for sale at a price below their true value.

Answer: A

With a best-efforts underwriting

With a best-efforts underwriting

A) the investment banking firm makes no guarantee to sell the securities at a particular price.
B) the investment banker does not bear the price risk associated with underwriting the issue.
C) compensation is based on the number of shares sold.
D) All of the above.

Answer: D

All of the following about a firm-commitment underwriting is true EXCEPT:

All of the following about a firm-commitment underwriting is true EXCEPT:

A) The investment banker guarantees the issuer a fixed amount of money from the stock sale.
B) The investment banker actually buys the stock from the firm.
C) The issuer bears the risk that the resale price might be lower than the price the underwriter pays.
D) The underwriter bears the risk that the resale price might be lower than the price the underwriter pays.

Answer: C

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Investment bankers provide three basic services when bringing securities to market—origination, underwriting, and distribution.
B) During the origination phase, the investment banker helps the firm determine whether it is ready for an IPO.
C) Origination is the risk-bearing part of investment banking.
D) Origination includes giving the firm financial advice and getting the issue ready to sell.

Answer: C

Basic services investment bankers provide when bringing securities to market include

Basic services investment bankers provide when bringing securities to market include

A) Origination
B) Underwriting
C) distribution.
D) All of the above.

Answer: D

Disadvantages of going public include all EXCEPT

Disadvantages of going public include all EXCEPT

A) Managers' tendency to focus on long-term profits.
B) The high cost of the IPO itself.
C) The costs of complying with ongoing SEC disclosure requirements.
D) The transparency that results from this compliance can be costly for some firms.

Answer: A

Which ONE of the following statements is true?

Which ONE of the following statements is true?

A) After the IPO, there is a less active secondary market for the firm's shares.
B) Only smaller amounts of capital can be raised through an IPO than the amount that can be raised through private sources.
C) Publicly traded firms find it easier to attract top management talent.
D) Going public can enable an entrepreneur to fund a growing business but not without giving up control.

Answer: C

Advantages of going public include all EXCEPT

Advantages of going public include all EXCEPT

A) Larger amount of capital can be raised this way than the amount that can be raised through private sources.
B) Publicly traded firms find it harder to attract top management talent.
C) Going public can enable an entrepreneur to fund a growing business without giving up control.
D) Additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost.

Answer: B

Which ONE of the following statements is true?

Which ONE of the following statements is true?

A) A typical venture capital fund may generate annual returns of 15 to 25 percent on the money that it invests, compared with an average annual return for the S&P 500 of almost 12 percent.
B) A typical venture capital fund may generate annual returns of 12 percent on the money that it invests, compared with an average annual return for the S&P 500 of about 20 percent.
C) A typical venture capital fund may generate annual returns of 12 percent on the money that it invests, compared with an average annual return for the S&P 500 of about 25 percent.
D) None of the above

Answer: A

The three principal ways in which venture capital firms exit venture-backed companies are

The three principal ways in which venture capital firms exit venture-backed companies are

A) selling to a strategic buyer, buying out the founder, and offering stock to the public.
B) selling to a strategic buyer, selling to a financial buyer, and buying out the founder.
C) selling to a strategic buyer, selling to a financial buyer, and offering stock to the public.
D) None of the above.

Answer: C

Provisions that are part of venture capital agreements include

Provisions that are part of venture capital agreements include

A) timing of exit, number of board positions after exit, and what price is acceptable.
B) timing of exit, the method of exit, and what price is acceptable.
C) the method of exit, number of board positions after exit, and what price is acceptable.
D) None of the above.

Answer: B

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Venture capitalists often require an entrepreneur to make a substantial personal investment in the business.
B) Syndication occurs when the originating venture capitalist buys off other venture capitalists involved in the venture.
C) Another factor that reduces risk is the venture capitalist's in-depth knowledge of the industry and technology.
D) The key idea behind staged funding is that each funding stage gives the venture capitalist an opportunity to reassess the management team and the firm's financial performance.

Answer: B

Tactics that venture capitalists use to reduce the risk of their investment include

Tactics that venture capitalists use to reduce the risk of their investment include

A) funding the ventures in stages, requiring entrepreneurs to make no personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize.
B) funding the ventures completely in the beginning, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize.
C) funding the ventures in stages, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize.
D) None of the above.

Answer: C

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Approximately $23 billion was invested in venture capital funds in 2010.
B) The venture capital industry as we know it today emerged in the late 1990s.
C) Modern venture capital firms tend to specialize in a specific line of business, such as hospitality, food manufacturing, or medical devices.
D) A significant number of venture capital firms focus on high-technology investments.

Answer: B

Which ONE of the following statements is true?

Which ONE of the following statements is true?

A) The venture capital industry as we know it today emerged in the late 1960s with the formation of the first venture capital limited partnerships.
B) Modern venture capital firms tend to specialize in a specific line of business, such as hospitality, food manufacturing, or medical devices.
C) A significant number of venture capital firms focus on high-technology investments.
D) All of the above are true statements.

Answer: D

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) The process by which many entrepreneurs raise ?seed? money and obtain other resources necessary to start their businesses is often called bootstrapping.
B) Most businesses are started by an entrepreneur who has a vision for a new business or product and a passionate belief in the concept's viability.
C) The initial ?seed? money usually comes from the entrepreneur or other founders.
D) The seed money is spent on developing an initial public offering.

Answer: D

Bootstrapping is the process by which

Bootstrapping is the process by which

A) many entrepreneurs raise - seed -money and obtain other resources necessary to start their businesses.
B) the entrepreneur often fleshes out his or her ideas and makes them operational.
C) most businesses are started by an entrepreneur.
D) none of the above.

Answer: A

The initial seed money comes from

The initial seed money comes from

A) public investors.
B) investment banks.
C) the entrepreneur or other founders.
D) commercial banks.

Answer: C

Which of the following is a short-term financing instrument?

Which of the following is a short-term financing instrument?

A) Accounts payable
B) Bank loans with a maturity of less than 1 year
C) Commercial paper
D) All of the above

Answer: D

Which of the following is the equation for net working capital?

Which of the following is the equation for net working capital?

A) Total assets - total liabilities
B) Current assets - current liabilities
C) Current assets/current liabilities
D) Total assets/total liabilities

Answer: B

Operating cycle: Trend Foods distributes its products to more than 100 restaurants and delis. The company's collection period is 32 days, and it keeps its inventory for 10 days. What is Trend's operating cycle?

Operating cycle: Trend Foods distributes its products to more than 100 restaurants and delis. The company's collection period is 32 days, and it keeps its inventory for 10 days. What is Trend's operating cycle?

A) 22 days
B) 32 days
C) 42 days
D) None of the above.

Answer: C

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Accounts payable (trade credit), bank loans, and commercial paper are common sources of short-term financing.
B) An informal line of credit is a verbal agreement between the firm and the bank, allowing the firm to borrow up to an agreed-upon upper limit.
C) An informal line of credit is also known as ?revolving credit.?
D) A formal line of credit is also known as ?revolving credit.?

Answer: C

Which one of the following statements is NOT true?

Which one of the following statements is NOT true?

A) Firms using matching maturity strategy fund all working capital needs with long-term borrowing.
B) Long-term financing strategy relies on long-term debt to finance both capital assets and working capital.
C) All working capital and a portion of fixed assets are funded with short-term debt when firms use the aggressive funding strategy.
D) Firms using a matching maturity strategy fund all working capital needs with short-term borrowing.

Answer: A