Analysis for Financial Management 12Th Edition BY Robert Higgins - Test Bank

Analysis for Financial Management 12Th Edition BY Robert Higgins – Test Bank

 

Instant Download – Complete Test Bank With Answers

 

 

Sample Questions Are Posted Below

 

 

Chapter 05 Test Bank

1. In the steps a company takes to prepare for an IPO, the “road show” precedes the “bake-off”.

 

FALSE

 

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Difficulty: 2 Medium

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2. The only reason why the price would fall on a corporate bond is if market interest rates increase.

 

FALSE

 

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Difficulty: 1 Easy

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3. After issue, the market price of a fixed-rate bond can differ substantially from its par value.

 

TRUE

 

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Difficulty: 1 Easy

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4. Bond investors should be more concerned with real returns than with nominal returns.

 

TRUE

 

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Difficulty: 1 Easy

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5. Investment–grade bonds are usually defined as bonds with ratings of BBB– or higher.

 

TRUE

 

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Difficulty: 1 Easy

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6. Private equity firms comprise a relatively insignificant portion of the American economy.

 

FALSE

 

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Difficulty: 1 Easy

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7. Shelf registration is possible for both debt and equity issues.

 

TRUE

 

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8. In a strong-form efficient market, insider trading is not profitable.

 

TRUE

 

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Difficulty: 2 Medium

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9. Principal is exchanged in interest rate swaps but not in currency swaps.

 

FALSE

 

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Difficulty: 2 Medium

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10. Valuing a call option requires an accurate estimate of the future value of the underlying asset.

 

FALSE

 

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Difficulty: 2 Medium

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11. Which one of the following statements is false?

 

1. Financial executives must design financial securities to meet the needs of the firm and its investors.
2. Financial instruments are subject to full disclosure requirements.
3. The design of financial instruments is greatly constrained by law and regulation.
4. Financial instruments are claims against a company’s cash flows and assets.
5. None of the options are correct.

 

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12. Which of the following securities has a purely fixed claim against a firm’s cash flows?

 

1. bonds
2. options
3. common stock
4. None of the options are correct.

 

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Difficulty: 1 Easy

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13. Which of the following securities has a purely residual claim against a firm’s cash flows?

 

1. preferred stock
2. callable bonds
3. common stock
4. non-callable bonds
5. None of the options are correct.

 

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14. Mike just purchased a bond which pays $40 every six months in interest. The $40 interest payment is also called the

 

1. coupon.
2. par value.
3. discount.
4. call premium.
5. yield.
6. None of the options are correct.

 

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15. A $1,000 par value bond with a fixed 10% rate of interest pays coupons semiannually. What amount will the bondholder receive on the bond’s maturity date?

 

1. $50
2. $100
3. $500
4. $1,000
5. $1,050
6. $1,100

 

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16. Zack owns a bond that will pay him $35 each year in interest plus a $1,000 principal payment at maturity. The $1,000 principal payment is called the

 

1. coupon.
2. par value.
3. discount.
4. yield.
5. call premium.
6. None of the options are correct.

 

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Difficulty: 1 Easy

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17. Which one of the following statements is true?

 

1. Debt instruments offer residual claims to future cash payouts.
2. Bonds with call provisions will have lower coupon rates than otherwise identical bonds.
3. Bondholders enjoy a direct voice in company decisions.
4. Bonds are low-risk investments that do well in inflationary periods.
5. Preferred shareholders are the first investors to be repaid in bankruptcy liquidation.
6. None of the options are correct.

 

 

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Difficulty: 2 Medium

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18. Which one of the following accurately orders the rate of return on financial securities from highest to lowest over most of recorded market history (the 1928-2016 period)?

 

1. Short-term government bills, long-term corporate bonds, long-term government bonds, common stocks
2. Long-term corporate bonds, long-term government bonds, common stocks, short-term government bills
3. Common stocks, long-term government bonds, long-term corporate bonds, short-term government bills
4. Common stocks, long-term corporate bonds, long-term government bonds, short-term government bills
5. Long-term corporate bonds, common stocks, short-term government bills, long-term government bonds
6. None of the options are correct.

 

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19. Which one of the following statements is true?

 

1. Equity securities offer fixed claims on future cash payouts.
2. Unlike bondholders, for their returns, shareholders rely entirely on price appreciation.
3. In theory, common shareholders exercise very little control over company decisions.
4. Historically, common shareholders have earned a risk premium as compensation for risk borne in excess of government bonds.
5. Preferred shareholders are the first investors to be repaid in bankruptcy liquidation.
6. None of the options are correct.

 

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Difficulty: 2 Medium

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20. You bought a yen-denominated corporate bond at the beginning of the year for ¥100,000. The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end. What holding period return, measured in yen, did you earn on the bond?

 

1. 3%
2. 7%
3. 10%
4. 13%
5. 30%
6. None of the options are correct.

 

The holding period return in yen was (3% × 100,000 + 10,000)/100,000 = 13%.

 

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21. You bought a yen–denominated corporate bond at the beginning of the year for ¥100,000. The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end. The exchange rate was $1 = ¥100 at the beginning of the year and $1 = ¥122 at year-end. What holding period return, measured in U.S. dollars, did you earn on the bond?

 

18. −18.03%
19. −7.38%
20. −5.03%
21. 3.0%
22. 10.0%
23. None of the options are correct.

 

You paid $1,000 for the bond (¥100,000/100). At the end of the year, you had interest income and a yen bond worth a total of $926.23 (¥113,000/122). Your dollar return was ($926.23 − $1,000)/$1,000 = −7.38 percent.

 

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Difficulty: 3 Hard

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22. You bought a yen-denominated corporate bond at the beginning of the year for ¥100,000. The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end. The exchange rate was $1 = ¥100 at the beginning of the year and $1 = ¥97 at year-end. What holding period return, measured in U.S. dollars, did you earn on the bond?

 

3. 3.09%
4. 6.09%
5. 13%
6. 16.49%
7. 30%
8. None of the options are correct.

 

You paid $1,000 for the bond (¥100,000/100). At the end of the year, you had interest income and a yen bond worth a total of $1,164.95 (¥113,000/97). The U.S. dollar holding period return would be ($1,164.95 − $1,000)/$1,000 = 16.49%.

 

 

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23. What is the holding period return for the year on a bond with a par value of $1,000 and a coupon rate of 8.5% if its price at the beginning of the year was $1,215 and its price at the end of the year was $1,020? Assume interest is paid annually.

 

11. −11.00%
12. −10.78%
13. −9.05%
14. 10.50%

 

(85 + 1,020 − 1,215)/1,215 = −0.0905

 

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24. Which of the following statements regarding junk bonds is true?

 

1. Junk bonds typically offer lower yields to maturity than investment-grade bonds.
2. Junk bonds have higher priority in bankruptcy than preferred stock.
3. Junk bonds offer no coupon payments to investors.
4. Junk bonds are typically defined as bonds with default probabilities of 25% or higher.

 

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Difficulty: 3 Hard

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25. Which of the following statements regarding preferred stock is true?

 

1. Holders of preferred stock have the same voting rights as common stockholders.
2. Preferred stock dividend payments are a deductible expense for corporate tax purposes.
3. Almost all public corporations are at least partly financed with preferred stock.
4. None of the options are correct.

 

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Difficulty: 2 Medium

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26. What would be the carried interest (at 20%) on a private equity portfolio with an initial value of $500 million that was subsequently liquidated for $750 million?

 

1. $50 million
2. $100 million
3. $150 million
4. $250 million

 

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Difficulty: 1 Easy

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27. Which of the following statements are true?
28. Underwriters help private companies access public stock markets through IPOs.
29. Shelf registrations and private placements are examples of seasoned security issues.

III. Issue costs for debt are typically greater than issue costs for equity.

1. Bearer bonds make it easier for investors to avoid paying taxes on interest income.

 

 

1. I and II only
2. I and III only
3. I, II, and IV only
4. I, III, and IV only
5. I, II, III, and IV
6. None of the options are correct.

 

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Difficulty: 2 Medium

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28. Carbon8 Corporation wants to raise $120 million in a seasoned equity offering, net of all fees. Carbon8 stock currently sells for $28.00 per share. The underwriters will require a fee of $1.25 per share, and indicate that the issue must be underpriced by 7.5%. In addition to the underwriter’s fee, the firm will incur $785,000 in legal, administrative, and other costs. How many shares must Carbon8 sell in order to raise the desired amount of capital?

 

4. 4.3 million
5. 4.5 million
6. 4.6 million
7. 4.9 million

 

The price will be set at 7.5% below the current price, or at 0.925 × 28.00 = $25.90. The underwriters will take $1.25 per share, leaving $24.65/share for Carbon8. Carbon8 needs to earn $120,785,000 at $24.65/share, so it must sell 120.785mil/24.65 = 4.9 million shares.

 

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Difficulty: 2 Medium

Gradable: automatic

 

29. At the end of 2016, Crane Industries, Inc.’s stock price was $30.75. A year later, it was $34.88. Per share dividends over the year were $0.55, while earnings per share were $1.33. What rate of return did the common stockholders earn in fiscal year 2017?

 

1. 1.79%
2. 4.33%
3. 13.43%
4. 15.22%
5. 17.76%
6. None of the options are correct.

 

Rate of return = (34.88 + 0.55 − 30.75)/30.75 = 15.22%

 

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30. At the end of 2016, Crane Industries, Inc.’s stock price was $30.75. A year later, it was $34.88. Per share dividends over the year were $0.55, while earnings per share were $1.33. What was the dividend yield in fiscal year 2017?

 

1. 1.79%
2. 4.33%
3. 13.43%
4. 15.22%
5. 17.76%
6. None of the options are correct. Dividend yield = 0.55/30.75 = 1.79%

 

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Difficulty: 1 Easy

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31. At the end of 2016, Crane Industries, Inc.’s stock price was $30.75. A year later, it was $34.88. Per share dividends over the year were $0.55, while earnings per share were $1.33. What was the percentage change in the share price in fiscal year 2017?

 

1. 1.79%
2. 4.33%
3. 13.43%
4. 15.22%
5. 17.76%
6. None of the options are correct.

 

Percentage change in share price = (34.88 − 30.75)/30.75 = 4.13/30.75 = 13.43%.

 

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Difficulty: 1 Easy

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32. Which of the following would allow a corporation to issue a bond at a lower coupon rate, all else equal?

 

1. The addition of a call provision to the bond
2. The removal of protective covenants from the bond
3. A deterioration in the corporation’s credit quality
4. An increase in the expected inflation rate
5. None of the options are correct.

 

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Difficulty: 2 Medium

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33. Which of the following statements related to market efficiency tend to be supported by current evidence?

 

1. Markets tend to respond quickly to new information.
2. It is difficult for the typical investor to earn above-average returns without taking above-average risks.

III. Short-run prices are difficult to predict accurately based on public information.

1. Markets are most likely strong-form efficient.

 

1. I and III only
2. II and IV only
3. I and IV only
4. I, III, and IV only
5. I, II, and III only
6. None of the options are correct

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Difficulty: 2 Medium

Gradable: automatic

 

34. Individuals who continually monitor the financial markets seeking mispriced securities

 

1. earn excess profits over the long term.
2. make the markets increasingly more efficient.
3. are never able to find a security that is temporarily mispriced.
4. are overwhelmingly successful in earning abnormal profits.
5. are always quite successful using only historical price information as their basis of evaluation.
6. None of the options are correct.

 

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Difficulty: 2 Medium

Gradable: automatic

 

35. Which of the following are the most likely reasons for why a stock price might not react at all on the day that new information related to the stock issuer is released?
36. Insiders knew the information prior to the announcement.
37. Investors need time to digest the information prior to reacting.

III. The information has no bearing on the value of the firm.

1. The information was anticipated.

 

1. I and II only
2. I and III only
3. II and III only
4. II and IV only
5. III and IV only
6. None of the options are correct

 

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Difficulty: 2 Medium

Gradable: automatic

 

36. In March, with the spot price of wheat at $5.75 per bushel, Hollywood Bakery longs 100 July wheat futures contracts (5,000 bushels each) on the CBOE at a futures price of $5.90 per bushel. In June, Hollywood Bakery closes out its futures contracts when the futures price is $5.80 per bushel. What is Hollywood Bakery’s gain (or loss) on the futures contracts?

 

1. A gain of $50,000
2. A gain of $25,000
3. A loss of $25,000
4. A loss of $50,000
5. None of the options are correct.

 

Gain on futures = ($5.80 − $5.90) × 500,000 bushels = −$50,000

 

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Difficulty: 2 Medium

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37. Which of the following variables does NOT affect the value of a stock option?

 

1. The predicted future price of the underlying stock
2. The current price of the underlying stock
3. The option’s time to maturity
4. The option’s strike price
5. The interest rate

 

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Difficulty: 2 Medium

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38. What type of financial instrument is depicted in the position diagram shown below?

 

1. Forward sale
2. Forward purchase
3. Call option
4. Put option

 

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Difficulty: 1 Easy

Gradable: automatic

 

39. The price of a call option tends to be lower when which of the following is higher (all else equal)?

 

1. The expected volatility of the underlying stock
2. The price of the underlying stock
3. The time to maturity
4. The strike price
5. None of the options are correct.

 

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Difficulty: 2 Medium

Gradable: automatic

 

40. Which of the following factors, when increased, will tend to cause the value of a put to decrease (all else equal)?

 

1. The expected volatility of the underlying stock
2. The price of the underlying stock
3. The time to maturity
4. The strike price
5. None of the options are correct.

 

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41. Suppose you purchase a call option on XYZ stock when the stock price is $81. The option premium is $3, and the strike price is $85. What is your net profit on the call option if the stock price is $89 at maturity?

 

1. −$7
2. −$3
3. $1
4. $4
5. $5

 

The gain on the call is 89 − 85 = $4; less the option premium of $3 gives a net profit of $1.

 

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Difficulty: 1 Easy

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42. Suppose you purchase a put option on XYZ stock when the stock price is $40. The option premium is $2, and the strike price is $39. What is your net profit on the put option if the stock price is $41 at maturity?

 

1. −$2
2. −$1
3. $0
4. $1
5. $2

 

The put option is out of the money at maturity, so the net profit is −$2.

 

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Difficulty: 2 Medium

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43. Principal amounts are usually exchanged

 

1. in currency swaps.
2. in interest rate swaps.
3. in both currency swaps and interest rate swaps.
4. in neither currency swaps nor interest rate swaps.

 

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Difficulty: 2 Medium

Gradable: automatic

 

44. Chapter 5 presents evidence that the average annual rate of return on common stocks over many years has exceeded the return on government bonds in the United States, while returns on common stocks have also exhibited more volatility than returns on U.S. government bonds. Suppose that last year, the realized rate of return on government bonds exceeded the return on common stocks. Your colleague suggests that “last year shows us that investors are now willing to settle for lower returns on stocks than on bonds.” How would you interpret this result?

 

The fact that government bonds earned a higher rate of return than common stocks in one year is not evidence that investors are suddenly willing to settle for lower returns on stocks than bonds. It means that investors’ expectations were not met or, alternatively, that investors were surprised. To take on additional risk, risk-averse investors require additional expected return. But expected returns are not the same as realized returns. Because stocks and bonds are risky, their returns will fluctuate from year to year, and bonds will earn higher returns than stocks in some years. But the expected returns of common stocks should always be higher than the expected returns of government bonds.

 

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Difficulty: 3 Hard

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45. Himmel Corp. wants to raise $100 million in a new stock issue. Its investment banker indicates that the sale of new stock will require 12 percent underpricing and a 7 percent spread.

 

1. Assuming Himmel’s stock price does not change from its current price of $50 per share, how many shares must the company sell and at what price to the public?
2. How much money will the investment banking syndicate earn on the sale?
3. Is the 12 percent underpricing a cash flow? Is it a cost? If so, to whom?

 

a.Stock Price	$	50.00
− 12% underpricing		6.00
Issue price		44.00
− 7% spread		3.08
Net to company	$	40.92
Desired revenue (millions)	$	100
Number of shares (millions)	$	2.444

 

3. Investment bankers’ revenue = $3.08 × 2.444 million = $7.528 million.
4. Underpricing is not a cash flow. It is, however, an opportunity cost to current owners because it means that more shares must be sold to raise $100 million and each share will represent a smaller ownership interest in the company.

 

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Difficulty: 2 Medium

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46. If the stock market in the United States is efficient, how do you explain the fact that some people make very high returns? Would it be more difficult to reconcile very high returns with efficient markets if the same people made extraordinary returns year after year?

 

Earning high returns in an efficient market is like winning at roulette. In any random process, there will be winners and losers, and some winners might win big. Earning consistently high returns over time is also possible in an efficient market, just like a gambler on a lucky streak might win repeatedly at roulette. The relevant question is whether the very high returns or the length of the winning streak is inconsistent with blind luck or not.

 

 

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Difficulty: 2 Medium

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47. You believe interest rates will soon fall.

 

 

1. Would you rather own a three-year, 6 percent coupon, fixed-rate bond or an equivalent-risk, three-year, floating-rate bond currently paying 6 percent interest?
2. Would your answer to (a) change if you were contemplating issuing a bond rather than owning one? If so, how?
3. Would your answer to (a) change if, as an investor, you believed interest rates would soon rise? If so, why?

 

 

 

1. I would rather own a fixed-rate bond because the interest income I receive from a floating-rate bond will fall as interest rates decline. Equivalently, the market value of the fixed-rate bond will rise as rates fall, but that of the floating-rate bond will not. (This presumes the fixed-rate bond is not callable.)
2. My answer would change. I would rather issue a floating-rate bond now because future interest payments will fall as rates decline.
3. My answer would change. As an investor, I would want to hold a floating-rate bond because interest income will rise as interest rates rise. Equivalently, the price of the fixed-income bond will fall as rates rise, while that of the floating-rate bond will not.

 

 

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Difficulty: 2 Medium

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48. Houston Corp., an American company, has a payment of ¥500 million due to Osaka Corp. one year from today. At the prevailing spot rate of 100 ¥/$, this would cost Houston $5 million, but Houston faces the risk that the ¥/$ rate will fall in the coming year, so that it will end up paying a higher amount in dollar terms. To hedge this risk, Houston has two possible strategies. The first strategy is to buy ¥500 million forward today at a one-year forward rate of 98 ¥/$. The second strategy is to pay a premium of $100,000 for a one-year call option on ¥500 million at an exchange rate of 0.96 ¥/$.

 

1. Suppose that in one year, the spot exchange rate is 95 ¥/$. What would be Houston’s net dollar cost for the payable under each strategy?
2. Suppose that in one year, the spot exchange rate is 105 ¥/$. What would be Houston’s net dollar cost for the payable under each strategy?
3. Which hedging strategy would you recommend to Houston Corp., if any? Why?

 

5. In the first strategy, the net cost in dollars is ¥500 million/98 = $5.102 million. In the second strategy, Houston Corp. exercises its option to exchange at 96 ¥/$ for a cost of ¥500 million/96 = $5.208 million. Including the cost of the option, the net cost is $5.308 million.
6. In the first strategy, the net cost in dollars is again ¥500 million/98 = $5.102 million. In the second strategy, Houston Corp. allows its option to expire and exchanges at the spot rate of 105 ¥/$ for a cost of ¥500 million/105 = $4.762 million. Including the cost of the option, the net cost is $4.862 million.
7. The first strategy allows Houston to lock in an exact cost without paying a premium up front. The second strategy requires a premium payment, but Houston retains the possibility of having a much lower net dollar cost if the dollar strengthens enough relative to the yen. The correct strategy for Houston depends on its risk tolerance, its expectations for exchange rate movements, and its cash availability.

 

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Difficulty: 3 Hard

Gradable: manual

49. ABC Corp. has an outstanding debt of $50 million on which it pays a 4 percent fixed interest rate annually. ABC just made its annual interest payment and has three years remaining until maturity. ABC wants to swap its fixed rate payments for floating rate payments. A bank offers ABC a three-year interest rate swap with annual payments in which ABC will pay LIBOR, currently at 4.2 percent, and receive a 3.8 percent fixed rate on $50 million notional principal. Suppose that LIBOR turns out to be 4.3 percent in one year, 4.4 percent in two years, and 4.5 percent in three years. Including interest payments on ABC’s outstanding debt and payments on the swap, what will be ABC’s net interest payments for the next three years?

 

The table below shows ABC’s net interest payments for years 1 through 3. Negative signs indicate cash flows paid by ABC and positive signs indicate cash flows received by ABC, all in dollars.

 

 

Year	LIBOR Outstanding Fixed leg of Floating leg				Net
		debt	swap	of swap	payment
0	4.2%	payment
1	4.3%	-2,000,000	1,900,000	-2,100,000	-2,200,000
2	4.4%	-2,000,000	1,900,000	-2,150,000	-2,250,000
3		-2,000,000	1,900,000	-2,200,000	-2,300,000

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Difficulty: 3 Hard

Gradable: manual

 

Chapter 05 Test Bank Summary

Category	# of Questions
Accessibility: Keyboard Navigation	49
Difficulty:  1 Easy	19
Difficulty:  2 Medium	24
Difficulty: 3 Hard	6
Gradable: automatic	43
Gradable: manual	6