Question: In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?

Answer Options:
a. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.
b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.
c. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.
d. The yen-dollar exchange rate in the 180-day forward market equals the yen-dollar exchange rate in the 90-day spot market.
e. The relationship between spot and forward interest rates cannot be inferred.

Answer: a. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.

Question: Borrowing funds on terms that would require immediate repayment of all loans if the firm is acquired, selling off at bargain prices the assets that originally made the firm a desirable target, and granting huge “golden parachutes” that open if the firm is acquired are 3 procedures used to defend against hostile takeovers. These strategies are known as “poison pills.”

Answer Options:
a. True
b. False

Correct Answer: a

Answer:

Question: Provided a firm does not use an extreme amount of debt, operating leverage typically affects only EPS, while financial leverage affects both EPS and EBIT.

Answer Options:
a. True
b. False

Answer: b. False

Question: Firms use defensive tactics to fight off undesired mergers. These tactics do NOT include

Answer Options:
a. raising antitrust issues.
b. developing poison pills.
c. getting white knights to bid for the firm.
d. repurchasing their own stock.
e. engaging in risk arbitrage.

Correct Answer: d

Answer:

Question: The distribution of synergistic gains between the stockholders of two merged firms is almost always based strictly on their respective market values before the announcement of the merger.

Answer Options:
a. True
b. False

Correct Answer: b

Answer:

Question: Which of the following is NOT a way risk management can be used to increase the value of a firm? a. Risk management can increase debt capacity. b. Risk management can help a firm maintain its optimal capital budget. c. Risk management can reduce the expected costs of financial distress. d. Risk management can help firms minimize taxes. e. Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments.

Answer: e. Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments.

Question: A lease-versus-purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset

Answer Options:
a. is financed with short-term debt.
b. is financed with long-term debt.
c. is financed with debt whose maturity matches the term of the lease.
d. is financed with a mix of debt and equity based on the firm’s target capital structure, i.e., at the WACC.
e. is financed with retained earnings.

Correct Answer: c

Answer:

Question: Since the primary rationale for any operating merger is synergy, in planning such mergers the development of accurate pro forma cash flows is the single most important task.

Answer Options:
a. True
b. False

Correct Answer: a

Answer:

Question: Which of the following statements is CORRECT?

Answer Options:
a. A firm’s business risk is determined solely by the financial characteristics of its industry.
b. The factors that affect a firm’s business risk include industry characteristics and economic conditions, both of which are generally beyond the firm’s control.
c. One of the benefits to a firm of being at or near its target capital structure is that this generally minimizes the risk of bankruptcy.
d. A firm’s financial risk can be minimized by diversification.
e. The amount of debt in its capital structure can under no circumstances affect a company’s EBIT and business risk.

Correct Answer: b

Answer:

Question: From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee’s

Answer Options:
a. equity cash flows.
b. capital budgeting project cash flows.
c. debt cash flows.
d. pension fund cash flows.
e. sales.

Correct Answer: c

Answer:

Question: Currently, a U.S. trader notes that in the 6-month forward market, the Japanese yen is selling at a premium (that is, you receive more dollars per yen in the forward market than you do in the spot market), while the British pound is selling at a discount. Which of the following statements is CORRECT?

Answer Options:
a. If interest rate parity holds, 6-month interest rates should be the same in the U.S., Britain, and Japan.
b. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Japan should have the lowest rates.
c. If interest rate parity holds among the three countries, Britain should have the highest 6-month interest rates and Japan should have the lowest rates.
d. If interest rate parity holds among the three countries, Japan should have the highest 6-month interest rates and Britain should have the lowest rates.
e. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Britain should have the lowest rates.

Answer: c. If interest rate parity holds among the three countries, Britain should have the highest 6-month interest rates and Japan should have the lowest rates.

Question: Which of the following statements is most CORRECT?

Answer Options:
a. Warrants have an option feature but convertibles do not.
b. One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds.
c. The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt.
d. The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant.
e. Warrants can sometimes be detached and traded separately from the security with which they were issued, but this is unusual.

Correct Answer: b

Answer:

Question: The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines.

Answer Options:
a. True
b. False

Correct Answer: a

Answer:

Question: The “preferred” feature of preferred stock means that it normally will provide a higher expected return than will common stock.

Answer Options:
a. True
b. False

Correct Answer: b

Answer:

Question: Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.

Answer Options:
a. True
b. False

Correct Answer: a

Answer:

Question: The trade-off theory states that capital structure decisions involve a tradeoff between the costs and benefits of debt financing.

Answer Options:
a. True
b. False

Answer: a. True

Question: In a world with no taxes, Modigliani and Miller (MM) show that a firm’s capital structure does not affect its value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., the firm’s value rises as it uses more and more debt, other things held constant.

Answer Options:
a. True
b. False

Answer: a. True

Question: Which of the following is most likely to occur as a result of the recapitalization?

Answer Options:
a. The ROA would increase.
b. The ROA would remain unchanged.
c. The return on investors’ capital would decline.
d. The return on investors’ capital would increase.
e. The ROE would increase.

Correct Answer: e

Answer:

Question: A detachable warrant is a warrant that can be removed from the security with which it was issued and traded separately from it. Most traded warrants are originally attached to bonds or preferred stocks.

Answer Options:
a. True
b. False

Correct Answer: a

Answer:

Question: The Modigliani and Miller (MM) articles implicitly assumed, among other things, that outside stockholders have the same information about a firm’s future prospects as its managers. That was called “symmetric information,” and it is questionable. The introduction of “asymmetric information” led to the development of the “signaling” theory of capital structure, which postulated that firms are reluctant to issue new stock because investors will interpret such an act as a signal that the firm’s managers are worried about its future. Other actions give off different signals, and the end result is that capital structure is affected by managers’ perceptions about how their financing decisions will affect investors’ views of the firm and thus its value.

Answer Options:
a. True
b. False

Answer: a. True

Question: Based on the information below, what is the firm’s optimal capital structure? a. Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $260.50. b. Debt = 60%; Equity = 40%; EPS = $3.05; Stock price = $289.00. c. Debt = 50%; Equity = 50%; EPS = $3.18; Stock price = $312.00. d. Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $304.00. e. Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $300.00.

Answer: c. Debt = 50%; Equity = 50%; EPS = $3.18; Stock price = $312.00.